Business Context and Reporting Period
Company: Data Systems & Software Inc. (DSSI)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 30, 1997
Business Overview: DSSI provides computer consulting, development services, and packaged software products. It also acts as a value-added reseller of computer hardware. The Company holds a significant investment in Tower Semiconductor Ltd. ("Tower").
Accounting Change: Effective December 31, 1996, DSSI ceased consolidating Tower's financial statements due to a change in voting control. Tower is now accounted for using the equity method. Consequently, 1997 results are not directly comparable to 1996 results, which included Tower on a consolidated basis.
Key Financial Metrics (Nine Months Ended Sept 30, 1997)
| Metric | Value (in thousands) |
|---|---|
| Total Sales | $29,274 |
| Gross Profit | $6,775 |
| Operating Loss | $(9,822) |
| Net Loss | $(5,679) |
| Loss Per Share | $(0.77) |
| Cash and Cash Equivalents | $1,035 |
| Working Capital | $3,900 (approx.) |
| Short-term Debt | $2,129 |
| Long-term Debt (net of current) | $560 |
Equity Income: The Company recorded $5,385 in equity income from its investment in Tower Semiconductor Ltd. for the nine-month period.
Material Changes vs. Prior Period
- Revenue Decline: Total sales dropped from $101,145 in the prior year period to $29,274. This decrease is primarily due to the deconsolidation of Tower Semiconductor, which previously contributed significant revenue.
- Operating Loss: The Company shifted from an operating income of $5,844 in the prior year to an operating loss of $(9,822). This is driven by the removal of Tower's profitable operations from the consolidated statement and increased expenses in the Computer Segment.
- Net Loss: Net loss increased significantly from $(109) in the prior year to $(5,679). The prior year included Tower's consolidated net income, whereas the current year reflects only equity income from Tower.
- Cash Flow: Net cash used in operating activities was $(5,429), compared to $17,963 provided in the prior year. This shift is largely due to the change in accounting for Tower and operating losses in the Computer Segment.
- Asset Write-downs: The Company recorded a write-down of approximately $2.0 million in capitalized software development costs during the first nine months of 1997.
Guidance, Outlook, and Risks
Management Commentary:
- Product Development: The Company is investing heavily in the development and marketing of its PHD and CybrCard products. R&D expenses increased due to write-downs of these products in Q1 1997.
- Cost Reduction: Management has begun a program to reduce expenditures related to PHD and CybrCard and is seeking outside financing.
- Liquidity: Working capital decreased due to operating losses. In October 1997, the Company received a $2.7 million cash dividend from Tower (net of taxes), which aids liquidity.
Risks and Contingencies:
- Liquidity Risk: Continued operating losses related to product investments may materially adversely affect liquidity and financial condition. There is no assurance that cost reduction or financing efforts will succeed.
- Asset Valuation: Future write-downs of capitalized software costs (specifically for the EPSM product) could significantly affect operating results.
- Currency Risk: Approximately 10% of sales are in New Israel Shekels (NIS). While most are dollar-linked, inflation in Israel exceeding NIS devaluation could increase dollar costs. The Company does not engage in hedging activities.
Investor Verification Checklist
- Accounting Method Change: Verify the impact of switching Tower Semiconductor from consolidation to equity method on year-over-year comparability.
- Software Write-downs: Confirm the magnitude and future probability of additional write-downs for PHD, CybrCard, and EPSM products.
- Liquidity Position: Assess the sufficiency of the $1.035 million cash balance and the $2.7 million dividend received in October 1997 to fund ongoing operations and product development.
- Financing Status: Monitor the progress of seeking outside financing for the PHD and CybrCard products.
- Debt Obligations: Review the terms of short-term debt ($2.1 million) and current maturities of long-term debt ($1.1 million) to ensure compliance with covenants given the operating losses.