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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, 2001
COMMISSION FILE NUMBER 0-19771
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 29, 2001: 6,994,553
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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, 2000 and September 30, 2001...................... 1
Consolidated Statements of Operations
for the three and nine month periods ended
September 30, 2000 and 2001 ...................................... 2
Consolidated Statement of Changes in Shareholders' Equity
for the nine month period ended September 30, 2001 ................ 3
Consolidated Statements of Cash Flows
for the nine month periods ended September 30, 2000 and 2001 ....... 4
Notes to Consolidated Financial Statements ......................... 5
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations .......................................... 9
PART II. OTHER INFORMATION
Item 1. Legal Proceedings ....................................................14
Item 2. Changes in Securities and Use of Proceeds.............................14
Item 4. Submission of Matters to a Vote of Security Holders...................14
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)
AS OF AS OF
DECEMBER 31, SEPTEMBER 30,
ASSETS 2000 2001
-------------- -------------
(unaudited)
Current assets:
Cash and cash equivalents.........................................................$ 10,877 $ 2,931
Short-term interest bearing bank deposits and debt securities..................... 5,994 6,729
Restricted cash................................................................... 302 6,309
Trade accounts receivable, net.................................................... 9,989 9,618
Inventory......................................................................... 448 935
Other current assets.............................................................. 1,154 1,831
--------- ---------
Total current assets.......................................................... 28,764 28,353
Investments............................................................................ 153 283
Property and equipment, net............................................................ 1,535 1,753
Goodwill and other intangible assets, net.............................................. 2,826 2,348
Long-term deposits..................................................................... 6,000 -
Other assets........................................................................... 543 482
Prepaid employee termination benefits.................................................. 2,336 2,436
--------- ---------
Total assets..................................................................$ 42,157 $ 35,655
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Short-term debt and current maturities of long-term debt..........................$ 591 $ 7,184
Trade accounts payable............................................................ 4,347 4,278
Accrued payroll, payroll taxes and social benefits................................ 1,677 1,877
Other current liabilities......................................................... 3,971 3,649
--------- ---------
Total current liabilities..................................................... 10,586 16,988
--------- ---------
Long-term liabilities:
Long-term debt.................................................................... 6,015 9
Liability for employee termination benefits....................................... 2,935 3,289
--------- ---------
Total long-term liabilities................................................... 8,950 3,298
--------- ---------
Minority interests..................................................................... 40 40
--------- ---------
Shareholders' equity:
Common stock - $.01 par value per share:
Authorized 20,000,000 shares; Issued - 8,035,334 and
8,111,867 shares at December 31, 2000 and September 30, 2001, respectively.... 80 81
Additional paid-in capital........................................................ 35,970 36,290
Warrants.......................................................................... 114 114
Deferred compensation............................................................. - (90)
Accumulated deficit............................................................... (8,813) (15,389)
Treasury stock, at cost - 990,647 and 1,173,914 shares at
December 31, 2000 and September 30, 2001, respectively........................ (4,770) (5,677)
---------- --------
Total shareholders' equity.................................................... 22,581 15,329
--------- -------
Total liabilities and shareholders' equity....................................$ 42,157 $ 35,655
========= =========
The accompanying notes are an integral part of these consolidated
financial statements.
-1-
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)
(in thousands, except per share data)
NINE MONTHS ENDED THREE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------- ------------------
2000* 2001 2000* 2001
----- ---- ----- ----
Sales:
Products ......................................................... $30,215 $25,436 $10,374 $7,235
Services ......................................................... 15,303 10,721 4,632 3,124
------- ------- ------- ------
45,518 36,157 15,006 10,359
------- ------- ------- ------
Cost of sales:
Products ......................................................... 24,558 19,854 8,696 5,469
Services ......................................................... 10,971 8,007 3,169 2,409
------- ------- ------- ------
35,529 27,861 11,865 7,878
------- ------- ------- ------
Gross profit ................................................. 9,989 8,296 3,141 2,481
Research and development expenses ..................................... 698 2,216 158 863
Selling, general and administrative expenses .......................... 12,358 13,220 3,805 4,526
Gain on sale of division .............................................. (1,144) -- (1,144) --
------- ------- ------- ------
Operating income (loss) ...................................... (1,923) (7,140) 322 (2,908)
Interest income ....................................................... 1,180 917 420 271
Interest expense ...................................................... (524) (361) (237) (94)
Other income (expense), net ........................................... (107) 26 82 31
------- ------- ------- ------
Income (loss) from continuing operations
before provision for income taxes ............................. (1,374) (6,558) 587 (2,700)
Provision (benefit) for income taxes .................................. 131 18 55 (94)
------- ------ ------- ------
Income (loss) from continuing operations .............................. (1,505) (6,576) 532 (2,606)
Gain on sale of discontinued operations, net of income taxes .......... 4,222 -- -- --
Loss from discontinued operations ..................................... (104) -- -- --
------- ------ ------- ------
Income (loss) before extraordinary item ............................... 2,613 (6,576) 532 (2,606)
Extraordinary loss on early redemption of debt ........................ 943 -- -- --
------- ------- ------- ------
Net income (loss) ................................................ $1,670 $(6,576) $532 $(2,606)
======= ======= ======= =======
Basic income (loss) per share:
Income (loss) from continuing operations ......................... $(0.20) $(0.95) $0.07 $(0.37)
Discontinued operations .......................................... 0.53 -- -- --
Extraordinary item ............................................... (0.12) -- -- --
------- ------ ----- ------
Net income (loss) ............................................ $0.21 $(0.95) $0.07 $(0.37)
======= ======= ===== ======
Weighted average number of shares outstanding - basic ................. 7,805 6,943 7,462 6,950
======= ======= ===== ======
Diluted income (loss) per share:
Income (loss) from continuing operations ......................... $(0.20) $(0.95) $0.07 $(0.37)
Discontinued operations .......................................... 0.53 -- -- --
Extraordinary item ............................................... (0.12) -- -- --
------- ------ ----- ------
Net income (loss) ............................................ $0.21 $(0.95) $0.07 $(0.37)
======= ======= ===== ======
Weighted average number of shares outstanding - diluted ............... 7,805 6,943 7,926 6,950
======= ======= ===== ======
* Certain amounts restated or reclassified; see Note 3.
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)
NUMBER COMMON PAIN-IN DEFERRED TREASURY ACCUMULATED
OF SHARES STOCK CAPITAL WARRANTS COMPENSATION STOCK DEFICIT TOTAL
--------- ----- -------- --------- ------------ -------- ------------ -----
Balances as of
January 1, 2001 8,035 $80 $35,970 $114 $ - $(4,770) $(8,813) $22,581
Issuance of deferred
compensation - - 90 - (90) - - -
Exercise of options 77 1 230 - - - - 231
Purchase of treasury shares - - - - (907) - (907)
Net loss - - - - - - (6,576) (6,576)
----- --- ------- ---- ---- -------- -------- -------
Balances as of
September 30, 2001 8,112 $81 $36,290 $114 $(90) $(5,677) $(15,389) $15,329
===== === ======= ==== ==== ======== ======== =======
The accompanying notes are an integral part of these consolidated
financial statements.
-3-
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
(dollars in thousands)
NINE MONTHS ENDED SEPTEMBER 30,
2000 2001
------------ ----------
(RESTATED)
Cash flows used in operating activities:
Net income (loss).................................................................$ 1,670 $ (6,576)
Adjustments to reconcile net income (loss) to
net cash used in operating activities:
Depreciation and amortization................................................. 1,195 986
Issuance of subsidiary shares to minority interests........................... 30 -
Gain on sale of investment held for sale...................................... (4,989) -
Allowance for doubtful accounts............................................... 1 (17)
Increase in liability for employee termination benefits....................... 169 354
Loss (gain) on sale of property, plant and equipment, net..................... (14) 32
Amortization of deferred compensation......................................... 73 -
Extraordinary loss on early redemption of debt................................ 943 -
Non-cash interest expense on convertible debentures and warrants.............. 37 -
Write-off of inventory........................................................ - 60
Receipt of investments for services rendered.................................. (123) (130)
Change in operating assets and liabilities:
Increase in accounts receivable and other current assets................... (1,084) (289)
Decrease (increase) in inventory........................................... 1,432 (547)
Decrease in other assets................................................... 375 61
Decrease in accounts payable and other liabilities ........................ (2,829) (191)
---------- -----------
Net cash used in operating activities......................................... (3,114) (6,257)
---------- ----------
Cash flows provided by (used in) investing activities:
Short-term bank deposits, net..................................................... (4,774) 994
Restricted cash................................................................... 210 (7)
Investment in long-term deposits.................................................. (16,000) -
Proceeds from maturity of long-term deposits...................................... 5,000 -
Investment in debt securities..................................................... - (2,810)
Proceeds from sale and maturity of debt securities................................ - 1,081
Purchase of property and equipment................................................ (548) (774)
Proceeds from sale of property and equipment...................................... 203 23
Proceeds from sale of Tower....................................................... 30,889 -
Funding of termination benefits................................................... (131) (100)
Purchase of intangible assets..................................................... (16) (7)
---------- ----------
Net cash provided by (used in) investing activities........................... 14,833 (1,600)
---------- ----------
Cash flows provided by (used in) financing activities:
Short-term debt, net.............................................................. (6,240) 606
Proceeds of long-term debt........................................................ 6,013 -
Repayments of long-term debt...................................................... (64) (19)
Proceeds from stock options exercises............................................. 66 231
Purchase of treasury shares....................................................... (740) (907)
Repurchase of outstanding warrants................................................ (375) -
Redemption of convertible debt.................................................... (2,001) -
---------- ----------
Net cash used in financing activities......................................... (3,341) (89)
---------- ----------
Net increase (decrease) in cash and cash equivalents................................... 8,378 (7,946)
Cash and cash equivalents at beginning of period....................................... 1,379 10,877
---------- ----------
Cash and cash equivalents at end of period.............................................$ 9,757 $2,931
========== ======
Supplemental cash flow information:
Cash paid during the period for:
Interest......................................................................$ 684 $ 339
========== ==========
Income taxes..................................................................$ 462 $ 463
========== ==========
Non-cash activities:
Issuance of shares from conversion of convertible debt........................$ 260 -
========== ==========
Adjustment of goodwill for inventory sold.....................................$ 456 -
========== ==========
Deferred compensation ........................................................ - $ 90
========== ==========
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. and subsidiaries (the "Company") have been prepared in
accordance with accounting principles generally accepted in the United States of
America for interim financial information and with the instructions to Article
10 of Regulation S-X. Accordingly, they do not include all of the information
and footnotes required by accounting principles generally accepted in the United
States of America for complete consolidated financial statements. In the opinion
of management, all adjustments considered necessary for a fair presentation have
been included. Operating results for the nine-month period ended September 30,
2001 are not necessarily indicative of the results that may be expected for the
year ending December 31, 2001. 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, 2000.
NOTE 2: SIGNIFICANT ACCOUNTING POLICIES
DEBT SECURITIES
Debt securities at September 30, 2001 consist of U.S. Treasury,
asset-backed and corporate debt securities. The Company classifies its debt
securities in one of three categories: trading, available-for-sale, or
held-to-maturity. Trading securities are bought and held principally for the
purpose of selling them in the near term. Held-to-maturity securities, are those
securities in which the Company has the ability and intent to hold the security
until maturity. All securities not included in trading or held-to-maturity, are
classified as available-for-sale.
Trading and available-for-sale securities are recorded at fair value.
Held-to-maturity securities are recorded at amortized cost, adjusted for the
amortization or accretion of premiums or discounts. Unrealized holding gains and
losses on trading securities, are included in operations. Unrealized holding
gains and losses, net of the related tax effect on available-for-sale securities
are excluded from operations and are reported as a separate component of other
comprehensive income until realized. Realized gains and losses from the sale of
available-for-sale securities are determined on a specific identification basis.
A decline in the market value of any available-for-sale or held-to-maturity
security, below cost that is deemed to be other than temporary, results in a
reduction in carrying amount to fair value. The impairment is charged to
operations and a new cost basis for the security is established. Premiums and
discounts are amortized or accreted over the life of the related
held-to-maturity or available-for-sale security as an adjustment to yield using
the effective interest method. Dividend and interest income are recognized when
earned. All investment in debt securities are classified as trading or
held-to-maturity and are recorded in short-term interest bearing bank deposits
and debt securities in the consolidated balance sheet at September 30, 2001.
DERIVATIVE INSTRUMENTS
In June 1998 and June 2000, the Financial Accounting Standards Board issued
SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities",
and SFAS No. 138, "Accounting for Certain Derivative Instruments and Certain
Hedging Activities", an amendment of SFAS No. 133, respectively, which establish
accounting and reporting standards for all derivative instruments and hedging
activities. These statements require an entity to recognize all derivatives as
either assets or liabilities in the balance sheet and measure those investments
at fair value. The Company's adoption of these pronouncements, on January 1,
2001, had no effect on the Company's consolidated results of operations,
financial position and financial disclosures, as the Company has no derivatives
or embedded derivatives requiring separate accounting and disclosure. In
addition, the Company does not engage in hedging activities of foreign currency.
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
In July 2001, the FASB issued Statement No. 141, BUSINESS COMBINATIONS, and
Statement No. 142, GOODWILL AND OTHER INTANGIBLE ASSETS. Statement 141 requires
that the purchase method of accounting be used for all business combinations
initiated after June 30, 2001 as well as all purchase method business
combinations completed after June 30, 2001. Statement 141 also specifies the
criteria intangible assets acquired in a purchase method business combination
must meet, to be recognized and reported apart from goodwill.
- 5 -
Statement 142 will require that goodwill and intangible assets with
indefinite useful lives no longer be amortized, but instead tested for
impairment at least annually in accordance with the provisions of Statement 142.
Statement 142 will also require that intangible assets with definite useful
lives be amortized over their respective estimated useful lives to their
estimated residual values, and reviewed for impairment in accordance with SFAS
No. 121, ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED
ASSETS TO BE DISPOSED Of.
The Company is required to adopt the provisions of Statement 141
immediately and Statement 142 effective January 1, 2002. Goodwill and intangible
assets acquired in business combinations completed before July 1, 2001 will
continue to be amortized prior to the adoption of Statement 142.
Statement 141 will require upon adoption of Statement 142, that the
Company evaluate its existing intangible assets and goodwill that were acquired
in a prior purchase business combination, and to make any necessary
reclassifications in order to conform with the new criteria in Statement 141 for
recognition apart from goodwill. Upon adoption of Statement 142, the Company
will be required to reassess the useful lives and residual values of all
intangible assets acquired in purchase business combinations, and make any
necessary amortization period adjustments by the end of the first interim period
after adoption. In addition, to the extent an intangible asset is identified as
having an indefinite useful life, the Company will be required to test the
intangible asset for impairment in accordance with the provisions of Statement
142 within the first interim period. Any impairment loss will be measured as of
the date of adoption and recognized as the cumulative effect of a change in
accounting principle in the first interim period.
In connection with the transitional goodwill impairment evaluation,
Statement 142 will require the Company to perform an assessment of whether there
is an indication that goodwill is impaired as of the date of adoption. Any
transitional impairment loss will be recognized as the cumulative effect of a
change in accounting principle in the Company's statement of operations.
As of the date of adoption, the Company expects to have unamortized
goodwill in the amount of $1,848 and unamortized other intangible assets in the
amount of $336, all of which will be subject to the transition provisions of
Statements 141 and 142. Amortization expense related to goodwill and other
intangible assets was $794 and $485 for the year ended December 31, 2000 and the
nine months ended September 30, 2001, respectively. Because of the extensive
effort needed to comply with adopting Statements 141 and 142, it is not
practicable to reasonably estimate the impact of adopting these Statements on
the Company's consolidated financial statements at the date of this report,
including whether any transitional impairment losses will be required to be
recognized as the cumulative effect of a change in accounting principle.
Also in June 2001, the FASB issued Statement No. 143, ACCOUNTING FOR
ASSET RETIREMENT OBLIGATIONS. Statement 143 applies to legal obligations
associated with the retirement of tangible long-lived assets that result from
the acquisition, construction, or development and/or the normal operation of a
long-lived asset for certain obligations of lessees. This Statement requires
entities to record the fair value of a liability for an asset retirement
obligation in the period incurred. The fair value of the liability is added to
the carrying amount of the associated asset and this additional carrying amount
is depreciated over the life of the asset. The liability is accreted at the end
of each period through charges to operating expense. If the obligation is
settled for other than the carrying amount of the liability the Company will
recognize a gain or loss on settlement. We are required to adopt the provision
of Statement No. 143 beginning January 1, 2003. We have not determined the
impact, if any, the adoption of this statement will have on our financial
position or results of operations.
In August 2001, the FASB issued Statement No. 144, ACCOUNTING FOR THE
IMPAIRMENT OF DISPOSAL OF LONG-LIVED ASSETS. This statement addresses financial
accounting and reporting for the impairment or disposal of long-lived assets.
This statement supercedes Statement No. 121, ACCOUNTING FOR THE IMPAIRMENT OF
LONG-LIVED ASSETS TO BE DISPOSED OF. This Statement establishes an accounting
model for impairment or disposal of long-lived assets by sale. Statement 144 is
required to be adopted beginning January 1, 2002. We have not determined the
impact, if any, the adoption of this statement will have on our financial
position or results of operations.
- 6 -
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(dollars in thousands)
NOTE 3: RESTATEMENT OF PREVIOUSLY REPORTED RESULTS
The financial data for the nine and three month periods ended September
30, 2000 differs from the data previously reported by the Company on Form 10-Q
as described below:
NINE MONTHS ENDED THREE MONTHS ENDED
SEPTEMBER 30, 2000 SEPTEMBER 30, 2000
------------------------- -------------------------
PREVIOUSLY AS PREVIOUSLY AS
REPORTED ADJUSTED REPORTED ADJUSTED
---------- ---------- ---------- ---------
Income (loss) from continuing operations $2,826 $(1,505)(1) $518 $532(4)
Gain on sale of discontinued operations, net of
income taxes -- 4,222 (2) -- --
Loss from discontinued operations, net of income taxes (104) (104) -- --
Extraordinary loss on early redemption of debt (340) (943)(3) -- --
------ ------ ---- -----
Net income $2,382 $1,670 $518 $532
====== ====== ==== =====
Basic and diluted income (loss) per share:
Income (loss) from continuing operations $0.38 $(0.20) $0.07 $0.07
Discontinued operations (0.01) 0.53 -- --
Extraordinary item (0.05) (0.12) -- --
----- ------ ----- -----
Net income per share. $0.32 $0.21 $0.07 $0.07
===== ====== ===== =====
(1) The gross gain on the sale of our interest in Tower of $4,989 has been
reclassified from other income (loss), net, to discontinued operations, to
properly reflect the sale as a discontinued operation (see (2) below).
Taxes related to the sale of $460 previously provided for in the second
quarter of 2000 have been offset against the gain. In addition, $198
originally classified as interest expense was reclassified as extraordinary
loss.
(2) The gain on sale of discontinued operations, net of taxes of $4,222 has
been reclassified from other income (loss), net, to properly reflect the
sale of our interest in Tower as a discontinued operation. Taxes related to
the sale of $460 previously provided for in the second quarter of 2000 and
$307 identified in the fourth quarter of 2000 have been offset against the
gain.
(3) The extraordinary loss on early redemption of debt was restated to include
an additional $405 loss that had been previously deferred and $198 that had
originally been classified as interest expense.
(4) Interest expense of $14 recorded in the third quarter was reclassified as
part of the first quarter's extraordinary loss.
NOTE 4: SUBSEQUENT EVENTS
In October 2001, the Company's subsidiary Decision Systems Israel Ltd.
(DSI), announced that it has signed a memorandum of understanding (MOU) with the
shareholders of Endan IT Solutions Ltd. ("Endan"), a privately-held Israeli IT
software and consulting firm. Under the MOU, DSI will acquire all of the
outstanding stock of Endan for consideration consisting of $500 in cash, $2,250
in DSSI common stock which as of September 30, 2001 would represent
approximately 374,000 shares of common stock and shares representing 32% of the
outstanding ordinary shares of DSI, the value of which has not yet been
determined. In addition, DSSI will lend DSI $1,000, enabling the repayment of a
loan previously made to Endan by Kardan Communications, Ltd., Endan's largest
shareholder.
Upon completion of the deal, DSSI will own 68% of DSI and the Endan
shareholders will own the remaining 32%. The current CEO of Endan will be the
CEO of DSI. As contemplated by the MOU, the DSSI common stock to be issued to
the Endan shareholders will be subject to a six-month lock up, and will be
registered by DSSI within four months after the closing. In the 90 days
following the lock up period, the Endan shareholders may then sell up to 50% of
their DSSI stock, and then may sell all of their DSSI stock thereafter. Kardan
Communications, Ltd., Endan's largest shareholder, will have certain veto rights
with respect to decisions by the DSI board of directors. The DSI shares held by
DSSI and the Endan shareholders are subject to rights of first refusal and
pre-emptive rights. Additionally, with respect to any proposed sale by DSSI of
its DSI shares, the Endan shareholders will have the right to include their DSI
shares in the sale in the same proportion as DSSI, and if DSSI has a proposed
sale of at least 85% of the number DSI shares it currently owns, DSSI can force
the Endan shareholders to sell their DSI shares to the same purchaser on a
proportional basis.
The parties agreed to complete the transaction by the end of November,
2001, subject to satisfactory due diligence review by each side and the receipt
of approvals by certain Israeli tax and regulatory authorities.
- 7 -
NOTE 5: SEGMENT INFORMATION
COMPUTER
CONSULTING
AND TOTAL
DEVELOPMENT UTILITY COMPUTER REPORTABLE
SERVICES SOLUTIONS HARDWARE SEGMENTS OTHER(*) TOTAL
------- --------- ---------- -------- ----- -----
Nine months ended September 30, 2001:
Revenues from external customers $9,647 $10,391 $16,005 $36,043 $114 $36,157
Intersegment revenues 275 836 75 1,186 - 1,186
Segment profit (loss) (1,469) (4,481) 980 (4,970) (8) (4,978)
Nine months ended September 30, 2000:
Revenues from external customers $14,829 $15,059 $15,397 $45,285 $233 $45,518
Intersegment revenues 190 1,209 186 1,585 - 1,585
Segment profit (loss) 1,504 (1,625) 370 249 22 271
Three months ended September 30, 2001:
Revenues from external customers $2,527 $4,283 $3,519 $10,329 $30 $10,359
Intersegment revenues 185 233 18 436 - 436
Segment profit (loss) (807) (1,458) 174 (2,091) - (2,091)
Three months ended September 30, 2000:
Revenues from external customers $4,520 $4,593 $5,847 $14,960 $46 $15,006
Intersegment revenues 3 534 9 546 - 546
Segment profit (loss) 1,446 (654) 178 970 (7) 963
- -----------
(*) Represents the operations of a Value Added Reseller software operation in
Israel that did not meet the quantitative thresholds of segment reporting.
RECONCILIATION OF SEGMENT PROFIT TO CONSOLIDATED NET PROFIT (LOSS)
NINE MONTHS ENDED THREE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------- -------------------------
2000* 2001 2000* 2001
----------- ------------ ------------ -----------
Total profit (loss) for reportable segments $ 249 $(4,970) $ 970 $ (2,091)
Other operational segment profit (loss) 22 (8) (7) -
------ ------- ----- ---------
Total 271 (4,978) 963 (2,091)
Unallocated amounts:
Net profit (loss) of corporate
headquarters 1,399** (1,598) (431) (515)
------ ------- ----- ---------
Total consolidated net income (loss) $1,670 $(6,576) $532 $ (2,606)
====== ======= ===== =========
-----------
(*) Certain amounts restated; see Note 3
(**)Includes a gain, net of income taxes, of $4,222 from the sale of Tower
shares and an extraordinary loss of $943 on early redemption of debt.
- 8 -
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
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 at "Item 1. Description of Business - Factors That May
Influence Future Results" in the Company's Annual Report on Form 10-K for the
year ended December 31, 2000, (the "2000 10-K").
During the periods included in this report, we operated in three reportable
segments: computer consulting and development services, computer hardware, and
utility solutions. The following analysis should be read together with the
segment information provided in Note 5 to the interim unaudited consolidated
financial statements included in this quarterly report, which information is
hereby incorporated by reference into this Item 2.
COMPUTER CONSULTING AND DEVELOPMENT SERVICES
Sales and gross profits in the third quarter and first nine months of 2001
decreased in comparison to the same periods in 2000. This decrease, particularly
in Israel, reflects a combination of, the impact of the continued downturn in
the hi-tech industry in general and the demand for consulting and development
services in particular. Gross profit margins in this segment also decreased
primarily due to the decrease in the highly profitable computer embedded
software sales. We currently do not expect the hi-tech downturn and resulting
trend of decreasing sales to improve in the next few quarters.
In October 2001 we signed a memorandum of understanding (MOU) to acquire
Endan IT Solutions Ltd., an Israeli company. Endan provides consulting and
software services and IT solutions using advanced technologies. Endan
specializes in billing solutions, and healthcare IT solutions. Among its leading
offerings are two proprietary software packages: E-asy Bill, a comprehensive
billing system targeted to the low to middle end markets, and Endan Clinic,
which is software designed for managing the procedures, patient and medical
databases and patient care of hospital oncology departments. Endan has over 100
employees, and had revenues of approximately $5 million during the first nine
months of 2001.
UTILITY SOLUTIONS
Although sales in this segment during the third quarter and first nine
months of 2001 were lower than those in the comparable periods of 2000, gross
profit margins have improved significantly, primarily due to the completion of a
number of projects that were incurring significant losses. In comparison to the
immediately preceding quarter, sales increased primarily due to increased
Maingate product sales as well as improved load control product sales. We have
invested significantly in enhancing our management to meet the challenges of
this increasingly competitive industry. We currently have numerous proposals to
potential customers pending for virtually all our products. The utility industry
characteristically has a long sales cycle and it is difficult to project when
these proposals will result in new sales, if at all. We believe that the new
management team, continued marketing efforts and heightened industry awareness
of the need to invest in products that increase efficiency will ultimately
result in increased sales.
COMPUTER HARDWARE
Although sales in the first nine months of 2001 were higher than the same
period in 2000, sales decreased in third quarter of 2001 in comparison to the
previous quarter and the third quarter of 2000. The decrease in sales resulted
from the slower economy, particularly since September 11th in the greater New
York area, which is our primary market. Gross profit margins improved
significantly in this segment, offsetting the decrease in sales, so that gross
profits remained stable in comparison to the third quarter of 2000. This
resulted from increased sales to higher margin customers as a result of the
continued aggressive marketing efforts. The market for hardware sales is highly
competitive and there is no assurance that we can maintain this level of
profitability or activity.
- 9 -
RESULTS OF OPERATIONS
The following table sets forth certain information with respect to the
results of operations of the Company for the three and nine month periods ended
September 30, 2000 and 2001, 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
2000 2000
to to
2000* 2001 2001 2000* 2001 2001
--------------- -------------- ------ ------------- --------------------- ------
($,000) % ($,000) % % ($,000) % ($,000) % of %
of of of of of
sales sales 2000 sales sales 2000
------- ----- ------- ----- ----- -------- ----- -------- ------ -----
Sales $45,518 100% $36,157 100% (21)% $15,006 100% $10,359 100% (31)%
Cost of sales 35,529 78 27,861 77 (22) 11,865 79 7,878 76 (34)
------- ----- ------- ----- -------- ----- -------- ----
Gross profit 9,989 22 8,296 23 (17) 3,141 21 2,481 24 (21)
R&D expenses 698 2 2,216 6 217 158 1 863 8 446
SG&A expenses 12,358 27 13,220 37 7 3,805 25 4,526 44 19
Gain on sale of division (1,144) 3 - - (100) 1,144 8 - - (100)
------- ----- ------- ----- -------- ----- -------- ----
Operating income (loss) (1,923) (4) (7,140) (20) 271 322 2 (2,908) (28) (1003)
Interest income, net 656 1 556 2 (15) 183 1 177 2 (3)
Other income (expense), net (107) (0) 26 0 (124) 82 1 31 0 (62)
------- ----- ------- ----- -------- ----- -------- ----
Income (loss) from
continuing operations
before income tax (1,374) (3) (6,558) (18) 377 587 4 (2,700) (26) (560)
Provision (benefit) for
income taxes 131 0 18 0 (86) 55 0 (94) 1 (271)
------- ----- ------- ----- -------- ----- -------- ----
Income (loss) from
continuing operations
after income taxes (1,505) (3) (6,576) (18) 337 532 4 (2,606) (25) (590)
Gain on sale of discontinued
operations, net of income
taxes 4,222 9 - - (100) - - - - -
Loss from discontinued
operations (104) (0) - - (100) - - - - -
------- ----- ------- ----- -------- ----- ------- ----
Income (loss) before 2,613 6 (6,576) (18) (352) 532 4 (2,606) (25) (590)
extraordinary item
Extraordinary loss on early
redemption of debt 943 (2) - - (100) - - - -
------- ----- ------- ----- -------- ----- -------- ----
Net income (loss) $1,670 4% $(6,576) (18)% (494)% $532 4% $(2,606) (25)% (590)%
======= ===== ======= ===== ======== ===== ======== ====
(*) Certain amounts restated or reclassified.: see Note 3 to the interim
financial statements included in this quarterly report.
SALES. The decrease in sales in the third quarter of 2001, as compared to
the third quarter of 2000, was primarily due to a $2.3 million, or 40%, decrease
in computer hardware sales and a $2 million, or 44%, decrease in the sale of
computer consulting and development services. The decrease in computer hardware
sales resulted from the slower economy, particularly since September 11th in the
greater New York area, which is our primary market. The decrease in computer
consulting and development sales, particularly in Israel, is primarily due to
the continued downturn in the hi-tech industry in general and the demand for
consulting and development services in particular.
Sales in the first nine months of 2001, decreased as compared to the
comparable period in 2000, primarily due to a $5.3 million, or 35%, decrease in
computer consulting and development sales, as well as a $4.7 million, or 31%,
decrease in utility solutions sales, particularly in the first six months of
this year. The decrease in computer consulting and development services segment
sales primarily resulted from the down turn in the hi-tech industry as well as
decreased sales of computer embedded software systems. The decrease in utility
solutions sales in the first six months of this year, was due to non-recurring
sales during the first six months of 2000 periods of backlog and component
inventory, purchased as part an acquisition by our Comverge subsidiary.
GROSS PROFIT. The decrease in gross profit in the third quarter and first
nine months of 2001, as compared to the same periods last year was due to the
decrease in computer consulting and development segment sales, particularly the
highly profitable computer embedded software sales, resulting in a $1.1 million,
or 80%, and $2.1 million, or 53% decrease in gross profits in this segment,
comparing the third quarter and first nine months periods of 2001 and 2000,
respectively. This decrease was partially offset by improved gross profit
margins in both the computer hardware and utility solutions segments. In
addition, the sales of these segments accounted for 75% and 73% of total sales
in the third quarter and first nine months of 2001, respectively, as compared to
70% and 67% in the 2000 periods. The improved profitability in these segments,
as well as their increased relative weight in total sales, caused gross profit
margins to increase to 24% and 23% in the third quarter and first nine months of
2001, respectively, compared to 21% and 22% in the same periods last year,
respectively.
- 10 -
RESEARCH AND DEVELOPMENT ("R&D"). The continued increase in R&D expenses,
since the second quarter of this year, was due to a concentrated effort in the
utility solution segment, to bring to market a more varied set of solutions,
while consolidating and integrating products already offered by our Comverge
subsidiary. Among the technologies developed are 900 MHz communication
capabilities to enhance our DCU load control product, latest generation CDPD
technology upgrade for our CDC product and upgrade and enhancement of the
control system software for our Maingate system currently being installed at
Gulf Power. In addition we have commenced an integration process of our
products, so as to increase efficiency, and offer our customers fewer but more
comprehensive products.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES ("SG&A"). The increase in
SG&A was due to increased administrative and marketing costs in the utility
solutions segment, where SG&A increased by $582,000, or 36%, and $1.4 million,
or 30%, in the third quarter and the first nine months of 2001, respectively, as
compared to the same periods in 2000. This increase was due primarily to costs
associated with the new CEO for this segment, including $200,000 for his hiring,
as well as our maintaining a high level of marketing and administrative costs,
in an effort to take advantage of the current increased market awareness of the
need for products which foster more efficient energy utilization.
GAIN ON SALE OF DIVISION. The gain in the third quarter and first nine
months of 2000 was from the sale of the computer consulting and development
segment's CinNetic division in the third quarter of that year.
INTEREST EXPENSE. The decrease in interest expense in the first nine
months of 2001 as compared to the same period in 2000 was due primarily to
interest expense recorded in 2000 in connection with the Company's convertible
debt, redeemed during that year. The decrease in interest expenses in the third
quarter of 2001 as compared to the third quarter of 2000, was due to a decrease
in expenses in all segments.
PROVISION (BENEFIT) FOR INCOME TAXES. The decrease in the provision for
income taxes in the first nine months of 2001 as compared to the same period in
2000, and the tax benefit in the third quarter of 2001, were due primarily to a
tax benefit occurring in the third quarter of 2001 resulting from prior years
taxes.
GAIN ON SALE OF DISCONTINUED OPERATIONS, NET OF INCOME TAXES. The gain,
net of taxes, in the first nine months of 2000, was from the sale of our Tower
investment, in the first quarter of that year.
FINANCIAL CONDITION
As of September 30, 2001 we had working capital of $11.4 million,
including non-restricted cash, cash equivalents and short-term interest bearing
deposits and debt securities of $9.7 million. In February 2000 we took a $6
million term loan from a bank which is secured by a $6 million bank deposit. The
loan bears interest at a rate of LIBOR plus 0.75% per annum and is repayable in
a single payment in February 2002. The changes on our balance sheet as of
September 30, 2001 as compared to our balance sheet as of December 31, 2000 in
restricted cash, long-term deposits, short-term debt and long-term debt reflects
the change in the classification of this loan from long-term to short-term debt.
Similarly, the company shifted its investment strategy from investing in cash
equivalent bank deposits in the prior year to investing in debt securities this
year. In addition, during the first nine months of 2001 we acquired 198,600 of
our own shares at a cost of $907,000.
We expect to sign a definitive agreement, based on the conditions
described in the MOU for our Endan acquisition, by the end of November this
year. Under the MOU, the consideration for this acquisition includes $500,000 in
cash, $2.25 million in DSSI Common Stock. In addition, DSSI will lend DSI $1
million, enabling the repayment of a loan previously made to Endan by Kardan
Communications, Ltd.
We believe we have adequate liquidity to finance our activities for the
near future. In the long term, we believe that as our Comverge subsidiary
matures, the requirement for continued research and development will decrease
and it will generate positive cashflows thereby eliminating the continued drain
on our working capital. In addition, as we broaden our computer software product
offering to include IT solutions with our Endan acquisition, the resulting
increase in profits will assure its positive cashflows.
- 11 -
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
In July 2001, the FASB issued Statement No. 141, BUSINESS COMBINATIONS, and
Statement No. 142, GOODWILL AND OTHER INTANGIBLE ASSETS. Statement 141 requires
that the purchase method of accounting be used for all business combinations
initiated after June 30, 2001 as well as all purchase method business
combinations completed after June 30, 2001. Statement 141 also specifies the
criteria intangible assets acquired in a purchase method business combination
must meet to be recognized and reported apart from goodwill. Statement 142 will
require that goodwill and intangible assets with indefinite useful lives no
longer be amortized, but instead tested for impairment at least annually in
accordance with the provisions of Statement 142. Statement 142 will also require
that intangible assets with definite useful lives be amortized over their
respective estimated useful lives to their estimated residual values, and
reviewed for impairment in accordance with SFAS No. 121, ACCOUNTING FOR THE
IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF.
We are required to adopt the provisions of Statement 141 immediately and
Statement 142 effective January 1, 2002. Goodwill and intangible assets acquired
in business combinations completed before July 1, 2001 will continue to be
amortized prior to the adoption of Statement 142.
Statement 141 will require upon adoption of Statement 142, that we evaluate
its existing intangible assets and goodwill that were acquired in a prior
purchase business combination, and to make any necessary reclassifications in
order to conform with the new criteria in Statement 141 for recognition apart
from goodwill. Upon adoption of Statement 142, we will be required to reassess
the useful lives and residual values of all intangible assets acquired in
purchase business combinations, and make any necessary amortization period
adjustments by the end of the first interim period after adoption. In addition,
to the extent an intangible asset is identified as having an indefinite useful
life, we will be required to test the intangible asset for impairment in
accordance with the provisions of Statement 142 within the first interim period.
Any impairment loss will be measured as of the date of adoption and recognized
as the cumulative effect of a change in accounting principle in the first
interim period.
In connection with the transitional goodwill impairment evaluation,
Statement 142 will require us to perform an assessment of whether there is an
indication that goodwill is impaired as of the date of adoption. Any
transitional impairment loss will be recognized as the cumulative effect of a
change in accounting principle in our statement of operations. As of the date of
adoption, we expect to have unamortized goodwill in the amount of $1,848 and
unamortized other intangible assets in the amount of $336, all of which will be
subject to the transition provisions of Statements 141 and 142. Amortization
expense related to goodwill and other intangible assets was $794 and $485 for
the year ended December 31, 2000 and the nine months ended September 30, 2001,
respectively. Because of the extensive effort needed to comply with adopting
Statements 141 and 142, it is not practicable to reasonably estimate the impact
of adopting these Statements on our consolidated financial statements at the
date of this report, including whether any transitional impairment losses will
be required to be recognized, as the cumulative effect of a change in accounting
principle.
Also in June 2001, the FASB issued Statement No. 143, ACCOUNTING FOR ASSET
RETIREMENT OBLIGATIONS. Statement 143 applies to legal obligations associated
with the retirement of tangible long-lived assets that result from the
acquisition, construction, or development and/or the normal operation of a
long-lived asset for certain obligations of lessees. This Statement requires
entities to record the fair value of a liability for an asset retirement
obligation in the period incurred. The fair value of the liability is added to
the carrying amount of the associated asset and this additional carrying amount
is depreciated over the life of the asset. The liability is accreted at the end
of each period through charges to operating expense. If the obligation is
settled for other than the carrying amount of the liability the Company will
recognize a gain or loss on settlement. We are required to adopt the provision
of Statement No. 143 beginning January 1, 2003. We have not determined the
impact, if any, the adoption of this statement will have on our financial
position or results of operations.
In August 2001, the FASB issued Statement No. 144, ACCOUNTING FOR THE
IMPAIRMENT OF DISPOSAL OF LONG-LIVED ASSETS. This statement addresses financial
accounting and reporting fo r the impairment or disposal of long-lived assets.
This statement supercedes Statement No. 121, ACCOUNTING FOR THE IMPAIRMENT OF
LONG-LIVED ASSETS TO BE DISPOSED OF. This Statement establishes an accounting
model for impairment or disposal of long-loved assets by sale. Statement 144 is
required to be adopted beginning January 1, 2002. We have not determined the
impact, if any, the adoption of this statement will have on our financial
position or results of operations.
- 12 -
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
In the normal course of business, we are exposed to fluctuations in
interest rates so we seek debt financing to make capital expenditures. We do not
employ specific strategies, such as the use of derivative instruments or
hedging, to manage our interest rate exposures. We currently have $1.7 million
invested in debt securities with maturities in excess of one year. These debt
securities are classified as trading securities and expose us to interest rate
risk with respect to the effect fluctuations of market interest rates have on
the valuation of these securities. The Company's investment in debt securities
is managed by a company, which is controlled by one of the Company's directors.
- 13 -
PART II - OTHER INFORMATION
ITEM 1: LEGAL PROCEEDINGS
None
Item 2: Changes in Securities and Use of Proceeds.
The Company entered into a restricted stock purchase agreement, dated as of
September 1, 2001, with Robert Chiste, the Chief Executive Officer of the
Company's subsidiary, Comverge Technologies, Inc. Pursuant to this agreement,
the Company issued to Mr. Chiste 50,000 shares of its common stock at a purchase
price of $5.95 per share. Mr. Chiste paid for the common stock by assigning and
endorsing to the Company a 6% subordinated note, due April 15, 2010, in the
principal amount of $297,500. Philip Services Corp. (NasdaqNM: PSCD) issued the
subordinated note in favor of Mr. Chiste note under a trust indenture with
Wilmington Trust Company. The subordinated note
o is assignable;
o pays interest semi-annually; and
o is subject to a sinking fund for the mandatory redemption of the
subordinated note by no more than four annual payments, beginning in
April 15, 2006.
The Company relied on Section 4(2) of the Securities Act of 1933 as its the
exemption from registration for the sale and issuance of the common stock to Mr.
Chiste.
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
Exhibit 10.1 Employment Agreement, dated as of September 1, 2001,
between Comverge Technologies, Inc. and Robert M. Chiste.
Exhibit 10.2 Restricted Stock Purchase Agreement, dated as of
September 1, 2001, between Comverge Technologies, Inc. and
Robert M. Chiste.
Exhibit 10.3 Option Agreement, dated as of September 1, 2001, between
Comverge Technologies, Inc. and Robert M. Chiste.
(b) Reports on Form 8-K: None
-14-
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by its
Principal Financial Officer thereunto duly authorized.
DATA SYSTEMS & SOFTWARE INC.
Dated: November 14, 2001
By: /s/ YACOV KAUFMAN
-----------------------------------
Yacov Kaufman
Chief Financial Officer
- 15 -