The following table presents information about the rate of inflation in Israel, the rate of devaluation of the NIS, the rate of inflation in Israel adjusted for the devaluation and, for 2004 through 2006, the devaluation rate of the Yen against the U.S. dollar:
B. LIQUIDITY AND CAPITAL RESOURCES
We have historically financed our operations primarily through sales of equity, issuance of convertible notes and the receipt of grants to fund research and development, as well as from bank loan proceeds. In 2005, we also used cash from operations to finance our operations.
We had working capital (total current assets net of total current liabilities) of $16.5 million as of December 31, 2004, a working capital deficit of $(6.3) million as of December 31, 2005 and working capital of $34.9 million as of December 31, 2006. The decrease in our working capital in 2005 occurred mainly as a result of collecting most of our accounts receivable and our decision to invest funds in long-term marketable securities, which are not included in working capital, partly offset by the repayment of our short-term bank loans, and a decrease in trade payables and deferred income. The increase in our working capital in 2006 occurred mainly as a result of a decrease in the balance of trade payables, accrued expenses and other payables and deferred income.
We had cash, cash equivalents, long-term marketable securities and bank deposits of $85.6 million as of December 31, 2006 compared to $117.8 million as of December 31, 2005, and $77.2 million as of December 31, 2004. Since all of our revenues in 2005 and substantially all of our revenues in 2006 were recognized ratably over a 14-month period from product delivery, the increase of cash, cash equivalents and marketable securities did not result in a corresponding increase in revenues recognized in 2005. We expect that the balance of our cash, cash equivalents and marketable securities will decline in 2007.
The majority of the amount of cash, cash equivalents and marketable securities was invested in securities denominated in U.S. dollars. In 2005, we repaid all of our bank borrowings in the amount of $31.0 million that were outstanding as of December 31, 2004.
In March 2007, we issued convertible notes in the aggregate principal amount of approximately $25.8 million. See below under “–Convertible Notes” for more details.
Net Cash Provided by/Used in Operating Activities
In 2006, we used $31.1 million of cash from operating activities primarily as a result of a decrease of $25.5 million in our deferred income and a decrease of $13.4 million in trade payables, accrued expenses and other payables, offset in part by our net income in the amount of $5.2 million.
In 2005, we generated $72.6 million of cash from operating activities primarily as a result of our net income and a decrease of $54.1 million of trade receivables and other receivables, offset by a decrease of $9.0 million in trade payables and accrued expenses and an increase of $6.9 million in deferred income. A substantial part of the sales related to the receivables collected by us in 2005 were not recognized as revenue in 2005. The decrease in the accounts receivable balance as of December 31, 2005 in comparison to December 31, 2004 resulted from a decrease in deliveries to customers in the last quarter of 2005 in comparison to the last quarter of 2004.
In 2004, we generated $938,000 of cash from operating activities primarily as a result of an increase in trade payables, and deferred income and trading of marketable securities, offset in part by our net loss and an increase in trade receivables.
Net Cash Provided by/Used in Investing Activities
Our principal investing activity relating to our operations has been the purchase of equipment and other fixed assets used in our business. These purchases totaled $3.9 million in 2004, $1.9 million in 2005 and $910,000 in 2006. Our capital expenditures in 2004, 2005 and 2006 were primarily for the procurement of telecommunications equipment and related software tools.
Our investing activities also included primarily the receipt of $58.3 million in 2006, $15.1 million in 2005 and $10.0 million in 2004 from marketable securities that came to maturity, offset by $48.3 million in 2006, $63.8 million in 2005 and $3.0 million in 2004 of investments in marketable securities.
Net Cash Provided by/Used in Financing Activities
In 2006, $1.7 million of cash was provided by financing activities as a result of the exercise of stock options. In 2005, we used $25.0 million in financing activities as we repaid $31.0 million of bank borrowings, offset in part by the receipt of $6.0 million from the exercise of stock options. In 2004, $14.9 million was provided by financing activities as bank borrowings of $31.0 million were offset in part by the payment of $16.2 million in cash to redeem the remaining outstanding principal amount of our convertible subordinated notes.
Convertible Notes
In March 2007, we issued convertible notes in the aggregate principal amount of approximately $25.8 million, resulting in net proceeds to us of approximately $25.0 million. The notes bear interest at the rate of 6% and are linked to the Israeli CPI. The notes are due in March 2017, and are subject to the right of the holders to request early repayment in March 2012. We have a right to force conversion of the notes if the market price of our ordinary shares exceeds $30 per share, subject to certain dilution adjustments, in any 20 trading days within a period of 30 consecutive trading days. If the forced conversion is effected on or prior to March 10, 2010, the notes will be converted based on a price of NIS 52.50 (approximately $12.50) per share. Thereafter, the notes would be converted based on a price of NIS 63.00 (approximately $15.00) per share. In each case, the conversion price is subject to adjustment for customary events.
43
The notes are convertible at the election of the holders into our ordinary shares at the initial conversion price of NIS 52.50 (approximately $12.50) per share if the conversion occurs by March 10, 2010 and at the initial conversion price of NIS 63.00 (approximately $15.00) per share if the conversion occurs thereafter, in each case subject to adjustment for customary events.
We undertook to register the notes on the Tel Aviv Stock Exchange within six months following issuance. If the registration is not concluded by that date, the holders will have the right to request repayment of the principal amount.
Convertible Subordinated Notes
In March 2000, we sold $125 million aggregate principal amount of 5.75% convertible subordinated notes due on April 1, 2005. From 2000 to 2004, we repurchased and redeemed the outstanding balance of the principal amount of our convertible subordinated notes for an aggregate amount of $70.4 million. As a result, as of December 31, 2004, none of the convertible subordinated notes issued in 2000 remained outstanding. The repurchase and redemption of convertible subordinated notes constituted our primary use of cash in financing activities in 2003 and 2004.
Bank Borrowings
On March 30, 2004, we borrowed $16.0 million from a bank in order to finance the early redemption of our convertible subordinated notes. This borrowing bore interest at a rate between 2.08% and 2.17% per year until maturity in May and July 2005. We have paid this loan on its maturity dates from the proceeds of our long-term marketable securities.
In December 2004, we borrowed $15.0 million from a bank at an interest rate of 3.8% per year in order to enhance our working capital in anticipation of an increase of sales. This loan was fully repaid in January 2005.
Working Capitial
We believe that we have sufficient working capital, including the net proceeds from our recent sale of convertible notes, to meet our anticipated operating and capital expenditure requirements for 2007 and 2008. If we do not have available sufficient cash to finance our operations, we may be required to obtain equity or debt financing. We cannot be certain that we will be able to obtain additional financing on acceptable terms or at all.
Government and Other Grants
The Government of Israel encourages research and development projects through the Office of Chief Scientist of the Israeli Ministry of Industry, Trade and Labor, or the OCS, pursuant to the Law for the Encouragement of Industrial Research and Development, 1984, as amended, commonly referred to as the “R&D Law”.
Under the R&D Law, a research and development plan that meets specified criteria is eligible for a grant of up to 50% of certain approved research and development expenditures. The plan must be approved by the Office of the Chief Scientist.
44
In prior years, we relied on grants from the Office of the Chief Scientist to finance a portion of our product development expenditures. During the three years ended December 31, 2006, we recognized research and development grants in an aggregate amount of approximately $4.7 million. As of December 31, 2006, total contingent liabilities to the Office of the Chief Scientist were approximately $6.5 million.
Under the terms of the grants we received from the Office of Chief Scientist, we are obligated to pay royalties of 3% during the first three years following commencement of royalty payments, and 4% to 5% thereafter. Pursuant to a proposed amendment to the R&D Law described below, we expect our royalty rate to be 3% – 5% per annum. Royalties are payable up to 100% of the amount of such grants, or up to 300% as detailed below, linked to the U.S. Dollar, plus annual interest at LIBOR. The payment of royalties is on all revenues derived from the sale of the products developed pursuant to the funded plans, including revenues from licensed ancillary services.
The Israeli government is currently in the process of formulating a proposed amendment to the royalty regulations promulgated under the R&D Law. The amendment proposes changes to the royalty rates, which would vary from company to company based on the amount of its revenues and approval date of its program, up to a rate of 6%, and, as of 2006, an increase to the rate of interest accruing on grants by 1% per year. The amendment proposes to have retroactive effect from January 1, 2006, although there is no assurance as to whether and when it will be adopted.
The R&D Law generally requires that a product developed under a program be manufactured in Israel. However, upon the approval of the Chief Scientist, some of the manufacturing volume may be performed outside of Israel, provided that the grant recipient pays royalties at an increased rate, which may be substantial, and the aggregate repayment amount is increased up to 300% of the grant, depending on the portion of the total manufacturing volume that is performed outside of Israel. The R&D Law further permits the OCS, among other things, to approve the transfer of manufacturing rights outside Israel in exchange for an import of different manufacturing into Israel as a substitute, in lieu of the increased royalties. We have obtained an approval from the Office of the Chief Scientist for manufacturing outside Israel. We intend to keep sufficient manufacturing activities in Israel so that, under certain assumptions, we will be subject to a repayment percentage of up to 150% of the grants we received and an increased royalty percentage payment. The R&D Law also allows for the approval of grants in cases in which the applicant declares that part of the manufacturing will be performed outside of Israel or by non-Israeli residents and the research committee is convinced that doing so is essential for the execution of the program. This declaration will be a significant factor in the determination of the Office of Chief Scientist whether to approve a program and the amount and other terms of benefits to be granted. For example, the increased royalty rate and repayment amount might be required in such cases.
The R&D Law also provides that know-how developed under an approved research and development program may not be transferred to third parties in Israel without the approval of the research committee. Such approval is not required for the sale or export of any products resulting from such research or development. The R&D Law further provides that the know-how developed under an approved research and development program may not be transferred to any third parties outside Israel, except in certain circumstances and subject to the OCS’ prior approval. The OCS may approve the transfer of OCS-funded know-how outside Israel, generally in the following cases: (a) the grant recipient pays to the OCS a portion of the sale price paid in consideration for such OCS-funded know-how (according to certain formulas), or (b) the grant recipient receives know-how from a third party in exchange for its OCS-funded know-how, or (c) such transfer of OCS-funded know-how arises in connection with certain types of cooperation in research and development activities.
45
The R&D Law imposes reporting requirements with respect to certain changes in the ownership of a grant recipient. The law requires the grant recipient and its controlling shareholders and foreign interested parties to notify the Office of the Chief Scientist of any change in control of the recipient or a change in the holdings of the means of control of the recipient that results in a non-Israeli becoming an interested party directly in the recipient, and requires the new interested party to undertake to the Office of the Chief Scientist to comply with the R&D Law. In addition, the rules of the Office of the Chief Scientist may require additional information or representations in respect of certain of such events. For this purpose, “control” is defined as the ability to direct the activities of a company other than any ability arising solely from serving as an officer or director of the company. A person is presumed to have control if such person holds 50% or more of the means of control of a company. “Means of control” refers to voting rights or the right to appoint directors or the chief executive officer. An “interested party” of a company includes a holder of 5% or more of its outstanding share capital or voting rights, its chief executive officer and directors, someone who has the right to appoint its chief executive officer or at least one director, and a company with respect to which any of the foregoing interested parties owns 25% or more of the outstanding share capital or voting rights or has the right to appoint 25% or more of the directors. Accordingly, any non-Israeli who acquires 5% or more of our ordinary shares will be required to notify the Office of the Chief Scientist that it has become an interested party and to sign an undertaking to comply with the R&D Law.
Effective Corporate Tax Rates in Israel
Generally, Israeli companies are subject to corporate tax on their taxable income at the rate of 31% for the 2006 tax year. Following an amendment to the Israeli Income Tax Ordinance [New Version], 1961 (the “Tax Ordinance”), which came into effect on January 1, 2006, the corporate tax rate is scheduled to decrease as follows: 29% for the 2007 tax year, 27% for the 2008 tax year, 26% for the 2009 tax year and 25% for the 2010 tax year and thereafter. Israeli companies are generally subject to capital gains tax at a rate of 25% for capital gains (other than gains deriving from the sale of listed securities) derived from assets purchased after January 1, 2003. However, the effective tax rate payable by a company that derives income from an Approved Enterprise program may be considerably less. For more information, please see “Item 10E. Taxation–Israeli Tax Considerations–Tax Benefits Under the Law for the Encouragement of Capital Investments, 1959.”
Under Israeli tax law, at December 31, 2006, we had accumulated losses for tax purposes amounting to approximately $138 million. These losses are available indefinitely to offset future taxable business income. As of December 31, 2006, our carry forward of capital losses for tax purposes were $39 million. Orckit and each of our subsidiaries are assessed on a stand-alone basis. Therefore, accumulated tax losses in each of the entities can offset future taxable business income only in the entity in which the losses were generated.
Dividend Policy
We have never declared or paid cash dividends on our capital stock. In the foreseeable future, we intend to use any future earnings for the operation and expansion of our business. Accordingly, we do not anticipate paying any cash dividends. Payment of future dividends, if any, will be at the discretion of our board of directors and the audit committee of the Board and will depend on various factors, such as our statutory retained earnings, financial condition, operating results and current and anticipated cash needs.
46
If we declare cash dividends, we will pay those dividends in New Israeli Shekels. Current Israeli law permits holders of our ordinary shares who are non-residents of Israel and who acquired their shares with a non-Israeli currency to repatriate all distributions on these shares in that non-Israeli currency.
Inventory
Inventory in 2005 and 2006 consisted primarily of finished products and raw materials and in 2004 primarily of finished products. Our inventory was $3.5 million as of December 31, 2006, $3.3 million as of December 31, 2005 and $5.5 million as of December 31, 2004. In 2006, our inventory level was similar to that of 2005. In 2006, we wrote off approximately $1.0 million of obsolete inventory due to the release of certain new sub-system line cards for our CM-100 product line. The decrease in inventory levels in 2005 resulted from a decrease in the volume of finished products due to a lower volume of shipments expected in the first quarter of 2006 in comparison to the first quarter of 2005.
C. RESEARCH AND DEVELOPMENT
We focus our research and development efforts on developing new products that address the need for solutions capable of supporting very high bandwidth services in telecommunications networks in metropolitan areas. We obtain extensive product development input from potential users and through participation in industry organizations and standards-setting bodies.
Our research and development staff consisted of 104 employees as of December 31, 2004, 133 employees as of December 31, 2005 and 144 employees as of December 31, 2006, most of whom are located in Israel and hold engineering or other advanced technical degrees. The number of research and development employees increased in 2006 and in 2005 because we increased our research and development efforts related to our CM-100 and CM-4000 product lines. Our gross research and development expenses were approximately $17.7 million in 2004, $16.3 million in 2005 and $17.4 million in 2006. These expenses were offset by grants from the Office of the Chief Scientist of the Ministry of Industry, Trade and Labor of the Government of Israel of approximately $2.7 million in 2004, $173,000 in 2005 and $1.9 million in 2006.
In 2006, the majority of our research and development work was focused on the CM-100 and CM-4000 product lines, addressing software and hardware capabilities. We expect that these efforts will continue and comprise substantially all of our 2007 research and development plan. We expect that we will continue to commit substantial resources to research and development in the future. We believe that a continued commitment to research and development is required to maintain our technical excellence and launch new innovative products in the metro transport and access markets. If our applications for Office of Chief Scientist grants are not approved or partially approved, or if we elect not to receive these grants, our net research and development expenses will increase.
47
D. TREND INFORMATION
The introduction of new data and video services to residential users and enterprises require significantly higher bandwidth support over metro networks. In areas where new high bandwidth services are offered, it is expected that demand for more robust metro products will increase. In response to this trend, we have focused on innovative telecom products for the metro area, where we expect to see a need for equipment upgrade over the coming years with the growth of new high bandwidth service offerings. These services are expected to include “quadruple play” services, that is, a bundled offering of voice, Internet access and high end high-definition (HD) video services, all based on IP protocols, offered by traditional telecom carriers, as well as TV over cellular services, that address video transmissions to advanced 3G and 3.5G handheld devices.
E. OFF-BALANCE SHEET ARRANGEMENTS
We do not have any “off-balance sheet arrangements” as such term is defined in Item 5E of Form 20-F.
F. TABULAR DISCLOSURE OF CONTRACTUAL OBLIGATIONS
The following table of our material contractual obligations as of December 31, 2006 summarizes the aggregate effect that these obligations are expected to have on our cash flows in the periods indicated.
| Payment due by period
($ in thousands)
|
|---|
Contractual Obligations
| Total
| Less than
1 year
| 1-3 years
| 3-5 years
| More
than 5
years
|
|---|
| | | | | | |
|---|
| | | | | |
|---|
| | | | | |
|---|
| Operating Lease Obligations | | | | 380 | | | 380 | 1 | | - | | | - | | | - | |
| Purchase Obligations | | | | 3,889 | | | 3,889 | | | - | | | - | | | - | |
Other Liabilities Reflected on our
Balance Sheet under U.S. GAAP | | | | 22,494 | | | 18,237 | 2 | | - | | | - | | | 4,257 | 3 |
| Total | | | | 26,763 | | | 22,506 | | | - | | | - | | | 4,257 | |
| 1 | Our major premises leases allow for early termination upon advance notice. Accordingly, this amount reflects lease payments for the applicable notice period.. The amount is presented in the 1-3 years column since this is the average life period of our lease obligations. |
48
| 2 | These amounts reflect the trade payables, accrued expenses, deferred income and other payables presented in our balance sheet. |
| 3 | This amount reflects our accrued severance pay liability. The time of its payment, in whole or in part, cannot be predicted and, as a result, this amount is presented in the more than 5 years column. Out of this amount, $3.2 million has been previously funded by our contributions to employee plans. |
In addition, as of December 31, 2006, our contingent liability to the Office of the Chief Scientist in respect of grants received was approximately $6.5 million. This liability is required to be repaid only by royalties based on revenues derived from products (and related services) whose development was funded with these grants. The foregoing table does not include approximately $25.8 million aggregate principal amount of convertible notes since these notes were issued after December 31, 2006. See above under “–Liquidity and Capital Resources–Convertible Notes.”
| ITEM 6. | DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES |
| A. | DIRECTORS AND SENIOR MANAGEMENT |
The following table sets forth certain information with respect to Orckit’s directors and executive officers.
Name
| Age
| Position
|
|---|
| | | |
|---|
| | |
|---|
| | |
|---|
| | |
|---|
| Eric Paneth | 57 | Chairman of the Board and Chief Executive Officer |
| Izhak Tamir | 54 | President and Director of Orckit and Chairman of the Board and Chief Executive Officer of Corrigent Systems |
| Aviv Boim | 40 | Chief Financial Officer |
| Leon Bruckman | 49 | Vice President, Chief Technology Officer of Corrigent Systems |
| Zvi Menahemi | 39 | Vice President, R&D of Corrigent Systems |
| Akio Ogiso | 52 | Vice President, Asia Pacific of Corrigent Systems |
| Oren Maymon | 35 | Vice President, Operations of Corrigent Systems |
| Miri Gelbman | 55 | Outside Director |
| Moshe Nir | 57 | Outside Director |
| Jed M. Arkin | 43 | Director |
| Moti Motil | 54 | Director |
The business experience of each of our directors and executive officers is as follows:
Mr. Paneth has been Chairman of the Board of Directors and Chief Executive Officer of Orckit since its founding in 1990. From 1975 until 1983, Mr. Paneth was a senior engineer in the Israeli Government, and from 1985 to 1990, was head of a technical department in the Israeli Government. From 1983 until 1985, he was employed by Linkabit Inc., in San Diego, California. Mr. Paneth holds an advanced engineering degree from the Israel Institute of Technology, commonly known as the Technion. Since January 2000, Mr. Paneth has been a director of Tikcro Technologies Ltd.
49
Mr. Tamir has been President and a Director of Orckit since its founding in 1990 and Chairman of the Board of Corrigent Systems since 2001 and Chief Executive Officer of Corrigent Systems since May 2007. Mr. Tamir has served as a Director of Gilat Satellite Networks Ltd. and of Scopus Video Networks since 2005. From 1987 until 1989, Mr. Tamir was employed by Comstream Inc., in San Diego, California. From 1985 until 1987, he was vice president of A.T. Communication Channels Ltd., a subsidiary of Bezeq - the Israel Telecommunications Corporation Ltd. From 1978 to 1985, he was a senior engineer in the Israeli Government. Mr. Tamir holds an engineering degree from the Technion and an M.B.A. from Tel Aviv University. Mr. Tamir has been chairman of the board of directors of Tikcro since January 2000 and its chief executive officer since August 2003.
Mr. Boim joined Orckit as Chief Financial Officer in February 1998. From August 1996 until February 1998, he was a banker with BT Alex. Brown Incorporated, an investment banking firm. From August 1993 until August 1996, Mr. Boim was a vice president of Giza Ltd., Tel Aviv, an investment banking firm. Mr. Boim holds a B.A. and an M.A. in economics and management from Tel Aviv University and an L.L.B. from Tel Aviv University Law School.
Mr. Bruckman joined Orckit in 1999 and currently serves as the Chief Technology Officer of Corrigent Systems. From September 2000 to February 2005, Mr. Bruckman served as Vice President and Chief System Architect of Corrigent Systems and from November 1999 to September 2000 Mr. Bruckman served as Vice President of system engineering of Corrigent Systems. From April 1996 to October 1999, Mr. Bruckman was Vice President of research and development and system engineering at HyNEX, which was acquired by Cisco. From August 1982 to March 1996, Mr. Bruckman held several positions with the access division of Tadiran Telecommunications, of which the last position was director of research and development. Mr. Bruckman holds a B.Sc. in Electrical Engineering from the Technion Institute and an MBA from Bar-Ilan University, Israel.
Mr. Menahemi has been Vice President of R&D of Corrigent Systems since April 2005. From January 2000 until April 2005, Mr. Menahemi was a project manager for Orckit. From 1997 to 2000, Mr. Menahemi served as hardware director for ADC Teledata Ltd. From 1995 until 1997, Mr. Menahemi served as senior system architecture engineer in Lannet. From 1989 to 1995, he was served as a senior engineer in the Israeli Defense Forces. Mr. Menahemi holds a B.Sc. degree in Electrical Engineering from Tel Aviv University.
Mr. Ogiso has been Vice President of Asia Pacific for Corrigent Systems since November 2005. From 2003 until 2005, Mr. Ogiso served as a country manager in Japan for Corrigent. From 1990 until 2002, Mr. Ogiso was employed by AT&T, which later became Lucent Technologies, where he served as managing director of customer operations/project management in Tokyo, Japan. From 1988 to 1990, he was a system division director for Raychem Corporation. From 1980 until 1988, he was employed by SECOM Co., Ltd. Mr. Ogiso holds a B.Sc. in Applied Mathematics from the Science University of Tokyo.
Mr. Maymon has served as Vice President, Operations of Corrigent Systems since March 2007. From 2000 to 2007, he served as a Purchasing Manager and as Planning and Supply Chain Director of Corrigent Systems. From 1995 to 2000, Mr. Maymon served as a Purchasing Manager of Mobilecomm Communications Ltd. Mr. Maymon holds a practical engineering degree in Industry and Management from the Israeli Government Institute for Technology.
Ms. Gelbman has been a Director of Orckit since November 2002. Ms. Gelbman has served since 1999 as founder and General Manager of Milgal Ltd., an Israeli privately-owned appliance distribution and service company. From 1984 to 1998, she was employed by IBM Israel in various positions. Her last role with IBM was as Manager of Quality and Customer Relationship Management (CRM).
50
Mr. Nir has been a Director of Orckit since November 2002. Mr. Nir has served since 1990 as Founder and CEO of privately-held Business Directions Ltd., a distributor of analytic management software. From 1985 to 1990, he served as manager of the economics and control department and member of the Executive Board of Elite Industries Ltd., a publicly traded food manufacturer in Israel. From 1974 to 1985, he held senior financial and control positions with Tempo Breweries and Soft Drinks Ltd., Tadiran Electronics Industries Ltd. and Clal Israel Ltd. He holds a B.A. degree in economics from Tel Aviv University, and an M.B.A. and Post Graduate Diploma in Computer and Information Sciences from the Recanati School of Management, Tel Aviv University.
Mr. Arkin has been a Director of Orckit since August 2001. From January 2000 through April, 2007, Mr. Arkin served as Chairman of MadahCom, Inc, a manufacturer of digital wireless public alerting systems. MadahCom was acquired by Cooper Industries (NYSE: CBE) in April, 2007. From March 2005 until April 2007, Mr. Arkin served as a director of Shamir Optical Industries Ltd. Since January 2005 he has been a director, and is currently Chairman, of Mosaic Crystals Ltd., a developer of Gallium Nitride semiconductor materials. From 1999 to 2001, he served as General Manager of merchant banking for Oscar Gruss & Son, a New York-based investment bank. From 1995 to 1998, Mr. Arkin served as Vice President of The Challenge Fund, an Israeli venture capital firm. He holds a B.A. from St. John’s College in Annapolis, Maryland, an M.B.A. from Harvard Business School and a J.D. from Harvard Law School.
Mr. Motil has been a Director of Orckit since November 2002. Mr. Motil has served since 1996 as Vice President Finance and an associate of Palmot Ltd., an investment company based in Israel, and has also served since 2006 as Chief Financial Officer of Gan-Bair Senior Citizen Residence Ltd., a subsidiary of Palmot Ltd. From 1991 until 1996, he served as Chief Financial Officer of the Israeli subsidiary of Jan-Bell Marketing Inc., a retail company. Mr. Motil holds a B.A. degree in economics and accounting from Tel-Aviv University and he is a C.P.A.
There are no family relationships between any of our directors or executive officers. There are no arrangements or understandings between any of our directors or executive officers and any other person pursuant to which our directors or executive officers were selected.
The aggregate direct remuneration paid by us to all persons as a group (12 persons,) who served in the capacity of director or executive officer in 2006, including the remuneration of Eric Paneth and Izhak Tamir detailed below, was approximately $3.0 million, which includes approximately $410,000 of pension, retirement or similar benefits, expenses reimbursed (including professional and other business association dues and expenses) and other fringe benefits. In 2006, we granted to this group (excluding Messrs. Paneth and Tamir) options to purchase an aggregate of 85,000 ordinary shares under the Orckit Israeli Share Incentive Plan. All of these options are contingent upon meeting various performance goals in addition to their vesting period. The options have an exercise price of $8.90 per share, which represented the market price of our ordinary shares on the date of grant. These options will expire in September 2013. In addition, 160,000 options which were granted in 2005 contingent upon meeting various performance goals had their goals modified in 2006.
51
Employment Agreements with Eric Paneth and Izhak Tamir
In 1993, we entered into an employment agreement with each of Mr. Paneth and Mr. Tamir. These agreements were extended several times over the years without modification of the employment terms. The original agreement with each of them provided, among other things, for an annual bonus based on specified percentages of our pre-tax income for the applicable year. No bonus was paid under this provision in 2003 or 2004. After review of our expected results for 2005, we concluded that the bonus based on pre-tax income for 2005 was going to be significant. Based on our publicly announced projection in April 2005 of $15.0 million of net income for 2005, the bonus for each of Mr. Paneth and Mr. Tamir based on pre-tax income of 2005 would have amounted to approximately $730,000. With the consent of Messrs. Paneth and Tamir, we reduced the rate of the annual bonus based on pre-tax income and eliminated any such bonus for 2005 with respect to the first $15.0 million of pre-tax income, as detailed below. Since our actual pre-tax income for 2005 was $22.2 million, the related bonus for each of Mr. Paneth and Mr. Tamir would have been approximately $1.1 million under the original agreement. Pursuant to the amended agreement, the related bonus for each of them was approximately $217,000.
Pursuant to the amended employment of each of Mr. Paneth and Mr. Tamir, each is entitled to an annual bonus based on our results of operations for 2006 and each subsequent fiscal year equal to the sum of: (i) 1.0% of the first $5.0 million of pre-tax income; (ii) 2.0% of pre-tax income between $5.0 million and $15.0 million; (iii) 3.0% of pre-tax income in excess of $15.0 million; and (iv) 0.25% of revenues. However, for 2005, the bonus with respect to pre-tax income was payable only to the extent that the amount of our pre-tax income exceeded $15.0 million and then only to the extent of 3% of the excess. The rate of the bonus based on revenues, equal to 0.25% of our revenues in each year, was not modified from the original agreement. As a result of these provisions, each of Mr. Paneth and Mr. Tamir received a bonus of approximately $214,000 with respect to 2006.
The original employment agreement of each of Mr. Paneth and Mr. Tamir provided for a base salary payable in NIS, linked to the Israeli CPI, and customary employee benefits, such as managers’ insurance and employment fund, which are grossed up to cover income tax liabilities, and a company car (or, at the employee’s election, a cash payment added to the base salary in lieu of a car). Under the original employment agreement, the base salary and employee benefits increased by 15% per year. Accordingly, the base salary and employee benefits for each of Mr. Paneth and Mr. Tamir for 2005 would have been approximately $630,000 (based on the exchange rate on March 31, 2005 of NIS 4.361 to one U.S. dollar).
The amended employment agreements reduced the base salary and employee benefits for 2005 of each of them, effective January 1, 2005, to the amount of NIS equal to $570,000 (based on the exchange rate on March 31, 2005 of NIS 4.361 to one U.S. dollar) and reduced the annual percentage used to adjust base salary from 15% to 5%, but subject to adjustments pursuant to the Israeli CPI beginning in 2006. The dollar equivalent of the salary will fluctuate in accordance with fluctuations of the exchange rate of the NIS to the U.S. dollar. There also may be adjustments as a result of changes in tax, national insurance and other applicable laws from time to time. Accordingly, the base salary and employee benefits of each of Mr. Paneth and Mr. Tamir for 2006 were approximately $605,000 (based on the average exchange rate in 2006 of NIS 4.452 to one U.S. dollar).
52
The employment agreement of each of Mr. Paneth and Mr. Tamir is not for a specific term and requires six months advance notice by either us or the employee to terminate the employment agreement. Upon termination of the employment for any reason by either us or by the employee, we would make a severance payment equal to the employee’s last monthly salary multiplied by the number of years that he worked for us. According to Israeli labor law, this is the amount of severance generally payable to any employee who is terminated by his employer. In the event that the employment of Mr. Paneth or Mr. Tamir is terminated under circumstances in which we would not be required to pay the full amount of severance pursuant to Israeli labor law, his non-competition period will be extended from one to two years in consideration of receiving the additional amount. Since we reserve for these severance payments in our financial statements on an ongoing basis, as required by generally accepted accounting principles, we do not expect to recognize an additional accounting expense for these severance payments upon the termination of employment. Neither employment agreement provides for any other payments or “golden parachutes” upon termination of employment. The amendments to the employment agreements with Mr. Paneth and Mr. Tamir were approved by our shareholders at our 2005 Annual General Meeting.
Corporate Governance Practices
We are incorporated in Israel and therefore are subject to various corporate governance practices under the Israeli Companies Law, 1999, or the Companies Law, relating to such matters as outside directors, the audit committee, the internal auditor and approvals of interested party transactions. These matters are in addition to the ongoing listing conditions of the Nasdaq Global Market and other relevant provisions of U.S. securities laws. Under the Nasdaq rules, a foreign private issuer may generally follow its home country rules of corporate governance in lieu of the comparable Nasdaq requirements, except for certain matters such as composition and responsibilities of the audit committee and the independence of its members. We plan to follow the Companies Law, the relevant provisions of which are summarized in this Annual Report, rather than comply with the Nasdaq requirements relating to the quorum for shareholder meetings, shareholder approval with respect to issuance of securities and sending annual reports to shareholders.
Nasdaq Requirements
Under the Nasdaq rules, a majority of our directors are required to be “independent directors” as defined in Nasdaq’s rules. We are also required to have an audit committee, all of whose members are “independent directors” as defined in Nasdaq’s rules. Four out of the six members of our board of directors, namely, Messrs. Arkin, Nir and Motil and Ms. Gelbman, are independent directors under the Nasdaq requirements. Messrs. Nir and Motil and Ms. Gelbman are the members of our audit committee.
We have adopted an audit committee charter as required by the Nasdaq rules. Our audit committee assists the board of directors in fulfilling its responsibility for oversight of the quality and integrity of our accounting, auditing and financial reporting practices and financial statements and the independence qualifications and performance of our independent auditors. The audit committee also has the authority and responsibility to oversee our independent auditors, to recommend for shareholder approval the appointment and, where appropriate, replacement of our independent auditors and to pre-approve audit fees and all permitted non-audit services and fees. Our audit committee is also authorized to act as our “qualified legal compliance committee”. As such, our audit committee will be responsible for investigating reports, made by attorneys appearing and practicing before the SEC in representing us, of perceived material violations of U.S. federal or state securities laws, breaches of fiduciary duty or similar material violations of U.S. law by us or any of our agents.
53
The Nasdaq rules require that director nominees be selected or recommended for the board’s selection either by a committee composed solely of independent directors or by a majority of independent directors. The compensation of a company’s chief executive officer and other executive officers is required to be approved either by a majority of the independent directors on the board or a committee comprised solely of independent directors. Our audit committee, which is composed solely of independent directors, is authorized to also act as the nominating committee and compensation committee. Under the Nasdaq rules, the approval of the audit committee is also required to effect related-party transactions that would be required to be disclosed in our annual report.
Israeli Companies Law
Board of Directors
According to the Companies Law and our articles of association, the oversight of the management of our business is vested in our board of directors. The board of directors may exercise all powers and may take all actions that are not specifically granted to our shareholders. As part of its powers, our board of directors may cause us to borrow or secure payment of any sum or sums of money for our purposes, at times and upon terms and conditions as it thinks fit, including the grant of security interests in all or any part of our property. Our board of directors may consist of between three and seven directors and currently consists of six directors.
Under the Companies Law, our board of directors must determine the minimum number of directors having financial and accounting expertise, as defined in the regulations, that our board of directors should have. In determining the number of directors required to have such expertise, the board of directors must consider, among other things, the type and size of the company and the scope and complexity of its operations. Our board of directors has determined that we require at least one director with the requisite financial and accounting expertise and that Mr. Motil has such expertise.
Our directors are elected at annual meetings of shareholders by a vote of the holders of at least 66-2/3% of the ordinary shares voting thereon. Directors generally hold office until the next annual meeting of shareholders. Our annual meeting of shareholders is required to be held at least once during every calendar year and not more than fifteen months after the last preceding meeting. The board of directors generally may temporarily fill vacancies in the board. Directors may be removed earlier from office by a resolution passed at a general meeting of shareholders by a vote of the holders of at least 75% of the ordinary shares voting thereon.
A resolution proposed at any meeting of the board of directors is deemed adopted if approved by a majority of the directors present and voting on the matter.
54
Outside Directors
Qualifications of Outside Directors
Under the Israeli Companies Law, companies incorporated under the laws of Israel whose shares are listed for trading on a stock exchange or have been offered to the public in or outside of Israel are required to appoint at least two outside directors. Outside directors are required to possess professional qualifications as set out in regulations promulgated under the Companies Law. Pursuant to our articles of association, we may appoint up to three outside directors. The Companies Law provides that a person may not be appointed as an outside director if the person or the person’s relative, partner, employer or any entity under the person’s control has, as of the date of the person’s appointment to serve as an outside director, or had, during the two years preceding that date, any affiliation with:
| | — | any entity controlling the company; or |
| | — | any entity controlled by the company or by its controlling entity. |
The term affiliation includes:
| | — | an employment relationship; |
| | — | a business or professional relationship maintained on a regular basis; |
| | — | service as an office holder, excluding service as an office holder during the three-month period in which the company first offers its shares to the public. |
The Companies Law defines the term “office holder” of a company to include a director, the chief executive officer and any officer of the company who reports directly to the chief executive officer.
No person can serve as an outside director if the person’s position or other business creates, or may create, a conflict of interest with the person’s responsibilities as an outside director or may otherwise interfere with the person’s ability to serve as an outside director.
Until two years from termination of office, a company may not engage an outside director to serve as an office holder and cannot employ or receive services from that person, either directly or indirectly, including through a corporation controlled by that person.
Election of Outside Directors
Outside directors are elected at meetings of shareholders by a vote of the holders of at least 66-2/3% of the ordinary shares voting thereon, provided that either:
55
| | — | at least one third of the shares of non-controlling shareholders voted at the meeting vote in favor of the outside director's election; or |
| | — | the total number of shares of non-controlling shareholders that voted against the election of the outside director does not exceed one percent of the aggregate voting rights in the company. |
The initial term of an outside director is three years and may be extended for one additional term of three years. Thereafter, he or she may be reelected by our shareholders for additional periods of up to three years each only if the audit committee and the board of directors confirm that, in light of the external director’s expertise and special contribution to the work of the board of directors and its committees, the reelection for such additional period is beneficial to the company. Outside directors may be removed from office only by a vote of the holders of at least 66-2/3% of the ordinary shares voting thereon, or by a court, and only if the outside directors cease to meet the statutory qualifications for their appointment or if they violate their duty of loyalty to the company. Each committee of a company’s board of directors that exercises a power of the board of directors is required to include at least one outside director, except for the audit committee, which is required to include all the outside directors.
Our outside directors are Ms. Gelbman and Mr. Nir, who were re-elected to a second three-year term in 2005.
Committees
Subject to the provisions of the Companies Law, our board of directors may delegate its powers to committees consisting of board members. Our board has formed an audit committee and an option committee.
Audit Committee
Under the Israeli Companies Law, our board of directors is required to appoint an audit committee, comprised of at least three directors, including all of the outside directors, but excluding:
| | — | the chairman of our board of directors; |
| | — | a controlling shareholder or a relative of a controlling shareholder; and |
| | — | any director employed by us or who provides services to us on a regular basis. |
The role of the audit committee is to identify flaws in the management of our business, including in consultation with the internal auditor and our independent accountants, to suggest remedial measures and to approve specified related party transactions. Under the Companies Law, the audit committee may not approve an action or a transaction with related parties or with its office holders unless at the time of approval at least two outside directors are serving as members of the audit committee and at least one of whom was present at the meeting in which any approval was granted. Our audit committee consists of Mr. Nir, Ms. Gelbman and Mr. Motil. Our audit committee also performs other functions as described above under “Nasdaq Requirements.”
56
Option Committee
Our Option Committee administrates our share option plan, including the grant of options in exchange for Corrigent options, subject to certain exceptions. Our Option Committee is empowered, among other things, to approve option grants, optionees, dates of grant and the exercise price of options, subject to guidelines adopted by our board of directors. Grants of options to executive officers and directors require additional approvals pursuant to the Companies Law and Nasdaq rules. Messrs. Paneth, Tamir and Nir are currently the members of our option committee.
Internal Auditor
Under the Companies Law, our board of directors is required to appoint an internal auditor proposed by the audit committee. The role of the internal auditor is to examine, among other things, whether our actions comply with the law and orderly business procedure. The internal auditor may not be an interested party, an office holder, or a relative of any of the foregoing, nor may the internal auditor be our independent accountant or its representative.
The Companies Law defines the term “interested party” to include a person who:
| | — | holds 5% or more of our outstanding share capital or voting rights; |
| | — | has the right to appoint one or more directors or the general manager; or |
| | — | who serves as a director or as the general manager. |
Approval of Specified Related Party Transactions Under Israeli Law
Fiduciary Duties of Office Holders
The Israeli Companies Law imposes a duty of care and a duty of loyalty on all office holders of a company. The duty of care requires an office holder to act with the level of care with which a reasonable office holder in the same position would have acted under the same circumstances. The duty of care includes a duty to use reasonable means to obtain:
| | — | information on the advisability of a given action brought for his approval or performed by him by virtue of his position; and |
| | — | all other important information pertaining to these actions. |
57
The duty of loyalty of an office holder includes a duty to:
| | — | refrain from any conflict of interest between the performance of his duties for the company and the performance of his other duties or his personal affairs; |
| | — | refrain from any activity that is competitive with the company; |
| | — | refrain from exploiting any business opportunity of the company to receive a personal gain for himself or others; and |
| | — | disclose to the company any information or documents relating to a company’s affairs which the office holder has received due to his position as an office holder. |
Disclosure of Personal Interest of an Office Holder
The Israeli Companies Law requires that an office holder of a company disclose to the company any personal interest that he may have and all related material information known to him, in connection with any existing or proposed transaction by the company. The disclosure is required to be made promptly and in any event no later than the board of directors meeting in which the transaction is first discussed. If the transaction is an extraordinary transaction, the office holder must also disclose any personal interest held by:
| | — | the office holder's spouse, siblings, parents, grandparents, descendants, spouse's descendants and the spouses of any of these people; or |
| | — | any corporation in which the office holder is a 5% or greater shareholder, director or general manager or in which he has the right to appoint at least one director or the general manager. |
Under Israeli law, an extraordinary transaction is a transaction that is:
| | — | not in the ordinary course of business; |
| | — | likely to have a material impact of the company's profitability, assets or liabilities. |
Under the Companies Law, once an office holder complies with the above disclosure requirement, the transaction can be approved, provided that it is not adverse to the company’s interest. A director who has a personal interest in a matter which is considered at a meeting of the board of directors or the audit committee will generally not be present at this meeting or vote on this matter unless a majority of the directors or members of the audit committee have a personal interest in the matter. If a majority of the directors have a personal interest in the matter, the matter also requires approval of the shareholders of the company. Under the Companies Law, unless the articles of association provide otherwise, a transaction with an office holder, or a transaction with a third party in which the office holder has a personal interest, requires approval by the board of directors. If it is an extraordinary transaction or an undertaking to indemnify or insure an office holder who is not a director, audit committee approval is required, as well. Arrangements regarding the compensation, indemnification or insurance of a director require the approval of the audit committee, board of directors and shareholders, in that order.
58
Disclosure of Personal Interests of a Controlling Shareholder
Under the Israeli Companies Law, the disclosure requirements which apply to an office holder also apply to a controlling shareholder of a public company. A controlling shareholder is a shareholder who has the ability to direct the activities of a company, including a shareholder that owns 25% or more of the voting rights if no other shareholder owns more than 50% of the voting rights, but excluding a shareholder whose power derives solely from his or her position on the board of directors or any other position with the company. Extraordinary transactions with a controlling shareholder or with a third party in which a controlling shareholder has a personal interest, and the terms of engagement of a controlling shareholder as an office holder or employee, require the approval of the audit committee, the board of directors and the shareholders of the company, in that order. The shareholder approval must be by a majority of the shares voted on the matter, provided that either:
| | — | at least one-third of the shares of shareholders who have no personal interest in the transaction and who vote on the matter vote in favor thereof; or |
| | — | the shareholders who have no personal interest in the transaction who vote against the transaction do not represent more than one percent of the voting rights in the company. |
For information concerning the direct and indirect personal interests of our office holders and principal shareholders in specified transactions with us, see Item 7A of this Annual Report.
Approval of Private Placements
Under the Companies Law, a private placement of securities requires approval by the board of directors and the shareholders of the company if it will cause a person to become a controlling shareholder or if:
| | — | the securities issued amount to 20% or more of the company's outstanding voting rights before the issuance; |
| | — | some or all of the consideration is other than cash or listed securities or the transaction is not on market terms; and |
| | — | the transaction will increase the relative holdings of a shareholder that holds 5% or more of the company’s outstanding share capital or voting rights or that will cause any person to become, as a result of the issuance, a holder of more than 5% of the company’s outstanding share capital or voting rights. |
59
The numbers and breakdowns of our employees as of the end of the past three years are set forth in the following table:
| As of December 31,
|
|---|
| 2004
| 2005
| 2006
|
|---|
| | | | |
|---|
| | | |
|---|
| | | |
|---|
| Numbers of employees by geographic location | | | | | | | | | | | |
| Israel | | | | 161 | | | 197 | | | 205 | |
| United States | | | | 10 | | | 10 | | | 10 | |
| Elsewhere | | | | 10 | | | 12 | | | 13 | |
|
| |
| |
| |
| Total workforce | | | | 181 | | | 219 | | | 228 | |
|
| |
| |
| |
| Numbers of employees by category of activity | | |
| MIS, finance and administration | | | | 23 | | | 28 | | | 28 | |
| Research and development | | | | 104 | | | 133 | | | 144 | |
| Manufacturing, testing and quality assurance | | | | 26 | | | 26 | | | 16 | |
| Sales and marketing | | | | 28 | | | 32 | | | 40 | |
|
| |
| |
| |
| Total workforce | | | | 181 | | | 219 | | | 228 | |
|
| |
| |
| |
Our number of employees increased by nine between December 31, 2005 and December 31, 2006 due to an increase in the number of employees engaged in product development and sales and marketing, offset in part by a decline in the number of employees engaged in manufacturing, testing and quality assurance.
Our number of employees increased by 38 between December 31, 2004 and December 31, 2005 mainly due to an increase in the number of employees engaged in product development.
We believe that we have been able to attract talented engineering and other technical personnel. None of our employees is represented by a labor union and we have not experienced a work stoppage. We believe that our relationship with our employees is good and that our future success will depend on a continuing ability to hire, assimilate and retain qualified employees.
Certain provisions of the collective bargaining agreements between the Histadrut (General Federation of Labor in Israel) and the Coordination Bureau of Economic Organizations, including the Industrialists Associations, are applicable to our employees by order of the Israeli Ministry of Labor and Welfare. These provisions principally concern cost of living increases, recreation pay and other conditions of employment.
Israeli labor laws and regulations are applicable to all of our employees in Israel. The laws principally concern matters such as paid annual vacation, paid sick days, the length of the workday, payment for overtime, insurance for work-related accidents, severance pay and other conditions of employment. Israeli law generally requires severance pay, which may be funded, in whole or in part, by Managers’ Insurance described below, in certain circumstances, including the retirement or death of an employee or termination of employment without cause, as defined under Israeli law. The payments to Managers’ Insurance in respect of severance obligations amount to approximately 8.3% of wages. Furthermore, Israeli employees are required to pay predetermined sums to the National Insurance Institute. The payments to the National Insurance Institute are approximately 18% of wages of which the employee contributes approximately 12% and the employer contributes approximately 6%.
60
We contribute amounts on behalf of most of our employees to funds known as Managers’ Insurance and/or pension funds. Each employee who agrees to participate in such funds contributes an amount equal to 5% of such employee’s base salary and the employer contributes approximately 15% of such salary, which 15% includes the 8.3% for severance pay.
As of March 31, 2007, Messrs. Eric Paneth and Izhak Tamir, each beneficially owned 1,224,063 ordinary shares, or 7.5% of our ordinary shares. This includes options to purchase (i) 60,000 of our ordinary shares at nominal value, which expire in August 2010, and (ii) 420,000 of our ordinary shares at $27.14 per share, which expire in June 2012. In addition, each of Messrs. Eric Paneth and Izhak Tamir hold stock options of Corrigent. Pursuant to the exchange program described below under “–Exchange of Corrigent Options”, on or after June 23, 2007, such options might be exchanged for options to acquire up to approximately 1.9% of our outstanding ordinary shares on a fully diluted basis after giving effect to such exchange as of the dates of such exchanges.
Except for Messrs. Paneth and Tamir, none of our executive officers or directors beneficially owns 1% or more of our outstanding ordinary shares.
At March 31, 2007, outstanding options to purchase a total of 5,250,860 ordinary shares (including options whose vesting is subject to our meeting specified performance goals) were outstanding under our share incentive plan, of which options to purchase a total of 1,497,862 ordinary shares were held by our directors and officers (11 persons) as a group. Our share incentive plan is administered by an option committee of our board of directors, which is empowered, subject to applicable law, to determine the optionees, dates of grant and the exercise price of options. Unless otherwise decided by our board of directors or the option committee, options granted under the share incentive plan are non-assignable except by the laws of descent. The outstanding options are exercisable at purchase prices which range from $0 to $27.14 per share, vest mainly over periods of up to five years, and have expiration dates which range from 2007 to 2016.
61
Exchange of Corrigent Options
At our annual meeting of shareholders held in June 2005, our shareholders approved the potential exchanges, from time to time, of all of the vested stock options of Corrigent, which constituted at that time approximately 10% of the outstanding share capital of Corrigent (on a fully diluted basis), for vested options for up to 10% of our outstanding ordinary shares (on a fully diluted basis after giving effect to such issuances). The goal of this program is to simplify our capital structure by increasing our fully diluted ownership percentage of Corrigent to up to 100%. Generally, our option committee, along with the board of directors of Corrigent, will determine the persons who will be offered to exchange and the amount and terms of such exchange. Our audit committee and board of directors will determine the amount and terms with respect to exchanges of Corrigent stock options held by Messrs. Paneth and Tamir, which will be on substantially the same terms as those of other option holders and will not occur prior to June 23, 2007. Corrigent options are exercisable for the par value of Corrigent shares, $0.01 per share, and the Orckit options granted in the exchanges would be exercisable at the same price. The issuance of our ordinary shares upon the exercise of our options received in any exchange will be covered by a Registration Statement on Form S-8 filed with the SEC under the Securities Act of 1933, as amended.
Corrigent does not intend to grant any additional options. Since the outstanding Corrigent options vest through the end of 2008, it is expected that the series of exchanges will not be completed earlier than the end of 2008. During 2005, our option committee approved certain exchanges, effective as of January 1, 2006, of approximately 3% of Corrigent capital stock on a fully diluted basis for options to purchase approximately 497,000 of Orckit’s ordinary shares. Following these exchanges, Orckit’s holding in Corrigent was increased from 90% to approximately 93% of Corrigent’s capital stock on a fully diluted basis. After giving effect to these exchanges, options to purchase up to approximately 7.0% of the ordinary shares of Orckit outstanding (on a fully diluted basis after giving effect to such exchanges) as of the dates of exchange could be issued in exchange for Corrigent options. The number of Orckit options issuable in exchange for Corrigent options may change as a result of a change in the value of Corrigent relative to the value of Orckit at the time of the exchange.
We will not be required to record an expense in our financial statements under U.S. generally accepted accounting principles in connection with these exchanges to the extent that the fair value of the Orckit options that we grant in exchange for Corrigent options does not exceed the fair value of the Corrigent options being exchanged. When the exchange program was initially approved in 2005, our audit committee and board of directors determined, based on an independent valuation, that the fair market value of 10% of the outstanding capital stock of Corrigent (on a fully diluted basis) at the time the exchange program was approved was equal to the value of 10% of the outstanding ordinary shares of Orckit (on a fully diluted basis).
If the fair market values of the exchangeable options are equal, then we will not record an expense in our financial statements in connection with the exchange. As a result, in any exchange, we will not issue Orckit options that represent a percentage of the fully diluted ownership of Orckit that is greater than the percentage of the fully diluted ownership of Corrigent represented by the Corrigent options to be exchanged. For example, if an exchange is for stock options constituting 2.5% of the outstanding capital stock of Corrigent (on a fully diluted basis), then we would issue in this exchange the lesser of (i) an amount of options for ordinary shares of Orckit equal to the fair market value of these Corrigent stock options on the exchange date or (ii) options for Ordinary Shares constituting 2.5% of the ordinary shares of Orckit outstanding (on a fully diluted basis after giving effect to such issuance) on the exchange date.
62
| ITEM 7. | MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS |
To our knowledge, (A) we are not directly or indirectly owned or controlled (i) by another corporation or (ii) by any foreign government and (B) there are no arrangements, the operation of which may at a subsequent date result in a change in control of Orckit.
The following table sets forth, as of March 31, 2007, the number of our ordinary shares, which constitute our only voting securities, beneficially owned by (i) all shareholders known to us to own more than 5% of our outstanding ordinary shares, and (ii) all of our directors and executive officers as a group. The voting rights of all shareholders are the same. As of March 31, 2007, 15,766,512 of our ordinary shares were outstanding.
Identity of Person or Group
| Amount Owned
| Percent of Class
|
|---|
| | | |
|---|
| | |
|---|
| | |
|---|
| | |
|---|
| Eric Paneth(1) | | | | 1,224,063 | | | 7.5 | % |
| Izhak Tamir(2) | | | | 1,224,063 | | | 7.5 | % |
| David J. Greene and Company, LLC(3) | | | | 1,195,252 | | | 7.6 | % |
| FMR Corp.(4) | | | | 1,089,400 | | | 6.9 | % |
All directors and executive officers as a group
(11 persons) | | | | 2,702,302 | (5) | | 15.9 | % |
| | (1)(2) | Includes, in the case of each of Messrs. Tamir and Paneth, 480,000 ordinary shares issuable upon the exercise of options that are currently vested or vest within 60 days following March 31, 2007 but excludes ordinary shares issuable upon the exercise of options that may be issued in the future in exchange for stock options of Corrigent held by each of them (see Item 6.E above). This figure also includes, in the case of each of Messrs. Tamir and Paneth, 420,000 ordinary shares subject to a six-year variable forward sale contract entered into with Credit Suisse Capital LLC on March 1, 2006. Under each such contract, 420,000 ordinary shares were pledged to Credit Suisse as collateral. |
| | (3) | Based on an initial Schedule 13G of David J. Greene and Company, LLC filed on February 8, 2007 with the Securities and Exchange Commission. |
| | (4) | Based on an initial Schedule 13G of FMR Corp. and Edward C. Johnson 3d filed on February 14, 2007 with the Securities and Exchange Commission. |
| | (5) | Includes 1,214,176 ordinary shares which may be purchased pursuant to options exercisable within sixty days following March 31, 2007. As discussed in Item 6.E above, stock options of Corrigent held by directors and executive officers of Orckit may be exchanged for options of Orckit. |
63
As of March 31, 2004, each of Mr. Paneth and Mr. Tamir beneficially owned 2,255,313 ordinary shares, or 16.7% of our outstanding ordinary shares. The reduction in each of their holdings was caused principally by (i) the waiver on February 14, 2005 of an option to purchase 420,000 ordinary shares at a 10% premium over the market price on the date of exercise, (ii) the sale of 300,000 ordinary shares on Nasdaq between February 1, 2005 and April 26, 2005, (iii) the sale of 520,000 ordinary shares on Nasdaq between July 1, 2005 and April 25, 2006 pursuant to a trading plan under Rule 10b5-1(c) entered into in May 2005 with respect to 600,000 ordinary shares and (iv) the transfer of 215,000 ordinary shares on December 8, 2005 to a blind trust for a period of two years, offset by increases in beneficial ownership attributable to (v) the vesting of 3,750 options which were not vested within 60 days from March 31, 2004 and (vi) the grant on June 23, 2005 of an option to purchase 420,000 ordinary shares at the market price on the date of grant with a seven year term. The objective of the blind trust referenced in clause (v) above is to extract value from the volatility of the shares while enabling Messrs. Paneth and Tamir to maintain their holdings in the shares, subject to market conditions. Commencing March 2006, the trust runs a yield enhancement program with respect to the shares. The program is run by actively managing the selling and buying back of options with respect to the shares. Shares of the trust might be assigned and delivered pursuant to transactions effected under the program. After two years, if the trust is not extended, the shares owned by the trust at that time will be distributed from the trust back to Messrs. Paneth and Tamir. The foregoing information is based mainly on reports on Schedule 13D filed with the SEC by Messrs. Paneth and Tamir.
As of March 31, 2007, there were 48 holders of record of our ordinary shares in the United States who collectively held approximately 96% of our outstanding ordinary shares. The number of record holders in the United States is not representative of the number of beneficial holders nor is it representative of where such beneficial holders are resident since many of these ordinary shares were held of record by brokers or other nominees.
| B. | RELATED PARTY TRANSACTIONS |
Tikcro Management Agreement
Following the sale of Tikcro’s business to STMicroelectronics in April 2003, we agreed to provide Tikcro administrative services. For the services rendered in 2004, Tikcro paid us $100,000. Fees paid by Tickro in 2005 were $72,000. In 2006, the fees paid by Tikcro were $48,000.
Siliquent Technologies
Siliquent Technologies, a provider of technology for the storage network applications industry, was founded in 2000 as a technology project. In October 2001, Siliquent Technologies, raised $10.0 million in equity financing from third parties. Certain of our directors, officers and employees had previously been granted securities in Siliquent with a nominal exercise price. In 2003, we participated in follow-on investment rounds in Siliquent and increased our investment by $1.0 million. In 2004, we participated in another follow on investment rounds in Siliquent for $1.4 million. In 2005, Broadcom acquired Siliquent, and the consideration paid for our holdings in Siliquent was $4.4 million. In addition, the consideration paid to certain of our directors and officers who were granted securities in Siliquent upon incorporation was approximately $198,000 in the aggregate.
We believe that any transactions involving affiliated parties were on terms no less favorable to us than could be obtained with non-affiliated parties.
64
| C. | INTERESTS OF EXPERTS AND COUNSEL |
Not applicable
| ITEM 8. | FINANCIAL INFORMATION |
Consolidated Statements and Other Financial Information
See Item 18.
Legal Proceedings
For a discussion of our legal proceedings, please see “Item 4 – Information on the Company – Legal Proceedings.”
Dividend Policy
For a discussion of our dividend policy, please see “Item 5.B – Operating and Financial Review and Prospects – Liquidity and Capital Resources – Dividend Policy.”
Significant Changes
No significant change has occurred since December 31, 2006, except as otherwise disclosed in this Annual Report.
| ITEM 9. | THE OFFER AND LISTING |
| A. | OFFER AND LISTING DETAILS |
Our ordinary shares are quoted on the Nasdaq Stock Market and the Tel-Aviv Stock Exchange under the symbol “ORCT”.
The following table sets forth, for the periods indicated, the high and low sales prices of our ordinary shares as reported on the Nasdaq Stock Market. The price per share of our ordinary shares and share count has been retroactively adjusted to reflect the (i) three-for-one stock split of our ordinary shares as of April 5, 2005 and (ii) one-for-five reverse share split effective as of November 27, 2002.
Calendar Year
| Price Per Share
|
|---|
| High
| Low
|
|---|
| | | |
|---|
| | |
|---|
| | |
|---|
| 2006 | | | $ | 31.22 | | $ | 6.75 | |
| 2005 | | | $ | 29.55 | | $ | 8.03 | |
| 2004 | | | $ | 8.57 | | $ | 4.82 | |
| 2003 | | | $ | 7.87 | | $ | 0.98 | |
| 2002 | | | $ | 7.20 | | $ | 0.90 | |
65
Calendar Period
| Price Per Share
|
|---|
| High
| Low
|
|---|
| | | |
|---|
| | |
|---|
| | |
|---|
| 2007 | | | | | | | | |
| Second Quarter (through May 9, 2007) | | | $ | 11.60 | | $ | 10.14 | |
| First Quarter | | | $ | 12.42 | | $ | 9.23 | |
| 2006 | | |
| First Quarter | | | $ | 31.22 | | $ | 20.04 | |
| Second Quarter | | | $ | 23.46 | | $ | 8.82 | |
| Third Quarter | | | $ | 10.60 | | $ | 6.75 | |
| Fourth Quarter | | | $ | 12.07 | | $ | 7.21 | |
| 2005 | | |
| First Quarter | | | $ | 20.50 | | $ | 8.03 | |
| Second Quarter | | | $ | 28.15 | | $ | 17.14 | |
| Third Quarter | | | $ | 29.55 | | $ | 21.97 | |
| Fourth Quarter | | | $ | 25.76 | | $ | 12.22 | |
Calendar Month
| Price Per Share
|
|---|
| High
| Low
|
|---|
| | | |
|---|
| | |
|---|
| | |
|---|
| 2007 | | | | | | | | |
| April | | | $ | 11.15 | | $ | 10.14 | |
| March | | | $ | 12.42 | | $ | 10.06 | |
| February | | | $ | 11.74 | | $ | 9.35 | |
| January | | | $ | 10.45 | | $ | 9.23 | |
| 2006 | | |
| December | | | $ | 11.85 | | $ | 9.50 | |
| November | | | $ | 12.07 | | $ | 8.23 | |
66
The following table sets forth, for the periods indicated, the high and low sales prices of our ordinary shares as reported on the Tel-Aviv Stock Exchange.
Calendar Year
| Price Per Share
|
|---|
| High
| Low
|
|---|
| | | |
|---|
| | |
|---|
| | |
|---|
| 2006 | | | $ | 30.91 | | $ | 6.78 | |
| 2005 | | | $ | 29.43 | | $ | 7.95 | |
| 2004 | | | $ | 8.53 | | $ | 4.93 | |
| 2003 | | | $ | 7.79 | | $ | 1.18 | |
Calendar Period
| Price Per Share
|
|---|
| High
| Low
|
|---|
| | | |
|---|
| | |
|---|
| | |
|---|
| 2007 | | | | | | | | |
| Second Quarter (through May 9, 2007) | | | | 11.76 | | | 10.15 | |
| First Quarter | | | | 12.41 | | | 9.33 | |
| 2006 | | |
| First Quarter | | | | 30.91 | | | 21.85 | |
| Second Quarter | | | | 23.54 | | | 8.74 | |
| Third Quarter | | | | 10.78 | | | 6.78 | |
| Fourth Quarter | | | | 12.08 | | | 7.29 | |
| 2005 | | |
| First Quarter | | | $ | 20.40 | | $ | 7.95 | |
| Second Quarter | | | $ | 27.82 | | $ | 17.63 | |
| Third Quarter | | | $ | 29.43 | | $ | 22.10 | |
| Fourth Quarter | | | $ | 25.71 | | $ | 16.23 | |
| 2004 | | |
| First Quarter | | | $ | 7.88 | | $ | 5.02 | |
| Second Quarter | | | $ | 8.05 | | $ | 5.09 | |
| Third Quarter | | | $ | 8.22 | | $ | 4.93 | |
| Fourth Quarter | | | $ | 8.53 | | $ | 5.14 | |
67
Calendar Month
| Price Per Share
|
|---|
| High
| Low
|
|---|
| | | |
|---|
| | |
|---|
| | |
|---|
| 2007 | | | | | | | | |
| April | | | | 11.07 | | | 10.15 | |
| March | | | | 12.41 | | | 10.29 | |
| February | | | | 11.77 | | | 9.49 | |
| January | | | | 10.45 | | | 9.33 | |
| 2006 | | |
| December | | | | 11.95 | | | 9.49 | |
| November | | | | 12.08 | | | 8.24 | |
The share prices as presented above in US dollars were originally denominated in New Israeli Shekels and were converted to US dollars using the representative exchange rate between the US dollar and the New Israeli Shekels published by the Bank of Israel for each applicable day in the presented period.
Our shares began trading on the Tel-Aviv Stock Exchange in April 2002. The trading volume of our shares on the TASE in 2002 was insignificant and, accordingly, we do not believe sales price information with respect to the limited trading of our ordinary shares on TASE in 2002 is meaningful.
Not applicable
Our ordinary shares are quoted on the Nasdaq Stock Market under the symbol ORCT. Our ordinary shares are also quoted on the Tel-Aviv Stock Exchange. Options relating to our ordinary shares began trading on the Chicago Board Options Exchange, the American Stock Exchange and the Philadelphia Stock Exchange in May 2005.
Not applicable
Not applicable
Not applicable
| ITEM 10. | ADDITIONAL INFORMATION |
Not applicable
68
| B. | MEMORANDUM AND ARTICLES OF ASSOCIATION |
Objects and Purposes
We were first registered under Israeli law on January 22, 1990 as a private company, and, on July 22, 1996, became a public company. Our registration number with the Israeli registrar of companies is 52-004287-0. Our object is to engage, directly or indirectly, in any lawful undertaking or business whatsoever, including, without limitation, as stipulated in our memorandum and articles of association, which are filed as exhibits to this Annual Report.
Borrowing Powers
Our articles of association provide that our board of directors may from time to time, in its discretion, cause us to borrow any sums of money for our purposes, and may secure or provide for the repayment of such sums in such manner, at such times and upon such terms and conditions in all respects as it thinks fit.
Transfer of Shares and Notices
Fully paid ordinary shares may be freely transferred pursuant to our articles of association unless the transfer is restricted or prohibited by another instrument. Unless otherwise prescribed by law, we will provide at least 21 calendar days’ prior notice of any general shareholders meeting.
Dividend and Liquidation Rights
Dividends on our ordinary shares may be paid only out of profits and other surplus, as defined in the Companies Law, as of our most recent financial statements or as accrued over a period of two years, whichever is higher. Our board of directors, with the approval of our audit committee, is authorized to declare dividends, provided that there is no reasonable concern that the dividend will prevent us from satisfying our existing and foreseeable obligations as they become due. In the event of our liquidation, after satisfaction of liabilities to creditors, our assets will be distributed to the holders of ordinary shares in proportion to their respective holdings. These dividend and liquidation rights may be affected by the grant of preferential dividends or distribution rights to the holders of a class of shares with preferential rights that may be authorized in the future.
Voting, Shareholders’ Meetings and Resolutions
Holders of ordinary shares have one vote for each ordinary share held on all matters submitted to a vote of shareholders. Under the Companies Law and our articles of association, most resolutions of our shareholders require approval by a simple majority of the ordinary shares voting thereon. Amendments to our articles of association and the election of directors require approval of 66-2/3% of our ordinary shares voting thereon, and liquidation and the removal of directors (other than outside directors) require approval of 75% of our ordinary shares voting thereon.
These voting rights may be affected by the grant of any special voting rights to the holders of a class of shares with preferential rights that may be authorized in the future.
69
We have two types of general shareholders meetings: the annual general meetings and extraordinary general meetings. Directors are elected only at annual general meeting. These meetings may be held either in Israel or in any other place the board of directors determines. An annual general meeting must be held in each calendar year, but not more than 15 months after the last annual general meeting. Our board of directors may convene an extraordinary meeting, from time to time, at its discretion and is required to do so upon the request of shareholders holding at least 5% of our ordinary shares.
The quorum required for a meeting of shareholders consists of at least two shareholders present in person or by proxy who hold or represent between them at least 25% of the outstanding voting shares, unless otherwise required by applicable rules. Nasdaq generally requires a quorum of 33-1/3%, but we have received an exemption and instead follow the generally accepted business practice for companies in Israel. A meeting adjourned for lack of a quorum generally is adjourned to the same day in the following week at the same time and place or any time and place as the chairman may designate with the consent of a majority of the voting power represented at the meeting and voting on the matter adjourned. At such reconvened meeting the required quorum consists of any two members present in person or by proxy, unless otherwise required by applicable rules.
Duties of Shareholders
Under the Companies Law, each and every shareholder has a duty to act in good faith in exercising his rights and fulfilling his obligations towards us and other shareholders and to refrain from abusing his power in us, such as in voting in the general meeting of shareholders on the following matters:
| | — | any amendment to the articles of association; |
| | — | an increase of our authorized share capital; |
| | — | approval of certain actions and transactions which require shareholder approval. |
In addition, each and every shareholder has the general duty to refrain from depriving other shareholders of their rights.
Furthermore, any controlling shareholder, any shareholder who knows that it possesses the power to determine the outcome of a shareholder vote and any shareholder that, pursuant to the provisions of the articles of association, has the power to appoint or to prevent the appointment of an office holder in us or any other power toward us is under a duty to act in fairness towards us. The Companies Law does not describe the substance of this duty of fairness. These various shareholder duties may restrict the ability of a shareholder to act in what the shareholder perceives to be its own best interests.
Anti-Takeover Provisions; Mergers and Acquisitions
The Israeli Companies Law includes provisions that allow a merger transaction and requires that each company that is a party to a merger have the transaction approved by its board of directors and a vote of the majority of its shares, at a shareholders’ meeting called on at least 21 days’ prior notice. For purposes of the shareholder vote, unless a court rules otherwise, the statutory merger will not be deemed approved if a majority of the shares present that are held by parties other than the other party to the merger, or by any person who holds 25% or more of the shares or the right to appoint 25% or more of the directors of the other party, vote against the merger. Upon the request of a creditor of either party of the proposed merger, the court may delay or prevent the merger if it concludes that there exists a reasonable concern that as a result of the merger, the surviving company will be unable to satisfy the obligations of any of the parties to the merger. In addition, a merger may not be completed unless at least (i) 50 days have passed from the time that the requisite proposal for the merger has been filed by each party with the Israeli Registrar of Companies and (ii) 30 days have passed since the merger was approved by the shareholders of each party.
70
The Companies Law also provides that an acquisition of shares of a public company must be made by means of a tender offer if as a result of the acquisition the purchaser would become a 25% or greater shareholder of the company and there is no existing 25% or greater shareholder in the company. An acquisition of shares of a public company must also be made by means of a tender offer if as a result of the acquisition the purchaser would become a 45% or greater shareholder of the company and there is no existing 45% or greater shareholder in the company. These requirements do not apply if the acquisition (i) occurs in the context of a private placement by the company that received shareholder approval, (ii) was from a 25% shareholder of the company and resulted in the acquirer becoming a 25% shareholder of the company or (iii) was from a 45% shareholder of the company and resulted in the acquirer becoming a 45% shareholder of the company. The tender offer must be extended to all shareholders, but the offeror is not required to purchase more than 5% of the company’s outstanding shares, regardless of how many shares are tendered by shareholders. The tender offer may be consummated only if (i) at least 5% of the company’s outstanding shares will be acquired by the offeror and (ii) the number of shares tendered in the offer exceeds the number of shares whose holders objected to the offer.
If, as a result of an acquisition of shares, the acquirer will hold more than 90% of a company’s outstanding shares, the acquisition must be made by means of a tender offer for all of the outstanding shares. If less than 5% of the outstanding shares are not tendered in the tender offer, all the shares that the acquirer offered to purchase will be transferred to it. The law provides for appraisal rights if any shareholder files a request in court within three months following the consummation of a full tender offer. If more than 5% of the outstanding shares are not tendered in the tender offer, then the acquirer may not acquire shares in the tender offer that will cause his shareholding to exceed 90% of the outstanding shares.
Israeli tax law also treats stock-for-stock acquisitions between an Israeli company and a foreign company less favorably than does U.S. tax law. For example, Israeli tax law may, under certain circumstances, subject a shareholder who exchanges his ordinary shares for shares of another corporation to taxation prior to the sale of the shares received in such stock-for-stock swap.
Our articles of association provide that our board of directors may, at any time in its sole discretion, adopt protective measures to prevent or delay a coercive takeover of us, including, without limitation, the adoption of a shareholder rights plan. In November 2001, our board of directors adopted a shareholder bonus rights plan pursuant to which share purchase bonus rights were distributed on December 6, 2001 at the rate of one right for each of our ordinary shares held by shareholders of record as of the close of business on that date.
71
The rights plan is intended to help ensure that all of our shareholders are able to realize the long-term value of their investment in us in the event of a potential takeover which does not reflect our full value and is otherwise not in the best interests of us and our shareholders. The rights plan is also intended to deter unfair or coercive takeover tactics.
Each right initially will entitle shareholders to buy one-half of one of our ordinary shares for $21.67. The rights generally will be exercisable and transferable apart from our ordinary shares only if a person or group becomes an “acquiring person” by acquiring beneficial ownership of 15% or more of our ordinary shares, subject to certain exceptions set forth in the rights plan, or commences a tender or exchange offer upon consummation of which such person or group would become an “acquiring person.” Subject to certain conditions described in the rights plan, once the rights become exercisable, the holders of rights, other than the acquiring person, will be entitled to purchase ordinary shares at a discount from the market price.
The rights will expire on December 31, 2011 and are generally redeemable by our board of directors, at $0.01 per right, at any time until the tenth business day following public disclosure that a person or group has become an “acquiring person.”
Our articles of association also provide that as long as any of our securities are publicly traded on a United States market or exchange, all proxy solicitations by persons other than our board of directors must be undertaken pursuant to the United States proxy rules, regardless of whether those proxy rules are legally applicable to us. These provisions of our articles of association could discourage potential acquisition proposals and could delay or prevent a change in control of us.
Modification of Class Rights
Our articles of association provide that the rights attached to any class (unless otherwise provided by the terms of that class), such as voting, rights to dividends and the like, may be varied by a shareholders’ resolution, subject to the sanction of a resolution passed by a majority of the holders of the shares of that class at a separate class meeting.
Indemnification, Exculpation and Insurance of Office Holders
Exculpation of Office Holders
Under the Companies Law, an Israeli company may not exempt an office holder from liability for breach of his duty of loyalty, but may exempt in advance an office holder from liability to the company, in whole or in part, for a breach of his duty of care (except in connection with distributions), provided the articles of association of the company allow it to do so. Our articles of association allow us to exempt our office holders to the fullest extent permitted by law, and we have done so.
Insurance of Office Holders
Our articles of association provide that, subject to the provisions of the Companies Law, we may enter into an insurance contract which would provide coverage for any monetary liability incurred by any of our office holders, with respect to an act performed in the capacity of an office holder for:
72
| | — | a breach of his duty of care to us or to another person; |
| | — | a breach of his duty of loyalty to us, provided that the office holder acted in good faith and had reasonable cause to assume that his act would not prejudice our interests; or |
| | — | a financial liability imposed upon him in favor of another person. |
We obtained liability insurance covering our officers and directors.
Indemnification of Office Holders
Our articles of association provide that we may indemnify an office holder against:
| | — | a financial liability imposed on or incurred by an office holder in favor of another person by any judgment, including a settlement or an arbitrator’s award approved by a court concerning an act performed in his capacity as an office holder. Such indemnification may be approved (i) after the liability has been incurred or (ii) in advance, provided that the undertaking is limited to types of events which our board of directors deems to be foreseeable in light of our actual operations at the time of the undertaking and limited to an amount or criterion determined by our board of directors to be reasonable under the circumstances, and further provided that such events and amounts or criterion are set forth in the undertaking to indemnify; |
| | — | reasonable litigation expenses, including attorney’s fees, expended by the office holder as a result of an investigation or proceeding instituted against him by a competent authority, provided that such investigation or proceeding concluded without the filing of an indictment against him and either (A) concluded without the imposition of any financial liability in lieu of criminal proceedings or (B) concluded with the imposition of a financial liability in lieu of criminal proceedings but relates to a criminal offense that does not require proof of criminal intent; and |
| | — | reasonable litigation expenses, including attorneys’ fees, expended by the office holder or charged to him by a court, in proceedings instituted against him by or on our behalf or by another person, or in a criminal charge from which he was acquitted, or a criminal charge in which he was convicted for a criminal offense that does not require proof of intent, in each case relating to an act performed in his capacity as an office holder. |
We have undertaken to indemnify our directors and officers pursuant to applicable law.
Limitations on Exculpation, Insurance and Indemnification
The Companies Law provides that a company may not exculpate or indemnify an office holder, or enter into an insurance contract which would provide coverage for any monetary liability incurred as a result of any of the following:
73
| | — | a breach by the office holder of his duty of loyalty unless, with respect to insurance coverage or indemnification, the office holder acted in good faith and had a reasonable basis to believe that the act would not prejudice the company; |
| | — | a breach by the office holder of his duty of care if the breach was committed intentionally or recklessly; |
| | — | any act or omission committed with the intent to derive an illegal personal benefit; or |
| | — | any fine imposed on the office holder. |
In addition, under the Companies Law, exculpation of, indemnification of, or procurement of insurance coverage for, our office holders must be approved by our audit committee and our board of directors and, if the beneficiary is a director, by our shareholders. We have obtained such approvals for the procurement of liability insurance covering our officers and directors and for the grant of indemnification letters to our officers and directors and have granted amended and restated indemnification and exculpation letters to our directors and officers that require us to indemnify them to the fullest extent permitted by applicable law.
Our articles of association also provide that, subject to the provisions of applicable law, we may procure insurance for or indemnify any person who is not an office holder, including without limitation, any of our employees, agents, consultants or contractors.
For a description of our convertible notes, see: –“Liquidity and Capital Resources–Convertible Notes” under Item 5B of this Annual Report on Form 20-F.
There are currently no Israeli currency control restrictions on payments of dividends or other distributions with respect to our ordinary shares or the proceeds from the sale of the shares, except for the obligation of Israeli residents to file reports with the Bank of Israel regarding certain transactions. However, legislation remains in effect pursuant to which currency controls can be imposed by administrative action at any time.
The ownership or voting of our ordinary shares by non-residents of Israel, except with respect to citizens of countries which are in a state of war with Israel, is not restricted in any way by our memorandum of association or articles of association or by the laws of the State of Israel.
The following is a general summary only and should not be considered as income tax advice or relied upon for tax planning purposes.
74
United States Federal Income Tax Considerations
The following summary describes the material U.S. federal income tax consequences to “U.S. Holders” (as defined below) arising from the purchase, ownership or disposition of our ordinary shares. This summary is based on the Internal Revenue Code of 1986, as amended, or the “Code,” the final, temporary and proposed U.S. Treasury Regulations promulgated thereunder and administrative and judicial interpretations thereof, all as of the date hereof and all of which are subject to change (possibly with retroactive effect) or different interpretations. For purposes of this summary, a “U.S. Holder” will be deemed to refer only to any of the following holders of our ordinary shares:
| | — | an individual who is either a U.S. citizen or a resident of the U.S. for U.S. federal income tax purposes; |
| | — | a corporation or other entity taxable as a corporation for U.S. federal income tax purposes created or organized in or under the laws of the U.S. or any political subdivision thereof; |
| | — | an estate the income of which is subject to U.S. federal income tax regardless of the source of its income; and |
| | — | a trust, if (a) a U.S. court is able to exercise primary supervision over the administration of the trust and one or more U.S. persons have the authority to control all substantial decisions of the trust, or (b) the trust has a valid election in effect under applicable U.S. Treasury Regulations to be treated as a U.S. person. |
This summary does not consider all aspects of U.S. federal income taxation that may be relevant to particular U.S. Holders by reason of their particular circumstances, including potential application of the U.S. federal alternative minimum tax, or any aspect of state, local or non-U.S. federal tax laws or U.S. federal tax laws other than U.S. federal income tax laws. In addition, this summary is directed only to U.S. Holders that hold our ordinary shares as “capital assets” within the meaning of Section 1221 of the Code and does not address the considerations that may be applicable to particular classes of U.S. Holders, including financial institutions, regulated investment companies, real estate investment trusts, pension funds, insurance companies, broker-dealers, tax-exempt organizations, grantor trusts, partnerships or other pass-through entities, holders whose functional currency is not the U.S. dollar, U.S. Holders who have elected mark-to-market accounting, U.S. Holders who acquired our ordinary shares through the exercise of options or otherwise as compensation, U.S. Holders who hold our ordinary shares as part of a “straddle,” “hedge” or “conversion transaction,” U.S. Holders selling our ordinary shares short, U.S. Holders deemed to have sold our ordinary shares in a “constructive sale,” and holders, directly, indirectly or through attribution, of 10% or more (by vote or value) of our outstanding ordinary shares. If a partnership (including for this purpose any entity, domestic or foreign, treated as a partnership for U.S. federal income tax purposes) is a beneficial owner of our ordinary shares, the U.S. federal income tax treatment of a partner in such partnership generally will depend upon the status of the partner and the activities of the partnership. A partnership that is a beneficial owner of our ordinary shares, and partners in such partnership, are urged to consult their own tax advisors regarding the U.S. federal income tax consequences of the purchase, ownership and disposition of our ordinary shares.
75
Each U.S. Holder should consult with its own tax advisor as to the particular tax consequences to it of the purchase, ownership and sale of our ordinary shares, including the effects of applicable tax treaties, state, local, foreign or other tax laws and possible changes in the tax laws.
Sale, Exchange or Other Taxable Disposition of Ordinary Shares
Subject to the discussion below under “Passive Foreign Investment Company Status,” a U.S. Holder’s sale, exchange or other taxable disposition of ordinary shares generally will result in the recognition by such U.S. Holder of capital gain or loss in an amount equal to the difference between the U.S. dollar value of the amount realized and the U.S. Holder’s tax basis in the ordinary shares disposed of (determined in U.S. dollars). This gain or loss will be long-term capital gain or loss if such ordinary shares have been held or are deemed to have been held for more than one year at the time of the disposition. Individual U.S. Holders currently are subject to a maximum tax rate of 15% on long-term capital gains for tax years beginning on or before December 31, 2010. Short-term capital gains generally are taxed at the same rates applicable to ordinary income. If the U.S. Holder’s holding period on the date of the taxable disposition is one year or less, such gain or loss will be a short-term capital gain or loss. See “–Israel–Capital Gains Tax” for a discussion of taxation by Israel of capital gains realized on sales of our ordinary shares. Any capital loss realized upon the taxable disposition of ordinary shares generally is deductible only against capital gains and not against ordinary income, except that non-corporate U.S. Holders generally may deduct annually from ordinary income up to $3,000 of capital losses in excess of capital gains. In general, any capital gain or loss recognized by a U.S. Holder upon the taxable disposition of ordinary shares will be treated as U.S.-source income or loss for U.S. foreign tax credit purposes. However, under the tax treaty between the United States and Israel, gain derived from the taxable disposition of ordinary shares by a U.S. Holder who is a resident of the U. S. for purposes of the treaty and who sells the ordinary shares within Israel may be treated as foreign-source income for U.S. foreign tax credit purposes.
A U.S. Holder’s tax basis in his, her or its ordinary shares generally will be the U.S. dollar purchase price paid by such U.S. Holder to acquire such ordinary shares. The U.S. dollar cost of an ordinary share purchased with foreign currency generally will be the U.S. dollar value of the purchase price on the date of purchase or, in the case of our ordinary shares that are purchased by a cash basis U.S. Holder (or an accrual basis U.S. Holder that so elects), on the settlement date for the purchase. Such an election by an accrual basis U.S. Holder must be applied consistently from year to year and cannot be revoked without the consent of the U.S. Internal Revenue Service. The holding period of each ordinary share owned by a U.S. Holder will commence on the day following the date of the U.S. Holder’s purchase of such ordinary share and will include the day on which the ordinary share is sold by such U.S. Holder.
In the case of a U.S. Holder who uses the cash basis method of accounting and who receives NIS in connection with the taxable disposition of ordinary shares, the amount realized will be based on the “spot rate” of exchange on the settlement date of such taxable disposition. If such U.S. Holder subsequently converts NIS into U.S. dollars at a conversion rate other than the spot rate in effect on the settlement date, he, she or it may have a foreign currency exchange gain or loss treated as ordinary income or loss for U.S. federal income tax purposes. A U.S. Holder who uses the accrual method of accounting may elect the same treatment required of cash method taxpayers with respect to a taxable disposition of ordinary shares, provided that the election is applied consistently from year to year. Such election may not be changed without the consent of the U.S. Internal Revenue Service. If an accrual method U.S. Holder does not elect to be treated as a cash method taxpayer (pursuant to U.S. Treasury Regulations applicable to foreign currency transactions), such U.S. Holder may be deemed to have realized an immediate foreign currency gain or loss for U.S. federal income tax purposes in the event of any difference between the U.S. dollar value of the NIS on the date of taxable disposition and the settlement date. Any such currency gain or loss generally would be treated as U.S. source ordinary income or loss and would be subject to tax in addition to any gain or loss recognized by such U.S. Holder on the taxable disposition of ordinary shares.
76
Treatment of Distributions
For U.S federal income tax purposes, the amount of a distribution with respect to our ordinary shares will equal the amount of cash distributed, the fair market value of any property distributed and the amount of any Israeli taxes withheld on such distribution as described below under “Israel – Tax on Dividends.” Other than distributions in liquidation or in redemption of our ordinary shares that are treated as exchanges, a distribution with respect to our ordinary shares paid by us to a U.S. Holder generally will be treated as a dividend to the extent that the distribution does not exceed our current and accumulated earnings and profits, as determined for U.S. federal income tax purposes. The amount of any distribution that exceeds these earnings and profits will be treated first as a non-taxable return of capital, reducing the U.S. Holder’s tax basis in his, her or its ordinary shares (but not below zero), and then generally as capital gain from a deemed sale or exchange of such ordinary shares. Corporate U.S. Holders generally will not be allowed a deduction under Section 243 of the Code for dividends received on our ordinary shares and thus will be subject to tax at the rate applicable to their taxable income. Currently, a noncorporate U.S. Holder’s “qualified dividend income” generally is subject to tax at a rate of 15%. For this purpose, “qualified dividend income” generally includes dividends paid by a foreign corporation if, among other things, the noncorporate U.S. Holder meets certain minimum holding period requirements and either (a) the stock of such corporation is readily tradable on an established securities market in the U.S., including the Nasdaq National Market, or (b) such corporation is eligible for the benefits of a comprehensive income tax treaty with the U.S. which includes an information exchange program and is determined to be satisfactory by the U.S. Secretary of the Treasury. The U.S. Secretary of the Treasury has indicated that the income tax treaty between the U.S. and Israel is satisfactory for this purpose. Dividends paid by us will not qualify for the 15% U.S. federal income tax rate, however, if we are treated, for the tax year in which the dividends are paid or the preceding tax year, as a “passive foreign investment company” for U.S. federal income tax purposes. See the discussion below under the heading “Passive Foreign Investment Company Status.” U.S. Holders are urged to consult their own tax advisors regarding the U.S. federal income tax consequences of their receipt of any distributions with respect to our ordinary shares.
A dividend paid by us in NIS will be included in the income of U.S. Holders at the U.S. dollar amount of the dividend, based on the “spot rate” of exchange in effect on the date of receipt or deemed receipt of the distribution, regardless of whether the payment is in fact converted into U.S. dollars. U.S. Holders will have a tax basis in the NIS for U.S. federal income tax purposes equal to that U.S. dollar value. Any gain or loss upon the subsequent conversion of the NIS into U.S. dollars or other disposition of the NIS will constitute foreign currency gain or loss taxable as ordinary income or loss and will be treated as U.S.-source income or loss for U.S. foreign tax credit purposes.
77
Dividends received with respect to our ordinary shares will constitute “portfolio income” for purposes of the limitation on the use of passive activity losses and, therefore, generally may not be offset by passive activity losses. Dividends received with respect to our ordinary shares also generally will be treated as “investment income” for purposes of the investment interest deduction limitation contained in Section 163(d) of the Code, and as foreign-source passive income for U.S. foreign tax credit purposes or, in the case of a U.S. Holder that is a financial services entity, financial services income. Subject to certain limitations, U.S. Holders may elect to claim as a foreign tax credit against their U.S. federal income tax liability any Israeli income tax withheld from distributions on our ordinary shares which constitute dividends under U.S. income tax law. U.S. Holders that do not elect to claim a foreign tax credit may instead claim a deduction for Israeli income tax withheld, but only if the U.S. Holder elects to do so with respect to all foreign income taxes in such year. In addition, special rules may apply to the computation of foreign tax credits relating to “qualified dividend income,” as defined above. The calculation of foreign tax credits and, in the case of a U.S. Holder that elects to deduct foreign income taxes, the availability of deductions are complex and involve the application of rules that depend on a U.S. Holder’s particular circumstances. U.S. Holders are urged to consult their own tax advisors regarding the availability to them of foreign tax credits or deductions in respect of any Israeli tax withheld or paid with respect to any dividends which may be paid with respect to our ordinary shares.
Passive Foreign Investment Company Status
Generally, a foreign corporation is treated as a passive foreign investment company (“PFIC”) for U.S. federal income tax purposes for any tax year if, in such tax year, either (i) 75% or more of its gross income (including its pro rata share of the gross income of any company in which it owns 25% or more of the shares by value) is passive in nature (the “Income Test”), or (ii) the average percentage of its assets during such tax year (including its pro rata share of the assets of any company in which it owns 25% or more of the shares by value) which produce, or are held for the production of, passive income (determined by averaging the percentage of the fair market value of its total assets which are passive assets as of the end of each quarter of such year) is 50% or more (the “Asset Test”). Passive income for this purpose generally includes dividends, interest, rents, royalties and gains from securities and commodities transactions.
There is no definitive method prescribed in the Code, U.S. Treasury Regulations or administrative or judicial interpretations thereof for determining the value of a foreign corporation’s assets for purposes of the Asset Test. The legislative history of the U.S. Taxpayer Relief Act of 1997 (the “1997 Act”), however, indicates that for purposes of the Asset Test, “the total value of a publicly-traded foreign corporation’s assets generally will be treated as equal to the sum of the aggregate value of its outstanding stock plus its liabilities.” It is unclear under current interpretations of the 1997 Act whether other valuation methods could be employed to determine the value of our assets.
Based on the composition of our gross income and the composition and value of our gross assets during 2005 and 2006, we do not believe that we were a PFIC in 2005 or 2006. However, it is likely, under the approach set forth in the legislative history to the 1997 Act, that we would have been classified as a PFIC in 2002, 2003 and 2004, primarily because (a) a significant portion of our assets consisted of cash, short- and long-term deposits and marketable securities from the remaining proceeds of our offerings, and (b) the relatively low public market valuation of our ordinary shares. In addition, there can be no assurance that we will not be deemed a PFIC in any future tax year.
78
Accordingly, U.S. Holders are urged to consult their own tax advisors for guidance as to our status as a PFIC in any tax year. For those U.S. Holders who determine that we are a PFIC in any tax year and notify us in writing of their request for the information required in order to effectuate the QEF Election described below, we will promptly make such information available to them.
If we are treated as a PFIC for U.S. federal income tax purposes for any year during a U.S. Holder’s holding period of ordinary shares and the U.S. Holder does not make a QEF Election or a “mark-to-market ” election (both as described below):
| | — | “Excess distributions” by us to a U.S. Holder would be taxed in a special way. “Excess distributions” with respect to any U.S. Holder are amounts received by such U.S. Holder with respect to our ordinary shares in any tax year that exceed 125% of the average distributions received by such U.S. Holder from us during the shorter of (i) the three previous years, or (ii) such U.S. Holder’s holding period of our ordinary shares before the then-current tax year. Excess distributions must be allocated ratably to each day that a U.S. Holder has held our ordinary shares. A U.S. Holder must include amounts allocated to the current tax year in his, her or its gross income as ordinary income for that year, pay tax on amounts allocated to each prior tax year in which we were a PFIC at the highest rate on ordinary income in effect for such prior year and pay an interest charge on the resulting tax at the rate applicable to deficiencies of U.S. federal income tax. |
| | — | The entire amount of any gain realized by a U.S. Holder upon the sale or other disposition of our ordinary shares also would be treated as an “excess distribution” subject to tax as described above. |
| | — | The tax basis in ordinary shares acquired from a decedent who was a U.S. Holder would not receive a step-up to fair market value as of the date of the decedent’s death, but instead would be equal to the decedent’s basis, if lower. |
Although we generally will be treated as a PFIC as to any U.S. Holder if we are a PFIC for any year during the U.S. Holder’s holding period, if we cease to be a PFIC, the U.S. Holder may avoid the consequences of PFIC classification for subsequent years if he, she or it elects to recognize gain based on the unrealized appreciation in his, her or its ordinary shares through the close of the tax year in which we cease to be a PFIC.
A U.S. Holder who beneficially owns shares of a PFIC must file U.S. Internal Revenue Service Form 8621 (Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund) with the U.S. Internal Revenue Service for each tax year in which he, she or it holds shares in a PFIC. This form describes any distributions received with respect to these shares and any gain realized upon the disposition of these shares.
For any tax year in which we are treated as a PFIC, a U.S. Holder may elect to treat his, her or its ordinary shares as an interest in a qualified electing fund (a “QEF Election”), in which case the U.S. Holder would be required to include in income currently his, her or its proportionate share of our earnings and profits in years in which we are a PFIC regardless of whether distributions of our earnings and profits are actually made to the U.S. Holder. Any gain subsequently recognized by the U.S. Holder upon the sale of his, her or its ordinary shares, however, generally would be taxed as capital gain and the denial of the basis step-up at death described above would not apply.
79
A U.S. Holder may make a QEF Election with respect to a PFIC for any tax year of the U.S. Holder. A QEF Election is effective for the tax year in which the election is made and all subsequent tax years of the U.S. Holder. Procedures exist for both retroactive elections and the filing of protective statements. A U.S. Holder making the QEF Election must make the election on or before the due date, as extended, for the filing of the U.S. Holder’s U.S. federal income tax return for the first tax year to which the election will apply. Upon his, her or its request, we will provide to each U.S. Holder, who wishes to make a QEF Election for any year in which we are treated as a PFIC, the information required to make a QEF Election and to make subsequent annual filings.
As an alternative to a QEF Election, a U.S. Holder generally may elect to mark his, her or its ordinary shares to market annually, recognizing ordinary income or loss (subject to certain limitations) equal to the difference, as of the close of the tax year, between the fair market value of his, her or its ordinary shares and the adjusted tax basis of such shares. If a mark-to-market election with respect to ordinary shares is in effect on the date of a U.S. Holder’s death, the normally available step-up in tax basis to fair market value will not be available. Rather, the tax basis of the ordinary shares in the hands of a U.S. Holder who acquired them from a decedent will be the lesser of the decedent’s tax basis or the fair market value of the ordinary shares. Once made, a mark-to-market election generally continues unless revoked with the consent of the U.S. Internal Revenue Service.
The implementation of many aspects of the Code’s PFIC rules requires the issuance of Treasury Regulations which in many instances have yet to be promulgated and which may have retroactive effect when promulgated. We cannot be sure that any of these regulations will be promulgated or, if so, what form they will take or what effect they will have on the foregoing discussion. Accordingly, and due to the complexity of the PFIC rules, U.S. Holders should consult their own tax advisors regarding our status as a PFIC and the eligibility, manner and advisability of making a QEF Election or a mark-to-market election if we are treated as a PFIC.
Information Reporting and Backup Withholding
Payments in respect of our ordinary shares that are made in the U.S. or by certain U.S.-related financial intermediaries may be subject to information reporting and backup withholding tax at rates equal to 28% through 2010 and 31 % after 2010 (unless legislation is enacted that provides otherwise). Information reporting will not apply, however, with respect to payments to certain U.S. Holders, including corporations and tax-exempt organizations. In addition, backup withholding will not apply to a U.S. Holder that (i) is a corporation or comes within certain exempt categories, and demonstrates that fact when so required, or (ii) furnishes a correct taxpayer identification number and furnishes other required certifications. U.S. Holders required to establish their exemption from backup withholding generally must provide a certification on IRS Form W-9 (or substitute form). Backup withholding is not an additional tax. Amounts withheld under the backup withholding rules may be credited against a U.S. Holder’s U.S. federal income tax liability, and a U.S. Holder may obtain a refund of any excess amounts withheld under the backup withholding rules by filing the appropriate claim for refund with the U.S. Internal Revenue Service. U.S. Holders should consult their own tax advisors regarding their qualification for an exemption from backup withholding and the procedures of obtaining such an exemption, if applicable.
80
Israeli Tax Considerations
The following discussion, which represents a summary of the current tax structure applicable to companies in Israel, with special reference to its effect on us, and certain Israeli tax laws affecting our shareholders, including U.S. shareholders, is for general information only and is not intended to substitute for careful or specific tax planning. To the extent that the discussion is based on legislation yet to be judicially or administratively interpreted, there can be no assurance that the views expressed herein will accord with any such interpretation in the future by the tax authorities or by the courts. This summary does not discuss all the aspects of Israeli tax law that may be relevant to a particular shareholder in light of his or her personal investment circumstances or to some types of investors that are subject to special treatment under Israeli law. This discussion is not intended, and should not be construed, as legal or professional tax advice, and does not cover all possible tax considerations. Accordingly, each investor should consult his or her own tax advisor as to the particular tax consequences of an investment in the ordinary shares including the effects of applicable Israeli or foreign or other tax laws and possible changes in the tax laws.
Corporate Tax Structure
Generally, Israeli companies are subject to corporate tax on their taxable income at the rate of 31% for the 2006 tax year. Following an amendment to the Israeli Income Tax Ordinance, or the Tax Ordinance, which came into effect on January 1, 2006, the corporate tax rate is scheduled to decrease as follows: 29% for the 2007 tax year, 27% for the 2008 tax year, 26% for the 2009 tax year and 25% for the 2010 tax year and thereafter. Israeli companies are generally subject to capital gains tax at a rate of 25% for capital gains (other than gains deriving from the sale of listed securities) derived from assets purchased after January 1, 2003. However, the effective tax rate payable by a company that derives income from an Approved Enterprise program may be considerably less, as further discussed below.
Tax Benefits Under the Law for the Encouragement of Capital Investments, 1959
Under the Law for Encouragement of Capital Investments, 1959, known as the Investments Law, by virtue of the “Approved Enterprise” status granted to some of our investment programs, we are entitled to various tax benefits. Until its amendment in April 2005 (as further discussed below), the Investments Law provided that a proposed capital investment in eligible facilities may, upon application to the Investment Center of the Ministry of Industry, Trade and Labor of the State of Israel, or the Investment Center, be designated as an “Approved Enterprise”. The period of tax benefits is seven years, commencing in the first year in which we earn taxable income from the approved enterprise, subject to certain limitations. Under certain circumstances, the period of tax benefits may be extended to ten years. Under this law, since we have elected what is known as the “alternative package”, our taxable income derived from an investment program designated as an Approved Enterprise is fully exempt from corporate tax for a period of two years, after which the income from these enterprises is taxable at the rate of 10% – 25% (depending on the level of foreign holdings in our ordinary shares) for the remainder of the period of tax benefits. The exemption is applicable as long as the gains are not distributed. Upon distribution, a 10% – 25% tax rate will apply, as described below.
81
Income generated from these Approved Enterprise programs includes income generated from the grant of a usage right with respect to know-how developed by the Approved Enterprise, income generated from royalties and income derived from a service which is auxiliary to such usage right or royalties, provided that such income is generated within the Approved Enterprise’s ordinary course of business, under the terms and conditions set by the Approved Enterprise programs. After the applicable benefit period expires, any such income from Approved Enterprise programs will be subject to tax at the full corporate tax rate.
On April 1, 2005, an amendment to the Investments Law came into force. Pursuant to the amendment, a company’s facility will be granted the status of “Approved Enterprise” only if it is proven to be an industrial facility (as defined in the Investments Law) that contributes to the economic independence of the Israeli economy and is a competitive facility that contributes to the Israeli gross domestic product. The amendment provides that the Israeli Tax Authority and not the Investment Center will be responsible for an Approved Enterprise under the alternative package of benefits, referred to as a “Benefited Enterprise”. A company wishing to receive the tax benefits afforded to a Benefited Enterprise is required to select the tax year from which the period of benefits under the Investment Law are to commence by simply notifying the Israeli Tax Authority within 12 months of the end of that year. In order to be recognized as owning a Benefited Enterprise, a company is required to meet a number of conditions set forth in the amendment, including making a minimal investment in manufacturing assets for the Benefited Enterprise and having completed a cooling-off period of no less than three years from the company’s previous year of commencement of benefits under the Investments Law. The amendment will apply to approved enterprise programs in which the year of election under the Investments Law is 2004 or later, unless such programs received approval from the Investment Center on or prior to December 31, 2004 in which case the amendment provides that terms and benefits included in any certificate of approval already granted will remain subject to the provisions of the law as they were on the date of such approval. There can be no assurance that we will receive future benefits under such amendment to the Investments Law.
Part of our income has been generated through our Approved Enterprises. If a company that has elected the “alternative package” distributes to its shareholders a cash dividend from tax-exempt income attributable to it, it would incur a tax liability on the amount distributed at the rate (10% to 25%) which would have been applicable had the company not elected the alternate package, and it will have to withhold tax at the rate of 15% with respect to the dividend distributed. Our taxes outside of Israel, mainly in Japan and the United States, are dependent on our operations in each jurisdiction as well as relevant laws and treaties.
Capital Gains Tax
Israeli law generally imposes a capital gains tax on the sale of any capital assets by residents of Israel, as defined for Israeli tax purposes, and on the sale of assets located in Israel, including shares in Israeli companies, by non-residents of Israel, unless a specific exemption is available or unless a tax treaty between Israel and the shareholder’s country of residence provides otherwise. The law distinguishes between the inflationary surplus and the real gain. The inflationary surplus is a portion of the total capital gain which is equivalent to the increase of the relevant asset’s purchase price attributable to the increase in the Israeli consumer price index, or in certain circumstances, a foreign currency exchange rate, between the date of purchase and the date of sale. The real gain is the excess of the total capital gain over the inflationary surplus.
82
The tax rate applicable to capital gains derived from the sale of shares, whether listed on a stock market or not, is 20% for Israeli individuals, unless such shareholder claims a deduction for financing expenses in connection with such shares, in which case the gain will generally be taxed at a rate of 25%. Additionally, if such shareholder is considered a “significant shareholder” at any time during the 12-month period preceding such sale (i.e., such shareholder holds directly or indirectly, including with others, at least 10% of any means of control in the company) the tax rate will be 25%. Israeli companies are subject to the corporate tax rate on capital gains derived from the sale of shares, unless such companies were not subject to the Income Tax Law (Inflationary Adjustments), 5745-1985, referred to as the Adjustments Law, (or certain regulations) as of August 10, 2005, in which case the applicable tax rate is 25%. However, the foregoing tax rates will not apply to dealers in securities and shareholders who acquired their shares prior to an initial public offering (which may be subject to different tax treatment).
The tax basis of shares acquired prior to January 1, 2003 will be determined in accordance with the average closing share price in the three trading days preceding January 1, 2003. However, a request may be made to the tax authorities to consider the actual adjusted cost of the shares as the tax basis if it is higher than such average price.
Non-Israeli residents are exempt from Israeli capital gains tax on any gains derived from the sale of shares of Israeli companies publicly traded on Nasdaq or a recognized stock market outside of Israel, provided that such capital gains are not derived from a permanent establishment in Israel, that such shareholders are not subject to the Adjustments Law and that such shareholders did not acquire their shares prior to the issuer’s initial public offering. However, non-Israeli corporations will not be entitled to such exemption if an Israeli resident (i) has a controlling interest of 25% or more in such non-Israeli corporation, or (ii) is the beneficiary of or is entitled to 25% or more of the revenues or profits of such non-Israeli corporation, whether directly or indirectly.
In some instances where our shareholders may be liable for Israeli tax on the sale of their ordinary shares, the payment of the consideration may be subject to the withholding of Israeli tax at the source.
Pursuant to a treaty between the governments of the United States and Israel, known as the U.S.-Israel Tax Treaty, the sale, exchange or disposition of shares by a person who holds the ordinary shares as a capital asset, who qualifies as a resident of the United States within the meaning of the treaty and who is entitled to claim the benefits afforded to a U.S. resident by the treaty will generally not be subject to Israeli capital gains tax. This exemption does not apply if the person holds, directly or indirectly, shares representing 10% or more of our voting power during any part of the 12-month period preceding the applicable sale, exchange or disposition, subject to specified conditions. However, under the treaty, such person would be permitted to claim a credit for the capital gains tax paid in Israel against the U.S. federal income tax imposed with respect to the applicable sale, exchange or disposition, subject to the limitations in U.S. laws applicable to foreign tax credits. The treaty does not relate to U.S state or local taxes.
83
Tax on Dividends
Non-residents of Israel are subject to income tax on income accrued or derived from sources in Israel. These sources of income include passive income such as dividends. On distributions of dividends other than bonus shares, or stock dividends, we would be required to withhold income tax at the source at the rate of 20%, or 25% for a shareholder that is considered a significant shareholder at any time during the 12-month period preceding such distribution, unless a different rate is provided in a treaty between Israel and the shareholder’s country of residence and a special certificate is provided. If the income out of which the dividend is being paid is attributable to an Approved Enterprise (or Benefited Enterprise), the rate is generally 15%. Under the U.S.-Israel Tax Treaty, if the income out of which the dividend is being paid is not attributable to an Approved Enterprise (or Benefited Enterprise), then income tax with respect to shareholders that are U.S. corporations holding at least 10% of our issued voting power during the part of the tax year which precedes the date of payment of the dividend and during the whole of its prior tax year, is required to be withheld at the rate of 12.5%.
| F. | DIVIDENDS AND PAYING AGENTS |
Not applicable
Not applicable.
We are subject to the informational requirements of the Securities Exchange Act of 1934, as amended, applicable to foreign private issuers and fulfill the obligations with respect to such requirements by filing reports with the Securities and Exchange Commission, or SEC. You may read and copy any document we file, including any exhibits, with the SEC without charge at the SEC’s public reference room at 100 F Street, N.E., Washington, D.C. 20549. Copies of such material may be obtained by mail from the Public Reference Branch of the SEC at such address, at prescribed rates. Please call the SEC at 1-800-SEC-0330 for further information on the public reference room. Certain of our SEC filings are also available to the public at the SEC’s website athttp://www.sec.gov.
As a foreign private issuer, we are exempt from the rules under the Exchange Act prescribing the furnishing and content of proxy statements, and our officers, directors and principal shareholders are exempt from the reporting and “short-swing” profit recovery provisions contained in Section 16 of the Exchange Act. In addition, we are not required under the Exchange Act to file periodic reports and financial statements with the SEC as frequently or as promptly as United States companies whose securities are registered under the Exchange Act. We have obtained an exemption from Nasdaq’s requirement to send an annual report to shareholders prior to our annual general meetings. We file annual reports on Form 20-F electronically with the SEC and post a copy on our website,www.orckit.com.
Not applicable
84
| ITEM 11. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
General
We are exposed to market risk, including movements in interest rates and foreign currency exchange rates. Our primary market risk exposure occurs because we generate most of our revenues in Japanese Yen but incur a majority of our salaries and related expenses and part of our other expenses in New Israeli Shekels.
From time to time, in management’s discretion, we may engage in hedging or other transactions intended to manage risks relating to foreign currency exchange rates. As of March 15, 2007, we were not involved in any hedging transactions. We may in the future undertake hedging or other similar transactions or invest in market risk sensitive instruments when our management determines that it is necessary to offset these risks.
Our interest rate and foreign exchange exposures are monitored by tracking actual and projected commitments.
Exchange Rate Risk Management
Our functional currency and that of our subsidiaries is the U.S. dollar.
From time to time, we assess our exposure to exchange rate risks and endeavor to limit this exposure through natural hedging, or by attempting to maintain a similar level of assets and liabilities in any given currency.
The table below presents our balance sheet exposure as of December 31, 2006 at fair value related to market risk sensitive instruments, mainly short term receivables cash, cash equivalents and payables in currencies other than U.S. dollars. Substantially all of such balance is in the currencies set forth in the table below. The information is presented in U.S. dollars (in millions), which is our reporting currency.
Please see also the explanatory notes below the table.
| New
Israeli
Shekels
| Japanese Yen
| Total
|
|---|
| | | | |
|---|
| | | |
|---|
| | | |
|---|
| | | |
|---|
| | | | | (3.6 | ) | | 4.4 | | | 0.8 | |
Explanatory notes:
1) Total balance sheet exposure relating to market risk sensitive instruments is the sum of the absolute figures (excess of assets over liabilities in the amount of $800,000). A devaluation of 5% of the U.S. dollar compared to the NIS would cause an increase in expenses of approximately $180,000. A devaluation of 5% of the U.S. dollar compared to the Japanese Yen would cause a decrease in expenses of approximately $220,000.
2) The data presented in the table reflects the exposure after taking into account the effect of the “natural” hedging.
85
Interest Rate Risk Management
As of December 31, 2006, we had $12.2 million of cash and cash equivalents, $33.8 million of short-term marketable securities, $38.1 million of long-term marketable securities and $1.5 million of long-term bank deposits. Our trading securities mature as follows: $33.8 million in 2007, and $38.1 million over a period from 2008 to 2009. Due to the relatively short-term maturities of the Company’s cash, deposits and securities portfolio, an immediate 10% change in the current interest rates (for example, from 5.0% to 5.5%) is not expected to have a material effect on its near-term financial condition or results of operations.
| ITEM 12. | DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES |
Not applicable
PART II
| ITEM 13. | DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES |
None
| ITEM 14. | MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS |
None
| ITEM 15. | CONTROLS AND PROCEDURES |
See Item 15T below.
| ITEM 15T. | CONTROLS AND PROCEDURES |
Disclosure Controls and Procedures
We performed an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) as of December 31, 2006. The evaluation was performed with the participation of our senior management and under the supervision and with the participation of our chief executive officer and chief financial officer. Based on this evaluation, our chief executive officer and chief financial officer have concluded that our disclosure controls and procedures are effective to alert them on a timely basis to material information required to be included in our periodic reports with the Securities and Exchange Commission.
Management’s Annual Report on Internal Control Over Financial Reporting
Our management, including our chief executive officer and chief financial officer, is responsible for establishing and maintaining adequate internal control over our financial reporting, as such term is defined in Rule 13a-15(f) under the Securities Exchange Act. Our internal control system was designed to provide reasonable assurance to our management and our board of directors regarding the reliability of financial reporting and the preparation and fair presentation of published financial statements for external purposes in accordance with generally accepted accounting principles. All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurances with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may decline.
86
Our management (with the participation of our chief executive officer and chief financial officer) conducted an evaluation, pursuant to Rule 13a-15(c) under the Exchange Act, of the effectiveness, as of the end of the period covered by this Annual Report, of our internal control over financial reporting based on the criteria set forth inInternal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on the results of this evaluation, management assessed the effectiveness of our internal control over financial reporting as at December 31, 2006 and concluded that our internal control over financial reporting was effective as of December 31, 2006.
This Annual Report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by our registered public accounting firm pursuant to temporary rules of the SEC that permit us to provide only management’s report in this Annual Report.
Changes in Financial Control Over Financial Reporting
In addition, there were no changes in our internal control over financial reporting that occurred during 2006 that have materially affected, or that are reasonably likely to materially affect, our internal control over financial reporting.
| Item 16A. | Audit Committee Financial Expert |
Our board of directors has determined that Mr. Motil qualifies as an “audit committee financial expert” as defined in Item 16A of Form 20-F and is “independent” as defined in the applicable regulations.
Our board of directors has adopted our Code of Ethics, a code that applies to all of our officers, directors and employees. We will provide our Code of Ethics free of charge to any person who requests a copy of it. Such requests may be sent to our offices in 126 Yigal Alon Street, Tel Aviv, Israel, attention: Controller.
| Item 16C. | Principal Accountant Fees and Services |
At our annual general meeting held in April 2007, our shareholders re-appointed Kesselman & Kesselman, a member of PricewaterhouseCoopers International Limited, to serve as our independent auditors. These accountants billed the following fees to us for professional services in each of the last two fiscal years:
87
| Year Ended December 31,
|
|---|
| 2006
| 2005
|
|---|
| | | |
|---|
| | |
|---|
| | |
|---|
| Audit Fees | | | $ | 106,000 | | $ | 112,000 | |
| Audit-Related Fees | | | | 16,000 | | | 32,000 | |
| Tax Fees | | | | 19,000 | | | 43,000 | |
| All Other Fees | | | | 16,000 | | | -- | |
|
| |
| |
| Total | | | $ | 157,000 | | $ | 187,000 | |
“Audit Fees” are the aggregate fees billed for the audit of our annual financial statements. This category also includes services that generally the independent accountant provides, such as statutory audits including audits required by the Office of the Chief Scientist and other Israeli government institutes, consents and assistance with and review of documents filed with the SEC.
“Audit-Related Fees” are the aggregate fees billed for assurance and related services that are reasonably related to the performance of the audit and are not reported under Audit Fees. These fees include mainly accounting consultations regarding the accounting treatment of matters that occur in the regular course of business, implications of new accounting pronouncements and other accounting issues that occur from time to time.
“Tax Fees” are the aggregate fees billed for professional services rendered for tax compliance, tax advice, other than in connection with the audit. Tax compliance involves preparation of original and amended tax returns, tax planning and tax advice.
“All Other Fees” include fees not included in any of the other categories. These fees were mainly for consultations and services provided in connection with internal control over financial reporting.
Our Audit Committee has adopted a pre-approval policy for the engagement of our independent accountant to perform certain audit and non-audit services. Pursuant to this policy, which is designed to assure that such engagements do not impair the independence of our auditors, the audit committee pre-approves annually a catalog of specific audit and non-audit services in the categories of Audit Service, Audit-Related Service, Tax Services and other services that may be performed by our independent accountants, and the maximum pre-approved fees that may be paid as compensation for each pre-approved service in those categories. Any proposed services exceeding the maximum pre-approved fees require specific approval by the Audit Committee.
None of the fees paid by us to our independent auditors during 2006 were for services approved pursuant to 2-01(c)(7)(i)(C) of Regulation S-K.
The Audit Committee may delegate its pre-approval authority to one or more of its members, subject to ratification by the entire Audit Committee.
Requests or applications to provide services that require specific approval by the Audit Committee are submitted to the Audit Committee by an executive officer of the Company, together with detailed back-up documentation and a statement as to whether, in the requesting executive officer’s view, the provision of such services by the outside auditor would impair its independence.
88
| ITEM 16D. | EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES. |
Not applicable.
| ITEM 16E. | PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS |
None.
| ITEM 17. | FINANCIAL STATEMENTS |
See Item 18.
| ITEM 18. | FINANCIAL STATEMENTS |
Our consolidated financial statements and related auditors’ report for the year ended December 31, 2006 are hereby incorporated by reference to our Report on Form 6-K, filed with the SEC on March 30, 2007.
The following exhibits are filed as part of this Annual Report:
89
| †1.110 | | Memorandum of Association, as amended. |
| 1.29 | | Sixth Amended and Restated Articles of Association. |
| 1.34 | | Bonus Rights Agreement, dated as of November 20, 2001, between Orckit Communications Ltd. and American Stock Transfer & Trust Company, as Rights Agent. |
| 1.41 | | Amendment No. 1, dated as of February 5, 2003, to Bonus Rights Plan, dated as of November 20, 2001, between Orckit Communications Ltd. and American Stock Transfer & Trust Company, as Rights Agent. |
| 4.19 | | Orckit Israeli Share Incentive Plan, as amended. |
| †4.53 | | Lease Agreement, dated September 28, 1999, between Orckit Communications Ltd. and Gush 7093 Helka 162 Ltd., private company # 51-058315-6. |
| 4.65 | | Corrigent Stock Option Plan (2001). |
| 4.107 | | Orckit Communications Ltd. 2003 Subsidiary Employee Share Incentive Plan. |
| 4.118 | | Letter of undertaking dated December 5, 2005 of Orckit Communications Ltd. to Bank Hapoalim B.M. |
| 4.128 | | Undertaking dated December 5, 2005 of Orckit Communications Ltd. to Bank Hapoalim B.M. |
| 4.138 | | Debenture dated December 5, 2005 of Orckit Communications Ltd. to Bank Hapoalim B.M. |
| 4.148 | | Debenture dated December 5, 2005 of Corrigent Systems Ltd. to Bank Hapoalim B.M |
| 4.1510 | | Amended and Restated Employment Agreement, dated as of June 23, 2005, between Orckit Communications Ltd. and Eric Paneth. |
| 4.1610 | | Amended and Restated Employment Agreement, dated as of June 23, 2005, between Orckit Communications Ltd. and Izhak Tamir. |
| 4.17* | | English summary of the terms and conditions of Convertible Notes issued in March 2007. |
| 8.1* | | Subsidiaries of Orckit Communications Ltd. |
| 12.1* | | Certification of Principal Executive Officer pursuant to 17 CFR 240.13a-14(a), as adopted pursuant toss.302 of the Sarbanes-Oxley Act |
90
| 12.2* | | Certification of Principal Financial Officer pursuant to 17 CFR 240.13a-14(a), as adopted pursuant toss.302 of the Sarbanes-Oxley Act |
| 13.1* | | Certification of Principal Executive Officer pursuant to 18 U.S.C.ss.1350, as adopted pursuant toss.906 of the Sarbanes-Oxley Act |
| 13.2* | | Certification of Principal Financial Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to 906 of the Sarbanes-Oxley Act |
| † | Translated in full or summary version; the original language version is on file with Orckit Communications Ltd. and is available upon request. |
| 1 | Incorporated by reference to Orckit Communications Ltd.‘s Registration Statement (File No. 000-28724) on Form 8-A/A. |
| 2 | Incorporated by reference to Orckit Communications Ltd.‘s Registration Statement (File No. 333-12178) on Form S-8. |
| 3 | Incorporated by reference to Orckit Communications Ltd.‘s Annual Report on Form 20-F for the fiscal year ended December 31, 2000. |
| 4 | Incorporated by reference to Orckit Communications Ltd.‘s Registration Statement (File No. 000-28724) on Form 8-A. |
| 5 | Incorporated by reference to Orckit Communications Ltd.‘s Annual Report on Form 20-F for the fiscal year ended December 31, 2001. |
| 6 | Incorporated by reference to Orckit Communications Ltd.‘s Annual Report on Form 20-F for the fiscal year ended December 31, 2003. |
| 7 | Incorporated by reference to Orckit Communications Ltd.‘s Annual Report on Form 20-F for the fiscal year ended December 31, 2002. |
| 8 | Incorporated by reference to Orckit Communications Ltd.‘s Annual Report on Form 20-F for the fiscal year ended December 31, 2004. |
| 9 | Incorporated by reference to Orckit Communication Ltd.‘s Registration Statement on Form S-8 (File No. 333-131991). |
| 10 | Incorporated by reference to Orckit Communications Ltd.‘s Annual Report on Form 20-F for the fiscal year ended December 31, 2005. |
91
SIGNATURES
The Registrant hereby certifies that it meets all of the requirements for filing on Form 20-F and that it has duly caused and authorized the undersigned to sign this Annual Report on its behalf.
| | ORCKIT COMMUNICATIONS LTD.
By: /s/ Izhak Tamir
——————————————
Izhak Tamir
President
Date: May 9, 2007 |
92
