ACFN

Business Context and Reporting Period

Company: Data Systems & Software Inc. (DSSI)
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2001
Business Overview: DSSI operates through three primary segments: Software Consulting and Development (primarily in Israel), Energy Intelligence Solutions (Comverge subsidiary), and Computer Hardware Sales (Databit subsidiary). In December 2001, the company acquired Endan IT Solutions Ltd., expanding its software capabilities into billing and healthcare sectors.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Decline: Total sales decreased 21% to $45.9 million from $57.8 million in 2000. This was driven by a 36% drop in Software Consulting ($12.2M vs $19.0M), a 19% drop in Energy Intelligence ($13.8M vs $17.1M), and an 8% drop in Hardware Sales ($19.8M vs $21.5M).
• Widening Losses: The company swung from a net income of $112,000 in 2000 to a net loss of $9.8 million in 2001. Operating losses more than doubled to $10.3 million.
• Expense Increases: Research and Development (R&D) expenses more than doubled to $2.3 million (from $0.9 million) due to product development in the energy segment. Selling, General, and Administrative (SG&A) expenses rose 8% to $17.6 million, largely due to new senior management hires at the Comverge subsidiary.
• Liquidity Deterioration: Working capital fell significantly from $18.2 million to $6.9 million. Cash and cash equivalents dropped from $10.9 million to $4.0 million.

Guidance, Outlook, and Risks

• Profitability Outlook: Management does not expect to achieve profitable operations in the first half of 2002 and is uncertain regarding the second half. The Energy Intelligence segment (Comverge) is the primary consumer of cash resources.
• Capital Needs: Comverge must raise outside capital to fund its business plan. If funding is not secured, the subsidiary plans to implement a cost-cutting operating plan by Q2 2002 to achieve breakeven cash flow by Q3 2002. This plan involves curtailing R&D, consolidating operations, and reducing marketing and salary expenses.
• Key Risks:
  • Market Deregulation: The pace of utility deregulation has slowed, potentially delaying the adoption of Comverge's products.
  • Third-Party Manufacturing: Reliance on a single manufacturer (in Chapter 11) for 70% of material purchases poses supply chain risks.
  • Geographic Concentration: Hardware sales are heavily concentrated in the New York City area (84% of segment sales), which was negatively impacted by the September 11th events.
  • Foreign Currency: Fluctuations in the Israeli Shekel (NIS) against the dollar could increase the cost of Israeli operations.
• Backlog: As of January 1, 2002, the total backlog was $24.9 million, with $23.2 million related to the Energy Intelligence segment (primarily a contract with Gulf Power).

Investor Verification Checklist

• Comverge Financing: Verify the status of Comverge's efforts to secure outside investment, as failure to do so will trigger severe cost-cutting measures that may hinder growth.
• Goodwill Impairment: Monitor the impact of the new SFAS No. 142 accounting standard on the $7.7 million in goodwill (mostly from the Endan acquisition), as the company must perform impairment testing in 2002.
• Supplier Risk: Confirm the resolution of supply chain issues regarding the Chapter 11 manufacturer providing 70% of Comverge's components.
• Endan Integration: Assess whether the acquisition of Endan delivers the projected revenue growth and cost synergies in the Israeli software segment.
• Cash Burn Rate: Track the monthly cash burn rate of the Comverge subsidiary against the $4.0 million cash balance to determine runway without new financing.