Business Context and Reporting Period
Company: Data Systems & Software Inc. (Note: Metadata listed "Acorn Energy" is incorrect; filing is for Data Systems & Software Inc.)
Filing Type: Form 10-Q
Period Ended: September 30, 1998
Business Overview: The Company provides computer consulting and development services, acts as a value-added reseller (VAR) of computer hardware, and develops two-way communication solutions for utilities. It also holds a significant investment in Tower Semiconductor Ltd. ("Tower"), accounted for using the equity method due to lack of majority voting control.
Key Financial Metrics
| Metric | Nine Months Ended Sep 30, 1998 | Nine Months Ended Sep 30, 1997 | Three Months Ended Sep 30, 1998 | Three Months Ended Sep 30, 1997 |
|---|---|---|---|---|
| Total Sales | $29,602 | $29,544 | $8,151 | $9,363 |
| Gross Profit | $6,545 | $4,647 | $1,700 | $2,511 |
| Gross Margin | 22% | 16% | 21% | 27% |
| Operating Loss | $(5,290) | $(10,132) | $(1,621) | $(2,427) |
| Net Loss | $(3,874) | $(6,464) | $(4,506) | $(1,403) |
| Net Loss Per Share (Basic) | $(0.53) | $(0.88) | $(0.62) | $(0.19) |
| Cash and Equivalents | $1,055 | $1,424 | -- | -- |
| Short-term Debt | $230 | $2,581 | -- | -- |
| Working Capital | $5.8 million | -- | -- | -- |
Note: All figures in thousands of dollars unless otherwise noted. 1997 figures are restated.
Material Changes vs. Prior Period
- Restatement of Prior Periods: Financial statements for 1997 were restated following an order by the Israel Securities Authority requiring the expensing of previously capitalized software development costs for the subsidiary DSI Israel.
- Operating Performance: Operating loss improved significantly (decreased by 48%) for the nine-month period, driven by a 41% increase in gross profit and a 23% reduction in SG&A expenses. However, the three-month operating loss widened slightly compared to the prior year quarter.
- Equity Income Reversal: Equity income from Tower Semiconductor turned into a significant loss of $2.9 million for the nine months ended September 1998, compared to $3.3 million income in the prior year, due to Tower's declining sales and capacity utilization.
- One-Time Gains and Losses: The Company recognized a $6.0 million gain on the sale of its PHD division in the second quarter of 1998. Conversely, it incurred approximately $2.0 million in "Other expenses" related to the write-off of an affiliate investment and accruals for debt guarantees.
- Liquidity: Short-term debt decreased from $2.58 million to $0.23 million. Cash and cash equivalents declined slightly to $1.055 million, though total liquid assets (including deposits and marketable securities) remained around $3 million.
Guidance, Outlook, Risks, and Unusual Items
- Unusual Items:
- PHD Division Sale: Sold assets and technology to Computer Associates International for ~$7 million, recognizing a ~$6 million gain.
- Affiliate Guarantees: Accrued ~$1.4 million in loss contingencies for guarantees of an affiliate's debt and wrote off the investment in that affiliate.
- Geotek Note: Established a $610 reserve for a doubtful debt related to a note from Geotek, which filed for Chapter 11 bankruptcy.
- Legal Proceedings: Settled litigation with a former employee for $500,000 cash plus 50,000 shares. Ongoing class-action litigation against Tower and the Company regarding alleged misstatements; outcome uncertain.
- Year 2000 Compliance: The Company is reviewing systems for Y2K compliance, expecting to complete remediation by the end of 1999. No significant costs incurred to date, but risks of system failure remain.
- Stock Repurchase: Purchased 139,600 shares of treasury stock in Q3 1998; authorized to purchase up to 500,000 shares total.
- Outlook: Management believes it has adequate liquidity to finance ongoing activities. Future results depend on Tower's performance and the outcome of legal contingencies.
Investor Verification Checklist
- Restatement Impact: Verify the full extent of the impact of the DSI Israel restatement on historical comparability and future earnings.
- Tower Semiconductor Exposure: Assess the severity of Tower's operating losses and the risk of further equity write-downs given the Company's lack of voting control.
- Contingency Accruals: Review the sufficiency of the $1.4 million accrual for affiliate debt guarantees and the potential exposure from the class-action lawsuit.
- Liquidity Constraints: Confirm that the $3 million in liquid assets is sufficient given the restrictions on cash distribution from subsidiaries like Tower and DSI Israel.
- Revenue Sustainability: Evaluate the sustainability of hardware VAR sales, which showed volatility and a decline in Q3 1998.