SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2003
COMMISSION FILE NUMBER: 0-19771
DATA SYSTEMS & SOFTWARE INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN CHARTER)
DELAWARE 22-2786081
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
200 ROUTE 17, MAHWAH, NEW JERSEY 07430
(Address of principal executive offices) (Zip Code)
(201) 529-2026
Registrant's telephone number, including area code
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
COMMON STOCK, PAR VALUE $.01 PER SHARE
COMMON STOCK PURCHASE RIGHTS
(TITLE OF CLASS)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes /x/ No / /
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. / /
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Act). Yes / / No / x /
The aggregate market value of the common stock held by non-affiliates
of the registrant at March 29, 2004 was approximately $23.7 million. The
aggregate market value was calculated by using the closing price of the stock on
that date on the Nasdaq National Market.
Number of shares outstanding of the registrant's common stock, as of March 29,
2004: 7,902,025
DOCUMENTS INCORPORATED BY REFERENCE:
Certain sections of the registrant's Proxy Statement to be filed
pursuant to Regulation 14A under the Securities Exchange Act of 1934 within 120
days of the end of the registrant's fiscal year are incorporated by reference
into Part III of this Form 10-K.
TABLE OF CONTENTS
PAGE
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PART I
Item 1. Business..................................................................................... 1
Item 2. Properties................................................................................... 10
Item 3. Legal Proceedings............................................................................ 10
Item 4. Submission of Matters to a Vote of Security Holders.......................................... 10
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters........................ 11
Item 6. Selected Financial Data...................................................................... 11
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................................................. 14
Item 7A. Quantitative and Qualitative Disclosures About Market Risk................................... 25
Item 8. Financial Statements and Supplementary Data.................................................. 25
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure...................................................................... 25
Item 9A. Controls and Procedures....................................................................... 26
PART III
Item 10. Directors and Executive Officers of the Registrant........................................... 27
Item 11. Executive Compensation....................................................................... 27
Item 12. Security Ownership of Certain Beneficial Owners
and Management............................................................................. 27
Item 13. Certain Relationships and Related Transactions............................................... 27
Item 14. Principal Accountant Fees and Services....................................................... 27
Part IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K............................. 28
Certain statements contained in this report are forward-looking in
nature. These statements can be identified by the use of forward-looking
terminology such as "believes", "expects", "may", "will", "should" or
"anticipates", or the negatives thereof, or comparable terminology, or by
discussions of strategy. You are cautioned that our business and operations are
subject to a variety of risks and uncertainties and, consequently, our actual
results may materially differ from those projected by any forward-looking
statements. Certain of such risks and uncertainties are discussed below under
the heading "Item 1. Business-Factors That May Affect Future Results."
EASYBILL(TM) and ONCOPRO(TM) are trademarks of our Endan IT Solutions
Ltd subsidiary. MAINGATE(R) is a registered trademark and POWERCAMP(TM) and
SUPERSTAT(TM) are trademarks of our Comverge, Inc. investment.
PART I
ITEM 1. BUSINESS
OVERVIEW
We operate in three reportable segments: software consulting and
development, energy intelligence solutions, and computer hardware. As we no
longer have control over our formerly consolidated subsidiary Comverge Inc. (see
Note 4 to the Consolidated Financial Statements), effective as of the second
quarter of 2003, we account for our investment in Comverge by the equity method
and no longer consolidate Comverge's balances and operating activity into our
consolidated balance sheet and statement of operations.
o SOFTWARE CONSULTING AND DEVELOPMENT--Providing consulting and
development services for computer software and systems, primarily
through our dsIT subsidiary.
o ENERGY INTELLIGENCE SOLUTIONS--Developing and marketing load
control, data communications and other energy intelligence
solutions for electric utilities and their customers, through our
Comverge investment.
o COMPUTER HARDWARE SALES--Serving as an authorized dealer and a
value-added-reseller (VAR) of computer hardware, through our
Databit subsidiary.
SALES BY ACTIVITY
The following table shows, for the years indicated, the dollar amount
and the percentage of the sales attributable to each of the segments of our
operations.
2001 2002 2003
------------------- ------------------- -------------------
Amount % Amount % Amount %
------------------- ------------ ------ ------------ ------
Software consulting and development........................... $12,279 27 $14,202 25 $12,156 35
Energy intelligence solutions................................. 13,793 30 19,023 34 4,700 13
Computer hardware sales....................................... 19,794 43 22,605 41 18,139 52
Other......................................................... 58 -- 56 -- 39 --
------------------- ------------ ------ ------------ ------
Total Sales $45,924 100 $55,886 100 $35,034 100
=================== ============ ====== ============ ======
SOFTWARE CONSULTING AND DEVELOPMENT
SERVICES
Through dsIT Technologies Ltd. ("dsIT"), we provide computer software
and systems consulting, development and integration services. dsIT is a systems
and software house, with significant capabilities in a wide range of application
areas, spanning military applications, security and public safety systems,
telecom and datacom systems, and command and control principal systems. Our
technological expertise includes state-of-the-art hardware with embedded
real-time software systems in a wide variety of applications, primarily
telecommunications, digital signal processing, image processing, software
testing and validation, electronic warfare, simulation and electro-optics. In
addition, we offer expertise and solutions products for billing, healthcare and
other IT applications.
We provide our services either on a time-and-materials or fixed-price
basis. When working on a time-and-materials basis, our engineers are generally
sent to the customer's premises to perform design and development activities
under the customer's direction. In these engagements, our personnel typically
have no specific obligation for product delivery. During 2001, 2002 and 2003,
sales attributable to services provided on a time-and-materials basis were $7.9
million, $10.3 million and $8.9 million, respectively, accounting for
approximately 64%, 73% and 73% of segment sales for such years, respectively.
When working on a fixed-price basis, we undertake to deliver software
or hardware/software solutions to a customer's specifications or requirements
for a particular project, accounting for these services on the
percentage-of-completion method. Since the profit margins on these projects are
primarily determined by our success in controlling project costs, margins on
these projects may vary substantially as a result of various factors, including
underestimating costs, difficulties associated with implementing new
technologies
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and economic and other changes that may occur during the term of the contract.
During 2001, 2002 and 2003, sales from fixed-price contracts were $4.4 million,
$3.9 million and $3.2 million, respectively, accounting for approximately 36%,
27% and 27% of segment sales for such years, respectively. Included in our fixed
price projects are sales and maintenance of our billing and healthcare
proprietary software, totaling $0.6 million and $1.1 million, during 2002 and
2003, respectively.
CUSTOMERS AND MARKETS
Israel has historically been the primary area of this segment's
operations, accounting for 88%, 95% and 98% of segment sales in 2001, 2002 and
2003, respectively. In the future, we expect virtually all of this segment's
sales to continue to originate from Israel. We have created significant
relationships with some of Israel's largest companies as well as its banking,
healthcare and electronics industries, two of which account for 12% and 10% of
segment sales in 2003. No other customer accounted for more than 10% of segment
revenues.
COMPETITION
Our software consulting and development activity faces competition from
numerous competitors, both large and small, operating in the Israeli and United
States markets, some with substantially greater financial and marketing
resources. We believe that our wide range of experience and long-term
relationships with large corporations in Israel and the United States will
enable us to compete successfully and obtain future business.
PROPRIETARY RIGHTS
We own two proprietary software packages: EASYBILL(TM), a comprehensive
customer service and billing system aimed at the low to middle end application
market; and ONCOPRO(TM), which manages hospital medical files and has advanced
applications for oncology departments. The intellectual property rights
resulting from our consulting and development services, are generally owned by
the customer for whom the services are performed.
ENERGY INTELLIGENCE SOLUTIONS
OVERVIEW
Although we no longer have control over Comverge as of the second
quarter of 2003, we continue to include Comverge's results in our financial
statements by the equity method. Comverge continues to play a major role in our
corporate strategy, and Comverge continues to have a material effect on our
financial results.
Comverge designs, develops and markets a full spectrum of products,
services and solutions to electric utilities and energy service companies and
their residential and business customers that provide energy intelligence - the
optimal transfer and usage of energy. Comverge's energy intelligence solutions
bring to bear a combination of hardware development and manufacturing
capabilities and a suite of software products which, together or separately,
help investor-owned utilities, energy service companies and other providers of
electricity, as well as their customers, address energy usage issues through
load control, data communications and analysis, real-time pricing and integrated
billing and reporting. Comverge's load control solutions allow its customers to
reduce usage or "shed load" during peak usage periods, such as the summer air
conditioning season, thereby reducing or eliminating the need to buy costly
additional power on the spot market, or invest in new peaking generation
capacity. This solution is both cost-effective and environmentally superior to
building new generation capabilities. Comverge's two-way data communications
solutions allow utilities to gather, transmit, verify and analyze real-time
usage information, and can be used for automated meter reading, support
time-of-use metering, theft detection, remote connect/disconnect and other
value-added services.
-2-
In 2003, Comverge began two new initiatives. In March, Comverge began
installation of its MainGate Home product for its largest customer, Gulf Power
and then in June, Comverge signed a long term Virtual Peaking Capacity(TM)
contract to provide significant peak load reduction to PacifiCorp, a subsidiary
of ScottishPower.
HISTORY
Since 1992, we have been designing, developing and marketing two-way
interactive communications solutions that provide real-time, remote automated
meter reading and data management capabilities to utilities internationally. We
developed state-of-the-art, high-speed, power line carrier technology and
deployed pilot systems in Thailand, Taiwan, Venezuela, Argentina, Israel and
Mexico.
In January 1998, Comverge acquired certain assets and licenses to
intellectual property from Lucent Technologies' Utilities Solution business
division. This licensed technology relates to a product which had been deployed
by Lucent using a two-way cable TV system as well as an Internet-based wireless
network. Comverge employs a number of the employees who were involved in
developing this product.
In August 1999, Comverge purchased the assets and business of
Scientific-Atlanta's Control Systems division, acquiring its load control and
gateway product lines and hiring a number of employees from this division.
During 2003, Comverge completed private equity financing in the amount
of $18.6 million and the finalization of terms for a new credit arrangement of
$5 million with a leading financial institution. Included in the group of
investors were Nth Power, EnerTech Capital Partners, Ridgewood Capital, E.ON
Venture Partners, Shell Internet Ventures, Easton Hunt Capital Partners and
Norsk Hydro Technology Ventures. In conjunction with the equity financing,
Comverge acquired the fixed assets and iNET(TM) software platform from Sixth
Dimension, Inc.
Comverge has an office in East Hanover, New Jersey from which its sales
and marketing and PowerCAMP(TM) software groups operate aided by its iNET(TM)
office in Newark, California. Comverge's administrative and engineering
personnel and principal product manufacturing facility are located in Atlanta,
Georgia. Comverge operates its installation program for Gulf Power from an
office in Pensacola, Florida. Comverge also and maintains a small research and
development center in Israel.
PRODUCTS AND SERVICES
Comverge offers data communications and load control product solutions
that address the information and control needs of the global energy market
through its power line technology and expertise it developed, combined with our
strategic acquisitions of technology, personnel, contracts and customer base
from Lucent, Scientific-Atlanta and Sixth Dimension. Comverge's technical
expertise includes load control, broadband, wireless and powerline
communications, as well as Internet and home networking and automation.
Comverge currently offers products and services in four product lines:
o Real-time usage information products;
o Load control products;
o Gateway products, which combine real-time information and control;
and
o PowerCAMP(TM) Software products that allow utilities to conserve,
analyze, monitor and price electric usage.
REAL-TIME USAGE INFORMATION PRODUCTS. Comverge markets the MainGate
C&I, which is a meter-reading device for gathering and transmitting real-time
usage information and providing distributed generation monitoring and control
for commercial and industrial customers. The MainGate C&I uses Internet-based
CDMA communications to transmit detailed information regarding patterns of
energy consumption and is targeted at industrial and commercial customers, an
important segment of the user market for energy companies. The use of CDMA for
data communication makes our product easier to install and less expensive to run
than products that require a dedicated telephone line. Comverge's alliances with
Verizon Wireless, AT&T Wireless and GTE give us a national platform from which
to market this product.
-3-
LOAD CONTROL PRODUCTS. Power distribution companies use load control
products to reduce peak electrical demand, avoiding the need to buy costly
electricity on the spot market or to build new generation facilities. Generators
and energy marketers can use load control products to free capacity during high
cost periods for resale to others. Comverge offers its customers two major load
control products: digital control units, also known as DCUs, and SuperStats(TM).
The DCU is a switch that can be connected to any appliance, such as an air
conditioner or water heater, and that permits the user to turn appliances on and
off from a remote location utilizing wireless communications. Comverge's
SuperStat(TM) product combines a programmable thermostat with a wireless
communication module to provide cooling systems direct load control, allowing
customers to choose when and how much energy to use, while giving the utility
the ability to control air conditioning systems through the thermostat during
peak usage periods.
GATEWAY PRODUCTS. Maingate(TM), Comverge's gateway product, is a system
designed around a communications "gateway," or bridge, which permits two-way
real-time communications between a local area network (LAN) (such as a "network"
of appliances and other devices within a home or a network of meters at multiple
users) and a wide area network (WAN) (such as cable, telephone or CDPD).
Maingate provides information and load control functionality to both the
electricity provider and its customers and can significantly reduce the
customer's electricity bills. When fully integrated with Comverge's
PowerCAMP(TM) software, Maingate(TM) provides our customers with a comprehensive
solution for their diverse energy management requirements.
Maingate(TM) provides two-way real time metering, time-of-use pricing,
load control and whole house surge suppression for residential users. In the
typical configuration, the central air conditioning system, controlled by a
SuperStat(TM) thermostat, the water heater and up to one additional appliance
within the home, are fitted with power line communication ("PLC") based load
control devices. The load control devices and the SuperStat(TM) are networked,
and linked via the Maingate gateway to the WAN. Maingate allows the customer to
automatically respond to energy price variations to minimize their usage during
high priced periods. Rollout of Maingate Home is being deployed for Florida's
Gulf Power under a contract that provides for the installation of Maingate into
40,000 homes.
POWERCAMP(TM) SOFTWARE PRODUCTS. PowerCAMP(TM) is an extensive suite of
software developed by our engineers and deployed in several countries. The
software used in PowerCAMP(TM) has been subject to extensive field-testing and
customer interaction and has been the backbone for monitoring and analyzing
utility meter reading and load management programs using Comverge products.
Comverge has taken this software and packaged and modularized it as a suite of
stand-alone software editions for utilities and their residential, commercial
and industrial customers. PowerCAMP(TM) can also serve those customers through a
web-based Application Service Provider, or ASP, model. With the acquisition of
the iNET(TM) software platform, Comverge has added technology for upstream
monitoring and control of capital assets by offering comprehensive monitoring
and control of power generation and substation assets.
CUSTOMERS AND MARKETS
Our energy intelligence solutions business has over 500 customers in
eight countries and we have an installed base of approximately 5,000,000
end-point installations worldwide. The global market for energy intelligence
solutions is immature and still emerging. Reliable information as to the current
size of the market we serve or its rate of growth is not readily available. The
anticipated growth in Comverge's market will be driven by the following factors:
o Increasing worldwide demand for electricity and volatility of
electricity prices;
o Anticipated market and regulatory incentives to manage peak usage
periods in an economically efficient and environmentally friendly
manner; and
o Continued deregulation of the electric utility industry in the United
States and resulting increased competition among electric service
companies.
Although the effects of the current trend toward deregulation in the
United States and overseas are not certain, we anticipate that the new, more
competitive environment, combined with expected government incentives and
mandates, will result in continued growth in the demand for products designed to
gather information and manage electricity usage.
-4-
Comverge's customers are generally domestic electric utilities,
electric service companies or prime contractors that serve electric utilities.
Comverge's largest customer is Florida's Gulf Power, which purchased
approximately $3 million in products and services in 2003. Comverge has
demonstrated that its CDC and SuperStat(TM) products generally work well in
small-scale deployments, and as its track record grows, Comverge expects to
expand its sales to its existing customers to full-scale deployments. In
addition to expanding relationships with existing customers, Comverge's strategy
is to take advantage of the relationships with these customers to extend its
sales to their affiliates, many of whom are owned by large utility holding
companies with several owned utilities. Comverge's has also formed joint
marketing partnerships with Verizon Wireless, Schlumberger and Honeywell, and
continues to plan to expand on these relationships. In September, Comverge
signed a five-year agreement with Landis+Gyr, a leading meter manufacturer, to
jointly market and develop commercial and industrial metering solutions.
COMPETITION
Within the emerging energy intelligence solutions market, we face
competition from a variety of companies and products, each of which is trying to
garner a larger market share. Key competitors include Itron, ABB, Schlumberger
and Mainstreet Networks with respect to Comverge's gateway products, CEPG with
respect to Comverge's commercial and industrial AMR products, and Cannon
Technologies and Itron with respect to Comerge's load control products. In
addition to these companies, there are many other competitors and potential
competitors vying for a portion of this as yet undefined market. Comverge
believes that its products offer significant competitive advantages because
they:
o have been proven in the field;
o offer significant technological advantages over competing products;
and/or
o cost less than many of our competitors' products.
However, some of our competitors have more resources, better market
recognition, a larger sales force or can offer features not offered by our
products. In addition, certain of our competitors manufacture and sell electric
meters or back-end billing or other software systems to utilities, possibly
providing them an advantage in marketing their utility solution products. We
cannot be certain that our products will win market acceptance or that we will
be able to capture a significant segment of the market.
PROPRIETARY RIGHTS
Comverge holds 12 patents and has 13 patents pending. Comverge attempts
to vigorously protect all of its proprietary rights. Certain products that
Comverge has developed and is developing incorporate or are derived from
intellectual property owned by third parties under license to Comverge.
In Comverge's product development activities, Comverge relies on a
combination of nondisclosure agreements and technical measures to establish and
protect its proprietary rights, if any, in its products. Comverge believes that
as a result of the rapid pace of technological change in the software and
real-time system industries, legal protection for its products, if any, will be
less significant to its prospects than the knowledge, ability and expertise of
its management and technical personnel.
COMPUTER HARDWARE SALES
PRODUCTS AND SERVICES
Through our Databit subsidiary, we sell and service PC-based computer
hardware, software, data storage, client/server and networking solutions
principally in the greater New York City metropolitan area. Databit is a
value-added-reseller and an authorized service provider for equipment and
software from such well-known industry leaders as Compaq, IBM, Microsoft,
Oracle, 3Com, Compaq/Hewlett-Packard, NEC, Acer, Apple and Dell. We offer our
customers a full range of systems integration services, including design,
implementation, hardware and software selection, and implementation of local and
wide area networks. In addition, we provide maintenance and service to customers
under extended service agreements. Our equipment and software sales and other
services are offered under separately negotiated and priced agreements.
-5-
CUSTOMERS AND MARKETS
Computer hardware segment sales include sales to two major customers,
Montefiore Medical Center, which accounted for approximately 25%, 22% and 28% of
segment sales in 2001, 2002 and 2003, respectively, and a large law firm, which
accounted for approximately 21% in 2002. Another law firm customer accounted for
12% of segment sales in 2001. No other customer accounted for more than 10% of
segment sales. We reduced our dependence on the New York metro market, which
accounted for 71% and 70% of segment revenues in 2003 and 2002, respectively,
compared 84% in 2001.
COMPETITION
The market for PCs and related peripheral hardware sales in which we
operate is characterized by severe competition in price-performance, breadth of
product line, financing capabilities, technical expertise, service and overall
reputation. Manufacturers have been increasing their direct sales efforts on the
Internet and otherwise, reducing prices to end-users, which reduces profit
margins for distributors and value-added-resellers such as Databit. Our
competitors include manufacturers, other VAR's, large equipment aggregators
(some of whom sell to us) and systems integrators. Many of our competitors have
longer operating histories, greater financial resources and buying power and
larger, established customer bases. We compete by offering attractive prices and
flexible payment terms, and by helping our customers evaluate their needs and
tailoring solutions by offering other value-added services such as configuration
and on-site service.
BACKLOG
As of December 31, 2003, our backlog of work to be completed was $3.2
million, $3.1 million of which related to our software consulting and
development segment (of which $2.2 million is related to our contracts with
Clalit Health Services). We estimate that we will perform approximately $1.8
million of our backlog work in 2004.
EMPLOYEES
At December 31, 2003, we employed a total of 210 people, including 160
persons in engineering and technical support, 16 in marketing and sales, and 30
in management, administration and finance. A total of 183 of our employees are
based in Israel. We consider our relationship with our employees to be
satisfactory.
We have no collective bargaining agreements with any of our employees.
However, with regard to our Israeli activities, certain provisions of the
collective bargaining agreements between the Israeli Histadrut (General
Federation of Labor in Israel) and the Israeli Coordination Bureau of Economic
Organizations (including the Industrialists Association) are applicable by order
of the Israeli Ministry of Labor. These provisions mainly concern the length of
the workday, contributions to a pension fund, insurance for work-related
accidents, procedures for dismissing employees, determination of severance pay
and other conditions of employment. We generally provide our Israeli employees
with benefits and working conditions beyond the required minimums. Israeli law
generally requires severance pay upon the retirement or death of an employee or
termination of employment without due cause. Furthermore, Israeli employees and
employers are required to pay specified amounts to the National Insurance
Institute, which administers Israel's social security programs. The payments to
the National Insurance Institute include health tax and are approximately 17% of
wages (up to a specified amount), of which the employee contributes
approximately 60% and the employer approximately 40%.
SEGMENT INFORMATION
For additional financial information regarding our operating segments,
foreign and domestic operations and sales, see "Item 7. Management's Discussion
and Analysis of Financial Condition and Results of Operations" and Note 17 to
our Consolidated Financial Statements included in this Annual Report.
FACTORS WHICH MAY AFFECT FUTURE RESULTS
We may from time to time make written or oral statements that contain
forward-looking information. However, our actual results may differ materially
from our expectations, statements or projections. The
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following risks and uncertainties could cause actual results to differ from our
expectations, statements or projections.
GENERAL FACTORS
WE HAVE A HISTORY OF OPERATING LOSSES AND DECREASING CASH AVAILABLE FOR
OPERATIONS.
We have in the past, and continue to experience operating losses,
although they have been decreasing over the years. In 2001, 2002 and 2003, we
had operating losses of $10.4 million, $8.2 million and $3.6 million,
respectively. Cash used in operations in 2001, 2002 and 2003 was $8.7 million,
$6.2 million and $1.0 million, respectively.
Our Comverge investment was the primary source of operating losses,
which amounted to losses of approximately $6.4 million, $2.2 million and $1.1
million in 2001, 2002, and 2003 (results consolidated in the first quarter of
2003), respectively. Of our net cash used in operating activities in 2003,
approximately $0.3 million was used in the energy intelligence solutions
segment, $0.6 million was provided by our Israeli software consulting and
development segment operations, $0.3 million was provided by our computer
hardware segment and $1.6 million was used by our corporate and other U.S.
activities. As described under the caption "Recent Developments" in "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations," throughout 2003, Comverge successfully completed private equity
financing and new credit arrangements which should provide sufficient financing
for Comverge to independently fund its activities.
We believe that as a result of Comverge's obtaining independent
financing, the release of previously restricted cash and anticipated improvement
in operating results in 2004 in our other U.S. and Israeli operating activities,
we currently have sufficient liquidity to fund all our activities for at least
the next 12 months. For additional discussion of our liquidity position and
factors that may affect our future liquidity, see the discussion under the
captions "Recent Developments" and "Liquidity and Capital resources" in "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations."
LOSS OF THE SERVICES OF A FEW KEY EMPLOYEES COULD HARM OUR OPERATIONS.
We depend on our key management and technical employees. The loss of
certain managers could diminish our ability to develop and maintain
relationships with customers and potential customers. The loss of certain
technical personnel could harm our ability to meet development and
implementation schedules. Most of our significant employees are bound by
confidentiality and non-competition agreements. We do not maintain a "key man"
life insurance policy on any of our executives or employees. Our future success
also depends on our continuing ability to identify, hire, train and retain other
highly qualified technical and managerial personnel. If we fail to attract or
retain highly qualified technical and managerial personnel in the future, our
business could be disrupted.
RISKS RELATED TO THE SOFTWARE CONSULTING AND DEVELOPMENT SEGMENT
FAILURE TO ACCURATELY FORECAST COSTS OF FIXED-PRICED CONTRACTS COULD REDUCE OUR
MARGINS.
When working on a fixed-price basis, we undertake to deliver software
or integrated hardware/software solutions to a customer's specifications or
requirements for a particular project. The profits from these projects are
primarily determined by our success in correctly estimating and thereafter
controlling project costs. Costs may in fact vary substantially as a result of
various factors, including underestimating costs, difficulties with new
technologies and economic and other changes that may occur during the term of
the contract. If, for any reason, our costs are substantially higher than
expected, we may incur losses on fixed-price contracts.
HOSTILITIES IN THE MIDDLE EAST REGION MAY FURTHER DEEPEN THE WEAKNESS IN THE
ISRAELI HI-TECH MARKET AND MAY HARM OUR ISRAELI OPERATIONS; OUR ISRAELI
OPERATIONS MAY BE NEGATIVELY AFFECTED BY THE OBLIGATIONS OF OUR PERSONNEL TO
PERFORM MILITARY SERVICE.
A substantial part of our software consulting and development services
segment is conducted in Israel. Accordingly, political, economic and military
conditions in Israel may directly affect this segment of our business. Over the
past three years, the Israeli hi-tech market has experienced a significant
downturn, particularly in the software consulting and development market. This
weakness has been prolonged by the
-7-
increase in unrest, terrorist activity and military action in and around Israel,
which began in September 2000 and which has continued with varying levels of
intensity into 2004. Any increase in hostilities in the Middle East involving
Israel could further weaken the Israeli hi-tech market, which may result in a
significant deterioration of the results of our Israeli operations. In addition,
an increase in hostilities in Israel could cause serious disruption to our
Israeli operations if acts associated with such hostilities result in any
serious damage to our offices or those of our customers or harm to our
personnel.
Many of our employees in Israel are obligated to perform military
reserve duty. In the event of severe unrest or other conflict, individuals could
be required to serve in the military for extended periods of time. Over the past
two years, there have been numerous call-ups of military reservists to active
duty, and it is possible that there will be additional call-ups in the future.
Our Israeli operations could be disrupted by the absence for a
significant period of time of one or more of our key employees or a significant
number of our other employees due to military service. Such disruption could
harm our Israeli operations.
EXCHANGE RATE FLUCTUATIONS COULD INCREASE THE COST OF OUR ISRAELI OPERATIONS.
Most of the sales in this segment stem from our Israeli operations and
a significant portion of those sales are in New Israeli Shekels ("NIS") linked
to the dollar. Such transactions are negotiated in dollars; however, for the
convenience of the customer, they are settled in NIS. The dollar value of the
revenues of our operations in Israel will decrease if the dollar is devalued in
relation to the NIS during the period from the invoicing of a transaction to its
settlement. In addition, significant portions of our expenses in those
operations are in NIS, so that if the dollar is devalued in relation to the NIS,
the dollar value of these expenses will increase.
FINANCIAL VIABILITY OF CLALIT HEALTH FUND.
In 2003, 12% of the software consulting and development segment's sales
and 14% of its receivables at December 31, 2003 were related to the Clalit
Health Fund. The Clalit Health Fund is the largest HMO in Israel and one of the
largest in the world. The fund has a history of running at a deficit, which in
the past has required numerous cost cutting plans and periodic assistance from
the Israeli government. Should the fund have to institute additional cost
cutting measures in the future, which may include restructuring of its terms of
payment, this could have a material adverse effect on the performance of this
segment.
RISKS RELATED TO THE ENERGY INTELLIGENCE SOLUTIONS SEGMENT
Although we no longer control Comverge and the business in our energy
intelligence solutions segment, we have made a significant investment in this
segment and it continues to have a material effect on our consolidated results.
Comverge revenues have fluctuated significantly from quarter to quarter and
Comverge continuously operates at a loss. The activities of this segment are
subject to many risks, including the following:
THE MARKET FOR OUR ENERGY INTELLIGENCE SOLUTIONS IS SUBJECT TO RAPID
TECHNOLOGICAL CHANGE; IF WE FAIL TO KEEP PACE, WE WILL HAVE DIFFICULTY
DEVELOPING AND MAINTAINING A MARKET FOR OUR PRODUCTS AND SERVICES.
The market for our energy intelligence solutions segment is
characterized by rapid technological change. Communications and networking
technologies are continuously changing and we will need to invest in continued
product development, both hardware and software, in order to keep pace with
these changing technologies. Although Comverge has been successful in raising
significant financing, over the long term, Comverge may not have adequate
resources to invest in development and accordingly, its development efforts may
not be successful.
THE PACE OF UTILITY DEREGULATION HAS BEEN SLOW; THE ULTIMATE REGULATORY
STRUCTURE OF THE UTILITY INDUSTRY MAY NOT PROVIDE MANDATES OR INCENTIVES TO
PURCHASE OUR PRODUCTS.
The electric utility industry is undergoing significant deregulation.
The pace of deregulation appears to have slowed due to the uncertainty about
deregulation in the wake of the energy crisis in California in 2000 and the
Enron reorganization. Market observers expect deregulation to include energy
choice and time-of-use pricing requirements, which will mandate, or favor
implementation by utilities of, load control programs and the use of automated
meter reading and data distribution. However, the pace of deregulation
-8-
has not been as rapid as expected and to date only a limited number of utilities
have made purchase commitments for automated meter reading and data distribution
systems. Many utilities have also deferred the purchase of load control systems,
pending resolution of broader industry and regulatory developments. The results
of deregulation are uncertain and may not result in the mandates or incentives
for the types of services which require AMR systems. If state and federal
regulation does not provide these requirements or incentives, the market for our
products may not develop as we expect.
WE MUST COMPETE WITH OTHER UTILITY SOLUTION PROVIDERS FOR MARKET ACCEPTANCE AND
CUSTOMERS.
While we believe that the systems offered by our energy intelligence
solutions segment offer advantages over competing load control and data
communications solutions, there are alternative solutions, and we cannot predict
what share of the market we will obtain. In addition, some of our competitors
have more sales and marketing resources, better brand recognition and/or
technologies that offer alternative advantages. If our potential customers do
not adopt our solutions or do so less rapidly than we expect, our future
financial results and our ability to achieve positive cash flow or profitability
will be harmed.
WE MAY ENCOUNTER DIFFICULTIES IN IMPLEMENTING OUR TECHNOLOGY, PRODUCTS AND
SERVICES.
Problems may occur in the implementation of our technology, products or
services, and we may not successfully complete the commercial implementation of
our technology on a wide scale. Future advances may render our technology
obsolete or less cost effective than competitive systems. Consequently, we may
be unable to offer competitive services or offer appropriate new technologies on
a timely basis or on satisfactory terms.
DELAYS, QUALITY CONTROL AND PRICE PROBLEMS COULD ARISE DUE TO OUR RELIANCE ON
THIRD-PARTY MANUFACTURERS OF CERTAIN COMPONENTS.
We use a limited number of outside parties to manufacture components of
some of our products. Our reliance on third party manufacturers exposes us to
risks relating to timeliness, quality control and pricing. We have experienced
certain delays and quality control problems from third-party manufacturers in
the past and we may experience such problems with our current manufacturers.
Implementing these new product offerings could cause some transitional delays
and the diversification could have a negative impact on price and quality
control. Such delays, price increases and/or quality control problems at our
third-party manufacturers could harm our relationships with our customers, our
operating results and cash flow.
RISKS RELATED TO THE COMPUTER HARDWARE SEGMENT
WE FACE LOW MARGIN, MASS MARKETING COMPETITION.
The market for PCs and related peripheral hardware sales in which we
operate is characterized by severe competition in price-performance and
financing capabilities. Manufacturers and on-line Internet vendors have been
increasing their direct sales efforts on the Internet and otherwise, reducing
prices to end-users, which reduce profit margins for distributors and value
added resellers such as our Databit subsidiary. Should this trend continue, it
could make our method of sales uneconomical and bring into question the
long-term viability of the business model used by Databit.
A LARGE PORTION OF OUR SALES ARE CONCENTRATED IN THE GREATER NEW YORK CITY
METROPOLITAN AREA.
Computer hardware sales to the greater New York City metropolitan area
represented 84%, 70% and 71% of the total segment sales for the years ended
December 31, 2001, 2002 and 2003, respectively. Furthermore, most of the sales
force for the segment is based in Manhattan and northern New Jersey. The
decrease in percentage of sales centered in the New York City metropolitan area
is partially attributable to the sales office we opened on the West Coast, which
we enhanced in 2003. There can be no assurance business will continue to grow
outside the New York City metropolitan area, and if the region suffers from an
economic downturn similar to that of 2001, our operating results could be
materially adversely affected.
-9-
ITEM 2. PROPERTIES
Our corporate headquarters and the principal offices for our U.S.
software consulting and development and hardware sales segments are located in
Mahwah, New Jersey in approximately 5,000 square feet of office space, at a rate
of $85,000 per annum, under a lease that expired in September 2003, although we
continue to rent these premises on a month-to-month basis. We also rent offices
of approximately 4,600 square feet in New York City, at a current rate of
$185,000 per annum, under a lease which expires in October 2005. Our West Coast
sales office for our hardware sales segment consists of 500 square feet located
in Los Angeles, California at a rate of $11,000 per annum, under a lease that
expires in March 2004. We also lease a 600 square foot sales office in southern
New Jersey at a current rent of $8,000 per annum.
Our Israeli activities are conducted in approximately 18,000 square
feet of office space in the Tel Aviv metropolitan area under a lease that
expires in August 2009. The annual rent is approximately $289,000. These
facilities are used for the Israeli operations of the software consulting and
development segment and the energy intelligence solutions segment. In addition,
as part of our acquisition of Endan, we acquired Endan's leased office space
located in the Tel Aviv metropolitan area and are subleasing this space. The
leases expire in October 2004 and the annual net rent expense is approximately
$19,000.
ITEM 3. LEGAL PROCEEDINGS
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On December 8, 2003, we conducted our annual meeting of stockholders.
At this meeting, the stockholders elected the following persons to serve as our
directors: George Morgenstern, Shane Yurman, Avi Kerbs and Elihu Levine. The
stockholders did not vote on any other matters.
-10-
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our Common Stock is currently traded on the Nasdaq SmallCap Market
under the symbol "DSSCE". Prior to March 3, 2003, our Common Stock traded on the
Nasdaq National Market System (NASDAQ/NNM). The following table sets forth, for
the periods indicated, the high and low reported sales prices per share of our
Common Stock on both the Nasdaq SmallCap Market and the Nasdaq National Market
System.
High Low
------- -------
2002:
First Quarter............................... $5.62 $3.83
Second Quarter.............................. 3.96 2.74
Third Quarter............................... 3.04 1.04
Fourth Quarter.............................. 1.93 0.84
2003:
First Quarter............................... $2.79 $0.91
Second Quarter.............................. 2.79 1.80
Third Quarter............................... 3.39 2.25
Fourth Quarter.............................. 3.45 2.45
As of March 23, 2004, the last reported sales price of our common stock
on the Nasdaq SmallCap Market was $23.7, there were 81 record holders of our
common stock and we estimate that there were 1,456 beneficial owners of our
common stock.
We paid no dividends in 2002 or 2003 and we presently do not intend to
pay any dividends in 2004.
The following table provides information about our equity compensation
plans as of December 31, 2003, including both stockholder approved plans and
non-stockholder approved plans. The section entitled "Compensation of Directors"
in our proxy statement for the annual meeting of stockholders held on December
8, 2003 contains a summary explanation of the Non-Employee Director's Stock
Option Plan, which has been adopted without the approval of stockholders, and is
incorporated herein by reference.
NUMBER OF SECURITIES
REMAINING AVAILABLE FOR
NUMBER OF SECURITIES TO WEIGHTED-AVERAGE FUTURE ISSUANCE UNDER
BE ISSUED UPON EXERCISE PRICE OF EQUITY COMPENSATION
EXERCISE OF OUTSTANDING PLANS (EXCLUDING
OUTSTANDING OPTIONS, OPTIONS, WARRANTS SECURITIES REFLECTED IN
WARRANTS AND RIGHTS AND RIGHTS COLUMN (a))
(a) (b) (c)
PLAN CATEGORY -------------------------------------------------------------------
Equity Compensation Plans Approved by Security Holders 817,750 $5.32 2,421,325
Equity Compensation Plans Not Approved by Security Holders 488,301 $4.00 929,616
------- ----- ---------
Total 1,308,051 $4.83 3,350,941
========= ===== =========
ITEM 6. SELECTED FINANCIAL DATA
The selected consolidated statement of operations data for the years
ended December 31, 2001, 2002 and 2003 and consolidated balance sheet data as of
December 31, 2002 and 2003 have been derived from our audited Consolidated
Financial Statements included in this Annual Report. The selected consolidated
statement of operations data for the years ended December 31, 1999 and 2000 and
the consolidated balance sheet data as of December 31, 1999, 2000 and 2001 have
been derived from our audited Consolidated Financial Statements not included
herein.
This data should be read in conjunction with our Consolidated Financial
Statements and related notes and "Item 7. Management's Discussion and Analysis
of Financial Condition and Results of Operations."
-11-
SELECTED CONSOLIDATED STATEMENT OF OPERATIONS DATA
For the Years Ended December 31,
---------------------------------
1999 2000 2001 2002 2003
---------------------- -------- -------- --------
(in thousands, except per share data)
Sales $ 39,708 $ 57,839 $ 45,924 $ 55,886 $ 35,034
Cost of sales ........................................... 31,615 45,606 37,612 42,971 27,976
-------- -------- -------- -------- --------
Gross profit ............................................ 8,093 12,233 8,312 12,915 7,058
Research and development expenses ............................ 1,269 928 2,284 1,526 153
Selling, general and administrative expenses ................. 12,471 16,340 16,617 16,689 10,498
Impairment of goodwill and investment ........................ -- -- 227 2,850 --
Gain on sale of subsidiary/division .......................... -- 1,144 397 -- --
-------- -------- -------- -------- --------
Operating loss .......................................... (5,647) (3,891) (10,419) (8,150) (3,593)
Interest income .............................................. 61 1,758 1,104 253 61
Interest expense ............................................. (910) (709) (459) (1,212) (788)
Loss on early redemption of debt ............................. -- (943) -- -- --
Other income (loss), net ..................................... (306) (50) (32) 113 (475)
-------- -------- -------- -------- --------
Loss from operations before taxes on income .............. (6,802) (3,835) (9,806) (8,996) (4,795)
Taxes on income .............................................. 62 171 (11) 28 (1)
-------- -------- -------- -------- --------
Loss from operations of the Company and its ............. (6,864) (4,006) (9,795) (9,024) (4,794)
consolidated subsidiaries
Share of losses in Comverge .................................. -- -- -- -- (1,752)
Minority interests, net of tax ............................... (275) -- -- 880 264
-------- -------- -------- -------- --------
Loss from continuing operations ......................... (7,139) .(4,006) (9,795) (8,144) (6,282)
Loss from discontinued operations, net of income taxes ....... (8,728) (104) -- -- --
Gain on sale of discontinued operations, net of income
taxes ...................................................... -- 4,222 -- -- --
-------- -------- -------- -------- --------
Net income (loss) ........................................ $(15,867) $ 112 $ (9,795) $ (8,144) $ (6,282)
======== ======== ======== ======== ========
Basic and diluted net income (loss) per share:
Loss from continuing operations ...................... $ (0.96) $ (0.54) $ (1.41) $ (1.11) $ (0.81)
Discontinued operations ................................... (1.17) 0.56 -- -- --
-------- -------- -------- -------- --------
Net income (loss) per share (basic and diluted) ......... $ (2.13) $ 0.02 $ (1.41) $ (1.11) $ (0.81)
======== ======== ======== ======== ========
Weighted average number of shares
outstanding - basic and diluted ................ 7,433 7,422 6,970 7,349 7,738
======== ======== ======== ======== ========
SELECTED CONSOLIDATED BALANCE SHEET DATA:
As of December 31,
------------------
1999 2000 2001 2002 2003
------------------------- ------- ------- -------
(in thousands)
Working capital ............................... $20,030 $18,178 $ 6,809 $ 2,845 $ 729
Total assets .................................. 50,458 42,157 39,244 3,347 17,674
Short-term and long-term ...................... 9,007 6,606 8,681 10,033 2,149
debt
Minority interests ............................ 10 40 2,530 1,609 1,367
Total shareholders' equity .................... 24,850 22,581 14,362 7,128 3,200
(1) Results for 1999 include the gain on the sale of our help desk segment. See
Notes 3 and 4 to the Consolidated Financial Statements included in this
Annual Report for a description of our various acquisitions and
dispositions of business operations and segments during the period from
2001 to 2003.
-12-
(2) Effective July 1, 2002, we adopted Statement of Financial Standards (SFAS)
No. 141, "Business Combinations" and effective January 1, 2002, adopted
SFAS No. 142, "Goodwill and Other Intangibles". As a result, we have ceased
amortization of all goodwill beginning January 1, 2002. Had SFAS No. 142
been adopted by us effective January 1, 2001, net loss and net loss per
share, basic and diluted, would have been as follows (in thousands, except
per share data):
Year ended
December 31,
2001
------------
Net loss as reported ...................................... $(9,795)
Plus: Goodwill amortization, net of income taxes .......... 502
------------
Adjusted net loss ......................................... $(9,293)
============
Net loss per share:
Basic and diluted - as reported ........................ $(1.41)
============
Basic and diluted - as adjusted ........................ $(1.33)
============
-13-
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW AND TREND INFORMATION
The following discussion includes statements that are forward-looking
in nature. Whether such statements ultimately prove to be accurate depends upon
a variety of factors that may affect our business and operations. Certain of
these factors are discussed in "Item 1. Description of Business-Factors That May
Influence Future Results."
We operate in three reportable segments: software consulting and
development, energy intelligence solutions, and computer hardware. As we no
longer have control over our formerly consolidated subsidiary Comverge (see Note
4 to the Consolidated Financial Statements), effective as of the second quarter
of 2003, we account for our investment in Comverge by the equity method and no
longer consolidate Comverge's balances and operating activity into our
consolidated balance sheet and statement of operations. The following analysis
should be read together with the segment information provided in Note 17 to our
Consolidated Financial Statements included in this report.
SOFTWARE CONSULTING AND DEVELOPMENT
Segment revenues decreased in 2003 compared to 2002, causing continuing
losses despite the significant cost cutting measures instituted during the past
two years. The decrease resulted primarily from the continued general weakness
in the global hi-tech markets and in the software consulting and development
market in particular. We currently expect segment revenues to increase in 2004;
this increase, coupled with the improved cost structure achieved, lead us to
believe that this segment will return to profitability in 2004.
Beginning in the fourth quarter of 2003, we started recognizing
revenues from the contract signed with Clalit Health Services, Israel's largest
HMO and one of the largest HMOs in the world, which awarded our dsIT subsidiary,
together with Yael Software, a $4 million contract, of which dsIT's portion is
approximately 50%. The contract includes the development and implementation of a
new Customer Care and Billing system, based entirely on dsIT's e-asyBillTM
billing system. The system, to be implemented over a one-year period with a
seven-year maintenance contract, is expected to generate revenues in the years
2004 through 2011. In the future, we expect that this product, as well as our
OncoProTM product and sonar technology systems, will have increased impact on
our results of operations.
In addition, the consulting market seems to be stabilizing and even
showing certain signs of growth that leave us optimistic regarding revenues from
this activity in 2004.
Finally, dsIT has been successful in bidding (together with Databit
from our Computer Hardware segment) for certain Israeli Ministry of Defense
(MoD) contracts and we expect this cooperation to produce increased revenues in
the future.
ENERGY INTELLIGENCE SOLUTIONS
During 2003, Comverge signed and closed on agreements (see Note 4 to
our Consolidated Financial Statements) for private equity financing totaling
$18.7 million. We invested $3.35 million in these financings, and $15.35 million
was invested by a group of leading energy venture capital investors, in exchange
for Series A Convertible Preferred Stock of Comverge.
Comverge's operating results for the period from January 1, 2003 to
March 31, 2003 have been consolidated and are included in our consolidated
statements of operations. Our share of Comverge's operating results for the
period from April 1, 2003 to December 31, 2003 (effective April 1, 2003) is
reflected in "Share of losses in Comverge" in our consolidated statements of
operations.
In 2003, Comverge saw a decrease in the market for its DCU and
Superstat families of products, causing a general decrease in sales. In
addition, in 2003 Comverge devoted significant attention to the capital raising
process mentioned above. However, during this period, Comverge signed its first
two major, long-term Virtual Peaking CapacityTM contracts to provide significant
peak load reduction to PacifiCorp, a subsidiary of Scottish Power, and to San
Diego Gas and Electric, a subsidiary of Sampora Energy. Although little revenue
was recognized with respect to these contracts in 2003, we expect them to have a
positive effect on revenues in future periods. Comverge signed a 10-year
contract extension modifying the contract with
-14-
Gulf Power for Price Responsive Load Management. Although this modification is
expected to bring the contract's total revenues to an excess of $50 million, it
will reduce revenues from this contract in the short term. However, it is not
expected to negatively impact overall operating results of Comverge. Over the
longer term, the contract modification is expected to improve this project's
profitability, due to product improvements and reductions in component costs.
COMPUTER HARDWARE
Sales in 2003 were lower than sales in 2002, primarily due to the
extraordinarily high amount of sales in the fourth quarter of 2002. We currently
expect to maintain average sales in 2004 at a level similar to that of the
fourth quarter of 2003, by further expanding our new offices in southern New
Jersey and on the West Coast. In addition, to offset the weakness in the
hardware resale market, we are attempting to diversify our revenue base and have
initiated efforts toward alternatives adding more value added software products
and services. These activities, together with continuing joint marketing efforts
with dsIT for Israeli Ministry of Defense projects, are intended to reduce
Databit's dependency on the computer hardware markets in the future.
CORPORATE
Comverge has been successful in raising approximately $18.6 million and
establishing bank credit lines of $5 million, so that although we no longer have
control over Comverge activities, we do not need to further fund Comverge
operations. George Morgenstern, our Chairman and Chief Executive Officer, has
retired from full-time employment, initiating his consulting contract as of
January 1, 2004, and has agreed to make himself available to fill other
appropriate positions the Board may desire. In light of our reduced involvement
with Comverge, the independent management in place at our dsIT and Databit
subsidiaries and our CEO's semi-retirement, we continue to evaluate our
corporate activities and structure. This evaluation includes exploration of
restructuring, acquisitions or mergers and/or other strategic alternatives. To
assist us in this effort, we have retained Foresight, a strategic and financial
consulting and research firm, to perform a valuation of our subsidiaries and
Comverge, as well as perform other analysis to be utilized by our Board of
Directors in its exploration of possible strategic alternatives. We expect to
continue this process and complete it within the next few months.
CRITICAL ACCOUNTING POLICIES
The Securities and Exchange Commission ("SEC") defines "critical
accounting policies" as those that require application of management's most
difficult, subjective or complex judgments, often as a result of the need to
make estimates about the effect of matters that are inherently uncertain and may
change in subsequent periods.
The following discussion of critical accounting policies represents our
attempt to report on those accounting policies which we believe are critical to
our consolidated financial statements and other financial disclosure. It is not
intended to be a comprehensive list of all of our significant accounting
policies, which are more fully described in Note 2 of the Notes to the
Consolidated Financial Statements included in this Annual Report. In many cases,
the accounting treatment of a particular transaction is specifically dictated by
generally accepted accounting principles, with no need for management's judgment
in their application. There are also areas in which the selection of an
available alternative policy would not produce a materially different result.
We have identified the following as critical accounting policies
affecting our company: principles of consolidation and investments in associated
companies, revenue recognition; foreign currency transactions; inventory; income
taxes; and goodwill and other long-lived assets.
PRINCIPLES OF CONSOLIDATION AND INVESTMENTS IN ASSOCIATED COMPANIES
Our consolidated financial statements include the accounts of all
majority-owned subsidiaries. All intercompany balances and transactions have
been eliminated. Minority interests in net losses are limited to the extent of
their equity capital. Losses in excess of minority interest equity capital are
charged against us in our consolidated statements of operations. Investments in
associated companies are accounted for by the equity method.
-15-
In April 2003, we, together with our then consolidated subsidiary,
Comverge, signed and closed on a definitive agreement with a syndicate of
venture capital firms raising an aggregate of $13,000 in capital funding. We
purchased $3,250 of Series A Convertible Preferred Stock issued by Comverge in
the equity financing and incurred transaction costs of an additional $294. In
December 2003, we invested an additional $100 in Series A-2 Convertible
Preferred Stock. A syndicate of venture capital firms purchased $7,750 of Series
A Convertible Preferred Stock issued by Comverge, and one member of the
syndicate also purchased $2,000 of Series A-1 Convertible Preferred Stock of
Comverge. In connection with the transaction, we also converted to equity
intercompany balances of $9,673. As a result of Comverge securing its equity
investments, we no longer control Comverge's activity and we are no longer
required to nor have any intention to fund Comverge's activity.
In connection with Comverge's April equity financing transactions,
Comverge acquired Sixth Dimension, Inc. in a purchase business combination,
valued at approximately $510, in exchange for 877,000 of Comverge's common
shares. In connection with this transaction, as a result of our dilution and the
new valuation of Comverge's common stock, we recorded an increase of $1,085 to
our common stock investment in Comverge. The adjustment was recorded to
additional-paid-in-capital.
Following Comverge's first equity transaction of the year, we held
approximately 50.6% of the outstanding capital voting stock of Comverge
(approximately 76% of Comverge's common stock and approximately 26% of
Comverge's Preferred Stock). As a result of the transaction, we are no longer
obligated to fund Comverge. Additionally, as a result of the April equity
transactions, we have a negative investment balance in Comverge's common stock
of $1,824. Due to our commitment to no longer fund Comverge, we have ceased to
record equity losses against our common stock investment. Our negative common
investment will only be adjusted upon disposition of the our common stock
investment or when we realize equity income from Comverge in excess of any
accumulated equity losses recorded on our Preferred Stock investment. Our
Preferred Stock investment of $3,644 (which was primarily financed by the
release of $3,000 of previously restricted cash) has been reduced by equity
losses in Comverge for the period of April 1, 2003 to December 31, 2003 of
$1,752.
In September 2003, Comverge completed an agreement raising an
additional $2,000 in capital funding in exchange for additional Series A
Convertible Preferred Stock issued by Comverge. Comverge utilized these funds to
repurchase the Series A-1 Convertible Preferred Stock previously issued by
Comverge. In October 2003, Comverge completed an agreement raising an additional
$5,600 in capital funding in exchange for additional Series A Convertible
Preferred Stock issued by Comverge.
Following the equity transactions in 2003, we remained Comverge's
largest shareholder, owning approximately 40.9% of the outstanding capital
voting stock of Comverge, which is comprised of approximately 17% of the
Preferred Stock and approximately 76% of Comverge's common stock.
As a result of the private equity financing transactions, Comverge is
no longer a controlled subsidiary of ours. Thus, effective April 1, 2003, we no
longer consolidated Comverge's balance sheet and results of operations, and from
that date, accounted for our investment in Comverge on the equity method.
As a result of Comverge's net loss during the nine months ended
December 31, 2003, we recognized $1,752 as equity loss representing 26% of
Comverge's losses for the period from April 1 to September 30, 2003 and 17% of
Comverge's losses for the period from October 1 to December 31, 2003 against our
Preferred Stock investment.
REVENUE RECOGNITION
Our revenue recognition policies are significant because our revenue is
a key component of our results of operations. Revenue from time-and-materials
service contracts, maintenance agreements and other services are recognized as
services are provided. Revenue on the sale of products and software are
recognized when substantial evidence of an arrangement exists, the price is
fixed and determinable, delivery or shipment has occurred and there is
reasonable assurance of collection of the sales proceeds. Such revenues
generally do not involve difficult, subjective or complex judgments.
In 2003, we derived $3.2 million of revenues from fixed-price
contracts, all of which are attributable to our software and consulting
development segment, representing approximately 9% of consolidated sales in
-16-
2003 ($3.9 million and 7%, and $4.4 million and 10%, in 2002 and 2001,
respectively), which require the accurate estimation of the cost, scope and
duration of each engagement. Revenue and the related costs for these projects
are recognized using the percentage-of-completion method as costs (primarily
direct labor) are incurred, with revisions to estimates reflected in the period
in which changes become known. If we do not accurately estimate the resources
required or the scope of work to be performed, or do not manage our projects
properly within the planned periods of time or satisfy our obligations under the
contracts, then future revenue and consulting margins may be significantly and
negatively affected or losses on existing contracts may need to be recognized.
Any such resulting changes in revenues and reductions in margins or contract
losses could be material to our results of operations.
FOREIGN CURRENCY TRANSACTIONS
The currency of the primary economic environment in which our corporate
headquarters and our U.S. subsidiaries operate is the United States dollar
("dollar"). Accordingly, the Company and all of its U.S. subsidiaries use the
dollar as their functional currency. We have several Israeli subsidiaries which
together account for approximately 34% of our net revenues for the year ended
December 31, 2003 (24% for the year ended December 31, 2002), and 55% of our
assets and 53% of our total liabilities as of December 31, 2003 (31% of our
assets and 23% of our total liabilities as of December 31, 2002).
The financial statements of the Company's Israeli subsidiaries whose
functional currency is the New Israeli Shekel ("NIS") have been translated using
the exchange rates in effect at the balance sheet date. Statements of operations
amounts have been translated using the exchange rate at date of transaction. In
2001, 2002 and 2003 the resulting translation adjustments are not reported,
since the effect is immaterial All exchange gains and losses denominated in
non-dollar currencies are reflected in other income (loss), net in the
consolidated statement of operations when they arise. Such foreign currency
gains (losses), net amounted to $(3), $154 and $(124) for the years ended
December 31, 2001, 2002 and 2003, respectively.
INVENTORIES
Inventories are stated at the lower of cost or market. Inventories have
been reduced by an allowance for excess and obsolete inventories to establish a
new cost basis. The allowance for excess and obsolete inventories at December
31, 2002 and 2003 was $43 and $13, respectively. The estimated allowance is
based on management's review of inventories on hand compared to estimated future
usage and sales. We evaluate the adequacy of these reserves quarterly.
INCOME TAXES
We have a history of unprofitable operations from losses incurred in a
number of our operations. These losses generated sizeable state, federal and
foreign tax net operating loss ("NOL") carryforwards as of December 31, 2003 of
approximately $5.9 million, $8.7 million and $10.0 million, respectively.
Generally accepted accounting principles require that we record a
valuation allowance against the deferred income tax asset associated with these
NOL carryforwards and other deferred tax assets if it is "more likely than not"
that we will not be able to utilize them to offset future income taxes. Due to
our history of unprofitable operations, we only recognize net deferred tax
assets in those subsidiaries in which we believe that it is "more likely than
not" that we will be able to utilize them to offset future income taxes in the
future. We currently provide for income taxes only to the extent that we expect
to pay cash taxes on current income.
It is possible, however, that we could be profitable in the future at
levels which cause management to conclude that it is more likely than not that
we will realize all or a portion of the NOL carryforwards and other deferred tax
assets. Upon reaching such a conclusion, we would immediately record the
estimated net realizable value of the deferred tax assets at that time and would
then provide for income taxes at a rate equal to our combined federal and state
effective rates or foreign rates. Subsequent revisions to the estimated net
realizable value of the deferred tax assets could cause our provision for income
taxes to vary significantly from period to period.
GOODWILL AND OTHER LONG-LIVED ASSETS
We review the carrying value of our long-lived assets held for use
whenever circumstances indicate there may be an impairment. For all assets
excluding goodwill, the carrying value of a long-lived asset is
-17-
considered impaired if the sum of the undiscounted cash flows is less than the
carrying value of the asset. If this occurs, an impairment charge is recorded
for the amount by which the carrying value of the long-lived asset exceeds its
fair value. The fair value is determined by applying a market- rate multiple to
the estimated near-term future revenue stream expected to be produced by the
segment. Effective July 1, 2001 and January 1, 2002, we adopted SFAS No. 141,
"Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible
Assets." Under these accounting standards, we no longer amortize our goodwill
and are required to complete an annual impairment test. For the purpose of
implementing SFAS No. 142, we have designated the fourth quarter as the period
of the annual test and determined that we have three reporting units, which are
the same as our three reportable segments. In 2002 we came to the conclusion
that due to the slow down in the hi-tech markets, we recognize an expense for
the impairment of goodwill and acquired software of $3.0 million ($2.4 million
net of minority interests). No impairment was found in the annual assessment for
the year ended December 31, 2003.
As of December 31, 2003, we had an aggregate of $4.4 million of
goodwill, all of which relates to our software consulting and development
segment. Additionally, at December 31, 2003, we had $0.1 million net book value
of other identifiable intangible assets.
STOCK-BASED COMPENSATION
The Company accounts for stock-based compensation issued to
non-employees on a fair value basis in accordance with SFAS No. 123 and EITF
Issue No. 96-18, "Accounting for Equity Instruments That Are Issued to Other
Than Employees for Acquiring, or in conjunction with Selling, Goods or Services"
and related interpretations. The Company uses the Black-Scholes valuation method
to estimate the fair value of the warrants. For warrants granted in 2003 the
Company used a risk free interest rate of 1.75%, their contractual life of two
years, an annual volatility of 88% and no expected dividends. The Company
estimated the fair value of these warrants to be approximately $97, which has
been charged to selling, general and administrative expense.
RESULTS OF OPERATIONS
The following table sets forth selected consolidated statement of
operations data as a percentage of our total sales:
Year Ended December 31,
-----------------------
1999 2000 2001 2002 2003
-------- -------- -------- -------- --------
Sales .................................................................. 100% 100% 100% 100% 100%
Cost of sales .......................................................... 80 79 82 77 80
---- ---- ---- ---- ----
20 21 18 23 20
Gross profit
Research and development expenses ...................................... 3 2 5 3 --
Selling, general and administrative expenses ........................... 31 28 36 30 30
Impairment of goodwill and investment .................................. -- -- -- 5 --
Gain on sale of subsidiary/division .................................... -- 2 1 -- --
---- ---- ---- ---- ----
Operating loss .................................................... (14) (7) (23) (15) (10)
Interest income (expense), net ......................................... (2) 2 2 (1) (2)
Loss on early redemption of debt ....................................... -- (2) -- -- --
Other income (loss), net ............................................... (1) -- -- -- (1)
---- ---- ---- ---- ----
Loss from operations before taxes on income ........................ (17) (7) (21) (16) (14)
Taxes on income ........................................................ -- -- -- -- --
---- ---- ---- ---- ----
Loss from operations of the Company and its consolidated
subsidiaries ................................................... (17) (7) (21) (16) (14)
Share of losses in Comverge ............................................ -- -- -- -- (5)
Minority interests, net of tax ......................................... (1) -- -- 1 1
---- ---- ---- ---- ----
Loss from continuing operations ................................... (18) (7) (21) (15) (18)
Loss from discontinued operations, net of income taxes ................. (22) -- -- -- --
Gain on sale of discontinued operations, net of income taxes ........... -- 7 -- -- --
---- ---- ---- ---- ----
Net income (loss) .................................................. (40)% --% (21)% (15)% (18)%
==== ==== ==== ==== ====
-18-
The following table sets forth certain information with respect to
revenues and profits of our three reportable business segments for the years
ended December 31, 2001, 2002 and 2003, including the percentages of revenues
attributable to such segments. The column marked "Other" aggregates information
relating to miscellaneous operating segments, which may be combined for
reporting under applicable accounting principles.
Software Energy
Consulting and Intelligence Computer
Development Solutions Hardware Other Total
----------- --------- --------
(dollars in thousands)
Year ended December 31, 2003:
Revenues from external customers .................... $ 12,156 $ 4,700 $ 18,139 $ 39 $ 35,034
Percentage of total revenues from external
customers ......................................... 35% 13% 52% -- 100%
Gross profit ........................................ 2,581 1,313 3,125 39 7,058
Share of losses in Comverge ......................... -- (1,752) -- -- (1,752)
Net loss ............................................ (849) (3,174) (199) (17) (4,239)
Year ended December 31, 2002:
Revenues from external customers .................... $ 14,202 $ 19,023 $ 22,605 $ 56 $ 55,886
Percentage of total revenues from external
customers ......................................... 25% 34% 41% -- 100%
Gross profit ........................................ $ 2,674 $ 6,087 $ 4,098 $ 56 $ 12,915
Impairment of goodwill and investments .............. $ 2,850 -- -- -- $ 2,850
Segment income (loss) ............................... (4,503) $ (2,161) $ 15 $ (2) $ (6,651)
Year ended December 31, 2001:
Revenues from external customers .................... $ 12,279 $ 13,793 $ 19,794 $ 58 $ 45,924
Percentage of total revenues from external
customers ......................................... 27% 30% 43% -- 100%
Gross profit ........................................ $ 2,104 $ 2,652 $ 3,498 $ 58 $ 8,312
Impairment of goodwill and investments .............. $ 227 -- -- -- $ 227
Segment income (loss) ............................... $ (2,052) $ (6,447) $ 1,006 $(217) $ (7,710)
2003 COMPARED TO 2002
SALES. Of the $20.9 million decrease in sales in 2003 compared to 2002,
$14.3 million was due to Comverge, which, since the second quarter of 2002, is
no longer fully consolidated. Sales decreased in the computer hardware sales
segment by $4.5 million, primarily due to the non-recurrence of the
extraordinarily high segment sales in the fourth quarter of 2002. In the
software consulting and development segment, sales decreased by $2.0 million,
primarily due to the decrease in the number of consultants and development
projects in 2003. This decrease is primarily attributable to the downturn in the
high-tech market in general and the software consulting and development market
in particular.
GROSS PROFIT. The decrease in gross profits and gross profit margins in
2003 as compared to 2002 was also primarily due to our company no longer fully
consolidating Comverge's operations since the second quarter of 2003. This
accounted for $4.8 million of the $5.9 million decrease. In addition, as
Comverge's gross profit margin was higher than the average in the group, ceasing
to consolidate its operations caused a decrease in our consolidated gross profit
margin. Gross profit in the computer hardware segment decreased in 2003 by $1.0
million, primarily due to the aforementioned decrease in sales. In the software
consulting and development segment, despite the significant decrease in sales,
gross profits remained relatively stable, with gross profit margins improving
from 19% in 2002 to 21% in 2003, due to the improved cost structure achieved as
a result of cost cutting measures implemented over the last two years, and the
completion of most of the projects running at lower profit margins in previous
periods.
RESEARCH AND DEVELOPMENT EXPENSES ("R&D"). The decrease in R&D expenses
was primarily due to our company no longer consolidating Comverge's operations
since the second quarter of 2003.
-19-
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES ("SG&A"). The discontinued
full consolidation of Comverge's operations since the second quarter of 2003
accounted for $4.3 million of the $6.2 million decrease in SG&A expenses in 2003
as compared to 2002. However, SG&A decreased in all our other activities as
well. In the software consulting and development segment, SG&A decreased by $0.6
million, or 17%, as a result of cost cutting measures begun in 2002 and
continuing through 2003. SG&A in our computer hardware sales segment also
decreased by $0.5 million, primarily due to reduced commissions on reduced
sales. Finally, corporate SG&A also decreased primarily due to reduced
professional fees and compensation expenses. We presently expect to be able to
maintain the current level of expenses in the software consulting and
development segment and further reduce corporate SG&A as we reduce compensation
expenses as a result of our CEO retiring and the implementation of his
consulting agreement.
INTEREST INCOME (EXPENSE). The decrease in net finance expenses is
attributable to completing the accretion of discounts and the amortization of
related costs in connection with convertible debt and warrants in 2002 and the
first few months of 2003, which accounted for approximately half the interest
expense in 2002.
OTHER LOSS, NET. The other loss in 2003 was primarily attributable to
the write-off of a stockholder's note received from Comverge's CEO.
EQUITY LOSS IN UNCONSOLIDATED SUBSIDIARY. The equity loss in 2003 was
attributable to Comverge, whose results we account for on an equity basis as of
the second quarter of 2003 (see Note 4 of our consolidated Financial
Statements). Our share of Comverge's $7.9 million net losses during the period
from April 1, 2003 to December 31, 2003 was $1.8 million. Comverge's increased
losses in 2003 of $9.3 million, compared to $2.2 million in 2002, was primarily
attributable to a decrease in sales, particularly those related to Comverge's
family of DCU and SuperstatTM products as well as those stemming from its Gulf
Power contract, where shipments have been suspended. Sales from the VPN
contracts will primarily effect future periods. In addition, SG&A in Comverge
has increased primarily due to increased advertising and marketing expenses,
particularly those related to marketing and advertising its new Utah -
PacifiCorp program.
MINORITY INTERESTS. Minority interests reflect the minority interests
in losses generated by our dsIT subsidiary.
2002 COMPARED TO 2001
SALES. Sales in 2002 were $55.9 million, increasing by $10.0 million,
or 22%, from $45.9 million in 2001, due to sales increases in all segments.
Energy intelligence solution sales increased by $5.2 million, or 38%,
from $13.8 million in 2001, to $19.0 million in 2002. The increase in this
segment's sales was primarily attributable to fulfillment of a large contract to
sell our Maingate C&I and PowerCAMP systems to a major utility and to a
generally higher level of business.
Sales in the computer hardware segment continued to improve, increasing
by $2.8 million, or 14%, from $19.8 million in 2001, to $22.6 million in 2002.
Although sales in this segment were improving through the year, the increase was
primarily attributable to the $9.2 million in sales in the fourth quarter of
2002. The increase in the fourth quarter of 2002 was primarily attributable to
sales of $4.5 million to a single customer.
Software consulting and development sales increased by $1.9 million, or
16%, from $12.3 million in 2001, to $14.2 million in 2002. This improvement in
sales was entirely attributable to the expanded revenue base achieved as a
result of the Endan acquisition by dsIT in December 2001, which more than offset
the general weakness in the global hi-tech markets and in the software
consulting and development market in particular.
GROSS PROFIT. Gross profit in 2002 was $12.9 million, increasing by
$4.6 million, or 55%, compared to 2001, with gross profit margins improving from
18% in 2001 to 23% in 2002. The increase in gross profits was attributable to
improvements in all segments, particularly in the energy intelligence solutions
segment.
Gross profit in the energy intelligence solution segment increased by
$3.4 million, or 130%, from $2.7 million, or 19% of sales, in 2001 to $6.1
million, or 32% of sales, in 2002. The increase in gross profit margin is
primarily attributable to a $0.7 million settlement with a former contract
manufacturer and an increase of approximately $2.7 million in sales of products
of higher margin products.
-20-
In the computer hardware segment, gross profit increased by $0.6
million, or 17%, primarily due to the increase in sales.
Gross profit in the software consulting and development segment also
increased by $0.6 million, or 27%, from $2.1 million, or 17% of sales, in 2001,
to $2.7 million, or 19% of sales, in 2002. The increase in gross profits was
primarily attributable to the increase in sales, as well as improved cost
structure.
RESEARCH AND DEVELOPMENT EXPENSES ("R&D"). R&D expenses decreased from
$2.3 million in 2001 to $1.5 million in 2002. This decrease was due to a
decrease in R&D expenditures in the energy intelligence solution segment, as it
shifted its emphasis from R&D in 2001 to marketing and sales in 2002.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES ("SG&A"). Despite the
significant increase in sales, SG&A remained relatively stable, increasing by
$0.1 million, from $16.6 million in 2001, to $16.7 million in 2002.
IMPAIRMENT OF GOODWILL AND INVESTMENT. The entire expense recorded was
due to our software consulting and development segment. With the acquisition of
Endan by our dsIT subsidiary in December 2001, we recognized goodwill and
acquired software valued at a total of $6.4 million. This value was supported by
third party valuations prepared at the time of the acquisition, based on sales
and business projections made at that time. Since then, the hi-tech market in
general and that of software consulting in particular have continued to
deteriorate. As a result, we recorded in 2002 a goodwill impairment charge of
$2.8 million. In addition, we recorded a write down of $90,000 with respect to
an investment in a start-up company.
INTEREST INCOME (EXPENSE). To finance our operations, we utilized our
investments, raised capital by issuing convertible debentures, and obtained
lines of credit. The utilization of our investments caused the decrease in
interest income and we expect interest income to further decrease in future
periods. We incurred finance expenses in connection with the capital raised
including interest and amortization of costs associated with the convertible
debt and warrants issued. Although the interest associated with the utilization
of lines of credit is expected to continue at the current level, the
amortization expenses are expected to decrease over the future quarters. Of the
$1.2 million of interest expense during the year ended December 31, 2002, $0.7
million was related to the accretion of discounts and the amortization of
related costs in connection with convertible debt and warrants.
MINORITY INTERESTS. Minority interests reflect the minority interests
in losses generated by our dsIT subsidiary, primarily due to the impairment of
goodwill and acquired software in this segment as described above.
LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 2003, we had working capital of $0.7 million,
including $1.2 million in cash and cash equivalents. Net cash used in operating
activities in 2003 was $1.0 million, all of which was used to finance corporate
expenses, which totaled $2.1 million. Our controlled operating entities had
positive cash flow from operations.
We believe that the proceeds of the financing and new credit
arrangements acquired by Comverge provide sufficient financing for Comverge to
independently fund its operations. Due to significant interest in Comverge held
by others and other restrictions, working capital and cash flows of Comverge
will not be available to finance other U.S. activities.
Of the total working capital at December 31, 2003, $0.2 million was in
our majority-owned dsIT subsidiary. Due to Israeli tax and company law
constraints as well as the significant minority interest in dsIT, such working
capital and cash flows from dsIT's operations are not available to finance U.S.
activities. As at December 31, 2003, dsIT was utilizing $0.9 million of its $1.1
million line of credit. dsIT's line of credit is denominated in NIS and bears
interest at a rate equal to the Israeli prime rate plus 1.4% per annum. The
Israeli prime rate fluctuates and as of December 31, 2003, was 6.7%. We believe
that dsIT will have sufficient liquidity to finance its activities from cash
flow from its own operations over the next 12 months. This is based on continued
utilization of its line of credit and improved operating results stemming from
continued cost reductions as well as growth in sales.
We believe that we have sufficient liquidity to finance our US-based
operating activities and our corporate activities for at least the 12 months
following the date of this report, utilizing the cash on hand of
-21-
$0.8 million as of March 22, 2004 and operating cash flow from expected
profitable operations of the computer hardware segment. However, due to our
liquidity, successful implementation of our plans is subject to risk and
uncertainties, including those associated with (i) maintaining and further
increasing the level of revenues obtained in the fourth quarter of 2003, and
(ii) effective and timely implementation of cost reductions already begun. Our
long-term liquidity is contingent on our ability to increase our revenue and
profit base, become cash flow neutral in our US based activities and attracting
equity investments to the extent required.
CONTRACTUAL OBLIGATIONS AND COMMITMENTS
Our contractual obligations and commitments at December 31, 2003,
excluding certain severance arrangements described below, principally include
obligations associated with our outstanding indebtedness, future minimum
operating lease obligations and contractual obligations to our CEO for payments
for his post-retirement consulting services to us, and are as set forth in the
following table:
Cash Payments Due During Year Ending December 31,
--------------------------------------------------------
(In Thousands)
After
Contractual Obligations Total 2004 2005 2006 2006
----------------------- ----- ---- ---- ---- ----
Long-term debt related to Israeli operations $1,291 $659 $435 $172 $25
Guarantees 558 558 -- -- --
Operating leases 3,208 1,298 803 335 771
Consulting agreement with CEO 1,304 -- 1,304 -- --
----- ----- ---------- ---- ----
Total contractual cash obligations $6,361 $2,515 $2,542 $507 $796
====== ====== ====== ==== ====
We expect to finance these contractual commitments from cash on hand
and cash generated from operations.
We also have obligations under various agreements and other
arrangements with officers and other employees with respect to severance
arrangements and multiyear employment agreements.
Previously, we accrued a loss for contingent performance of bank
guarantees, the balance of which was $558,000 at December 31, 2003. A portion of
these guarantees was collateralized by means of a deposit of $241,000 as of
December 31, 2003. Although we've accrued this loss, we contested this liability
and expect an Israeli Supreme Court decision in this regard within the next few
months.
Under Israeli law and labor agreements, dsIT is required to make
severance payments to dismissed employees and to employees leaving employment
under certain other circumstances. The obligation for severance pay benefits, as
determined by the Israeli Severance Pay Law, is based upon length of service and
last salary. These obligations are substantially covered by regular deposits
with recognized severance pay and pension funds and by the purchase of insurance
policies. As of December 31, 2003, we accrued a total of $3.7 million for
potential severance obligations, of which approximately $2.4 million was funded
with cash to insurance companies.
Under the terms of his employment agreement with us, we have an
obligation to pay our Chief Executive Officer consulting fees over a seven-year
period starting January 1, 2004. During the first four years of the consulting
period, we have to pay our CEO $237,000 per year, equal to 50% of his salary in
effect as of December 31, 2003. During the last three years of the consulting
period, we must pay $119,000 per year, equal to 25% of that salary. In addition,
we must pay contributions to a non-qualified defined contribution retirement
plan equal to 25% of the consulting fee. In accordance with the employment
contract, we are obliged to fund amounts payable for the term of the consulting
period by the purchase of an annuity or similar investment product at the
beginning of the consulting period. The CEO has agreed to forgo the commitment
of immediate funding for the next twelve months or until we acquire additional
funding.
We also have a severance arrangement under an employment agreement with
our Chief Financial Officer to pay severance under certain circumstances. If our
CFO employment agreement is terminated by us or by him for reasons other than
for cause, we must pay him (i) an amount equal to 150% of his last month's
salary multiplied by the number of years (including partial years) that the CFO
worked for us, plus (ii) an amount equal to six times his last month's salary.
Our severance obligation would be reduced by the
-22-
amount contributed by us to certain Israeli pension and severance funds pursuant
to the CFO's employment agreement. As of December 31, 2003, the unfunded portion
of such severance obligation was $84,000.
We also have a severance arrangement under an employment agreement with
the Chief Executive Officer of dsIT to pay severance under certain
circumstances. If his employment agreement is terminated by us or by him for
reasons other than for cause, we must pay him (i) an amount equal to his last
month's salary multiplied by the number of years (including partial years) that
he worked for Endan and dsIT. Our severance obligation would be reduced by the
amount contributed by us to certain Israeli pension and severance funds pursuant
to his employment agreement. As of December 31, 2003, the unfunded portion of
such severance obligation was $117,000.
IMPACT OF INFLATION AND CURRENCY FLUCTUATIONS
A majority of our sales are denominated in dollars. The remaining
portion is primarily denominated in NIS, linked to the dollar. Such sales
transactions are negotiated in dollars; however, for the convenience of the
customer they are settled in NIS. These transaction amounts are linked to the
dollar between the date the transactions are entered into until the date they
are effected and billed. From the time these transactions are effected and
billed through the date of settlement, amounts are primarily unlinked. The
majority of our expenses in Israel are in NIS, while a portion is in dollars or
dollar-linked NIS.
The dollar cost of our operations in Israel may be adversely affected
in the future by a revaluation of the NIS in relation to the dollar, should it
be significantly different from the rate of inflation. In 2003 the appreciation
of the NIS against the dollar was 7.6%, whereas in 2002 the devaluation of the
NIS against the dollar was 7.3%. Inflation in Israel was -1.9% in 2003 and 6.5%
during 2002. During the first two months of 2004, the NIS was devalued against
the dollar by 2.4% and inflation during this period was 0.0%.
As of December 31, 2003, virtually all of our monetary assets and
liabilities that were not denominated in dollars or dollar-linked NIS were
denominated in NIS. In the event that in the future we have material net
monetary assets or liabilities that are not denominated in dollar-linked NIS,
such net assets or liabilities would be subject to the risk of currency
fluctuations.
PAYMENTS TO RELATED PARTIES
We paid an individual as a director and vice president, who is the son
of our Chief Executive Officer, approximately $197,000, $230,000 and $273,000
for the years ending December 31, 2001, 2002 and 2003, respectively. We also
have engaged certain of our directors and former directors to render
professional services to us. One of our former directors, who is also the
son-in-law of our Chief Executive Officer, is principal of a law firm that we
engage to perform legal services for us. We paid to this firm legal fees and
out-of-pocket disbursements (which includes fees and expenses of special counsel
hired on our behalf) of approximately $575,000, $630,000 and $403,000 for the
years ended December 31, 2001, 2002 and 2003, respectively. The chief executive
officer of the Company's Israeli subsidiary has a loan from the subsidiary that
was acquired in 2001. The loan balance and accrued interest at December 31, 2002
and 2003 was $48,000 and $52,000, respectively. The loan has no defined maturity
date, is denominated in NIS, is linked to the Index and bears interest at 4% per
annum. Comverge has made loans of $10,000 each to both our Chief Executive
Officer and Chief Financial Officer. The loans had an initial maturity date of
January 3, 2002 and were extended at that time to mature on January 3, 2004. The
loans bear interest at 4.25% per annum. The balance of the loans and accrued
interest at December 31, 2002 and 2003 was $25,000 and $26,000, respectively.
-23-
SUMMARY QUARTERLY FINANCIAL DATA (UNAUDITED)
The following table sets forth certain of our unaudited quarterly
consolidated financial information for the years ended December 31, 2002 and
2003. This information should be read in conjunction with our Consolidated
Financial Statements and the notes thereto.
2002 2003
-------------------------------------------- -----------------------------------------
First Second Third Fourth First Second Third Fourth
Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter
-------- -------- -------- -------- -------- ------- ------- -------
(Restated)
(in thousands, except per share amounts)
Sales ................................. $ 12,808 $ 12,783 $ 11,269 $ 19,026 $ 12,868 $ 7,285 $ 6,684 $ 8,197
Cost of sales ......................... 9,830 10,191 8,906 14,044 9,799 5,994 5,481 6,702
-------- -------- -------- -------- -------- ------- ------- -------
Gross profit .......................... 2,978 2,592 2,363 4,982 3,069 1,291 1,203 1,495
Research and development expenses ..... 460 550 256 260 153 -- -- --
Selling, general and
administrative expenses ............. 4,300 4,452 3,923 4,014 4,302 2,108 1,984 2,104
Impairment of goodwill and
investment .......................... -- -- 2,760 90 -- -- -- --
-------- -------- -------- -------- ------- ------- -------
Operating income (loss) ............... (1,782) (2,410) (4,576) 618 (1,386) (817) (781) (609)
Interest income (expense), net ........ (1) (146) (393) (419) (332) (291) (56) (48)
Other income (loss), net .............. 27 66 56 (36) (14) (151) (243) (67)
-------- -------- -------- -------- -------- ------- ------- -------
Loss before taxes on income ........... (1,756) (2,490) (4,913) 163 (1,732) (1,259) (1,080) (724)
Taxes on income ....................... 42 15 7 (36) 12 22 (27) (8)
-------- -------- -------- -------- -------- ------- ------- -------
Loss from operations of the
Company and its consolidated
subsidiaries ........................ (1,798) (2,505) (4,920) 199 (1,744) (1,281) (1,053) (716)
Minority interests, net of tax ........ (4) 207 649 28 (17) 121 35 125
Share of loss in Comverge ............. -- -- -- -- -- (550) (611) (591)
-------- -------- -------- -------- -------- ------- ------- -------
Net income (loss) ..................... $ (1,802) $ (2,298) $ (4,271) $ 227 $ (1,761) $(1,710) $(1,629) $(1,182)
======== ======== ======== ======== ======== ======= ======= =======
Basic and diluted net income (loss)
per share:
Net income (loss) per share ........... $ (0.25) $ (0.31) $ (0.58) $ 0.03 $ (0.24) $ (0.22) $ (0.21) $ (0.15)
======== ======== ======== ======== ======== ======= ======= =======
Weighted average number of
shares outstanding - basic .......... 7,353 7,353 7,353 7,335 7,345 7,792 7,894 7,902
======== ======== ======== ======== ======== ======= ======= =======
Weighted average number of
shares outstanding - diluted ........ 7,353 7,353 7,353 7,336 7,345 7,792 7,894 7,902
======== ======== ======== ======== ======== ======= ======= =======
Results have been restated for the second and third quarters of 2003 following
the determination that no change of our interest in Comverge occurred following
issuance of Comverge's preferred stock. In addition, we utilized a final value
based on a third party valuation of the 877,000 shares of Comverge's common
stock issued in connection with Comverge's purchase of 6D in April 2003. As a
result of these changes, we decreased by $3,269 the gain previously recorded in
our additional paid-in capital and reduced the investment and our resulting
equity in the losses of Comverge in both the second and third quarters of 2003.
In addition, we determined that we are no longer committed to fund Comverge,
and, due to our negative common stock investment in Comverge, should cease to
record equity losses against our common investment and will continue to record
equity losses against our preferred investment in Comverge.
The effect of the restatement on our net loss and basic and diluted loss per
share for the six and three month periods ended June 30, 2003 and the nine and
three month periods ended September 30, 2003 is shown below:
Three Nine Three
Six months months months months
ended ended ended ended
---------- ---------- ---------- ----------
June 30, 2003 September 30, 2003
------------------------- -------------------------
Net loss as reported $(4,422) $(2,661) $(6,153) $(1,731)
Effect of restatement 951 951 1,053 102
------- ------- ------- -------
Net loss - as restated $(3,471) $(1,710) $(5,100) $(1,629)
======= ======= ======= =======
Basic and diluted net loss per
share - as reported $ (0.58) $ (0.34) $ (0.80) $ (0.22)
Effect of restatement 0.12 0.12 0.14 0.01
------- ------- ------- -------
Basic and diluted net loss per
share - as restated $ (0.46) $ (0.22) $ (0.66) $ (0.21)
======= ======= ======= =======
The effect of the restatement with respect to the three and nine month periods
ended September 30, 2003 were previously reflected in an amendment on Form
10-Q/A which we filed with the SEC on March 30, 2004.
-24-
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
GENERAL
We are required to make certain disclosures regarding our 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.
In the normal course of business, we are exposed to fluctuations in
interest rates on lines-of-credit and long-term debt incurred to finance our
operations in Israel, currently $0.9 million and $1.3 million, respectively.
Additionally, our monetary assets and liabilities (net liability of
approximately $1.4 million) in Israel are exposed to fluctuations in exchange
rates. We do not employ specific strategies, such as the use of derivative
instruments or hedging, to manage our interest rate or exchange rate exposures.
FAIR VALUE OF FINANCIAL INSTRUMENTS
Fair values of financial instruments included in current assets and
current liabilities are estimated to approximate their book values due to the
short maturity of such investments. Fair value for long-term debt and long-term
deposits are estimated based on the current rates offered to us for debt and
deposits with similar terms and remaining maturities. The fair value of our
long-term debt and long-term deposits are not materially different from their
carrying amounts.
CONCENTRATIONS OF CREDIT RISK
Financial instruments, which potentially subject us to concentrations
of credit risk, consist principally of cash and cash equivalents, short and
long-term bank deposits, and trade receivables. The counterparty to a majority
of our cash equivalent deposits as well as our short and long-term bank deposits
is a major financial institution of high credit standing. We do not believe
there is significant risk of non-performance by these counterparties.
Approximately 28% of the trade accounts receivable at December 31, 2003 was due
from a U.S. customer that pays its trade receivables over usual credit periods.
Credit risk with respect to the balance of trade receivables is generally
diversified due to the large number of entities comprising our customer base.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Furnished at the end of this report commencing on page F-1.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
On October 9, 2003, KPMG LLP ("KPMG") notified us that as of that date,
it had resigned as our independent auditor.
KPMG's audit reports on our consolidated financial statements for the
past two fiscal years did not contain an adverse opinion or disclaimer of
opinion, and were not qualified or modified as to uncertainty, audit scope or
accounting principles, except where the reports of KPMG refer to our adoption of
FAS No. 141, "Business Combinations", for purchase method business combinations
completed after June 30, 2001, SFAS No. 142, "Goodwill and Other Intangible
Assets", effective January 1, 2002.
-25-
During the two most recent fiscal years and through October 9, 2003,
there were no disagreements between us and KPMG as to any matter of accounting
principles or practices, financial statement disclosure, or audit scope or
procedure, which disagreement, if not resolved to the satisfaction of KPMG,
would have caused it to make reference to the subject matter of the disagreement
in its reports on the financial statements for such periods within the meaning
of Item 304(a)(1)(iv) of Regulation S-K.
On January 14, 2004, the Registrant engaged Kesselman & Kesselman, a
member of PricewaterhouseCoopers International Limited ("Kesselman"), as our
independent auditors for the fiscal year ended December 31, 2003. Kesselman has
also been engaged to review our interim financial statements contained in our
quarterly report on Form 10-Q for the quarter ended September 30, 2003, which
was filed on November 14, 2003 without an independent auditor review, subsequent
to KPMG's resignation.
ITEM 9A. CONTROLS AND PROCEDURES
EVALUATION OF CONTROLS AND PROCEDURES
We carried out an evaluation, under the supervision and with the
participation of our management, including the Chief Executive Officer and the
Chief Financial Officer, of the design and operation of our disclosure controls
and procedures. Based on this evaluation, our Chief Executive Officer and Chief
Financial Officer concluded that as of December 31, 2003, our disclosure
controls and procedures were effective for gathering, analyzing and disclosing
the information we are required to disclose in the reports we file with the SEC
under the Securities Exchange Act of 1934, within the time periods specified in
the SEC's rules and forms.
CHANGES IN CONTROLS AND PROCEDURES
There have been no significant changes in our internal controls or in
other factors that could significantly affect disclosure controls and procedures
subsequent to the date of our most recent evaluation.
-26-
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information relating to each of our directors and nominees for
director and the information relating to our executive officers will appear
under the captions "Election of Directors - Certain Information Regarding
Directors and Officers" and "Compliance with Section 16(a) of the Securities and
Exchange Act of 1934" in our definitive proxy statement for the 2004 Annual
Meeting of Stockholders (the "2004 Proxy Statement"), and is hereby incorporated
by reference.
The information required by this Item pursuant to Item 401(h) and
401(i) of Regulation S-K relating to an audit committee financial expert and
identification of the Audit Committee of our Board of Directors will appear
under the heading "Corporate Governance" in the 2004 Proxy Statement, and is
hereby incorporated by reference.
We have adopted a written code of ethics that applies to our principal
executive officer, principal financial officer, and principal accounting officer
or controller, and/or persons performing similar functions. Our code of ethics
is being filed with this Annual Report as an exhibit hereto.
ITEM 11. EXECUTIVE COMPENSATION
The information relating to compensation of directors and executive
officers will appear under the captions "Executive and Director Compensation -
Compensation of Directors", "Executive and Director Compensation - Compensation
Committee Interlocks and Insider Participation", "Executive and Director
Compensation - Employment Arrangements", "Executive and Director Compensation -
Executive Compensation" and "Compensation Report of the Board of Directors" in
the 2004 Proxy Statement, and is hereby incorporated by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
AND RELATED STOCKHOLDER MATTERS
The information relating to security ownership will appear under the
caption "Stock Ownership of Certain Beneficial Owners and Management" in the
2004 Proxy Statement, and is hereby incorporated by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information relating to certain relationships and transactions will
appear under the caption "Executive and Director Compensation - Certain Related
Party Transactions" in the 2004 Proxy Statement, and is hereby incorporated by
reference.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information relating to principal accountant fees and services and
audit committee pre-approval policies and procedures will appear under the
caption "Principal Accountant Fees and Services" in the 2004 Proxy Statement,
and is hereby incorporated by reference.
-27-
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) EXHIBITS:
3.1 Certificate of Incorporation of the Registrant, with amendments thereto
(incorporated herein by reference to Exhibit 3.1 to the Registrant's
Registration Statement on Form S-1 (File No. 33-70482) (the "1993
Registration Statement")).
3.2 By-laws of the Registrant (incorporated herein by reference to Exhibit
3.2 to the Registrant's Registration Statement on Form S-1 (File No.
33-44027) (the "1992 Registration Statement")).
3.3 Amendments to the By-laws of the Registrant adopted December 27, 1994
(incorporated herein by reference to Exhibit 3.3 of the Registrant's
Current Report on Form 8-K dated January 10, 1995).
4.1 Specimen certificate for the Common Stock (incorporated herein by
reference to Exhibit 4.2 to the 1992 Registration Statement).
4.2 Securities Purchase Agreement between the Registrant and Bounty
Investors LLC, dated as of October 12, 1999, including Form of Warrant
(incorporated herein by reference to Exhibit 1 to the Registrant's
Current Report on Form 8-K dated October 12, 1999 (the "October 1999
8-K")).
4.3 Form of Registration Rights Agreement between the Registrant and Bounty
Investors LLC, dated as of October 12, 1999 (incorporated herein by
reference to Exhibit 1 to October 1999 8-K).
4.4 Warrant to Purchase Common Stock of the Registrant, dated October 12,
1999 (incorporated herein by reference to Exhibit 4.4 to the
Registrant's Annual Report on Form 10-K for the year ended December 31,
2000 (the "2000 10-K")).
4.5 Securities Purchase Agreement, dated as of June 11, 2002, by and among
the Registrant, Databit, Inc. and Laurus Master Fund, Ltd. ("Laurus")
(including the forms of convertible note and warrant) (incorporated
herein by reference to Exhibit 10.1 to the Registrant's Current Report
on Form 8-K dated June 11, 2002).
4.6 Purchase and Security Agreement, dated as of December 4, 2002, made by
and between Comverge ("Comverge") and Laurus (incorporated herein by
reference to Exhibit 10.1 to the Registrant's Current Report on Form
8-K dated December 5, 2002 (the "December 2002 8-K")).
4.7 Convertible Note, dated December 4, 2002, made by and among Comverge,
Laurus and, as to Articles III and V only, the Registrant (incorporated
herein by reference to Exhibit 10.2 to the December 2002 8-K).
4.8 Common Stock Purchase Warrant, dated December 5, 2002, issued by the
Registrant to Laurus (incorporated herein by reference to Exhibit 10.3
to the December 2002 8-K).
4.9 Registration Rights Agreement, dated as of December 4, 2002, by and
between the Registrant and Laurus (incorporated herein by reference to
Exhibit 10.4 to the December 2002 8-K).
*10.1 Employment Agreement between the Registrant and George Morgenstern,
dated as of January 1, 1997 (incorporated herein by reference to
Exhibit 10.1 to the Registrant's Annual Report on Form 10-K for the
year ended December 31, 1997 (the "1997 10-K")).
*10.2 Employment Agreement between the Registrant and Yacov Kaufman, dated
as of January 1, 1999 (incorporated herein by reference to Exhibit
10.22 of the Registrants Annual Report on Form 10-K for the year ended
December 31, 1999 (the "1999 10-K")).
*10.3 1991 Stock Option Plan (incorporated herein by reference to Exhibit
10.4 to the 1992 Registration Statement).
*10.4 1994 Stock Incentive Plan, as amended (incorporated herein by
reference to Exhibit 10.4 to the Registrant's Form 10-K for the year
ended December 31, 1995 (the "1995 10-K")).
*10.5 1994 Stock Option Plan for Outside Directors, as amended (incorporated
herein by reference to Exhibit 10.5 to the 1995 10-K).
10.6 1995 Stock Option Plan for Non-management Employees (incorporated
herein by reference to Exhibit 10.6 to the 1995 10-K).
-28-
10.7 Asset Purchase Agreement, dated as of August 2, 2000, by and among the
Registrant, International Data Operations, Inc., and Eclipse Networks,
Inc. (incorporated herein by reference Exhibit 10.1 to the Registrant's
Quarterly Report on Form 10-Q for the quarter ended September 30,
2000).
10.8 Credit Agreement dated as of February 7, 2000 between Comverge and Bank
Leumi USA (incorporated herein by reference to Exhibit 10.12 of the
1999 10-K).
10.9 License Agreement between the Registrant and Lucent Technologies Inc.
dated as of January 9, 1998 (incorporated herein by reference to the
Registrant's Current Report on Form 8-K dated February 17, 1998).
10.10 Warrant Repurchase Agreement, dated September 25, 2000, among the
Registrant, Bank Leumi USA and Bank Leumi le-Israel (incorporated
herein by reference to Exhibit 10.11 to the 2000 10-K).
10.11 Agreement dated January 26, 2002, between the Registrant and Bounty
Investors LLC (incorporated herein by reference to Exhibit 10.12 to the
2000 10-K).
10.12 Lease Agreement, dated February 5, 2002, between Duke-Weeks Realty
Limited Partnership and Comverge, (incorporated herein by reference to
Exhibit 10.13 to the 2000 10-K).
*10.13 Stock Option Agreements, dated as of October 1, 1999, between Powercom
Control Systems Ltd. and George Morgernstern, Yacov Kaufman and Harvey
E. Eisenberg (and related promissory notes) (incorporated herein by
reference to Exhibit 10.14 to the 2000 10-K).
10.14 Share Purchase Agreement, dated as of November 29, 2001, by and among
the Registrant, Decision Systems Israel Ltd., Endan IT Solutions Ltd.,
Kardan Communications Ltd., Neuwirth Investments Ltd., Jacob Neuwirth
(Noy) and Adv. Yossi Avraham, as Trustee for Meir Givon (incorporated
herein by reference to Exhibit 10.1 to the Registrant's Current Report
on Form 8-K dated December 13, 2001).
10.15 Registration Rights Agreement, dated as of December 13, 2002, by and
among the Registrant, Kardan Communications Ltd. and Adv. Yossi
Avraham, as Trustee for Meir Givon (incorporated herein by reference to
Exhibit 10.2 to the Registrant's Current Report on Form 8-K dated
December 13, 2002).
*10.16 Employment Agreement, dated as of September 1, 2002, by and between
Comverge and Robert M. Chiste (incorporated herein by reference to
Exhibit 10.1 to the Registrant's Quarterly Report on Form 10-Q for the
quarter ended September 30, 2002).
*10.17 Restricted Stock Purchase Agreement, dated as of September 1, 2002, by
and between the Registrant and Robert M. Chiste (incorporated herein by
reference to Exhibit 10.2 to the Registrant's Quarterly Report on Form
10-Q for the quarter ended September 30, 2002).
-29-
*10.18 Option Agreement, dated as of September 1, 2002, by and between
Comverge and Robert M. Chiste (incorporated herein by reference to
Exhibit 10.3 to the Registrant's Quarterly Report on Form 10-Q for the
quarter ended September 30, 2002).
10.19 Contract for Asset Management Services between the Registrant and
Malley Associates Capital Management, Inc. (incorporated herein by
reference to Exhibit 10.1 to the Registrant's Quarterly Report on Form
10-Q for the quarter ended March 31, 2002).
*10.20 Employment Agreement dated as of March 30, 2002 between Comverge and
Joseph D. Esteves (incorporated herein by reference to Exhibit 10.1 to
the Registrant's Quarterly Report on Form 10-Q for the quarter ended
June 30, 2002).
10.21 Agreement, dated as of January 31, 2002, between Comverge and Bank
Leumi USA (incorporated herein by reference to Exhibit 10.21 to the
Registrant's Annual Report on Form 10-K for the year ended December 31,
2001 (the "2001 10-K").
10.22 $6,000,000 Term Note of Comverge dated as of January 31, 2002, payable
to Bank Leumi USA (incorporated herein by reference to Exhibit 10.22 to
the 2001 10-K).
*10.23 First Amendment to Employment Agreement, dated as of May 17, 2002, by
and between the Registrant and George Morgenstern (incorporated herein
by reference to Exhibit 10.23 to the 2001 10-K).
10.24 Agreement, dated as of January 31, 2003, between Comverge and Bank
Leumi USA (including form of $6,000,000 Term Note of Comverge dated as
of January 31, 2003, payable to Bank Leumi USA) (incorporated herein by
reference to Exhibit 10.24 to the Registrant's Annual Report on Form
10-K for the year ended December 31, 2002 (the "2002 10-K").
10.25 Agreement, dated as of February 25, 2003, between the Registrant and
J.P. Turner & Company, L.L.C. (incorporated herein by reference to
Exhibit 10.25 to the 2002 10-K).
*10.26 Second Amendment to Employment Agreement, dated as of March 12, 2002,
between the Registrant and George Morgenstern (incorporated herein by
reference to Exhibit 10.1 to the Registrant's Quarterly Report on Form
10-Q for the quarter ended March 31, 2002).
*10.27 Amendment to Employment Agreement, dated as of June 1, 2002, between
the Registrant and Yacov Kaufman (incorporated herein by reference to
Exhibit 10.1 to the Registrant's Quarterly Report on Form 10-Q for the
quarter ended June 30, 2002).
10.28 Guaranty, dated December 4, 2002, made by the Registrant in favor of
Laurus (incorporated herein by reference to Exhibit 10.5 to the
December 2002 8-K).
10.29 Preferred Stock Purchase Agreement, dated as of April 7, 2003, by and
among Comverge, the Registrant and the other investors named therein
(incorporated herein by reference to Exhibit 10.29 to the 2002 10-K).
10.30 Investors' Rights Agreement, dated as of April 7, 2003, by and among
Comverge, the Registrant and the investors and Comverge management
named therein (incorporated herein by reference to Exhibit 10.30 to the
2002 10-K).
10.31 Co-Sale and First Refusal Agreement, dated as of April 7, 2003, by and
among Comverge, the Registrant and the investors and stockholders named
therein (incorporated herein by reference to Exhibit 10.31 to the 2002
10-K).
10.32 Voting Agreement, dated as of April 7, 2003, by and among Comverge, the
Registrant and the other investors named therein (incorporated herein
by reference to Exhibit 10.32 to the 2002 10-K).
-30-
10.33 Letter Agreement, dated as of April 1, 2003, by and between the
Registrant and Laurus (incorporated herein by reference to Exhibit
10.33 to the 2002 10-K).
#14.1 Code of Ethics of the Registrant.
#21.1 List of subsidiaries.
#23.1 Consent of KPMG LLP.
#23.2 Consent of Kesselman & Kesselman.
#23.3 Consent of PricewaterhouseCoopers LLP.
#31.1 Certification pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
#31.2 Certification pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
+32.1 Certification pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
+32.2 Certification pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
----------------
* This exhibit includes a management contract, compensatory plan or
arrangement in which one or more directors or executive officers of the
Registrant participate.
# This Exhibit is filed herewith.
+ This Exhibit is furnished herewith.
-31-
(b) FINANCIAL STATEMENT SCHEDULES.
None.
(c) REPORTS ON FORM 8-K.
(i) Report on Form 8-K, dated October 9, 2003, filed on October
16, 2003, relating to the resignation of KPMG LLP as the
Registrant's certifying accountant.
(ii) Report on Form 8-K, dated November 14, 2003, filed on November
26, 2003, relating to the announcement by the Registrant of
its financial results for the third quarter ended September
30, 2003.
(iii) Report on Form 8-K, dated December 10, 2003, filed on December
10, 2003, relating to the Registrant's announcement that it
had received a notice from The NASDAQ Stock Market indicating
that the Company was not in compliance with Marketplace Rule
4310(c)14 and that the Registrant was subject to delisting
from The NASDAQ Stock Market.
-32-
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, in the Township of
Mahwah, State of New Jersey, on March 31, 2004.
DATA SYSTEMS & SOFTWARE INC.
BY /s/ GEORGE MORGENSTERN
--------------------------------------------------
George Morgenstern
Chairman of the Board, President
and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed by the following persons on behalf of the
registrant, in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ GEORGE MORGENSTERN Chairman of the Board; President; Chief Executive March 31, 2004
- -------------------------------------------- Officer; and Director
George Morgenstern
/s/ YACOV KAUFMAN Vice President, Chief Financial Officer March 31, 2004
- -------------------------------------------- (Principal Financial Officer and Principal
Yacov Kaufman Accounting Officer)
/s/ SHANE YURMAN Director March 31, 2004
- --------------------------------------------
Shane Yurman
/s/ AVI KERBS Director March 31, 2004
- --------------------------------------------
Avi Kerbs
/s/ ELI LEVINE Director March 31, 2004
- --------------------------------------------
Eli Levine
-33-
DATA SYSTEMS & SOFTWARE INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED FINANCIAL STATEMENTS OF DATA SYSTEMS & SOFTWARE INC.:
Report of Kesselman and Kesselman................................................................................... F-2
Report of KPMG LLP ................................................................................................. F-3
Consolidated Balance Sheets
as of December 31, 2002 and December 31, 2003................................................................... F-4
Consolidated Statements of Operations
for the years ended December 31, 2001, December 31, 2002 and December 31, 2003.................................. F-5
Consolidated Statements of Changes in Shareholders' Equity
for the years ended December 31, 2001, December 31, 2002 and December 31, 2003................................... F-6
Consolidated Statements of Cash Flows
for the years ended December 31, 2001, December 31, 2002 and December 31, 2003................................... F-7
Notes to Consolidated Financial Statements.......................................................................... F-10
CONSOLIDATED FINANCIAL STATEMENTS OF COMVERGE, INC.:
Report of PriceWaterhouseCoopers, LLP............................................................................... F-34
Consolidated Balance Sheet
as of December 31, 2003........................................................................................ F-35
Consolidated Statements of Operations
for the year ended December 31, 2003............................................................................. F-36
Comverge Consolidated Statement of Changes in Shareholders' Equity
for the year ended December 31, 2003............................................................................. F-37
Comverge Consolidated Statements of Cash Flows
for the year ended December 31, 2003............................................................................. F-38
Notes to Consolidated Financial Statements.......................................................................... F-39
F-1
Report of Independent Auditors
To the Board of Directors and Shareholders of
Data Systems & Software Inc.
We have audited the accompanying consolidated balance sheet of Data Systems &
Software Inc. (hereafter the "Company") and its subsidiaries as of December 31,
2003, and the related consolidated statements of operations, shareholders equity
and of cash flows for the year then ended. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audit.
We conducted our audit in accordance with auditing standards generally accepted
in the United States of America and in Israel, including those prescribed by the
Israeli Auditors (Mode of Performance) Regulations, 1973. Those standards
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by management, as well
as evaluating the overall financial statement presentation. We believe that our
audit provides a reasonable basis for our opinion.
In our opinion, the 2003 consolidated financial statements referred to above
present fairly, in all material respects, the financial position of the Company
and its subsidiaries at December 31, 2003, and the results of their operations
and their cash flows for the year then ended in conformity with accounting
principles generally accepted in the United States of America.
/s/ Kesselman & Kesselman
March 31, 2004
Tel Aviv, Israel
F-2
Independent Auditors' Report
The Board of Directors and Shareholders of
Data Systems & Software Inc.:
We have audited the accompanying consolidated balance sheet of Data
Systems & Software Inc. and subsidiaries as of December 31, 2002, and the
related consolidated statements of operations, changes in shareholders' equity,
and cash flows for each of the years in the two-year period ended December 31,
2002. These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Data Systems
& Software Inc. and subsidiaries as of December 31, 2002, and the results of
their operations and their cash flows for each of the years in the two-year
period ended December 31, 2002 in conformity with accounting principles
generally accepted in the United States of America.
As discussed in Notes 2 and 9 to the consolidated financial statements,
the Company adopted Statements of Financial Accounting Standards No. 141,
"Business Combinations", for purchase method business combinations completed
after June 30, 2001, and No. 142, "Goodwill and Other Intangibles", effective
January 1, 2002.
/s/ KPMG LLP
Short Hills, New Jersey
March 7, 2003, except as to the first paragraph of Note 4 and the second and
third sentences of the third paragraph of Note 10(b), which are as of April 10,
2003
F-3
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
ASSETS As of December 31,
-------------------------------
2002 2003
Current assets:
Cash and cash equivalents........................................................... $1,150 $1,213
Restricted cash................................................................ 241 241
Accounts receivable, net....................................................... 12,267 7,053
Inventory...................................................................... 2,217 88
Other current assets........................................................... 1,443 661
-------------- -----------
Total current assets.......................................................... 17,318 9,256
-------------- -----------
Investment in Comverge, net............................................................ -- 68
Property and equipment, net............................................................ 1,972 814
Long-term deposit - restricted......................................................... 5,700 --
Other assets........................................................................... 599 613
Funds in respect of employee termination benefits...................................... 2,425 2,379
Goodwill .............................................................................. 4,929 4,430
Other intangible assets, net........................................................... 404 114
-------------- -----------
Total assets.................................................................. $33,347 $17,674
============== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Short-term bank credit and current maturities of long-term debt................ $2,531 $1,517
Convertible note, net.......................................................... 1,224 --
Trade accounts payable......................................................... 5,096 2,586
Accrued payroll, payroll taxes and social benefits............................. 2,211 1,451
Other current liabilities...................................................... 3,411 2,973
-------------- -----------
Total current liabilities..................................................... 14,473 8,527
-------------- -----------
Long-term liabilities:
Long-term debt................................................................. 6,278 632
Other liabilities.............................................................. 477 227
Liability for employee termination benefits.................................... 3,382 3,721
-------------- -----------
Total long-term liabilities................................................ 10,137 4,580
Commitments and contingencies (Note 13)
Minority interests..................................................................... 1,609 1,367
-------------- -----------
Shareholders' equity:
Common stock - $0.01 par value per share:
Authorized - 20,000,000 shares; Issued - 8,161,867 and 8,749,729 shares
for 2002 and 2003, respectively............................................ 82 87
Additional paid-in capital..................................................... 37,687 39,595
Warrants....................................................................... 364 461
Deferred compensation.......................................................... (7) --
Accumulated deficit............................................................ (26,787) (33,069)
Treasury stock, at cost - 845,704 and 839,704 shares for 2002 and 2003,
respectively ............................................................. (3,913) (3,874)
Shareholder's note.................................................................. (298) --
-------------- -----------
Total shareholders' equity........................................................... 7,128 3,200
-------------- -----------
Total liabilities and shareholders' equity.................................... $33,347 $17,674
============== ===========
The accompanying notes are an integral part of these consolidated
financial statements.
F-4
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT NET LOSS PER SHARE DATA)
YEAR ENDED DECEMBER 31,
--------------------------------------------------
2001 2002 2003
--------------- -------------- ---------------
Sales:
Products .......................................................... $ 32,717 $ 39,831 $ 22,006
Services .......................................................... 8,830 12,149 9,791
Projects .......................................................... 4,377 3,906 3,237
-------- -------- --------
Total sales ..................................................... 45,924 55,886 35,034
-------- -------- --------
Cost of sales:
Products .......................................................... 27,122 30,994 18,201
Services .......................................................... 6,754 8,689 6,997
Projects .......................................................... 3,736 3,288 2,778
-------- -------- --------
Total cost of sales ............................................. 37,612 42,971 27,976
-------- -------- --------
Gross profit ..................................................... 8,312 12,915 7,058
Operating expenses:
Research and development expenses ................................. 2,284 1,526 153
Selling, general and administrative expenses ...................... 16,617 16,689 10,498
Impairment of goodwill ............................................ -- 2,760 --
Impairment of investments ......................................... 227 90 --
Gain on issuance of subsidiary stock .............................. 397 -- --
-------- -------- --------
Total operating expenses ........................................ 18,731 21,065 10,651
-------- -------- --------
Operating loss ............................................................ (10,419) (8,150) (3,593)
Interest income ........................................................... 1,104 253 61
Interest expense .......................................................... (459) (1,212) (788)
Other income (loss), net .................................................. (32) 113 (475)
-------- -------- --------
Loss before taxes on income ............................................... (9,806) (8,996) (4,795)
Taxes on income ........................................................... (11) 28 (1)
-------- -------- --------
Loss from operations of the Company and its consolidated
subsidiaries .............................................................. (9,795) (9,024) (4,794)
Share in losses of Comverge ............................................... -- -- (1,752)
Minority interests in losses of subsidiary, net of tax .................... -- 880 264
-------- -------- --------
Net loss .................................................................. $ (9,795) $ (8,144) $ (6,282)
======== ======== ========
Net loss per share - basic and diluted .................................... $ (1.41) $ (1.11) $ (0.81)
======== ======== ========
Weighted average number of shares
outstanding - basic and diluted ............................. 6,970 7,349 7,738
======== ======== ========
The accompanying notes are an integral part of these consolidated
financial statements.
F-5
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(IN THOUSANDS)
Additional Deferred
Number of Common Paid-In Compen- Accumulated Treasury Shareholder's
Shares Stock Capital Warrants sation Deficit Stock Note Total
--------- ------ ---------- -------- -------- ----------- --------- ------------- --------
Balances as of December 31, 2000 8,035 $80 $ 35,970 $ 114 $-- $ (8,813) $(4,770) $-- $ 22,581
Exercise of options 77 1 192 -- -- (35) 73 -- 231
Issuance of shares 50 1 297 -- -- -- -- (298) --
Issuance of deferred compensation -- -- 16 -- (16) -- -- -- --
Amortization of deferred
compensation -- -- -- -- 2 -- -- -- 2
Treasury shares issued in respect
of acquisition at average cost -- -- 506 -- -- -- 1,744 -- 2,250
Purchase of treasury shares -- -- -- -- -- -- (907) -- (907)
Net loss -- -- -- -- -- (9,795) -- -- (9,795)
--------- ------ ---------- -------- -------- ----------- --------- ------- --------
Balances as of December 31, 2001 8,162 $82 $ 36,981 $ 114 $(14) $(18,643) $(3,860) $(298) $ 14,362
Grant and amortization of stock
option compensation -- -- 18 -- 7 -- -- -- 25
Expiration of warrants -- -- 114 (114) -- -- -- -- --
Value of convertible note and
convertible portion of line of
credit allocated to beneficial
conversion feature and related
warrants -- -- 574 364 -- -- -- -- 938
Purchase of treasury shares -- -- -- -- -- -- (53) -- (53)
Net loss -- -- -- -- -- (8,144) -- -- (8,144)
--------- ------ ---------- -------- -------- ----------- --------- ------- --------
Balances as of December 31, 2002 8,162 $82 $ 37,687 $ 364 $ (7) $(26,787) $(3,913) $(298) $ 7,128
Amortization of deferred
compensation -- -- -- -- 7 -- -- -- 7
Issuance of shares as compensation 50 * 50 -- -- -- -- -- 50
Exercise of options 11 * (25) -- -- -- 41 -- 16
Issuance of shares in lieu of
debt repayment 127 1 239 -- -- -- -- -- 240
Conversion of line of credit, net
of professional fees 400 4 559 -- -- -- -- -- 563
Issuance of warrants for
professional services -- -- -- 97 -- -- -- -- 97
Purchase of treasury shares -- -- -- -- -- -- (2) -- (2)
Write off of stockholder's note -- -- -- -- -- -- -- 298 298
Equity from issuance of shares by
Comverge -- -- 1,085 -- -- -- -- -- 1,085
Net loss -- -- -- -- -- (6,282) -- -- (6,282)
--------- ------ ---------- -------- -------- ----------- --------- ------- --------
Balances as of December 31, 2003 8,750 $87 $ 39,595 $ 461 $-- $(33,069) $(3,874) $-- $ 3,200
========= ====== ========== ======== ======== =========== ========= ======= ========
* Less than $1
The accompanying notes are an integral part of these consolidated
financial statements.
F-6
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
YEAR ENDED DECEMBER 31,
----------------------------------------------
2001 2002 2003
------------- ------------- -------------
Cash flows used in operating activities:
Net loss .................................................................... $ (9,795) $(8,144) $(6,282)
Adjustments to reconcile net loss to net cash used in
operating activities (see Schedule A) ...................................... 1,060 1,908 5,332
-------- ------- -------
Net cash used in operating activities ....................................... (8,735) (6,236) (950)
-------- ------- -------
Cash flows provided by investing activities:
Withdrawal of long-term deposit ............................................ -- 300 5,700
Short-term bank deposits, net ............................................... 5,994 -- --
Investment in debt securities ............................................... (3,215) (154) --
Proceeds from sale and maturity of marketable and debt securities ........... 1,383 2,031 --
Amounts funded for employee termination benefits ............................ (437) (579) (474)
Utilization of employee termination benefits ................................ 401 807 235
Acquisitions of property and equipment ...................................... (904) (492) (231)
Proceeds from sale of property and equipment ................................ 23 28 16
Business acquisitions - see Schedule C ...................................... (500) -- --
Business dispositions - see Schedule D ...................................... -- -- (3,644)
-------- ------- -------
Net cash provided by investing activities ................................... 2,745 1,941 1,602
-------- ------- -------
Cash flows provided by (used in) financing activities:
Purchase of treasury stock .................................................. (907) (53) (2)
Issuance of subsidiary shares to minority interests ......................... -- -- 22
Proceeds from employee stock option exercises ............................... 231 -- 16
Proceeds from issuance of convertible note, net of issuance costs ........... -- 1,749 --
Short-term debt borrowings (repayments), net ................................ 836 (510) (860)
Proceeds from borrowings of long-term debt .................................. -- 679 835
Repayments of long-term debt and debt acquired in acquisition ............... (1,022) (445) (600)
-------- ------- -------
Net cash provided by (used in) financing activities ......................... (862) 1,420 (589)
-------- ------- -------
Net increase (decrease) in cash and cash equivalents .............................. (6,852) (2,875) 63
Cash and cash equivalents at beginning of year .................................... 10,877 4,025 1,150
-------- ------- -------
Cash and cash equivalents at end of year .......................................... $ 4,025 $ 1,150 $ 1,213
======== ======= =======
Supplemental cash flow information:
Cash paid during the year for:
Interest ................................................................ $ 372 $ 579 $ 328
======== ======= =======
Income taxes ............................................................ $ 459 $ 138 $ 136
======== ======= =======
The accompanying notes are an integral part of these consolidated
financial statements.
F-7
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
SCHEDULES TO CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
YEAR ENDED DECEMBER 31,
------------------------------------------
2001 2002 2003
------------- ------------ -------------
A. Adjustments to reconcile net loss to net cash used in operating
activities:
Depreciation and amortization ......................................................... $ 1,338 $ 1,155 $ 527
Minority interests .................................................................... -- (921) (264)
Impairment of goodwill and acquired software .......................................... -- 3,000 --
Share in losses of Comverge ........................................................... -- -- 1,752
Change in the allowance for doubtful accounts ......................................... (279) (46) (159)
Deferred taxes ........................................................................ 14 (107) (98)
Increase (decrease) in liability for employee termination benefits .................... 332 (429) 739
Gain on issuance of subsidiary stock .................................................. (397) -- --
Loss (gain) on sale of marketable securities and debt securities, net ................. 4 (49) --
Loss from write-down of investment .................................................... 227 90 --
Loss on write-off of stockholder's note ............................................... -- -- 298
Write-down of inventory ............................................................... 391 -- --
Loss (gain) on sale of property and equipment, net .................................... 33 (4) (47)
Stock and stock option compensation ................................................... 2 25 57
Accretion of discount on convertible debt and amortization of related
costs ............................................................................ -- 679 500
Receipt of investments for services rendered .......................................... (164) -- --
Other ................................................................................. 7 (208) 70
Changes in operating assets and liabilities, net of effect of acquisitions:
Restricted cash .................................................................. (15) 76 --
Decrease (increase) in accounts receivable and other assets ...................... 1,508 (1,111) 3,267
Decrease (increase) in inventory ................................................. (601) (1,559) 293
Increase (decrease) in accounts payable and other liabilities .................... (1,340) 1,317 (1,603)
------- ------- -------
$ 1,060 $ 1,908 $ 5,332
======= ======= =======
B. Non-cash investing and financing activities:
Issuance of common stock in lieu of debt repayment................................ $803
Increase in investment in Comverge from issuance of preferred and
common stock credited to additional paid-in capital............................... $1,085
Accrued expenses incurred in investment of Comverge............................... $200
Adjustment of treasury stock and additional-paid-in-capital with
respect to options exercised...................................................... $41
Adjustment of goodwill............................................................ $48
Accounts payable incurred in acquisition of fixed assets.......................... $50
Value of beneficial conversion feature and related warrants on
issuance of convertible debt...................................................... $938
Increase in deferred tax liability associated with adjustment of
intangible assets................................................................. $17
Issuance of shares for debt....................................................... $298
Issuance of deferred compensation................................................. $16
Shares of subsidiary issued in respect of acquisition............................. $2,938
Treasury shares issued in respect of acquisition.................................. $2,250
Reduction of goodwill from realization of acquired deferred tax asset............. $180
Write-off of retired and fully depreciated property and equipment................. $1,842
F-8
C. Assets/liabilities acquired in acquisitions:
Current assets.................................................................... $(2,124)
Property, equipment and other assets.............................................. (995)
Goodwill and intangibles.......................................................... (6,570)
Current liabilities............................................................... 1,958
Long-term debt.................................................................... 1,319
Other liabilities, minority interests and deferred taxes.......................... 3,662
Shareholders' equity.............................................................. 2,250
-----------
$(500)
===========
D. Assets/liabilities disposed of in disposition of Comverge:
Current assets.................................................................... $4,634
Property, equipment and other assets.............................................. 1,190
Goodwill ......................................................................... 499
Intangibles....................................................................... 214
Short-term debt................................................................... (3,880)
Current liabilities............................................................... (2,340)
Other liabilities................................................................. (517)
Cash investment in Comverge....................................................... (3,444)
-----------
$(3,644)
===========
The accompanying notes are an integral part of these consolidated
financial statements.
F-9
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
NOTE 1--NATURE OF OPERATIONS
(a) Description of Business
Data Systems & Software Inc., a Delaware corporation ("DSSI"), through
its subsidiaries (collectively, the "Company") and its equity investment (see
Note 4) in Comverge Inc. ("Comverge"), (i) provides software consulting and
development services, (ii) is an authorized dealer and a value-added-reseller of
computer hardware, and (iii) provides energy intelligence solutions for
utilities and energy companies (through Comverge). The Company's operations are
based in the United States and in Israel. DSSI's shares were transferred from
the Nasdaq National Market effective March 3, 2003 and its shares are currently
traded on the Nasdaq SmallCap Market. As to principal customers and principal
markets - see Note 17.
(b) Financing of Operations
As of December 31, 2003, the Company had working capital of $729,
including $1,213 in unrestricted cash and cash equivalents. Net cash of $950 was
used in operating activities during 2003. The net loss for the year ended
December 31, 2003 of $6,282 included the Company's share of unconsolidated
losses of Comverge of $1,752 and other non-cash expenses and losses of $1,382.
The primary source of the Company's cash provided by operating activities during
2003 was collections of trade accounts receivables and other current assets in
excess of reductions in accounts payable and other liabilities of $1,664 net.
Net cash of $1,602 provided by investing activities was primarily from the
release of previously restricted cash of $5,700, of which $3,444 was invested in
Comverge. Net cash of $589 used in financing activities was primarily due to net
payments of debt of $625.
The working capital of $729 at December 31, 2003, included working
capital of $188 in the Company's majority owned Israeli subsidiary, dsIT
Technologies Ltd (dsIT). Due to Israeli tax and company law constraints, as well
as the significant minority interest in dsIT, working capital and cash flows
from dsIT's operations are not readily available to finance U.S. based
activities.
Since April 2003, the Company's formerly consolidated subsidiary,
Comverge completed private equity financings totaling approximately $18,600 (see
Note 4). As a result of the financing, Comverge no longer requires additional
funding from the Company. As part of the agreements related to the private
equity financing, Comverge received a new $5,000 unsecured credit facility.
As of February 28, 2004 the Company's wholly-owned US operations (i.e.,
excluding dsIT and Comverge) had an aggregate of $965 in unrestricted cash and
cash equivalents, reflecting an approximately $200 decrease from the balance as
of December 31, 2003.
(c) Accounting Principles
The consolidated financial statements have been prepared in conformity
with accounting principles generally accepted in the United States of America.
(d) Use of Estimates in Preparation of Financial Statements
The preparation of consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and the disclosure of contingent assets and
liabilities as of the date of the financial statements, and the reported amounts
of revenues and expenses during the reporting periods. Actual results could
differ from those estimates.
NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
FOREIGN CURRENCY TRANSACTIONS
The currency of the primary economic environment in which the
operations of DSSI and its U.S. subsidiaries are conducted is the United States
dollar ("dollar"). Accordingly, the Company and all of its U.S. subsidiaries use
the dollar as their functional currency. The financial statements of the
Company's Israeli subsidiaries whose functional currency is the New Israeli
Shekel ("NIS") have been translated using the
F-10
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
exchange rates in effect at the balance sheet date. Statements of operations
amounts have been translated using the exchange rate at date of transaction. In
2001, 2002 and 2003 the resulting translation adjustments are not reported,
since the effect is immaterial. All exchange gains and losses denominated in
non-dollar currencies are reflected in other income (loss), net in the
consolidated statement of operations when they arise. Such foreign currency
gains (losses), net amounted to $(3), $154 and $(124) for the years ended
December 31, 2001, 2002 and 2003, respectively.
PRINCIPLES OF CONSOLIDATION AND PRESENTATION
The consolidated financial statements of the Company include the
accounts of all majority-owned subsidiaries. All intercompany balances and
transactions have been eliminated. Minority interests in net losses are limited
to the extent of their equity capital. Losses in excess of minority interest
equity capital are charged against the Company.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments, which include
short-term deposits (up to three months from date of deposit) that are not
restricted as to withdrawal or use, to be cash equivalents.
INVENTORY
Inventories are stated at the lower of cost or market. Cost is
determined for raw materials, spare parts and supplies on the average cost
method. For finished goods and merchandise inventories, cost is determined on
the first-in, first-out method.
INVESTMENTS IN ASSOCIATED COMPANIES
Investments in associated companies are accounted for by the equity
method.
OTHER INVESTMENTS
Investments in private companies over whose operating and financial
policies the Company does not have the power to exercise significant influence,
are accounted for by the cost method. In 2001, 2002 and 2003, the Company
recorded write-downs of $227, $90 and $0, respectively, with regard to
investments in such companies.
PROPERTY AND EQUIPMENT
Property and equipment are presented at cost at the date of
acquisition. Depreciation and amortization is calculated based on the
straight-line method over the estimated useful lives of the depreciable assets,
or in the case of leasehold improvements, the lease term. Improvements are
capitalized while repairs and maintenance are charged to operations as incurred.
GOODWILL AND ACQUIRED INTANGIBLE ASSETS
Goodwill represents the excess of cost over the fair value of net
assets of businesses acquired. The Company adopted the provisions of SFAS No.
141, "Business Combinations" as of July 1, 2001 and SFAS No. 142, "Goodwill and
Other Intangible Assets", as of January 1, 2002. SFAS No. 141 requires that the
purchase method of accounting be used for all business combinations and
specifies the criteria that intangible assets acquired in a business combination
must meet to be recognized and reported separately from goodwill. In accordance
with SFAS No. 142, goodwill and acquired intangible assets determined to have an
indefinite useful life are not amortized, but instead tested for impairment at
least annually. SFAS No. 142 also requires that intangible assets with estimable
useful lives be amortized over their respective estimated useful lives to their
estimated residual values, and reviewed for impairment in accordance with SFAS
No. 144, "Accounting for Impairment or Disposal of Long-Lived Assets".
SFAS No. 142 requires the Company to assess annually whether there is
an indication that goodwill is impaired, or more frequently if events and
circumstances indicate that the asset might be impaired during the year. The
Company performs its annual impairment test at the conclusion of its annual
budget process, generally in the fourth quarter of each year (though in 2002,
the Company recorded an impairment in the third quarter based on its judgment
that an impairment had occurred with respect to its software consulting and
development segment). The Company has identified its operating segments as its
reporting units for purposes of the impairment test and assigned its goodwill
and intangible assets to its software consulting and development and energy
intelligence solutions segments. The Company determines the carrying value of
each reporting unit by assigning the assets and liabilities, including the
existing goodwill and intangible assets, to those reporting units. The Company
then determines the fair value of each reporting unit and compares it to the
carrying amount of the reporting unit. Calculating the fair value of the
reporting units requires significant estimates and assumptions by management. To
the extent the carrying amount of a reporting unit exceeds the fair value of the
reporting unit, there is an indication that the reporting unit goodwill may be
impaired and a second step of the impairment test is performed to determine the
amount of the impairment to be recognized, if any.
In accordance with SFAS No. 141, goodwill from the Company's
acquisition of Endan IT Solutions Ltd. ("Endan") in December 2001 (see Note 3)
is not amortized. Goodwill from other acquisitions prior to the adoption of SFAS
No. 141 and No. 142 was amortized on a straight-line basis over the expected
periods to be benefited, ranging from five to seven years, and assessed for
recoverability using a methodology consistent with that of SFAS No. 121,
"Accounting for Impairment of Long-Lived Assets and for Long-Lived Assets to be
Disposed Of" (see "Impairment of Long-Lived Assets" below).
Identifiable intangible assets deemed to have an indefinite life are
tested annually for impairment, or more frequently if events and circumstances
indicate that the asset might be impaired during the year. An impairment loss is
recognized to the extent that the carrying amount exceeds the asset's fair value
as determined based on discounted cash flows associated with the asset. The
Company has not identified any indefinite life intangible assets.
The costs of licensed technology and software are presented at
estimated fair value at acquisition date. These costs are amortized on a
straight-line basis over the term of the license or estimated useful life of the
software, generally five years.
The costs of registered patents and patents pending acquired from third
parties are presented at estimated fair value at acquisition date. In addition,
registration costs and fees for patents are capitalized. Registered patent costs
are amortized over the estimated remaining useful life of the patents, from four
to fourteen years. Costs for patents pending are not amortized until they are
issued.
F-11
IMPAIRMENT OF LONG-LIVED ASSETS
Effective January 1, 2002, the Company adopted SFAS No. 144. This
Statement requires that long-lived assets, except those addressed by SFAS No.
142, be reviewed for impairment whenever events or changes in circumstances
indicate that the carrying amount of an asset may not be recoverable.
Recoverability of assets to be held and used is measured by a comparison of the
carrying amount of an asset to the undiscounted future net cash flows expected
to be generated by the asset. If the carrying amount of an asset exceeds its
estimated future undiscounted cash flows, an impairment charge is recognized by
the amount by which the carrying amount of the asset exceeds the fair value of
the asset. SFAS No. 144 requires the Company to separately report discontinued
operations and extends that reporting to a component of an entity that either
has been disposed of (by sale, abandonment, or in a distribution to owners) or
is classified as held for sale. Assets to be disposed of are reported at the
lower of the carrying amount or fair value less costs to sell. The adoption of
SFAS No. 144 did not have any impact on the Company's consolidated financial
statements because the impairment assessment under SFAS No. 144 is largely
unchanged from the Company's previous policy.
Through December 31, 2001, the carrying values of long-lived assets and
goodwill were reviewed for impairment whenever events or changes in
circumstances occurred that indicated that the net carrying amount would not be
recoverable. The review was based on comparing the carrying amount of the
long-lived assets to the undiscounted estimated cash flows over their remaining
useful lives. If the sum of the expected undiscounted future cash flows was less
than the carrying amount of the assets, the Company would recognize an
impairment loss. The impairment loss, if determined to be necessary, would be
measured as the amount by which the carrying amount of the asset exceeds the
fair value of the asset. Assets to be disposed of were reported at the lower of
the carrying amount or fair value, less cost to sell.
TREASURY STOCK
Company shares held by the Company are presented as a reduction of
shareholders' equity, at their cost to the Company.
REVENUE RECOGNITION
Revenue from time-and-materials service contracts, maintenance
agreements and other services are recognized as services are provided.
Revenues from fixed-price contracts to design, develop, manufacture or
modify complex load control or other equipment and software to customer
specifications are recognized the percentage-of-completion method in a long-term
contract transaction. The percentage-of-completion is determined based on labor
hours incurred. Percentage-of-completion estimates are reviewed periodically,
and any adjustments required are reflected in the period when such estimates are
revised. Losses on contracts, if any, are recognized in the period in which the
loss is determined.
Revenues from the sale of software licenses are recognized when a
license agreement exists, delivery has occurred, the license fee is fixed or
determinable, and collectibility is reasonably assured. Maintenance and
subscription revenue is recognized ratably over the contract period.
Revenues on the sale of products, which are shipped from the Company's
stock of inventory, are recognized when the products are shipped provided that
appropriate signed documentation of the arrangement, such as a signed contract,
purchase order or letter of agreement, has been received, the fee is fixed or
determinable and collectibility is reasonably assured.
In accordance with Emerging Issues Task Force ("EITF") Issue No. 99-19
"Recording Revenue Gross as a Principal Versus Net as an Agent", revenue from
drop shipments of third-party hardware and software sales are recognized upon
delivery, and recorded at the gross amount when the Company is responsible for
fulfillment of the customer order, has latitude in pricing, customizes the
product to the customer's specifications and has discretion in the selection of
the supplier.
F-12
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
CONCENTRATION OF CREDIT RISK - ALLOWANCE FOR DOUBTFUL ACCOUNTS
Financial instruments, which potentially subject the Company to
concentrations of credit risk, consist principally of cash and cash equivalents,
short and long-term bank deposits and trade receivables. The counterparty to a
majority of the Company's cash equivalent deposits as well as its short-term
bank deposits is a major financial institution of high credit standing. The
Company does not believe there is significant risk of non-performance by the
counterparty. Approximately 28% and 12% of the trade accounts receivable at
December 31, 2003 and 2002, respectively, were due from a U.S. customer that
pays its trade receivables over usual credit periods (as to revenues from such
customer - see Note 17(e)). Credit risk with respect to the balance of trade
receivables is generally diversified due to the large number of entities
comprising the Company's customer base.
An appropriate allowance for doubtful accounts is included in respect
of specific debts of which collection is in doubt. The Company performs ongoing
credit evaluations of its customers and usually does not require collateral.
RESEARCH AND DEVELOPMENT EXPENSES
Research and development costs consisting primarily of labor and
related costs are charged to operations as incurred.
ADVERTISING EXPENSES
Advertising expenses are charged to operations as incurred. Advertising
expenses in the years ended December 31, 2001, 2002 and 2003 totaled $120, $171
and $35, respectively.
WARRANTY PROVISION
Comverge generally warrants its products against certain manufacturing
and other defects. These product warranties are provided for specific periods of
time and/or usage of the product depending on the nature of the product, the
geographic location of its sale and other factors. As of December 31, 2002, the
Company had accrued $52 for estimated product warranty claims, which was
included in other current liabilities. The accrued product warranty costs were
based primarily on historical experience of actual warranty claims as well as
current information on repair costs. Warranty claims expense for each of the
years 2001 and 2002 were: $302 and $(250), respectively. Starting the second
quarter of 2003, the Company no longer consolidates Comverge's activities.
The following table provides the changes in the Company's product
warranties for the year ended December 31, 2003:
Year ended December 31,
------------------------------
2002 2003
------------- -------------
Warranty provision at beginning of the period $302 $52
Accruals for warranties issued during the period 87 23
Warranty settlements made during the period (2) (23)
Changes in liability for pre-existing warranties during the period,
including expirations (335) --
Other - deconsolidation of Comverge (see Note 4) -- (52)
------------- -------------
Warranty provision at the end of the period $52 $--
============= =============
The Company grants its customers one-year product warranty. No
provision was made in respect of warranties based on the Company's previous
history.
ISSUANCE OF STOCK OF SUBSIDIARY
The Company recognizes gains and losses from the issuance of subsidiary
stock through the consolidated statement of operations. In non-cash
transactions, when the assurance as to the reliability of the fair value of the
non-cash asset received is difficult to determine, gains and losses are recorded
in additional paid in capital.
STOCK-BASED COMPENSATION
The Company applies Accounting Principles Boar Opinion ("APB") No. 25,
"Accounting for Stock
F-13
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
Issued to Employees" and the related interpretations in accounting for its stock
option grants to employees and directors, with the disclosure provisions of SFAS
No. 123, "Accounting for Stock-Based Compensation". Under APB No. 25,
compensation expense is computed under the intrinsic value method of accounting
to the extent that the fair value of the underlying shares on the date of the
grant exceed the exercise price of the share option, and thereafter amortized on
a straight-line basis against income over the expected service period.
Had compensation cost for the Company's option plans been determined
based on the fair value at the grant dates of awards, consistent with the method
prescribed in SFAS No. 123, the Company's net income (loss) and loss per share
would have been changed to the pro forma amounts indicated below:
Year Ended December 31,
-----------------------
2001 2002 2003
---- ---- ----
Net loss as reported $ (9,795) $ (8,144) $ (6,282)
Plus: Stock-based employee compensation expense included in
reported net income, net of related tax effects 2 25 57
Less: Total stock-based employee compensation expense determined
under fair value based method for all awards, net of related
tax effects 718 1,199 502
------------- ----------- -----------
Pro forma net loss $ (10,511) $ (9,318) $ (6,727)
============= =========== ===========
Net loss per share:
Basic and diluted - as reported $ (1.41) $ (1.11) $ (0.81)
============= =========== ===========
Basic and diluted - pro forma $ (1.51) $ (1.27) $ (0.87)
============= =========== ===========
The pro forma information in the above table also gives effect to the
application of SFAS No. 123 on the share option plans of the Company's
subsidiaries.
The Company accounts for stock-based compensation issued to
non-employees on a fair value basis in accordance with SFAS No. 123 and EITF
Issue No. 96-18, "Accounting for Equity Instruments That Are Issued to Other
Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services"
and related interpretations.
INCOME TAXES
Deferred income taxes reflect the net tax effects of temporary
differences between the carrying amounts of assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes, as well as
operating loss, capital loss and tax credit carryforwards. Deferred tax assets
and liabilities are classified as current or non-current based on the
classification of the related assets or liabilities for financial reporting, or
according to the expected reversal dates of the specific temporary differences,
if not related to an asset or liability for financial reporting. Valuation
allowances are established against deferred tax assets if it is more likely than
not that they will not be realized. Deferred tax assets and liabilities are
measured using enacted tax rates expected to apply to taxable income in the
years in which those temporary differences are expected to be recovered or
settled. The effect on deferred tax assets and liabilities of a change in tax
rates or laws is recognized in operations in the period that includes the
enactment date.
BASIC AND DILUTED NET INCOME (LOSS) PER SHARE
Basic net income (loss) per share is computed by dividing net income
(loss) by the weighted average number of shares outstanding during the year,
excluding treasury stock. Diluted net income (loss) per share is computed by
dividing net income (loss) by the weighted average number of shares outstanding
plus the dilutive potential of common shares which would result from the
exercise of stock options and warrants or conversion of convertible securities.
However, the dilutive effects of stock options, warrants and convertible
securities are excluded from the computation of diluted net income (loss) per
share if doing so would be antidilutive.
RECENTLY ISSUED ACCOUNTING PRINCIPLES
In January 2003, the FASB issued FASB Interpretation No. 46,
"Consolidation of Variable Interest Entities" (FIN 46). Under FIN 46, entities
are separated into two populations: (1) those for which voting
F-14
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
interests are used to determine consolidation (this is the most common) and (2)
those for which variable interests are used to determine consolidation. FIN 46
explains how to identify Variable Interest Entities (VIEs) and how to determine
when a business enterprise should include the assets, liabilities,
non-controlling interests, and results of activities of a VIE in its
consolidated financial statements.
Since issuing FIN 46, the FASB has proposed various amendments to the
Interpretation and has deferred its effective date. Most recently, in December
2003, the FASB issued a revised version of FIN 46 (FIN 46-R), which also
provides for a partial deferral of FIN 46. This partial deferral established the
effective date for public entities to apply FIN 46 and FIN 46-R based on the
nature of the variable interest entity and the date upon which the public
company became involved with the variable interest entity. In general, the
deferral provides that (i) for variable interest entities created before
February 1, 2003, a public entity must apply FIN 46-R at the end of the first
interim or annual period ending after March 15, 2004, and may be required to
apply FIN 46 at the end of the first interim or annual period ending after
December 15, 2003, if the variable interest entity is a special purpose entity,
and (ii) for variable interest entities created after January 31, 2003, a public
company must apply FIN 46 at the end of the first interim or annual period
ending after December 15, 2003, as previously required, and then apply FIN 46-R
at the end of the first interim or annual reporting period ending after March
15, 2004.
The Company currently has no variable interests in any VIE.
Accordingly, the Company believes that the adoption of FIN 46 and FIN 46-R will
not have a material impact on its financial position, results of operations and
cash flows.
In December 2003, the FASB issued FAS No. 132 (revised 2003),
"Employers' Disclosures about Pensions and Other Postretirement Benefits, an
amendment of FASB Statements No. 87, 88 and 106, and a revision of FASB
Statement No. 132 ("FAS 132 (revised 2003)"). This Statement revises employer's
disclosures about pension plans and other postretirement benefit plans. It does
not change the measurement or recognition of those plans. The new rules require
additional disclosures about the assets, obligations, cash flows, and net
periodic benefit cost of defined benefit pension plans and other postretirement
benefit plans.
Part of the new disclosures provisions are effective for 2003 calendar
year-end financial statements, and accordingly have been applied by the company
in these consolidated financial statements.
The remaining provisions of FAS 132 (revised 2003), which have a later
effective date, are currently being evaluated by the Company.
RECLASSIFICATIONS
Certain reclassifications have been made to the Company's prior years'
consolidated financial statements to conform with the current year's
consolidated financial statement presentation.
NOTE 3--ACQUISITION
In December 2001, a subsidiary of the Company acquired 100% of the
shares of Endan IT Solutions Ltd. ("Endan") in a transaction accounted for as a
purchase business combination and partial sale of a subsidiary. Endan was a
privately-held Israeli information technology software and consulting firm and
as a result of the acquisition became an integral part of the Company's software
consulting and development segment. The acquisition was consummated in order to
broaden the Company's markets into information technology and to take advantage
of economies of scale and synergistic cost savings. Endan's results of
operations are included in the Company's consolidated statement of operations
beginning January 1, 2002. Results for the period from acquisition to December
31, 2001 were not included in the Company's consolidated statement of operations
as they were immaterial.
The aggregate purchase price for Endan was $5,788, comprised of (i)
$2,250 representing the issuance of 365,210 shares of DSSI common stock valued
at $6.16 per share, (ii) $2,912 representing the estimated value of 32% of the
outstanding ordinary shares of dsIT, (iii) $500 of cash, (iv) $100 of estimated
closing costs and (v) $26 representing the fair value of options to purchase
dsIT ordinary shares in exchange for the cancellation of outstanding Endan stock
options. The Company recognized a gain of $397 on the issuance of ordinary
shares representing a 32% interest in dsIT connection with this transaction.
F-15
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
In addition to the purchase consideration mentioned above, in December
2001, the Company also repaid a $1,000 loan previously made by Kardan
Communications Ltd. ("Kardan"), Endan's majority shareholder prior to the
acquisition.
The following table summarizes the estimated fair value of the assets
acquired and liabilities assumed at December 31, 2001 adjusted for valuations of
intangible assets received in 2002, the effective date of acquisition before the
repayment of the Kardan debt.
Current assets $2,075
Property and equipment 609
Intangible assets 620
Goodwill 6,039
Other assets 314
-------
Total assets acquired 9,657
-------
Current liabilities 1,858
Long-term debt 1,319
Other liabilities 495
Deferred tax liability created in acquisition 197
-------
Total liabilities assumed 3,869
-------
Net assets acquired $5,788
=======
The intangible assets represent the fair value of software licenses
acquired (five-year useful life). The goodwill resulting from the acquisition is
not deductible for income tax purposes and will not be amortized for financial
statement purposes in accordance with SFAS No. 142. The entire goodwill acquired
was assigned to the software consulting and development segment.
The following unaudited pro forma information presents a summary of
consolidated results of operations of the Company as if this acquisition had
occurred at the beginning of each of the periods presented, with pro forma
adjustments to give effect to the amortization of acquired intangibles and a
reduction of interest expense resulting from Endan's repayment of a $1,000 loan.
The unaudited pro forma information does not include the amortization of
goodwill acquired, as it is not required to be amortized pursuant to SFAS No.
142. The gain on the partial sale of 32% of dsIT is excluded from the unaudited
pro forma consolidated results of operations as it is non-recurring. The
unaudited pro forma consolidated results of operations are provided for
illustrative purposes only and do not purport to represent what the Company's
results of operations would actually have been, nor do they purport to project
the Company's results of operations for any future period.
YEAR ENDED
DECEMBER 31,2001
(UNAUDITED)
Net sales................................................. $52,355
Gross profit.............................................. $10,849
Net loss ................................................. $(9,884)
Loss per share - basic and diluted........................ $ (1.35)
Upon receipt of third-party valuation information, it was determined
that the fair value of software licenses acquired (five-year useful life) was
$500 and that the fair value of backlog acquired (one-year useful life) was
$120. The acquired goodwill resulting from the acquisition was $5,387. The
entire goodwill acquired was assigned to the software consulting and development
segment. The goodwill resulting from the acquisition is not deductible for
income tax purposes and will not be amortized for financial statement purposes
in accordance with SFAS No. 142.
NOTE 4--DISPOSITIONS
On April 7, 2003, the Company and its then consolidated subsidiary,
Comverge, signed and closed on a definitive agreement with a syndicate of
venture capital firms raising an aggregate of $13,000 in capital funding. The
Company purchased $3,250 of Series A Convertible Preferred Stock issued by
Comverge in the equity financing and incurred transaction costs of an additional
$294. A syndicate of venture capital firms purchased $7,750 of Series A
Convertible Preferred Stock issued by Comverge, and one member of the syndicate
also purchased $2,000 of Series A-1 Convertible Preferred Stock of Comverge. In
connection with the transaction, the Company converted to equity intercompany
balances of $9,673. The purchaser of the Series A-1 Preferred Stock was granted
a put option exercisable in April 2004 and Comverge received a right to call all
the Series A-1 Preferred Stock for $2,000, at anytime on or before April 18,
2004.
F-16
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
In September 2003, Comverge completed an agreement raising an
additional $2,000 in capital funding in exchange for additional Series A
Convertible Preferred Stock issued by Comverge. Comverge utilized these funds to
repurchase the Series A-1 Convertible Preferred Stock previously issued by
Comverge.
The Preferred Stock is convertible into Comverge's common stock
initially on a one-for-one basis subject to adjustment for the achievement of
certain performance criteria. Conversion is mandatory on (i) in the event that
the holders of at least a majority of the then-outstanding shares of Series A
Preferred consent to such conversion or (ii) upon the closing of a firmly
underwritten public offering of shares of Common Stock of Comverge at a per
share price not less than five times the original per-share purchase price of
the Preferred Stock. The holders of Preferred Stock have no mandatory redemption
rights. Under Comverge's Amended and Restated Certificate of Incorporation, the
holders of Comverge common stock have the right to elect two of the five
directors on Comverge's Board. Certain preferred shareholders other than the
Company have the right to elect the other three directors. Pursuant to a voting
agreement, one of the directors elected by the holders of the Comverge common
stock must be the Chief Executive Officer (CEO) of Comverge. The Company's
chairman and CEO and Comverge's CEO were elected as the initial directors by the
Comverge common stockholders.
In connection with Comverge's April equity financing transactions,
Comverge acquired Sixth Dimension, Inc. ("6D") in a purchase business
combination, valued at approximately $510, in exchange for 877,000 of Comverge's
common shares. In connection with this transaction, as a result of our dilution
and this new valuation of Comverge's common stock, we recorded an increase of
$1,085 to our common stock investment in Comverge. The adjustment was recorded
to additional-paid-in-capital. Some of the venture capital participants in
Comverge's equity financing transaction were the principal owners in 6D prior to
the acquisition. 6D is an early stage Internet-based software company, whose
iNET product enables a broad range of energy services including: upstream
facility metering, monitoring, and control; performance-based operations and
proactive maintenance; economic demand response and active load curtailment;
aggregated distributed generation; power reliability and quality monitoring; and
other real-time capital equipment analysis using a low-cost, robust, software
for service delivery. The acquisition adds to Comverge's product offering,
technology for upstream monitoring & control of capital assets, by combining
6D's real-time, internet-based, data warehousing iNET software with the
analytical and metering capabilities of Comverge's PowerCAMP software
applications.
Following Comverge's April equity transactions of the year, the Company
held approximately 50.6% of the outstanding capital voting stock of Comverge
(approximately 76% of Comverge's common stock and approximately 26% of
Comverge's Preferred Stock). As a result of the transaction, the Company is no
longer obligated to fund Comverge. Additionally, as a result of the April equity
transactions, the Company has a negative investment balance in Comverge's common
stock of $1,824. Due to the Company's commitment to no longer fund Comverge, the
Company has ceased to record equity losses against its common stock investment.
The Company's negative common investment will only be adjusted upon disposition
of the Company's common stock investment or when the Company realizes equity
income from Comverge in excess of any accumulated equity losses recorded on its
Preferred Stock investment.
F-17
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
Also, in connection with the equity financing in April, Comverge
secured a $6,500 credit facility with a leading financial institution.
Comverge's new credit facility includes a $1,500 term loan secured by a Company
pledge of a $1,500 restricted deposit at Comverge's new lender, and a revolving
line of credit of up to $5,000 secured by the assets of Comverge. Comverge
agreed to make certain prepayments of the $1,500 term loan and the new lender
agreed to the release of amounts equal to such payments from the pledge account,
subject to Comverge's compliance with certain financial and other covenants in
its agreement with the lender. Such covenants have been subsequently either
fulfilled or waived. The $1,500 restricted deposit was released in December
2003.
In October 2003, Comverge completed an agreement raising an additional
$5,600 in capital funding in exchange for additional Series A Convertible
Preferred Stock issued by Comverge.
The Company entered into various agreements with Comverge and the
syndicate of venture capital investors. These agreements provide for, among
other things, restrictions on the transfer of the Company's shares of Series A
Preferred Stock and Comverge common stock, the voting of the Company's Series A
Preferred Stock and Comverge common stock, the Company's right to receive
quarterly and annual financial reports from Comverge and registration rights for
the Company's Series A Preferred Stock and Comverge common stock.
Until December 31, 2003, the Company had an option to purchase from
Comverge up to $1,500 of Series A-2 Convertible Preferred Stock. The Series A-2
Preferred Stock has the same purchase price as the Series A-1 Preferred Stock.
The Series A-2 Preferred Stock has the same rights as the Series A and the
Series A-1 Preferred Stock, except the Series A-2 Preferred Stock is junior in
priority in liquidation (which includes the sale of Comverge) to both the Series
A and Series A-1 Preferred Stock. On December 22, 2003, the Company exercised
its option and invested an additional $100 in Series A-2 Convertible Preferred
Stock.
As a result of the equity transactions in 2003, the Company owned
approximately 40.9% of the outstanding capital voting stock of Comverge,
comprised of approximately 17% of the Preferred Stock and approximately 76% of
Comverge's common stock.
As a result of the private equity financing transactions and other
agreements described above, Comverge is no longer a controlled subsidiary of the
Company. Thus, effective April 1, 2003, the Company no longer consolidates
Comverge's balance sheet and results of operations, and accounts for its
investment in Comverge on the equity method.
The Company's Preferred Stock investment of $3,644 (which was primarily
financed by the release of $3,000 of previously restricted cash) has been
reduced by equity losses in Comverge for the period of April 1, 2003 to December
31, 2003 of $1,752.
Summary unaudited financial information for Comverge as at December 31,
2003 and for the period from April 1 to December 31, 2003 is as follows:
F-18
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
FINANCIAL POSITION As at December
31, 2003
-------------------
Cash and cash equivalents $4,570
Other current assets 6,949
Property, plant, and equipment, net 2,097
Intangible and other assets, net 1,405
-------------------
Total assets $15,021
===================
Current liabilities $4,136
Long-term debt 1,346
Other non-current liabilities 816
-------------------
Total liabilities 6,298
Convertible preferred stock 18,525
Shareholders' deficit (9,802)
-------------------
Total liabilities and shareholder's equity $15,021
===================
Period from
April 1, 2003 to
RESULTS OF OPERATIONS December 31, 2003
-------------------
Sales $10,942
Operating loss $(7,578)
Net loss $(7,955)
The activity in the Company's investments in Comverge during the nine
months ended December 31, 2003 is as follows:
Investment in Comverge common stock
Conversion of inter-company balances to equity $ 9,673
Accumulated deficit at March 31, 2003 (12,582)
Adjustment of the Company's investment from dilution of common shares 1,085
-------------------
Total investment in Comverge common stock $(1,824)
-------------------
Investment in Comverge preferred stock
Cash paid for preferred stock of Comverge $ 3,350
Transaction costs 294
-------------------
Investment balance prior to equity loss 3,644
Equity loss in Comverge - April 1 to December 31, 2003 (1,752)
-------------------
Total investment in Comverge preferred stock $ 1,892
-------------------
Investment in Comverge, net $ 68
===================
As a result of Comverge's net loss during the nine months ended December
31, 2003, the Company recognized $1,752 as equity loss representing 26% of
Comverge's losses for the period from April 1 to September 30, 2003 and 17% of
Comverge's losses for the period from October 1 to December 31, 2003 against its
Preferred Stock investment.
NOTE 5--ACCOUNTS RECEIVABLE, NET
Accounts receivable, net, consists of the following: As of December 31,
------------------
2002 2003
----------- -----------
Trade accounts receivable $11,341 $6,480
Unbilled work-in-process 1,140 628
Allowance for doubtful accounts (214) (55)
----------- -----------
Accounts receivable, net $12,267 $7,053
=========== ===========
F-19
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
Unbilled work-in-process represents direct labor and expenses incurred
on consulting contracts that have not been invoiced to the customer as of the
end of the period. Such amounts are generally billed upon the completion of a
project milestone.
Bad debt expense related to trade accounts receivable was $71, $194 and
$50 for the years ended December 31, 2001, 2002 and 2003, respectively.
NOTE 6--INVENTORY
Inventory consists of the following: As of December 31,
--------------------------
2002 2003
--------- -----------
Raw materials, spare parts and supplies $1,396 $50
Work-in-process 161 --
Finished goods and merchandise 660 38
--------- -----------
$2,217 $88
========= ===========
NOTE 7--OTHER CURRENT ASSETS
Other current assets consist of the following: As of December 31,
----------------------------
2002 2003
----------- -----------
Prepaid expenses $355 $135
Interest receivable 41 --
Income tax receivable 215 267
Deferred income taxes 205 87
Other 627 172
----------- -----------
$1,443 $661
=========== ===========
NOTE 8--PROPERTY AND EQUIPMENT, NET
Property and equipment consist of the following:
Estimated
Useful Life
(in years) As of December 31,
----------------------------
Cost: 2002 2003
----------- -----------
Computer hardware and software 3 $2,727 $1,103
Office furniture and equipment 4-10 2,530 873
Motor vehicles 4-7 592 515
Leasehold improvements Term of lease 316 258
----------- -----------
6,165 2,749
----------- -----------
Accumulated depreciation and amortization
Computer hardware and software 2,573 894
Office furniture and equipment 1,288 662
Motor vehicles 221 249
Leasehold improvements 111 130
----------- -----------
4,193 1,935
----------- ===========
Property and equipment, net $1,972 $814
=========== ===========
Depreciation and amortization in respect of property and equipment
amounted to $687, $834 and $451 for 2001, 2002 and 2003, respectively.
F-20
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
NOTE 9--GOODWILL AND OTHER INTANGIBLE ASSETS
Effective July 1, 2001 and January 1, 2002 the Company adopted the
provisions of SFAS No. 141 and No. 142, respectively. In connection with the
initial adoption of SFAS No. 142, the Company performed a transitional
impairment evaluation of goodwill and concluded that there was no indication of
impairment as of January 1, 2002. Upon adoption of SFAS No. 142, the Company
evaluated its existing intangible assets and goodwill and determined that no
reclassifications were necessary in order to conform with the classification
criteria of SFAS No. 141 for recognition separate from goodwill. The Company
also assessed the useful lives and residual values of all amortizable intangible
assets and determined that no adjustments were necessary.
Amortization expense related to goodwill was $502 for the year ended
December 31, 2001. In accordance with SFAS No. 142, goodwill arising from the
Company's acquisition of Endan in December 2001 has not been amortized. Net loss
and basic and diluted net loss per share, adjusted to exclude goodwill
amortization, as if the provisions of SFAS No. 142 had been adopted on January
1, 2000, are as follows:
Year Ended
December
31, 2001
-----------
Net loss, as reported .................................... $(9,795)
Plus: Goodwill amortization .............................. 502
-------
Adjusted net loss ........................................ $(9,293)
=======
Net loss per share:
Basic and diluted -- as reported ....................... $(1.41)
=======
Basic and diluted -- ad asjusted ....................... $(1.33)
=======
As the end of the third quarter of 2002, management believed that there
was an other than temporary decline in the hi-tech market in general, and in the
software consulting market in Israel in particular. As required by SFAS No. 142,
the Company evaluated its goodwill for impairment as of September 30, 2002 which
indicated that its software consulting and development segment's goodwill was
impaired. The fair value of the software consulting and development segment was
determined by applying a market-rate multiple to the estimated near-term future
revenue stream expected to be produced by the segment (the method used at the
time of the Endan acquisition). As a result, the Company recognized a provision
for goodwill impairment of $2,760 and 2002. In the fourth quarters of 2002 and
2003, the Company performed its annual impairment test and no additional
indications of goodwill impairment were noted.
Software Energy
Consulting and Intelligence
Development Solutions
Segment Segment Total
---------------- ---------------- ---------------
Balance as of December 31, 2001 $7,238 $499 $7,737
Adjustment to goodwill acquired (48) -- (48)
Impairment charge (2,760) -- (2,760)
---------------- ---------------- ---------------
Balance as of December 31, 2002 $4,430 $499 $4,929
---------------- ---------------- ---------------
Deconsolidation of Comverge -- (499) (499)
Balance as of December 31, 2003 $4,430 $ -- $4,430
================ ================ ===============
The following table presents certain information on the Company's
intangible assets as of December 31, 2003 and 2002. All intangibles assets are
being amortized over their estimated useful lives, as indicated below, with no
estimated residual values.
As of December 31, 2003
--------------------------------------------------
Weighted average Gross
amortization carrying Accumulated Net carrying
period amount amortization amount
----------------------- ------------- ----------------- ----------------
Amortizing intangible assets:
Software licenses 5.0 yrs $260 $146 $114
============= ================= =================
As of December 31, 2002
--------------------------------------------------
Weighted average Gross
amortization carrying Accumulated Net carrying
period amount amortization amount
----------------------- ------------- ----------------- ----------------
Amortizing intangible assets:
Licenses 5.0 yrs $568 $563 $ 5
Patents 15.0 yrs 288 70 218
Software licenses 5.0 yrs 260 79 181
------------- ----------------- ----------------
Total $1,116 $712 $404
============= ================= ================
Amortization in respect of license, patents, software licenses and
acquired backlog amounted to $147, $321 and $76 for 2001, 2002 and 2003,
respectively. In 2002, in connection with the Company's evaluation of the
software consulting and development segment goodwill, the Company recognized an
impairment charge of $240 for software licenses, included in cost of service
sales.
Amortization expense with respect to intangible assets for each of the
next four years is estimated as follows:
Year Ended December 31,
-----------------------
2004 $32
2005 32
2006 32
2007 18
-----------
$114
===========
F-21
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
NOTE 10--DEBT AND CONVERTIBLE NOTE
Debt consists of the following:
As of December 31,
-----------------------------
2002 2003
------------ -----------
Bank debt $6,486 $1,291
Lines of credit, net of discount 2,315 858
Capital lease obligations 8 --
------------ -----------
8,809 2,149
Less: current portion (2,531) (1,517)
------------ -----------
Long-term bank debt $6,278 $632
============ ===========
(a) Bank debt
Bank debt as of December 31, 2003 represents loans received by the
Company's Israeli subsidiaries from Israeli banks which are denominated in New
Israeli Shekels (NIS) of which $115 is linked to the Israeli Consumer Price
Index (the Index) and $1,176 is unlinked (at December 31, 2002, $104 and $601,
respectively, and $81 linked to the U.S. dollar). At December 31, 2003, the
loans bear a weighted average interest rate of 8.6% (December 31, 2002, 7.8%).
During the year ended December 31, 2003, the Index decreased by 1.9% (increased
by 6.5% in 2002) and the NIS appreciated in value against the U.S. dollar by
7.6% (depreciated by 7.3% in 2002). In connection with these loans, a lien in
favor of the Israeli banks was placed on some of dsIT's assets.
Bank debt as of December 31, 2002 included a $5,700 loan, which was
payable in a single installment upon maturity in February 2004. In connection
with this loan, the Company was required to deposit $5,700 with the lender as
collateral for the loan. In March 2003, using the collateralized deposit, the
Company repaid $3,000 of the loan in connection with its additional investment
in Comverge (see Note 4) (the Company had previously repaid $200 of the loan in
2003). As the compensating balance was required for the term of the loan, the
deposit was shown as a non-current asset in 2002.
The aggregate maturities of debt are as follows:
Year Ending December 31,
------------------------
2004................................................. $659
2005................................................. 435
2006................................................. 172
2007................................................. 25
-------
$1,291
(b) Lines of credit
(i) At December 31, 2003, the Company had approximately $1,140 in
Israeli credit lines available to dsIT, of which approximately $858 was then
being used and $282 was available for future draws. These credit lines are
generally for a term of one year, denominated in NIS and bear interest at a
weighted average rate of the Israeli prime rate per annum plus 1.4% (at December
31, 2002, plus 0.9%). The Israeli prime rate fluctuates and as of December 31,
2003 was 6.7% (December 31, 2002, 10.6%). The Company has a floating lien and
provided guarantees of up to $500 with respect to dsIT's lines of credit.
(ii) In December 2002, the Company's subsidiary Comverge, Inc., secured
a three-year $2 million revolving line of credit from Laurus Master Fund, Ltd.
("Laurus") of which $1 million was outstanding at December 31, 2002. The line of
credit was closed as a result of Comverge's equity financing transactions in
April 2003 (see Note 4).
In addition, Laurus was able to convert up to an aggregate of $600 of
the line of credit into shares of the Company's common stock at a fixed
conversion price of $1.50. On April 10, 2003, the Company received $600 from
Laurus in connection with the sale to them of 400,000 shares of the Company's
common stock. Such sale was in lieu of the conversion by Laurus of $600 of the
credit line it afforded Comverge. The Company also issued a five-year warrant to
purchase 190,000 shares of the Company's common stock, exercisable in three
tranches at exercise prices ranging from $2.00 to $3.34 per share, all of which
were immediately exercisable.
F-22
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
The Company used the Black-Scholes valuation method to estimate the
fair value of the warrants to purchase 190,000 shares of common stock of the
Company, using a risk free interest rate of 3.1%, its contractual life of five
years, an annual volatility of 82% and no expected dividends. The Company
estimated the fair value of the beneficial conversion feature and related
warrants at the issuance of the convertible line of credit to be approximately
$244 and credited such amount to additional paid-in capital. The Company
recorded interest expense of $178 and $66, with respect to the beneficial
conversion feature of the warrants during the years ended December 31, 2003 and
2002, respectively. The unamortized debt discount from the related warrants of
$178, was included in short-term debt and current maturities of long-term debt,
net at December 31, 2002. In addition, Comverge recorded debt issuance costs of
$86 with respect to the issuance of the line of credit. The Company recorded
amortization of such costs of $7 during the year ended December 31, 2003
(amortization is only for the period during which the Company consolidated the
results of Comverge - see Note 4).
(c) Convertible note
In June 2002, the Company completed a transaction with Laurus, pursuant
to which Laurus made a $2,000 investment in the Company in exchange for a 10%
convertible note and a three-year warrant to purchase 125,000 shares of the
Company's common stock at an exercise price of $4.20 per share. Under the 10%
convertible note, the Company made interest-only payments for the first three
months and thereafter ten payments of $200 plus accrued interest on the
outstanding balance. In 2003, the Company issued to Laurus 127,196 shares of its
common stock as settlement of $240 of the convertible note.
The Company used the Black-Scholes valuation method to estimate the
fair value of the 125,000 warrants to purchase common stock of the Company,
using a risk free interest rate of 3.0%, its contractual life of three years, an
annual volatility of 73% and no expected dividends. The Company estimated the
fair value of the beneficial conversion feature and related warrant at the
issuance of the convertible note to be approximately $692. Such amount was
credited to additional paid-in capital and is being charged to interest expense
over the conversion period (with respect to the note) and the term of the note
(with respect to the warrants), using the effective interest method. In the
years ended December 31, 2003 and 2002, the Company recorded $176 and $516,
respectively of the interest expense with respect to the beneficial conversion
feature and warrants. The face value debt of $1,400, less $176 of unamortized
debt discount, from the beneficial conversion feature and the related warrants,
was included in short-term debt and current maturities of long-term debt, net,
at December 31, 2002. In addition, the Company incurred other debt issuance
costs of $167 with respect to the issuance of the convertible note. In the years
ended December 31, 2003 and 2002, the Company recorded interest expense of $42
and $125, respectively, with respect other debt issuance costs.
NOTE 11--OTHER CURRENT LIABILITIES
Other current liabilities consists of the following:
As of December 31,
------------------------
2002 2003
---------- ----------
Taxes payable $827 $795
Lien allowance 558 558
Deferred revenue 224 239
Warranty provision 52 --
Accrued expenses 952 755
Other 798 626
---------- ----------
$3,411 $2,973
========== ==========
NOTE 12--LIABILITY FOR EMPLOYEE TERMINATION BENEFITS
(a) Israeli labor law generally requires payment of severance pay upon
dismissal of an employee or upon termination of employment in certain
other circumstances. The Company has recorded a severance pay liability
for the amount that would be paid if all its Israeli employees were
dismissed at the balance sheet date, on an undiscounted basis, in
accordance with Israeli labor law. This liability is computed based upon
the number of years of service multiplied by the latest monthly salary.
The amount of accrued severance
F-23
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
pay as determined above represents the Company's severance pay liability
in accordance with labor agreements in force and based on salary
components, which in the opinion of management create entitlement to
severance pay.
The liability is partially funded by insurance policies. The amounts
funded are included among investments and long-term receivables as funds
in respect of employee termination benefits. The Company may only utilize
the insurance policies for the purpose of disbursement of severance pay.
(b) Severance pay expenses amounted to approximately, $1,394, $1,280 and
$1,132 for the years ended December 31, 2001, 2002 and 2003,
respectively.
(c) The Company expects to contribute $444 to the insurance policies in
respect of its severance pay obligations in the year ended December 31,
2004.
NOTE 13--COMMITMENTS AND CONTINGENCIES
(a) Leases of Property and Equipment
Office rental and automobile leasing expenses, for 2001, 2002 and 2003,
were $1,521, $2,171 and $1,521, respectively. The Company and its subsidiaries
lease office space and equipment under operating lease agreements. Those leases
will expire on different dates from 2004 to 2009. The lease payments are mainly
in dollars or are linked to the exchange rate of the dollar. Future minimum
lease payments on non-cancelable operating leases as of December 31, 2003 are as
follows:
Year Ending December 31,
------------------------
2004................................................. $1,298
2005................................................. 803
2006................................................. 335
2007................................................. 289
2008................................................. 289
Thereafter........................................... 193
--------
$3,207
========
(b) Employee Retirement Savings Plan
The Company sponsors a tax deferred retirement savings plan that
permits eligible U.S. employees to contribute varying percentages of their
compensation up to the limit allowed by the Internal Revenue Service. This plan
also provides for discretionary Company contributions, of which none were made
for the years ended December 31, 2001, 2002 and 2003.
(c) Guarantees
Previously, the Company accrued a loss for contingent performance of
bank guarantees. The Company's remaining commitment under these guarantees
(included in other current liabilities) is $558 at December 31, 2002 and 2003.
The Company has collateralized a portion of these guarantees by means of a
deposit (classified as restricted cash) of $241 as of December 31, 2002 and
2003.
The Company's subsidiaries have provided various performance, advance
and tender guarantees as required in the normal course of its operations. As at
December 31, 2003, such guarantees totaled approximately $355 and were due to
expire through December 2004.
See Note 10(b) with respect to guarantees on the Company's lines of
credit.
(d) Litigation
The Company is involved in various other legal actions and claims
arising in the ordinary course of business. In the opinion of management, the
ultimate disposition of these matters will not have a material adverse effect on
the Company's consolidated financial position, results of operations or cash
flow.
F-24
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
NOTE 14--SHAREHOLDERS' EQUITY
(a) Share Capital
The Company's ordinary shares are traded on the Nasdaq SmallCap Market.
(b) Stock Option Plans
The Company's stock option plans provide for the granting to officers,
directors and other key employees of options to purchase shares of common stock
at not less than 85% of the market value of the Company's common stock on the
date of grant. The purchase price must be paid in cash. Each option is
exercisable to one share of the Company's common stock. All options expire
within five to ten years from the date of the grant, and generally vest over a
two to three year period from the date of the grant. At December 31, 2003, the
total authorized number of options or other equity instruments available for
grant under the various plans was 3,350,941.
A summary status of the Company's option plans as of December 31, 2001,
2002 and 2003, as well as changes during each of the years then ended, is
presented below:
2001 2002 2003
------------------------- -------------------------- --------------------------
Weighted Weighted Weighted
Number of Average Number of Average Number of Average
Options Exercise Options Exercise Options Exercise
(in shares) Price (in shares) Price (in shares) Price
------------- ----------- ------------ ------------ ------------ ------------
Outstanding at beginning of year 1,554,775 $5.01 1,568,442 $5.11 1,738,767 $5.18
Granted 273,500 5.38 236,000 5.38 17,000 1.86
Exercised (91,866) 2.51 -- -- (10,666) 1.70
Forfeited and expired (167,967) 6.04 (65,675) 4.26 (437,050) 6.17
------------- ------------ ------------
Outstanding at end of year 1,568,442 $5.11 1,738,767 $5.18 1,308,051 $4.83
============= ============ ============
Exercisable at end of year 1,102,404 $4.85 1,557,395 $5.21 1,282,048 $4.88
============= ============ ============
Under various employee option plans of the Company, 192,500, 195,000
and 15,000 options were granted to related parties of the Company in the years
ending December 31, 2001, 2002 and 2003, respectively. During the years ended
December 31, 2001, 2002, and 2003, no options were exercised by related parties
to purchase common shares of the Company. As of December 31, 2001, 2002, and
2003, the number of outstanding options held by the related parties amount to
1,092,250, 1,289,750 and 932,250 options, respectively.
The following table summarized information about options outstanding and
exercisable at December 31, 2003:
Exercisable as of
Outstanding as of December 31, 2003 December 31, 2003
-------------------------------------------------------------------------
Weighted
Average Weighted Weighted
Remaining Average Average
Number Contractual Exercise Number Exercise
Range of Exercise Prices Outstanding Life Price Exercisable Price
------------------------ -------------- ------------ ------------ ------------ -------------
(in shares) (in years) (in shares)
-------------- ------------ ------------
$1.15 - 2.02 229,834 3.06 $1.82 213,166 $1.82
$2.44 - 4.00 198,000 2.55 3.25 188,665 3.21
$4.50 - 6.00 470,467 2.56 5.44 470,467 5.44
$6.06 - 7.88 409,750 0.96 6.59 409,750 6.59
-------------- ------------ ------------ ------------ -------------
1,308,051 2.14 $4.83 1,282,048 $4.88
============== ============ ============ ============ =============
The weighted average grant-date fair value of the options granted
during 2001, 2002 and 2003, amounted to $3.27, $2.46 and $1.51 per option,
respectively. The Company utilized the Black-Scholes option pricing model to
estimate fair value, utilizing the following assumptions for the respective
years (all in weighted averages):
F-25
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
2001 2002 2003
-------------- -------------- --------------
Risk-free interest rate 4.9% 4.2% 3.9%
Expected life of options, in years 6.1 5.3 9.4
Expected annual volatility 60% 78% 78%
Expected dividend yield None None None
The Company's Israeli subsidiary adopted a stock option plan that
allows the grant of options for up to 573,268 shares of common stock of the
Israeli subsidiary. Through December 31, 2003 170,659 options were granted, no
options were exercised and no options were forfeited.
If all options are exercised, the Company's share in the Israeli
Subsidiary will decrease from approximately 68% to approximately 65%.
At December 31, 2003, the weighted-average remaining contractual life
of the stock options outstanding is approximately 5.22 years.
(b) Warrants
The Company has issued warrants at exercise prices equal to or greater
than market value of the Company's common stock at the date of issuance. A
summary of warrants activity follows:
2001 2002 2003
------------------------- -------------------------- --------------------------
Weighted Weighted Weighted
Number of Average Number of Average Number of Average
Warrants Exercise Warrants Exercise Warrants Exercise
(in shares) Price (in shares) Price (in shares) Price
------------- ----------- ------------ ------------ ------------ ------------
Outstanding at beginning of year 120,000 $3.07 120,000 $3.07 315,000 $3.36
Granted -- -- 315,000 3.36 120,000 2.25
Forfeited -- -- 120,000 3.07 -- --
------------- ----------- ------------ ------------ ------------ ------------
Outstanding at end of year 120,000 $3.07 315,000 $3.36 435,000 $3.06
============= =========== ============ ============ ============ ============
Exercisable end of year 120,000 $3.07 315,000 $3.36 435,000 $3.06
============= =========== ============ ============ ============ ============
The following table summarized information about warrants outstanding and
exercisable at December 31, 2003:
Exercisable as of
Outstanding as of December 31, 2003 December 31, 2003
------------------------------------------------------------------------
Weighted
Average Weighted Weighted
Remaining Average Average
Number Contractual Exercise Number Exercise
Exercise Price Outstanding Life Price Exercisable Price
-------------- -------------- ------------ ------------ ------------ -------------
(in shares) (in years) (in shares)
-------------- ------------ ------------
$2.00 90,000 2.08 $2.00 90,000 $2.00
$2.34 60,000 3.93 2.34 60,000 2.34
$2.50 60,000 1.16 2.50 60,000 2.50
$3.34 100,000 3.93 3.34 100,000 3.34
$4.20 125,000 1.50 4.20 125,000 4.20
-------------- ------------ ------------ ------------ -------------
435,000 2.47 $3.06 435,000 $3.06
============== ============ ============ ============ =============
In February 2003, the Company engaged a third-party for the purposes of
providing investor awareness and business advisory services for a period of one
year. The Company pays a monthly advisory fee, totaling $90 over the period of
the agreement. In addition, the Company granted the third-party common stock
purchase warrants for the purchase of 120,000 shares of the Company's common
stock (60,000 at $2.00 per share and 60,000 at $2.50 per share). The warrants
became fully vested on May 26, 2003 and expire on February 25, 2005. The Company
used the Black-Scholes valuation method to estimate the fair value of the
warrants, using a risk free interest rate of 1.75%, their contractual life of
two years, an annual volatility of 88% and no expected
F-26
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
dividends. The Company estimated the fair value of the warrants to be
approximately $97, which has been charged to selling, general and administrative
expense. Total expenses with respect to warrants granted to service providers
amounts to $0, $0, and $97 for the years ended December 31, 2001, 2002 and 2003,
respectively.
See Notes 10(b) and 10(c) with respect to warrants issued in 2002.
(c) Stock Awards
In September 2001, the Company entered into a restricted stock purchase
agreement with the then newly hired Chief Executive Officer (CEO) of the
Company's energy intelligence solutions segment subsidiary. Pursuant to this
agreement, the Company issued to the segment CEO 50,000 shares of its common
stock at a purchase price of $5.95 per share. The common stock was paid for by
assigning and endorsing to the Company a 6% subordinated note, due April 15,
2010, in the principal amount of $298. The subordinated note was issued by
Philip Services Corp. (NasdaqNM: PSCD) in favor of the segment CEO under a trust
indenture with Wilmington Trust Company. The subordinated note was reflected as
a reduction in shareholders' equity. PSCD has recently filed for bankruptcy and
the Company has written off this note to other loss in 2003.
In January 2003, the CEO of the energy intelligence solutions segment
subsidiary received a restricted stock grant of 50,000 shares of common stock of
the Company. The Company recognized an expense of $50, which has been charged to
selling, general and administrative expense.
(d) Stock Repurchase Program
In September 2000, the Company's Board of Directors authorized the
purchase of up to 500,000 shares of the Company's common stock. In August 2002,
the Company's Board of Directors authorized the purchase of up to 300,000 more
shares of the Company's common stock. During 2002 and 2003, the Company
purchased 37,000 and 2,000 of its common stock, respectively (in 2003, the
Company also issued 9,000 treasury shares with respect to options exercised),
and at December 31, 2003 owned in the aggregate 839,704 of its own shares.
(e) Other
In March 1996, the Company's Board of Directors adopted a stockholder
rights plan providing for the distribution of common stock purchase rights at
the rate of one right for each share of the Company's common stock held by
shareholders of record as of the close of business on April 1, 1996. The rights
plan is designed to deter coercive takeover tactics, including the accumulation
of shares in the open market or through private transactions, and to prevent an
acquirer from gaining control of the Company without offering a fair price to
all of the Company's shareholders. Each right initially entitles shareholders to
buy one-half of a share of common stock of the Company for $15. Generally, the
right will be exercisable only if a person or group acquires beneficial
ownership of 15% or more of the Company's common stock or commences a tender or
exchange offer upon consummation of which such person or group would
beneficially own 15% or more of the Company's common stock.
If any person ("Acquiring Person") becomes the beneficial owner of 15%
or more of the Company's common stock, other than pursuant to a tender or
exchange offer for all outstanding shares of the Company approved by a majority
of the Company's independent directors, then, subject to certain exceptions set
forth in the rights plan, each right not owned by the Acquiring Person or
related parties will entitle its holder to purchase, at the right's then current
exercise price, shares of the Company's common stock (or in certain
circumstances, as determined by the Board of Directors, cash, other property or
other securities) having a value of twice the right's then current exercise
price. The Company will generally be entitled to redeem the rights at one half
of one cent per right at any time until 10 days (subject to extension) following
a public announcement that a 15% position has been acquired. The rights plan
will expire in March 2006.
F-27
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
NOTE 15--INCOME TAXES
(a) Composition of loss before income taxes is as follows:
Year Ended December 31,
-----------------------
2001 2002 2003
---- ---- ----
Domestic $(6,767) $(4,805) $(3,739)
Foreign (3,039) (4,191) (1,056)
----------- ----------- -----------
$(9,806) $(8,996) $(4,795)
=========== =========== ===========
Income tax expense (benefit) consists of the following:
Year Ended December 31,
-----------------------
2001 2002 2003
---- ---- ----
Current:
Federal $(29) $-- $--
State and local (56) 24 18
Foreign 60 80 79
----------- ----------- -----------
(25) 104 97
----------- ----------- -----------
Deferred:
Federal $-- $-- $--
State and local 14 (13) (10)
Foreign -- (63) (88)
----------- ----------- -----------
14 (76) (98)
----------- ----------- -----------
Total income tax expense (benefit) $(11) $28 $(1)
=========== =========== ===========
(b) Effective Income Tax Rates
Set forth below is a reconciliation between the federal tax rate and the
Company's effective income tax rates:
Year Ended December 31,
----------------------------------------------
2001 2002 2003
------------- ------------- -------------
Statutory Federal rates 34% 34% 34%
Increase (decrease) in income tax rate resulting from:
Non-deductible expenses (4) (12) 1
State and local income taxes, net 5 4 5
Other (1) 1 --
Valuation allowance (34) (27) (40)
----------- ----------- -----------
Effective income tax rates 0% 0% 0%
=========== =========== ===========
(c) Analysis of Deferred Tax Assets (Liabilities)
Deferred tax assets consist of the following: As of December 31,
--------------------------
2002 2003
----------- -----------
Accelerated depreciation for tax purposes $13 $24
Intangible asset basis differences 77 --
Other temporary differences 1,434 1,016
Net operating and capital loss carryforwards 11,630 7,764
----------- -----------
13,154 8,804
Valuation allowance (12,634) (8,552)
----------- -----------
Net deferred tax assets $520 $252
=========== ===========
Deferred tax liabilities consist of the following: As of December 31,
--------------------------
2002 2003
----------- -----------
Intangible asset basis differences $197 $41
Other temporary differences 210 --
----------- -----------
Total deferred tax liabilities $407 $41
=========== ===========
F-28
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
Net deferred tax assets consist of the following: As of December 31,
--------------------------
2002 2003
----------- -----------
Deferred tax assets - current $205 $87
Deferred tax assets - non-current 315 167
Deferred tax liabilities - non-current (407) (41)
----------- -----------
Net deferred tax assets $113 $211
=========== ===========
No valuation allowance is established for the Company's operations,
which are reasonably expected to utilize their deferred tax assets. Valuation
allowances relate principally to net operating loss and capital loss
carryforwards and foreign tax credit carryforwards. The change in the valuation
allowance in 2002 was an increase of $2,593 whereas in 2003 there was a decrease
of $4,082. The decrease was due primarily to the deconsolidation of Comverge
(see Note 4).
(d) Summary of Tax Loss Carryforwards
As of December 31, 2003, the Company had various net operating loss
carryforwards, which expire as follows:
Federal State Foreign
------------- ----------- -----------
EXPIRATION:
2004-2007 $-- $113 $--
2008 -- 801 --
2009 -- 2,316 --
2010 -- 2,642 --
2019-2023 8,699 -- --
Unlimited -- -- 9,996
------------- ----------- -----------
Total $8,699 $5,872 $9,996
============= =========== ===========
NOTE 16--RELATED PARTY BALANCES AND TRANSACTIONS
(a) The Company paid consulting and other fees to directors of $109, $98 and
$112 for the years ended December 31, 2001, 2002 and 2003, respectively,
which are included in selling, general and administrative expenses.
(b) The Company paid legal fees for services rendered and out-of-pocket
disbursements to a firm in which a principal is a former director and is
the son-in-law of the Company's Chief Executive Officer, of approximately
$575, $630 and $403 for the years ended December 31, 2001, 2002 and 2003,
respectively. Approximately $90 and $106 was owed to this firm as of
December 31, 2002 and 2003, respectively, and is included in other
current liabilities.
(c) The Company paid a director, who is a vice president of the Company,
president of it's Databit subsidiary, and who is also the son of the
Company's Chief Executive Officer, approximately $197, $230 and $273 for
the years ending December 31, 2001, 2002 and 2003, respectively.
(d) An asset management firm that is controlled by a former director of the
Company provided discretionary asset management services to the Company.
The Company paid $13 and $12 for these services for the years ended
December 31, 2001 and 2002, respectively. The engagement with the asset
management firm was terminated in September 2002.
(e) The Company received $35 and $6 of rent from a company controlled by the
Chief Executive Officer for the years ended December 31, 2002 and 2003,
respectively.
(f) The chief executive officer of the Company's Israeli subsidiary has a
loan from the subsidiary that was acquired in 2001. The loan balance and
accrued interest at December 31, 2002 and 2003 was $48 and $52,
respectively. The loan has no defined maturity date, is denominated in
NIS, is linked to the Index and bears interest at 4%.
F-29
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(g) The Company's formerly consolidated Comverge subsidiary extended loans of
$10 each to both the Company's Chief Executive Officer and Chief
Financial Officer. The loans had an initial maturity date of January 3,
2002 and were extended at that time to mature on January 3, 2004. The
loans bear interest at 4.25% per annum. The balances of the loan and
accrued interest at December 31, 2002 and 2003 were $25 and $26,
respectively.
NOTE 17--SEGMENT REPORTING AND GEOGRAPHIC INFORMATION
(a) General Information
The Company has three reportable segments: software consulting and
development, computer hardware sales and energy intelligence solutions.
(i) The software consulting and development segment provides computer
software and systems consulting and development services
(ii) The computer hardware segment is an authorized dealer and
value-added reseller of computer hardware.
(iii) The energy intelligence solutions segment develops load control
and data communication solutions for utilities.
The Company's reportable segments are strategic business units that
offer different products and services. They are managed separately because each
business requires different technology and marketing strategies. Similar
operating segments that operate in different countries are aggregated into one
reportable segment.
(b) Information about Profit or Loss and Assets
The accounting policies of all the segments are those described in the
summary of significant accounting policies. The Company evaluates performance
based on the profit or loss from operations before income taxes not including
nonrecurring gains and losses.
The Company accounts for intersegment sales and transfers as if the
sales or transfers were to third parties, that is, at current market prices. The
Company does not systematically allocate assets to the divisions of the
subsidiaries constituting its consolidated group, unless the division
constitutes a significant operation. Accordingly, where a division of a
subsidiary constitutes a segment that does not meet the quantitative thresholds
of SFAS No. 131, depreciation expense is recorded against the operations of such
segment, without allocating the related depreciable assets to that segment.
However, where a division of a subsidiary constitutes a segment that does meet
the quantitative thresholds of SFAS No. 131, related depreciable assets, along
with other identifiable assets, are allocated to such division.
F-30
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
The following tables represent segmented data for the years ended December 31,
2003, 2002 and 2001:
SOFTWARE ENERGY
CONSULTING AND INTELLIGENCE COMPUTER
DEVELOPMENT SOLUTIONS(**) HARDWARE OTHER(*) TOTAL
-------------- ------------- -------- -------- --------
Year ended December 31, 2003:
Revenues from external customers $ 12,156 $ 4,700 $ 18,139 $ 39 $ 35,034
Intersegment revenues -- 284 20 -- 304
Interest income 17 1 -- -- 18
Interest expense 288 108 159 -- 555
Depreciation and amortization 350 158 16 -- 524
Segment gross profit 2,581 1,313 3,125 39 7,058
Segment loss (849) (3,174) (199) (17) (4,239)
Minority interests 264 -- -- -- 264
Income tax expense (benefit) (10) 1 8 -- (1)
Segment assets 11,640 68 4,324 -- 16,032
Expenditures for equity investments -- 3,444 -- -- 3,444
Expenditures for segment assets 162 54 15 -- 231
Year ended December 31, 2002:
Revenues from external customers $ 14,202 $ 19,023 $ 22,605 $ 56 $ 55,886
Intersegment revenues 19 1,125 87 -- 1,231
Interest income 8 5 -- -- 13
Interest expense 323 201 464 -- 988
Depreciation and amortization 580 552 17 -- 1,149
Segment gross profit 2,674 6,087 4,098 56 12,915
Segment loss (4,503) (2,161) 15 (2) (6,651)
Minority interests 880 -- -- -- 880
Income tax expense (benefit) 11 6 11 -- 28
Segment assets 12,614 7,872 5,651 -- 26,137
Expenditures for segment assets 112 407 14 -- 533
Year ended December 31, 2001:
Revenues from external customers $ 12,279 $ 13,793 $ 19,794 $ 58 $ 45,924
Intersegment revenues 283 1,164 107 -- 1,554
Interest income 18 3 -- -- 21
Interest expense 154 311 -- -- 465
Depreciation and amortization 281 706 22 -- 1,009
Segment gross profit 2,104 2,652 3,498 58 8,312
Segment loss (2,052) (6,447) 1,006 (217) (7,710)
Minority interests -- -- -- -- --
Income tax expense (benefit) 57 10 21 -- 88
Segment assets 16,297 5,537 2,886 -- 24,720
Expenditures for segment assets 361 512 20 -- 893
(*) Represents segments below the quantitative thresholds of SFAS No. 131,
as follows: in 2003 and 2002, a VAR software operation in Israel and a
holding company; and in 2001, a VAR software operation in Israel, a
holding company and residual operations from the Company's multimedia
software segment.
(**) Operating results of Comverge (the Energy Intelligence Solutions
segment) are no longer consolidated beginning the second quarter of
2003 - see Note 4. Segment loss in 2003 includes the Company's share of
Comverge's losses from April 1 to December 31, 2003 of $1,752 (on the
Company's preferred stock investment) and other expense of $298,
relating to the write-off of a stockholder's note received from
Comverge's CEO.
F-31
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
The following tables represent a reconciliation of the segment data to
consolidated statement of operations and balance sheet data for the years ended
December 31, 2001, 2002 and 2003:
Year Ended December 31,
------------------------------------------------------
2001 2002 2003
-------------- ------------- -------------
Revenues:
Total revenues for reportable segments $ 45,866 $ 55,830 $ 34,995
Other operational segment revenues 58 56 39
-------- -------- --------
Total consolidated revenues $ 45,924 $ 55,886 $ 35,034
======== ======== ========
Income (loss)
Total loss for reportable segments $ (7,493) $ (6,649) $ (4,222)
Other operational segment operating loss
(217) (2) (17)
-------- -------- --------
Total operating loss (7,710) (6,651) (4,239)
Net loss of corporate headquarters (2,085) (1,493) (2,043)
-------- -------- --------
Consolidated loss $ (9,795) $ (8,144) $ (6,282)
======== ======== ========
As of December 31,
--------------------------
2002 2003
----------- -----------
Assets:
Total assets for reportable segments $26,137 $16,032
Unallocated amounts: Net assets of corporate headquarters * 7,210 1,642
----------- -----------
Total consolidated assets $33,347 $17,674
=========== ===========
* In 2003 includes cash and cash equivalents of $1,116 as well as restricted
cash of $241. In 2002 includes cash and cash equivalents of $897 as well as
long-term bank deposits of $5,700.
Other Significant Items Segment Consolidated
Totals Adjustments Totals
------------- --------------- -----------------
Year ended December 31, 2003
Depreciation and amortization $524 $3 $527
Expenditures for assets 231 -- 231
Interest expense 555 233 788
Year ended December 31, 2002
Depreciation and amortization $1,149 $6 $1,155
Expenditures for assets 533 1 534
Interest expense 988 224 1,212
The reconciling items are all corporate headquarters data, which are not
included in the segment information. None of the other adjustments are
significant.
Year Ended December 31,
--------------------------------------------
2001 2002 2003
------------- ------------- -------------
Revenues based on location of customer:
United States $33,800 $41,622 $21,682
Israel 10,382 13,700 13,087
Far East 540 51 11
Other 1,202 513 254
----------- ----------- -----------
$45,924 $55,886 $35,034
=========== =========== ===========
F-32
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
As of December 31,
--------------------------
2002 2003
----------- -----------
Long-lived assets located in the following countries:
Israel $1,016 $780
United States 956 34
----------- -----------
$1,972 $814
=========== ===========
(e) Revenues from Major Customers
Consolidated Sales
Year Ended December 31,
------------------------
Customer Segment 2001 2002 2003
-------- ------- ---- ---- ----
% of Total % of Total % of Total
Revenues Revenues Revenues Revenues Revenues Revenues
-------- ---------- -------- ---------- -------- ----------
A Computer hardware $4,894 10.7 $4,910 8.8 $5,143 14.7
------ ---- ----- --- ------ ----
NOTE 18--FINANCIAL INSTRUMENTS
Fair values of financial instruments included in current assets and
current liabilities are estimated to approximate their book values, due to the
short maturity of such instruments. Fair values for long-term debt and long-term
deposits as of December 31, 2003 and 2002 are estimated based on the current
rates offered to the Company for debt and deposits with the similar terms and
remaining maturities. The fair value of the Company's long-term debt and
long-term deposits are not materially different from their carrying amounts.
F-33
REPORT OF INDEPENDENT AUDITORS
To Board of Directors and Shareholders of Comverge, Inc.
In our opinion, the accompanying consolidated balance sheet and the related
consolidated statement of operations, changes in shareholders' deficit and cash
flows present fairly, in all material respects, the financial position of
Comverge, Inc. and its subsidiaries at December 31, 2003, and the results of
their operations and their cash flows for the year then ended in conformity with
accounting principles generally accepted in the United States of America. These
financial statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audit. We conducted our audit of these statements in accordance with
auditing standards generally accepted in the United States of America, which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
/s/ PricewaterhouseCoopers LLP
Atlanta, Georgia
March 29, 2004
F-34
COMVERGE, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
DECEMBER 31, 2003
- -------------------------------
(IN THOUSANDS OF DOLLARS, EXCEPT PER SHARE DATA)
ASSETS
Current assets
Cash and cash equivalents $ 4,570
Accounts receivable 3,021
Inventory 3,404
Other current assets 524
-----------------------
Total current assets 11,519
Property and equipment, net 2,097
Goodwill and other intangible assets, net 993
Prepaid employee termination benefits 375
Other assets 37
-----------------------
Total assets $ 15,021
=======================
LIABILITIES AND SHAREHOLDERS' DEFICIT
Current liabilities
Accounts payable $ 2,793
Deferred revenue 371
Accrued expenses and other current liabilities 972
-----------------------
Total current liabilities 4,136
Long-term liabilities
Long-term bank debt 1,346
Liability for employee termination benefits 644
Other liabilities 172
-----------------------
Total long-term liabilities 2,162
Commitments and Contingencies (Note 8)
Convertible Preferred Stock
Series A, $.01 par value per share authorized, 10,394,416 shares; issued and
outstanding 8,954,946 shares at December 31, 2003; net of offering costs of
$217; liquidation preference at December 31, 2003 $27,995 18,425
Series A-2, $.01 par value per share authorized, 541,145 shares; issued and
outstanding 35,996 shares at December 31, 2003; liquidation preference at
December 31, 2003 $150 100
-----------------------
18,525
Shareholders' Deficit
Common stock $.01 par value per share
Authorized 20,009,774 shares; issued and outstanding 5,814,743 shares
at December 31, 2003 58
Additional paid-in capital 18,961
Accumulated deficit (28,821)
-----------------------
Total shareholders' deficit (9,802)
-----------------------
Total liabilities and shareholders' deficit $ 15,021
=======================
The accompanying notes are an integral part of these
financial statements.
F-35
COMVERGE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
YEAR ENDED DECEMBER 31, 2003
- ------------------------------------
(IN THOUSANDS OF DOLLARS)
Revenue
Product $ 12,592
Service 3,050
------------
Total revenue 15,642
------------
Cost of Revenue
Product 9,763
Service 875
------------
Total cost of revenue 10,638
------------
Gross profit 5,004
General and administrative expenses 7,777
Marketing and selling expenses 4,177
Depreciation and amortization 1,166
Research and development expenses 615
------------
Operating loss (8,731)
Interest and other expense, net 586
------------
Net loss $ (9,317)
============
The accompanying notes are an integral part of these
financial statements.
F-36
COMVERGE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN
SHAREHOLDERS' DEFICIT YEAR ENDED DECEMBER 31, 2003
- --------------------------------------------------------------------------------
(IN THOUSANDS OF DOLLARS)
ADDITIONAL
NUMBER OF COMMON PAID-IN ACCUMULATED
SHARES STOCK CAPITAL DEFICIT TOTAL
-----------------------------------------------------------------------
BALANCES, DECEMBER 31, 2002 4,937 $ 49 $ 8,587 $ (19,504) $ (10,868)
Issuance of Common Stock 877 9 501 - 510
Contribution of debt by affiliated investor - - 9,673 - 9,673
Executive compensation payable by affiliated investor - - 200 - 200
Net loss - - - (9,317) (9,317)
------------------------------------------------------- -----------
BALANCES, DECEMBER 31, 2003 5,814 $ 58 $ 18,961 $ (28,821) $ (9,802)
========== =========== =========== =============== ===========
The accompanying notes are an integral part of these
financial statements.
F-37
COMVERGE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
YEAR ENDED DECEMBER 31, 2003
- ------------------------------------
(IN THOUSANDS OF DOLLARS)
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $ (9,317)
Adjustments to reconcile net loss to net cash used in operating activities
Depreciation and amortization 1,166
Executive compensation payable by affiliate investor 200
Write-off of fixed assets 62
Changes in operating assets and liabilities
Accounts receivable 579
Prepaid expenses and other assets (286)
Inventory (1,364)
Accounts payable 1,596
Accrued expenses and other liabilities 231
------------------
Net cash used in operating activities (7,133)
------------------
CASH FLOWS USED IN INVESTING ACTIVITIES
Acquisition of property and equipment (1,485)
Funding of termination benefits (69)
------------------
Net cash used in investing activities (1,554)
------------------
CASH FLOWS PROVIDED BY FINANCING ACTIVITIES
Proceeds from Series A Preferred Stock issuances net of $217 offering costs 18,425
Proceeds from Series A-1 Preferred Stock issuance 2,000
Repurchase of Series A-1 Preferred Stock (2,000)
Proceeds from Series A-2 Preferred Stock issuance 100
Repayments of long-term debt (8,200)
Borrowings under credit facility 2,822
Net cash provided by financing activities 13,147
Net increase in cash and cash equivalents 4,460
Cash and cash equivalents at beginning of year 110
------------------
Cash and cash equivalents at end of year $ 4,570
SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES
Cash paid for interest $ 190
Affiliated investor contribution of debt to paid-in-capital $ 9,673
Assets/liabilities acquired in acquisition
Property and Equipment $ (472)
Identified intangible $ (104)
Other current liabilities $ 66
Issuance of shares in respect of acquisition $ 510
The accompanying notes are an integral part of these financial
statements.
F-38
COMVERGE, INC. AND SUBSIDIARIES NOTES
TO CONSOLIDATED FINANCIAL STATEMENT
DECEMBER 31, 2003
(ALL NOTES IN THOUSANDS OF DOLLARS, EXCEPT PER SHARE DATA)
1. DESCRIPTION OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF BUSINESS
Comverge, Inc., a Delaware corporation, and its subsidiaries
(collectively, the "Company"), provides energy intelligence systems
(including hardware and software products and the installation of such
products) to energy suppliers and their residential, commercial and
industrial customers. Prior to April 2003, the Company was a wholly-owned
subsidiary of Data Systems & Software, Inc. ("DSSI"). In April 2003 and
continuing thereafter the Company completed a series of equity financings
totalling approximately $18,600 (Note 9). As a result of these
transactions, at December 31, 2003, DSSI remained the Company's largest
shareholder owning approximately 41 percent of the Company's issued and
outstanding voting equity.
USE OF ESTIMATES IN PREPARATION OF FINANCIAL STATEMENTS
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and the disclosure of contingent assets
and liabilities as of the date of the financial statements, and the
reported amounts of revenues and expenses during the reporting periods.
Actual results could differ from those estimates.
FOREIGN CURRENCY TRANSLATIONS
The currency of the primary economic environment in which the operations
of the Company are conducted is the United States dollar ("dollar").
Accordingly, Comverge and its subsidiaries use the dollar as their
functional currency. All exchange gains and losses denominated in
non-dollar currencies are presented on a net basis in operating expense,
in the consolidated statement of operations when they arise. Such foreign
currency loss, net, amounted to $15 for the year ended December 31, 2003.
PRINCIPLES OF CONSOLIDATION AND PRESENTATION
The consolidated financial statements of the Company include the accounts
of its subsidiaries. The consolidated financial statements have been
prepared in conformity with accounting principles generally accepted in
the United States of America. All intercompany balances and transactions
have been eliminated.
CASH AND CASH EQUIVALENTS
The company considers all highly liquid investments with an original
maturity of three months or less to be cash equivalents. Cash and cash
equivalents consist of cash and demand deposits in banks and short-term
investments.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
The allowance for doubtful accounts is based on specific identification
of accounts considered to be doubtful of collection. As of December 31,
2003, there were no accounts identified as doubtful of collection.
INVENTORY
Inventories are stated at the lower of cost or market. Cost is determined
for raw materials, spare parts, supplies on the first-in, first-out cost
method. For work in process and finished goods, cost is
F-39
COMVERGE, INC. AND SUBSIDIARIES NOTES
TO CONSOLIDATED FINANCIAL STATEMENT
DECEMBER 31, 2003
(ALL NOTES IN THOUSANDS OF DOLLARS, EXCEPT PER SHARE DATA)
determined on the basis of standard costs, adjusted for variances, which
approximates the first-in, first out method of cost.
PROPERTY AND EQUIPMENT
Property and equipment are presented at cost or fair value at the date of
acquisition. Depreciation is calculated based on the straight-line method
over the estimated useful lives of the depreciable assets, or in the case
of leasehold improvements, the shorter of the lease term or useful life.
Improvements are capitalized while repairs and maintenance are expensed
as incurred.
INTANGIBLES
Goodwill represents the excess of cost over the fair value of the net
assets of subsidiaries acquired in purchase transactions. Goodwill is not
being amortized in accordance with Statement on Financial Accounting
Standards No. 142 GOODWILL AND OTHER INTANGIBLE ASSETS.
The costs of licensed technology are presented at estimated fair value at
acquisition date. These costs are amortized on a straight-line basis over
the term of the license, generally five years.
The costs of registered patents and patents pending acquired from third
parties are presented at estimated fair value at acquisition date. In
addition, registration costs and fees for patents are capitalized.
Registered patents costs are amortized over the estimated remaining
useful life of the patents, from four to fourteen years. Costs for
patents pending are not amortized until they are issued.
REVENUE RECOGNITION
The Company recognizes revenues when the following criteria have been
met: delivery has occurred, the price is fixed and determinable,
collection is probable, and persuasive evidence of an arrangement exits.
Revenue from time-and-materials service contracts and other services are
recognized as services are provided. Revenue for maintenance contracts is
recognized on a straight-line basis over the life of the contract.
Revenues from fixed-price service contracts are recognized as services
are provided using the percentage-of-completion method as labor costs are
incurred, in the proportion that actual costs incurred bear to total
estimated costs. Percentage-of-completion estimates are reviewed
periodically, and any adjustments required are reflected in the period
when such estimates are revised. Losses on contracts, if any, are
recognized in the period in which the loss is determined.
In accordance with Emerging Issues Task Force issue 00-10, ACCOUNTING FOR
SHIPPING AND HANDLING FEES AND COSTS, the Company reports shipping and
handling revenues and their associated costs in Revenue and Cost of
Revenue, respectively.
WARRANTY PROVISION
Comverge generally warrants its products against certain manufacturing
and other defects. These product warranties are provided for specific
periods of time and/or usage of the product depending on the nature of
the product, the geographic location of its sale and other factors. As of
December 31, 2003 the Company had accrued $152 for estimated product
warranty costs, which was included in other current liabilities. The
accrued product warranty costs were based primarily on estimated costs to
satisfy customer warranty claims. Warranty claims expense for 2003 were
$20.
Year ended December 31, 2003
Warranty provision at beginning of period $52
Accruals for warranties issued during the period 100
Warranty settlements during the period (20)
Changes in liability for pre-existing warranties during the period, 20
including expirations
Warranty provision at the end of period $152
ADVERTISING EXPENSES
Advertising costs are expensed as incurred. Advertising expense amounted
to $813 for the year ended December 31, 2003.
F-40
COMVERGE, INC. AND SUBSIDIARIES NOTES
TO CONSOLIDATED FINANCIAL STATEMENT
DECEMBER 31, 2003
(ALL NOTES IN THOUSANDS OF DOLLARS, EXCEPT PER SHARE DATA)
RESEARCH AND DEVELOPMENT EXPENSES
Research and development costs are expensed as incurred.
STOCK-BASED COMPENSATION The Company accounts for employee and director
stock-based compensation in accordance with Accounting Principles Board
Opinion No. 25 ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES and related
interpretations. In accordance therewith, the Company records
compensation expense on fixed stock options and restricted common stock
granted to employees and directors at the date of grant if the current
market price of the Company's common stock exceeds the exercise price of
the options and restricted common stock. Compensation expense on variable
stock option grants is estimated until the measurement date. Deferred
compensation is amortized to compensation expense over the vesting period
of the underlying options. The Company complies with the disclosure
provisions of Statement on Financial Accounting Standards No. 123,
ACCOUNTING FOR STOCK-BASED COMPENSATION ("SFAS 123"). As such, the
Company provides pro forma net income and pro forma earnings per share
disclosures for employee and director stock option grants as if the
fair-value-based method defined in SFAS No. 123 had been applied. The
Company's net loss for the year, as reported, was $9,317. Total
stock-based compensation expense determined under the fair value method
for all awards, net of related tax effects, was $52. Based on the fair
value method, the Company's pro forma net loss for 2003 was $9,369. The
Company's stock-based employee compensation plan is described more fully
in Note 10.
The Company accounts for stock-based compensation issued to consultants
on a fair value basis in accordance with SFAS No. 123 and EITF Issue No.
96-18, ACCOUNTING FOR EQUITY INSTRUMENTS THAT ARE ISSUED TO OTHER THAN
EMPLOYEES FOR ACQUIRING, OR IN CONJUNCTION WITH SELLING, GOODS OR
SERVICES.
INCOME TAXES
Deferred income taxes reflect the net tax effects of temporary
differences between the carrying amounts of assets and liabilities for
financial reporting purposes and the amounts used for income tax
purposes, as well as operating loss, capital loss and tax credit carry
forwards. Deferred tax assets and liabilities are classified as current
or noncurrent based on the classification of the related assets or
liabilities for financial reporting, or according to the expected
reversal dates of the specific temporary differences, if not related to
an asset or liability for financial reporting. Valuation allowances are
established against deferred tax assets if it is more likely than not
that they will not be realized.
Income taxes associated with the undistributed earnings of a subsidiary
are provided for in accordance with Accounting Principals Board Opinion
No. 23, when the Company has sufficient evidence that the subsidiary has
invested or will invest the undistributed earnings indefinitely. If it is
determined that the undistributed earnings of a subsidiary will be
remitted in the foreseeable future, all taxes related to the remittance
of such undistributed earnings are provided for in the current period as
income tax expense.
IMPAIRMENT OF LONG-LIVED ASSETS
The Company evaluates the recoverability of its long-lived assets and
certain identifiable intangible assets in accordance with SFAS 144,
ACCOUNTING FOR THE IMPAIRMENT OR DISPOSAL OF LING-LIVED ASSETS. SFAS 144
requires recognition of impairment in the event the net book value of
such assets exceeds the future undiscounted cash flows attributable to
such assets. If impairment is indicated, the carrying amount of the asset
is written down to fair value. The Company has identified no such
impairments.
F-41
COMVERGE, INC. AND SUBSIDIARIES NOTES
TO CONSOLIDATED FINANCIAL STATEMENT
DECEMBER 31, 2003
(ALL NOTES IN THOUSANDS OF DOLLARS, EXCEPT PER SHARE DATA)
SIGNIFICANT RISKS AND UNCERTAINTIES
The Company's operations are subject to certain risks and uncertainties
including, but not limited to; a history of unprofitably and the
inability to fund its operations with free cash flow, the continued
ability to obtain financing on commercially reasonable terms, operating
results that are often volatile and difficult to predict, the ability to
develop new products and the market's acceptance of those products, a
highly competitive marketplace, the reliance on strategic relationships
as distribution channels to market products, the use of technology
licensed from third parties, the potential of product defects, the
commoditization of products and resulting pricing pressures, lengthy
sales cycles of our utility customers, the ability to manage growth,
possible disruption in commercial activities due to terrorist activity
and armed conflict, delays in product development and related release
schedules, the ability to protect intellectual property and the need to
retain key personnel. Additionally, the Company has a significant share
of a market that, presently, is very small making it difficult to achieve
internal growth absent a significant market expansion. Any of these
factors could impair our ability to expand our operations or to generate
significant revenues and cash flows from those markets in which we
operate. As a result of the above and other factors, the Company's
financial condition can vary significantly from year-to-year.
IMPACT OF RECENT ACCOUNTING PRONOUNCEMENTS
In August 2001, the Financial Accounting Standards Board ("FASB") issued
SFAS 143, ACCOUNTING FOR ASSET RETIREMENT OBLIGATIONS. SFAS 143 addresses
accounting and reporting for obligations associated with the retirement
of tangible long-lived assets and the associated asset retirement costs.
This statement requires that the fair value of a liability for asset
retirement obligations be recognized in the period in which is incurred
if a reasonable estimate of fair value can be made. The associated asset
retirement costs are, capitalized as part of the carrying amount of the
long-lived asset. The liability is accreted to its present value each
period while the cost is depreciated over its useful life. We adopted the
provisions of this statement in 2003 and the effect of adopting this
statement did not have any effect on our results of operations, financial
position, or cash flows.
In June 2002, the FASB issues SFAS 146, ACCOUNTING FOR COSTS ASSOCIATED
WITH EXIT OR DISPOSAL ACTIVITIES. SFAS 146 requires that a liability for
costs associated with an exit or disposal activity by recognized and
measured initially at fair value only when the liability is incurred. A
fundamental conclusion reached by the FASB in this statement is that an
entity's commitment to an exit plan, by itself, does not create a present
obligation to others that meets our definition of a liability. We adopted
the provisions of this statement in 2003 and the effect of adopting this
statement did not have any effect on our results of operations, financial
position, or cash flows.
In November 2002, the FASB reached a consensus on Emerging Issues Task
Force issue 00-21 ACCOUNTING FOR REVENUE ARRANGEMENTS WITH MULTIPLE
DELIVERABLES (the "Issue"). The guidance in this issue is effective for
revenue arrangements entered into fiscal years beginning after June 15,
2003. The Issue addresses certain aspects of the accounting by a vendor
for arrangements under which it will perform multiple revenue-generating
activities. Specifically, the Issue addresses how to determine whether an
arrangement involving multiple deliverables contains more than one
earnings process AND, if it does, how to divide the arrangement into
separate units of accounting consistent with the identified earnings
processes for revenue recognition purposes. The Issue also addresses how
arrangement consideration should be measured and allocated to the
separate units of accounting in the arrangement. The Company is
analyzing the effect the adoption of this standard will have.
F-42
COMVERGE, INC. AND SUBSIDIARIES NOTES
TO CONSOLIDATED FINANCIAL STATEMENT
DECEMBER 31, 2003
(ALL NOTES IN THOUSANDS OF DOLLARS, EXCEPT PER SHARE DATA)
In November 2002, the FASB issued FASB Interpretation 45, Guarantor's
Accounting and Disclosure Requirements of Guarantees, including Indirect
Guarantees of Indebtedness of Others. This interpretation clarifies the
requirements of SFAS 5, Accounting for Contingencies, relating to
guarantors accounting for and disclosure of, the issuance of certain
types of guarantees. This interpretation is intended to improve the
comparability of financial reporting by requiring identical accounting
for guarantees issued with a separately identified premium and guarantees
issued without a separately identified premium. The interpretation's
provisions for initial recognition and measurement are required on a
prospective basis to guarantees issued or modified after December 31,
2002. We adopted the provisions of this interpretation in 2003 and the
effect of adopting these provisions did not have any effect on our
financial position, results operations, or cash flows.
In May 2003, the FASB issued SFAS 150, ACCOUNTING FOR CERTAIN FINANCIAL
INSTRUMENTS WITH CHARACTERISTIC OF BOTH LIABILITIES AND EQUITY. SFAS 150
establishes standards for classifying and measuring as liabilities
certain financial instruments that embody obligations of the issuer and
have characteristics of both liabilities and equity. SFAS 150 represents
a significant change in practice in the accounting for a number of
financial instruments, including mandatorily redeemable equity
instruments and certain equity derivatives that frequently are used in
connection with share repurchase programs. We adopted the provisions of
this statement in 2003 and the effect of adopting this statement did not
have any effect on our results of operations, financial position, or cash
flows.
In January 2003, the FASB issued FASB Interpretation No. 46,
"Consolidation of Variable Interest Entities" (FIN 46). Under FIN 46,
entities are separated into two populations: (1) those for which voting
interests are used to determine consolidation (this is the most common)
and (2) those for which variable interests are used to determine
consolidation. FIN 46 explains how to identify Variable Interest Entities
(VIEs) and how to determine when a business enterprise should include the
assets, liabilities, non-controlling interests, and results of activities
of a VIE in its consolidated financial statements.
Since issuing FIN 46, the FASB has proposed various amendments to the
Interpretation and has deferred its effective date. Most recently, in
December 2003, the FASB issued a revised version of FIN 46 (FIN 46-R),
which also provides for a partial deferral of FIN 46. This partial
deferral established the effective date for public entities to apply FIN
46 and FIN 46-R based on the nature of the variable interest entity and
the date upon which the public company became involved with the variable
interest entity. In general, the deferral provides that (i) for variable
interest entities created before February 1, 2003, a public entity must
apply FIN 46-R at the end of the first interim or annual period ending
after March 15, 2004, and may be required to apply FIN 46 at the end of
the first interim or annual period ending after December 15, 2003, if the
variable interest entity is a special purpose entity, and (ii) for
variable interest entities created after January 31, 2003, a public
company must apply FIN 46 at the end of the first interim or annual
period ending after December 15, 2003, as previously required, and then
apply FIN 46-R at the end of the first interim or annual reporting period
ending after March 15, 2004.
The Company currently has no variable interests in any VIE. Accordingly,
the Company believes that the adoption of FIN 46 and FIN 46-R will not
have a material impact on its financial position, results of operations
and cash flows.
2. ACQUISITIONS
On April 7, 2003, the Company acquired from an unrelated company, Sixth
Dimension, Inc. ("6D"), certain property and equipment and technological
know-how (software) relating to its iNET software platform in exchange
for 877,000 of its common shares (the "Acquisition"). The Acquisition was
accounted for using the purchase method of accounting. The Company
acquired a business including property and equipment, intellectual
property, certain contracts with customers and all of 6D's employees. In
consideration of the Company's acquisition, certain 6D investors
purchased $3,750 of the Company's Series A Preferred Stock. 6D is an
early stage Internet-based software company, whose iNET platform enables
a broad range of energy services including: upstream facility metering,
monitoring, and control; performance-based operations and proactive
maintenance; economic demand response and active load curtailment;
aggregated distributed generation; power reliability and quality
monitoring; and other real-time capital equipment analysis using a
low-cost, robust, software for service delivery. The iNET platform adds
to Comverge's product offering, technology for upstream monitoring and
control of capital assets, by combining real-time, internet-based, data
warehousing capabilities with the analytical and metering capabilities of
the Company's PowerCAMP software applications.
F-43
COMVERGE, INC. AND SUBSIDIARIES NOTES
TO CONSOLIDATED FINANCIAL STATEMENT
DECEMBER 31, 2003
(ALL NOTES IN THOUSANDS OF DOLLARS, EXCEPT PER SHARE DATA)
The purchase price of the acquired assets was $510, determined by an
independent appraisal of the value of the Company's common shares issued
in respect of the Acquisition as of the Acquisition date. As a result of
the Acquisition, the Company recorded an intangible asset, the iNET
software, of $104. This asset will be amortized on a straight line basis
over three years from the Acquisition date.
3. PROPERTY AND EQUIPMENT
Property and equipment, at December 31, 2003, consisted of the following:
ESTIMATED
USEFUL LIFE
(IN YEARS)
-------------
Load control equipment 10 $ 973
Computer hardware and software 3 1,807
Office furniture and equipment 5-7 1,657
Leasehold improvements Term of lease 103
-------------
4,540
Accumulated depreciation 2,443
-------------
Property and equipment, net $ 2,097
=============
Depreciation in respect of property and equipment amounted to $831 for
and the year ended December 31, 2003.
4. GOODWILL AND INTANGIBLE ASSETS
As of December 31, 2003 the Company had goodwill balances of $499.
Intangible assets and accumulated amortization as of December 31, 2003,
consisted of the following:
ESTIMATED
USEFUL LIFE
(IN YEARS)
-----------
Technological Know-How 5 $ 1,436
Acquired Software 3 104
License 5 568
Patents 4-14 287
------------
2,395
Accumulated amortization 1,901
------------
Identified intangible assets with finite lives, net $ 494
============
F-44
COMVERGE, INC. AND SUBSIDIARIES NOTES
TO CONSOLIDATED FINANCIAL STATEMENT
DECEMBER 31, 2003
(ALL NOTES IN THOUSANDS OF DOLLARS, EXCEPT PER SHARE DATA)
The Company uses the straight line method of computing amortization
expense. Amortization expense for the year ended December 31, 2003 was
$335. Estimated amortization expense for the next five years is as
follows:
(IN THOUSANDS OF DOLLARS)
2004 $ 266
2005 50
2006 24
2007 15
2008 15
5. LONG-TERM DEBT
On April 7, 2003, in connection with a private equity financing, the
Company entered into a $6,500 credit facility ("New Credit Facility")
with a major United States commercial bank. The facility consisted of a
three-year term loan ("Term Loan") of $1,500 bearing interest at the
prime rate and a $5,000, three year, revolving credit facility
("Revolving Facility") bearing interest between prime+1.5 percent and
prime+2.0 percent per annum. Initial borrowings were used to refinance
certain debt. The Term Loan was secured by cash collateral in a like
amount pledged by DSSI and was repaid by the Company in December 2003.
Interest paid on this Term Loan totaled $45 in 2003. The Revolving
Facility is secured by virtually all of the assets of the Company
including the Company's intellectual property. Borrowings under the
Revolving Facility can be requested, from time to time, as formula and/or
non-formula advances. The borrowing availability for formula based
advances is calculated monthly based upon 80 percent of eligible
receivables and eligible inventory limited to the lesser of (i) 25
percent of FMV, (ii) 80 percent of net orderly liquidation value or (iii)
$500. Non-formula advances are limited to $700. The ability of the
Company to request nonformula advances terminates on October 7, 2004, at
which time any non-formula advances, plus accrued interest thereon, must
be repaid. At December 31, 2003, the Company had $1,346 outstanding under
the Revolving Facility of which $700 represented non-formula advances and
$646 represented formula advances. Since the Company had both the ability
and intent to refinance the $700 non-formula portion of this debt as of
December 31, 2003, it is classified as long-term. In January 2004, the
company repaid the non-formula advances and increased formula advances in
a like amount. As of December 31, 2003, the Company had unutilized
borrowing availability under its Revolving Facility of approximately
$2,000. The Revolving Facility terminates on April 6, 2006, at which time
the principal amount of all outstanding advances plus accrued interest
thereon must be repaid.
6. LIABILITY FOR EMPLOYER TERMINATION BENEFITS
Under Israeli law and labor agreements, one of the Company's
subsidiaries, Comverge Control Systems, is required to make severance and
pension payments to dismissed employees and to employees leaving
employment in certain other circumstances. The obligation for severance
pay benefits, as determined by the Israeli Severance Pay Law, is based
upon length of service and last salary. These obligations are
substantially covered by regular deposits with recognized severance pay
and pension funds and by the purchase of insurance policies. The pension
plans are multi-employer
F-45
COMVERGE, INC. AND SUBSIDIARIES NOTES
TO CONSOLIDATED FINANCIAL STATEMENT
DECEMBER 31, 2003
(ALL NOTES IN THOUSANDS OF DOLLARS, EXCEPT PER SHARE DATA)
and independent of the Company. Pension and severance costs for 2003 of
$217 is included in selling, general and administrative expenses.
7. INCOME TAXES
The Company has Federal, state, and foreign net operating losses of
approximately $17,591, $13,009 and $2,950, respectively, at December 31,
2003. The Federal net operating loss carryforwards begin expiring in 2019
and state net operating loss carryforwards begin expiring in 2006. During
year ended December 31, 2003, certain substantial changes in the
Company's ownership, as defined in the provisions of the Internal Revenue
Code, result in a limitation on the utilization of a significant portion
of the Federal and state net operating losses on an annual basis.
At December 31, 2003, the Company has provided a valuation allowance for
the full amount of its net deferred tax asset since realization of any
future tax benefit cannot be sufficiently assured.
A reconciliation of income tax expense (benefit) at the statutory federal
income tax rate and income taxes as reflected in the consolidated
financial statements is as follows:
2003
-------
Federal income tax at statutory federal rate 34.0%
State income tax expense 6.0%
Other (0.4%)
Valuation Allowance (39.6%)
-------
Effective tax rate 0%
=======
Deferred tax assets (liabilities) consist of the following:
2003
-------
Deferred tax assets
Net operating loss carryforwards $ 7,981
Other 735
Deferred tax liabilities (185)
-------
8,531
Valuation Allowance (8,531)
-------
Net deferred tax assets (liabilities) $ 0
=======
8. COMMITMENTS AND CONTINGENCIES (a)
Leases of Property and Equipment
Rental and leasing expenses, for 2003, amounted to $532. Future minimum
rental payments and lease payments on non-cancelable operating leases as
of December 31, 2003 are as follows:
(IN THOUSANDS OF DOLLARS)
YEAR ENDING DECEMBER 31,
2004 $ 535
2005 434
2006 325
2007 174
2008 169
(b) Employee Retirement Savings Plan
The Company sponsors a tax deferred retirement savings plan that permits
eligible U.S. employees to contribute varying percentages of their
compensation up to the limit allowed by the Internal Revenue Service.
This plan also provides for discretionary Company contributions. No
discretionary contributions were made for the year ended December 31,
2003.
(c) Royalties
The Company is committed to pay royalties to the Government of Israel on
proceeds from the sale of certain products in which the Government of
Israel participated in the research and development by way of grants.
Royalties are currently payable at a rate of 4.5 percent of the annual
sales of the product. The amount payable as royalties is limited to the
amount of the original grant of $595. The net amount due in respect of
these grants amounted to approximately $418 at December 31, 2003.
F-46
COMVERGE, INC. AND SUBSIDIARIES NOTES
TO CONSOLIDATED FINANCIAL STATEMENT
DECEMBER 31, 2003
(ALL NOTES IN THOUSANDS OF DOLLARS, EXCEPT PER SHARE DATA)
9. SHAREHOLDERS' DEFICIT
CONTRIBUTION OF DSSI DEBT TO PAID-IN-CAPITAL
In April of 2003, by agreement, and in consideration of the sale of the
Company's Series A and A-1 preferred shares and the placement of a New
Credit Facility, DSSI and its affiliated companies (other than the
Company) contributed accrued management fees and the principal amount of
loans, advances and accrued interest thereon in the amount of $9,673 to
paid in capital.
COMMON STOCK
Holders of the Company's common stock are entitled to dividends if and
when declared by the board of directors. The holders of Common Stock,
voting as a separate class, are entitled to elect two members of the
Board of Directors at each meeting or pursuant to each consent of the
Corporation's stockholders for the election of directors, and to remove
from office such directors and to fill any vacancy caused by the
resignation, death or removal of such directors.
CONVERTIBLE PREFERRED STOCK
During 2003, the Company sold to investors (i) 8,954,946 shares of its
Series A Convertible Preferred Stock ("Series A Preferred") for $18,663,
(ii) 721,527 shares of its Series A-1 Convertible Preferred Stock
("Series A-1 Preferred") for $ 2,000 and (iii) 35,996 of its Series A-2
Convertible Preferred Stock ("Series A-2 Preferred") for $100. The
Company repurchased its Series A-1 Preferred in 2003, pursuant to a put
right of an investor for $2,000 plus accrued dividends of $74 which
dividends were recognized as a financial expense in 2003.
The rights, preferences and privileges attached to the Series A and
Series A-2 (Collectively, the "Preferred Stock") are as follows:
(a) Conversion
The Preferred Stock is convertible into the Company's common stock
initially on a one-for-one basis subject to adjustment for the
achievement of certain performance criteria. Conversion is mandatory on
(i) in the event that the holders of at least a majority of the
then-outstanding shares of Series A Preferred consent to such conversion
or (ii) upon the closing of a firmly underwritten public offering of
shares of Common Stock of the Company at a per share price not less than
five times the original per-share purchase price of the Preferred Stock.
The holders of Preferred Stock have no mandatory redemption rights.
(b) Board of Directors
The holders of Series A Preferred Stock, voting as a separate class,
shall be entitled to elect three members of the Board of Directors at
each meeting or pursuant to each consent of the Corporation's
stockholders for the election of directors, and to remove from office
such directors and to fill any vacancy caused by the resignation, death
or removal of such directors. After December 31, 2003, the board can be
increased by no more than two additional seats based on a majority vote
of the then members of the board. The additional two seats shall be
filled by outside directors, who shall be selected by a majority of the
other members of the Board of Directors, including the affirmative vote
of at least two of the directors designated by the holders of Series A
Preferred.
F-47
COMVERGE, INC. AND SUBSIDIARIES NOTES
TO CONSOLIDATED FINANCIAL STATEMENT
DECEMBER 31, 2003
(ALL NOTES IN THOUSANDS OF DOLLARS, EXCEPT PER SHARE DATA)
(c) Dividends
In the event the Company declares and pays any dividend on its common
stock other than stock or other dividends payable solely in shares of
common stock, the Company must also pay to the holders of Preferred Stock
the dividends that would have been payable had all of the outstanding
Preferred Stock been converted to common stock immediately prior to the
record date of the dividend.
The holders of shares of Preferred Stock, on a PARI PASSU basis and in
preference to the holders of any shares of any other class of capital
stock of the Company, shall be entitled to receive, when, as and if
declared by the Board of Directors, but only out of funds legally
available therefor, dividends at the rate of 8 percent per annum based,
in each case, on the original Preferred Stock issue price. Dividends are
noncumulative.
(d) Voting
The Preferred Stock shall vote together with all other classes and series
of stock of the Company as a single class on all actions to be taken by
the stockholders of the Company.
(e) Liquidation Preferences
Upon any liquidation, dissolution or winding up of the Company, whether
voluntary or involuntary, the holders of shares of Series A Preferred
Stock shall be entitled to be paid, on a pari passu basis, before any
distribution or payment is made upon the Series A-2 Preferred Stock or on
the common stock an amount equal to 1.5 times the original Series A issue
price per share plus all declared and unpaid dividends. After payment to
the holders of Series A Preferred Stock of the full amounts to which they
are entitled the holders of Series A-2 Preferred Stock shall be entitled
to be paid, before any distribution or payment is made upon the common
stock, an amount equal to 1.5 times the original Series A-2 issue price
per share plus all declared but unpaid dividends. After the preferential
payments have been made in full, any additional remaining assets shall be
distributed ratably to the holders of Preferred Stock (on an as-converted
basis) and common stock until such holders of Preferred Stock have
received, inclusive of their liquidation amount, an amount equal to 5
times their original issue price per share. After payment all
preferential amounts, the entire remaining assets of the Company legally
available for distribution, if any, shall be distributed ratably among
the holders of its common stock.
Unless otherwise agreed by holders of at least 66 2/3 percent of the
then-outstanding shares of Preferred Stock, a liquidation, dissolution or
winding up of the Company shall also include (i) the acquisition or sale
of the Company unless the Company's stockholders of record as constituted
immediately prior to such acquisition or sale will, immediately after
such acquisition or sale hold at least 50 percent of the voting power of
the surviving or acquiring entity or (ii) a sale, lease or other
conveyance or disposition of all or substantially all of the assets of
the Company, including a sale of all or substantially all of the assets
of the Company's subsidiaries, if such assets constitute substantially
all of the assets of the Company and such subsidiaries taken as a whole.
F-48
COMVERGE, INC. AND SUBSIDIARIES NOTES
TO CONSOLIDATED FINANCIAL STATEMENT
DECEMBER 31, 2003
(ALL NOTES IN THOUSANDS OF DOLLARS, EXCEPT PER SHARE DATA)
(f) Anti-dilution Rights
The conversion prices of Preferred Shares are subject to broad-based
weighted average anti-dilution adjustments to reduce dilution in the
event that the Company issues additional equity securities (other than
Board approved employee incentives, including stock options) at a
purchase price less than the then-applicable conversion price of the
Series A Preferred. The conversion price is also be subject to
proportional adjustment for stock splits, stock dividends,
recapitalizations and the like.
(g) Protective Provisions
For so long as at least 100,000 shares of Series A Preferred remain
outstanding, consent of the holders of at least a majority of the Series
A Preferred shall be required to (i) alter or change the rights,
preferences or privileges of the Series A Preferred, (ii) create (by
reclassification or otherwise) any new class or series of shares having
rights, preferences or privileges senior to or on a parity with the
Series A Preferred, (iii) amend or waive any provision of the Company's
Articles of Incorporation or Bylaws, (iv) increase or decrease the
authorized number of shares of Common or Preferred Stock, (v) redeem any
shares of Common Stock (other than pursuant to equity incentive
agreements with service providers giving the Company the right to
repurchase shares upon the termination of services), (vi) consummate any
merger, other corporate reorganization, sale of control, or any
transaction in which all or substantially all of the assets of the
Company are sold, (vii) increase or decrease the authorized size of the
Company's Board of Directors or the Compensation Committee of the Board
of Directors, (viii) pay or declare any dividend on any shares of Common
or Preferred Stock, (ix) liquidate or dissolve the Company, (x) increase
the number of shares reserved for issuance under the Option Plan, (xi)
issue any shares of capital stock of the Company or options to acquire
capital stock of the Company under the Option Plan, unless such issuance
is approved by the Board of Directors and the Compensation Committee of
the Board of Directors, or (xii) authorize or incur any additional
indebtedness in excess of $500,000 (other than the revolving Credit
Facility), unless such incurrence of indebtedness is approved by the
Board of Directors, including at least two of the directors designated by
the holders of Series A Preferred.
10. STOCK OPTION PLANS
The Company's stock option plans provide for the granting to officers,
directors and other key employees of options to purchase shares of common
stock at not less than 85 percent of the estimated market value of the
Company's common stock on the date of grant. The purchase price must be
paid in cash. At December 31, 2003, the Company had issued 2,215,830
options under the various plans of which 74,658 options had been
exercised by optionees. Options expire between five years and ten years
from the date of the grant. The options generally vest over a two to
three year period from the date of the grant. At December 31, 2003,
43,481 options were available for grant under the various plans.
F-49
COMVERGE, INC. AND SUBSIDIARIES NOTES
TO CONSOLIDATED FINANCIAL STATEMENT
DECEMBER 31, 2003
(ALL NOTES IN THOUSANDS OF DOLLARS, EXCEPT PER SHARE DATA)
A summary status of the Company's option plans as of December 31, 2003,
as well as changes during the year then ended, is presented below:
NUMBER OF WEIGHTED
OPTIONS AVERAGE
(IN SHARES) EXERCISE PRICE
OUTSTANDING AT BEGINNING OF YEAR 943,530 $1.20
Granted 1,278,800 $1.20
Exercised (219) $1.20
Forfeited (6,281) $1.20
--------- -----
OUTSTANDING AT END OF YEAR 2,215,830 $1.20
--------- -----
Exercisable at end of year 921,094 $1.16
========= =====
NUMBER AVERAGE REMAINING NUMBER
EXERCISE PRICES OUTSTANDING CONTRACTUAL LIFE EXERCISABLE
- ---------------------- ---------------- -------------------- -------------
(In Shares) (In Years) (In Shares)
$0.40 146,079 0.75 146,079
$1.20 1,956,509 5.42 698,854
$1.31 64,361 7.87 42,907
$2.00 12,192 1.76 8,795
$4.00 36,689 2.25 24,459
---------------- -------------
2,215,830 5.11 921,094
================ =============
The weighted average grant-date fair value of the 1,278,800 options
granted during 2003 was zero. The Company utilized the Black-Scholes
option pricing model to estimate fair value, utilizing the following
assumptions for the respective years (all in weighted averages):
Risk-free interest rate 5.38%
Expected life of options, in years 5.0
Expected annual volatility 0%
Expected dividend yield None
F-50
COMVERGE, INC. AND SUBSIDIARIES NOTES
TO CONSOLIDATED FINANCIAL STATEMENT
DECEMBER 31, 2003
(ALL NOTES IN THOUSANDS OF DOLLARS, EXCEPT PER SHARE DATA)
During 2002, the Company repriced certain incentive stock options of ten
employees. One of these employee's options were repriced, pursuant to his
employment agreement, from $4.00 to $1.20 per share. The Company also
repriced certain incentive stock options of ten employees (including the
aforementioned employee) who held certain anti-dilution options from
$1.94 to $1.31 per share. As a result of these repricings, the options
are accounted for as variable awards with a compensation charge
recognized for periodic changes in the intrinsic value of the option
until the award expires, is exercised, or is forfeited. At December 31,
2003, no compensation charge was recognized related to these options
since the fair market value of the common stock was below the exercise
prices.
11. MAJOR CUSTOMER
During the year ended December 31, 2003, the Company had one customer
which accounted for 18.5 percent of the Company's total revenue. The
total accounts receivable from this customer was $172 at December 31,
2003. No other customer accounted for more than 10% of the Company's
total revenue.
12. RELATED PARTY TRANSACTIONS AND BALANCES
An affiliate of DSSI charged the Company's Israeli subsidiary, Comverge
Control Systems, $138 in consideration of it providing office space and
certain accounting and administrative services which amount is included
in general and administrative expense. Also, DSSI paid a cash bonus of
$200 to an executive officer of the Company in January 2004 related to
performance metrics achieved during 2003. This amount was recognized in
the Company's Statement of Operations as compensation expense and
included in general and administrative expense. Because the Company had
no obligation to reimburse DSSI for such bonus payment, it is classified
on the Company's balance sheet as a contribution to paid-in-capital.
Additionally, in January of 2003, DSSI granted the Company's Chief
Executive Officer a restricted stock grant of 50,000 shares of common
stock of DSSI. Also, in 2003, the Company purchased $100 of computers and
other equipment from an affiliate of DSSI of which $62 is recorded in
property and equipment and $38 is recorded as a general and
administrative expense.
Prior to April 2003, DSSI charged the Company $130 in consideration of
certain management fees and interest on advances and loans made by DSSI
to the Company and included in selling and administrative services. Such
amount was classified on the Company's balance sheet as a liability to
DSSI. By agreement, in April 2003, such amount was contributed to the
Company's paid in capital. See Note 9. Also by agreement, subsequent to
April 2003, no management fees are payable to DSSI.
The Company extended loans of $10 each to both the Chief Executive
Officer and Chief Financial Officer of DSSI. The loans had an initial
maturity date of January 3, 2002, and were extended at that time to
mature on January 3, 2004. The loans bear interest at 4.25 percent per
annum. The balance of the loans and accrued interest at December 31, 2003
were $26.
The Company has 38,724 stock options issued and outstanding to executive
officers of affiliated companies.
F-51
COMVERGE, INC. AND SUBSIDIARIES NOTES
TO CONSOLIDATED FINANCIAL STATEMENT
DECEMBER 31, 2003
(ALL NOTES IN THOUSANDS OF DOLLARS, EXCEPT PER SHARE DATA)
13. SUBSEQUENT EVENT
In December 2003, the Company signed an executory agreement with an
investor to sell $3,000 of its Series A preferred shares contingent upon
the successful completion of a joint development agreement ("Development
Agreement") between its subsidiary and the Company. The proceeds of the
sale were placed in escrow pending the completion of a Development
Agreement. In March of 2004, a Development Agreement was executed between
Comverge and the investor's subsidiary and the $3,000 of proceeds were
released to the Company completing the sale of its Series A preferred
shares.
F-52