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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended: October 31, 2002
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission file number: 000-20688
Datatec Systems, Inc.
---------------------
(Exact name of Registrant as specified in its charter)
Delaware 94-2914253
- ------------------------------- -------------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
23 Madison Road, Fairfield, NJ 07004
- ------------------------------- -------------------------------
(Address of principal executive (Zip Code)
offices)
(973) 808-4000
---------------------------
Registrant's telephone number, including area code
Check 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 past 12
months (or for such shorter period that the Registrant was required to file such
reports) and (2) has been subjected to such filing requirements for the past 90
days. Yes /X/ No / /.
The number of shares of Registrant's Common Stock outstanding on October 31,
2002 was 35,838,258.
DATATEC SYSTEMS, INC.
FORM 10-Q
THREE MONTHS ENDED OCTOBER 31, 2002
INDEX
PART I: FINANCIAL INFORMATION
Page
Item 1: Condensed Consolidated Financial Statements
Balance Sheets at April 30, 2002 and
October 31, 2002 3
Statements of Operations for the three and six
months ended October 31, 2001 (as restated) and 2002 4
Statements of Comprehensive Income
(Loss) for the three and six months ended
October 31, 2001 (as restated) and 2002 5
Statements of Cash Flows for the six months ended
October 31, 2001 (as restated) and 2002 6
Notes to Unaudited Condensed Consolidated Financial
Statements 7 - 12
Item 2: Management's Discussion and Analysis of Financial
Condition and Results of Operations 13 - 22
Item 3: Quantitative and Qualitative Disclosure
About Market Risk 22
Item 4: Controls and Procedures 22
PART II: OTHER INFORMATION
Item 6: Exhibits and Reports on Form 8-K 23
Signature Page 24
Certifications 25-26
2
PART I - FINANCIAL INFORMATION
Item 1: Condensed Consolidated Financial Statements
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
(unaudited)
April 30, 2002 October 31, 2002
-------------- -----------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 49 $ 65
Receivables, net 21,803 41,867
Inventory 3,176 2,946
Prepaid expenses and other current assets 724 1,361
-------- --------
Total current assets 25,752 46,239
Property and equipment, net 3,259 3,351
Goodwill, net 2,665 2,665
Other assets 4,170 3,427
-------- --------
TOTAL ASSETS $ 35,846 $ 55,682
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Short-term borrowings $ 17,464 $ 22,705
Accounts payable 7,789 13,250
Accrued and other liabilities 3,742 10,139
Subordinated secured convertible debentures, net of
unamortized discount -- 1,690
-------- --------
28,995 47,784
Total current liabilities
-------- --------
LONG-TERM DEBT:
Due to related parties 1,414 1,414
Capital lease obligation 2 --
Subordinated secured convertible debentures, net of
unamortized discount 1,457 --
-------- --------
Total long-term debt 2,873 1,414
-------- --------
STOCKHOLDERS' EQUITY:
Common stock, $0.001 par value (authorized 75,000,000
shares; issued and outstanding 35,591,000 shares and
35,838,000 shares as of April 30, 2002 and October
31, 2002, respectively) 36 36
Additional paid-in capital 53,531 53,690
Accumulated deficit (49,239) (46,890)
Accumulated other comprehensive loss (350) (352)
-------- --------
Total stockholders' equity 3,978 6,484
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS'
EQUITY $ 35,846 $ 55,682
======== ========
The accompanying notes to unaudited condensed consolidated financial statements
are an integral part of these condensed consolidated financial statements.
3
DATATEC SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS EXCEPT FOR SHARE AND PER SHARE AMOUNTS)
(unaudited)
For The Three Months Ended For The Six Months Ended
October, 31 October, 31
-------------------------- ------------------------
2001 2002 2001 2002
(As (As
Restated) Restated)
--------- ------- --------- -------
Revenue $ 19,598 $ 33,203 $ 37,660 $ 56,275
Cost of revenue 13,090 25,445 25,406 41,991
------------ ------------ ------------ ------------
Gross profit 6,508 7,758 12,254 14,284
Selling, general and
administrative expenses 5,954 5,211 12,134 10,265
------------ ------------ ------------ ------------
Operating income 554 2,547 120 4,019
Interest expense (468) (930) (1,050) (1,670)
------------ ------------ ------------ ------------
Income (loss) before minority interest 86 1,617 (930) 2,349
Minority interest (148) -- (318) --
------------ ------------ ------------ ------------
Net income (loss) ($ 62) $ 1,617 ($ 1,248) $ 2,349
============ ============ ============ ============
Earnings (loss) per common
share -
Basic ($ 0.00) $ 0.05 ($ 0.04) $ 0.07
============ ============ ============ ============
Diluted ($ 0.00) $ 0.05 ($ 0.04) $ 0.07
============ ============ ============ ============
Weighted average common
shares outstanding -
Basic 33,862,000 35,793,000 33,853,000 35,738,000
============ ============ ============ ============
Diluted 33,862,000 35,954,000 33,853,000 35,858,000
============ ============ ============ ============
The accompanying notes to unaudited condensed consolidated financial statements
are an integral part of these condensed consolidated financial statements.
4
DATATEC SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF
COMPREHENSIVE INCOME (LOSS)
(IN THOUSANDS)
(unaudited)
For The Three Months Ended For The Six Months Ended
October, 31 October, 31
-------------------------- ------------------------
2001 2002 2001 2002
(As (As
Restated) Restated)
--------- ----- -------- ------
Net income (loss) ($ 62) $ 1,617 ($1,248) $ 2,349
Other comprehensive income
(loss) -
Foreign currency translation
adjustment -- -- 4 (2)
------- ------- ------- -------
Comprehensive income (loss) ($ 62) $ 1,617 ($1,244) $ 2,347
======= ======= ======= =======
The accompanying notes to unaudited condensed consolidated financial statements
are an integral part of these condensed consolidated statements.
5
DATATEC SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(unaudited)
For the Six Months Ended
October 31,
------------------------
2001 2002
(As Restated)
------------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) ($ 1,248) $ 2,349
Adjustments to reconcile net income (loss) to net cash used
in operating activities --
Depreciation and amortization 2,373 2,061
Accretion of preferred stock discount 38 233
Changes in operating assets and liabilities:
Increase in accounts receivable (871) (20,065)
Decrease in inventory 954 230
Decrease (increase) in prepaid expenses and other assets 288 (630)
(Decrease) increase in accounts payable, accrued and
other liabilities (5,840) 11,900
-------- --------
Net cash (used) in operating activities (4,306) (3,922)
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment (215) (970)
Investment in software development (414) (446)
-------- --------
Net cash used in investing activities (629) (1,416)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in short-term borrowings 4,457 5,223
Payments of indebtedness (110) (26)
Net proceeds from issuance of common stock and warrant 118 159
-------- --------
Net cash provided by financing activities 4,465 5,356
-------- --------
Net effect of foreign currency translation on cash 4 (2)
-------- --------
Net increase (decrease) in cash and cash equivalents (466) 16
Cash and cash equivalents at beginning of period 571 49
-------- --------
Cash and cash equivalents at end of period $ 105 $ 65
======== ========
The accompanying notes to unaudited condensed consolidated financial statements
are an integral part of these condensed consolidated financial statements.
6
DATATEC SYSTEMS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
(1) Business
Datatec Systems, Inc. and its subsidiaries (the "Company" or "Datatec") are in
the business of providing rapid and accurate technology deployment services and
licensing software tools to support enterprises in the delivery of complex IT
solutions.
(2) Basis of Presentation
The condensed consolidated financial statements include the accounts of the
Company and its subsidiaries. All intercompany accounts and transactions have
been eliminated.
The accompanying unaudited condensed consolidated financial statements have been
prepared in conformity with generally accepted accounting principles applicable
to interim financial information and with the instructions to Form 10-Q and
Article 10 of Securities and Exchange Commission ("SEC") 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 financial statements. In the opinion of management, all adjustments
(consisting of normal recurring adjustments) considered necessary for fair
presentation have been included. Operating results for the three and six months
ended October 31, 2002 are not necessarily indicative of the results that may be
expected for a full year. The accompanying financial statements should be read
in conjunction with the consolidated financial statements and notes thereto
included in Datatec's annual report on Form 10-K for the year ended April 30,
2002.
Change In Accounting
The Company has changed its method of estimating progress toward completion of
its contracts. Under its previous method, the percentage of direct labor
incurred to date to total estimated direct labor to be incurred on a project was
used to determine a contract's percentage of completion, while under the new
method, the percentage of total costs incurred to date to total estimated costs
to be incurred on a project is used to determine a contract's percentage of
completion. The change was made to reflect the impact of non-labor charges and
to more accurately measure a contract's progress towards completion. In
accordance with Accounting Principles Board Opinion No. 20, "Accounting
Changes," paragraph 27, the financial statements of prior periods have been
adjusted to apply the new method retroactively. The effects of the accounting
change applied retroactively to the Company's restated results (See Note 9) are
shown below:
Effect Of
Change In As
Three months ended As Restated Accounting Retroactively
October 31, 2001: (See Note 9) Principle Adjusted
- ----------------- ------------ --------- --------
Net loss ($761,000) $699,000 ($62,000)
Net loss per share - basic ($0.02) $0.02 ($0.00)
Net loss per share - diluted ($0.02) $0.02 ($0.00)
Six months ended October
31, 2001:
- ------------------------
Net loss ($2,875,000) $1,627,000 ($1,248,000)
Net loss per share - basic ($0.09) $0.05 ($0.04)
Net loss per share - diluted ($0.09) $0.05 ($0.04)
7
The balance of accumulated deficit at April 30, 2002 has been adjusted for the
effect of applying retroactively the new method of accounting, as follows (in
thousands):
April 30, 2002
---------------------
Accumulated deficit, as previously reported ($50,938)
Accumulated deficit, as retroactively adjusted ($49,239)
(3) Earnings Per Share
Basic earnings per share is calculated using the weighted average number of
shares outstanding for the three and six months ended October 31, 2001 and 2002.
Diluted earnings per share is calculated using the weighted average number of
shares outstanding plus the incremental potentially dilutive shares from assumed
conversions of options, debt and preferred stock for the three and six months
ended October 31, 2001 and 2002. Outstanding options and warrants have been
excluded for the three and six months ended October 31, 2001 as their inclusion
would have been anti-dilutive for these periods. Outstanding options and
warrants of 4,386,000 and 4,492,000 have been excluded for the three and six
months ended October 31, 2002, respectively, as their inclusion would have been
anti-dilutive for these periods.
In accordance with SFAS No. 128, the following table reconciles net loss and net
loss per share amounts used to calculate basic and diluted loss per share:
For The Three Months Ended For The Six Months Ended
October, 31 October, 31
-------------------------- ------------------------
2001 2002 2001 2002
(As (As
Restated) Restated)
--------- --------- ---------- ---------
Numerator:
Net income (loss) ($ 62,000) $1,617,000 ($1,248,000) $ 2,349,000
========== ========== =========== ===========
Denominator:
Weighted average
common shares
outstanding -
Basic 33,862,000 35,793,000 33,853,000 35,738,000
========== ========== =========== ===========
Diluted 33,862,000 35,954,000 33,853,000 35,858,000
========== ========== =========== ===========
Net income (loss) per share:
Basic ($ 0.00) $ 0.05 ($ 0.04) $ 0.07
========== ========== =========== ===========
Diluted ($ 0.00) $ 0.05 ($ 0.04) $ 0.07
========== ========== =========== ===========
(4) Short-term Borrowings
In November 2000, the Company replaced its current lender and entered into a
credit line with IBM Credit Corporation. Under the credit line, the Company has
a revolving loan that provides for maximum borrowings of $16.0 million that was
increased from $14.0 million on July 25, 2001. Availability under the revolving
loan is calculated as the sum of 85% of eligible accounts receivable, as
defined, and 35% and 25% of cable and non-cable eligible inventory,
8
respectively, as defined. The amounts outstanding under the credit line as of
April 30, 2002 and October 31, 2002 were $14.5 million and $20.3 million,
respectively. There were no additional available borrowings, as defined, as of
October 31, 2002. Since October 31, 2002, IBM Credit Corporation has granted the
Company additional availability as the Company's accounts receivable and
inventory have increased. The maximum amount eligible to be borrowed has been
temporarily increased to $21.0 million. This increase in the maximum amount
eligible to be borrowed is available to the Company through December 31, 2002,
at which time, if necessary, the Company will request and, as has been the case
in the past, expects to receive sufficient borrowing availability to meet its
then current needs. The revolving loan accrues interest at the prime rate plus
4.25% and matures in November 2003. However, IBM Credit Corporation has notified
the Company that it does not intend to renew its working capital financing line
and term loan beyond August 1, 2003. As a result, the Company is actively
seeking replacement financing.
The Company also has a $3.0 million term loan with IBM Credit Corporation that
is due in February 2003 but repayment has been extended to no later than August
1, 2003. The full amount of the term loan was outstanding as of April 30, 2002.
The term loan accrues interest at the prime rate plus 4.25% and, beginning in
August 2002 is payable in monthly installments of principal and interest of
$300,000. The balance of the term loan outstanding as of October 31, 2002
amounted to $2.4 million and is included in short-term borrowings on the balance
sheet.
The Company was not in compliance with one or more of the financial covenants of
its credit facility as of the quarter ended October 31, 2002. The Company and
IBM Credit Corporation entered into an Acknowledgment, Waiver and Amendment to
the Inventory and Working Capital Financing Agreement for the quarter ended
October 31, 2002.
(5) Subordinated Secured Convertible Debentures.
On April 3, 2002 the Company raised $2.0 million of financing (less
out-of-pocket transaction costs of $0.170 million) to be used for working
capital purposes by issuing an aggregate of $2.0 million principal amount of
Subordinated Secured Convertible Debentures and Warrants to purchase an
aggregate of 270,000 shares of the Company's Common Stock at $1.416 per share.
The debentures mature on July 2, 2003 and bear interest at a rate of 5% per
annum. The interest is due quarterly on March 31, June 30, September 30, and
December 31 of each year (with the first interest payment due and payable on
September 30, 2002) and is payable in cash or Common Stock at the Company's
option. The Company recorded a discount of $582,000 in connection with the
issuance of the Debentures. The warrants have been valued at approximately
$291,000, based on the Black Scholes Pricing Model utilizing the following
assumptions: expected life of 5.0 years; volatility of 119 percent, and risk
free borrowing rate of 4.405 percent. This amount has been recorded as a
discount against the debt and will be accreted as interest expense over the
remaining life of the debt. In addition, in accordance with Emerging Issues Task
Force Issue No. 98-5, an embedded beneficial conversion feature of approximately
$291,000 has been recognized as additional paid-in-capital and will be accreted
as additional interest expense over the remaining life of the debt. Through
October 31, 2002, $272,000 of the above discounts has been accreted. The
Debentures are secured by all assets of the Company, which security interest is
junior to the security interest granted to the Company's existing senior lender.
The holder of each Debenture is entitled, at its option, to convert at any time
the principal amount of the Debenture or any portion thereof, together with
accrued but unpaid interest, into shares of the Company's Common Stock at a
conversion price for each share of Common Stock equal to the lower of (a) $1.16
or (b) 100% of the average of the two lowest closing bid prices of the Common
Stock on the principal market during the twenty consecutive trading days ending
with the last trading day prior to the date of conversion. The conversion price
9
may not be less than the floor price of $0.65, except to the extent that the
Company does not exercise its right to redeem the Debentures.
The agreement with the investors contains a requirement for the Company to have
effected the registration of a sufficient number of shares of its Common Stock
by July 2, 2002 or incur penalties equal to: (1) 2% of the product obtained by
multiplying the average closing sale price for the immediately preceding 30-day
period times the number of registrable securities the investor holds or may
acquire pursuant to conversion of the Convertible Debenture and the exercise of
Warrants on the last day of the applicable 30-day period (without giving effect
to any limitation on conversion or exercise) and (2) 3% of the product for all
continuing or subsequent registration defaults.
Although the Company filed the required registration statement with the
Securities and Exchange Commission within the required time period, such
registration statement has not yet been declared effective and as such, the
Company is currently in default of its Registration Rights Agreement with the
Debenture holders and is incurring the penalties described herein. Pursuant to
an agreement dated September 27, 2002, the Company issued an aggregate of 60,736
shares of Common Stock to the investors in exchange for the cancellation of
penalties incurred through August 1, 2002. As of October 31, 2002, penalties
under this default amounted to approximately $282,000.
Also, the Debentures contain a provision which reduces the conversion price by
five percent (5%) if the Company's Common Stock into which the Debenture is
converted is not listed on NASDAQ National Market or NASDAQ Smallcap Market on
the conversion date and will be reduced by an additional five percent (5%) on
such date if the Common Stock is also not listed on the Over-The-Counter
Bulletin Board (without, in either such case, regard to the Floor Price). The
conversion price is subject to further reduction in the event the Company sells
Common Stock below the applicable conversion price.
(6) RECENT ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards ("SFAS") No. 141, "Business Combinations," and
SFAS No. 142, "Goodwill and Other Intangible Assets" (collectively "the
Standards"). The Standards require all business combinations initiated after
June 30, 2001 to be accounted for using the purchase method of accounting, that
goodwill no longer be subject to amortization but rather be reviewed
periodically for impairment and that other identifiable intangibles be separated
and those with finite lives be amortized over their useful lives. Goodwill and
intangible assets with indefinite lives must be assessed once a year for
impairment and more frequently if circumstances indicate a possible impairment.
The first step of the two-step impairment assessment identifies potential
impairment and compares the fair value of the applicable reporting unit with its
carrying amount, including goodwill. If the fair value of the reporting unit
exceeds its carrying value, goodwill of the reporting unit is not considered
impaired, and the second step of the impairment test is not necessary. If the
carrying value of the reporting unit exceeds its fair value, the second step of
the impairment test shall be performed to measure the amount of impairment loss,
if any. The Company was required to adopt these provisions on May 1, 2002;
however, it elected to early adopt the Standards on May 1, 2001 as permitted and
evaluated the carrying value of its goodwill and other intangible assets. Based
on its evaluation, which, in part, was based on certain fair value assumptions,
the Company determined that there is no impairment to its goodwill and other
intangible assets. Subsequent impairment tests will be performed, at a minimum,
in the fourth quarter of each fiscal year, in conjunction with the Company's
annual planning process.
10
The Company was assisted in its measurement of fair value by an independent
valuation firm. The measurement of fair value was based on an evaluation of
future discounted cash flows, public company trading multiples and merger and
acquisition transaction multiples. The Company's discounted cash flow evaluation
used a range of discount rates that corresponds to the Company's weighted
average cost of capital. This discount range is consistent with that used for
investment decisions and takes into account the specific and detailed operating
plans and strategies of the reporting unit.
Goodwill is no longer amortized under SFAS No. 142.
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement
Obligations," which addresses financial accounting and reporting for obligations
associated with the retirement of tangible long-lived assets and the associated
retirement costs. SFAS No. 143 applies to legal obligations associated with the
retirement of long-lived assets that result from the acquisition, construction,
development and normal operation of long-lived assets except for certain
obligations of lessees. The provisions of this Statement are required to be
applied starting with fiscal years beginning after June 15, 2001. The Company
adopted the new accounting standard on existing long-lived assets during the
quarter ended July 31, 2002. There was no impact on the Company's financial
position or results of operations for the quarter as a result of adopting this
standard.
In August 2001, the FASB issued 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
supercedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and
Long-Lived Assets to Be Disposed Of," and the accounting and reporting
provisions of Accounting Principles Board ("APB") Opinion No. 30, "Reporting the
Results of Operations - Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions," for the disposal of a segment of a business. This Statement also
amends Accounting Research Bulletin No. 51, "Consolidated Financial Statements,"
to eliminate the exception to consolidation for a subsidiary for which control
is likely to be temporary. The Company adopted the new accounting standard on
existing long-lived assets during the quarter ended July 31, 2002. There was no
impact on the Company's financial position or results of operations for the
quarter as a result of adopting this standard.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No.
4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections."
This Statement eliminates the automatic classification of gain or loss on
extinguishment of debt as an extraordinary item of income and requires that such
gain or loss be evaluated for extraordinary classification under the criteria of
APB Opinion No. 30. This Statement also requires sale-leaseback accounting for
certain lease modifications that have economic effects that are similar to
sale-leaseback transactions and makes various other technical corrections to
existing pronouncements. This Statement will be effective for the Company for
the fiscal year ending April 30, 2004. The Company does not believe that
adoption of this Statement will have a material effect on the Company's results
of operations or financial position.
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities." SFAS No. 146 will supercede Emerging Issues
Task Force Issue No. 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring)." SFAS No. 146 requires that costs associated
with an exit or disposal plan be recognized when incurred rather than at the
date of a commitment to an exit or disposal plan. SFAS No. 146 is to be applied
prospectively to exit or disposal activities initiated after December 31, 2002.
The Company does not believe that adoption of this Statement will have a
material effect on the Company's results of operations or financial position.
11
(7) SUPPLEMENTAL DISCLOSURE OF CASH FLOWS
Cash paid relating to interest during the three and six months ended October
31 (in thousands):
Three Three Six Six
Months Months Months Months
-----------------------------------------------
2001 2002 2001 2002
-----------------------------------------------
Interest paid $ 447 $ 548 $ 978 $ 1,047
(8) LEGAL PROCEEDINGS
On September 22, 2000, Petsmart, Inc. filed a complaint against the Company in
the Superior Court of Maricopa County, Arizona. Petsmart has alleged that it has
been damaged by the Company's failure to satisfactorily complete work
contemplated by an agreement between the parties. Damages were unspecified. At a
settlement meeting held on April 17, 2002, discussions were held in which
Petsmart proposed a series of settlement offers under which the Company would
pay damages ranging between $7,000,000 and $8,000,000. In a letter to the
Company dated May 3, 2002, Petsmart proposed settlement offers under which the
Company would pay damages ranging between $5,000,000 and $7,000,000. The Company
believes that it has meritorious defenses to the claims and it intends to defend
this vigorously. Datatec has further counter-claimed against Petsmart for
amounts owing to the Company under the contract.
(9) RESTATEMENT OF FINANCIAL STATEMENTS
During fiscal 2002, the Company determined that it should have included indirect
costs as a component of cost of revenue in its previously issued financial
statements. Also, the Company identified certain errors in its previously issued
financial statements related to total estimated contract values, total costs
incurred with certain long term contracts and certain accrued and prepaid
expenses. As a result, the Company has restated its previously issued financial
statements for the three and six months ended October 31, 2001.
A summary of the significant effect of the restatement is set forth below.
As
Three months ended Previously Restatement
October 31, 2001: Reported Adjustment As Restated
- ------------------ ---------- ----------- -----------
Gross profit $7,306,000 ($1,496,000) $5,810,000
Operating income (loss) $292,000 ($437,000) ($145,000)
Net loss ($324,000) ($437,000) ($761,000)
Net loss per share - basic ($0.01) ($0.01) ($0.02)
Net loss per share - diluted ($0.01) ($0.01) ($0.02)
Six months ended October
31, 2001:
- ------------------------
Gross profit $13,680,000 ($3,052,000) $10,628,000
Operating loss ($737,000) ($770,000) ($1,507,000)
Net loss ($2,105,000) ($770,000) ($2,875,000)
Net loss per share - basic ($0.06) ($0.02) ($0.09)
Net loss per share - diluted ($0.06) ($0.02) ($0.09)
12
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion of results of operations and financial condition is
based upon and should be read in conjunction with Datatec's Consolidated
Financial Statements and Notes for the year ended April 30, 2002. The following
discussion also gives effect to the restatement and change in accounting
discussed in Notes 2 and 9 to the condensed consolidated financial statements.
FORWARD-LOOKING STATEMENTS
This quarterly report on Form 10-Q contains "forward-looking statements" within
the meaning of the Private Securities Litigation Reform Act of 1995. These
statements can sometimes be identified by the use of forward-looking words such
as "anticipate," "believe," "estimate," "expect," "intend," "may," "will," and
similar expressions. These statements are based on management's current
expectations and are subject to risks, uncertainties and assumptions. Should one
or more of these risks or uncertainties materialize or should underlying
assumptions prove incorrect, actual results may vary materially from those
anticipated, expected, estimated or projected.
The following factors, among others, could cause actual results to differ
materially from those described in the forward-looking statements: changes in
demand for, or in the mix of, Datatec's services; project delays or
cancellations; cost overruns with regard to fixed price projects; competitive
pressures; general economic conditions; Datatec's inability to replace its
current working capital financing line, and other such factors related to
financing, obtaining new projects and delivering its services at targeted
margins.
RESTATEMENT OF FINANCIAL STATEMENTS
During fiscal 2002, the Company determined that it should have included indirect
costs as a component of cost of revenue in its previously issued financial
statements. Also, the Company identified certain errors in its previously issued
financial statements related to total estimated contract values, total costs
incurred with certain long term contracts and certain accrued and prepaid
expenses. As a result, the Company has restated its previously issued financial
statements for the three and six months ended October 31, 2001. See discussion
in Note 9 to the condensed consolidated financial statements.
CHANGE IN ACCOUNTING
The Company has changed its method of estimating progress toward completion of
its contracts. Under its previous method, the percentage of direct labor
incurred to date to total estimated direct labor to be incurred on a project was
used to determine a contract's percentage of completion, while under the new
method, the percentage of total costs incurred to date to total estimated costs
to be incurred on a project is used to determine a contract's percentage of
completion. The change was made to reflect the effect of non-labor charges and
to more accurately measure a contract's progress towards completion. In
accordance with Accounting Principles Board Opinion No. 20, "Accounting
Changes," paragraph 27, the financial statements of prior periods have been
adjusted to apply the new method retroactively. See discussion in Note 2 to the
condensed consolidated financial statements.
RECENT DEVELOPMENTS
Subordinated Secured Convertible Debentures. On April 3, 2002 the Company raised
$2.0 million of financing (less out-of-pocket transaction costs of $0.170
million) to be used for working capital purposes by issuing an aggregate of $2.0
million principal amount of Subordinated Secured Convertible Debentures and
13
Warrants to purchase an aggregate of 270,000 shares of the Company's Common
Stock at $1.416 per share. The debentures mature on July 2, 2003 and bear
interest at a rate of 5% per annum. The interest is due quarterly on March 31,
June 30, September 30, and December 31 of each year (with the first interest
payment due and payable on September 30, 2002) and is payable in cash or Common
Stock at the Company's option. The Company recorded a discount of $582,000 in
connection with the issuance of the Debentures. The warrants have been valued at
approximately $291,000, based on the Black Scholes Pricing Model utilizing the
following assumptions: expected life of 5.0 years; volatility of 119 percent,
and risk free borrowing rate of 4.405 percent. This amount has been recorded as
a discount against the debt and will be accreted as interest expense over the
remaining life of the debt. In addition, in accordance with Emerging Issues Task
Force Issue No. 98-5, an embedded beneficial conversion feature of approximately
$291,000 has been recognized as additional paid-in-capital and will be accreted
as additional interest expense over the remaining life of the debt. Through
October 31, 2002, $272,000 of the above discounts has been accreted. The
Debentures are secured by all assets of the Company, which security interest is
junior to the security interest granted to the Company's existing senior lender.
The holder of each Debenture is entitled, at its option, to convert at any time
the principal amount of the Debenture or any portion thereof, together with
accrued but unpaid interest, into shares of the Company's Common Stock at a
conversion price for each share of Common Stock equal to the lower of (a) $1.16
or (b) 100% of the average of the two lowest closing bid prices of the Common
Stock on the principal market during the twenty consecutive trading days ending
with the last trading day prior to the date of conversion. The conversion price
may not be less than the floor price of $0.65, except to the extent that the
Company does not exercise its right to redeem the Debentures.
The agreement with the investors contains a requirement for the Company to have
effected the registration of a sufficient number of shares of its Common Stock
by July 2, 2002 or incur penalties equal to: (1) 2% of the product obtained by
multiplying the average closing sale price for the immediately preceding 30 day
period times the number of registrable securities the investor holds or may
acquire pursuant to conversion of the Convertible Debenture and the exercise of
Warrants on the last day of the applicable 30 day period (without giving effect
to any limitation on conversion or exercise) and (2) 3% of the product for all
continuing or subsequent registration defaults.
Although the Company filed the required registration statement with the
Securities and Exchange Commission within the required time period, such
registration statement has not yet been declared effective and as such, the
Company is currently in default of its Registration Rights Agreement with the
Debenture holders and is incurring the penalties described herein. Pursuant to
an agreement dated September 27, 2002, the Company issued an aggregate of 60,736
shares of Common Stock to the investors in exchange for the cancellation of
penalties incurred through August 1, 2002. As of October 31, 2002, penalties
under this default amounted to approximately $282,000.
Also, the Debentures contain a provision which reduces the conversion price by
five percent (5%) if the Company's Common Stock into which the Debenture is
converted is not listed on NASDAQ National Market or NASDAQ Smallcap Market on
the conversion date and will be reduced by an additional five percent (5%) on
such date if the Common Stock is also not listed on the Over-The-Counter
Bulletin Board (without, in either such case, regard to the Floor Price). The
conversion price is subject to further reduction in the event the Company sells
Common Stock below the applicable conversion price.
14
SENIOR CREDIT FACILITY. The Company's existing credit facility with IBM Credit
Corporation consists of (i) a $16 million three-year revolving credit facility
and (ii) a $3 million three-year term loan payable in monthly installments of
principal and interest. The borrowings under the revolving line of credit are
based on a formula of 85% of eligible receivables and 25-35% of eligible
inventory. Both the revolving line of credit and the term loan bear interest at
prime plus 4.25%. The amounts outstanding under the credit line as of April 30,
2002 and October 31, 2002 were $14.5 million and $20.3 million, respectively,
while the amounts outstanding under the term loan as of April 30, 2002 and
October 31, 2002 were $3.0 million and $2.4 million, respectively. There were no
additional available borrowings, as defined, as of October 31, 2002. Since
October 31, 2002, IBM Credit Corporation has granted the Company additional
availability as the Company's accounts receivables and inventory have increased.
The maximum amount eligible to be borrowed has been temporarily increased to
$21.0 million. This increase in the maximum amount eligible to be borrowed is
available to the Company through December 31, 2002, at which time, if necessary,
the Company will request and, as has been the case in the past, expects to
receive sufficient borrowing availability to meet its then current needs.
IBM Credit Corporation has notified the Company that it does not intend to renew
the existing revolving credit facility or its term loan beyond August 1, 2003.
Accordingly, the Company is in the process of seeking a replacement for these
facilities. Although the Company believes that it will be able to refinance this
debt, there can be no assurance that it will be able to do so.
BUSINESS DESCRIPTION
Datatec Systems, Inc. and its subsidiaries (the "Company" or "Datatec") are in
the business of providing rapid and accurate technology deployment services and
licensing software tools, designed to accelerate the delivery of complex
Information Technology ("IT") solutions for Technology Providers and
Enterprises. The Company markets its services primarily to large Original
Equipment Manufacturers ("OEM"), systems integrators, independent software
vendors, telecommunications carriers and service providers (collectively,
"Technology Providers") as well as to a select number of "Fortune 2000"
customers in the United States and Canada.
The Company's deployment services include the following: (i) the process of
"customizing" Internetworking devices such as routers and switches and computing
devices such as servers and workstations to meet the specific needs of the user
(hereinafter referred to as "configuration"), (ii) the process of integrating
these hardware devices as well as integrating operational and application
software on a network to ensure that they are compatible with the topology of
the network and all legacy systems (hereinafter referred to as "integration")
and (iii) the process of physically installing technology on networks
(hereinafter referred to as "installation"). Also, the Company licenses its
software tools through its Global Integration Services division to organizations
with their own installation forces.
The Company utilizes internally developed Web-enabled implementation tools that
differentiate its deployment services. These tools, together with its
proprietary processes, allow the Company to rapidly and efficiently deliver high
quality and cost effective large-scale technology deployment solutions to its
clients, which it does primarily on a fixed time/fixed cost basis. The
components of the Company's implementation model are made up of a combination of
people, processes and technology that include:
o The utilization of eDeploy(TM), a Web-based software tool that provides
collaboration capabilities for remote planning and design, communication
capabilities through fax, voice, data, or digital photographs and
monitoring capabilities, ensures that best practices are employed and
that mission critical milestones or timelines are escalated to
supervisory levels if missed by the responsible parties. These features
and others are designed to enhance the speed, accuracy and productivity
of the deployment process.
15
o The utilization of IW2000 provides automation and mass customization in
the configuration/integration of Computing and Internetworking devices
as well as application and operational software. This automation
significantly reduces labor costs through time savings as well as
through reduced technical skill level requirements.
o Two (2) staging and configuration centers at which the Company carries
out most of its complex integration and configuration processes. By
conducting these activities at Datatec's staging centers, and utilizing,
where applicable, its software tools, the Company is able to prepare and
rollout project components so that they arrive at a customer site in a
"plug and play" state. In this way, customers' operations are minimally
disrupted.
o A field deployment force capable of delivering all types of complex
technologies due to the "plug and play" nature of the Company's
"configuration/integration" process.
The Company operates out of 15 offices and has a field deployment team of
approximately 585 people, allowing it to conduct multiple, simultaneous
large-scale deployments across the United States and Canada. The Company's
deployment capabilities further enable Technology Providers to rapidly increase
the "absorption" of their products in the marketplace.
CRITICAL ACCOUNTING POLICIES
The Company's deployment services are generally provided at a fixed contract
price pursuant to purchase orders or other agreements with its customers, while
its software licensing is done on a "per seat" basis over a specified period of
time and its Application Service Provider ("ASP") activities are based on usage.
Services from deployment activities are performed primarily under long-term
contracts but may be performed under short-term workorders or time and material
arrangements. The Company's typical long-term contract contains multiple
elements designed to track the various services required under the arrangement
with the customer. These elements are used to identify components of progress
billings but are combined for revenue recognition purposes. The Company
recognizes revenue earned under long-term contracts utilizing the percentage of
completion method of accounting by measuring a contract's percentage of
completion as determined by the percentage of total costs incurred to date to
total estimated costs. Contracts are reviewed at least quarterly and if
necessary, revenue, costs and gross margin are adjusted prospectively for
revisions in estimated total contract value and total estimated contract costs.
Estimated losses are recognized when identified.
In certain cases, the Company procures materials for customers that are for use
by other service providers. Costs related to these materials are recorded as
inventory when the goods are received by the Company, and revenue and the
related cost are recognized when these goods are shipped to the customer or its
designee. Revenue and related cost of revenue for the three and six months ended
October 31, 2002 amounted to approximately $0.600 million and $0.459 million,
respectively. Revenue and related costs of these materials for the three and six
months ended October 31, 2001 were immaterial and not accounted for separately.
Payment milestones differ according to the customer and the type of work
performed. Generally, the Company invoices customers and payments are received
throughout the deployment process and, in certain cases, in advance of work
performed if a substantial amount of up front costs is required. In certain
cases, payments are received from customers after the completion of site
installation. However, revenue and costs are only recognized on long-term
contracts to the extent of the contracts' percentage of completion. Unbilled
16
revenue, which is classified as a current asset, is recorded for the amount of
revenue earned in excess of billings to customers. Deferred revenue is recorded
as a current liability for the amount of billings in excess of revenue earned.
The Company's cost of deployment services consists of four main categories:
labor, materials, project expenses and allocated indirect costs. The Company
estimates progress toward completion of its contracts by applying the percentage
of costs incurred to date to total estimated costs to be incurred on a project.
Direct costs (labor, materials, and project expenses) are charged directly to
projects as they are incurred. Indirect costs, which include amortization of the
eDeploy(TM) software and various other overhead expenses, are then applied to
projects and a gross margin is determined. This enables management to track all
costs associated with delivering services to its customers. Project managers and
other field supervisors manage and are evaluated, in part, on how projects'
actual direct costs compare to their estimated direct costs. Operations
management manages and is evaluated, in part, on how projects' actual gross
margins compare to targeted gross margins.
Labor consists of salaries and benefits of the Company's field installation
force as well as staging and configuration personnel. The materials category
includes all materials used in the installation process such as connectors, wall
plates, conduits, and data and electrical cable. Project expenses include travel
and living expenses for the installation teams, equipment rentals and other
costs that are not labor or materials costs. In addition, indirect costs, such
as software amortization, warehouse expense, material handling costs, etc., are
allocated to projects on bases that reflect management's estimate of absorption
of these costs by each project (generally direct labor hours).
The Company capitalizes certain computer software costs incurred in accordance
with Statement of Financial Accounting Standards No. 86, "Accounting for the
Costs of Computer Software to be Sold, Leased or Otherwise Marketed." Also, the
Company capitalizes certain costs of computer software developed or obtained for
internal use in accordance with Statement of Position No. 98-1, "Accounting for
the Costs of Computer Software Developed or Obtained for Internal Use." Once
technological feasibility has been established, software development costs are
captured in the Company's job costing system under specific projects related to
the development effort. Costs related to software developed for external use are
amortized using the greater of the ratio that current gross revenue for a
product bears to the total of current and anticipated future gross revenues for
the product, or a maximum of three years using the straight-line method
beginning when the products are available for general release to customers.
Amortization of the costs of software used in delivery of the Company's services
is charged to cost of revenue as incurred. Costs related to internal use
software are amortized over a period not to exceed three years.
In June 2001, the FASB issued Statement of Financial Accounting Standards No.
142, "Goodwill and Other Intangible Assets." With the adoption of Statement 142,
goodwill is no longer subject to amortization over its estimated useful life.
Rather, goodwill will be subject to at least an annual assessment for impairment
by applying a fair-value-based test. Although the new rules are effective for
fiscal years beginning after December 15, 2001, early adoption is allowed if an
entity's fiscal year begins after March 15, 2001. The Company has elected early
adoption of SFAS No. 142 and based on its evaluation, which, in part, was based
on certain fair value assumptions, the Company determined that there is no
impairment to its goodwill and other intangible assets. Had early adoption not
been elected, the amortization of goodwill would have been $109,000 and $218,000
for each of the three and six months ended October 31, 2001 and 2002.
17
RESULTS OF OPERATIONS
The consolidated statements of operations for the Company for the three and six
months ended October 31 are summarized below (in thousands):
Three Months Three Months
Ended October 31, Ended October 31,
2001 2002
---------------------- --------------------
$ % $ %
---------------------------------------------
Revenue $ 19,598 100.0% $ 33,203 100.0%
Cost of revenues 13,090 66.8% 25,445 76.6%
-------- -------- -------- --------
Gross profit 6,508 33.2% 7,758 23.4%
Selling, general and administrative
expenses 5,954 30.4% 5,211 15.7%
-------- -------- -------- --------
Operating income 554 2.8% 2,547 7.7%
Interest expense (468) (2.4%) (930) (2.8%)
-------- -------- -------- --------
Income before minority interest 86 0.4% 1,617 4.9%
Minority interest (148) (0.7%) -- --
-------- -------- -------- --------
Net (loss) income
($ 62) (0.3%) $ 1,617 4.9%
======== ======== ======== ========
Six Months Ended Six Months Ended
October 31, 2001 October 31, 2002
------------------- --------------------
$ % $ %
------------------------------------------
Revenue $ 37,660 100.0% $ 56,275 100.0%
Cost of revenues 25,406 67.5% 41,991 74.6%
-------- ------- -------- -------
Gross profit 12,254 32.5% 14,284 25.4%
Selling, general and
administrative expenses 12,134 32.2% 10,265 18.2%
-------- ------- -------- -------
Operating income 120 0.3% 4,019 7.2%
Interest expense (1,050) (2.8%) (1,670) (3.0%)
-------- ------- -------- -------
Income (loss) before minority
interest (930) (2.5%) 2,349 4.2%
Minority interest (318) (0.8%) -- --
-------- -------- -------- -------
Net (loss) income ($ 1,248) (3.3%) $ 2,349 4.2%
======== ======== ======== =======
18
REVENUE. Revenue for the three months ended October 31, 2002 and 2001 was $33.2
million and $19.6 million, respectively, representing an increase of 69.4%,
while revenue for the six months ended October 31, 2002 and 2001 was $56.3
million and $37.7 million, respectively, representing an increase of 49.3%. The
increase in revenue for the three and six months is attributable primarily to an
increase in work performed on long-term contracts entered into during the fourth
quarter of fiscal 2002 and the first quarter of fiscal 2003 and related
materials requirements, which comprised a greater portion of the total contract
value than in the prior periods.
GROSS PROFIT. Gross profit for the three months ended October 31, 2002 and 2001
amounted to $7.8 million and $6.5 million, respectively, representing an
increase of 20.0%, while gross profit for the six months ended October 31, 2002
and 2001 was $14.3 million and $12.3 million, respectively, representing an
increase of 16.3%. Gross profit as a percentage of revenue was 23.4% and 33.2%
for the three months ended October 31, 2002 and 2001, respectively, and 25.4%
and 32.5% for the six months ended October 31, 2002 and 2001, respectively. The
decreases in the gross margins are attributed to an increase in the materials
component of revenue and a substantial increase in the number of field personnel
(585 field deployment personnel at October 31, 2002 from 280 field deployment
personnel at July 31, 2002), which resulted in increased down time while these
new employees were being trained and greater than anticipated labor and related
costs incurred on certain projects. Materials typically are sold at gross
margins that are lower than the gross margins realized on the service component
of revenue.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses for the three months ended October 31, 2002 were $5.2
million compared to $6.0 million for the three months ended October 31, 2001,
while selling, general and administrative expenses for the six months ended
October 31, 2002 were $10.3 million compared to $12.1 million for the six months
ended October 31, 2001. As a percentage of sales, selling, general and
administrative expenses were 15.7% for the three months ended October 31, 2002
compared to 30.4% for the three months ended October 31, 2001, while for the six
months ended October 31, 2002 and 2001 selling, general and administrative
expenses as a percentage of sales were 18.2% and 32.2%, respectively. The
decreases in selling, general and administrative expenses as a percentage of
revenue are attributable to a cost reduction program initiated by the Company
during the fiscal year ended April 30, 2001 which carried into the period ended
October 31, 2002.
INTEREST EXPENSE. Net interest expense for the three and six months ended
October 31, 2002 were $0.930 million and $1.67 million, respectively, compared
to $0.468 million and $1.050 million for the three and six months ended October
31, 2001, respectively.
LIQUIDITY AND CAPITAL RESOURCES
CHANGES IN MAJOR BALANCE SHEET CLASSIFICATIONS
CURRENT ASSETS. Current assets as of October 31, 2002 and April 30, 2002
amounted to approximately $46.2 million and $25.8 million, respectively. The
increase of approximately $20.4 million is the result of higher billings,
primarily for materials revenue, generated during the quarter ended October 31,
2002 and deferred materials cost related to certain materials that were billed
but not shipped to certain customers.
CURRENT LIABILITIES. Current liabilities as of October 31, 2002 and April 30,
2002 amounted to approximately $47.8 million and $29.0 million, respectively.
The increase of approximately $18.8 million is attributable primarily to an
increase in short-term borrowing of approximately $5.2 million, an increase in
accounts payable of approximately $5.5 million, an increase in accrued and other
liabilities of approximately $6.4 million and the reclassification of
approximately $1.7 million subordinated secured convertible debentures to
19
current liabilities as they are due in July 2003. The increases in short-term
borrowings and accounts payable are related to funding requirements for
expenditures related to the Company's growth in revenue, while the increase in
accrued and other liabilities is related to an increase in deferred revenue
related to advanced billings on contracts in progress.
CASH FLOW. Cash used in operating activities decreased to $3.9 million for the
six months ended October 31, 2002 as compared to $4.3 million for the six months
ended October 31, 2001. Cash used in operating activities for the six months
ended October 31, 2002 is primarily attributable to increases in unbilled
revenue offset by increases in accounts payable, accrued liabilities and
deferred revenue, while cash used in operating activities for the six months
ended October 31, 2001 is primarily attributable to the net loss for the period
and a decrease in accounts payable, accrued liabilities and deferred revenue.
Short-term borrowings increased by approximately $5.2 million and $4.5 million
for the six months ended October 31, 2002 and 2001, respectively. The borrowed
funds were used primarily to fund the increased expenditures required by the
increased revenues.
LIQUIDITY
Although the Company realized net income of $2.4 million for the six months
ended October 31, 2002, took dramatic measures to cut costs and continues to
manage its cash aggressively, it is still experiencing a significant strain on
its cash resources. The primary reason for the strain on resources is the
increased requirements for expenditures for field personnel, job expenses and
materials related to the increased revenue. As a result, the Company's working
capital financing line regularly remains at or close to its maximum allowable
levels and the average days outstanding on its trade payables have extended
beyond normal credit terms granted by vendors. Furthermore, IBM Credit
Corporation, the Company's working capital lender, has notified the Company that
it does not intend to renew its working capital financing line and term loan
beyond August 1, 2003. As a result, the Company is actively seeking replacement
financing.
Achievement of its fiscal 2003 operating plan, including maintaining adequate
capital resources, depends upon the timing of work performed by the Company on
existing projects, the ability of the Company to gain and perform work on new
projects, the ability of the Company to maintain positive relations with its key
vendors and the ability of the Company to raise permanent capital and replace
its current working capital financing line within the timeframe required to meet
its spending requirements. Multiple project cancellations, delays in the timing
of work performed by the Company on existing projects, the inability of the
Company to gain and perform work on new projects, or the inability of the
Company to raise permanent capital and replace its current working capital
financing line in a timely fashion could have an adverse impact on the Company's
liquidity and on its ability to execute its operating plan.
The Company has taken a variety of actions to ensure its continuation as a going
concern. A summary of recent events and the Company's completed or planned
actions are as follows:
Demand for the Company's services has increased dramatically and the
backlog of contracted business as of December 2, 2002 was at $77.4 million
and its sales pipeline stood at $199.7 million as of that date.
The Company initiated and completed substantial cost saving measures during
the fiscal years ended April 30, 2001 and 2002 and now has a cost structure
in line with its expected revenue.
As a result of the increase in demand for the Company's services and the
cost reduction measures initiated over the past two years, the Company
achieved profitability during the fourth quarter of fiscal 2002 and during
20
each of the first two quarters of fiscal 2003. It expects to maintain
profitability throughout fiscal 2003.
Management has been seeking to replace its working capital financing line
and raise additional permanent capital to support its growth in business.
It is encouraged by the preliminary response it has received from the
financial community and it believes that it will be able to raise the
necessary financing, although there can be no assurance that it will be
able to do so.
The Company was not in compliance with one or more of the financial covenants of
its credit facility as of the quarter ended October 31, 2002. The Company and
IBM Credit Corporation entered into an Acknowledgment, Waiver and Amendment to
the Inventory and Working Capital Financing Agreement for the quarter ended
October 31, 2002.
IBM Credit Corporation has notified the Company that it does not intend to renew
its working capital financing line and term loan beyond August 1, 2003. As a
result, the Company is actively seeking replacement financing.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board ("FASB") issued SFAS No.
141, "Business Combinations," and SFAS No. 142, "Goodwill and Other Intangible
Assets" (collectively "the Standards"). The Standards require all business
combinations initiated after June 30, 2001 to be accounted for using the
purchase method of accounting, that goodwill no longer be subject to
amortization but rather be reviewed periodically for impairment and that other
identifiable intangibles be separated and those with finite lives be amortized
over their useful lives. Goodwill and intangible assets with indefinite lives
must be assessed once a year for impairment and more frequently if circumstances
indicate a possible impairment. The first step of the two-step impairment
assessment identifies potential impairment and compares the fair value of the
applicable reporting unit with its carrying amount, including goodwill. If the
fair value of the reporting unit exceeds its carrying value, goodwill of the
reporting unit is not considered impaired, and the second step of the impairment
test is not necessary. If the carrying value of the reporting unit exceeds its
fair value, the second step of the impairment test must be performed to measure
the amount of impairment loss, if any. The Company was required to adopt these
provisions on May 1, 2002; however, it elected to early adopt the Standards on
May 1, 2001 as permitted and evaluated the carrying value of its goodwill and
other intangible assets. Based on its evaluation, which, in part, was based on
certain fair value assumptions, the Company determined that there is no
impairment to its goodwill and other intangible assets. Subsequent impairment
tests will be performed, at a minimum, in the fourth quarter of each fiscal
year, in conjunction with the Company's annual planning process.
The Company was assisted in its measurement of fair value by an independent
valuation firm. The measurement of fair value was based on an evaluation of
future discounted cash flows, public company trading multiples and merger and
acquisition transaction multiples. The Company's discounted cash flow evaluation
used a range of discount rates that corresponds to the Company's weighted
average cost of capital. This discount range is consistent with that used for
investment decisions and takes into account the specific and detailed operating
plans and strategies of the reporting unit.
Goodwill is no longer amortized under SFAS No. 142.
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement
Obligations," which addresses financial accounting and reporting for obligations
associated with the retirement of tangible long-lived assets and the associated
retirement costs. SFAS No. 143 applies to legal obligations associated with the
retirement of long-lived assets that result from the acquisition, construction,
21
development and normal operation of long-lived assets except for certain
obligations of lessees. The provisions of this Statement are required to be
applied starting with fiscal years beginning after June 15, 2001. The Company
adopted the new accounting standard on existing long-lived assets during the
quarter ended July 31, 2002. There was no impact on the Company's financial
position or results of operations for the quarter as a result of adopting this
standard.
In August 2001, the FASB issued 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
supercedes SFAS Statement No. 121, "Accounting for the Impairment of Long-Lived
Assets and Long-Lived Assets to Be Disposed Of," and the accounting and
reporting provisions of APB Opinion No. 30, "Reporting the Results of Operations
- - Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions," for
the disposal of a segment of a business. This Statement also amends Accounting
Research Bulletin No. 51, "Consolidated Financial Statements," to eliminate the
exception to consolidation for a subsidiary for which control is likely to be
temporary. The Company adopted the new accounting standard on existing
long-lived assets during the quarter ended July 31, 2002. There was no impact on
the Company's financial position or results of operations for the quarter as a
result of adopting this standard.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No.
4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections."
This Statement eliminates the automatic classification of gain or loss on
extinguishment of debt as an extraordinary item of income and requires that such
gain or loss be evaluated for extraordinary classification under the criteria of
APB Opinion No. 30. This Statement also requires sale-leaseback accounting for
certain lease modifications that have economic effects that are similar to
sale-leaseback transactions and makes various other technical corrections to
existing pronouncements. This Statement will be effective for the Company for
the fiscal year ending April 30, 2004. The Company does not believe that
adoption of this Statement will have a material effect on the Company's results
of operations or financial position.
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities." SFAS No. 146 will supercede Emerging Issues
Task Force Issue No. 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring)." SFAS No. 146 requires that costs associated
with an exit or disposal plan be recognized when incurred rather than at the
date of a commitment to an exit or disposal plan. SFAS No. 146 is to be applied
prospectively to exit or disposal activities initiated after December 31, 2002.
The Company does not believe that adoption of this Statement will have a
material effect on the Company's results of operations or financial position.
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
There has been no material change in the market risk of financial instruments
since the Company filed its annual report on Form 10-K for the fiscal year ended
April 30, 2002.
ITEM 4: CONTROLS AND PROCEDURES
Based on their evaluation, as of a date within 90 days of the filing of this
Form 10-Q, the Company's Chief Executive Officer and Chief Financial Officer
have concluded the Company's disclosure controls and procedures (as defined in
Rules 13a-14 and 15d-14 under the Securities Exchange Act of 1934) are
effective. There have been no significant changes in internal controls or in
other factors that could significantly affect these controls subsequent to the
date of their evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
22
PART II - OTHER INFORMATION
ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K
a) Exhibits
Exhibit No. Exhibits
10.1 Acknowledgment, Waiver and Amendment to Financing Agreement
dated December 12, 2002 by and between the Company and IBM
Credit Corporation.
99.1 Certification of Chief Executive Officer.
99.2 Certification of Chief Financial Officer.
b) Reports on Form 8-K
None.
23
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 the
undersigned thereunto duly authorized.
DATATEC SYSTEMS, INC.
Date: December 13, 2002 By: /s/ Albert G. Pastino
---------------------------------
Albert G. Pastino
Chief Financial Officer
24
CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER
Section 302 Certification
I, Isaac J. Gaon, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Datatec
Systems, Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date");
and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors and
the audit committee of registrant's board of directors (or persons
performing the equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes
in internal controls or in other factors that could significantly
affect internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Date: December 13, 2002
-----------------------
/s/ Isaac J. Gaon
-----------------------
Isaac J. Gaon
Chief Executive Officer
25
CERTIFICATION OF PRINCIPAL FINANCIAL OFFICER
Section 302 Certification
I, Albert G. Pastino, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Datatec
Systems, Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date");
and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors and
the audit committee of registrant's board of directors (or persons
performing the equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes
in internal controls or in other factors that could significantly
affect internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Date: December 13, 2002
-----------------------
/s/ Albert G. Pastino
-----------------------
Albert G. Pastino
Chief Financial Officer
26