Business Context and Reporting Period
This Form 10-Q covers the quarterly period ended September 30, 2005, for Data Systems & Software Inc. (DSSI). The company operates primarily in two segments: software consulting and development, and computer hardware. A material event during this period was the August 18, 2005, sale of the outsourcing consulting business of its subsidiary, dsIT Technologies Ltd., which is now reported as discontinued operations. The company is refocusing its software segment on defense solutions (sonar technology) and commercial IT solutions.
Key Financial Metrics
| Metric | Nine Months Ended Sep 30, 2005 | Three Months Ended Sep 30, 2005 |
|---|---|---|
| Total Sales | $16,627,000 | $5,273,000 |
| Gross Profit | $3,295,000 (19.8% margin) | $973,000 (18.5% margin) |
| Operating Loss | $(2,045,000) | $(807,000) |
| Net Loss | $(1,138,000) | $(127,000) |
| Cash and Cash Equivalents | $674,000 | $674,000 |
| Working Capital | $1,609,000 | $1,609,000 |
| Total Debt (Current + Long-term) | $492,000 | $492,000 |
Note: Figures are in thousands. Net loss includes a significant gain from discontinued operations.
Material Changes vs. Prior Period
- Revenue: Total sales for the nine months ended September 30, 2005, increased 4.5% to $16.6 million from $15.9 million in the prior year period. However, sales for the third quarter decreased 4.3% to $5.3 million, driven by a decline in computer hardware sales partially offset by growth in software development.
- Profitability: The company reported a net loss of $1.1 million for the nine-month period, compared to $0.9 million in the prior year. This loss was significantly mitigated by a $0.9 million gain on the sale of discontinued operations and $0.8 million in net income from those discontinued operations.
- Discontinued Operations: The sale of the dsIT outsourcing consulting business resulted in a one-time gain of $915,000. Without this transaction, the company's operating losses would have been substantially higher.
- Goodwill: Goodwill decreased from $4.4 million to $0.1 million due to the elimination of goodwill associated with the sold business segment.
Guidance, Outlook, and Risks
- Liquidity: Management believes that unrestricted cash ($0.7 million), restricted cash to be released in November 2005 ($0.4 million), and anticipated profits from US operations will provide sufficient liquidity for the next 12 months.
- Restructuring: Following the sale of the consulting business, dsIT is undergoing a restructuring to focus on defense sonar technology and commercial IT solutions (OncoPro, EasyBill). Management expects professional fees to decrease in the near future.
- Comverge Investment: The company's investment in Comverge has been reduced to zero due to accumulated losses. Future equity income will only be recorded if Comverge recovers to a specific equity level. Comverge has formed a strategic alliance with Cellnet Technology for smart grid solutions.
- Risks:
- Concentration: A significant portion of working capital ($0.4 million) is held in the Israeli subsidiary (dsIT) and is not readily available for US operations due to tax laws and minority interests.
- Contractual Obligations: The company has significant future obligations, including $1.4 million in CEO consulting fees and $2.9 million in potential severance obligations for Israeli employees.
- Market Risk: Exposure to interest rate fluctuations on Israeli lines of credit and foreign currency exchange rates.
Investor Verification Checklist
- Discontinued Operations Impact: Verify the sustainability of earnings without the one-time gain ($915k) and income ($818k) from the sold consulting business.
- Liquidity Constraints: Confirm the availability of the $0.4 million restricted cash in November 2005 and the ability of US operations to generate sufficient cash flow independently.
- CEO Compensation: Review the $1.4 million contractual obligation for CEO consulting fees and its impact on future cash burn.
- Comverge Recovery: Assess the likelihood of Comverge recovering its equity value to allow DSSI to recognize future equity income.
- Debt Covenants: Monitor compliance with bank covenants, particularly regarding the Israeli subsidiary's line of credit.