UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 20–F
| ¨ | REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF 1934 |
OR
x | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended December 31, 2012
OR
| ¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
OR
| ¨ | SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
Date of event requiring this shell company report……………….
For the transition period from_____________to_________________
Commission file number 0-28724
ORCKIT COMMUNICATIONS LTD.
(Exact name of Registrant as specified in its charter
and translation of Registrant’s name into English)
ISRAEL
(Jurisdiction of incorporation or organization)
126 Yigal Allon Street, Tel Aviv 67443, Israel��
(Address of principal executive offices)
Izhak Tamir, CEO and CFO, +972-3-6962121, info@orckit.com, 126 Yigal Allon Street, Tel Aviv 67443, Israel
(Name, Telephone, E-mail and/or Facsimile number and Address of Company Contact Person)
Securities registered or to be registered pursuant to Section 12(b) of the Act.
| Title of Each Class | Name of Each Exchange On Which Registered |
Securities registered or to be registered pursuant to Section 12(g) of the Act.
Ordinary Shares, no par value
(Title of Class)
Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act.
None
(Title of Class)
Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of the period covered by the annual report.
As of December 31, 2012, the Registrant had outstanding 31,041,295 Ordinary Shares, no par value.
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
o Yes x No
If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
o Yes x No
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
x Yes o No
Indicate by check mark whether registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
x Yes o No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer o Accelerated filer o Non-accelerated filer x
Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing:
x U.S. GAAP
| | o | International Financial Reporting Standards as issued by the International Accounting Standards Board |
o Other
If “Other” has been checked in response to the previous question indicate by check mark which financial statement item the Registrant has elected to follow.
Item 17 o Item 18 o
If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
o Yes x No
This Annual Report contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, or the Securities Act, and Section 21E of the Exchange Act. These forward-looking statements can generally be identified as such because the context of the statement will include words such as “may,” “intends,” “plans,” “believes,” “anticipates,” “expects,” “estimates,” “predicts,” “potential,” “continue,” or “opportunity,” the negative of these words or words of similar import. Similarly, statements that describe our business outlook or future economic performance, anticipated revenues, expenses or other financial items, introductions and advancements in development of products, and plans and objectives related thereto, and statements concerning assumptions made or expectations as to any future events, conditions, performance or other matters, are also forward-looking statements. Forward-looking statements are subject to risks, uncertainties and other factors which could cause actual results to differ materially from those stated in such statements. Factors that could cause or contribute to such differences include, but are not limited to, those set forth under Item 3.D, “Key Information – Risk Factors” of this Annual Report.
Our actual results of operations and execution of our business strategy could differ materially from those expressed in, or implied by, the forward-looking statements. In addition, past financial and/or operating performance is not necessarily a reliable indicator of future performance and you should not use our historical performance to anticipate results or future period trends. We can give no assurances that any of the events anticipated by the forward-looking statements will occur or, if any of them do, what impact they will have on our results of operations and financial condition. In evaluating our forward-looking statements, you should specifically consider the risks and uncertainties set forth under Item 3.D, “Key Information – Risk Factors” of this Annual Report.
Unless the context otherwise requires, “Orckit,” “us,” “we” and “our” refer to Orckit Communications Ltd. and its subsidiaries.
References to “NIS” are to New Israeli Shekels, the lawful currency of the State of Israel. Unless specified otherwise, translations of NIS into U.S. dollars are provided based on the exchange rate at the date on which the event occurred. The exchange rates used are the representative exchange rates published by the Bank of Israel.
PART I
ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS
Not applicable
ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE
Not applicable
ITEM 3. KEY INFORMATION
A. SELECTED FINANCIAL DATA
The following selected consolidated financial data as of December 31, 2011 and 2012 and for each of the years ended December 31, 2010, 2011 and 2012 are derived from our audited consolidated financial statements included in this Annual Report, which have been prepared in accordance with generally accepted accounting principles in the United States. The selected consolidated financial data as of December 31, 2008, 2009 and 2010 and for each of the years ended December 31, 2008 and 2009 are derived from our audited consolidated financial statements not included in this Annual Report. The selected consolidated financial data set forth below should be read in conjunction with and are qualified by reference to “Item 5. Operating and Financial Review and Prospects” and the consolidated financial statements and the notes thereto and the other financial information appearing elsewhere in this Annual Report.
| | | | |
| | | 2008 | | | 2009 | | | 2010 | | | 2011 | | | 2012 | |
| Statement of Operations Data: | | (in thousands, except per share data) | |
| Revenues | | $ | 17,256 | | | $ | 12,727 | | | $ | 14,631 | | | $ | 15,585 | | | $ | 11,193 | |
| Cost of revenues | | | 9,606 | | | | 8,244 | | | | 9,340 | | | | 8,646 | | | | 4,069 | |
| Gross profit | | | 7,650 | | | | 4,483 | | | | 5,291 | | | | 6,939 | | | | 7,124 | |
| Research and development expenses | | | 24,925 | | | | 15,330 | | | | 16,667 | | | | 13,118 | | | | 8,212 | |
| Less grants | | | 2,066 | | | | 1,722 | | | | 2,569 | | | | 3,209 | | | | 2,689 | |
| Research and development expenses, net | | | 22,859 | | | | 13,608 | | | | 14,098 | | | | 9,909 | | | | 5,523 | |
| Selling, general and administrative expenses | | | 19,164 | | | | 15,677 | | | | 16,498 | | | | 13,419 | | | | 8,908 | |
| Operating loss | | | (34,373 | ) | | | (24,802 | ) | | | (25,305 | ) | | | (16,389 | ) | | | (7,307 | ) |
| Financial expenses, net | | | 179 | | | | 362 | | | | 1,642 | | | | 4,991 | | | | 1,473 | |
| Gain from early extinguishment of notes | | | - | | | | 2,985 | | | | - | | | | - | | | | - | |
| Income (expenses) from adjustments related to convertible notes | | | 2,265 | | | | (883 | ) | | | (28 | ) | | | 3,622 | | | | 1,867 | |
| Other income | | | - | | | | - | | | | 1,624 | | | | 369 | | | | 446 | |
| Net loss | | | (32,287 | ) | | | (23,062 | ) | | | (25,351 | ) | | | (17,389 | ) | | | (6,467 | ) |
| Net loss per share – basic | | $ | (1.97 | ) | | $ | (1.40 | ) | | $ | (1.33 | ) | | $ | (0.77 | ) | | $ | (0.24 | ) |
| Net loss per share – diluted | | $ | (1.97 | ) | | $ | (1.40 | ) | | $ | (1.33 | ) | | $ | (0.84 | ) | | $ | (0.27 | ) |
| Weighted average number of ordinary shares outstanding-basic | | | 16,386 | | | | 16,483 | | | | 19,024 | | | | 22,689 | | | | 26,477 | |
| Weighted average number of ordinary shares outstanding- diluted | | | 16,386 | | | | 16,483 | | | | 19,024 | | | | 24,484 | | | | 29,830 | |
| | | As of December 31, | |
| | | 2008 | | | 2009 | | | 2010 | | | 2011 | | | 2012 | |
| Balance Sheet Data: | | (in thousands) | |
| Cash, cash equivalents, bank deposits, marketable and other securities and long-term investments | | $ | 66,821 | | | $ | 47,343 | | | $ | 35,546 | | | $ | 23,188 | | | $ | 3,227 | |
| Working capital (1) | | | 41,723 | | | | 22,931 | | | | 20,602 | | | | 211 | | | | 3,753 | |
| Total assets | | | 82,189 | | | | 56,357 | | | | 53,257 | | | | 40,322 | | | | 15,499 | |
| Convertible subordinated notes, Series A and Series B | | | 25,731 | | | | 21,996 | | | | 24,938 | | | | 29,071 | | | | 13,493 | |
| Share capital, additional paid-in capital and warrants (2) | | | 336,048 | | | | 337,774 | | | | 356,373 | | | | 358,134 | | | | 360,534 | |
| Shareholders’ equity (capital deficiency) | | | 36,761 | | | | 17,464 | | | | 11,252 | | | | (4,115 | ) | | | (8,387 | ) |
| | (1) | Total current assets net of total current liabilities |
| | (2) | Net of treasury shares |
B. CAPITALIZATION AND INDEBTEDNESS
Not applicable
C. REASONS FOR THE OFFER AND USE OF PROCEEDS
Not applicable
D. RISK FACTORS
We are subject to various risks and uncertainties relating to or arising out of the nature of our business and general business, economic, financial, legal and other factors or conditions that may affect us. We believe that the occurrence of any one or some combination of the following factors could have a material adverse effect on our business, financial condition, cash flows and results of operations.
Risks Relating to Our Business and Industry
We have a significant amount of debt and require a significant amount of cash to fund our operating activities and repay our debt. There is substantial doubt as to our ability to continue as a going concern, and our note holders are considering to initiate liquidation proceedings.
We used cash in our operating activities in the amount of $31.2 million in 2010, $16.5 million in 2011 and $7.8 million in 2012. We expect to consume cash in our operating activities in 2013. As of December 31, 2012, the total amount of our cash and cash equivalents amounted to approximately $3.2 million (including $0.35 million of restricted cash) and we had a capital deficiency in the amount of $8.4 million.
Pursuant to the arrangement between us and the holders of our NIS-denominated Series A convertible notes and our Series B convertible notes under Section 350 of the Israeli Companies Law 5759-1999, which became effective on July 2, 2012, or the Arrangement, only an aggregate of approximately $3.5 million principal amount of these notes were converted into equity (8,246,044 of our ordinary shares). As of December 31, 2012, we had outstanding Series A notes and Series B notes in the aggregate principal amounts of approximately $10.8 million and $4.4 million, respectively. We paid our note holders approximately $1.3 million in April 2, 2013.
We are required to pay our note holders approximately 11.8 million in July 2014 and approximately $4.2 million in December 2017 (not including interest and CPI adjustments). We will require additional financing and a significant improvement in our results of operations if we are to be able to operate our business and make all required payments to our note holders. The agreement with Networks3 described below in the next risk factor is subject to significant conditions and there is no assurance that the transactions contemplated by this agreement will be consummated. These facts raise substantial doubt as to our ability to continue as a going concern, and our audited financial statements for the year ended December 31, 2012 include an explanatory paragraph to this effect by our independent registered public accounting firm.
In addition, during the week of April 28, 2013, our Series A note holders are holding a vote on a proposal to authorize the trustee of such notes to initiate legal proceedings against us and our office holders, including a proceeding for involuntary liquidation, and a proposal to demand that we immediately redeem the secured promissory notes in the aggregate principal amount of $5.0 million that we issued to funds affiliated with Hudson Bay Capital.
In addition, if the value of the NIS compared to the U.S. dollar increases, the U.S. dollar value of the principal amount of both series of our convertible notes would also increase. We may be unable to repay the principal amount of the notes when due. If we are unable to generate sufficient cash flows or otherwise obtain funds necessary to make required payments on these notes, we will be in default under the respective trust agreements governing the notes which could, in turn, cause defaults under any other future indebtedness.
The amount of debt we have incurred could adversely affect us in a number of ways, including by:
| | · | placing us at a competitive disadvantage as compared to our competitors who have less or no debt; |
| | · | limiting our ability to obtain additional financing; |
| | · | limiting our flexibility in planning for, or reacting to, changes in our business;making us more vulnerable to a downturn in our business and the economy generally; |
| | · | requiring us to apply all or a substantial portion of our cash towards payments on our debt, instead of using those funds for other purposes, such as working capital or capital expenditures; |
| | · | leading our suppliers to require advance payments, thereby harming our cash flows; |
| | · | harming our financial condition and results of operations; and |
| | · | resulting in our liquidation, in which case our ordinary shares will have no value. |
In particular, our customers and potential customers could be deterred from doing business with us out of a concern about our weak financial condition. For example, in 2012, during the lengthy approval process for the Arrangement, a number of telecommunication providers deferred making business commitments to us pending the implementation of the Arrangement, and when only a small amount of notes were converted into equity pursuant to the Arrangement, they decided not to proceed with us. A painful example of this was KDDI, a Tier 1 customer in Japan, to whom we sold more than $200 million of our CM-100 network element, primarily in 2005. In 2011, we presented to KDDI our new technology that was expected to enable KDDI to upgrade old network elements in a cost-efficient manner, without replacing existing infrastructure. This project, if implemented, could have generated a significant amount of revenues for us over the life of the network. However, KDDI had notified us that their decision to award this project to us was subject to the successful conclusion of a financial restructuring, and after the disappointing implementation of the Arrangement they decided not to award us this project.
We need additional financing to operate our business and repay our debt.
We need to raise additional capital to operate our business and repay our debt. The substantial cash required to fund our operating activities and repay our outstanding notes could impede our ability to operate successfully and to invest in our business. We have not generated cash from operations during any of the years in the period from 2007 through 2012. We need to raise equity or debt, commercialize our intellectual property, or do a combination of these transactions. The high amount of our debt, even after the implementation of the Arrangement, has discouraged prospective investors from investing in our equity. We may not be able to obtain additional financing on acceptable terms or at all. This would inhibit our ability to operate our business. Our financial condition has already forced us to significantly curtail our operations in 2012. If we are unable to obtain adequate funds on reasonable terms, we may be required to further curtail operations significantly or obtain funds by entering into financing agreements on unattractive terms, which could adversely affect our results of operations and our ability to operate. If we issue ordinary shares to new investors, especially given the low prevailing market prices of our ordinary shares, our shareholders will be significantly diluted.
On March 12, 2013, we entered into a Strategic Investment Agreement with Networks3, Inc., a non-practicing entity controlled by Hudson Bay Capital, in order to commercialize our patents and raise equity and debt financing, as well as a Note Purchase Agreement with two funds managed by Hudson Bay Capital. However, the Strategic Investment Agreement is subject to significant closing conditions, including the retirement of our Series A notes and Series B notes, which would require a court-approved arrangement pursuant to Section 350 of the Israeli Companies Law, and the approval of the Office of the Chief Scientist on terms satisfactory to Networks3, and there is no assurance that the transactions contemplated by this agreement will be consummated. See Item 10.C – "Additional Information-Material Contracts-Patent and Financing Transactions". Any such arrangement would involve the payment to our note holders of cash and other assets and the issuance of equity securities.
We have a history of substantial losses. We may experience additional losses in the future.
We have incurred significant research and development expenses addressing the development of the metro CM-100 and CM-4000 products, both telecommunication equipment products addressing high transmission of data for the metropolitan area. We incurred operating losses of approximately $32 million in 2007, $34 million in 2008, $25 million in 2009, $25 million in 2010, $16 million in 2011 and $7 million in 2012. We also incurred significant net losses in each of those years and expect to incur a net loss in 2013. We cannot be sure that we will be able to become profitable.
We have recently made significant reductions in our personnel in order to preserve our cash. This prevents us from being awarded large contracts with Tier 1 customers and could harm our ability to attract and support other customers, as well.
In 2011 and in multiple stages in 2012, in order to reduce our cash expenditures, we decreased our expenses, mainly by reducing our headcount, in all areas, including research and development, sales and marketing and customer support. We have also reduced our administrative headcount, thereby increasing the administrative responsibilities of the remaining employees. There is no assurance that the reduction in these expenses will improve our results of operations. The reduction in these expenses means that we no longer have the capacity to compete in tenders for projects with Tier 1 customers, and we have no ability to support projects of this scope. It could also materially harm our ability to attract new Tier 2 customers and satisfy our existing customers. If we fail to satisfy our customers, we could face legal claims for breach of our maintenance and support obligations.
Recent and future economic conditions, may adversely affect our business.
The current economic and credit environment is having a negative impact on business around the world. The impact of these conditions on the technology industry and our major current and potential customers has been severe.
Conditions may continue to be depressed or may be subject to further deterioration which could lead to a further reduction in consumer and customer spending overall, which could have an adverse impact on sales of our products. A disruption in the ability of our current and potential significant customers to access liquidity could cause serious disruptions or an overall deterioration of their businesses which could lead to a significant reduction in their orders of our products, the inability or failure on their part to meet their payment obligations to us and the cancellation or reduction of future projects, any of which could have a material adverse effect on our results of operations and liquidity. In addition, any disruption in the ability of customers to access liquidity could lead customers to request longer payment terms from us or long-term financing of their purchases from us. If we are unable to grant extended payment terms when requested by customers, our sales could decrease. Granting extended payment terms or a significant adverse change in a customer’s financial and/or credit position would have an immediate negative effect on our cash balances, and could require us to assume greater credit risk relating to that customer’s receivables or limit our ability to collect receivables related to purchases by that customer. As a result, we may have to defer recognition of revenues, our reserves for doubtful accounts and write-offs of accounts receivable may increase and our losses may increase.
We depend on sales to a limited number of significant customers. The loss of a significant customer, or a decrease in purchases by a significant customer, could have a material adverse effect on our results of operations.
Our revenues from 2004 through 2007 were dependent on sales of one product line, the CM-100, to KDDI, a Japanese telecommunication carrier, which has remained a significant customer. Approximately 23.1% of our revenues in 2010, 16.6% of our revenues in 2011 and 25.3% of our revenues in 2012 were derived from sales of CM-100 metro products and services to KDDI. KDDI purchased the CM-100 for initial coverage deployment in its metropolitan area network and began significant deployment in late 2004, continuing through 2005. KDDI’s deployments of the CM-100 decreased in 2006 through 2011. Deployments and revenues from KDDI for 2013 will be insignificant. In 2007, we introduced the CM-4000, a metro product with additional features and capabilities. KDDI has not made and is not expected to make purchases of this product. In 2012, KDDI decided not to award a large upgrade project to us due to our weak financial condition. Moreover, as part of our cost-cutting program in 2012, after KDDI and its distributor did not agree to our request to increase their maintenance payments to us, we terminated the employment of most of the employees who were experts in the CM-100, closed our office in Japan and stopped issuing invoices for support services to the distributor. This resulted in a significant reduction in our overall maintenance revenues and could harm our ability to generate additional sales from KDDI. We do not know for how long a period of time KDDI will continue to purchase the CM-100 from us, nor do we have any control or influence over the purchasing decisions of KDDI, including the quantities and timing of purchases by KDDI.
In 2008, our products were selected by Media Broadcast GmbH as a network infrastructure building block for network solutions deployed by Deutsche Telekom’s wholesale business unit, and leased to a leading cable operator in Germany. Media Broadcast, which was a subsidiary of Deutsche Telekom, began purchasing and deploying our products in 2008, becoming our second largest customer in 2008. Approximately 44.1% of our revenues in 2008 were derived from sales of metro products to Media Broadcast. Sales to Media Broadcast decreased significantly thereafter and constituted 6.6% of our revenues in 2010, 2.6% of our revenues in 2011 and 3.1% of our revenues in 2012. The cable operator that is the ultimate user of our products has decided to build its own network structure. Accordingly, our revenues from Media Broadcast are expected to consist primarily of the sale of services for equipment previously sold and therefore are expected to continue to be low. We do not know for how long a period of time Media Broadcast will continue to purchase services from us.
In 2009, our CM-4000 products were selected by Bharat Sanchar Nigam Limited (BSNL) in India as part of a nationwide, next generation broadband, triple play network based on gigabit passive optical network (GPON) and carrier Ethernet technologies. In 2010, after receipt of a required approval from TSEC in India, a condition for making sales to BSNL, we started to recognize revenues from sales to BSNL through two OEM channels. We recognized approximately $5.9 million of revenues in 2010, which represented 40.0% of our revenues in 2010, approximately $2.6 million of revenues in 2011, which represented 16.8% of our revenues in 2011, and approximately $0.2 million of revenues in 2012, which represented 1.2% of our revenues in 2012. We had expected to receive a follow-on order from BSNL in an amount of 381 million Indian Rupees equal to approximately $7 million in the third quarter of 2011 through ITI Ltd., a local OEM channel. Since then, we believed on several occasions that we were on the verge of receiving this order, only to be frustrated by new obstacles. As a result, we wrote off approximately $550,000 of inventory in our 2012 financial results.
In June 2009, our CM-4000 was selected by Mexico’s MetroNet as their main network infrastructure building block. The CM-4000 was selected to replace MetroNet’s existing carrier Ethernet switches that were at the end of their life and could not be purchased any longer. Interoperability between our CM-4000 and their existing equipment was a requirement that enabled MetroNet to continue delivery of Carrier Ethernet services to leading carriers in Mexico over a multi-vendor network until the expected transition to a full CM-4000 network is completed. Deliveries of our CM-4000 in Mexico started at the end of 2008. Sales to Metronet increased significantly thereafter and constituted 3.7% of our revenues in 2010, 6.7% of our revenues in 2011 and 13.4% of our revenues in 2012. We cannot be sure that this customer will continue to purchase our products to the same extent, if at all.
In late 2009, a leading Scandinavian telecommunication service provider selected our CM-4000 product to enable services migration and expansion for residential, enterprise and mobile subscribers with shipments beginning in late 2009. Sales to this customer represented 9.3% of our revenues in 2010, 23.1% of our revenues in 2011 and 10.2% of our revenues in 2012. We cannot be sure that this customer will continue to purchase our products.
We have a business collaboration arrangement with 3M Services to distribute our CM-4000 packet transport gears, which led to the selection of our CM-4000 product by several new customers, most of which are regional operators in Germany. Sales to 3M accounted for 6.7% of our revenues in 2010, 18.6% of our revenues in 2011 and 25.6% of our revenues in 2012. In March 2013, 3M Services informed us that one of its customers to whom we sold products that later became the subject of a recall is preparing to file a lawsuit against 3M Services, for damages of approximately $1.3 million, in connection with products supplied by us. 3M Services informed us, in turn, that it reserves its right to sue us in connection with this matter. We cannot be sure that this company will continue to distribute our products to the same extent, if at all.
For the past several years, we have depended on sales of our CM product lines to a limited number of customers for the substantial majority of our revenues. This dependence will continue in 2013 and beyond. Demand for CM products will likely decline because we stopped the development of Layer-3 functionality as a result of our cost reductions, which is causing us to lose our competitive edge. We do not have sufficient resources to develop new features required by our customers and prospective customers and have completely abandoned our efforts to win Tier 1 customers. In the case of Tier 2 customers, we require guaranteed revenues to finance the development of required features. This requirement significantly reduces our ability to win new Tier 2 customers and reduces our ability to preserve existing Tier 2 customers. There is no assurance that customers will continue to purchase our products or that they will not choose another vendor. The loss of 3M or Metronet as a customer or the loss or a significant decrease in revenues from 3M or Metronet would have a material adverse effect on our results of operations unless we are able to generate significant additional revenues from other customers.
We need to make sales to additional customers of our existing products and to develop additional new products and solutions in order to become profitable.
We need to make sales to additional customers and to develop additional products and solutions in order to become profitable. Since 2004, the significant majority of our revenues have been derived from our CM-100 product line to a very limited number of customers. In 2008, we added a second generation product line, the CM-4000, which has started to be commercially deployed and accounted for the majority of our revenues in 2010, 2011 and 2012. There is no specific obligation on any customer to purchase products from us. Thus, we cannot be sure of the amount of our products that will be purchased as a result of selections of our products by new customers, or the period of time over which our products may be purchased by any customers. If we do not receive significant product orders, our results of operations will be materially adversely affected and we may not be able to become profitable. While we have an initial marketing definition for a new product and solution, we lack the financial resources to develop it. Potential investors are likely to be deterred by the significant amount of our debt. Even if we succeed in funding the development of this new project, initial sales of the products would not generate revenue before July 2014, when the final payments to our Series A note holders are due.
We depend on third party distributors for the sale of our products. If these distributors do not succeed in selling our products, or if we are not able to maintain our relationship with them, our results of operations will suffer.
Our sales of products to KDDI are made through OKI Electric Industry Co., Ltd., our sales of products to SK Broadband are made through Global Telecom, our sales of products to BSNL are made through ITI Ltd. and Alphion Corporation, both distributors in India, as well as through an additional OEM channel, and our sales in Germany are currently made mainly through 3M Services. We also make sales through distributors for other smaller scale customers. We are dependent on the marketing and sales efforts of our distributors to convince customers or end-users to purchase our products and to provide local support services. If a distributor terminates or adversely changes its relationship with us, we may be unsuccessful in replacing it. The loss of a distributor could impair our ability to sell our products and materially adversely affect our results of operations.
The purchasing patterns in the markets we address will likely result in our revenues being highly volatile.
Sales of our product lines are dependent on the capital equipment expenditure budgets of telecommunication carriers for metro network equipment. The purchasing patterns of telecommunication carriers for this type of expansion project are subject to high volatility. Uncertainty with respect to consumer spending as a result of weak economic conditions could cause our customers to delay the placing of orders and slow the pace of reorders. We have experienced a concentrated and inconsistent pattern of purchasing by KDDI, SK Broadband, Media Broadcast BSNL and by the customers of 3M. We have limited experience with respect to the purchasing patterns of other newer customers as well. While product selections and subsequent deliveries may last several years, the purchasing pattern during the deployment period is highly uncertain and, accordingly, our revenues are likely to be subject to high volatility.
A substantial amount of our shipments are currently made in countries in which we have limited experience in selling and servicing metro products. This lack of experience could materially adversely impact our results of operations.
In 2008, a substantial portion of our shipments was to Germany. In 2009, a substantial portion of our shipments was to Korea, and, in late 2009, we began to make shipments of our metro products to India and a country in Scandinavia. Telecommunication equipment sales in these countries are subject to high quality and strict delivery requirements. We have limited experience in making sales of metro products into these markets and could face business requirements for quality, delivery, service and support that we may not meet. Failure to meet these requirements could have a material adverse effect on our results of operations.
Successful introduction of service applications by telecommunication carriers that are expected to drive demand for our metro products could be delayed or slow to emerge.
Service applications that drive the demand for our metro telecommunication products are related to the offering of data and video services and their associated infrastructure, such as mobile backhauling, mobile broadband, video-on-demand, HDTV, and Internet TV, as well as other media services by telecommunication carriers over data networks. These types of services require very high bandwidth for packet-based transmissions and, as a result, require an upgrade of metropolitan, or metro, network equipment and access equipment. The availability of these services has begun to emerge in Asia, the United States, parts of Europe and Latin America, but is still limited in the breadth of services offered as well as in the number of subscribers. The launch of these services requires significant capital investment in equipment by telecommunication carriers in the access and metro networks. Delays in the launch of these services or slow subscriber additions to these services will have an adverse effect on the demand for our metro products. If the growth of these services continues to be limited, we will be required to invest additional resources and use more cash in our research and development, as well as in marketing efforts, in an effort to attain and maintain a competitive position in these markets before we can benefit from commercial selection and revenues from our products. Telecommunication carriers could select solutions offered by our competitors to provide these services. Thus, even if the demand for these services increases, we cannot be sure that this increased demand will result in increased sales of our products.
Our future revenues will depend upon requirements by our customers and potential customers to develop new products and features and whether we have sufficient resources to meet these requirements. We currently do not have sufficient resources to develop new products, features or solutions.
In order to win new orders from our current customers and receive orders from new customers, we are required from time to time to develop new product features. These development projects require us to expend significant time and resources, usually before we are selected as a supplier and without any assurance that we will be selected if we develop the requested products or features. Following the significant reductions in our headcount and budget in 2012, we do not have sufficient resources to develop new features required by our customers and prospective customers. We have completely abandoned the efforts to win Tier 1 customers. In the case of Tier 2 customers, we require guaranteed revenues to finance the development of required features. This requirement significantly reduces our ability to win new Tier 2 customers and reduces our ability to preserve existing Tier 2 customers. While we have an initial marketing definition for a new product and solution, we lack the financial resources to develop it. Potential investors are likely to be deterred by the significant amount of our debt.
Our future growth will depend upon the development of new products and solutions.
While we have an initial marketing definition for a new product and solution, we lack the financial resources to develop it. Potential investors are likely to be deterred by the significant amount of our debt. Even if we succeed in funding the development of this new project, initial sales of the products would not generate revenue before July 2014, when the final payments to our Series A note holders are due. Our future success depends on the acceptance of our new product by the target customers and the development of the market. We have no control over the development of these target markets. Even if our technologies are accepted, relationships with customers must be developed in order to be successful. Furthermore, competing technologies in the targeted areas may be utilized in the majority of these target markets. This would leave us with a small market to address.
We may not be able to keep pace with emerging industry standards for our existing products. This could make these products more costly or unacceptable to potential customers and may make them obsolete in the near future.
Industry-wide standards for MPLS, MPLS-TP, PWE and synchronization, as well as various aspects of the standards applicable to Ethernet, continue to be enhanced. Until mid-2012, we spent significant resources to support these standards and evaluate new requirements as they were proposed by industry working groups, but we are unable to continue to do so due to our financial condition. The failure to support evolving standards will limit acceptance of our products. Since these products are integrated into networks consisting of elements manufactured by various companies, they must support a number of current and future industry standards and practices. Accordingly, our inability to keep pace with emerging industry standards could make these products more costly or unacceptable to potential customers and may make them obsolete in the near future.
Because telecommunication companies must obtain in-house and regulatory approvals before they can order our products, expected sales of our products to new customers or new products to existing customers are likely to be subject to a long sales cycle, which may harm our business.
Before telecommunication companies can purchase our products, these products must undergo a lengthy approval process. Evaluations and modifications of our products to meet customers’ requirements are likely to take several years prior to commercial selection. Accordingly, we are required to submit enhanced versions of products undergoing the approval process and products in development for approval.
The following factors, among others, affect the length of the approval process:
| | · | the time required for telecommunication companies to determine and publish specifications; |
| | · | the technological priorities and budgets of telecommunication companies; |
| | · | product acceptance tests; and |
| | · | the regulatory requirements applicable to telephone companies. |
Delays in the product approval process could seriously harm our business and results of operation.
Because of rapid technological and other changes in the market for telecommunication products, we must continually develop and market new products and product enhancements while reducing production costs. We currently lack sufficient resources to develop new products and product enhancements.
The market for our products is characterized by:
| | · | rapid technological change; |
| | · | frequent product introductions and enhancements; |
| | · | evolving industry standards; |
| | · | changes in end-user requirements; and |
| | · | changes in services offered by telecommunication companies. |
Technologies or standards applicable to our products could become obsolete or fail to gain widespread, commercial acceptance, resulting in losses and inventory write-offs. Rapid technological change and evolving technological standards are resulting in relatively short life cycles for our products. Short life cycles for our products could cause decreases in product prices at the end of the product life cycle, inventory write-offs and a lower rate of return on our research and development expenditures. Due to our financial condition, we do not expect to be able to respond effectively to technological changes or new product introductions by others or to try to develop or market new products.
The market for our telecommunication products is intensely competitive. Because substantially all of our competitors have much greater resources than we have, it may be difficult for us to effect commercial sales or to achieve operating profitability.
The market for our products is intensely competitive, and we expect competition to increase in the future. Many of our current and potential competitors are large and established companies and have better name recognition and greater financial, technical, manufacturing, marketing and personnel resources than we. Consolidation has increased the size and scope of a number of our competitors. Any of these competitive factors could make it more difficult for us to attract and retain customers, cause us to lower our prices in order to compete and reduce our market share and revenues, any of which could have a material adverse effect on our financial condition and results of operations. The expansion of research and design facilities in China and India, where engineering costs are significantly lower compared to the United States, Western Europe or Israel, has increased and could further increase competition and price pressure for our products. In addition, manufacturers of telecommunication equipment in China are attempting to leverage their success in supplying telecommunication equipment to local carriers in Asia and market and sell their products outside China.
The competitors in our markets are numerous and we expect competition to increase in the future. The principal competitors for our products include Alcatel-Lucent, Brocade, Ciena, Cisco Systems, Inc., ECI Telecom Ltd., Ericsson, Extreme Networks, Inc., Fujitsu, Hitachi, Huwaei, Juniper Networks, NEC, Nokia-Siemens Networks, Tellabs, UTStarcom and ZTE.
Government regulation of telecommunication companies could adversely affect the demand for our products.
Telecommunication regulatory policies affecting the availability of telephone companies’ services, and other terms on which telephone companies conduct their business, may impede the market penetration of our metro products. For example, our CM-100 and CM-4000 product lines address high bandwidth packets, and are dependent on new service offerings, such as video services, which require regulatory approvals for introduction by telecommunication carriers, including for the scope of content, service packages and tariffs. Telecommunication companies in markets in other countries in which we may attempt to sell our products are also subject to evolving governmental regulation or state monopolies. Changes in laws or regulations in Japan, the United States, Korea, India, Latin America, Germany, the rest of Europe or elsewhere could materially adversely affect our ability, and the ability of our customers, to deploy our products.
We currently use one subcontractor to manufacture and assemble our products, source components and provide other services. In addition, some of our suppliers are sole suppliers. Our business could suffer if we cannot retain or replace our sole subcontractor or a sole supplier.
We currently use one subcontractor for product assembly, component sourcing, inventory warehousing, testing and shipment. As a result, we are highly dependent on this subcontractor. In addition, some of the components used in our products are purchased, by us or by our subcontractor, from suppliers that are the sole source of such components.
We have not entered into multi-year agreements with assurances of supply with any of our suppliers or subcontractor. Our reliance on one subcontractor and on third-party suppliers involves several risks, including:
| | · | the potential absence of adequate capacity if we are able to sell a significant amount of our products; |
| | · | the unavailability of, or interruption in access to, certain process technologies; |
| | · | reduced control over product quality, delivery, schedules, manufacturing yields and costs; and |
| | · | higher per unit prices we could be charged for the manufacturing services we purchase based on the amount of services purchased. |
Shortages of raw materials or production capacity constraints at our suppliers or subcontractor could negatively affect our ability to meet product delivery obligations and result in increased costs for affected products that we may not be able to recover. Use of a subcontractor also involves the risk of reduced control over product quality, delivery schedules and manufacturing yields, as well as limited negotiating power to reduce costs.
In order to have an adequate supply of components with a long lead-time for delivery, we may order significant quantities of components in advance of receiving a purchase order from a customer. A shortage in the supply of key semiconductor and other components could affect our ability to manufacture and deliver our products and result in lower revenues. We may be unable to find alternative sources in a timely manner, if at all, if our major subcontractor were unwilling or unable to provide us with key components.
In addition, supply from single source suppliers limits our ability to purchase components at competitive prices and could require us to maintain higher inventory levels. This could increase our need for working capital and could increase the risk of an inventory write-off. In addition, we may also be charged higher per unit prices for certain components whose costs are unit sensitive. This would adversely affect our gross profit margins and results of operations. If we cannot obtain sufficient manufacturing services or key components as required, or develop alternative sources if and as required in the future, product shipments may be delayed or reduced. This could adversely affect our end-user relationships, business and results of operations.
We are subject to regulations that require us to use components based on environmentally friendly materials. Compliance with these regulations has increased our costs and is expected to continue to increase our costs. Failure to comply with these regulations could materially adversely affect our results of operations.
We are subject to telecommunication industry regulations requiring the use of environmentally-friendly materials in telecommunication equipment. For example, pursuant to a European Union directive, telecommunication equipment suppliers were required to eliminate lead solders from their products (the “RoHs6 regulations”). Although we believe that we are in compliance with the RoHs6 regulations, the tests for compliance with these regulations are limited in their ability to fully ensure compliance. If, in spite of the tests performed, we are not in compliance with these regulations, it could harm our ability to sell our products in Europe and in any other countries that may adopt these regulations. In addition, we have not tested all of our products for RoHs compliance. We have relied on the results for products tested in deciding not to test all of our products. If products that we elected not to test are found not to be compliant with these regulations, it could harm our ability to sell the products that are not compliant.
Compliance with these regulations, especially with respect to the requirement that products be lead free, as well as additional regulations that are likely to apply in the future, requires us to undertake significant expense with respect to the re-design of our products. This could also result in part or all of our inventory becoming obsolete. We may also be required to pay higher prices for components that comply with these regulations. In addition, such regulations could reduce our production yield and decrease our gross margin. We may not be able to pass these higher component costs and the cost of the decrease in production yield on to our customers. We cannot at this point estimate the expense that will be required to redesign our products in order to include “environmentally friendly” components. We cannot be sure that we will be able to comply with such regulations, that we will be able to comply on a cost effective basis or that a sufficient supply of compliant components will be available to us. Compliance with such regulations has increased our product design costs and could continue to increase these costs.
Our inability or failure to comply with these regulations could have a material adverse effect on our results of operations.
We could incur substantial costs if customers assert warranty claims or request product recalls, especially after our cost-cutting measures in 2012.
Any significant product returns or claims under our warranty or post-contract hardware and software support services, or PCS, could have a material adverse effect on our business and results of operations. We offer complex products that have in the past and may in the future contain errors, defects or failures when introduced or as new versions are released. If we deliver products with defects, errors or bugs or if we undergo a product recall as a result of errors or failures, market acceptance of our products could be lost or delayed and we could be the subject of substantial negative publicity. This could have a material adverse effect on our business and results of operations. We commenced commercial sales of our metro product in 2004. While to date we have not incurred warranty expenses that exceeded our estimates, we could incur a higher level of warranty expense claims at any time compared to our prior experience. We have agreed to indemnify our customers in some circumstances against liability from defects in the products sold by us and expect to continue to provide a similar indemnity in connection with future sales. In some cases, our indemnity also covers indirect damages. Product liability claims could seriously harm our business, financial condition and results of operations. In addition, in certain circumstances, a deterioration of our financial condition could give rise to warranty claims or rights to terminate agreements and return our equipment, which would further harm our financial condition. This risk is more acute after the reduction of our customer support personnel as part of our cost-cutting measures in 2012. In fact, during the first quarter of 2013, we commenced a global product recall of one our products that was marketed in 2012 and are in the process of replacing approximately 250 units. In March 2013, 3M Services informed us that one of its customers to whom we sold products that later became the subject of such recall is preparing to file a lawsuit against 3M Services, for damages of approximately $1.3 million, in connection with products supplied by us. 3M Services informed us that it reserves its right to sue us, in turn, in connection with this matter.
We are subject to international business risks.
We sell and market our CM-4000 products internationally, in Japan, Korea, India and other countries in Asia, Latin America and Europe. Expansion of our international business requires significant management attention and financial resources. Our international sales and operations are subject to numerous risks inherent in international business activities, including:
| | · | compliance with foreign laws and regulations; |
| | · | staffing and managing foreign operations; |
| | · | import or currency control restrictions; |
| | · | burdens that may be imposed by tariffs and other trade barriers; |
| | · | local and international taxation; |
| | · | increased risk of collections; |
| | · | seasonal reduction of business activities; and |
| | · | political and economic factors, as well as natural disasters, that may adversely affect our customers and potential customers. |
These factors, as well as different technical standards or product requirements for our systems in different markets, may limit our ability to penetrate foreign markets.
We depend on a limited number of key personnel who would be difficult to replace. If we lose the service of these individuals, our business could be harmed.
Our growth and future success largely depends on the managerial and technical skills of Eric Paneth, our Chairman of the Board, Izhak Tamir, our Chief Executive Officer, and four other members of senior management. If any of them is unable or unwilling to continue with us, our business could be harmed and our results of operations could be materially and adversely affected.
We have experienced periods of growth and consolidation of our business. If we cannot adequately manage our business, our results of operations will suffer.
We have experienced both growth and consolidation in our operations from sales of our metro products. In November 2008, in order to decrease our expenses, we substantially decreased our employee head count. Beginning in late 2009, we increased our research and development and sales and marketing expenses primarily as a result of the hiring of new employees. In 2011 and 2012, we once again reduced our expenses, primarily as a result of reductions in personnel. Future growth or consolidation may place a significant strain on our managerial, operational and financial resources.
Our proprietary technology is difficult to protect and unauthorized use of our proprietary technology by third parties may impair our ability to compete effectively.
We may not be able to prevent the misappropriation of our technology, and our competitors may independently develop technologies that are substantially equivalent or superior to ours. We have filed U.S. and international patent applications covering certain of our technologies. To protect our unpatented proprietary know-how, we rely on technical leadership, trade secrets and confidentiality and non-disclosure agreements. These agreements and measures may not adequately protect our technology and it may be possible for a third party to copy or otherwise obtain and use our technology without our authorization or to develop similar technology.
There is a risk that we may violate the proprietary rights of others.
We are subject to the risk of adverse claims and litigation alleging infringement of the intellectual property rights of other companies. Many participants in the telecommunication industry have an increasing number of patents and patent applications and have frequently commenced litigation based on alleged infringement. We indemnify our customers with respect to infringement of third party proprietary rights by our products. Third parties may assert infringement claims in the future and these claims may require us to enter into license arrangements or result in costly litigation, regardless of the merits of these claims. Licensing may be unavailable or may not be obtainable on commercially reasonable terms.
We face foreign exchange currency risks.
We operate in a number of territories and typically our prices are determined in local currencies of the countries in which we operate. The main currencies of the countries in which we operate are the U.S. dollar, Japanese Yen (“Yen”), NIS, Rupee and Euro. A major part of our expenses are denominated in U.S. dollars and in NIS. In particular, we are obligated to pay interest on, and to repay the principal of, our convertible notes in NIS. The majority of our salaries are also paid in NIS. We currently do not use hedge instruments.
We are likely to face risks from fluctuations in the value of the Yen, NIS, Euro and the Rupee compared to the U.S. dollar, our functional currency in our financial statements. Since our sales prices to KDDI are determined in Yen, based on currency exchange rates that prevailed in prior years, an increase in the value of the U.S. dollar against the Yen would cause us to recognize lower dollar revenues and gross profit in our financial statements. In 2010, the value of the U.S. dollar significantly decreased against the Yen, and in 2011, the value of the U.S dollar slightly decreased against the Yen. In 2012, the value of the U.S dollar slightly increased against the Yen.
Since some of our sales prices in Europe are linked to the Euro, an increase in the value of the U.S. dollar against the Euro would cause us to recognize lower dollar revenues and gross profit in our financial statements. In 2010, the value of the U.S. dollar increased slightly against the Euro, and in 2011 through 2012, the value of the U.S. dollar slightly increased against the Euro. Since our salary and other expenses are denominated in NIS, a decrease in the value of the U.S. dollar against the NIS would cause us to recognize higher dollar expenses in our financial statements. In 2010, the value of the U.S. dollar decreased against the NIS, and in 2011 through 2012, the value of the U.S. dollar increased against the NIS.
Our sales in India are currently denominated in U.S. dollars. However, we cannot be sure that future sales in India, if any, will be in U.S. dollars. If future sales in India are made in Indian Rupees and the value of the U.S. dollar against the Indian Rupee should decrease, it would cause a decrease in the revenues reported in our financial statements and adversely affect our results of operations.
We are subject to taxation in several countries.
Because we operate in several countries, mainly in Israel, Japan, Germany, Korea, India, Mexico and a country in Scandinavia, we are subject to taxation in multiple jurisdictions. We are required to report to and are subject to local tax authorities in Israel, the United States, Japan, Korea and India and cannot be sure of the amount of taxes we may become obligated to pay in these countries. In addition, our income that is derived from sales to customers in one country might also be subject to taxation in other countries. The tax authorities in the countries in which we operate may not agree with our tax position. Our tax benefits from carry forward losses and other tax planning benefits such as Israeli Approved Enterprise programs, may prove to be insufficient due to Israeli tax limitations, or may prove to be insufficient to offset tax liabilities from foreign tax authorities. Foreign tax authorities may also use our gross profit or our revenues in each territory as the basis for determining our income tax, and our operating expenses might not be considered for related tax calculations. This could adversely affect our results of operations.
Risks Relating to Our Operations in Israel
Potential political, economic or military instability in Israel may adversely affect our results of operations.
Our principal offices and many of our subcontractors and suppliers are located in Israel. Accordingly, political, economic and military conditions in Israel affect our operations. Since the establishment of the State of Israel in 1948, a number of armed conflicts have taken place between Israel and its Arab neighbors. A state of hostility, varying in degree and intensity, has led to security and economic problems for Israel. Since October 2000, there has been a marked increase in hostilities between Israel and the Palestinians, and in 2007, Hamas, an Islamist movement responsible for many attacks against Israelis, took control of the Gaza Strip. Recent political events in various countries in the Middle East have weakened the stability of those countries, resulting in violence and the strengthening of extremists. In addition, Iran has threatened to attack Israel and is widely believed to be developing nuclear weapons. Iran is also believed to have a strong influence among extremist groups in areas that neighbor Israel, such as Hamas in Gaza and Hezbollah in Lebanon. This situation may potentially escalate in the future to violent events which may affect Israel and us.
The future of relations between Israel and the Palestinian Authority is uncertain. Terror attacks, armed conflicts or political instability in the region could negatively affect local business conditions and harm our results of operations. We cannot predict the effect on us of the increase in the degree of violence by Palestinians against Israel or the effect of recent uprisings, political instability or military action elsewhere in the Middle East. Furthermore, several countries restrict doing business with Israel and Israeli companies, and additional companies may restrict doing business with Israel and Israeli companies as a result of an increase in hostilities or anti-Israel sentiment. This may also seriously harm our operating results, financial condition and the ability to expand our business.
Our results of operations may be negatively affected by the obligation of our personnel to perform military service.
Most of our male employees in Israel are obligated to perform military reserve duty from time to time. In addition, in the event of a military conflict or other attack on Israel, including the ongoing conflict with the Palestinians, these persons could be required to serve in the military for extended periods of time and on very short notice. The absence of a number of our officers and employees for significant periods could disrupt our operations and harm our business.
Our results of operations may be adversely affected by inflation rates in Israel.
We could be exposed to risk if the rate of inflation in Israel exceeds the rate of devaluation of the NIS in relation to the Yen, U.S. dollar, Euro, Rupee and other currencies of other foreign countries in which we operate, or if the timing of such devaluation lags behind inflation in Israel. In that event, the cost in U.S. dollars of our operations in Israel would increase and our U.S. dollar-measured results of operations would be adversely affected. For example, in 2012, the value of the U.S. dollar decreased in relation to the NIS by 2.3%, while inflation in 2012 increased by 1.6%. As a result, our salary expenses, which are primarily linked to the NIS, increased in U.S. dollar terms. In 2011, the value of the U.S. dollar increased in relation to the NIS by 7.7%, while inflation in 2011 increased by 2.2%, and in 2010, the value of the U.S. dollar decreased in relation to the NIS by 6.0%, while inflation increased by 2.7%. Our issuance in March 2007 and June 2011 of convertible notes that are denominated in NIS has made us more sensitive to increases in the value of the NIS relative to the U.S. dollar. In 2012, the value of the U.S. dollar decreased in relation to the NIS, and the Israeli CPI increased, which caused us to record significant financial expenses in relation to the Series A notes and Series B notes. Due to these fluctuations, we may record higher or lower expenses in our financial statements.
We benefit from government grant programs that may be reduced and may be unavailable to us in the future. Our participation in these programs restricts our ability to freely transfer manufacturing rights and technology out of Israel, which limits our ability to commercialize our intellectual property
Since our inception, we have relied on grants from the Israeli government and other institutions for the financing of a portion of our product development expenditures. Due to reductions of the budget of Israel’s Office of the Chief Scientist of the Ministry of Industry, Trade and Labor, the amount of grants we receive from the Israeli government in the future might be lower than in prior years, if we receive any at all. We recognized grants in the amount of $2.6 million in 2010, $3.2 million in 2011 and $2.7 million in 2012.
Generally, according to Israeli law, any products developed with grants from the Office of the Chief Scientist, or OCS, are required to be manufactured in Israel, unless we obtain prior approval of a governmental committee. As a condition to obtaining this approval, we may be required to pay the OCS up to 300% of the grants we received and to repay these grants at an accelerated rate, depending on the portion of manufacturing performed outside Israel. We have obtained an approval from the OCS to manufacture part of our products outside Israel. We intend to keep sufficient manufacturing activities in Israel so that we will be subject to a repayment percentage of up to 150% of the grants we received. In addition, we are prohibited from transferring to third parties the knowhow developed with these grants without the prior approval of a governmental committee. If such approval is given, we may be required to pay the OCS all or significant portion of the proceeds from transferring to third parties the knowhow developed with these grants. Based on a request from the OCS, we reported and made certain payments related to our manufacturing activities outside of Israel. In addition, the OCS has claimed that we are required to repay grants related to a research and development project that was cancelled. We are disputing some of the claims made by the OCS and are attempting to negotiate a settlement of the claim. While we have made a provision in our financial statements to cover the estimated outcome of this claim, the amount we ultimately pay may exceed our estimate. If we cancel additional projects, the OCS may demand the repayment of grants we received in the past. The OCS may also dispute our reports related to our manufacturing activities outside of Israel. If we are required to pay the OCS more than what we provided for in our financial statements, it could adversely affect our results of operations. As of December 31, 2012, our total contingent royalties to the OCS is approximately $18 million. The position of the OCS is that we would be required to pay at least this amount if we were to transfer our technology outside Israel. If the OCS does not modify this position, our proposed patent sale to Networks3 will not be economically viable and will not be consummated.
The tax benefits to which we are currently entitled require us to meet several conditions and may be terminated or reduced in the future, which would increase our taxes.
We are entitled to certain government programs and tax benefits, particularly as a result of the “Approved Enterprise” status of most of our existing facilities. If we fail to meet eligibility conditions in the future, our tax benefits could be reduced or canceled.
For more information about Approved Enterprises, see “Item 5.B - Liquidity and Capital Resources – Effective Corporate Tax Rates in Israel,” and “Item 10.E – Taxation – Israeli Tax Considerations – Tax Benefits Under the Law for the Encouragement of Capital Investments, 1959” in this Annual Report, and Note 8a to the financial statements for the year ended December 31, 2012, included in this Annual Report.
It may be difficult to enforce a U.S. judgment against us and our officers and directors or to assert U.S. securities law claims in Israel.
Service of process upon our directors and officers may be difficult to effect in the United States because all these parties reside outside the United States. Any judgment obtained in the United States against such parties may not be collectible in the United States.
It may be difficult to assert U.S. securities law claims in original actions instituted in Israel. Israeli courts may refuse to hear a claim based on a violation of U.S. securities laws because Israel is not the most appropriate forum to bring such a claim. In addition, even if an Israeli court agrees to hear a claim, it may determine that Israeli law and not U.S. law is applicable to the claim. If U.S. law is found to be applicable, the content of applicable U.S. law must be proved as a fact, which can be a time-consuming and costly process. Certain matters of procedure will also be governed by Israeli law. There is little binding case law in Israel addressing these matters.
However, subject to time limitations, Israeli courts may enforce a U.S. judgment in a civil matter, if:
| | · | adequate service of process has been effected and the defendant has had a reasonable opportunity to be heard; |
| | · | the judgment and its enforcement are not contrary to the law, public policy, security or sovereignty of the State of Israel; |
| | · | the judgment was rendered by a court of competent jurisdiction, in compliance with due process and the rules of private international law prevailing in Israel; |
| | · | the judgment was not obtained by fraudulent means and does not conflict with any other valid judgment in the same matter between the same parties; |
| | · | no action between the same parties in the same matter is pending in any Israeli court at the time the lawsuit is instituted in a U.S. court; and |
| | · | the U.S. courts are not prohibited from enforcing judgments of the Israeli courts. |
Provisions of Israeli law may delay, prevent or make an acquisition of us more difficult, which could depress our share price.
The Israeli Companies Law, 5759-1999, or the Companies Law, generally requires that a merger be approved by the board of directors and a majority of the shares voting on the proposed merger. Upon the request of any creditor of a party to the proposed merger, a court may delay or prevent the merger if it concludes that there is a reasonable concern that, as a result of the merger, the surviving company will be unable to satisfy its obligations. In addition, a merger may generally not be completed unless at least (i) 50 days have passed since the filing of the merger proposal with the Israeli Registrar of Companies and (ii) 30 days have passed since the merger was approved by the shareholders of each of the parties to the merger.
Also, in certain circumstances an acquisition of shares in 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 or 45% or greater shareholder of the company (unless there is already a 25% or greater or a 45% or greater shareholder of the company, respectively). If, as a result of an acquisition, the acquirer would hold more than 90% of a company’s shares, the acquisition must be made by means of a tender offer for all of the shares.
The described restrictions could prevent or make more difficult an acquisition of Orckit, which could depress our share price.
Risks Relating to the Ownership of our Ordinary Shares
We need to effect another arrangement with the holders of our Series A notes and Series B notes as a condition to closing the patent and financing transaction with Networks3. If such an arrangement is effected, our shareholders are expected to experience significant dilution as a result of the exchange of our notes for ordinary shares under the terms of the proposed arrangement.
According to the terms of the arrangement proposed by us, the Series A notes and the Series B notes would be extinguished in exchange for cash, ordinary shares, warrants to purchase ordinary shares, and our shares in Networks3. While we cannot predict the number of equity securities that would be issued in connection with the arrangement, such an arrangement would result in significant dilution of the holdings of our shareholders.
The ordinary shares that may be issued to our note holders in such an arrangement will be freely tradable, and the note holders may promptly try to sell such shares in the public markets. There is no assurance that there will be sufficient liquidity to enable such sales. Such sales, and the potential for such sales, could cause the market price of our ordinary shares to decline significantly. They also might make it more difficult for us to sell equity or equity-related securities in the future at a time and price that we deem appropriate.
The trading market for our ordinary shares has low liquidity, which could make it difficult for our shareholders to sell their shares at desired prices and amounts.
Our ordinary shares currently are quoted on the OTCQB, an inter-dealer quotation service operated by OTC Markets Group for companies that are current in their SEC reporting obligations. There are no financial or qualitative standards to be traded on this platform. Currently, we do not meet the initial listing conditions of the NASDAQ Stock Market. The market for shares quoted on the OTCQB is typically less liquid than that for shares listed on the NASDAQ Stock Market. This could make it more difficult for our shareholders to sell their shares at desired prices and amounts, which could also adversely affect our ability to raise future capital through the sale of our ordinary shares.
We have recently started filings reports in Israel in accordance with the Israeli securities regulations. These regulations require additional costs and management attention and could result in sanctions.
In addition to the OTCQB, our ordinary shares are listed on the Tel Aviv Stock Exchange, or the TASE. For so long as our ordinary shares were listed on the NASDAQ Stock Market, we filed a copy of each SEC report with the Israel Securities Authority and were not required to file additional reports under the Israeli securities regulations. However, following our delisting from the NASDAQ Stock Market, the Israel Securities Authority demanded that we start to file reports pursuant to the Israeli securities regulations. While we do not concur with the Israel Securities Authority's interpretation of the law, we agreed to start filing such reports. This entails additional management attention, increased legal and accounting expenses and enhanced exposure to sanctions for possible violations of Israeli securities laws. Among these requirements, is the preparation of our financial statements in accordance with International Financial Reporting Standards, rather than U.S. GAAP, which will require us to retain and pay additional accounting consultants. This, in addition to the resignation of our Controller in January 2013, has increased the time and attention required of Izhak Tamir, who serves as both our Chief Executive Officer and Chief Financial Officer, for financial reporting matters.
Holders of our ordinary shares who are U.S. residents face certain income tax risks. In any tax year, we could be deemed a passive foreign investment company, which could result in adverse U.S. federal income tax consequences for U.S. holders of our ordinary shares.
Based on the composition and value of our gross assets during 2007, 2008 and 2009, it is likely that we would be deemed to have been a passive foreign investment company, or PFIC, for U.S. federal income tax purposes during each of such years. For 2006, 2010, 2011 and 2012, we believe that we would not be deemed to have been a PFIC. There can be no assurance that we will not be deemed a PFIC for any future tax year in which, for example, the value of all our assets, as measured by the public market valuation of our ordinary shares and the amount of our liabilities, declines in relation to the value of our passive assets (such as cash, cash equivalents and marketable securities). If we are a PFIC for any tax year, U.S. holders of our ordinary shares during such year may be subject to increased U.S. federal income tax liabilities and reporting requirements for such year and succeeding years, even if we are no longer a PFIC in such succeeding years.
U.S. residents should carefully read “Item 10.E - Taxation – United States Federal Income Tax Considerations” in this Annual Report for a more complete discussion of the U.S. federal income tax risks related to owning and disposing of our ordinary shares and the consequences of PFIC status.
We do not satisfy all the conditions for continued listing on the TASE. If we are unsuccessful in regaining compliance, the TASE may transfer our shares to the maintenance list.
On January 21, 2013, we received a notice from the TASE that our shareholders' equity as of September 30, 2012, which was a deficit of $8.2 million, failed to meet the minimum requirement under the TASE Bylaws, which is NIS 2.0 million (approximately $500,000 based on the U.S. Dollar/NIS exchange rate at that time). We have until June 30, 2013 to satisfy the TASE's minimum shareholders' equity requirement. In the event that we fail to do so, the TASE will consider transferring our ordinary shares to the maintenance list. Trading on the maintenance list is more limited than on the main list of the TASE.
We do not intend to pay cash dividends.
We have never declared or paid any cash dividends on our ordinary shares. We currently intend to retain future earnings, if any, for funding growth. Accordingly, we do not expect to pay any cash dividends in the foreseeable future.
One shareholder who is also our Chief Executive Officer may be able to control us.
As of December 31, 2012, Izhak Tamir, our Chief Executive Officer, Chief Financial Officer and a member of our Board of Directors, beneficially owned an aggregate of 4,850,409 ordinary shares, representing 15.6% of our outstanding ordinary shares, including 4,747,409 ordinary shares, 25,000 ordinary shares issuable upon the exercise of warrants at an exercise price of $5.66 per share and 78,000 ordinary shares issuable upon the exercise of warrants at an exercise price of $3.50 per share.
Currently, Mr. Tamir is not party to a shareholders’ agreement with other shareholders. However, if Mr. Tamir acts together with other shareholders, together they may have the power to control the outcome of matters submitted for the vote of shareholders, including the approval of significant change in control transactions. The equity interest in Orckit of Mr. Tamir may make certain transactions more difficult and result in delaying or preventing a change in control of us unless approved by him.
Our shareholder bonus rights plan and the super-majority voting requirements in our articles of association may delay, prevent or make more difficult a hostile acquisition of us, which could depress our share price.
In November 2001, we adopted a shareholder bonus rights plan pursuant to which share purchase bonus rights were distributed to our shareholders. These rights generally will be exercisable and transferable apart from our ordinary shares only if a person or group acquires beneficial ownership of 15% or more of our ordinary shares, or commences a tender or exchange offer upon consummation of which that person or group would hold such a beneficial interest. Once these rights become exercisable and transferable, the holders of rights, other than the person or group triggering their transferability, will be generally entitled to purchase our ordinary shares at a discount from the market price. The rights will expire on December 31, 2014, unless our Board takes action to amend the expiration date. While these rights remain outstanding, they may make an acquisition of us more difficult and result in delaying or preventing a change in control of Orckit.
In addition, our articles of association require the approval of the holders of at least 75% of our ordinary shares voting on the matter to remove a director from office and the approval of at least two-thirds of our ordinary shares voting on the matter to elect a director. These requirements could also delay or prevent a change of control of our company.
Our share price has fluctuated significantly and could continue to fluctuate significantly.
The market price for our ordinary shares, as well as the prices of shares of other technology companies, has been volatile. Between January 1, 2008 through December 31, 2012, our share price has fluctuated from a low of $0.14 to a high of $8.00. The following factors may cause significant fluctuations in the market price of our ordinary shares:
| | · | fluctuations in our quarterly revenues and earnings or those of our competitors; |
| | · | shortfalls in our operating results compared to levels forecast by securities analysts; |
| | · | changes in the conversion prices of our convertible notes, as occurred pursuant to the Arrangement and as our note holders request from time to time; |
| | · | announcements concerning us, our competitors or telecommunication companies; |
| | · | announcements concerning our customers; |
| | · | announcements of technological innovations; |
| | · | the introduction of new products; |
| | · | changes in product price policies involving us or our competitors; |
| | · | market conditions in the industry; |
| | · | the conditions of the securities markets, particularly in the technology and Israeli sectors; and |
| | · | political, economic and other developments in the State of Israel and worldwide. |
In addition, stock prices of many technology companies fluctuate significantly for reasons that may be unrelated or disproportionate to operating results. The factors discussed above may depress or cause volatility of our share price, regardless of our actual operating results.
Our quarterly results of operations, including revenues, net income and net loss, net income and net loss per share, and cash flow, have fluctuated significantly in the past, and these fluctuations are expected to continue. Fluctuations in our results of operations may disappoint investors and result in a decline in our share price.
We have experienced and expect to continue to experience significant fluctuations in our quarterly results of operations. In some periods, our operating results may be below public expectations or below revenue levels and operating results reached in prior quarters or in the corresponding quarters of the previous year. If this occurs, the market price of our ordinary shares could decline. The following factors have affected our quarterly results in the past and are likely to affect our quarterly results in the future:
| | · | size and timing of orders, including order deferrals and delayed shipments; |
| | · | acquiring a new customer or losing a customer; |
| | · | problems with our products that are installed in customer networks; |
| | · | length of approval processes or market testing; |
| | · | technological changes in the telecommunication industry; |
| | · | accuracy of telecommunication company, distributor and original equipment manufacturer forecasts of their customers’ demands; |
| | · | changes in our operating expenses; |
| | · | the timing of approval of government research and development grants; |
| | · | disruption in our sources of supply; |
| | · | competitive pricing pressures; |
| | · | funding required for our operations; |
| | · | general economic conditions; |
| | · | terms and conditions of supply agreements with our customers and their impact on our recognition of revenues from these agreements; |
| | · | changes in our revenue recognition practice as a result of changes in the commercial terms between us and our customers; |
| | · | determination of the fair value of the conversion feature in our convertible notes; |
| | · | timely payments of receivables by customers; |
| | · | changes in payment terms between us and our suppliers which could accelerate the timing of payments by us and negatively affect our working capital and cash balances; |
| | · | changes in payment terms between us and our customers which could defer the timing of payments by our customers and negatively affect our working capital and cash balances; and |
| | · | actions taken by us or by others in respect of our convertible notes. |
Other factors could also impact our results. Therefore, the results of past periods may not be relied on as an indication of our future performance.
Our actual financial results might vary from our publicly disclosed financial forecasts.
From time to time, we publicly disclose financial forecasts. Our forecasts reflect numerous assumptions concerning our expected performance, as well as other factors which are beyond our control and which might not turn out to be correct. As a result, variations from our forecasts could be material. Our financial results are subject to numerous risks and uncertainties, including those identified throughout this “Risk Factors” section. If our actual financial results are worse than our financial forecasts, the price of our ordinary shares may decline.
Investors may experience significant dilution as a result of financing transactions or the issuance of ordinary shares under outstanding securities convertible into or exercisable for our ordinary shares or the sale of shares under our Standby Equity Purchase Agreement.
As discussed above, we need to raise additional capital to operate our business and repay our debt beyond April 2013. We may not be able to obtain additional financing on acceptable terms or at all. If we are unable to obtain adequate funds on reasonable terms, we may be required to further curtail operations significantly or obtain funds by entering into financing agreements on unattractive terms. If we issue ordinary shares to new investors, especially given the low prevailing market prices of our ordinary shares, the ownership stake of our existing shareholders will be significantly diluted.
In addition, we may issue additional ordinary shares upon the conversion or exercise of our outstanding stock options, warrants and convertible subordinated notes, and other rights to acquire our ordinary shares. Specifically, as of December 31, 2012, our Series A notes were convertible at a price of NIS7.61 per share into an aggregate of 5,326,823 ordinary shares, and our Series B notes were convertible at a price of NIS7.61 per share into an aggregate of 2,173,825 ordinary shares. Representatives of our Series A notes have requested that we consider lowering the conversion prices of such notes. As of that date, we also had outstanding stock options to acquire an aggregate of 9,131,872 ordinary shares at exercise prices ranging from $0.010 to $11.46 per share and warrants to acquire an aggregate of 2,529,771 ordinary shares at exercise prices ranging from 3.50 to $5.66 per share. The issuance of ordinary shares upon the conversion or exercise of such securities will dilute our shareholders' ownership stake.
On August 3, 2010, we entered into a Standby Equity Purchase Agreement, or SEPA, with YA Global Master SPV Ltd., or YA Global, a fund managed by U.S.-based Yorkville Advisors, as investor under the SEPA. The SEPA provides that over a commitment period of up to three years and upon the terms and subject to the conditions set forth therein, YA Global is committed, on our request, to purchase up to $10 million of our ordinary shares in multiple tranches at a price equal to 95.5% of the lowest daily volume weighted average price of our ordinary shares on NASDAQ during the five NASDAQ trading days following our advance notice, subject to restrictions that YA Global ownership of our shares will not exceed 4.99% and that shares are not purchased in an amount exceeding $500,000 per week. While we have not as yet requested that shares be purchased under the SEPA, we might choose to do so in the future, although our delisting from NASDAQ, the low prevailing market prices and trading volume of our ordinary shares may preclude this possibility. The sale of our ordinary shares pursuant to the SEPA would result in dilution of the percentage of our ordinary shares held by current and future shareholders. Because the sales pursuant to the SEPA would be made based on prevailing market prices at the time advances are made, the prices at which we sell these shares and the number of shares we would issue would vary, perhaps significantly, with the market price of our ordinary shares.
There may be an adverse effect on the market price of our shares as a result of shares being sold or available for sale in the future. If our shareholders sell substantial amounts of our ordinary shares, including shares issued upon the exercise of outstanding options, warrants or convertible notes, the market price of our ordinary shares may fall. In addition, the ordinary shares that may be purchased by YA Global under the SEPA would be freely tradable, and YA Global may promptly resell the shares we agree to issue to them under the SEPA in the public markets. Such sales, and the potential for such sales, could cause the market price of our ordinary shares to decline significantly. To the extent our share price declines, any advances requested by us under the SEPA would require the issuance of a greater number of ordinary shares to YA Global to raise a given dollar amount for us. This may result in significant dilution to our shareholders. These sales also might make it more difficult for us to sell equity or equity-related securities in the future at a time and price that we deem appropriate.
Our ordinary shares are listed for trading in more than one market and this may result in price variations.
Our ordinary shares are listed for trading on OTCQB and the TASE. Trading in our ordinary shares on these markets is made in different currencies (U.S. dollars on OTCQB and NIS on TASE), and at different times (resulting from different time zones, different trading days and different public holidays in the United States and Israel). The trading prices of our ordinary shares on these two markets can often differ, resulting from the factors described above, as well as differences in exchange rates. Any decrease in the trading price of our ordinary shares on one of these markets could cause a decrease in the trading price of our ordinary shares on the other market.
We are subject to ongoing costs and risks associated with complying with extensive corporate governance and disclosure requirements.
As an Israeli company subject to U.S. federal securities laws and Israeli securities laws, we spend a significant amount of management time and resources to comply with laws, regulations and standards relating to corporate governance and public disclosure, including the Sarbanes-Oxley Act of 2002, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, SEC regulations, Israeli securities regulations and the Companies Law. Section 404 of the Sarbanes-Oxley Act requires an annual review and evaluation of our internal control over financial reporting of the effectiveness of these controls by our management. There is no guarantee that these efforts will result in management assurance that our internal control over financial reporting is adequate in future periods. In connection with our compliance with Section 404 and the other applicable provisions of the Sarbanes-Oxley Act, our management and other personnel devote a substantial amount of time, and we may need to hire additional accounting and financial staff, to assure that we continue to comply with these requirements. The additional management attention and costs relating to compliance with the foregoing requirements could materially and adversely affect our financial results.
ITEM 4. INFORMATION ON THE COMPANY
A. HISTORY AND DEVELOPMENT OF THE COMPANY
Our History
Orckit Communications Ltd. was incorporated in 1990 under the laws of the State of Israel. Our principal executive offices are located at 126 Yigal Allon Street, Tel Aviv 67443 Israel and our telephone number is (972-3) 696–2121. Our agent in the United States, Puglisi Associates, is located at 850 Library Avenue, Suite 204 Newark, Delaware 19711.
Major Developments since January 1, 2012
On January 1, 2012, to enable us to carry out our business plan while seeking a settlement with the holders of our Series A notes and Series B notes, we filed with the Tel Aviv District Court a petition (the "Petition") under Section 350 of the Companies Law for a stay of proceedings on actions by creditors, including our note holders. Following the filing of the Petition, we and the representatives of the holders of our Series A notes agreed to devote additional time to negotiate an arrangement, without the involvement of the Court, that would defer the March 2012 early redemption right of each Series A note holder for a portion of the principal amount of the notes. Accordingly, on January 2, 2012, we and such representatives jointly filed a request with the Court to suspend the Petition.
In January 2012, our CM-4000 was selected by OKI Network Integration Co., Ltd., a Japanese customer, as a channel for Vic Tokai. Sales to Vic Tokai accounted for approximately 6.7% of our revenues in 2012.
On February 15, 2012, Orckit reached a written agreement with the respective representatives of the holders of its Series A convertible notes and the holders of its Series B convertible notes with respect to a proposed arrangement under Section 350 of the Israeli Companies Law (the "Arrangement"). On February 22, 2012, we filed a petition with the Court regarding the Arrangement, as required by the Section 350 of the Companies Law, and on February 26, 2012, we formally withdrew the Petition. For more information about the terms of the Arrangement, see Item 10C of this Annual Report.
On March 29, 2012, a NASDAQ Listing Qualifications Panel determined to transfer the listing of our ordinary shares to the NASDAQ Capital Market and granted us until June 27, 2012 to achieve compliance with the $2.5 million stockholders’ equity requirement for continued listing for that market.
On April 19, 2012, our shareholders approved the Arrangement, as well as an increase in our authorized share capital from 95,000,000 ordinary shares to 170,000,000 ordinary shares, to become effective as of the effective date of the Arrangement.
On May 10, 2012, we held a joint meeting of our Series A note holders and Series B note holders to approve the Arrangement. The holders of each series of notes unanimously and duly approved the Arrangement and the amended trust agreement related thereto.
On May 14, 2012, we filed a petition with the Court requesting its final approval of the Arrangement, subject to the satisfaction of all conditions precedent.
On June 5, 2012 and on June 7, 2012, respectively, Messrs. Izhak Tamir and Eric Paneth, each provided an unsecured loan to the Orckit in the amount of $200,000, which would be converted into ordinary shares in an equity offering as part of the satisfaction of their commitments pursuant to the Arrangement. The loans do not bear interest, are subordinated to all of our obligations pursuant to the Series A and Series B notes and may be repaid only after the note holders have been fully repaid.
On June 19, 2012, we received the final approval of the District Court of Tel Aviv to the Arrangement, following the approval of the Tel Aviv Stock Exchange and the Israel Securities Authority.
On June 20, 2012, we were notified by the NASDAQ Stock Market that trading in our shares would be suspended on NASDAQ effective with the open of trading on June 22, 2012. On June 22, 2012, our ordinary shares started trading on the OTCQB.
On July 2, 2012, we consummated the Arrangement. Pursuant to the terms of the Arrangement, the conversion price of the Series A notes was reduced from NIS 63.00 (approximately $16.10) per share to NIS 1.37 (approximately $0.35) per share during the period from July 3, 2012 to July 22, 2012. Thereafter, the conversion price of the Series A notes increased to NIS 7.61 (approximately $1.95) per share. The conversion price of the Series B notes was reduced from NIS 10.00 (approximately $2.56) per share to NIS 7.61 (approximately $1.95) per share during the period from July 3, 2012 to July 12, 2012. Thereafter, the conversion price of the Series B notes was further reduced to NIS 1.83 (approximately $0.47) per share until August 6, 2012. Thereafter, the conversion price of the Series B notes returned to NIS 7.61 per share.
On July 3, 2012, we exercised our right to appeal the June 20, 2012 decision of the NASDAQ Listing Qualifications Panel.
Between July 3, 2012 and August 6, 2012, an aggregate of NIS 3,260,125 (approximately $816,000) principal amount of Series A notes were converted into 2,379,653 ordinary shares, and an aggregate of NIS 10,720,285 (approximately $2,685,000) principal amount of Series B notes were converted into 5,858,079 ordinary shares. The above-mentioned conversions of Series B notes include the conversion of NIS 6,731,000 (approximately $1,686,000) aggregate principal amount of Series B notes held by Mr. Izhak Tamir, and NIS 546,000 (approximately $137,000) aggregate principal amount of Series B notes held by Mr. Eric Paneth, which were all the notes held by them.
On August 2, 2012, we announced a plan to reduce expenses by approximately $6 million per fiscal year by, among other things, dismissing approximately 40 employees across all our departments.
On August 17, 2012, the NASDAQ Listing and Hearings Review Council issued a decision that affirmed the Panel decision to delist our securities. We continue to be subject to the U.S. securities laws and the regulations of the U.S. Securities and Exchange Commission. Our ordinary shares also continue to be listed on the Tel Aviv Stock Exchange.
During August 2012, we repaid an aggregate principal amount of NIS 29,662,842 (approximately $7.4 million) of Series A notes and an aggregate principal amount of NIS 2,117,181 (approximately $525,000) of Series B. During October 2012, we repaid an aggregate principal amount of NIS 7,535,235 (approximately $1.9 million) of Series A notes and an aggregate principal amount of NIS 1,398,724 (approximately $358,000) of Series B notes.
On September 4, 2012, we announced a plan to further reduce expenses by, among other things, dismissing an additional 25 employees across all company departments. We also announced then that, effective October 2, 2012, Eric Paneth would serve as Chairman of the Board, for no compensation, in lieu of being our Chief Executive Officer.
On September 14, 2012, we notified the Israeli Securities Authority that we have acquiesced to its demand to start filing reports pursuant to the Israeli securities regulations, without admitting that we are required by law to do so.
On October 30, 2012, we announced that KDDI had decided not to award us a large network upgrade project as a result of our financial condition and that a global OEM with whom we were in an advance stage of developing a broad strategic relationship had decided to develop its own technology rather than offer our products to its customers. We also announced our decision to focus on marketing efforts on Tier 2 customers rather than Tier 1 customers.
During the night of November 6, 2012, a fire broke out in the server room of our headquarters. As a result, a portion of our servers and communication equipment was damaged. Our operations were partially restored on November 25, 2012 through the use of a temporary solution, and nearly all information that was damaged in the fire was restored. As of March 20, 2013, a permanent solution was found, and our insurance provider has covered all direct damages resulting from the fire.
On March 12, 2013, we entered into a Strategic Investment Agreement with Networks3, Inc., a non-practicing entity controlled by Hudson Bay Capital, in order to commercialize our patents and raise equity and debt financing, as well as a Note Purchase Agreement with two funds managed by Hudson Bay Capital. See Item 10.C – "Additional Information—Material Contracts—Patent and Financing Transactions".
Principal Capital Expenditures
Our principal capital expenditures to date have been the purchase of equipment and other software tools used in our business. These purchases totaled $557,000 in 2010, $653,000 in 2011. No purchases were made in 2012. We used internal resources to finance these capital expenditures.
B. BUSINESS OVERVIEW
General
We develop, market and sell telecommunication transport equipment capable of supporting the growing capacity demands for Ethernet services and high bandwidth video services, such as high definition television, or HDTV, Internet Protocol television, or IPTV, video on demand, or VoD, and interactive television (together known also as “video services”), 2G, 3G and 4G mobile backhauling, as well as other types of data services and voice services, whether transmitted over wireline or cellular networks, in metropolitan networks. Our target customers are telecommunication service providers active in metropolitan areas.
We focus on the needs of metropolitan area networks that primarily address a transmission capacity of 10 or more Gigabits per second, or Gbps. The majority of metropolitan area networks are currently operating at a transmission capacity of 10 Gbps or below, because they were initially designed to address voice traffic and later upgraded to support high speed Internet service connections. Introduction of mobile broadband technologies such as LTE, and the penetration of content-based services such as IPTV with the transition from Standard Definition (SD) to High Definition (HD) content, together with the migration from linear TV (Broadcast/Multicast) to VoD and growth of Over the Top (OTT) content and file sharing over the Internet, are expected to drive the need for growth in network transmission capacity.
Our first generation product line, CM-100 was first delivered for commercial deployment in 2004. In 2004, this product was selected for commercial deployment by KDDI Corporation in Japan, or KDDI, a major telecommunication carrier in Japan. KDDI deployed the CM-100 product line as part of a nation-wide build up in Japan of an advanced metro network that is intended to carry “residential triple play” services, which are a bundled offering of voice services, Internet access and a range of video and other media services, as well as Ethernet services for business customers and TDM circuit emulation for 3G mobile backhauling, all based on IP protocols.
Media Broadcast GmbH in Germany began deploying the CM-100 in 2008, and we began shipping our products to SK Broadband in Korea in late 2008. Several additional customers have also deployed the CM-100 product line.
Our next generation product line, CM-4000, was introduced in 2007 and added new technologies on top of those of CM-100, which address the evolving requirements of service providers delivering broadband services to their fixed and mobile subscribers.
Our CM-4000 product lines are designed to enable the provision and management of data, video and voice transport services in an efficient manner that is expected to reduce the costs of transport service providers. Supporting fiber-optic infrastructures, the CM-4000 supports a wide range of interfaces for video, data and voice, together with synchronization technologies which are essential for, but not limited to, backhauling of mobile broadband traffic. It provides multi-service capabilities and reliability similar to the CM-100, while offering higher switching capacity and larger Ethernet user port density. Shipments of the CM-4000 began in 2008.
Our CM-4000 metropolitan product lines are optical transport solutions that are designed to handle not only the growing demand for video and data services by telecommunication company customers and small to medium size businesses, but also support most traditional voice services, in compliance with the technical specifications required by existing synchronous voice transmission on copper and on optical media, PDH, SONET or SDH. The CM-4000 product lines are designed to provide the benefits of both Ethernet and TDM (SONET/SDH and PDH) protocols. The product lines are also designed to avoid integrating costly protocol-dependant mapping functionalities that are generally required in adapting SONET/SDH platforms to support data traffic, as well as the costs of hybrid fabric platforms (also known as POTS) that handle both TDM and packet-based traffic.
In 2009, our CM-4000 products were selected and started to be deployed by BSNL in India as part of a nationwide, next generation broadband, triple play network. In November 2009, a leading Scandinavian telecommunication service provider selected our CM-4000 product to enable services migration and expansion for residential, enterprise and mobile subscribers with shipments beginning in late 2009. Our CM-4000 products were also chosen and deployed by Technoserv a leading Russian distributor dedicated to system integration, MetroNet, a Mexican telecommunication service provider, several customers in Germany through 3M Services, as well as by several additional customers.
Following the significant reductions in our headcount and budget in 2012, since the end of 2012 we do not have sufficient resources to develop new features required by our customers and prospective customers. We have completely abandoned the efforts to win Tier 1 customers and we stopped development of Layer-3 functionality. As a result of the above and the downsizing, we are losing our competitive edge. In the case of Tier 2 customers, we require guaranteed revenues to finance the development of required features. This requirement significantly reduces our ability to win new Tier 2 customers and reduces our ability to preserve existing Tier 2 customers. As a result, we expect our revenues in 2013 to be lower than in 2012. While we have an initial marketing definition for a new product and solution, we lack the financial resources to develop it.
Metro Transport Telecommunication Markets, Technology and Products
The fiber optic networks of many telecommunication companies in the Metro Transport market located in metropolitan areas are experiencing a shift from carrying primarily voice traffic to carrying a growing mix of data, video and voice traffic. Data transmissions are based on internet protocol, or IP, and carry services such as voice over IP, or VoIP, Internet access and various video services, as well as advanced data services for business customers. Video services include broadcasting streaming video and multicasting streaming video that is either identical or can be differentiated by subscriber choice, either at standard definition capacity or at HDTV capacity. In addition, these services include transmission of all of these services over a cellular network to advanced handheld devices over third generation, 3G or 3.5G, cellular networks and fourth generation, or LTE (Long Term Evolution), cellular networks. Data traffic volumes carried over these metropolitan area networks are surpassing voice traffic volumes. Data traffic is forecasted for further growth over the coming years. This increase in data relative to voice traffic is mainly a result of the rapid growth of the Internet, video services and business services.
Offerings to consumers of high speed data services have reached millions of subscribers worldwide. These services are offered either over fiber connections or a combination of fiber and fast access technologies, such as ADSL release 2, very high speed digital subscriber line, or VDSL, and VDSL release 2, wireless or cable networks. Connecting subscribers with fiber is expected to allow for significantly higher speed services, mainly data and video services and, as a result, will require an upgrade of metro telecommunication equipment with technologies that enable very high speed transmissions of data services over fiber networks.
The main driver for growth of data traffic is the adoption of new video services by consumers, as well as the explosive growth in the use of tablets and smart phones. Services such as video-on-demand, HDTV, catch-up TV, file sharing and Internet-TV, delivered over fixed and mobile broadband access technologies, are imposing new requirements on service providers’ networks in terms of bandwidth scaling and quality of service. Video services require peak bandwidth capacity on orders of magnitude higher than deployed for Internet access services, but only at certain hours of the day. Additionally, video services have different characteristics than internet access and voice services. Video services are sensitive to jitter, loss and delay. In addition, existing mechanisms to ensure quality of experience that were developed to address traditional services are insufficient for HDTV and other new video services. Our CM product line was designed to address these requirements for the delivery of video services to consumers.
Telecommunication companies have typically managed their data transfer capacity needs through their existing metro transport technologies. These technologies were originally designed for transporting voice services. These traditional solutions, however, are not designed to support high levels of data services traffic. Traditional networks are also inefficient when transporting data as they fail to utilize inherent differences in the type of network support that is required for the transmission of data traffic. Data traffic is generally less susceptible to corruption resulting from minor time delays and less time-sensitive than voice traffic. In addition, the flow of data traffic is often characterized by rapid bursts, with dynamically varying levels of utilization of communication channels, as opposed to the flow of voice traffic, which has characteristically constant levels of channel utilization.
A range of new solutions is being developed to address the need of carriers and service providers to be able to support higher levels of data traffic within metropolitan areas, commonly referred to as metro transport. One type of solution, consisting of a router or switch that transports packets of data, focuses on the characteristics of data traffic without supporting the full range of time division multiplexing, or TDM, circuit services that meet the stringent timing requirements needed for some legacy services. In this type of solution, data services and legacy services are transmitted and maintained in different metro networks. Another type of solution, known as packet-optics transport system, or POTS, uses hybrid fabrics to support both types of traffic, while using duplicated hardware and, in many cases, also duplicated fiber infrastructure. A third type of solution, known as packet transport networks, or PTN, attempts to take advantage of the characteristics of data traffic while continuing to support traditional voice traffic over a converged metro network. We offer this third type of solution that provides transmission capacities of 10 Gbps and higher, and supports transmission of both packets of data and the full range of traditional circuit-based voice and data services over the same network. Data services supported include the transmission of a range of video services, whether in standard or HDTV mode, as well as over cellular networks. We expect that the metro transport solution for the transmission of traditional voice and increased data traffic will combine the efficient transport of data services based on Ethernet protocol with high reliability voice services based on SONET/SDH protocol.
Major metro transport technologies include the following voice and/or data protocols:
SONET / SDH. SONET is the American National Standards Institute, or ANSI, standard for synchronous voice transmission on optical media. The international equivalent of SONET is synchronous digital hierarchy, or SDH. Together, these two protocols ensure standards to enable digital networks to interconnect internationally and existing conventional transmission systems to utilize fiber with the help of interfaces that connect network end-users, called tributary attachments.
Ethernet. Ethernet is the most widely-installed local area network, or LAN, technology. It is often used in college dormitories and office buildings. In recent years, through development of new protocols and technologies, Ethernet has evolved to become the standard interface of choice for new deployments in the Wide Area Network, or WAN, as well. In particular, new protocols that improve carriers’ fault management and performance management of Ethernet-based networks have been introduced.
Multiprotocol Label Switching. Multiprotocol label switching, or MPLS, is a standards-approved technology for speeding up network traffic flow and making it easier to manage. MPLS involves setting up a specific path for a given sequence of packets, identified by a label put in each packet, thus saving the time needed for a router to look up the address to the next node to forward the packet to. MPLS is called multiprotocol because it allows multiple protocols to be transported on top of it. In addition to moving traffic faster overall, MPLS makes it easy to manage a network for quality of service, or QoS. For these reasons, MPLS is gradually being adopted as networks begin to carry more and different mixtures of traffic.
MPLS Transport Profile (MPLS-TP). MPLS-TP is an emerging standard that adds operations, administration and management, or OAM, capabilities from the SONET/SDH world to the data world, and eases the operation of packet transport networks for personnel who are familiar with the operation of legacy SONET/SDH networks.
Pseudo Wire Emulation. Pseudo wire emulation, or PWE, is a standards-approved technology for mapping different services over packet switched networks, such as MPLS. A pseudowire emulates a point-to-point link that provides a single service which is perceived by its user as an unshared link or circuit of the chosen service and can be used as a convergence layer for multi-service systems.
Carrier Ethernet. Carrier Ethernet refers to a combination of technologies, including Ethernet, MPLS and PWE, that enable telecommunication network providers to provide high-bandwidth data services to consumers and enterprises. Standards for carrier Ethernet networks are being developed by multiple industry organizations, including the IEEE, IETF, MEF and others. We are a leading participant in defining carrier Ethernet standards.
Synchronous Ethernet. Synchronous Ethernet is a standard that provides means to deliver frequency synchronization, required for transport of TDM services and backhauling of 2G, 3G and LTE FDD traffic, in quality that is equivalent to SONET/SDH, over Ethernet interfaces.
IEEE 1588v2. IEEE 1588v2 is a standard that provides the means to deliver phase and frequency synchronization over packet networks. While frequency synchronization can be provided by legacy SONET/SDH networks, phase synchronization, required for TDD LTE and WiMax, cannot be provided by such legacy networks, and the (more expensive) alternative is to have all the base stations in such wireless networks synchronized using GPS.
CM-4000 Product
Our CM-4000 product line, the successor to our CM-100 product line, became commercially available in January 2008. The CM-4000 family of products provides a solution for packet transport networks in the metro area. It provides multiservice capabilities and reliability, offers high bandwidth support, with multiple products ranging from metro access to metro core.
We believe that our CM-4000 switches address the needs for next-generation packet transport networks with a cost-effective combination of Ethernet and TDM. Our solution is designed to ensure service quality and availability, while enabling a reduction of capital and operating expenses. Using CM-4000 switches enables a customer to achieve network convergence with a plug-and-play network management system, or NMS, that easily interacts with operating support system, or OSS, service applications. The CM-4000 is a high-capacity MPLS and MPLS-TP based transport switch providing high service availability and scalability, and simplified end-to-end “point-and-click” management through its service/application-oriented CM-view NMS.
By cost-effectively enabling a mix of Ethernet and TDM traffic over the same network infrastructure, the CM-4000 helps to secure a service providers’ investment, enabling deployment of advanced mobile broadband, residential multi-play and business Ethernet services, together with traditional TDM services, and the means to gradually migrate them to Ethernet through interworking technologies.
Our CM-4000 was designed to efficiently deliver a mix of TDM and advanced packet services over a single, converged transport infrastructure. It offers a traffic management scheme that provides end-to-end performance during congestion, and enables dynamic bandwidth reclamation and optimal bandwidth utilization for the delivery of the following packet and TDM services:
| | o | E-Line, E-Tree and E-LAN services with differentiated quality of service, or QoS, application-aware classification and service level agreement, or SLA, guarantee; |
| | o | Ethernet virtual private line, or EVPL, and virtual private LAN services, or VPLS; |
| | o | SONET/SDH to Ethernet interworking; |
| | o | A full range of TDM (PDH and SONET/SDH) private line services; and |
| | o | Non-blocking SONET/SDH low-order and high-order cross connect. |
These services enable the delivery of end-user applications such as multi-play (VoIP, broadcast video, VoD, shifted TV, network private video recorder, or nPVR, and high speed internet access, or HSI), business Ethernet, 3.5G/4G wireless backhaul and on-demand content distribution. They also facilitate the migration towards all-IP by providing a viable path to convergence through the introduction of SONET/SDH to Ethernet interworking.
Our CM-4000 product line includes the CM-4314, CM-4206, CM-4140 and CM-401x systems. These systems can be deployed in a variety of topologies, including ring, mesh and tree, over one or multiple 10 Gbps wavelengths.
In October 2008, we launched the CM-4140. The CM-4140 is a cost-optimized, low-power and small-footprint MPLS-based carrier Ethernet transport switch. It offers a full suite of carrier-class Ethernet and TDM services for aggregating residential multi-play services, business connectivity and mobile backhaul applications. We believe that it offers a combination of price, power and footprint that compares favorably to competitive solutions. Its cost structure, low power consumption and small size enable service providers to expand the MPLS from the metro core to the edge of the aggregation network, benefiting from an end-to-end MPLS network across the aggregation and core network.
The CM-4140 is interoperable with leading third party MPLS switches/routers in the industry and enables Tier 1 service providers to benefit from a “best in class” network solution for the first layer of aggregation that can work together with third party high-capacity and large-scale MPLS switch/routers in the second layer of aggregation. In addition, the CM-4140 was designed to address the needs of Tier 2 and Tier 3 carriers, as well as to complement our existing product offerings.
In June, 2011, we announced the introduction of our CM-401x PTN access product line. The new product portfolio is based on 14G full duplex of non-blocking, switching capacity, packed in 1RU with a broad mixture of Ethernet, PDH and SDH interfaces. With the introduction of CM-401x, we strengthened our offering for telecommunication service providers worldwide by offering end-to-end PTN solutions ranging from access to core. This portfolio is aimed at mobile 2G/3G/4G cellular or hub site gateways, as well as service providers delivering enterprise services.
The CM-4206 and CM-4314 systems support a common set of interchangeable interface cards and common modules. They support a rich set of Ethernet, TDM, MPLS, MPLS-TP and synchronization functionality with two different chassis form factors, and utilize a common hardware and software architecture.
Sales, Marketing and Service
Sales and Marketing. We market our products to telecommunication companies both directly and indirectly through original equipment manufacturers, strategic alliances and agency and distribution arrangements
As part of our plan to reduce our operational expenditures, we closed our offices around the world, other than in India and Germany, and we focus our efforts on supporting our existing marketing channels for Tier 2 customers, especially with 3M Germany, and other Tier 2 customers worldwide. At the same time, we are working on developing a new product and solution that could possibly enable us to increase our sales in the future.
As of December 31, 2012, overall marketing and sales efforts were conducted by approximately seven employees or agents.
The following is a summary of revenues by geographic area based on the location of the end users for the last three years:
| | | Year ended December 31 | |
| | | | | | | | | | |
| | | (In thousands) | |
| Japan | | $ | 3,485 | | | $ | 2,694 | | | $ | 3,587 | |
| Germany | | | 1,947 | | | | 3,308 | | | | 3,217 | |
| India | | | 5,852 | | | | 2,622 | | | | 224 | |
| Scandinavia | | | 1,360 | | | | 3,601 | | | | 1,152 | |
| Mexico | | | 538 | | | | 1,184 | | | | 1,519 | |
| Other | | | 1,449 | | | | 2,176 | | | | 1,494 | |
| | | $ | 14,631 | | | $ | 15,585 | | | $ | 11,193 | |
The substantial majority of our revenues in 2008 and 2009 were generated from our CM-100 metro product line. The majority of our revenues in 2010, 2011 and 2012 were generated from our CM-4000 metro product line. Our sales to KDDI in Japan accounted for 23.1% of our revenues in 2010, 16.6% of our revenues in 2011, and 25.3% of our revenues in 2012. Sales to Media Broadcast in Germany accounted for 6.6% of our revenues in 2010, 2.6% of our revenues in 2011 and 3.1% of our revenues in 2012. Sales to SK Broadband in Korea accounted for 1.7% of our revenues in 2010, 0.8% of our revenues in 2011, and 0.8% of our revenues in 2012. Sales to BSNL in India accounted for 40% of our revenues in 2010, 16.8% of our revenues in 2011 and 2% of our revenues in 2012. Sales to 3M accounted for 6.7% of our revenues in 2010, 18.6% of our revenues in 2011 and 25.6% of our revenues in 2012. Sales to a Scandinavian service provider accounted for 9.3% of our revenues in 2010, 23.1% of our revenues in 2011 and 10.3% of our revenues in 2012. We expect to depend on purchases by a very limited number of telecommunication carriers for the substantial majority of our revenues.
Approval Process. Telecommunication companies are significantly larger than us and consequently are able to exert a high degree of influence over us. Prior to selling our products to telecommunication companies, we are required to undergo lengthy approval processes. Evaluation can last for over a year for enhanced products or products based on newer technologies.
The length of the approval process is affected by a number of factors, including the complexity of the product involved, technological and budgetary priorities of the telecommunication companies and regulatory issues affecting telecommunication companies. A telecommunication company will usually conduct technical trials after completing a laboratory evaluation that tests a new product’s function and performance against industry standards. After completion of technical trials, field trials simulate operations to evaluate performance and to assess ease of installation and operation. Throughout the approval process, we commit senior technical and marketing personnel to participate in technology, field and market trials and to actively support the evaluation efforts.
The introduction of our CM-4140 and CM-401x products shortened this long cycle of trials for simple deployment applications because these platforms are installed closer to the access portion of the network, while other platforms are installed closer to the core of the network.
Commercial deployment of a new product usually involves substantially greater numbers of systems and locations than the field trial stage. In the first phase of commercial deployment, a telecommunication company installs the equipment in selected locations for certain applications. This phase is followed by general deployment which involves greater numbers of systems and locations. Telecommunication companies typically select a number of suppliers for general deployment to ensure that their needs can be met. Subsequent orders, if any, are placed under a single or multi-year supply agreement.
Following selection for commercial deployment, the introduction of successive generations of products or upgraded software versions is vital to our business, because it enhances functionality and reduces costs. Our growth substantially depends on commercial acceptance of advanced products and technology by telecommunication companies and acceptance of new data services by subscribers, as well as our ability to develop new technologies and sell new products.
Services and Support. We offer repair services as part of our warranty services and technical support services for our products. We usually do not provide installation services. We expect that our local distributor or reseller will provide the first level of service and support. More extensive repair and technical support is offered at our headquarters in Israel pursuant to software support and hardware warranty obligations. We also offer telephone support and provide product training to our carrier customers on a case-by-case basis. When we utilize a reseller for sales to a customer, we deliver our products to our resellers and usually they are responsible for installation. Alternatively, in Germany, the reseller can ask us to complete installation for an agreed price. Second level support services that address identification and documentation of field failures are provided by our local office in the relevant territory or by our office in Israel.
To date, substantially all of our product sales outside the United States are subject to an initial warranty and support protection period of up to two years. Sales in the U.S. are subject to an initial warranty and support period of up to five years. Our warranty generally covers defects in materials or workmanship and failure to meet published specifications, but excludes damage caused by improper use and other express or implied warranties. Based on market conditions, we may agree to indemnify our customers in some circumstances against liability from defects in our products or for indirect damages. In the event that there are material deficiencies or defects in the design or manufacture of our products, the affected products could be subject to recall. In such cases, we may be required to repair affected products even if they are no longer under warranty. Our exposure to indirect damages arising from failures covered by our warranty could be significant.
Customers and End-users
To date, our CM-100 products have been commercially deployed by KDDI in Japan, Media Broadcast in Germany and SK Broadband in Korea. Our CM-4000 products have been commercially deployed by BSNL in India and by multiple Tier2 and Tier3 customers around the world.
CM-100 customers and end users
Our sales to KDDI in Japan, which began in 2004, are made pursuant to agreements and related terms of sale with OKI, a distributor of telecommunication and enterprise products in Japan. We provide to KDDI a product warranty and post-contract hardware and software support services with respect to products sold. OKI provides on-site product support services and training. Our distribution agreement sets general distribution terms regarding any sales that are made to targeted customers. OKI submits purchase orders for products on an as needed basis and is not committed to purchase any specific quantity of our products. In 2012, KDDI decided not to award a large upgrade project to us due to our weak financial condition. Moreover, as part of our cost-cutting program in 2012, after KDDI and OKI did not agree to our request to increase maintenance payments to us, we terminated the employment of most of our employees who were expert in the CM-100, closed our office in Japan and stopped issuing invoices for support services to OKI. This resulted in a significant reduction in our overall maintenance revenues and could harm our ability to generate additional sales from KDDI.
In February 2008, our CM-100 and CM-4000 product lines were selected by Media Broadcast GmbH, or Media Broadcast, as a network infrastructure building block for network solutions deployed by Deutsche Telekom’s wholesale business unit, and leased to a leading cable operator in Germany. Deployments of our CM-100 products in two regions began in 2008 and deliveries were also made, to a lesser extent, in 2009, to a lesser extent in 2010, and to an even lesser extent in 2011. Further deliveries of our CM-100 products, initial deployment of our CM-4000 products and any expansion of service for Media Broadcast are subject to the cable operator’s decisions. Our sales to Media Broadcast in Germany are made pursuant to a master sales agreement that governs sales to them. We provide to Media Broadcast a product warranty and post-contract hardware and software support services with respect to products sold. Media Broadcast will provide on-site product support services and training to the end user. The master agreement sets general terms regarding sales that are made to targeted customers. Media Broadcast submits purchase orders for products on an as needed basis and is not committed to purchase any specific quantity of products.
CM-4000 customers and end users
Since 2008, we have had a business collaboration with 3M Services to distribute our CM-4000 packet transport gears. This strategic alliance has led to the selection of our CM-4000 product by a number of customers, most of which are regional operators in Germany. Among our new customers are VSE NET, EnviaTel, HEAG MediaNet and e.discom Telekommunikation GmbH, each of which selected our CM-4000 products for delivery of Ethernet services for business customers. Deployments of our CM-4000 products by some of these customers began in 2011. We provide to 3M Services a product warranty and post-contract hardware and software support services with respect to products sold. 3M Services provides on-site product support services and training to the end user. The master agreement sets general terms regarding sales that are made to targeted customers. 3M Services submits purchase orders for products on a need basis and is not committed to purchase any specific quantity of products.
In June 2009, our CM-4000 was selected by Mexico’s MetroNet as their main network infrastructure building block. The CM-4000 was selected to replace MetroNet’s existing carrier Ethernet switches that were at the end of their life and could not be purchased any longer. Interoperability between our CM-4000 and their existing equipment was a requirement that enabled MetroNet to continue delivery of Carrier of Carrier Ethernet services to leading carriers in Mexico over a multi-vendor network until the expected transition to a full CM-4140 network is completed. Deliveries of our CM-4000 in Mexico started at the end of 2008 and continued in higher volumes in 2009, 2010 and 2011. Our sales to MetroNet in Mexico are made directly. We provide to MetroNet a product warranty and post-contract hardware and software support services with respect to products sold, as well as on-site product support services and training. MetroNet submits purchase orders for products on an as needed basis and is not committed to purchase any specific quantity of products.
In September 2009, our CM-4000 was selected by a Scandinavian service provider to replace its TDM legacy network (SDH) with a packet based transport network (PTN). Originally, the CM-4000 was selected to deliver a mix of legacy TDM services and packet based services over a converged packet network. It is now being used primarily for 4G LTE backhauling. Deliveries of our CM-4000 started with low volumes at the end of 2009, and continued with a higher volume in 2010 and 2011 and reduced significantly in 2012. Our sales to this customer are made directly. We provide a product warranty and post-contract hardware and software support services with respect to products sold, as well as on-site product support services and training. This customer submits purchase orders for products on an as needed basis and is not committed to purchase any specific quantity of products.
In September 2009, our CM-4000 products were selected by BSNL in India as part of a nationwide, next generation broadband, triple play network based on gigabit passive optical network (GPON) and carrier Ethernet technologies. In 2010 we started to recognize revenues from sales to BSNL. Our initial sales to BSNL were made pursuant to an agreement of sale with an OEM distributor of telecommunication equipment in India. In November 2010, we announced the receipt of an additional purchase order and immediate deployment of our CM-4000 products from Alphion Corporation, a distributor in India, for deployment to BSNL through ITI Ltd. Our solutions are being deployed as part of a nationwide, next generation broadband, triple play network based on GPON and carrier Ethernet technologies. Through both channels, we provide to BSNL a product warranty and post-contract hardware and software support services with respect to products sold.
Manufacturing
Currently we use one subcontractor for component sourcing, inventory warehousing, board assembly, testing and shipment. We believe that we can satisfy our production requirements using this one major subcontractor, and we expect to continue to utilize this major subcontractor and other third parties to manufacture, assemble and test our products.
Telecommunication company orders are short term and typically involve short delivery time frames. The manufacture of products is mainly against purchase orders, and we usually do not order products based on sales forecasts and do not keep products in inventory. We and our manufacturers perform final quality control and extensive testing prior to shipping. Product quality and reliability are of prime concern in all phases of the manufacturing process. Our facilities are subject to the ISO9001 certification process. This certification is required in order to sell to many telecommunication companies.
In procuring components, we and our subcontractors rely on a number of suppliers of semiconductor solutions that are the sole source for certain of the components. In order to have an adequate supply of components with a long lead-time for delivery, we periodically order significant quantities of components from single source semiconductor component suppliers.
Industry Standards and Government Regulations
Our products must comply with industry standards relating to telecommunication equipment. Before completing sales in a country, our products must comply with local telecommunication standards, recommendations of quasi-regulatory authorities and recommendations of standards-setting committees. In addition, public carriers require that equipment connected to their networks comply with their own standards. Telecommunication-related policies and regulations are continuously reviewed by governmental and industry standard-setting organizations and are subject to amendment or change. Although we believe that our products currently meet applicable industry and government standards, we cannot be sure that our products will comply with future standards.
We are subject to telecommunication industry regulations and requirements set by telecommunication carriers that address a wide range of areas including quality, final testing, packaging and use of environmentally friendly components. We comply with the European Union's Restriction of Hazardous Substances Directive that required telecommunication equipment suppliers to stop the usage of some materials that are not environmentally friendly by July 1, 2006, known as the “RoHS regulations.” Further regulations, known as the “RoHS6” regulations, require suppliers to stop the usage of lead in solders in telecommunication equipment. An extension for compliance with the RoHS6 regulations that currently has no time limit was granted under the Directive. We expect that other countries, including countries we operate in, will adopt similar directives or other additional regulations. We believe that we are in compliance with the RoHS and RoHS6 regulations, although tests for compliance with these regulations are limited in their ability to fully ensure compliance.
Competition
We compete on the basis of technological capability and price. Many of our competitors and potential competitors have greater financial, technological, manufacturing, marketing and personnel resources than we have. The expansion of research and development facilities in Asia, where engineering and production costs are lower compared to the United States, Western Europe or Israel, has increased and could further increase competition and price pressure on our products.
The main competing solutions for our PTN product lines are Layer-3 routers and pure-play carrier Ethernet switches and hybrid platforms known as POTS. Older generation SONET/SDH based platforms cannot address the scalability requirements posed by the fast growth of video and other data services. Layer-3 routers were the first to address the new requirements for high bandwidth scalability and pure-play carrier-Ethernet switches offering a similar value proposition at a lower price, however focused on the delivery of data services, without the full range of legacy TDM services. POTS platforms are using hybrid fabrics to support both type of traffic, while using duplicated hardware and, in many cases, also duplicated fiber infrastructure. In the last 12 months, technological development in the market led to reduced prices for products that have Layer-3 functionality. Since we stopped development of Layer-3 as a result of our cost reduction, we are losing our competitive edge.
Our competitors in our targeted markets of metro and access telecommunication equipment are numerous and we expect competition to increase in the future. Our principal competitors for our products include Alcatel-Lucent, Brocade, Ciena, Cisco Systems, Inc., ECI Telecom Ltd., Ericsson, Extreme Networks, Fujitsu, Huwaei, Juniper, NEC, Nokia-Siemens Networks, Tellabs, UTStarcom, and ZTE.
Intellectual Property Rights
We regard certain areas of our technology as proprietary. We have obtained several patents and have filed U.S. and international patent applications covering certain key areas of our technologies. In general, we have relied on a combination of technical leadership, trade secret, copyright and trademark law and nondisclosure agreements to protect our unpatented proprietary know-how. Our proprietary technology incorporates algorithms, software, system design and hardware design that we believe is not easily copied. We believe that, because of the rapid pace of technological change in the telecommunication industry, patent and copyright protection are less significant to our competitive position than factors such as the knowledge, ability and experience of our personnel, new product development, market recognition and ongoing product maintenance and support.
C. ORGANIZATIONAL STRUCTURE
List of Significant Subsidiaries
Our wholly-owned subsidiary, Orckit-Corrigent Ltd., is an Israeli company, and our indirect wholly-owned subsidiary, Orckit - Corrigent Telecom India Pvt. Ltd., is an Indian company.
D. PROPERTY, PLANTS AND EQUIPMENT
As of December 31, 2012, our principal offices in Tel Aviv occupied approximately 43,000 square feet of space, which was subsequently reduced as a result of our downsizing to approximately 18,300 square feet of space. The lease agreement expires on December 31, 2015. We have an option to terminate this lease agreement upon six months' prior written notice. We believe that our offices and facilities are adequate for our current needs and that suitable additional or substitute space will be available when needed.
ITEM 4A. UNRESOLVED STAFF COMMENTS
ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS
Our operating and financial review and prospects should be read in conjunction with our financial statements, accompanying notes thereto and other financial information appearing elsewhere in or incorporated by reference in this Annual Report.
We have suffered recurring losses as well as negative cash flows from operating activities in recent years and through the date of issuance of our financial statements for the year ended December 31, 2012. As of December 31, 2012, we had a capital deficiency of $8.4 million. During 2012, we negotiated an Arrangement with the holders of our Series A notes and Series B notes, as more fully described in Item 10.C of this Annual Report. The Arrangement was consummated on July 2, 2012. An aggregate of only approximately $3.5 million principal amount of these notes were converted into ordinary shares pursuant to the Arrangement. Accordingly, we are required to pay to our note holders approximately $11.9 million in July 2014 and approximately $4.2 million December 2017.
On March 12, 2013, we entered into a Strategic Investment Agreement with Networks3, Inc., a non-practicing entity controlled by Hudson Bay Capital, in order to commercialize our patents and raise equity and debt financing, as well as a Note Purchase Agreement with two funds managed by Hudson Bay Capital. However, the Strategic Investment Agreement is subject to significant closing conditions, including the retirement of our Series A notes and Series B notes, which would require a court-approved arrangement pursuant to Section 350 of the Israeli Companies Law, and the approval of the Office of the Chief Scientist on terms satisfactory to Networks3, and there is no assurance that the transactions contemplated by this agreement will be consummated. See Item 10.C – "Additional Information—Material Contracts—Patent and Financing Transactions". Our management believes that in order for us to continue to fund our operations and make our scheduled debt payments, we will need to consummate the transaction with Networks3 or raise capital. There is no assurance that we will be successful in raising additional capital on favorable terms, if at all.
The foregoing information raises substantial doubt as to our ability to continue as a going concern, and our audited financial statements for the year ended December 31, 2012 include an explanatory paragraph to this effect by our independent registered public accounting firm. Our consolidated financial statements for the year ended December 31, 2012 have been prepared assuming that we will continue as a going concern and do not include any adjustments that might result from the resolution of these uncertainties.
Overview
Orckit was founded in 1990. We are an Israeli corporation engaged in the design, development, manufacture and marketing of telecommunication equipment that enables transmission of broadband services. We develop, market and sell telecommunication transport equipment capable of supporting the growing capacity demands for Ethernet services and high bandwidth video services, such as HDTV, Internet Protocol television, or IPTV, and video on demand, or VoD, and interactive television (together known also as “video services”), 2G, 3G and 4G mobile backhauling, as well as other types of data services and voice services, whether transmitted over wireline or cellular networks, in metropolitan networks. Our target customers are Tier 2 telecommunication service providers active in metropolitan areas. Our metro products consist of our CM-100, our first generation product line, and CM-4000, our second generation product line, as well as CM-View, the corresponding network management system. The CM-4000 product together with the CM-View is called Packet Transport Network (PTN).
The end-user base for our products is comprised primarily of telecommunication companies, and has historically been concentrated in each year among a small number of companies. Although the total number of our customers has increased, we expect that we will continue to experience high customer concentration.
The first significant customer for our metro product was KDDI, a Japanese telecommunications carrier that began purchasing our products in 2004 and accounted for approximately $3.4 million (23.1%) of our revenues in 2010, $2.6 million (16.6%) of our revenues in 2011 and $2.8 million (25.3%) of our revenues in 2012. In early 2008, our product was selected by Media Broadcast GmbH, a German customer, as a network infrastructure building block for network solutions deployed by Deutsche Telekom’s wholesale business unit, and leased to a leading cable operator in Germany. Sales to Media Broadcast represented $968,000 (6.6%) of our revenues in 2010, $404,000 (2.6%) of our revenues in 2011 and $348,000 (3.1%) of our revenues in 2012.
Sales to SK Broadband in Korea, which began purchasing our products in 2008, accounted for approximately $242,000 (1.7%) of our revenues in 2010, $117,000 (0.8%) of our revenues in 2011 and $85,000 (0.8%) of our revenues in 2012. Sales to a U.S. based customer accounted for $136,000 (0.9%) of our revenues in 2010, $194,000 (1.2%) of our revenues in 2011 and $130,000 (1.1%) of our revenues in 2012. In 2010, we started to recognize revenues from sales to BSNL, an Indian telecommunications company, to which sales are made through two channel partners. Sales to BSNL accounted for approximately $5.9 million (40.0%) of our revenues in 2010, $2.6 million (16.8%) of our revenues in 2011 and $224,000 (2%) of our revenues in 2012.
In June 2009, our CM-4000 was selected by Mexico’s MetroNet as their main network infrastructure building block. Sales to Metronet constituted $538,000 (3.7%) of our revenues in 2010, $1.1 million (6.7%) of our revenues in 2011 and $1.5 million (13.4%) of our revenues in 2012.
In September 2009, our CM-4000 was selected by a Scandinavian service provider to replace its TDM legacy network (SDH) with a packet based packet transport network (PTN). Sales to this customer represented $1.4 million (9.3%) of our revenues in 2010, $3.6 million (23.1)% of our revenues in 2011 and $1.2 million (10.3%) of our revenues in 2012.
We have been involved in strategic cooperation with 3M Services GmbH (formerly known as Quante-Netzwerke GmbH) since 2008 to distribute our CM-4000 packet transport gears. 3M Services is part of the 3M Group which has representatives in more than 70 countries and provides full-service solutions in the telecommunications sector. This strategic alliance has led to the selection of our CM4000 product by numerous new customers in Germany and Luxembourg, including EnviaTEL GmbH, VSE NET GmbH, Cegecom S.A., K-net Telekommunikation Gmbh, HEAG MediaNet and e.discom Telekommunikation GmbH. 3M Services provides support to these customers. Aggregate sales to various customers through our strategic alliance with 3M Services represented $979,000 (6.7%) of our revenues in 2010, $2.9 million (18.6%) of our revenues in 2011 and $2.9 million (25.6%) of our revenues in 2012.
In March 2011, we announced that three new service providers had selected our PTN solution for migration from their legacy SONET/SDH networks to packet based networks. Two providers are based in the Caribbean and Latin America region and the third in Eastern Europe. We began to recognize revenues from these customers in the second quarter of 2012.
On June 21, 2011, we announced the introduction of our CM-401x PTN access product line. The new product portfolio is based on 14G of full duplex non-blocking, switching capacity, packed in 1RU with a broad mixture of Ethernet, PDH and SDH interfaces. With the introduction of CM-401x, we strengthened our offering for telecommunication service providers worldwide by offering end-to-end PTN solutions ranging from access to core. This portfolio is aimed at mobile 2G/3G/4G cellular or hub site gateways, as well as service providers delivering enterprise services.
On December 14, 2011, we announced that Cable Color, a leading telecommunication service provider in Honduras, had selected our IP/MPLS and MPLS-TP based CM-4000 PTN switches and the accompanying CM-View network management system in order to introduce a networking environment for broadband and enterprise VPN services. Cable Color operates a highly advanced network using state-of-the-art technologies to provide a wide range of broadband services to its customers.
Our product sales to end-users are subject to fluctuation from quarter to quarter and year to year.
As a result of our continuing losses and the uncertain economic climate around the world, we decreased our headcount in 2011, which caused our operating expenses to be lower in 2011 than in 2010. In 2012, after the disappointing level of conversions of our notes to ordinary shares pursuant to the Arrangement, we further significantly decreased our headcount and vacated space, which caused our operating expenses to be lower in 2012 than in 2011. As a result of the downsizing measures taken in the second half of 2012, our operating expenses will be lower in 2013 than in 2012.
Following the significant reductions in our headcount and budget in 2012, we do not have sufficient resources to develop new features required by our customers and prospective customers. We have completely abandoned the efforts to win Tier 1 customers and we stopped development of Layer-3 functionality. As a result of the above and the downsizing, we are losing our competitive edge. In the case of Tier 2 customers, we require guaranteed revenues to finance the development of required features. This requirement significantly reduces our ability to win new Tier 2 customers and reduces our ability to preserve existing Tier 2 customers. As a result, we believe that our revenues in 2013 will be lower than in 2012. While we have an initial marketing definition for a new product and solution, we lack the financial resources to develop it.
We have reported losses in each of 2007 through 2012 and expect to report a loss for 2013. We will need to increase our revenues significantly in order to become profitable.
A number of trends in the communications industry are driving growth in demand for network capacity and are expected to increase demand for carrier Ethernet transport systems. These trends include:
| | o | Growth of Internet usage and Internet protocol traffic. Internet protocol network traffic continues to grow significantly as bandwidth used per Internet user and the total number of Internet users increase; |
| | o | Increasing broadband penetration and higher speed access technologies. Communications service providers are offering broadband internet access to an increasing number of business and enterprise subscribers to support voice, video and high speed data offerings. In addition, wireless technologies such as 3G, WiMax and LTE are allowing high bandwidth to mobile devices; and |
| | o | Attractiveness of bandwidth-intensive applications. New applications (e.g., video-on-demand, music downloads, tele-presence, over the top, and file sharing.), and network delivery of larger file formats (e.g., HD video) necessitate an increase in network capacity to accommodate high-quality delivery of these bandwidth-intensive services. |
Our metro products address high-bandwidth packet services. We expect that the mix of voice, video and data, business services over wireline and wireless networks and the use of smart phones and tablets will grow and drive the demand for our metro products. However, the growth of these services will be subject to the ability of telecommunication carriers to offer services at a price that is attractive to subscribers while generating profits to carriers sufficient to justify a significant investment in new equipment. Our future success will be directly affected by the ability of our customers to add subscribers for these new data services. As a result of our significant reductions in research and development personnel in 2012, we currently upgrade our CM4000 product only based on concrete requirements and guaranteed revenue, which could make our product less attractive than those of our competitors.
The current economic and credit environment is having a negative impact on business around the world. Our business is particularly subject to conditions in the telecommunications industry which impact our major customers and potential customers. Such conditions may be depressed or may be subject to deterioration which could lead to a reduction in consumer and customer spending overall, which could have an adverse impact on sales of our products. A disruption in the ability of our significant customers to access liquidity could cause serious disruptions or an overall deterioration of their businesses which could lead to a significant reduction in their orders for our products and the inability or failure on their part to meet their payment obligations to us, any of which could have a material adverse effect on our results of operations and liquidity. In addition, any disruption in the ability of customers to access liquidity could lead customers to request longer payment terms from us or long-term financing of their purchases from us. Granting extended payment terms or a significant adverse change in a customer’s financial and/or credit position could reduce our cash balances, require us to assume greater credit risk relating to that customer’s receivables, cause us to defer recognition of revenues or limit our ability to collect receivables related to purchases by that customer. As a result, our reserves for doubtful accounts and write-offs of accounts receivable could increase.
| Critical Accounting Policies and Estimates |
We prepare our consolidated financial statements in conformity with accounting principles generally accepted in the United States of America. These accounting principles require management to make certain estimates, judgments and assumptions based upon the information available at the time they are made, historical experience and various other factors believed to be reasonable under the circumstances. These estimates, judgments and assumptions can affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the periods presented. Management evaluates its estimates and judgments on an on-going basis.
Critical accounting estimates are those that are most important to the portrayal of our financial condition and our results of operations, and require management’s most difficult, subjective and complex judgments, as a result of the need to make estimates about the effect of matters that are inherently uncertain. Our most critical accounting estimates, discussed below, pertain to revenue recognition, provision for servicing products under warranty, inventories, fair value of financial instruments, stock-based compensation and other-than-temporary impairments of marketable and non-marketable securities. In determining these estimates, management must use amounts that are based upon its informed judgments and best estimates. We evaluate our estimates on an ongoing basis. We base our estimates on historical experience and on various other assumptions that we believe are reasonable under the circumstances. The results of these estimates form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions and conditions.
We are also subject to risks and uncertainties that may cause actual results to differ from estimates and assumptions, such as changes in the economic environment, competition, foreign exchange, taxation and governmental programs. Certain of these risks, uncertainties and assumptions are discussed in the risk factors disclosed in our filings with the SEC. To facilitate the understanding of our business activities, described below are certain accounting policies that are relatively more important to the portrayal of our financial condition and results of operations and that require management's more subjective judgments.
Revenue recognition
Revenues from sales of products are recognized when delivery occurs and title passes to the customer, provided that appropriate signed documentation of an arrangement exists, the fee is fixed or determinable and collectability is reasonably assured.
Certain of our arrangements include hardware that functions together with software to provide the essential functionality of the product. Through December 31, 2010, software revenue recognition guidance also applies to non-software deliverables, such as computer hardware, if the software is essential to the functionality of the non-software deliverables, as is the case with our deliverables. Accordingly, revenues from sales of software products were recognized when, in addition to the criteria mentioned above, vendor-specific objective evidence, or VSOE, of fair value for undelivered elements exists. VSOE is typically based on the price charged when an element is sold separately or, if an element is not sold separately, on the price established by authorized management, if it is probable that the price, once established, will not be changed when this element is commercially sold.
In October 2009, the Financial Accounting Standard Board, or the FASB, issued Accounting Standard Update No. 2009-14: Certain Revenue Arrangements That Include Software Elements - ("ASU 2009-14"). ASU 2009-14 amends the scope of the software revenue guidance in Topic 985-605 to exclude, among other things, non-software components of tangible products and software components of tangible products when the software components and non-software components of the tangible product function together to deliver the tangible product’s essential functionality. We adopted this guidance on a prospective basis for revenue arrangements entered into, or materially modified, on or after January 1, 2011. Accordingly, such arrangements are no longer accounted for in accordance with the FASB’s software revenue guidance. Rather, they are accounted for in accordance with the new guidance for multiple-deliverable arrangements.
We grant to customers post-contract hardware and software support services, or PCS, in connection with our sales. VSOE of the fair value of PCS was established based on our practice with our customers. Therefore, revenues from the sale of products were recognized upon delivery (when the criteria mentioned above are met), and the fair value of PCS is deferred and recognized over the term of the PCS.
In October 2009, the FASB issued Accounting Standard Update No. 2009-13, Revenue Recognition (Topic 605) – Multiple-Deliverable Revenue Arrangements ("ASU 2009-13"). We adopted this guidance on a prospective basis for revenue arrangements entered into, or materially modified, on or after January 1, 2011. Under the new guidance, we separate our multiple-deliverable arrangements into more than one unit of accounting when both of the following criteria are met:
| | (1) | The delivered item(s) has value to the customer on a stand-alone basis; and |
| | (2) | If the arrangement includes a general right of return relative to the delivered item(s), delivery or performance of the undelivered item(s) is considered probable and substantially within our control. |
If these criteria are met, consideration is allocated at inception of the arrangement to all deliverables on the basis of the relative selling price. The selling price of each deliverable is based upon the following selling price hierarchy: VSOE if available, third party evidence of selling price, or TPE, if VSOE is not available, or the best estimate of selling price if neither VSOE nor TPE is available. Under the new guidance, if VSOE and TPE are not determinable, we utilize our best estimate of selling price in order to allocate consideration for those deliverables. Our best estimate of selling price is developed by considering multiple factors including, but not limited to, sales, costs, margin objectives and geographical location.
The adoption of the amended guidance in both ASU 2009-13 and ASU 2009-14 did not have, nor is it expected to have, a material effect on our financial statements based on our current operations.
We do not, in the normal course of business, provide a right of return to our customers.
Convertible subordinated notes
We issued Series A notes in 2007 and Series B notes in 2011. On July 2, 2012, we consummated the Arrangement with the holders of our Series A notes and Series B notes. The Arrangement was considered to be a troubled debt restructuring under ASC 470-60 based on both quantitative and qualitative factors. Based on the future undiscounted cash flow payments being greater than the net carrying value of the original debt, no gain was recorded in our statement of operations. A new effective interest rate was established based on the revised cash flows as a result of the Arrangement. On our consolidated balance sheet, we record the Series A notes based on their debt value plus the fair value of their derivative component and the Series B notes at their fair value.
Provision for servicing products under warranty
Sales of substantially all of our metro products to customers are subject to varying warranty periods that do not exceed two years with respect to sales outside the United States. Sales in the United States are subject to warranty periods of up to five years. The annual provision for warranty is calculated as a percentage of our revenues, based on historical experience, or where historical experience is not available, based on management estimates for expenses which may be required, to cover the amounts necessary to settle product-related matters existing as of the balance sheet date and which may arise during the warranty period.
The amount of our estimated warranty liability may change if the costs incurred due to product failures increase in the future and exceed our estimates. In the event of any future problems with our products, we may need to increase the amount of our reserves.
Inventories
We periodically evaluate the quantities of inventories on hand relative to current and historical selling prices and historical and projected sales volume and technological obsolescence. Based on these evaluations, inventory write-offs and write-down provisions are provided to cover risks arising from slow moving items, technological obsolescence, excess inventories, discontinued products and for market prices lower than cost. We had expected to receive a follow-on order from BSNL in an amount of Indian Rupees equal to approximately $7 million in the third quarter of 2011 through ITI Ltd., a local OEM channel. Since then, we believed on several occasions that we were on the verge of receiving this order, only to be frustrated by new obstacles. If we do not receive this purchase order, we will also not be able to receive any follow-on orders from BSNL. In our financial statements for the year 2012, we wrote off approximately $550,000 of our inventory that can be sold to BSNL only.
Fair value of financial instruments
We determined that the conversion feature of our convertible subordinated notes is an embedded derivative. Since the economic characteristics and risks of the conversion feature are not clearly and closely related to the economic characteristics and risks of the host contract, the convertible subordinated notes, the conversion option must be separated and measured as a derivative.
We measured the fair value of the conversion feature on the issuance date using the following key parameters: standard deviation, time to expiration, the risk free rate of return and the value of the underlying asset. A change in one of the parameters is likely to alter the valuation of the conversion feature. The conversion feature is evaluated at each reporting period, and the difference in fair value is recorded as financial income or expense.
Stock-based compensation expense
We utilize the Black-Scholes option pricing model to estimate the fair value of stock-based compensation at the date of grant, which requires subjective assumptions, including dividend yields, expected volatility of our share price, expected life of the option and risk-free interest rates. Further, as required, we estimate forfeitures for options granted which are not expected to vest. Changes in these inputs and assumptions can materially affect the measure of estimated fair value of our stock-based compensation.
Other-than-temporary impairments of marketable securities
Debt securities are classified as available-for-sale. These securities are reported at fair value, with unrealized gains and losses reported as a separate component of comprehensive income (loss) in shareholders’ equity. When securities do not have an active market, fair value is determined using a valuation model. Unrealized losses that are considered to be other-than-temporary are charged to income as an impairment charge. Realized gains and losses on sales of securities, as well as premium or discount amortization, are included in the consolidated statement of operations as financial income or expenses. We do not hold any securities for trading purposes.
An other-than-temporary impairment is triggered when there is intent to sell the security, it is more likely than not that the security will be required to be sold before recovery of its amortized cost basis, or we do not expect to recover the entire amortized cost basis of the security. If the debt security’s market value is below amortized cost and we either intend to sell the security or it is more likely than not that we will be required to sell the security before recovery of its amortized cost basis, we record an other-than-temporary impairment charge to financial expenses for the entire amount of the impairment. For the remaining debt securities, if an other-than-temporary impairment exists, we separate the other-than-temporary impairment into the credit loss portion and the non-credit loss portion. The credit loss portion is the difference between the amortized cost of the security and our best estimate of the present value of the cash flows expected to be collected from the debt security. The non-credit loss portion is the residual amount of the other-than-temporary impairment. The credit loss portion is recorded as a charge to financial expenses, and the non-credit loss portion is recorded as a separate component of other comprehensive income (loss).
Results of Operations
The following table sets forth certain items from our audited consolidated statement of operations as a percentage of total revenues for the periods indicated:
| | | 2010 | | | 2011 | | | 2012 | |
| Revenues | | | 100 | % | | | 100 | % | | | 100 | % |
| Cost of revenues | | | 63.8 | | | | 55.5 | | | | 36.4 | |
| Gross profit | | | 36.2 | | | | 44.5 | | | | 63.6 | |
| Research and development expenses, net | | | 96.4 | | | | 63.6 | | | | 49.3 | |
| Selling, general and administrative expenses | | | 112.8 | | | | 86.1 | | | | 79.5 | |
| Operating loss | | | (173.0 | ) | | | (105.2 | ) | | | (65.3 | ) |
| Financial expenses, net | | | 11.2 | | | | 32.0 | | | | 13.2 | |
| Adjustments related to Series A and Series B convertible notes | | | (0.2 | ) | | | 23.2 | | | | 16.7 | |
| Other income | | | 11.1 | | | | 2.4 | | | | 4.0 | |
| Net loss | | | (173.3 | )% | | | (111.6 | )% | | | 57.8 | % |
Revenues. The majority of our revenues of $14.6 million in 2010 were generated from sales to BSNL and KDDI. Additional sales were made to a number of smaller customers. The majority of our revenues in 2010 were generated from our CM-4000 product line. Our revenues increased in 2010 mainly as a result of the sales to BSNL, a new customer in 2010, partially offset by a decrease in revenues from sales to KDDI, Media Broadcast, SK Broadband and a U.S. customer. The majority of our revenues of $15.6 million in 2011 were generated from sales to BSNL, KDDI, a Scandinavian telecommunication service provider and sales made to customers through our alliance with 3M Services. Additional sales were made to a number of smaller customers. The substantial majority of our revenues in 2011 were generated from our CM-4000 product line. Our revenues increased slightly in 2011 mainly as a result of an increase in the sales our Scandinavian customer, sales to customers through 3M Services and sales to other new smaller customers, partially offset by a decrease in revenues from sales to KDDI and Media Broadcast. The majority of the $11.1 million in 2012 was generated from 3M ($2.9 million) and from KDDI ($2.8 million).
Gross Profit. Cost of revenues consists primarily of salaries, raw materials, subcontracting costs, costs for integration, assembly and testing of finished products, expenses related directly to operational activities, costs related to post-contract hardware and software support services, PCS, and maintenance services and the payment of royalties to the OCS. Gross profit was $7.1 million, or 63.6% of revenues, in 2012, compared $6.9 million, or 44.5% of revenues, in 2011, compared to $5.3 million, or 36.2% of revenues, in 2010. The increase in our gross profit percentage in 2011 was primarily attributable to the increase in revenues, which caused our fixed costs to be allocated over a greater amount of revenues, a decrease in fixed costs and to sales of products at a relatively higher gross margin. The increase in our gross profit percentage in 2012 was primarily attributable to the fact that we did not have substantial revenues from India, where the gross margin is much lower than the gross margin generated from revenues in other regions.
Operating Expenses
| | | For the years ended December 31 ($ in millions) | | | % Change | |
| | | 2010 | | | 2011 | | | 2012 | | | 2011 vs. 2010 | | | 2012 vs. 2011 | |
| Research and development, net | | | 14.1 | | | | 9.9 | | | | 5.5 | | | | (29.7 | ) | | | (44.4 | ) |
| Selling, general and administrative | | | 16.5 | | | | 13.4 | | | | 8.9 | | | | (18.7 | ) | | | (33.6 | ) |
| Total operating expenses | | | 30.6 | | | | 23.3 | | | | 14.4 | | | | (23.8 | ) | | | (44.6 | ) |
Research and Development Expenses, net. Research and development expenditures consist primarily of materials, depreciation and salaries and related costs for engineering and technical personnel and subcontracting costs associated with developing new products and features. Our costs for research and development are expensed as incurred. Government grants for research and development are offset against our gross research and development expenditures. Research grants were $2.6 million in 2010, $3.2 million in 2011 and $2.7 million in 2012. Our net research and development expenses were lower in 2011 compared to 2010 mainly due to a decrease in salaries and related expenses which resulted from a headcount reduction we effected in the second quarter of 2011. We also consumed less materials and retained fewer sub-contractors for research and received slightly higher research and development grants in 2011. Research grants were higher in 2011 than in 2010 mainly because we received approval for higher grants compared to 2010. Our net research and development expenses were lower in 2012 compared to 2011 mainly due to the headcount reduction that we effected in the second quarter of 2011 having been in effect for all of 2012 and additional reductions of headcount effected over the course of 2012. We also consumed less materials and retained fewer sub-contractors for research and received lower research and development grants in 2012. Research grants were lower in 2012 than in 2011 mainly because we invested less expenses in research and development, causing the grants that cover such expenses to be lower. We anticipate that we will incur a lower level of research and development expenditures in 2013 in comparison to 2012 mainly because the headcount reduction that we effected over the course of 2012 will be in effect for all of 2013.
Selling, General and Administrative Expenses. Selling, general and administrative expenses consist primarily of costs relating to promotion, trade shows, compensation costs for marketing and sales personnel, and other general corporate expenses. Selling, general and administrative expenses were lower in 2011 than in 2010 mainly due to a decrease of approximately $1.5 million in salaries and related expenses as a result of our lower headcount as well as, in certain cases, lower compensation paid to certain employees, as well as due to approximately $870,000 of income resulting from the elimination of a provision for a legal claim that was settled in 2011. Selling, general and administrative expenses were significantly lower in 2012 than in 2011 mainly due to lower expenses as a result of the decrease in our headcount that we effected in the second quarter of 2011 being in effect for all of 2012 and additional reductions of headcount effected over the course of 2012. We expect that selling, general and administrative expenses will be lower in 2013 as in 2012, as the headcount and investment in these activities is significantly lower in 2013.
Financial Expenses, net; and Expenses from Valuation of Conversion Feature. In 2011, our financial income from interest on short-term and long-term investments and on bank deposits, was more than offset by our financial expense, which includes interest payments with respect to our Series A notes and Series B notes and amortization of the issuance costs of the Series A notes, as well as impairment of marketable securities. We also incurred expense from valuation of the conversion feature embedded in our Series A notes in 2010 and 2012. In 2011, we reported income from the valuation to market value of our Series B notes and had an expense of $2.7 million from an other-than-temporary impairment of marketable securities. In 2012, we reported income of $2.0 million from the valuation to market value of our Series B notes and had financial expenses of $1.5 million (mainly interest) in respect of convertible subordinated notes and losses from realization of marketable securities.
The aggregate effect of these financial items resulted in income of $1.7 million in 2010, an expense of $5.0 million in 2011 and an expense of $1.5 million in 2012. We had financial expenses of $28,000 in 2010, a financial income of $1,000 in 2011 and financial expenses of $118,000 in 2012 resulting from the valuation of the conversion terms embedded in our Series A notes. In 2011 and 2012, we also had financial income of $3.6 million and $2.0 million, respectively, from the valuation to market value of our Series B notes. We anticipate that in 2013 we will have financial expense in respect of our convertible notes, which can be offset or increased from changes in the market value of our Series B notes.
Other Income. We had other income of $1.6 million in 2010 as a result of the sale of our minority interest shares investment in another company, additional income of $369,000 in 2011 as a result of a release of funds from escrow and an income of $446,000 from the sale and disposal of fixed assets in 2012.
Impact of Inflation, Devaluation and Fluctuation of Currencies on Results of Operations, Liabilities and Assets
As of December 31, 2012, the majority of our assets in non-dollar currencies were in NIS. A devaluation of the Yen, NIS or Euro in relation to the U.S. dollar would have the effect of decreasing the dollar value of our assets in Yen, NIS or Euro, to the extent the underlying value is Yen, NIS or Euro based. A devaluation of the Yen, NIS or Euro would also have the effect of reducing the U.S. dollar amount of any of our liabilities that are payable in these currencies (unless such payables are linked to the U.S. dollar). Furthermore, a devaluation of the NIS would also have an effect on the U.S. dollar conversion price of our convertible subordinated notes. A devaluation of the NIS in relation to the U.S. dollar would have the effect of decreasing the dollar value of the conversion price of the notes.
In 2010 and 2011 a substantial portion of our sales were denominated in Yen and Euro. A substantial part of our expenses, principally payroll and payments to Israeli vendors, is in NIS, while a significant portion of the cost of goods sold is in U.S. dollars. A substantial portion of our cash, cash equivalents and marketable securities is in NIS. Our results of operations are adversely affected by increases in the rate of inflation in Israel when such increases are not offset by a corresponding devaluation of the NIS against the U.S. dollar. The results are also affected by the currency exchange rate between the U.S. dollar and the Yen and Euro. In 2010 and 2011 the value of the U.S. dollar declined against the Yen. In 2012, the value of the U.S. dollar declined against the Yen. In 2010 the value of the U.S. dollar also declined against the NIS, which caused our NIS denominated expenses to increase. In 2011, the value of the U.S. dollar increased against the NIS, which caused our NIS denominated expenses to decrease. In 2012, the value of the U.S. dollar decreased against the NIS, which caused our NIS denominated expenses to increase.
We are not presently engaged in hedging transactions. We may, however, enter into foreign currency derivatives, mainly forward exchange contracts, in order to protect our cash flows in respect of existing assets.
The following table presents information about the rate of inflation in Israel, the rate of revaluation (devaluation) of the NIS versus the U.S. dollar, the rate of inflation in Israel adjusted for the devaluation and, for 2008 through 2012, the devaluation rate of the Yen against the U.S. dollar (all in %):
| Years Ended December 31, | | Israeli Inflation Rate | | | NIS Revaluation (Devaluation) Rate | | | Israel Inflation Adjusted for Devaluation | | | Yen Revaluation (Devaluation) Rate | |
| 2008 | | | 3.8 | | | | (1.1 | ) | | | 4.9 | | | | (19.1 | ) |
| 2009 | | | 3.9 | | | | (0.7 | ) | | | 4.6 | | | | 2.1 | |
| 2010 | | | 2.7 | | | | (6.0 | ) | | | 8.7 | | | | (13.1 | ) |
| 2011 | | | 2.2 | | | | 7.7 | | | | 5.5 | | | | (5.1 | ) |
| 2012 | | | 1.6 | | | | (2.3 | ) | | | 3.9 | | | | (9.9 | ) |
B. LIQUIDITY AND CAPITAL RESOURCES
We have historically financed our operations primarily through sales of equity, issuance of convertible notes, receipt of research and development grants, sale or maturity of marketable securities and loans from banks.
We had working capital (total current assets net of total current liabilities) of $19.6 million as of December 31, 2010, $211,000 as of December 31, 2011 and $3.8 million as of December 31, 2012. The decrease in our working capital in 2011 occurred primarily as a result of the reclassification of our Series A notes from long-term to short-term liabilities due to the right of the holders to request early redemption in March 2012, which has been extended to June 2012 in connection with the Arrangement. The increase in our working capital in 2012 occurred primarily as a result of the classification of a large portion of our convertible notes from current liabilities to long-term liabilities as a result of the Arrangement with our note holders, which postponed some of the payments on the account of the notes.
We had cash, cash equivalents, long and short-term securities, other securities and bank deposits of $3.2 million as of December 31, 2012, compared to $23.2 million as of December 31, 2011 and to $35.5 million as of December 31, 2010. The decrease in our cash, cash equivalents, long- and short-term securities and bank deposits in 2011 resulted primarily from the use of the funds for operating activities, offset, in part, by $8.0 million raised by us through the public offering of our Series B notes in 2011. As of December 31, 2010 and 2011, our entire securities portfolio was classified as available for sale. The decrease in our cash, cash equivalents, long and short-term securities and bank deposits in 2012 resulted primarily from our losses and from the payments we made to repay a portion of our convertible notes in accordance with the Arrangement. We expect that the balance of our cash, cash equivalents and securities will continue to be low in 2013.
The majority of our cash, cash equivalents and securities were invested in securities denominated in NIS.
Recent Financings
During 2010, we raised approximately $17.0 million of net proceeds from the sale to investors of ordinary shares and warrants.
In April 2010, we completed the sale of 2,635,000 units at a price of $3.78 per unit in a registered direct offering. Each unit consisted of one ordinary share, a primary warrant to purchase 0.25 of one ordinary share at an exercise price of $5.66 per share and a warrant to purchase 0.25 of one ordinary share at an exercise price of $11.32 per share contingent on our election to force conversion of the primary warrant under certain conditions. We also sold an aggregate of 175,000 units to Izhak Tamir and Eric Paneth, two of our affiliates, which, under Israeli law, was subject to shareholder approval that was received at a shareholders’ meeting held in May 2010. Including those sales, we sold 2,810,000 ordinary shares and primary warrants to purchase up to 702,500 ordinary shares, plus the related contingent warrants to purchase up to 702,500 ordinary shares. The gross proceeds of the offering were approximately $10.6 million and the net proceeds of the offering were approximately $9.7 million.
In December 2010, we completed the sale of 2,805,452 units at a price of $2.75 per unit in a public offering. Each unit consisted of one ordinary share and a warrant to purchase 0.60 of one ordinary share at an exercise price of $3.50 per share. Catalyst Private Equity Partners (Israel) II LP, or Catalyst, a private equity fund, purchased 669,090 units in the offering. Mr. Yair Shamir, one of our outside directors at that time, serves as the Chairman of the management company of this fund. We also sold an aggregate of 240,000 units to Izhak Tamir and Eric Paneth. As required by Israeli law, the sales to Messrs. Tamir and Paneth were approved at our extraordinary general meeting of shareholders held in March 2011. Including those sales, we sold 3,045,452 ordinary shares and warrants to purchase up to 1,827,271 ordinary shares. The gross proceeds of the offering were approximately $8.4 million and the net proceeds of the offering were approximately $7.8 million. Proceeds of $660,000 from the sales to Messrs. Tamir and Paneth were received in March 2011 upon the receipt of the abovementioned shareholder approval. The units purchased by Messrs. Tamir and Paneth and Catalyst were purchased pursuant to subscription agreements entered into by each of them on terms and conditions that were substantially the same as those provided in the underwriting agreement entered into in connection with the public offering, except that no underwriting commission was payable by us with respect to the sale of these units. The participation in the offering by Messrs. Tamir and Paneth and Catalyst was approved by our audit committee and board of directors.
In June 2011, we issued Series B convertible notes due December 31, 2017 in a public offering in Israel in the aggregate principal amount NIS 30.8 million (approximately $9.0 million based on the U.S. Dollar/NIS exchange rate at that time) at a price of NIS 940 per unit (each unit comprised of NIS 1,000 principal amount of Series B Notes). The Series B notes bear interest at the rate of 8% per year, are not linked to the Israeli CPI and were convertible into our ordinary shares at the election of the holder thereof at the price of NIS 10.00 per share (approximately $2.75 based on the U.S. Dollar/NIS exchange rate at April 10, 2013). (The conversion price and other terms of the Series B notes were amended pursuant to the Arrangement; see Item 10.C in this Annual Report under "Arrangement with Note Holders".) The gross proceeds of the offering were approximately $8.5 million and the net proceeds of the offering were approximately $8.0 million. As of December 31, 2012, the aggregate principal amount outstanding under the Series B notes was approximately $4.4 million (based on the U.S. Dollar/NIS exchange rate at December 31, 2012). The issuance included the sale to Mr. Tamir of NIS 6,731,000 principal amount of the Series B notes (approximately $1.99 million based on the exchange rate at that time) and to Mr. Paneth of NIS 546,000 principal amount of our Series B notes (approximately $160,000 based on the exchange rate at that time). In addition, Catalyst Private Equity Partners (Israeli) II, LP and affiliated funds, purchased an aggregate of NIS 3,724,000 of our Series B notes (approximately $1.1 million based on the exchange rate at that time). The purchases by Messrs. Tamir and Paneth and by the Catalyst funds were made on the same terms as all other individual investors and institutional investors, respectively, in our public offering in Israel. Mr. Yair Shamir, an outside director of Orckit at that time, served as the Chairman of the management company of the Catalyst funds.
In June 2012, pursuant to the terms of the Arrangement, each of Mr. Tamir and Mr. Paneth provided an unsecured loan to us in the amount of $200,000. The loans do not bear interest, unless otherwise approved by our audit committee and board of directors. The loans are subordinated to all of our obligations pursuant to the Series A notes and Series B notes and may be repaid only after the note holders have been fully repaid. The loans will convert into ordinary shares upon the closing of an equity financing in which Mr. Tamir and Mr. Paneth have undertaken to invest $1.0 million each. For more information, see Item 10.C of this Annual Report under "Arrangement with Note Holders".
Cash Used in Operating Activities
In 2012, we used $7.8 million of cash in operating activities primarily as a result of our net loss of $6.5 million, a decrease in trade payables, accrued expenses and other payables of $2.9 million and the change in market value of our Series B notes, which created non-cash income in the amount of $2.0 million, partly offset mainly by a decrease in trade receivables and other current assets of $2.6 million.
In 2011, we used $16.5 million of cash in operating activities primarily as a result of our net loss of $17.4 million and $3.9 million in adjustments in the value of our Series A and Series B notes, offset in part, by non-cash charges of $1.1 million for stock based compensation and from accrued interest, premium amortization, currency differences on, and net loss from sale of marketable securities of $2.1 million.
In 2010, we used $31.2 million of cash in operating activities primarily as a result of our net loss of $25.4 million, an increase of $6.2 million in our trade receivables, an increase in $2.1 million in other current assets and from interest, premium amortization and currency differences on securities of $1.5 million, offset, in part, by non-cash charges of $1.6 million for stock based compensation, and from $2.9 million in adjustments in the value of our Series A convertible notes. Trade receivables and other current assets increased primarily due to an increase in open customer accounts at the end of 2010 resulting from the increase in sales during the fourth quarter of 2010. Adjustments to the value of our convertible notes caused our obligation to increase primarily because of the change in NIS-U.S. dollar exchange rate and the increase in the Israeli consumer price index.
Cash Provided by Investing Activities
Investing activities provided $18.3 million of cash in 2012, $3.7 million of cash in 2011 and $13.7 million in 2010. Our principal investing activities included proceeds from marketable securities and bank deposits of $19.0 million in 2012, $12.6 million in 2011 and $21.4 million in 2010, offset in part by purchases of marketable securities of $0.14 million in 2012, $8.9 million in 2011 and $9.7 million in 2010 and. In 2010, we also received $2.8 million of proceeds from the sale of an equity investment.
Our principal investing activity relating to our operations has been the purchase of equipment, software and other fixed assets used in our business. These purchases totaled $557,000 in 2010, $653,000 in 2011. Our capital expenditures in 2010 and 2011 were primarily for the procurement of telecommunication equipment and related software tools.
Cash Provided by Financing Activities
In 2012, we used $11.2 million in financing activities primarily as a result of our repayment of a portion of our convertible notes. In 2011, we generated $8.0 million of net proceeds from the offering of our Series B notes. In 2010, we generated $17.0 million of net proceeds from two offerings of our ordinary shares and warrants.
Series A Convertible Notes
In March 2007, we issued NIS-denominated Series A convertible notes in the aggregate principal amount of approximately $25.8 million (based on the U.S. Dollar/NIS exchange rate at that time), which bear interest at the rate of 6% per year and are linked to the Israeli CPI. The Series A notes are due in March 2017, but were subject to the right of each holder to request early redemption on March 14, 2012. The early redemption right was postponed until the consummation of the Arrangement on July 2, 2012, pursuant to which our repayment obligation was spread out over several years; see Item 10.C in this Annual Report under "Arrangement with Note Holders". In the first quarter of 2009, we paid $3.0 million to repurchase approximately 25% of the then principal amount of the outstanding Series A notes. As of December 31, 2012, the aggregate principal amount outstanding under the Series A notes was approximately $10.8 million (based on the U.S. Dollar/NIS exchange rate at December 31, 2012).
The Series A notes were convertible at the election of each holder into our ordinary shares at the conversion price of NIS 63.00 per share (approximately $17.3 based on the U.S. Dollar/NIS exchange rate at April 10, 2013). The conversion price and other terms of the Series A notes were amended pursuant to the Arrangement; see Item 10.C in this Annual Report under "Arrangement with Note Holders".
Standby Equity Purchase Agreement
In August 2010, we entered into a Standby Equity Purchase Agreement, or SEPA, with YA Global Master SPV Ltd., a fund managed by U.S. based Yorkville Advisors. The agreement provides that, upon the terms and conditions set forth in the agreement, YA Global is committed, upon our request, to purchase up to $10 million of our ordinary shares in tranches over a commitment period of up to three years. Investments would only be made such that YA Global and its affiliates will not hold more than 4.99% of our ordinary shares at any point in time during the period of the agreement and that shares are not purchased in an amount exceeding $500,000 per week. Shares would be issued pursuant the agreement under our existing effective shelf registration statement.
For each ordinary share purchased under the SEPA, YA Global will pay 95.5% of the lowest daily volume weighted average price, or VWAP, of the ordinary shares on NASDAQ during the five NASDAQ trading days following our advance notice. The amount of each advance requested may be up to $500,000, unless otherwise mutually agreed to by us and YA Global. For each advance notice, we may indicate a minimum acceptable price, which may not be higher than 95% of the last closing price of our ordinary shares on NASDAQ at the time of delivery of the advance notice. If during the five NASDAQ trading day pricing period following any advance notice the VWAP for the ordinary shares is below the indicated minimum acceptable price, the amount of the advance will generally be reduced by 20% for each day the VWAP is below the minimum acceptable price and that trading day will be excluded from the pricing period for purposes of determining the purchase price. We have not used the SEPA. As a result of our delisting from NASDAQ in 2012, we may not be able to use the SEPA. If we do use the SEPA, the low prevailing market prices and trading volume of our ordinary shares will result in lower proceeds from sales of our shares pursuant to the SEPA.
Working Capital
We will need to increase our working capital during 2013, which might be done through the closing of the transaction with Networks3, the issuance of share capital or the receipt of research and development grants. We cannot be certain that we will be able to obtain sufficient additional financing through the above methods.
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.” We also participate in similar government plans outside Israel, although the majority of our research and development funding is obtained from the government of Israel.
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. Each plan must be approved by the OCS.
In prior years, we relied on grants from the OCS to finance a portion of our product development expenditures. During the three years ended December 31, 2012, we recognized research and development grants in an aggregate amount of approximately $8.5 million. As of December 31, 2012, our total contingent liabilities to the OCS were approximately $18 million.
Under the terms of the grants we received from the OCS, we are obligated to pay royalties of 3% during the first three years following commencement of royalty payments, and up to 5% thereafter. Pursuant to a possible amendment to the R&D Law, our royalty rate may be 3% - 6% 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 R&D Law generally requires that a product developed under a program be manufactured in Israel. However, upon notification to the OCS (and provided that the OCS did not object within 30 days), up to 10% of a company’s approved Israeli manufacturing volume, measured on an aggregate basis, may be transferred out of Israel. In addition, upon the approval of the Chief Scientist, a greater portion 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 OCS 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 OCS whether to approve a program and the amount and other terms of benefits to be granted. For example, an 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 special 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 or the price paid in consideration for the sale of the grant recipient itself, as the case may be (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.
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 OCS 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 in the recipient, and requires the new interested party to undertake to the OCS to comply with the R&D Law. In addition, the rules of the OCS may require additional information or representations in respect of certain 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 OCS that it has become an interested party and to sign an undertaking to comply with the R&D Law.
Based on a request from the OCS, we reported and made certain payments related to our manufacturing activities outside of Israel. In addition, the OCS has claimed that we are required to repay grants related to a research and development project that was cancelled. We are disputing some of the claims made by the OCS and are attempting to negotiate a settlement of the claim. While we have made a provision in our financial statements to cover the estimated outcome of this claim, the amount we ultimately pay may exceed our estimate. If we cancel additional projects, the OCS may demand the repayment of grants we received in the past. The OCS may also dispute our reports related to our manufacturing activities outside of Israel. If we are required to pay the OCS more than we provided for in our financial statements, it could adversely affect our results of operations.
Effective Corporate Tax Rates in Israel
Generally, Israeli companies are subject to corporate tax on their taxable income at the rate of 25% for the 2010 tax year and 24% for the 2011 tax year. Following an amendment to the Israeli Income Tax Ordinance [New Version], 1961 (the “Tax Ordinance”), which came into effect on January 1, 2012, the corporate tax rate for 2012 and future tax years was set at the rate of 25%. Israeli companies are generally subject to capital gains tax at the corporate tax rate. 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 10.E Taxation—Israeli Tax Considerations—Tax Benefits Under the Law for the Encouragement of Capital Investments, 1959.”
Under Israeli tax law, at December 31, 2012, we had accumulated losses for tax purposes amounting to approximately $285 million. These losses are available indefinitely to offset future taxable business income. As of December 31, 2012, our carry forward of capital losses for tax purposes were approximately $62 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. For 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 audit committee and our board of directors and will depend on various factors, such as our statutory retained earnings, financial condition, operating results and current and anticipated cash needs. Under the amended trust agreements governing our Series A notes and Series B notes, we are not permitted to distribute dividends until the fourth early redemption payment date of July 1, 2014.
In the event we declare cash dividends, we will pay those dividends in NIS. 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 consists primarily of finished products and raw materials. Our inventory was $3.7 million as of December 31, 2012, $4.1 million as of December 31, 2011 and $3.2 million as of December 31, 2010. Our inventory level was at a similar level in 2012 and 2011. Our inventory level was higher in 2011 than in 2010 due to a higher amount of finished products at the end of 2011 in comparison to the preceding year. In our financial statements for the year 2012, we wrote off approximately $550,000 of our inventory that cannot be sold to any customer other than BSNL.
C. RESEARCH AND DEVELOPMENT, PATENTS AND LICENSES, ETC.
In 2009 through 2012, the majority of our research and development work was focused on the CM-4000 product line. Our research and development expenditures consisted primarily of salaries and related costs, materials and subcontracting costs associated with developing new products. Following the significant reductions in our headcount and budget in 2012, we do not have sufficient resources to develop new features required by our customers and prospective customers. If requested by customers or prospective customers, we now require guaranteed revenue before we start the development of required features. While we have an initial marketing definition for a new product and solution, we lack the financial resources to develop it.
Our research and development staff consisted of 122 employees as of December 31, 2010, 90 employees as of December 31, 2011 and 14 employees as of December 31, 2012, most of whom are located in Israel and hold engineering or other advanced technical degrees. Our gross research and development expenses were approximately $16.7 million in 2010, $13.1 million in 2011 and $8.2 million in 2012. These expenses were offset by grants from the OCS of the Ministry of Industry, Trade and Labor of the Government of Israel and other research and development grants of approximately $2.6 million in 2010, $3.2 million in 2011 and 2.7 million in 2012. A reduction in the number of our research and development personnel was effected in the second quarter of 2011 and began to affect our research and development expenses in the third quarter of 2011. Accordingly, our research and development expenses were lower in 2011 than in 2010. Research and development expenses in 2012 were lower than in 2011 due to the reduction in the number of our research and development personnel having been effected in the second half of 2012. We expect that research and development expenses in 2013 will be lower than in 2012 due to lower number of employees and the fact that the new product if developed is Software based.
D. TREND INFORMATION
The introduction by telecommunication carriers of new data and video services to residential users and enterprises requires 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 focused on innovative telecommunication products for the metro area, where we expected to see a need for equipment upgrades with the growth of new high bandwidth service offerings. These services include “triple 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 telecommunication carriers. Services offered may also include Ethernet service for business customers. In addition, we believe more operators are looking at ways to smoothly migrate their SDH network to a packet based transport infrastructure. Features included in our products enable this smooth migration. In addition, we expect growth in the provision of advanced data and content over cellular services that provide data and video transmissions to advanced 3G and 3.5G and LTE handheld devices, driven by, among other things, the use of smart phones and tablets. Following the significant reductions in our headcount and budget in 2012, we stopped development of Layer-3 functionality. As a result of the above and the downsizing we are losing our competitive edge and do not expect to take advantage of this trend.
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, 2012 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 | |
| Long-Term Debt Obligations | | | 13,493 | | | | 1,395 | 1 | | | 11,612 | | - | | | 486 | |
| Operating Lease Obligations | | | 200 | | | | 200 | 2 | | | | | - | | | - | |
| Purchase Obligations | | | 812 | | | | 812 | | | | | | - | | | - | |
| Other Liabilities Reflected on our Balance Sheet under U.S. GAAP | | | 10,393 | | | | 7,320 | 3 | | | 717 | | - | | | 2,356 | 4 |
| Total | | | 24,898 | | | | 9,727 | | | | 12,329 | | - | | | 2,842 | |
______________
1 The amount presented in the less than 1 year column is based on the Arrangement with our note holders. The Series B notes are presented at fair value, which on the balance sheet date is lower than the debt value. The total obligation value (without taking into account adjustments for the conversion feature embedded in the Series A and Series B notes and the interest obligation) is $17.4 million. The above amounts do not include future interest.
2 Our major premises leases allow for early termination upon advance notice. This amount reflects lease payments for a full year.
3 These amounts reflect the trade payables, accrued expenses, deferred income and other payables presented in our balance sheet.
4 This amount reflects our accrued severance pay liability, long-term convertible loan from shareholders and our provision for Uncertainty in Income Taxes under FASB Interpretation No. 48. 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. Of this amount, $1.6 million has been previously funded for the coverage of our accrued severance pay liability by our contributions to employee plans.
In addition, as of December 31, 2012, our contingent liability to the Office of the Chief Scientist in respect of grants received was approximately $18 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. If we cancel projects financed by the OCS, the OCS may demand the repayment of grants we received in the past.
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 as of March 31, 2013.
| Name | Age | Position |
| Eric Paneth | 63 | Chairman of the Board |
| Izhak Tamir | 60 | Chief Executive Officer, Chief Financial Officer and Director of Orckit and Chief Executive Officer of Orckit-Corrigent |
Yossi Barshishat | 40 | Vice President, Research and Development |
| Oren Tepper | 41 | Vice President, Corporate Sales |
| Oren Maymon | 41 | Vice President, Operations |
Jed M. Arkin(1)(2) | 49 | Director |
Moti Motil(1)(2) | 60 | Director |
Moshe Nir(1)(2) | 62 | Outside Director |
Amiram Levinberg(1)(2) | 57 | Outside Director |
Naomi Steinfeld(1)(2) | 45 | Outside Director |
| (1) | Member of the Audit Committee. |
| (2) | Member of the Compensation Committee. |
The business experience of each of our directors and executive officers is as follows:
Eric Paneth has been a director of Orckit since its founding in 1990 and Chairman of the Board since October 2012. Mr. Paneth also served as our Chief Executive Officer from 1990 until October 2012 and as our Chairman of the Board from 1990 until July 2008. From 1975 until 1983, Mr. Paneth was a senior engineer in the Israeli Government, and from 1985 to 1990, he was head of a technical department in the Israeli Government. From 1983 until 1985, he was employed by Linkabit Inc., in San Diego, California. Since January 2000, Mr. Paneth has been a director of Tikcro Technologies Ltd., and he has served as its Chief Executive Officer since November 2008. Mr. Paneth holds an advanced engineering degree from the Technion.
Izhak Tamir has been President and a director of Orckit since its founding in 1990. He has also served as our Chief Financial Officer since July 2012 and as our Chief Executive Officer since October 2012. From July 2008 to September 2011, Mr. Tamir also served as our Chairman of the Board of Directors. Mr. Tamir had also served as Chairman of the Board of our subsidiary, Orckit-Corrigent Ltd., since 2001 and Chief Executive Officer of Orckit-Corrigent since May 2007. From 2005 until 2012, Mr. Tamir served as a director of Gilat Satellite Networks Ltd. 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 has served as Chairman of the Board of Directors of Tikcro Technologies Ltd. since January 2000 and was its Chief Executive Officer from August 2003 to December 2007. Mr. Tamir holds an engineering degree from the Israel Institute of Technology, commonly known as the Technion and an M.B.A. from Tel Aviv University.
Yossi Barshishat has been our Vice President, Research and Development since June 2010. Previously, Mr. Barshishat co-founded Quadomedia Inc. and served as its Vice President, Research and Development from January 2009 to May 2010. From July 2008 to January 2009, Mr. Barshishat was involved in the establishment and development of green technology solutions for the smart meters market. From April 2005 until July 2008, Mr. Barshishat served as the software director of Corrigent Systems and from 1997 to 2005, he served as software team manager and in numerous other development positions for various companies. Mr. Barshishat holds a B.A. degree in economics and in computer sciences from Bar-Ilan University, and holds a Master of Business Administration (MBA) with specialization in entrepreneurship and strategic from Tel-Aviv University.
Oren Tepper has been our Vice President of Corporate Sales since October 2007, and since 2006, he has also served as our Vice President of Business Development. From 2002 to 2006, he served as Regional Sales Director of Siemens Communications Fixed Networks (currently NSN) responsible for sales in the Asia Pacific region, Latin America and parts of Europe. From 2001 to 2002, Mr. Tepper served as Technical Sales Director for Speedwise, a startup company which was acquired by Orsus Solutions.
Oren Maymon has been our Vice President, Operations since March 2007. From 2000 to 2007, Mr. Maymon served as a purchasing manager and as a planning and supply chain director at Corrigent Systems. Previously, from 1997 until 2000, Mr. Maymon served as a purchasing manager of Mobilecomm Communications Ltd. Mr. Maymon holds a B.A in business administration from the Academic College of Management in Rishon Lezion.
Jed M. Arkin has been a director of Orckit since August 2001. Since January 2005, he has been a director, and is currently Chairman, of Mosaic Crystals Ltd., a developer of Gallium Nitride semiconductor materials. 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. 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.
Moti Motil has been a director of Orckit since November 2002 and served as our Chairman of the Board of Directors from September 2011 until October 2012. Since 1996, Mr. Motil has served as Vice President Finance and an associate of Palmot Ltd., an investment company based in Israel, and since 2006 has also served 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 Certified Public Accountant in Israel.
Moshe Nir has been an outside 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.
Amiram Levinberg has been an outside director of Orckit since November 2008. Mr. Levinberg co-founded Gilat Satellite Networks Ltd. and served as a director of Gilat from its inception until April 2004. From July 2005 to December 2011, Mr. Levinberg served as the Chairman of the Board and Chief Executive Officer of Gilat, and he continues to serve as its Chairman of the Board. From July 1995 until April 2003, he served as Gilat’s President. Until 2002, Mr. Levinberg also served as Gilat’s Chief Operations Officer. Until July 1995, he served as Gilat’s Vice President of Engineering. From 1977 to 1987, Mr. Levinberg served in a research and development unit of the Israel Defense Forces, where he managed a large research and development project. He was awarded the Israel Defense Award in 1988. Mr. Levinberg also serves on the board of directors of Cardboard Industries and Kargal, a cardboard manufacturer in Israel. He holds a B.Sc. degree in Electrical Engineering and Electronics and a M.Sc. degree in Digital Communications from the Technion.
Naomi Steinfeld has been an outside director of Orckit since October 2011. Ms. Steinfeld is the managing partner of Naomi Steinfeld & Co., a law firm that specializes in tax and international business law, since 1998. She has been practicing law since 1996, following six years as a certified tax advisor. Ms. Steinfeld also lectures on tax law in the Executive MBA program at Tel Aviv University. From 2008 to 2011, Ms. Steinfeld has served as a director of Israel Aerospace Industries Ltd., Israel's leading aerospace and aviation manufacturer, and of CIH Cross-Israel Highway, the company responsible for planning, building and operating the Trans-Israel Highway. From March 2011, Ms. Steinfeld served as a director of Polar Communication Ltd. Ms. Steinfeld holds an LL.B. degree and an LL.M. degree, concentrating in international commerce, both from Tel Aviv University.
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.
B. COMPENSATION
The aggregate direct remuneration paid by us to all persons as a group (13 persons) who served in the capacity of director or executive officer in 2012 was approximately $2.3 million, which includes approximately $0.8 million for the provision and payment of pension, retirement or similar benefits, and other fringe benefits. In 2012, we granted to this group options to purchase an aggregate of 4,140,000 ordinary shares under the Orckit Israeli Share Incentive Plan. The options had an exercise price of $0.14-0.23 per share, which represented a price equal to the market price of our ordinary shares on the date of grant. These options will expire in 2019.
The following tables set forth the compensation of our senior office holders during the year ended December 31, 2012. We have disclosed the information in the following tables in our annual report for the year ended December 31, 2012 filed with the Israel Securities Authority on March 21, 2013 pursuant to the Israeli Securities Law, 5728-1968, and the regulations promulgated thereunder.
a. Compensation of the five most highly compensated senior office holders of our company or of any entity under the control of our company (in U.S. Dollars, in terms of cost to the company) (1):
| Details of the Compensation Recipient | | | Compensation on Behalf of Services | | | | |
| Name | | Position | | Scope of Position | | | Salary(2) | | | Bonus | | | Stock-based Compen-sation | | | Sales Commission | | | Total | |
Eli Aloni(3) | | EVP, Technology and Marketing | | | 100 | % | | | 256,003 | | | | | | | 6,923 | | | | | | | 262,926 | |
| Izhak Tamir | | CEO and CFO of Orckit and Chairman of the board and CEO of Orckit-Corrigent | | | 100 | % | | | 206,145 | (4) | | | | | | | | | | 48,881 | | | | 255,025 | |
Oren Tepper(5) | | VP Corporate Sales | | | 100 | % | | | 163,690 | | | | | | | 3,214 | | | | 57,356 | | | | 224,260 | |
Uri Shalom(6) | | VP, Business Development | | | 100 | % | | | 185,142 | | | | 47,668 | | | | 2,868 | | | | | | | | 235,678 | |
Inbar Rozenberg(7) | | VP, Human Resources | | | 100 | % | | | 189,544 | | | | 48,238 | | | | 1,941 | | | | | | | | 239,723 | |
| (1) | Includes all compensation recognized in our financial statements for the year ended December 31, 2012 plus compensation paid to such office holders following the end of the year for all services provided during the year. |
| (2) | Includes all salary-related benefits, such as car, telephone, social benefits, termination benefits, etc. |
| (3) | Mr. Aloni's employment ended on January 20, 2013. In July 2012, he was granted options to purchase 190,000 ordinary shares under our share incentive plan, at an exercise price of $0.23 per share, for a seven-year term. The options vest quarterly over a two-year period. He was previously granted options to purchase 623,412 ordinary shares. All vesting ceases and vested options may be exercised until the end of 2013. |
| (4) | Mr. Tamir's salary reflects a reduced salary by 33% pursuant to the Arrangement for all of 2012. We owe Mr. Tamir $247,150 for unpaid salary, which was deferred at the initiative of Mr. Tamir. Mr. Tamir is entitled to a bonus equal to 0.25% of our annual revenues. |
| (5) | Mr. Tepper is entitled to sales commission equal to 0.5% of our annual revenues. In July 2012, he was granted options to purchase 190,000 ordinary shares under our share incentive plan, at an exercise price of $0.23 per share, for a seven-year term. The options vest quarterly over a two-year period. In December 2012, he was granted options to purchase 1,000,000 ordinary shares under our share incentive plan, at an exercise price of $0.14 per share, for a seven-year term. The options vest quarterly over a four-year period commencing September 30, 2013. The options were granted in consideration for a reduction in salary during the vesting period equal to the value of the options based on the Black and Scholes valuation method and, if vested, will not terminate following termination of employment. |
| (6) | Mr. Shalom ceased to be an officer of the company on February 28, 2013. He served as our Chief Financial Officer until June 2012. In July 2012, he was granted options to purchase 190,000 ordinary shares under our share incentive plan, at an exercise price of $0.23 per share, for a seven-year term. The options vest quarterly over a two-year period. All vesting ceases and vested options may be exercised until the end of 2013. |
| (7) | Ms. Rozenberg's will cease ceased to be an officer of the company on May 28, 2013. In July 2012, she was granted options to purchase 125,000 ordinary shares under our share incentive plan, at an exercise price of $0.23 per share, for a seven-year term. The options vest quarterly over a two-year period. All vesting ceases and vested options may be exercised until the end of 2013. |
b. Compensation of the three most highly compensated senior officers of our company whose compensation was provided solely in connection with such office holder's service to our company, if not included in the table above (in U.S. Dollars, in terms of cost to the company):
| Details of the Compensation Recipient | | | Compensation on Behalf of Services | | | Other Compen- sation | | | | |
| Name | | Position | | Scope of Position | | | | | | Salary | | | Bonus | | | Stock-based Compen-sation | | | Sales Comis-sion | | | Director compen-sation | | | Total | |
Eric Paneth(1) | | Chairman | | | | | | | | | | | 113,788 | | | | | | | | | | | | 37,208 | | | | | | | | 150,996 | |
Director Compen-sation(2) | | Directors | | | | | | | | | | | | | | | | | | | | | | | | | | | 60,363 | | | | 60,363 | |
| (1) | Mr. Paneth's salary reflects a reduced salary by 33% pursuant to the Arrangement from January 1, 2012 until October 1, 2012, when Mr. Paneth resigned as our Chief Executive Officer. We owe Mr. Paneth approximately $261,123 for unpaid salary, which was deferred at the initiative of Mr. Paneth, and $496,000 for unpaid severance obligations. Mr. Paneth was entitled to a bonus equal to 0.25% of our annual revenues when he was an officer. |
| (2) | The compensation package of our directors is described below under "Director Compensation". This amount reflects the total compensation for 2012. |
Director Compensation
Pursuant to the requirements of the Companies Law, remuneration of our directors generally requires shareholder approval. In October 2011, our shareholders approved a three-year compensation package for each of our five non-employee directors, comprised of options to purchase up to 27,754 ordinary shares for each of the upcoming three years and cash compensation in the amount of NIS 20,710 (then equivalent to $5,788) per year and NIS 1,200 (then equivalent to $335) per meeting. The cash component represents the minimum amount permitted to be paid under the applicable regulations promulgated under the Companies Law. The options were granted under the Orckit Israeli Share Incentive Plan and have an exercise price of $1.59 per share, which represents a 25% premium above the closing price per share of our ordinary shares on the Nasdaq Stock Market on the last trading day preceding the date of the shareholder meeting at which the options were granted. The options vest for so long as the director continues to serve, over a period of three years, in three equal installments of 27,754 on each of the first, second, and third anniversary of the date of grant. The options, to the extent vested, will expire at the earlier of seven years from the date of grant or six months from termination of the director's service. Mr. Paneth, our Chairman of the Board, receives no compensation from us.
C. BOARD PRACTICES
Corporate Governance Practices
We are incorporated in Israel and therefore are subject to various corporate governance practices under the Companies Law, relating to such matters as outside directors, the audit committee, the compensation committee, the internal auditor and approvals of interested party transactions. These matters are in addition to the relevant provisions of U.S. securities laws.
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 such 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 seven 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.
Under the Companies Law, the chairman of the board of a company is not permitted to hold another position in the company or a subsidiary thereof other than chairman or director of a subsidiary or, if approved by a special majority of shareholders, chief executive officer of the company.
Outside Directors
Qualifications of Outside Directors
Under the Companies Law, public companies 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 (i) such person or person’s relative or affiliate has, at the date of appointment, or had at any time during the two years preceding such date, any affiliation with the company, a controlling shareholder thereof or their respective affiliates; or (ii) in a company that does not have a 25% shareholder, if such person has an affiliation with any person who, at the time of appointment, is the chairman, the chief executive officer, the chief financial officer or a 5% shareholder of the company. The term “affiliation” is broadly defined in the Companies Law, including an employment relationship, a business or professional relationship, control or service as an office holder.
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 the lapse of two years from termination of office, a company or its controlling shareholder may not give any direct or indirect benefit to the former outside director.
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:
| | · | at least a majority 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 two percent of the aggregate voting rights in the company. |
The initial term of an outside director is three years and may be extended for up to two additional three-year terms. A company whose shares are listed on a major stock exchange listed in the applicable regulations may reelect an outside director 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 outside director’s expertise and special contribution to the work of the board of directors and its committees, the reelection for such additional period would be in the interest of the company. Reelection of an outside director may be effected through one of the following mechanisms: (1) the board of directors proposed the reelection of the nominee and the election was approved by the shareholders by the majority required to appoint outside directors for their initial term; or (2) a shareholder holding 1% or more of the voting rights proposed the reelection of the nominee, and the reelection is approved by a majority of the votes cast by the shareholders of the company, excluding the votes of controlling shareholders and those who have a personal interest in the matter as a result of their relations with the controlling shareholders, provided that the aggregate votes cast in favor of the reelection by such non-excluded shareholders constitute more than 2% of the voting rights in 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 under the Companies Law are Mr. Nir, Mr. Levinberg, and Ms. Steinfeld.
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 a compensation committee.
Audit Committee
Under the 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. The members of the audit committee must satisfy certain independence qualifications under the Companies Law, and the chairman of the audit committee is required to be an outside director. The responsibilities of the audit committee include identifying and examining flaws in the business management of the company and suggesting appropriate course of actions, recommending approval of interested party transactions, assessing the company's internal audit system and the performance of its internal auditor. Our audit committee also 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 recommend for shareholder approval the appointment of our independent auditors and to pre-approve audit fees and all permitted non-audit services and fees. Our audit committee consists of Messrs. Nir (Chairman), Arkin, Motil and Levinberg and Ms. Steinfeld.
Compensation Committee
Our compensation committee is authorized to, among other things, review, approve and recommend to our board of directors base salaries, incentive bonuses, including the specific goals and amounts, stock option grants, employment agreements, and any other benefits, compensation or arrangements of our executive officers and directors. Under a recent amendment to the Companies Law, our compensation committee is required to propose for shareholder approval by a special majority, a policy governing the compensation of office holders based on specified criteria, to review modifications to the compensation policy from time to time, to review its implementation and to approve the actual compensation terms of office holders prior to approval by the board of directors. The members of the compensation committee must satisfy certain independence qualifications under the Companies Law, and the chairman of the compensation committee is required to be an outside director. Our compensation committee consists of Messrs. Nir (Chairman), Arkin, Motil and Levinberg and Ms. Steinfeld.
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 proper business procedure. The internal auditor must satisfy certain independence requirements. Our internal auditor is Doron Cohen of Fahn Kanne – Grant Thornton.
D. EMPLOYEES
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, | |
| | | 2010 | | | 2011 | | | 2012 | |
| Numbers of employees by geographic location | | | | | | | | | |
| Israel | | | 181 | | | | 121 | | | | 34 | |
| Elsewhere | | | 20 | | | | 28 | | | | 4 | |
| Total workforce | | | 201 | | | | 149 | | | | 38 | |
| Numbers of employees by category of activity | | | | | | | | | | | | |
| MIS, finance and administration | | | 22 | | | | 19 | | | | 12 | |
| Research and development | | | 122 | | | | 90 | | �� | | 14 | |
| Manufacturing, testing and quality assurance | | | 15 | | | | 11 | | | | 7 | |
| Sales and marketing (including employed agents) | | | 42 | | | | 29 | | | | 5 | |
| Total workforce | | | 201 | | | | 149 | | | | 38 | |
Our number of employees decreased by 52 between December 31, 2010 and December 31, 2011. This decrease was mainly due to the headcount reduction undertaken in the second quarter of 2011.
Our number of employees decreased by 111 between December 31, 2011 and December 31, 2012. This decrease was mainly due to the multiple headcount reductions effected over the course of 2012.
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, social contributions 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, pension plans, 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 17.5% of wages, of which the employee contributes approximately 12% and the employer contributes approximately 5.5%.
We contribute amounts on behalf of our employees to funds known as Managers’ Insurance and/or pension funds at rates that are not lower than the minimum set under applicable law. In most of the cases, 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 (including payments for disability insurance), which 15% includes the 8.3% for severance pay.
E. SHARE OWNERSHIP
As of March 31, 2012, Mr. Izhak Tamir beneficially owned aggregate of 4,850,409 ordinary shares, representing 15.6% of our outstanding ordinary shares, consisting of 4,747,409 ordinary shares, 25,000 ordinary shares issuable upon the exercise of warrants at an exercise price of $5.66 per share, 78,000 ordinary shares issuable upon the exercise of warrants at an exercise price of $3.50 per share.
As of , March 31, 2013, Mr. Eric Paneth beneficially owned 1,407,378 ordinary shares, or 4.5% of our ordinary shares, consisting of 1,322,628 ordinary shares, 18,750 ordinary shares issuable upon the exercise of warrants at an exercise price of $5.66 per share and 66,000 ordinary shares issuable upon the exercise of warrants at an exercise price of $3.50 per share.
Except for Messrs. Paneth and Tamir, none of our executive officers or directors beneficially owns 1% or more of our outstanding ordinary shares.
As of April 10, 2013, options to purchase a total of 9,953,421 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 4,574,021 ordinary shares were held by our directors and officers (10 persons) as a group. Our share incentive plan is administered by the 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, 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 0.01 to 11.46 per share. Option awards generally vest over periods of between three to seven years and generally have a contractual term of from seven to eleven years.
Performance-based Options of Eric Paneth and Izhak Tamir
At our annual general meeting of shareholders held on July 3, 2008, our shareholders approved option grants to each of Mr. Paneth and Mr. Tamir under a multi-year incentive plan pursuant to the following terms:
| | · | the exercise price per share is $6.19, which was the closing price per share of our ordinary shares on the NASDAQ Stock Market on the last trading day preceding the date of the annual general meeting; |
| | · | the options are divided into five annual tranches of 75,000 ordinary shares each (for an aggregate of 375,000 options over five years) and vest, for so long as the option holder continues to serve, only if the applicable cumulative revenue thresholds are met, as follows: |
| | o | $130 million for 2009-2010; |
| | o | $250 million for 2009-2011; |
| | o | $420 million for 2009-2012; and |
| | o | $600 million for 2009-2015. |
| | · | the options expire six months after the earlier of (i) the date on which our independent auditor delivers to us its signed audit report with respect to our consolidated financial statements for 2016 or (ii) the termination of the option holder’s service; |
| | · | if the revenue threshold for any period set forth above is met, then the option tranche relating to that period will vest, and any unvested option tranches relating to any previous periods will also vest; and |
| | · | notwithstanding the foregoing, if the revenue threshold of the final option tranche is met prior to the end of the applicable period, then that option tranche (and any previous unvested option tranches) will vest (but in any event not before the delivery of the signed audit report with respect to our annual consolidated financial statements with respect to 2013). |
Revenues are determined in accordance with our audited consolidated financial statements for the applicable years. Such financial statements will be prepared in accordance with U.S. GAAP, and the condition with respect to revenues is deemed to be satisfied or not satisfied, as the case may be, on the date on which our independent auditor delivers to us its signed audit report with respect to our annual consolidated financial statements for the applicable year. Our audit committee is authorized to resolve any questions in the interpretation of the terms of the options that may arise.
Alternatively, all options vest if there is a “Change of Control” prior to the expiration of the term of the options. A “Change of Control” means (i) a merger, share sale or other transaction or series of transactions in which securities possessing a majority of the voting power of our outstanding securities become “beneficially owned” (as such term is used in Rule 13d-3 promulgated under the Securities Exchange Act of 1934, as amended) by a person or persons different from the persons holding those securities immediately prior to such transaction(s) or (ii) the sale, transfer or other disposition of all or substantially all of our consolidated assets or business in one or more transactions.
The foregoing options granted to each of Mr. Tamir and Mr. Paneth, if vested and exercised in full, would constitute an aggregate of approximately 0.2% of our ordinary shares per year, or an aggregate of 1.2% of our outstanding ordinary shares for all of his five option tranches. These percentages are based on the number of ordinary shares outstanding on March 31, 2013, after giving effect to the exercise of such person’s options. No options vested under these grants in 2009, 2010, 2011 or 2012.
Under U.S. GAAP, until such time as the performance conditions are assumed to be satisfied, the ordinary shares underlying such options are not treated as being outstanding for purposes of computing our fully diluted earnings per share.
ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS
A. MAJOR SHAREHOLDERS
To our knowledge, (A) we are not directly or indirectly owned or controlled (i) by another corporatin or (ii) by any foreign government, (B) there are no arrangements, the operation of which may at a subsequent date result in a change in control of Orckit and (C) there were no beneficial owners of 5% or more of our ordinary shares as of April 25, 2013, other than Mr. Izhak Tamir, whose holdings are described above in Item 6E.
The following table sets forth, as of March 31, 2013, 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. Beneficial ownership is determined in accordance with the rules of the SEC based on voting and investment power with respect to such ordinary shares. Ordinary shares issuable pursuant to options, warrants or convertible notes that are currently exercisable or exercisable or convertible within 60 days of March 31, 2013 are deemed to be outstanding and to be beneficially owned by the person holding such options, warrants or notes for the purpose of computing the percentage ownership of such person, but are not deemed to be outstanding for the purpose of computing the percentage ownership of any other person. All information with respect to the beneficial ownership of any principal shareholder has been furnished by such shareholder or is based on the most recent Schedule 13D or 13G filed with the SEC and, unless otherwise indicated, we believe that persons named in the table have sole voting and sole investment power with respect to all the Ordinary Shares shown as beneficially owned, subject to community property laws, where applicable. As of March 31, 2013, 31,060,682 of our ordinary shares were outstanding.
| Identity of Person or Group | | Number of Ordinary Shares | | | Percent Beneficially Owned | |
| Izhak Tamir | | | 4,850,409 | (1) | | | 15.6 | % |
| All directors and executive officers as a group (10 persons) | | | 6,257,817 | (2) | | | 17.5 | % |
| (1) | Includes (i) 4,747,409 ordinary shares, (ii) 25,000 ordinary shares issuable upon the exercise of warrants at an exercise price of $5.66 per share and (iv) 78,000 ordinary shares issuable upon the exercise of warrants at an exercise price of $3.50 per share. |
| (2) | Includes 4,761,771 ordinary shares issuable upon the exercise of options, warrants and convertible notes held by our directors and executive officers that are currently vested or vest within 60 days following March 31, 2013. |
As of March 1, 2010, Messrs. Paneth and Tamir each beneficially owned 1,679,267 ordinary shares, or 9.8% of our outstanding ordinary shares. The changes in their respective holdings reflected above were caused by the following events: (i) the purchase in May 2010 by Mr. Tamir of 100,000 units and by Mr. Paneth of 75,000 units on the same terms as our April 2010 registered direct offering, with each unit consisting of one ordinary share, a primary warrant to purchase 0.25 of one ordinary share at an exercise price of $5.66 per share and a contingent warrant to purchase 0.25 of one ordinary share at an exercise price of $11.32 per share; (ii) the purchase in March 2011 by Mr. Tamir of 130,000 units and by Mr. Paneth of 110,000 units on the same terms as our December 2010 public offering, with each unit consisting of one ordinary share and a warrant to purchase 0.60 of one ordinary share at an exercise price of $3.50 per share; (iii) the purchase in June 2011 by Mr. Tamir of NIS 6,731,000 principal amount of our Series B notes (approximately $1.99 million based on the U.S. Dollar/NIS exchange rate at that time) and by Mr. Paneth of NIS 546,000 principal amount of our Series B notes (approximately $160,000 based on the U.S. Dollar/NIS exchange rate at that time), on the same terms as our public offering of these notes in Israel; (iv) the termination in December 2011 of the variable forward sale contract with Credit Suisse Capital LLC entered into in March 2006 between each of Mr. Tamir and Mr. Paneth with respect to 420,000 ordinary shares each; (v) the expiration on June 23, 2012 of options held by each of Mr. Tamir and Mr. Paneth to purchase 420,000 ordinary shares at an exercise price of $27.14 per share; and (vi) the conversion on July 16, 2012 of the Series B notes referenced in clause (iii) above into 3,678,142 ordinary shares by Mr. Tamir and 298,361 ordinary by Mr. Paneth, at a conversion price of NIS 1.83 per share (approximately $0.47 based on the U.S. Dollar/NIS exchange rate at that time). As of March 31, 2013, Mr. Paneth beneficially owned less than 5% of our outstanding ordinary shares.
As of May 1, 2012, Catalyst Private Equity Partners (Israel) II, LP and affiliated funds beneficially owned 1,370,625 of our ordinary shares, or 5.8% of our outstanding shares. Catalyst's holdings included 401,454 ordinary shares issuable upon the exercise of warrants at an exercise price of $3.50 per share and 372,400 ordinary shares issuable upon the conversion of Series B notes at a conversion price of NIS 10.00 per share (prior to the Arrangement). On March 14, 2013, Catalyst filed a Schedule 13G reporting beneficial ownership of only 401,454 ordinary shares represented by such warrants, or 1.3% of our outstanding shares.
As of April 22, 2013, there were 28 holders of record of our ordinary shares in the United States who collectively held approximately 67.3% 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
On April 1, 2010, we completed the sale of 2,635,000 units at a price of $3.78 per unit in a registered direct offering. Each unit consisted of one ordinary share, a primary warrant to purchase 0.25 of one ordinary share at an exercise price of $5.66 per share and a contingent warrant to purchase 0.25 of one ordinary share at an exercise price of $11.32 per share. In addition, after receipt in May 2010 of shareholder approval as required by Israeli law, we sold 100,000 units to Izhak Tamir, our Chairman of the Board (at that time) and President, and 75,000 units to Eric Paneth, our Chief Executive Officer and a director. The units purchased by each of Messrs. Tamir and Paneth were purchased pursuant to subscription agreements, entered into by Messrs. Tamir and Paneth, on terms and conditions that were substantially the same as the units sold in the registered direct offering, except that no placement agent fee was payable by us with respect to the units purchased by Messrs. Tamir and Paneth. The participation in the offering by Messrs. Tamir and Paneth was also approved by our audit committee and board of directors.
On December 3, 2010, we completed the sale of 2,805,452 units at a price of $2.75 per unit in an underwritten public offering. Each unit consisted of one ordinary share and a warrant to purchase 0.60 of one ordinary share at an exercise price of $3.50 per share. Catalyst Private Equity Partners (Israel) II LP, or Catalyst, a private equity fund, purchased 669,090 units in the offering. Mr. Yair Shamir, one of our outside directors at that time, serves as the Chairman of the management company of this fund. In addition, after receipt in March 2011 of shareholder approval as required under Israeli law, we sold 130,000 units to Izhak Tamir, our Chairman of the Board (at that time) and President, and 110,000 units to Eric Paneth, our Chief Executive Officer and a director. The units purchased by Messrs. Tamir and Paneth and Catalyst were purchased pursuant to subscription agreements entered into by each of them on terms and conditions that were substantially the same as those provided in the underwriting agreement entered into in connection with the public offering, except that no underwriting commission was payable by us with respect to the sale of these units. The participation in the offering by Messrs. Tamir and Paneth and Catalyst was approved by our audit committee and board of directors.
In June 2011, we issued Series B convertible notes due December 31, 2017 in a public offering in Israel in the aggregate principal amount NIS 30,779,000 (approximately $9.0 million based on the U.S. Dollar/NIS exchange rate at that time) at a price of NIS 940 per unit (each unit comprised of NIS 1,000 principal amount of Series B Notes). The Series B notes bear interest at the rate of 8% per year, are not linked to the Israeli CPI and are convertible into our ordinary shares at the election of the holder thereof at the price of NIS 10.00 per share (approximately $2.95 based on the U.S. Dollar/NIS exchange rate at June 12, 2011). Mr. Tamir purchased NIS 6,731,000 principal amount of our Series B notes (approximately $1.99 million based on the U.S. Dollar/NIS exchange rate at that time) and Mr. Paneth purchased NIS 546,000 principal amount of our Series B Notes (approximately $160,000 based on the U.S. Dollar/NIS exchange rate at that time) In addition, Catalyst Private Equity Partners (Israeli) II, LP and affiliated funds purchased an aggregate of NIS 3,724,000 principal amount of our Series B Notes (approximately $1.1 million based on the U.S. Dollar/NIS exchange rate at that time). The purchases by each of Messrs. Tamir and Paneth and by the Catalyst funds were made on the same terms and conditions as those of all the other individual investors and institutional investors, respectively, in the public offering in Israel. Mr. Yair Shamir, one of our outside directors at the time, serves as the Chairman of the management company of the Catalyst funds. Because of potential conflicts of interest that may arise as a result of Mr. Shamir’s role at Catalyst and the investments by the Catalyst funds in us and his role as one of our outside directors, Mr. Shamir resigned from our board of directors in June 2011. The participation in the offering by Messrs. Tamir and Paneth and by the Catalyst funds was approved by our audit committee and board of directors. In July 2012, each of Mr. Tamir and Mr. Paneth converted all of his Series B notes into 3,678,142 and 298,361 ordinary shares, respectively, pursuant to the terms of the Arrangement.
In June 2012, pursuant to the terms of the Arrangement, each of Mr. Tamir and Mr. Paneth provided an unsecured loan to us in the amount of $200,000. The loans do not bear interest, unless otherwise approved by our audit committee and board of directors. The loans are subordinated to all of our obligations pursuant to the Series A notes and Series B notes and may be repaid only after the note holders have been fully repaid. The loans will convert into ordinary shares upon the closing of an equity financing in which Mr. Tamir and Mr. Paneth have undertaken to invest $1.0 million each. For more information, see Item 10.C of this Annual Report under "Arrangement with Note Holders—Terms of the Arrangement—Additional Provisions".
We believe that any transactions involving affiliated parties were on terms no less favorable to us than could be obtained with non-affiliated parties.
C. INTERESTS OF EXPERTS AND COUNSEL
Not applicable
ITEM 8. FINANCIAL INFORMATION
Consolidated Statements and Other Financial Information
See Item 18.
Legal Proceedings
We are not currently a party to any material pending legal proceedings, nor is any of our property the subject of any material pending legal proceeding. However, in March 2013, 3M Services informed us that one of its customers to whom we sold products that later became the subject of a recall is preparing to file a lawsuit against 3M Services, for damages of approximately $1.3 million, in connection with products supplied by us. 3M Services informed us, in turn, that it reserves its right to sue us in connection with this matter.
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, 2012, 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 OTCQB under the symbol “ORCT” and the TASE.
On January 3, 2012, we received a notification from the NASDAQ Listing Qualifications Staff indicating that our ordinary shares will be delisted from the NASDAQ Global Market because we did not satisfy the minimum $10 million shareholders’ equity requirement for continued listing on that market, unless we requested a hearing before a Nasdaq Listing Qualifications Panel. On March 28, 2012, we received a notification from the Panel that it has granted our request for continued listing, as well as our request that our shares be transferred to the NASDAQ Capital Market. The minimum shareholders' equity requirement of the NASDAQ Capital Market is $2.5 million. The Panel conditioned our continued listing on the NASDAQ Capital Market on our satisfying this requirement by June 27, 2012 and demonstrating to the Panel our ability to maintain compliance through 2012. On May 10, 2012, we received a notice from the Nasdaq Listing Council that it would review the decision of the Nasdaq Listing Qualifications Panel. On June 20, 2012, we were notified by the NASDAQ Stock Market that trading in the our securities would be suspended on NASDAQ effective with the open of trading on June 22, 2012. On June 22, 2012, our ordinary shares started trading on the OTCQB. The OTCQB is an interdealer quotation system for broker-dealers to trade unlisted securities. On December 7, 2012 the NASDAQ filed a notification of the removal of our shares from being listed. We continue to be subject to the U.S. securities laws and the regulations of the U.S. Securities and Exchange Commission.
On January 21, 2013, we received a notice from the TASE that our shareholders' equity as of September 30, 2012, which was a deficit of $8.2 million, failed to meet the minimum requirement under the TASE Bylaws, which is NIS 2.0 million (approximately $500,000 based on the U.S. Dollar/NIS exchange rate at that time). We have until June 30, 2013 to satisfy the TASE's minimum shareholders' equity requirement. ��In the event that we fail to do so, the TASE will consider transferring our ordinary shares to the maintenance list. Trading on the maintenance list is more limited than on the main list of the TASE.
The following table sets forth, for the periods indicated, the high and low sale prices of our ordinary shares as reported on the NASDAQ Global Market through March 29, 2012, on the NASDAQ Capital Market from March 30, 2012 through June 21, 2012 and on the OTCQB since June 22, 2012.
| | | Price Per Share | |
| | | High | | | Low | |
| Calendar Year | | | | | | | | |
| 2012 | | $ | 0.86 | | | $ | 0.11 | |
| 2011 | | $ | 3.35 | | | $ | 0.84 | |
| 2010 | | $ | 5.81 | | | $ | 2.18 | |
| 2009 | | $ | 4.39 | | | $ | 1.77 | |
| 2008 | | $ | 9.34 | | | $ | 1.90 | |
Calendar Period | | Price Per Share | |
| 2013 | | High | | | Low | |
| First Quarter | | $ | 0.51 | | | $ | 0.15 | |
| Second Quarter (through April 12, 2013) | | $ | 0.26 | | | $ | 0.18 | |
| 2012 | | High | | | Low | |
| First Quarter | | $ | 0.86 | | | $ | 0.38 | |
| Second Quarter | | $ | 0.65 | | | $ | 0.15 | |
| Third Quarter | | $ | 0.25 | | | $ | 0.15 | |
| Fourth Quarter | | $ | 0.27 | | | $ | 0.11 | |
| | | | | | | | | |
| 2011 | | | | | | | | |
| First Quarter | | $ | 3.20 | | | $ | 2.55 | |
| Second Quarter | | $ | 3.35 | | | $ | 2.01 | |
| Third Quarter | | $ | 2.46 | | | $ | 1.14 | |
| Fourth Quarter | | $ | 1.51 | | | $ | 0.84 | |
Calendar Month | | Price Per Share | |
| | | High | | | Low | |
| 2013 | | | | | | | | |
| April (through April 12, 2013) | | $ | 0.26 | | | $ | 0.18 | |
| March | | $ | 0.31 | | | $ | 0.18 | |
| February | | $ | 0.29 | | | $ | 0.20 | |
| January | | $ | 0.51 | | | $ | 0.15 | |
| 2012 | | | | | | | | |
| December | | $ | 0.20 | | | $ | 0.11 | |
| November | | $ | 0.25 | | | $ | 0.15 | |
| October | | $ | 0.27 | | | $ | 0.17 | |
The following table sets forth, for the periods indicated, the high and low sale prices of our ordinary shares as reported on the Tel-Aviv Stock Exchange.
| Calendar Year | | Price Per Share | |
| | | High | | | Low | |
| 2012 | | $ | 0.90 | | | $ | 0.13 | |
| 2011 | | $ | 3.25 | | | $ | 0.82 | |
| 2010 | | $ | 5.79 | | | $ | 2.29 | |
| 2009 | | $ | 4.45 | | | $ | 1.90 | |
| 2008 | | $ | 9.23 | | | $ | 2.10 | |
Calendar Period | | Price Per Share | |
| | | High | | | Low | |
| 2013 | | | | | | | | |
| First Quarter | | $ | 0.48 | | | $ | 0.13 | |
| Second Quarter (through April 21, 2013) | | $ | 0.22 | | | $ | 0.19 | |
| 2012 | | | | | | | | |
| First Quarter | | $ | 0.90 | | | $ | 0.41 | |
| Second Quarter | | $ | 0.51 | | | $ | 0.21 | |
| Third Quarter | | $ | 0.25 | | | $ | 0.16 | |
| Fourth Quarter | | $ | 0.25 | | | $ | 0.13 | |
| 2011 | | | | | | | | |
| First Quarter | | $ | 3.21 | | | $ | 2.52 | |
Second Quarter | | $ | 3.25 | | | $ | 1.98 | |
Third Quarter | | $ | 2.41 | | | $ | 1.16 | |
Fourth Quarter | | $ | 1.55 | | | $ | 0.82 | |
| | | | | | | | | |
Calendar Month | | Price Per Share | |
| | | High | | | Low | |
| 2013 | | | | | | | | |
| April (through April 21, 2013) | | $ | 0.22 | | | $ | 0.19 | |
| March | | $ | 0.32 | | | $ | 0.20 | |
| February | | $ | 0.28 | | | $ | 0.21 | |
| January | | $ | 0.48 | | | $ | 0.13 | |
| 2012 | | | | | | | | |
| December | | $ | 0.19 | | | $ | 0.13 | |
| November | | $ | 0.22 | | | $ | 0.18 | |
| October | | $ | 0.25 | | | $ | 0.19 | |
| | | | | | | | | |
The share prices as presented above in U.S. dollars were originally denominated in NIS and were converted to U.S. dollars using the representative exchange rate between the US dollar and the NIS published by the Bank of Israel for each applicable day in the presented period.
B. PLAN OF DISTRIBUTION
Not applicable
C. MARKETS
Our ordinary shares are quoted on the OTCQB under the symbol ORCT. Our ordinary shares are also quoted on the TASE. See Item 9A of this Annual Report.
D. SELLING SHAREHOLDERS
Not applicable
E. DILUTION
Not applicable
F. EXPENSES OF THE ISSUE
Not applicable
ITEM 10. ADDITIONAL INFORMATION
A. SHARE CAPITAL
Not applicable
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.
Approval of Certain Transactions
A recent amendment to the Companies Law imposes new approval requirements for the compensation of office holders. Every public company must adopt a compensation policy, recommended by the compensation committee and approved by the board of directors and the shareholders, in that order, no later than September 2013. The shareholder approval requires a majority of the votes cast by shareholders, excluding any controlling shareholder and those who have a personal interest in the matter (similar to the threshold described in the next paragraph below). In general, all office holders’ terms of compensation – including fixed remuneration, bonuses, equity compensation, retirement or termination payments, indemnification, liability insurance and the grant of an exemption from liability – must comply with the company's compensation policy. In addition, the compensation terms of directors, the chief executive officer, and any employee or service provider who is considered a controlling shareholder must be approved separately by the compensation committee, the board of directors and the shareholders of the company (by the same majority noted above), in that order. The compensation terms of other officers require the approval of the compensation committee and the board of directors. In addition, under the Companies Law and our articles of association, other types of transactions with our officers or directors or a transaction with another person in which such officer or director has a personal interest must be approved by our board of directors, and if such transaction is considered an extraordinary transaction (as defined below), the transaction must be approved by the audit committee and the board of directors.
The Companies Law also requires that any extraordinary transaction with a controlling shareholder or an extraordinary transaction with another person in which a controlling shareholder has a personal interest must be approved by the audit committee, the board of directors and the shareholders of the company, in that order. The shareholder approval must be by a simple majority, provided that (i) such majority vote includes at least a simple majority of the total votes of shareholders having no personal interest in the transaction or (ii) the total number of votes of shareholders mentioned in clause (i) above who voted against such transaction does not exceed 2% of the total voting rights in the company. Any such extraordinary transaction whose term is longer than three years requires further shareholder approval every three years, unless (with respect to transactions not involving management fees or employment terms) the audit committee approves that a longer term is reasonable under the circumstances.
The Companies Law prohibits any person who has a personal interest in a matter from participating in the discussion (and voting pertaining to such matter in the company’s board of directors or audit committee), except for in circumstances where the majority of the board of directors has a personal interest in the matter, in which case such matter must be approved by the company’s shareholders.
An “extraordinary transaction” is defined in the Companies Law as any of the following: (i) a transaction not in the ordinary course of business; (ii) a transaction that is not on market terms; or (iii) a transaction that is likely to have a material impact on the company’s profitability, assets or liability.
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. |
Fiduciary Duties of Directors and Officers
The Companies Law imposes a duty of care and a duty of loyalty on the directors and officers of a company. The duty of care requires a director or office holder to act with the level of care with which a reasonable director or officer in the same position would have acted under the same circumstances. It 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.
The duty of loyalty of a director or officer includes a general duty to act in good faith for the benefit of the company, and particularly 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 director or officer has received due to his position as such. |
The Companies Law requires that directors, officers or a controlling shareholder of a public company disclose to the company any personal interest that he or she may have, including all related material facts or documents in connection with any existing or proposed transaction by the company. The disclosure must be made without delay and no later than the first board of directors meeting at which the transaction is first discussed.
Board of Directors
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.
Neither our memorandum nor our articles of association, nor the laws of the State of Israel require retirement of directors at a certain age, or share ownership for director qualification, nor do they contain any restriction on the board of directors’ borrowing powers.
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.
Limitations on the Rights to Own Securities
The ownership or voting of 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.
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.
We have two types of general shareholders' meetings: annual general meetings and extraordinary general meetings. Directors are elected only at annual general meetings. 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. 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.
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.
Anti-Takeover Provisions; Mergers and Acquisitions
The 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 to 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.
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 six months following the consummation of a full tender offer, but the acquirer is entitled to stipulate that tendering shareholders forfeit their appraisal rights. 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.
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, 2014, unless our Board takes action to amend the expiration date. The rights are generally redeemable by our board of directors, at a nominal price 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.
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:
| | · | 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 have 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 or in connection with a financial sanction; 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; and |
| • | a financial obligation imposed upon an office holder and reasonable litigation expenses, including attorney fees, expended by the office holder as a result of an administrative proceeding instituted against him. Without derogating from the generality of the foregoing, such obligation or expense will include a payment which the office holder is obligated to make to an injured party as set forth in Section 52(54)(a)(1)(a) of the Israeli Securities Law, 1968 – 5728 (the "Securities Law") and expenses that the office holder incurred in connection with a proceeding under Chapters H'3, H'4 or I'1 of the Securities Law, including reasonable legal expenses, which term includes attorney fees. |
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:
| | · | 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.
C. MATERIAL CONTRACTS
For a description of our Standby Equity Purchase Agreement, see “–Liquidity and Capital Resources—Convertible Notes” and “-Liquidity and Capital Resources-Standby Equity Purchase Agreement” under Item 5.B of this Annual Report on Form 20-F.
Arrangement with Note Holders
Background
As of December 31, 2011, we had outstanding NIS-denominated Series A convertible notes in the aggregate principal amount of approximately $28 million (including approximately $6.8 million aggregate principal amount of Series A notes that were purchased in the open market by one of our subsidiaries in 2009), which bear interest at the rate of 6% per year and are linked to the Israeli consumer price index ("CPI"). The Series A notes are due in March 2017, but were subject to the right of each holder to request early repayment of all or part of the principal amount of the notes held by it on March 14, 2012, with a penalty of approximately 3% of the indexed principal amount (equal to the last payable interest coupon preceding the early repayment request).
As of December 31, 2011, we also had outstanding NIS-denominated Series B convertible notes in the aggregate principal amount of approximately $8 million, which bear interest at the rate of 8% per year and are not linked to the Israeli CPI. The Series B notes are due in December 2017 and were not originally entitled to early redemption.
Because it was likely that the holders of the Series A notes would request early redemption of their notes in March 2012, in the fourth quarter of 2011, we and the representatives of the Series A note holders entered into negotiations with respect to the terms of an arrangement that would defer the payments to the note holders that request early redemption in consideration for decreasing the conversion prices of the notes. The negotiations on the terms of a proposed arrangement on our behalf were led by independent members of our Board of Directors. On January 9, 2012, we reached an agreement in principle regarding the fundamental terms of the Arrangement with the representatives of our Series A note holders. The representatives of our Series B note holders then became part of these negotiations because any such arrangement would require their approval.
On February 15, 2012, following the approval of our audit committee and board of directors, we entered into a written agreement regarding the terms of the Arrangement with the representatives of our Series A note holders and the representatives of our Series B note holders. On February 22, 2012, we filed a petition with the District Court of Tel Aviv regarding the Arrangement, as required by Section 350 of the Companies Law. On March 2, 2012, the Court approved our request to convene meetings of our Series A note holders, our Series B note holders and our shareholders to vote upon the Arrangement.
At the Extraordinary Meeting of Shareholders held on April 19, 2012 (adjourned from its original date of April 15, 2012), our shareholders approved the Arrangement by the requisite majority and approved an increase in our authorized share capital from 95,000,000 ordinary shares to 170,000,000 ordinary, effective upon the effective date of the Arrangement.
On May 10, 2012, we held a joint meeting of our Series A note holders and Series B note holders to approve the Arrangement, and voting by written ballot was open until May 13, 2012. The holders of the Series A and Series B notes unanimously and duly approved the Arrangement and the amended trust agreement related thereto.
On May 14, 2012, we filed a petition with the Court requesting its final approval of the Arrangement, subject to the satisfaction of all closing conditions. On June 19, 2012, we received the final approval of the District Court of Tel Aviv to the Arrangement, following the approval of the Tel Aviv Stock Exchange and the Israel Securities Authority.
On July 2, 2012, we consummated the Arrangement with the holders of our Series A notes and Series B notes.
Terms of the Arrangement
The main provisions of the Arrangement are summarized below.
Early Redemption of Notes
Under the Arrangement, we have paid an aggregate of approximately $11.6 million to our note holders, as set forth below:
In August 2012, we repaid NIS 29,662,842 (approximately $7.4 million) aggregate principal amount of the Series A notes and NIS 2,117,181 (approximately $0.5 million) aggregate principal amount of the Series B notes. In October 2012, we repaid NIS 7,535,235 (approximately $1.9 million) aggregate principal amount of the Series A notes and NIS 1,398,724 (approximately $0.4 million) aggregate principal amount of the Series B notes. In April 2013, we repaid NIS 4,310,968 (approximately $1.2 million) aggregate principal amount of the Series A notes and NIS 559,730 (approximately $0.2 million) aggregate principal amount of the Series B notes.
The remaining balance is as follows ($ in millions):
| Payment Date | | Series A Notes | | | Series B Notes | |
| July 2014 | | | 11.9 | | | | 0.2 | |
| December 2017 | | | - | | | | 4.2 | |
Conversion of Notes into Ordinary Shares
Pursuant to the terms of the Arrangement, the conversion price of the Series A notes was reduced from NIS 63.00 (approximately $16.88 as of December 31, 2012) per share to NIS 1.37 (approximately $0.37) per share during the period from July 3, 2012 to July 22, 2012. Thereafter, the conversion price of the Series A notes increased to NIS 7.61 (approximately $2.04) per share. The conversion price of the Series B notes was reduced from NIS 10.00 (approximately $2.68) per share to NIS 7.61 (approximately $2.04) per share during the period from July 3, 2012 to July 12, 2012. Thereafter, the conversion price of the Series B notes was further reduced to NIS 1.83 (approximately $0.49) per share until August 6, 2012. Thereafter, the conversion price of the Series B notes returned to NIS 7.61 per share.
Between July 3, 2012 and August 6, 2012, an aggregate of NIS 3,260,125 (approximately $816,000) principal amount of Series A notes was converted into 2,379,653 ordinary shares, and an aggregate of NIS 10,720,285 (approximately $2,685,000) principal amount of Series B notes was converted into 5,858,079 ordinary shares. The above-mentioned conversions of Series B notes include the conversion of NIS 6,731,000 (approximately $1,686,000) aggregate principal amount of Series B notes held by Mr. Izhak Tamir and NIS 546,000 (approximately $137,000) aggregate principal amount of Series B notes held by Mr. Eric Paneth, which were all the notes held by them.
The foregoing does not include NIS 26,000,000 (approximately $7.2 million based on the U.S. Dollar/NIS exchange rate at April 10, 2013) aggregate principal amount of Series A notes that were purchased in the open market by one of our subsidiaries in 2009, which are now secured by a lien in favor of the trustee of Series A notes. Since our balance sheet is consolidated with that of our subsidiaries, these notes are not included among our consolidated liabilities. Our subsidiary does not plan to convert the notes into ordinary shares and is prohibited under the terms of the Arrangement from selling them or from requesting the early redemption thereof.
Forced Conversion
Pursuant to the Arrangement, we have the right to force the conversion of the Series A notes and the Series B notes at the price of $1.95 per share if the prevailing market price of our ordinary shares is at least $3.00 per share. Prevailing market price is the price on the Tel Aviv Stock Exchange for any 20 trading days within a period of 30 consecutive trading days.
Additional Provisions
The Arrangement also included the following material provisions:
Until January 1, 2014, we are not be permitted, directly or indirectly, to repurchase any Series A notes or Series B notes, unless the price per NIS 1.00 principal amount of the notes is not more than NIS 0.60.
We were required to use our best efforts to raise an aggregate amount of $10 million of equity by September 30, 2012. Despite making such efforts, we were unable to raise any equity by that date.
Each of Mr. Tamir and Mr. Paneth undertook to invest in our equity financings that take place by April 2, 2013 at least 10% of each such financing, up to an aggregate amount of $1.0 million each, if the aggregate amount raised from other investors in such offerings is not less than $7.0 million.
Messrs. Tamir and Paneth each provided a subordinated loan to us in the amount of $200,000, which would be converted into ordinary shares in an equity offering as part of the satisfaction of their commitments described in the immediately preceding paragraph.
The monthly salary of each of Mr. Tamir and Mr. Paneth was reduced by 33% for the period between January 1, 2012 and October 2, 2013. In October 2012, Mr. Paneth resigned from his position as our Chief Executive Officer and began serving as our Chairman of the Board for no compensation.
We are permitted to incur debt that is senior to the notes, subject to the following principle conditions: (i) the amount of our senior debt outstanding may not exceed $5 million; (ii) senior debt may be incurred no earlier than August 1, 2012 and only after we have used our best efforts to effect an equity financing; and (iii) we must ensure that our early redemption payments to our Series A note holders and Series B note holders due on October 2, 2012 in accordance with the Arrangement will be timely made. We have already satisfied the second and third conditions.
We are not permitted to distribute dividends or to engage in transactions with controlling shareholders (if any), in each case until the fourth early redemption payment date of July 1, 2014.
We were required to reimburse the representatives of the Series A note holders and the representatives of the Series B note holders for the expenses incurred by them in connection with the Arrangement.
The note holders, Orckit and our office holders waived any claims against each other related to the period ending on the effective date of the Arrangement. The parties to the waiver also agreed that no claim or demand would be made against us or our officers and directors in connection with the Arrangement or the approval thereof.
Conditions Precedent
The Arrangement was subject to the satisfaction of the following material conditions by million. At the time, these notes had an aggregate principal amount of $6.3 million, which has increased since then due to increases in the CPI and the exchange rate.
Most of the dollar amounts set forth in this Item 10.C are denominated in NIS in the relevant documents. The U.S. dollar amounts set forth above have been translated for convenience according to an exchange rate which was the representative rate of exchange published by the Bank of Israel at the applicable date.
Patent and Financing Transactions
On March 12, 2013, we entered into a Strategic Investment Agreement with Networks3, Inc., a non-practicing entity controlled by Hudson Bay Capital. Pursuant to the agreement, Networks3 will pay us $8 million upon closing, of which $5 million is for the purchase of our patent portfolio, $2.5 million is for the purchase of 4,747,409 of our newly issued ordinary shares at the price of $0.52 per share (constituting approximately 13.3% of our outstanding share capital after giving effect to the issuance thereof), and $0.5 million is for the purchase of an unsecured subordinated note in the principal amount of $0.5 million. The note will bear interest at the applicable federal rate (approximately 1% per year), will mature on the third anniversary of the closing and will be guaranteed by Corrigent. Of such proceeds, $5 million is designated to repay our Senior A notes and Senior B notes, and $3 million is required to be used to finance our ongoing activities.
In addition, we will be issued common stock of Networks3 constituting 10% of its outstanding capital stock (after giving effect to the issuance thereof) and will have the right to receive a percentage of the profits of Networks3, if any, generated in the future by payments from third parties for past and future use of patents in the patent portfolio. Our participation percentage will start at 25% of aggregate profits in excess of $7.5 million and will decrease in steps down to 5% of profits in excess of $250 million.
The closing of the Strategic Investment Agreement is conditioned upon various conditions, including the approval of the Israeli Office of the Chief Scientist of the sale of the patent portfolio on terms acceptable to Networks3 in its sole discretion, the retirement of our Senior A notes and Senior B notes, and our having at least $1.0 million in cash on the closing date and no debt (other than certain existing debt). The retirement of the notes will require a court approved arrangement with the note holders under Section 350 of the Israeli Companies Law. There is no assurance that the transactions contemplated by this agreement will be consummated.
On March 12, 2013, we also entered into a Note Purchase Agreement with two funds managed by Hudson Bay Capital to issue and sell to them senior secured notes in the aggregate principal amount of $5 million. This transaction was consummated on March 18, 2013. The notes bear interest at the rate of 1.5% per year until July 30, 2013 and 15% per year thereafter. The notes will mature on the earlier of May 31, 2014 and the closing of the transactions contemplated by the aforementioned Strategic Investment Agreement. We have the right to redeem the notes at any time, in whole or in part. If an event of default occurs and the notes are redeemed after July 1, 2013, by either by the holders thereof or by us, or if a bankruptcy event or a change of control of Orckit occurs at any time, we would be required to pay an additional 20% of the outstanding principal amount plus all the interest that would have accrued under the notes until the scheduled maturity date. The notes are secured by a first priority lien on the patent portfolio of Orckit and Orckit-Corrigent and are guaranteed by Orckit-Corrigent.
The Strategic Investment Agreement, the Note Purchase Agreement and the material exhibits thereto are filed as exhibits to this annual report. The foregoing summary does not purport to be comprehensive and is qualified in its entirety by reference to such agreements.
D. EXCHANGE CONTROLS
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.
E. TAXATION
The following is a general summary only and should not be considered as income tax advice or relied upon for tax planning purposes.
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, partners or other equity owners in partnerships or other pass-through entities, U.S. 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 U.S. 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.
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, 2012. Beginning in 2013, the maximum tax rate applicable to long-term capital gains currently is scheduled to rise to 20%. 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 is treated as a short-term capital gain or loss. See “Israeli Tax Considerations —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, although the tax treaty between the United States and Israel may permit gain derived from the taxable disposition of ordinary shares by a U.S. Holder to 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 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 ordinary shares owned by a U.S. Holder will commence on the day following the date of the U.S. Holder’s purchase of such ordinary shares and will include the day on which the ordinary shares are 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 a 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.
Treatment of Distributions
For U.S. federal income tax purposes, the amount of any 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 “Israeli Tax Considerations -- 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 to a U.S. Holder generally will be treated as a dividend to the extent 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% or 20% depending on the shareholders' income. 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. 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 current 15% or 20% 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.”
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.
Dividends received with respect to our ordinary shares will constitute “portfolio income” for purposes of the limitation on the deductibility 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 involves the application of complex rules that depend on a U.S. Holder’s particular circumstances.
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.
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 publicly-traded 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”) 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 whether other valuation methods could be employed to determine the value of our assets for purposes of the Asset Test.
Based on the approach to valuation of a public company's assets set forth in the legislative history of the 1997 Act, we believe, based on the composition of our gross income, the composition and value of our gross assets and the amount of our liabilities, that we would be deemed to have been a PFIC during each of 2002, 2003, 2004, 2007, 2008 and 2009, but not during each of 2005, 2006, 2010, 2011 or 2012. There can be no assurance that we will not be deemed a PFIC in any future tax year.
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):
| | · | The U.S. Holder would be required to (a) report as ordinary income any so-called “excess distributions” allocated to the current tax year, (b) pay tax on amounts allocated to each prior tax year in which we were a PFIC at the highest rate applicable to ordinary income in effect for such prior year and (c) pay an interest charge on the resulting tax at the rate applicable to deficiencies of U.S. federal income tax. “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. |
| | · | The entire amount of any gain realized by such 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 of ordinary shares acquired from a decedent who was a U.S. Holder generally 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 such U.S. Holder’s 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 such U.S. Holder recognizes gain upon a disposition of our ordinary shares, receives certain distributions from us or makes the QEF Election or mark-to-market election described below.
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.
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 for 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 a QEF Election must make the election by completing U.S. Internal Revenue Service Form 8621 and attaching it to such U.S. Holder’s U.S. federal income tax return for the first tax year to which the election will apply, and must satisfy additional filing requirements each year the election remains in effect. Upon the request of a U.S. Holder who wishes to make a QEF Election, we will provide to such U.S. Holder 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 generally will not be available. Rather, the tax basis of the ordinary shares in the hands of a U.S. Holder who acquires 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. For example, under legislation enacted by the U.S. in 2010, U.S. Holders will be required to file a special information return for each year in which we are treated as a PFIC.
Due to the complexity of the PFIC rules and the uncertainty of their application in many circumstances, U.S. Holders should consult their own tax advisors regarding our status as a PFIC and, if we are treated as a PFIC, compliance with the applicable reporting requirements and the eligibility, manner and advisability of making a QEF Election or a mark-to-market election.
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 a rate that currently is 28%. 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). The backup withholding tax 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 for obtaining such an exemption, if applicable.
The foregoing discussion of certain U.S. federal income tax considerations is a general summary only and should not be considered as income tax advice or relied upon for tax planning purposes. Each U.S. Holder should consult with his, her or its own tax advisor regarding U.S. federal, state, local and non-U.S. income and other tax consequences of the acquisition, ownership and disposition of our ordinary shares.
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 24% for the 2011 tax year and 25% for the 2012 tax year. Following an amendment to the Israeli Income Tax Ordinance, or the Tax Ordinance, which came into effect on January 1, 2012, the corporate tax rate will remain at the rate of 25% for future tax years. Israeli companies are generally subject to capital gains tax at the corporate tax rate. However, the effective tax rate payable by a company that derives income from an Approved, Benefitted or Preferred 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. Tax benefits as an Approved Enterprise, can be reduced or cancelled if the company manufactures its products outside of Israel. In any event, tax rates will not exceed the regular corporate tax rates described above.
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 on the earlier of the last date available for filing of the tax return for such year or within 12 months of the end of such 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. 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 March 31, 2005, 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.
Reform of the Investments Law - 2011
On December 29, 2010, the Israeli parliament approved an amendment to the Investments Law, effective as of January 1, 2011, which constitutes a reform of the incentives regime under such law. This amendment revises the objectives of the Investments Law to focus on achieving enhanced growth in the business sector, improving the Israeli industry’s competitiveness in international markets and creating employment and development opportunities in remote areas of Israel. The amendment allows enterprises meeting certain required criteria to enjoy grants as well as tax benefits. The amendment also introduces certain changes to the map of geographic development areas for purposes of the Investments Law, which will take effect in future years.
The amendment generally abolishes the previous tax benefit routes that were afforded under the Investments Law, specifically the tax-exemption periods previously allowed, and introduces new tax benefits for industrial enterprises meeting the criteria of the law, which include the following:
| | · | A reduced corporate tax rate for industrial enterprises, provided that more than 25% of their annual income is derived from export, which will apply to the enterprise’s entire preferred income so that in the tax years 2011-2012 the reduced tax rate was 10% for preferred income derived from industrial facilities located in development area A and 15% for those located elsewhere in Israel, in the tax years 2013-2014 the reduced tax rate will be 7% for development area A and 12.5% for the rest of Israel, and in the tax year 2015 and onwards the reduced tax rate will be 6% for development area A and 12% for the rest of Israel. |
| | · | The reduced tax rates will no longer be contingent upon making a minimum qualifying investment in productive assets. |
| | · | A definition of “preferred income” was introduced into the Investments Law to include certain types of income that are generated by the Israeli production activity of a preferred enterprise. |
| | · | A reduced dividend withholding tax rate of 15% will apply to dividends paid from preferred income to both Israeli and non-Israeli investors, with an exemption from such withholding tax applying to dividends paid to an Israeli company. |
| | · | A special tax benefits route will be granted to certain industrial enterprises entitling them to a reduced tax rate of 5% for preferred income derived from industrial facilities located in development area A and 8% for those located elsewhere in Israel, provided certain threshold requirements are met and such enterprise can demonstrate its significant contribution to Israel’s economy and promotion of national market objectives. |
The amendment will generally apply to preferred income produced or generated by a Preferred Company (as defined in the Investments Law) commencing from January 1, 2011. The amendment provides various transition provisions which allow, under certain circumstances, to apply the new regime to investment programs previously approved or elected under the Investments Law in its previous form. Although this recent amendment took effect on January 1, 2011, the transitional provisions of its adoption also allow the company to defer its adoption to future years.
Captured Earnings - Amendment of the Investments Law - 2012
As explained above, under the Approved and Benefited Enterprise regimes, a company that pays a dividend out of income derived during the tax exemption period, referred to as Captured Earnings, will be subject to corporate tax in respect of the amount distributed at the rate which would have been applicable had the company not been exempt from tax under the aforementioned regimes.
On November 12, 2012, an amendment to the Investments Law was published which provided, under certain circumstances, reduced corporate tax rates applicable for Captured Earnings accumulated until December 31, 2011, which are distributed. The reduced corporate tax rates are determined in accordance with the amount of Captured Earnings which is distributed. In addition, the dividend recipient is taxed at the reduced rate of 15% under the aforementioned regimes.
Unless extended, the above amendment, which was published as a temporary provision, will apply to companies that elect to distribute Captured Earnings no later than the lapse of one year from the date of publication of the amendment.
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 CPI, 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.
As of January 1, 2012, the tax rate generally applicable to capital gains derived from the sale of shares, whether listed on a stock market or not, is 25% 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 30%. 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 30%. 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). Israeli companies are subject to the corporate tax rate on capital gains derived from the sale of listed shares.
As of January 1, 2013, shareholders that are individuals who have taxable income that exceeds NIS 800,000 (equivalent to approximately $215,000 on that date) in a tax year (linked to the consumer price index), will be subject to an additional tax, referred to as High Income Tax, at the rate of 2% on their taxable income for such tax year in excess of such amount. For this purpose, taxable income includes taxable capital gains from the sale of our shares and taxable income from dividend distributions.
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 the Tel Aviv Stock Exchange or a recognized stock market outside of Israel, such as NASDAQ, provided that such capital gains are not derived from a permanent establishment in Israel and that such shareholders did not acquire their shares prior to the issuer’s initial public offering (in which case a partial exemption may be available). However, non-Israeli corporations will not be entitled to such exemption if Israeli residents (i) have a controlling interest of 25% or more in such non-Israeli corporation, or (ii) are the beneficiaries of or are 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.
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, the income tax rate is 25%, or 30% 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 from the Israeli Tax Authority is provided. If the income out of which the dividend is being paid is attributable to an Approved Enterprise (or Benefited Enterprise or Preferred 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 or Preferred Enterprise) and if not more than 25% of our gross income consists of interest or dividends, 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%.
For information with respect to the applicability of High Income Tax on dividends, see "Capital Gains Tax" above.
F. DIVIDENDS AND PAYING AGENTS
Not applicable
G. STATEMENT BY EXPERTS
Not applicable.
H. DOCUMENTS ON DISPLAY
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 at http://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 file annual reports on Form 20-F electronically with the SEC and post a copy on our website, www.orckit.com.
We also file annual, quarterly and immediate reports and other information in Hebrew with the Israeli Securities Authority through its fair disclosure electronic system called MAGNA. You may review these filings on the website of the MAGNA system operated by the Israeli Securities Authority at www.magna.isa.gov.il or on the website of the TASE at www.tase.co.il.
I. SUBSIDIARY INFORMATION
Not applicable
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 part of our revenues in Dollar, Yen and Euros, but incur a majority of our salaries and related expenses and part of our other expenses in NIS. Our Series A notes and Series B notes are denominated in NIS. As of December 31, 2012, we had debt in NIS under our Series A notes and Series B notes equal to $15.8 million and we had no investments denominated in NIS. This may change in the future.
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 April 10, 2013, 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 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, 2012 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 (liabilities are presented in brackets).
Please see also the explanatory notes below the table.
| New Israeli Shekels | European Euro | Total |
| (14.6) | 1.0 | (13.6) |
Explanatory notes:
1) Total balance sheet exposure relating to market risk sensitive instruments is the sum of the absolute figures (excess of liabilities over assets in the amount of $13.6 million). A devaluation of 10% of the U.S. dollar compared to the NIS would cause a decrease in expenses of approximately $1.46 million. A devaluation of 10% of the U.S. dollar compared to the Euro would cause an increase in expenses of approximately $100,000.
2) The data presented in the table reflects the exposure after taking into account the effect of the “natural” hedging.
Interest Rate Risk Management
As of December 31, 2012, we had $3,227 million of cash and cash equivalents.
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
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, 2012. 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 concluded that our disclosure controls and procedures were effective as of December 31, 2012.
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.
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 in Internal 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, 2012 and concluded that our internal control over financial reporting was effective as of December 31, 2012.
Attestation Report of the Registered Public Accounting Firm
Not applicable.
Changes in Internal Control Over Financial Reporting
As part of our cost reduction plan in 2012, Mr. Izhak Tamir, our President at the time and presently our Chief Executive Officer, assumed the responsibilities of Chief Financial Officer, as well, and we adapted our internal control over financial reporting accordingly. There were no other changes in our internal control over financial reporting that occurred during 2012 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 Moshe Nir qualifies as an “audit committee financial expert” as defined in Item 16A of the Form 20-F rules and is “independent” as defined in the applicable regulations.
Item 16B. Code of Ethics
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 February 18, 2013, 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:
| | | Year Ended December 31, | |
| | | 2012 | | | 2011 | |
| | | | | | | |
| Audit Fees | | $ | 105,000 | | | $ | 134,000 | |
| Audit-Related Fees | | | 15,000 | | | | 19,000 | |
| Tax Fees | | | 30,000 | | | | 42,000 | |
| All Other Fees | | | | | | |
| Total | | $ | 150,000 | | | $ | 195,000 | |
“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.
Our audit committee pre-approves all services that may be performed by our independent accountants, and the maximum pre-approved fees that may be paid as compensation for such services. 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 2012 were for services approved pursuant to Rule 2-01(c)(7)(i)(C) of Regulation S-X
The audit committee may delegate its pre-approval authority to one or more of its members, subject to ratification by the entire audit committee.
ITEM 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES
Not applicable.
ITEM 16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS
Not applicable.
ITEM 16F. CHANGE IN REGISTRANT’S CERTIFYING ACCOUNTANT
ITEM 16G. CORPORATE GOVERNANCE
Not applicable.
ITEM 16H. MINE SAFETY DISCLOSURE
PART III
ITEM 17. FINANCIAL STATEMENTS
See Item 18.
ITEM 18. FINANCIAL STATEMENTS
The information required by this item is set forth in our current report on Form 6-K filed with the SEC on March 21, 2013, and is incorporated by reference herein.
ITEM 19.EXHIBITS
The following exhibits are filed as part of this Annual Report:
| Exhibit |
| †1.1 | Memorandum of Association, as amended. |
| 1.2 | Ninth Amended and Restated Articles of Association. |
| 1.3 | Bonus Rights Agreement, dated as of November 20, 2001, between Orckit Communications Ltd. (Orckit”) and American Stock Transfer & Trust Company, as Rights Agent (incorporated by reference to our Registration Statement (File No. 000-28724) on Form 8-A). |
| 1.4 | Amendment No. 1, dated as of February 5, 2003, to Bonus Rights Plan, dated as of November 20, 2001, between Orckit and American Stock Transfer & Trust Company, as Rights Agent (incorporated by reference to our Registration Statement (File No. 000-28724) on Form 8-A/A, Amendment No. 1). |
| 1.5 | Amendment No. 2, dated as of December 5, 2011, to Bonus Rights Plan, dated as of November 20, 2001, between Orckit and American Stock Transfer & Trust Company, LLC, as Rights Agent (incorporated by reference to our Registration Statement (File No. 000-28724) on Form 8-A/A, Amendment No. 2). |
| 4.1 | Orckit Israeli Share Incentive Plan, as amended (incorporated by reference to our Registration Statement on Form S-8 (File No. 333-131991)). |
| †4.2 | Lease Agreement, dated September 28, 1999, between Orckit and Gush 7093 Helka 162 Ltd., private company # 51-058315-6 (incorporated by reference to our Annual Report on Form 20-F for the fiscal year ended December 31, 2000). |
| 4.3 | Amended and Restated Employment Agreement, dated as of June 23, 2005, between Orckit and Izhak Tamir (incorporated by reference to our Annual Report on Form 20-F for the fiscal year ended December 31, 2005). |
4.4 | Standby Equity Purchase Agreement dated August 3, 2010, between YA Global Master SPV Ltd. and Communications Ltd. (incorporated by reference to our Report on Form 6-K filed on August 4, 2010). |
4.5 | Form of Warrant to Purchase Ordinary Shares, issued on April 1, 2010 (incorporated by reference to our Report on Form 6-K filed on March 29, 2010). |
4.6 | Form of Contingent Warrant to Purchase Ordinary Shares, issued on April 1, 2010 (incorporated by reference to our Report on Form 6-K filed on March 29, 2010). |
4.7 | Placement Agency Agreement, dated March 26, 2010, by and between Orckit and Roth Capital Partners, LLC. (incorporated by reference to our Report on Form 6-K filed on March 29, 2010). |
4.8 | Form of Subscription Agreement for Affiliated Investors (incorporated by reference to our Report on Form 6-K filed on March 29, 2010). |
| 4.9 | Underwriting Agreement, dated November 30, 2010, by and between Orckit and Cowen and Company, LLC, as representative for the several underwriters. (incorporated by reference to our Report on Form 6-K filed on November 30, 2010). |
4.10 | Form of Subscription Agreement for founders (incorporated by reference to our Report on Form 6-K filed on November 30, 2010). |
4.11 | Form of Warrant to Purchase Ordinary Shares, issued on December 3, 2010 (incorporated by reference to our Report on Form 6-K filed on November 30, 2010). |
| †4.12 | English summary of undertakings of Izhak Tamir toward the trustees of Orckit's note holders re: undertakings required by Arrangement, dated February 20, 2012 (incorporated by reference to Exhibit 4.16 of our Annual Report on Form 20-F for the fiscal year ended December 31, 2011). |
| †4.13 | English summary of undertakings of Eric Paneth toward the trustees of Orckit's note holders re: undertakings required by Arrangement, dated February 20, 2012 (incorporated by reference to Exhibit 4.17 of our Annual Report on Form 20-F for the fiscal year ended December 31, 2011). |
| 4.14 | Loan Agreement between Orckit and Izhak Tamir, dated March 29, 2012 (incorporated by reference to Exhibit 4.18 of our Annual Report on Form 20-F for the fiscal year ended December 31, 2011). |
| 4.15 | Loan Agreement between Orckit and Eric Paneth, dated March 29, 2012 (incorporated by reference to Exhibit 4.19 of our Annual Report on Form 20-F for the fiscal year ended December 31, 2011). |
| †4.16 | English summary of the terms and conditions of Series A convertible notes, as amended pursuant to the Arrangement on July 2, 2102 (incorporated by reference to Exhibit 4.20 of our Annual Report on Form 20-F for the fiscal year ended December 31, 2011). |
| †4.17 | English summary of the terms and conditions of Series B convertible notes, as amended pursuant to the Arrangement on July 2, 2012 (incorporated by reference to Exhibit 4.21 of our Annual Report on Form 20-F for the fiscal year ended December 31, 2011). |
| 4.18 | Strategic Investment Agreement, dated as of March 12, 2013, between Orckit and Networks3, Inc. (incorporated by reference to our Report on Form 6-K/A filed on March 13, 2013). |
| 4.19 | Form of Subordinated Promissory Note (incorporated by reference to our Report on Form 6-K/A filed on March 13, 2013). |
| 4.20 | Form of Guaranty by Corrigent of Subordinated Promissory Note (incorporated by reference to our Report on Form 6-K/A filed on March 13, 2013). |
| 4.21 | Form of Investors' Rights Agreement among Networks3 and the shareholders named therein (incorporated by reference to our Report on Form 6-K/A filed on March 13, 2013). |
| 4.22 | Note Purchase Agreement, dated as of March of 12, 2013, among Orckit and the Buyers named therein (incorporated by reference to our Report on Form 6-K/A filed on March 13, 2013). |
| 4.23 | Form of Senior Secured Promissory Note (incorporated by reference to our Report on Form 6-K/A filed on March 13, 2013). |
| 4.24 | Form of Pledge and Security Agreement among Orckit, Corrigent and the Collateral Agent (incorporated by reference to our Report on Form 6-K/A filed on March 13, 2013). |
| 4.25 | Form of Guaranty by Corrigent of Senior Secured Promissory Note (incorporated by reference to our Report on Form 6-K/A filed on March 13, 2013). |
| 8.1 | Subsidiaries of Orckit Communications Ltd. |
| 12.1* | Certification of Principal Executive Officer and Principal Financial Officer pursuant to 17 CFR 240.13a-14(a), as adopted pursuant to §302 of the Sarbanes-Oxley Act |
| 13.1* | Certification of Principal Executive Officer and Principal Financial Officer pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act |
| 15.1 | Audited Consolidated Financial Statements as of December 31, 2011 and 2012 and for the years ended December 31, 2010, 2011 and 2012 (incorporated by reference to our Report on Form 6-K filed on March 21, 2013) |
| 101.1** | Interactive Data Files (in XBRL format) of the following materials from our Annual Report on Form 20-F for the year ended December 31, 2012: (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Operations, and (iii) Consolidated Statements of Changes in Equity (Capital Deficiency), (iv) Consolidated Statements of Cash Flows and (v) Notes to Financial Statements |
** In accordance with Rule 406T of Regulation S-T, the information in Exhibit 101 is furnished and deemed not filed or a part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, is deemed not filed for purposes of Section 18 of the Exchange Act of 1934, and otherwise is not subject to liability under these sections and shall not be incorporated by reference into any registration statement or other document filed under the Securities Act of 1933, as amended, except as expressly set forth by specific reference in such filing.
† Translated in full or summary version; the original language version is on file with Orckit Communications Ltd. and is available upon request.
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 | |
| | | Name: Izhak Tamir | |
| | | Title: Chief Executive Officer | |
| | | Date: April 29, 2013 | |
EXHIBIT INDEX
1.1† Memorandum of Association, as amended
1.2 Ninth Amended and Restated Articles of Association
8.1 Subsidiaries of Orckit Communications Ltd.
| 12.1 | Certification of Principal Executive Officer and Principal Financial Officer pursuant to 17 CFR 240.13a-14(a), as adopted pursuant to §302 of the Sarbanes-Oxley Act |
| 13.1 | Certification of Principal Executive Officer and Principal Financial Officer pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act |
| 101* | Interactive Data Files (in XBRL format) of the following materials from our Annual Report on Form 20-F for the year ended December 31, 2012: (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Operations, and (iii) Consolidated Statements of Changes in Equity (Capital Deficiency), (iv) Consolidated Statements of Cash Flows and (v) Notes to Financial Statements |
[† Translated in full or summary version; the original language version is on file with Orckit Communications Ltd. and is available upon request.]
* In accordance with Rule 406T of Regulation S-T, the information in Exhibit 101 is furnished and deemed not filed or a part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, is deemed not filed for purposes of Section 18 of the Exchange Act of 1934, and otherwise is not subject to liability under these sections and shall not be incorporated by reference into any registration statement or other document filed under the Securities Act of 1933, as amended, except as expressly set forth by specific reference in such filing.
102
