================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2002 COMMISSION FILE NUMBER 0-19771
- --------------------------------------------------------------------------------
DATA SYSTEMS & SOFTWARE INC.
(Exact name of registrant as specified in charter)
------------------------------------------------------------------
DELAWARE 22-2786081
(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification no.)
200 ROUTE 17, MAHWAH, NEW JERSEY 07430
(Address of principal executive offices) (Zip code)
(201) 529-2026
Registrant's telephone number, including area code
---------------------------------------------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
|X| Yes |_| No
Number of shares outstanding of the registrant's common stock, as of
August 5, 2002: 7,353,163
================================================================================
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Item 1. Unaudited Consolidated Financial Statements
Consolidated Balance Sheets
as of December 31, 2001 and June 30, 2002 . . . . . . . . . . . . . . 1
Consolidated Statements of Operations
for the three and six month periods ended June 30, 2001 and 2002 . . . 2
Consolidated Statement of Changes in Shareholders' Equity
for the six month period ended June 30, 2002 . . . . . . . . . . . . . 3
Consolidated Statements of Cash Flows
for the six month periods ended June 30, 2001 and 2002 . . . . . . . . 4
Notes to Consolidated Financial Statements . . . . . . . . . . . . . . . 5
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations . . . . . . . . . . . . . . . . . . . . . 11
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K . . . . . . . . . . . . . . . . . . . . 16
SIGNATURES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
Exhibits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18
Certain statements contained in this report are forward-looking in nature. These
statements are generally identified by the inclusion of phrases such as "we
expect", "we anticipate", "we believe", "we estimate" and other phrases of
similar meaning. Whether such statements ultimately prove to be accurate depends
upon a variety of factors that may affect our business and operations. Many of
these factors are described in our most recent Annual Report on Form 10-K as
filed with Securities and Exchange Commission.
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(dollars in thousands, except per share data)
As of As of
December June 30,
ASSETS 31, 2001 2002
--------- ---------
(unaudited)
Current assets:
Cash and cash equivalents $ 4,025 $ 3,054
Short-term interest bearing bank deposits and debt securities 1,828 1,898
Restricted cash 317 6,345
Trade accounts receivable, net 10,197 9,630
Inventory 658 2,300
Other current assets 1,858 1,206
--------- ---------
Total current assets 18,883 24,433
Investments 90 90
Property and equipment, net 2,296 2,157
Goodwill, net of accumulated amortization of $2,677 at December 31, 2001 7,737 7,689
Other intangible assets, net 909 709
Long-term deposits 6,000 -
Other assets 676 602
Prepaid employee termination benefits 2,653 2,589
--------- ---------
Total assets $ 39,244 $ 38,269
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Short-term debt and current maturities of long-term debt,
net of discount of $638 $ 2,499 $ 9,408
Trade accounts payable 4,010 5,328
Accrued payroll, payroll taxes and social benefits 2,193 2,049
Other current liabilities 3,372 3,533
--------- ---------
Total current liabilities 12,074 20,318
--------- ---------
Long-term liabilities:
Long-term debt 6,182 645
Other liabilities 285 308
Liability for employee termination benefits 3,811 3,746
--------- ---------
Total long-term liabilities 10,278 4,699
--------- ---------
Minority interests 2,530 2,279
--------- ---------
Shareholders' equity:
Common stock - $.01 par value per share:
Authorized - 20,000,000 shares; Issued - 8,161,867 shares 82 82
Additional paid-in capital 36,981 37,690
Warrants 114 114
Deferred compensation (14) (11)
Accumulated deficit (18,643) (22,744)
Treasury stock, at cost - 808,704 shares (3,860) (3,860)
Shareholder's note (298) (298)
--------- ---------
Total shareholders' equity 14,362 10,973
--------- ---------
Total liabilities and shareholders' equity $ 39,244 $ 38,269
========= =========
The accompanying notes are an integral part of these consolidated financial statements.
- 1 -
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)
(in thousands, except per share data)
Six months ended Three months ended
June 30, June 30,
------------------ ------------------
2001 2002 2001 2002
-------- -------- -------- --------
Sales:
Products $18,201 $17,661 $ 8,948 $ 8,960
Services 7,597 7,930 3,621 3,823
-------- -------- -------- --------
25,798 25,591 12,569 12,783
-------- -------- -------- --------
Cost of sales:
Products 14,693 14,051 7,171 7,230
Services 5,598 5,970 2,582 2,961
-------- -------- -------- --------
20,291 20,021 9,753 10,191
-------- -------- -------- --------
Gross profit 5,507 5,570 2,816 2,592
Research and development expenses 1,353 1,010 871 550
Selling, general and administrative expenses 8,386 8,752 4,203 4,452
-------- -------- -------- --------
Operating loss (4,232) (4,192) (2,258) (2,410)
Interest income 646 146 262 53
Interest expense (267) (293) (78) (199)
Other income (loss), net (5) 92 56 66
Minority interests - 203 - 207
-------- -------- -------- --------
Loss before provision for income taxes (3,858) (4,044) (2,018) (2,283)
Provision for income taxes 112 57 85 15
-------- -------- -------- --------
Net loss $(3,970) $(4,101) $(2,103) $(2,298)
Basic and diluted net loss per share:
Net loss per share $ (0.57) $ (0.56) $ (0.30) $ (0.31)
======== ======== ======== ========
Weighted average number of shares
outstanding - basic and diluted 6,937 7,353 6,910 7,353
======== ======== ======== ========
The accompanying notes are an integral part of these consolidated financial statements.
- 2 -
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY (unaudited)
(in thousands)
Additional
Number of Common Paid-In Deferred Treasury Shareholder's Accumulated
Shares Stock Capital Compensation Warrants Stock Note Deficit Total
---------- ------- ----------- ------------- ---------- --------- ------------- ------------ --------
Balances as of
December 31, 2001 8,162 $ 82 $ 36,981 $ (14) $ 114 $(3,860) $(298) $(18,643) $14,362
Grant and recognition
of stock option
compensation - - 17 3 - - - - 20
Value of 10%
convertible note
allocated to beneficial
conversion feature and
related warrants - - 692 - - - - - 692
Net loss - - - - - - - (4,101) (4,101)
---------- ------- ----------- ------------- ---------- --------- ------------- ------------ --------
Balances as of
June 30, 2002 8,162 $ 82 $ 37,690 $ (11) $ 114 $(3,860) $(298) $(22,744) $10,973
========== ======= =========== ============= ========== ========= ============= ============ ========
The accompanying notes are an integral part of these consolidated financial statements.
- 3 -
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
(dollars in thousands)
Six months ended June 30,
-------------------------
2001 2002
-------- --------
Cash flows used in operating activities:
Net loss $(3,970) $(4,101)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Depreciation and amortization 651 676
Allowance for doubtful accounts 23 (87)
Stock option compensation - 20
Accretion of discount on convertible note - 54
Minority interest - (203)
Write-off of minority interest balance - (40)
Unrealized gain on debt securities - (13)
Increase (decrease) in liability for employee termination benefits 201 (65)
Exchange adjustment on long-term debt - (27)
Loss on disposition of property and equipment 37 14
Write-off of inventory 26 -
Receipt of investments for services rendered (130) -
Change in operating assets and liabilities:
Decrease (increase) in accounts receivable and other current assets (577) 1,473
Increase in inventory (187) (1,642)
Decrease in other assets 35 91
Increase in accounts payable and other liabilities 848 1,233
-------- --------
Net cash used in operating activities (3,043) (2,617)
-------- --------
Cash flows provided by (used in) investing activities:
Short-term bank deposits, net 696 -
Restricted cash (5) (28)
Proceeds from sale and maturity of debt securities 400 411
Investment in debt securities (1,865) (468)
Acquisitions of property and equipment (600) (201)
Funding of termination benefits (90) 64
Acquisition of intangible assets (4) (2)
-------- --------
Net cash used in investing activities (1,468) (224)
-------- --------
Cash flows provided by (used in) financing activities:
Short-term debt, net (10) (572)
Proceeds from issuance of convertible note - 2,000
Borrowings of long-term debt - 646
Repayments of long-term debt (5) (37)
Convertible note issuance costs - (167)
Proceeds from stock options exercises 186 -
Purchase of treasury stock (779) -
-------- --------
Net cash (used in) provided by financing activities (608) 1,870
-------- --------
Net decrease in cash and cash equivalents (5,119) (971)
Cash and cash equivalents at beginning of period 10,877 4,025
-------- --------
Cash and cash equivalents at end of period $ 5,758 $ 3,054
-------- --------
Supplemental cash flow information:
Cash paid during period for interest $ 230 $ 192
======== ========
Cash paid during period for income taxes $ 437 $ 67
======== ========
Non-cash investing and financing activities:
Accounts payable incurred in acquisition of fixed assets $ 100
Value of beneficial conversion feature and related warrants on issuance of convertible
note $ 692
========
Adjustment of goodwill and intangible assets $ 48
========
Increase in deferred tax liability associated with adjustment of intangible assets $ 17
========
The accompanying notes are an integral part of these consolidated financial statements.
- 4 -
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
(dollars in thousands, except per share data)
NOTE 1: BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements of Data
Systems & Software Inc. and subsidiaries (the "Company") have been prepared in
accordance with accounting principles generally accepted in the United States of
America for interim financial information and with the instructions to Article
10 of Regulation S-X. Accordingly, they do not include all of the information
and footnotes required by accounting principles generally accepted in the United
States of America for complete consolidated financial statements. In the opinion
of management, all adjustments considered necessary for a fair presentation have
been included. Operating results for the three and six-month periods ended June
30, 2002 are not necessarily indicative of the results that may be expected for
the year ending December 31, 2002. These unaudited consolidated financial
statements should be read in conjunction with the consolidated financial
statements and footnotes thereto for the year ended December 31, 2001 included
in the Company's Annual Report on Form 10-K filed with the Securities and
Exchange Commission. Certain reclassifications have been made to the Company's
prior period's consolidated financial statements, to conform to the current
period's consolidated financial statement presentation.
NOTE 2: FINANCING OF OPERATIONS
As of June 30, 2002 the Company had working capital of approximately
$4,115, including $4,952 in nonrestricted cash, cash equivalents and debt
security investments. Of the total working capital, $802 was in the Company's
majority-owned Israeli subsidiary dsIT and, due to Israeli tax and company law
constraints as well as the significant minority interest in dsIT, such working
capital is not available to finance US activities. Net cash used in operating
activities during the second quarter of 2002 was $3,039 as compared to $422 net
cash provided during the first quarter of 2002. The primary factors for the
Company's net cash usage during the second quarter of 2002, was its loss for the
period of $2,298 and a $1,473 investment in inventory by Comverge. These uses
of cash were offset in part by a decrease of $433 in the Company's accounts
receivable and other current asset balances and $332 of non-cash depreciation
and amortization expense included in the Company's net loss during the second
quarter. Additional liquidity for the US operations was provided during the
second quarter of 2002 through the issuance of a $2,000 convertible note, due on
various dates through June 2003 (see Note 3).
As of July 31, 2002 the Company's US operations had an aggregate of
approximately $3,900 in cash, cash equivalents and short-term debt securities.
The Company believes that these funds together with expected net cash flow from
operations will be sufficient to fund its US operating and corporate activities
for at least the next 12 months. This outlook reflects the following trends:
- - Except for the significant investment in raw material inventory noted
above, Comverge's operating cash flow continued to improve in the second
quarter of 2002, a trend which the Company expects will continue through
the rest of the year. The Company expects Comverge to use less than $500 of
additional cash before turning cash flow positive in the fourth quarter.
The anticipated improvement in operating cash flow in the fourth quarter of
this year results from (i) expected increases sales from contracts in hand
and new business currently being negotiated, (ii) expected improved profit
margins on these sales and (iii) planned decreases in selling, general and
administrative expenses. Cash flow for the second half of 2002 will also be
positively impacted by expected utilization of the increased raw material
inventory purchased by Comverge in the second quarter. Although visibility
regarding sales, and therefore profits and cash flow, for the first half of
2003 is still limited, the negative cash flow in Comverge for the entire 12
month period ending June 30, 2003 is not expected to exceed $1,000.
- 5 -
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
(dollars in thousands, except per share data)
- - Results of the Company's domestic operations other than Comverge (i.e., the
computer hardware sales segment and the US operations of the software
consulting and development segment), improved during the quarter, although
they were still marginally negative. The Company expects these activities
to operate at or better than cash flow neutral during the remainder of the
year and the first half of 2003.
- - The Company's corporate expenses have been reduced over the recent quarters
and management has recently taken steps to further reduce these costs.
- - The Company intends to pay most or the entire principal amount of its
convertible note described in Note 3 by delivering shares of its common
stock, thereby conserving cash.
While the Company has not been successful in attracting outside funding for
Comverge to date, and the current state of the capital markets is not favorable
for raising such funds, the Company's long-term strategy remains to establish
independent outside funding to finance its activities. As planned, such
financing would allow the Company to utilize the $6,000 restricted deposit,
currently pledged to guarantee the Comverge bank loan, to finance its other US
activities over the longer term. The Company may also pursue alternative
asset-based financing to provide additional liquidity for its US operating and
corporate activities. However, there are no assurances that the Company or
Comverge will be able to raise additional capital or secure alternative
financing or raise amounts sufficient to meet the long-term needs of the
business.
dsIT is fully utilizing its line of credit of $2,000. The Company believes
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, improved operating results stemming
from continued cost reduction, and payment cycle on receivables.
The Company believes that its plans to finance its operations over the next
12 months can be successfully implemented on a timely basis in a manner which
will not impede the Company's ability to implement its current business
strategy. However, successful execution of these plans is subject to significant
risks and uncertainties, including those associated with (i) timely manufacture
and delivery of products, (ii) obtaining additional business from current and
prospective customers, and (iii) effective and timely implementation of the
Company's planned reductions in direct costs and expenses.
Should the Company be unsuccessful in implementing, on a timely basis, its
plan to finance its operations for the next 12 months, the Company may need to
take additional and more drastic measures to reduce costs and expenses. These
measures, should they prove necessary, could negatively affect the Company's
ability to execute its business strategy.
NOTE 3: CONVERTIBLE NOTE
On June 11, 2002, the Company completed a transaction with Laurus Master
Fund, Ltd., pursuant to which Laurus made a $2,000 investment in the Company in
exchange for a 10% convertible note due on various dates through June 30, 2003
and a three-year warrant to purchase 125,000 shares of DSSI common stock at an
exercise price of $4.20 per share.
Laurus may convert the convertible note at any time into shares of DSSI
common stock at a fixed conversion price of $3.49, subject to certain
restrictions in the agreement. The Company may pay the principal and interest
on the convertible note, which has a one-year term, in cash, shares of DSSI
common stock, or a combination of cash and stock, at the Company's option.
-6-
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
(dollars in thousands, except per share data)
Based on its current liquidity status, the Company currently expects to
pay most or all of the principal in shares of common stock. Should the Company
so choose, the conversion price will be the lesser of (i) $3.49 and (ii) 83% of
the average of the 10 lowest closing prices during the 30 trading days prior to
the date of notice of payment. The Company will make interest-only payments
until October 1, 2002, at which time the Company will pay interest and one-tenth
of the principal. Laurus was granted a security interest in the Company's
Databit subsidiary's accounts receivable.
The Company estimated the fair value of the beneficial conversion feature
and related warrants at the issuance of the convertible note to be approximately
$692. Such amount was credited to additional paid-in capital and will be
charged to interest expense over the conversion periods, using the effective
interest method (approximately $54 for the three and six months ended June 30,
2002). The face value debt of $2,000, less $638 of unamortized debt discount
from the beneficial conversion feature and the related warrants, is included in
short-term debt and current maturities of long-term debt, net at June 30, 2002.
In addition, the Company incurred debt issuance costs of $167 with respect to
the issuance of the convertible note. These costs will be amortized to interest
expense using the effective interest method over the life of the note.
The interest expense with respect to the convertible note consisting of
interest payments at a rate of 10%, the amortization of debt issuance costs and
the accretion of the carrying value of the convertible note to its face value
(debt discount) are expected to be recognized in the consolidated statement of
operations as follows:
Quarter ended June 30, 2002 $64
Quarter ending September 30, 2002 $307
Quarter ending December 31, 2002 $246
Quarter ending March 31, 2003 $150
Quarter ending June 30, 2003 $61
NOTE 4: NEWLY ADOPTED ACCOUNTING PRINCIPLES
The Company adopted the remaining provisions of Statement of Financial
Accounting Standards (SFAS) No. 141, "Business Combinations" and all of the
provisions of SFAS No. 142, "Goodwill and Other Intangible Assets", effective
January 1, 2002. Upon adoption of SFAS No. 142, the Company evaluated its
existing intangible assets and goodwill that were acquired in purchase business
combinations, so as to make any necessary reclassifications in order to conform
with the new classification criteria in SFAS No. 141 for recognition separate
from goodwill. Additionally, the Company has identified its reporting units to
be its operating segments and allocated the goodwill at January 1, 2002 as
follows: software consulting and development - $7,190, and energy intelligence
solutions - $499. The Company reassessed the useful lives and residual values of
all intangible assets acquired, in order to make any necessary amortization
period adjustments. If an intangible asset is identified as having an
indefinite useful life, the Company is required to test the intangible asset for
impairment in accordance with the provisions of SFAS No. 142.
Impairment is measured as the excess of carrying value over the fair value
of an intangible asset with an indefinite life. Any impairment loss is measured
as of January 1, 2002 and is recognized as a cumulative effect of a change in
accounting principle. In connection with the adoption of SFAS No. 142, the
Company evaluated its intangible assets and determined that it has no indefinite
useful life intangibles. The Company has also evaluated the remaining useful
lives of its intangible assets that will continue to be amortized and determined
that no revision to the useful lives is required.
- 7 -
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
(dollars in thousands, except per share data)
The Company was required to perform a transitional goodwill impairment
assessment within six months of adoption of SFAS No. 142. The Company completed
its transitional goodwill impairment assessment, with no adjustment to the
carrying value of its goodwill as of January 1, 2002. The goodwill impairment
assessment involves estimating the fair value of the reporting unit and
comparing it with its carrying amount. If the fair value of the reporting unit
exceeds its carrying amount, additional steps are followed to recognize a
potential impairment loss. Calculating the fair value of the reporting units
requires significant estimates and assumptions by management. The Company
estimated the fair value of its reporting units by using third-party valuations
of the reporting units. The annual impairment test is to be performed in the
fourth quarter.
The Company ceased amortization of goodwill acquired in purchase business
combinations, completed prior to July 1, 2001. Pro forma net loss and pro forma
basic and diluted loss per share for the six and three months ended June 30,
2001, adjusted to exclude goodwill amounts no longer amortized, are as follows:
Six months ended Three months ended
June 30, 2001 June 30, 2001
------------------ --------------------
Net loss:
As reported $ (3,970) $ (2,103)
Add back: Goodwill amortization 253 126
------------------ --------------------
Pro forma net loss $ (3,717) $ (1,977)
================== ====================
Basic and diluted net loss per share:
As reported $ (0.57) $ (0.30)
Add back: Goodwill amortization 0.03 0.01
------------------ --------------------
Pro forma net loss per share $ (0.54) $ (0.29)
================== ====================
Amortization of intangible assets for the six months ended June 30, 2002
was $250. Amortization expense for each of the next five years and thereafter is
estimated as follows:
Year ending December 31,
- ---------------------------
2002 $447
2003 217
2004 180
2005 36
2006 36
Thereafter 41
------
$957
======
Other intangible assets consists of: As of As of
December 31, June 30,
2001 2002
------------- ---------
Cost:
License $ 567 $ 567
Patents 279 281
Software and software licenses 572 500
Backlog - 120
------------- ---------
$ 1,418 $ 1,468
------------- ---------
Less: Accumulated Amortization:
License $ 456 $ 514
Patents 53 72
Software licenses - 89
Backlog - 84
------------- ---------
$ 509 $ 759
------------- ---------
Other intangible assets, net $ 909 $ 709
============= =========
- 8 -
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
(dollars in thousands, except per share data)
Effective January 1, 2002, the Company also adopted SFAS No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets". SFAS No. 144
addresses financial accounting and reporting for the impairment or disposal of
long-lived assets. SFAS No. 144 requires that long-lived assets 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 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
companies 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 had no impact on
the Company's consolidated financial statements because the impairment
assessment under SFAS No. 144 is largely unchanged from SFAS No. 121. The
provisions of this statement for assets held for sale or other disposal
generally are required to be applied prospectively to newly initiated disposal
activities and, therefore, will depend on future actions initiated by
management.
NOTE 5: INVENTORY
Inventory consists of the following: As of As of
December 31, June 30,
2001 2002
-------- --------
Raw materials, spare parts and supplies $409 $2,115
Work-in-process - 105
Finished goods and merchandise 249 80
-------- --------
$658 $2,300
======== ========
NOTE 6: ACQUISITIONS
In December 2001, the Company's dsIT subsidiary acquired 100% of the shares
of Endan IT Solutions Ltd., for an aggregate purchase price of $5,788. The
transaction was accounted for as a purchase business combination and partial
sale of a subsidiary. The results of operations and cash flows of Endan have
been included in our consolidated financial statements beginning January 1,
2002. For further information, refer to the notes to the consolidated financial
statements for the year ended December 31, 2001 included in our annual report on
Form 10-K. At December 31, 2001, the Company was in the process of obtaining
third-party valuations of certain intangible assets and evaluating the outcome
of the litigation discussed in Note 15 (e) to our December 31, 2001 consolidated
financial statements; thus, the allocation of the purchase price was preliminary
and subject to refinement. Upon receipt of third-party valuation information,
it was determined that the fair value of software licenses acquired (five-year
useful life) initially recorded at $500 at December 31, 2001 was $428 and that
the fair value of backlog acquired (one-year useful life), not initially
recorded, was $120. The acquired goodwill resulting from the acquisition was
reduced by $48 as a result of these valuations and related deferred taxes were
adjusted. The entire goodwill acquired was assigned to the software consulting
and development segment. The Company continues to evaluate the status of the
aforementioned litigation. While the Company does not expect an adverse ruling,
any amounts awarded or paid during 2002 will increase or decrease the goodwill.
During the second quarter of 2002, the Company's Comverge subsidiary
purchased certain assets to be used in a 70MW energy conservation program in the
greater Houston, Texas area for $100.
- 9 -
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
(dollars in thousands, except per share data)
NOTE 7: SEGMENT INFORMATION
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
(dollars in thousands, except per share data)
NOTE 7: SEGMENT INFORMATION
Software Energy
Consulting and Intelligence Computer
Development Solutions Hardware Other Total
---------------- -------------- ---------- ------- --------
Six months ended June 30, 2002:
Revenues from external customers $ 7,297 $ 9,424 $ 8,777 $ 93 $25,591
Intersegment revenues 19 479 46 - 544
Segment gross profit 1,292 2,774 1,459 45 5,570
Segment income (loss) (894) (1,868) (25) 5 (2,782)
Six months ended June 30, 2001:
Revenues from external customers $ 7,120 $ 6,108 $ 12,486 $ 84 $25,798
Intersegment revenues 90 603 57 - 750
Segment gross profit 1,563 1,705 2,186 53 5,507
Segment income (loss) (662) (3,023) 806 (8) (2,887)
Three months ended June 30, 2002:
Revenues from external customers $ 3,462 $ 4,770 $ 4,521 $ 30 $12,783
Intersegment revenues - 208 29 - 237
Segment gross profit 503 1,334 745 10 2,592
Segment income (loss) (720) (1,017) 1 (15) (1,751)
Three months ended June 30, 2001:
Revenues from external customers $ 3,340 $ 2,719 $ 6,472 $ 38 $12,569
Intersegment revenues 87 289 32 - 408
Segment gross profit 827 706 1,255 28 2,816
Segment income (loss) (284) (1,901) 549 - (1,636)
RECONCILIATION OF SEGMENT INCOME (LOSS) TO NET LOSS:
Six months ended Three months ended
June 30, June 30,
------------------ ------------------
2001 2002 2001 2002
-------- -------- -------- --------
Total loss for reportable segments $(2,879) $(2,787) $(1,636) $(1,736)
Other operational segment income (loss) (8) 5 - (15)
-------- -------- -------- --------
Total operating loss (2,887) (2,782) (1,636) (1,751)
Net loss of corporate headquarters (1,083) (1,319) (467) (547)
-------- -------- -------- --------
Total net loss $(3,970) $(4,101) $(2,103) $(2,298)
======== ======== ======== ========
-10-
DATA SYSTEMS & SOFTWARE INC.
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 our Annual Report on Form 10-K for the year ended
December 31, 2001 (the "2001 10-K") under "Factors That May Influence Future
Results" and in "Item 1. Description of Business - Factors That May Influence
Future Results".
During the periods included in this report, we operated in three reportable
segments: software consulting and development, energy intelligence solutions,
and computer hardware. The following analysis should be read together with the
segment information provided in Note 7 to the interim unaudited consolidated
financial statements included in this quarterly report, which information is
hereby incorporated by reference into this Item 2.
Software Consulting and Development
The acquisition of Endan, in December 2001, expanded our revenue base with
little incremental overhead by utilizing economies of scale which offset the
continued weakness in the hi-tech sector in general and the software consulting
and development market in particular. As a result of the continuing weakness in
the market, the revenues and results of operations in the second quarter of 2002
were below those of the immediately preceding quarter. We expect that these
market conditions and seasonal factors will cause revenues in the third quarter
of 2002 to be below those of the second quarter. In the second quarter of 2002,
dsIT continued to work on improving its cost structure while increasing its
marketing efforts to further expand its revenue base. The continuing effort to
reduce costs and the investment in marketing are expected to provide improved
operating results in the last quarter of this year. The recent unrest in Israel
has not had a direct material effect on our business there, although it has had
a negative effect on the Israeli economy. Should the unrest continue, it is
unclear how our business there will be affected in the future.
Energy Intelligence Solutions
In the second quarter of 2002, sales continued to increase, primarily due
to two new pilot projects for MaingateTM and SuperStatsTM products and a
significant increase in MaingateTM shipments to Gulf Power.
Although we expect sales in the third quarter of this year to be below
those of the second quarter, we expect generally to increase sales in the fourth
quarter, and continue to improve our operating results. This improvement will be
based in part on new business, including our recently announced $3.2 million
contract for an integrated deployment of our MaingateTM wireless web gateway
system, combined with the sale of our PowerCAMPTM End-to-End Energy
IntelligenceTM software solution for PPL Electric Utilities (PPL).
In the second quarter of 2002, Comverge increased its investment in raw
material inventory by $1.4 million in order to (i) facilitate an orderly
transfer of manufacturing operations to two new manufacturers, (ii) meet
increased third and fourth quarter production requirements and (iii) take
advantage of favorable pricing and extended terms of payment received. It is
anticipated that this additional investment in inventory will be absorbed and
generate cash from sales over the next 12 months, with most of it by the end of
the year.
Aside from this investment, which is temporary in nature, Comverge's
operating cash flow continued to improve in the second quarter of 2002, a trend
which the Company expects will continue through the year.
- 11 -
We expect that Comverge's net negative cash flow for the remainder of the
third quarter will not exceed $500,000 and that Comverge will be cash flow
positive in the last quarter of 2002. The anticipated improvement in operating
cash flow in the fourth quarter of this year results from (i) expected increases
in sales from contracts in hand and new business currently being negotiated,
(ii) expected improved profit margins on these sales and (iii) planned decreases
in selling, general and administrative expenses. Going forward into 2003,
although we lack sufficient visibility regarding sales, and therefore profits
and cash flow, we expect to improve Comverge's cost structure and gross profit
margins.
During the second quarter of 2002, Comverge purchased a 70MW energy
conservation program, managed by a wholly owned subsidiary, Texas Energy
Partners, formed for this purpose. The new operation has 50,000 residential
customers in the greater Houston area and accounts for up to 160 megawatts of
Virtual Peaking Capacity (TM), under emergency conditions.
The current state of the capital markets has not been favorable for raising
outside funding for Comverge. Although this remains our long-term strategy, in
the short-term Comverge will fund its growth internally.
Computer Hardware
Although Databit's sales in the second quarter and six moths ended June 30,
2002 were below sales in the comparable periods last year, they continued to
improve for the third consecutive quarter, and while we expect the third quarter
to be lower than the second quarter of this year, we expect sales to increase
again in the fourth quarter and to generally maintain the current level of sales
for the remainder of the year.
RESULTS OF OPERATIONS
The following table sets forth certain information with respect to the
results of our operations for the three and six months ended June 30, 2001 and
2002, including the percentage of total revenues during each period attributable
to selected components of operations statement data and for the period to period
percentage changes in such components.
Six months ended June 30, Three months ended June 30,
----------------------------------------- -----------------------------------------
2001 2002 Change 2001 2002 Change
---------------- ---------------- ------ ---------------- ---------------- ------
% of % of % of % of % of % of
($,000) sales ($,000) sales 2001 ($,000) sales ($,000) sales 2001
-------- ------ -------- ------ ----- -------- ------ -------- ------ -----
Sales $25,798 100% $25,591 100% (1)% $12,569 100% $12,783 100% 2%
Cost of sales 20,291 79 20,021 78 (1) 9,753 78 10,191 80 4
-------- ------ -------- ------ -------- ------ -------- ------
Gross profit 5,507 21 5,570 22 1 2,816 22 2,592 20 (8)
R&D expenses 1,353 5 1,010 4 (25) 871 7 550 4 (37)
SG&A expenses 8,386 33 8,752 34 4 4,203 33 4,452 35 6
-------- ------ -------- ------ -------- ------ -------- ------
Operating loss (4,232) (16) (4,192) (16) (1) (2,258) (18) (2,410) (19) 7
Interest income (expense), net 379 1 (147) (1) (139) 184 1 (146) (1) (179)
Other income (loss), net (5) 0 92 0 56 0 66 1 18
Minority interests - - 203 1 - - 207 2
-------- ------ -------- ------ -------- ------ -------- ------
Loss before provision for
income taxes (3,858) (15) (4,044) (16) 5 (2,018) (16) (2,283) (18) 13
Provision for income taxes 112 0 57 0 (49) 85 1 15 0 (82)
-------- ------ -------- ------ -------- ------ -------- ------
Net loss $(3,970) (15)% $(4,101) (16)% 3% $(2,103) (17) % $(2,298) (18)% 9%
======== ====== ======== ====== ======== ====== ======== ======
Sales. Sales in the second quarter of 2002 were $12.8 million, similar to
sales of the immediately preceding quarter and 2% above the second quarter of
2001. This reflects an increase in energy intelligence solution sales by our
Comverge subsidiary, offset by a similar decrease in sales in our computer
hardware segment. Sales in the first six months of 2002 were $25.6 million, 1%
below sales in the same period in 2001, primarily due to a decrease in computer
hardware sales, as well as a small decrease in software consulting and
development sales, mostly offset by the increase in Comverge sales, during this
period.
- 12 -
Sales in Comverge in the second quarter of 2002 were $4.8 million and in
the first six months of this year were $9.4 million, increasing by 76% and 54%,
compared to the same periods in 2001, respectively. This increase was primarily
attributable to the aforementioned new pilot projects for our Maingate and
SuperStat products and increased Maingate shipments to Gulf Power.
Sales in the computer hardware segment continued to improve and were $4.5
million and $8.8 million in the second quarter and first six months of 2002,
respectively. Although still 30% below sales in the same periods of 2001 due to
the downturn in the economy, particularly since 9/11, sales continued the
improvement shown in the first quarter of 2002, increasing by 6% over sales in
the first quarter of 2002.
Software consulting and development sales were $3.5 million and $7.3
million in the second quarter and first six months of 2002, respectively,
increasing by 3% compared to the same periods of 2001. This improvement, albeit
small, 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 the second quarter of 2002 was $2.6 million,
decreasing by 8% compared to the second quarter of 2001. Gross profit in the
first six months of 2002 was $5.6 million, similar to the same period in 2001.
The decrease in the second quarter of 2002 was primarily attributable to the
aforementioned decrease in computer hardware sales and the lost gross profit
from those sales. The gross profit from the increase in Comverge sales
partially offset the decrease in the other segments.
Selling, general and administrative expenses ("SG&A"). In the second
quarter and first six months of 2002, SG&A was $4.5 million and $8.8 million,
respectively, increasing marginally over the same periods in 2001. This
reflects increases in all the operating segments, partially offset by a decrease
in corporate expenses.
Interest expense. We had net interest expense in both the three month and
six month periods in 2002, as compared to net interest income in the 2001
periods, due primarily to the decrease in funds invested as they are utilized to
finance our domestic operations, as well as the decrease in interest rates and
return on our investments. The convertible debenture issued at the end of June
2002 did not have a material affect on the results of the periods reported. The
financial expense associated with this debenture will be recorded over the next
four quarters, weighted towards the third and fourth quarters of 2002.
LIQUIDITY AND CAPITAL RESOURCES
As of June 30, 2002 we had working capital of approximately $4.1 million,
including $5.0 million in nonrestricted cash, cash equivalents and debt security
investments. Of the total working capital, $802,000 was in our majority-owned
Israeli subsidiary dsIT and, due to Israeli tax and company law constraints as
well as the significant minority interest in dsIT, such working capital is not
available to finance US activities. Net cash used in operating activities
during the second quarter of 2002 was $3.0 million as compared to $422,000 net
cash provided during the first quarter of 2002. The primary factors for our net
cash usage during the second quarter of 2002 was our loss for the period of $2.3
million and a $1.4 million investment in inventory by Comverge. These uses of
cash were offset in part by a decrease of $433,000 in our accounts receivable
and other current asset balances and $332,000 of non-cash depreciation and
amortization expense included in our net loss during the second quarter.
Additional liquidity for the US operations was provided during the second
quarter of 2002 through the issuance of a $2.0 million convertible note, due on
various dates through June 2003 (see Note 3).
As of July 31, 2002 we had an aggregate of $3.9 million in cash, cash
equivalents and short-term debt securities. We believe that these funds
together with expected net cash flow from operations will be sufficient to fund
our US operating and corporate activities for at least the next 12 months. This
outlook reflects the following trends:
- 13 -
- - Except for the significant investment in raw material inventory noted
above, Comverge's operating cash flow continued to improve in the second
quarter of 2002, a trend which we expect will continue through the rest of
the year. We expect Comverge to use less than $500,000 of additional cash
before turning cash flow positive in the fourth quarter. The anticipated
improvement in operating cash flow in the fourth quarter of this year
results from (i) expected increases sales from contracts in hand and new
business currently being negotiated, (ii) expected improved profit margins
on these sales and (iii) planned decreases in selling, general and
administrative expenses. Cash flow for the second half of 2002 will also be
positively impacted by expected utilization of the increased raw material
inventory purchased by Comverge in the second quarter. Although visibility
regarding sales, and therefore profits and cash flow, for the first half of
2003 is still limited, the negative cash flow in Comverge for the entire 12
month period ending June 30, 2003 is not expected to exceed $1.0 million.
- - Results of our domestic operations other than Comverge (i.e., the computer
hardware sales segment and the US operations of the software consulting and
development segment), improved during the quarter, although they were still
marginally negative. We expect these activities to operate at or better
than cash flow neutral during the remainder of the year and the first half
of 2003.
- - Our corporate expenses have been reduced over the recent quarters and
management has recently taken steps to further reduce these costs.
- - We intend to pay most or the entire principal amount of our convertible
note described in Note 3 by delivering shares of our common stock, thereby
conserving cash.
While we have not been successful in attracting outside funding for
Comverge to date, and the current state of the capital markets is not favorable
for raising such funds, our long-term strategy remains to establish independent
outside funding to finance Comverge's activities. As planned, such financing
would allow us to utilize the $6.0 million restricted deposit, currently pledged
to guarantee the Comverge bank loan, to finance our other US activities over the
longer term. We may also pursue alternative asset-based financing to provide
additional liquidity for our US operating and corporate activities. However,
there are no assurances that we or Comverge will be able to raise additional
capital or secure alternative financing or raise amounts sufficient to meet the
long-term needs of the business.
dsIT is fully utilizing its line of credit of $2.0 million. 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, improved, operating results stemming from
continued cost reduction, and payment cycle on receivables.
We believe that our plans to finance our operations over the next 12 months
can be successfully implemented on a timely basis in a manner which will not
impede our ability to implement our current business strategy. However
successful execution of these plans is subject to significant risks and
uncertainties, including those associated with (i) timely manufacture and
delivery of products, (ii) obtaining additional business from current and
prospective customers, and (iii) effective and timely implementation of our
planned reductions in direct costs and expenses.
Should we be unsuccessful in implementing, on a timely basis, our plan to
finance our operations for the next 12 months, we may need to take additional
and more drastic measures to reduce costs and expenses. These measures, should
they prove necessary, could negatively affect our ability to execute our
business strategy.
- 14 -
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
In the normal course of business, we are exposed to fluctuations in
interest rates on the $6.0 million of debt incurred to finance our capital
expenditures as well as short-term and long-term debt, currently $2.0 million
and $645,000, respectively, to finance our operations in Israel. Our
convertible note, with a face value of $2.0 million, has a fixed rate of
interest of 10%; however, the conversion feature of our convertible note is
exposed to fluctuations in the price of our common stock. Additionally, our
monetary assets and liabilities (net liability of approximately $590,000) in
Israel are exposed to fluctuations in exchange rates. We do not employ specific
strategies, such as the use of derivative instruments or hedging, to manage our
interest rate or exchange rate exposures. In addition, we currently have $1.6
million invested in debt securities with maturities in excess of one year. These
debt securities are classified as trading securities and expose us to interest
rate risk with respect to the effect fluctuations of market interest rates have
on the valuation of these securities. Our investment in debt securities is
managed by a company controlled by one of our directors.
-15 -
PART II - OTHER INFORMATION
ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K
-------------------------------------
(a) Exhibits
10.1 Securities Purchase Agreement relating to the purchase and sale of the
convertible note and the warrant, including the forms of the convertible
note and the warrant (incorporated herein by reference to Exhibit 10.1 to
our Current Report on Form 8-K, dated June 11, 2002).
99.1 Certification of Chief Executive Officer pursuant to Section 906 of
Sarbanes-Oxley Act of 2002.
99.2 Certification of Chief Financial Officer pursuant to Section 906 of
Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K
Report on Form 8-K, dated June 11, 2002, filed on June 12, 2002, relating to the
$2 million investment in us by Laurus Master Fund, Ltd.
- 16 -
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by its
Principal Financial Officer thereunto duly authorized.
DATA SYSTEMS & SOFTWARE INC.
Dated: August 9, 2002
By: /S/ Yacov Kaufman
--------------------------------
Yacov Kaufman
Vice President and Chief Financial Officer
- 17 -