UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 20-F
(Mark One)
o | REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF 1934 |
x | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2014 |
OR
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ______ to ______ |
OR
o | 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_______________ |
Commission File Number 001-36073
ENZYMOTEC LTD.
(Exact Name of Registrant as specified in its charter)
ISRAEL
(Jurisdiction of incorporation or organization)
Enzymotec Ltd.
Sagi 2000 Industrial Area
P.O. Box 6
Migdal Ha’Emeq 2310001, Israel
(Address of principal executive offices)
Ariel Katz
President and Chief Executive Officer
Enzymotec Ltd.
Sagi 2000 Industrial Area
P.O. Box 6
Migdal Ha’Emeq 2310001, Israel
+972-74-717-7177
+972-74-7177-008
(Name, telephone, email 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 | |
Ordinary Shares, par value NIS 0.01 per share | Nasdaq Stock Market LLC | |
(Nasdaq Global Select Market) |
Securities registered or to be registered pursuant to Section 12(g) of the Act: None
Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act: None
Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of December 31, 2014: 22,482,509 ordinary shares, NIS 0.01 par value per share
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act:
Yes o No x
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:
Yes o No x
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:
Yes x No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (section 229.405 of this chapter), and (2) has been subject to such filing requirements for the past 90 days:
Yes x No o
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 x | Non-accelerated filer o |
Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing:
U.S. GAAP x | International Financial Reporting Standards as issued by the International Accounting Standards Board o | Other o |
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):
Yes o No x
PRELIMINARY NOTES
Introduction
As used herein, and unless the context suggests otherwise, the terms “Enzymotec,” “we,” “us,” “our,” the “Company” and similar designations refer to Enzymotec Ltd. and its wholly-owned subsidiaries, Enzymotec USA, Inc., VAYA Pharma, Inc., Enzymotec Australia Pty Ltd. and, where the context so requires, its 80%-owned subsidiary VAYA Pharma Pte Ltd., a Singapore company, or its 50%-owned joint venture, Advanced Lipids AB, a Swedish company or its 50%-owned joint venture, Advanced Omega A/S, a Danish company and the term “AL” refers to our 50%-owned joint venture, Advanced Lipids AB. In this document, references to “NIS” or “shekels” are to New Israeli Shekels, and references to “dollars” or “$” refer to U.S. dollars.
The dollar is the currency of the primary economic environment in which our operations are conducted and is our reporting currency. The majority of our sales are in dollars; the majority of our expenses are incurred in dollars; and the majority of our financing has been provided in dollars. Transactions and balances originally denominated in dollars are presented at their original amounts. Balances in non-dollar currencies are translated into dollars using historical and current exchange rates for non-monetary and monetary balances, respectively. For non-dollar transactions and other items in the consolidated statements of operations and comprehensive income (indicated below), the following exchange rates are used: (i) for transactions-exchange rates at transaction dates; and (ii) for other items (derived from non-monetary balance sheet items such as depreciation and amortization, etc.) — historical exchange rates. Currency transaction gains and losses are recorded in financial income (expenses), as appropriate.
The functional currency of our equity investee, Advanced Lipids, is the Swedish Krona, which is the currency of the primary economic environment in which the operations of Advanced Lipids are conducted. Currency translation adjustments are presented within other comprehensive income (loss).
Market and Industry Data and Forecasts
This annual report includes statistical data, market data and other industry data and forecasts, which we obtained from market research, publicly available information and independent industry publications and reports that we believe to be reliable sources.
Special Note Regarding Forward-Looking Statements
This annual report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) and the safe harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995, that are based on our management’s beliefs and assumptions and on information currently available to our management. Forward-looking statements include information concerning our possible or assumed future results of operations, business strategies, financing plans, competitive position, industry environment, potential growth opportunities, potential market opportunities and the effects of competition. Forward-looking statements include all statements that are not historical facts and can be identified by terms such as “anticipates,” “believes,” “could,” “seeks,” “estimates,” “expects,” “intends,” “may,” “plans,” “potential,” “predicts,” “projects,” “should,” “will,” “would” or similar expressions that convey uncertainty of future events or outcomes and the negatives of those terms. These statements include, but are not limited to, statements regarding:
• | our ability to compete in the markets in which we or AL sell our products; |
• | our expectations regarding future growth, including our ability to develop new products; |
• | our ability to effectively operate through our joint ventures; |
• | our ability to obtain raw materials and manage related costs; |
• | our ability to maintain and expand relationships with our existing customers and to develop relationships with new customers; |
• | our ability to maintain and grow our reputation and the acceptance of our products; |
• | our expectations regarding the outcome of litigation or other legal proceedings; and |
• | our ability to maintain adequate protection of our intellectual property. |
The preceding list is not intended to be an exhaustive list of all of our forward-looking statements. Forward-looking statements reflect our current views with respect to future events and are based on assumptions and subject to risks and uncertainties, including those described in “Item 3.D. Key Information—Risk factors.” In addition, the section of this annual report entitled “Item 4– Information on the Company” contains information obtained from independent industry sources that we have not independently verified.
You should not put undue reliance on any forward-looking statements. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee that future results, levels of activity, performance and events and circumstances reflected in the forward-looking statements will be achieved or will occur. Except as required by law, we undertake no obligation to update publicly any forward-looking statements for any reason after the date of this annual report, to conform these statements to actual results or to changes in our expectations.
TABLE OF CONTENTS
Page | ||
Part I | ||
1 | ||
1 | ||
1 | ||
Selected Financial Data | 1 | |
Risk Factors | 6 | |
28 | ||
History and Development of Enzymotec | 28 | |
Business Overview | 30 | |
Organizational Structure | 46 | |
Property, Plants and Equipment | 47 | |
47 | ||
47 | ||
Operating Results | 48 | |
Liquidity and Capital Resources | 62 | |
Research and Development, Patents and Licenses | 64 | |
Trend Information | 66 | |
Off-Balance Sheet Arrangements | 67 | |
Contractual Obligations | 67 | |
68 | ||
Directors and Senior Management | 68 | |
Compensation of Officers and Directors | 72 | |
Board Practices | 75 | |
Employees | 88 | |
Share Ownership | 89 | |
89 | ||
Major Shareholders | 89 | |
Related Party Transactions | 93 | |
94 | ||
Consolidated Financial Statements and Other Financial Information | 94 | |
Significant Changes | 96 |
97 | ||
Offer and Listing Details | 97 | |
Plan of Distribution | 97 | |
Markets | 98 | |
Selling Shareholders | 98 | |
Dilution | 98 | |
Expenses of the Issue | 98 | |
98 | ||
Share Capital | 98 | |
Memorandum of Association and Articles of Association | 98 | |
Material Contracts | 103 | |
Exchange Controls | 103 | |
Taxation | 103 | |
Documents on Display | 113 | |
113 | ||
115 |
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 table sets forth our selected consolidated financial data, which is derived from our consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles in the United States of America, or U.S. GAAP. You should read the following selected consolidated financial data in conjunction with “Item 5: Operating and Financial Review and Prospects” and our consolidated financial statements and the related notes included elsewhere in this annual report on Form 20-F. The selected consolidated statements of operations data for the years ended December 31, 2012, 2013 and 2014 and the selected consolidated balance sheet data as of December 31, 2013 and 2014 is derived from our audited consolidated financial statements presented elsewhere in this annual report. The consolidated statements of operations data for the years ended December 31, 2010 and 2011 and the selected consolidated balance sheet data as of December 31, 2010, 2011 and December 31, 2012 has been derived from our previously reported audited consolidated financial statements which are not included in this annual report.
You should read this selected financial data in conjunction with, and it is qualified in its entirety by, reference to our historical financial information and other information provided in this annual report including “Item 5. Operating and Financial Review and Prospects” and our consolidated financial statements and related notes. The historical results set forth below are not necessarily indicative of the results to be expected in future periods.
Year ended December 31, | ||||||||||||||||||||
2010 | 2011 | 2012 | 2013 | 2014 | ||||||||||||||||
(in thousands, except per share data) | ||||||||||||||||||||
Consolidated statements of operations data: | ||||||||||||||||||||
Net revenues | $ | 17,440 | $ | 23,019 | $ | 37,867 | $ | 64,975 | $ | 47,103 | ||||||||||
Cost of revenues | 11,459 | 13,468 | 19,815 | 32,110 | 18,316 | |||||||||||||||
Gross profit | 5,981 | 9,551 | 18,052 | 32,865 | 28,787 | |||||||||||||||
Operating expenses: | ||||||||||||||||||||
Research and development, net | 3,062 | 3,860 | 4,611 | 5,947 | 5,986 | |||||||||||||||
Selling and marketing | 2,012 | 3,580 | 5,191 | 6,725 | 8,034 | |||||||||||||||
General and administrative | 2,306 | 2,458 | 2,935 | 8,434 | 7,475 | |||||||||||||||
Total operating expenses | 7,380 | 9,898 | 12,737 | 21,106 | 21,495 | |||||||||||||||
Operating income (loss) | (1,399 | ) | (347 | ) | 5,315 | 11,759 | 7,292 | |||||||||||||
Financial income (expenses), net | (427 | ) | (416 | ) | (539 | ) | (531 | ) | 499 | |||||||||||
Income (loss) before taxes on income | (1,826 | ) | (763 | ) | 4,776 | 11,228 | 7,791 | |||||||||||||
Taxes on income | (141 | ) | (137 | ) | (180 | ) | (324 | ) | (406 | |||||||||||
Share in profits of equity investee | 61 | 36 | 186 | 491 | 453 | |||||||||||||||
Net income (loss) | $ | (1,906 | ) | $ | (864 | ) | $ | 4,782 | $ | 11,395 | $ | 7,838 | ||||||||
Earnings (loss) per ordinary share:(1) | ||||||||||||||||||||
Basic | $ | (0.71 | ) | $ | (0.29 | ) | $ | 0.33 | $ | 0.66 | $ | 0.36 | ||||||||
Diluted | $ | (0.71 | ) | $ | (0.29 | ) | $ | 0.28 | $ | 0.53 | $ | 0.34 | ||||||||
Weighted average number of ordinary shares used in computing earnings (loss) per ordinary share:(1) | ||||||||||||||||||||
Basic | 2,692,647 | 2,965,481 | 2,996,624 | 7,544,387 | 21,902,057 | |||||||||||||||
Diluted | 2,692,647 | 2,965,481 | 3,461,877 | 9,286,456 | 23,210,573 |
As of December 31, | ||||||||||||||||||||
2010 | 2011 | 2012 | 2013 | 2014 | ||||||||||||||||
(in thousands) | ||||||||||||||||||||
Consolidated balance sheet data: | ||||||||||||||||||||
Cash and cash equivalents | $ | 1,980 | $ | 4,787 | $ | 2,729 | $ | 74,430 | $ | 10,315 | ||||||||||
Current assets | 14,900 | 21,801 | 26,649 | 107,899 | 70,343 | |||||||||||||||
Current liabilities | 9,132 | 12,276 | 11,546 | 16,996 | 8,828 | |||||||||||||||
Total assets | 38,652 | 45,629 | 50,970 | 136,373 | 138,250 | |||||||||||||||
Total debt | 9,500 | 11,200 | 5,900 | 4,200 | - | |||||||||||||||
Total liabilities | 15,618 | 18,100 | 16,789 | 18,470 | 9,978 | |||||||||||||||
Shareholders’ equity | $ | 23,034 | $ | 27,529 | $ | 34,181 | $ | 117,903 | $ | 128,272 |
Year ended December 31, | ||||||||||||
2012 | 2013 | 2014 | ||||||||||
(in thousands) | ||||||||||||
Supplemental financial data: | ||||||||||||
Adjusted EBITDA(2) | $ | 7,262 | $ | 16,074 | $ | 11,420 | ||||||
Non-GAAP net income (2) | 5,049 | 13,786 | 9,083 |
______________
(1) | Basic and diluted earnings per ordinary share is computed based on the basic and diluted weighted average number of ordinary shares outstanding during each period using the two-class method for participating preferred shares for the period before our initial public offering. For additional information, see Notes 1 and 16 to our consolidated financial statements included elsewhere in this annual report. |
(2) | Adjusted EBITDA and non-GAAP net income are non-GAAP financial measures. For definitions of these financial measures and reconciliations to our net income, see “— Non-GAAP Financial Measures” below. |
2
Segment Data
The following tables summarize segment data for the years ended December 31, 2012, 2013 and 2014, which is derived from Note 5 to our consolidated financial statements included elsewhere in this annual report. The financial information included in this table under the heading “Nutrition segment” includes the results of operations of AL using the proportionate consolidation method. While under the equity method used in the presentation of our consolidated statements of operations, we recognize our share in the net results of AL as a share in profits of equity investee, under U.S. GAAP, for purposes of segment reporting, we are required to present our results of operations on the same basis provided to and utilized by management to analyze the relevant segment’s results of operations, which is achieved using the proportionate consolidation method of reporting. Under the proportionate consolidation method, we recognize our proportionate share of the gross revenues of AL and record our proportionate share of the joint venture’s costs of production in our statement of operations. For more information regarding the accounting treatment of AL in our consolidated and segment statements of operations, see “Item 5. Operating and Financial Review and Prospects — Operating Results — Joint venture accounting.”
Year ended December 31, 2012 | ||||||||||||||||||||
Nutrition Segment | VAYA Pharma Segment | Total Segment Results of Operations | Elimination(1) | Consolidated Results of Operations | ||||||||||||||||
(in thousands) | ||||||||||||||||||||
Net revenues | $ | 44,380 | $ | 1,832 | $ | 46,212 | $ | (8,345 | ) | $ | 37,867 | |||||||||
Cost of revenues(2) | 27,297 | 588 | 27,885 | (8,087 | ) | 19,798 | ||||||||||||||
Gross profit(2) | 17,083 | 1,244 | 18,327 | (258 | ) | 18,069 | ||||||||||||||
Operating expenses(2) | 7,850 | 4,637 | 12,487 | — | 12,487 | |||||||||||||||
Depreciation and amortization | 1,304 | 118 | 1,422 | |||||||||||||||||
Adjusted EBITDA(5) | $ | 10,537 | $ | (3,275 | ) | $ | 7,262 |
3
Year ended December 31, 2013 | ||||||||||||||||||||
Nutrition Segment | VAYA Pharma Segment | Total Segment Results of Operations | Elimination(1) | Consolidated Results of Operations | ||||||||||||||||
(in thousands) | ||||||||||||||||||||
Net revenues | $ | 76,167 | $ | 4,444 | $ | 80,611 | $ | (15,636 | ) | $ | 64,975 | |||||||||
Cost of revenues(2) | 45,804 | 1,255 | 47,059 | (14,981 | ) | 32,078 | ||||||||||||||
Gross profit(2) | 30,363 | 3,189 | 33,552 | (655 | ) | 32,897 | ||||||||||||||
Operating expenses(3) | 13,009 | 6,020 | 19,029 | — | 19,029 | |||||||||||||||
Depreciation and amortization | 1,415 | 136 | 1,551 | |||||||||||||||||
Adjusted EBITDA(5) | $ | 18,769 | $ | (2,695 | ) | $ | 16,074 |
Year ended December 31, 2014 | ||||||||||||||||||||
Nutrition Segment | VAYA Pharma Segment | Total Segment Results of Operations | Elimination(1) | Consolidated Results of Operations | ||||||||||||||||
(in thousands) | ||||||||||||||||||||
Net revenues | $ | 55,815 | $ | 5,641 | $ | 61,456 | $ | (14,353 | ) | $ | 47,103 | |||||||||
Cost of revenues(2) | 30,605 | 1,435 | 32,040 | (13,775 | ) | 18,265 | ||||||||||||||
Gross profit(2) | 25,210 | 4,206 | 29,416 | (578 | ) | 28,838 | ||||||||||||||
Operating expenses(4) | 13,347 | 6,957 | 20,304 | (3 | ) | 20,301 | ||||||||||||||
Depreciation and amortization | 2,112 | 196 | 2,308 | |||||||||||||||||
Adjusted EBITDA(5) | $ | 13,975 | $ | (2,555 | ) | $ | 11,420 |
____________________
(1) | Represents the change from proportionate consolidation to the equity method of accounting. | |
(2) | Includes depreciation and amortization, but excludes share-based compensation expense. | |
(3) | Includes depreciation and amortization, but excludes share-based compensation expense and IPO-related bonuses. | |
(4) | Includes depreciation and amortization, but excludes share-based compensation expense and secondary offering expenses. | |
(5) | Adjusted EBITDA is a non-GAAP financial measure. For a definition and a reconciliation of adjusted EBITDA to our net income, see “— Non-GAAP Financial Measures” below. |
4
Non-GAAP Financial Measures
Adjusted EBITDA and non-GAAP net income are metrics used by management to measure operating performance. Adjusted EBITDA represents net income excluding (a) financial income (expenses), net, (b) taxes on income, (c) depreciation and amortization, (d) share-based compensation expense and (e) other unusual income or expenses, and after giving effect to the change from the equity method of accounting for our joint venture to the proportionate consolidation method. Non-GAAP net income represents net income excluding (i) share-based compensation expense; and (ii) other unusual income or expenses.
We present adjusted EBITDA as a supplemental performance measure because we believe it facilitates operating performance comparisons from period to period and company to company by backing out potential differences caused by variations in capital structures (affecting interest expenses, net), changes in foreign exchange rates that impact financial assets and liabilities denominated in currencies other than our functional currency (affecting financial income (expenses), net), tax positions (such as the impact on periods or companies of changes in effective tax rates) and the age and book depreciation of fixed assets (affecting relative depreciation expense). In addition, both adjusted EBITDA and non-GAAP net income exclude the non-cash impact of share-based compensation expense and a number of unusual items that we do not believe reflect the underlying performance of our business. Because adjusted EBITDA and non-GAAP net income facilitate internal comparisons of operating performance on a more consistent basis, we also use adjusted EBITDA and non-GAAP net income in measuring our performance relative to that of our competitors.
Adjusted EBITDA and non-GAAP net income are not measures of our financial performance under U.S. GAAP and should not be considered as alternatives to net income, operating income or any other performance measures derived in accordance with U.S. GAAP or as alternatives to cash flow from operating activities as measures of our profitability or liquidity. Adjusted EBITDA and non-GAAP net income have limitations as analytical tools, and you should not consider these financial measures in isolation or as a substitute for analysis of our results as reported under U.S. GAAP as the excluded or included items may have significant effects on our operating results and financial condition. When evaluating our performance, you should consider adjusted EBITDA and non-GAAP net income alongside other financial performance measures, including cash flow metrics, net income, operating income and our other U.S. GAAP results.
The following table presents a reconciliation of adjusted EBITDA to net income for each of the periods indicated:
Year ended December 31, | ||||||||||||
2012 | 2013 | 2014 | ||||||||||
(in thousands) | ||||||||||||
Reconciliation of adjusted EBITDA: | ||||||||||||
Adjusted EBITDA | $ | 7,262 | $ | 16,074 | $ | 11,420 | ||||||
Accounting for joint venture | (258 | ) | (655 | ) | (575 | ) | ||||||
Depreciation and amortization | (1,422 | ) | (1,551 | ) | (2,308 | ) | ||||||
Secondary offering related expenses /IPO-related bonuses | ― | (1,000 | ) | (393 | ) | |||||||
Share-based compensation expense | (267 | ) | (1,109 | ) | (852 | ) | ||||||
Operating income | 5,315 | 11,759 | 7,292 | |||||||||
Financial income (expenses), net | (539 | ) | (531 | ) | 499 | |||||||
Income before taxes on income | 4,776 | 11,228 | 7,791 | |||||||||
Taxes on income | (180 | ) | (324 | ) | (406) | |||||||
Share in profits of equity investee | 186 | 491 | 453 | |||||||||
Net income | $ | 4,782 | $ | 11,395 | $ | 7,838 |
5
The following table presents a reconciliation of non-GAAP net income to net income for each of the periods indicated:
Year ended December 31, | ||||||||||||
2012 | 2013 | 2014 | ||||||||||
(in thousands) | ||||||||||||
Reconciliation of non-GAAP net income: | ||||||||||||
Non-GAAP net income | $ | 5,049 | $ | 13,786 | $ | 9,083 | ||||||
Interest expense relating to early repayment of long-term debt | ― | (282 | ) | ― | ||||||||
Secondary offering related expenses /IPO-related bonuses | ― | (1,000 | ) | (393 | ) | |||||||
Share-based compensation expense | (267 | ) | (1,109 | ) | (852 | ) | ||||||
Net income | $ | 4,782 | $ | 11,395 | $ | 7,838 |
B. Capitalization and Indebtedness |
Not applicable.
C. Reasons for the Offer and Use of Proceeds |
Not applicable.
D. Risk Factors |
Investing in our ordinary shares involves a high degree of risk. You should carefully consider the following risk factors, in addition to the other information set forth in this Form 20-F, before purchasing our ordinary shares. If any of the following risks actually occurs, our business, financial condition and results of operations could suffer. In that case, the trading price of our ordinary shares would likely decline and you might lose all or part of your investment.
6
Risks relating to our business and industry
A high proportion of the sales of the InFat product is sold to end users in China and to a single company.
In 2014, sales of InFat, the infant formula ingredient product sold by our joint venture, AL, accounted for 28.2% of our total net revenues (or 45.1% of our total segment net revenues based on the proportionate consolidation method). China is AL’s largest market for nutrition products containing InFat. Sales of InFat are spread among a number of different non-Chinese manufacturers primarily producing products containing InFat for Chinese infant formula brands, as well as a number of different Chinese manufacturers. The infant nutrition products produced by such manufacturers and using InFat may be sold under the manufacturers’ own brand name, or manufactured for sale by third parties under such third party’s own brand name, and in some cases, the third parties have their branded product manufactured by several different manufacturers. In 2014, we estimate that approximately 30% of total InFat net revenues were attributable to sales in China by, and under the brand name of, Biostime International Holdings Ltd., a large Chinese pediatric nutrition company. We estimate that sales of InFat attributable to sales in China by, and under the name of, Biostime accounted for between 7% and 9% of our consolidated net revenues in 2014. Regulatory changes in China in 2014 with respect to the production of infant formula adversely impacted some of AL’s customers, reducing their sales and resulting in a decrease in sales of InFat which is an ingredient in some of AL’s customers’ infant formulas. Further regulatory changes may negatively affect our revenues and results of operations. In addition, Chinese authorities have recently launched investigations and levied fines related to alleged price fixing by infant nutrition companies including Biostime and may do so in the future. To the extent that there are future investigations regarding alleged anti-competitive practices by our end customers, their reputations and results of operations could be harmed, which in turn could adversely impact our business, financial condition and results of operations. Furthermore, the percentage of our net revenues attribute to sales in China by, and under the brand name of Biostime decreased in 2014, primarily as a result of Biostime losing market share in China which we believe is due to greater online sales of infant nutrition products compared to supermarkets and health stores, resulting in increased competition for Biostime and other AL customers. In addition, InFat is not currently produced in China or another country that has a free trade arrangement with China and, as a result, our ability to compete against other producers of infant formula ingredients produced in China or such other country could be limited. Were Biostime, for any reason, to suffer further decreases in sales, or to cease operations, or discontinue the inclusion of the InFat ingredient in all or a significant portion of the infant nutrition products sold under its brand name or Biostime or other Chinese pediatric nutrition companies were to use a competitor’s ingredient, this could significantly adversely affect sales of the InFat product, which could materially adversely impact our business, financial condition and results of operations.
The demand for products based on Omega-3and in particular, premium products, such as krill oil, has declined and may continue to decline following a significant increase in manufacturing capacity by manufacturers of these products, resulting in intense competition and price pressure.
Krill oil accounted for 40.6% of our total net revenues (or 31.1% of our total segment net revenues, based on the proportionate consolidation method) in 2014. After significant demand for Omega-3 products and krill oil products during recent years and, in particular, during 2013, consumer demand for these products decreased substantially in 2014. We believe that this decrease in 2014 resulted primarily from changes in consumer preferences, driven in part by recent negative publicity regarding Omega-3 as well as a recall of krill oil-based products in Australia by an Australian krill oil brand. As a result of such decreased demand, we experienced a significant decline in orders for krill oil products, which resulted in a decrease in net revenues from the sale of krill oil products in the year ended December 31, 2014 compared to the year ended December 31, 2013. In addition, as a result of strong market growth in 2013, krill oil suppliers have recently increased capacity and the lower demand in the krill oil market in 2014 resulted in intensified competition and price pressure. We cannot provide any assurance that the demand for Omega-3 products and in particular, krill oil products, which are sold at higher prices than standard Omega-3 products, will improve and such demand may continue to decline, based on consumer preferences and new information and clinical studies. Even if demand for these products increases again, such increases may not be sustainable. If there is a new or further decrease in demand for these products or price decreases, our revenues will decrease and our results of operations will be adversely affected.
Our offering of products as “medical foods” in the United States may be challenged by regulatory authorities.
The products offered within our VAYA Pharma segment are sold under physician supervision in the United States as “medical foods,” on the basis of their meeting the criteria for “medical foods” in the Federal Food, Drug, and Cosmetic Act (the “FDCA”) and FDA regulations. The term medical food is defined in the FDCA as a food which is formulated to be consumed or administered enterally under the supervision of a physician and which is intended for the specific dietary management of a disease or condition for which distinctive nutritional requirements, based on recognized scientific principles, are established by medical evaluation. See “Item 3. Key Information — Risk Factors — Risks related to government regulation — VAYA Pharma segment” below. Medical foods are not required to undergo premarket review or approval by the FDA.
7
We believe that our VAYA Pharma products meet the criteria for “medical foods” established by the FDCA, and that the labeling and marketing of our medical foods is consistent with FDA regulatory requirements. However, our offering of one or more of these products as “medical food” could be challenged by the FDA. The FDA has recently issued warning letters to other companies challenging the classification of their products as “medical food.” We believe that these letters indicate that the FDA may be applying a more narrow interpretation of what qualifies as a “medical food.” Given this enhanced focus on medical food companies, we cannot provide any assurance that we will not also receive such a letter and the FDA could take the position that one or more of our medical food products may not be lawfully sold in the United States as “medical food.” If such a challenge were to occur we could incur significant costs responding to such a claim and defending our products’ status as medical foods and ultimately litigation. If we are unable to demonstrate to the FDA’s satisfaction that the product(s) meet the regulatory requirements for “medical foods,” we would need to suspend further sale and distribution of the alleged violative products in, and could be required to withdraw such product or products from the U.S. market. We could seek to re-position the products as “dietary supplements,” a distinct category of “food” under the FDCA and FDA regulations. This would require new labels, labeling and revised claims for the products, and would impose other regulatory requirements on us not applicable to “medical foods.” The United States is the principal market for the sales of the products of our VAYA Pharma segment and the cessation of such sales, even for a limited period, could have a material adverse effect on our operations, financial situation, operating results and business prospects. In addition, were we to be unsuccessful in obtaining FDA approval in the United States, this could significantly adversely affect the sale of the products outside the United States.
We rely on AarhusKarlshamn AB, or AAK, our Swedish joint venture partner, to manufacture InFat and certain matters related to the joint venture are the subject of disagreement.
All of the revenues from sales of our InFat product are derived from sales by AL. The term of this joint venture expires on December 31, 2016, subject to extension for additional three-year periods, unless we or AAK duly terminate the joint venture upon giving notice of termination no later than twelve months prior to the applicable expiration date. There can be no assurance that we or AAK will continue its relationship with the other party beyond the expiration of the current term of the joint venture.
We are precluded from competing with AL during the term of the relationship. Further, if upon termination of the agreement we sell our share in AL to AAK pursuant to the buy/sell mechanism contained in the joint venture agreement, we would be subject, during the three-year period after the end of provision of services under the agreement, to non-competition obligations. Such obligations would preclude us from developing or producing InFat or competing products. Such non-competition obligations could limit our development and sales of new or existing products and could have a material adverse effect on our business, financial condition and results of operations.
In addition, under the joint venture agreement, we and AAK are each responsible for particular functions related to the production, marketing and sale of the final InFat product. In particular, we are responsible for research and development, business development and marketing, and AAK is responsible for the production, management of inventory, logistics relating to the sales and delivery of the InFat product and obtaining permits and licenses related to AL’s operations in Sweden.
In May 2014, AAK submitted a claim for arbitration against us to the International Chamber of Commerce in Amsterdam, the Netherlands, seeking a declaration that our disclosures in connection with our initial public offering violated the non-disclosure obligations related to AL contained in the joint venture agreement and constituted a material and intentional breach of the agreement. AAK did not seek any remedies in connection with such alleged breach other than declaratory relief, however, AAK indicated that it may pursue additional remedies in the future to the extent that the arbitration results in a determination that we breached the joint venture agreement as alleged by AAK. It is our position based on legal advice we received that we were permitted to disclose information related to AL which was required to be disclosed in connection with our initial public offering, and we believe that we have complied with the procedures set forth in the joint venture agreement for such disclosure.
AAK also sought a declaration that after a notice of termination has been provided by one party and neither party provides the other party with a buy-sell notice before by December 31, 2016, the procedure may no longer be triggered and the joint venture will terminate on December 31, 2016 and all post-termination covenants concerning non competition and continued supply will not apply. Our position is that the joint venture agreement can only be terminated by one party buying the other party's share through the buy-sell process, and that if the buy-sell process is not concluded by December 31, 2016 with one party acquiring the interest of the other party, then the termination is ineffective and the joint venture continues.
We filed counterclaims against AAK in the arbitration with respect to operational aspects of the joint venture in which we claimed that AAK’s conduct in these respects jeopardized the value of the joint venture and that AAK’s conduct during our initial public offering was meant to jeopardize the offering. For more information on the pending arbitration see “Item 8. Financial Information — Consolidated Financial Statements and Other Financial Information — Legal Proceedings.”
Under the joint venture agreement, pending such dispute, the parties are required to continue to conduct the operations of the joint venture in accordance with the agreement and fulfill their responsibilities thereunder. While the operations of the joint venture have generally continued in their ordinary course, the arbitration has strained the relationship of the Company and AAK resulting in disagreements between the parties with respect to operational matters and the extent to which the handling of these matters serves the best interests of AL. The outcome of this legal proceeding is inherently uncertain. The existence of such arbitration proceedings could be disruptive to the joint venture’s activities, already requires significant attention from our management, and an adverse determination could have a material adverse effect on our business.
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Irrespective of any disagreement, AAK may have economic or business interests or goals that are inconsistent with ours. Moreover, we currently participate in one other joint venture to pursue additional business opportunities and may enter into other joint ventures in the future. Any current or future joint venture partner may:
• | take actions contrary to our policies or objectives; |
• | undergo a change of control; |
• | experience financial and other difficulties; or |
• | be unable or unwilling to fulfill its obligations under the joint venture, |
each of which may affect our financial condition or results of operations. In addition, no assurance can be given that the actions or decisions of our joint venture partner(s) will not affect our joint ventures in a way that hinders our corporate objectives or that causes material adverse effects on our business, financial condition or results of operations.
We are subject to a degree of customer concentration and our customers do not enter into long-term purchase commitments with us.
In the year ended December 31, 2014, our thirteen largest customers accounted for nearly half of our revenues. Other than with respect to InFat, our customers generally do not enter long-term purchase commitments with us and we may therefore have limited insight into their future purchasing plans. Our largest customers may determine to lower their purchasers or cease purchasing our products completely. For example, one of our largest purchasers of krill products, which accounted for 15% of our revenues in 2013, purchased our products at a significantly lower level in 2014. Even if a significant customer continues to purchase our products at the same or a greater level, their decision to defer a purchase, even for a few weeks, could materially adversely impact our results of operations in a particular quarter. Although customer concentration has decreased, our business may not develop in a manner that would make us less reliant on a small number of large customers. Our results of operations may be materially adversely affected if a significant customer elects to stop purchasing our products and we are unable to find new purchasers to offset the loss of that customer.
We depend on third parties to obtain raw materials, in particular krill, necessary for the production of our products.
We depend on third parties to supply krill meal, an essential raw material for the production of our krill oil, which accounted for 40.6% of our total net revenues (or 31.1% of our total segment net revenues, based on the proportionate consolidation method) in 2014. Krill are small crustaceans found in oceans throughout the world. There are two primary ocean regions where krill is harvested: the Southern Ocean (Antarctic krill) and the North Pacific Ocean, mainly off the coasts of Japan and Canada (Pacific krill). We currently purchase krill meal pursuant to a memorandum of understanding with the owners of a vessel that harvests Antarctic krill (and which processes the freshly caught krill into krill meal onboard the vessel). We may also purchase krill meal from several other suppliers based on our needs. There are a limited number of vessels capable of producing krill meal onboard. In 2013, a distribution company from which we previously purchased krill meal declared bankruptcy and although no material disruption to our krill meal supply occurred and we were able to make alternative arrangements with the owner of the vessel, if we, for any reason, are no longer able to obtain the krill meal from a supplier on terms reasonable to us, or at all, this would have a material adverse effect on our results of operations and financial condition. In 2014, we also purchased frozen krill, which, while more expensive to process into krill meal onshore compared to krill from vessels that process krill meal onboard, is more readily obtainable. We also signed a toll processing agreement in 2014 with a toll processor for processing the frozen krill into krill meal. We do not, however, have a long-term supply agreement with any supplier of frozen krill. We intend to meet our krill meal needs in the future by sourcing krill meal both from vessels that process krill meal onboard and suppliers of frozen krill. While we have expanded our supplier base by beginning to use frozen krill, we cannot give any assurance regarding our ability to secure sufficient supply sources at competitive prices and upon fair and reasonable contractual terms and conditions or successfully implement the requisite logistical changes required. Any inability to obtain krill or krill meal would have a material adverse effect on our financial conditions and results of operations. In the event that we have to increase our reliance on frozen krill, which costs more than krill that is purchased from vessels that process krill meal onboard, our gross profits may be adversely affected.
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We are dependent on a single facility that houses the majority of our operations.
Our administrative headquarters, all of our research and development laboratories and our production plant are located in a single facility in the Sagi 2000 Industrial Area, near Migdal Ha’Emeq, Israel. The manufacture of all of the products that we sell takes place at this facility, other than the final InFat product, our Omega-PC product, and certain grades of our Sharp GPC product. Although the InFat product sold by AL is manufactured in Sweden, the production of the InFat enzymes, the core element for the manufacture of InFat, also takes place at our Migdal Ha’Emeq facility. Accordingly, we are highly dependent on the uninterrupted and efficient operation of this facility. If operations at this facility were to be disrupted as a result of equipment failures, earthquakes and other natural disasters, fires, accidents, work stoppages, power outages, acts of war or terrorism or other reasons, our business, financial condition and results of operations could be materially adversely affected. Lost sales or increased costs that we may experience during the disruption of operations may not be recoverable under our insurance policies, and longer-term business disruptions could result in a loss of customers. If this were to occur, our business, financial condition and operations could be materially negatively impacted.
As a result of alleged infringement on intellectual property, we may have to pay royalties with respect to sales of our krill oil products in the United States or Australia and any infringement of intellectual property of others could also require us to pay royalties.
Our commercial success depends in part on our ability to operate without infringing upon the proprietary rights of others. Beginning in October 2011, Neptune, one of our principal competitors in the krill oil products market, filed a series of complaints in the U.S. District Court for the District of Delaware alleging patent infringement by one or more of our krill oil products. In addition, in April 2013, we received a Notice of Institution of Investigation from the U.S. International Trade Commission, or ITC, regarding a similar complaint filed by Neptune in that forum.
In April 2014, we signed a final settlement and license agreement with Neptune which resulted in the termination and dismissal of the above mentioned complaints and investigation. According to the settlement and license agreement, we made a one-time settlement payment to Neptune. In addition, we agreed, among other things, that, in the event that the outcome of an Inter Partes Review, or IPR, in the US or a reexamination in Australia for certain agreed claims in Neptune’s patent is unfavorable to us, we will be obligated to pay royalties to Neptune with respect to sales in the US or in Australia respectively.
If the IPR in the U.S. or the reexamination in Australia results in unfavorable outcomes to us we may be subject to license fees or royalties. If we are found to have infringed patents of any other third party which are determined to be valid and enforceable, we may be subject to monetary damages, including in the form of lost profits or a royalty. In the case of another third party, it may also be granted injunctive relief which would prevent us from selling the infringing products in the jurisdiction in which it has patent, a significant market for our krill oil products. In addition to any monetary damages awarded against us, in some instances we have also agreed to be financially responsible for any damages awarded against certain of our customers as a result of the purchase, importation, use, sale or offer to sell of our products if they are found to infringe certain of Neptune’s intellectual property rights and we may have to agree to similar terms. Moreover, defending against these claims or similar claims in the future has been and may continue to be time-consuming, costly and has and may in the future divert management’s time and attention from our business. Thus, these proceedings could materially adversely impact our business and financial results.
Potential future acquisitions of companies or technologies may distract our management, may disrupt our business and may not yield the returns expected.
We may acquire or make investments in businesses, technologies or products, whether complementary or otherwise, as a means to expand our business, if appropriate opportunities arise. We cannot give assurances that we will be able to identify future suitable acquisition or investment candidates, or, if we do identify suitable candidates, that we will be able to make the acquisitions or investments on reasonable terms or at all. In addition, we have no prior experience in integrating acquisitions and we could experience difficulties incorporating an acquired company’s personnel, operations, technology or product offerings into our own or in retaining and motivating key personnel from these businesses. We may also incur unanticipated liabilities. The financing of any such acquisition or investment, or of a significant general expansion of our business, may not be readily available on favorable terms. Any significant acquisition or investment, or major expansion of our business, may require us to explore external financing sources, such as an offering of our equity or debt securities. We cannot be certain that these financing sources will be available to us or that we will be able to negotiate commercially reasonable terms for any such financing, or that our actual cash requirements for an acquisition, investment or expansion will not be greater than anticipated. In addition, any indebtedness that we may incur in such a financing may inhibit our operational freedom, while any equity securities that we may issue in connection with such a financing would dilute our shareholders. Any such difficulties could disrupt our ongoing business, distract our management and employees, increase our expenses and adversely affect our results of operations. Furthermore, we cannot provide any assurance that we will realize the anticipated benefits and/or synergies of any such acquisition or investment.
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We anticipate that the markets in which we participate will become more competitive and we may be unable to compete effectively.
We believe that the number of companies seeking to develop products in the markets in which we compete will increase in the future. Competitors range in size from small, single product companies to large, multifaceted corporations, which have greater financial, technical, marketing and other resources than those available to us.
The InFat product is an ingredient used in the general infant nutrition products market. The majority of the oils used in the infant nutrition market are currently vegetable oil blends, although bovine milk fat is also used to some extent. In contrast, InFat addresses the sn-2 palmitate market which currently holds less than 10% share of the infant formula oils market as a whole. We currently compete directly in the sn-2 palmitate market with IOI Loders Croklaan, however, we believe that as the market for sn-2 palmitate grows, it may encourage more specialty oil producers to seek to develop and offer competitive products, increasing the level of competition that we face.
In the krill oil market, we primarily compete with Aker BioMarine AS (which merged with Aker Seafoods Holding AS), Neptune Technologies & Bioressources Inc. and Rimfrost USA, LLC (a joint venture of Avoca, Inc. and Olympic Seafood AS). See Item 3. Key Information - Risk Factors - Risk realting to our business and industry - The demand for products based on Omega-3 and in particular, premium products, such as Krill oil, has declined and may continue to decline following a sagnificant increase in manufacturing capacity by manufacturers of these products, resulting in intense competition and price pressure. In the market for our PS product line, our principal competitors are Chemi Nutraceuticals Inc., Lipoid GmbH and Lipogen Ltd.
The “medical food” category was legally established in the United States in 1988. Nevertheless, the medical foods market is relatively new and our VAYA Pharma products currently face little direct competition from other medical food manufacturers. However, as the market develops, we could face future competition from companies seeking to enter the market, in particular, large multi-national nutrition companies, such as Abbott Laboratories, Nestlé and Danone (through its clinical nutrition subsidiary, Numico N.V.), which have expressed interest in the medical food segment. Such potential competitors may have greater financial, technical, marketing and other resources than those available to us, and, accordingly, the ability to devote greater resources than we can to the development, promotion, sale and support of products. In addition, physicians may prefer to prescribe prescription drugs produced by pharmaceutical drug manufacturers rather than our medical food products and customers may prefer to use prescription drugs instead of our medical food products due to the present limited reimbursement by third party payers.
Any business combinations or mergers among our competitors that result in larger competitors with greater resources or distribution networks, or the acquisition of a competitor by a major technology, pharmaceutical or nutrition corporation seeking to enter the markets in which we operate, could further result in increased competition and have a material adverse effect on our business, financial condition and results of operations.
We may not be able to successfully expand our production or processing capabilities.
In 2013, we expanded our Migdal Ha’Emeq manufacturing facility with equipment that enables us to extract krill oil from krill meal using technologically advanced equipment and proprietary processes which we expected would result in a better cost structure, production of higher quality krill oil and the ability to utilize and sell byproducts of the krill oil extraction process. During the first quarter of 2014, we initiated the new krill meal extraction facility and as of the second quarter of 2014, the entire extraction process was being performed in house at our Migdal Ha’Emeq manufacturing facility. Nevertheless, as the extraction facility has only recently begun production, we are still working to improve the efficiency of our production. In addition, we plan to complete a capacity increase project in our current facility during the second quarter of 2015 for production of our nutrition segment products. In the longer term, we may build an additional production plant adjacent to our existing facility in order to further expand our production capacity. There can be no assurance that we will successfully complete the expansion of our current production facility and that we will achieve the cost savings and efficiencies that we anticipated. In addition, with respect to any further expansion, to the extent we determine to undertake such expansion, there can be no assurance that we will be able to obtain the requisite approvals, overcome operational challenges of implementing expansion projects, or have the necessary capital resources for the construction of this plant, or if we do, that the plant will be built or that it will satisfy demand. Conversely, there can be no assurance, even if we build an additional plant, that demand for our products will increase commensurate with the increased production capacity. Furthermore, we cannot assure you that any of these projects will be implemented in a timely and cost efficient manner, and that our current production will not be adversely affected by the operational challenges of implementing the expansion projects.
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Our gross profits may be adversely affected if we are only able to obtain lower quality krill meal or if we need to purchase a greater percentage of frozen krill meal than we anticipate.
The quality of the krill meal we source for our krill oil products, meaning the level of oils found in the krill meal, impacts our gross profit as higher quality krill meal results in greater yield. The amount of oil we are able to extract from the krill meal we purchase varies based on both seasonal fluctuations in fat percentages of the krill harvested and the extraction procedure used to extract the oil.
Until the first quarter of 2014, the first stage of processing krill meal into crude krill oil was carried out for us by a dedicated contract manufacturer in India. In the first quarter of 2014, we moved this processing stage in-house, enabling us to complete the first stage of turning krill meal into crude krill oil ourselves using technologically advanced equipment and proprietary processes. In addition, in 2014, we purchased frozen krill from a supplier of frozen krill and signed a toll processing agreement for the onshore manufacturing of krill meal from frozen krill. We intend to meet our krill meal needs in the future by sourcing krill meal from both vessels that process krill meal onboard and suppliers of frozen krill. We anticipate that, while purchasing frozen krill and processing it into krill meal onshore is significantly more costly than purchasing krill meal from vessels that process krill meal onboard, sourcing frozen krill will allow us to purchase a greater percentage of the total krill we use in a given year during the winter months when the fat percentage in the krill harvested is highest, which would reduce our exposure to seasonal fluctuation. If we are unable to source krill effectively, our gross profit margin may continue to be affected materially by the quality of the krill we source and our ability to obtain frozen krill.
Our ability to obtain krill may be affected by conservation regulation or initiatives.
A substantial part of our activities in the Nutrition segment requires the use of krill. Limits on krill harvesting established by the Commission for the Conservation of Antarctic Marine Living Resources may limit our revenue. The commission limits the amount of krill that may be harvested in Antarctic waters according to specific ocean areas. Additionally, the commission regulates the licensing of vessels eligible to harvest krill in these specific Antarctic Ocean areas. In the areas currently being fished for krill, the commission has established a combined annual catch limit of 620,000 metric tons. In 2013, approximately 215,000 metric tons were harvested. The substantial majority of harvested krill is used for aquaculture feed and fish bait while only a small portion is used for human consumption, the latter of which offers higher profit margins. The commission has established limits because increases in krill catches could have a negative effect on the ecosystem, including other marine life, particularly birds, seals and fish which mainly depend on krill for food. The lowering of these quotas or other developments impacting the ability to source krill, such as adoption of additional conservation measures, may reduce the future availability of krill and cause significant increases in its price. Any such development could harm our sales and gross profits.
Our product development cycle is lengthy and uncertain, and our development or commercialization efforts for our products may be unsuccessful.
We are currently working on more than ten products, including new uses and applications for existing products that are in various stages of development. Some of these products address new medical indications or provide new nutritional or medical benefits, while others provide different levels or concentrations of active ingredients and offer improved secondary characteristics. Research and development is a time-consuming, expensive and uncertain process that takes years to complete, with no guarantee of a favorable outcome. Because of the long and challenging product development cycle, evolving regulatory environment, changing market conditions and other factors, there is significant uncertainty as to the future development, success and commercialization of any products we may attempt to develop or commercialize. Even if our existing products prove to be successful, we may spend years and dedicate significant financial and other resources developing products that may never be commercialized. If we are unsuccessful in developing promising products, securing any necessary regulatory approvals and commercializing such products after having invested significant resources, efficiently or not at all, such failures could have a material and adverse effect on our business, financial condition and results of operations.
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Variations in the cost of raw materials for the production of InFat may have a material adverse effect on our business, financial conditions and results of operations.
The cost and variability in price of raw materials related to the production of InFat, primarily vegetable oil and fatty acids, is a key factor in the profitability of AL and of our Nutrition segment as a whole. In 2014, the cost of raw materials comprised a majority of the costs of revenues of AL. While certain of AL’s customer contracts contain pricing formulae under which the prices of products are adjusted to reflect changes in the costs of raw materials, the adjustments do not fully insulate AL from such changes. In addition, even where InFat prices are adjusted pursuant to customer contracts which contain pricing formulae, increases in price can adversely affect sales, as the increased costs to the end-user may make such products less attractive, thereby reducing demand, and also expose AL to increased competition. Such developments could have a material adverse effect on our business, financial condition and results of operations.
We are generally reliant upon third parties for the distribution and commercialization of our products.
Part of our strategy is to enter into and maintain arrangements with third parties that are generally exclusive with respect to a particular territory related to the marketing, sales and distribution of our products. Our revenues are dependent in part on the successful efforts of these third parties. Entering into strategic relationships can be a complex process and the interests of our distribution partners may not be or may not remain aligned with our interests. There can be no assurance that our distribution partners will market, sell and/or distribute our products successfully or choose the best means for achieving commercialization of our products. Some of our current and future distribution partners may decide to compete with us, refuse or be unable to fulfill or honor their contractual obligations to us, or reduce their commitment to, or even abandon, their relationships with us. Further, there can be no assurance that any such third-party collaboration will be on favorable terms. We may not be able to control the amount and timing of resources our distribution partners devote to our products or the efforts they expend in obtaining any requisite local approvals for our products. In addition, we may incur liabilities relating to the distribution and commercialization by our distributors of our products. While the agreements with such distributors generally include customary indemnification provisions indemnifying us for liabilities relating to the packaging of our products and their use and storage, there can be no assurance that these indemnification rights will be sufficient in amount, scope or duration to fully offset the potential liabilities associated with our distributors handling and use of our products. Any such liabilities, individually or in the aggregate, could have a material adverse effect on our business, financial condition or results of operations.
Disruption to our IT system could adversely affect our reputation and have a material adverse impact on our business and results of operations.
Our business operations and research and development technologies rely on our IT system to collect, analyze and store our data. While we utilize offsite back-up storage, there can be no guarantee that such back-up storage, together with our existing onsite back-up storage, will be effective if it becomes necessary to rely on them. Furthermore, we can provide no assurance that our current IT system is fully protected against third-party intrusions, viruses, hacker attacks, information or data theft or other similar threats. As we continue to develop our technologies, we may need to update our IT system and storage capabilities. However, if our existing or future IT system does not function properly, or if the IT system proves incompatible with new technologies, we could experience interruptions in data transmissions and slow response times, preventing us from completing routine research and business activities. Furthermore, disruption or failure of our IT system due to technical reasons, natural disaster or other unanticipated catastrophic events, including power interruptions, storms, fires, floods, earthquakes, hacker attacks or security breaches, acts of war and terrorism could significantly impair our ability to deliver our products on schedule and materially and adversely affect our relationships with our partners and customers, our business, our reputation and our results of operations.
We are not able to predict the results of clinical trials, which may prove unsuccessful or be delayed by certain factors.
We conduct clinical and pre-clinical studies to support the efficacy and safety of our products and their ingredients during their development, to extend known benefits and to uncover new benefits of our existing products and ingredients. While clinical trials are generally not required with respect to regulatory approvals for our nutrition products, we use the results of these trials to maximize the product’s reach to new customers and as a basis for establishing long-term supply agreements. Further, if in the future we seek to market products as prescription drugs, we will be required to conduct clinical trials to establish the safety and efficacy of such products. Although prior to initiating clinical trials, our compounds are tested on animals in pre-clinical trials to test their toxicity and efficacy, pre-clinical trials on animals cannot predict fully whether a proposed product will prove to be safe or effective in humans. Pre-clinical and clinical data required for regulatory approval must be developed under strict regulatory standards and may be found, on review by health regulatory authorities, to be of insufficient quality to support an application for commercialization of a product or to substantiate claims concerning a currently marketed product’s safety or effectiveness. In addition, positive results in previous clinical studies of our products may not be predictive of similar results in future clinical trials and interim results during a clinical trial do not necessarily predict final results. A number of companies in the pharmaceutical industry have suffered significant setbacks in late-stage clinical trials even after achieving promising results in early-stage development. Our clinical trials may produce negative or inconclusive results, and we may decide, or regulators may require us, to conduct additional clinical trials. Moreover, clinical data may be susceptible to varying interpretations and analyses, and some companies that have believed their product candidates performed satisfactorily in preclinical studies and clinical trials have nonetheless failed to obtain FDA approval for their products.
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Recruitment of participants in a clinical study is challenging. Identification of the appropriate study population and sites is a crucial point for success. Clinical studies with infants to test the safety and efficacy of our ingredients for infant formula are challenging since parents are frequently reluctant to permit their children to participate in trials. A number of other factors could affect the feasibility and outcome of clinical trials, including, but not limited to, study design, the size of the available study population, the eligibility criteria for participation in the clinical trials, and the availability of clinical trial sites. Prior to initiating a clinical trial, we carefully select the study population and sites with the goal of having the best chances of success and to avoid delays in study recruitment. In addition, we seek to ensure that all other study related activities, such as product supply and data capture, are ready prior to initiation in order to avoid administrative delay. Nevertheless, our clinical trials may not be successful and may be delayed or otherwise terminated prior to the end of recruitment.
Administering our product candidates to humans may produce undesirable and unexpected side effects. These side effects could interrupt, delay or halt clinical trials of our product candidates and could result in the FDA or other regulatory authorities denying approval of our product candidates for any or all targeted indications. Our ability to commercialize any new products is dependent upon the success of product development efforts and the success of clinical studies. Existing products may be the subject of post-marketing clinical trials. If these clinical trials and product development efforts fail to produce satisfactory results, or if we are unable to maintain the financial and operational capability to complete these development efforts, we may be unable to generate revenues for existing products and potential new products.
We may not be able to achieve increased market acceptance for our products.
The degree of market acceptance for our products and those of our customers will depend upon a number of factors, including the receipt of regulatory approvals, the establishment and demonstration in the medical community of the clinical efficacy and safety of the products, and the establishment and demonstration of the potential advantages over competing products. Additionally, to gain market acceptance for our VAYA Pharma products we must establish and demonstrate the potential advantages over existing and new treatment methods and we may have to expand the reimbursement of government and third-party payers. As of the end of the fourth quarter of 2014, approximately 30% of sales of VAYA Pharma products in the United States received some form of reimbursement. In the case of our Nutrition products, market acceptance is dependent on the acceptance of the product and appropriate distribution with large retailers, competitive pricing and the extent to which the products fulfill customer expectations and demands. There can be no assurance that consumers, physicians, patients, payers, the medical community in general, distributors or retailers will accept and utilize any existing or new products that may be developed by us. Failure to achieve such market acceptance for our products could have a material adverse effect on our growth, business, financial condition or results of operations.
We could be subject to product liability lawsuits, which could result in costly and time-consuming litigation and significant liabilities.
The development of pharmaceutical, medical food and human nutrition products involves an inherent risk of product liability claims and associated adverse publicity. Our products may be found to be harmful, or to contain harmful substances. This exposes us to substantial risk of litigation and liability and/or may force us to discontinue production of certain products. Although we have product liability insurance for up to $10.0 million (per claim and in the aggregate per year), this coverage may not insure us against all claims made. Product liability insurance is costly and often limited in scope. There can be no assurance that we will be able to obtain or maintain insurance on reasonable terms or to otherwise protect ourselves against potential product liability claims that could impede or prevent commercialization of a material product or line of products. Furthermore, a product liability claim could damage our reputation, whether or not such claims are covered by insurance or are with or without merit. A product liability claim against us, or the withdrawal of a product from the market, could have a material adverse effect on our business or financial condition. Furthermore, product liability lawsuits, regardless of their success, would likely be time consuming and expensive to resolve and would divert management’s time and attention, which could seriously harm our business.
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We could incur significant costs in complying with environmental, health and safety laws or permits or as a result of satisfying any liability or obligation imposed under such laws or permits.
We are subject to extensive environmental, health and safety laws and regulations in a number of jurisdictions, primarily Israel, governing, among other things, the use, storage, registration, handling and disposal of chemicals, waste materials and sewage; chemicals, air, water and ground contamination; air emissions and the cleanup of contaminated sites, including any contamination that results from spills due to our failure to properly dispose of chemicals, waste materials and sewage. In particular, our operations at our Migdal Ha’Emeq manufacturing facility use chemicals and produce emissions, waste materials and sewage, and accordingly require permits from various governmental authorities. These authorities conduct periodic inspections in order to review and ensure our compliance with the various regulations. Our manufacturing processes include pollutant emissions which at peak capacity approach maximum permitted levels. During 2014, in order to meet regulatory requirements, we invested approximately $0.2 million in advanced biotechnology for effluent treatment solution in our current facility, which we anticipate will be operational in the first quarter of 2015. Nevertheless, such equipment may not be completely effective or may malfunction, which could result in a violation of regulations or our need to stop operations at our manufacturing facility until we can make any necessary repairs or improvements to ensure we are compliant with regulatory requirements.
These laws, regulations and permits could potentially require the expenditure by us of significant amounts for compliance and/or remediation. Laws and regulations relating to environmental matters are often subject to change. In the event of any changes or new laws or regulations, we could be subject to new compliance measures or to penalties for activities which were previously permitted. If we fail to comply with such laws, regulations or permits, we may be subject to fines and other civil, administrative or criminal sanctions, including the revocation of permits and licenses necessary to continue our business activities. In addition, we may be required to pay damages or civil judgments in respect of third-party claims, including those relating to personal injury (including exposure to hazardous substances we use, store, handle, transport, manufacture or dispose of), property damage or contribution claims. Some environmental laws allow for strict, joint and several liability for remediation costs, regardless of comparative fault. We may be identified as a potentially responsible party under such laws. Such developments could have a material adverse effect on our business, financial condition and results of operations.
We depend on international sales, which expose us to risks associated with the business environment in those countries.
Our revenues are derived from sales in multiple countries around the world, primarily through exports from Israel to distributors. The majority of our sales are to customers outside the United States and less than 3% of our sales are to customers in Israel. We anticipate that international sales will continue to account for the majority of our revenues in the foreseeable future.
Our international operations and sales are subject to a number of risks, including:
• | potentially longer accounts receivable collection periods and greater difficulties in their collection; |
• | potential instability of local economies; |
• | impact of potential military or civil conflicts and other political risks; |
• | disruptions or delays in shipments caused by customs brokers, work stoppages or government agencies; |
• | potential imposition by governments of controls that prevent or restrict the transfer of funds; |
• | regulatory limitations imposed by foreign governments and unexpected changes in regulatory requirements, tariffs, customs, duties, tax laws and other trade barriers; |
• | difficulties in staffing and managing foreign operations; |
• | laws and business practices favoring local competition and potential preference for locally produced products; |
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• | potentially adverse tax consequences; |
• | difficulties in protecting or enforcing intellectual property rights in certain foreign countries, particularly in Asia; and |
• | fluctuations in exchange rates, described below. |
If we fail to overcome the challenges that we encounter in our international sales operations, our business and results of operations could be materially adversely affected.
Global economic and social conditions could adversely impact sales of our products, especially if they are branded as premium products.
The uncertain direction and relative weakness of the global economy, difficulties in the financial services sector and credit markets and other macroeconomic factors could adversely affect our business. The prospects for economic growth in Europe as well as in the United States, China and other countries remain uncertain. Without global economic growth, the anticipated growth in the sales of our products could be adversely affected or delayed, especially given the premium branding of some of our products. For example, the inclusion of the InFat ingredients, which may be more than twice as expensive as certain vegetable oil blends, in infant nutrition products tends to increase the price of the end product and, in difficult economic times, a manufacturer may be unwilling to take such measures, if its principal competitors continue to sell lower priced products.
Our business relies on the experience and expertise of our senior management, as well as on our ability generally to retain existing, or hire additional, skilled personnel.
Our success depends upon the continued service and performance of our senior management. The loss of the services of any of these individuals could delay or prevent the continued successful implementation of our strategy, or could otherwise affect our ability to manage our company effectively and to carry out our business plan. Members of our senior management team may resign at any time and there can be no assurance that we will be able to continue to retain such individuals.
Our growth and success also depend on our ability to attract and retain additional highly qualified and skilled technical, scientific, sales, managerial and finance personnel. Competition for skilled personnel is intense and the unexpected loss of an employee with a particular skill could materially adversely affect our operations until a replacement can be found and trained. If we cannot retain our existing skilled scientific and technical personnel and attract and retain sufficiently additional skilled scientific and technical personnel, as required, for our research and development and manufacturing operations on acceptable terms, we may not be able to continue to develop and commercialize our existing products or new products. Further, any failure to effectively integrate new personnel could prevent us from successfully growing our company.
Under applicable employment laws, we may not be able to enforce covenants not to compete.
We generally enter into non-competition agreements with our employees. These agreements prohibit our employees, if they cease working for us, from competing directly with us or working for our competitors or clients for a limited period. We may be unable to enforce these agreements under the laws of the jurisdictions in which our employees work and it may be difficult for us to restrict our competitors from benefitting from the expertise our former employees or consultants developed while working for us. For example, Israeli courts have required employers seeking to enforce non-compete undertakings of a former employee to demonstrate that the competitive activities of the former employee will harm one of a limited number of material interests of the employer which have been recognized by the courts, such as the secrecy of a company’s confidential commercial information or the protection of its intellectual property. If we cannot demonstrate that such interests will be harmed, we may be unable to prevent our competitors from benefiting from the expertise of our former employees or consultants and our ability to remain competitive may be diminished.
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If we fail to manage our growth effectively, our business could be disrupted.
Our future financial performance and ability to commercialize our products and to compete effectively will depend, in part, on our ability to manage any future growth effectively. We have made and expect to continue to make significant investments to enable our future growth through, among other things, new product innovation, clinical trials for new products and expansion of our manufacturing facility. We must also be prepared to further increase production capabilities, expand our work force and to train, motivate and manage additional employees as the need for additional personnel arises. Our personnel, facilities, systems, procedures and controls may not be adequate to support our future operations. Any failure to manage future growth effectively could have a material adverse effect on our business and results of operations.
Risks related to government regulation
We are subject to significant and increasing government regulations regarding the sale and marketing of our products.
The selling and marketing of our products are generally subject to comprehensive laws, regulations and standards enforced by various regional, national and local regulatory bodies, including the Food and Drug Administration, or FDA, the Federal Trade Commission, or FTC, and U.S. Department of Agriculture, or USDA, in the United States, the European Commission in the European Union, the Therapeutic Goods Administration, or TGA, in Australia, the Ministry of Health in China, the Health Sciences Authority, or HAS in Singapore, and the Ministry of Health in Israel and others. Compliance with the various regulatory bodies' requirements is costly and time consuming. See “Item 4. Information on Enzymotec — Business Overview — Government regulation” below. Furthermore, legal and regulatory demands are increasing in a number of countries with respect to our products, and legislative bodies may repeal laws or enact new laws that would impact the sale and marketing of our products or development of new products. Additionally, regulatory authorities may change processes, regulations, and policies related to our products, which could impact product development, commercialization and business operations and require us to make changes to our products, the claims we make regarding our products or our operations. In addition, there is a lack of harmonization among the laws, regulations and standards in the principal countries in which we sell our products.
Nutrition Segment
Where regulatory approvals are required for our nutrition products, the process of obtaining such approvals can be costly and time consuming and there is no guarantee of approval. Such processes therefore could delay or prevent the production and commercialization of new products. In addition, if we fail to comply with any legal or regulatory requirement, or fail to obtain any necessary regulatory approval we could be subject to various enforcement actions, including warning letters, fines, product recalls or seizures, interruption in or suspension of product manufacturing capabilities, other operating restrictions, injunctions, delays in obtaining or inability to obtain product approvals, other civil penalties and criminal sanctions. Any such enforcement action may result in significant unanticipated expenditures and may have a material adverse effect on our reputation, operations, financial situation or operating results.
The regulatory requirements we face similarly may impact our reputation, operations, financial situation or operating results. For example, legislation in the United States requires companies that manufacture or distribute dietary supplements, including certain products of our Nutrition segment, to report serious adverse events allegedly associated with their products to the FDA and maintain recordkeeping procedures for all alleged adverse events (serious and non-serious). As a result, consumers, the press or government regulators may misinterpret reports of adverse events as evidence that the ingredient or product caused the reported event, which could lead to consumer confusion, damage to our reputation, banned or recalled ingredients or products, increased insurance costs, class action litigation and a potential increase in product liability litigation, among other things.
Further, we comply with current GMP guidelines for food for human consumption and are subject to periodic self-assessment. We are subject to regular inspections with respect to our GMP compliance by the Israeli Ministry of Health. We also maintain an ISO 9001-2008 quality system certificate and a Hazard Analysis and Critical Control Points (HACCP) certificate for food safety. For more information regarding the regulations affecting our nutrition products, see “Item 4.E. Information on Enzymotec — Business Overview – Government regulation — Nutrition segment.”
VAYA Pharma Segment
The products offered by our VAYA Pharma segment are sold under physician supervision in the United States as “medical foods,” which do not require premarket approval, on the basis of their meeting the criteria for “medical foods” in the FDCA and FDA regulations. Although we believe that our VAYA Pharma products meet the criteria for “medical foods” established by the FDCA, and that the labeling and marketing of our medical foods is consistent with FDA regulatory requirements, our offering of one or more of these products as “medical food” could be challenged by the FDA, which could have a material adverse effect on the results and operations of our VAYA Pharma segment. For more information regarding this risk, see “—Our offering of products as “medical foods” in the United States may be challenged by regulatory authorities.”
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The FTC regulates certain aspects of the advertising and marketing of our products. Under the Federal Trade Commission Act, a company must be able to substantiate both the express and implied claims that are conveyed by an advertisement. It is not uncommon for the FTC to conduct an investigation of the claims that are made about products in new and emerging areas of science that involve a potentially vulnerable population such as infants and children, or that relate to conditions impacting significant portions of the population. Any adverse action by the FTC could have a negative impact on our results of operations and financial condition.
Sales in the United States of the products of our VAYA Pharma segment are significantly impacted by the reimbursement policies of government healthcare or private health insurers.
The products offered by our VAYA Pharma segment are sold in the United States on the basis of their meeting the requirements for “medical foods,” as interpreted and enforced by the FDA. Medical foods are not required to undergo premarket review or approval by the FDA, as is required for prescription drugs. However, primarily because our VAYA Pharma products are not approved as prescription drugs by the FDA, most consumers purchasing these products in the United States are currently unable to obtain reimbursement from third-party payers under government healthcare or private insurance plans, which generally do not provide reimbursement for medical foods. As of the end of the fourth quarter of 2014, approximately 30% of sales of VAYA Pharma products in the United States received some form of reimbursement. While we are attempting to broaden acceptance of our VAYA Pharma products as eligible for reimbursement by third-party payers, no assurance can be given that we will be successful in our efforts. We believe that, unless we are able to obtain widespread reimbursement for our VAYA Pharma products in the United States, future sales and profitability of our VAYA Pharma products may be significantly adversely impacted and we may be unable to achieve our projected sales of these products, which could have a material adverse effect on our business, financial condition and results of operations.
Should any of our products receive FDA approval as a prescription drug, such pharmaceutical products may still not qualify for reimbursement or the terms of such reimbursement may prevent the product from being sold at a cost-effective price.
In 2013, we started the process of seeking FDA approval for one of our VAYA Pharma products, Vayarol, as a prescription drug. See “Item 4.E. Information on Enzymotec — Business Overview — Government regulation” below. There can be no assurance that this process will be successful. If we do receive FDA approval for Vayarol, or any of our other VAYA Pharma products, as a prescription drug, consumers purchasing such products in the United States may be able to more easily obtain reimbursement from third-party payers under government healthcare or private insurance plans. However, we would then be subject to the reimbursement policies of such third-party payers and their efforts to contain or reduce the costs of health care. In addition, certain U.S. federal and state laws currently apply to the pricing and reporting of price information for prescription drugs. There also have been, and we expect that there will continue to be, a number of U.S. federal and state proposals to further increase government control over pricing and profitability of prescription drugs. Moreover, the emphasis on managed health care in the United States has increased and will continue to increase the pressure on the pricing of pharmaceuticals. Third-party payers are increasingly challenging the prices charged for medical products. To the extent that we succeed in obtaining FDA prescription drug approval for any of our products, there can be no assurance that such product will qualify for reimbursement from third-party payers, or if it does, whether the terms of such reimbursement will be considered cost-effective or will be sufficient to allow the sale of these products by us on a competitive basis.
Risks related to our intellectual property
We may not be able to protect our proprietary technology or prevent its unauthorized use by third parties.
Our ability to obtain and maintain patent protection and trade secret protection for our intellectual property and proprietary technologies, our products and their uses is important to our commercial success. We rely on a combination of patent, copyright, trademark and trade secret laws, non-disclosure and confidentiality agreements, licenses, assignments of invention agreements and other restrictions on disclosure and use to protect our intellectual property rights.
We have been granted over 85 patents in more than a dozen countries and have applications for approximately 80 additional patents pending worldwide.
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Patents that claim specific molecules or active ingredients are generally considered to be the strongest form of intellectual property protection for products that are new molecules. However, as the main ingredients of our products are derived from nature, those types of claims are generally not available for our products. Instead, our issued patents and pending patent applications cover specifically selected narrow compositions, proprietary processes used in the manufacture of certain products, or specific uses for certain products. Accordingly, other parties may compete with us, for example, by independently developing or obtaining similar or competing technologies, designing around our patents and/or marketing competing products that do not claim our patented uses.
Furthermore, there can be no assurance that patent applications relating to our products, processes or technologies will result in patents being issued, or that any patents that have been issued will be adequate to protect our intellectual property or that we will enjoy patent protection for any significant period of time. Additionally, any issued patents may be challenged by third parties, and patents that we hold may be found by a judicial authority to be invalid or unenforceable. If any of our composition-of-matter patents or pending applications was to be subject to a successful challenge or failed to issue, our business and competitive advantage could be significantly affected. Other parties may independently develop similar or competing technology or design around any patents that may be issued to or held by us. Our current patents will expire or they may otherwise cease to provide meaningful competitive advantage, and we may be unable to adequately develop new technologies and obtain future patent protection to preserve our competitive advantage or avoid adverse effects on our business.
In addition to seeking patents for some of our proprietary technologies, processes and products, we also rely on trade secrets, including unpatented know-how, technology and other proprietary information in attempting to develop and maintain a competitive position. However, trade secret protection is risky and uncertain and the disclosure or independent development of our proprietary technology could have a material adverse impact on our business and results of operations. Any party with whom we have executed non-disclosure and/or non-use agreements may breach those agreements and disclose our proprietary technology, including our trade secrets, and we may not be able to obtain adequate remedies for such breaches. Enforcing a claim that a party illegally disclosed or misappropriated a trade secret is difficult, expensive and time-consuming, and a favorable outcome is not guaranteed. In addition, if any of our trade secrets were to be lawfully obtained or independently developed by a competitor, we would have no right to prevent such third party, or those to whom they communicate such technology or information, from using that technology or information to compete with us.
We cannot be certain that the steps that we have taken will prevent the misappropriation or other violation of our confidential information and other intellectual property, particularly in foreign countries, such as China, in which laws may not protect our proprietary rights as fully as in the United States and other developed economies. Moreover, if we lose any key personnel, we may not be able to prevent the unauthorized disclosure or use of our technical knowledge or other trade secrets by those former employees. If we are unable to maintain the security of our proprietary technology, this could materially adversely affect our competitive advantage, business and results of operations.
We may become subject to litigation regarding intellectual property rights.
Our commercial success depends in part on our ability to operate without infringing upon the proprietary rights of others. In recent years, there has been significant litigation in the United States and abroad involving patents and other intellectual property rights in the industries in which we operate. As discussed above, we were previously involved in legal proceedings in the United States concerning our krill oil products with Neptune, one of our principal competitors in the krill oil market which resulted in a final settlement and license agreement.
We may also, in the future, be a party to litigation to determine the scope and validity of our own intellectual property, which, if resolved adversely to us, could invalidate or render unenforceable our intellectual property or generally preclude us from restraining competitors from commercializing products using technology developed by us. In addition, because patent applications can take many years until the patents issue, there may be applications now pending of which we are unaware, which may later result in issued patents that our products may infringe. If any of our products infringe a valid and enforceable patent, or if we wish to avoid potential intellectual property litigation or alleged infringement, we may not be able to sell applicable products unless and until we can obtain a license, which we may not be able to obtain on commercially reasonable terms, if at all. Alternatively, we could be forced to pay substantial royalties or redesign a product to avoid infringement. A successful claim of infringement against us, or our failure or inability to develop non-infringing technology or license the infringed technology, on acceptable terms and on a timely basis, if at all, could materially adversely affect our business and results of operations. These outcomes could also directly and indirectly benefit our competitors, including, for example, by obtaining judgments against or payments from us, reputational harm to us and our products, and/or gaining market share from us. Furthermore, litigation to establish or challenge the validity of patents, to defend against infringement, enforceability or invalidity claims or to assert infringement, invalidity or enforceability claims against others, if required, regardless of its success, would likely be time-consuming and expensive to resolve and would divert management’s time and attention, which could seriously harm our business.
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In addition to our existing agreements related to the Neptune litigation (see “Item 8. Financial Information — Consolidated Financial Statements and Other Financial Information — Legal Proceedings”) we may in the future agree to be financially responsible for any damages awarded against certain of our customers, and in some cases the cost of defense for such customers, as a result of the purchase, importation, use, sale or offer to sell of our products that a third party claims infringes its intellectual property rights. If any of the products at issue are found to infringe the valid and enforceable intellectual property right of such third party, the payment of such damages could have a materially adverse impact on our financial results and business.
It is possible that the products currently marketed or under development by us may in the future be found to infringe patents issued or licensed to others or otherwise violate the intellectual property rights of others. Likewise, it is possible that other parties may independently develop similar technologies, duplicate our technologies or, with respect to patents that are issued to us, or rights licensed to us, design around the patented aspects of the technologies. Third parties may also obtain patents that we may need to license from them in order to conduct our business.
Changes in U.S. or foreign patent law could diminish the value of patents in general, thereby impairing our ability to protect our products.
Obtaining and enforcing patents involves technological and legal complexity, and is costly, time consuming, and inherently uncertain. Patent policy also continues to evolve in the United States and many foreign jurisdictions and the issuance, scope, validity, enforceability and commercial value of our patent rights are highly uncertain. For example, the U.S. Supreme Court has ruled on several patent cases in recent years, including narrowing the scope of patent protection available in certain circumstances or weakening the rights or remedies of patent owners in certain situations. In addition to increasing uncertainty with regard to our ability to obtain patents in the future, this combination of events has created uncertainty with respect to the value of patents, once obtained. Furthermore, decisions by the U.S. Congress, the federal courts, and the U.S. Patent and Trademark Office or comparable authorities in foreign jurisdictions could change the laws and regulations governing patents in unpredictable ways that may weaken or undermine our ability to obtain new patents or to enforce our existing patents and patents we might obtain in the future.
We may not be able to protect our intellectual property rights throughout the world.
Filing, prosecuting, maintaining and defending patents on each of our products in all countries throughout the world would be prohibitively expensive, and our intellectual property rights in some countries outside the United States are less extensive than those in the United States. In addition, the laws of some foreign countries do not protect intellectual property rights to the same extent as federal and state laws in the United States. Also, it may not be possible to effectively enforce intellectual property rights in some foreign countries at all or to the same extent as in the United States and other countries. Consequently, we are unable to prevent third parties from using our inventions in all countries, or from selling or importing products made using our inventions in the jurisdictions in which we do not have (or are unable to effectively enforce) patent protection. Competitors may use our technologies in jurisdictions where we have not obtained patent protection to develop, market or otherwise commercialize their own products, and we may be unable to prevent those competitors from importing those infringing products into territories where we have patent protection but enforcement is not as strong as in the United States. These products may compete with our products and our patents and other intellectual property rights may not be effective or sufficient to prevent them from competing in those jurisdictions. Moreover, competitors or others in the chain of commerce may raise legal challenges against our intellectual property rights or may infringe upon our intellectual property rights, including through means that may be difficult to prevent or detect.
Many companies have encountered significant problems in protecting and defending intellectual property rights in foreign jurisdictions, including China, a significant market for InFat and other products. The legal systems of certain countries, including China, have not historically favored the enforcement of patents or other intellectual property rights, which could hinder us from preventing the infringement of our patents or other intellectual property rights in those countries and result in substantial risks to us.
Furthermore, proceedings to enforce our patent rights in the United States or foreign jurisdictions could result in substantial costs and divert our efforts and attention from other aspects of our business, could put our patents at risk of being invalidated or interpreted narrowly and our patent applications at risk of not issuing, and could provoke third parties to assert patent infringement or other claims against us. We may not prevail in any lawsuits that we initiate and the damages or other remedies awarded, if any, may not be commercially meaningful. Accordingly, our efforts to enforce our intellectual property rights in the United States and around the world may be inadequate to obtain a significant commercial advantage from the intellectual property that we develop or license from third parties.
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Risks related to our ordinary shares
The market price of our ordinary shares may be subject to fluctuation, regardless of our operating results and financial condition. As a result, our shareholders could lose all or part of their investment.
The stock market in general, and the market price of our ordinary shares, have been and will be subject to fluctuation, whether due to, or irrespective of, our operating results and financial condition. During 2014, our share price ranged from $6.43 to $29.50. The market price of our ordinary shares on the NASDAQ Global Select Market may fluctuate as a result of a number of factors, some of which are beyond our control, including, but not limited to:
• | actual or anticipated variations in our and our competitors’ results of operations and financial condition; |
• | market acceptance of our products; |
• | the mix of products that we sell, and related services that we provide; |
• | changes in earnings estimates or recommendations by securities analysts, if our ordinary shares continue to be covered by analysts; |
• | the results of operations of AL and the outcome of our arbitration proceedings with AAK; |
• | development of technological innovations or new competitive products by others; |
• | outcome of litigation in which we may be involved from time to time; |
• | announcements of technological innovations or new products by us; |
• | publication of the results of pre-clinical or clinical trials for any of our products or products under development; |
• | failure by us to achieve a publicly announced milestone; |
• | delays between our expenditures to develop and market new or enhanced products and the generation of sales from those products; |
• | developments concerning intellectual property rights, including our involvement in litigation; |
• | regulatory developments and the decisions of regulatory authorities as to the marketing of our current products or the approval or rejection of new or modified products; |
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• | changes in the amounts that we spend to develop, acquire or license new products, technologies or businesses; |
• | changes in our expenditures to promote our products; |
• | our sale or proposed sale, or the sale by our significant shareholders, of our ordinary shares or other securities in the future; |
• | changes in key personnel; |
• | success or failure of research and development projects of us or our competitors; |
• | the trading volume of our ordinary shares; and |
• | general economic and market conditions and other factors, including factors unrelated to our operating performance. |
These factors and any corresponding price fluctuations may materially and adversely affect the market price of our ordinary shares and result in substantial losses being incurred by our investors. In the past, following periods of market volatility, public company shareholders have often instituted securities class action litigation. Lawsuits brought against us by shareholders, such as the shareholder class action suits filed in September 2014 against us, our directors, certain of our executive officers and underwriters of our initial public offering, could cause us to incur substantial costs defending the lawsuits and divert the resources and attention of our management from the operation of our business.
If equity research analysts do not continue to publish research or reports about our business or if they issue unfavorable commentary or downgrade our ordinary shares, the price of our ordinary shares could decline.
The trading market for our ordinary shares will rely in part on the research and reports that equity research analysts publish about us and our business. We do not have control over these analysts and we do not have commitments from them to write research reports about us. The price of our ordinary shares could decline if one or more equity research analysts downgrades our ordinary shares or if those analysts issue other unfavorable commentary or cease publishing reports about us or our business.
Future sales of our ordinary shares could reduce the market price of our ordinary shares.
If our existing shareholders, particularly our largest shareholders, our directors, their affiliates, or our executive officers, sell a substantial number of our ordinary shares in the public market, the market price of our ordinary shares could decrease significantly. The perception in the public market that these shareholders might sell our ordinary shares could also depress the market price of our ordinary shares and could impair our future ability to obtain capital, especially through an offering of equity securities.
We have incurred and could continue to incur increased costs as a result of operating as a public company, and our management has been and may continue to be required to devote substantial time to new compliance initiatives.
We completed our initial public offering in 2013 and, as a public company whose ordinary shares are listed in the United States, we have incurred and will continue to incur significant accounting, legal and other expenses, including costs associated with our reporting requirements under the U.S. Securities Exchange Act of 1934, as amended, or the Exchange Act. We could also incur additional costs associated with corporate governance requirements, including requirements under Section 404 and other provisions of the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act, as well as rules implemented by the SEC and the NASDAQ Global Select Market, and provisions of Israeli corporate law applicable to public companies. These rules and regulations could continue to increase our legal and financial compliance costs and make some activities more time-consuming and costly. We are currently evaluating and monitoring developments with respect to these rules, and we cannot predict or estimate the amount of additional costs we may incur or the timing of such costs.
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As an “emerging growth company,” as defined in the Jumpstart Our Business Startups Act of 2012 effective on April 5, 2012, or the JOBS Act, we take advantage of certain temporary exemptions from various reporting requirements, including, but not limited to, not being required to comply with the auditor attestation requirements of Section 404 of the Sarbanes Oxley Act (and the rules and regulations of the SEC thereunder). When these exemptions cease to apply, we expect to incur additional expenses and devote increased management effort toward ensuring compliance with them. We cannot predict or estimate the amount of additional costs we may incur as a result of becoming a public company or the timing of such costs.
Changes in the laws and regulations affecting public companies will result in increased costs to us as we respond to their requirements. These laws and regulations could make it more difficult or more costly for us to obtain certain types of insurance, including director and officer liability insurance, and we may be forced to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. The impact of these requirements could also make it more difficult for us to attract and retain qualified persons to serve on our board of directors, our board committees or as executive officers. We cannot predict or estimate the amount or timing of additional costs we may incur in order to comply with such requirements.
We have never paid cash or non-cash dividends on our share capital, and we do not anticipate paying any cash or non-cash dividends in the foreseeable future.
We have never declared or paid cash or non-cash dividends on our share capital, nor do we anticipate paying any cash or non-cash dividends on our share capital in the foreseeable future. We currently intend to retain all available funds and any future earnings to fund the development and growth of our business. As a result, capital appreciation, if any, of our ordinary shares will be investors’ sole source of gain for the foreseeable future. In addition, Israeli law limits our ability to declare and pay dividends, and may subject our dividends to Israeli withholding taxes and our payment of dividends (out of tax-exempt income) may subject us to certain Israeli taxes, to which we would not otherwise be subject (see “Item 8.A. Financial Information — Consolidated Financial Statements and Other Financial Information — Dividend policy”, “Item 10.B. Additional Information — Memorandum of Association and Articles of Association—Dividend and liquidation rights” and “Item 10.E. Additional Information — Taxation — Israeli tax considerations and government programs”).
As a foreign private issuer, we are permitted to follow certain home country corporate governance practices instead of otherwise applicable SEC and NASDAQ requirements, which may result in less protection than is accorded to investors under rules applicable to domestic U.S. issuers.
As a foreign private issuer, we are permitted to, and do, follow certain home country corporate governance practices instead of those otherwise required under the Listing Rules of the NASDAQ Stock Market for domestic U.S. issuers. For instance, we follow home country practice in Israel with regard to the quorum requirement for shareholder meetings. As permitted under the Israeli Companies Law, our articles of association provide that the quorum for any meeting of shareholders shall be the presence of at least two shareholders present in person, by proxy or by a voting instrument, who hold at least 25% of the voting power of our shares instead of 33 1/3% of the issued share capital requirement. These quorum requirements for the meeting of our shareholders are lower than is customary for domestic issuers. We may in the future elect to follow home country practices in Israel with regard to other matters, including the formation of compensation, nominating and corporate governance committees, separate executive sessions of independent directors and non-management directors and the requirement to obtain shareholder approval for certain dilutive events (such as for the establishment or amendment of certain equity-based compensation plans, issuances that will result in a change of control of the company, certain transactions other than a public offering involving issuances of a 20% or more interest in the company and certain acquisitions of the stock or assets of another company). Following our home country governance practices as opposed to the requirements that would otherwise apply to a U.S. company listed on the NASDAQ Global Select Market may provide less protection to you than what is accorded to investors under the Listing Rules of the NASDAQ Stock Market applicable to domestic U.S. issuers.
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As a foreign private issuer, we are not subject to the provisions of Regulation FD or U.S. proxy rules and are exempt from filing certain Exchange Act reports.
As a foreign private issuer, we are exempt from the rules and regulations under the Exchange Act related to 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 annual and current reports and financial statements with the SEC as frequently or as promptly as U.S. domestic companies whose securities are registered under the Exchange Act, we are permitted to disclose limited compensation information for our executive officers on an individual basis and we will generally be exempt from filing quarterly reports with the SEC under the Exchange Act. Moreover, we are not required to comply with Regulation FD, which restricts the selective disclosure of material nonpublic information to, among others, broker-dealers and holders of a company’s securities under circumstances in which it is reasonably foreseeable that the holder will trade in the company’s securities on the basis of the information. These exemptions and leniencies will reduce the frequency and scope of information and protections to which you may otherwise have been eligible in relation to a U.S. domestic issuer.
We would lose our foreign private issuer status if a majority of our directors or executive officers are U.S. citizens or residents and we fail to meet additional requirements necessary to avoid loss of foreign private issuer status. Although we have elected to comply with certain U.S. regulatory provisions, our loss of foreign private issuer status would make such provisions mandatory. The regulatory and compliance costs to us under U.S. securities laws as a U.S. domestic issuer may be significantly higher. If we are not a foreign private issuer, we will be required to file periodic reports and registration statements on U.S. domestic issuer forms with the SEC, which are more detailed and extensive than the forms available to a foreign private issuer. We may also be required to modify certain of our policies to comply with accepted governance practices associated with U.S. domestic issuers. Such conversion and modifications will involve additional costs. In addition, we may lose our ability to rely upon exemptions from certain corporate governance requirements on U.S. stock exchanges that are available to foreign private issuers.
We are an “emerging growth company” and the reduced disclosure requirements applicable to emerging growth companies may make our ordinary shares less attractive to investors.
We are an “emerging growth company,” as defined in the JOBS Act, and we take advantage of certain exemptions from various requirements that are applicable to other public companies that are not “emerging growth companies.” Most of such requirements relate to disclosures that we would only be required to make if we cease to be a foreign private issuer in the future. Nevertheless, as a foreign private issuer that is an emerging growth company, we will not be required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act, for up to five fiscal years after the date of our initial public offering. We will remain an emerging growth company until the earliest of: (a) the last day of our fiscal year during which we have total annual gross revenues of at least $1.0 billion; (b) December 31, 2018, the last day of our fiscal year following the fifth anniversary of the closing of our initial public offering; (c) the date on which we have, during the previous three-year period, issued more than $1.0 billion in non-convertible debt; or (d) the date on which we are deemed to be a “large accelerated filer” under the Exchange Act. When we are no longer deemed to be an emerging growth company, we will not be entitled to the exemptions provided in the JOBS Act discussed above. We cannot predict if investors will find our ordinary shares less attractive as a result of our reliance on exemptions under the JOBS Act. If some investors find our ordinary shares less attractive as a result, there may be a less active trading market for our ordinary shares and our share price may be more volatile.
While we believe our existing internal control over financial reporting is effective under Section 404 of the Sarbanes-Oxley Act of 2002, as an emerging growth company, we are currently not required to obtain an auditor attestation regarding our internal control.
We are required to comply with the internal control, evaluation and certification requirements of Section 404 of the Sarbanes-Oxley Act as of this annual report. Accordingly, only in 2014 did we commence the process of determining whether our existing internal controls over financial reporting systems are compliant with Section 404. As of December 31, 2014, we are not required to obtain an auditor attestation since, among others, as of June 30, 2014, our market capitalization related to public holdings was under $700 million and our status as an "emerging growth company" was preserved. Unless we lose our status as an “emerging growth company” under the JOBS Act prior to the end of the fiscal year in which the fifth anniversary of our IPO occurred, we will not be required to obtain an auditor attestation under Section 404 of the Sarbanes-Oxley Act until the year ended December 31, 2018. We cannot predict whether we will need to implement remedial actions in order to implement effective control over financial reporting. The determination and any remedial actions required could result in us incurring additional costs that we did not anticipate. Irrespective of compliance with Section 404, any failure of our internal controls could have a material adverse effect on our stated results of operations and harm our reputation. As a result, we may experience higher than anticipated operating expenses, as well as higher independent auditor fees during and after the implementation of these changes. If we are unable to implement any of the required changes to our internal control over financial reporting effectively or efficiently, it could adversely affect our operations, financial reporting and/or results of operations and could result in an adverse opinion on internal controls from our independent auditors.
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Our U.S. shareholders may suffer adverse tax consequences if we are characterized as a passive foreign investment company.
Generally, if for any taxable year 75% or more of our gross income is passive income, or at least 50% of the average quarterly value of our assets (which may be determined in part by the market value of our ordinary shares, which is subject to change) are held for the production of, or produce, passive income, we would be characterized as a passive foreign investment company, or PFIC, for U.S. federal income tax purposes. Based on our gross income and gross assets, we do not believe that we were classified as a PFIC for the taxable year ended December 31, 2014. There can be no assurance that we will not be considered a PFIC for 2015 or any future taxable year. PFIC status is determined as of the end of the taxable year and depends on a number of factors, including the value of a corporation’s assets and the amount and type of its gross income. Furthermore, because the value of our gross assets is likely to be determined in large part by reference to our market capitalization, a decline in the value of our ordinary shares may result in our becoming a PFIC. If we are characterized as a PFIC, our U.S. shareholders may suffer adverse tax consequences, including having gains realized on the sale of our ordinary shares treated as ordinary income, rather than a capital gain, the loss of the preferential rate applicable to dividends received on our ordinary shares by individuals who are U.S. Holders (as defined in “Item 10.E. Additional Information — Taxation — U.S. federal income tax consequences”), and having interest charges apply to distributions by us and the proceeds of share sales. Certain elections exist that may alleviate some of the adverse consequences of PFIC status and would result in an alternative treatment (such as mark-to-market treatment) of our ordinary shares; however, we do not intend to provide the information necessary for U.S. holders to make qualified electing fund elections if we are classified as a PFIC. See “Item 10.E. Additional Information — Taxation — Passive foreign investment company consequences.”
Risks primarily related to our operations in Israel
Our headquarters, manufacturing and other significant operations are located in Israel and, therefore, our results may be adversely affected by political, economic and military instability in Israel.
Our headquarters, manufacturing and principal research and development facilities are located in northern Israel. In addition, the majority of our key employees, officers and directors are residents of Israel. Accordingly, political, economic and military conditions in Israel may directly affect our business. Since the establishment of the State of Israel in 1948, a number of armed conflicts have taken place between Israel and its neighboring countries. Any hostilities involving Israel or the interruption or curtailment of trade between Israel and its trading partners could adversely affect our operations and results of operations. In addition, our operations may be adversely affected by the call-up of certain of our employees, including members of our senior management, to active military service in the case of such hostilities.
During the Second Lebanon War of 2006, between Israel and Hezbollah, a militant Islamic movement, rockets were fired from Lebanon into Israel causing casualties and major disruption of economic activities in northern Israel. An escalation in tension and violence between Israel and the militant Hamas movement (which controls the Gaza Strip) and other Palestinian Arab groups, culminated with Israel’s military campaign in Gaza in December 2008 and again in November 2012 and in July and August 2014 in an endeavor to prevent continued rocket attacks against Israel’s southern towns. It is unclear whether any negotiations that may occur between Israel and the Palestinian Authority will result in an agreement. In addition, Israel faces threats from more distant neighbors, in particular, Iran, an ally of Hezbollah and Hamas.
Our commercial insurance does not cover losses that may occur as a result of an event associated with the security situation in the Middle East. Although the Israeli government is currently committed to covering the reinstatement value of direct damages that are caused by terrorist attacks or acts of war, we cannot assure you that this government coverage will be maintained, or if maintained, will be sufficient to compensate us fully for damages incurred. Any losses or damages incurred by us could have a material adverse effect on our business. Any armed conflict involving Israel could adversely affect our operations and results of operations.
Further, our operations could be disrupted by the obligations of personnel to perform military service. As of December 31, 2014, we had 136 employees based in Israel, some of whom may be called upon to perform up to 54 days in each three year period (and in the case of officers, up to 84 days in each three year period) of military reserve duty until they reach the age of 40 (and in some cases, depending on their specific military profession up to 45 or even 49 years of age) and, in certain emergency circumstances, may be called to immediate and unlimited active duty. The number of our employees that were called to military reserve duty in the last three years was 19, including only one member of management. Our operations could be disrupted by the absence of a significant number of employees related to military service, which could materially adversely affect our business and results of operations.
Several countries, principally in the Middle East, restrict doing business with Israel and Israeli companies, and additional countries may impose restrictions on doing business with Israel and Israeli companies whether as a result of hostilities in the region or otherwise. In addition, there have been increased efforts by activists to cause companies and consumers to boycott Israeli goods based on Israeli government policies. Such actions, particularly if they become more widespread, may adversely impact our ability to sell our products.
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Exchange rate fluctuations between the U.S. dollar and the Israeli shekel, the Euro and other non-U.S. currencies may negatively affect our earnings.
The dollar is our functional and reporting currency. Although most of our revenues and a portion of our expenses are denominated in U.S. dollars, a significant portion of our cost of revenues and operating expenses is incurred in Israeli shekels. As a result, we are exposed to the risks that the shekel may appreciate relative to the dollar, or, if the shekel instead devalues relative to the dollar, that the inflation rate in Israel may exceed such rate of devaluation of the shekel, or that the timing of such devaluation may lag behind inflation in Israel. In any such event, the dollar cost of our operations in Israel would increase and our dollar-denominated results of operations would be adversely affected. We cannot predict any future trends in the rate of inflation in Israel or the rate of devaluation (if any) of the shekel against the dollar. For example, the rate of devaluation of the dollar against the shekel was approximately 2.3% in 2012, and approximately 7.0% in 2013, which was compounded by inflation in Israel at a rate of approximately 1.6% and 1.8%, respectively. This had the effect of increasing the dollar cost of our operations in Israel. While the dollar appreciated relative to the shekel by 12.0% in 2014, eclipsing the 0.2% rate of deflation in Israel in that year, there is no guarantee that the prior trend of dollar devaluation relative to the shekel will not return in the future. If the dollar cost of our operations in Israel increases, our dollar-measured results of operations will be adversely affected. Our operations also could be adversely affected if we are unable to effectively hedge against currency fluctuations in the future.
Although most of our revenues and a portion of our expenses are denominated in dollars, we do have substantial revenues and certain expenses that are denominated in other currencies apart from the dollar and the shekel, particularly the euro. Therefore, our operating results and cash flows are also subject to fluctuations due to changes in the relative values of the dollar and these foreign currencies. These fluctuations could negatively affect our operating results and could cause our revenues and net income or loss to vary from quarter to quarter. Furthermore, to the extent that we increase our revenues in certain countries, such as several countries in the Asia Pacific region, where our sales are denominated in dollars, a strengthening of the dollar versus other currencies could make our products less competitive in those foreign markets and collection of receivables more difficult.
We engage in currency hedging activities. These measures, however, may not adequately protect us from material adverse effects due to the impact of inflation in Israel or from fluctuations in the relative values of the dollar and foreign currencies in which we transact business, and may result in a financial loss. For further information, see “Item 11. Quantitative and Qualitative Disclosures About Market Risk” elsewhere in this annual report.
We may become subject to claims for remuneration or royalties for assigned service invention rights by our employees, which could result in litigation and adversely affect our business.
We enter into assignment of invention agreements with our employees pursuant to which such individuals agree to assign to us all rights to any inventions created in the scope of their employment or engagement with us. A significant portion of our intellectual property has been developed by our employees in the course of their employment for us. Under the Israeli Patent Law, 5727-1967, or the Patent Law, inventions conceived by an employee during the scope of his or her employment with a company are regarded as “service inventions,” which belong to the employer, absent a specific agreement between the employee and employer giving the employee service invention rights. The Patent Law also provides that if there is no such agreement between an employer and an employee, the Israeli Compensation and Royalties Committee, or the Committee, a body constituted under the Patent Law, shall determine whether the employee is entitled to remuneration for his or her inventions. Recent decisions by the Committee have created uncertainty in this area, as it held that employees may be entitled to remuneration for their service inventions despite having specifically waived any such rights. However, a recent decision by the Committee held that such right can be waived by the employee. The Committee further held that an explicit reference to the waived right is not necessary in every circumstance in order for the employee’s waiver of such right to be valid. Such waiver can be formalized in writing or orally or be implied by the actions of the parties in accordance with the rules of interpretation of Israeli contract law. Although our employees have agreed to assign to us service invention rights, we may face claims demanding remuneration in consideration for assigned inventions. As a consequence of such claims, we could be required to pay additional remuneration or royalties to our current and/or former employees, or be forced to litigate such claims, which could negatively affect our business.
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The government tax benefits that we currently receive require us to meet several conditions and may be terminated or reduced in the future.
Some of our operations in Israel, referred to as “Approved Enterprises” and “Benefited Enterprises,” carry certain tax benefits under the Law for the Encouragement of Capital Investments, 5719-1959, or the Investment Law. Based on an evaluation of the relevant factors under the Investment Law, including the level of foreign (i.e. non-Israeli) investment in our company, we have determined that our effective tax rate to be paid with respect to all of our Israeli operations under these benefits programs is 0%, based on the available level of benefits under the law. Substantially all of our income before taxes can be attributed to these programs. If we do not meet the requirements for maintaining these benefits, they may be reduced or cancelled and the relevant operations would be subject to Israeli corporate tax at the standard rate, which is 26.5% for 2014 and thereafter. In addition to being subject to the standard corporate tax rate, we could be required to refund any tax benefits that we have already received, plus interest and penalties thereon. Even if we continue to meet the relevant requirements, the tax benefits that our current “Approved Enterprise” and “Benefited Enterprises” receive may not be continued in the future at their current levels or at all. If these tax benefits were reduced or eliminated, the amount of taxes that we pay would likely increase, as all of our operations would consequently be subject to corporate tax at the standard rate, which could adversely affect our results of operations. Additionally, if we increase our activities outside of Israel, for example, by way of acquisitions, our increased activities may not be eligible for inclusion in Israeli tax benefit programs. See “Item 10.E. Additional Information — Taxation — Tax benefits under the Law for the Encouragement of Capital Investments, 5719-1959” for additional information concerning these tax benefits.
We received Israeli government grants for certain research and development activities. The terms of those grants require us to satisfy specified conditions and to pay penalties in addition to repayment of the grants upon certain events.
Our research and development efforts were and are financed in part through grants from the Office of the Chief Scientist in the Israeli Ministry of Economy (formerly the Ministry of Industry, Trade and Labor), or OCS.
Even following full repayment of any OCS grants, we must nevertheless continue to comply with the requirements of the Israeli Law for the Encouragement of Industrial Research and Development, 1984, and related regulations, or the Research Law. When a company develops know-how, technology or products using OCS grants, the terms of these grants and the Research Law restrict the transfer outside of Israel of such know-how, and the manufacturing or manufacturing rights of such products, technologies or know-how, without the prior approval of the OCS. Therefore, if aspects of our technologies are deemed to have been developed with OCS funding, the discretionary approval of an OCS committee would be required for any transfer to third parties outside of Israel of know-how or manufacturing or manufacturing rights related to those aspects of such technologies. We may not receive those approvals. Furthermore, the OCS may impose certain conditions on any arrangement under which it permits us to transfer technology or development out of Israel.
The transfer of OCS-supported technology or know-how outside of Israel may involve the payment of significant penalties and other amounts, depending upon the value of the transferred technology or know-how, the amount of OCS support, the time of completion of the OCS-supported research project and other factors. These restrictions and requirements for payment may impair our ability to sell our technology assets outside of Israel or to outsource or transfer development or manufacturing activities with respect to any product or technology outside of Israel. Furthermore, the consideration available to our shareholders in a transaction involving the transfer outside of Israel of technology or know-how developed with OCS funding (such as a merger or similar transaction) may be reduced by any amounts that we are required to pay to the OCS.
Provisions of Israeli law and our amended articles of association may delay, prevent or otherwise impede a merger with, or an acquisition of, us, even when the terms of such a transaction are favorable to us and our shareholders.
Israeli corporate law regulates mergers, requires tender offers for acquisitions of shares above specified thresholds, requires special approvals for transactions involving directors, officers or significant shareholders and regulates other matters that may be relevant to such types of transactions. For example, a tender offer for all of a company’s issued and outstanding shares can only be completed if the acquirer receives positive responses from the holders of at least 95% of the issued share capital. Completion of the tender offer also requires approval of a majority of the offerees that do not have a personal interest in the tender offer, unless at least 98% of the company’s outstanding shares are tendered. Furthermore, the shareholders, including those who indicated their acceptance of the tender offer (unless the acquirer stipulated in its tender offer that a shareholder that accepts the offer may not seek appraisal rights), may, at any time within six months following the completion of the tender offer, petition an Israeli court to alter the consideration for the acquisition. See “Item 10.B. Additional Information — Memorandum of Association and Articles of Association— Acquisitions under Israeli law” for additional information.
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Our amended articles of association provide that our directors (other than external directors) are elected on a staggered basis, such that a potential acquirer cannot readily replace our entire board of directors at a single annual general shareholder meeting. This could prevent a potential acquirer from receiving board approval for an acquisition proposal that our board of directors opposes.
Furthermore, Israeli tax considerations may make potential transactions unappealing to us or to our shareholders whose country of residence does not have a tax treaty with Israel exempting such shareholders from Israeli tax. For example, Israeli tax law does not recognize tax-free share exchanges to the same extent as U.S. tax law. With respect to mergers, Israeli tax law allows for tax deferral in certain circumstances but makes the deferral contingent on the fulfillment of a number of conditions, including, in some cases, a holding period of two years from the date of the transaction during which sales and dispositions of shares of the participating companies are subject to certain restrictions. Moreover, with respect to certain share swap transactions, the tax deferral is limited in time, and when such time expires, the tax becomes payable even if no disposition of the shares has occurred. These provisions could delay, prevent or impede an acquisition of us or our merger with another company, even if such an acquisition or merger would be beneficial to us or to our shareholders.
It may be difficult to enforce a judgment of a U.S. court against us, our officers and directors or the Israeli experts named in this annual report in Israel or the United States, to assert U.S. securities laws claims in Israel or to serve process on our officers and directors and these experts.
We are incorporated in Israel. All of our executive officers and the Israeli experts and all but two of our directors listed in this annual report reside outside of the United States, and most of our assets and most of the assets of these persons are located outside of the United States. Therefore, a judgment obtained against us, or any of these persons, including a judgment based on the civil liability provisions of the U.S. federal securities laws, may not be collectible in the United States and may not be enforced by an Israeli court. It also may be difficult to effect service of process on these persons in the United States or to assert U.S. securities law claims in original actions instituted in Israel. Israeli courts may refuse to hear a claim based on an alleged violation of U.S. securities laws reasoning that Israel is not the most appropriate forum in which 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 proven as a fact by expert witnesses, 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 that addresses the matters described above. As a result of the difficulty associated with enforcing a judgment against us in Israel, it may not be possible to collect any damages awarded by either a U.S. or foreign court.
The rights and responsibilities of our shareholders are governed by Israeli law, which differs in some material respects from the rights and responsibilities of shareholders of U.S. companies.
The rights and responsibilities of the holders of our ordinary shares are governed by our amended articles of association and by Israeli law. These rights and responsibilities differ in some material respects from the rights and responsibilities of shareholders in U.S.-based corporations. In particular, a shareholder of an Israeli company has a duty to act in good faith and in a customary manner in exercising its rights and performing its obligations towards the company and other shareholders, and to refrain from abusing its power in the company, including, among other things, in voting at a general meeting of shareholders on matters such as amendments to a company’s articles of association, increases in a company’s authorized share capital, mergers and acquisitions and related party transactions requiring shareholder approval. In addition, a shareholder who is aware that it possesses the power to determine the outcome of a shareholder vote or to appoint or prevent the appointment of a director or executive officer in the company has a duty of fairness toward the company. There is limited case law available to assist us in understanding the nature of this duty or the implications of these provisions. These provisions may be interpreted to impose additional obligations and liabilities on holders of our ordinary shares that are not typically imposed on shareholders of U.S. corporations.
ITEM 4: Information on Enzymotec
A. History and Development of Enzymotec |
Our History
Enzymotec Ltd. is a profitable nutritional ingredients and medical foods company. Our proprietary technologies, research expertise, and clinical validation process enable us to develop differentiated solutions across a variety of products. Our innovative and diverse product suite addresses the entire human life-cycle — from infancy to old age — and is comprised of novel key ingredients in products ranging from infant formula to nutritional supplements, as well as branded medical foods, sold only under a doctor’s supervision. We market our product portfolio to established global consumer companies and physicians and target large and growing consumer health and wellness markets. Our strategic partnerships, state-of-the-art good manufacturing practice (“GMP”)-compliant manufacturing facility, and global sales and marketing infrastructure enable us to develop, manufacture and market our comprehensive product solutions to our customers globally.
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Our clinically-validated products include bio-functional lipid-based compounds designed to address dietary needs, medical disorders and common diseases. Lipids represent a major structural component of all life and are essential for cell structure and important biological functions, including energy storage and cell signaling. Our proprietary technologies enable us to identify appropriate lipid-modifying enzymes and then improve the activity of these enzymes to enhance their efficiency, stability and recyclability, as well as to enable their use in organic media. These enhanced enzymes are then utilized to restructure lipids found in natural sources including krill, fish, vegetable sources and bovine milk. We transform the lipids from these raw materials into lipids that are familiar to the human body but cannot be extracted efficiently or in sufficient yield, are not provided in sufficient amounts through normal dietary intake or cannot otherwise be manufactured. For example, our leading infant formula ingredient product, InFat, is produced through modifying the molecular structure of vegetable oils to create an ingredient that more closely resembles a key component of human breast milk that is known to facilitate healthy infant development. Similarly, Vayarin, one of our branded medical foods, utilizes the same technologies to create a safe and stimulant-free solution for the dietary management of certain lipid imbalances associated with attention deficit hyperactivity disorder (“ADHD”) in children. Our expertise also allows us to produce lipid ingredients that have beneficial secondary characteristics, such as extended shelf life, nutrient absorption and improved scent or taste profile. We leverage our technology platform to develop new products, improve our existing leading product portfolio and create new product categories.
We were founded in 1998, launched our first product in 2003 and since then have designed, developed and launched 14 additional products, generating sales in over 30 countries. Our net revenues, adjusted EBITDA and net income for 2014 were $47.1 million, $11.4 million and $7.8 million, respectively. For further discussion on the important events in the development of our business, see “Item 5. Operating and Financial Review and Prospects—Company overview and development.” For a further description of the seasonality of the company’s main business, see “Item 5.A. Operating and Financial Review and Prospects—Operating Results—Seasonality.”
In September 2013, we listed our shares on the Nasdaq Global Select Market. We are a company limited by shares organized under the laws of the State of Israel. We are registered with the Israeli Registrar of Companies. Our registration number is 51-260924-9. Our principal executive offices are located at Sagi 2000 Industrial Area P.O. Box 6, Migdal Ha’Emeq 2310001, Israel, and our telephone number is +972-74-717-7177. Our website address is www.enyzmotec.com. Information contained on, or that can be accessed through, our website does not constitute a part of this annual report and is not incorporated by reference herein. We have included our website address in this annual report solely for informational purposes. Our agent for service of process in the United States is Enzymotec USA, Inc., and its telephone number is +1 (973) 912-9400.
Principal Capital Expenditures
The majority of our investment activities have historically been related to the construction and expansion of our manufacturing facilities and the purchase of manufacturing equipment and components for our production lines. Capital expenditures for purchase of property, plant and equipment and intangible assets were $1.2 million, $4.9 million and $6.4 million in the years ended December 31, 2012, 2013 and 2014, respectively. Capital expenditures for purchase of property, plant and equipment for the year ended December 31, 2012 were for ordinary course capital expenditures and expansion of our manufacturing capacity. Capital expenditures for purchase of property, plant and equipment for the year ended December 31, 2013 were primarily related to our manufacturing facility expansion project, which is enabling us to extract krill oil from krill meal ourselves using technologically advanced equipment and proprietary processes. Capital expenditures for purchase of property, plant and equipment and intangible assets for the year ended December 31, 2014 were primarily related to the completion of our manufacturing facility expansion project as well as to our capacity increase project in our current facility that is expected to be completed during the second quarter of 2015 and to payment of a license fee in connection with the settlement of claims by Neptune Technologies & Bioresources Inc.
In general, we anticipate that we will have further capital expenditures in 2015 relating to the completion of the capacity increase project in our current facility that is expected to be completed during the second quarter of 2015. We have leased additional space next to our existing facility in northern Israel for purposes of constructing an additional manufacturing facility. In the event that we determine to construct a new manufacturing facility, capital expenditures would increase significantly, but we currently do not have any plans to do so. The timing and amount of the capital expenditures associated with this project, if we do undertake it, is uncertain. We may also seek to employ our capital to acquire complementary businesses or technologies.
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B. Business Overview |
We have two reportable segments, our Nutrition segment and our VAYA Pharma segment, both of which offer a variety of products that leverage our lipid-related expertise. Our Nutrition and VAYA Pharma segments represented 88.0% and 12.0% of net revenues in 2014, respectively. For a geographic breakdown of our revenues, see “Item 5.A. Operating Results—Components of statements of operations—Net revenues by geographical region.”
Nutrition. Our Nutrition segment develops and manufactures nutritional ingredient products based on lipids, such as phospholipids, which form the structural basis of cell membranes and are easily recognized, incorporated and used by the body. Our customer base for this segment includes leading infant formula and nutritional supplement companies such as Biostime and International Vitamin Corporation, or IVC. Our two best-selling nutritional ingredient products are InFat, a clinically-proven fat ingredient for infant formula, and krill oil.
Our premium infant formula ingredient products seek to more closely resemble the composition and properties of human breast milk fat, which is considered the “gold standard” in infant nutrition because of both its short and long term health and developmental benefits, to facilitate healthy infant development. Peer reviewed clinical studies published in 2012, 2013 and 2014 demonstrate that our leading formula ingredient product, InFat, provides unique benefits such as stronger bones, improved intestinal flora and reduced crying, in addition to reduced constipation, improved calcium absorption and more efficient energy intake. As a result, we believe InFat is the most significant development to infant formula ingredients since DHA and ARA were introduced to the market almost 15 years ago. The next generation of our infant formula ingredient products targets additional attributes of key lipids found in human breast milk such as improved brain development. InFat has been achieving rapid penetration in the Chinese and other Asian markets, and we believe that we have significant opportunities in other developing markets and developed markets such as North America and Europe. InFat is sold and marketed through Advanced Lipids AB, or AL, our joint venture with AarhusKarlshamn AB, or AAK, a Sweden-based, global producer of specialty oils.
Our krill oil products, which provide the benefits of omega-3 fatty acids, have significantly improved bioavailability over competing products in the market. We use our technological and manufacturing know-how to provide additional secondary benefits such as improved scent, taste and shelf life. Our other products in this segment are targeted at improving brain health and providing benefits in memory, learning abilities and concentration. In addition, we add value to our customers through product customization, clinical validation, regulatory expertise and quality control. We believe there are significant growth opportunities in other geographic markets beyond our core markets in the United States and Australia, and also intend to capitalize on consumer trends towards supplementing their diets with premium health and wellness products.
VAYA Pharma. VAYA Pharma, develops, manufactures and sells branded, under physician supervision-only medical foods for the dietary management of patients with certain medical conditions or diseases having special, medically determined nutrient requirements. Although medical foods must be proven to be safe and effective as demonstrated in human clinical studies, they do not require the same expensive and time-consuming regulatory approval process typical of prescription drugs. Our U.S. medical foods business generated its first revenues in 2011 and currently consists of three branded products, all based on our proprietary lipid-based technologies, which address the dietary management of the following conditions: hypertriglyceridemia (Vayarol); lipid imbalances associated with ADHD in children (Vayarin); and lipid imbalances associated with early memory impairment (Vayacog). Our products are designed to provide a safe, cost-effective, first-line dietary therapy. We are currently executing additional clinical studies for two of our medical food products, to reach an expanded consumer market and to support additional marketing claims. In addition to our existing products, we have several other products to address additional indications in the development phase. We currently market VAYA Pharma products in the United States through sales representatives based in large metropolitan areas of nine states and in Singapore, Teva in Israel and Dexcel Pharma in Ukraine and have plans to expand both in the United States and other international markets.
Our technology
Our technology and research and development platform supports product development for both of our reportable segments by leveraging our core scientific expertise in lipid and enzymatic technologies. Our research and development activities are directed towards developing bio-functional lipid ingredients and final products. In order to achieve this goal, we have developed and continue to develop and utilize sophisticated proprietary technologies and know-how that enable us to extract lipids from natural sources, separate and analyze lipid molecules and use enzymes to synthesize lipid molecules known to the body. We have established a proprietary toolset that allows us to efficiently convert the lipids that we obtain from natural sources into those that have unique structural and functional characteristics.
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Our technology encompasses four distinct but interrelated domains, each of which comprises part of our product development cycle:
• | enzyme processes; |
• | lipid modification; |
• | lipid analysis; and |
• | process technology and development. |
In connection with enzyme processes, we have developed a technological platform that modifies crude enzymes which improves their activity and enables their utilization in synthesis in organic media, such as oils and organic solvents, with enhanced efficiency, stability and recyclability.
Using that enzymatic technology platform, we modify lipids found in natural sources such as krill, fish, soybeans, sunflowers, bovine milk and other sources in order to synthesize lipids that mimic the composition and properties of other lipids that are naturally occurring in the human body. For instance, our PS product line involves the synthesis of phosphatidylserine, or PS, a component of brain membranes and brain function, and the InFat product is a sn-2 palmitate oil product which more closely resembles the composition and properties of human breast milk fat.
Our synthesis of lipids is predicated on our expertise in lipid analysis. This expertise enables us to analyze and map the structure of lipid molecules, which also assists us in separating and quantifying different lipid classes within various compounds. We also utilize our lipid analysis expertise for conducting biochemical analysis for the purpose of supporting regulatory applications, designing and conducting preclinical and clinical trials and for the quantification of other elements found in lipids, such as antidioxidants, minor contaminants and other minor components.
We leverage the data and information gained from our enzyme process, lipid modification and lipid analysis technologies in order to extract, purify and synthesize modified lipid fractions, which we then use to formulate and produce our products. Our process and engineering know-how includes an emphasis on developing cost effective processes, and focuses on quality, repeatability and safety. Our process know-how relates to the entire production process, from sourcing raw materials and designing technical specifications for use by our suppliers in developing, improving and incorporating various production technologies, such as extraction, filtration, drying, oxidation control and fermentation.
Our products
Nutrition segment
Our Nutrition segment sells lipid compositions and bioactive ingredients as ingredients for infant formula, adult nutrition products and dietary supplements, which we tailor to the special needs of the nutrition industry. These ingredients are sold by us to three types of customers: (i) companies that manufacture the end-product themselves; (ii) companies that outsource manufacturing of the end product; and (iii) outsourced manufacturers of the end product.
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InFat | Soy-PS | K•REAL, our krill oil | PS Line of Products | GPC Line of Products | ||||
• A clinically-proven fat ingredient for infant formula that more closely resembles the composition and properties of human breast milk fat. • Offered by AL. | • An infant nutrition ingredient to improve cognitive and mental performance. | • Pure K•REAL • High Potency K•REAL • Custom made K•REAL | • Sharp PS • Sharp PS SILVER • Sharp PS GOLD • Sharp PS GREEN | • Sharp GPC • Sharp GPC ACTIVE |
InFat — InFat is a clinically-proven lipid ingredient for infant formula that more closely resembles the composition and properties of human breast milk fat. The product was originally developed by us and its initial sales, from 2004 to 2006, were made directly by us. In 2007, we entered into a joint venture with AAK relating to the production, marketing, sale and distribution of InFat. As a result, all sales of the product are now made through AL, the joint venture company. See “— Joint Venture with AAK” below.
Human breast milk is considered the optimum nutrition for infants, as it provides the perfect balanced diet to meet the needs of the growing child. Accordingly, the ultimate goal for every infant formula producer is to offer a product as similar as possible in its functional and nutritional benefits to human breast milk. The special fat structure in human breast milk, which is known as sn-2 palmitate, is found in all women and offers clinically proven benefits for infant development. Through the use of our proprietary technologies, we have developed an enzymatic process to restructure vegetable oils into a sn-2 palmitate enriched fat, the InFat ingredient for infant formula, which more closely resembles the fat composition and properties of human breast milk fat.
Our published peer reviewed clinical studies demonstrate that formula containing InFat provides infants with unique benefits, such as stronger bones, improved intestinal flora and reduced crying, in addition to reduced constipation, improved calcium absorption and more efficient energy intake.
The InFat ingredient sold by AL is fully customized according to customers’ requirements, ranging from a concentrate form of InFat to complete blends of InFat with various additional vegetable oils for use by infant nutrition manufacturers.
Soy-PS — Our Soy-PS product is our other lipid ingredient for infant formula. The PS lipid is found naturally in human breast milk and is essential for brain development and normal nerve function. Our PS formulation is derived from soybean lecithin and is designed to improve cognitive and mental performance.
Krill Oil — We are a leading manufacturer of krill oil, a premium omega-3 bound to phospholipids. Our product, K•REAL, previously known as Krill Oil+, which was first commercialized in 2006, is manufactured by us according to rigorous quality and freshness standards. Krill oil offers advantages over competing products, such as fish oil, due to the bio-availability of krill oil and the ease with which the omega-3 fatty acids are absorbed into the bloodstream. Our krill oil also offers the additional benefits of increased shelf life and improved scent and taste profiles as compared with competitor products.
We offer the following krill oil products:
• | Pure K•REAL, characterized by its purity, freshness, high stability and low viscosity; |
• | High Potency K•REAL, which contains enriched levels of omega-3 fatty acids, without dilution of the level of phospholipids found in pure krill oil; and |
• | Custom made K•REAL, suited for specific customer needs, including different grades of K•REAL, more cost-effective K•REAL through the reduction of phospholipid levels, and the inclusion of higher levels of certain ingredients as compared to our other K•REAL products. |
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K•REAL is processed only from Antarctic krill, which we source from vessels and facilities approved for food handling and storage by the appropriate national food safety authorities. These vessels and facilities are also approved by members of the Commission for the Conservation of Antarctic Marine Living Resources, an international commission with responsibility for the conservation of Antarctic marine ecosystems. We have conducted comprehensive safety evaluations of K•REAL krill ingredients and have determined them to be “Generally Recognized as Safe” (GRAS) for certain conventional food and medical food uses. We notified the FDA of our GRAS determinations and the FDA issued a “no questions” response letter advising us that the FDA accepts our conclusion that our K•REAL krill ingredients are GRAS. Further, K-REAL krill oil has obtained “Novel Food” status in the European Union.
PS line of products — This consists of a range of food supplements, containing Phosphatidylserine, or PS, a phospholipid component of cell membranes and a building block of the human brain. Research has indicated that PS has a role in the proper signal processing and cell-to-cell communication functions of nerve cells. These products are sold by us as a powder (generally for use in tablets, capsules and functional foods) and as a liquid or dispersion (generally for use in soft gels). This line of products includes the following:
• | Sharp PS — This is a soybean-derived PS brain nutrient, introduced in 2003. It is a nutritional supplement for adults, intended to improve cognitive capabilities, such as memory. Sharp PS is also shown to benefit other populations, such as young persons, by improving memory, learning abilities and concentration. |
• | Sharp PS SILVER — This is a patent protected blend of two different active ingredients, PS and omega-3, derived from soybean and fish oils, introduced in 2008. It is intended to improve mental and cognitive abilities. |
• | Sharp PS GOLD — This patented compound nutrient, introduced in 2006, offers high potency PS together with targeted deliveries of DHA to the brain. It mimics human PS found in the brain. Two versions of this product are available, one derived from fish oil and the other from krill oil. Clinical trials have shown that Sharp PS GOLD is effective in improving memory in elderly persons suffering from age-associated memory decline. |
• | Sharp PS GREEN — This is a soy-free PS food supplement, derived from sunflowers, introduced in 2010, aimed at the large and growing market of health conscious and environmentally-concerned consumers who demand clean, pure, soy allergen-free and non-GMO (genetically modified organisms) ingredients. Sharp PS GREEN is also offered in a special gummy-bears application intended for children under out trade name SharpKidz. |
GPC line of products — This consists of a range of food supplements, containing L-Alpha Glycerylphosphorylcholine, or alpha GPC, a natural choline compound found in the brain. Alpha GPC is the simplest phospholipid, and a key metabolite in choline metabolism signaling. In addition, alpha GPC serves as an organic osmolyte and assists in proper kidney function and may play a role in sperm motility. Alpha GPC is naturally occurring in certain foods, such as milk, eggs and meat, in low amounts. Alpha GPC is sold in the United States as a dietary supplement and in Europe and South America as a drug for patients suffering from dementia related to Alzheimer’s disease or cerebrovascular conditions, such as strokes.
Our GPC products are sold by us as a powder (generally for use in tablets and capsules) and as a liquid (generally for use in soft gels and drops).
This line of products includes the following:
• | Sharp GPC — This product, derived from soybeans and introduced in 2011, is used for improving cognitive functions for different age populations. It is also suitable for use by aging persons facing the deterioration of their cognitive functioning. Sharp GPC is available in various forms, including a powder (with 99% maximum purity) and a liquid (with 85% maximum purity) for different applications. |
• | Sharp GPC ACTIVE — This product, derived from soybeans and introduced in 2011, is an alpha-GPC-based complex (comprised of 45% alpha-GPC), which has the known beneficial value of GPC on human health, especially on cognitive function and additional important biological activity, resulting from the presence of other naturally occurring, lecithin-derived compounds. Sharp GPC ACTIVE is a naturally-sweet, water-based platform, which is compatible with a wide range of nutrients and does not require special preservatives. |
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We also have a new nutritional ingredient product, InCog, that we plan to launch in 2015 and several other products in various stages of development.
We are currently marketing Omega-PC, which is an extract from cold-water wild fish containing omega-3 fatty acids bound to both phospholipids and triglycerides. The nutritional benefits of fish and fish oil are widely accepted due to the presence of DHA and EPA fatty acids. However, current fish oil products contain DHA and EPA attached to triglycerides, whereas up to 30% of the DHA and EPA found in cold-water fish are bound to phospholipids. Thus, Omega-PC is the closest to a natural way to consume omega-3. Clinical evidence demonstrates that DHA and EPA bound to phospholipids are absorbed better than DHA and EPA bound to triglycerides. Our Omega-PC aims to provide the benefits of DHA and EPA along with the improved absorption of omega-3. We are currently considering whether or not we will continue to offer this product in the future.
In 2014, we also began production and sale of Pro•krill, our first product that is for uses other than human consumption. Pro•krill is an enriched protein preparation left after the krill oil is extracted, which we are able to access now that we perform krill oil extraction in-house. It has a unique composition of amino acids making it a very good source of protein for aqua culture.
Clinical Validation
InFat. From August 2010 to October 2012, we conducted several comparative trials to assess the benefits of InFat compared to standard vegetable fat. The trials divided a sample pool of infants into either two or three groups. In both cases, one group was provided a diet with InFat, while a second group was provided a diet with a control fat, consisting of either standard infant formula or standard vegetable fat. In certain trials, a group given human breast milk served as a reference point. The P values represent a measure of statistical significance, with P<0.05 considered statistically significant.
● | The first trial, which included 36 term infants (8 of which were in the control group, 14 of which were given InFat and 14 of which were breast fed), showed that breast-fed infants and infants who were given a diet with InFat rather than the control fat for six weeks had higher counts of Lactobacilli and Bifidobacteria bacteria (P<0.01), suggesting that InFat promotes a healthy intestinal micro flora and might enhance infants’ gut health and immunity. Additionally, the Lactobacillus counts between the infants fed InFat and the breast-fed infants were comparable (P>0.05). The results of this trial were presented at the Federation of American Societies for Experimental Biology (FASEB) Conference (United States, July 2011) and the International Conference on Nutrition and Growth (Paris, March 2012) and published in the Journal of Pediatric Gastroenterology and Nutrition in 2013. These results support the growing understanding that the composition of the intestinal microbiota is influenced by factors in the milk diet of the young infant. |
● | The second trial, which included 83 term infants (28 of which were in the control group, 30 of which were given InFat and 25 of which were breast fed), revealed that at 12 weeks of life term infants who were provided the InFat-enriched formula instead of the control formula had higher bone strength parameters (tested by a non-invasive ultrasound bone sonometry device measuring the speed of sound (“SOS”) along the bone) (P<0.05) and were comparable to breast-fed infants (P>0.05). The results indicate that the InFat formula increases infants’ bone strength. These results were published in Calcified Tissue International in 2012. A second outcome of this clinical trial revealed that feeding term infants formula with InFat for the 12 weeks after birth lowered the daily crying duration in comparison to feeding with control formula (P<0.05) and the control formula group infants cried for a longer duration in comparison to the breastfed group (P<0.3). These results were published in Prostaglandins, Leukotrienes and Essential Fatty Acids in 2013 and in BMC Pediatrics in 2014. Importantly, further analysis of the diurnal crying pattern revealed that feeding term infants formula with InFat for the 12 weeks after birth decreased the percentage of infants who cried, especially in the afternoon and evening hours (P<0.05), and also the daily crying duration (P<0.05), compared to infants fed a standard formula. These results were published in BMC Pediatrics in 2014. The results of this trial were also presented at the European Society for Paediatric Gastroenterology Hepatology and Nutrition (“ESPGHAN”) Conference (Italy 2011) and the International Society for the Study of Fatty Acids and Lipids (“ISSFAL”) Congress (Vancouver, May 2012). |
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● | In July 2011, we completed a comparative, open label 12-week trial, comparing the development of 75 Chinese infants divided into two groups (34 of which were given InFat and 41 of which were breast fed). During the trial, the first group was provided with a diet including InFat and the second group served as a reference and was given breast milk. The final results of the trial showed that InFat formula was not statistically significantly different from human breast milk in terms of body growth, prevention of hard stools and infant well-being (P>0.05). These results highlight the comparability of InFat lipids compared to those found in human breast milk. We are currently preparing the results for publication. |
● | In October 2012, we completed the clinical phase of a comparative, randomized, double-blinded, multi-centered, 24-week trial, to compare the development of 171 Chinese full term infants, enrolled at five Chinese FDA-approved medical centers in different cities in China, divided into three groups (57 of which were in the control group, 57 of which were given InFat and 57 of which were breast fed). The purpose of the study was to assess the efficacy of infant formula with high percentage of palmitic acid at the sn-2 position (InFat) as compared to standard vegetable oil based infant formula on general gastrointestinal tolerance and fat excretion, reducing calcium soaps formation and stool hardness in Chinese formula-fed term infants on top of prebiotics, a common bioactive ingredient in infant formulas, which was shown to promote nutrient absorption, benefit stool consistency and reduce crying. During the trial, the first group was provided with a diet including InFat, the second was provided with a diet including control standard vegetable oil and the third group was given breast milk to serve as a reference for the trial results. The study aimed to identify the advantages of InFat pertaining to fat absorption and gastrointestinal tolerance in full-term infants on top of prebiotics. Results showed that at six weeks postnatal, the amount of free fatty acids excreted in stool was lower in the sn-2 palmitate and breast milk groups compared to the control group, and most of the fatty acids excreted were in the form of soaps. Importantly, these effects were observed although both InFat and the vegetable oil formula contained prebiotics. These results were presented at the Nutrition & Growth conference in Barcelona in January 2014 and at the ESPGHAN conference in Jerusalem in June 2014. These results were published in a book published by Nova Publisher in 2014. A second outcome of this clinical trial revealed that feeding term infants formula with InFat for the 12 weeks after birth lowered the daily crying duration in comparison to feeding with control formula (P<0.05). The control formula group had higher daily crying duration also in comparison to the breastfed group (P<0.01). A further analysis of the diurnal crying pattern revealed that feeding term infants formula with InFat for the 12 weeks after birth decreased the percentage of infants who cried, especially in the morning and evening hours (P<0.05) compared to infants fed a standard formula. The percentage of infants who cried in the control group was higher in the control group also compared to the breastfed group (P<0.05). There was no difference between the percentage of crying infants at week 12 between infants fed with formula containing InFat and breastfed infants. These results were published in a book by Nova Publisher in 2014 and presented at the ESPGHAN conference in Jerusalem in June 2014. |
Krill Oil. In December 2011, we completed a comparative, double-blind, placebo controlled randomized crossover, three phase clinical trial, to compare the absorption of omega-3 fatty acids in both red blood cells and plasma after consumption of krill oil, fish oil or placebo by 24 healthy adult participants. During the trial, each group went through three four-week phases in which they were provided with one of the following three supplements: three grams of our krill oil supplement (K-REAL), three grams of fish oil and three grams of placebo. Between each phase there was an eight-week wash out period before the next supplement was provided. The final results of the trial showed significantly higher levels of absorption of EPA, the sum of EPA and DHA as determined by the omega-3 index, and omega-3 fatty acids in both the plasma and red blood cells when provided krill oil in contrast to either fish oil or the placebo (P<0.05). These results indicate that krill oil has a positive and superior efficacy of the absorption of EPA and omega-3 fatty acids in both the red blood cells and the plasma when compared to fish oil supplements. In addition, the participants completed a questionnaire on status of memory, mood and concentration at the end of each treatment phase. Based on the results of these questionnaires, krill oil treatment was found to improve memory, mood and ability to concentrate compared with fish oil or control treatments. These results were published in Lipids in Health and Disease 2013.
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In April 2012, we completed a comparative, single-blind crossover, four-week clinical trial consisting of 20 healthy adults, to compare omega-3 fatty acid absorption after the intake of high potency krill oil and the intake of pure krill oil. During the trial, the group was provided with 1.5 grams of our high potency krill oil (K-REAL). Omega-3 fatty acid absorption was then compared to the levels measured when the same group of adults was provided with twice the amount of pure krill oil as given in a previous trial. The results of the trial showed that both supplements had a similar absorption of omega-3 fatty acids, despite the fact that during the trial the participants provided with high potency krill oil were only given half the quantity of supplementation compared to the previous trial. These results enable us to market to our customers high potency krill oil that allows for the reduction of krill oil consumption by half while retaining the benefits of taking a full dose of pure krill oil.
Sharp PS. In March 2008, we completed a single center, open-label, 12-week clinical trial, to observe the effects of Sharp PS on cognitive functions in elderly volunteers with subjective memory complaints. During the trial, the volunteers were provided with 300 mg/day of soy-PS. The final results of the trial, in which 26 subjects completed the study, demonstrated statistical significance on improving memory recognition, memory recall, executive function and mental flexibility (P<0.05). The results indicate that the daily intake of soy-PS, as found in Sharp PS, has a high efficacy on cognitive function, including memory parameters, executive function, and mental flexibility. These results were published in Clinical Interventions in Aging in 2013.
Sharp PS Gold. In November 2007, we completed an open-label, six week pilot study, to observe the effects of Sharp PS Gold on cognitive functions in eight elderly volunteers with subjective memory complaints. During the trial, the volunteers were provided with 300 mg/day of PS and 37.5 mg/day of EPA and DHA. The final results of the trial showed positive effects on cognitive function, specifically on memory recall and the ability to store, hold and retrieve information (P<0.05). These results indicate that the daily intake of PS bound to DHA and EPA, which is found in the Sharp PS Gold, over a six-week period, has a positive impact on cognitive functions, including long-term memory processes. These results were published in Clinical Interventions in Aging in 2010.
Cognitex. In April 2009, we completed an open-label, 12-week clinical trial that observed the effects of Cognitex on cognitive functions in twenty-six elderly volunteers with subjective memory complaints. Cognitex, a premium product manufactured by one of our customers, is a formulation of Sharp PS Gold, glycerylphosphorylcholine (GPC) and other ingredients. During the trial, the volunteers were provided with Cognitex three times a day. The final results of the trial showed positive effects on cognitive function, with significant improvement in memory abilities, attention, visual learning, and daily activities commencing within the first two weeks of the trial (P<0.05). Such improvement was sustained without further improvement over the course of the study, with the exception of the activities of daily living measure, which demonstrated an additional statistically significant improvement following the ten additional weeks (P<0.05). These results indicate that the daily intake of Cognitex has a positive significant effect on cognitive functions, commencing within the first two weeks of its intake, including improvement in memory abilities, attention, visual learning, and daily activities. These results were published in the Journal of Dietary Supplements in 2011.
VAYA Pharma segment
Our VAYA Pharma segment is dedicated to the discovery, development, manufacture and marketing of innovative clinically-tested, effective and safe lipid-based medical foods for the cardiovascular and neurological markets, as well as for the pharmaceutical drug markets. Our VAYA Pharma segment currently offers the following products:
Vayarin | Vayacog | Vayarol | ||
For clinical dietary management of certain lipid imbalances associated with ADHD. | For clinical dietary management of certain lipid imbalances associated with early memory impairment. | For the clinical dietary management of patients with high triglyceride levels, (particularly those at risk for an increase in blood concentrations of low density lipoprotein cholesterol (LDL-C) upon omega-3 administration). |
In the United States, each of three products currently offered by our VAYA Pharma segment is sold as a “medical food,” available only under the supervision of a physician (either by prescription or acquired directly from a physician in the context of the physician patient-relationship), meeting the criteria for medical foods enumerated by the FDA. See “— Government regulation” below.
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Below is a brief description of each of this segment’s current products:
• | Vayarin — The Vayarin capsule, introduced in Israel in 2010 and in the United States in 2011, is an orally administered under physician supervision medical food for the clinical dietary management of certain lipid imbalances associated with attention deficit-hyperactivity disorder, or ADHD. These capsules are aimed at children and pre-adolescents with ADHD, children who are reluctant to start drug therapy or are intolerant to stimulant therapy, or children with a more pronounced hyperactive-impulsive behavior, as well as mood and behavior dysregulation. Vayarin contains Lipirinen, a proprietary composition containing EPA-enriched PS omega-3, which is derived from krill. |
• | Vayacog — The Vayacog capsule, introduced in 2011, is an orally administered under physician supervision medical food for the clinical dietary management of certain lipid imbalances associated with early memory impairment. These capsules are aimed at people with subjective memory impairment, those suffering from normal age-associated memory decline and people with mild cognitive impairment (MCI). Vayacog contains Lipicogen, a proprietary composition containing DHA-enriched PS omega-3, derived from both fish and soybean. |
• | Vayarol — Our Vayarol product, introduced as a dietary supplement in the United States and Israel in 2007 and 2009, respectively and as a medical food in the United States in 2011, is marketed as an orally administered under physician supervision medical food for the clinical dietary management of hypertriglyceridemia. Outside the United States, Vayarol targets those suffering from hypertriglyceridemia, individuals who are reluctant to start drug therapy for this condition, or those with borderline to moderate mixed hyperlipidemia. In the latter case, it is administered to patients with mild elevation of LDL cholesterol or who are intolerant to statins and other medications. Vayarol contains Lipirolen, a proprietary composition containing phytosterol esters of omega-3, which is derived from fish oil and soybean. |
While our current focus is to expand our three current products, we also have a number of VAYA products in various stages of development.
Clinical Validation
VAYA Pharma’s clinical studies have been focused on three therapeutic segments: ADHD, early memory impairment, and hyperlipidemia. Efficacy was evaluated using validated outcome measures, including tools assessed by professional clinicians, raters, and health providers. These studies also monitored safety and tolerability. In the below-described clinical studies, P<0.05 was considered statistically significant. In light of the positive results of the Vayarol clinical trials, we have been in discussions with the FDA regarding the development of Vayarol as a full prescription drug for hypertriglyceridemia. For more information regarding the FDA approval process of Vayarol, see “— Government regulations.”
Vayarol. We completed a comparative, semi-randomized, multiple phase, crossover clinical trial, to test the effects of Vayarol on the lipid profiles of 21 mildly overweight, hypercholesterolemic subjects. The trial included four phases of 29 days each, in which the participants’ diets were identical except for the differing supplemental treatment oil provided in each phase, which consisted of Vayarol (early formulation), control olive oil, fish oil and commercial phytosterols. Following each phase, the participants had a 28-day wash out period before being provided with a different treatment. The final results of the trial showed that Vayarol was safe and well-tolerated by the trial participants and that the administration of Vayarol resulted in lower fasting and postprandial triglyceride levels as compared to any other tested treatments, including fish oil (P=0.025 and 0.0001, respectively). In addition, Vayarol administration resulted in substantial reduction of ApoB levels and total/HDL cholesterol ratio in comparison with fish oil administration (P<0.05). These results were published in the American Journal of Clinical Nutrition in 2006 and Lipids in Health and Disease in 2007.
We completed a comparative, randomized double-blinded, placebo controlled, multi-centered 12-week clinical trial, to observe the effects of Vayarol on lipid profiles and other coronary heart disease risk factors in 91 mixed hyperlipidemic subjects, who had both elevated low-density lipoprotein triglycerides and elevated cholesterol (“LDL-C”), divided into two groups. During the trial, one group (46 subjects) was provided with Vayarol and the second (45 subjects) was provided with a placebo. The final results of the trial, which were received in December 2008, showed that Vayarol was found to be safe and well-tolerated by the trial participants and that the Vayarol group had reduced levels of triglycerides by 19% (P=0.025), without experiencing LDL-C elevation. Vayarol was also shown to significantly reduce inflammation, as measured by a decrease in C-reactive protein (P=0.018), and reduce diastolic blood pressure by 7% (P=0.036). We believe these results indicate that the daily intake of Vayarol is beneficial for the dietary management of hypertriglyceridemia. The study results were published in Cardiovascular Drug Therapy in 2010.
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Vayarin. We completed a comparative, double-blinded, randomized placebo controlled 12-week clinical trial, to compare the effects of Vayarin on ADHD symptoms in 83 inattentive children to an omega-3 supplement or a placebo. During the trial, one group (29 subjects) was provided with Vayarin (an early formulation), the second (28 subjects) was provided with fish oil supplements offered as a competing market product and the third (26 subjects) was given a placebo. The Test of Variables of Attention (TOVA), a well-established, computer-based assessment of executive functions, in particular inattention, was used to measure efficacy. The final results of the trial showed that Vayarin was safe and well-tolerated and also demonstrated that it had a significant effect on children’s executive function (P<0.05). Specifically, the findings indicated that it had a significant effect on children’s attention performance, demonstrated by superior results in the total TOVA score as compared to those observed in the groups who were provided with either fish oil or a placebo. The findings further suggest that providing inattentive children with high EPA/DHA phosphatidylserine preparation can affect visual, sustained attention performance. We believe these results indicate that Vayarin might have efficacy compared to other competing fish oil supplements and represents an attractive and safe product for the dietary management of ADHD. These results were published in the American Journal of Clinical Nutrition in 2008.
We completed a comparative, double-blinded, randomized, placebo controlled 15-week clinical trial, followed by a 15-week open-label extension, to observe the effects of Vayarin on ADHD symptoms in 200 children with ADHD. During the trial, one group (137 subjects) was provided with Vayarin and the second group (63 subjects) was provided with a placebo. The primary efficacy measure of the study was the Conners’ Teacher Rating Scale Revised Long-Hebrew Version (CRS-T) which is a questionnaire answered by a child’s teacher to assess symptoms of ADHD. Other assessments included the Conners’ Parent Rating Scale Revised Long-Hebrew Version (CRS-P), which is answered by the child’s parent and additionally, quality of life was assessed by the Child Health Questionnaire (CHQ) which assesses physical and psychosocial concepts related to the child’s well-being. The final results of the trial, which were received in 2009, showed that while there was no significant difference between the Vayarin and control groups in any of the CRS-T subscales, a significant reduction was observed in one ADHD symptom as well as a trend of reduction in other ADHD symptoms and significant improvement on quality of life was also shown. Further, we observed a significant reduction in certain ADHD symptoms on both the CRS-T and CRS-P subscales in a subgroup of children (78 subjects) with a more pronounced hyperactive/impulsive behavior in combination with mood and behavioral dysregulation. In addition, Vayarin was found to be safe and well-tolerated by the trial participants. We believe these results, though they require a follow-up study for confirmation, indicate that Vayarin is an effective and safe new approach for the clinical dietary management of ADHD. These results were presented at the annual meeting of the American Academy of Child & Adolescent Psychiatry (AACAP) in 2010 and 2011 and published in European Psychiatry in 2011 and 2013.
Vayacog. We completed a comparative, double-blinded, randomized placebo controlled 15-week clinical trial, followed by a 15-week open-label extension, to observe the effects of Vayacog on cognitive abilities in 157 elderly persons with memory complaints, divided into two groups. During the trial, one group of participants (79 subjects) received Vayacog and the second group (78 subjects) received a placebo. The purpose of the trial was to evaluate the efficacy and safety of Vayacog in improving the cognitive function of non-demented elderly with memory complaints. The final results of the trial showed that Vayacog had a significant effect, compared to placebo, on improving short-term memory (P<0.05) as well as being safe and well-tolerated by the trial participants. In addition, subgroup analysis suggests that participants with relatively good cognitive performance at the beginning of the study (78 subjects) were more likely to respond to Vayacog. These results indicate that the daily intake of Vayacog can serve as an effective and safe new approach for the clinical dietary management of early memory impairment. The study results were presented in the International Conference on Alzheimer’s Disease (ICAD, 2010) and in Alzheimer’s Disease International conference (ADI, 2010) and published in Dementia and Geriatric Cognitive Disorders in 2010 and 2014, and in BMC Neurology in 2011.
Marketing, sales and distribution
Nutrition segment
We sell our nutrition products to manufacturers of branded products in different markets around the world. Those manufacturers then incorporate them into their own products and sell them to end customers.
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Sales and distribution of the InFat product are carried out by AL. In most of our markets sales are conducted directly by AL. See “— Joint Venture with AAK” below. Additionally, AL sells through distributors and agents in Korea, New Zealand, Australia and, along with direct sales to certain brands, in China.
The marketing, sales and distribution of our Soy-PS product is carried out by local distributors.
We sell our krill, PS and GPC products to companies that manufacture and market dietary supplements, to food companies that combine our bioactive ingredients in functional food applications, and to distributors of these products. In North America, the marketing, sales and distribution of these products are carried out through our wholly-owned U.S. subsidiary, Enzymotec USA, Inc. Outside North America, we perform the primary marketing and sales roles, while the distribution and marketing support of these products is generally carried out by local distributors and agents.
VAYA Pharma segment
In the United States, which accounted for the substantial majority of our VAYA Pharma sales in 2014, the marketing and sales of these products are carried out directly by the dedicated sales personnel of our wholly-owned U.S. subsidiary, VAYA Pharma Inc. The vast majority of our VAYA Pharma products are distributed by pharmaceutical wholesalers, with small percentage sold directly to physicians and on-line directly to end users. We currently market our VAYA products in the United States through sales representatives based in large metropolitan areas of nine states and plan to expand our marketing efforts, including by hiring additional sales representatives in the United States.
The products offered by our VAYA Pharma segment are sold in the United States on the basis of their meeting the criteria for medical foods, as enumerated by the FDA. Medical foods are not required to undergo premarket review or approval by the FDA. However, primarily because our VAYA Pharma products are not approved as prescription drugs by the FDA, most consumers purchasing these products in the United States are currently unable to obtain reimbursement from third-party payers under government healthcare or private insurance plans, which generally do not provide reimbursement for medical foods. As of the end of the fourth quarter of 2014, approximately 30% of sales of VAYA Pharma products in the United States received some form of reimbursement. We are attempting to broaden acceptance of our VAYA Pharma products as eligible for reimbursement by third-party payers.
Outside the United States, most of the sales, marketing and distribution of the VAYA Pharma products is carried out by license partners, generally pharmaceutical companies under exclusive license agreements. In Singapore, we have recently established VAYA Pharma PTE Ltd. together with our local partner. The entity’s business model is similar to our U.S. subsidiary subject to the local regulations in Singapore.
Our customers and partners
We sell our nutrition products to manufacturers of branded products in different markets around the world. For example, we have developed relationships with infant formula manufacturers who partner with us in bringing our ingredients for infant formula to the end-user market. With respect to our other Nutrition products, we target customers that have a significant presence in the vitamin and mineral supplement, or VMS, industry within their geographic markets. In our VAYA Pharma segment, the majority of our products are sold directly to customers by our dedicated sales personnel, but we have also partnered with leading pharmaceutical companies to provide our products outside of the United States and Singapore.
Nutrition segment
AL, our 50% owned Swedish joint venture company, seeks to position InFat as a strategic ingredient that enables its customers to strengthen their premium brands of infant formula. We believe that this strategy will help create long-term relationships and customer commitments to InFat.
AL is currently party to strategic agreements with two leading providers of infant nutrition products to the Chinese market. Of these two agreements, we consider the agreement with Biostime to be material to our results of operations because we estimate that sales of InFat attributable to sales by, and under the brand name of, Biostime accounted for between 7% to 9% of our consolidated net revenues in 2014. The agreement contains multi-year minimum purchase undertakings by Biostime and minimum supply guarantees by AL, subject to an agreed pricing formula. We have also entered into agreements with these customers to collaborate on research activities related to infant nutrition products, including working with the customers to upgrade their infant nutrition products. We believe that these collaborative research activities provide additional value to our customers. We do not derive any revenues from these collaborative research activities and they are not material to our business.
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AL also seeks to target new infant formula manufacturers and brands to incorporate the InFat products into their products.
Sn-2 palmitate has been incorporated in infant formula products by companies such as Danone, Nestlé and Heinz. AL is a major supplier of the sn-2 palmitate in the market.
During 2014, we commenced sales of Omega-PC together with a joint venture partner. While we are in discussions with our partner for termination of the joint venture, we are currently considering whether to continue marketing Omega-PC even if the joint venture is terminated.
The other customers in our Nutrition segment include leading VMS manufacturers and retailers. We target customers with well-developed marketing and distribution infrastructure, strong relationships with and knowledge of their end-customers, awareness of global industry trends and scientific expertise in our fields, such as IVC and Pharmavite.
We are currently seeking to establish strategic relationships with customers that market and sell their products to mass market retailers (such as Wal-Mart and Costco). We are also working with leading nutrition companies to combine our ingredients into their products and present our ingredients in new applications, such as gummy bears and powders.
VAYA Pharma segment
In the United States and in Singapore, the marketing and sales of our VAYA Pharma products are carried out directly by the dedicated sales personnel of VAYA Pharma Inc. in the US and of VAYA Pharma PTE Ltd. in Singapore, and the vast majority of products are distributed by pharmaceutical wholesalers with smaller percentage sold to physicians and on-line directly to end users. Outside of the United States and Singapore, where we are not developing our own specialized marketing and sales staff of medical representatives, we seek to partner with leading providers of pharmaceuticals and other health products in specific geographic markets by licensing our VAYA Pharma brands, often on an exclusive basis, in order to leverage our partners’ market presence and distribution capabilities. To date, we have partnered with Teva Pharmaceuticals in Israel, Daewon Pharmaceutical in South Korea and Dexcel Pharma in Ukraine. We do not currently derive material revenues from these arrangements.
Sourcing, manufacture and production
The principal raw materials used by us in the manufacture of our products consist of krill biomass, fish biomass, lecithins and oils derived from fish and certain plants (primarily soybean, canola and sunflower), amino acids, as well as various enzymes.
Krill oil, unlike fish oil, is extracted from its crude biomass in a delicate process, as many of its nutrients are extremely sensitive to heat. The krill used by us is harvested in the cold waters of the Southern Ocean and sold to us primarily pursuant to an agreement between us and the owners of a fishing vessel, as described below. Once harvested, the krill is processed into krill meal aboard the trawler, a process that must be carried out within a short time after capture, primarily in order to prevent the enzymes in the krill from causing a rapid breakdown of the valuable nutrients in the krill. We believe there are approximately ten such vessels with the capability to process raw krill into krill meal. We also purchase krill meal from several agents and recently began purchasing frozen krill.
We have entered into a binding memorandum of understanding, or MOU, with the owners of the vessel, under which we have operated since 2013, together with purchase orders, and intend to enter into a final agreement in the future. According to the terms of the MOU, the fishing vessel will operate according to our needs and demands for krill meal during the annual seven month krill harvesting season from 2013 until 2016. The MOU also provides that in the event of a sale of the vessel, we have a right of first refusal to acquire the vessel. The MOU does not provide termination rights for either party.
Until the first quarter of 2014, the first stage of processing krill meal into crude krill oil was carried out for us by a dedicated contract manufacturer in India. In 2013, we expanded our Migdal Ha’Emeq manufacturing facility and in the first quarter of 2014 we started to perform the first stage of the extraction process, turning krill meal into crude krill oil, ourselves using technologically advanced equipment and our proprietary processes. The crude krill oil is then processed through purification using our proprietary Multi Stage Oil, or MSO, extraction process, which ensures that the krill oil’s natural attributes remain intact for at least two years (its stated shelf life), without diluting efficacy or potency, to produce our K•REAL products.
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The fish and plant lecithins and oils and the amino acids used by us in the manufacture of our products are readily available and generally sold by multiple suppliers.
The enzymes used by us in connection with the manufacture of the InFat product and our Sharp PS line of products are each purchased from single suppliers. However, in both instances, we maintain a substantial inventory which would enable us sufficient time to find an alternative source, should our current supplier be unable to supply sufficient quantities.
With the exception of processing a portion of krill meal into crude krill oil, as discussed above, the manufacture of certain grades of our Sharp GPC product, our Omega-PC product and the final InFat product, all of our products are manufactured at our plant in Migdal Ha’Emeq, Israel. See “Item 4.D. Information on Enzymotec — Property, Plants and Equipment — Property and infrastructure” below. In addition, the enzymes used for the manufacture of the InFat product go through a special process, known as immobilization, carried out by us at our Migdal Ha’Emeq plant. We then ship those enzymes to AAK, where they are used as the core element for the production of InFat through the restructuring of the vegetable oils procured by AAK. InFat production currently takes place in the dedicated production facility built and owned by AAK in Karlshamn, Sweden, which has a fully automated production line equipped with the technology to ensure full product consistency. See “— Joint Venture with AAK” below.
The capsulation and packaging of our VAYA Pharma products, which are currently the only products sold by us in final form for use by the end user, is carried out by third-party contractors.
Joint venture with AAK
AL is a joint venture we established with AarhusKarlshamn AB, a Swedish company also known as AAK, regarding the production, marketing, sale and distribution of our InFat product, which is sold to the infant nutrition industry for use in infant formula. AAK is one of the world’s leading manufacturers of specialty vegetable oils and fats. Pursuant to the joint venture agreement, we supply the enzymes used in the manufacture of InFat, and AAK manufactures the final InFat product. For a discussion of the accounting treatment of AL’s results of operations, see “Item 5.A. Operating and Financial Review and Prospects — Operating Results— Joint venture accounting.”
Supply and production arrangements. We have agreed to supply exclusively to AAK the enzymes used in the production of InFat. These enzymes represent our proprietary patented production technology for the InFat product. AAK has the sole responsibility over the purchase and procurement of other raw materials, namely the fats, for the InFat product, and is responsible for its production which takes place in a designated facility built by AAK for the joint venture. AAK has agreed to supply exclusively to the joint venture the InFat products produced by it. We do not have a supply agreement with AL. Subject to extension related to the buy/sell mechanism discussed below, both supply agreements terminate upon the termination of the joint venture.
Joint venture responsibilities. We are responsible for research and development, as well as business development (including penetration of new markets) and marketing activities on behalf of the JV while drawing on AAK’s expertise. We are also responsible for regulatory matters related to the joint venture. We license the InFat trade name to the joint venture.
AAK is responsible for capital expenditures in respect of increased production capacity; the management of inventory and warehousing; logistics relating to the actual sales and delivery of the product; collection of trade receivables from customers of AL; obtaining permits and licenses related to AL’s operations in Sweden; and procuring product liability insurance.
We have an ongoing disagreement with AAK over certain operational matters, including responsibility for certain functions related to sales of the joint venture’s products.
Joint venture management. All decisions of AL require mutual consent of us and AAK. AL has a board of directors consisting of four members, two of whom are appointed by AAK and two of whom are appointed by us. Members of the board serve until they are removed by the joint venture partner responsible for appointing them or until they resign. From among the four board members a chairman is chosen to serve for a period of two years. The right to appoint the chairman alternates every two years between AAK and us. All actions taken by the board must be taken unanimously by the board members present at a meeting. In addition to the board of directors of AL, the day-to-day management of AL is the responsibility of a committee comprised of two members, a Managing Director and a Technical Director, one appointed by us and the other appointed by AAK. Members of this committee may not serve concurrently as board members but serve until they are removed by the joint venture partner who appointed them or until they resign. The Managing Director has the power and authority to make all decisions concerning the day-to-day affairs of AL but must discuss and deliberate with the Technical Director prior to taking action. The position of Managing Director is for a period of two years and the right to appoint the Managing Director alternates between AAK and us. Furthermore, the right to appoint the Managing Director belongs to the party not appointing the chairman of the board of directors in that particular year.
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Restrictions related to the joint venture. The joint venture agreement includes restrictions on the ability of both joint venture parties to transfer their shares in AL, non-disclosure obligations and non-competition obligations, both during the term of the joint venture and after termination of the agreement and the parties’ obligations thereunder. In the event of the sale of AL pursuant to the buy/sell mechanism discussed below, the party that sells its share in AL will be subject, during the three-year period after the end of provision of services under the joint venture agreement, to non-competition obligations. Pursuant to these obligations, the selling party may not, among other restrictions, develop or sell InFat or products that directly compete with InFat, excluding those competing products that the selling party developed and sold prior to the non-competition period.
Liability for breach of agreement. If either we or AAK fails to perform any of our respective obligations under the joint venture agreement, such partner shall be deemed to have breached the joint venture agreement and shall have 90 days from receipt of notice from the other party specifying the breach to cure such breach. If, after the expiration of that period, the breach is not corrected, then the partner in breach shall be liable to the other partner for all direct and foreseeable damages caused to it or to AL by the breach, in addition to any other remedy the other partner is entitled to pursuant to the joint venture agreement. In no event shall either partner be liable for special, incidental or consequential damages.
Dispute resolution. If a dispute arises related to the joint venture, we are first required to attempt to resolve the dispute through friendly consultations between us and AAK. If these consultations do not lead to a resolution within 30 days the dispute is referred to our chairman and the chairman of AAK to continue negotiations. If, after an additional 30 days, the dispute is still not resolved, either party may submit the matter to arbitration in accordance with the terms of the agreement.
Termination. The joint venture agreement’s initial term runs until December 31, 2016. Thereafter, the agreement will be automatically extended for consecutive periods of three years, unless terminated by notice of either party at least 12 months prior to a term’s expiration . Additionally, the agreement may be terminated in customary circumstances, such as in the case of intentional material breach of the agreement or if a partner becomes controlled by a competitor of AL. The joint venture agreement provides for a mechanism that would allow one partner to acquire all of the shares in AL held by the other partner upon termination of the joint venture. Specifically, in the event that one party notifies the other party of its intent to terminate the agreement (other than in the case of an intentional, material breach that causes grave and serious damage), either party may notify the other of its intent to buy the other party’s shares in AL by making an unconditional, irrevocable offer to purchase the other party’s shares. The agreement also provides for a counteroffer mechanism, such that the party who is willing to pay the highest price for AL will be entitled to purchase the other party’s shares in AL. Additionally, in cases of an intentional material breach of the agreement causing grave and serious damage (subject to a 90-day cure period), the non-breaching party has the right to purchase the shares of the breaching party for no consideration and to continue the business of AL post termination. This includes extending the supply obligations (or any other obligations) of the breaching party necessary to conduct the business of AL post-termination for a period of three years.
Dispute with AAK. In May 2014, AAK submitted a request for arbitration against us seeking certain declaratory relief with respect to the joint venture agreement. AAK alleges that our disclosures in connection with our initial public offering violated the non-disclosure obligations related to AL contained in the joint venture agreement. It is our position based on legal advice we received that we were permitted to disclose information related to AL and required to be disclosed under law in connection with our initial public offering, as well as subsequently in connection with our public company status, and we believe that we have complied with the other limitations in the joint venture agreement. AAK also sought a declaration that following notice of termination provided by one party, if neither party provides the other party with a buy-sell notice before December 31, 2016, the joint venture will terminate. We filed counterclaims against AAK with respect to certain disputed operational issues which we raised and for AAK’s conduct during our initial public offering. See “Item 3.D. Key Information — Risk Factors — Risks relating to our business and Industry — We rely on AAK, our Swedish joint venture partner to manufacture InFat, and certain matters related to the joint venture are the subject of a disagreement.”
Competition
The level of competition we face varies from product to product. However, we believe that the number of companies seeking to develop products in the markets in which we compete will increase. Competitors range in size from small, single product companies to large, multifaceted corporations, which may have greater financial, technical, marketing and other resources than those available to us. Many of these competitors or potential competitors may have greater name recognition and broader product lines than we do.
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Nutrition
With respect to the InFat product, we currently compete with one other company offering an sn-2 palmitate product, IOI Loders Croklaan, a Malaysian company, which offers a product under the Betapol brand name. We expect that others may seek to enter the sn-2 palmitate market. Further, InFat competes with other products in the general infant nutritional product market. The majority of market participants are currently using various vegetable oil blends, although bovine milk fat is also used to some extent. Accordingly, our main challenge in this market is to enlarge InFat’s market share by convincing customers to use InFat instead of lower-cost regular vegetable oil. We believe that as the sn-2 palmitate market share grows, it will encourage more specialty oil producers to endeavor to develop and offer competitive products.
With respect to our krill products, as we expected, krill oil suppliers have recently increased capacity due to strong market growth in 2013 and the general decline in the krill oil market in 2014 resulted in intensified competition. Our three principal competitors in the krill oil market are: Aker BioMarine AS (which recently merged with Aker Seafoods Holding AS), a Norwegian company; Neptune Technologies & Bioressources Inc., a Canadian company; and Rimfrost USA, LLC, a joint venture of Avoca, Inc., and Olympic Seafood AS. In the PS market, our principal competitors are Chemi Nutraceuticals Inc., Lipoid GmbH and Lipogen Ltd. We expect that competition will remain intense with significant manufacturing capacity available among our competitors.
VAYA Pharma
Our VAYA Pharma products currently face little direct competition in the medical foods market. However, even though we are positioning ourselves as a first line therapy, the present major growth challenge, principally in the United States, which constitutes our largest market for medical foods products, is that physicians may prefer to prescribe prescription drugs produced by pharmaceutical drug manufacturers rather than our medical food products. Further, potential customers may prefer to use prescription drugs instead of our medical foods products, as they may be deterred from purchasing our products due to the present lack of reimbursement from third party payers. The prescriptions likely to be prescribed by physicians and used by patients include drugs produced by large, well-established pharmaceutical companies as well as specialty pharmaceutical sales and marketing companies and specialized cardiovascular disease, or CVD, biopharmaceutical companies. For our Vayarol product, the principal prescription drugs with which we compete include Lovaza, marketed by GlaxoSmithKline plc, Niaspan marketed by AbbVie (formerly Abbott Laboratories), and Vascepa marketed by Amarin Corporation plc; for our Vayarin product, Strattera produced by Eli Lilly & Co., Intuniv (guanfacine) produced by Shire plc, and generic products, such as Ritalin. We believe there are not presently any drugs that address the indication addressed by Vayacog in the market.
Our VAYA Pharma products currently face little direct competition from other medical foods manufacturers, as we believe that there are high barriers to entry in the medical foods market. While they do not currently market medical foods that compete with our products, we are aware that large multi-national nutrition companies, such as Abbott Laboratories, Nestlé and Danone (through its clinical nutrition subsidiary, Numico N.V.) have expressed interest in the medical food market. Such potential competitors may have greater financial, technical, marketing and other resources than those available to us and, accordingly, the ability to devote greater resources than we can to the development, promotion, sale and support of products. However, even if such companies do enter the medical food market, we would not view them as significant competitors to the extent that their medical foods products address different indications than our medical foods products.
Government regulation
Nutrition Segment
The selling and marketing of our nutrition products are generally subject to comprehensive laws, regulations and standards enforced by various regional, national and local regulatory bodies, including the FDA in the United States, the European Commission in the European Union, the Therapeutic Goods Administration (the “TGA”) in Australia, the Ministry of Health in China, the Ministry of Health in Israel and others.
In the United States, two regulatory pathways exist for dietary ingredients, one for ingredients marketed in food and the other for dietary ingredients marketed in nutritional supplements. Dietary ingredients that were marketed in nutritional supplements prior to October 1994 are not subject to premarket authorization requirements. All other dietary ingredients must undergo a “premarket notification” process. This process requires the manufacturer to detail the quality and safety of the ingredient and file such information with the FDA at least 85 days prior to placing the ingredient on the market as a dietary supplement.
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Food ingredients must be determined to be safe prior to being added to foods. The following categories of food ingredients are considered to be safe by the FDA:
• | a food additive that has received pre-market approval from the FDA; |
• | an ingredient that is generally recognized, among qualified experts, as having been adequately shown to be safe under the conditions of its intended use (referred to as generally recognized as safe, or “GRAS”); or |
• | an ingredient that was determined to be safe for use in food prior to September 6, 1958 (a list of these substances that are GRAS are published by the FDA in the Federal Register). |
For an ingredient to be considered GRAS, the manufacturer of the ingredient must provide information on the quality and safety of the ingredient for its intended use as well as the results of relevant clinical studies. Such information is reviewed by qualified experts who determine whether the ingredient has been adequately shown to be GRAS. Additionally, such information may be voluntarily submitted to the FDA for review. If the FDA is satisfied with the determination of the new ingredient as GRAS, it will issue an Agency Response Letter advising that the agency has no questions regarding the safety conclusions of the ingredient.
We have conducted comprehensive safety evaluations of our InFat, Sharp PS, Sharp PS Gold, Sharp PS Green and krill oil ingredients, which were found to be GRAS following a review by qualified experts. We have voluntarily notified the FDA of our GRAS determinations and received a “no questions” response letter from the FDA advising us that the FDA accepts our conclusions that these ingredients are GRAS. We have submitted the dossier for Omega-PC to the FDA in order to receive GRAS determinations for it. In addition, we obtained regulatory approvals for our ingredients in main markets such as Europe, China and Australia as well as other countries in Asia and America.
The selling and marketing of our nutrition products are generally subject to comprehensive laws, regulations and standards enforced by various regional, national and local regulatory bodies, including the FDA in the United States, the European Commission in the European Union, the TGA in Australia, the Ministry of Health in China and the Ministry of Health in Israel.
VAYA Pharma segment
Medical foods
In the United States, the products currently offered by our VAYA Pharma segment are sold as medical foods, consistent with the statutory and FDA regulatory criteria for “medical foods.” The products are available only under the supervision of a physician (acquired on prescription or directly from a physician). The term “medical food,” as defined in the Orphan Drug Amendments of 1988 to the FDCA, is a food “which is formulated to be consumed or administered enterally under the supervision of a physician and which is intended for the specific dietary management of a disease or condition for which distinctive nutritional requirements, based on recognized scientific principles, are established by medical evaluation.” The FDA has issued regulations detailing the agency’s interpretation of the characteristics of food products that qualify as “medical foods.” Accordingly, under FDA regulations, a food qualifies as a “medical food” only if:
• | it is specially formulated and processed (as opposed to a naturally occurring foodstuff used in its natural state), for the partial or exclusive feeding of a patient by means of oral intake or enteral feeding by tube; |
• | it is intended for the dietary management of a patient who, because of therapeutic or chronic medical needs, has limited or impaired capacity to ingest, digest, absorb, or metabolize ordinary foodstuffs or certain nutrients, or who has other special medically determined nutrient requirements, the dietary management of which cannot be achieved by modification of the normal diet alone; |
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• | it provides nutritional support specifically modified for the management of the unique nutrient needs that result from the specific disease or condition, as determined by medical evaluation; |
• | it is intended to be used under medical supervision; and |
• | it is intended only for a patient receiving active and ongoing medical supervision wherein the patient requires medical care on a recurring basis for, among other things, instructions on the use of the medical food. |
The FDA has recently issued warning letters to other medical food companies challenging the classification of their products as “medical food.” We believe that these letters indicate that the FDA may be applying a more narrow interpretation of what qualifies as a “medical food.” Given this enhanced focus on medical food companies, we cannot provide any assurance that we will not also receive such a letter and the FDA could take the position that one or more of our medical foods products may not be lawfully sold in the United States as “medical food.” If such a challenge were to occur we could incur significant costs associated with responding and defending our products’ status as medical foods and ultimately litigation. If we are not able to demonstrate to the FDA’s satisfaction that the product(s) meet the regulatory requirements for “medical foods,” we may be forced to suspend sale and distribution of such products in the U.S. market or attempt to reposition the products as a supplement.
Outside the United States, the question of whether our VAYA Pharma products are categorized as prescription products, and the extent to which they can be purchased without medical supervision, depends upon national, regional and local laws and regulations, as well as the sales and marketing strategy adopted by our local license partners following discussions with us. For example, in Israel these products may be purchased over the counter, without a prescription, whereas in South Korea, one of our products, Vayarol will be sold and marketed, subject to approval, as a prescription drug.
Prescription drugs
In the United States, the FDA regulates drugs under the FDCA, and implementing regulations. The process of obtaining regulatory approvals and the subsequent compliance with appropriate federal, state, local and foreign statutes and regulations requires the expenditure of substantial time and financial resources. Failure to comply with the applicable U.S. requirements at any time during the product development process, approval process or after approval, may subject an applicant to a variety of administrative or judicial sanctions, such as the FDA’s refusal to approve pending New Drug Applications or NDAs, withdrawal of an approval, imposition of a clinical hold, issuance of warning letters, product recalls, product seizures, total or partial suspension of production or distribution, injunctions, fines, refusals of government contracts, restitution, disgorgement or civil or criminal penalties.
The process required by the FDA before a drug may be marketed in the United States generally involves the following:
• | completion of preclinical laboratory tests, animal studies and formulation studies in compliance with the FDA’s good laboratory practice, or GLP, regulations; |
• | submission to the FDA of an investigational new drug application, or IND, which must become effective before human clinical trials may begin; |
• | approval by an independent institutional review board, or IRB, at each clinical site before each trial may be initiated; |
• | performance of adequate and well-controlled human clinical trials in accordance with good clinical practices, or GCP, to establish the safety and efficacy of the proposed drug or biological product for each indication; |
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• | submission to the FDA of an NDA; |
• | satisfactory completion of an FDA advisory committee review, if applicable; |
• | satisfactory completion of an FDA inspection of the manufacturing facility or facilities at which the product is produced to assess compliance with cGMP, and to assure that the facilities, methods and controls are adequate to preserve the drug’s identity, strength, quality and purity; and |
• | FDA review and approval of the NDA. |
We may use our R&D platform to seek to penetrate the prescription pharmaceuticals market. In 2010, we commenced the process of seeking FDA approval for Vayarol as a prescription drug for the reduction of triglyceride levels in patients with hypertriglyceridemia. We submitted an Investigational New Drug Application, or IND, briefing package to the FDA in April 2013. Based on comments we received from the FDA and a subsequent teleconference with FDA representatives, we believe that the FDA would require us to design a more extensive Phase 3 clinical trial. In light of the FDA’s expanded requirements for the investigational program and the crowded market for hypertriglyceridemia treatments, we have decided to hold further activities with respect to Vayarol and are evaluating our next steps, reconsidering the costs and benefits of this project or initiation of this project with one of our other products for a different indication with greater commercial opportunity.
Environmental matters
We are subject to extensive environmental, health and safety laws and regulations in a number of jurisdictions, primarily Israel, governing, among other things: the use, storage, registration, handling and disposal of chemicals, waste materials and sewage; chemicals, air, water and ground contamination; air emissions and the cleanup of contaminated sites, including any contamination that results from spills due to our failure to properly dispose of chemicals, waste materials and sewage. Our operations at our Migdal Ha’Emeq manufacturing facility use chemicals and produce waste materials and sewage. Our activities require permits from various governmental authorities including, local municipal authorities, the Ministry of Environmental Protection, the Ministry of Health and the Ministry of Agriculture. The Ministry of Environmental Protection, the Ministry of Health, the Ministry of Agriculture, local authorities and the municipal water and sewage company conduct periodic inspections in order to review and ensure our compliance with the various regulations.
These laws, regulations and permits could potentially require the expenditure by us of significant amounts for compliance and/or remediation. If we fail to comply with such laws, regulations or permits, we may be subject to fines and other civil, administrative or criminal sanctions, including the revocation of permits and licenses necessary to continue our business activities. In addition, we may be required to pay damages or civil judgments in respect of third-party claims, including those relating to personal injury (including exposure to hazardous substances we use, store, handle, transport, manufacture or dispose of), property damage or contribution claims. Some environmental laws allow for strict, joint and several liability for remediation costs, regardless of comparative fault. We may be identified as a potentially responsible party under such laws. Such developments could have a material adverse effect on our business, financial condition and results of operations.
In addition, laws and regulations relating to environmental matters are often subject to change. In the event of any changes or new laws or regulations, we could be subject to new compliance measures or to penalties for activities which were previously permitted. For instance, new Israeli regulations were promulgated in 2012 relating to the discharge of sewage by plants into the sewer system. These regulations establish new and potentially significant fines for discharging forbidden or irregular sewage into the sewage system. In addition, our manufacturing processes include pollutant emissions, which at peak capacity approach maximum permitted levels. Accordingly, we recently completed the installation of an emissions treatment solution in our current facility.
C. Organizational Structure |
The legal name of our company is Enzymotec Ltd. and we are organized under the laws of the State of Israel. We have three wholly-owned subsidiaries: Enzymotec USA, Inc. and VAYA Pharma, Inc., both incorporated in the United States and Enzymotec Australia Pty Ltd. incorporated in Australia. We also have a 50%-owned joint venture in Advanced Lipids AB, a Swedish company, a 50%-owned joint venture in Advanced Omega A/S, a Danish company, and we own 80% of VAYA Pharma PTE Ltd., a Singapore company.
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D. Property, Plants and Equipment |
Property and infrastructure
Our principal executive and administrative offices, research and development laboratories and production plant are in the Sagi 2000 Industrial Area, near Migdal Ha’Emeq, Israel. These facilities are built on a plot of approximately 107,600 square feet, leased in 2007 from the Israel Land Administration pursuant to a 98 year lease (expiring in May 2105) for approximately $136,000, with additional related payments of approximately $314,000 to the Israeli Ministry of Economy (formerly the Ministry of Industry, Trade and Labor) and the Israeli Tax Authority. Currently, these facilities consist of approximately 70,000 square feet of built space.
Our production plant is located in a building currently comprising four floors, each of approximately 6,000 square feet. The production process is fully automated. The equipment installed at the production plant includes reactors, solid — liquid separation systems, distillation systems, a deodorization system, drying, blending and packaging systems as well as a pilot plant dedicated to research and experiments.
In addition, in 2013, we completed construction of an approximately 7,500 square feet extension to our production plant. This extension has enhanced our production capabilities and is equipped to enable us to extract crude krill oil ourselves from krill meal using new and technologically advanced equipment and proprietary processes. All of the krill oil extraction process, which was previously exclusively performed for us by a contract manufacturer in India has been brought in-house in 2014 and the agreement with the Indian manufacturer has been terminated.
Our plant utilities infrastructure (including, among other items, a steam boiler, cooling and chilled water systems and a water purification system) are designed to support 100% expansion of production beyond our expected capacity upon the completion of our current expansion, as discussed above.
In October 2011, we exercised an option for a long-term (98-year) lease for an adjoining plot of approximately 107,600 square feet from the Israel Land Administration for approximately $60,000, with additional related payments of approximately $370,000 to the Israeli Ministry of Economy (formerly the Ministry of Industry, Trade and Labor), upon which we may build an additional manufacturing facility. This plot is held pursuant to, and for the remainder of the term of, the lease of the plot upon which our current facilities are built. Pursuant to our lease agreement, we are obligated to complete certain construction projects by August 2016 and to the extent that we determine that we will not meet such obligations, we will enter into negotiations with the Israel Land Administration to modify the terms of our lease.
Office space is also leased by our two U.S. subsidiaries, in Morristown, New Jersey (approximately 300 square feet) and Greenville, South Carolina (approximately 2,000 square feet) and to our Chinese representative office (approximately 1,000 square feet) in Shanghai. All our facilities are fully utilized.
ITEM 4A: Unresolved Staff Comments
Not applicable.
ITEM 5: Operating and Financial Review and Prospects
Company overview
We are a leading global supplier of specialty lipid-based products and solutions. We develop, manufacture and market innovative bio-functional lipid ingredients, as well as final products, based on sophisticated proprietary processes and technologies. We deliver our products and solutions through the following two reportable segments:
• | Nutrition segment. This segment develops and manufactures nutritional ingredients for infant formulas and dietary supplements. These ingredients include InFat, a proprietary, clinically-proven infant formula fat ingredient that more closely resembles human breast milk fat to facilitate healthy infant development and premium phosopholipid-based bioactive ingredients for nutritional supplements. Our best-selling nutritional ingredient for dietary supplements is krill oil, which provides the benefits of omega-3 fatty acids. Our other nutritional ingredients for dietary supplements are targeted at improving brain health and providing benefits in memory, learning abilities and concentration. | |
• | VAYA Pharma segment. This segment develops, manufactures and sells branded lipid-based medical foods for the dietary management of medical disorders and common diseases. This is a research-based, specialty pharmaceutical segment, which currently offers medical food products for the cardiovascular and neurological markets. Our VAYA Pharma products are currently the only products sold by us for use by end users. |
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The following are the key milestones in our business and financial development:
• | We were founded in 1998. | |
• | In 2003, we initiated sales of our nutritional ingredients for dietary supplements, our first products offered for sale. | |
• | In 2004, we generated our first revenues from InFat. | |
• | In 2007, we entered into a joint venture arrangement with our Swedish joint venture partner, AarhusKarlshamn AB, or AAK, a global producer of specialty vegetable fats and established our Swedish joint venture, Advanced Lipids AB or AL. Our InFat product is now offered exclusively through our joint venture. | |
• | In 2008, we initiated Enzymotec USA, Inc.’s operations in the United States. | |
• | In 2009, we completed the building of our headquarters and manufacturing facility in Migdal Ha’Emeq, Israel, where we produce many of our products. This facility significantly increased our manufacturing capacity and streamlined our operations. | |
• | In 2011, we initiated sales of our VAYA Pharma products in the United States. | |
• | In the fourth quarter of 2013, we completed our manufacturing facility expansion project, which has enabled us to move the entire krill oil extraction process, which we previously outsourced, in-house. We also completed our initial public offering and listing on the NASDAQ Global Select Market. | |
• | In 2014, we began extracting krill oil in house and we established Enzymotec Australia PTY Ltd. in Australia and VAYA Pharma PTE Ltd. in Singapore to expand our in house sales and marketing capabilities. |
A. Operating Results |
Components of our statements of operations |
Net revenues
Revenues are recorded net of reserves for returns (primarily related to rights granted to distributors of VAYA Pharma products which have been negligible to date), and net of cash discounts and distribution fees.
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Nutrition segment
We sell many of our Nutrition products, including our krill oil, to companies that manufacture and market dietary supplements and to distributors of these ingredients and products. Sales of our InFat product are made through AL to companies that provide balanced infant nutrition products, primarily in China. For an explanation of our commercial arrangement with our joint venture and how we account for our joint venture, see “— Joint venture accounting” below.
VAYA Pharma segment
We sell our VAYA Pharma products in the United States as medical food through wholesalers of pharmaceutical products. Outside of the United States, we sell our VAYA Pharma products to pharmaceutical companies in various countries. We rely upon those pharmaceutical companies not only to distribute our products, but to execute substantially all selling and marketing activities related to our VAYA Pharma products in those countries. Under U.S. law, distributors of medical food have the right to return unused products. Accordingly, we recognize revenues from the sale of VAYA Pharma products in the United States net of provisions for returns that can be reasonably estimated, cash discounts and distribution fees to wholesalers.
Net revenues by geographical region
The following table presents net revenues by geographic breakdown of customers in dollars and as a percentage of net revenues for the periods indicated. This data refers to the location of the customer to whom we directly sell and does not take into consideration the location of the end-user (to the extent it is different).
Year ended December 31, | ||||||||||||||||||||||||
2012 | 2013 | 2014 | ||||||||||||||||||||||
Net Revenues | Percentage | Net Revenues | Percentage | Net Revenues | Percentage | |||||||||||||||||||
($ in thousands) | ||||||||||||||||||||||||
Geographical region | ||||||||||||||||||||||||
North America | $ | 17,487 | 46 | % | $ | 35,458 | 55 | % | $ | 25,810 | 55 | % | ||||||||||||
Europe | 6,828 | 18 | 10,382 | 15 | 10,395 | 22 | ||||||||||||||||||
Australia & New Zealand | 11,763 | 31 | 10,811 | 17 | 2,388 | 5 | ||||||||||||||||||
Asia | 1,497 | 4 | 7,735 | 12 | 7,019 | 15 | ||||||||||||||||||
Israel | 292 | 1 | 589 | 1 | 1,491 | 3 | ||||||||||||||||||
Total | $ | 37,867 | 100 | % | $ | 64,975 | 100 | % | $ | 47,103 | 100 | % |
Many of the sales made by our European, Australian and New Zealand customers are made into Asia and we believe that approximately 30% of our net revenues are derived from end customers in Asia.
Costs of revenues and gross profit
Our costs of revenues consist of costs of raw materials, as well as labor, utility and maintenance costs associated with the operation of our manufacturing facility, depreciation and shipping and handling. We allocate depreciation of our manufacturing facility, which is used by each of our segments, to each segment on the basis of actual use. The key driver of cost of revenues is the level of production, as increased output requires additional raw materials and labor.
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Our gross profit is influenced by a number of factors. The most important of these is the cost of raw materials. The main factors influencing the cost of revenues and gross profit of each of our segments are set forth below.
Nutrition
Gross profit of our Nutrition segment is primarily a function of the cost of raw materials, which comprised the majority of the costs of revenues in the year ended December 31, 2014 under the proportionate consolidation method. With respect to our InFat product, the cost of raw materials comprised a majority of the costs of revenues of AL in 2014. While certain of AL’s customer contracts contain pricing formulae under which the prices of products are adjusted to reflect changes in the costs of raw materials, the adjustments do not fully insulate AL from such changes. In addition, even where InFat prices are adjusted pursuant to customer contracts that contain pricing formulae, increases in price can adversely affect sales and also expose AL to increased competition. AL’s gross profit is also influenced by the mix of products sold, as the InFat products with the higher levels of concentration of our proprietary sn-2 palmitate component carry higher profit margins than the other InFat blends that we offer.
Further, a material portion of our costs of revenues for our nutritional ingredients is comprised of the costs of sourcing raw krill meal and extracting krill oil from the meal. We currently purchase the majority of the krill meal pursuant to an agreement with the owners of a vessel that harvests Antarctic krill and processes the freshly caught krill into krill meal. Pursuant to this agreement, the price we pay for krill meal is based on a minimum fixed price through the end of 2016 that is subject to upward adjustment depending on the quality of the krill meal. In 2014, we also purchased frozen krill, which following processing into krill meal, we intend to begin using in 2015. We entered into a toll processing agreement with a third party to process krill meal from the frozen krill. In general, purchasing frozen krill and processing it into krill meal is significantly more costly than krill harvested by vessels that process krill meal onboard which will likely cause our gross margin to be lower in 2015.
Prior to 2014, our costs related to our krill products also included payments to an Indian manufacturer for processing krill meal and extracting krill oil, which resulted in lower gross profits. In addition, our gross profit is affected by the quality of the krill meal we source, meaning the level of oils found in the krill meal, as higher quality krill meal results in greater yield and less processing. During 2013, we expanded our Migdal Ha’Emeq manufacturing facility and equipped it to enable us to extract krill oil ourselves using technologically advanced equipment and processes. In the first quarter of 2014 we moved the entire krill oil extraction process in-house. This has helped us to save all processing costs, which were approximately $1.6 million in 2013, which had previously been paid to our Indian manufacturer. In addition, moving the extraction process in house has enabled us to sell many of the marketable byproducts of the krill oil extraction process that we previously could not sell due to Indian export restrictions, thereby further increasing revenues and gross profit. The extraction process at our new facility is also more efficient than it had been at our outsourced manufacturer due to our use of new technologies. Accordingly, we believe that this move has positively impacted and will positively impact the gross profit of our Nutrition segment. We anticipate that our more efficient process may offset the additional cost of our using frozen krill alongside the krill harvested by vessel.
VAYA Pharma
The gross profit of VAYA Pharma is influenced primarily by the sale prices of its products. The gross profit from sales of VAYA Pharma products in the United States is higher than the gross profit from sales in other markets due to the fact that we perform sales and marketing of VAYA Pharma products in the United States through our dedicated sales staff, and accordingly charge higher sales prices to our wholesale distributors than to distributors in other countries who perform sales and marketing functions for us. The costs of revenues are primarily comprised of costs of production, which accounted for approximately 75% of costs of revenues in 2014, and encapsulation, packaging and bottling of these products, which accounted for substantially the entire balance of the segment’s costs of revenues in 2014.
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Operating expenses
Research and development expenses
Research and development expenses consist primarily of salaries and other employee benefits of our research and development personnel, costs of clinical trials and laboratory expenses, which include materials and depreciation of laboratory equipment. Research and development expenses are presented net of grants received from Israel’s OCS. For additional information regarding these grants, see “Item 5.B. Operating and Financial Review and Prospects — Liquidity and Capital Resources — Government Grants.” We charge all research and development expenses to operations as they are incurred. We expect research and development expenses to increase in absolute terms as we continue to conduct clinical trials this year to reinforce the science as well as develop new indications of our products. In 2014, we initiated a study for Vayarin for adults with ADHD, a long-term study for Vayacog for patients with mild cognitive impairment, and a study for a product for children with Autism Spectrum Disorder
Selling and marketing expenses
Selling and marketing expenses consist primarily of salaries and other employee benefits of our sales and marketing personnel, global marketing expenses and sales commissions. The majority of our selling and marketing expenses are generated by our VAYA Pharma segment, which maintains a dedicated sales and marketing staff in the United States consisting of medical representatives. As part of our growth strategy, we intend to increase our dedicated U.S. VAYA Pharma sales and marketing staff and therefore expect selling and marketing expenses to increase in absolute terms and as a percentage of our consolidated net revenues.
General and administrative expenses
General and administrative expenses consist primarily of salaries and other employee benefits for our managerial and administrative personnel, together with associated overhead costs. Other significant general and administrative costs include professional fees for accounting and legal services. If our sales grow, we expect our general and administrative expenses to increase in absolute terms, but to decrease as a percentage of our consolidated net revenues.
Financial income (expenses), net
Financial income (expenses) consist of interest income accrued on our bank deposits and marketable securities, changes in the fair value of foreign currency forward transactions which are not qualified as hedge transactions, foreign currency gains and losses and interest paid in respect of our long-term liabilities under our September 2009 bank financing agreement which was repaid in full in January 2014. For more information regarding these facilities, please see “Item 5.B. Operating and Financial Review and Prospects — Liquidity and Capital Resources”
Currency exchange rates
As our functional currency for all of our operations other than AL is the dollar, any movements in the currencies of other countries in which we operate can have an impact on our operating results. While the majority of our sales are in dollars and most of our expenses are in dollars, we do have exposure to the Euro and NIS. In addition, the functional currency of AL, is the Swedish Krona, and therefore the results of operations of our Nutrition segment, as reported in Note 5 to our consolidated financial statements included elsewhere in this annual report, are also influenced by fluctuations of the dollar against the Swedish Krona. For a discussion of our efforts to reduce our exposure to exchange rate fluctuations, see “Item 11. Quantitative and Qualitative Disclosures about Market Risk.”
Taxes on income
The standard corporate tax rate in Israel is 26.5%; for the 2012 and 2013 tax years it was 25%.
As discussed in greater detail below under “Item 10.E. Additional Information — Taxation — Israeli tax considerations and government programs,” we have received various tax benefits under the Investment Law. Under the Investment Law, our effective tax rate to be paid with respect to our Israeli taxable income under these benefits programs is 0%. The majority of the benefits we receive under the Investment Law are pursuant to programs that are scheduled to expire in 2022.
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Under the Investment Law and other Israeli legislation, we are entitled to certain additional tax benefits, including accelerated depreciation and amortization rates for tax purposes on certain assets, deduction of public offering expenses in three equal annual installments and amortization of other intangible property rights for tax purposes.
Our non-Israeli subsidiaries are taxed according to the tax laws in their respective jurisdictions of organization. We estimate our effective tax rate for the coming years based on the planned future financial results of our current business in existing and new markets and the key factors affecting our tax liability. Accordingly, we estimate that our effective tax rate will be lower than 10% of our income before taxes on income for the years 2015 through 2017.
Share in profits of equity investee
Under U.S. GAAP, we are required to account for the results of operations of AL, using the equity method, meaning that we recognize our share in the net results of AL as a share in profits of equity investee. See “— Joint venture accounting” below.
Joint venture accounting
Under our joint venture arrangement with AAK, each joint venture partner is responsible for particular functions related to the production, marketing and sale of the final InFat product. The direct costs of production of each partner are factored into the division of the joint venture’s revenues, as described below.
We manufacture enzymes that we supply to AAK, which then produces the final InFat product at its dedicated facility in Sweden using those enzymes together with other raw materials that AAK is responsible for sourcing. AAK is also responsible for all labor and other costs of production, including freight and logistics, as well as for capital expenditures for increased capacity, inventory storage and management, receivables collection and product liability insurance. We are responsible for research and development, as well as business development (including penetration of new markets) and marketing activities.
Once it has produced the final product, AAK sells it to AL, which sells the product to three types of customers: (i) companies that manufacture the end product themselves; (ii) companies that outsource manufacturing of the end product; and (iii) outsourced manufacturers of the end product. The difference between revenues from sales and the overall direct production costs of the joint venture partners represents the profit of AL, which is allocated between us and AAK on a 50:50 basis. This settlement does not include our operating expenses incurred in relation to the JV nor does it include depreciation or financing costs of AAK. Therefore, we are responsible for funding our operating expenses associated with our role in the joint venture and AAK is responsible for funding its other operating costs not directly related to the production of InFat, depreciation and financing costs.
Under U.S. GAAP, we are required to account for the results of operation of AL using the equity method, meaning that we recognize our share in the net results of AL as a share of profits of an equity investee. Accordingly, the revenues we recognize from the arrangement under U.S. GAAP are the amounts we charge to AAK, or our direct costs of production plus our share of the JV profits. Revenue from sales to AAK is recognized upon the sale of the product by AL to its customers. For purposes of segment reporting under U.S. GAAP, which requires presentation on the same basis provided to and utilized by management to analyze the relevant segment’s results of operations, we account for the results of operations of AL using the proportionate consolidation method.
Under the proportionate consolidation method, we recognize our proportionate share (50%) of the gross revenues of AL and record our proportionate share (50%) of the joint venture’s costs of production in our income statement.
Since under the equity method we do not include our proportionate share of the revenues, costs of revenues and operating expenses of the JV in our results of operation, our consolidated U.S. GAAP results of operations reflect lower revenues and a higher gross profit margin than our results of operation accounted for on a proportionate consolidation basis, as shown for purposes of segment reporting.
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Comparison of year-to-year results of operations
The following table sets forth certain consolidated statement of income data as a percentage of total net revenues for the years indicated. All items are included in, or derived from, our consolidated statements of operations. The year-to-year comparison of financial results is not necessarily indicative of future results.
Year ended December 31, | ||||||||||||
2012 | 2013 | 2014 | ||||||||||
Net revenues | 100.0 | % | 100.0 | % | 100.0 | % | ||||||
Cost of revenues | 52.3 | 49.4 | 38.9 | |||||||||
Gross profit | 47.7 | 50.6 | 61.1 | |||||||||
Operating expenses | ||||||||||||
Research and development, net | 12.2 | 9.2 | 12.7 | |||||||||
Selling and marketing | 13.7 | 10.4 | 17.1 | |||||||||
General and administrative | 7.8 | 13.0 | 15.9 | |||||||||
Total operating expenses | 33.7 | 32.5 | 45.7 | |||||||||
Operating income | 14.0 | 18.1 | 15.4 | |||||||||
Financial income (expense), net | (1.4 | ) | (0.8 | ) | 1.1 | |||||||
Income before taxes on income | 12.6 | 17.3 | 16.5 | |||||||||
Taxes on income | (0.5 | ) | (0.5 | ) | (0.1 | ) | ||||||
Share in profits of equity investee | 0.5 | 0.8 | 0.1 | |||||||||
Net income | 12.6 | % | 17.5 | % | 16.6 | % |
Year ended December 31, 2014 compared with year ended December 31, 2013
Net revenues
Total net revenues decreased by $17.9 million, or 27.5%, to $47.1 million in the year ended December 31, 2014 from $65.0 million in the year ended December 31, 2013. The decrease was due to a decrease of $19.1 million in sales of our Nutrition segment partially offset by an increase of $1.2 million in sales of our VAYA Pharma segment.
Nutrition segment
Based on the equity method of accounting for our joint venture, net revenues of our Nutrition segment in the year ended December 31, 2014 were $41.5 million, representing a decrease of 31.5% from net revenues of $60.5 million in the year ended December 31, 2013. Based on the proportionate consolidation method, net revenues of our Nutrition segment in the year ended December 31, 2014 were $55.8 million, representing a decrease of 26.7% from net revenues of $76.2 million in the year ended December 31, 2013. The change was due to: (i) a decrease of $15.8 million in the volume of sales of krill products, representing a decrease of 45.2% in the sales of these products from the year ended December 31, 2013, driven primarily by decreased sales in the United States and in Australia. Approximately $8.4 million of the decrease in sales of krill products was from one customer in the United States that had not placed orders with us since the second quarter of-2014. In addition, approximately $5.7 million of the decrease in sales of krill products was from our distributor in Australia, as a result of the decreased demand for krill and Omega-3 products in the Australian market, (ii) a decrease of $4.6 million in InFat sales (based on the proportionate consolidation method) by AL, resulting primarily from the Chinese infant formula market undergoing a shift in how infant formula is sold. Historically, local brands, where a majority of AL customers are positioned, were sold primarily through supermarkets and health stores. Increasingly, sales are migrating to an e-commerce platform, thereby inviting increased competition and affecting the market share of AL customers. In addition, new Chinese regulation which became effective in 2014 required both domestic and foreign infant formula companies, including some of AL’s customers, to make certain changes to their supply and production chain. This had a short term effect on the sales of AL’s customers and correspondingly on InFat which is an ingredient in some of AL’s customer’s infant formulas.
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VAYA Pharma segment
Net revenues for our VAYA Pharma segment in the year ended December 31, 2014 were $5.6 million, representing an increase of 26.9% over net revenues of $4.4 million in the year ended December 31, 2013. The increase in net revenues reflected increased volume of sales as we continued penetrating the U.S. market.
Cost of revenues and gross profit
The following table presents net revenues, cost of revenues and gross profit in dollars and as a percentage of net revenues for the years indicated, and the percentage change in such amounts year-over-year:
Year ended December 31, | Change in | As a percentage of net revenues for the year ended December 31, | ||||||||||||||||||||||
2013 | 2014 | dollars | percentage | 2013 | 2014 | |||||||||||||||||||
(in thousands) | ||||||||||||||||||||||||
Net revenues | $ | 64,975 | 47,103 | $ | (17,872 | ) | (27.5 | )% | ||||||||||||||||
Cost of revenues | 32,110 | 18,316 | (13,794 | ) | (43.0 | )% | 49.4 | % | 38.9 | % | ||||||||||||||
Gross profit | $ | 32,865 | 28,787 | $ | (4,078 | ) | (12.4 | )%) | 50.6 | % | 61.1 | % |
Gross profit decreased by $4.1 million, or 12.4%, to $28.8 million in the year ended December 31, 2014, from $32.9 million in the year ended December 31, 2013. The decrease in absolute gross profit relates primarily to our decreased volume of sales in the year ended December 31, 2014, compared to the year ended December 31, 2013.
Gross profit margin increased to 61.1% for the year ended December 31, 2014 from 50.6% for the year ended December 31, 2013. Approximately 680 basis points of the increase in gross profit margin were due to the operation of our new extraction facility and other improvements in production efficiency. Approximately 370 basis points of the increase in gross profit margin resulted from changes in the mix of products sold, as net revenues in the year ended December 31, 2014 reflected an increase in the volume of sales of InFat (as a percentage of consolidated sales) which when accounted for by the equity method carry a higher gross margin, and an increase in sales of VAYA Pharma products, which carry a higher gross margin than some of our other products.
Nutrition segment
Based on the equity method of accounting for our joint venture, gross profit of our Nutrition segment in the year ended December 31, 2014 decreased by $5.1 million, to $24.6 million, from $29.7 million in the year ended December 31, 2013, and gross profit margin increased to 59.4% in the year ended December 31, 2014 from 49.1% in the year ended December 31, 2013. Based on the proportionate consolidation method, gross profit of our Nutrition segment in the year ended December 31, 2014 decreased by $5.2 million to $25.2 million from $30.4 million in the year ended December 31, 2013, and gross profit margin increased to 45.2% in the year ended December 31, 2014 from 39.9% in the year ended December 31, 2013. The decrease in absolute gross profit was due to lower volume of sales of our Nutrition products. The increase in gross profit margin was due primarily to improvements in production efficiency as well as to a higher volume of sales of InFat in the year ended December 31, 2014 in relation to other Nutrition products. InFat, which when accounted for by the equity method, carries a higher margin than other Nutrition products.
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VAYA Pharma segment
Gross profit for our VAYA Pharma segment in the year ended December 31, 2014 increased by $1.0 million to $4.2 million from $3.2 million in the year ended December 31, 2013, due to increased volume of sales. Gross profit margin increased to 74.6% in the year ended December 31, 2014 from 71.8% in the year ended December 31, 2013, primarily due to increased volume of sales in the United States, where our gross margins on sales of VAYA Pharma products are higher than in other markets.
Operating expenses
The following table presents the types of operating expenses in dollars and as a percentage of net revenues for the years indicated, and the percentage change in such amounts year-over-year:
Year ended December 31, 2013 | Year-over-year change | Year ended December 31, 2014 | ||||||||||||||||||||||
($ in thousands) | Percentage of total net revenues | ($ in thousands) | (Percentage) | ($ in thousands) | Percentage of total net revenues | |||||||||||||||||||
Research and development, net | $ | 5,947 | 9.2 | % | $ | 39 | 0.7 | % | $ | 5,986 | 12.7 | % | ||||||||||||
Selling and marketing | 6,725 | 10.4 | 1,309 | 19.5 | 8,034 | 17.1 | ||||||||||||||||||
General and administrative | 8,434 | 13.0 | (959 | ) | (11.4 | ) | 7,475 | 15.9 | ||||||||||||||||
Total operating expenses | $ | 21,106 | 32.5 | % | $ | 389 | 1.8 | % | $ | 21,495 | 45.7 | % |
Research and development expenses slightly increased by $39,000, to $6.0 million in the year ended December 31, 2014, from $5.9 million in the year ended December 31, 2013. As a percentage of net revenues, our research and development expenses increased to 12.7% in the year ended December 31, 2014 from 9.2% in the year ended December 31, 2013. The increase in absolute amounts reflected an increase of $0.3 million in expenses related to clinical trials partially offset by a decrease of $0.2 million in laboratory expenses. The increase in research and development expenses as a percentage of net revenues reflected the overall decrease in net revenues. Grants from the OCS decreased by $52,000, or 26.4%, to $0.1 million in the year ended December 31, 2014, from $0.2 million in the year ended December 31, 2013.
Selling and marketing expenses increased by $1.3 million, or 19.5%, to $8.0 million in the year ended December 31, 2014, from $6.7 million in the year ended December 31, 2013. As a percentage of net revenues our selling and marketing expenses increased to 17.1% in the year ended December 31, 2014 from 10.4% in the year ended December 31, 2013. The increase in selling and marketing expenses both as an absolute amount and as a percentage of net revenues reflected primarily an increase of $0.6 million in salaries, due primarily to the addition of sales personnel for the VAYA Pharma segment in the United States and an increase of $0.2 million in marketing activities (primarily marketing activities related to the marketing of VAYA Pharma products) and also due to an increase in license amortization expenses of $0.4 million related to the settlement and license agreement signed with Neptune Technologies & Bioresources Inc. and Acasti Pharma Inc. Sales and marketing expenses as a percentage of net revenues was also impacted by the overall decrease in net revenues.
General and administrative expenses decreased by $1.0 million, or 11.4%, to $7.5 million in the year ended December 31, 2014, from $8.4 million in the year ended December 31, 2013. As a percentage of net revenues, our general and administrative expenses increased to 15.9% in the year ended December 31, 2014 from 13.0% in the year ended December 31, 2013. The decrease in general and administrative expenses as an absolute amount was due to a decrease in litigation expenses of $1.0 million (mainly related to a decrease in Neptune patent litigation offset by an increase in litigation costs related to the arbitration with AAK and the class action. The decrease was also due to a decrease of $1.0 million in salaries (mainly related to the bonuses granted to certain of our employees in connection with our initial public offering, or IPO, in October 2013 that were recorded in the fourth quarter of 2013), as well as a decrease in share-based compensation expenses of $0.4 million (primarily as a result of the acceleration of vesting of options in the fourth quarter of 2013 related to the IPO). This was partially offset by expenses of $0.4 million related to the secondary offering we conducted in February 2014, other expenses of $0.7 million relating to being a public company and an increase of $0.2 million in allowance for doubtful accounts. The increase in general and administrative expenses as a percentage of net revenues reflected the overall decrease in net revenues, partially offset by the decrease in the absolute amount of general and administrative expenses. We anticipate that general and administrative expenses may increase in 2015 as a result of legal costs relating to the arbitration with AAK.
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Financial income (expenses), net
The following table presents our financial income (expenses), net, in dollars and as a percentage of net revenues for the years indicated, and the percentage change in such amounts year-over-year:
Year ended December 31, 2013 | Year-over-year change | Year ended December 31, 2014 | ||||||||||
(in thousands) | ||||||||||||
Financial income (expenses), net | $ | (531 | ) | $ | 1,030 | $ | 499 | |||||
Percentage of total net revenues | (0.8 | )% | 1.1 | % |
For the year ended December 31, 2014, financial income was $0.5 million, compared to financial expenses of $0.5 million for the year ended December 31, 2013, primarily due to decrease in financial expenses of $0.5 million related to the long-term loans that were repaid in January 2014, interest received and accrued on our bank deposits and marketable securities of $0.3 million and foreign currency exchange differences of $0.3 million, partially offset by a decrease in gain in respect of derivatives of $0.1 million.
Year ended December 31, 2013 compared with year ended December 31, 2012
Net revenues
Total net revenues increased by $27.1 million, or 71.6%, to $65.0 million in the year ended December 31, 2013 from $37.9 million in the year ended December 31, 2012. The increase was due primarily to a significant increase in the volume of sales in our Nutrition segment.
Nutrition segment
Based on the equity method of accounting for our joint venture, net revenues of our Nutrition segment in the year ended December 31, 2013 were $60.5 million, representing an increase of 68.0% over net revenues of $36.0 million in the year ended December 31, 2012. Based on the proportionate consolidation method, net revenues of our Nutrition segment in the year ended December 31, 2013 were $76.2 million, representing an increase of 71.6% over net revenues of $44.4 million in the year ended December 31, 2012. The change was due to (i) an increase of $16.0 million in the volume of sales of krill products, representing an increase of 84% in the sales of this product over the year ended December 31, 2012, driven primarily by increased volume of sales in the United States reflecting increased demand for premium omega-3 products in that market; and (ii) an increase of $15.8 million in the volume of sales of InFat by AL, which we believe reflects increased market penetration due to growing awareness of the benefits of InFat, especially in the Chinese market. Approximately $9.2 million of the increase in sales of krill products was from one customer in the United States that placed initial orders with us in 2012 and significantly increased those orders in 2013.
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VAYA Pharma segment
Net revenues for our VAYA Pharma segment in the year ended December 31, 2013 were $4.4 million, representing an increase of 142.6% over net revenues of $1.8 million in the year ended December 31, 2012. The increase in net revenues reflected increased volume of sales as we continued penetrating the U.S. market.
Cost of revenues and gross profit
The following table presents net revenues, cost of revenues and gross profit in dollars and as a percentage of net revenues for the years indicated, and the percentage change in such amounts year-over-year:
Year ended December 31, | Increase in | As a percentage of net revenues for the year ended December 31, | ||||||||||||||||||||||
2012 | 2013 | dollars | percentage | 2012 | 2013 | |||||||||||||||||||
(in thousands) | ||||||||||||||||||||||||
Net revenues | $ | 37,867 | $ | 64,975 | $ | 27,108 | 71.6 | % | ||||||||||||||||
Cost of revenues | 19,815 | 32,110 | 12,295 | 62.0 | 52.3 | % | 49.4 | % | ||||||||||||||||
Gross profit | $ | 18,052 | $ | 32,865 | $ | 14,813 | 82.1 | % | 47.7 | % | 50.6 | % |
Gross profit increased by $14.8 million, or 82.1%, to $32.9 million in the year ended December 31, 2013, from $18.1 million in the year ended December 31, 2012. The change in absolute gross profit reflects primarily our increased volume of sales. The increase in gross profit margin from 47.7% to 50.6% is due primarily to increased volume of sales of InFat, which carries a higher gross margin than our other products.
Nutrition segment
Based on the equity method of accounting for our joint venture, gross profit of our Nutrition segment in the year ended December 31, 2013 increased by $12.9 million, to $29.7 million, from $16.8 million in the year ended December 31, 2012, and gross profit margin increased to 49.1% in the year ended December 31, 2013 from 46.7% in the year ended December 31, 2012. Based on the proportionate consolidation method, gross profit of our Nutrition segment in the year ended December 31, 2013 increased by $13.3 million to $30.4 million from $17.1 million in the year ended December 31, 2012, and gross profit margin increased to 39.9% in the year ended December 31, 2013 from 38.5% in the year ended December 31, 2012. The increase in absolute gross profit was due to increased volume of sales of our Nutrition products. The increase in gross profit margin was due primarily to a higher volume of sales of InFat in the year ended December 31, 2013 in relation to other Nutrition products, as InFat carries a higher margin than other Nutrition products, as well as improvements in production efficiency and the leveraging of fixed production costs.
VAYA Pharma segment
Gross profit for our VAYA Pharma segment in the year ended December 31, 2013 increased by $1.9 million to $3.2 million from $1.2 million in the year ended December 31, 2012, due to increased volume of sales. Gross profit margin increased to 71.8% in the year ended December 31, 2013 from 67.9% in the year ended December 31, 2012, primarily due to increased volume of sales in the United States, where our gross margins on sales of VAYA Pharma products are higher than in other markets.
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Operating expenses
The following table presents the types of operating expenses in dollars and as a percentage of net revenues for the years indicated, and the percentage change in such amounts year-over-year:
Year ended December 31, 2012 | Year-over-year change | Year ended December 31, 2013 | ||||||||||||||||||||||
($ in thousands) | Percentage of total net revenues | ($ in thousands) | (Percentage) | ($ in thousands) | Percentage of total net revenues | |||||||||||||||||||
Research and development, net | $ | 4,611 | 12.2 | % | $ | 1,336 | 29.0 | % | $ | 5,947 | 9.2 | % | ||||||||||||
Selling and marketing | 5,191 | 13.7 | 1,534 | 29.6 | 6,725 | 10.4 | ||||||||||||||||||
General and administrative | 2,935 | 7.8 | 5,499 | 187.4 | 8,434 | 13.0 | ||||||||||||||||||
Total operating expenses | $ | 12,737 | 33.7 | % | $ | 8,369 | 65.7 | % | $ | 21,106 | 32.5 | % |
Research and development expenses increased by $1.3 million, or 29.0%, to $5.9 million in the year ended December 31, 2013, from $4.6 million in the year ended December 31, 2012. As a percentage of net revenues, however, our research and development expenses decreased to 9.2% in the year ended December 31, 2013 from 12.2% in the year ended December 31, 2012. The increase in absolute amounts reflected an increase of $0.4 million in regulatory expenses, an increase of $0.4 million in salaries, an increase of $0.2 million in patent and trademarks expenses, an increase of $0.2 million in laboratory expenses and a decrease of $0.1 million in government participation in the form of grants from the OCS. Grants from the OCS decreased by $0.1 million, or 25.6%, to $0.2 million in the year ended December 31, 2013, from $0.3 million in the year ended December 31, 2012. The decrease in research and development expenses as a percentage of net revenues reflected the increase in net revenues in both segments.
Selling and marketing expenses increased by $1.5 million, or 29.6%, to $6.7 million in the year ended December 31, 2013, from $5.2 million in the year ended December 31, 2012. As a percentage of net revenues, however, our selling and marketing expenses decreased to 10.4% in the year ended December 31, 2013 from 13.7% in the year ended December 31, 2012. The increase in absolute amounts reflected an increase of $1.0 million in salaries, due primarily to the addition of sales personnel for the VAYA Pharma segment in the United States and an increase of $0.6 million in marketing activities in the United States (primarily marketing activities related to the marketing of VAYA Pharma products). The decrease in selling and marketing expenses as a percentage of net revenues reflected the increase in net revenues in both segments.
General and administrative expenses increased by $5.5 million, or 187.4%, to $8.4 million in the year ended December 31, 2013, from $2.9 million in the year ended December 31, 2012. As a percentage of net revenues, our general and administrative expenses increased to 13.0% in the year ended December 31, 2013 from 7.8% in the year ended December 31, 2012.
The increase in absolute amounts reflected an increase of $2.6 million incurred in connection with the Neptune patent litigation, an increase of $1.6 million in salaries ($1.0 million of which relates to the bonuses granted to certain of our employees in connection with our initial public offering), an increase of $0.8 million in share-based compensation expense, primarily related to the issuance of restricted shares to two of our directors and the acceleration of options upon our initial public offering and an increase of $0.4 million in audit and legal expenses. The increase in general and administrative expenses as a percentage of net revenues reflected the increase in absolute amount, partially offset by the increase in net revenues in both segments.
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Financial expenses, net
The following table presents our financial expenses, net, in dollars and as a percentage of net revenues for the years indicated, and the percentage change in such amounts year-over-year:
Year ended December 31, 2012 | Year-over-year change | Year ended December 31, 2013 | ||||||||||
(in thousands) | ||||||||||||
Financial expenses, net | $ | 539 | (1.4 | )% | $ | 531 | ||||||
Percentage of total net revenues | (1.4 | )% | (0.8 | )% |
Our financial expenses, net were $0.5 million in the year ended December 31, 2013 and the year ended December 31, 2012. As a percentage of net revenues, however, our financial expenses decreased to 0.8% in the year ended December 31, 2013 from 1.4% in the year ended December 31, 2012 due to the increase in net revenues.
Seasonality
Our revenues generally are not affected by seasonality.
Critical accounting estimates and assumptions
We have prepared our consolidated financial statements and related disclosures in conformity with U.S. GAAP. This has required us to make estimates based on our judgments and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results may differ from those estimates. See “Item 3.D. Key Information—Risk factors” for a discussion of the possible risks which may affect these estimates. Note 1 to our consolidated financial statements contained elsewhere in this annual report describes the significant accounting policies and principles that are used to prepare our consolidated financial statements.
We have identified several critical accounting estimates that required us to use assumptions about matters that were uncertain at the time of our estimates. Had we used different assumptions, the amounts we recorded could have been significantly different. Additionally, if we had used different assumptions or had different conditions existed, our financial condition or results of operations could have been materially different. The critical accounting policies that were impacted by the estimates, assumptions, and judgments used in the preparation of our consolidated financial statements are discussed below.
Revenue recognition
We recognize revenues from sales of products to customers, including distributors, when persuasive evidence of a sale arrangement exists, delivery has occurred, the sales price is fixed or determinable and collectability is reasonably assured. We recognize revenues related to AL from sales to AAK only upon sales by AL to its customers. Revenues are recorded net of reserves for returns and net of cash discounts and distribution fees.
We provide a right of return to U.S. distributors upon expiration of the medical food products sold in the VAYA Pharma segment, in compliance with applicable regulations. The majority of our product returns are the result of product dating. Accordingly, we record a reserve for estimated sales returns based on historical experience with actual returns, as well as specific factors, such as levels of inventory in the distribution channel, product dating and expiration. Returns to date have been inconsequential. Revenues from product sales are also recorded net of cash discounts and distribution fees, which can be reasonably estimated.
Share-based compensation
Under U.S. GAAP, we account for employee share-based compensation awards classified as equity awards in accordance with the provisions of ASC No. 718, “Compensation — Stock Based Compensation”, which requires us to measure the cost of options based on the fair value of the award on the grant date. We also apply ASC No. 718, “Compensation — Stock Based Compensation” and ASC No. 505-50, “Equity Based Payments to Non-Employees” with respect to options issued to consultants and other non-employees.
We selected the binomial option pricing model as the most appropriate method for determining the estimated fair value of our share-based compensation awards. The fair value of share-based compensation awards is recognized as an expense over the requisite service period, which is usually the vesting period, net of estimated forfeitures. We estimate forfeitures based on historical experience and anticipated future conditions. We recognize compensation cost for an award with service conditions that has a graded vesting schedule using the straight-line method based on the multiple-option award approach.
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When options are granted as consideration for services provided by consultants and other non-employees, the grant is accounted for based on the fair value of the consideration received or the fair value of the options issued, whichever is more reliably measurable. The fair value of the options granted is measured on a final basis at the end of the service period and is recognized over the service period using the straight-line method.
Option valuations. The determination of the grant date fair value of options using an option pricing model is affected by estimates and assumptions regarding a number of complex and subjective variables. The key variables are as follows:
Fair Value of our Ordinary Shares. Prior to our initial public offering, due to the absence of a public market for our ordinary shares, the fair value of our ordinary shares for purposes of determining the exercise price for award grants was determined in good faith by our management and approved by our board of directors. In connection with preparing our financial statements, our management considered the fair value of our ordinary shares based on a number of objective and subjective factors consistent with the methodologies outlined in the American Institute of Certified Public Accountants Practice Aid, Valuation of Privately-Held-Company Equity Securities Issued as Compensation, referred to as the AICPA Practice Aid. The fair value of our ordinary shares is now determined based on the trading price on the NASDAQ Global Select Market. |
Volatility. The expected share price volatility was based on the historical equity volatility of the ordinary shares of publicly traded comparable companies with a trading history as long as the contractual term. |
Risk-Free Interest Rate. The annual risk-free interest rate was based on the interest curve for U.S. government bonds for periods corresponding to the life term of the option on the grant date. |
Contractual Term. The contractual term is 10 years. This was then adjusted based on data regarding our historical post-vesting exit rates. Pre-vesting exit rates were reflected in an adjustment to the number of options recognized in expenses. |
Early Exercise Multiple. The early exercise multiple was based on the early exercise multiple data of publicly traded comparable companies with a trading history as long as the contractual term. |
Dividend Yield. We have never declared or paid any cash dividends and do not presently plan to pay cash dividends in the foreseeable future. Consequently, we used an expected dividend yield of zero. |
If any of the assumptions used changes significantly, share-based compensation awards for future awards may differ materially compared with the awards granted previously.
Research and development expenses
Research and development expenses are charged to income as incurred. Participation from government departments and from research foundations for development of approved projects is recognized as a reduction of expense as the related costs are incurred. The main components of the research and development expenses are salaries and related expenses, laboratory, clinical research and regulatory related expenses.
Taxes on income
Deferred income taxes are determined by the asset and liability method based on the estimated future tax effects of differences between the financial accounting and the tax bases of assets and liabilities under the applicable tax law. Deferred tax balances are computed using the tax rates expected to be in effect at the time when these differences reverse. Valuation allowances in respect of the deferred tax assets are provided when it is more likely than not that all or a portion of the deferred income tax assets will not be realized. See Note 11g to our consolidated financial statements contained elsewhere in this annual report for additional information regarding the composition of the deferred taxes.
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We assess our valuation allowance considering different indicators, including profitability of the different entities around the world and the ability to utilize the deferred tax assets in subsequent years.
Tax benefits recognized in our consolidated financial statements are those that our management deems at least more likely than not to be sustained, based on technical merits. The amount of benefits recorded for these tax benefits is measured as the largest benefit our management deems more likely than not to be sustained.
Contingencies
Certain conditions may exist as of the date of our financial statements, which may result in a loss to us but which will only be resolved when one or more future events occur or fail to occur. We assess such contingent liabilities and estimated legal fees, if any, and such assessment inherently involves an exercise of judgment. In assessing loss contingencies related to legal proceedings that are pending against us, or unasserted claims that may result in such proceedings, we evaluate the perceived merits of any legal proceedings or unasserted claims as well as the perceived merits of the amount of relief sought or expected to be sought.
We apply the guidance in ASC Topic 450-20-25, issued by the Financial Accounting Standards Board, or FASB, when assessing losses resulting from contingencies. If the assessment of a contingency indicates that it is probable that a material loss has been incurred and the amount of the liability can be estimated, then the estimated liability is recorded as accrued expenses in our financial statements. If the assessment indicates that a potential material loss contingency is not probable but is reasonably possible, or is probable but cannot be estimated, then the nature of the contingent liability, together with an estimate of the range of possible loss if determinable and material are disclosed. Loss contingencies considered to be remote are generally not disclosed unless they involve guarantees, in which case the guarantees are disclosed.
Impairment of long-lived assets
We test long-lived assets (including intangible assets) for impairment whenever events or circumstances present an indication of impairment. If the sum of expected future cash flows (undiscounted and without interest charges) of the assets is less than the carrying amount of such assets, an impairment loss would be recognized. The assets would be written down to their estimated fair values, calculated based on the present value of expected future cash flows (discounted cash flows), or some other fair value measure. As of December 31, 2014, 2013 and 2012, we did not recognize an impairment loss for its long-lived assets.
New and Revised Financial Accounting Standards
The JOBS Act permits emerging growth companies such as us to delay adopting new or revised accounting standards until such time as those standards apply to private companies. We have irrevocably elected not to avail ourselves of this and, therefore, we are subject to the same new or revised accounting standards as other public companies that are not emerging growth companies.
Recently Issued Accounting Pronouncements
See note 1 to our consolidated financial statements.
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B. Liquidity and Capital Resources |
Liquidity
A summary of our statement of cash flows for the years ended December 31, 2012, 2013 and 2014 is as follows:
Year ended December 31, | ||||||||||||
2012 | 2013 | 2014 | ||||||||||
(in thousands) | ||||||||||||
Net income | $ | 4,782 | $ | 11,395 | $ | 7,838 | ||||||
Depreciation and amortization | 1,422 | 1,551 | 2,308 | |||||||||
Change in inventories | (3,100 | ) | (2,584 | ) | (9,629 | ) | ||||||
Change in accounts receivable | (3,806 | ) | (6,965 | ) | 5,304 | |||||||
Change in accounts payable and accruals | 3,590 | 3,052 | 3,868 | |||||||||
Net cash provided by operating activities | 3,023 | 7,390 | 1,965 | |||||||||
Net cash used in investing activities | (1,278 | ) | (5,025 | ) | (63,558 | ) | ||||||
Net cash provided by (used in) financing activities | (3,803 | ) | 69,336 | (2,522 | ) | |||||||
Net increase (decrease) in cash and cash equivalents | (2,058 | ) | 71,701 | (64,115 | ) | |||||||
Balance of cash and cash equivalents at end of year | 2,729 | 74,430 | 10,315 |
Cash flows provided by operating activities
Cash flows from operating activities consist primarily of net income adjusted for certain non-cash items. Adjustments to net income for non-cash items include depreciation and amortization and share-based compensation expense. In addition, operating cash flows are impacted by changes in operating assets and liabilities, which include inventories, accounts receivable and other assets and accounts payable.
We generated $2.0 million in cash from operating activities in the year ended December 31, 2014, while in the year ended December 31, 2013 we generated $7.4 million from operating activities. Cash from operating activities in the year ended December 31, 2014 was due primarily to our achieving net income of $7.8 million and to a decrease of $5.3 million in accounts receivable due to the decreased sales, as well as $2.3 million in depreciation and amortization and $0.9 million in share-based compensation expense. This was partially offset by an increase of $9.6 million in inventories reflecting our strategy of building inventories from certain single source suppliers to partially manage supply risk as well as a result of the decreased sales, share of profits of equity investee of $0.5 million and a decrease of $3.9 million in accounts payable due to the decreased activity in the fourth quarter of 2014 compared to the activity in the fourth quarter of 2013. Cash from operating activities in the year ended December 31, 2013 was due primarily to our achieving net income of $11.4 million and to an increase of $3.1 million in accounts payable reflecting primarily increased purchases of raw materials due to increased activity, as well as $1.6 million in depreciation and amortization and $1.1 million in share-based compensation expense. This was partially offset by an increase of $2.6 million in inventories reflecting our increased activity as well as our strategy of building inventories from certain single source suppliers to partially manage supply risk and an increase of $7.0 million in accounts receivable due to increased sales.
The $3.0 million in cash provided by operating activities in the year ended December 31, 2012 was due primarily to our achieving net income of $4.8 million and to an increase of $3.6 million in accounts payable reflecting primarily increased purchases of raw materials due to increased activity, as well as $1.4 million in depreciation and amortization. This was partially offset by an increase of $3.1 million in inventories reflecting our increased activity as well as our strategy of building inventories from certain single source suppliers to partially manage supply risk and an increase of $3.8 million in accounts receivable due to increased sales.
Working capital
Our working capital, which we define as accounts receivable plus inventory less accounts payable, increased from $20.7 million at December 31, 2013 to $29.3 million at December 31, 2014 due to an increase in inventory of $9.6 million and a decrease in accounts payable of $4.0 million, partially offset by a decrease in accounts receivables of $5.0 million. Working capital as a percentage of net revenues increased from 31.8% at December 31, 2013 to 62.2% at December 31, 2014, mainly reflecting increases in our inventories conversion period as a result of our strategy of building inventories from certain single source suppliers to partially manage supply risk as well as a result of the decreased sales. Working capital increased from $14.1 million at December 31, 2012 to $20.7 million at December 31, 2013. However, working capital as a percentage of net revenues decreased from 37.2% at December 31, 2012 to 31.8% at December 31, 2013, reflecting a decrease in days of sales outstanding and in our inventories conversion period.
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Cash flows used in investing activities
In the year ended December 31, 2014, we invested the substantial portion of the cash proceeds of the offerings of our securities into bank deposits and marketable securities. Otherwise, the majority of our investment activities have historically been related to the construction and expansion of our manufacturing facilities and the purchase of manufacturing equipment and components for our production lines. Cash flows used in investing activities in the year ended December 31, 2014 amounted to $63.6 which reflects primarily our investment of $62.5 million, mostly comprised of proceeds from our IPO, in bank deposits and marketable securities, purchase of property, plant and equipment and intangible assets of $6.4 million (mainly related to the construction and expansion of our manufacturing facility and the one-time settlement payment to Neptune), partially offset by $5.3 million in proceeds from the sale of marketable securities. Cash flows used in investing activities in the year ended December 31, 2013 amounted to $5.0 million that was mainly related to our manufacturing facility expansion project, which has enabled us to extract krill oil from krill meal ourselves using technologically advanced equipment and proprietary processes. Cash flows used in investing activities in the year ended December 31, 2012 amounted to $1.2 million and related primarily to normal capital expenditures.
We expect cash used in investing activities to increase significantly when and if we will commence the construction on our new manufacturing facility. While we anticipate that construction of this new facility will require significant capital expenditures, we have not yet started construction of the facility or even entered into contracts relating to the construction and therefore it would not be completed, if we do undertake it, before 2016. The timing and amount of the capital expenditures associated with this project, if we do undertake it, is uncertain. In addition, cash used in investing activities would increase to the extent that we acquire complementary businesses or assets.
Cash flows provided by (used in) financing activities
Cash used in financing activities in the year ended December 31, 2014 amounted to $2.5 million, which reflects primarily a repayment in full of $4.2 million of our long-term loan, partially offset by proceeds from exercises of options by employees of $1.8 million.
We generated $69.3 million in cash from financing activities in the year ended December 31, 2013, which reflects primarily $62.8 million of net proceeds from our IPO and $8.2 million received in an investment in our preferred shares and warrants, partially offset by a repayment of $1.0 million in short-term loans under our working capital credit facility and repayment of $0.7 million under our long-term loan.
Cash used in financing activities in the year ended December 31, 2012 amounted to $3.8 million, which reflects primarily a repayment of $4.6 million in short-term loans under our working capital credit facility and a repayment of $0.7 million on our long-term loan, partially offset by an investment of $1.5 million in our preferred shares and warrants.
Capital resources
We have traditionally funded our operations with a combination of cash generated from operating activities, third-party debt consisting mainly of long-term and short-term bank credit facilities, as well as cash generated through the sale of equity securities.
In September 2009, we entered into a credit facility for long-term loans with an Israeli bank which expired as of December 31, 2013 and was fully repaid.
As of December 31, 2013, we had $4.2 million in outstanding principal amount under a long-term credit facility. On January 31, 2014, we repaid this amount in full and, as a result, we accrued $150,000 in early repayment fees.
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We believe that, based on our current business plan, our cash, cash equivalents and short-term bank deposits on hand and cash from operations, we will be able to meet our capital expenditure and working capital requirements, and liquidity needs for at least the next twelve months. We may require additional capital in the future, and therefore may engage in debt or equity financings to meet our longer term liquidity and future growth objectives.
C. Research and Development, Patents and Licenses |
Research and development
We believe that our leading position as a developer and manufacturer of innovative bioactive ingredients is due in part to our expertise in lipids and enzymes accompanied by our policy of shared research and development resources across our organization and leveraging the significant cross benefits.
We maintain an ongoing program of research and development, or R&D, to substantiate our clinical evidence and to enlarge our technological platform and process capabilities in relation to, among other things, lipid chemistry, enzymatic technology and lipid analysis. The primary aim of our R&D program is to develop improved and more affordable products. We therefore focus on the enhancement of our existing product lines in order to reinforce our competitive strengths and expand the scope of our existing products into new indications. We have a pipeline of more than ten products, including new uses and applications for existing products, in various stages of development. Some of these products address new medical indications or provide new dietary or medical benefits, while others provide different levels/concentrations of active ingredients and offer improved secondary characteristics. In addition to further substantiating the value and efficacy of our existing products, our R&D program also focuses on the development of additional lipid-based products.
As all of our products are derived from our expertise in lipids biochemistry and our capabilities in analyzing lipid structure, composition and performance, much of our R&D is not divided based on segment or product line. Rather, more general R&D is conducted and only after particular R&D is seen to relate to the development of a new product or the enhancement of an existing product does that R&D become associated with a specific product line or segment. We believe that this helps us leverage shared R&D resources across our organization.
We have several new nutritional ingredient products for infant formula under development planned to launch within the next few years.
We invest a significant amount of our resources in R&D as we believe that superior technology is key to maintaining a leading market position. Our R&D expenses were $4.6 million, $5.9 million and $6.0 million in 2012, 2013 and 2014, respectively, representing 12.2%, 9.2% and 12.7% of net revenues, respectively.
We may use our R&D platform to seek to penetrate the prescription pharmaceuticals market. For more information regarding our prescription pharmaceuticals, see “Item 4.B. Information on Enzymotec — Business Overview — Government regulation — VAYA Pharma — Prescription drugs.”
In 2015, we intend to introduce Incog, Incog is a marine-based lipid composition for use in infant nutrition products that is intended to mimic certain characteristics of human breast milk. InCog is produced by enriching lipids with a bio-functional DHA-rich phospholipid that is present in human breast milk and is highly concentrated in the developing human brain. This compound was found to support cognitive functioning and is being developed as a key cognitive ingredient for early nutrition. InCog is currently in the clinical development phase. This ingredient is approved as GRAS by the FDA for marketing in the United States for the general population. We are currently in the process of applying for GRAS certification for infants. We are also in the process of preparing a submission for registration in China and Europe, and we hope to obtain regulatory approval for InCog in Europe during the second half of 2015.
We hope that InCog will generate incremental revenues, but we do not expect it to be material to our results of operations in the near term.
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We currently have several products in our VAYA Pharma segment in various stages of development. These include compositions based on phosphatidylserine (PS) and phosphatidylcholine (PC), two phospholipids known to support cognitive, behavioral and metabolic human functions. We are developing and evaluating these products, which will each contain PS-Omega3 or PC-Omega3, for the treatment of various cognitive, behavioral, mood or metabolic disorders. None of these products is expected to be individually material to our business in the near term.
Clinical Trials
Even though our nutritional ingredients and medical foods products are generally not required to undergo clinical trials prior to approval by the FDA or other regulatory authorities, we nonetheless conduct clinical and pre-clinical studies to support the efficacy and safety of our products and their ingredients and to extend and validate their benefits for human health. Pre-clinical studies allow us to substantiate the safety of our products and obtain preliminarily indications of their pharmacological profile and mechanism of the action. Through January 31, 2015, we had conducted 11 pre-clinical studies, according to the principles of Good Laboratory Practices (GLP) and completed 14 clinical studies, according to the principles of Good Clinical Practices (GCP). As a result, we have developed significant experience in planning, designing, executing, analyzing and publishing clinical studies.
In 2014, we initiated a number of clinical trials, including a clinical trial for a product on managing Autism Spectrum Disorder symptoms, a clinical trial on Vayarin for adults with Attention Deficit Hyperactivity Disorder and a clinical trial on long term efficacy of Vayacog in mild cognitive impairment. We also finalized the clinical phase of a clinical study of Vayarol for reducing triglyceride levels in patients with hypertriglyceridemia.
Our R&D team manages our clinical studies and is deeply involved with project planning, trial design, execution, outcome analyses and manuscript submission. During the design, execution and publication of our studies, our R&D team consults with key opinion leaders in the relevant field of research to optimize both design and execution, as well as to strengthen the scientific and academic level of the investigational plan. Our clinical studies have been conducted in collaboration with leading medical and research centers in countries such as Israel, Canada, China and The Netherlands including Meir Medical Center, Israel; Sourasky Medical Center, Israel; Sheba Medical Center, Israel; and McGill University, Canada. For information regarding the clinical validation of our various products, see “Item 4.B. Information on Enzymotec — Business Overview — Our products — Nutrition segment — Clinical validation” and “ Item 4.B. Information on Enzymotec — Business Overview — Our products — VAYA Pharma segment — Clinical validation.”
Intellectual property
Our proprietary technology is important to the development, manufacture, and sale of our products, and we seek to protect such technology and other intellectual property through a combination of patents, copyrights, trademarks, trade secrets, non-disclosure and confidentiality agreements, licenses, assignments of invention and other contractual arrangements with our employees, consultants, partners, suppliers, customers and others. We rely on our research and development program, clinical trials, production techniques and marketing and distribution programs to advance our products.
As of January 31, 2015, we had been granted over 85 patents and had applications for approximately 80 additional patents pending worldwide. Our principal granted patents relate to our technologies arising out of novel formulations, their beneficial uses and processes for the manufacturing thereof, rather than claiming specific molecules or active ingredients.
• | InFat. The patent portfolio for the InFat products includes issued patents and pending applications directed to formulations, manufacturing process and methods of use. Our current and potential customers for InFat include major global nutrition companies with worldwide operations. The majority of manufacturers of infant formulas containing InFat are located in Europe, New Zealand and Australia, where we have issued patents. In China, which is our largest end user market for InFat products, we have one issued patent covering a formulation and a process related to InFat and another issued patent covering a use related to InFat. In addition we have pending applications covering uses and a particular composition and manufacturing process. In Europe, we have three issued patents: one claiming a formulation which expires in 2024, and two claiming uses of InFat which expire in 2024 and 2028 and are currently under opposition proceedings. We also have a number of pending applications related to InFat in Europe. In each of New Zealand and Australia, we have issued patents claiming a manufacturing process for InFat, which expire in 2020 and 2018, respectively. In addition, we have two issued patents in Australia and one in New Zealand which cover uses related to InFat and expire in 2028 and 2031, as well as a pending application in New Zealand. While the United States is not currently a major market for InFat, we do believe it presents a growth opportunity for InFat. In the United States, we have one issued patent claiming a manufacturing process, which expires in 2017, and two issued patents claiming methods of use, which expire in 2026 and 2031, respectively. We also have seven pending U.S. applications covering particular compositions and uses related to the InFat products. We also have issued patents related to these products in Israel, Mexico, South Korea, India, Canada, Hong Kong, and Russia, and patent applications pending in various countries around the world. |
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• | PS Products. The patent portfolio for our PS products (including Sharp PS) includes patents and patent applications directed to formulations, manufacturing processes, and methods of use. In each of the United States and Europe, the two largest markets for our PS products, we own one issued patent covering a formulation related to Sharp PS, which expires in the United States in 2026 and in Europe in 2024. We also have issued counterparts to that patent in Australia, Canada, Japan Hong Kong and South Korea. |
• | VAYA Products. The patent portfolio for our various VAYA products (including Vayarol, Vayacog and Vayarin) includes patents and patent applications directed to formulations and methods of use. The United States is currently the largest market for our VAYA products. We have four issued patents in the United States covering formulations or methods of use related to Vayarin, of which three of these patents also cover formulations or uses of Vayacog. None of these patents expires before 2024. We also have an issued U.S. patent covering method of use of Vayacog, which expires in 2030, and two issued patents covering a formulation of Vayarol and a use related to Vayarol, which expire in 2024 and in 2026, respectively. One or more patents related to one or more of our VAYA products have also been issued in each of Australia, Canada, China, Europe, Hong Kong, India, Israel, Japan, Mexico, New Zealand, the Philippines, Russia and South Korea. |
We have an exclusive license under a family of third party patents related to a process for the enzymatic production of PS, Vayarin and Vayacog including issued patents in the United States, Europe, China and Japan, each expiring in 2016. Under that license, we have the right to enforce the licensed patents against third party infringers. Royalties payable under that license are not material to our results of operations.
While our policy is to obtain patents by application, license or otherwise, to maintain trade secrets and to seek to operate without infringing on the intellectual property rights of third parties, technologies related to our business have been rapidly developing in recent years. Loss or invalidation of certain of our patents, or a finding of unenforceability or limited scope of certain of our intellectual property, could have a material adverse effect on us. See “Item 8.A. Financial Information — Consolidated Financial Statements and Other Financial Information — Legal Proceedings” below.
In addition to patent protection, we also rely on trade secrets, including unpatented knowhow, technology and other proprietary information in attempting to develop and maintain our competitive position.
We also rely on protection available under trademark laws. We currently hold registered trademarks in various jurisdictions for the mark “MSO” and certain other key product names, including “InFat”, “K•REAL”, “Sharp PS”, “Vayarol”, “Vayacog” and “Vayarin”.
We believe that, while our patents provide us with a competitive advantage, our success depends primarily on our marketing, business development, know-how and ongoing research and development efforts. Accordingly, we believe that the expiration of any of our patents, or the failure of any of our patent applications to result in issued patents, would have no more than a short-term adverse effect on our business or financial position. Nevertheless, we are continuously working to generate a new cluster of patents to reinforce our IP position and protect the competitive edge we are creating in the market. In any event, there can be no assurance that our patents or other intellectual property rights will afford us a meaningful competitive advantage.
D. Trend Information |
Other than as disclosed elsewhere in this annual report, we are not aware of any trends, uncertainties, demands, commitments or events for the period from January 1, 2014 to December 31, 2014 that are reasonable likely to have a material adverse effect on our net revenues, income, profitability, liquidity or capital resources, or that caused the disclosed financial information to be not necessarily indicative of future operating results or financial condition.
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E. Off-Balance Sheet Arrangements |
Except for standard operating leases, we do not engage in any off-balance sheet arrangements, such as the use of unconsolidated subsidiaries, structured finance, special purpose entities or variable interest entities.
F. Contractual Obligations |
Our future contractual cash obligations as of December 31, 2014 in excess of one year are summarized in the following table:
Total (2) | Less than 1 year | 1 – 3 years | 3 – 5 years | More than 5 years | ||||||||||||||||
(in thousands) | ||||||||||||||||||||
Purchase commitments (1) | $ | 2,316 | $ | 1,544 | $ | 772 | $ | – | $ | – | ||||||||||
Operating lease obligations | 1,337 | 592 | 659 | 86 | – | |||||||||||||||
Total | $ | 3,653 | $ | 2,136 | $ | 1,431 | $ | 86 | $ | – |
(1) | Consists of commitments to purchase raw materials. |
(2) | Excludes future projected royalty payments of approximately 3%-5% of revenues derived from research and development projects that were funded in part by grants received from the OCS. |
In addition, we have entered into a 10-year toll manufacturing agreement with respect to one of our products. Under the terms of the agreement, we have committed for minimum purchasing through the entire term of the agreement. In the event that we fail to meet our minimum purchase requirements or otherwise terminate the agreement, we will be required to pay a termination payment which is based on a fixed amount of up to $500,000 reduced by the amount actually purchased before termination.
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ITEM 6: Directors, Senior Management and Employees
A. Directors and Senior Management |
The following table sets forth information for our executive officers and directors as of the date of this annual report. Unless otherwise stated, the address for our directors and executive officers is c/o Enzymotec Ltd., Sagi 2000 Industrial Area, P.O. Box 6, Migdal Ha’Emeq 2310001, Israel.
Name | Age | Position(s) | ||
Executive officers | ||||
Ariel Katz | 56 | President and Chief Executive Officer | ||
Oren Bryan | 40 | Vice President and Chief Financial Officer | ||
Gai Ben-Dror | 46 | Vice President – Process Development | ||
Ariel Blumovich | 36 | Vice President – Business Development | ||
Shachar Carmi | 50 | Vice President – Nutrition Division | ||
Robert Crim | 57 | President and CEO VAYA Pharma USA | ||
Itay Dromi | 50 | Vice President – Human Resources and Information Systems | ||
Yariv Gratz | 50 | Vice President – Operations | ||
Directors | ||||
Steve Dubin (3)(4) | 61 | Chairman of the Board | ||
Nir Belzer (2)(4) | 52 | Director | ||
Holger Liepmann(4) | 63 | Director | ||
Dov Pekelman (1)(4) | 74 | Director | ||
Yossi Peled (4) | 67 | Director | ||
Michal Silverberg (1)(2)(4)(5) | 38 | Director | ||
Joseph Tenne (1)(2)(3)(4)(5) | 59 | Director | ||
Imanuel (Mani) Wasserman (3)(4) | 48 | Director |
(1) | Member of our audit committee. |
(2) | Member of our compensation committee. |
(3) | Member of our nominating and governance committee. |
(4) | Independent director under the rules of the NASDAQ Stock Market. |
(5) | External director under the Israeli Companies Law. See “— Board Practices — External directors.” |
Our executive officers
Dr. Ariel Katz has served as our President and Chief Executive Officer since joining us in 2000. He has also served as the head of our VAYA Pharma segment from January 2012 to August 2014. Prior to joining Enzymotec, Dr. Katz held various positions with the Dead Sea Bromine Group of Israel Chemicals Ltd. over a period of 14 years, including senior positions in research and development, plant management, marketing and business development. Dr. Katz holds a bachelor’s degree in chemistry and a master’s degree in economic management both from Ben-Gurion University of the Negev, Beer Sheva, Israel, and a PhD in engineering in the field of artificial intelligence from Exeter University, UK. Dr. Katz was a guest lecturer in the Biotechnology Department of the Technion — Israel Institute of Technology, Haifa, Israel from 2003 to 2010.
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Oren Bryan has served as our Vice President and Chief Financial Officer since June 2008. Prior to joining Enzymotec, he served as Chief Financial Officer of MIND C.T.I. Ltd., a global provider of real-time, product-based mediation, billing and customer care solutions for voice, data, video and content service from 2006 to 2008 and Controller of MIND C.T.I. Ltd. from 2005 to 2006. Before working at MIND C.T.I. Ltd., Mr. Bryan served as Controller of both Dor Chemicals Ltd. from 2001 to 2005 and a private software company from 2000 to 2001. Between 1997 and 2000, he was an accountant with Kost, Forer, Gabbay and Kasierer, a member of Ernst & Young Global. Mr. Bryan is a certified public accountant and holds a bachelor’s degree in economics and accounting from Haifa University, Israel.
Gai Ben-Dror has served as our Vice President — Process Development and previously as our Director of Process Development since joining Enzymotec in December 2001. As Director of Process Development, he was responsible for the development and commercialization of all of our products and for the building of our technological and analytical teams. Prior to joining us, Mr. Ben-Dror was a plant and pilot engineer in the Dead Sea Bromine Group of Israel Chemicals Ltd. from 1996 to 2000. Prior to that he worked as a research team leader at Sense-IT Ltd., a hardware development company, and as a project manager at Chimtec Ltd., a water treatment engineering company. He holds a bachelor’s degree in chemical engineering and an M.B.A. from Ben-Gurion University of the Negev, Beer Sheva, Israel.
Ariel Blumovich has served as our Vice President – Business Development since July 2014. Prior to joining Enzymotec, Mr. Blumovich served from 2010 to 2014 as Global Business Development Manager at the Samsung Group in South Korea, in which role he executed high-growth deals in the pharmaceutical and hi-technology business segments, including multinational joint-ventures, licensing, sales agreement, and strategic alliances. Prior to joining Samsung, Mr. Blumovich held positions at Sanofi-Aventis, Teva Pharmaceutical Industries, Ltd., and Israeli Electric Corp. He received his M.B.A. from The Tuck School of Business at Dartmouth College and his B.Sc, Mechanical Engineering from The Technion – Israel Institute of Technology.
Shachar Carmi has served as our Vice President – Sales, Nutrition Division since July 2014 and became our Vice President Nutrition Division in February 2015. Prior to joining Enzymotec, from 2009 to June 2014, he served as Vice President – Sales and Marketing at Biobee Sde Eliyahu, a leading producer of bumble bees for natural pollination and beneficial insects used in agriculture as an alternative to chemical pesticides. From 2007 to 2009, he served as Product Manager at Hazera Genetics, a leading breeder and supplier of vegetable seeds. Prior to that, he held positions at Milestone Agriculture, Inc. and Click Software. Mr. Carmi received his B.Sc. in Industrial Engineering from Tel Aviv University.
Robert Crim has served as President and CEO of Vaya Pharma USA since August 2014. Mr. Crim has over 15 years experience in the global clinical nutrition and medical foods area. Prior to joining Vaya Pharma, from 2010 to 2014, Mr. Crim was an independent consultant focusing on medical nutrition and healthcare clients. From 2004 to 2010, he held positions of increasing responsibility at Danone/Numico, including General Manager of the SHS business and Regional Vice President – North America and Global Business Development as well as serving on the Executive Committee of the Medical Nutrition Division. Prior to that, Mr. Crim held positions at Abbott, including Vice President – Consumer Nutritionals where he was responsible for the Ensure and Glucerna businesses. Mr. Crim has also held positions at Johnson & Johnson and Procter and Gamble. He received his M.B.A from University of Michigan and his B.A. from Harvard University.
Itay Dromi has served as our Vice President – Human Resources since July 2014. Mr. Dromi has over 20 years of global experience in human resources and organizational management. Prior to joining Enzymotec, Mr. Dromi served from 2010 to 2014 in multiple senior human resource positions at Teva Pharmaceutical, Ltd, including as Vice President – Human Resources TGO Asia Region and as Vice President – Human Resources of the Chemical Division. Mr. Dromi previously held human resource positions at Ultrashape and Delta Galil Industries. Mr. Dromi received his M.B.A from Bar Ilan University and an M.A. in Public Administration from the University of Haifa.
Yariv Gratz has served as our Vice President – Operations since June 2014. Prior to joining Enzymotec, Mr. Gratz served from 2010 to 2014 as Director of Operations at Nilit Ltd. where he was responsible for managing manufacturing facilities in Israel and China including global engineering and projects department and the industrial engineering unit, overseeing a total of 650 employees. Prior to this position, he served as Vice President – Operations for MIS – Israel. From 1992 to 2010, he held positions at Sanmina SCI, EIL – Electrochemical Industries and Gadot Bio Chem. Mr. Gratz received his M.B.A. from Herriot Watt and B.Sc. in Chemical Engineering from The Technion – Israel Institute of Technology.
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Our directors
Steve Dubin has served as Chairman of our board of directors since January 2014 and previously served as Vice Chairman since his appointment as a director in April 2013. Since November 2011, Mr. Dubin has been a Principal in SDA Ventures LLC, a firm focused on assisting emerging growth and middle-market companies, primarily in the health & wellness and nutritional products markets, on matters including corporate development, business acquisition, customer relations, growth strategies and corporate finance. In connection with SDA Ventures, Mr. Dubin acts as a Senior Advisor to Paine & Partners, LLC, a global private equity investment firm located in New York, Chicago, and San Francisco, for the purpose of identifying and executing investment opportunities in the global human and animal food and nutritional products industries. From 2006 until its acquisition by Royal DSM N.V. in February 2011, Mr. Dubin served as Chief Executive Officer and a member of the board of directors of Martek Biosciences Corporation. He later served as President of DSM’s Nutritional Lipids Division from February 2011 through October 2011 and as a Senior Advisor to DSM Nutritional Products from November 2011 through October 2012. After joining Martek in 1992 and serving in various management positions, including Chief Financial Officer, Treasurer, Secretary, General Counsel and Senior Vice President, Business Development, he served as President of Martek from 2003 to 2006. From 2000 to 2003, Mr. Dubin co-founded and co-managed a Maryland-based, angel-investing club and was “Of Counsel” to Mintz, Levin, Cohn, Ferris, Glovsky and Popeo, P.C., a U.S. law firm, during part of 2001 and 2002. Mr. Dubin currently serves as a member of the board of two privately held companies, Alcresta, Inc. and NeurExpand Brain Center LLC, formerly The Brain Center, LLC (where he serves as Vice Chair of the board of directors). From March 2013 through March 2014, Mr. Dubin was a director of MyCell Technologies and its subsidiary Oceans Omega LLC. During 2011 and 2012, he was a member of the board of directors of Scerene Healthcare, Inc. Mr. Dubin is a certified public accountant and a member of the Maryland Bar. He holds a bachelor’s degree in accounting from the University of Maryland and a J.D. from the National Law Center at George Washington University.
Nir Belzer has served as a director of Enzymotec since January 2007. Mr. Belzer is a co-founder of Aquagro Fund L.P., one of Israel’s first funds to focus on clean technologies, and has served as its Managing Partner since 2007. In addition, he is a co-founder of the Millennium Materials Technologies funds, one of which is a major shareholder of ours, and has served as Managing Partner of Millennium Materials Technologies funds since 1998. Mr. Belzer has 20 years of extensive experience in venture capital management, including fund management in Israel’s IDB Group. From 1995 to 1997, Mr. Belzer worked in the Israeli high tech industry, at Globes, a leading Israeli financial newspaper, as a Marketing Manager, and at Israel Aerospace Industries Ltd., as an avionics engineer for the Lavi project. Mr. Belzer was appointed as a director pursuant to Millennium Materials Technologies’ appointment rights under our articles of association in effect prior to our initial public offering. He holds a bachelor’s degree in mathematics and computer science, and avionics and an M.B.A. from Tel Aviv University.
Holger Liepmann has served as a director of Enzymotec since February 2015. Mr. Liepmann served in various positions with Abbott Laboratories from 1986 until his retirement in 2011. From 2006 to 2011, he served as executive vice president, Nutritional Products of Abbott Laboratories. In this capacity he was responsible for all aspects of Abbott Laboratories’ global nutritional business, including R&D, manufacturing, supply chain and commercial operations, and reported to Abbott’s CEO. Previously, he served as executive vice president, Pharmaceutical Products Group, senior vice president, Abbott International, the commercial operations for Abbott’s international pharmaceutical business, and vice president Japan Operations. Prior to joining Abbott, Mr. Liepmann worked for Bayer AG in a variety of capacities between 1975 and 1986, both in the US and in Germany. Mr. Liepmann earned a bachelor’s degree from Dartmouth College and a master’s degree in business administration from Stanford.
Prof. Dov Pekelman has served as a director of Enzymotec since October 2010. In addition, Professor Pekelman currently serves as the Chairman of the special committee of the board of directors of Taro Pharmaceuticals Industries Ltd. (NYSE: TARO), as well as Chairman of Atera Networks Ltd.. Prof. Pekelman serves on the board of directors of the Interdisciplinary Center (IDC), Herzliya, Israel and is Chairman of the IDC Corporation, the center’s economic arm. From 1985 to 2008, Professor Pekelman served as a senior consultant to Teva Pharmaceutical Industries Ltd. (NASDAQ: TEVA) and also founded and ran a leading, Israeli-based management-consulting firm, P.O.C. Ltd. Previously, he served on the board of directors of several industrial corporations, including Koor Industries Ltd. (TASE: KOR), and was also a member of the advisory committee of the Bank of Israel. He holds bachelor’s degree from the Technion — Israel Institute of Technology, Haifa, Israel and a doctorate from the University of Chicago.
Yossi Peled has served as a director of Enzymotec since June 2001. From June 2009 to October 2011, Mr. Peled was the Chairman of our board of directors. In addition, he has served as the Chief Executive Officer of Galam Ltd. since 1987 and from 1977 until 1984. Mr. Peled is a member of the board of directors of a number of companies within the Galam Group, including Eurosweet GmbH (of which he is Chairman) and Galam Invest Ltd. From 2001 to 2003, Mr. Peled served as the Chairman of the board of directors of Lehavot Fire Protection Ltd., Israel’s leading fire protection equipment manufacturer. Previously, he held various managerial roles in Kibbutz Maanit and HaKibbutz HaArtzi, the national kibbutz organization in Israel, which represents more than 250 kibbutzim. Mr. Peled studied business administration at the Ruppin Academic Center, Israel, and executive business management at “Lahav” of the Faculty of Management Tel Aviv University.
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Michal Silverberg has served as a director of Enzymotec since September 2013. In 2014 Ms. Silverberg became a Senior Director for TVI (Takeda Ventures Inc). Since 2007, Ms. Silverberg has worked in various positions in Novo Nordisk Inc., a global healthcare company headquartered in Denmark with shares listed on the Copenhagen and New York Stock Exchanges. Since 2010, she has served as Senior Director, New Product Commercialization & Business Development for the BioPharm unit. Prior to joining Novo Nordisk, Ms. Silverberg held various positions in a biotech company, an investment group and the Office of the Chief Scientist of Israel (Technological Incubators). Ms. Silverberg holds a B.A. in Economics and Business Management from Haifa University, Israel, an M.B.A. from Tel Aviv University, Israel, and an M.A. in Biotechnology from Columbia University, New York.
Joseph Tenne has served as a director of Enzymotec since September 2013. Mr. Tenne serves as the VP Finance of Itamar Medical, Ltd., an Israeli company listed on the Tel Aviv Stock Exchange, since August 2014. Mr. Tenne has served as a financial expert external director and the chairman of the audit committee of the MIND C.T.I. Ltd., an Israeli company whose shares are listed on the NASDAQ, since August 2014, as an external director and a member of the audit committee of Orbotech Ltd., an Israeli company listed on the NASDAQ since July 2014, as an independent director and a member of the audit committee of Ratio Oil Exploration (Finance) Ltd., an Israeli company listed on the Tel Aviv Stock Exchange since January 2015, and has served as a director of AudioCodes Ltd., an Israeli company listed on NASDAQ and on the Tel Aviv Stock Exchange since June 2003. Mr. Tenne is a financial expert, independent director and a member of the audit, compensation and nomination committees of AudioCodes. From March 2005 until April 2013, Mr. Tenne served as the Chief Financial Officer of Ormat Technologies, Inc., a company listed on the New York Stock Exchange, which is engaged in the geothermal and recovered energy business. From January 2006 until April 2013, Mr. Tenne also served as the Chief Financial Officer of Ormat Industries Ltd., an Israeli holding company that was listed on the Tel Aviv Stock Exchange and was the parent company of Ormat Technologies, Inc. From 2003 to 2004, Mr. Tenne was the Chief Financial Officer of Treofan Germany GmbH & Co. KG, a German company, which is engaged in the development, production and marketing of oriented polypropylene films, which are mainly used in the food packaging industry. From 1997 until 2003, Mr. Tenne was a partner in Kesselman & Kesselman, Certified Public Accountants in Israel and a member of PricewaterhouseCoopers International Limited (PwC Israel). Mr. Tenne holds a B.A. in Accounting and Economics and an M.B.A. from Tel Aviv University. Mr. Tenne is also a Certified Public Accountant in Israel.
Dr. Imanuel (Mani) Wasserman has served as a director of Enzymotec since October 2011. Dr. Wasserman is a co-founder of Beresheit General Partner Ltd., the general partner of Manof I funds, a NIS 2 billion Israeli fund, and has served as its managing partner since its inception in 2009. The fund is the first and largest of three “Manof” funds, initiated by the Israeli government to provide liquidity to the Israeli economy by providing debt, mezzanine and equity financings. The Israeli government committed to invest up to NIS 0.5 billion in the fund, and the remaining commitment to invest up to NIS 1.5 billion was made by leading Israeli financial institutions. Previously, he was a co-founder and managing director of Magna Capital Ltd., an Israeli strategy and M&A consulting firm, from 2000 to 2009. In addition, Dr. Wasserman worked as a lawyer, from 1992 to 1994 and from 1997 to 1999, with Zellermayer Pelossof and Co., an Israeli law firm. From 1995 to 1996, he was a foreign lawyer at Fried, Frank, Harris, Shriver and Jacobson, a U.S. law firm. Dr. Wasserman is the Chairman of Zohar Dalia, an Israeli manufacturer of cleaning products and raw materials. He currently serves as a director for the following companies: Beresheit General Partner Ltd., Galam Ltd., Cargal Ltd., Plasto-sac Ltd., Controp Ltd. and Aeronautics Ltd. Dr. Wasserman holds a bachelor’s degree in industrial engineering, an LLB, an LLM and a doctorate in law, all from Tel Aviv University. Dr. Wasserman was appointed as a director pursuant to Galam’s appointment rights under our articles of association in effect prior to our initial public offering.
Arrangements concerning election of directors; family relationships
Our current board of directors consists of eight directors. Pursuant to our articles of association in effect prior to our initial public offering, certain of our shareholders had rights to appoint members of our board of directors. See “— Directors and Senior Management.”
All rights to appoint directors and observers terminated upon the closing of the initial public offering, although currently-serving directors that were appointed pursuant to such rights will continue to serve pursuant to their appointment until the annual meeting of shareholders at which the term of their class of director expires.
We are not a party to, and are not aware of, any voting agreements among our shareholders. In addition, there are no family relationships among our executive officers and directors.
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B. Compensation of Officers and Directors |
Compensation of executive officers and directors
The aggregate compensation paid and share-based compensation and other payments expensed by us and our subsidiaries to our directors and executive officers with respect to the year ended December 31, 2014 was $2.2 million. This amount includes approximately $0.2 million set aside or accrued to provide pension, severance, retirement or similar benefits or expenses, but does not include business travel, relocation, professional and business association dues and expenses reimbursed to office holders, and other benefits commonly reimbursed or paid by companies in our industry. As of December 31, 2014, options to purchase 730,406 ordinary shares granted to our current directors and executive officers were outstanding under our equity incentive plans at a weighted average exercise price of $5.43 per share. In addition, as of December 31, 2014, 81,380 restricted shares units and 136,510 restricted shares were granted to our current directors and executive officers of which 19,550 restricted shares were vested. We do not have any written agreements with any director providing for benefits upon the termination of such director’s relationship with our company or our subsidiaries.
Summary Compensation Table
The table below reflects the compensation paid to or earned by our five most highly compensated office holders during or with respect to the year ended December 31, 2014. All amounts reported in the table are in terms of cost to the Company, as recognized in our financial statements for the year ended December 31, 2014.
Name and Position | Salary Cost (1) | Bonus (2) | Share-Based Compensation (3) | All Other Compensation (4) | Directors’ Fees | Total | ||||||||||||||||||
(in thousands) (5) | ||||||||||||||||||||||||
Steve Dubin Chairman of the Board | $ | - | $ | - | $ | 412 | $ | - | $ | 120 | $ | 532 | ||||||||||||
Ariel Katz President and CEO | 301 | - | - | 46 | - | 347 | ||||||||||||||||||
Oren Bryan Vice President and CFO | 187 | - | 21 | 21 | - | 229 | ||||||||||||||||||
Gai Ben Dror Vice President – Process Development | 167 | - | - | 23 | - | 190 | ||||||||||||||||||
Ram Shemer Marketing Director – Nutrition Division | 133 | - | 11 | 23 | - | 167 |
(1) | Represents the office holder’s gross salary plus payment of mandatory social benefits made by the Company on behalf of such office holder. Such benefits may include, to the extent applicable to the office holder, payments, contributions and/or allocations for savings funds (e.g., Managers’ Life Insurance Policy), education funds (referred to in Hebrew as “keren hishtalmut”), pension, severance, and risk insurance (e.g., life, or work disability insurance), convalescence pay and social security payments. |
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(2) | No bonuses were paid to any of the office holders for the year ended December 31, 2014. |
(3) | Represents grant date fair value computed in accordance with accounting guidance for equity-based compensation. For a discussion of the assumptions used in reaching this valuation, see Note 10 of the notes to our consolidated financial statements included elsewhere in this annual report. |
(4) | Represents other benefits provided to such office holder, which include (i) car expenses, including lease costs, gas and maintenance, provided to the office holder, (ii) unused vacation accruals and redemption, and (iii) accruals for severance pay. |
(5) | Some of the amounts were translated from NIS into U.S. dollars using the average exchange rate during the year ended December 31, 2014 of NIS 3.577 = U.S.$ 1.00, based on the daily representative rate of exchange between the NIS and the U.S. dollar reported by the Bank of Israel. |
Employment agreements with executive officers; consulting and directorship services provided by directors
We have entered into written employment agreements with all of our executive officers. These agreements contain provisions standard for a company in our industry regarding non-competition, confidentiality of information and assignment of inventions. See “Item 3.D. Key Information — Risk factors — Risks relating to our business and industry — Under applicable employment laws, we may not be able to enforce covenants not to compete” for a further description of the enforceability of non-competition clauses. These agreements do not provide for benefits upon the termination of these executives’ respective employment with us, other than payment of salary and benefits during the required notice period for termination of these agreements, which varies under these individual agreements. See “Item 6.D. Directors, Senior Management and Employees — Employees —Agreements and arrangements with, and compensation of, directors and executive officers” for additional information.
We receive consulting and directorship services from certain of our directors. The amounts payable pursuant to these arrangements have been approved by our board of directors and shareholders.
Equity incentive plans
The following are our equity incentive plans:
2003 Israeli Share Option Plan with 2012 U.S. Addendum
In November 2003, we adopted our 2003 Israeli Share Option Plan and in June 2012, we adopted the 2012 U.S. Addendum to this plan. This plan, including the 2012 U.S. Addendum, is referred to as the 2003 Plan. The 2003 Plan permits the grant of options to purchase our ordinary shares to the employees, officers, directors and service providers of our company and our subsidiaries (to whom we refer as permitted grantees). The 2003 Plan was terminated on August 21, 2013, although option awards outstanding as of that date will continue in full force in accordance with the terms under which they were granted. There were 2,000,560 options outstanding under the 2003 Plan at the time it was terminated.
The 2003 Plan is administered by our board of directors, which determined, subject to Israeli law, the grantees of awards and the terms and provisions of the grant, including, the number of shares, exercise prices, vesting schedules, acceleration of vesting and the other matters necessary in the administration of the 2003 Plan.
The 2003 Plan provides for the grant by us of awards under various tax regimes including, without limitation, pursuant to Sections 102 and 3(i) of the Israeli Income Tax Ordinance, to which we refer as the Ordinance, and Section 422 of the U.S. Internal Revenue Code of 1986, as amended, to which we refer as the Code. The Israeli Tax Authority, to which we refer as the ITA, approved the 2003 Plan, as required by applicable law.
Section 102 of the Ordinance allows employees, directors and officers, who are not controlling shareholders and who are Israeli residents, to receive favorable tax treatment for compensation in the form of shares or options. Section 102 of the Ordinance includes two alternatives for tax treatment involving the issuance of options or shares to a trustee for the benefit of the grantees and also includes an additional alternative for the issuance of options or shares directly to the grantee. Section 102(b)(2) of the Ordinance, the most favorable tax treatment for grantees, permits the issuance to a trustee under the “capital gains track.” In order to comply with the terms of the capital gains track, all options granted under a specific plan and subject to the provisions of Section 102 of the Ordinance, as well as the shares issued upon exercise of such options and other shares received subsequently following any realization of rights with respect to such options, such as share dividends and share splits, must be registered in the name of a trustee selected by the board of directors and held in trust for the benefit of the relevant employee, director or officer. The trustee may not release these options or shares to the holders thereof before the second anniversary of the registration of the options in the name of the trustee. However, under this track, we are not allowed to deduct an expense with respect to the issuance of the options or shares.
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The 2003 Plan provides that options granted to our employees, directors and officers who are not controlling shareholders and who are considered Israeli residents are intended to qualify for special tax treatment under the “capital gains track” provisions of Section 102(b)(2) of the Ordinance. Our Israeli non-employee service providers and controlling shareholders may only be granted options under Section 3(i) of the Ordinance, which does not provide for similar tax benefits.
Options granted under the 2003 Plan to U.S. residents may qualify as “incentive stock options” within the meaning of Section 422 of the Code, or may be non-qualified. The exercise price for “incentive stock options” must not be less than the fair market value on the date on which an option is granted, or 110% of the fair market value if the option holder holds more than 10% of our share capital.
Options awarded under the 2003 Plan, generally vest over a four-year period from the effective date of grant, 25% on each anniversary of the date of grant. Any option not exercised within ten years from the grant date or within three months from termination of employment (and in certain cases, according to a resolution of the board of directors) will expire, unless extended by the board of directors. All option agreements for outstanding options include provisions for accelerated vesting upon the occurrence of certain events, including the completion of our initial public offering, or in the event of change in control, as defined. Pursuant to these provisions, 50% of every grantee’s unvested outstanding options under the 2003 Plan will vest immediately and the vesting of the remaining 50% will be accelerated to the earlier of: (i) one year from the date of closing of such initial public offering or event of change in control, subject to the grantee continuing to serve in the capacity of a permitted grantee under the plan; or (ii) in the event of change in control, the date upon which the grantee’s services are terminated, other than in the event of termination for cause.
2013 Omnibus Equity Incentive Plan
In August 2013, we adopted our 2013 Omnibus Equity Incentive Plan, which we refer to as the 2013 Plan, and which was approved by our shareholders on September 2, 2013. The 2013 Plan provides for the grant of options, restricted shares, restricted share units and other share-based awards to our company’s and our subsidiaries’ respective directors, employees, officers, consultants, advisors and to any other person whose services are considered valuable to us or any of our affiliates. Following the approval of the 2013 Plan by the Israeli tax authorities, we will only grant options or other equity incentive awards under the 2013 Plan, although previously-granted options and awards will continue to be governed by our 2003 Plan. The number of shares reserved under the plan is automatically increased annually on January 1 of each year by a number of ordinary shares equal to the lowest of (i) 2% of our outstanding shares; (ii) a number of shares determined by our board of directors, if so determined prior to January 1 of the year on which the increase will occur; and (iii) 1,360,000 shares.
The 2013 Plan is administered by our board of directors or by a committee designated by the board of directors, which shall determine, subject to Israeli law, the grantees of awards and the terms of the grant, including, exercise prices, vesting schedules, acceleration of vesting and the other matters necessary in the administration of the 2013 Plan. The 2013 Plan enables us to issue awards under various tax regimes including, without limitation, pursuant to Sections 102 and 3(i) of the Ordinance, and as “incentive stock options” under Section 422 of the Code and nonqualified stock options, as discussed under “2003 Israeli Share Option Plan with 2012 U.S. Addendum” above.
We currently intend to grant options under the 2013 Plan only to our employees, directors and officers who are not controlling shareholders and are considered Israeli residents, under the capital gains track of Section 102(b)2 of the Ordinance.
Awards under the 2013 Plan may be granted until September 2, 2023, ten years from the date on which the 2013 Plan was approved by our shareholders.
Options granted under the 2013 Plan generally vest over four years commencing on the date of grant such that 25% vest on the first anniversary of the date of grant and an additional 6.25% vest at the end of each subsequent three-month period thereafter for 36 months. Options, other than certain incentive share options, that are not exercised within ten years from the grant date expire, unless otherwise determined by our board of directors or its designated committee, as applicable. Incentive share options granted to a person holding more than 10% of our voting power will expire within five years from the date of the grant. In the event of termination of employment or services for reasons of disability or death, or retirement, the grantee, or in the case of death, his or her legal successor, may exercise options that have vested prior to termination within a period of one year from the date of disability or death, or within three months following retirement. If we terminate a grantee’s employment or service for cause, all of the grantee’s vested and unvested options will expire on the date of termination. If a grantee’s employment or service is terminated for any other reason, the grantee may exercise his or her vested options within 90 days of the date of termination. Any expired or unvested options return to the pool for reissuance.
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In the event of a merger or consolidation of our company, or a sale of all, or substantially all, of our shares or assets or other transaction having a similar effect on us, then without the consent of the option holder, our board of directors or its designated committee, as applicable, may but is not required to (i) cause any outstanding award to be assumed or an equivalent award to be substituted by such successor corporation or (ii) in case the successor corporation refuses to assume or substitute the award (a) provide the grantee with the option to exercise the award as to all or part of the shares or (b) cancel the options against payment in cash in an amount determined by the board of directors or the committee as fair in the circumstances. Notwithstanding the foregoing, our board of directors or its designated committee may upon such event amend or terminate the terms of any award, including conferring the right to purchase any other security or asset that the board of directors shall deem, in good faith, appropriate.
Restricted share awards are ordinary shares that are awarded to a participant subject to the satisfaction of the terms and conditions established by the board of directors or a committee designated by the board of directors. Until such time as the applicable restrictions lapse, restricted shares are subject to forfeiture and may not be sold, assigned, pledged or otherwise disposed of by the participant who holds those shares. Generally, if a grantee’s employment or service is terminated for any reason prior to the expiration of the time when the restrictions lapse, shares that are still restricted will be forfeited.
The following table presents certain data for our 2003 Plan and 2013 Plan as at December 31, 2014.
Grants of restricted shares | Grants of restricted shares units (RSU) | Grants of share options | |||||||||||||||||||||||||||||||
Plan | Shares available for future grants | Number of vested shares | Number of unvested shares | Number of vested RSUs | Number of unvested RSUs | Aggregate number exercised | Aggregate number outstanding | Weighted average exercise price of outstanding options | |||||||||||||||||||||||||
2003 Plan | — | — | - | - | 1,993,585 | 1,035,611 | 2.85 | ||||||||||||||||||||||||||
2013 Plan | 67,772 | (1) | 48,620 | 116,960 | - | 269,231 | - | 552,001 | 13.77 |
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(1) | As of January 1, 2015, the reserved pool under the 2013 Plan increased to 517,422 pursuant to the provisions of the 2013 Plan. |
From January 1, 2015 through February 17, 2015, we granted an additional 343,813 options and 164,148 restricted shares units to our employees, officers and directors.
C. Board Practices |
Board of Directors
Under the Israeli Companies Law, the management of our business is vested in our board of directors. Our board of directors may exercise all powers and may take all actions that are not specifically granted to our shareholders or to management. Our executive officers are responsible for our day-to-day management and have individual responsibilities established by our board of directors. Our Chief Executive Officer is appointed by, and serves at the discretion of, our board of directors, subject to the employment agreement that we have entered into with him. All other executive officers are also appointed by our board of directors, and are subject to the terms of any applicable employment agreements that we may enter into with them.
We comply with the rule of the NASDAQ Stock Market that a majority of our directors be independent. Our board of directors has determined that all of our directors are independent under such rules. The definition of independent director under NASDAQ rules and external director under the Israeli Companies Law overlap to a significant degree such that we would generally expect the two directors serving as external directors to satisfy the requirements to be independent under NASDAQ rules. The definition of external director under the Israeli Companies Law includes a set of statutory criteria that must be satisfied, including criteria whose aim is to ensure that there is no factor that would impair the ability of the external director to exercise independent judgment. The definition of independent director under NASDAQ rules specifies similar, although less stringent, requirements in addition to the requirement that the board consider any factor which would impair the ability of the independent director to exercise independent judgment. In addition, both external directors and independent directors serve for a period of three years; external directors pursuant to the requirements of the Israeli Companies Law and independent directors pursuant to the staggered board provisions of our articles of association. However, external directors must be elected by a special majority of shareholders while independent directors may be elected by an ordinary majority. See “— External directors” for a description of the requirements under the Israeli Companies Law for a director to serve as an external director.
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Under our amended articles of association, our board of directors must consist of at least seven and not more than 11 directors, including at least two external directors required to be appointed under the Israeli Companies Law. At any time, the minimum number of directors (other than external directors) may not fall below five. Our board of directors currently consists of eight directors, including our two external directors. Other than our external directors, for whom special election requirements apply under the Israeli Companies Law, as detailed below, our directors are divided into three classes with staggered three-year terms. Each class of directors consists, as nearly as possible, of one-third of the total number of directors constituting the entire board of directors (other than the external directors). At each annual general meeting of our shareholders, the election or re-election of directors following the expiration of the term of office of the directors of that class of directors, will be for a term of office that expires on the third annual general meeting following such election or re-election, such that each year the term of office of only one class of directors will expire. Each director will hold office until the annual general meeting of our shareholders for the year in which his or her term expires, unless they are removed by a vote of 65% of the voting power of our shareholders at a general meeting of our shareholders or upon the occurrence of certain events, in accordance with the Israeli Companies Law and our amended articles of association.
Our directors are divided among the three classes as follows:
• | the Class I directors are Holger Liepmann and Yossi Peled, and their terms will expire at the annual general meeting of shareholders to be held in 2017; |
• | the Class II directors are Imanuel (Mani) Wasserman and Nir Belzer, and their terms will expire at the annual general meeting of shareholders to be held in 2015; and |
• | the Class III directors are Steve Dubin and Dov Pekelman, and their terms will expire at the annual general meeting of shareholders to be held in 2016. |
In addition, our amended articles of association allow our board of directors to appoint directors to fill vacancies on our board of directors, for a term of office equal to the remaining period of the term of office of the director(s) whose office(s) have been vacated. External directors are elected for an initial term of three years and may be elected for additional three-year terms under the circumstances described below. External directors may be removed from office only under the limited circumstances set forth in the Israeli Companies Law. See “— External directors” below.
Under the Israeli Companies Law and our articles of association, nominations for directors may be made by any shareholder holding at least 1% of our outstanding voting power. However, any such shareholder may make such a nomination only if a written notice of such shareholder’s intent to make such nomination has been given to our Secretary (or, if we have no Secretary, our Chief Executive Officer). Any such notice must include certain information, including, among other things, a description of all arrangements between the nominating shareholder and the proposed director nominee(s) and any other person pursuant to which the nomination(s) are to be made by the nominating shareholder, the consent of the proposed director nominee(s) to serve as our director(s) if elected and a declaration signed by the nominee(s) declaring that there is no limitation under the Israeli Companies Law preventing their election, and that all of the information that is required under the Israeli Companies Law to be provided to us in connection with such election has been provided.
Under the Israeli Companies Law, our board of directors must determine the minimum number of directors who are required to have accounting and financial expertise. See “— External directors.” In determining the number of directors required to have such expertise, our 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 the minimum number of directors of our company who are required to have accounting and financial expertise is one.
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External directors
Under the Israeli Companies Law, we are required to include at least two members who qualify as external directors. Joseph Tenne and Michal Silverberg currently serve as our external directors.
The provisions of the Israeli Companies Law set forth special approval requirements for the election of external directors. External directors must be elected by a majority vote of the shares present and voting at a shareholders meeting, provided that either:
• | such majority includes at least a majority of the shares held by all shareholders who are non-controlling shareholders and do not have a personal interest in the election of the external director (other than a personal interest not deriving from a relationship with a controlling shareholder) that are voted at the meeting, excluding abstentions, to which we refer as a disinterested majority; or |
• | the total number of shares voted by non-controlling shareholders and by shareholders who do not have a personal interest in the election of the external director against the election of the external director does not exceed two percent (2%) of the aggregate voting rights in the company. |
The term “controlling shareholder” is defined in the Israeli Companies Law as a shareholder with the ability to direct the activities of the company, other than by virtue of being an office holder. A shareholder is presumed to be a controlling shareholder if the shareholder holds 50% or more of the voting rights in a company or has the right to appoint the majority of the directors of the company or its general manager. With respect to certain matters, a controlling shareholder is deemed to include a shareholder that holds 25% or more of the voting rights in a public company if no other shareholder holds more than 50% of the voting rights in the company, but excludes a shareholder whose power derives solely from his or her position as a director of the company or from any other position with the company.
Our two external directors serve on the Board for fixed three-year periods. Under the Israeli Companies law, the initial term of an external director is three years. Thereafter, an external director may be reelected by shareholders to serve in that capacity for up to two additional three-year terms, provided that either:
(i) | his or her service for each such additional term is recommended by one or more shareholders holding at least 1% of the company’s voting rights and is approved at a shareholders meeting by a disinterested majority, where the total number of shares held by non-controlling, disinterested shareholders voting for such reelection exceeds 2% of the aggregate voting rights in the company, subject to additional restrictions set forth in the Israeli Companies Law with respect to the affiliations of the external director nominee; or |
(ii) | his or her service for each such additional term is recommended by the board of directors and is approved at a shareholders meeting by the same majority required for the initial election of an external director (as described above). |
The term of office for external directors for Israeli companies traded on certain foreign stock exchanges, including the NASDAQ Global Select Market, may be extended indefinitely in increments of additional three-year terms, in each case provided that the audit committee and the board of directors of the company confirm that, in light of the external director’s expertise and special contribution to the work of the board of directors and its committees, the reelection for such additional period(s) is beneficial to the company, and provided that the external director is reelected subject to the same shareholder vote requirements (as described above). Prior to the approval of the reelection of the external director at a general shareholders meeting, the company’s shareholders must be informed of the term previously served by him or her and of the reasons why the board of directors and audit committee recommended the extension of his or her term.
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External directors may be removed from office by a special general meeting of shareholders called by the board of directors, which approves such dismissal by the same shareholder vote percentage required for their election or by a court, in each case, only under limited circumstances, including ceasing to meet the statutory qualifications for appointment, or violating their duty of loyalty to the company. If an external directorship becomes vacant and there are fewer than two external directors on the board of directors at the time, then the board of directors is required under the Israeli Companies Law to call a shareholders’ meeting as soon as practicable to appoint a replacement external director.
Each committee of the board of directors that exercises the powers of the board of directors must include at least one external director, except that the audit committee and the compensation committee must include all external directors then serving on the board of directors, and an external director must serve as the chairperson thereof. Under the Israeli Companies Law, external directors of a company are prohibited from receiving, directly or indirectly, any compensation from the company other than for their services as external directors pursuant to the Israeli Companies Law and the regulations promulgated thereunder. Compensation of an external director is determined prior to his or her appointment and may not be changed during his or her term subject to certain exceptions.
The Israeli Companies Law provides that a person is not qualified to be appointed as an external director if (i) the person is a relative of a controlling shareholder of the company, or (ii) if that person or his or her relative, partner, employer, another person to whom he or she was directly or indirectly subordinate, or any entity under the person’s control, has or had, during the two years preceding the date of appointment as an external director: (a) any affiliation or other disqualifying relationship with the company, with any person or entity controlling the company or a relative of such person, or with any entity controlled by or under common control with the company; or (b) in the case of a company with no shareholder holding 25% or more of its voting rights, had at the date of appointment as an external director, any affiliation or other disqualifying relationship with a person then serving as chairman of the board or chief executive officer, a holder of 5% or more of the issued share capital or voting power in the company or the most senior financial officer.
The term relative is defined in the Israeli Companies Law as a spouse, sibling, parent, grandparent or descendant; spouse’s sibling, parent or descendant; and the spouse of each of the foregoing persons.
Under the Israeli Companies Law, the term affiliation and the similar types of disqualifying relationships include (subject to certain exceptions):
• | an employment relationship; |
• | a business or professional relationship even if not maintained on a regular basis (excluding insignificant relationships); |
• | control; and |
• | service as an office holder, excluding service as a director in a private company prior to the initial public offering of its shares if such director was appointed as a director of the private company in order to serve as an external director following the initial public offering. |
The term “office holder” is defined in the Israeli Companies Law as a general manager, chief business manager, deputy general manager, vice general manager, any other person assuming the responsibilities of any of these positions regardless of that person’s title, a director and any other manager directly subordinate to the general manager.
In addition, no person may serve as an external director if that person’s position or professional or other activities create, or may create, a conflict of interest with that person’s responsibilities as a director or otherwise interfere with that person’s ability to serve as an external director or if the person is an employee of the Israel Securities Authority or of an Israeli stock exchange. A person may furthermore not continue to serve as an external director if he or she received direct or indirect compensation from the company including amounts paid pursuant to indemnification or exculpation contracts or commitments and insurance coverage for his or her service as an external director, other than as permitted by the Israeli Companies Law and the regulations promulgated thereunder.
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Following the termination of an external director’s service on a board of directors, such former external director and his or her spouse and children may not be provided a direct or indirect benefit by the company, its controlling shareholder or any entity under its controlling shareholder’s control. This includes engagement as an office holder of the company or a company controlled by its controlling shareholder or employment by, or provision of services to, any such company for consideration, either directly or indirectly, including through a corporation controlled by the former external director. This restriction extends for a period of two years with regard to the former external director and his or her spouse or child and for one year with respect to other relatives of the former external director.
If at the time at which an external director is appointed all members of the board of directors who are not controlling shareholders or relatives of controlling shareholders of the company are of the same gender, the external director to be appointed must be of the other gender. A director of one company may not be appointed as an external director of another company if a director of the other company is acting as an external director of the first company at such time.
According to the Israeli Companies Law and the regulations promulgated thereunder, a person may be appointed as an external director only if he or she has professional qualifications or if he or she has accounting and financial expertise (each, as defined below); provided that, at least one of the external directors must be determined by our board of directors to have accounting and financial expertise. However, if at least one of our other directors (i) meets the independence requirements under the Exchange Act; (ii) meets the standards of the NASDAQ Stock Market rules for membership on the audit committee; and (iii) has accounting and financial expertise as defined under Israeli Companies Law, then neither of our external directors is required to possess accounting and financial expertise as long as each possesses the requisite professional qualifications.
A director with accounting and financial expertise is a director who, due to his or her education, experience and skills, possesses an expertise in, and an understanding of, financial and accounting matters and financial statements, such that he or she is able to understand the financial statements of the company and initiate a discussion about the presentation of financial data. A director is deemed to have professional qualifications if he or she has any of (i) an academic degree in economics, business management, accounting, law or public administration; (ii) an academic degree or has completed another form of higher education in the primary field of business of the company or in a field which is relevant to his/her position in the company; or (iii) at least five years of experience serving in one of the following capacities, or at least five years of cumulative experience serving in two or more of the following capacities: (a) a senior business management position in a company with a significant volume of business; (b) a senior position in the company’s primary field of business; or (c) a senior position in public administration or service. The board of directors is charged with determining whether a director possesses financial and accounting expertise or professional qualifications.
Our board of directors has determined that Joseph Tenne has accounting and financial expertise and possesses professional qualifications as required under the Israeli Companies Law.
Audit Committee
Our audit committee consists of Dov Pekelman, along with our two external directors, Joseph Tenne and Michal Silverberg. Joseph Tenne serves as the Chairman of the audit committee.
Companies Law Requirements
Under the Israeli Companies Law, we are required to have an audit committee comprised of at least three directors, including all of the external directors and one of whom must serve as chairman of the committee. The audit committee may not include the chairman of the board, a controlling shareholder of the company, a relative of a controlling shareholder, a director employed by or providing services on a regular basis to the company, to a controlling shareholder or to an entity controlled by a controlling shareholder or a director who derives most of his or her income from a controlling shareholder.
In addition, under the Israeli Companies Law, the audit committee of a publicly traded company must consist of a majority of unaffiliated directors. In general, an “unaffiliated director” under the Israeli Companies Law is defined as either an external director or as a director who meets the following criteria:
• | he or she meets the qualifications for being appointed as an external director, except for (i) the requirement that the director be an Israeli resident (which does not apply to companies such as ours whose securities have been offered outside of Israel or are listed outside of Israel); and (ii) the requirement for accounting and financial expertise or professional qualifications; and |
• | he or she has not served as a director of the company for a period exceeding nine consecutive years. For this purpose, a break of less than two years in the service shall not be deemed to interrupt the continuation of the service. |
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NASDAQ Listing Requirements
Under the NASDAQ corporate governance rules, we are required to maintain an audit committee consisting of at least three independent directors, each of whom is financially literate and one of whom has accounting or related financial management expertise.
Our audit committee consists of Joseph Tenne, chairman, and Michal Silverberg and Dov Pekelman, each of whom is an independent director in accordance with Rule 10A-3(b)(1) under the Exchange Act and satisfies the independent director requirements under the NASDAQ Stock Market rules. All members of our audit committee meet the requirements for financial literacy under the NASDAQ corporate governance rules. Our board of directors has determined that Joseph Tenne meets the requirements of an audit committee financial expert as defined by the SEC rules.
Audit Committee Role
Our board of directors has adopted an audit committee charter that sets forth the responsibilities of the audit committee consistent with the rules and regulations of the SEC and the NASDAQ Stock Market rules, as well as the requirements for such committee under the Israeli Companies Law, including the following:
• | oversight of our independent registered public accounting firm and recommending the engagement, compensation or termination of engagement of our independent registered public accounting firm to the board of directors in accordance with Israeli law; |
• | recommending the engagement or termination of the person filling the office of our internal auditor; and |
• | recommending the terms of audit and non-audit services provided by the independent registered public accounting firm for pre-approval by our board of directors. |
Our audit committee provides assistance to our board of directors in fulfilling its legal and fiduciary obligations in matters involving our accounting, auditing, financial reporting, internal control and legal compliance functions by pre-approving the services performed by our independent accountants and reviewing their reports regarding our accounting practices and systems of internal control over financial reporting. Our audit committee also oversees the audit efforts of our independent accountants and takes those actions that it deems necessary to satisfy itself that the accountants are independent of management.
Under the Israeli Companies Law, our audit committee is responsible for:
(i) | determining whether there are deficiencies in the business management practices of our company, including in consultation with our internal auditor or the independent auditor, and making recommendations to the board of directors to improve such practices; |
(ii) | determining whether to approve certain related party transactions (including transactions in which an office holder has a personal interest and whether any such transaction is extraordinary or material under Israeli Companies Law) (see “— Approval of related party transactions under Israeli law”); |
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(iii) | establishing the approval process (including, potentially, the approval of the audit committee) for certain transactions with a controlling shareholder or in which a controlling shareholder has a personal interest; |
(iv) | where the board of directors approves the working plan of the internal auditor, examining such work plan before its submission to the board of directors and proposing amendments thereto; |
(v) | examining our internal controls and internal auditor’s performance, including whether the internal auditor has sufficient resources and tools to dispose of its responsibilities; |
(vi) | examining the scope of our independent auditor’s work and compensation and submitting a recommendation with respect thereto to our board of directors or shareholders, depending on which of them is considering the appointment of our auditor; and |
(vii) | establishing procedures for the handling of employees’ complaints as to the management of our business and the protection to be provided to such employees. |
Our audit committee may not approve any actions requiring its approval (see “— Approval of related party transactions under Israeli law”), unless at the time of the approval a majority of the committee’s members are present, which majority consists of unaffiliated directors including at least one external director.
Compensation Committee and Compensation Policy
Our compensation committee consists of Joseph Tenne, chairman, and Michal Silverberg and Nir Belzer, each of whom is independent under NASDAQ Stock Market rules.
Under the Israeli Companies Law, the board of directors of a public company must appoint a compensation committee. The compensation committee must be comprised of at least three directors, including all of the external directors, who must constitute a majority of the members of, and include the chairperson of, the compensation committee. However, subject to certain exceptions, Israeli companies whose securities are traded on stock exchanges such as the NASDAQ Global Select Market, and who do not have a controlling shareholder, do not have to meet this majority requirement; provided, however, that the compensation committee meets other Israeli Companies Law composition requirements, as well as the requirements of the jurisdiction where the company’s securities are traded. Each compensation committee member who is not an external director must be a director whose compensation does not exceed an amount that may be paid to an external director. The compensation committee is subject to the same Israeli Companies Law restrictions as the audit committee as to who may not be a member of the compensation committee.
The duties of the compensation committee include the recommendation to the company’s board of directors of a policy regarding the terms of engagement of office holders, to which we refer as a compensation policy. That policy must be adopted by the company’s board of directors, after considering the recommendations of the compensation committee, and will need to be brought for approval by the company’s shareholders, which approval requires what we refer to as a Special Majority Approval for Compensation. A Special Majority Approval for Compensation requires shareholder approval by a majority vote of the shares present and voting at a meeting of shareholders called for such purpose, provided that either: (a) such majority includes at least a majority of the shares held by all shareholders who are not controlling shareholders and do not have a personal interest in such compensation arrangement; or (b) the total number of shares of non-controlling shareholders and shareholders who do not have a personal interest in the compensation arrangement and who vote against the arrangement does not exceed 2% of the company’s aggregate voting rights..
We have adopted a compensation policy which serves as the basis for decisions concerning the financial terms of employment or engagement of office holders, including exculpation, insurance, indemnification or any monetary payment or obligation of payment or other benefit in respect of employment or engagement. The compensation policy must relate to certain factors, including advancement of the company’s objectives, the company’s business plan and its long-term strategy, and creation of appropriate incentives for office holders. It must also consider, among other things, the company’s risk management, size and the nature of its operations. The compensation policy must furthermore consider the following additional factors:
• | the knowledge, skills, expertise and accomplishments of the relevant office holder; |
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• | the office holder’s roles and responsibilities and prior compensation agreements with him or her; |
• | the relationship between the terms offered and the average compensation of the other employees of the company, including those employed through manpower companies; |
• | the impact of disparities in salary upon work relationships in the company; |
• | the possibility of reducing variable compensation at the discretion of the board of directors; and the possibility of setting a limit on the exercise value of non-cash variable equity-based compensation; and |
• | as to severance compensation, the period of service of the office holder, the terms of his or her compensation during such service period, the company’s performance during that period of service, the person’s contribution towards the company’s achievement of its goals and the maximization of its profits, and the circumstances under which the person is leaving the company. |
The compensation policy must also include the following principles: |
• | the link between variable compensation and long-term performance and measurable criteria; |
• | the relationship between variable and fixed compensation, and the ceiling for the value of variable compensation; |
• | the conditions under which an office holder would be required to repay compensation paid to him or her if it was later shown that the data upon which such compensation was based was inaccurate and was required to be restated in the company’s financial statements; |
• | the minimum holding or vesting period for variable, equity-based compensation; and |
• | maximum limits for severance compensation. |
The compensation committee is responsible for (a) recommending the compensation policy to a company’s board of directors for its approval (and subsequent approval by its shareholders) and (b) duties related to the compensation policy and to the compensation of a company’s office holders as well as functions previously fulfilled by a company’s audit committee with respect to matters related to approval of the terms of engagement of office holders, including:
• | recommending whether a compensation policy should continue in effect, if the then-current policy has a term of greater than three (3) years (approval of either a new compensation policy or the continuation of an existing compensation policy must in any case occur every three years); |
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• | recommending to the board of directors periodic updates to the compensation policy; |
• | assessing implementation of the compensation policy; |
• | approving compensation terms of executive officers, directors and employees that require approval of the compensation committee; |
• | determining whether the compensation terms of a chief executive officer nominee, which were determined pursuant to the compensation policy, will be exempt from approval of the shareholders because such approval would harm the ability to engage with such nominee; and |
• | determining, subject to the approval of the board and under special circumstances, override a determination of the company’s shareholders regarding certain compensation related issues. |
Compensation Committee Role
Our board of directors has adopted a compensation committee charter setting forth the responsibilities of the compensation committee, which include:
• | the responsibilities set forth in the compensation policy; |
• | reviewing and approving the granting of options and other incentive awards to the extent such authority is delegated by our board of directors; and |
• | reviewing, evaluating and making recommendations regarding the compensation and benefits for our non-employee directors. |
Nominating and Governance Committee
Our nominating and governance committee consists of Mani Wasserman, chairman, Steve Dubin and Joseph Tenne. Our board of directors has adopted a nominating and governance committee charter that sets forth the responsibilities of the nominating and governance committee, which include:
• | overseeing and assisting our board in reviewing and recommending nominees for election as directors; |
• | assessing the performance of the members of our board; and |
• | establishing and maintaining effective corporate governance policies and practices, including, but not limited to, developing and recommending to our board a set of corporate governance guidelines applicable to our company. |
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Internal Auditor
Under the Israeli Companies Law, the board of directors of an Israeli public company must appoint an internal auditor recommended by the audit committee. An internal auditor may not be:
• | a person (or a relative of a person) who holds 5% or more of the company’s outstanding shares or voting rights; |
• | a person (or a relative of a person) who has the power to appoint a director or the general manager of the company; |
• | an office holder (including a director) of the company (or a relative thereof); or |
• | a member of the company’s independent accounting firm, or anyone on its behalf. |
The role of the internal auditor is to examine, among other things, our compliance with applicable law and orderly business procedures. The audit committee is required to oversee the activities and to assess the performance of the internal auditor as well as to review the internal auditor’s work plan. . Our internal auditor is an employee of the Israeli member firm of KPMG and not functioning as an employee or officer of the company.
Approval of related party transactions under Israeli law
Fiduciary duties of directors and executive officers
The Israeli Companies Law codifies the fiduciary duties that office holders owe to a company. Each person listed in the table under “—Directors and Senior Management” is an office holder under the Israeli Companies Law.
An office holder’s fiduciary duties consist of a duty of care and a duty of loyalty. The duty of care requires an office holder to act with the level of care with which a reasonable office holder in the same position would have acted under the same circumstances. The duty of loyalty requires that an office holder act in good faith and in the best interests of the company.
The duty of care includes a duty to use reasonable means to obtain:
• | information on the advisability of a given action brought for his or her approval or performed by virtue of his or her position; and |
• | all other important information pertaining to any such action. |
The duty of loyalty includes a duty to:
• | refrain from any conflict of interest between the performance of his or her duties to the company and his or her other duties or 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 herself or others; and |
• | disclose to the company any information or documents relating to the company’s affairs which the office holder received as a result of his or her position as an office holder. |
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Disclosure of personal interests of an office holder and approval of certain transactions |
The Israeli Companies Law requires that an office holder promptly disclose to the board of directors any personal interest that he or she may be aware of and all related material information or documents concerning any existing or proposed transaction with the company. An interested office holder’s disclosure must be made promptly and in any event no later than the first meeting of the board of directors at which the transaction is considered. A personal interest includes an interest of any person in an act or transaction of a company, including a personal interest of such person’s relative or of a corporate body in which such person or a relative of such person is a 5% or greater shareholder, director or general manager or in which he or she has the right to appoint at least one director or the general manager, but excluding a personal interest stemming from one’s ownership of shares in the company. A personal interest furthermore includes the personal interest of a person for whom the office holder holds a voting proxy or the personal interest of the office holder with respect to his or her vote on behalf of a person for whom he or she holds a proxy even if such shareholder has no personal interest in the matter. An office holder is not, however, obliged to disclose a personal interest if it derives solely from the personal interest of his or her relative in a transaction that is not considered an extraordinary transaction. Under the Israeli Companies Law, an extraordinary transaction is defined as any of the following:
• | a transaction other than in the ordinary course of business; |
• | a transaction that is not on market terms; or |
• | a transaction that may have a material impact on a company’s profitability, assets or liabilities. |
If it is determined that an office holder has a personal interest in a transaction which is not an extraordinary transaction, approval by the board of directors is required for the transaction, unless the company’s articles of association provide for a different method of approval. Further, so long as an office holder has disclosed his or her personal interest in a transaction, the board of directors may approve an action by the office holder that would otherwise be deemed a breach of his or her duty of loyalty. However, a company may not approve a transaction or action that is not in the best interests of the company or that is not performed by the office holder in good faith. An extraordinary transaction in which an office holder has a personal interest requires approval first by the company’s audit committee and subsequently by the board of directors. The compensation of, or an undertaking to indemnify or insure, an office holder who is not a director requires approval first by the company’s compensation committee, then by the company’s board of directors. If such compensation arrangement or an undertaking to indemnify or insure is inconsistent with the company’s stated compensation policy or if the office holder is the chief executive officer (apart from a number of specific exceptions), then such arrangement is further subject to a Special Majority Approval for Compensation. . Arrangements regarding the compensation, indemnification or insurance of a director require the approval of the compensation committee, board of directors and shareholders by ordinary majority, in that order, and under certain circumstances, a Special Majority Approval for Compensation.
Generally, a person who has a personal interest in a matter which is considered at a meeting of the board of directors or the audit committee may not be present at such a meeting or vote on that matter unless the chairman of the relevant committee or board of directors (as applicable) determines that he or she should be present in order to present the transaction that is subject to approval. If a majority of the members of the audit committee or the board of directors (as applicable) has a personal interest in the approval of a transaction, then all directors may participate in discussions of the audit committee or the board of directors (as applicable) on such transaction and the voting on approval thereof, but shareholder approval is also required for such transaction.
Disclosure of personal interests of controlling shareholders and approval of certain transactions |
Pursuant to Israeli law, the disclosure requirements regarding personal interests that apply to directors and executive officers also apply to a controlling shareholder of a public company. In the context of a transaction involving a shareholder of the company, a controlling shareholder also includes a shareholder who holds 25% or more of the voting rights in the company if no other shareholder holds more than 50% of the voting rights in the company. For this purpose, the holdings of all shareholders who have a personal interest in the same transaction will be aggregated. The approval of the audit committee or the compensation committee, the board of directors and the shareholders of the company, in that order is required for (a) extraordinary transactions with a controlling shareholder or in which a controlling shareholder has a personal interest, (b) the engagement with a controlling shareholder or his or her relative, directly or indirectly, including through a company under the control of the controlling shareholder, for the provision of services to the company, (c) the terms of engagement and compensation of a controlling shareholder or his or her relative who is an office holder or (d) the employment of a controlling shareholder or his or her relative by the company, other than as an office holder. In addition, the shareholder approval requires one of the following, which we refer to as a Special Majority:
• at least a majority of the shares held by all shareholders who do not have a personal interest in the transaction and who are present and voting at the meeting approves the transaction, excluding abstentions; or
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• the shares voted against the transaction by shareholders who have no personal interest in the transaction and who are present and voting at the meeting do not exceed 2% of the voting rights in the company.
To the extent that any such transaction with a controlling shareholder is for a period extending beyond three years, approval is required once every three years, unless, with respect to certain transactions, the audit committee determines that the duration of the transaction is reasonable given the circumstances related thereto.
Arrangements regarding the compensation, indemnification or insurance of a controlling shareholder in his or her capacity as an office holder require the approval of the compensation committee, board of directors and shareholders by a Special Majority, in that order, and the terms thereof may not be inconsistent with the company’s stated compensation policy.
Pursuant to regulations promulgated under the Israeli Companies Law, certain transactions with a controlling shareholder or his or her relative, or with directors, that would otherwise require approval of a company’s shareholders may be exempt from shareholder approval upon certain determinations of the audit committee and board of directors. Under these regulations, a shareholder holding at least 1% of the issued share capital of the company may require, within 14 days of the publication of such determinations, that despite such determinations by the audit committee and the board of directors, such transaction will require shareholder approval under the same majority requirements that would otherwise apply to such transactions.
Shareholder duties |
Pursuant to the Israeli Companies Law, a shareholder has a duty to act in good faith and in a customary manner toward the company and other shareholders and to refrain from abusing his or her power in a company, including, among other things, in voting at a general meeting and at shareholder class meetings with respect to the following matters:
• | an amendment to the company’s articles of association; |
• | an increase of the company’s authorized share capital; |
• | a merger; or |
• | the approval of related party transactions and acts of office holders that require shareholder approval. |
A shareholder also has a general duty to refrain from discriminating against other shareholders.
In addition, certain shareholders have a duty of fairness toward the company. These shareholders include any controlling shareholder, any shareholder who knows that he or she has the power to determine the outcome of a shareholder vote and any shareholder who has the power to appoint or to prevent the appointment of an office holder of the company or other power towards the company. The Israeli Companies Law does not define the substance of the duty of fairness, except to state that the remedies generally available upon a breach of contract will also apply in the event of a breach of the duty to act with fairness.
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Exculpation, insurance and indemnification of directors and officers
Under the Israeli Companies Law, a company may not exculpate an office holder from liability for a breach of the duty of loyalty. An Israeli company may exculpate an office holder in advance from liability to the company, in whole or in part, for damages caused to the company as a result of a breach of duty of care but only if a provision authorizing such exculpation is included in its articles of association. Our articles of association include such a provision. A company may not exculpate in advance a director from liability arising out of a prohibited dividend or distribution to shareholders.
Under the Israeli Companies Law, a company may indemnify an office holder in respect of the following liabilities and expenses incurred for acts performed by him or her as an office holder, either pursuant to an undertaking made in advance of an event or following an event, provided its articles of association include a provision authorizing such indemnification:
• | financial liability imposed on him or her in favor of another person pursuant to a judgment, including a settlement or arbitrator’s award approved by a court. However, if an undertaking to indemnify an office holder with respect to such liability is provided in advance, then such an undertaking must be limited to events which, in the opinion of the board of directors, can be foreseen based on the company’s activities when the undertaking to indemnify is given, and to an amount or according to criteria determined by the board of directors as reasonable under the circumstances, and such undertaking shall detail the abovementioned foreseen events and amount or criteria; |
• | reasonable litigation expenses, including attorneys’ fees, incurred by the office holder (1) as a result of an investigation or proceeding instituted against him or her by an authority authorized to conduct such investigation or proceeding, provided that (i) no indictment was filed against such office holder as a result of such investigation or proceeding; and (ii) no financial liability was imposed upon him or her as a substitute for the criminal proceeding as a result of such investigation or proceeding or, if such financial liability was imposed, it was imposed with respect to an offense that does not require proof of criminal intent; and (2) in connection with a monetary sanction; and |
• | reasonable litigation expenses, including attorneys’ fees, incurred by the office holder or imposed by a court in proceedings instituted against him or her by the company, on its behalf, or by a third party, or in connection with criminal proceedings in which the office holder was acquitted, or as a result of a conviction for an offense that does not require proof of criminal intent. |
Under the Israeli Companies Law, a company may insure an office holder against the following liabilities incurred for acts performed by him or her as an office holder if and to the extent provided in the company’s articles of association:
• | a breach of the duty of loyalty to the company, provided that the office holder acted in good faith and had a reasonable basis to believe that the act would not harm the company; |
• | a breach of duty of care to the company or to a third party, to the extent such a breach arises out of the negligent conduct of the office holder; and |
• | a financial liability imposed on the office holder in favor of a third party. |
Under the Israeli Companies Law, a company may not indemnify, exculpate or insure an office holder against any of the following:
• | a breach of the duty of loyalty, except for indemnification and insurance for a breach of the duty of loyalty to the company to the extent that the office holder acted in good faith and had a reasonable basis to believe that the act would not harm the company; |
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• | a breach of duty of care committed intentionally or recklessly, excluding a breach arising out of the negligent conduct of the office holder; |
• | an act or omission committed with intent to derive illegal personal benefit; or |
• | a fine or forfeit levied against the office holder. |
Under the Israeli Companies Law, exculpation, indemnification and insurance of office holders in a public company must be approved by the compensation committee and the board of directors and, with respect to certain office holders or under certain circumstances, also by the shareholders. See “— Approval of related party transactions under Israeli law.”
Our articles of association permit us to exculpate, indemnify and insure our office holders to the fullest extent permitted or to be permitted by the Israeli Companies Law.
In addition, we have entered into agreements with each of our directors and executive officers exculpating them from liability to us for damages caused to us as a result of a breach of duty of care and undertaking to indemnify them, in each case, to the fullest extent permitted by our articles of association and Israeli law.
The maximum indemnification amount set forth in such agreements is limited to an amount the higher of (x) 25% of our total shareholders’ equity based on our most recently published financial statements prior to the time that indemnification is paid; or (y) $25 million; provided, however, that in relation to indemnification claimed in connection with a public offering of our securities, the amount, if higher, shall be equal to the aggregate proceeds raised by us and/or selling shareholders. The maximum amount set forth in such agreements is in addition to any amount paid (if paid) under insurance and/or by a third-party pursuant to an indemnification arrangement.
We have obtained directors and officers liability insurance for the benefit of our office holders and intend to continue to maintain such coverage and pay all premiums thereunder to the fullest extent permitted by the Israeli Companies Law.
D. Employees |
The total number of our full-time employees and the distribution of our employees (i) geographically; and (ii) according to main area of activity, as of the end of each of the last three years, are set forth in the following two tables, respectively:
Number of full-time employees by region as of December 31, | ||||||||||||
2012 | 2013 | 2014 | ||||||||||
Region | ||||||||||||
Israel | 104 | 126 | 136 | |||||||||
United States | 26 | 30 | 31 | |||||||||
China | 1 | 2 | 2 | |||||||||
Australia | - | - | 1 | |||||||||
Total | 131 | 158 | 170 |
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Number of full-time employees by area of activity as of December 31, | ||||||||||||
2012 | 2013 | 2014 | ||||||||||
Area of Activity | ||||||||||||
Management and administrative | 19 | 26 | 28 | |||||||||
Research and development | 27 | 29 | 34 | |||||||||
Operations and manufacture | 37 | 49 | 52 | |||||||||
Sales and marketing | 37 | 43 | 45 | |||||||||
Quality | 11 | 11 | 11 | |||||||||
Total | 131 | 158 | 170 |
During the periods covered by the above tables, we did not employ a significant number of temporary employees.
Israeli labor laws govern the length of the workday, minimum wages for employees, procedures for hiring and dismissing employees, determination of severance pay, annual leave, sick days, advance notice of termination, payments to the National Insurance Institute, and other conditions of employment and include equal opportunity and anti-discrimination laws. While none of our employees is party to any collective bargaining agreements, 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 in Israel by order of the Israeli Ministry of the Economy (formerly the Ministry of Industry, Trade and Labor). These provisions primarily concern pension fund benefits for all employees, insurance for work-related accidents, recuperation pay and travel expenses. We generally provide our employees with benefits and working conditions beyond the required minimums.
We have never experienced any employment-related work stoppages and believe our relationships with our employees are good.
E. Share Ownership |
For information regarding the share ownership of our directors and executive officers, please refer to “Item 6.B. Directors, Senior Management and Employees—Compensation—Option plans” and “Item 7.A. Major Shareholders and Related Party Transactions—
Major Shareholders.”
Our directors and executive officers hold, in the aggregate, as of February 17, 2015, options exercisable for 982,893 ordinary shares, which have a weighted average exercise price of $5.89 per share and have expiration dates generally ten years after the grant date of the option. In addition, as of February 17, 2015, our directors and executive officers hold, in the aggregate, 199,854 restricted share unites and 136,510 restricted shares.
ITEM 7: Major Shareholders and Related Party Transactions
A. Major Shareholders |
The following table sets forth information with respect to the beneficial ownership of our ordinary shares as of February 17, 2015:
• | each person or entity known by us to own beneficially more than 5% of our outstanding ordinary shares; |
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• | each of our executive officers and directors individually; and |
• | all of our executive officers and directors as a group. |
The beneficial ownership of our ordinary shares is determined in accordance with the rules of the SEC and generally includes any shares over which a person exercises sole or shared voting or investment power, or the right to receive the economic benefit of ownership. For purposes of the table below, we deem ordinary shares issuable pursuant to options that are currently exercisable or exercisable within 60 days of February 17, 2015 to be outstanding and to be beneficially owned by the person holding the options for the purposes of computing the percentage ownership of that person, but we do not treat them as outstanding for the purpose of computing the percentage ownership of any other person. The percentage of ordinary shares beneficially owned is based on 22,495,779 ordinary shares outstanding as of February 17, 2015.
Except where otherwise indicated, we believe, based on information furnished to us by such owners, that the beneficial owners of the ordinary shares listed below have sole investment and voting power with respect to such shares.
As of February 17, 2015, we are aware of five U.S. persons that are holders of record of our shares. Such holders of record currently hold, in the aggregate, 17,227,725 ordinary shares, constituting 76.6% of the beneficial ownership of our outstanding ordinary shares.
Unless otherwise noted below, each shareholder’s address is c/o Enzymotec Ltd., Sagi 2000 Industrial Area, P.O. Box 6, Migdal Ha’Emeq 2310001, Israel.
Shares Beneficially Owned | ||||||||
Name of Beneficial Owner | Number | Percent | ||||||
Principal and Selling Shareholders | ||||||||
Galam Ltd.(1) | 4,623,232 | 20.6 | % | |||||
Paulson & Co. Inc. (2) | 4,238,275 | 18.8 | % | |||||
Visium Balanced Master Fund, Ltd. (3) | 2,125,000 | 9.4 | % | |||||
XT Hi-Tech Investments (1992) Ltd.(4) | 1,889,315 | 8.4 | % | |||||
Directors and officers | ||||||||
Steve Dubin | * | * | ||||||
Nir Belzer(5) | 231,182 | 1.0 | % | |||||
Holger Liepmann | — | — | ||||||
Dov Pekelman | * | * | ||||||
Yossi Peled | * | * | ||||||
Michal Silverberg | * | * | ||||||
Joseph Tenne | * | * | ||||||
Imanuel (Mani) Wasserman | — | — | ||||||
Ariel Katz(6) | 424,646 | 1.9 | % | |||||
Oren Bryan | * | * | ||||||
Gai Ben-Dror | * | * | ||||||
Ariel Blumovich | — | — | ||||||
Shahar Carmi | — | — | ||||||
Robert Crim | — | — | ||||||
Itay Dromi | — | — | ||||||
Yaniv Gratz | — | — | ||||||
All directors and executive officers as a group (16 persons)(7) | 1,132,413 | 4.9 | % |
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* | Less than 1% of our outstanding ordinary shares. |
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(1) | Based on a Schedule 13G filed by Galam Ltd. filed on February 12, 2015, consists of 3,318,856 ordinary shares held by Galam Management and Marketing Agricultural Cooperative Society Ltd. (“Galam M&M”) and 1,304,376 ordinary shares held by Galam Ltd. (“Galam Ltd.”), its wholly-owned subsidiary. The management boards of the two entities are comprised of the same people and hold voting and dispositive power over the shares held by the two entities. As such, the members of the boards may be deemed to be the beneficial owners of those shares. There are 13 members of the management boards, two of which, Imanuel (Mani) Wasserman and Yossi Peled, are also members of our board of directors. A majority of the shares of Galam M&M are held by Ochmanit the Economic Union for Ma’anit Agricultural Cooperative Society Ltd. (“Ochmanit”). Ochmanit is wholly-owned by Kibbutz Ma’anit and its members with 51% of the voting rights held by Kibbutz Ma’anit. A majority of the members of the management boards of Galam M&M and Galam Ltd. are appointed by Ochmanit, in part based on candidates nominated by a vote of the members of Kibbutz Ma’anit. Established in 1935, Kibbutz Ma’anit is a communal society, referred to in Hebrew as a “kibbutz,” with approximately 180 members located near Pardes-Hanna between Tel Aviv and Haifa. The Kibbutz is engaged in a number of economic activities, including agriculture and industrial operations, and holds its assets on a communal basis. No members of Kibbutz Ma’anit are employed by us. The address of this shareholder is Kibbutz Ma’anit, 3785500, Israel. | |
(2) | Based on a Schedule 13G/A filed by Paulson & Co. Inc. on February 17, 2015, consists of 4,238,275 ordinary shares held by Paulson & Co. Inc. (“Paulson”), an investment advisor that is registered under Section 203 of the Investment Advisers Act of 1940. In its role as investment advisor, or manager, Paulson possesses voting and/or investment power over our shares that are owned by various onshore and offshore investment funds and separate managed accounts (the “Funds”). All securities reported above are owned by the Funds. The address of this shareholder is 1251 Avenue of the Americas, New York, NY 10020. |
(3) | Based on a Schedule 13G/A filed by Visium Balanced Master Fund, Ltd. on February 12, 2015, includes 2,125,000 ordinary shares held by Visium Balanced Master Fund, Ltd., a Cayman Islands corporation (“VBMF”). Visium Asset Management, LP, a Delaware limited partnership (“VAM”) is an investment manager of the pooled assets of VBMF and as such may be deemed to beneficially own the ordinary shares held by VBMF. JG Asset, LLC, a Delaware limited liability company (“JG Asset”), is the General Partner of VAM and as such may be deemed to beneficially own the ordinary shares beneficially owned by VAM. Jacob Gottlieb, a natural person, is the Managing Member of JG Asset and as such may be deemed to beneficially own the ordinary shares beneficially owned by JG Asset. This shareholder’s principal business office is c/o Visium Asset Management, LP, 888 Seventh Avenue, New York, NY 10019. |
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(4) | Consists of 1,889,315 shares held by XT Hi-Tech Investments (1992) Ltd. (formerly Ofer Hi-Tech Investments Ltd.). XT Hi-Tech Investments (1992) Ltd. is an indirect wholly-owned subsidiary of XT Investments Ltd., which is a direct wholly-owned subsidiary of XT Holdings Ltd. (formerly Ofer Holdings Group Ltd.), of which Orona Investments Ltd., or Orona, and Lynav Holdings Ltd., or Lynav, are each the direct owners of one-half of the outstanding ordinary shares. Udi Angel indirectly controls Orona. Lynav is held 95% by CIBC Bank and Trust Company (Cayman) Ltd., or CIBC, as trustee of a discretionary trust established in the Cayman Islands. Udi Angel is member of the board of directors of XT Hi-Tech Investments (1992) Ltd. and has a casting vote with respect to various decisions taken by the board, including voting and disposition over our shares. As such, he may be deemed to have beneficial ownership over our shares held by XT Hi-Tech Investments (1992) Ltd. The address of this shareholder is 9 Andre Saharov Street, P.O. Box 15090, Haifa 31905, Israel. |
(5) | Consists of 8,000 shares held by Mr. Belzer in “street name,” 6,505 shares held by Millennium Materials Technologies Fund II L.P., or MMT. Also consists of 197,374 shares held of record by M-4 Management L.P., or M-4 and 19,303 shares issuable upon the exercise of options held by Mr. Belzer. The general partner of MMT is Millennium Materials II Fund Management Company Ltd., or MMC2. Mr. Belzer is one of four persons that controls MMC2 and, as such, he may be deemed to share beneficial ownership over our shares held by MMT. Mr. Belzer controls the general partner of M-4 and therefore beneficially owns the shares held by M-4. Mr. Belzer’s address is 6 Koifman Street, Floor 14, Tel Aviv 68012, Israel. |
(6) | Consists of 118,646 shares held by a trustee on behalf of Dr. Katz and 306,000 shares issuable upon the exercise of options. |
(7) | Consists of 455,457 shares, 116,960 restricted shares and 559,996 shares issuable upon the exercise of options. Please see footnotes (5) and (6) above for further information concerning the composition of the shares beneficially owned by our executive officers and directors. |
The following sets forth the changes in percentage ownership of our major shareholders:
Immediately following our initial public offering on September 26, 2013, Galam Ltd. (and its affiliates) beneficially owned 6,521,880 ordinary shares or 31.3% of our issued and outstanding ordinary shares. On February 12, 2015, Galam Ltd. filed a Schedule 13G stated that as of December 31, 2014 it beneficially owned 4,623,232 ordinary shares or 20.6% of our issued and outstanding ordinary shares.
Immediately following the consummation of our initial public offering on September 26, 2013, XT Hi-Tech Investments (1992) Ltd. beneficially owned 3,068,704 ordinary shares or 14.7% of our issued and outstanding ordinary shares. Following our secondary offering on March 5, 2014, XT Hi-Tech Investments (1992) Ltd. beneficially owned 1,889,915 ordinary shares or 8.4% of our issued and outstanding ordinary shares.
Immediately following the consummation of our initial public offering on September 26, 2013, Millennium Materials Technologies Fund II L.P , or Millennium beneficially owned 1,667,156 ordinary shares or 8.0% of our issued and outstanding ordinary shares. Following our secondary offering on March 5, 2014, Millennium beneficially owned 536,888 ordinary shares or 1.6% of our issued and outstanding ordinary shares.
Immediately following the consummation of our initial public offering on September 26, 2013, Arancia International, Inc. beneficially owned 1,075,828 ordinary shares or 5.2% of our issued and outstanding ordinary shares. Following our secondary offering on March 5, 2014, Arancia International, Inc.beneficially owned 762,634 ordinary shares or approximately 3.5% of our issued and outstanding ordinary shares.
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On February 14, 2014, Paulson & Co. filed a Schedule 13G with the SEC stating that it beneficially owned 1,733,030 ordinary shares, or 8.3% of our issued and outstanding ordinary shares. On March 10, 2014, Paulson & Co. filed a Schedule 13G/A stating that it beneficially owned 4,177,830 ordinary shares or 19.24% of our issued and outstanding ordinary shares. On February 17, 2015, Paulson & Co. filed a Schedule 13G/A stating that, as of December 31, 2014, it beneficially owned 4,238,275 ordinary shares, which is 18.8% of our issued and outstanding ordinary shares.
On March 10, 2014, VBMF filed a Schedule 13G with the SEC stating that it beneficially owned 1,140,000 ordinary shares, or 5.2% of our issued and outstanding ordinary shares. On February 12, 2015, VBMF filed a Schedule 13G/A with the SEC stating that, as of December 31, 2014 it beneficially owned 2,125,000 ordinary shares, which is 9.4% of our issued and outstanding ordinary shares.
None of the Company’s major shareholders listed above have different voting rights.
B. Related Party Transactions |
Investors’ Rights Agreement
Pursuant to our Amended and Restated Investors’ Rights Agreement (the “Investors’ Rights Agreement”), dated as of September 22, 2013, certain of our shareholders hold registration rights as described below.
Demand registration rights
Subject to the terms of the any lock-up agreements entered into by parties to the Investors’ Rights Agreement, at the request of the holders of a majority of the then outstanding ordinary shares that are registrable pursuant to the Investors’ Rights Agreement, we must register any or all of these shareholders’ ordinary shares as follows:
• | before we become eligible under applicable securities laws to file a registration statement on Form F-3, we are required to effect up to two such registrations, but only if the minimum anticipated aggregate offering price of the shares to be registered exceeds $5.0 million, and |
• | after we become eligible under applicable securities laws to file a registration statement on Form F-3, we are required to effect an unlimited number of registrations, but only (1) if the minimum anticipated aggregate offering price of the shares to be registered exceeds $1.0 million, and (2) up to two within a period of twelve months. |
Such registration must also include any additional registrable securities requested to be included in such registration by any other holders of registrable ordinary shares who are party to the Investors’ Rights Agreement or entitled thereunder.
Our obligation to effect a registration is subject to certain qualifications and limitations, including (i) our right to postpone a registration during the period that is 60 days (30 days in the case of a Form F-3 Registration) before our good faith estimate of the date of filing of, and ending on the date 180 days (90 days in the case of a Form F-3 Registration) after the effective date of, a registration statement initiated by us; (ii) our right to postpone a registration no more than once in any 12 month period for a period of up to 90 days in the event of our furnishing a certificate signed by the Chairman of our board of directors that states that in the good faith judgment of our board of directors, it would be materially detrimental to us or our shareholders for such registration statement to either become effective or remain effective, because such action would (a) materially interfere with a significant acquisition, corporate reorganization, or other similar transaction involving us; (b) require premature disclosure of material information that we have a bona fide business purpose for preserving as confidential; or (c) render us unable to comply with requirements under the Securities Act or Exchange Act; and (iii) our right not to effect a Form F-1 Registration if the initiating holders propose to dispose of shares that may be immediately registered pursuant to a previously requested Form F-3 Registration.
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Piggyback registration rights
All of our shareholders that are a party to the Investors’ Rights Agreement have the right to request that we include their registrable securities in certain registration statements that we file in connection with the public offering of our shares. If the public offering that we are effecting is underwritten, the right of any shareholder to include shares in the registration related thereto is conditioned upon the shareholder accepting the terms of the underwriting as agreed between us and the underwriters and then only in such quantity as the underwriters in their sole discretion determine will not jeopardize the success of an offering.
Expenses
We have agreed to pay all expenses incurred in carrying out the above registrations, including the reasonable fees of one counsel chosen by the selling shareholders that are a party to the Investors’ Rights Agreement. However, each shareholder participating in such registration or sale is responsible for its pro rata portion of the customary and standard discounts or commissions payable to any underwriter, as well as transfer taxes owed in connection with the sale of its shares and any individual shareholder or group of shareholders that retains separate advisors is entirely responsible for the fees and expenses related thereto.
Agreements and arrangements with, and compensation of, directors and executive officers
Employment agreements
We have entered into written employment agreements with each of our executive officers. These agreements provide for notice periods of varying duration for termination of the agreement by us or by the relevant executive officer, during which time the executive officer will continue to receive base salary and benefits. These agreements also contain customary provisions regarding noncompetition, confidentiality of information and assignment of inventions. However, the enforceability of the noncompetition provisions may be limited under applicable law. See “Item 3.D. Key Information — Risk factors — Risks relating to our business and industry — Under applicable employment laws, we may not be able to enforce covenants not to compete” for a further description of the enforceability of non-competition clauses.
Indemnification agreements
Our articles of association permit us to exculpate, indemnify and insure each of our directors and office holders to the fullest extent permitted by the Israeli Companies Law. We have entered into indemnification agreements with each of our directors and executive officers, undertaking to indemnify them to the fullest extent permitted by Israeli law, including with respect to liabilities resulting from a public offering of our shares, to the extent that these liabilities are not covered by insurance. We have also obtained Directors and Officers insurance for each of our executive officers and directors. For further information, see “Item 6.C. Directors, Senior Management and Employees — Board Practices — Exculpation, insurance and indemnification of directors and officers.”
C. Interests of experts and counsel |
Not applicable.
ITEM 8: Financial Information
A. Consolidated Financial Statements and Other Financial Information |
Consolidated Financial Statements
We have appended our consolidated financial statements at the end of this annual report, starting at page F-2, as part of this annual report.
Legal Proceedings
Patent litigations and proceedings related to Neptune Technologies & Bioressources Inc.
We were previously party to a number of actions initiated by Neptune Technologies & Bioressources Inc., which we refer to as Neptune, in which Neptune has claimed that our krill oil products infringe certain of its patents, namely U.S. Patent Nos. 8,030,348, 8,278,351 and 8,383,675. We refer to these three patents as the ‘348 patent, the ‘351 patent and the ‘675 patent, respectively. The complaints with respect to each of these patents were filed against us and certain other parties in the U.S. District Court for the District of Delaware, which we refer to as the District Court, in October 2011, October 2012 and February 2013, respectively. In each of the complaints, Neptune sought both permanent injunctions prohibiting us from making or selling the allegedly infringing products and an unspecified amount of monetary damages against us and the other defendants.
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Additionally, in April 2013, we received a notice of an investigation by the U.S. International Trade Commission, or ITC, regarding complaints filed before the ITC by Neptune and its subsidiary, Acasti Pharma Inc. Neptune and its subsidiaries instituted these complaints against us and certain of Neptune’s other principal competitors in the United States alleging a violation of Section 337 of the Tariff Act of 1930 by reason of alleged infringement of the ‘351 patent and the ‘675 patent.
In April 2014 we signed a final settlement and license agreement with Neptune and Acasti. The ITC investigation and U.S. federal court actions were terminated and dismissed accordingly.
According to the terms of the settlement and license agreement, we received a worldwide non-exclusive license to the entire ‘348 patent family for as long as any patent in that family exists, for all of the Company’s relevant current products and future anticipated products under development.
The settlement and license agreement required a one-time upfront payment that we paid to Neptune. Further royalties payment to Neptune depend upon the outcome of (1) Inter Partes Review, or IPR, proceedings in the U.S. Patent Office, or USPTO, of certain agreed claims of the ’351 patent, and (2) a potential Australian post-grant reexamination of certain agreed claims of Neptune’s Australian Patent AU2002322233.
With respect to the ‘351 patent, in March 2014, the USPTO issued a decision instituting an IPR of the agreed claims of the ‘351 patent filed by Aker BioMarine AS, or Aker, concluding that there is reasonable likelihood that Aker will prevail in demonstrating unpatentability of those claims. On July 9, 2014, the USPTO issued a decision instituting our IPR of the agreed claims of the ‘351 patent and granted us motion to join our IPR with Aker’s IPR. The USPTO held a final hearing in the ‘351 IPR on October 31, 2014, but has not yet issued its decision. The ‘351 patent is also the subject of an ex parte reexamination, which has been stayed pending the outcome of Aker’s ‘351 IPR. Prior to the reexamination being stayed, the Patent Office rejected all claims of the ‘351 patent in a January 2, 2014 office action. That action is not final and Neptune will have an opportunity to respond once the stay is lifted.
Under the terms of the final license and settlement agreement, we submitted our post-grant reexamination to the Australian Patent Office on December 12, 2014. On January 28, 2015, the Australian Patent Office issued a reexamination report, finding that all the agreed claims lack novelty. Neptune has until March 28, 2015 to overcome the examiner’s objections, either by argument or amendment.
Claim for finder’s fee
In March 2013, a claim was filed against us in the Haifa District Court, Israel, seeking a finder’s fee in connection with funds invested in our company by one of our investors.
The claim was based upon an agreement entered into in March 2000, between us and the plaintiff, pursuant to which we agreed to pay him a finder’s fee should he introduce us to an investor who would invest an amount in excess of $500,000 in our company. In previous litigation between us and the plaintiff concerning this agreement, the plaintiff claimed to have been entitled to a finder’s fee in respect of an investment made by an investor in us, although the investment materialized more than a year later. This previous claim was adjudicated in the plaintiff’s favor and we paid him a fee of $75,000.
In the new claim, the plaintiff alleged that he was entitled to an additional finder’s fee in the amount of NIS 6.2 million (approximately $1.8 million) in connection with the multiple investments made by the same investor over the past 11 years. In May 2014 a settlement agreement was signed between us and the plaintiff under which we paid the plaintiff a fee of $78,000 as full and final settlement for all claims.
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Arbitration with AAK
In May 2014, AAK submitted a request for arbitration to the International Chamber of Commerce in Amsterdam, the Netherlands, seeking a determination of the arbitrators that our disclosure of information in connection with our initial public offering was an intentional, material breach of the joint venture agreement. The request, as further developed in AAK’s statement of claim, filed on November 14, 2014, indicates that AAK believes AL is exposed to likely damage in the future as a result of the level of disclosure that the Company made about it although AAK does not provide any specific instance of this having occurred. AAK’s statement of claim does not state a measure of damages, seek termination of the joint venture agreement or seek to determine what harm, if any, was caused to AL or AAK. In addition, the statement of claim seeks declaratory relief as to the correct interpretation of certain provisions of the buy-sell mechanism under the joint venture agreement. AAK’s position is that following notice of termination provided by one party, if neither party provides the other party with a buy-sell notice before December 31, 2016, the joint venture will terminate. On December 12, 2014, we submitted our statement of defense and counterclaims in which we stated our position that we were permitted to disclose information related to AL and required to be disclosed under law in connection with our initial public offering, as well as subsequently in connection with our public company status, and we believe that we have complied with the other limitations in the joint venture agreement. We also stated our position that the joint venture agreement can only be terminated by one party buying the other party’s share, such that if the buy-sell process is not concluded by December 31, 2016, the termination is ineffective and the joint venture is automatically renewed for additional three-year period. In addition, we filed counterclaims against AAK with respect to certain disputed operational issues which we raised and with respect to AAK’s conduct during our initial public offering. On January 23, 2015, AAK submitted its statement of defense with respect to our counterclaims. The arbitration hearing is scheduled for June 2015, and an award is expected by no later than December 31, 2015.
Securities Class Action
On September 5, 2014 and September 30, 2014, two stockholders filed class action complaints in the United States District Court for the District of New Jersey, or the Court, purportedly on behalf of all persons who acquired the Company’s ordinary shares in its initial public offering or between September 27, 2013 and August 4, 2014. The lawsuits name as defendants the Company, its directors, certain of its officers and the underwriters of its initial public offering and assert claims under the United States federal securities laws. On February 11, 2015, the Court consolidated the cases as In re Enzymotec Ltd. Securities Litigation, Master File No. 14-CV-05556 though a schedule for an amended complaint and responses thereto has not yet been set. The Company believes that the lawsuits are without merit and intends to defend itself vigorously.
Dividend policy
We have never declared or paid cash or non-cash dividends to our shareholders and we do not intend to pay cash or non-cash dividends in the foreseeable future. We intend to reinvest any earnings in developing and expanding our business. Any future determination relating to our dividend policy will be at the discretion of our board of directors and will depend on a number of factors, including future earnings, our financial condition, operating results, contractual restrictions, capital requirements, business prospects, our strategic goals and plans to expand our business, applicable law and other factors that our board of directors may deem relevant.
See “Item 3.D. Key Information — Risk factors — Risks related to an investment in our ordinary shares — We have never paid cash or non-cash dividends on our share capital, and we do not anticipate paying any cash or non-cash dividends in the foreseeable future” for an explanation concerning the payment of dividends under Israeli law.
B. Significant Changes |
No significant changes have occurred since December 31, 2014, except as otherwise disclosed in this annual report.
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ITEM 9: The Offer and Listing
A. Offer and Listing Details |
Our ordinary shares began trading publicly on the NASDAQ Global Select Market on September 27, 2013 under the symbol “ENZY.” The following table sets forth, for the periods indicated, the high and low sales prices of our ordinary shares as reported by the NASDAQ Global Select Market.
Period | High | Low | ||||||
Annual | ||||||||
Year ended December 31, 2014 | $ | 30.40 | $ | 6.34 | ||||
Year ended December 31, 2013 | $ | 35.12 | $ | 14.25 | ||||
Quarterly | ||||||||
First Quarter 2015 (through February 26, 2015) | $ | 8.40 | $ | 5.38 | ||||
Fourth Quarter 2014 | $ | 8.75 | $ | 6.34 | ||||
Third Quarter 2014 | $ | 15.40 | $ | 6.62 | ||||
Second Quarter 2014 | $ | 22.39 | $ | 12.10 | ||||
First Quarter 2014 | $ | 30.40 | $ | 20.52 | ||||
Fourth Quarter 2013 | $ | 35.12 | $ | 16.31 | ||||
Third Quarter 2013 (beginning on September 27, 2013) | $ | 19.38 | $ | 14.25 | ||||
Most Recent Six Months | ||||||||
February 2015 (through February 26, 2015) | $ | 8.40 | $ | 5.38 | ||||
January 2015 | $ | 7.74 | $ | 6.71 | ||||
December 2014 | $ | 8.40 | $ | 6.64 | ||||
November 2014 | $ | 8.75 | $ | 6.34 | ||||
October 2014 | $ | 7.62 | $ | 6.35 | ||||
September 2014 | $ | 8.86 | $ | 6.62 |
The closing sale price of our ordinary shares, as reported by the NASDAQ Global Select Market, on February 26, 2015, was $8.18 per ordinary share.
B. Plan of Distribution |
Not applicable.
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C. Markets |
See “— Offer and Listing Details” above.
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 of Association and Articles of Association |
General
As of February 26, 2015, our authorized share capital consists of 100,000,000 ordinary shares, par value NIS 0.01 per share.
All of our outstanding ordinary shares will be validly issued, fully paid and non-assessable. Our ordinary shares are not redeemable and do not have any preemptive rights.
Registration number and purposes of the company
Our registration number with the Israeli Registrar of Companies is 51-260924-9. As set forth in Article 3 of our amended articles of association, our purpose is to engage in any lawful activity.
Voting rights and conversion
All ordinary shares will have identical voting and other rights in all respects.
Transfer of shares
Our fully paid ordinary shares are issued in registered form and may be freely transferred under our amended articles of association, unless the transfer is restricted or prohibited by another instrument, applicable law or the rules of a stock exchange on which the shares are listed for trade. The ownership or voting of our ordinary shares by non-residents of Israel is not restricted in any way by our amended articles of association or the laws of the State of Israel, except for ownership by nationals of some countries that are, or have been, in a state of war with Israel.
Election of directors
Our ordinary shares do not have cumulative voting rights for the election of directors. As a result, the holders of a majority of the voting power represented at a shareholders meeting have the power to elect all of our directors, subject to the special approval requirements for external directors described under “Item 6.C. Directors, Senior Management and Employees — Board Practices — External directors.”
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Under our amended articles of association, our board of directors must consist of not less than five but no more than nine directors, not including two external directors as required by the Israeli Companies Law. Pursuant to our amended articles of association, other than the external directors, for whom special election requirements apply under the Israeli Companies Law, the vote required to appoint a director is a simple majority vote of holders of our voting shares, participating and voting at the relevant meeting. In addition, our directors, other than the external directors, are divided into three classes that are each elected at a general meeting of our shareholders every three years, in a staggered fashion (such that one class is elected each year), and serve on our board of directors until they are removed by a vote of 65% of the voting power of our shareholders at a general or special meeting of our shareholders or upon the occurrence of certain events, in accordance with the Israeli Companies Law and our amended articles of association. In addition, our amended articles of association allow our board of directors to appoint directors to fill vacancies on the board of directors to serve for a term of office equal to the remaining period of the term of office of the directors(s) whose office(s) have been vacated. External directors are elected for an initial term of three years, may be elected for additional terms of three years each under certain circumstances, and may be removed from office pursuant to the terms of the Israeli Companies Law. See “Item 6.C. Directors, Senior Management and Employees — Board Practices — External directors.
Dividend and liquidation rights
We may declare a dividend to be paid to the holders of our ordinary shares in proportion to their respective shareholdings. Under the Israeli Companies Law, dividend distributions are determined by the board of directors and do not require the approval of the shareholders of a company unless the company’s articles of association provide otherwise. Our amended articles of association do not require shareholder approval of a dividend distribution and provide that dividend distributions may be determined by our board of directors.
Pursuant to the Israeli Companies Law, the distribution amount is limited to the greater of retained earnings or earnings generated over the previous two years, according to our then last reviewed or audited financial statements, provided that the date of the financial statements is not more than six months prior to the date of the distribution, or we may distribute dividends that do not meet such criteria only with court approval. In each case, we are only permitted to distribute a dividend if our board of directors and the court, if applicable, determines that there is no reasonable concern that payment of 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 our ordinary shares in proportion to their shareholdings. This right, as well as the right to receive dividends, may be affected by the grant of preferential dividend or distribution rights to the holders of a class of shares with preferential rights that may be authorized in the future.
Exchange controls
There are currently no Israeli currency control restrictions on remittances of dividends on our ordinary shares, proceeds from the sale of the shares or interest or other payments to non-residents of Israel, except for shareholders who are subjects of countries that are, or have been, in a state of war with Israel.
Shareholder meetings
Under Israeli law, we are required to hold an annual general meeting of our shareholders once every calendar year that must be held no later than 15 months after the date of the previous annual general meeting. All meetings other than the annual general meeting of shareholders are referred to in our amended articles of association as extraordinary general meetings. Our board of directors may call extraordinary general meetings whenever it sees fit, at such time and place, within or outside of Israel, as it may determine. In addition, the Israeli Companies Law provides that our board of directors is required to convene an extraordinary general meeting upon the written request of (i) any two of our directors or one-quarter of the members of our board of directors or (ii) one or more shareholders holding, in the aggregate, either (a) 5% or more of our outstanding issued shares and 1% of our outstanding voting power or (b) 5% or more of our outstanding voting power.
Subject to the provisions of the Israeli Companies Law and the regulations promulgated thereunder, shareholders entitled to participate and vote at general meetings are the shareholders of record on a date to be decided by the board of directors, which may be between four and 40 days prior to the date of the meeting. Furthermore, the Israeli Companies Law requires that resolutions regarding the following matters must be passed at a general meeting of our shareholders:
• | amendments to our articles of association; |
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• | appointment or termination of our auditors; |
• | appointment of external directors; |
• | approval of certain related party transactions; |
• | increases or reductions of our authorized share capital; |
• | a merger; and |
• | the exercise of our board of director’s powers by a general meeting, if our board of directors is unable to exercise its powers and the exercise of any of its powers is required for our proper management. |
The Israeli Companies Law and our amended articles of association require that a notice of any annual general meeting or extraordinary general meeting be provided to shareholders at least 21 days prior to the meeting and if the agenda of the meeting includes the appointment or removal of directors, the approval of transactions with office holders or interested or related parties, or an approval of a merger, notice must be provided at least 35 days prior to the meeting.
Under the Israeli Companies Law and under our amended articles of association, shareholders are not permitted to take action via written consent in lieu of a meeting.
Voting rights
Quorum requirements
Pursuant to our amended articles of association, holders of our ordinary shares have one vote for each ordinary share held on all matters submitted to a vote before the shareholders at a general meeting. As a foreign private issuer, the quorum required for our general meetings of shareholders consists of at least two shareholders present in person, by proxy or written ballot who hold or represent between them at least 25% of the total outstanding voting rights. A meeting adjourned for lack of a quorum is generally adjourned to the same day in the following week at the same time and place or to a later time or date if so specified in the notice of the meeting. At the reconvened meeting, any two or more shareholders present in person or by proxy shall constitute a lawful quorum.
Vote requirements
Our amended articles of association provide that all resolutions of our shareholders require a simple majority vote, unless otherwise required by the Israeli Companies Law or by our amended articles of association. Under the Israeli Companies Law, each of (i) the approval of an extraordinary transaction with a controlling shareholder; and (ii) the terms of employment or other engagement of the controlling shareholder of the company or such controlling shareholder’s relative (even if not extraordinary) requires, the approval described above under “Item 6.C. Directors, Senior Management and Employees — Board Practices — Approval of related party transactions under Israeli law — Fiduciary duties of directors and executive officers — Disclosure of personal interests of controlling shareholders and approval of certain transactions.” Under our amended articles of association, the alteration of the rights, privileges, preferences or obligations of any class of our shares requires a simple majority of the class so affected (or such other percentage of the relevant class that may be set forth in the governing documents relevant to such class), in addition to the ordinary majority vote of all classes of shares voting together as a single class at a shareholder meeting. Our amended articles of association also require that the removal of any director from office (other than our external directors) or the amendment of the provisions of our amended articles relating to our staggered board requires the vote of 65% of the voting power of our shareholders. Another exception to the simple majority vote requirement is a resolution for the voluntary winding up, or an approval of a scheme of arrangement or reorganization, of the company pursuant to Section 350 of the Israeli Companies Law, which requires the approval of holders of 75% of the voting rights represented at the meeting, in person, by proxy or by voting deed and voting on the resolution.
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Access to Corporate Records
Under the Israeli Companies Law, shareholders are provided access to: minutes of our general meetings; our shareholders register and principal shareholders register, articles of association and financial statements; and any document that we are required by law to file publicly with the Israeli Companies Registrar or the Israel Securities Authority. In addition, shareholders may request to be provided with any document related to an action or transaction requiring shareholder approval under the related party transaction provisions of the Israeli Companies Law. We may deny this request if we believe it has not been made in good faith or if such denial is necessary to protect our interest or protect a trade secret or patent.
Modification of class rights
Under the Israeli Companies Law and our amended articles of association, the rights attached to any class of share, such as voting, liquidation and dividend rights, may be amended by adoption of a resolution by the holders of a majority of the shares of that class present at a separate class meeting, or otherwise in accordance with the rights attached to such class of shares, as set forth in our amended articles of association.
Registration rights
For a discussion of registration rights we have granted to certain of our shareholders, please see “Item 7.B. Major Shareholders and Related Party Transactions — Related Party Transactions — Investors’ rights agreement.”
Acquisitions under Israeli law
Full tender offer
A person wishing to acquire shares of an Israeli public company and who would as a result hold over 90% of the target company’s issued and outstanding share capital is required by the Israeli Companies Law to make a tender offer to all of the company’s shareholders for the purchase of all of the issued and outstanding shares of the company. A person wishing to acquire shares of a public Israeli company and who would as a result hold over 90% of the issued and outstanding share capital of a certain class of shares is required to make a tender offer to all of the shareholders who hold shares of the relevant class for the purchase of all of the issued and outstanding shares of that class. If the shareholders who do not accept the offer hold less than 5% of the issued and outstanding share capital of the company or of the applicable class, and more than half of the shareholders who do not have a personal interest in the offer accept the offer, all of the shares that the acquirer offered to purchase will be transferred to the acquirer by operation of law. However, a tender offer will also be accepted if the shareholders who do not accept the offer hold less than 2% of the issued and outstanding share capital of the company or of the applicable class of shares.
Upon a successful completion of such a full tender offer, any shareholder that was an offeree in such tender offer, whether such shareholder accepted the tender offer or not, may, within six months from the date of acceptance of the tender offer, petition an Israeli court to determine whether the tender offer was for less than fair value and that the fair value should be paid as determined by the court. However, under certain conditions, the offeror may include in the terms of the tender offer that an offeree who accepted the offer will not be entitled to petition the Israeli court as described above.
If (a) the shareholders who did not respond or accept the tender offer hold at least 5% of the issued and outstanding share capital of the company or of the applicable class or the shareholders who accept the offer constitute less than a majority of the offerees that do not have a personal interest in the acceptance of the tender offer, or (b) the shareholders who did not accept the tender offer hold 2% or more of the issued and outstanding share capital of the company (or of the applicable class), the acquirer may not acquire shares of the company that will increase its holdings to more than 90% of the company’s issued and outstanding share capital or of the applicable class from shareholders who accepted the tender offer.
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Special tender offer
The Israeli Companies Law provides that an acquisition of shares of an Israeli public company must be made by means of a special tender offer if as a result of the acquisition the purchaser would become a holder of 25% or more of the voting rights in the company. This requirement does not apply if there is already another holder of at least 25% of the voting rights in the company. Similarly, the Israeli Companies Law provides that an acquisition of shares in a public company must be made by means of a special tender offer if as a result of the acquisition the purchaser would become a holder of more than 45% of the voting rights in the company, if there is no other shareholder of the company who holds more than 45% of the voting rights in the company, subject to certain exceptions.
A special tender offer must be extended to all shareholders of a company but the offeror is not required to purchase shares representing more than 5% of the voting power attached to the company’s outstanding shares, regardless of how many shares are tendered by shareholders. A special tender offer may be consummated only if (i) at least 5% of the voting power attached to 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 (excluding the purchaser, controlling shareholders, holders of 25% or more of the voting rights in the company or any person having a personal interest in the acceptance of the tender offer). If a special tender offer is accepted, then the purchaser or any person or entity controlling it or under common control with the purchaser or such controlling person or entity may not make a subsequent tender offer for the purchase of shares of the target company and may not enter into a merger with the target company for a period of one year from the date of the offer, unless the purchaser or such person or entity undertook to effect such an offer or merger in the initial special tender offer.
Merger
The Israeli Companies Law permits merger transactions if approved by each party’s board of directors and, unless certain requirements described under the Israeli Companies Law are met, by a majority vote of each party’s shares, and, in the case of the target company, a majority vote of each class of its shares, voted on the proposed merger at a shareholders meeting.
For purposes of the shareholder vote, unless a court rules otherwise, the merger will not be deemed approved if a majority of the votes of shares represented at the shareholders meeting that are held by parties other than the other party to the merger, or by any person (or group of persons acting in concert) who holds (or hold, as the case may be) 25% or more of the voting rights or the right to appoint 25% or more of the directors of the other party, vote against the merger. If, however, the merger involves a merger with a company’s own controlling shareholder or if the controlling shareholder has a personal interest in the merger, then the merger is instead subject to the same Special Majority approval that governs all extraordinary transactions with controlling shareholders (as described under “Item 6.C. Directors, Senior Management and Employees — Board Practices — Approval of related party transactions under Israeli law — Fiduciary duties of directors and executive officers — Disclosure of personal interests of controlling shareholders and approval of certain transactions”).
If the transaction would have been approved by the shareholders of a merging company but for the separate approval of each class or the exclusion of the votes of certain shareholders as provided above, a court may still approve the merger upon the request of holders of at least 25% of the voting rights of a company, if the court holds that the merger is fair and reasonable, taking into account the value of the parties to the merger and the consideration offered to the shareholders of the company.
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 the merging entities, and may further give instructions to secure the rights of creditors.
In addition, a merger may not be consummated unless at least 50 days have passed from the date on which a proposal for approval of the merger was filed by each party with the Israeli Registrar of Companies and at least 30 days have passed from the date on which the merger was approved by the shareholders of each party.
Anti-takeover measures under Israeli law
The Israeli Companies Law allow us to create and issue shares having rights different from those attached to our ordinary shares, including shares providing certain preferred rights with respect to voting, distributions or other matters and shares having preemptive rights. Currently, no preferred shares are authorized under our amended articles of association. In the future, if we do authorize, create and issue a specific class of preferred shares, such class of shares, depending on the specific rights that may be attached to it, may have the ability to frustrate or prevent a takeover or otherwise prevent our shareholders from realizing a potential premium over the market value of their ordinary shares. The authorization and designation of a class of preferred shares will require an amendment to our amended articles of association, which requires the prior approval of the holders of a majority of the voting power attaching to our issued and outstanding shares at a general meeting. The convening of the meeting, the shareholders entitled to participate and the majority vote required to be obtained at such a meeting will be subject to the requirements set forth in the Israeli Companies Law as described above in “— Voting rights.”
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Borrowing powers
Pursuant to the Israeli Companies Law and our amended articles of association, our board of directors may exercise all powers and take all actions that are not required under law or under our amended articles of association to be exercised or taken by our shareholders, including the power to borrow money for company purposes.
Changes in capital
Our articles of association enable us to increase or reduce our share capital. Any such changes are subject to the provisions of the Israeli Companies Law and must be approved by a resolution duly passed by our shareholders at a general meeting by voting on such change in the capital. In addition, transactions that have the effect of reducing capital, such as the declaration and payment of dividends in the absence of sufficient retained earnings or profits, require the approval of both our board of directors and an Israeli court.
C. Material Contracts |
For a description of the registration rights present in our Amended and Restated Investors’ Rights Agreement, please refer to “Item 7.B. Major Shareholders and Related Party Transactions—Related Party Transaction—Investors’ rights agreement.”
We entered into an underwriting agreement between us and Merrill Lynch, Pierce, Fenner & Smith Incorporated and Jefferies LLC, as representatives of the underwriters, on September 26, 2013, with respect to the ordinary shares sold in our initial public offering in the United States. We have agreed to indemnify the underwriters against certain liabilities, including liabilities under the Securities Act, and to contribute to payments the underwriters may be required to make in respect of such liabilities.
D. Exchange Controls |
In 1998, Israeli currency control regulations were liberalized significantly, so that Israeli residents generally may freely deal in foreign currency and foreign assets, and non-residents may freely deal in Israeli currency and Israeli assets. There are currently no Israeli currency control restrictions on remittances of dividends on the ordinary shares or the proceeds from the sale of the shares provided that all taxes were paid or withheld; however, legislation remains in effect pursuant to which currency controls can be imposed by administrative action at any time.
Non-residents of Israel may freely hold and trade our securities. Neither our articles of association nor the laws of the State of Israel restrict in any way the ownership or voting of ordinary shares by non-residents, except that such restrictions may exist with respect to citizens of countries which are in a state of war with Israel. Israeli residents are allowed to purchase our ordinary shares.
E. Taxation |
The following description is not intended to constitute a complete analysis of all tax consequences relating to the acquisition, ownership and disposition of our ordinary shares. You should consult your own tax advisor concerning the tax consequences of your particular situation, as well as any tax consequences that may arise under the laws of any state, local, foreign or other taxing jurisdiction.
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Israeli tax considerations and government programs
The following is a brief summary of the material Israeli tax laws applicable to us, and certain Israeli Government programs that benefit us. This section also contains a discussion of material Israeli tax consequences concerning the ownership and disposition of our ordinary shares. This summary does not discuss all the aspects of Israeli tax law that may be relevant to a particular investor in light of his or her personal investment circumstances or to some types of investors subject to special treatment under Israeli law. Examples of such investors include residents of Israel or traders in securities who are subject to special tax regimes not covered in this discussion. Because parts of this discussion are based on new tax legislation that has not yet been subject to judicial or administrative interpretation, we cannot assure you that the appropriate tax authorities or the courts will accept the views expressed in this discussion. The discussion below is subject to change, including due to amendments under Israeli law or changes to the applicable judicial or administrative interpretations of Israeli law, which change could affect the tax consequences described below.
General corporate tax structure in Israel
Israeli companies are generally subject to corporate tax, currently at the rate of 26.5% of a company’s taxable income. However, the effective tax rate payable by a company that derives income from an Approved Enterprise, a Benefited Enterprise or a Preferred Enterprise (as discussed below) may be considerably less. Capital gains derived by an Israeli company are subject to tax at the prevailing corporate tax rate.
Starting in the year ended December 31, 2014, the Company elected to compute its taxable income in accordance with Income Tax Regulations (Rules for Accounting for Foreign Investors Companies and Certain Partnerships and Setting their Taxable Income), 1986. Accordingly, the taxable income or loss is calculated in dollars. Applying these regulations reduces the effect of dollar-NIS exchange rate on the Company’s Israeli taxable income.
Law for the Encouragement of Industry (Taxes), 5729-1969
The Law for the Encouragement of Industry (Taxes), 5729-1969, generally referred to as the Industry Encouragement Law, provides several tax benefits for “Industrial Companies.”
The Industry Encouragement Law defines an “Industrial Company” as a company resident in Israel, which was incorporated in Israel and of which 90% or more of its income in any tax year, other than income from defense loans, is derived from an “Industrial Enterprise” owned by it and located in Israel. An “Industrial Enterprise” is defined as an enterprise whose principal activity in a given tax year is industrial production.
The following corporate tax benefits, among others, are available to Industrial Companies:
• | amortization over an eight-year period of the cost of purchased know-how and patents and rights to use a patent and know-how which are used for the development or advancement of the Industrial Enterprise; |
• | under limited conditions, an election to file consolidated tax returns with related Israeli Industrial Companies; and |
• | expenses related to a public offering are deductible in equal amounts over three years. |
We currently qualify as an Industrial Company within the meaning of the Industry Encouragement Law. There can be no assurance that we will continue to qualify as an Industrial Company or that the benefits described above will be available in the future.
Law for the Encouragement of Capital Investments, 5719-1959
The Law for the Encouragement of Capital Investments, 5719-1959, generally referred to as the Investment Law, provides certain incentives for capital investments in production facilities (or other eligible assets) by “Industrial Enterprises” (as defined under the Investment Law).
The Investment Law was significantly amended effective April 1, 2005, or the 2005 Amendment, and further amended as of January 1, 2011, or (the 2011 Amendment”. Pursuant to the 2005 Amendment, tax benefits granted in accordance with the provisions of the Investment Law prior to its revision by the 2005 Amendment remain in force but any benefits granted subsequently are subject to the provisions of the 2005 Amendment. Similarly, the 2011 Amendment introduced new benefits to replace those granted in accordance with the provisions of the Investment Law in effect prior to the 2011 Amendment. However, companies entitled to benefits under the Investment Law as in effect prior to January 1, 2011 were entitled to choose to continue to enjoy such benefits, provided that certain conditions are met, or elect instead, irrevocably, to forego such benefits and have the benefits of the 2011 Amendment apply. We have examined the possible effect, if any, of these provisions of the 2011 Amendment on our financial statements and have decided, at this time, not to opt to apply the new benefits under the 2011 Amendment.
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Tax benefits prior to the 2005 Amendment
An investment program that is implemented in accordance with the provisions of the Investment Law prior to the 2005 Amendment, referred to as an “Approved Enterprise,” is entitled to certain benefits. A company that wished to receive benefits as an Approved Enterprise must have received approval from the Investment Center of the Israeli Ministry of Economy (formerly the Ministry of Industry, Trade and Labor), or the Investment Center. Each certificate of approval for an Approved Enterprise relates to a specific investment program in the Approved Enterprise, delineated both by the financial scope of the investment and by the physical characteristics of the facility or the asset.
In general, an Approved Enterprise is entitled to receive a grant from the Government of Israel or an alternative package of tax benefits, known as the alternative benefits track. The tax benefits from any certificate of approval relate only to taxable income attributable to the specific Approved Enterprise. Income derived from activity that is not integral to the activity of the Approved Enterprise does not enjoy tax benefits.
In addition, a company that has an Approved Enterprise program is eligible for further tax benefits if it qualifies as a Foreign Investors’ Company (“FIC”), which is a company with a level of foreign investment, as defined in the Investment Law, of more than 25%. The level of foreign investment is measured as the percentage of rights in the company (in terms of shares, rights to profits, voting and appointment of directors), and of combined share and loan capital, that are owned, directly or indirectly, by persons who are not residents of Israel. The determination as to whether a company qualifies as an FIC is made on an annual basis.
If a company elects the alternative benefits track and distributes a dividend out of income derived by its Approved Enterprise during the tax exemption period it will be subject to corporate tax in respect of the amount of the distributed dividend (grossed-up to reflect the pre-tax income that it would have had to earn in order to distribute the dividend) at the corporate tax rate which would have been applicable without the benefits under the alternative benefits track. In addition, dividends paid out of income attributed to an Approved Enterprise are generally subject to withholding tax at source at the rate of 15% or such lower rate as may be provided in an applicable tax treaty.
The Investment Law also provides that an Approved Enterprise is entitled to accelerated depreciation on its property and equipment that are included in an Approved Enterprise program during the first five years in which the equipment is used.
The benefits available to an Approved Enterprise are subject to the fulfillment of conditions stipulated in the Investment Law and its regulations and the criteria in the specific certificate of approval. If a company does not meet these conditions, it would be required to refund the amount of tax benefits, as adjusted by the Israeli consumer price index, and interest.
We currently have Approved Enterprise programs under the Investment Law, which, we believe, entitle us to certain tax benefits. The tax benefit period for these programs has not yet commenced. We have elected the alternative benefits program which provides for the waiver of grants in return for tax exemptions. Accordingly, taxable income from our Approved Enterprise programs (once generated) will be tax exempt for a period of ten years commencing with the year we will first earn such taxable income.
Tax benefits subsequent to the 2005 Amendment
The 2005 Amendment applies to new investment programs commencing after 2004, but does not apply to investment programs approved prior to April 1, 2005. The 2005 Amendment provides that terms and benefits included in any certificate of approval that was granted before the 2005 Amendment became effective (April 1, 2005) will remain subject to the provisions of the Investment Law as in effect on the date of such approval. Pursuant to the 2005 Amendment, the Investment Center will continue to grant Approved Enterprise status to qualifying investments. The 2005 Amendment, however, limits the scope of enterprises that may be approved by the Investment Center by setting criteria for the approval of a facility as an Approved Enterprise, such as provisions generally requiring that at least 25% of the Approved Enterprise’s income be derived from exports.
The 2005 Amendment provides that a certificate of approval from the Investment Center will only be necessary for receiving cash grants. As a result, it was no longer necessary for a company to obtain an Approved Enterprise certificate of approval in order to receive the tax benefits previously available under the alternative benefits track. Rather, a company may claim the tax benefits offered by the Investment Law directly in its tax returns, provided that its facilities meet the criteria for tax benefits set forth in the 2005 Amendment. In order to receive the tax benefits, the 2005 Amendment states that a company must make an investment which meets all of the conditions, including exceeding a minimum investment amount specified in the Investment Law. Such investment allows a company to receive “Benefited Enterprise” status, and may be made over a period of no more than three years from the end of the year in which the company chose to have the tax benefits apply to its Benefited Enterprise.
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The extent of the tax benefits available under the 2005 Amendment to qualifying income of a Benefited Enterprise depends on, among other things, the geographic location in Israel of the Benefited Enterprise. The location will also determine the period for which tax benefits are available. Such tax benefits include an exemption from corporate tax on undistributed income generated by the Benefited Enterprise for a period of between two to ten years, depending on the geographic location of the Benefited Enterprise in Israel, and a reduced corporate tax rate of between 10% to 25% for the remainder of the benefits period, depending on the level of foreign investment in the company in each year. The benefits period is limited to 12 or 14 years from the year the company first chose to have the tax benefits apply, depending on the location of the company.
A company qualifying for tax benefits under the 2005 Amendment which pays a dividend out of income derived by its Benefited Enterprise during the tax exemption period will be subject to corporate tax in respect of the amount of the dividend (grossed-up to reflect the pre-tax income that it would have had to earn in order to distribute the dividend) at the corporate tax rate which would have otherwise been applicable. Dividends paid out of income attributed to a Benefited Enterprise are generally subject to withholding tax at source at the rate of 15% or such lower rate as may be provided in an applicable tax treaty.
The benefits available to a Benefited Enterprise are subject to the fulfillment of conditions stipulated in the Investment Law and its regulations. If a company does not meet these conditions, it may be required to refund the amount of tax benefits, as adjusted by the Israeli consumer price index, and interest, or other monetary penalties.
We currently have Benefited Enterprise programs under the Investments Law, which, we believe, entitle us to certain tax benefits. The tax benefit period for these programs has not yet commenced but is expected to end in 2022. During the benefits period, the majority of the taxable income from our Benefited Enterprise programs (once generated) will be tax exempt for a period of ten years commencing with the year we will first earn taxable income relating to such enterprises, subject to the 12 or 14 year limitation described above.
Tax benefits under the 2011 Amendment
The 2011 Amendment canceled the availability of the benefits granted to companies under the Investment Law prior to 2011 and, instead, introduced new benefits for income generated by a “Preferred Company” through its “Preferred Enterprise” (as such terms are defined in the Investment Law) as of January 1, 2011. The definition of a Preferred Company includes a company incorporated in Israel that is not wholly-owned by a governmental entity, and that has, among other things, Preferred Enterprise status and is controlled and managed from Israel. Pursuant to the 2011 Amendment, a Preferred Company is entitled to a reduced corporate tax rate of 15% with respect to its income derived by its Preferred Enterprise in 2011 and 2012, unless the Preferred Enterprise is located in a specified development zone, in which case the rate is 10%. Under the 2011 Amendment, such corporate tax rates were reduced from 15% and 10%, respectively, to 12.5% and 7%, respectively, in 2013. Such corporate tax rates were increased to 16% and 9%, respectively, in 2014 and thereafter. Our facilities are located in a specified development zone.
Dividends paid out of income attributed to a Preferred Enterprise are generally subject to withholding tax at source at the rate of 20% or such lower rate as may be provided in an applicable tax treaty. However, if such dividends are paid to an Israeli company, no tax is required to be withheld (although, if such dividends are subsequently distributed to individuals or a non-Israeli company, withholding tax at a rate of 20% or such lower rate as may be provided in an applicable tax treaty will apply).
The 2011 Amendment also provided transitional provisions to address companies already enjoying existing tax benefits under the Investment Law. These transitional provisions provide, among other things, that unless an irrevocable request is made to apply the provisions of the Investment Law as amended in 2011 with respect to income to be derived as of January 1, 2011: (i) the terms and benefits included in any certificate of approval that was granted to an Approved Enterprise which chose to receive grants before the 2011 Amendment became effective will remain subject to the provisions of the Investment Law as in effect on the date of such approval, and subject to certain other conditions; (ii) terms and benefits included in any certificate of approval that was granted to an Approved Enterprise which had participated in an alternative benefits track before the 2011 Amendment became effective will remain subject to the provisions of the Investment Law as in effect on the date of such approval, provided that certain conditions are met; and (iii) a Benefited Enterprise can elect to continue to benefit from the benefits provided to it before the 2011 Amendment came into effect, provided that certain conditions are met.
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The termination or substantial reduction of any of the benefits available under the Investment Law could materially increase our tax liabilities.
We have examined the possible effect, if any, of the provisions of the 2011 Amendment on our financial statements and have decided, at this time, not to apply the new benefits under the 2011 Amendment.
Taxation of our shareholders
Capital Gains Taxes Applicable to Non-Israeli Resident Shareholders . A non-Israeli resident who derives capital gains from the sale of shares in an Israeli resident company that were purchased after the company was listed for trading on a stock exchange outside of Israel will be exempt from Israeli tax so long as the shares were not held through a permanent establishment that the non-resident maintains in Israel. However, non-Israeli corporations will not be entitled to the foregoing 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. Such exemption is not applicable to a person whose gains from selling or otherwise disposing of the shares are deemed to be business income.
Additionally, a sale of securities by a non-Israeli resident may be exempt from Israeli capital gains tax under the provisions of an applicable tax treaty. For example, under the United States-Israel Tax Treaty, the disposition of shares by a shareholder who (i) is a U.S. resident (for purposes of the treaty); (ii) holds the shares as a capital asset; and (iii) is entitled to claim the benefits afforded to such person by the treaty, is generally exempt from Israeli capital gains tax. Such exemption will not apply if: (i) the capital gain arising from the disposition can be attributed to a permanent establishment in Israel; (ii) the shareholder holds, directly or indirectly, shares representing 10% or more of the voting capital during any part of the 12-month period preceding the disposition, subject to certain conditions; or (iii) such U.S. resident is an individual and was present in Israel for 183 days or more during the relevant taxable year. In such case, the sale, exchange or disposition of our ordinary shares would be subject to Israeli tax, to the extent applicable; however, under the United States-Israel Tax Treaty, the taxpayer would be permitted to claim a credit for such taxes against the U.S. federal income tax imposed with respect to such sale, exchange or disposition, subject to the limitations under U.S. law applicable to foreign tax credits. The United States-Israel Tax Treaty does not relate to U.S. state or local taxes.
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 source. Shareholders may be required to demonstrate that they are exempt from tax on their capital gains in order to avoid withholding at source at the time of sale. Specifically, in transactions involving a sale of all of the shares of an Israeli resident company, in the form of a merger or otherwise, the Israel Tax Authority may require from shareholders who are not liable for Israeli tax to sign declarations in forms specified by this authority or obtain a specific exemption from the Israel Tax Authority to confirm their status as non-Israeli resident, and, in the absence of such declarations or exemptions, may require the purchaser of the shares to withhold taxes at source.
Taxation of Non-Israeli Shareholders on Receipt of Dividends. Non-Israeli residents are generally subject to Israeli withholding tax on the receipt of dividends paid on our ordinary shares at the rate of 25%, unless relief is provided in a treaty between Israel and the shareholder’s country of residence (subject to the receipt of a valid certificate from the Israeli Tax Authority allowing for a reduced tax rate). With respect to a person who is a “substantial shareholder” at the time of receiving the dividend or on any time during the preceding twelve months, the applicable withholding tax rate is 30%, unless such “substantial shareholder” holds such shares through a nominee company, in which case the rate is 25%. A “substantial shareholder” is generally a person who alone or together with such person’s relative or another person who collaborates with such person on a permanent basis, holds, directly or indirectly, at least 10% of any of the “means of control” of the corporation. “Means of control” generally include the right to vote, receive profits, nominate a director or an executive officer, receive assets upon liquidation, or order someone who holds any of the aforesaid rights how to act, regardless of the source of such right. Under the United States-Israel Tax Treaty, the maximum rate of tax withheld at source in Israel on dividends paid to a holder of our ordinary shares who is a U.S. resident (for purposes of the United States-Israel Tax Treaty) is 25%. A distribution of dividends to non-Israeli residents is subject to withholding tax at source at a rate of 15% if the dividend is distributed from income attributed to an Approved Enterprise or a Benefited Enterprise and 20% if the dividend is distributed from income attributed to a Preferred Enterprise, unless a reduced tax rate is provided under an applicable tax treaty. We cannot assure you that in the event we declare a dividend we will designate the income out of which the dividend is paid in a manner that will reduce shareholders’ tax liability.
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If the dividend is attributable partly to income derived from an Approved Enterprise, Benefited Enterprise or Preferred Enterprise, and partly to other sources of income, the withholding rate will be a blended rate reflecting the relative portions of the two types of income. U.S. residents who are subject to Israeli withholding tax on a dividend may be entitled to a credit or deduction for Untied States federal income tax purposes in the amount of the taxes withheld, subject to detailed rules contained in U.S. tax legislation.
Excess Tax
Individuals who are subject to tax in Israel are also subject to an additional tax at a rate of 2% on annual income exceeding NIS 811,560 for 2014, which amount is linked to the annual change in the Israeli consumer price index, including, but not limited to, dividends, interest and capital gain, subject to the provisions of an applicable tax treaty.
Estate and gift tax
Israeli law presently does not impose estate or gift taxes.
U.S. federal income tax consequences
The following is a description of the material U.S. federal income tax consequences relating to the acquisition, ownership and disposition of our ordinary shares. This description addresses only the U.S. federal income tax consequences to holders that are initial purchasers of our ordinary shares and that will hold such ordinary shares as capital assets. This description does not address tax considerations applicable to holders that may be subject to special tax rules, including, without limitation:
• | banks, financial institutions or insurance companies; |
• | real estate investment trusts, regulated investment companies or grantor trusts; |
• | dealers or traders in securities, commodities or currencies; |
• | tax exempt entities or organizations, including an “individual retirement account” or “Roth IRA” as defined in Section 408 or 408A of the Code (as defined below), respectively; |
• | certain former citizens or long-term residents of the United States; |
• | persons that received our shares as compensation for the performance of services; |
• | persons that will hold our shares as part of a “hedging,” “integrated” or “conversion” transaction or as a position in a “straddle” for U.S. federal income tax purposes; |
• | partnerships (including entities classified as partnerships for U.S. federal income tax purposes) or other pass-through entities, or holders that will hold our shares through such an entity; |
• | S corporations; |
• | holders that acquire ordinary shares as a result of holding or owning our preferred shares; |
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• | U.S. Holders (as defined below) whose “functional currency” is not the U.S. Dollar; or |
• | holders that own directly, indirectly or through attribution 10% or more of the voting power or value of our shares. |
Moreover, this description does not address the U.S. federal estate, gift, or alternative minimum tax consequences, or any U.S. state, local or non-U.S. tax consequences of the acquisition, ownership and disposition of our ordinary shares.
This description is based on the U.S. Internal Revenue Code of 1986, as amended, or the Code, existing, proposed and temporary U.S. Treasury Regulations promulgated thereunder and administrative and judicial interpretations thereof, in each case as in effect and available on the date hereof. All the foregoing is subject to change, which change could apply retroactively and could affect the tax consequences described below. There can be no assurances that the U.S. Internal Revenue Service, or IRS, will not take a different position concerning the tax consequences of the acquisition, ownership and disposition of our ordinary shares or that such a position would not be sustained. Holders should consult their own tax advisors concerning the U.S. federal, state, local and foreign tax consequences of acquiring, owning and disposing of our ordinary shares in their particular circumstances.
For purposes of this description, the term “U.S. Holder” means a beneficial owner of our ordinary shares that, for U.S. federal income tax purposes, is (i) a citizen or resident of the United States; (ii) a corporation (or entity treated as a corporation for U.S. federal income tax purposes) created or organized in or under the laws of the United States, any state thereof, or the District of Columbia; (iii) an estate the income of which is subject to U.S. federal income tax regardless of its source; or (iv) a trust (x) with respect to which a court within the United States is able to exercise primary supervision over its administration and one or more U.S. persons have the authority to control all of its substantial decisions or (y) that has elected to be treated as a domestic trust for U.S. federal income tax purposes.
A “Non-U.S. Holder” is a beneficial owner of our ordinary shares that is neither a U.S. Holder nor a partnership (or other entity treated as a partnership for U.S. federal income tax purposes).
If a partnership (or any other entity treated as a partnership for U.S. federal income tax purposes) holds our ordinary shares, the U.S. federal income tax consequences relating to an investment in our ordinary shares will depend in part upon the status of the partner and the activities of the partnership. Such a partner or partnership should consult its tax advisor regarding the U.S. federal income tax consequences of acquiring, owning and disposing of our ordinary shares in its particular circumstances.
Unless otherwise indicated, this discussion assumes that the Company is not, and will not become, a “passive foreign investment company, or a PFIC, for U.S. federal income tax purposes. See “— Passive foreign investment company consequences” below.
Persons considering an investment in our ordinary shares should consult their own tax advisors as to the particular tax consequences applicable to them relating to the acquisition, ownership and disposition of our ordinary shares, including the applicability of U.S. federal, state and local tax laws and non-U.S. tax laws.
Distributions
If you are a U.S. Holder, the gross amount of any distribution made to you with respect to our ordinary shares before reduction for any Israeli taxes withheld therefrom, other than certain distributions, if any, of our ordinary shares distributed pro rata to all our shareholders, generally will be includible in your income as dividend income to the extent such distribution is paid out of our current or accumulated earnings and profits as determined under U.S. federal income tax principles. We do not expect to maintain calculations of our earnings and profits under U.S. federal income tax principles. Therefore, U.S. Holders should expect that the entire amount of any distribution generally will be reported as dividend income. Non-corporate U.S. Holders may qualify for the lower rates of taxation with respect to dividends on ordinary shares applicable to long-term capital gains (i.e., gains from the sale of capital assets held for more than one year), provided that certain conditions are met, including certain holding period requirements and the absence of certain risk reduction transactions. However, such dividends will not be eligible for the dividends received deduction generally allowed to corporate U.S. Holders. To the extent that the amount of any distribution by us exceeds our current and accumulated earnings and profits as determined under U.S. federal income tax principles, it will be treated first as a tax-free return of your adjusted tax basis in our ordinary shares and thereafter as either long-term or short-term capital gain depending upon whether the U.S. Holder has held our ordinary shares for more than one year as of the time such distribution is received.
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If you are a U.S. Holder, dividends paid to you with respect to our ordinary shares will be foreign source income, which may be relevant in calculating your foreign tax credit limitation. Subject to certain conditions and limitations, Israeli tax withheld on dividends may be deducted from your taxable income or credited against your U.S. federal income tax liability. The limitation on foreign taxes eligible for credit is calculated separately with respect to specific classes of income. For this purpose, dividends that we distribute generally should constitute “passive category income,” or, in the case of certain U.S. Holders, “general category income.” A foreign tax credit for foreign taxes imposed on distributions may be denied if you do not satisfy certain minimum holding period requirements. The rules relating to the determination of the foreign tax credit are complex, and you should consult your tax advisor to determine whether and to what extent you will be entitled to this credit.
The amount of a distribution paid to a U.S. Holder in a foreign currency will be the dollar value of the foreign currency calculated by reference to the spot exchange rate on the day the U.S. Holder receives the distribution, regardless of whether the foreign currency is converted into U.S. dollars at that time. Any foreign currency gain or loss a U.S. Holder realizes on a subsequent conversion of foreign currency into U.S. dollars will be U.S. source ordinary income or loss. If dividends received in foreign currency are converted into U.S. dollars on the day they are received, a U.S. Holder generally should not be required to recognize foreign currency gain or loss in respect of the dividend.
Subject to the discussion below under “—Backup Withholding Tax and Information Reporting Requirements,” if you are a Non-U.S. Holder, you generally will not be subject to U.S. federal income (or withholding) tax on dividends received by you on your ordinary shares, unless you conduct a trade or business in the United States and such income is effectively connected with that trade or business (or, if required by an applicable income tax treaty, the dividends are attributable to a permanent establishment or fixed base that such holder maintains in the United States).
Sale, exchange or other disposition of our ordinary shares
Subject to the discussion below under “— Passive foreign investment company consequences,” if you are a U.S. Holder, you generally will recognize gain or loss on the sale, exchange or other disposition of our ordinary shares equal to the difference between the amount realized on such sale, exchange or other disposition and your adjusted tax basis in our ordinary shares, and such gain or loss will be capital gain or loss. The adjusted tax basis in an ordinary share generally will be equal to the cost of such ordinary share. If you are a non-corporate U.S. Holder, capital gain from the sale, exchange or other disposition of ordinary shares is generally eligible for a preferential rate of taxation applicable to capital gains, if your holding period determined at the time of such sale, exchange or other disposition for such ordinary shares exceeds one year (i.e., such gain is long-term capital gain). The deductibility of capital losses for U.S. federal income tax purposes is subject to limitations under the Code. Any such gain or loss that a U.S. Holder recognizes generally will be treated as U.S. source income or loss for foreign tax credit limitation purposes.
For a cash basis taxpayer, units of foreign currency paid or received are translated into U.S. dollars at the spot rate on the settlement date of the purchase or sale. In that case, no foreign currency exchange gain or loss will result from currency fluctuations between the trade date and the settlement date of such a purchase or sale. An accrual basis taxpayer, however, may elect the same treatment required of cash basis taxpayers with respect to purchases and sales of our ordinary shares that are traded on an established securities market, provided the election is applied consistently from year to year. Such election may not be changed without the consent of the IRS. For an accrual basis taxpayer who does not make such election, units of foreign currency paid or received are translated into U.S. dollars at the spot rate on the trade date of the purchase or sale. Such an accrual basis taxpayer may recognize exchange gain or loss based on currency fluctuations between the trade date and the settlement date. Any foreign currency gain or loss a U.S. Holder realizes will be U.S. source ordinary income or loss.
The determination of whether our ordinary shares are traded on an established securities market is not entirely clear under current U.S. federal income tax law.
Subject to the discussion below under “Backup Withholding Tax and Information Reporting Requirements,” if you are a Non-U.S. Holder, you generally will not be subject to U.S. federal income or withholding tax on any gain realized on the sale or exchange of such ordinary shares unless:
• | such gain is effectively connected with your conduct of a trade or business in the United States (or, if required by an applicable income tax treaty, the gain is attributable to a permanent establishment or fixed base that you maintain in the United States); or |
• | you are an individual and have been present in the United States for 183 days or more in the taxable year of such sale or exchange and certain other conditions are met. |
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Passive foreign investment company consequences
If we were to be classified as a PFIC in any taxable year, a U.S. Holder would be subject to special rules generally intended to reduce or eliminate any benefits from the deferral of U.S. federal income tax that a U.S. Holder could derive from investing in a non-U.S. company that does not distribute all of its earnings on a current basis.
A non-U.S. corporation will be classified as a PFIC for U.S. federal income tax purposes in any taxable year in which, after applying certain look-through rules with respect to the income and assets of subsidiaries, either (i) at least 75% of its gross income is “passive income” or (ii) at least 50% of the average quarterly value of its total gross assets (which would generally be measured by fair market value of the assets, and for which purpose the total value of our assets may be determined in part by the market value of our ordinary shares, which is subject to change) is attributable to assets that produce “passive income” or are held for the production of passive income.
Passive income for this purpose generally includes dividends, interest, royalties, rents, gains from commodities and securities transactions, the excess of gains over losses from the disposition of assets which produce passive income, and includes amounts derived by reason of the temporary investment of funds raised in offerings of our ordinary shares. If a non-U.S. corporation owns at least 25% by value of the stock of another corporation, the non-U.S. corporation is treated for purposes of the PFIC tests as owning its proportionate share of the assets of the other corporation and as receiving directly its proportionate share of the other corporation’s income. If we are classified as a PFIC in any year with respect to which a U.S. Holder owns our ordinary shares, we will continue to be treated as a PFIC with respect to such U.S. Holder in all succeeding years during which the U.S. Holder owns our ordinary shares, regardless of whether we continue to meet the tests described above.
Based on the composition of our income and the composition and estimated fair market values of our assets, we do not believe that we were a PFIC for the taxable year ended December 31, 2014 and based on our future projections, we do not expect to be a PFIC for the taxable year ended December 31, 2015. There can be no assurance that we will not be considered a PFIC for any taxable year. PFIC status is determined as of the end of the taxable year and depends on a number of factors, including the value of a corporation’s assets and the amount and type of its gross income. Furthermore, because the value of our gross assets is likely to be determined in large part by reference to our market capitalization, a decline in the value of our ordinary shares may result in our becoming a PFIC. Even though we have determined that we were not a PFIC for the year ended December 31, 2014, there can be no assurance that the IRS will agree with our conclusion.
If we were a PFIC, and you are a U.S. Holder, then unless you make one of the elections described below, a special tax regime will apply to both (a) any “excess distribution” by us to you (generally, your ratable portion of distributions in any year which are greater than 125% of the average annual distribution received by you in the shorter of the three preceding years or your holding period for our ordinary shares) and (b) any gain realized on the sale or other disposition of the ordinary shares. Under this regime, any excess distribution and realized gain will be treated as ordinary income and will be subject to tax as if (a) the excess distribution or gain had been realized ratably over your holding period, (b) the amount deemed realized in each year had been subject to tax in each year of that holding period at the highest marginal rate for such year (other than income allocated to the current period or any taxable period before we became a PFIC, which would be subject to tax at the U.S. Holder’s regular ordinary income rate for the current year and would not be subject to the interest charge discussed below), and (c) the interest charge generally applicable to underpayments of tax had been imposed on the taxes deemed to have been payable in those years. In addition, dividend distributions made to you will not qualify for the lower rates of taxation applicable to long-term capital gains discussed above under “—Distributions.”
Certain elections exist that may alleviate some of the adverse consequences of PFIC status and would result in an alternative treatment (such as mark-to-market treatment) of our ordinary shares. If a U.S. Holder makes the mark-to-market election, the U.S. Holder generally will recognize as ordinary income any excess of the fair market value of the ordinary shares at the end of each taxable year over their adjusted tax basis, and will recognize an ordinary loss in respect of any excess of the adjusted tax basis of the ordinary shares over their fair market value at the end of the taxable year (but only to the extent of the net amount of income previously included as a result of the mark-to-market election). If a U.S. Holder makes the election, the U.S. Holder’s tax basis in the ordinary shares will be adjusted to reflect these income or loss amounts. Any gain recognized on the sale or other disposition of ordinary shares in a year when we are a PFIC will be treated as ordinary income and any loss will be treated as an ordinary loss (but only to the extent of the net amount of income previously included as a result of the mark-to-market election). The mark-to-market election is available only if we are a PFIC and our ordinary shares are “regularly traded” on a “qualified exchange.” Our ordinary shares will be treated as “regularly traded” in any calendar year in which more than a de minimis quantity of the ordinary shares are traded on a qualified exchange on at least 15 days during each calendar quarter. The NASDAQ Global Select Market is a qualified exchange for this purpose and, consequently, if the ordinary shares are regularly traded, the mark-to-market election will be available to a U.S. Holder.
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We do not intend to provide the information necessary for U.S. Holders to make qualified electing fund elections if we are classified as a PFIC. U.S. Holders should consult their tax advisors to determine whether any of these elections would be available and if so, what the consequences of the alternative treatments would be in their particular circumstances.
If we are determined to be a PFIC, the general tax treatment for U.S. Holders described in this section would apply to indirect distributions and gains deemed to be realized by U.S. Holders in respect of any of our subsidiaries that also may be determined to be PFICs.
If a U.S. Holder owns ordinary shares during any year in which we are a PFIC and the U.S. Holder recognizes gain on a disposition of our ordinary shares or receives distributions with respect to our ordinary shares, the U.S. Holder generally will be required to file an IRS Form 8621 (Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund) with respect to the company, generally with the U.S. Holder’s federal income tax return for that year. If our company were a PFIC for a given taxable year, then you should consult your tax advisor concerning your annual filing requirements.
The U.S. federal income tax rules relating to PFICs are complex. Prospective U.S. investors are urged to consult their own tax advisors with respect to the acquisition, ownership and disposition of our ordinary shares, the consequences to them of an investment in a PFIC, any elections available with respect to our ordinary shares and the IRS information reporting obligations with respect to the acquisition, ownership and disposition of our ordinary shares.
Medicare tax
Certain U.S. Holders that are individuals, estates or trusts are subject to a 3.8% tax on all or a portion of their “net investment income,” which may include all or a portion of their dividend income and net gains from the disposition of ordinary shares. Each U.S. Holder that is an individual, estate or trust is urged to consult its tax advisors regarding the applicability of the Medicare tax to its income and gains in respect of its investment in our ordinary shares.
Certain reporting requirements with respect to payments to foreign corporations
U.S. Holders paying more than U.S. $100,000 for our ordinary shares generally will be required to file IRS Form 926 reporting the payment for our ordinary shares to any foreign corporation. Substantial penalties may be imposed upon a U.S. Holder that fails to comply. Each U.S. Holder should consult its own tax advisor as to the possible obligation to file IRS Form 926.
Backup withholding tax and information reporting requirements
U.S. backup withholding tax and information reporting requirements may apply to certain payments to certain holders of stock. Information reporting generally will apply to payments of dividends on, and to proceeds from the sale or redemption of, our ordinary shares made within the United States, or by a U.S. payor or U.S. middleman, to a holder of our ordinary shares, other than an exempt recipient (including a payee that is not a U.S. person that provides an appropriate certification and certain other persons). A payor will be required to withhold backup withholding tax from any payments of dividends on, or the proceeds from the sale or redemption of, ordinary shares within the United States, or by a U.S. payor or U.S. middleman, to a holder, other than an exempt recipient, if such holder fails to furnish its correct taxpayer identification number or otherwise fails to comply with, or establish an exemption from, such backup withholding tax requirements. Any amounts withheld under the backup withholding rules will be allowed as a credit against the beneficial owner’s U.S. federal income tax liability, if any, and any excess amounts withheld under the backup withholding rules may be refunded, provided that the required information is timely furnished to the IRS.
Foreign asset reporting
Certain U.S. Holders who are individuals are required to report information relating to an interest in our ordinary shares, subject to certain exceptions (including an exception for shares held in accounts maintained by financial institutions) by filing IRS Form 8938 (Statement of Specified Foreign Financial Assets) with their federal income tax return. U.S. Holders are urged to consult their tax advisors regarding their information reporting obligations, if any, with respect to their ownership and disposition of our ordinary shares.
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THE DISCUSSION ABOVE IS A GENERAL SUMMARY. IT DOES NOT COVER ALL TAX MATTERS THAT MAY BE OF IMPORTANCE TO A PROSPECTIVE INVESTOR. EACH PROSPECTIVE INVESTOR IS URGED TO CONSULT ITS OWN TAX ADVISOR ABOUT THE TAX CONSEQUENCES TO IT OF AN INVESTMENT IN ORDINARY SHARES IN LIGHT OF THE INVESTOR’S OWN CIRCUMSTANCES.
F. Dividends and Paying Agents |
Not applicable.
G. Statement by Experts |
Not applicable.
H. Documents on Display |
We are currently subject to the information and periodic reporting requirements of the Exchange Act applicable to foreign private issuers and fulfill the obligations of those requirements by filing reports with the SEC. We file periodic reports and other information with the SEC through its electronic data gathering, analysis and retrieval (EDGAR) system.
As a foreign private issuer, we are exempt from the rules under the Exchange Act relating to 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. However, we are required to file with the SEC, within 120 days after the end of each subsequent fiscal year, an annual report on Form 20-F containing financial statements which will be examined and reported on, with an opinion expressed, by an independent public accounting firm. We also intend to furnish with the SEC reports on Form 6-K containing quarterly unaudited financial information.
Our securities filings, including this annual report and the exhibits thereto, are available for inspection and copying at the public reference facilities of the SEC located at Room 1580, 100 F Street, N.E., Washington, D.C. 20549. Additionally, you may obtain copies of the documents at prescribed rates by writing to the Public Reference Section of the SEC at 100 F Street, N.E., Washington, D.C. 20549. Please call the SEC at 1-800-SEC-0330 for further information on the public reference room. The SEC maintains a website at http://www.sec.gov from which certain filings may be accessed. Our filings with the SEC are also available to the public through this website at http://www.sec.gov.
As permitted under NASDAQ Stock Market Rule 5250(d)(1)©, we post our annual reports filed with the SEC on our website at http://ir.enzymotec.com. We will furnish hard copies of such reports to our shareholders free of charge upon written request. The information contained on our website is not part of this or any other report filed with or furnished to the SEC.
I. Subsidiary Information |
Not applicable.
ITEM 11: Quantitative and Qualitative Disclosures About Market Risk
Quantitative and qualitative disclosure about market risk
Market risk is the risk of loss related to changes in market prices, including interest rates and foreign exchange rates, of financial instruments that may adversely impact our consolidated financial position, results of operations or cash flows.
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Foreign currency exchange risk.
The U.S. dollar is our functional and reporting currency, with net revenues denominated in U.S. dollars accounting for 75% and 73% of our net revenues in 2013 and 2014. While we incur expenses primarily in U.S. dollars, a significant portion of expenses are denominated in shekels, accounting for 34% and 38% of our expenses in 2013 and 2014, respectively. We also have expenses, although to a much lesser extent, in other non- dollar currencies, in particular the euro. This exposes us to risk associated with exchange rate fluctuations vis-à-vis the U.S. dollar. Furthermore, we anticipate that a material portion of our expenses, principally of salaries and related personnel expenses, will continue to be denominated in shekels.
To the extent the U.S. dollar weakens against the shekel, we will experience a negative impact on our profit margins. A devaluation of the shekel in relation to the U.S. dollar has the effect of reducing the U.S. dollar amount of our expenses that are payable in shekels, unless those expenses or payables are linked to the U.S. dollar. Conversely, any increase in the value of the shekel in relation to the U.S. dollar has the effect of increasing the U.S. dollar value of our unlinked shekel expenses, which would have a negative impact on our profit margins. In 2014, the value of the shekel depreciated in relation to the U.S. dollar by approximately 12.0%, the effect of which was offset by a negative inflation of Israel, at a rate of approximately 0.2%. In 2013, the value of the shekel appreciated in relation to the U.S. dollar by approximately 7.0%, the effect of which was compounded by inflation in Israel, at the rate of approximately 1.8%.
In Europe, our net revenues are received primarily in euros, accounting for approximately 22% and 27% of our total net revenues in 2013 and 2014, respectively, and such net revenues exceed our expenses incurred in euros. Accordingly, if the euro appreciates relative to the U.S. dollar, the U.S. dollar value of our sales is positively impacted, as was the case in 2012 and 2013, when the euro appreciated by 2.0% and 4.5%, respectively, in relation to the U.S. dollar. However, if the euro depreciates relative to the U.S. dollar, the U.S. dollar value of our sales is negatively impacted, as was the case in 2014, when the euro depreciated by 11.8%.
Because exchange rates between the U.S. dollar and the shekel (as well as between the U.S. dollar and other currencies) fluctuate continuously, such fluctuations have an impact on our results of operations and period-to-period comparisons of our results. The effects of foreign currency re-measurements are reported in our consolidated financial statements of operations. We engage in currency hedging activities in order to reduce some of this currency exposure. These measures, however, may not adequately protect us from material adverse effects due to the impact of foreign currency fluctuations.
The following table presents information about the changes in the exchange rates of the shekel against the U.S. dollar and changes in the exchange rates of the euro against the U.S. dollar:
Change in Average Exchange Rate | ||||||||
Period | Shekel against the U.S. dollar (%) | Euro against the U.S. dollar (%) | ||||||
2013 | (6.4 | ) | 3.5 | |||||
2014 | (0.9 | ) | (0.2 | ) |
The net effect of risks stemming from currency exchange rate fluctuations on our operating results can be quantified as follows:
• | An increase of 10% in the value of the shekel relative to the U.S. dollar in the year ended December 31, 2014 would have resulted in a net decrease in the U.S. dollar reporting value of our operating income of $1.5 million, due to the adverse impact on our operating margins that we would experience as a result of such an increase, while a 10% decrease in value of the shekel relative to the U.S. dollar in the year ended December 31, 2014 would have caused a net increase in the U.S. dollar reporting value of our operating income of $1.5 million for 2014, due to the favorable effect on our operating margins that would result from such devaluation of the shekel. |
114
• | An increase of 10% in the value of the euro relative to the U.S. dollar in 2014 would have resulted in a net increase in the U.S. dollar reporting value of our operating income of $1.1 million, due to the favorable effect on our operating margins that we would experience as a result of such an increase, while a decrease of 10% in the value of the euro relative to the U.S. dollar in 2013 would have resulted in a net decrease in the U.S. dollar reporting value of our operating income of $1.1 million for 2013, due to the adverse impact on our operating margins that would result from such devaluation of the euro. |
We will continue to monitor exposure to currency fluctuations. Instruments that may be used to hedge future risks may include foreign currency forward and swap contracts. These instruments may be used to selectively manage risks, but there can be no assurance that we will be fully protected against material foreign currency fluctuations. See Note 13 to our consolidated financial statements contained elsewhere in this annual report for additional information regarding foreign exchange risk management.
Inflation-related risks
We do not believe that the rate of inflation in Israel has had a material impact on our business to date, however, our costs in Israel will increase if inflation in Israel exceeds the devaluation of the shekel against the U.S. dollar or if the timing of such devaluation lags behind inflation in Israel.
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
Initial Public Offering
Our initial public offering closed on October 2, 2013. We issued a total of 5,073,800 ordinary shares with aggregate proceeds of $71.0 million (including the option to purchase additional shares) at a price per share of $14.00. Under the terms of the offering, we incurred aggregate underwriting discounts of $5.0 million (including the option to purchase additional shares), resulting in net proceeds of $66.1 million. We also incurred expenses of $3.2 million in connection with the offering.
From the effective date of the registration statement and until December 31, 2014, we used approximately $8 million of the net proceeds for the purchase of property, plant and equipment and intangible assets, $1 million of the net proceeds to pay bonuses to certain of our employees, including some of our executive officers, $11 million for funding our increased working capital and approximately $4 million of the net proceeds to pay the remaining balance of an existing long-term credit facility, including acceleration fees.
We may use a portion of the balance of the net proceeds to meet our anticipated increased working capital requirements and for other general corporate purposes. We may also use a portion of our net proceeds to fund the construction of the additional manufacturing facility. We may use also a portion of our net proceeds for exploring opportunities to accelerate growth in our core business through acquisitions of complementary businesses or technologies. We do not currently have specific plans or commitments with respect to the balance of net proceeds from the initial offering, and, accordingly, are unable to quantify the allocation of such proceeds among the various potential uses. Our management has significant flexibility in applying the net proceeds of the initial public offering.
ITEM 15: Controls and Procedures
(a) Disclosure Controls and Procedures. Our management, including our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of December 31, 2014. Based on such evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of December 31, 2014, our disclosure controls and procedures were effective such that the information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
115
(b) Management’s Annual Report on Internal Control Over Financial Reporting. Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. Internal control over financial reporting is defined in Rule 13a-15(f) or 15d-15(f) promulgated under the Exchange Act as a process designed by, or under the supervision of, the company’s principal executive and principal financial officers and effected by the company’s board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that:
· | pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets; |
· | provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and |
· | provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements. |
Our management, including our Chief Executive Officer and Chief Financial Officer, assessed the effectiveness of our internal control over financial reporting as of December 31, 2014. In making such assessment, our management used the criteria established in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on such assessment, management has concluded that, as of December 31, 2014, our internal control over financial reporting is effective to provide reasonable assurance regarding the reliability of financial reporting and the preparation of consolidated financial statements for external reporting purposes in accordance with generally accepted accounting principles.
(c) Attestation report of the registered public accounting firm. This annual report does not include an attestation report of our independent registered public accounting firm regarding internal controls over financial reporting because the Jumpstart Our Business Startups Act (“JOBS Act”) provides an exemption from such requirement as we qualify as an emerging growth company.
(d) Changes in Internal Control Over Financial Reporting. During the period covered by this report, no changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) have occurred that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
ITEM 16: Reserved
ITEM 16A: Audit Committee Financial Expert
All members of our audit committee meet the requirements for financial literacy under the applicable rules and regulations of the SEC and the NASDAQ corporate governance rules. Our board of directors has determined that Joseph Tenne is an audit committee financial expert as defined by the SEC rules and has the requisite financial experience as defined by the NASDAQ corporate governance rules. In addition, Mr. Tenne is independent as such term is defined in Rule 10A-3(b)(1) under the Exchange Act and under the listing standards of NASDAQ.
ITEM 16B: Code of Ethics
We have adopted a Code of Business Conduct and Ethics applicable to all of our directors and employees, including our Chief Executive Officer, Chief Financial Officer, controller or principal accounting officer, or other persons performing similar functions, which is a “code of ethics” as defined in this Item 16B of Form 20-F promulgated by the SEC. The full text of the Code of Business Conduct and Ethics is posted on our website at http://ir.enzymotec.com. Information contained on, or that can be accessed through, our website does not constitute a part of this Form 20-F and is not incorporated by reference herein. If we make any amendment to the Code of Business Conduct and Ethics or grant any waivers, including any implicit waiver, from a provision of said code, we will disclose the nature and basis of such amendment or waiver on a Form 6-K or on our website to the extent required by the rules and regulations of the SEC, including the instructions to Item 16B of Form 20-F. We granted no waivers under our Code of Business Ethics and Conduct in 2014.
116
ITEM 16C: Principal Accountant Fees and Services
Fees paid to the Auditors
The following table sets forth, for each of the years indicated, the fees billed by our independent registered public accounting firm, Kesselman & Kesselman (a member firm of Pricewaterhouse Coopers International Limited) (PwC Israel).
Year ended December, 31 | ||||||||
2013 | 2014 | |||||||
(in thousands of U.S. dollars) | ||||||||
Audit fees | $ | 330 | $ | 210 | ||||
Audit-related fees | ― | ― | ||||||
Tax fees | 40 | 37 | ||||||
All other fees | ― | ― | ||||||
Total | $ | 370 | $ | 247 |
Audit fees for the years ended December 31, 2013 and 2014 were for professional services rendered for the audit of our annual consolidated financial statements as of December 31, 2013 and 2014, review of consolidated quarterly financial statements, statutory audits of Enzymotec and its subsidiaries, issuance of comfort letters, consents and assistance with review of documents filed with the SEC (including our registration statement on Form F-1 related to our initial public offering in 2013 and registration statement on Form F-1 related to a follow-on offering in 2014).
Tax fees for the years ended December 31, 2013 and 2014 were for services related to tax compliance, including tax returns and claims for refund, and tax planning and tax advice, including assistance with tax audits and appeals, and assistance with respect to requests for rulings from tax authorities.
Audit Committee’s Pre-Approval Policies and Procedures
Our audit committee provides assistance to our board of directors in fulfilling its legal and fiduciary obligations in matters involving our accounting, auditing, financial reporting, internal control and legal compliance functions by pre-approving the services performed by our independent accountants and reviewing their reports regarding our accounting practices. Our audit committee also oversees the audit efforts of our independent accountants and takes those actions that it deems necessary to satisfy itself that the accountants are independent of management.
Enzymotec’s audit committee is responsible for the oversight of its independent auditors’ work. The audit committee’s policy is to pre-approve all audit and non-audit services provided by PwC and other members of PricewaterhouseCoopers International Limited. These services may include audit services, audit-related services, tax services and other services, as further described above. The audit committee sets forth the basis for its pre-approval in detail, listing the particular services or categories of services which are pre-approved, and setting forth a specific budget for such services. Additional services may be pre-approved by the audit committee on an individual basis. Once services have been pre-approved, PwC and management then report to the audit committee on a periodic basis regarding the extent of services actually provided in accordance with the applicable pre-approval and the fees for the services performed. Such fees for 2013 and 2014 were pre-approved by the audit committee in accordance with these procedures.
117
ITEM 16D: Exemptions from the Listing Standards for Audit Committees
Not applicable.
ITEM 16E: Purchase of Equity Securities by the Company and Affiliated Purchasers
Not applicable.
ITEM 16F: Change in Registrant’s Certifying Accountant
None.
ITEM 16G: Corporate Governance
As a foreign private issuer, we are permitted to, and do, follow certain home country corporate governance practices instead of those otherwise required under the NASDAQ Stock Market rules for domestic U.S. issuers. For instance, we follow home country practice in Israel with regard to the quorum requirement for shareholder meetings. As permitted under the Israeli Companies Law, our articles of association provide that the quorum for any meeting of shareholders shall be the presence of at least two shareholders present in person, by proxy or by a voting instrument, who hold at least 25% of the voting power of our shares instead of 33 1/3% of the issued share capital requirement. We may in the future elect to follow home country practices in Israel with regard to other matters, including the formation of compensation, nominating and corporate governance committees, separate executive sessions of independent directors and non-management directors and the requirement to obtain shareholder approval for certain dilutive events (such as for the establishment or amendment of certain equity-based compensation plans, issuances that will result in a change of control of the company, certain transactions other than a public offering involving issuances of a 20% or more interest in the company and certain acquisitions of the stock or assets of another company). Following our home country governance practices as opposed to the requirements that would otherwise apply to a U.S. company listed on the NASDAQ Global Select Market may provide less protection to you than what is accorded to investors under the NASDAQ Stock Market requirements applicable to domestic U.S. issuers.
ITEM 16H: Mine Safety Disclosures
Not applicable.
PART III
ITEM 17: Financial Statements
Not applicable.
ITEM 18: Financial Statements
We have appended our consolidated financial statements at the end of this annual report, starting at page F-2, as part of this annual report.
ITEM 19: Exhibits
See exhibit index incorporated herein by reference.
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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.
Enzymotec Ltd. | ||
By: | /s/ Ariel Katz | |
Ariel Katz | ||
President and Chief Executive Officer |
Dated: March 2, 2015
119
ANNUAL REPORT ON FORM 20-F
INDEX OF EXHIBITS
Exhibit no. | Description of exhibit | |
1.1 | Amended and Restated Articles of Association of the Registrant (3) | |
2.1 | Amended and Restated Investors’ Rights Agreement, dated September 22, 2013, by and among the Registrant and the other parties thereto (3) | |
4.1 | Agreement between the Israel Land Administration and Registrant, dated September 17, 2009 relating to Registrant’s facility at the Sagi 2000 Industrial Area, Migdal Ha’Emeq, Israel and Addendum thereto dated August 14, 2013∞(2) | |
4.2 | Shareholders’ Agreement between AarhusKarlshamn AB (publ) and Enzymotec Ltd. regarding the joint venture company Advanced Lipids AB dated June 14, 2007†(1) | |
4.4 | Enzymotec Ltd. Employee Share Option Plan (1999) (4) | |
4.5 | Enzymotec Ltd. 2003 Israeli Share Option Plan, as amended as of April 17, 2013 (4) | |
4.6 | 2012 U.S. Addendum to 2003 Israeli Share Option Plan (4) | |
4.7 | Enzymotec Ltd. 2013 Omnibus Equity Incentive Plan (2) | |
4.8 | Form of indemnification agreement by and between Enzymotec Ltd. and each of its directors and executive officers (4) | |
4.9 | Memorandum of Understanding by and among Antarctic Sea Fisheries S.A. and Enzymotec Ltd. dated April 23, 2013†(4) | |
4.10 | Amendment to Memorandum of Understanding by and among Antarctic Sea Fisheries S.A. and Enzymotec Ltd. dated June 14, 2013 (4) | |
4.11 | Enzymotec Ltd. 2014 Compensation Policy (5) | |
8.1 | List of subsidiaries of Enzymotec Ltd. | |
12.1 | Certification of Principal Executive Officer required by Rule 13a-14(a) and Rule 15d-14(a) (Section 302 Certifications) | |
12.2 | Certification of Principal Financial Officer required by Rule 13a-14(a) and Rule 15d-14(a) (Section 302 Certifications) | |
13.1 | Certification of Principal Executive Officer and Principal Financial Officer required by Rule 13a-14(b) and Rule 15d-14(b) (Section 906 Certifications), furnished herewith | |
15.1 | Consent of Kesselman & Kesselman, a member firm of PricewaterhouseCoopers International Limited, an independent registered public accounting firm | |
101.INS | XBRL Document | |
101.SCH | XBRL Taxonomy Extension Schema Document | |
101.CAL | XBRL Taxonomy Extension Calculation Linkbase Document | |
101.DEF | XBRL Taxonomy Definition Linkbase Document | |
101.LAB | XBRL Taxonomy Extension Label Linkbase Document | |
101.PRE | XBRL Taxonomy Extension Presentation Linkbase Document |
∞ | English summary of original Hebrew document. |
† | Portions of this exhibit have been omitted and filed separately with the SEC pursuant to a confidential treatment request. |
(1) | Previously filed with the SEC on August 22, 2013 pursuant to a registration statement on Form F-1 (File No. 333-190781) and incorporated by reference herein. |
(2) | Previously filed with the SEC on September 16, 2013 pursuant to a pre-effective amendment to a registration statement on Form F-1 (File No. 333-190781) and incorporated by reference herein. |
(3) | Previously filed with the SEC on September 24, 2013 pursuant to a pre-effective amendment to a registration statement on Form F-1 (File No. 333-190781) and incorporated by reference herein. |
(4) | Previously filed with the SEC on September 27, 2013 pursuant to a post-effective amendment to a registration statement on Form F-1 (File No. 333-190781) and incorporated by reference herein. | |
(5) | Previously furnished to the SEC on May 30, 2014 as part of Exhibit 99.1 to a current report on Form 6-K and incorporated by reference herein. |
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ENZYMOTEC LTD.
Page | |
F-2 | |
F-3 | |
F-5 | |
F-6 | |
F-7 | |
F-8 |
F - 1
ENZYMOTEC LTD.
2014 ANNUAL REPORT
ENZYMOTEC LTD.
2014 ANNUAL REPORT
TABLE OF CONTENTS
Page | |
F-2 | |
CONSOLIDATED FINANCIAL STATEMENTS: | |
F-3 - F-4 | |
F-5 | |
F-6 | |
F-7 | |
F-8 - F-34 |
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Shareholders of
ENZYMOTEC LTD.
We have audited the accompanying consolidated balance sheets of Enzymotec Ltd. (the "Company") and its subsidiaries as of December 31, 2014 and 2013 and the related consolidated statements of operations and comprehensive income, changes in shareholders' equity and cash flows for each of the three years in the period ended December 31, 2014. These financial statements are the responsibility of the Company’s Board of Directors and management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by the Company’s Board of Directors and management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company and its subsidiaries at December 31, 2014 and 2013 and the consolidated results of their operations and comprehensive income and their cash flows for each of the three years in the period ended December 31, 2014 in conformity with accounting principles generally accepted in the United States of America.
Tel-Aviv, Israel | Kesselman & Kesselman |
March 2, 2015 | Certified Public Accountants (Isr.) |
A member firm of PricewaterhouseCoopers International Limited |
Kesselman & Kesselman, Trade Tower, 25 Hamered Street, Tel-Aviv 6812508, Israel, |
P.O Box 50005 Tel-Aviv 6150001 Telephone: +972 -3- 7954555, Fax:+972 -3- 7954556, www.pwc.com/il |
F - 2
ENZYMOTEC LTD.
CONSOLIDATED BALANCE SHEETS
December 31 | ||||||||
2014 | 2013 | |||||||
U.S. dollars in thousands | ||||||||
A s s e t s | ||||||||
CURRENT ASSETS: | ||||||||
Cash and cash equivalents | $ | 10,315 | $ | 74,430 | ||||
Short-term bank deposits | 19,970 | |||||||
Marketable securities | 1,943 | |||||||
Accounts receivable: | ||||||||
Trade | 13,433 | 18,788 | ||||||
Other | 3,110 | 2,738 | ||||||
Inventories | 21,572 | 11,943 | ||||||
Total current assets | 70,343 | 107,899 | ||||||
NON-CURRENT ASSETS: | ||||||||
Investment in equity investee | 1,152 | 809 | ||||||
Marketable securities | 35,287 | |||||||
Funds in respect of retirement benefits obligation | 994 | 1,190 | ||||||
Intangibles, long-term deposits and other | 1,200 | 111 | ||||||
PROPERTY, PLANT AND EQUIPMENT: | ||||||||
Cost | 38,237 | 33,385 | ||||||
L e s s - accumulated depreciation and amortization | 8,963 | 7,021 | ||||||
29,274 | 26,364 | |||||||
Total assets | $ | 138,250 | $ | 136,373 |
F - 3
ENZYMOTEC LTD.
CONSOLIDATED BALANCE SHEETS
December 31 | ||||||||
2014 | 2013 | |||||||
U.S. dollars in thousands | ||||||||
Liabilities and shareholders' equity | ||||||||
CURRENT LIABILITIES: | ||||||||
Current maturity of long-term loans | $ | - | $ | 4,200 | ||||
Accounts payable and accruals: | ||||||||
Trade | 5,259 | 6,418 | ||||||
Other | 3,569 | 6,378 | ||||||
Total current liabilities | 8,828 | 16,996 | ||||||
LONG TERM LIABILITY - | ||||||||
Retirement benefits obligation | 1,150 | 1,474 | ||||||
COMMITMENTS AND CONTINGENCIES (Note 9) | ||||||||
Total liabilities | 9,978 | 18,470 | ||||||
SHAREHOLDERS' EQUITY: | ||||||||
Ordinary shares of NIS 0.01 par value at December 31, 2014 and 2013: authorized – 100,000,000 shares; issued and outstanding 22,482,509 shares and 21,564,820 shares, respectively. | 57 | 55 | ||||||
Additional paid-in capital | 122,075 | 119,547 | ||||||
Accumulated other comprehensive loss | (64 | ) | (65 | ) | ||||
Retained earnings (accumulated deficit) | 6,204 | (1,634 | ) | |||||
Total shareholders' equity | 128,272 | 117,903 | ||||||
Total liabilities and shareholders' equity | $ | 138,250 | $ | 136,373 |
The accompanying notes are an integral part of the consolidated financial statements.
F - 4
ENZYMOTEC LTD.
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
Year ended December 31 | ||||||||||||
2014 | 2013 | 2012 | ||||||||||
U.S. dollars in thousands (except per share data) | ||||||||||||
NET REVENUES | $ | 47,103 | $ | 64,975 | $ | 37,867 | ||||||
COST OF REVENUES | (18,316 | ) | (32,110 | ) | (19,815 | ) | ||||||
GROSS PROFIT | 28,787 | 32,865 | 18,052 | |||||||||
OPERATING EXPENSES: | ||||||||||||
Research and development - net | (5,986 | ) | (5,947 | ) | (4,611 | ) | ||||||
Selling and marketing | (8,034 | ) | (6,725 | ) | (5,191 | ) | ||||||
General and administrative | (7,475 | ) | (8,434 | ) | (2,935 | ) | ||||||
T O T A L OPERATING EXPENSES | (21,495 | ) | (21,106 | ) | (12,737 | ) | ||||||
OPERATING INCOME | 7,292 | 11,759 | 5,315 | |||||||||
FINANCIAL INCOME (EXPENSES) - net | 499 | (531 | ) | (539 | ) | |||||||
INCOME BEFORE TAXES ON INCOME | 7,791 | 11,228 | 4,776 | |||||||||
TAXES ON INCOME | (406 | ) | (324 | ) | (180 | ) | ||||||
SHARE IN PROFITS OF EQUITY INVESTEES | 453 | 491 | 186 | |||||||||
NET INCOME | 7,838 | 11,395 | 4,782 | |||||||||
OTHER COMPREHENSIVE INCOME (LOSS): | ||||||||||||
Unrealized loss on marketable securities | (125 | ) | ||||||||||
Currency translation adjustments on equity investees | (202 | ) | 11 | 14 | ||||||||
Changes in unrealized gains or losses in respect of derivative | ||||||||||||
instruments designated for cash flow hedge | 328 | 171 | 92 | |||||||||
TOTAL COMPREHENSIVE INCOME | $ | 7,839 | $ | 11,577 | $ | 4,888 | ||||||
EARNINGS PER SHARE: | ||||||||||||
Basic | $ | 0.36 | $ | 0.66 | $ | 0.33 | ||||||
Diluted | $ | 0.34 | $ | 0.53 | $ | 0.28 | ||||||
WEIGHTED AVERAGE NUMBER OF ORDINARY | ||||||||||||
SHARES USED IN COMPUTATION OF EARNINGS PER SHARE: | ||||||||||||
Basic | 21,902,057 | 7,544,387 | 2,996,624 | |||||||||
Diluted | 23,210,573 | 9,286,456 | 3,461,877 |
The accompanying notes are an integral part of the consolidated financial statements.
F - 5
ENZYMOTEC LTD.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
Ordinary shares | Preferred shares | Ordinary shares | Preferred shares | Additional paid-in capital | Accumulated other comprehensive income(loss) | Retained earnings (accumulated deficit) | Total | |||||||||||||||||||||||||
Number of shares | U.S. dollars in thousands | |||||||||||||||||||||||||||||||
BALANCE AT DECEMBER 31, 2011 | 2,996,624 | 166,801 | $ | 8 | $ | * | $ | 45,685 | $ | (353 | ) | $ | (17,811 | ) | $ | 27,529 | ||||||||||||||||
CHANGES IN THE YEAR ENDED DECEMBER 31, 2012: | ||||||||||||||||||||||||||||||||
Comprehensive income | 106 | 4,782 | 4,888 | |||||||||||||||||||||||||||||
Share-based compensation expense | 267 | 267 | ||||||||||||||||||||||||||||||
Issuance of B2 preferred shares and warrants, net of issuance costs | 4,127 | $ | * | 1,497 | 1,497 | |||||||||||||||||||||||||||
BALANCE AT DECEMBER 31, 2012 | 2,996,624 | 170,928 | $ | 8 | $ | * | $ | 47,449 | $ | (247 | ) | $ | (13,029 | ) | $ | 34,181 | ||||||||||||||||
CHANGES IN THE YEAR ENDED DECEMBER 31, 2013: | ||||||||||||||||||||||||||||||||
Comprehensive income | 182 | 11,395 | 11,577 | |||||||||||||||||||||||||||||
Exercise of options by employees | 47,940 | * | 8 | 8 | ||||||||||||||||||||||||||||
Issuance of B2 preferred shares and warrants, net of issuance costs | 18,856 | $ | * | 6,850 | 6,850 | |||||||||||||||||||||||||||
Exercise of warrants | 5,663 | 1,340 | 1,340 | |||||||||||||||||||||||||||||
Conversion of preferred shares to ordinary shares and bonus share distribution | 13,290,396 | (195,447 | ) | 33 | (* | ) | (33 | ) | ||||||||||||||||||||||||
Issuance of ordinary shares in an initial public offering, net of issuance costs | 5,073,800 | 14 | 62,824 | 62,838 | ||||||||||||||||||||||||||||
Issuance of restricted shares | 156,060 | * | * | |||||||||||||||||||||||||||||
Share-based compensation expense | 1,109 | 1,109 | ||||||||||||||||||||||||||||||
BALANCE AT DECEMBER 31, 2013 | 21,564,820 | — | $ | 55 | $ | — | $ | 119,547 | $ | (65 | ) | $ | (1,634 | ) | $ | 117,903 | ||||||||||||||||
CHANGES IN THE YEAR ENDED DECEMBER 31, 2014: | ||||||||||||||||||||||||||||||||
Comprehensive income | 1 | 7,838 | 7,839 | |||||||||||||||||||||||||||||
Exercise of options by employees | 908,169 | 2 | 1,754 | 1,756 | ||||||||||||||||||||||||||||
Issuance of restricted shares | 9,520 | * | * | |||||||||||||||||||||||||||||
Share issuance costs | (78 | ) | (78 | ) | ||||||||||||||||||||||||||||
Share-based compensation expense | 852 | 852 | ||||||||||||||||||||||||||||||
BALANCE AT DECEMBER 31, 2014 | 22,482,509 | — | $ | 57 | $ | — | $ | 122,075 | $ | (64 | ) | $ | 6,204 | 128,272 |
* Represents an amount of less than $1,000.
The accompanying notes are an integral part of the consolidated financial statements.
F - 6
ENZYMOTEC LTD.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year ended December 31 | ||||||||||||
2014 | 2013 | 2012 | ||||||||||
U.S. dollars in thousands | ||||||||||||
CASH FLOWS FROM OPERATING ACTIVITIES: | ||||||||||||
Net Income | $ | 7,838 | $ | 11,395 | $ | 4,782 | ||||||
Adjustments required to reflect cash flows from operations: | ||||||||||||
Depreciation and amortization | 2,308 | 1,551 | 1,422 | |||||||||
Share in profits of equity investee | (453 | ) | (491 | ) | (186 | ) | ||||||
Share-based compensation expense | 852 | 1,109 | 267 | |||||||||
Gain on sale of property, plant and equipment | (3 | ) | ||||||||||
Change in inventories | (9,629 | ) | (2,584 | ) | (3,100 | ) | ||||||
Change in accounts receivable | 5,304 | (6,965 | ) | (3,806 | ) | |||||||
Change in accounts payable and accruals | (3,868 | ) | 3,052 | 3,590 | ||||||||
Change in other non-current assets | (141 | ) | 49 | 9 | ||||||||
Change in retirement benefits obligation | (246 | ) | 277 | 45 | ||||||||
Net cash provided by operating activities | 1,965 | 7,390 | 3,023 | |||||||||
CASH FLOWS FROM INVESTING ACTIVITIES: | ||||||||||||
Purchase of property, plant and equipment and intangible assets | (6,361 | ) | (4,885 | ) | (1,248 | ) | ||||||
Investment in bank and other deposits | (20,009 | ) | 10 | 16 | ||||||||
Investment in marketable securities | (42,499 | ) | ||||||||||
Investment in equity investee | (92 | ) | ||||||||||
Proceeds from sale of marketable securities | 5,285 | |||||||||||
Proceeds from sale of property, plant and equipment | 6 | |||||||||||
Change in funds in respect of retirement benefits obligation | 118 | (156 | ) | (46 | ) | |||||||
Net cash used in investing activities | (63,558 | ) | (5,025 | ) | (1,278 | ) | ||||||
CASH FLOWS FROM FINANCING ACTIVITIES: | ||||||||||||
Change in short-term loans | (1,000 | ) | (4,600 | ) | ||||||||
Repayment of long-term bank loan | (4,200 | ) | (700 | ) | (700 | ) | ||||||
Proceeds from exercise of options by employees | 1,756 | 8 | - | |||||||||
Proceeds from exercise of warrants | 1,340 | - | ||||||||||
Share issuance costs | (78 | ) | ||||||||||
Proceeds from initial public offering, net of issuance costs of $8.2 million | 62,838 | - | ||||||||||
Proceeds from issuance of equity and warrants | 6,850 | 1,497 | ||||||||||
Net cash provided by (used in) financing activities | (2,522 | ) | 69,336 | (3,803 | ) | |||||||
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS | (64,115 | ) | 71,701 | (2,058 | ) | |||||||
BALANCE OF CASH AND CASH EQUIVALENTS | ||||||||||||
AT BEGINNING OF YEAR | 74,430 | 2,729 | 4,787 | |||||||||
BALANCE OF CASH AND CASH EQUIVALENTS | ||||||||||||
AT END OF YEAR | $ | 10,315 | $ | 74,430 | $ | 2,729 |
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: | ||||||||||||
Interest paid | $ | 187 | $ | 385 | $ | 544 | ||||||
Income taxes paid, net of refunds | $ | 691 | $ | 161 | $ | 135 |
Supplementary information on financing and investing activities not involving cash flows
At December 31, 2014, 2013 and 2012, trade payables include $622,000 $632,000 and $ 563,000, respectively, in respect of acquisition of property, plant and equipment. These balances will be given recognition in these statements upon payment.
The accompanying notes are an integral part of the consolidated financial statements.
F - 7
ENZYMOTEC LTD.
NOTES TO FINANCIAL STATEMENTS
NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES
The consolidated financial statements have been prepared in conformity with accounting principles generally accepted in United States of America ("U.S. GAAP"). The significant accounting policies were applied on a consistent basis, as follows:
a. | General |
Enzymotec Ltd. (the "Company" or "Enzymotec"), an Israeli company, which, together with its subsidiaries, develops, manufactures, markets and sells innovative bio-functional lipid ingredients, as well as final products, based on sophisticated proprietary processes and technologies.
The Company's sales are made to companies that market dietary supplements, to distributors related to those companies, to nutrition companies that provide balanced nutrition to babies and to pharmaceutical companies that market the products as treating diseases by providing the body with optimal amounts of substances which are natural to the body. In the VAYA Pharma segment, the majority of the products are sold directly to customers in the U.S. through wholesalers. Outside the U.S., sales are made through leading pharmaceutical companies. As to sales by geographic locations and major customers, see Note 5.
In June 2007, the Company entered into a joint collaboration agreement with a Swedish vegetable oil company (the "Partner" or "AAK") for the manufacture, marketing and sale of products to the infant food industry and established Advance Lipids AB, a Swedish company jointly owned by both parties in equal proportions ("Advanced Lipids") for this purpose, see also Note 4.
b. | Use of estimates in preparation of financial statements |
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results may differ from those estimates. As applicable to these financial statements, the most significant estimates and assumptions relate to contingencies and derivatives.
c. | Functional currency |
The U.S. dollar ("dollar") is the currency of the primary economic environment in which the operations of the Company are conducted. The majority of the Company's sales are denominated in dollars; the majority of the Company’s expenses are incurred in dollars; and the majority of the Company’s financing has been provided in dollars.
Transactions and balances originally denominated in dollars are presented at their original amounts. Balances in non-dollar currencies are translated into dollars using historical and current exchange rates for non-monetary and monetary balances, respectively. For non-dollar transactions and other items in the consolidated statements of operations and comprehensive income (loss) (indicated below), the following exchange rates are used: (i) for transactions - exchange rates at transaction dates; and (ii) for other items (derived from non-monetary balance sheet items such as depreciation and amortization, etc.) - historical exchange rates. Currency transaction gains and losses are recorded in financial income or expenses, as appropriate.
F - 8
ENZYMOTEC LTD.
NOTES TO FINANCIAL STATEMENTS (continued)
NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES (continued):
The functional currency of the Company's equity investee, Advanced Lipids, is the Swedish Krona, which is the currency of the primary economic environment in which the operations of Advanced Lipids are conducted. Currency translation adjustments are presented within other comprehensive income (loss).
d. | Principles of consolidation |
The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. Intercompany balances and transactions have been fully eliminated. Profits from intercompany sales have also been eliminated.
e. | Investment in equity investees |
The Company’s investment in equity investees, which is a less-than-majority-owned entity in which the Company exercises significant influence over operating and financial policies, is accounted for using the equity method of accounting. Under the equity method, original investments are recorded at cost and adjusted by the Company’s share of undistributed profits or losses of such company. The Company’s profits from equity investees have been reflected as "share in profits of equity investee" in the consolidated statements of operations and comprehensive income.
f. | Cash equivalents |
The Company considers all highly liquid investments, which include short-term bank deposits (up to three months from date of deposit) that are not restricted as to withdrawal or use, to be cash equivalents.
g. | Inventories |
Inventories include raw materials and finished products and are valued at the lower of cost or market. The inventories are determined as follows:
Raw materials and supplies - on the "first-in, first-out" basis;
Products in process and finished products: the raw and packaging materials on the "first-in, first-out" basis; the capitalized production cost – on an average basis over the production period.
h. | Investment in securities |
Investment in securities consists of debt securities classified as available-for-sale and recorded at fair value. The fair value of quoted securities is based on current market value.
Unrealized gains (losses) of available-for-sale securities, net of taxes, are reflected in other comprehensive income. Unrealized losses considered to be temporary are reflected in other comprehensive income; unrealized losses that are considered to be other-than-temporary are charged to income as an impairment charge. Realized gains and losses for debt securities are included in financial income (expenses) -net.
The Company considers available evidence in evaluating potential impairments of its investments, including the duration and extent to which fair value is less than cost. For debt securities, an other-than-temporary impairment has occurred if the Company does not expect to recover the entire amortized cost basis of the debt security. If the Company does not intend to sell the impaired debt security, and it is not more likely than not it will be required to sell the debt security before the recovery of its amortized cost basis, the amount of the other-than-temporary impairment are charged to income included in financial income (expenses) - net, is limited to the portion attributed to credit loss. The remaining portion of the other-than-temporary impairment related to other factors is recognized in other comprehensive income.
F - 9
ENZYMOTEC LTD.
NOTES TO FINANCIAL STATEMENTS (continued)
NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES (continued):
i. | Intangible assets |
Intangible assets represent licenses to sell in certain territories (see also Note 9f (1)) and are shown at historical cost. Licenses have a finite useful life and are carried at cost, net of accumulated amortization. Amortization is calculated using the straight-line method over the estimated useful life of the license.
j. | Property, plant and equipment |
These assets are stated at cost, net of accumulated depreciation and amortization. The assets are depreciated by the straight-line method on the basis of their estimated useful lives.
Annual rates of depreciation are as follows:
% | ||
Computers and software | 33 | |
Buildings | 2 | |
Vehicles | 15 | |
Manufacturing equipment | 7-10 | |
Laboratory equipment | 7-20 | |
(Mainly 15%) | ||
Furniture and office equipment | 6-15 |
Leasehold improvements are amortized by the straight-line method over the term of the lease, which is shorter than the estimated useful life of the improvements.
k. | Impairment of long-lived assets |
The Company tests long-lived assets (including intangible assets) for impairment whenever events or circumstances present an indication of impairment. If the sum of expected future cash flows (undiscounted and without interest charges) of the assets is less than the carrying amount of such assets, an impairment loss would be recognized. The assets would be written down to their estimated fair values, calculated based on the present value of expected future cash flows (discounted cash flows), or some other fair value measure.
For the years ended December 31, 2014, 2013 and 2012, the Company did not recognize an impairment loss for its long-lived assets.
l. | Revenue recognition |
The Company recognizes revenue from sales of its products to customers, including distributors, when persuasive evidence of sales arrangement exists, delivery has occurred, the sales price is fixed or determinable and collectability is reasonably assured. See also Note 4 for timing of revenue recognition related to the Company's joint collaboration agreement.
The Company provides a right of return to its U.S. distributors upon expiry of the medical food products sold in the Vaya Pharma segment. Accordingly, the Company records a reserve for estimated sales returns based on historical experience as well as specific factors, such as levels of inventory in the distribution channel, product dating and expiration. Returns to date have been inconsequential. Revenues from product sales are also recorded net of cash discounts and distribution fees, which can be reasonably estimated.
m. | Research and development expenses |
Research and development expenses are charged to income as incurred. Participation from government departments and from research foundations for development of approved projects is recognized as a reduction of expense as the related costs are incurred. The main components of the research and development expenses are salaries and related expenses, laboratory, clinical research and regulatory related expenses.
F - 10
ENZYMOTEC LTD.
NOTES TO FINANCIAL STATEMENTS (continued)
NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES (continued):
n. | Contingencies |
Certain conditions may exist as of the balance sheet date, which may result in a loss to the Company but which will only be resolved when one or more future events occur or fail to occur. Management assesses such contingent liabilities, if any, and such assessment inherently involves an exercise of judgment. In assessing loss contingencies related to legal proceedings that are pending against the Company or unasserted claims that may result in such proceedings, management evaluates the perceived merits of any legal proceedings or unasserted claims as well as the perceived merits of the amount of relief sought or expected to be sought.
Management applies the guidance in Accounting Standards Codification ("ASC") 450-20-25 when assessing losses resulting from contingencies. If the assessment of a contingency indicates that it is probable that a material loss has been incurred and the amount of the liability can be estimated, then the estimated liability is recorded as accrued expenses in the Company’s consolidated financial statements. If the assessment indicates that a potential material loss contingency is not probable but is reasonably possible, or is probable but cannot be estimated, then the nature of the contingent liability, together with an estimate of the range of possible loss if determinable and material are disclosed. Loss contingencies considered to be remote by management are generally not disclosed unless they involve guarantees, in which case the guarantees are disclosed.
o. | Income taxes |
Deferred income taxes are determined by the asset and liability method based on the estimated future tax effects of differences between the financial accounting and the tax bases of assets and liabilities under the applicable tax law. Deferred tax balances are computed using the tax rates expected to be in effect at the time when these differences reverse. Valuation allowances in respect of the deferred tax assets are provided when it is more likely than not that all or a portion of the deferred income tax assets will not be realized. See Note 11g for additional information regarding deferred taxes.
The Company assesses its valuation allowance considering different indicators, including profitability of the different entities in the different tax jurisdictions, the ability to utilize the deferred tax assets in subsequent years, etc.
Upon the distribution of dividends from the tax-exempt income of an "Approved Enterprise" or "Benefitted Enterprise" (see also Note 11a (3)), the amount distributed is subject to tax at the rate that would have been applicable had the Company not been exempted from payment thereof. The Company intends to permanently reinvest the amounts of tax exempt income and it does not intend to distribute such dividends. Therefore, no deferred income taxes have been provided in respect of such tax-exempt income.
The Company may incur an additional tax liability in the event of an inter-company dividend distribution from foreign subsidiaries; no additional deferred income taxes have been provided, since it is the Company’s policy not to distribute dividends in the foreseeable future that may result in additional tax liability.
Taxes that would apply in the event of disposal of investments in foreign subsidiaries have not been taken into account in computing deferred income taxes, as it is the Company’s intent and ability to hold these investments.
Tax benefits recognized in the consolidated financial statements are those that management deems at least more likely than not to be sustained, based on technical merits. The amount of benefits recorded for these tax benefits is measured as the largest benefit management deems more likely than not to be sustained.
F - 11
ENZYMOTEC LTD.
NOTES TO FINANCIAL STATEMENTS (continued)
NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES (continued):
p. | Share-based compensation |
The Company accounts for employees and directors share-based compensation awards classified as equity awards using the grant-date fair value method. The fair value of share-based compensation transactions is recognized as an expense over the requisite service period, net of estimated forfeitures. The Company estimates forfeitures based on historical experience and anticipated future conditions. Performance-based awards are expensed over the requisite service period when the achievement of performance criteria is probable.
The Company elected to recognize compensation cost for an award with only service conditions that has a graded vesting schedule using the straight-line method based on the multiple-option award approach.
When options are granted as consideration for services provided by consultants and other non-employees, the grant is accounted for based on the fair value of the consideration received or the fair value of the options issued, whichever is more reliably measurable. The fair value of the options granted is measured on a final basis at the end of the related service period and is recognized over the related service period using the straight-line method.
q. | Shipping and handling costs |
Shipping and handling costs on sales are classified as a component of cost of revenues.
r. | Advertising |
Costs related to advertising and promotion of products, are charged to selling and marketing expense as incurred.
s. | Earnings per share |
Basic earnings per share are computed by dividing net income applicable to ordinary shareholders by the weighted average number of shares of the Company's ordinary shares outstanding for each period.
Diluted earnings per share are calculated by dividing net income applicable to ordinary shareholders by the fully-diluted weighted-average number of ordinary shares outstanding during each period. Potentially dilutive shares are comprised of: (i) incremental ordinary shares issuable upon the exercise of share options, restricted shares or warrants, using the treasury stock method; and (ii) shares issuable upon conversion of preferred shares using the “if-converted” method. For the Company's performance-vested share awards, their contingent features result in an assessment for any potentially dilutive common stock by using the end of the reporting period as if it were the end of the contingency period for all awards granted.
Basic and diluted earnings per share are presented in conformity with the two-class method for participating securities for the period prior to their conversion upon the Company's initial public offering in October 2013 when all preferred shares were converted into ordinary shares. Under this method the earnings per share for each class of shares (ordinary shares and preferred shares) are calculated assuming 100% of the Company’s earnings are distributed as dividends to each class of shares based on their contractual rights.
F - 12
ENZYMOTEC LTD.
NOTES TO FINANCIAL STATEMENTS (continued)
NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES (continued):
t. | Derivatives |
The Company purchases foreign exchange derivative financial instruments (mainly forward exchange contracts, and written and purchased currency options). The transactions are designed to hedge the Company’s currency exposure.
Derivatives that do not qualify for hedge accounting are recognized on the balance sheet at their fair value, with changes in the fair value recognized as a component of “financial income (expenses) - net” in the consolidated statements of operations and comprehensive income (loss).
Changes in the fair value of derivatives that are highly effective and designated as cash flow hedges are reported as a component of other comprehensive income or loss and reclassified into earnings in the same line-item associated with the forecasted transaction and in the same periods during which the hedged transaction impacts earnings.
For derivatives that do not qualify for hedge accounting, the cash flows associated with these derivatives are reflected as cash flows from operating activities in the consolidated statements of cash flows.
For derivatives that qualify for hedge accounting, the cash flows associated with these derivatives are reported in the consolidated statements of cash flows consistently with the classification of cash flows from the underlying hedged items that these derivatives are hedging.
u. | Fair value measurement |
The Company measures fair value and discloses fair value measurements for financial assets and liabilities. Fair value is based on the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.
The fair value of the financial instruments included in the working capital of the Company is usually identical or close to their carrying value. The fair value of bank borrowing also approximates the carrying value since it bears interest at rates close to the prevailing market rates.
The three levels of inputs that may be used to measure fair value are as follows:
Level 1 - Quoted prices (unadjusted) in active markets that are accessible at the measurement date for assets or liabilities. The fair value hierarchy gives the highest priority to Level 1 inputs.
Level 2 - Observable prices that are based on inputs not quoted on active markets, but corroborated by market data.
Level 3 - Unobservable inputs are used when little or no market data is available. The fair value hierarchy gives the lowest priority to Level 3 inputs.
In determining fair value, the Company utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs to the extent possible and considers counterparty credit risk in its assessment of fair value.
v. | Concentration of credit risks, trade receivables and suppliers |
Financial instruments that potentially subject the Company to concentration of credit risk consist principally of cash and cash equivalents, bank deposits, marketable securities and trade receivables. The Company deposits cash and cash equivalents with highly rated financial institutions, mainly Israeli and U.S. banks. Deposits in U.S. banks are federally insured up to $250,000 per account.
F - 13
ENZYMOTEC LTD.
NOTES TO FINANCIAL STATEMENTS (continued)
NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES (continued):
The Company has not experienced any credit losses in these accounts and does not believe it is exposed to any significant credit risk on these instruments. The Company performs ongoing credit evaluations to estimate the need for maintaining reserves for potential credit losses. An allowance for doubtful accounts is recognized on a specific basis with respect to those amounts that the Company has determined to be doubtful of collection. Following are the changes in the allowance for doubtful accounts for the year ended December 31, 2014. There was no change in the years ended December 31, 2013 and 2012.
Year ended December 31 | ||||
2014 | ||||
U.S. dollars in thousands | ||||
Balance at beginning of year | $ | - | ||
Charged to cost and expenses | 245 | |||
Balance at end of year | $ | 245 |
At December 31, 2014, one customer accounted for more than 10% of gross accounts receivable with a balance of $2,930,000. At December 31, 2013, two customers accounted for more than 10% of gross accounts receivable with balances of $4,172,000 and $3,688,000.
The Company is dependent on third parties to supply krill meal, an essential raw material for the production of krill oil, which accounted for 40.6%, 53.8% and 49.8% of total net revenues in 2014, 2013 and 2012, respectively. The Company currently purchases krill meal pursuant to a memorandum of understanding with the owners of a vessel that harvests Antarctic krill. It also purchases krill meal from several other suppliers, subject to availability. There are a limited number of vessels capable of producing krill meal onboard. In 2013, a distribution company from which the Company previously purchased krill meal declared bankruptcy. However, no material disruption to the krill meal supply occurred and the Company was able to make alternative arrangements with the owner of the vessel. In 2014, the Company also purchased frozen krill, which, while more expensive to process into krill meal onshore compared to krill from vessels processed onboard, is more readily obtainable. The Company also signed a toll processing agreement in 2014 with a toll processor for processing the frozen krill into krill meal. The Company intends to meet its krill meal needs in the future by sourcing krill meal both from vessels that process krill meal onboard and suppliers of frozen krill. However, if the Company, for any reason, is no longer able to obtain the krill meal from a supplier on terms reasonable to it, or at all, this would have a material adverse effect on its results of operations and financial condition.
w. | Recently issued accounting pronouncements |
In May 2014, the Financial Accounting Standards Board ("FASB") issued guidance on revenue from contracts with customers that will supersede most current revenue recognition guidance, including industry-specific guidance. The underlying principle is that an entity will recognize revenue upon the transfer of goods or services to customers in an amount that the entity expects to be entitled to in exchange for those goods or services. The guidance provides a five-step analysis of transactions to determine when and how revenue is recognized. Other major provisions include capitalization of certain contract costs, consideration of the time value of money in the transaction price, and allowing estimates of variable consideration to be recognized before contingencies are resolved in certain circumstances. The guidance also requires enhanced disclosures regarding the nature, amount, timing and uncertainty of revenue and cash flows arising from an entity’s contracts with customers. The guidance is effective for the interim and annual periods beginning on or after December 15, 2016 (January 1, 2017 for the Company. Early adoption is not permitted). The guidance permits the use of either a retrospective or cumulative effect transition method. The Company is currently evaluating the impact of the amended guidance on its consolidated financial statements.
F - 14
ENZYMOTEC LTD.
NOTES TO FINANCIAL STATEMENTS (continued)
NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES (continued):
In August 2014, the FASB issued amended guidance related to disclosure of uncertainties about an entity’s ability to continue as a going concern. The new guidance requires management to evaluate whether there is substantial doubt about the entity’s ability to continue as a going concern and, as necessary, to provide related footnote disclosures. The guidance has an effective date of December 31, 2016. The Company believes that the adoption of this new standard will not have a material impact on its consolidated financial statements.
NOTE 2 - INITIAL PUBLIC OFFERING ("IPO") AND SECONDARY OFFERING
On October 2, 2013, the Company closed its IPO in the United States with respect to the sale of 5,073,800 ordinary shares. In connection with the IPO, the Company’s ordinary shares were listed on the NASDAQ Global Select Market. The IPO price was $14 per share. After deducting the underwriting discount and the offering expenses, the net proceeds to the Company from the offering amounted to $62,838,000. The number of shares offered included the underwriters’ option to purchase an additional 661,800 ordinary shares at the IPO price that was exercised in full prior to closing.
Upon the closing of the IPO, all warrants issued to the Company’s former preferred shareholders were exercised for preferred shares, which subsequently converted together with all other outstanding preferred shares into ordinary shares. The following table details the number of ordinary shares outstanding following the closing of the IPO as of October 2, 2013:
Number of shares | ||||
Ordinary shares outstanding at September 30, 2013 | 3,167,304 | |||
Ordinary shares issued following the conversion of the preferred shares outstanding | 12,905,312 | |||
Ordinary shares issued following the exercise of preferred share warrants and subsequent conversion | 385,084 | |||
Ordinary shares issued in the IPO (including the underwriters’ option to purchase additional shares) | 5,073,800 | |||
Total ordinary shares outstanding at October 2, 2013 | 21,531,500 |
In connection with the closing of the IPO and in accordance with their original terms, the vesting period for certain options was accelerated such that options to purchase 262,888 ordinary shares vested and became exercisable upon the closing of the IPO and options to purchase 224,740 ordinary shares vested and became exercisable after one year from the closing of the IPO. Additionally, restricted shares, whose vesting was also subject to the occurrence of a change in control event (i.e. closing of an IPO) will vest according to their vesting schedule, see also Note 10c.
In addition, following the closing of the IPO, the Company's Board of Directors approved a grant of 9,520 fully vested restricted shares to the Company's then-current Vice Chairman of the Board of Directors, see also Note 10c.
Accordingly, the Company recorded $0.9 million of share-based compensation expense in the fourth quarter of 2013 in respect of vested options and restricted shares.
In addition, the Company recorded $1.0 million of expense in respect of IPO-related bonuses to certain employees. Such bonuses were partly subject to the closing of the IPO ($0.5 million) and partly subject to the Company's market capitalization exceeding an agreed upon level for at least 30 trading days within 24 months following its IPO ($0.5 million). As all conditions were met, the Company recorded the expense in the fourth quarter of 2013.
On March 5, 2014, the Company closed a registered public offering by certain selling shareholders of 5,403,685 ordinary shares at $28.00 per share, which included 704,828 shares purchased pursuant to the full exercise of the underwriters' option to purchase additional shares. The Company did not receive any proceeds from the sale of these shares. The Company recognized in the statement of operations and comprehensive income $0.4 million expenses in respect of such offering.
F - 15
ENZYMOTEC LTD.
NOTES TO FINANCIAL STATEMENTS (continued)
NOTE 3 - PROPERTY, PLANT AND EQUIPMENT
Composition of property and equipment grouped by major classifications is as follows:
December 31 | ||||||||
2014 | 2013 | |||||||
U.S. dollars in thousands | ||||||||
Manufacturing equipment | $ | 19,488 | $ | 17,993 | ||||
Buildings | 10,472 | 10,269 | ||||||
Laboratory equipment | 3,536 | 2,792 | ||||||
Land* | 951 | 951 | ||||||
Furniture, office equipment and computers | 1,272 | 1,082 | ||||||
Leasehold improvements | 161 | 161 | ||||||
Vehicles | 27 | 18 | ||||||
Advances on account of acquisition of machinery and equipment | 2,330 | 119 | ||||||
38,237 | 33,385 | |||||||
Less: accumulated depreciation and amortization | 8,963 | 7,021 | ||||||
29,274 | $ | 26,364 |
* Land includes long-term leasehold rights in Israel with useful lives of 98 years.
Depreciation and amortization expense totaled $1,941,000, $1,551,000 and $1,422,000 for the years ended December 31, 2014, 2013 and 2012, respectively.
NOTE 4 - JOINT COLLABORATION AGREEMENT
As described in Note 1, the Company has entered into a joint collaboration agreement with a Swedish vegetable oil company. The joint collaboration agreement's initial term ends on December 31, 2016. Thereafter the agreement will be automatically extended for consecutive periods of three years, unless terminated by a notice of either party at least 12 months prior to its expiration. Under the joint collaboration agreement and two related supply agreements entered into between the parties, the activities of the joint operations are allocated as follows:
The Company has the responsibility for production of the enzyme, research and development, marketing and business development activities. The Partner has responsibility for the supply chain (purchase and procurement of raw materials, managing stock, delivery and collection).
Advanced Lipids operates as a low risk distributor of the joint collaboration. The Company recognizes revenues from its sales to the Partner only upon sale by Advanced Lipids to its customers. As described in Note 1e, the Company accounts for its investment in Advanced Lipids using the equity method of accounting and recognizes its 50% proportionate share of the profit or loss of Advanced Lipids. For the years ended December 31, 2014, 2013 and 2012, sales of the Company through this joint collaboration amounted to $13,280,000, $16,666,000 and $8,183,000, respectively. At December 31, 2014 and 2013, the receivable balance was $2,321,000 and $5,370,000, respectively.
In May 2014, AAK submitted a request for arbitration against the Company seeking a declaration that the Company breached the confidentiality provisions of the agreement by disclosing confidential information of the joint venture in its registration statement for its IPO, as well as a declaration regarding the correct interpretation of certain provisions of the joint venture agreement. AAK's statement of claim does not state a measure of damages, seek termination of the joint venture agreement or seek to determine what harm, if any, was caused to AL or AAK. On December 12, 2014, the Company submitted its answer to AAK’s arbitration request rejecting AAK's allegations and including also a counter claim, in which the Company is seeking monetary damages from AAK due to various breaches of the joint collaboration agreement by AAK. On January 23, 2015, AAK submitted its statement of defense with respect to the Company's counterclaims. The arbitration hearing is scheduled for June 2015, and an award is expected by no later than December 31, 2015. The outcome of this arbitration is inherently uncertain. Any such proceedings could be disruptive to the joint venture’s activities and require significant attention from management.
F - 16
ENZYMOTEC LTD.
NOTES TO FINANCIAL STATEMENTS (continued)
NOTE 5 - SEGMENT INFORMATION:
a. | Segment information: |
The Chief Executive Officer ("CEO") is the Company’s chief operating decision-maker ("CODM"). At December 31, 2014, management has determined that there are two operating segments, based on the Company's organizational structure, its business activities and information reviewed by the CODM for the purposes of allocating resources and assessing performance.
Nutrition. This segment develops and manufactures lipid compositions and bioactive ingredients as ingredients for infant formula and dietary supplements, which are tailored to the special needs of the nutrition industry. These ingredients include InFat, a proprietary, clinically-proven infant formula fat ingredient that mimics human breast milk fat to facilitate healthy infant development and premium phospholipids-based bioactive ingredients for nutritional supplements. The best-selling product is krill oil, which provides the anti-aging benefits of Omega-3 fatty acids. Other products are targeted at improving brain health and providing benefits in memory, learning abilities and concentration.
The Nutrition Segment includes the results of Advanced Lipids and other activities performed at the Company level. For accounting purposes, the results of Advanced Lipids are recorded using the equity method of accounting. For management purposes, the results of Advanced Lipids are analyzed based on proportionate consolidation, which represents the Company's share (50%) of the gross results of Advanced Lipids.
VAYA Pharma. This segment develops, manufactures and sells branded lipid-based medical foods for the dietary management of medical disorders and common diseases. This is a research-based, specialty pharmaceutical segment, which currently offers medical foods products for the cardiovascular and neurological markets.
The CODM assesses the performance based on a measure of "Adjusted EBITDA" (earnings before financial expenses, tax, depreciation and amortization and excluding share-based compensation expenses and other unusual income or expenses).
The measure of assets has not been disclosed for each segment as it is not regularly provided to the CODM.
Segment data for the year ended December 31, 2014 is as follows:
Nutrition | Vaya Pharma | Total | Elimination*** | Consolidated | ||||||||||||||||
U.S. dollars in thousands | ||||||||||||||||||||
Net revenues from external customers | $ | 55,815 | $ | 5,641 | $ | 61,456 | $ | (14,353 | ) | $ | 47,103 | |||||||||
Cost of revenues* | 30,605 | 1,435 | 32,040 | (13,775 | ) | 18,265 | ||||||||||||||
Gross profit* | 25,210 | 4,206 | 29,416 | (578 | ) | 28,838 | ||||||||||||||
Operating expenses** | 13,347 | 6,957 | 20,304 | (3 | ) | 20,301 | ||||||||||||||
Depreciation and amortization | 2,112 | 196 | ||||||||||||||||||
Adjusted EBITDA | $ | 13,975 | $ | (2,555 | ) | |||||||||||||||
Share-based compensation expense | 852 | |||||||||||||||||||
Secondary offering expenses | 393 | |||||||||||||||||||
Operating Income | $ | 7,292 | ||||||||||||||||||
Financial income - net | 499 | |||||||||||||||||||
Income before taxes on income | $ | 7,791 |
* | Including depreciation and amortization but excluding share based compensation expense. |
** | Including depreciation and amortization, but excluding share-based payment and Secondary offering expenses. |
*** | Representing the change from proportionate consolidation to the equity method of accounting. |
F - 17
ENZYMOTEC LTD.
NOTES TO FINANCIAL STATEMENTS (continued)
NOTE 5 - SEGMENT INFORMATION (continued):
Segment data for the year ended December 31, 2013 is as follows:
Nutrition | Vaya Pharma | Total | Elimination** | Consolidated | ||||||||||||||||
U.S. dollars in thousands | ||||||||||||||||||||
Net revenues from external customers | $ | 76,167 | $ | 4,444 | $ | 80,611 | $ | (15,636 | ) | $ | 64,975 | |||||||||
Cost of revenues* | 45,804 | 1,255 | 47,059 | (14,981 | ) | 32,078 | ||||||||||||||
Gross profit* | 30,363 | 3,189 | 33,552 | (655 | ) | 32,897 | ||||||||||||||
Operating expenses* | 13,009 | 6,020 | 19,029 | 19,029 | ||||||||||||||||
Depreciation and amortization | 1,415 | 136 | ||||||||||||||||||
Adjusted EBITDA | $ | 18,769 | $ | (2,695 | ) | |||||||||||||||
IPO related bonus | 1,000 | |||||||||||||||||||
Share-based compensation expense | 1,109 | |||||||||||||||||||
Operating Income | $ | 11,759 | ||||||||||||||||||
Financial expenses - net | (531 | ) | ||||||||||||||||||
Income before taxes on income | $ | 11,228 |
* | Including depreciation and amortization but excluding share based compensation expense and IPO related bonus. |
** | Representing the change from proportionate consolidation to the equity method of accounting. |
Segment data for the year ended December 31, 2012 is as follows:
Nutrition | Vaya Pharma | Total | Elimination** | Consolidated | ||||||||||||||||
U.S. dollars in thousands | ||||||||||||||||||||
Net revenues from external customers | $ | 44,380 | $ | 1,832 | $ | 46,212 | $ | (8,345 | ) | $ | 37,867 | |||||||||
Cost of revenues* | 27,297 | 588 | 27,885 | (8,087 | ) | 19,798 | ||||||||||||||
Gross profit* | 17,083 | 1,244 | 18,327 | (258 | ) | 18,069 | ||||||||||||||
Operating expenses* | 7,850 | 4,637 | 12,487 | 12,487 | ||||||||||||||||
Depreciation and amortization | 1,304 | 118 | ||||||||||||||||||
Adjusted EBITDA | $ | 10,537 | $ | (3,275 | ) | |||||||||||||||
Share-based compensation expense | 267 | |||||||||||||||||||
Operating income | 5,315 | |||||||||||||||||||
Financial expenses - net | (539 | ) | ||||||||||||||||||
Income before taxes on income | $ | 4,776 |
* | Including depreciation and amortization but excluding share based compensation expense. |
** | Representing the change from proportionate consolidation to the equity method of accounting. |
F - 18
ENZYMOTEC LTD.
NOTES TO FINANCIAL STATEMENTS (continued)
NOTE 5 - SEGMENT INFORMATION (continued):
b. | Entity wide information: |
1) | Net revenues by geographic location were as follows: |
Year ended December 31 | ||||||||||||
2014 | 2013 | 2012 | ||||||||||
U.S. dollars in thousands | ||||||||||||
North America | $ | 25,810 | $ | 35,458 | $ | 17,487 | ||||||
Europe | 10,395 | 10,382 | 6,828 | |||||||||
Australia | 2,388 | 10,811 | 11,763 | |||||||||
Asia | 7,019 | 7,735 | 1,497 | |||||||||
Israel | 1,491 | 589 | 292 | |||||||||
Total revenues | $ | 47,103 | $ | 64,975 | $ | 37,867 |
2) | Substantially all of the Company's long lived assets are located in Israel. |
3) | Revenues from sales of three products out of the Nutrition Segment, which exceed 10% of total revenues, are as follows: |
Year ended December 31 | ||||||||||||
2014 | 2013 | 2012 | ||||||||||
U.S. dollars in thousands | ||||||||||||
Krill oil | $ | 19,131 | $ | 34,926 | $ | 18,841 | ||||||
InFat | $ | 13,280 | $ | 16,666 | $ | 8,183 | ||||||
Sharp PS | $ | 5,505 | $ | 5,248 | $ | 4,978 |
4) | Net revenues from single customers out of the Nutrition Segment that exceed 10% of total net revenues in the relevant year: |
Year ended December 31 | ||||||||||||
2014 | 2013 | 2012 | ||||||||||
U.S. dollars in thousands | ||||||||||||
Customer A | $ | 1,958 | $ | 7,692 | $ | 9,426 | ||||||
Customer B | $ | 1,471 | $ | 9,833 | $ | 595 |
NOTE 6 - INVENTORIES
December 31 | ||||||||
2014 | 2013 | |||||||
U.S. dollars in thousands | ||||||||
Raw materials and supplies | $ | 12,240 | $ | 6,550 | ||||
In-process inventories | $ | 6,644 | $ | 3,790 | ||||
Finished goods | $ | 2,688 | $ | 1,603 | ||||
$ | 21,572 | $ | 11,943 |
F - 19
ENZYMOTEC LTD.
NOTES TO FINANCIAL STATEMENTS (continued)
NOTE 7 – BORROWINGS
In September 2009, the Company entered into a financing agreement (the "Financing Agreement") with a bank (the "Bank"), which amounted to $10.6 million and was comprised of $7 million long-term loans and $3.6 million short term credit line for financing of working capital. The short-term credit line expired on December 31, 2013.
In February 2010, the Company entered into an interest rate swap agreement, in respect of $5.6 million principal amount long-term loan, with a third party to change the interest from floating rate to fixed rate . The above transaction was qualified for cash flows hedge accounting.
In December 2013, the Company notified the Bank that it was exercising its right for early repayment of the entire loan ($4.2 million at December 31, 2013). Accordingly, the loan was classified as a current maturity and the interest rate swap transaction no longer qualified for cash flows hedge accounting. As a result, the Company recorded $282,000 of financial expenses in the fourth quarter of 2013, representing the fair value of the cash flow hedge transaction mentioned above and the early repayment fee. The loan was repaid in full at January 31, 2014. Following the early repayment of the loan, the Company has removed all charges and liens, as well as financial covenants, in respect of the loan.
NOTE 8 - EMPLOYEE RIGHTS UPON RETIREMENT
The Company is required to make severance payments with respect to its Israeli employees upon dismissal of an employee or upon termination of employment in certain circumstances.
In accordance with the current employment agreements with most of its Israeli employees, the Company makes regular deposits with certain insurance companies for accounts controlled by each applicable employee in order to secure the employee’s retirement benefit obligation. The Company is fully relieved from any severance pay liability with respect to each such employee after it makes the payments on behalf of the employee. The liability accrued in respect of these employees and the amounts funded, as of the respective agreement dates, are not reflected in the Company’s consolidated balance sheets, as the amounts funded are not under the control and management of the Company and the pension or severance pay risks have been irrevocably transferred to the applicable insurance companies (the “Contribution Plan”).
With regard to the employees without a Contribution Plan, the liability is funded in part by the purchase of insurance policies or by the establishment of pension funds with dedicated deposits in the funds. These policies are the Company's assets. The severance payment liability to the employees (based upon length of service and the latest monthly salary - one month’s salary for each year of employment) is recorded on the Company's balance sheets under “retirement benefits obligation”. The liability is recorded as if it was payable at each balance sheet date on an undiscounted basis. In the years ended December 31, 2014, 2013 and 2012, the Company deposited $147,000, $156,000 and $139,000, respectively, with insurance companies and pension funds in connection with its severance payment obligations.
The amounts of severance payment expenses were $392,000, $506,000 and $284,000 for the years ended December 31, 2014, 2013 and 2012, respectively, of which $312,000, $230,000 and $145,000 in the years ended December 31, 2014, 2013 and 2012, respectively, were in respect of the Contribution Plan and funded accordingly. Gains (losses) on the amounts funded in insurance companies and pension funds, in respect of retirement benefit obligation totaled ($78,000), $154,000 and $74,000 for the years ended December 31, 2014, 2013 and 2012, respectively.
The Company expects to contribute approximately $490,000 in the year ending December 31, 2015 to insurance companies in connection with its severance liabilities for its operations for that year, $335,000 of which will be contributed to a Contribution Plan.
F - 20
ENZYMOTEC LTD.
NOTES TO FINANCIAL STATEMENTS (continued)
NOTE 9 - COMMITMENTS AND CONTINGENCIES:
a. | Operating leases |
As of December 31, 2014, minimum future rentals under operating leases of office space, machinery and equipment and vehicles for periods in excess of one year amounted to $1,337,000 and were to be paid as follows: 2015 - $592,000; 2016 - $483,000; 2017 - $176,000; 2018 - $71,000; 2019 – $15,000. The lease expenses in each of the years ended December 31, 2014, 2013 and 2012 were $868,000, $452,000 and $355,000, respectively.
b. | Marketing and distribution agreements |
The Company has entered into marketing and distribution agreements with commercial entities with respect to its products. Under the terms of the agreements, the distributors have received rights to distribute the products in a defined territory and for various periods.
c. | Toll manufacturing agreement |
The Company has entered into a 10 year toll manufacturing agreement with respect to one of its products. Under the terms of the agreement, the Company has committed for minimum purchasing through the term of the agreement. The Company can terminate the agreement with a 90 day notice, subject to payment of termination payment which is based on a fixed amount of up to $500,000 reduced by actual purchasing before termination.
d. | Joint Venture ("JV") agreement |
On December 4, 2013, the Company signed a JV agreement with Polar Omega A/S ("Polar"), a Danish company specializing in the production of marine phospholipids from sustainable fish sources for the commercialization of Omega PC™, a new premium fish based omega-3 product. Under the agreement, the Company will be responsible for global sales and marketing, research and development, and for the intellectual property regarding Omega PC™. Polar will be responsible for supply chain, including sourcing of raw materials and manufacturing Omega PC™. The parties are currently discussing the termination of the joint venture.
e. | Royalties: |
1) | The Company is committed to pay royalties to the Office of the Chief Scientist of the Israeli Ministry of Economy (the "Chief Scientist"); the royalties are computed based on the Company’s net revenues arising from know-how in the research and development in which the Chief Scientist participated by way of grants. Under the terms of the Company’s funding from the Chief Scientist, royalties of 3%-5% are payable on sales of products developed from a project so funded, up to 100% of the amount of the grant received by the Company (dollar linked with the addition of annual interest at LIBOR rate). At the time the grants were received, successful development of the related projects was not assured. In the case of failure of a project that was partly financed by royalty-bearing Government grants, the Company is not obligated to pay any such royalties to the Israeli Government. At December 31, 2014, the maximum royalty amount payable (including interest) by the Company is approximately $3.1 million. |
2) | In 2001, the Company and a third party (the U.S. Partner) entered into an agreement for the development, manufacture and supply of a new product. The development of this product was funded by BIRD – Israel-U.S. Binational Industrial Research and Development Foundation (the "BIRD Foundation"). The Company is committed to pay royalties to the BIRD Foundation which are computed based on the Company’s net revenues from sale of products in the development of which the BIRD Foundation participated. |
The U.S. Partner has terminated the research project and the BIRD Foundation gave its consent to the termination as above. Therefore, the Company is not expected to derive any revenues from the said research; however, in case such revenues shall arise to the Company, the maximum royalty amount payable by the Company is $ 370,000 as of December 31, 2014.
F - 21
ENZYMOTEC LTD.
NOTES TO FINANCIAL STATEMENTS (continued)
NOTE 9 - COMMITMENTS AND CONTINGENCIES (continued):
3) | Royalty expenses for the years ended December 31, 2014, 2013 and 2012 were recorded in cost of revenues and amounted to $115,000, $101,000 and $40,000, respectively. |
f. | Litigation: |
1) | The Company was a party to a number of actions initiated by Neptune Technologies & Bioressources Inc., ("Neptune"), in which Neptune has claimed that the Company's krill oil products infringe certain of its patents, namely U.S. Patent Nos. 8,030,348, 8,278,351 and 8,383,675, ( the "348 patent", the "351 patent" and the "675 patent", respectively). The complaints asserting each of these patents were filed against the Company and certain other parties in the United States District Court for the District of Delaware, (the "District Court"), in October 2011, October 2012 and February 2013, respectively. In each of the complaints, Neptune sought both permanent injunctions prohibiting the Company from making or selling the allegedly infringing products and an unspecified amount of monetary damages against the Company and the other defendants. The Company has agreed to indemnify and be financially responsible for any damages awarded against certain of its customers resulting from the purchase, importation, sale or use of the Company's products in the event such products are found to infringe certain of Neptune's patent rights. |
Additionally, in April 2013, the Company received a notice of an investigation by the United States International Trade Commission, ("ITC"), regarding complaints filed before the ITC by Neptune and its subsidiary, Acasi Pharma Inc. Neptune and its subsidiaries instituted these complaints against the Company and certain of Neptune’s other principal competitors in the United States alleging a violation of section 337 of the Tariff Act of 1930 by reason of alleged infringement of the 351 patent and the 675 patent.
On April 27, 2014, the Company signed a settlement agreement with Neptune (the "Settlement Agreement"). Pursuant to the Settlement Agreement, the Neptune patent litigations were dismissed with prejudice on May 2, 2014 and the ITC action was terminated on June 12, 2014. Under the Settlement Agreement, the Company received a worldwide non-exclusive license to the entire "348 patent family" for as long as any patent in that family exists, for all of the Company's relevant current products and future anticipated products under development in consideration of a one-time upfront payment to Neptune. This payment is recorded as intangible asset, which is being amortized over the life of the "348 patent family". Any further payments to Neptune depend upon the outcome of (1) Inter Partes Review (“IPR”) proceedings in the U.S. Patent Office (“USPTO”) of certain agreed claims of the "351 Patent" and (2) a potential Australian post-grant reexamination of certain agreed claims of Neptune’s Australian Patent AU2002322233.
With respect to the "351 patent", on March 2014, the USPTO issued a decision instituting an IPR of the agreed claims of the "351 patent" filed by Aker BioMarine AS (“Aker”), concluding that there is reasonable likelihood that Aker will prevail in demonstrating unpatentability of those claims. On July 9, 2014, the USPTO issued a decision instituting the Company’s IPR of the agreed claims of the "351 patent" and granted the Company’s motion to join the Company’s IPR with Aker’s IPR. The "351 patent" is also the subject of an ex parte reexamination, which has been stayed pending the outcome of Aker’s 351 IPR. Prior to the reexamination being stayed, the Patent Office rejected all claims of the "351 patent" in a January 2, 2014 office action. That action is not final and Neptune will have an opportunity to respond once the stay is lifted. Management believes that it is not probable that Aker and/or the Company will lose their IPR proceedings, and that the USPTO will find the agreed claims of the "351 patent" to be valid. Accordingly, the Company has not included any provision in its financial statements for these claims.
F - 22
ENZYMOTEC LTD.
NOTES TO FINANCIAL STATEMENTS (continued)
NOTE 9 - COMMITMENTS AND CONTINGENCIES (continued):
With respect to Neptune’s Australian Patent AU2002322233, on September 30, 2014, pursuant to the terms of the Settlement Agreement, an arbitrator selected the agreed claims of Neptune’s Australian Patent AU200232223. Under the terms of the Settlement Agreement, the Company submitted its post-grant reexamination to the Australian Patent Office ("APO") on December 12, 2014. On January 28, 2015, the APO issued a reexamination report, finding that all the agree claims lack novelty. Neptune has until March 28, 2015 to overcome the examiner’s objections, either by argument or amendment. If Neptune does not do so, the APO may begin proceedings for revocation of the Australian Patent.
2) | In March 2013, a claim was filed against the Company in the Haifa District Court, Israel, seeking a finder’s fee in connection with funds invested in the Company by one of its investors (the "Claim"). |
The Claim is based upon an agreement, dated March 2000, between the Company and the plaintiff, pursuant to which the Company agreed to pay him a finder’s fee, should he introduce the Company to an investor who would invest an amount in excess of $500,000 in the Company. In previous litigation between the Company and the plaintiff concerning this agreement, the plaintiff claimed to have been entitled to finder's fee in respect of an investment made by an investor in the Company, although the investment materialized more than a year later. This previous claim was adjudicated in his favor and the Company paid him a fee of $75,000.
In the present Claim, the plaintiff alleges that he is entitled to an additional finder’s fee in the amount of NIS 6.2 million (approximately $1.8 million) in connection with the multiple investments made by the same investor over the past 11 years. In May 2014, the parties signed an agreement, under which the Company paid the plaintiff a fee of $78,000 as full and final settlement for all claims.
3) | On September 5, 2014 and September 30, 2014, two stockholders filed class action complaints in the United States District Court for the District of New Jersey purportedly on behalf of all persons who acquired the Company's securities in its IPO or between September 27, 2013 and August 4, 2014. The lawsuits name as defendants the Company, its directors, certain of its officers and the underwriters of its initial public offering and assert claims under the United States federal securities laws. On February 11, 2015, the Court consolidated the cases as In re Enzymotec Ltd. Securities Litigation, Master File No. 14-CV-05556 though a schedule for an amended complaint and responses thereto has not yet been set. The Company believes that the lawsuits are without merit and intends to defend itself vigorously. Management believes an estimate of the likelihood that the Company might incur financial loss as a result of this litigation, as required by ASC 450-20-50-4, "Contingencies", cannot be made at this time, given the early stage of these lawsuits. Accordingly, the Company has not included any provision in its consolidated financial statements for this claim. Under the underwriting agreement, the Company is obligated to provide indemnification to the underwriters in connection with legal proceedings, as defined in the agreement. |
4) | As to arbitration with AAK, see Note 4. |
F - 23
ENZYMOTEC LTD.
NOTES TO FINANCIAL STATEMENTS (continued)
NOTE 10 - SHAREHOLDERS' EQUITY
a. | Share capital: |
1) | On September 2, 2013, the Company's shareholders approved an increase in its authorized share capital to an aggregate of NIS 1 million divided into 100 million ordinary shares. On September 12, 2013, the Company effected a bonus share distribution under which: (i) 67 bonus shares were issued for each share outstanding prior to such distribution; and (ii) the conversion rate for each preferred share, option and warrant was adjusted to reflect such bonus share distribution. |
2) | Ordinary shares |
The ordinary shares confer upon their holders voting rights and the right to participate in shareholders' meetings (the holders of shares of NIS 0.01 par values are entitled to one vote per share), the right to receive profits and the right to share in excess assets upon liquidation of the Company.
3) | Preferred shares |
Until the closing of the IPO (see Note 2), the A, B, B1 and B2 preferred shares conferred upon their holders voting rights similar to the ordinary shares and the right to participate in dividends in priority to holders of ordinary shares. In addition, the holders of preferred shares had additional preferential rights including liquidation, conversion and other rights as defined. Upon the closing of the IPO, all outstanding preferred shares were converted into ordinary shares and accordingly the former preferred shareholders are no longer entitled to such preferential rights.
4) | Share Purchase Agreement ("SPA") |
In September 2011, the Company signed an SPA with certain of its shareholders. Following this SPA and certain amendments signed by the Company, certain shareholders invested in the Company, during the years 2011 through 2013, a total of $12.5 million in exchange for Series B2 Preferred shares NIS 0.01 par value and at a price per share equal to $5.34.
In addition, the Company issued to each of the investors warrants to purchase additional Series B2 Preferred shares amounting to 20% of the number of Series B2 Preferred shares purchased by them as part of the investment round.
Upon the closing of the IPO (see Note 2), all warrants issued to the Company’s former preferred shareholders were exercised for preferred shares on a cashless and non-cashless basis, in consideration of $1.3 million, with respect to the non-cashless exercise only. The underlying preferred shares subsequently converted into ordinary shares.
b. | Option plans |
In 2001, 2003 and 2013 the Company’s Board of Directors approved option plans for employees, directors and service providers (the "Plans"). Through December 31, 2014, the Company granted as part of the Plans 4,491,361 options and 442,829 restricted shares (see c. below) to employees, directors and service providers. Each option is exercisable into one ordinary share of NIS 0.01 par value. On December 31, 2014, 67,772 shares were available for issuance upon grants of options or restricted shares under the Plans.
From the effective date of grant, options generally vest over a 4-year period 25% each year. Immediately upon exercise, the ordinary shares issued will have the same rights as all other ordinary shares. In general, any option not exercised within 10 years from the grant date or within three months from the termination of employment will expire, unless extended by the Board of Directors.
F - 24
ENZYMOTEC LTD.
NOTES TO FINANCIAL STATEMENTS (continued)
NOTE 10 - SHAREHOLDERS' EQUITY (continued):
The Plans with respect to Israeli employees are intended to be governed by the terms stipulated by Section 102 of the Israeli Income Tax Ordinance. In accordance with the capital gain track chosen by the Company and pursuant to the terms thereof, the Company is not allowed to claim, as an expense for tax purposes, the amounts credited to employees as a benefit, including amounts recorded as salary benefits in the Company’s accounts, in respect of options granted to employees under the Plan - with the exception of the work-income benefit component, if any, determined on the grant date. Options granted to employees from other countries are subject to similar terms with certain changes required for local regulations.
The fair value of options granted during the years ended December 31, 2014, 2013 and 2012 was $3.57, $2.02 and $0.23, respectively.
The fair value of each option granted is estimated on the date of grant using the binomial option-pricing model, with the following assumptions:
Year ended December 31 | ||||||||||||
2014 | 2013 | 2012 | ||||||||||
Dividend yield | 0 | % | 0 | % | 0 | % | ||||||
Expected volatility | 71 | % | 67 | % | 60 | % | ||||||
Risk-free interest rate | 2.44 | % | 1.8 | % | 2.2 | % | ||||||
Contractual term | 10 years | 10 years | 10 years | |||||||||
Early exercise multiple | 178%-203 | % | 215% -246 | % | 218% -229 | % |
The expected volatility is based on the historical volatility of comparable companies. The risk-free interest rate assumption is derived from the interest curve for U.S. government bonds for periods corresponding to the life term of the option on the grant date. The early exercise multiple was based on data of comparable companies.
The total unrecognized compensation cost of options granted to employees, directors and service providers (not including compensation cost in respect of restricted shares, see d. below) at December 31, 2014 is $1,720,000 which is expected to be recognized over a period of 3.6 years.
A summary of share option plans (excluding restricted shares information, see d. below), and related information, under all of the Company’s equity incentive plans for the years ended December 31, 2014, 2013 and 2012 are as follows:
Options granted to employees, directors and service providers:
Year ended December 31 | ||||||||||||||||||||||||
2014 | 2013 | 2012 | ||||||||||||||||||||||
Number of shares upon exercise | Weighted average exercise price* | Number of shares upon exercise | Weighted average exercise price* | Number of shares upon exercise | Weighted average exercise price* | |||||||||||||||||||
Outstanding at the beginning of the year | 1,967,784 | 2.51 | 1,866,940 | 2.13 | 1,789,760 | 2.08 | ||||||||||||||||||
Granted | 554,433 | 13.76 | 174,420 | 6.02 | 168,980 | 3.12 | ||||||||||||||||||
Exercised | (908,169 | ) | 1.94 | (47,940 | ) | 0.15 | ||||||||||||||||||
Forfeited | (26,436 | ) | 9.73 | (25,636 | ) | 3.12 | (91,800 | ) | 3.12 | |||||||||||||||
Outstanding at the end of the year | 1,587,612 | 6.64 | 1,967,784 | 2.51 | 1,866,940 | 2.13 | ||||||||||||||||||
Exercisable at the end of the year | 1,039,011 | 2.87 | 1,747,532 | 2.29 | 1,335,112 | 1.74 |
* In dollars per share.
F - 25
ENZYMOTEC LTD.
NOTES TO FINANCIAL STATEMENTS (continued)
NOTE 10 - SHAREHOLDERS' EQUITY (continued):
The following table summarizes information concerning outstanding and exercisable options as of December 31, 2014:
Options outstanding | Options exercisable | |||||||||||||||||||||||||
Shares | ||||||||||||||||||||||||||
Shares upon | Aggregate | upon | Aggregate | |||||||||||||||||||||||
exercise of | Weighted | intrinsic | exercise of | Weighted | intrinsic | |||||||||||||||||||||
options | average | value | options | average | value | |||||||||||||||||||||
outstanding | remaining | (U.S. | outstanding | remaining | (U.S. | |||||||||||||||||||||
Exercise | at end of | contractual | dollars in | at end of | contractual | dollars in | ||||||||||||||||||||
prices * | year | life | thousands) | year | life | thousands) | ||||||||||||||||||||
0.0001 | 77,870 | 2.49 | 595 | 77,870 | 2.49 | 595 | ||||||||||||||||||||
1.47 | 193,800 | 3.62 | 1,196 | 193,800 | 3.62 | 1,196 | ||||||||||||||||||||
3.12 | 637,941 | 6.01 | 2,883 | 637,941 | 6.01 | 2,883 | ||||||||||||||||||||
5.34 | 126,000 | 8.27 | 290 | 126,000 | 8.27 | 290 | ||||||||||||||||||||
13.76 | 538,401 | 9.62 | - | - | - | - | ||||||||||||||||||||
14 | 13,600 | 8.76 | - | 3,400 | 8.76 | - | ||||||||||||||||||||
1,587,612 | 6.97 | 4,964 | 1,039,011 | 5.58 | 4,964 |
* In dollars per share
The aggregate intrinsic value in the above table represents the total pre-tax intrinsic value, based on the Company's closing share price of $7.64 on December 31, 2014, less the exercise price. This represents the potential amount receivable by the option holders had all option holders exercised their options as of such date.
c. | Restricted shares and restricted share units |
In August 2013, the Company's Board of Directors approved a grant of 156,060 restricted shares to the current chairman of the Board of Directors. The restricted shares are subject to vesting over four years commencing on March 31, 2013 and to other vesting milestones as follows: (i) the vesting of 104,040 restricted shares is subject to the occurrence of a change of control event, as defined; and (ii) the vesting of 52,020 restricted shares is subject to: (a) the occurrence of a change of control event, as defined and (b) the achievement of a market cap milestone, as defined. Following the closing of the IPO, the change in control event occurred and accordingly, the 104,040 restricted shares will vest according to their vesting schedule. In addition, the market cap milestone was met after year-end and the 52,020 restricted shares will vest according to their vesting schedule. The fair value of restricted shares is estimated based on the market value of the Company's stock on the date of award. The Company recorded an expense of $412,000 and $377,000 for the years ended December 31 2014 and 2013, respectively in respect of such restricted shares. The total unrecognized compensation expense in respect of such restricted shares is $926,000, which is expected to be recognized over a period of 2.25 years.
In November 2013, in connection with the closing of the IPO, the Company's Board of Directors approved a grant of 9,520 fully vested restricted shares to the previous vice chairman of the Board of Directors. The Company recorded an expense of $294,000 in the fourth quarter of 2013 in respect of such restricted shares. Such shares were issued in January 2014.
In August 2014, the Company's Board of Directors approved a grant of 277,249 restricted share units to the Company's employees. The restricted share units are subject to vesting over four years commencing on August 15, 2014. The fair value of these restricted share units is estimated based on the market value of the Company's stock on the date of award. The Company recorded an expense of $170,000 in the year ended December 31, 2014 in respect of such restricted share units. The total unrecognized compensation expense in respect of such restricted shares units is $1,585,000, which is expected to be recognized over a period of 3.6 years.
F - 26
ENZYMOTEC LTD.
NOTES TO FINANCIAL STATEMENTS (continued)
NOTE 10 - SHAREHOLDERS' EQUITY (continued):
A summary of restricted share units' information for the year ended December 31, 2014:
Year ended December 31 | ||||
2014 | ||||
Number of restricted share units upon exercise | ||||
Outstanding at the beginning of the year | - | |||
Granted | 277,249 | |||
Forfeited | (8,018 | ) | ||
Outstanding at the end of the year | 269,231 | |||
Vested at the end of the year | - |
d. | Share based compensation expense: |
The following table illustrates the effect of share-based compensation (including restricted shares and restricted share units information) expense on the consolidated statement of operations and comprehensive income:
Year ended December 31 | ||||||||||||
2014 | 2013 | 2012 | ||||||||||
U.S. dollars in thousands | ||||||||||||
Cost of revenues | $ | 51 | $ | 32 | $ | 17 | ||||||
Research and development expenses -net | 103 | 56 | 60 | |||||||||
Selling and marketing expenses | 146 | 77 | 40 | |||||||||
General and administrative expenses | 552 | 944 | 150 | |||||||||
$ | 852 | $ | 1,109 | $ | 267 |
e. | Accumulated other comprehensive loss: |
December 31 | ||||||||
2014 | 2013 | |||||||
U.S. dollars in thousands | ||||||||
Unrealized loss on marketable securities | $ | (125 | ) | |||||
Currency translation adjustment | (177 | ) | $ | 25 | ||||
Unrealized gain (loss) from cash flow hedge* | 238 | (90 | ) | |||||
$ | (64 | ) | $ | (65 | ) |
* | In the year ended December 31, 2013, amount of $261,000 in respect of unrealized loss from cash flow hedge was reclassified from accumulated other comprehensive loss into financial expenses. |
In the year ended December 31, 2014, amounts of $60,000 and $470,000 in respect of unrealized gain (loss) from cash flow hedge were reclassified from accumulated other comprehensive income into financial income and revenues, respectively.
F - 27
ENZYMOTEC LTD.
NOTES TO FINANCIAL STATEMENTS (continued)
NOTE 11 - TAXES ON INCOME:
a. | The Company |
The Company is taxed according to Israeli tax laws:
1) Measurement of results for tax purposes
As explained in Note 1c, the dollar is the functional currency of the Company, and the Company's consolidated financial statements are presented in dollars. The difference between the changes in the Israeli shekel ("NIS") and the exchange rate of the dollar, both on an annual and a cumulative basis causes a difference between taxable income and income reflected in these consolidated financial statements.
ASC 740-10-25, "Income Taxes", prohibits the recognition of deferred tax liabilities or assets that arise from differences between the financial reporting and tax bases of assets and liabilities that are premeasured from the local currency into dollars using historical exchange rates, and that result from changes in exchange rates or indexing for tax purposes. Consequently, the abovementioned differences were not reflected in the computation of deferred tax assets and liabilities.
Starting in the year ended December 31, 2014, the Company elected to compute its taxable income in accordance with Income Tax Regulations (Rules for Accounting for Foreign Investors Companies and Certain Partnerships and Setting their Taxable Income), 1986. Accordingly, the taxable income or loss is calculated in dollars. Applying these regulations reduces the effect of dollar-NIS exchange rate on the Company’s Israeli taxable income.
2) Tax rates
The income of the Company (other than income from "Approved Enterprise" or "Benefited Enterprise", see 3. below) is taxed at the regular corporate tax rate. On December 6, 2011, the "Tax Burden Distribution Law" Legislation Amendments (2011) was published. Under this law, the corporate tax rate was set at 25% as from 2012 and thereafter. On August 5, 2013, the Law for Change of National Priorities (Legislative Amendments for Achieving the Budgetary Goals for 2013-2014), 2013 was published. Under this law, the corporate tax rate was raised to 26.5% beginning in 2014 and thereafter.
3) | Tax benefits under the Law for the Encouragement of Capital Investments, 1959 (the "Investment Law") |
Under the Investment Law, including Amendment No. 60 to the Investment Law that was published in April 2005, by virtue of the Approved Enterprise or Benefited Enterprise status granted to certain of its production facilities the Company is entitled to various tax benefits.
The main benefit arising from such status is the reduction in tax rates on income derived from an Approved Enterprise. Income derived from Approved or Benefited Enterprises is tax exempt for a period of up to ten years period of benefits. The period of tax benefits, as described above, is subject to limitations of the earlier of 12 years from the commencement of production, or 14 years from the date of approval. As of December 31, 2014, the period of benefits has not yet commenced.
In the event of distribution of cash dividends from income which was tax exempt as above, the amount distributed will be subject to the tax rate it was exempted from.
The Company is entitled to claim accelerated depreciation in respect of equipment used by the Approved or Benefited Enterprises during five tax years.
F - 28
ENZYMOTEC LTD.
NOTES TO FINANCIAL STATEMENTS (continued)
NOTE 11 - TAXES ON INCOME (continued):
Entitlement to the above benefits is conditioned upon the Company fulfilling the conditions stipulated by the Investment Law and regulations published thereunder, and in the certificate of approval for the specific investments in Approved Enterprises. In the event of failure to comply with these conditions, the benefits may be canceled and the Company may be required to refund the amount of the benefits, in whole or in part, with the addition of linkage differences to the Israeli consumer price index and interest.
4) | Amendment of the Investment Law |
Under an amendment 68 to the Investment Law (“Amendment 68”), a uniform corporate tax rate will apply to all qualifying industrial income of such company
(“Industrial Company”), as opposed to the previous law’s incentives, which were limited to income from Approved Enterprises during their benefits period. Under the law, when the election is made, the uniform tax rate (for 2014 and on) will be 9% in areas in Israel designated as Development Zone A.
The benefits are granted to companies that qualify under criteria set forth in the Investment Law; for the most part, those criteria are similar to the criteria that have existed in the Investment Law prior to its amendment and the benefit period is unlimited in time. Under the transitional provisions of the Investment Law, a company is allowed to continue to enjoy the tax benefits available under the Investment Law prior to its amendment until the end of the period of benefits, as defined in the Investment Law. In each year during the period of benefits of its Approved or Benefitted Enterprises, the Company will be able to opt for application of the Amendment, thereby making available to itself the tax rates as above. The Company's election to apply the Amendment is irrevocable.
As of December 31, 2014, the Company decided not to adopt the application of Amendment 68.
5) | Losses for tax purposes, carried forward to future years |
Carryforward tax losses of the Company at December 31, 2014, approximated $8.5 million.
b. | Non- Israeli Subsidiaries |
Subsidiaries that are incorporated outside of Israel are assessed for tax under the tax laws in their countries of residence. The principal tax rates (Federal and State) applicable to the subsidiaries incorporated in the U.S. is approximately 40%.
c. | Tax assessments |
The Company and its subsidiaries have not been assessed since incorporation. In accordance with the Israeli Income Tax Ordinance, tax assessments of the Company through tax year 2010 are considered final.
F - 29
ENZYMOTEC LTD.
NOTES TO FINANCIAL STATEMENTS (continued)
NOTE 11 - TAXES ON INCOME (continued):
d. | Income before income taxes is composed of the following: |
Year ended December 31 | ||||||||||||
2014 | 2013 | 2012 | ||||||||||
U.S. dollars In thousands | ||||||||||||
Israel | $ | 7,138 | $ | 10,414 | $ | 4,360 | ||||||
Non-Israeli subsidiaries | 653 | 814 | 416 | |||||||||
$ | 7,791 | $ | 11,228 | $ | 4,776 | |||||||
e. | Taxes on income - current - |
non-Israeli subsidiaries | $ | 406 | $ | 324 | $ | 180 |
f. | Uncertain tax positions |
As of December 31, 2014 and 2013, the Company had not accrued a provision for uncertain tax positions.
g. | Deferred income taxes |
Deferred taxes are computed using the tax rates expected to be in effect when those differences reverse. Since the Company is entitled to a tax exemption for a period of ten years, the tax rate used in computation of deferred taxes on its carry forward losses and timing differences is zero.
h. | Reconciliation of theoretical tax expense to actual tax expense: |
Year ended December 31 | ||||||||||||
2014 | 2013 | 2012 | ||||||||||
U.S. dollars in thousands | ||||||||||||
Income before taxes on income | $ | 7,791 | $ | 11,228 | $ | 4,776 | ||||||
Theoretical tax expenses (benefit) at the statutory rate (2014 – 26.5%; 2013 and 2012-25%) | 2,065 | 2,807 | 1,194 | |||||||||
Increase (decrease) in taxes on income due to: | ||||||||||||
Computation of deferred taxes at a rate, which is different than statutory rate | (1,314 | ) | (2,033 | ) | (1,157 | ) | ||||||
Difference between income reported for tax purposes and income for financial reporting purposes – mainly dollar – NIS differences and issuance costs | (675 | ) | (754 | ) | ||||||||
Non-deductible expenses- mainly share-based compensation expense | 256 | 183 | 74 | |||||||||
Different effective tax rates applicable to the subsidiaries | 74 | 121 | 69 | |||||||||
$ | 406 | $ | 324 | $ | 180 |
F - 30
ENZYMOTEC LTD.
NOTES TO FINANCIAL STATEMENTS (continued)
NOTE 12 - SUPPLEMENTARY FINANCIAL STATEMENT INFORMATION
December 31 | ||||||||
2014 | 2013 | |||||||
U.S. dollars in thousands | ||||||||
a. | Accounts receivable - other: |
Advance to supplier | $ | 128 | $ | 1,153 | ||||
Institutions | 1,126 | 1,065 | ||||||
Chief Scientist | 65 | 77 | ||||||
Fair value of derivatives | 905 | 1 | ||||||
Prepaid expenses and sundry | 886 | 442 | ||||||
$ | 3,110 | $ | 2,738 |
b. | Accounts payable and accruals - other: |
Employees and payroll related institutions | $ | 727 | $ | 2,470 | ||||
Provision for vacation and recreation pay | 402 | 426 | ||||||
Royalties payable | 93 | 57 | ||||||
Fair value of derivatives | 217 | 222 | ||||||
Accrued expenses and sundry | 2,130 | 3,203 | ||||||
$ | 3,569 | $ | 6,378 |
Year ended December 31 | ||||||||||||
2014 | 2013 | 2012 | ||||||||||
U.S. dollars in thousands | ||||||||||||
c. | Research and development expenses - net: |
Total expenses | $ | 6,131 | $ | 6,144 | $ | 4,876 | ||||||
Less - participation and grants | 145 | 197 | 265 | |||||||||
$ | 5,986 | $ | 5,947 | $ | 4,611 |
d. | Finance expenses - net: |
Interest expenses and other bank charges | $ | (139 | ) | $ | (595 | ) | $ | (657 | ) | |||
Interest income | 332 | 50 | ||||||||||
Foreign exchange gain (losses) – net | 276 | (82 | ) | (102 | ) | |||||||
Gain in respect of derivatives – net | 30 | 96 | 220 | |||||||||
$ | 499 | $ | (531 | ) | $ | (539 | ) |
NOTE 13 - FAIR VALUE MEASUREMENT
Financial items carried at fair value as of December 31, 2014 and 2013 are classified in the tables below in one of the three categories described in Note 1u:
December 31, 2014 | ||||||||
U.S. dollars in thousands | ||||||||
Level 1 | Level 2 | |||||||
Cash and cash equivalents - cash deposits | $ | 10,315 | ||||||
Marketable securities- debt securities | 37,230 | |||||||
Derivatives: | ||||||||
Interest rate swap (liabilities) | $ | (19 | ) | |||||
Forward contracts and currency options (current liabilities) designated as hedging instruments | (39 | ) | ||||||
currency options (current liabilities) | (159 | ) | ||||||
Forward contracts and currency options (current assets) designated as hedging instruments | 807 | |||||||
Currency options (current assets) | 98 | |||||||
$ | 47,545 | $ | 688 |
F - 31
ENZYMOTEC LTD.
NOTES TO FINANCIAL STATEMENTS (continued)
NOTE 13 - FAIR VALUE MEASUREMENT (Continued)
December 31, 2013 | ||||||||
U.S. dollars in thousands | ||||||||
Level 1 | Level 2 | |||||||
Cash and cash equivalents - | ||||||||
cash deposits | $ | 74,430 | ||||||
Derivatives: | ||||||||
Interest rate swap (current liabilities) | $ | (132 | ) | |||||
Forward contracts (current liabilities) designated as hedging instruments | (90 | ) | ||||||
Forward contracts and currency options (current assets) | 1 | |||||||
$ | 74,430 | $ | (221 | ) |
Foreign exchange risk management
The Company enters into forward exchange contracts in non-functional currencies and purchases and writes non-functional currency options in order to hedge the currency exposure on identifiable balance sheet items. In addition, the Company takes steps to reduce exposure by using “natural” hedging. The currency hedged items are usually denominated in NIS. The writing of options is part of a comprehensive currency hedging strategy. These transactions are for periods of less than one year. The counterparties to the derivatives is comprised of major banks and, in view of the current financial environment, the Company is monitoring the associated inherent credit risks. The above transactions do not qualify for hedge accounting.
In December 2014 and 2013, the Company entered into forward exchange contracts in respect of forecasted sales transactions at a notional amount of €7.6 million and €11.2 million, respectively (approximately $9.2 million at December 31, 2014).
Such transactions were entered into to reduce the exposure from sales denominated in euros. These transactions qualify for cash flow hedge accounting.
NOTE 14- MARKETABLE SECURITIES
a. | Available-for-sale securities |
Available-for-sale securities are comprised of debt securities.
As of December 31, 2014 the fair value, amortized cost and gross unrealized holding gains and losses of such securities are as follows:
Fair value | Amortized cost | unrealized holding gains | unrealized holding losses | |||||||||||||
U.S. dollars in thousands | ||||||||||||||||
December 31, 2014 | 37,230 | 37,355 | 32 | 157 |
Investments in marketable securities are classified based on the remaining period until maturity.
F - 32
ENZYMOTEC LTD.
NOTES TO FINANCIAL STATEMENTS (continued)
NOTE 14- MARKETABLE SECURITIES (Continued)
b. | Contractual maturities |
The contractual maturities of debt securities are as follows:
December 31, 2014 | ||||
U.S. dollars in thousands | ||||
2015 | $ | 1,943 | ||
2016 | 6,047 | |||
2017 | 18,011 | |||
2018 and thereafter | 11,229 | |||
$ | 37,230 |
NOTE 15 - RELATED PARTIES:
Year ended December 31 | ||||||||||||
2014 | 2013 | 2012 | ||||||||||
U.S. dollars in thousands | ||||||||||||
Directors’ fees | $ | 246 | $ | 143 | $ | 21 |
At December 31, 2014, there were 141,966 options outstanding with an average exercise price of $4.16 that were granted to directors. At December 31, 2014, 131,766 out of these options were exercisable. As to restricted shares granted to the Chairman and the previous Vice Chairman of the Board of Directors, see Note 10c.
NOTE 16 - EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted earnings per share for the years indicated (in thousands, except per share amounts):
Year ended December 31 | ||||||||||||
2014 | 2013 | 2012 | ||||||||||
Basic earnings per share: | ||||||||||||
Net income | $ | 7,838 | $ | 11,395 | $ | 4,782 | ||||||
Amount allocated to participating preferred shareholders | (6,439 | ) | (3,798 | ) | ||||||||
Net income applicable to ordinary shareholders –basic | $ | 7,838 | $ | 4,956 | $ | 984 | ||||||
Weighted average ordinary shares outstanding | 21,902,057 | 7,544,387 | 2,996,624 | |||||||||
Basic earnings per share | $ | 0.36 | $ | 0.66 | $ | 0.33 | ||||||
Diluted earnings per share: |
Net income applicable to ordinary shareholders – diluted | $ | 7,838 | $ | 4,956 | $ | 984 | ||||||
Weighted average number of shares used in the computation of basic earnings per share | 21,902,057 | 7,544,387 | 2,996,624 | |||||||||
Add - | ||||||||||||
additional shares from the assumed exercise of employee options and restricted shares vesting | 1,308,516 | 1,742,069 | 465,253 | |||||||||
Weighted average number of shares used in the computation of diluted earnings per share | 23,210,573 | 9,286,456 | 3,461,877 | |||||||||
Diluted earnings per share | $ | 0.34 | $ | 0.53 | $ | 0.28 |
F - 33
ENZYMOTEC LTD.
NOTES TO FINANCIAL STATEMENTS (continued)
NOTE 16 - EARNINGS PER SHARE (Continued):
For the year ended December 31, 2014, 552,001 options to employees were excluded from the calculation of the diluted earnings per share for the year since their effect was anti-dilutive.
For the year ended December 31, 2013, 13,600 options to employees, 52,020 restricted shares and all preferred shares (12,905,312) were excluded from the calculation of the diluted earnings per share for the year since their effect was anti-dilutive or certain performance conditions were not satisfied at the end of the year.
For the year ended December 31, 2012, 1,100,580 options to employees and all warrants to preferred shareholders (211,548) and preferred shares (11,623,104) were excluded from the calculation of the diluted earnings per share for the year since their effect was anti-dilutive.
F - 34