UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 20-F
(Mark One)
[ ] REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE
SECURITIES EXCHANGE ACT OF 1934
OR
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED January 31, 2003
----------------
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ______________ TO _______________
Commission File number 1-14842
e-SIM Ltd.
----------
(Exact name of Registrant as specified in its charter)
Israel
------
(Jurisdiction of incorporation or organization)
19 Hartum Street, Jerusalem 91450, Israel
-----------------------------------------
(Address of principal executive offices)
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)
- ------------------- -------------------------------------------
None None
Securities registered or to be registered pursuant to Section 12(g) of the Act.
Number of Ordinary Shares, NIS 0.1 par value per share
------------------------------------------------------
(Title of Class)
Securities for which there is a reporting obligation
pursuant to Section 15(d) of the Act.
None
----
(Title of Class)
Indicate the number of outstanding shares of each of the issuer's classes of
capital or common stock as of the close of the period covered by the annual
report:
11,665,359 Ordinary Shares, NIS 0.1 par value per share
-------------------------------------------------------
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
|X| Yes |_| No
Indicate by check mark which financial statement item the registrant has elected
to follow.
|_| Item 17 |X| Item 18
INTRODUCTION
Unless otherwise indicated, as used in this annual report, the terms "e-SIM,"
"we," "us" and "our," mean e-SIM Ltd. and its consolidated subsidiaries.
This annual report includes "forward-looking statements," within the meaning of
the Private Securities Litigation Reform Act of 1995, with respect to our
business, financial condition and results of operations. Statements that use the
terms "believe," "anticipate," "expect," "plan," "intend," "estimate,"
"anticipate," "project" and similar expressions in the affirmative and the
negative are intended to identify forward-looking statements. These statements
reflect our current views with respect to future events and are based on current
assumptions, expectations, estimates and projections about our business and the
markets in which we operate and are subject to risks and uncertainties. Actual
events (including our results) could differ materially from those anticipated in
these forward-looking statements as a result of various factors, including the
risks discussed in "Item 4. Information on the Company--Company Risk Factors"
and elsewhere in this annual report. Except as required by applicable law,
including the securities laws of the United States, we do not undertake any
obligation nor intend to update or revise any forward-looking statements,
whether as a result of new information, future events or otherwise.
All references in this annual report to dollars or $ are to U.S. dollars and all
references to NIS are to new Israeli shekels. The representative rate of
exchange of the NIS to the dollar as published by the Bank of Israel for January
31, 2003 was NIS 4.814 per $1.00.
For the purposes of this annual report, references to the years 1998, 1999,
2000, 2001 and 2002 mean our fiscal years ended on January 31 of the following
year.
TABLE OF CONTENTS
PAGE
PART ONE........................................................................................1
Item 1 IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS..................................1
Item 2 OFFER STATISTICS AND EXPECTED TIMETABLE................................................1
Item 3 KEY INFORMATION........................................................................1
Item 4 INFORMATION ON THE COMPANY.............................................................6
Item 5 OPERATING AND FINANCIAL REVIEW AND PROSPECTS..........................................39
Item 6 DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES............................................56
Item 7 MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS.....................................72
Item 8 FINANCIAL INFORMATION.................................................................74
Item 9 THE OFFER AND LISTING.................................................................76
Item 10 ADDITIONAL INFORMATION................................................................78
Item 11 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK............................96
Item 12 DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES................................97
PART TWO.......................................................................................97
Item 13 DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES.......................................97
Item 14 MATERIAL MODIFICATIONS OF THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS..........97
Item 15 CONTROL AND PROCEDURES ...............................................................98
Item 16 [RESERVED]............................................................................99
PART THREE.....................................................................................99
Item 17 FINANCIAL STATEMENTS.................................................................99
Item 18 FINANCIAL STATEMENTS.................................................................99
Item 19 EXHIBITS.............................................................................99
PART ONE
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
We have derived the selected consolidated financial data set forth below as of
January 31, 2002 and January 31, 2003 and for the years ended January 31, 2001,
January 31, 2002 and January 31, 2003 from the audited consolidated financial
statements and related notes included elsewhere in this annual report. We have
derived the selected consolidated financial data as of January 31, 1999, January
31, 2000 and January 31, 2001 and for the years ended January 31, 1999, and
January 31, 2000 from audited consolidated financial statements that are not
included in this annual report. We prepare our consolidated financial statements
in accordance with generally accepted accounting principles in the United
States, or U.S. GAAP. The selected consolidated financial data set forth below
should be read together with and are qualified by reference to "Item 5.
Operating and Financial Review and Prospects" and our consolidated financial
statements and related notes, included elsewhere in this annual report.
1
CONSOLIDATED STATEMENTS OF OPERATIONS DATA:
YEAR ENDED JANUARY 31,
-----------------------------------------------------------------------------------------------
1999 2000 2001 2002 2003
---------------- ---------------- ---------------- ---------------- -----------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Revenues:
Products..................... $ 3,994 $ 4,243 $ 6,818 $ 3,031 $ 3,304
Services..................... 1,314 1,796 3,063 2,005 2,916
---------------- ---------------- ---------------- ---------------- -----------------
5,308 6,039 9,881 5,036 6,220
---------------- ---------------- ---------------- ---------------- -----------------
Cost of revenues:
Products..................... 596 358 383 169 267
Services..................... 878 1,201 1,735 1,776 1,663
---------------- ---------------- ---------------- ---------------- -----------------
1,474 1,559 2,118 1,945 1,930
---------------- ---------------- ---------------- ---------------- -----------------
Gross profit...................... 3,834 4,480 7,763 3,091 4,290
---------------- ---------------- ---------------- ---------------- -----------------
Operating expenses and costs:
Product development ......... - 725 2,475 - -
Web-site development ........ - 570 800 - -
Research and development,
net....................... 1,557 2,244 2,774 2,610 1,464
Selling, marketing, general
and administrative, net.... 5,527 6,576 8,751 7,854 4,261
Restructuring and impairment
of web-site development.... - - - 910 -
---------------- ---------------- ---------------- ---------------- -----------------
Total operating expenses.......... 7,084 10,115 14,800 11,374 5,725
---------------- ---------------- ---------------- ---------------- -----------------
Operating loss.................... 3,250 5,635 7,037 8,283 1,435
Financial expenses (income), net.. 72 (236) (230) 210 (9)
Other expenses, net .............. - - 730 426 94
---------------- ---------------- ---------------- ---------------- -----------------
Loss before taxes on income....... 3,322 5,399 7,537 8,919 1,520
Taxes on income................... 20 51 56 62 199
---------------- ---------------- ---------------- ---------------- -----------------
Net loss .........................$ 3,342 $ 5,450 $ 7,593 $ 8,981 $ 1,719
================ ================ ================ ================ =================
Basic and diluted net loss per
share..........................$ 0.39 $ 0.52 $ 0.65 $ 0.77 $ 0.15
================ ================ ================ ================ =================
Weighted average number of shares
used in computing basic and
diluted net loss per share..... 8,558 10,456 11,643 11,663 11,665
================ ================ ================ ================ =================
2
CONSOLIDATED BALANCE SHEET DATA:
AS OF JANUARY 31,
-----------------------------------------------------------------------
1999 2000 2001 2002 2003
------------ ------------ ------------ ------------ ------------
(IN THOUSANDS)
Cash and cash equivalents..................... $ 8,941 $ 12,618 $ 6,683 $ 1,305 $ 627
Total assets.................................. 12,315 17,123 13,454 4,615 3,669
Short-term bank credit and current maturities
of long-term bank loans.................... 679 262 218 3,360 2,084
Current maturities of convertible bank loans.. - - - 840 690
Convertible loan from a related party......... - - - - 190
Long-term bank loans, net of current maturities
and convertible loans...................... 79 18 2,486 - -
Shareholders' equity (deficiency)............. $ 9,105 $ 13,064 $ 5,721 $ (3,275) $ (4,891)
(B) CAPITALIZATION AND INDEBTEDNESS
Not applicable.
(C) REASONS FOR THE OFFER AND USE OF PROCEEDS
Not applicable.
(D) RISK FACTORS
We are subject to a variety of risks, including the following:
o we have future capital needs and the availability of additional
financing is uncertain;
o We do not anticipate that we will have sufficient cash on hand to
make the principal payment of $2,866,000 that will be due on our
outstanding short-term and convertible bank loans on August 31,
2004.
o we have a history of losses and may not achieve profitability;
o the recent outbreak of SARS in the Asia-Pacific region and its
continued spread could hurt sales of our products;
o our customers' markets are currently experiencing a prolonged and
severe downturn;
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o if we fail to timely complete the development and introduction of
new products, our results of operations may suffer;
o we may not satisfy the requirements for quotation on the OTC
Bulletin Board;
o we have effected a major restructuring of our corporate activities
which may adversely affect our business;
o we have significant fluctuations in our business and our results of
operations are unpredictable;
o we are subject to risks of technological change and need to develop
new products and applications and new versions of, and enhancements
to, our existing products;
o we depend on certain key personnel;
o we are subject to competition;
o we are subject to certain risks relating to sales and distribution,
and we are dependent on a limited number of distributors;
o we have risks associated with international sales;
o our business and financial condition could be negatively impacted by
the financial instability of our customers;
o we have risks relating to the long sales cycle for our Rapid
products;
o we are subject to risks of product defects as well as other
potential liability;
o we depend on certain proprietary technology;
o we could become subject to litigation regarding intellectual
property rights, which could seriously harm our business;
o we depend on third-party proprietary technology;
o we may pursue acquisitions that present risks and that may not be
successful;
o we may be liable for information displayed on and communicated
through our web-sites;
o inflation and currency fluctuations may adversely affect our
results;
o the price of our ordinary shares is highly volatile;
o if we are characterized as a passive foreign investment company, our
U.S. shareholders may suffer adverse tax consequences;
4
o we are located in the State of Israel, which entails various special
risks;
o we are subject to risks associated with joint development projects;
o we have risks associated with revenues based on royalties;
o the share ownership in us is concentrated in a limited number of
shareholders;
o we are subject to Israeli law, which could prevent or make difficult
a change of control and therefore depress the price of our shares;
and
o it may be difficult to enforce a U.S. judgment against us, and our
officers and directors named in this annual report, to assert U.S.
securities laws claims in Israel and to serve process on
substantially all of our officers and directors.
For a more detailed discussion of the risks affecting our business, see "Item 4.
Business - Company Risk Factors."
5
ITEM 4
INFORMATION ON THE COMPANY
(A) HISTORY AND DEVELOPMENT OF THE COMPANY
e-SIM Ltd., formerly known as Emultek Ltd., was incorporated as a corporation
under the laws of the State of Israel in 1989, and commenced operations in 1991
as a software development and consultation company.
Our corporate headquarters are located at 19 Hartum Street, Jerusalem, Israel,
and our telephone number is 972-2-587-0770. We have additional offices in Tokyo,
Japan. Our research and development department is located in Teradion, Israel.
Some of our simulation development services are provided by a sub-contractor
located in Bangalore, India. In 1996 we established a wholly-owned subsidiary in
the United States, e-SIM, Inc., a Delaware corporation. e-SIM, Inc. has an
office at 225 S. Lake Avenue, suite 300, Pasadena, CA 91101 and its telephone
number is (626) 584-7810. In 1998 we established a wholly-owned subsidiary in
Japan, e-SIM Japan Ltd. In 1999 we established a wholly-owned subsidiary in
France, e-SIM Europe SARL.
We completed our initial public offering in July 1998, and began trading on the
American Stock Exchange. Our name was changed from Emultek Ltd. to e-SIM Ltd. in
June 1999. In March 2000, we changed our listing to the NASDAQ National Market
and our ordinary shares were traded on the NASDAQ National Market System under
the symbol "ESIM." In February 2002, our ordinary shares were delisted by the
NASDAQ National Market as a result of our failure to meet NASDAQ's continued
listing requirements. Trading in our ordinary shares is currently conducted in
the over-the-counter market on the OTC Bulletin Board Service, also known as
OTCBB.
In 1998, we changed our fiscal year, and since then our fiscal year ends on
January 31, instead of December 31.
We are a certified ISO 9001 company.
Our first product, Rapid, was released in 1992. Leveraging the simulation
technology utilized in Rapid, we developed RapidSimulation, which was first
released in early 1994. RapidSimulation enables developers of embedded systems
software to use a visual and intuitive, object-based process to create simulated
computer prototypes of their products that are fully functional, interactive and
behaviorally identical to the products represented. RapidSimulation was also
used as a development product in computer based training, or CBT, for generating
interactive simulations of embedded systems.
In September 1997, we broadened our product line by introducing RapidPLUS, a
software development product that consists of a suite of integrated modules,
each of which supports a different stage of the embedded systems applications.
In March 1998, we further expanded RapidPLUS by introducing a module to
automatically generate efficient and compact source code for applications
software directly from the simulated prototype. This module was developed with
6
the assistance of, and partial funding by, Motorola, Inc. RapidSimulation is one
of the primary modules of RapidPLUS and is no longer offered as a separate
product.
We also provide web-based product simulations built with RapidPLUS for
electronics companies. Our simulation technology generates animated interactive
virtual models that look and behave like real products with interactive
walk-through features that allow for step-by-step use of the product for product
development purposes and for e-commerce, marketing, customer support, Internet
or Intranet use. These simulations, which we market under the name
"LiveProducts," are used for product launches, promotion, web-based customer
support, as well as training for sales and support forces and customers. The
LiveProducts are typically bundled in our "LiveManual" product that includes a
web-based user manual and interactive live feature demonstrations. The terms
"LiveManuals" and "LiveProducts" are sometimes used interchangeably.
In addition to providing customers with finished product simulations, in 2000 we
began licensing the right to use the
LiveProducts-generating technology to prepare simulations. The technology
license grants the customer the right to use the technology in a limited
geographic area for a limited period of time by creating LiveProducts for third
parties. We generate revenue from these sales in several ways, including
technology licensing fees and royalties from revenues generated by our
customers.
In 2001 we introduced RapidPLUS Web Studio, a new module to the RapidPLUS family
of products. RapidPLUS Web Studio allows our customers to generate their own
LiveProducts simulations. As part of the RapidPLUS Web Studio package, our
customers receive the Scenario Authoring Tool, or SAT, which allows them to
create interactive feature demonstrations for the generated LiveProducts.
Our web-site, LiveManuals.com, supports and augments our LiveProducts,
LiveManuals and RapidPLUS Web Studio products and services. It serves as a
showcase and hosting infrastructure for LiveManuals of electronics products that
we create for manufacturers, where users can view simulations and manuals in a
single place and learn how to use their products. The web-site is a marketing
tool and is not regarded by us as a source of revenue.
In 2001 we revised our product-packaging scheme and made it modular. This allows
our customers to choose only those modules they require and reduces the initial
purchase price for new users of our products. Under the new scheme, RapidPLUS
DOC is sold as the base product, to which our customers may choose to add a C
code generator to create RapidPLUS CODE or a Java code generator to create the
RapidPLUS Web Studio product. The pricing structure has also been adjusted
accordingly. In 2002 we added a new product and module to the RapidPLUS family,
called RapidPLUS Xpress. RapidPLUS Xpress is an easy to learn tool that enables
non-technical designers of user interfaces to easily design product simulations
and generate graphic diagrams from them. RapidPLUS Xpress is sold either as a
stand-alone tool or as an add-on to RapidPLUS DOC. For a discussion of a claim
we have received that RapidPLUS Xpress breaches the copyright of a competitor,
see "Item 8. Financial Information - Consolidated Statements and Other Financial
Information - Legal Proceedings."
In 2002 we decided to focus our development and marketing efforts primarily on
the wireless device industry, particularly on wireless device platform solution
suppliers. The RapidPLUS set of modules includes easy-to-use software
development tools and customizable reference designs that can be used by
companies that manufacture devices based on platforms, and are an essential part
of the platform vendor's offering. Our new business model for this sector is
7
built upon the sales of our RapidPLUS development tools, sales of our reference
design, training and development and consulting services, and royalties per
handset manufactured.
CORPORATE RESTRUCTURING
In the second half of 2001 and first quarter of 2002, we effected a major
restructuring of our corporate activities. As part of this restructuring, we
merged our Software Tools Division and LiveProducts Division, closed offices in
the U.S., France and Sweden and relocated our Japanese offices to a customer's
facilities. We reduced our staff in all categories, particularly from the former
LiveProducts division, whose sales and marketing department was eliminated
entirely and whose responsibilities were taken over by other existing staff. In
addition, we reduced significantly our research and development department. The
restructuring led to a significant cost saving and reduction in our losses.
Despite the staff reductions, our revenues for the year 2002 increased over our
revenues in 2001. However, the reduction in staff may in the future limit our
ability to take advantage of market opportunities or to develop new products.
CAPITAL EXPENDITURES
For a description of our principal capital expenditures, please see note 4 to
our consolidated financial statements, included elsewhere in this annual report.
ACQUISITION WRITE-OFF
In March 2000, we entered into a letter of intent with a company, referred to as
the subject company, that is engaged in the development of technology
complementary to our LiveProducts business, with respect to a possible
acquisition of the subject company by us in exchange for a certain number of our
ordinary shares. As part of the letter of intent, we invested $1 million, in
exchange for approximately 2.75% of the outstanding capital stock of the subject
company and received a two-year license for the subject company's technology. In
addition, we extended loans to the subject company of approximately $149,000. To
date, the subject company has not repaid these loans as required by their terms.
Additionally, in light of the general global decline in valuation of high
technology companies, and the prospects of the subject company in particular, we
believed that none of our investment is now recoverable. As a result, we wrote
off $730,000 of the investment in 2000 and in 2001 decided to write off the
balance of our investment and loan in the amount of $426,000. For additional
information concerning this investment and loan see note 2e to our consolidated
financial statements, included elsewhere in this annual report. The acquisition
of the subject company was not completed and we do not presently believe that it
will be effected.
(B) BUSINESS OVERVIEW
We provide simulation-based technology for use in the design, development,
documentation, promotion, customer support and training of interactive
electronics products and systems, particularly to the wireless device industry.
Based on proprietary technology, we provide a MMI solution, tools and services
that allow our customers to use on-screen, graphically accurate and behaviorally
complete simulations they created of their products to help improve them, reduce
8
the time and cost involved in bringing them to market, effectively train sales
and support personnel, reduce the cost and complexity of customer support, and
provide a low-cost and efficient method of reaching target consumers.
Most electronics products today incorporate embedded systems. Embedded systems
consist of a microprocessor and related software, incorporated within
electronics products, which are dedicated to performing specific tasks quickly
and reliably. Consumer electronics products are becoming increasingly complex as
manufacturers design these products with increasing numbers of features and
capabilities. The complexity of electronics products makes it more difficult for
a manufacturer to support the entire life cycle of these products, from design
through sales and customer support.
The simulation-centric approach of our RapidPLUS products addresses many
problems in the traditional wireless device and electronic product life cycle,
from development through sale and customer support. RapidPLUS includes RapidPLUS
Xpress, RapidPLUS/CODE, RapidPLUS/DOC, RapidCBT and RapidPLUS Web Studio.
RapidPLUS enables manufacturers of consumer and industrial electronics products
to use a visual and intuitive, object-based process to create simulated computer
prototypes of their products. These prototypes are fully functional, interactive
and behaviorally identical to the products represented. Simulated prototypes can
be used to support the entire product life cycle, from design of embedded
systems, including their various functions and user interfaces, through
on-screen manipulation and modification, code generation into the actual devices
and web-based simulation. We also sell a MMI reference design to wireless
platform and device manufacturers so that handset developers can more easily and
quickly develop the future MMI of the phone. We offer a set of MMI customization
tools to handset manufacturers to add and alter currently existing features in
our MMI design.
RAPIDPLUS
Our main product family is RapidPLUS, a suite of integrated software tools.
RapidPLUS provides a means of quickly and easily creating product simulations.
The RapidPLUS toolset is sold in several packages, including RapidPLUS Xpress,
RapidPLUS/CODE, RapidPLUS/DOC, RapidCBT and RapidPLUS Web Studio. Each of these
packages serves a different part of the product's life cycle, based on the
initial product simulation. The packages and their content may change from time
to time based on e-SIM's business and technological considerations.
The RapidPLUS modules are used throughout the product's life cycle as follows:
Product Design. RapidPLUS DOC and RapidPLUS Xpress are used to create virtual
prototypes of user interface for new products in order to visualize, communicate
and improve the product's design. Customers can test new design alternatives,
ensure their designs are complete and consistent, and communicate their concepts
with other parts of the organization or external bodies, before developing and
manufacturing the product.
Documentation. RapidPLUS/DOC is used to generate technical documentation from
the prototype/simulation. This documentation includes functional and graphic
information about the product, and can be updated automatically when changes are
made to the prototype/simulation. The documentation can serve as a specification
to engineers and as a basis for user manuals.
9
Code Generation. Using RapidPLUS/CODE users can generate compact and efficient C
code from the prototype, to be used as the user-interface part of their
product's software, and which can be linked to other software modules. Changes
in the simulation/prototype are immediately reflected in the generated code. To
run on the product, the generated code requires a software component, which we
call a Kernel, to be located in the microprocessing unit of the product. This
Kernel needs to be "ported" to the specific runtime environment (processor,
operating system and other software modules) that exists on the product.
Typically, for a fee we provide our customers with this porting service.
In addition to selling the RapidPLUS CODE software tool, we charge our customers
a licensing fee for each customer product shipped with the Kernel embedded in
it.
Training. RapidPLUS/DOC, RapidPLUS Web Studio, and RapidCBT can be used to
create interactive training courses, based on simulations of a product or
system. The simulation can be incorporated with external CBT software to provide
a complete training application. The simulations can be used to train users of
the simulated systems, as well as internal sales and support personnel.
Sales and Marketing. RapidPLUS Web Studio can be used to generate LiveProducts
or LiveManuals Java applications from simulations, for use over the Internet or
on CDs, allowing customers to use simulations of the products for a trial period
before purchasing the actual products. The simulations can be used for
e-commerce sites, virtual product launches, as promotional material or as parts
of virtual product catalogs.
Customer Support. Java simulations generated by RapidPLUS Web Studio (either
LiveProducts or LiveManuals) can be used by internal customer support personnel
to eliminate the need to keep physical samples of the products. They can also be
used to enable customers to obtain self-help over the Internet, or can be
incorporated into electronic user manuals distributed on CDs with the products.
The simulations can also be incorporated into LiveManuals.
RapidPLUS's philosophy is based on the concept that any information about a
feature of a product or system should be specified in only one place. While each
feature may be represented in different formats for different parts of the
organization and in different life cycle stages, all these representations
should emanate from a single information source. The RapidPLUS simulation
provides this "information hub." Any changes to the RapidPLUS simulation can
automatically and easily be propagated and generate new updated code, new
documentation, new testing scenarios, new training materials and new marketing
aids. This single-source principle ensures synchronization between all these
aspects and facilitates effective interaction among the various parts of the
organization and the process.
MMI REFERENCE DESIGN
We sell a reference design for the development of MMIs for mobile devices to
vendors of the hardware and software platform on which the mobile device will be
run. The reference design provides the blueprint for the eventual creation of
the user interface of the mobile device, using our RapidPLUS solution. The
reference design can be adapted by the mobile device platform manufacturer to a
variety of platforms they manufacture and must be customized for each customer.
By embedding the MMI reference design in the platform that is offered to the
10
mobile device handset manufacturers, the attractiveness of their particular
platform is increased.
MMI CUSTOMIZATION TOOLS
We sell a set of customization tools to mobile device handset manufacturers that
are used to customize the basic MMI reference design provided in the RapidPLUS
solution to the demands of the manufacturers' target consumers.
LIVEPRODUCTS AND LIVEMANUALS
We provide technology and services to deliver product simulations and electronic
manuals over the Internet.
LiveProducts are used for product launches, promotion, web-based customer
support, as well as training for sales and support forces and customers. When a
LiveProduct is bundled into a LiveManual, as is typically the case, it provides
a web-based user manual and interactive live feature demonstrations.
PRINCIPAL MARKETS
We target the following markets:
WIRELESS PLATFORM AND DEVICE MANUFACTURING MARKET
The RapidPLUS product family, together with our wireless device MMI reference
design and customization tools, targets as its main market the wireless platform
and device manufacturing industries. The potential for our MMI solution in this
market is growing primarily due to the change in the nature of the mobile
manufacturing industry. According to a 2002 report by Edge Consult entitled
"Commoditisation Hits the Handset," in the future, the mobile device market will
not be dominated by manufacturers, such as Nokia, Motorola, Sony and Ericsson,
who owned the technological know-how for phone development and were also
involved in all aspects of phone production. Rather, there are now new entrants
in the field vying for the phone manufacturing business. According to this
report, handsets will no longer necessarily be developed, produced, marketed,
distributed and supported by the same company. Since production cost is a key
factor in handset manufacture, manufacturing companies that have not previously
been in the business of mobile device manufacture are now beginning to acquire
the technological know-how they require to develop their portions of the handset
in order to be able to produce a complete handset ready for sale, and are
becoming involved in producing the final handset. In order to achieve this goal,
these companies require reference designs and pre-integrated platforms. Major
semiconductor manufacturers, as well as major phone manufacturers, have started
to create and sell these platforms. Increasingly, these platforms include larger
amounts of the hardware and software required to create a wireless device, thus
enabling the manufacturers to reach the market quickly with good products at a
low cost, low risk and without requiring deep technical know-how of the wireless
domain.
The MMI is becoming a significant part of the platform offering, as creation of
a MMI by the manufacturer is difficult and time consuming. Furthermore, the MMI
11
is a major differentiator between different brands. Platform and device
manufacturers require assistance developing the MMI solution to be incorporated
into the products they sell.
The main forces driving the rapid changes in the wireless platform and device
manufacturing market are currently as follows:
o pressure to lower development costs;
o pressure to reduce time to market;
o increased complexity of design;
o lack of available engineering talent;
o limited marketable windows of opportunity due to increased
competition; and
o value proposition being highest for software content and lower for
hardware features.
We believe that RapidPLUS is a development tool that addresses the needs of
platform and device manufacturers and enables them to meet the challenges of the
wireless platform market. Our technology provides wireless platform and device
manufacturers with a solution that is both inexpensive and does not require
prior expertise and experience, and enables the quick development of the mobile
device's interface.
Our strategy for this market includes focusing our sales, marketing and research
and development on wireless platform vendors. For example, in 2002 we entered
into an agreement with Motorola Semiconductors HK Ltd. providing Motorola with
the right to use RapidPLUS as the user interface component for its wireless
platforms and chipset reference designs, and to resell RapidPLUS to manufacturer
customers. Motorola sells a wireless platform that includes hardware, software
and tools that enable manufacturer customers to quickly create wireless
handsets. Motorola provides its customers with a reference design for a complete
handset. The user interface of this reference design has been created using
RapidPLUS. Motorola offers its customers RapidPLUS Code as a tool for user
interface development and customization of the reference design. Motorola has
sold this platform to fourteen companies that are using RapidPLUS to develop the
user interfaces of their cellular phones.
In January 2002, we entered into an agreement with Ericsson Mobile Platforms AB,
under which we provide Ericsson with a key component for the user interface of
its platform and embed our technology into the platform, thus enabling
Ericsson's customers to easily integrate RapidPLUS-generated code into its
products. In addition, in August 2002, we entered into a promotion agreement
with Ericsson pursuant to which Ericsson will actively help promote RapidPLUS to
its customers.
In October 2002, we also entered into an agreement with IXI Mobile, creator of
the Personal Mobile Gateway, to develop the MMI for the reference design for the
user interface of some of IXI's products, and include RapidPLUS as part of its
standard Software Development Kit.
12
EMBEDDED SYSTEMS SOFTWARE MARKET
The embedded systems software market provides tools and services to embedded
systems manufacturers. Many of the factors driving changes in the wireless
platform and device manufacturing markets, noted above, apply to the manufacture
of electronic products incorporating increasingly complex embedded systems.
As with the wireless platform market, a major part of our strategy for the
embedded systems consists of expanding distribution channels to include leading
embedded system software vendors and software manufacturers, as well as
enhancing and developing our relationships with our existing distributors. For
example, in 2002 we extended the term of existing agreements with the Yamagata
Printing Co. Ltd. and NSW in Japan, providing for distribution rights to these
customers and sale licenses to our RapidPLUS products.
In addition to the transactions with wireless platform manufacturers such as
Motorola, Ericsson and IXI in 2002, we licensed RapidPLUS products to product
manufacturing customers. Our target customers in the embedded software market
typically are manufacturers of consumer electronics products, office automation
equipment and automotive systems.
During the last three years, our revenues from RapidPLUS products (our total
revenues except revenues from the Live Products) were $9,489,000 in 2000,
$4,352,000 in 2001 and $5,193,000 in 2002. These amounts include revenues from
services and maintenance, which were $2,671,000 in 2000, $1,321,000 in 2001 and
$1,889,000 in 2002.
INTERNET BASED CUSTOMER SUPPORT, TRAINING AND E-COMMERCE
We believe that the Internet has gained, and will continue to gain, momentum as
a medium for conducting business. As part of this trend, we believe there will
be an increasing demand for use of the web to enable and facilitate better
customer support and training. The value proposition behind Internet-based self
help results from the easy availability of support services to consumers and the
savings to the service providers through the use of the web to provide support
services to consumers. We believe that our technology and LiveProducts, allowing
consumers to be interactively guided and supported with respect to a wide range
of consumer electronics products, can be an important part of delivering this
value. Companies that launch new products often need to be able to train sales
forces and support personnel located around the world. Since time to market is
an essential element in the success of a new product, companies must ensure that
all the elements are in place when the product is ready off the production line.
Simulation-based training materials help ensure that this goal is achieved.
Our strategy for the Internet includes marketing our LiveProducts and
LiveManuals solutions to consumer electronics manufacturers, retailers, and
wireless carriers as well as licensing our LiveProducts technology to third
parties who will themselves produce LiveProducts or LiveManuals for their
customers in different geographic areas. In 2002, we produced LiveProducts for
leading companies, including Nikon Corporation, Samsung Telecommunications
America, L.P, Sprint PCS and Panasonic Consumer Electronics Company. Several of
these customers were repeat users of our products and services. We began our
Internet based activities in 1999, and had revenues from these activities of
$49,000, $392,000, $684,000 and $1,027,000 in 1999, 2000, 2001 and 2002,
respectively.
13
In order to provide our customers with LiveProduct simulations, in 1999 we
established a simulation development facility in Bangalore, India with a local
sub-contractor. The sub-contractor is responsible for obtaining facilities and
all necessary equipment, as well as hiring qualified personnel required to
develop simulations for our LiveProducts customers. All personnel are employed
directly by the sub-contractor, except for a supervisor of the project who is
employed directly by us. We pay the sub-contractor a monthly fee based on the
number and type of personnel employed in that period by the sub-contractor to
work exclusively on our projects. As of June 30, 2003, approximately 27 of the
sub-contractor's employees were exclusively engaged in the development of
simulations for our LiveProducts customers.
TECHNOLOGY
Our technology for creating prototypes and simulations is based on a highly
graphical, point and click intuitive development environment. The technology
relies on two programming principles:
o state charts, which are used to define the behavior of the system;
and
o component (or object) technology, which is used to describe the
different graphic and functional elements of the system.
The combination of these technologies provides a flexible framework for
simulation development, which allows a user to develop simulations in a quick,
cost-effective and visual and intuitive manner.
A special module included in our RapidPLUS products provides the capability to
generate fully functional C code from the prototype. The generated C code can
then be compiled and linked to other software modules. The generated code is
compact and efficient, due to its unique architecture, which relies on a state
machine engine that resides on the target system. Integration of the generated
code with external software is efficiently accomplished by allowing the users to
define any component of the system as an interface-only component, and then
generating a well-documented Application Programming Interface to that
component, to be integrated with the external software.
Additional modules in our RapidPLUS products facilitate automatic documentation
generation, generation of testing scenarios and integration with CBT software
packages.
We have also developed a technology to generate compact Java code to enable
delivery and use of simulations created using RapidPLUS over the Internet. The
simulations, which we call LiveManuals and LiveProducts, can be embedded inside
web pages and viewed with any standard browser. To augment the simulation
content, we have developed a Scenario Authoring Tool, or SAT. The SAT is used to
create interactive feature demonstrations about the products showing, for
example, how to store a number in a wireless handset's phone book. The
demonstrations mimic a user's interaction with the real product, and are
annotated with graphical, textual and synchronized voice-overs. Java code
generation and SAT are the main features of RapidPLUS Web Studio.
RESEARCH AND DEVELOPMENT
We believe that our innovative technology is a core strength and that our
ability to enhance our existing products and applications, develop and introduce
new products and applications on a timely basis, maintain technological
14
competitiveness and meet customer requirements is essential to our future
success. Accordingly, and despite our corporate restructuring, in which we
decreased the number of research and development employees, we devote, and
intend to continue to devote, a significant portion of our personnel and
financial resources to research and development of our core technology and to
customer projects developed based on this technology. The reduction in research
and development staff may, however, limit our ability to take advantage of
market opportunities or to develop new products or applications in the future,
although so far it has not. In addition, in order to successfully develop new
and enhanced products, we seek to develop and maintain close relationships with
customers and remain responsive to their needs.
Our core technology, products and applications are developed in our research and
development facility in Israel. Product development teams include experts in
computer science, electronic engineering, advanced mathematical techniques,
computer graphics, physics and other fields. Our research and development
efforts have been financed primarily by revenues and cash flows from operations,
equity investments, borrowings from banks and other parties and governmental and
other grants, such as the programs sponsored by the Office of the Chief
Scientist and the BIRD Foundation.
As of June 30, 2003, our research and development department consisted of 11
software developers, two product testers, one technical writer, one systems
manager, one general assistant and our Vice President - Research and
Development. The research and development department is divided into two major
teams: RapidPLUS core technology, including code generation, and LiveManuals,
each headed by a team manager who reports to our Vice President--Research and
Development. In addition, we employ a Chief Scientist who reports directly to
our Chief Executive Officer and is responsible for the planning and design of
future architecture and development of our products, based on requirements
defined by our marketing department. We achieved ISO-9001 certification during
2002, which enables us to expand our marketing efforts to those customers and
governmental authorities who require that certification.
GOVERNMENT AND OTHER GRANTS
Generally, grants from the Office of the Chief Scientist constitute up to 50% of
certain research and development expenses for the development of products
intended for export. Under the terms of the Office of the Chief Scientist's
participation, a royalty at a rate of 3.5% to 5% of the sales of products
developed in, and related revenues generated by, a project funded by the Office
of the Chief Scientist must be paid beginning with the commencement of sales of
these products. The royalty payments end when 100% to 150% of the grant is
repaid in NIS linked to the dollar. Through January 31, 2003, we obtained grants
from the Office of the Chief Scientist in the aggregate amount of approximately
$1.8 million for certain of our research and development projects. Also, through
January 31, 2003, we have paid or accrued royalties to the Office of the Chief
Scientist in the aggregate amount of approximately $1,279,000. As of January 31,
2003, the aggregate amount of the contingent obligation to the Office of the
Chief Scientist was approximately $621,000.
Since March 1998, the Israeli Government, through the Fund for Encouragement of
Marketing Activities Abroad has awarded us grants related to our foreign
marketing expenses. These grants are awarded for specific expenses we incur in
our foreign marketing activities, based on expenses reported to the Fund for
Encouragement of Marketing Activities Abroad. All marketing grants received from
the Fund for Encouragement of Marketing Activities Abroad are linked to the
15
dollar and are repayable in the form of royalty payments in the amount of 4%
(plus interest at the rate of six-month LIBOR) of any increase in export sales
we realize up to the total amount of grants we receive. If we do not achieve an
increase in export sales, we have no obligation to pay any royalties or return
any funds received through these grants. All payments are linked to the dollar.
Through January 31, 2003, we obtained grants in the aggregate of $778,000 from
the Fund for Encouragement of Marketing Activities Abroad and have paid or
accrued royalties in the amount of $282,000. As of January 31, 2003, the
aggregate amount of the contingent obligation to the Fund for Encouragement of
Marketing Activities Abroad was $496,000.
Some of the accrued royalties to the Office of the Chief Scientist and the Fund
for Encouragement of Marketing Activities Abroad were not paid when due. In
January 2003, we reached a settlement regarding payments to the Office of the
Chief Scientist and the Fund for Encouragement of Marketing Activities Abroad.
For additional information concerning the terms of this settlement, see "Item 5.
Operating and Financial Review and Prospects - Research and Development, Patents
and Licenses - Research and Development Grants."
Terms of Israeli Government grants also require that the research and
development be conducted by the applicant for the grant as specified in the
application and that the manufacturing of products developed with Israeli
Government grants be performed in Israel, unless special approval has been
granted. Separate Israeli Government consent is required to transfer to third
parties technologies developed through projects in which the Government
participates. These restrictions, however, do not apply to exports from Israel
of products developed using these technologies. Because the Government of Israel
has from time to time revised its policies regarding the availability of grants,
we cannot assure you that the Israeli Government's support of research and
development will continue.
Through January 31, 2003, we received grants in the aggregate amount of
approximately $394,000 from the BIRD Foundation. We are obligated to pay
royalties to the BIRD Foundation on the proceeds from sales of products,
referred to as the development packages, resulting from the research and
development which the BIRD Foundation funded. The payments are of $250 for each
development package per license and $2,500 for each development package of
products per site. The total amount of the royalties may not exceed 150% of the
grants received. All the payments are linked to the dollar.
Through January 31, 2003, we paid or accrued royalties to the BIRD Foundation in
the aggregate amount of approximately $201,000. As of January 31, 2003, the
aggregate amount of the contingent obligation to the BIRD Foundation was
approximately $389,000.
BUSINESS MODEL
We generate revenue from license fees, technology transfer fees, professional
service fees, LiveManuals development fees, support contracts fees, runtime
licensing fees and right to use fees.
16
LICENSE FEES
License fees are generated by license agreements providing our customers with
the right to use our products on a non-exclusive basis, including our RapidPLUS
CODE, RapidPLUS DOC, RapidPLUS Web Studio, RapidPLUS Xpress, RapidCBT and our
Wireless Device Reference Design.
TECHNOLOGY TRANSFER FEES
We license our Java code generation technology and associated methodologies and
practices to companies on a regional time-based basis. These license
arrangements provide for license fees, as well as royalties from sales to our
customers of products and services based on our technology.
PROFESSIONAL SERVICE FEES
Our technical services team generates revenue from MMI contract development,
consulting and mentoring and training users of our products. Charges are based
on price lists, specific contracts or per-period fees.
LIVEMANUALS DEVELOPMENT FEES
We sell our customers simulations of the customer's products for fees that
depend on the complexity of the product and the simulation. Together with these
simulations, we also offer our customers additional items such as electronic
user manuals. We refer to these combined simulations and user manuals as
LiveProducts or LiveManuals.
SUPPORT CONTRACTS FEES
With license agreements, customers typically purchase a one-year service
agreement which provides them with customer support and enables them to receive
periodic updates and new releases of the licensed products. The customer may
elect to renew the agreement each year.
RUNTIME LICENSING FEES
We charge runtime license fees for our wireless device reference designs, and
for our embedded Kernel. Code generated by RapidPLUS/Code requires the state
machine Kernel to run in an embedded application. Typically we charge a fee for
every state machine Kernel in a product sold. This method of charging is common
in our industry. The fee is usually on a sliding scale based on volume.
RIGHT TO USE FEES
Customers who use RapidPLUS simulations over the web typically are required to
pay us a fee for the right to use them. We charge these fees either on a
one-time basis per each web-site on which the simulations are deployed or on an
annual basis permitting unlimited use.
SALES AND MARKETING
Our sales are based on a global sales organization with a mixture of direct and
indirect sales. We have subsidiaries, primarily engaged in sales and service, in
the U.S., Japan and France. As part of our restructuring, which commenced in the
second quarter of 2001, we significantly reduced our sales and marketing staff
in the U.S. and Europe. Our U.S. staff had been primarily involved in the sales
and marketing of LiveManuals and our LiveManuals.com web-site. As we have ceased
to invest in the LiveManuals.com web-site, much of this staff was no longer
required. We have redeployed our international sales force and assigned some of
17
our staff involved in sales in Asia also to take responsibility for European
sales.
We continue to have several distribution agreements in the U.S., Europe and
Asia, on exclusive and non-exclusive bases. In 2002, we entered into agreements
with Motorola Semiconductors HK Ltd. and with IXI Mobile (R&D) Ltd. providing
them with various rights, including the right to resell RapidPLUS to customers
who acquire their products or services. Distributors are supported and trained
by our local and Israel-based personnel. In many cases we actively participate
in the sale processes of our distributors. We seek to combine the expertise of
our personnel and knowledge of the product and the target markets with the local
distributor's knowledge and contacts with the local market, as well as their
familiarity with the local business culture.
18
The following chart indicates sales by our principal distributors as percentages
of our total revenues for the years ended January 31, 2001, 2002 and 2003:
NAME OF DISTRIBUTOR 2000 2001 2002
- -------------------------------------- ------------------- -------------------- -------------------
Kobe Steel......................... 5% 15% -
Tatung............................. - 13% 1%
Yamagata........................... 7% 6% 33%
Virtual Products International..... - 6% 3%
Telelogic GmbH..................... 4% 3% -
Nippon Systemware ................. 28% 1% 8%
Simulis ........................... 11% - 1%
Intus.............................. 8% - -
The following table presents total revenues attributed to geographic information
based on the location of the customers for the years ended January 31, 2001,
2002 and 2003 and long-lived assets as of January 31, 2001, 2002 and 2003:
2000 2001 2002
--------------------------------- ---------------------------------- ----------------------------------
TOTAL LONG-LIVED TOTAL LONG-LIVED TOTAL LONG-LIVED
REVENUES ASSETS REVENUES ASSETS REVENUES ASSETS
--------------- --------------- ---------------- ---------------- ---------------- ----------------
(IN THOUSANDS)
Israel........... $ 70 $ 1,045 $ 55 $ 780 $ 240 $ 469
Japan............ 4,255 49 1,421 32 2,794 30
Far East*........
1,367 - 1,622 - 649 -
U.S.............. 2,725 1,130 1,258 252 1,297 35
Europe........... 1,464 43 680 14 1,240 -
--------------- --------------- ---------------- ---------------- ---------------- ----------------
Total........... $ 9,881 $ 2,267 $ 5,036 $ 1,078 $ 6,220 $ 534
=============== =============== ================ ================ ================ ================
*Excluding Japan.
19
The following chart represents our main customers, by percentage of revenues for
the years ended January 31, 2001, 2002 and 2003:
CUSTOMER 2000 2001 2002
- ---------------------------------------- ------------------------- ------------------------ -----------------------
Kobe Steel ........................ 5% 15% -
Tatung............................. - 13% 1%
Nippon Systemware.................. 28% 1% 8%
Simulis............................ 11% - 1%
Yamagata .......................... 7% 6% 33%
DEPENDENCE ON THIRD PARTY RIGHTS
We rely, and expect to continue to rely, on certain software that we license
from third parties, including software that is integrated with internally
developed software and used in our products to perform key functions. Some of
this software may be required to complete the development of products that we
intend to offer in the future. We cannot assure you that these third-party
providers will remain in business, that they will continue to support their
technology or that their technology will otherwise be available to us on
commercially reasonable terms.
COMPETITION
The wireless device MMI market is a competitive one. Our main competition comes
from companies that sell the MMI as part of a wider suite of integrated
products. Among these are semiconductor vendors who have their in-house MMI
solution, such as Infineon, Agere and Skyworks. There are also companies that
provide core software for wireless devices such as protocol stacks, that also
provide an MMI solution. Most notable of these is TTPCom. Other competitors in
this market are 3Glabs, which is targeted at the high-end of the market and
WildSeed, which offers an integrated hardware/software MMI solution.
The embedded systems software development industry is highly competitive and is
characterized by rapidly advancing technology. We believe that the principal
competitive factors in this industry are technological innovation,
functionality, reliability, service, reputation, pricing and the ability to
provide integrated solutions.
In order to maintain and improve our position in the embedded industry, we
believe we need to continue to enhance our existing products and to develop new
products and applications and product and application extensions. We believe
that the principal competition for our products comes from embedded systems
applications software development solutions that are developed in-house by our
customers or potential customers rather than those purchased from independent
software vendors like us. Many organizations that develop their software
solutions in-house have substantial internal programming resources with the
capability to develop specific solutions for their needs. A decision to use our
20
products may involve a fundamental shift in the software development process
used by these companies. Consequently, we must persuade many potential customers
to replace their in-house solutions, into which substantial resources have been
invested, with our products. We also compete with other independent software
vendors who provide products addressing certain stages of the development cycle
for products incorporating embedded systems applications software. Software
providers competing with our products at various stages of the embedded systems
applications software development cycle include Altia, Inc., Virtual Prototypes,
Inc., ZipC, Inc. and Gaio, Inc. Many of our existing and potential competitors
have substantially greater financial, technical, marketing and sales resources
than we do. Because we have derived most of our revenues from sales of and
services related to the RapidPLUS family of products, the effects of competition
are more intense than if we had a broader product offering. One of our
competitors has alleged that certain features of our newly released RapidPLUS
version 7 breach that party's copyright, a claim we believe to be of no merit.
For a discussion of this matter, see "Item 8. Financial Information -
Consolidated Statements and Other Financial Information - Legal Proceedings."
The Internet market is also highly competitive and is characterized by rapid
technological change and intense competition. There are technologies currently
available that compete with LiveProducts and which may prove to be difficult to
compete with, such as Macromedia's Flash and ShockWave Director.
(C) ORGANIZATIONAL STRUCTURE
We have three wholly-owned subsidiaries:
o e-SIM Inc., incorporated under the laws of the State of Delaware and
responsible for sales, marketing and technical support in the U.S.;
o e-SIM Japan Ltd., incorporated under the laws of Japan and
responsible for sales, marketing and technical support in Japan; and
o e-SIM Europe SARL, incorporated under the laws of France. This
subsidiary suspended operations in July 2002.
(D) PROPERTY, PLANTS AND EQUIPMENT
We currently lease a facility of approximately 7,494 square feet in Teradion,
Israel. The annual lease payment is approximately $23,000. The lease expires in
December 2005.
Our headquarters and executive offices are located in a facility of
approximately 5,745 square feet in Jerusalem, Israel. The annual lease payment
is approximately $71,000. The lease expires in March 2006.
We have received a claim from the landlord of our former premises in Jerusalem
demanding various lease and lease-related payments and claiming that we entered
into an agreement to renew our lease. We consider these claims to be without
merit. For a further discussion see "Item 8. Financial Information -
Consolidated Statements and Other Financial Information - Legal Proceedings."
21
We decided to close our U.S. offices, as our U.S. employees currently work from
home, and have subleased the facilities until the expiration of our lease
period. The sublease arrangement does not cover the entire cost of the lease and
we therefore still have monthly lease payments of approximately $2,000 per month
until August 2003.
Our Japanese subsidiary utilizes approximately 435 square feet belonging to our
customer Yamagata Printing Co. Ltd. in Tokyo, Japan under an agreement that
expires in December 2003, for which it pays no rent but reimburses Yamagata
Printing Co. Ltd. for all expenses incurred, which are approximately $3,500 per
year. We believe that our current space is adequate for our current requirements
and that additional space will be available upon reasonable terms, if needed.
(E) COMPANY RISK FACTORS
YOU SHOULD CAREFULLY CONSIDER THE FOLLOWING RISK FACTORS AND OTHER INFORMATION
INCLUDED IN THIS ANNUAL REPORT. THE RISKS AND UNCERTAINTIES DESCRIBED BELOW ARE
NOT THE ONLY ONES WE FACE. ADDITIONAL RISKS AND UNCERTAINTIES THAT WE ARE
PRESENTLY NOT AWARE OF, OR THAT WE CURRENTLY DEEM IMMATERIAL, MAY ALSO ARISE.
OUR BUSINESS, FINANCIAL CONDITION AND RESULTS OF OPERATIONS COULD BE MATERIALLY
ADVERSELY AFFECTED BY ANY OF THESE KNOWN OR UNKNOWN RISKS. WE CANNOT ASSURE YOU
THAT WE WILL SUCCESSFULLY ADDRESS ANY OF THESE RISKS. IN THE EVENT THAT ONE OR
MORE OF THE RISKS SET FORTH BELOW OCCURS, OUR SHARE PRICE COULD DECREASE AND YOU
MAY LOSE ALL OR PART OF YOUR INVESTMENT.
We have future capital needs and the availability of additional financing is
uncertain. As of June 30, 2003, we had cash and cash equivalents of $798,000,
which represents an increase in our cash and cash equivalents of $627,000 as of
January 31, 2003, and a significant decline from our cash and cash equivalents
of $1.3 million as of January 31, 2002. These funds are held primarily in
dollars, but also in NIS, Euros and Pounds Sterling. We believe that these
funds, together with anticipated revenues from our operations (including
collection of trade receivables and a convertible loan of $1 million received
from Smithfield Investments B.V. in July 2003, as discussed below), will be
sufficient to fund our anticipated operating expenses, interest payments and
capital expenditures for at least the next twelve months and the payment of
scheduled principal payments on our outstanding loans through July 2004. Our
ability to generate revenues and manage costs as anticipated may be adversely
affected by a variety of factors, including those discussed in this Company Risk
Factors section. If we are unable to generate anticipated revenues from our
operations, or if our operating expenses, interest payments or capital
expenditures are higher than anticipated, we will be required to seek to raise
additional funds through public or private debt or equity issuances. Additional
debt or equity financing, whether obtained through public or private debt or
equity financing, may not be available when needed or may not be available on
terms acceptable to us, if at all. If this additional financing is not available
when needed our business will be adversely affected, we may not be able to
continue operations and we may be forced to pursue a sale of the company or a
substantial part of our assets on terms, which if available at all, may not be
attractive to our shareholders.
In August 2002, we entered into agreements with specified banks amending certain
provisions of our prior agreements with these banks, including providing us with
an aggregate of $4.2 million of short-term and convertible loans and extending
the scheduled maturity of the loans. Pursuant to the amended terms, we have made
monthly payments of principal and interest of the loans in an aggregate of
$70,000 per month (subject to increase if our revenues exceed certain specified
amounts). The unpaid balance of the loans (approximately $3.5 million) was to
22
become due on August 31, 2003. In July 2003, the banks extended the scheduled
maturity of the loans to August 31, 2004 and we have agreed to increase our
minimum monthly payments of principal and interest to $80,000 per month (subject
to increase if our revenues exceed certain specified amounts) and to grant these
banks liens on our right to receive revenues pursuant to agreements with two
major customers. The banks can demand payment of the loans prior to the maturity
date upon the occurrence of an event of default under the loan agreements, such
as non-payment of scheduled principal and interest payments, our liquidation or
the occurrence of events that the banks believe harm or might harm our ability
to perform our obligations under the loan agreements.
In August 2002, we entered into an agreement with Gibralt Holdings Ltd., or
Gibralt, a party controlled by Samuel Belzberg, who is a director of our company
and the father of Marc Belzberg, our chairman, chief executive officer and one
of our major shareholders. Under the terms of the agreement, Gibralt agreed to
lend us an aggregate of $950,000 at an annual interest rate of 6% maturing on
February 28, 2003. We have repaid $760,000 of the loan to Gibralt. Pursuant to
the agreement, $190,000 of aggregate principal amount of the loan was not
repaid. Gibralt has the right to convert this outstanding principal amount into
our ordinary shares at the price per share of $0.14 for a period of five years
from the date of the loan agreement. Because Gibralt is considered a related
party and the transaction involves a conversion right of a portion of the loan,
the transaction is subject to approval by our audit committee, board of
directors and shareholders. Although the transaction was properly approved by
our audit committee and board of directors, it is still pending shareholder
approval. We plan to submit the transaction for shareholder approval at our next
general meeting of shareholders. We cannot assure you that the transaction will
be approved. If our shareholders do not approve the transaction, we will be
required to repay the balance of the loan amounting to $190,000 in cash.
In July 2003, we entered into a convertible loan agreement with Smithfield
Investments B.V., or Smithfield, an entity controlled by Marc Belzberg, our
chairman, chief executive officer and one of our major shareholders, pursuant to
which Smithfield agreed to lend us an aggregate of $1 million maturing on August
1, 2004 and bearing no interest. Until that date, Smithfield may convert the
principal amount on the loan into our ordinary shares at a price per share of
$0.18. In addition, if Smithfield elects to convert the entire loan amount into
our ordinary shares, it will receive a warrant to purchase $3,000,000 worth of
our ordinary shares at an exercise price per share of $0.54. According to the
terms of the convertible loan agreement, we will have the right to compel
Smithfield to convert the loan in its entirety into our ordinary shares if we
consummate an equity investment of at least $1 million. The transaction was
approved by our board of directors and audit committee and is subject to
shareholder approval. The transaction also requires shareholder approval for an
increase in our authorized share capital. We plan to submit the transaction and
the increase in our authorized share capital for shareholder approval at our
next general meeting of shareholders. We cannot assure you the transaction or
the increase in share capital will be approved. However, Smithfield has agreed
that if our shareholders do not approve this transaction or the increase in
share capital, it will provide the amount of the investment as a loan, if
failure to provide it would affect our ability to continue operations as a going
concern.
We do not anticipate that we will have sufficient cash on hand to make the
principal payment of $2,866,000 that will be due on our outstanding short-term
and convertible bank loans on August 31, 2004. As a result, prior to that
maturity date we will need to negotiate new terms with the existing bank lenders
23
to extend the maturity of the loans or obtain new debt or equity financing from
an alternative source to finance or repay our existing loans. We cannot assure
you that the banks will agree to any extension of the maturity of the loans, if
requested to do so, or what the terms of any such extension may be. We also
cannot assure you that any new debt or equity financing will be available if we
are required to refinance or repay the existing loans, or what the terms of any
such new financing will be. If the outstanding loans are not extended,
refinanced or repaid, our business will be adversely affected, we may not be
able to continue operations and we may be forced to pursue a sale of our company
or a substantial part of our assets on terms, which if available at all, may not
be attractive to our shareholders.
If additional funds are raised through the issuance of equity securities, the
net tangible book value per share may decrease, the percentage ownership of our
then current shareholders may be diluted and such new equity securities may have
rights, preferences or privileges senior or more advantageous to those of the
holders of our ordinary shares.
We have a history of losses and may not achieve profitability. We began
operations in 1991 as a software consulting company and began commercial
shipment of our initial Rapid software products in 1994. We incurred significant
operating and net losses in every fiscal year since our inception and we may
continue to incur losses in the future. Although our revenues have grown from
approximately $991,891 in 1995 to $9.9 million in 2000, we suffered a decline in
revenues of 49.1% to $5.0 million in 2001. However, in 2002 our revenues
increased to $6.2 million, a 24% increase compared with 2001. In spite of this
increase in revenues, we have an accumulated deficit of $37.8 million at the end
of 2002. Our net losses in 2002 were $1.7 million, which represents a decrease
of 81% compared with net losses of $9.0 in 2001.
Despite continuing expense reduction measures, our operating expenses may not
decrease as rapidly as anticipated. As a result, net cash outflows and net
operating losses may continue for the near term. If our sales do not increase or
if our expenses increase at a greater pace than our revenues, we will not be
profitable. Even if we achieve profitability, we may not be able to sustain or
increase it on a quarterly or annual basis. We may not be able to sustain our
revenue growth, expand our business properly or achieve profitability.
Our future prospects should be considered in light of the risks, expenses and
difficulties frequently encountered by companies in new and rapidly evolving
industries. These risks include establishing and increasing market acceptance of
our products and systems, responding effectively to competitive pressures,
offering high quality customer service and support, introducing, on a timely
basis, advanced versions of, and enhancements to, our existing products and
successfully marketing and supporting these advanced versions and enhancements.
We cannot assure you that we will be able to satisfactorily address these risks.
We expect to continue to incur operating losses in 2003 and may continue to
incur operating losses thereafter. Our revenues may not grow sufficiently to
enable us to achieve or sustain profitability.
The recent outbreak of SARS in the Asia-Pacific region and its continued spread
could harm sales of our products. The recent outbreak of severe acute
respiratory syndrome, or SARS, that began in the Asia-Pacific Region may have a
negative impact on our business. Our business may be affected by a number of
24
SARS-related factors, including, but not limited to, disruptions in the
operations of our distributors, customers and their partners, reduced sales in
certain markets, and increased costs related to conducting our business abroad.
If this or any other factor hinders our ability to sell our products or provide
our support services to our customers, there could be a significant disruption
in our business. Any such disruption could adversely affect our business,
financial condition and results of operations.
Our customers' markets are currently experiencing a prolonged and severe
downturn. The global economic slowdown has had a particularly severe impact on
certain of our customers' markets, including in particular the Internet,
telecommunications and consumer electronics markets. Due to these adverse market
conditions, we have experienced diminished business opportunities and decreased
sales. In addition, the September 11, 2001 terrorist attacks on the United
States and the subsequent military response, as well as the current situation in
Iraq, have had, and may continue to have, a negative effect on the global
economy and our business and customers. Any similar acts of violence or war may
further negatively affect our business environment, revenues and profitability
and could also result in a disruption of our business or the businesses of our
customers. A continuation of this economic trend and the continued global
tightening of capital markets will affect the demand for our products and
services in the future and could have a significant negative impact on our
revenues and the price of our shares.
If we fail to timely complete the development and introduction of new products,
our results of operations may suffer. Growth in our sales and revenues is
dependent, to a significant extent, upon the commercial success and market
acceptance of our products. To this end, we are involved in the development and
introduction of new products and applications and advanced versions and
enhancements to our existing products. A number of risks are inherent in this
process, and we may not successfully complete the development or introduction of
these products and applications. The development of new technologies and
products is complex and uncertain, and requires close collaboration and
continued technological advancement involving multiple hardware and software
design teams within our company, our customers and outside suppliers of key
components. These factors may result in a failure to introduce new products and
applications, and advanced versions of, and enhancements to, our existing
products in a timely manner, if at all. If we fail to timely complete the
development and introduction of new products and applications, and advanced
versions of, and enhancements to, our existing products, our results of
operations may suffer.
We may not satisfy the requirements for quotation on the OTC Bulletin Board
Service. In February 2002, our ordinary shares were delisted from the NASDAQ
National Market as a result of our failure to meet NASDAQ's continued listing
requirements. Trading in our ordinary shares is currently conducted in the over
the counter market, or the OTCBB. If we cannot satisfy OTCBB's requirements for
quotation, it may remove our ordinary shares from its service. To continue to be
quoted on the OTCBB, among other things, we must remain current in our filings
with the Securities and Exchange Commission, referred to as the Commission, or
other regulatory bodies and must have a market maker for our stock. We cannot
assure you that we will continue to satisfy these or other quotation
requirements in the future. If this occurs, our ordinary shares may be removed
from the OTCBB and trading in the ordinary shares may be conducted on "Pink
Sheets Electronic Quotation Service." As a result, an investor would likely find
it significantly more difficult to dispose of, or to obtain accurate quotations
as to the value of, our ordinary shares and the prices of our ordinary shares
may be lower than those that might otherwise be available through the OTCBB.
25
We have effected a major restructuring of our corporate activities which may
adversely affect our business. In the second half of 2001 and first quarter of
2002, we effected a major restructuring of our corporate activities. As part of
this restructuring, we merged our Software Tools Division and LiveProducts
Division, closed offices in the U.S., France and Sweden and relocated our
Japanese office to a customer's facilities. We reduced our staff in all
categories, particularly from the former LiveProducts division, whose sales and
marketing department was eliminated entirely and whose responsibilities were
taken over by other existing staff. In addition, we reduced significantly our
research and development department. Although the restructuring has led to a
significant costs saving, such that our total operating costs for 2002 were $5.7
million compared to $11.4 million for 2001 and our gross revenue increased to
$6.2 million in 2002, compared with $5.0 million in 2001, the reduction in staff
may limit our ability to market our existing products, take advantage of market
opportunities or develop and market new products in the future.
We have significant fluctuations in our business and our results of operations
are unpredictable. We have experienced, and expect to continue to experience,
significant quarterly and annual variations in our results of operations. These
variations in our results of operations may make it difficult for investors to
make reliable period-to-period comparisons of our performance or predictions as
to our future performance and may contribute to volatility in our share price.
These variations result from a variety of factors, including:
o the strength of the market for technology products generally;
o the timing, composition and size of orders from our customers (which
may be impacted by a variety of factors affecting our customers and
not directly related to our products and services);
o the market acceptance of our products;
o the various types of distribution channels we employ, including
direct sales and sales through distributors;
o the timing of new enhancement or product announcements by us and our
competitors;
o our ability to continue to develop, introduce and deliver new and
enhanced products on a timely basis and in a cost effective manner;
o our ability to offer new products at competitive prices;
o our ability to anticipate customer needs and demand; and
o currency exchange rate fluctuations and economic conditions in the
geographical areas in which we operate.
Moreover, our revenues in each quarter are derived primarily from a fairly small
number of large orders, some of which are from new customers. For example, in
the second quarter of 2003, 40% of revenues were derived from one order. The
26
deferral or loss of one or more significant sales could materially affect our
operating results in any fiscal quarter, especially if there are significant
sales and marketing expenses associated with the deferred or lost sales. Because
large orders generate disproportionately large revenues, our revenues and the
rate of growth of our revenues for a particular quarter may reach levels that
may not be sustained in subsequent quarters. Consequently, our inability to
obtain large orders from our customers or delays in the shipment of, or payment
for, any such order could significantly impact our quarterly results.
For these reasons, you should not rely on period-to-period comparisons of our
financial results to predict our future performance. Our future results of
operations may fall below the expectations of our investors, which would likely
cause the trading price of our ordinary shares to decline. Our expense levels
are based, in part, on our expectations of future revenues. If our revenues are
below expectations, our results of operations are likely to be adversely
affected. Net income may decline due to decreased revenues because we may not be
able to promptly reduce expenses correspondingly to the decrease in revenues. In
light of the above, we believe that our business activity and results of
operations in any quarter are not necessarily indicative of any longer trends in
our business and it may be difficult for investors to evaluate our prospects.
We are subject to risks of technological change and need to develop new products
and applications and new versions of, and enhancements to, our existing
products. The market for our products is characterized by rapid technological
developments, evolving industry standards, swift changes in customer
requirements, computer operating environments and software applications, and
frequent new product introductions and enhancements. To succeed, we must:
o anticipate changes in the market for our products and customer
expectations;
o meet changing and increasing customer expectations;
o continue to enhance our existing products;
o develop and introduce in a timely manner new products and
applications and new versions of, and enhancements to, our existing
products incorporating technological advances; and
o comply with emerging industry standards.
Our products may become obsolete if we fail to successfully anticipate or react
to change. To the extent that one or more of our current or new competitors
introduces products that more effectively address customer needs, our business,
financial condition and results of operations could be materially adversely
affected. In addition, negative reviews of our new or existing products in
industry publications could have a material adverse effect on our sales.
As part of our corporate restructuring, we reduced our research and development
expenses during 2001 and the first quarter of 2002 by approximately 50%. So far
these cutbacks have not adversely affected our ability to introduce new products
and applications and new versions of, and enhancements to, our existing products
and the timing of their introduction. However, we cannot assure you that the
27
reduction of research and development costs will not affect our future revenues
and our ability to compete in the markets in which we operate in the future. We
have decided not to proceed with the development of a new product designed to be
a completely new version of our RapidPLUS toolset and, instead, have relied upon
the knowledge gained in the course of development to introduce new modules and
versions of our existing RapidPLUS product. Although we believe this is a
prudent and cost-effective approach to advancing the development of our
products, we cannot be sure that these new modules and versions will gain market
acceptance.
In the past, we have, on occasion, experienced delays in the release of new
products and product enhancements, including new modules. If we are unable to
successfully develop and introduce new products and applications and new
versions of, and enhancements to, our existing products in a timely manner in
response to changing market conditions or customer requirements, our business,
financial condition and results of operations would be materially adversely
affected.
We depend on certain key personnel. Our future performance depends, to a
significant extent, upon the continued service of our key technical, development
and management personnel. The loss of the services of certain of these
individuals would have a material adverse effect on our results. None of our
employees has a long-term employment contract. Our future success also depends
on our ability to continue to attract, train and retain highly qualified
technical sales and marketing personnel and we cannot assure you that we can
attract, train or retain such personnel. If we are unable to hire and integrate
such personnel on a timely basis in the future, our business, financial
condition and results of operations could be materially adversely affected.
We are subject to competition. The wireless device MMI market and the embedded
systems software development industry are both highly competitive and
characterized by rapidly advancing technology. We expect competition to increase
in the future. We believe that the principal competitive factors in this
industry are technological innovation, functionality, reliability, service,
reputation, pricing and the ability to provide integrated solutions.
In order to maintain and improve our position in both the wireless device MMI
market and the embedded industry, we must continue to enhance our existing
products and to develop new products and applications and product and
application extensions. In our restructuring, we have reduced the number of
employees engaged in research and development. This reduction may adversely
affect our ability to compete with our competitors by introducing to the market
new products and applications and new versions of, and enhancements to, or
existing products in a timely manner or at all.
We believe that the main competition in the wireless device MMI market is from
companies that sell the MMI as part of a wider suite of integrated products.
Among these are semiconductor vendors who have their in-house MMI solution, such
as Infineon, Agere and Skyworks. Other competitors are companies that provide
core software for wireless devices such as protocol stacks, that also provide an
MMI solution. Most notable of these is TTPCom. Additional competition in this
market comes from 3Glabs, targeted at the high-end of the market, and WildSeed,
who offer an integrated hardware/software MMI solution.
We believe that the principal competition for our products in the embedded
systems market comes from embedded systems applications software development
solutions that are developed in-house by our customers or potential customers
28
rather than those purchased from independent software vendors like us. Many
organizations that develop their software solutions in-house have substantial
internal programming resources with the capability to develop specific solutions
for their needs. A decision to use our products may involve a fundamental shift
in the software development process used by these companies. Consequently, we
must persuade many potential customers to replace their in-house solutions, into
which substantial resources have been invested, with our products. We also
compete with other independent software vendors who provide products addressing
certain stages of the development cycle for products incorporating embedded
systems applications software. Software providers competing with our products at
various stages of the embedded systems applications software development cycle
include Altia, Inc., Virtual Prototypes, Inc., ZipC, Inc. and Gaio, Inc.
Many of our existing and potential competitors have substantially greater
financial, technical, marketing and sales resources than we do. Because we have
derived most of our revenues from sales of and services related to the RapidPLUS
family of products, the effects of competition could be more adverse than if we
had a broader product offering.
Some of our current and potential competitors have longer operating histories,
greater name recognition, access to larger customer bases and significantly
greater financial, technical and marketing resources than we do. Many of our
competitors have well-established relationships with our current and potential
customers and have extensive knowledge of our target markets. As a result, they
may be able to adapt more quickly to new or emerging technologies and changes in
customer requirements or to devote greater resources to the promotion and sale
of their products than us. We expect to face increasing competitive pressures
from both current and future competitors.
The Internet market is also highly competitive and is characterized by rapid
technological change and intense competition. There are technologies currently
available that compete with LiveProducts and which may prove to be difficult to
compete with, such as Macromedia's Flash and ShockWave Director. We cannot
assure you that our current and potential competitors, will not develop products
that may be more effective than our current or future products or that our
technologies and products will not be rendered obsolete by such developments.
Competitive pressures in our markets could cause us to reduce the prices of our
products, which would result in reduced profit margins. We believe that our
ability to compete successfully will depend on a number of factors both within
and outside our control, including price, quality, availability, customer
service and support, breadth of product line, product performance and features,
rapid time-to-market delivery capabilities, reliability, timing of new product
introductions by us, our customers and our competitors, and the ability of our
customers to obtain financing. We cannot assure you that we will have the
financial resources, technical expertise, or marketing, sales, distribution, and
customer service and support capabilities to compete successfully against our
current and future competitors. If we fail to compete successfully, our
business, financial condition and results of operations would be materially
adversely affected.
We are subject to certain risks relating to sales and distribution, and we are
dependent on a limited number of distributors. Although we are developing
further distribution channels through third parties, we continue to rely
principally on our direct sales and marketing force. Our marketing strategy
includes sales through distributors as well as direct sales by our own sales
force. As of June 30, 2003, we had 10 direct sales and marketing employees, a
29
63% reduction in sales and marketing staff since we began our restructuring in
the second quarter of 2001. We cannot assure you that our reduced sales force
will be sufficient to effectively support our anticipated business or that our
sales and marketing organization will successfully compete against the more
extensive and well-funded sales and marketing organizations of many of our
current and future competitors.
In addition to our direct sales force, we rely on sales by our distributors. In
2000, sales to Nippon Systemware in Japan, Simulis Inc. in the U.S. and Intus
Technologies Co. in South Korea accounted for approximately 28%, 11% and 8%, of
our revenues, respectively. In 2001, sales to Kobe Steel Co. Ltd. and Yamagata
in Japan, and to Tatung Co. in Taiwan and Virtual Products International, Inc.,
or VPI, in South Korea, accounted for approximately 15%, 13%, 6% and 6% of our
revenues, respectively. In 2002 sales to Yamagata and NSW accounted for
approximately 33% and 8% of our revenue, respectively. We cannot assure you that
these distributors will satisfy any minimum purchase obligations they may have
in the future or renew their agreements with us. We cannot assure you that we
will be able to attract other third parties that will be able to market our
products effectively and provide timely and cost-effective customer support and
service. Some of our arrangements with our distributors and resellers do not
contain minimum purchase requirements, and certain of these distributors and
resellers may carry competing product offerings. Moreover, we cannot assure you
that any distributor or reseller will continue to distribute or resell our
products. The inability to recruit, or the loss of, important sales personnel,
distributors or resellers could have a material adverse effect on our business,
financial condition and results of operations. If anticipated orders from
distributors and resellers fail to materialize, our business, operating results
and financial condition will be materially adversely affected.
Additionally, our sales and marketing efforts could be adversely affected by
changes in the financial condition of our distributors and agents, or by other
changes to their respective businesses or markets.
We have risks associated with international sales. A key component of our
strategy is to continue to expand operations in existing international markets
outside of Israel, and to enter new international markets. Substantially all of
our sales have been made and are expected to continue to be made, directly or
indirectly, in the international markets, with sales in the U.S., Japan, the Far
East (excluding Japan) and Europe representing 20.9%, 44.9%, 10.5% and 20%,
respectively, of our total revenue for 2002; 25.0%, 60.4% and 13.5%,
respectively, of our total revenues for 2001; and 27.6%, 56.9% and 14.8%,
respectively, of our total revenues for 2000. We currently maintain direct sales
and service offices or personnel in the U.S. and Japan and have distributors and
resellers in Europe and the Far East. A substantial portion of our sales has
been made, and is expected to continue to be made, in the U.S., the Far East and
Europe, although the relative amount of sales in each of these markets is
expected to change. For additional information see note 13b to our consolidated
financial statements, included elsewhere in this annual report.
There are certain risks inherent in doing business in international markets,
including:
o difficulties in collecting accounts receivable;
o foreign currency risks;
30
o financial and political instability;
o longer payment cycles.
o lack of acceptance of products not adapted for the local market;
o cultural differences in the conduct of business;
o difficulties in staffing and managing foreign operations;
o withholding taxes restricting the repatriation of earnings;
o unexpected changes in regulatory requirements;
o burdens of complying with a wide variety of foreign laws; and
o tariffs and other trade barriers.
Any of these factors could adversely affect the success of our international
operations. In some markets, adaptation of our products to the local culture,
language and requirements is critical for local market acceptance of our
products and market penetration. We may incur substantial costs and experience
delays in adapting our products for local markets, and we cannot assure you that
any adapted product will achieve market acceptance or generate significant
revenues. We cannot assure you that one or more of these factors will not have a
material adverse effect on our business, financial condition and results of
operations.
Our business and financial condition could be negatively impacted by the
financial instability of our customers. We sell our products and provide
services to wireless device platform solutions vendors, embedded systems
manufacturers and distributors located around the world based on pre-qualified
payment terms. Financial difficulties of a customer could cause us credit risk
relating to that customer's receivables. Our inability to collect on our trade
accounts receivable from any one of these customers could have a material
adverse effect on our business and financial condition.
We have risks relating to the long sales cycle for our Rapid products. A
decision to use our Rapid products often entails a fundamental change in a
customer's product engineering methods, and replacement of all or a significant
part of a customer's in-house solutions. Consequently, we devote significant
marketing efforts to educating potential customers about the benefits of
adopting the Rapid methodology. In addition, using RapidPLUS/CODE (the code
generation module of our RapidPLUS product) involves taking a risk of embedding
machine-generated code in the embedded product. Consequently, customers need to
be confident that the generated code functions correctly and efficiently. In
light of the need to educate a customer about the benefits of the Rapid
products, convince customers of the reliability of our code generation
capability, the critical role software development plays in the customer's
business and the significant costs involved in implementing our products on a
large scale within that business, our sales cycle is relatively long, typically
approximately six months for a large order to a new customer. Because of this,
31
we are often required to devote more time to, and spend more money on, marketing
our products than would be necessary if sales were made more quickly. We cannot
assure you that any sales will result from our extensive sales and marketing
efforts. Moreover, any significant marketing expenses that we incur before we
receive any revenues generated as a result of these efforts, could have a
material adverse effect on our business, financial condition and results of
operations. The length of the sales cycles may continue to increase in light of
the more conservative spending by many customers and potential customers due to
current market conditions.
We are subject to risks of product defects as well as other potential liability.
As a result of their complexity, software products, including those we develop
and market, may contain undetected errors or compatibility problems,
particularly when first introduced or when new versions of, and enhancement to,
our existing products are released. We cannot assure you that errors will not be
found in new products or applications or in new versions of, or enhancements to,
our existing products after they have been shipped, despite our testing as well
as the testing and use by current and potential customers. These errors could
result in the loss of, or delay in, market acceptance of our products, which
could have a material adverse effect on our business, financial condition and
results of operations.
The increasing use of our products for applications in markets where the failure
of our products could cause substantial property damage or personal injury could
subject us to significant product liability claims. In addition, our products
may be used for applications in mission-critical business systems where the
failure of our products could result in substantial economic loss. Our license
and other agreements with our customers typically contain provisions designed to
limit our exposure to potential product liability and other claims. However, the
limitation of liability provisions contained in our agreements are not effective
in all circumstances and in all jurisdictions. Although we have not experienced
any product liability or economic loss claims to date, the conduct of our
business entails the risk of such claims. We carry insurance against product
liability risks and errors or omissions coverage, although we cannot assure you
that insurance coverage will continue to be available to us on commercially
reasonable terms or at all.
A product liability claim or claim for economic loss brought against us in
excess of, or outside the limits of, our insurance coverage, or a product recall
involving our software, could have a material adverse effect on our business,
financial condition and results of operations.
We depend on certain proprietary technology. Our success is dependent, to a
significant extent, upon our proprietary technology. To protect our proprietary
rights, we rely on a combination of copyright, trademark, patent and trade
secret laws, together with non-disclosure and other contractual confidentiality
procedures, which provide only limited protection. In addition, we have filed
patent applications, most of which are currently pending, in Israel, the U.S.,
Europe, India, Japan, Hong Kong, South Korea, Canada, China and Taiwan in
respect of certain aspects of our core technology, and intend to file additional
applications in certain other countries. We cannot assure you that these patents
will be issued or that if issued, these patents will not be challenged or
invalidated, or be of sufficient scope or strength to provide us with meaningful
protection or commercial advantage. As part of our confidentiality procedures,
we generally enter into non-disclosure agreements with our employees,
consultants, distributors and development partners that limit access to, and
distribution of, our software, documentation and other proprietary information.
Despite our efforts to protect our proprietary rights, it may be possible for
32
unauthorized parties to copy our products or to reverse engineer or obtain and
use information that we regard as proprietary. In addition, the laws of some
foreign countries do not protect our proprietary rights as fully as do the laws
of the United States or Israel. We cannot assure you that our efforts to protect
our proprietary rights will be adequate nor that our competitors will not
independently develop technologies that are substantially equivalent or superior
to our technologies.
We could become subject to litigation regarding intellectual property rights,
which could seriously harm our business. Third parties have in the past asserted
against us, and may in the future assert against us, infringement claims or
claims that we have violated a patent or infringed a copyright, trademark or
other proprietary right belonging to them. For instance, recently, one of our
competitors has alleged that certain features of our newly released RapidPLUS
version 7 breach that party's copyright, a claim we believe to be without merit.
In addition, based on the size and sophistication of our competitors and the
history of rapid technological change in our industry, we anticipate that
several competitors may have intellectual property rights that could relate to
our products. Therefore, we may need to litigate to defend against claims of
infringement or to determine the validity or scope of the proprietary rights of
others. Similarly, we may need to litigate to enforce or uphold the validity of
our patents, trademarks and other intellectual property rights. Other actions
may involve ownership disputes over our intellectual property or the
misappropriation of our trade secrets or proprietary technology. As a result of
these actions, we may have to seek licenses to a third party's intellectual
property rights. These licenses may not be available to us on reasonable terms
or at all. In addition, if we decide to litigate these claims, the litigation
could be expensive and time consuming and could result in court orders
preventing us from selling our then-current products or from operating our
business. Any infringement claim, even if not meritorious, could result in the
expenditure of significant financial and managerial resources and harm our
business, financial condition and results of operations.
We depend on third-party proprietary technology. We rely, and expect to continue
to rely, on certain software that we license from third parties, including
software that is integrated with internally developed software and used in our
products to perform key functions. Some of this software may be required to
complete the development of products that we intend to offer in the future. We
cannot assure you that these third-party providers will remain in business, that
they will continue to support their technology or that their technology will
otherwise be available to us on commercially reasonable terms. The loss of, or
inability to, maintain or obtain any of these software licenses could result in
delays or cancellations in product shipments until equivalent software can be
identified and licensed or developed and integrated with our products. Any such
delay or cancellation could have a material adverse affect on our business,
financial condition and results of operations.
For certain of our customers, we provide hosting services on our LiveManuals.com
web-site. Capacity constraints and system failures could damage our reputation
for reliability in providing these services. Our ability to perform properly
requires that we have adequate capacity in our computer systems to handle the
traffic on our web-site. We have designed our systems to be scalable. However,
if the number of users of our service increases substantially or the demand is
not as anticipated, we will need to significantly expand and upgrade our
technology and network infrastructure. We do not know whether we will be able to
predict accurately the rate or timing of these increases or changes in demand or
to expand and upgrade our systems and infrastructure to accommodate them in a
timely manner. If our systems cannot be expanded or upgraded as required, we
could experience unexpected disruptions in service, slower response times,
decreased customer service and customer satisfaction and delays in the
33
introduction of new products and services. Any of these problems could impair
our reputation, damage our brand name and cause our revenues to decrease. Our
ability to provide high-quality customer service also depends on the efficient
and uninterrupted operation of our computer and communications hardware systems.
Our web-site service could experience periodic system interruptions. Any system
failure that causes an interruption in service or decreases the responsiveness
of our web-site could impair our reputation, damage our brand name, cause our
revenues to decrease and could adversely affect our business, financial
condition and results of operations.
We may pursue acquisitions that present risks and that may not be successful. In
the future, we may pursue acquisitions to enhance our technology and diversify
our product and service offerings and customer base or for other strategic
purposes. We have a limited history of making acquisitions and we cannot be
certain that any future acquisitions will be successful. In March 2000, we
entered into a letter of intent with a company, referred to as the subject
company, that engaged in the development of technology complementary to our
LiveProducts business, with respect to a possible acquisition of the subject
company by us in exchange for a certain number of our ordinary shares. As part
of the letter of intent, we invested $1 million, in exchange for approximately
2.75% of the outstanding capital stock of the subject company and received a
two-year license for the subject company's technology. In addition, we extended
loans to the subject company of approximately $149,000. To date, the subject
company has not repaid these loans as required by their terms. Additionally, in
light of the general global decline in valuation of high technology companies,
and the prospects of the subject company in particular, we believe that none of
our investment is now recoverable. As a result, we wrote off $730,000 of the
investment in 2000 and in 2001 decided to write off the balance of our
investment and loan in the amount of $426,000. For additional information
concerning this investment and loan see note 2e to our consolidated financial
statements, included elsewhere in this annual report.
We may be liable for information displayed on and communicated through our
web-sites. We may be subject to claims for defamation, negligence, copyright or
trademark infringement or based on other theories of liability relating to the
information that we publish on our web-sites. These claims have been brought
against online companies as well as print publications in the past. Based on
hyperlinks that we provide to other web-sites, we may also be subjected to
claims based upon online content that we do not control but that is accessible
from our web-site. Any costs incurred as a result of liability or asserted
liability for such claims could damage our brand, reputation, business,
financial condition and results of operations.
Inflation and currency fluctuations may adversely affect our results. We may be
adversely affected if the rate of inflation in Israel exceeds the rate of
devaluation of the NIS against the dollar.
Most of our sales are made in dollars and we incur substantial expenses in
dollars and NIS. The dollar cost of our operations in Israel is influenced by
the extent to which any increase in the rate of inflation in Israel is not
offset, or is offset on a lagging basis, by a devaluation of the NIS in relation
to the dollar.
The inflation rate in Israel was 3.1% in 2001 and 5.5% in 2002 and the deflation
rate was 0.1% in 2000. At the same time, the devaluation of the NIS against the
dollar was 1.4% in 2000, 11.2% in 2001 and 4.6% in 2002.
34
As a result of the devaluation of the dollar against the NIS exceeding the
inflation rate, we experienced a decrease in the dollar costs of our operations
in Israel in 2000, 2001 and 2002, primarily because substantially all our
revenues are received in dollars and salaries in Israel are paid in NIS and are
not directly linked to the rate of inflation. However, these fluctuations did
not materially affect our results of operations.
In recent years, the Israeli Government's monetary policy contributed to
relative price and exchange rate stability despite fluctuating rates of economic
growth. However, in the last month of 2001 and throughout the first half of
2002, there was a significant devaluation of the NIS and an increase in
inflation, while in the first half of 2003, there was a significant revaluation
of the NIS and a decrease in the rate of inflation. We cannot assure you that
the Israeli Government will be successful in its efforts to keep prices and
exchange rates relatively stable. We do not currently engage in any hedging
arrangements to offset risks associated with fluctuations in foreign currency
exchange rates, but may do so in the future. As a result, price and exchange
rate instability could have a material adverse effect on our business, financial
condition and results of operations.
The price of our ordinary shares is highly volatile. The trading price of our
ordinary shares fluctuates significantly. For example, the price of our ordinary
shares in our initial public offering in July 1998 was $7.00. Our share price
has been as low as $0.07 per share in October 2002 and as high as $38 per share
in March 2000. In the last twelve months, we have experienced a drop in trading
volume, which has increased the volatility of the trading price of our shares.
Prices of our ordinary shares may fluctuate in response to a number of events
and factors, including:
o quarterly variations in our results of operations;
o changes in our operating expense level or losses;
o performance of technology companies generally;
o new products, services and strategic developments by us or our
competitors;
o announcements of innovations;
o changes in financial estimates and recommendations by securities
analysts with respect to our Company, companies engaged in similar
business or technology companies generally;
o general stock market conditions, particularly with respect to
technology companies; and
o general conditions of the economies of the countries in which we do
business.
Any of these events may cause our share price to fall, which may adversely
affect our business and financing opportunities.
In addition, global stock markets have recently experienced and may continue to
experience significant price decreases and price and volume fluctuations which
have particularly affected the market prices of the stocks of high technology
35
companies, Internet-related companies and Israeli companies, including
ourselves.
If we are characterized as a passive foreign investment company, our U.S.
shareholders may suffer adverse tax consequences. If, for any taxable year, our
passive income, or our assets which produce passive income, exceed specified
levels, we may be characterized as a passive foreign investment company, or
PFIC, for U.S. federal income tax purposes. This characterization could result
in adverse U.S. tax consequences for our U.S. shareholders, which may include
having gains realized on the sale of our ordinary shares treated as ordinary
income, rather than as capital gains income, and having potentially punitive
interest charges apply to the proceeds of sales of our ordinary shares. We
believe we were not a PFIC for our fiscal year ended January 31, 2003. However,
the tests for determining PFIC status are applied annually and it is difficult
to make accurate predictions of future income and assets, which are relevant to
this decision. Accordingly, we cannot assure you that we will not become a PFIC.
For a more detailed discussion of the consequences of our being classified as a
PFIC, see Item 10.E "Additional Information-Taxation-United States Federal
Income Tax Considerations." U.S. shareholders are urged to consult with their
own U.S. tax advisors with respect to the U.S. tax consequences of investing in
our ordinary shares.
We are located in the State of Israel, which entails various special risks. We
are incorporated under the laws of the State of Israel, and our principal
offices, manufacturing and research and development facilities are located in
Israel. Although virtually all of our sales are currently made to customers
outside Israel, we are nonetheless influenced by political, economic and
military conditions affecting Israel. Any major hostilities involving Israel or
the interruption or curtailment of trade between Israel and its present trading
partners could have a material adverse effect on our operations. Since September
2000, there has been an escalation of violence in the West Bank and Gaza Strip
and increased terrorist activity within Israel, causing a deceleration of the
Israeli economy. Furthermore, several countries restrict business with Israeli
companies. We could be adversely affected by further set-backs to the peace
process in the Middle East or by restrictive laws or policies directed toward
Israel or Israeli businesses.
We benefit from programs sponsored by the Government of Israel for the support
of research and development and marketing, as well as favorable tax rates
available to "Approved Enterprises" in Israel. To be eligible for these programs
and tax benefits, we must continue to meet certain conditions, including
reaching certain revenue and export levels. If we fail to meet these conditions
in the future, we could be required to refund tax benefits that we expect to
receive. In addition, the Government of Israel has reduced the benefits
available under a number of government sponsored programs and has indicated its
intention to further reduce benefits in the future.
The termination or adverse modification of these programs or our inability to
take advantage of them would cause the costs of our operations in Israel to
materially increase and result in an adverse effect on the results of our
operations as a whole. To the extent that we increase our activities outside of
Israel, which could result from, among other things, future acquisitions, these
increased activities generally will not be eligible for benefit programs
sponsored by the State of Israel. Accordingly, the effective cost of our future
research and development activities in particular, and our operations in
general, could significantly increase.
36
Additionally, Israeli adult male citizens and permanent residents through the
age of 48 are obligated to perform up to 39 days of military reserve duty
annually. Some of our officers and employees are currently obligated to perform
annual reserve duty. Furthermore, all these persons are subject to being called
to active duty at any time under emergency circumstances. Although we have
operated without any material disruption under these requirements since we began
operations, we cannot assess the full impact of these requirements on our
workforce or business if conditions should change, and we cannot predict the
effect on us of any expansion or reduction of these obligations.
We are subject to risks associated with joint development projects. In the past
we have joined other companies in joint development projects, and we may
continue to do so in the future. We undertake certain risks when we enter these
joint development projects. These risks include:
o loss of control over the development of aspects of the jointly
developed product;
o loss of control over timing of any module/product introduction and
availability; and
o disputes concerning rights with respect to any technology used or
developed in the joint development process.
In addition, our joint development activities may not result in new products or
enhancements and any products or enhancements developed may not be commercially
successful.
We have risks associated with revenues based on royalties. As a result of our
new emphasis on runtime license fees, we expect to derive an increasing
percentage of our revenues from such fees in the future, rather than from the
sale of Rapid PLUS licenses. As a result, we will be increasingly dependant on
the sale by our customers of their own products that incorporate our kernels for
our revenues. This business model relies upon our customers' volume of sales and
on their promptness in paying royalties to us, may delay recognition and receipt
of revenues, which may adversely affect our profitability and financial
position.
Concentration of Share Ownership. As of July 31, 2003, our directors, executive
officers and principal shareholders and their affiliates beneficially owned
approximately 72% of our outstanding ordinary shares. As a result, these
shareholders are able to exercise significant influence over all matters
requiring shareholder approval, including the election of directors and approval
of significant corporate transactions. Such concentration of ownership may have
the effect of delaying or preventing a change in control in us. See "Item 7 --
Major Shareholders and Related Party Transactions."
Provisions of Israeli Law could delay, prevent or make difficult a change of
control and therefore depress the price of our shares. The Israeli Companies Law
generally requires that a merger be approved by the board of directors and a
majority of the shares voting on the proposed merger. Unless a court rules
otherwise, the merger will not be deemed approved if a majority of the shares
held by parties other than the other party to the merger (or by any person who
holds 25% or more of the shares or the right to appoint 25% or more of the
directors of the other party) vote against the merger. Upon the request of any
creditor of a party to the proposed merger, a court may delay or prevent the
merger if it concludes that there is a reasonable concern that, as a result of
the merger, the surviving company will be unable to satisfy its obligations.
37
Finally, a merger may not be completed unless at least 70 days have passed since
the filing of the merger proposal with the Israeli Registrar of Companies.
In certain circumstances an acquisition of shares in a public company must be
made by means of a tender offer if, as a result of the acquisition, the
purchaser would become a 25% or 45% shareholder of the company (unless there is
already a 25% or a majority shareholder of the company, respectively). If, as a
result of an acquisition, the acquirer would hold more than 90% of a company's
shares, the acquisition must be made by means of a tender offer for all of the
shares. The described restrictions could prevent or make more difficult an
acquisition of our company, which could depress our share price.
Also, Israel tax law treats some acquisitions, such as stock-for-stock exchanges
between an Israeli company and a foreign company, less favorably than U.S. tax
laws. For example, Israeli tax law may, under certain circumstances, subject a
shareholder who exchanges his ordinary shares for shares in another corporation,
to taxation prior to the sale of the shares received in such stock-for-stock
swap.
It may be difficult to enforce a U.S. judgment against us, and our officers and
directors named in this annual report, to assert U.S. securities laws claims in
Israel and to serve process on substantially all of our officers and directors.
We are incorporated in Israel. Most of our executive officers and directors
named in this annual report are nonresidents of the United States, and a
substantial portion of the assets of these persons are located outside the
United States. It may be difficult for an investor, or any other person or
entity, to enforce a U.S. court judgment based upon the civil liability
provisions of U.S. federal securities laws in an Israeli court or to effect
service of process upon these persons. Additionally, it may be difficult for an
investor, or any other person or entity, to enforce civil liabilities under U.S.
federal securities laws in original actions instituted in Israel.
38
ITEM 5
OPERATING AND FINANCIAL REVIEW AND PROSPECTS
(A) OPERATING RESULTS
CRITICAL ACCOUNTING POLICIES
Our consolidated financial statements have been prepared in conformity with U.S.
GAAP. Under U.S. GAAP, when more than one accounting method or policy or its
application is generally accepted, our management selects the accounting method
or policy that it believes to be most appropriate in the specific circumstances.
Our management considers some of these accounting policies as critical. A
critical accounting policy is an accounting policy that management believes is
both most important to the portrayal of our financial condition and results and
requires management's most difficult subjective or complex judgment, often as a
result of the need to make accounting estimates about the effect of matters that
are inherently uncertain. While our significant accounting policies are
discussed in note 2 to our consolidated financial statements, included elsewhere
in this annual report, we believe the following accounting policies to be
critical:
Revenue recognition
We derive our revenues from license fees for our products, technology transfer
fees from licensing our Java code generation technology, training fees,
mentoring and consulting fees, support fees, runtime licensing fees, and right
to use fees derived from ordinary use of the RapidPLUS simulations over the web.
We sell our products primarily through our direct sales force or indirectly
through resellers, who are considered end-users. We also generate revenues by
providing full-product simulations for delivery over the Internet and Intranet,
and from fees derived from the use of these simulations.
We implement Statement of Position, or SOP, 97-2, "Software Revenue
Recognition," as amended. Revenues from software arrangements are recognized
upon delivery of the product, when no future obligation exists, collection is
probable, the product fee is otherwise fixed or determinable and persuasive
evidence of an arrangement exists. SOP 97-2 requires revenue earned on software
arrangements involving multiple elements to be allocated to each element based
on the relative fair value of the elements. We have also adopted SOP 98-9,
"Modification of SOP 97-2, Software Revenue Recognition with Respect to Certain
Transactions," for all transactions entered into after January 1, 2000. Our
Vendor Specific Objective Evidence, also known as VSOE, used to allocate the
sales price to maintenance, support, consulting services, including
implementation, and training, is based on the renewal ratio of such services and
the price charged when these elements are sold separately. SOP 98-9 requires
that revenue be recognized under the "residual method" when (1) VSOE of fair
value exists for all undelivered elements and no VSOE exists for the delivered
elements, and (2) all revenue recognition criteria of SOP 97-2, as amended, are
satisfied. Under the residual method, any discount in the arrangement is
allocated to the delivered element. We do not grant our customers a right of
return.
Maintenance and support revenues included in multiple element arrangements are
deferred and recognized on a straight-line basis over the term of the
maintenance and support agreement.
39
We are entitled to royalties for licensing certain of our software tools.
Revenues from royalties are recognized when such royalties are reported to us or
in a lump sum following a buyout agreement whereby a customer pays an overall
agreed amount instead of royalties on a per item or per use basis.
Revenues from consulting services, implementation, and training included in
multiple element arrangement are recognized at the time such services are
rendered.
Revenues from product simulations are recognized based on SOP 81-1 "Accounting
for Performance of Construction Type and Certain Production Type Contracts,"
using contract accounting on a percentage of completion method, on the basis of
units of work completed. A provision for estimated losses on uncompleted
contracts is recorded in the period in which such losses are first identified,
in the amount of the estimated loss for the entire contract. As of January 31,
2003, no such estimated losses were identified. Estimated gross profit or loss
from long-term contracts may change due to changes in estimates resulting from
differences between actual performance and original forecasts. Such changes in
estimated gross profit are recorded in results of operations when they are
reasonably determinable by management, on a cumulative catch-up basis.
We are entitled to usage fees upon licensing of the product simulation to end
users. Revenues from usage fees are recognized when such revenues are reported
to us or at such time when a buyout agreement is signed with the end customer.
In contracts in which acceptance by the customer of particular aspects of the
transaction is required, we defer revenues dependant upon such acceptance until
the acceptance is confirmed.
Deferred revenue includes unearned amounts received under maintenance and
support contracts, and amounts received from customers but not recognized as
revenues.
Allowance for doubtful accounts and provision for bad debts.
We continuously monitor collection and payment from our customers and maintain
allowances for doubtful accounts and for estimated losses resulting from the
inability of our customers to make required payments. We have provided for these
allowances based on assumptions relating to the financial condition of our
customers in accordance with our management's estimates and historical
experience, plus an additional general reserve of 3%. If the financial condition
of our customers were to deteriorate, resulting in an impairment of their
ability to make payments, additional allowances may be required, the extent of
which is inherently uncertain. Our trade receivables are mainly derived from
sales to customers located primarily in the United States, the Far East and
Europe. We perform ongoing credit evaluation of our customers.
We generally do not require collateral; however, in certain circumstances, we
may require letters of credit, other collateral or additional guarantees.
Reclassification
Certain amounts from prior years have been reclassified to conform to the
current year's presentation. The reclassification has no effect on previously
reported net losses, shareholder's equity or cash flows.
40
Use of estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
effect the amounts reported in the financial statements and accompanying notes.
Actual results could differ from those estimates.
Restructuring
Note 1c to our consolidated financial statements, included elsewhere in this
annual report, describes restructuring charges which we recorded in 2002 in
connection with cost reduction initiatives that we implemented in response to
the decline in revenues which we experienced during 2001. Although we do not
anticipate significant changes, the actual costs may differ from these
estimates. In addition, in the event that adverse conditions continue to
prevail, generally in our industry or particularly with respect to our business,
we may be required to implement further restructuring measures which may require
additional restructuring charges. We are not currently able to determine whether
or to what extent additional charges may be required.
Contingencies
We are, from time to time, subject to proceedings and other claims related to
vendors and other matters. We are required to assess the likelihood of any
outcomes to these matters as well as potential ranges of probable losses. A
determination of the amount of reserves required, if any, for these
contingencies is made after careful analysis of each individual issue. The
required reserves may change in the future due to new developments in each
matter or changes in approach such as a change in settlement strategy in dealing
with these matters.
41
RESULT OF OPERATIONS
The following table sets forth, for the periods indicated, line items from our
consolidated statements of operations for the most recent three years:
YEAR ENDED JANUARY 31,
--------------------------------------------------------------------
2001 2002 2003
------------------- -------------------- -------------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Revenues:
Products................................................ $ 6,818 $ 3,031 $ 3,304
Services................................................ 3,063 2,005 2,916
------------------- -------------------- -------------------
......................................................... 9,881 5,036 6,220
------------------- -------------------- -------------------
Cost of revenues:
Products................................................ 383 169 267
Services................................................ 1,735 1,776 1,663
------------------- -------------------- -------------------
......................................................... 2,118 1,945 1,930
------------------- -------------------- -------------------
Gross profit............................................ 7,763 3,091 4,290
------------------- -------------------- -------------------
Operating expenses and costs:
Product development .................................... 2,475 - -
Web-site development ................................... 800 - -
Research and development, net........................ 2,774 2,610 1,464
Selling , marketing, general and administrative,
net ................................................ 8,751 7,854 4,261
Restructuring and impairment of
web-site development............................... - 910 -
------------------- -------------------- -------------------
Total operating expenses................................ 14,800 11,374 5,725
------------------- -------------------- -------------------
Operating loss.......................................... 7,037 8,283 1,435
Financial expenses (income), net ....................... (230) 210 (9)
Other expenses, net..................................... 730 426 94
------------------- -------------------- -------------------
Loss before taxes on income............................. 7,537 8,919 1,520
Taxes on income......................................... 56 62 199
------------------- -------------------- -------------------
Net loss ............................................... $ 7,593 $ 8,981 $ 1,719
=================== ==================== ===================
Basic and diluted net loss per share.................... $ 0.65 $ 0.77 $ 0.15
=================== ==================== ===================
Weighted average number of shares used in
computing basic and diluted net loss per share....... 11,643 11,663 11,665
=================== ==================== ===================
42
The following table sets forth, for the periods indicated, line items from our
consolidated statements of operations as percentages of our revenues for the
most recent three years:
YEAR ENDED JANUARY 31,
--------------------------------------------------------------------
2001 2002 2003
------------------- ------------------- -------------------
Revenues:
Products............................................ 69.0% 60.2% 53.1%
Services......................................... 31.0% 39.8% 46.9%
------------------- ------------------- -------------------
100.0% 100.0% 100.0%
------------------- ------------------- -------------------
Cost of revenues:
Products............................................ 3.9% 3.4% 4.3%
Services......................................... 17.6% 35.2% 26.7%
------------------- ------------------- -------------------
21.5% 38.6% 31.0%
------------------- ------------------- -------------------
Gross profit........................................ 78.5% 61.4% 69%
------------------- ------------------- -------------------
Operating expenses and costs:
Product development ............................. 25.0% - -
Web-site development ............................ 8.1% - -
Research and development, net ................... 28.1% 51.8% 23.5%
Selling, marketing, general and
administrative, net ............................ 88.6% 156% 68.5%
Restructuring and impairment of
web-site development .......................... - 18.1% -
------------------- ------------------- -------------------
Total operating expenses............................ 149.8% 225.9% 92%
------------------- ------------------- -------------------
Operating loss...................................... 71.3% 164.5% 23%
Financial expenses (income), net ................... (2.3%) 4.2% (0.1%)
Other expenses, net................................. 7.4% 8.4% 1.5%
------------------- ------------------- -------------------
Loss before taxes on income ........................ 76.4% 177.1% 24.4%
Taxes on income..................................... 0.6% 1.23% 3.2%
------------------- ------------------- -------------------
Net loss ........................................... 77% 178.3% 27.6%
=================== =================== ===================
43
2002 COMPARED WITH 2001
Revenues. Revenues increased 24% to $6.2 million in 2002, compared with $5.0
million in 2001. While product revenues for 2002 increased by only 9% to $3.3
million, compared with $3.0 million in 2001, revenues from services increased by
45% to $2.9 million compared with $2 million in 2001. Revenues from services
related to software sales for 2002 increased by 43% to $1.9 million compared
with $1.3 million in 2001. This increase was primarily attributable to a large
project we entered into with a leading wireless platform vendor. Revenues from
Live Products services for 2002 increased by 50% to $1 million compared with
$684,000 in 2001, as a result of new orders received from new and existing
customers. The increase in product revenues in 2002 is primarily attributable to
increased product sales to one of our major customers.
Cost of Revenues. Cost of revenues consisted primarily of salaries of our
technical support staff, expenses incurred in connection with our Indian
sub-contractor for the development of LiveProduct simulations provided to our
customers, royalties to the Office of the Chief Scientist and the cost of
freight, software production, manuals and packaging. Cost of product revenues
increased 58% to $267,000 in 2002, compared with $169,000 in 2001. The increase
of cost of product revenues is primarily attributable to the increase in the
cost of manuals, packaging, freight and royalties to the Office of the Chief
Scientist. Cost of service revenues decreased by 6% to $1.7 million for 2002
compared with $1.8 million in 2001. The decrease in cost of services revenues is
primarily attributable to a decrease of 47% in services for software-related
sales to $533,000 in 2002 from $997,000 in 2001, mainly due to the decrease in
our technical support staff. This decrease was partially offset by an increase
in costs of services in Live Products by 45% to $1.1 million in 2002, compared
with $778,000, in 2001 due to an increase in Live Products sales. Overall, cost
of revenues as a percentage of revenues decreased from 38.6% in 2001 to 31.0% in
2002.
Product development costs. In 2001, we decided to cease all investments in our
LiveManuals web-site. Accordingly, we incurred no product development costs in
both 2001 and 2002.
Web-site development costs. In 2001, we decided to cease all investments in our
LiveManuals web-site. Accordingly, we incurred no web-site development costs in
2001 and 2002.
Research and development expenses, net. Research and development expenses, net,
consisted primarily of salaries and other related expenses for research and
development personnel, as well as the cost of facilities and depreciation of
capital expenditures. Research and development expenses, net of grants from the
Office of the Chief Scientist decreased 44% to $1.5 million for 2002, compared
with $2.6 million for 2001. This decrease was primarily attributable to the
downsizing of our research and development staff in 2002, and was partially
offset by the lack of funding from the Office of the Chief Scientist in 2002
compared with grants of $427,000 obtained in 2001. Research and development
expenses, net decreased as a percentage of revenues to 24% for 2002 compared
with 52% for 2001.
Selling, marketing, general and administrative expenses, net. Selling,
marketing, general and administrative expenses, net, decreased in 2002 by 46% to
$4.3 million compared with $7.9 million in 2001. The decrease is primarily
attributable to the restructuring plan that we implemented beginning in 2001 and
which included staff reductions, closure of offices outside Israel and related
expenses. Selling and marketing expenses, net, consisted primarily of salaries
44
for sales personnel, expenses related to our subsidiaries, costs of travel,
advertising and promotional activities, and royalties paid for governmental
grants and to the BIRD Foundation. Selling and marketing expenses, net,
decreased by 53% to $2.7 million for 2002 compared with $5.7 million for 2001.
This decrease was primarily attributable to the reduction in sales and marketing
staff and related expenses. Selling and marketing expenses, net, decreased as a
percentage of revenues to 43% in 2002 from 113% in 2001. General and
administrative expenses consisted primarily of costs associated with management
compensation, professional fees and office expenses. General and administrative
expenses decreased 28% to $1.6 million for 2002 compared with $2.2 million for
2001. This decrease was primarily attributable to a reduction in salaries, legal
fees and lease expenses.
Restructuring and impairment of web-site development costs. In the first quarter
of 2001, we embarked on a significant restructuring effort. Since the
restructuring entailed a reduction of approximately 60% of our workforce, most
of the costs associated with the restructuring consisted of severance payments
and other benefits to former employees and payments for vacant office space,
amounting to $309,000. In 2002 we incurred no further costs related to
restructuring.
In 2001 we determined that the costs we incurred in developing our
Livemanuals.com web-site were not recoverable and wrote off the net value of the
investment in the web-site, which was $601,000. There were no further expenses
related to the web-site development in 2002.
For further information on impairment of web-site development costs, see note 2i
to our consolidated financial statements, included elsewhere in this annual
report.
Operating loss. Our operating loss decreased by 82% to $1.4 million for 2002
compared with $8.3 million for 2001. As a percentage of revenues, operating loss
decreased to 23% for 2002 from 164.5% for 2001. This decrease in the amount of
our operating loss and as a percentage of our revenues is primarily attributable
to our increased revenues and to the decrease in operating expenses and costs
resulting from our corporate restructuring.
Financial expenses (income), net. In 2002 financial income, net was
approximately $9,000 compared with financial expenses, net of $210,000 in 2001.
Financial expenses (income), net consists primarily of interest expenses on
loans and lines of credit, interest earned on deposits and gain or expense
resulting from foreign currency exchange rate differences. The change from
financial expense to financial income in 2002 is primarily attributable to
favorable foreign exchange rate differences partially offset by interest
expenses on loans and lines of credit.
Other expenses, net. In 2002 other expenses, net consisted of loss and expense
incurred in connection with sales of certain fixed assets and a write-off
expense related to obsolete property and equipment. In 2001 other expenses, net
consisted of a write-off expense related to the impairment of an investment. For
a more detailed discussion of the impairment of the investment and related
write-off in 2001, see "Item 4. Information on the Company - History and
Development of the Company - Acquisition Write Off." Accordingly, other
expenses, net decreased by 78% in 2002 to $94,000 compared with $426,000 in
2001.
45
Taxes on income. Taxes on income increased 220% to $199,000 in 2002 compared
with $62,000 in 2001, an increase primarily attributable to withholding tax paid
as a result of a single transaction. Taxes on income increased as a percentage
of revenues to 3% in 2002, compared to 1% in 2001.
2001 COMPARED WITH 2000
Revenues. Our operating results in 2001 were adversely affected by the general
economic slowdown and subsequent reduction in spending, which have had a
particularly severe impact on the entire software industry. Many software
developers and service providers in markets throughout the world have
experienced, and continue to experience, substantial declines in sales and
revenues and have incurred significant operating losses. The worldwide economic
downturn has impaired the ability of existing and prospective customers to
finance purchases of our products. As a result, although the prices of our
RapidPLUS tools have remained relatively stable, our revenues have decreased due
to reductions in the number and size of orders placed by our existing and new
customers. Our revenues decreased 49.0% to $5.0 million in 2001, compared with
$9.9 million in 2000. Product revenues for 2001 decreased 55.5% to $3.0 million,
compared with $6.8 million in 2000. The decrease was primarily attributable to
the decrease in revenues generated in Asia to $3.1 million for 2001 compared
with $5.7 million for 2000 and revenues generated in the U.S. to $1.3 million
for 2001 compared with $2.7 million for 2000. The reduction in sales of our
RapidPLUS products was offset in part by an increase of $292,000 in LiveProducts
sales.
Cost of revenues. Cost of revenues consisted primarily of salaries of the
technical support staff, expenses incurred in connection with our Indian
sub-contractor, royalties to the Office of the Chief Scientist and the cost of
freight, media, software production, manuals and packaging. The payments to our
Indian sub-contractor were for the development of LiveProduct simulations
provided to our customers. Cost of product revenues decreased 55.8% to $169,000
for 2001 compared with $383,000 for 2000, together with a 55.5% decrease in
product revenues. The decrease in cost of products revenues was primarily
attributable to the decrease in product sales. Cost of service revenues remained
virtually unchanged at $1.8 million for 2001 compared with $1.7 million for
2000. The slight increase in cost of service revenues is attributable to the
increase in LiveProducts revenues which was not wholly offset by the decrease in
services provided in respect of RapidPLUS products. Overall, the cost of
revenues as a percentage of revenues increased from 21.5% in 2000 to 38.6% in
2001.
Product development costs. Product development costs consisted primarily of
expenses incurred in connection with our Indian sub-contractor and salaries and
other related expenses for simulation development for the LiveManuals web-site.
These expenses were incurred in developing product simulations as content for
our LiveManuals web-site, which was launched in October 2000. Product
development costs decreased to zero for 2001 from $2.5 million for 2000. This
decrease was attributable to our decision to stop investments in the LiveManuals
website.
Web-site development costs. Web-site development costs consisted primarily of
outsourcing services, salaries and other development-related expenses for the
LiveManuals.com web-site development. Web-site development costs decreased to
zero for 2001 from $800,000 for 2000. This decrease was attributable to the
management decision to stop investments in developing the LiveManuals web-site.
46
Research and development expenses, net. Research and development expenses, net,
consisted primarily of salaries and other related expenses for research and
development personnel, as well as the cost of facilities and depreciation of
capital expenditures. Research and development expenses, net of grants from the
Office of the Chief Scientist decreased 5.9% to $2.6 million for 2001, compared
with $2.8 million for 2000. This decrease was primarily attributable to funding
of $427,000 we obtained from the Office of the Chief Scientist for 2001 compared
with $238,000 for 2000. Research and development costs increased as a percentage
of revenues to 51.8% for 2001 compared with 28.1% for 2000.
Selling, marketing, general and administrative expenses, net. Selling,
marketing, general and administrative expenses, net, decreased in 2001 by 10% to
$7.9 million compared with $8.8 million in 2000. The decrease is primarily
attributable to the restructuring plan that we implemented beginning in 2001 and
which included staff reductions, closure of offices outside Israel and related
expenses. Selling and marketing expenses, net, consisted primarily of salaries
for sales personnel, expenses related to the subsidiaries, costs of travel,
advertising and promotional activities. Selling and marketing expenses, net
decreased 10.0% to $5.7 million for 2001 compared with $6.3 million for 2000.
This decrease was primarily attributable to the reduction in our LiveProducts
sales and marketing staff.
General and administrative expenses, net consisted primarily of costs associated
with management compensation, professional fees and office expenses. General and
administrative expenses decrease 10.5% to $2.2 million for 2001 compared to $2.5
million for 2000. This decrease was primarily attributable to a reduction in
investor relations expenses, travel expenses, salaries and the number of
personnel we employ.
Restructuring and impairment of web-site development costs. Beginning in the
second quarter of 2001 we decided to implement a series of organizational
changes in an effort to adjust our expenses to anticipated revenues,
particularly in light of a substantial reduction in market demand for products
such as ours. This initiative included a reduction in office facilities utilized
in our operations and a reduction of our personnel worldwide by approximately 74
employees, or approximately 60% of our workforce. Most of the employees affected
by the restructuring were entitled to a notice period, severance payments and
other benefits, and we recorded $272,000 in costs related to the reduction of
our workforce. Payments for vacant office space for remaining lease periods
following the closure of certain of our facilities and for other related
obligations is estimated at $37,000. The total cost associated with our
restructuring was $309,000, most of which was paid in cash by January 31, 2002.
We expect that as a result of this restructuring our operating expenses in 2002
will be reduced.
During the second quarter of 2001, we determined that the costs we incurred in
developing our Livemanuals.com web-site were not recoverable. Therefore,
$601,000, which represents the net value of the investment in the web-site, was
written off.
For further information on restructuring and impairment of web-site development
costs, see notes 1c and 2i to our consolidated financial statements, included
elsewhere in this annual report.
Operating loss. Operating loss increased 17.6% to $8.3 million for 2001 compared
with $7.1 million for 2000. As a percentage of revenues, operating loss
increased to 165.7% for 2001 from 71.9% for 2000. This increase in the amount of
our operating loss and as a percentage of our revenues is primarily attributable
to factors discussed above.
47
Financial expenses (income), net. In 2001, financial expenses, net were $210,000
compared with financial income, net of $230,000 for 2000. This change was
primarily attributable to a $5.4 million decrease in the cash and cash
equivalents from $6.7 million as of January 31, 2001 to $1.3 million as of
January 31, 2002 and to an increase in the outstanding balance of bank loans.
Other expenses, net. Other expenses consisted of a write-off expense related to
the impairment of an investment. For additional information see "Item 4.
Information on the Company - History and Development of the Company -
Acquisition Write Off." Other expenses decreased 41.7% to $420,000 for 2001,
compared with $720,000 for 2000 when the major part of this investment was
written off.
Taxes On Income. Taxes on income increased 11% to $62,000 in 2001, compared with
$56,000 in 2000. This increase is primarily attributable to increased revenues
of our subsidiaries.
IMPACT OF INFLATION AND CURRENCY FLUCTUATIONS
Most of our sales are made in dollars and we incur substantial expenses in
dollars and NIS. The dollar cost of our operations in Israel is influenced by
the extent to which any increase in the rate of inflation in Israel is not
offset, or is offset on a lagging basis, by a devaluation of the NIS in relation
to the dollar. The inflation rate in Israel was 3.1% in 2001 and 5.5% in 2002,
and the deflation rate was 0.1% in 2000. At the same time, the devaluation of
the NIS against the dollar was 1.4% in 2000, 11.2% in 2001 and 4.6% in 2002. The
representative rate of exchange of the NIS to the dollar, as published by the
Bank of Israel for January 31, 2003 and for June 30, 2003, was NIS 4.814 and NIS
4.312 per $1, respectively. As a result of the devaluation of the dollar against
the NIS exceeding the inflation rate, we experienced decreases in the dollar
costs of our operations in Israel in 2000, 2001 and 2002 primarily because
substantially all our revenues are received in dollars and salaries in Israel
are paid in NIS and are not directly linked to the rate of inflation. However,
these fluctuations did not materially affect our results of operations. In
recent years, the Israeli Government's monetary policy contributed to relative
price and exchange rate stability despite fluctuating rates of economic growth.
However, throughout 2002, there was a significant devaluation of the NIS and an
increase in inflation. If this trend continues, we expect that this will lead to
a reduction in our dollar costs. We cannot assure you that the Israeli
Government will be successful in its efforts to keep prices and exchange rates
stable. We do not currently engage in any hedging arrangements to offset risks
associated with fluctuations in foreign currency exchange rates, but may do so
in the future. As a result, price and exchange rate instability could have a
material adverse effect on our business, financial condition and results of
operations.
CONDITIONS IN ISRAEL
We are incorporated under Israeli law and our principal offices and operations
are located in the State of Israel. Political, economic and military conditions
in Israel directly affect our operations. Since the establishment of the State
of Israel in 1948, a number of armed conflicts have taken place between Israel
and its Arab neighbors and a state of hostility, varying from time to time, in
intensity and degree, has led to security and economic problems for Israel.
Israel signed a peace treaty with Egypt in 1979 and a peace treaty with Jordan
in 1994. Since 1993, a joint Israeli-Palestinian declaration of principles and
several other agreements have been signed between Israel and the Palestinians.
In May 2000 the Israeli Defense Forces withdrew from southern Lebanon. Israel
has not entered into any peace agreement with Syria and Lebanon. In the last 2
48
and a half years, hostilities between Israel and the Palestinians, including the
Palestinian Authority, have increased. The hostilities include terrorist acts in
Israel and military operations in the West Bank and the Gaza Strip.
The future of Israel's relations with its Arab neighbors and the Palestinians is
uncertain and several countries, companies and organizations continue to
restrict business with Israel and with Israeli companies. We believe that in the
past these practices have not had a material adverse effect on us. However, we
could be negatively affected by adverse developments in the peace process or by
restrictive laws, policies or practices directed towards Israel or Israeli
businesses.
TRADE AGREEMENTS
Israel is a member of the United Nations, the International Monetary Fund, the
International Bank for Reconstruction and Development and the International
Finance Corporation. Israel is a signatory to the General Agreement on Tariffs
and Trade, which provides for reciprocal lowering of trade barriers among its
members. In addition, Israel has been granted preferences under the Generalized
System of Preferences from the United States, Australia, Canada and Japan. These
preferences allow Israel to export the products covered by these programs either
duty-free or at reduced tariffs.
Israel and the European Union, known as the EU, concluded a Free Trade Agreement
in July 1975, which confers certain advantages on Israeli exports to most
European countries and obligates Israel to lower its tariffs on imports from
these countries over a number of years. In 1985, Israel and the United States
entered into an agreement to establish a free-trade area. The free-trade area
has eliminated all tariff and specified non-tariff barriers on most trade
between the two countries. On January 1, 1993, an agreement between Israel and
the European Free Trade Association, known as EFTA, which includes Austria,
Finland, Iceland, Liechtenstein, Norway, Sweden and Switzerland, established a
free-trade zone between Israel and the EFTA nations. In November 1995, Israel
entered into a new agreement with the EU, which includes redefinition of rules
of origin and other improvements, including providing for Israel to become a
member of the research and technology programs of the EU. In recent years,
Israel has established commercial and trade relations with a number of other
nations, including China, India, Russia, Turkey and other nations in Eastern
Europe and Asia.
(B) LIQUIDITY AND CAPITAL RESOURCES
We have funded our operations primarily through public and private sales of
equity securities, sales of products and services, borrowings from banks, and,
to a lesser extent, through research and development grants from the Office of
the Chief Scientist and the BIRD Foundation and grants from the Fund for
Encouragement of Marketing Activities Abroad. Cash and cash equivalents and
short-term deposits were $6.7 million, $1.3 million and $0.6 on January 31,
2001, January 31, 2002 and January 31, 2003, respectively. Net cash used in
operating activities was $5.6 million, $6.7 million and $127,000 in 2000, 2001,
and 2002 respectively. Our capital expenditures since inception have been
related primarily to computers, equipment, renovations of facilities and
vehicles, and were approximately $826,000, $147,000 and $63,000 in 2000, 2001
and 2002, respectively.
On January 31, 2003, we had approximately $2.76 million of short-term bank loans
outstanding. The bank loans, which were, as of January 31, 2003, scheduled to
mature in August 2003 include approximately $690,000 of convertible bank loans.
49
All the bank loans bear interest at a weighted average rate of 5.31% linked to
the dollar. All our bank loans are secured by substantially all of our assets.
We also have a $190,000 convertible loan payable to Gibralt, which pending
shareholder approval, will be convertible into our ordinary shares in the next
five years. As of June 30, 2003, we had $3,185,000 of bank loans outstanding,
which included $690,000 of convertible bank loans. In August 2002, we entered
into agreements with the banks who provided us the short-term and convertible
loans to extend the scheduled maturity of the loans and to make certain other
changes to their terms. Pursuant to the amended terms, we have made minimum
monthly payments of principal and interest on the loans in an aggregate of
$70,000 per month. As of January 31, 2003, the scheduled maturity of the unpaid
balance (approximately $3.5 million) of the loans was August 31, 2003. In July
2003, the banks extended the scheduled maturity of the loans to August 31, 2004
and we have agreed to increase our minimum monthly payments of principal and
interest to $80,000 (subject to increase if our revenues exceed certain
specified amounts) and to grant these banks liens on our right to receive
revenues pursuant to agreements with two major customers. The banks can demand
payment of the loans prior to the maturity date upon the occurrence of an event
of default under the loan agreements, such as non-payment of scheduled principal
and interest payments, liquidation of our company or occurrence of events that
the banks believe harm or might harm our ability to perform our obligations
under the loan agreements. In addition, under our agreements with these banks,
until at least one half of the outstanding principal of the loans has been
repaid, we may not make any cash payment of management fees to any shareholder
holding, directly or indirectly, 5% or more of our shares, or to any related
party of such shareholder, including, without limitation, Yozma Hofsheet Ltd.,
to whom we presently owe management fees.
In August 2002, we entered into an agreement with Gibralt, a company controlled
by Samuel Belzberg, who is a director of our company and the father of Marc
Belzberg, our chairman, chief executive officer and one of our major
shareholders, pursuant to which Gibralt agreed to lend us $950,000 at an annual
interest rate of 6%, maturing on February 28, 2003. We have since repaid
$760,000 of the loan to Gibralt. In accordance with the provisions of the
agreement, $190,000 of aggregate principal amount was not repaid and, pending
shareholder approval, Gibralt will have the right to convert this amount into
our ordinary shares at a price per share of $0.14. Because Gibralt, which is an
affiliate of one of our directors, is considered a related party and the
transaction involves the right to convert into shares a portion of the loan, the
transaction required approval by our audit committee, board of directors and
shareholders Although the transaction was properly approved by our audit
committee and board of directors, it is still pending shareholder approval. We
plan to submit the transaction for shareholder approval at our next general
meeting of shareholders. If our shareholders do not approve the transaction, we
will be required to repay the balance of the loan amounting to $190,000 in cash.
In July 2003, we entered into a convertible loan agreement with Smithfield, an
entity controlled by Marc Belzberg, our chairman, chief executive officer and
one of our major shareholders, pursuant to which Smithfield agreed to lend us $1
million maturing on August 1, 2004 and bearing no interest. Until that date,
Smithfield may convert the principal amount of the loan into our ordinary shares
at a price per share of $0.18. In addition, if Smithfield elects to convert the
entire loan amount into our ordinary shares, it will receive a warrant to
purchase $3,000,000 worth of our ordinary shares at a price per share of $0.54.
According to the terms of the convertible loan agreement, we will have the right
to compel Smithfield to convert the loan in its entirety into our ordinary
shares if we consummate an equity investment of at least $1 million. Since
Smithfield is considered a related party, the transaction was approved by our
50
board of directors and audit committee and is subject to shareholder approval.
The transaction also requires shareholder approval for an increase in our
authorized share capital. We plan to submit the transaction and the increase in
our authorized share capital for shareholder approval at our next general
meeting of shareholders. Smithfield has agreed that if our shareholders do not
approve this transaction or the increase in share capital, it will provide the
amount of the investment as a loan, if failure to provide it would affect our
ability to continue operations as a going concern.
As of June 30, 2003, we had cash and cash equivalents of $798,000, which
represents an increase in our cash and cash equivalents of $627,000 as of
January 31, 2003, is slightly less than our position of $1.3 million and $0.9
million as of January 31, 2002 and July 31, 2002, respectively, but which
constitutes a significant decline from our cash and cash equivalents of $6.7
million as of January 31, 2001. These funds are held primarily in dollars, but
also in NIS, Euros and Pounds Sterling. We believe that these funds, together
with anticipated revenues and cash flows from our operations (including
collection of trade receivables and a convertible loan of $1 million received
from Smithfield in July 2003, as discussed above) will be sufficient to fund our
anticipated operating expenses, interest payments and capital expenditures for
at least the next twelve months and the payment of scheduled principal payments
on our outstanding loans through July 2004. Our ability to generate revenues and
manage costs as anticipated may be adversely affected by a variety of factors,
including those discussed under "Item 4. Information on the Company - Company
Risk Factors." If we are unable to generate anticipated revenues from our
operations, or if our operating expenses, interest payments or capital
expenditures are higher than anticipated, we will be required to seek to raise
additional funds through public or private debt or equity issuances. Additional
debt or equity financing, whether obtained through public or private debt or
equity financing, may not be available when needed or may not be available on
terms acceptable to us, if at all. If this additional financing is not available
when needed our business will be adversely affected, we may not be able to
continue operations and we may be forced to pursue a sale of our company or a
substantial part of our assets on terms, which if available at all, may not be
attractive to our shareholders.
We do not anticipate that we will have sufficient cash on hand to make the
principal payment of $2,866,000 that will be due on our outstanding short-term
and convertible bank loans due on August 31, 2004. As a result, prior to that
date we will need to negotiate new repayment terms with the existing bank
lenders or obtain new debtor equity financing from an alternative source to
repay the existing loans. We cannot assure you that the banks will agree to any
extension of the repayment dates, if requested to do so, or what the terms of
any such extension may be. We also cannot assure you that any new debt or equity
financing will be available, if we are required to refinance the existing loans,
or what the terms of any such new financing will be. If the outstanding loans
are not extended or refinanced, our business will be adversely affected, we may
not be able to continue operations and we may be forced to pursue a sale of our
company or a substantial part of our assets on terms, which if available at all,
may not be attractive to our shareholders.
51
The following table sets forth a summary of our contractual obligations and
commercial commitments as of January 31, 2003 and the periods in which these
obligations and commitments are due:
PAYMENT DUE BY PERIOD
---------------------------------------------------------------------------------------------
LESS THAN MORE THAN
TOTAL 1 YEAR 1-3 YEARS 3-5 YEARS 5 YEARS
--------------- ------------------- ----------------- ----------- --------------
Bank loans (1)................. $2,070,000 $2,070,000 $ - $ - $ -
Convertible loans (1).......... 690,000 690,000 - - -
Lease obligations.............. 350,000 154,000 196,000 - -
Office of the Chief Scientist (2) 567,000 100,000 467,000 - -
BIRD (3)....................... 25,000 25,000 - - -
Fund for Encouragement of
Marketing Activities
Abroad (4)....................
228,000 50,000 178,000 - -
Bank guarantees (5)............ 16,000 16,000 - - -
Trade payables................. 630,000 630,000 - - -
Related parties (6)(7)......... 1,849,000 1,849,000 - - -
Employees and payroll accruals. 643,000 643,000 - - -
Other accrued expenses and other
liabilities.................... 65,000 65,000 - - -
--------------- ------------------- ----------------- ----------- --------------
$7,133,000 $6,292,000 $841,000 $ - $ -
=============== =================== ================= =========== ==============
(1) In July 2003, we entered into an agreement with the banks that
provided for the refinancing of these loans. For a more detailed
discussion of the current terms of these loans see the discussion set
forth above in this section.
(2) Consists of amounts due pursuant to our agreement with the Office of
the Chief Scientist and the Fund for Encouragement of Marketing
Activities Abroad. Excludes an aggregate amount of approximately
52
$621,000 payable to the Office of the Chief Scientist as royalties on
certain future revenues.
(3) Consists of amounts due on certain recognized sales. Excludes an
aggregate amount of approximately $389,000 payable to BIRD as
royalties on certain future revenues.
(4) Consists of amounts due pursuant to our agreement with the Office of
the Chief Scientist and the Fund for Encouragement of Marketing
Activities Abroad. Excludes an aggregate amount of approximately
$496,000 payable to the Fund for Encouragement of Marketing
Activities Abroad as royalties on certain future revenues.
(5) In June 2003, the bank guarantees were exercised in connection with a
dispute relating to the lease of our former premises. For further
discussion, see "Item 8. Financial Information - Consolidated
Statements and Other Financial Information - Legal Proceedings."
(6) For details of some of these liabilities, see "Item 7. Major
Shareholders and Related Party Transactions - Interests of Management
in Certain Transactions."
(7) Includes a $190,000 convertible loan made by Gibralt.
In addition to the above, as of January 31, 2003, our aggregate liability with
respect to accrued severance pay was $869,000. The date on which these
liabilities will become due depends on the date of termination of employment of
the employees for whom accrual has been made.
We do not currently engage in any hedging arrangements to offset risks
associated with fluctuations in foreign currency exchange rates.
(C) RESEARCH AND DEVELOPMENT, PATENTS AND LICENSES
RESEARCH AND DEVELOPMENT GRANTS
We participate in programs sponsored by the Israeli Government for the support
of research and development activities. Through January 31, 2003, we had
obtained grants from the Office of the Chief Scientist aggregating $1.8 million
for certain of our research and development projects. We are obligated to pay
royalties to the Office of the Chief Scientist at the rate of 3.5% to 5% of the
sales of the products and other related revenues generated from these projects,
up to an amount equal to 100% to 150% of the grants received. Through January
31, 2003, we have paid or accrued royalties to the Office of the Chief Scientist
in the aggregate amount of $1.3 million. On January 31, 2003, the aggregate
liability to the Office of the Chief Scientist, which is contingent on our
income, was $621,000. Some of the accrued royalties were not paid when due In
January 2003, we reached a settlement regarding payments to the Office of the
Chief Scientist. The terms of the settlement for the return of overdue payments
to the Office of the Chief Scientist for research and development grants and for
marketing grants from the Fund for the Encouragement of Marketing Activities,
discussed below, are as follows: a single payment of $30,000 made in February
2003, four quarterly payments of $30,000 commencing April 30, 2003, a payment of
$45,000 in April 2004 and a payment of $50,000 in July 2004. We have also agreed
to pay 5% of revenues exceeding certain projected sales presented. We will not
53
be required to pay on-going royalties until July 2004, at which time we will
negotiate the payment terms of the remaining debt with the Office of the Chief
Scientist. Of the funds paid to the Office of the Chief Scientist according to
the new payment schedule, two-thirds will be for research and development grants
and the other third for marketing grants from the Fund for the Encouragement of
Marketing Activities.
We also participate in a program sponsored by the BIRD Foundation, pursuant to
which a portion of our development expenses was funded. Through January 31,
2003, we obtained grants in the aggregate amount of $394,000 from the BIRD
Foundation. We are obligated to pay royalties to the BIRD Foundation on the
proceeds from sales of products resulting from the research and development
which the BIRD Foundation funded. The total amount of the royalties may not
exceed 150% of the grants received. All the payments are linked to the dollar.
Through January 31, 2003, we paid or accrued royalties to the BIRD Foundation in
the aggregate amounts of $201,000. As of January 31, 2003, the aggregate amount
of the contingent obligation to the BIRD Foundation was $389,000.
Research and development costs, net consist of the following:
2000 2001 2002
---- ---- ----
(IN THOUSANDS)
Total costs $ 3,012 $ 3,037 $ 1,464
Less grants and participations (238) (427) -
------------------ ---------------- ---------------
$ 2,774 $ 2,610 $ 1,464
================== ================ ===============
MARKETING GRANTS
In March 1998, the Israeli Government, through the Fund for the Encouragement of
Marketing Activities Abroad, awarded us grants relating to our foreign marketing
expenses. These grants are awarded for specific expenses incurred by us in our
foreign marketing activities, based upon expenses we reported to the Fund for
the Encouragement of Marketing Activities Abroad. All marketing grants received
from the Fund for the Encouragement of Marketing Activities Abroad are linked to
the dollar and are repayable in the form of royalty payments in the amount of 4%
(plus interest at the rate of six-month LIBOR) of any increase in export sales
realized by us up to the total amount of grants we received. If we do not
achieve an increase in export sales, we have no obligation to pay any royalties
or to return any funds received through these grants. All payments are linked to
the dollar.
Through January 31, 2003, we obtained grants in the aggregate amount of $778,000
from the Fund for the Encouragement of Marketing Activities Abroad and have paid
or accrued royalties in the amount of $293,000. The aggregate amount of the
income-contingent obligation to the Fund for the Encouragement of Marketing
Activities was $485,000. As discussed above, some of the accrued royalties were
not paid when due in January 2003. In January 2003, we reached a settlement
54
regarding payments to the Office of the Chief Scientist. For additional
information concerning the terms of this settlement, see "- Research and
Development Grants."
(D) TREND INFORMATION
We believe that our business currently is being materially adversely affected by
the global slowdown of the technology market generally and specifically the
consumer electronics products, wireless handsets, office automation equipment
and automotive systems markets in which many of our customers operate. As a
result of this slowdown, our customers have been reducing significantly the
amount of their discretionary purchases (including for the products and services
we sell) and making it difficult for us to predict the timing and magnitude of
their future purchases from us. We believe that we will continue to be adversely
affected as long as the slowdown continues.
As a result of the global slowdown and its impact on some of our customers, our
revenues for the first quarter of 2003 were lower than those for the last
quarter of 2002, even though they are still slightly higher than the revenues
for the comparable quarter of 2002. Although the prices of our RapidPLUS tools
have remained relatively stable, our revenues have decreased primarily as a
result of reductions in the number and size of orders placed by our existing and
new customers. In response to lower revenues over the course of the last two
years, we initiated and completed a corporate restructuring plan, including
reducing our head count, streamlining our operations and reducing expenses to
achieve greater efficiencies.
For additional information concerning our anticipated liquidity and capital
resources, see "- Liquidity and Capital Resources."
In addition, we currently focus primarily on the wireless platform and wireless
devices markets. As the importance and complexity of the MMI in the wireless
platform offering increases and more wireless platform vendors and wireless
device manufacturers require assistance in developing the MMIs to be
incorporated into the platforms and wireless devices they sell, we believe that
our RapidPLUS tools will come to play a more significant role in the wireless
platform and wireless devices markets. We believe that RapidPLUS offers timely
solutions to many of the major challenges facing wireless platform vendors and
wireless device manufacturers, including pressure to lower development costs and
time to market, increased design complexity and limited marketing opportunities
due to increased competition. Because our technology provides wireless platform
vendors and wireless device manufacturers with a solution that is cost
efficient, does not require prior expertise and experience, and enables the
quick development of the mobile device's interface, an increasing portion of our
revenues is derived from license of our products and services to customers in
the wireless platform and wireless device industries.
55
ITEM 6
DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES
(A) DIRECTORS AND SENIOR MANAGEMENT
Our directors and executive officers and their ages are as follows:
NAME AGE POSITION
- ---- --- --------
Marc Belzberg ........... 48 Chairman of the Board of Directors and Chief
Executive Officer
Yaron Eldad ............. 38 Chief Operating Officer, Chief Financial
Officer and Secretary
Uri Yaffe................ 39 Senior Vice President, Corporate Sales
Frederick Rotbart ....... 53 Chief Scientist
Avi Hitelman ............ 47 Vice President, Research and Development
Reuven Kleinman.......... 44 Vice President, Business Development
Nir Gazit................ 40 Vice President, Technical Services
Samuel Belzberg ......... 74 Director
Amir Galili (1).......... 49 Director
John McDonald (1)(2)..... 73 Director and Vice Chairman
Kim Campbell (1)(2)...... 56 Director
(1) Member of the Audit Committee (2) External Director (as required under
Israeli law)
MARC BELZBERG has served as the Chairman of the Board of Directors since 1993
and Chief Executive Officer since 1998. Mr. Belzberg also served as our
President from 1993 to March 2001. Mr. Belzberg is also a director of the
Jerusalem Post and a director of Smithfield. Mr. Belzberg is chairman of the
Bnei Akiva youth movement, worldwide, chairman of the Foundation of Jewish
Renaissance and chairman of the OneFamily Fund. Prior to joining us, Mr.
Belzberg was the first president of First City Capital Corporation from 1983 to
1990 and was a private investor from 1990 to 1993. Mr. Belzberg received an
M.B.A. from New York University and a B.A. from Yeshiva University. Mr. Belzberg
is the son of Samuel Belzberg, a Director of our company.
YARON ELDAD has served as our Chief Financial Officer since 1995, as our
Secretary since 1996 and as our Chief Operating Officer since 2002. Prior to
joining our company, Mr. Eldad had an independent auditing practice from 1994 to
1995. Mr. Eldad was employed by Nissan Caspi CPA from 1993 to 1994, and by
Shekhter & Maas CPA from 1991 to 1993, both of which are private auditing firms
in Israel. Mr. Eldad received a B.A. in economics and accounting from Ben Gurion
University and an MBA from the Hebrew University, and is a Certified Public
Accountant in Israel.
URI YAFFE was appointed our Senior Vice President of Corporate Sales in 1999.
Prior to that appointment, Mr. Yaffe served as our European Managing Director
from 1998 to 1999. Prior to joining us, from 1992 to 1997 Mr. Yaffe managed the
Debriefing, Command and Control Business Unit at BVR Technologies, which
56
develops, manufactures and markets advanced computer-based training, simulation
and analysis systems for military applications. Mr. Yaffe received a BSC in
Business Management from New Haven University.
FREDERICK ROTBART is one of the founders of our company and has served as our
Chief Scientist since 1991. Prior to joining us, Dr. Rotbart was an independent
software consultant working primarily for Wang Computers Inc. from 1989 to 1990.
Dr. Rotbart received a Ph.D. in theoretical physics from Tel Aviv University.
AVI HITELMAN has served as our Vice President, Research and Development since
1996. Prior to joining us, Mr. Hitelman served as team leader at Elbit Computer
Ltd. from 1982 to 1987 and as Project Manager from 1990 to 1995, and as a
software team leader at Techlogic Ltd. from 1987 to 1990. Mr. Hitelman received
an M.S. in electrical engineering from the Technion Institute of Technology.
REUVEN KLEINMAN was appointed our Vice President of Business Development in
January 1999. From 1995 to 1999, he served as Product Marketing Manager and
Director of Business Development. From 1990 to 1995, Mr. Kleinman was CEO of
Galcon and GalTech in Kibbutz Kfar Blum. Mr. Kleinman holds a BSC with honors in
physics and computer science from Tel Aviv University.
NIR GAZIT has served as our Vice President of Technical Services since June
1999. He joined our company in 1994 where he served as Support and Application
engineer until 1996. At that time he was promoted to Director of Customer
Support until 1999. Mr. Gazit holds a B.A. in Industrial Engineering from Tel
Aviv University.
SAMUEL BELZBERG has been a Director since October 1997. Mr. Belzberg has served
as President of Bel-Fran Investments Ltd. (a private investment company) since
1968, President and Chief Executive Officer of Gibralt Holdings Ltd. (a personal
investment company), which is a shareholder of ours, since 1995, Chairman of
Balfour Holdings, Inc. (a real estate development company) since 1992 and a
Director of Smithfield. He also founded First City Financial Corporation. Mr.
Belzberg serves as a director of several public companies. Mr. Belzberg received
a B.A. in commerce from the University of Alberta, Edmonton and an honorary
Ph.D. from Simon Fraser University. He was awarded the Order of Canada in 1989,
promoted to Officer of the Order of Canada in 2002 and received the Governor
General Award of Canada in 1992. Mr. Belzberg is the father of Marc Belzberg,
our Chairman of the Board and Chief Executive Officer.
AMIR GALILI is one of the founders of our company and has served as a Director
since 1991, as our Chief Executive Officer from 1991 to 1993, and as Vice
President, Training, Support and Applications from 1993 to 1997. Mr. Galili
resigned from his Vice President position on March 31, 1997. Since July 1997,
Mr. Galili has served as Chairman of the Board of Directors and Chief Executive
Officer of Trivnet Ltd., a software company. Prior to founding e-SIM, Mr. Galili
worked at Elbit Ltd. and was involved in the development of the Lavi fighter
plane project at Israel Aircraft Industries from 1985 to 1987. Mr. Galili
received a B.Sc. in electronics and an M.B.A. from Tel Aviv University.
JOHN MCDONALD has served as Vice Chairman of the Board of Directors since 1999.
Mr. McDonald is the retired President of Casio, Inc. and is currently a
management and marketing consultant. Mr. McDonald joined Casio in 1975 as
57
President of Casio Europe and Managing Director of its United Kingdom
Subsidiary. Mr. McDonald served as President of Casio from 1978 to 1999. Mr.
McDonald holds a B.A. in English from Brooklyn College.
KIM CAMPBELL joined our Board of Directors in 2001. Ms. Campbell served as
Canada's nineteenth Prime Minister, in 1993, and has held cabinet portfolios as
Minister of Justice, Attorney General, Minister of National Defense and
Veterans' Affairs, and Minister of State for Indian Affairs and Northern
Development. Ms. Campbell served as Consul General of Canada in Los Angeles from
1996 to 2000. She sits on the governing board of Northeastern University and
chairs the Council of Women World Leaders based at the John F. Kennedy School of
Government at Harvard. Ms. Campbell serves on the Board of Directors of ICN
Pharmaceuticals. Ms. Campbell is currently on the faculty of Harvard University.
In addition to these officers and directors, Ken Dixon, who served as President
of e-SIM, Inc., ceased his employment during 2002.
Except for Messrs. M. Belzberg, Eldad, Rothbart, S. Belzberg, Galili and Yaffe,
as of July 31, 2003, none of our directors or executive officers owned more than
one percent of the outstanding ordinary shares. For information as to the share
ownership of Messrs. M. Belberg, Eldad, Rothbart, S. Belzberg and Galili, see
"Item 7 - Major Shareholders and Related Party Transactions."
(B) COMPENSATION
The following table sets forth the aggregate compensation paid to, or accrued on
behalf of, all our directors and officers as a group for the year ended January
31, 2003.
SALARIES, DIRECTORS' FEES PENSION, RETIREMENT AND
COMMISSIONS AND BONUSES SIMILAR BENEFITS
----------------------- ----------------
All directors and officers as a group
(12 persons)(1)(2) $1,164,000 $244,000
(1) Includes a management fee payable to an affiliate of Samuel Belzberg.
(2) Includes the compensation of Ken Dixon.
Our directors who are not executive officers or external directors currently do
not receive cash compensation for their services on the board of directors or
any of its committees. However, we granted five non-executive directors options
to purchase an aggregate of 174,000 ordinary shares as of January 31, 2003 at
exercise prices ranging from $0.14 to $6.5 per share. We may in the future grant
additional options or other compensation to non-executive directors. All of the
non-executive directors are reimbursed for their expenses for each meeting of
board of directors attended.
58
Pursuant to the Israeli Companies Law, 5759-1999, referred to as the Companies
Law, annual compensation of the external directors is subject to regulations
promulgated under the Companies Law. These regulations provide mandatory minimum
and maximum rates of compensation for external directors, based on the company's
net worth. We have fixed the annual compensation for external directors in the
minimum amount permitted by the Israeli regulations. ....
The following table sets forth certain information pertaining to all of our
directors and officers as a group, who held office at any time during the period
indicated, concerning (i) options granted by us, (ii) options exercised, and
(iii) options unexercised as of January 31, 2003:
FEBRUARY 1, 2002-
JANUARY 31, 2003
OPTIONS GRANTED
Number of ordinary shares......................... 1,008,376
Average exercise price per ordinary share......... $0.15
Weighted average remaining exercise period........ 5.05 years
OPTIONS CANCELLED
Number of ordinary shares......................... 371,000
Average exercise price per ordinary share......... $4.05
UNEXERCISED OPTIONS
Number or ordinary shares......................... 1,810,019
Average exercise price per ordinary share......... $0.28
Weighted average remaining exercise period........ 6.38 years
(C) BOARD PRACTICES
APPOINTMENT OF DIRECTORS AND TERMS OF OFFICERS
Our directors, other than our external directors, are elected by our
shareholders at an annual general shareholders' meeting and hold office until
the next annual general shareholders' meeting which is required to be held at
least once in every calendar year, but not more than fifteen months after the
last preceding annual general shareholders' meeting. Until the next annual
general shareholders' meeting, shareholders may elect new directors to fill
vacancies in, or increase the number of, members of the board of directors in a
special meeting of the shareholders. Our board of directors may appoint any
person as a director temporarily to fill any vacancy created in the board of
directors. Any director so appointed may hold office until the first general
shareholders' meeting convened after the appointment and may be re-elected. The
appointment and terms of office of all our executive officers are determined by
our board of directors, except that the appointment of the chairman of the board
of directors, the chief executive officer and the president must also be
approved by the shareholders. The terms of office of the directors must be
approved, under the Companies Law, by the audit committee, the board of
directors and the shareholders.
59
None of our directors has the right to receive any benefit upon termination of
his or her office. None of our directors has a service contract with us. For
information regarding the arrangements pursuant to which Marc Belzberg provides
services to us on behalf of Yozma Hofsheet Ltd., see "Item 7. Major Shareholders
and Related Party Transactions - Related Party Transactions - Interests of
Management in Certain Transactions."
EXTERNAL DIRECTORS
We are subject to the provisions of the Companies Law, which became effective on
February 1, 2000 superseding most of the provisions of the Israeli Companies
Ordinance (New Version), 5743-1983. The Minister of Justice has adopted
regulations exempting companies, like us, whose shares are traded outside of
Israel from some provisions of the Companies Law.
Under the Companies Law, companies incorporated under the laws of Israel whose
shares have been offered to the public in or outside of Israel are required to
appoint two external directors. The Companies Law provides that a person may not
be appointed as an external director if the person or the person's relative,
partner, employer or any entity under the person's control, has, as of the date
of the person's appointment to serve as external director, or had, during the
two years preceding that date, any affiliation with the company, any entity
controlling the company or any entity controlled by the company or by this
controlling entity. The term affiliation includes:
o an employment relationship;
o a business or professional relationship maintained on a regular
basis;
o control; and
o service as an office holder.
No person can serve as an external director if the person's position or other
business creates, or may create, conflict of interests with the person's
responsibilities as an external director. Until the lapse of two years from
termination of office, a company may not engage an external director to serve as
an office holder and cannot employ or receive services from that person, either
directly or indirectly, including through a corporation controlled by that
person.
External directors are to be elected by a majority vote at a shareholders'
meeting, provided that either (1) the majority of shares voted at the meeting,
including at least one-third of the shares of non-controlling shareholders voted
at the meeting, vote in favor of the election; or (2) the total number of shares
of non-controlling shareholders voted against the election of the external
director does not exceed one percent of the aggregate voting rights in the
company. However, under regulations promulgated under the Companies Law, the
board of directors of companies whose shares are traded outside of Israel may
determine that a director, who was appointed before February 1, 2000 and
complies with the non-affiliation requirements of an external director, will be
designated as an external director, without shareholder approval, until the
completion of that director's original nomination period, in accordance with
such regulations.
60
The initial term of an external director is three years and may be extended for
an additional three years. Each committee of our board of directors is required
to include at least one external director and our audit committee is required to
include both external directors. Ms. Kim Campbell and Mr. John McDonald
currently serve as our external directors. Ms. Campbell was appointed to a
three-year term at our annual general meeting of shareholders held in July 2001.
Mr. McDonald, who has been a director since 1999, was appointed by the board to
serve as an external director, replacing another director who had resigned. His
appointment to a three year term will be brought to our shareholders for their
approval at our next annual general meeting.
AUDIT COMMITTEE
Under the Companies Law, the board of directors of any company that is required
to nominate external directors must also appoint an audit committee, comprised
of at least three directors including all of the external directors, but
excluding a:
o chairman of the board of directors; and
o controlling shareholder or his or her relative and any director
employed by the company or who provides services to the company on a
regular basis.
The role of the audit committee is to examine flaws in the business management
of the company in consultation with the internal auditor and the company's
independent accountants and to suggest appropriate courses of action. In
addition, the approval of the audit committee is required to effect certain
specified actions and transactions with office holders and interested parties.
The audit committee is responsible for supervising the activities of the
internal auditor.
An interested party is defined in the Companies Law as a 5% or greater
shareholder, any person or entity who has the right to designate one or more
directors or the general manager of the company or any person who serves as a
director or as a general manager.
An audit committee may not approve an action or a transaction with an interested
party or with an office holder unless at the time of approval the two external
directors are serving as members of the audit committee and at least one of whom
was present at the meeting in which an approval was granted.
Our board of directors has established an audit committee, which consists of Mr.
McDonald, Ms. Campbell and Mr. Galili.
The composition of our Audit Committee satisfies the requirements of the
Companies Law.
INTERNAL AUDITOR
Under the Companies Law, the board of directors must also appoint an internal
auditor proposed by the audit committee. The role of the internal auditor is to
examine whether the company's actions comply with the law and orderly business
procedure. Under the Companies Law, the internal auditor may not be an
interested party, an office holder, or an affiliate, or a relative of an
interested party, an office holder or affiliate, nor may the internal auditor be
the company's independent accountant or its representative. Daniel Shapira,
61
Certified Public Accountant (Israel), currently serves as our Internal Auditor.
APPROVAL OF SPECIFIED RELATED PARTY TRANSACTIONS UNDER ISRAELI LAW
FIDUCIARY DUTIES OF OFFICE HOLDERS
The Companies Law imposes a duty of care and a duty of loyalty on all office
holders of a company, including directors and executive officers. The duty of
care requires an office holder to act with the level of care with which a
reasonable office holder in the same position would have acted under the same
circumstances. The duty of care includes a duty to use reasonable means to
obtain:
o information on the appropriateness of a given action brought for his
or her approval or performed by him or her by virtue of his or her
position; and
o any other important information pertaining to the previous actions.
The duty of loyalty of an office holder includes a duty to:
o refrain from any conflict of interest between the performance of his
or her duties in the company and his or her personal affairs;
o refrain from any activity that is competitive with the company;
o refrain from usurping any business opportunity of the company to
receive a personal gain for himself or herself or others; and
o disclose to the company any information or documents relating to a
company's affairs which the office holder has received due to his or
her position as an office holder.
Under the Companies Law, the board of directors must approve all compensation
arrangements of office holders who are not directors. Directors' compensation
arrangements also require audit committee approval before board approval and
shareholder approval. Pursuant to new regulations promulgated under the
Companies Law in 2002, directors' compensation arrangements no longer require
shareholder approval if the audit committee and board of directors determine
that these compensation arrangements are solely for the benefit of the company.
The Companies Law requires that an office holder of a company promptly disclose
any personal interest that he or she may have and all related material
information known to him or her, in connection with any existing or proposed
transaction by the company. A personal interest of an office holder includes an
interest of a company in which the office holder is, directly or indirectly, 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. In the
case of an extraordinary transaction, the office holder's duty to disclose
applies also to a personal interest of the office holder's relative. The office
holder must also disclose any personal interest held by the office holder's
spouse, siblings, parents, grandparents, descendants, spouse's descendants and
the spouses of any of the foregoing. Under Israeli law, an extraordinary
transaction is a transaction:
62
o other than in the ordinary course of business;
o other than on market terms; or
o that is likely to have a material impact on the company's
profitability, assets or liabilities.
Under the Companies Law, once an office holder complies with the above
disclosure requirement, the board of directors may approve a transaction between
the company and an office holder, or a third party in which an office holder has
a personal interest, unless the articles of association provide otherwise. A
transaction that is adverse to the company's interest cannot be approved.
If a transaction is an extraordinary transaction, both the audit committee and
the board of directors must approve the transaction. Under specific
circumstances, shareholder approval may also be required. An office holder 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 this meeting or
vote on this matter.
DISCLOSURE OF PERSONAL INTERESTS OF A CONTROLLING SHAREHOLDER
Under the Companies Law, the disclosure requirements that apply to an office
holder also apply to a controlling shareholder of a public company. A
controlling shareholder includes a shareholder who holds 25% or more of the
voting rights in a public company if no other shareholder owns more than 50% of
the voting rights in the company. Extraordinary transactions with a controlling
shareholder or in which a controlling shareholder has a personal interest, and
the terms of compensation of a controlling shareholder who is an office holder,
require the approval of the audit committee, the board of directors and the
shareholders of the company. The shareholder approval must include either:
o at least one-third of the shareholders who have no personal interest
in the transaction and are present and voting, in person, by proxy
or by written ballot, at the meeting; or
o a majority of the voting power present and voting, provided that the
shareholders who have no personal interest in the transaction who
vote against the transaction do not represent more than one percent
of the voting rights in the company.
For information concerning the direct and indirect personal interests of certain
of our office holders and principal shareholders in certain transactions with
us, see "Item 7. Major Shareholders and Related Party Transactions."
The Companies Law requires that every shareholder who participates, either by
proxy or in person, in a vote regarding a transaction with a controlling
shareholder, indicate whether or not that shareholder has a personal interest in
the vote in question, the failure of which results in the invalidation of that
shareholder's vote.
However, under the Companies Regulations (Relief From Related Party
Transactions), 5760-2000, and subsequent amendments thereto, promulgated
pursuant to the Companies Law, each of the following transactions between a
company and its controlling shareholder(s) do not require shareholder approval:
63
o an extension of the term of an existing related party transaction,
provided that the original transaction was duly approved in
accordance with the applicable provisions of the Companies Law or
the Israeli Securities Law and regulations under these laws;
o a transaction that has been approved by the audit committee and the
board of directors as being solely for the benefit of the company;
o a transaction between the company and its controlling shareholder(s)
directly or with any other person when a controlling shareholder has
a personal interest in the transaction, provided that the audit
committee and the board of directors approve the transaction and
determine that the transaction is in accordance with the terms
defined in a duly approved framework transaction. A framework
transaction is a transaction that defines general terms under which
the company may, in the ordinary course of business, enter into
transactions of a similar type;
o a transaction between the company and its controlling shareholder(s)
or with any other person when a controlling shareholder has a
personal interest in the transaction, for the purpose of entering
into, or submitting an offer for, a joint transaction of the company
and such controlling shareholder or related party with a third
party, provided that the audit committee and the board of directors
have approved the transaction and that the terms of the transaction
in relation to the company are not materially different from those
relating to the controlling shareholder(s) or a corporation in its
or their control, taking into account their proportionate
participation in the transaction; or
o a transaction between companies that are controlled by the same
controlling shareholder or between the company and its controlling
shareholder(s) or between the company and any other person when a
controlling shareholder has a personal interest in the transaction,
provided that for each public company involved, its audit committee
and its board of directors find that the transaction is in
accordance with market terms, in the ordinary course of business and
is not detrimental to the welfare of the company.
Pursuant to these regulations, compensation arrangements between a publicly held
company and its controlling shareholder(s) serving as director(s) do not require
shareholder approval if the following conditions are met:
o the compensation arrangements are approved by the audit committee
and the board of directors as being solely for the benefit of the
company;
o the compensation arrangements do not commit the company to more than
an aggregate of NIS 25,000 in expenditures and provided such
arrangements are limited to no more than two years; and
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o The compensation awarded to the controlling shareholder is identical
to the compensation of the external directors or other directors and
does not exceed the maximum amount permitted to be paid to external
directors by Israeli regulations.
The Companies Law further provides that a shareholder shall refrain from
oppressing other shareholders. In addition, any controlling shareholder, any
shareholder who knows that he or she possesses power to determine the outcome of
a shareholder vote, and any shareholder who, pursuant to the provisions of a
company's articles of association, has the power to appoint or prevent the
appointment of an office holder in the company, or has any other power over the
company, is under a duty to act with fairness towards the company. A breach of
the above duty of fairness will be considered as a breach of the fiduciary duty
of an office holder as described above.
EXEMPTION, INSURANCE AND INDEMNIFICATION OF DIRECTORS AND OFFICERS
Under the Companies Law, an Israeli company may not exempt an office holder from
liability with respect to a breach of his or her duty of loyalty, but may exempt
in advance an office holder from his or her liability to the company, in whole
or in part, with respect to a breach of his or her duty of care.
OFFICE HOLDER INSURANCE
Our articles of association provide that, subject to the provisions of the
Companies Law, we may enter into a contract for the insurance of the liability
of any of our office holders with respect to:
o a breach of his or her duty of care to us or to another person;
o a breach of his or her fiduciary duty to us, provided that the
office holder acted in good faith and had reasonable cause to assume
that his or her act would not prejudice our interests;
o a financial liability imposed upon him or her in favor of another
person concerning an act performed by him or her in his or her
capacity as an office holder; or
o any other incident for which it is or shall be permitted to insure
the liability of an office holder.
INDEMNIFICATION OF OFFICE HOLDERS
Our articles of association provide that we may indemnify an office holder
against:
o a monetary liability imposed on him or her in favor of another
person pursuant to a judgment, including a judgment given in a
settlement or an arbitrator's award approved by the court concerning
an act performed in his or her capacity as an office holder;
o reasonable litigation expenses, including legal fees, incurred by an
office holder or which he or she is ordered to pay by a court, in
proceedings we institute against him or instituted on our behalf or
65
by another person, or in a criminal charge from which he or she was
acquitted, or a criminal charge in which he or she was convicted for
a criminal offense that does not require proof of intent, in each
case relating to an act performed in his or her capacity as an
office holder; and
o any other obligation or expense for which it is or shall be
permitted to indemnify a director or an officer.
The Companies Law provides that a company may exempt an office holder
prospectively from liability, in whole or in part, for damage resulting from a
breach of his or her duty of care towards the company, if its articles of
association so provide. On July 13, 2001, our shareholders approved new articles
of association enabling us to provide our office holders with prospective
indemnification in accordance with the Companies Law.
LIMITATIONS ON INSURANCE AND INDEMNIFICATION
The Companies Law provides that a company may not indemnify an office holder nor
enter into an insurance contract that would provide coverage for any monetary
liability incurred as a result of any of the following:
o a breach by the office holder of his or her duty of loyalty unless
the office holder acted in good faith and had a reasonable basis to
believe that the act would not prejudice the company;
o a breach by the office holder of his or her duty of care if the
breach was done intentionally or recklessly;
o any act or omission done with the intent to derive an illegal
personal benefit; or
o any fine levied against the office holder as a result of a criminal
offense.
Under the Companies Law, the shareholders of a company may include in its
articles of association either of the following provisions:
o a provision authorizing the company to grant in advance an
undertaking to indemnify an office holder, provided that the
undertaking is limited to specified classes of events which the
board of directors deems foreseeable at the time of grant and is
limited to an amount determined by the board of directors to be
reasonable under the circumstances; or
o a provision authorizing the company to retroactively indemnify an
office holder.
Each of the foregoing provisions is included in our articles of association that
have been approved by our shareholders.
66
In addition, under the Companies Law, indemnification of, and procurement of
insurance coverage for, our office holders must be approved by our audit
committee and board of directors and, in specified circumstances, by our
shareholders.
Our shareholders have approved an indemnification of our directors to the
maximum extent permitted by the Companies Law and exculpation of the directors
from all liability for damage resulting from any director's breach of care
towards us, pursuant to the provisions of the articles of association. We have
acquired directors' and officers' liability insurance covering the officers and
directors of the Company for certain claims.
ALTERNATE DIRECTORS
The Companies Law allows for the appointment of alternate directors if the
company's articles so provide. Our articles of association, include provisions
for the appointment of alternate directors, subject to certain provisions of the
Companies Law. Alternate directors appointed by our directors may not already be
directors and may serve in such capacity on behalf of only one director at a
time. Although alternate directors have all the rights and obligations of the
appointing directors, they may not in turn appoint alternates for themselves,
nor do they have standing at any meeting of the board of directors or committee
thereof while the appointing director is present. Without derogating from the
relevant provisions of the Companies Law, alternate directors are solely
responsible for their own acts and defaults, and are not deemed agents of their
appointing directors. None of our directors have appointed alternate directors.
(D) EMPLOYEES
As of January 31, 2003, we had 54 employees worldwide, of whom 13 were employed
in technical support and shipping, 18 in research and development, 6 in
simulation development, 10 in sales and marketing and 7 in corporate management,
finance and general administration. Of these employees, 42 were employed in
Israel, 4 in the U.S., 3 in Europe and 5 in Japan. In addition to our employees,
our Indian sub-contractor employed, as of June 30, 2003 approximately 27
employees who were engaged solely in producing simulations for us.
As of January 31, 2002, we had 53 employees worldwide, of whom 11 were employed
in technical support and shipping, 17 in research and development, 5 in
simulation development, 12 in sales and marketing and 8 in corporate management,
finance and general administration. Of these employees, 38 were employed in
Israel, 7 in the U.S., 4 in Europe and 4 in Japan. In addition to our employees,
our Indian sub-contractor employed, as of July 31, 2002, approximately 45
employees who were engaged solely in producing simulations for us.
As of January 31, 2001, we had 127 employees worldwide, of whom 24 were employed
in technical support, 44 in research and development, 20 in simulation
development, 28 in sales and marketing and 11 in corporate management, finance
and general administration. The reduction in the number of our employees between
2000 and 2001 is primarily attributable to the restructuring of our business,
which included the merging of the LiveProducts and Software Embedded Tools
division, thereby eliminating entirely our LiveProducts sales and marketing
67
department, which we effected in the 2001 and the reduction of our research and
development staff, in an effort to adjust our level of expenses to our
anticipated revenues.
Our employees are not party to any collective bargaining agreement. We are,
however, subject to certain labor-related statutes, and to certain provisions of
collective bargaining agreements between the Histadrut (General Federation of
Labor in Israel) and the Coordinating Bureau of Economic Organizations
(including the Industrialists' Association), which are applicable to our Israeli
employees by virtue of expansion orders of the Israeli Ministry of Labor and
Welfare. These statutes and provisions principally concern the length of the
work day, minimum daily wages for professional workers, contributions to pension
funds, insurance for work-related accidents, procedures for dismissing
employees, determination of severance pay, annual vacation, sick pay and other
conditions of employment. We generally provide our employees with benefits and
working conditions beyond the required minimum.
We have written employment agreements, which include non-competition and
confidentiality provisions, with our management employees. The employment
agreements with each of the executive officers require the employee to dedicate
his or her full working time to his or her duties at our company and provide for
an indefinite term of employment that continues until terminated by either us or
the employee, subject to applicable notice periods. The agreements specify the
employee's compensation package, which typically consist of a base salary (which
for Israeli employees is linked to changes in the Israeli Consumer Price Index,
referred to as CPI), certain life and disability insurance benefits and pension
plan benefits, participation in a professional advancement fund and the use of a
company car. Officers are eligible to receive a bonus and stock options from us
based upon certain criteria and limits established by us.
Israeli law generally requires the payment by employers of severance pay upon
the retirement or death of an employee or upon termination of employment by the
employer without due cause and, under certain circumstances, upon voluntary
termination by the employee. We currently fund our ongoing severance obligations
by making monthly payments to approved severance funds or insurance policies.
However, as of January 31, 2003, we had accrued a liability on our books in the
amount of $869,000 in respect of severance pay obligations that is partly funded
through insurance policies in the amount of $598,000. See note 2q to our
consolidated financial statements, included elsewhere in this annual report. In
addition, according to the National Insurance Law, Israeli employees and
employers are required to pay specified sums to the National Insurance
Institute, which is similar to the U.S. Social Security Administration. Since
January 1, 1995, such amounts also include payments for national health
insurance. The payments to the National Insurance Institute are approximately
14.5% of wages (up to a specified amount), of which the employee contributes
approximately 66% and the employer contributes approximately 34% (including
national health tax). The majority of our permanent Israeli employees are
covered by life and pension insurance policies providing customary benefits to
employees, including retirement and severance benefits. We contribute 13.33% to
15.83% of base wages (depending on the employee) to such plans and permanent
employees contribute 5% of base wages.
In August 2001, as part of our cost cutting measures, our employees agreed to a
temporary reduction in salary of 10%. This reduction was made permanent in
January of 2002. However, we agreed with our employees that their social
68
benefits, including severance pay calculations and payment in lieu of holidays,
would continue to be based on their salary prior to the reduction.
We consider our relationship with our employees to be good and have never
experienced a material labor dispute, strike or work stoppage.
For certain information regarding the arrangements pursuant to which Marc
Belzberg provides services to us on behalf of Yozma Hofsheet Ltd., see "Item 7.
Major Shareholders and Related Party Transactions - Related Party Transactions -
Interests of Management in Certain Transactions."
(E) SHARE OWNERSHIP
The following table sets forth certain information regarding beneficial
ownership of our ordinary shares by our directors and officers as of July 31,
2003. The voting rights of our officers and directors do not differ from the
voting rights of other holders of ordinary shares.
NUMBER OF ORDINARY PERCENTAGE OF ORDINARY
SHARES BENEFICIALLY SHARES BENEFICIALLY
NUMBER OF ORDINARY PERCENTAGE OF OWNED ASSUMING OWNED ASSUMING
SHARES BENEFICIALLY OUTSTANDING ORDINARY SHAREHOLDER SHAREHOLDER
NAME AND ADDRESS OWNED (1) SHARES (2)(3) APPROVAL (4) APPROVAL (4)
---------------- --------- ------------- ------------ ------------
Marc Belzberg (5).......... 3,200,805 27.4% 14,311,916 62.8%
Yaron Eldad................ 187,977 1.6% 187,977 1.6%
Fredrick Rotbart........... 500,958 4.3% 500,958 4.3%
Avi Hitelman............... * * * *
Reuven Klienman............ * * * *
Nir Gazit.................. * * * *
Uri Yaffe.................. 128,802 1.1% 128,802 1.1%
Samuel Belzberg (6)........ 134,602 1.1% 1,491,745 11.4%
Amir Galili................ 977,515 8.4% 977,515 8.4%
John McDonald.............. * * * *
Kim Campbell............... * * * *
* Less than one percent of the outstanding ordinary shares.
(1) Except as otherwise noted and pursuant to applicable community property
laws, each person named in the table has sole voting and investment
power with respect to all ordinary shares listed as owned by such
person. Shares beneficially owned include shares that may be acquired
pursuant to options that are exercisable within 60 days of July 31,
2003.
69
(2) Ordinary shares deemed beneficially owned by virtue of the right of any
person or group to acquire such shares within 60 days of July 31, 2003,
are treated as outstanding only for the purposes of determining the
percent owned by such person or group.
(3) The percentages shown are based on 11,665,359 ordinary shares issued and
outstanding as of July 31, 2003.
(4) Assumes (i) shareholder approval of the July 2002 convertible loan
agreement with Gibralt, which is controlled by Samuel Belzberg, and the
July 2003 convertible loan agreement with Smithfield, which is
controlled by Marc Belzberg and Solomon Spira, as discussed in note (5)
below and (ii) conversion in full of all outstanding convertible loans
into our ordinary shares.
(5) Marc Belzberg's beneficial interest is held through Smithfield.
Smithfield is a wholly owned subsidiary of Bellevue Investments N.V.,
referred to as Bellevue. Salomon Spira, the father-in-law of Marc
Belzberg, holds all of the voting rights and 10% of the economic rights
(e.g., rights to distributions and liquidation proceeds) of Bellevue.
Marc Belzberg holds 90% of the economic rights (but none of the voting
rights) of Bellevue. Smithfield holds 3,184,805 ordinary shares. The
shares held by Smithfield include 220,000 shares purchased by Smithfield
from a third party in April, 2001.
(6) Samuel Belzberg's beneficial interest is held through Gibralt, which is
controlled by him. He is the father of Marc Belzberg.
As a group, officers and directors hold options to purchase an aggregate of
1,660,019 ordinary shares at exercise prices ranging from $0.02 to $6.50 per
share. These options have a weighted average exercise price of $0.283 per share
and are exercisable until various times from July 2003 to February 2013.
OPTION PLANS
In June 1996, our board of directors approved the grant of options to a number
of officers, directors and employees, specifying the basic terms of the options
granted and providing that these options shall be subject to a stock option
plan, referred to as the 1996 Option Plan, to be established at a later date. In
July 1997, the board of directors approved the 1996 Option Plan and adopted our
1997 Employee and Director Stock Option Plan, referred to as the 1997 Option
Plan, and in September 1999 adopted the 1999 Option Plan. The purpose of these
option plans is to enable us to attract and retain qualified officers, directors
and employees and to motivate these persons with an equity participation in our
company.
On September 11, 2002, following the decline of the price of our ordinary shares
on the OTCBB, our board of directors voted to reprice 1,071,328 options
previously granted to our employees with exercise prices ranging between $ 0.14
- - $ 22.50 to the nominal value of the shares into which such shares are
exercisable. Of the resulting compensation expenses of $126,000, $63,000 was
recognized in the year ended January 31, 2003. For further information, see note
10d to our consolidated financial statements. The discussion of our options
plans below includes the prices of our share options following the repricing.
70
General. The 1996 Option Plan authorizes the issuance of options to purchase an
aggregate of 339,985 ordinary shares, all of which options have been granted to
officers, directors and employees with exercise prices ranging from $0.02 to
$2.12 per share. Options to acquire 160,141 ordinary shares are currently
outstanding under the 1996 Option Plan.
The 1997 Option Plan authorizes the issuance of options to purchase an aggregate
of 1,042,446 ordinary shares, all of which options have been granted to
officers, directors and employees with exercise prices ranging from $0.02 to
$6.50 per share. Options to acquire 882,898 ordinary shares are currently
outstanding under the 1997 Option Plan.
The 1999 Option Plan authorizes the issuance of options to purchase an aggregate
of 1,800,000 ordinary shares, of which options to acquire 1,293,754 ordinary
shares are currently outstanding and have been granted to officers, directors
and employees with exercise prices ranging from $0.02 to $1.50 per share.
Upon the occurrence of any ordinary share split, reverse ordinary share split,
recapitalization or rights offerings or other substantially similar corporate
transaction or event, we shall make such equitable changes or adjustments
necessary to the number of shares subject to each outstanding option in order to
prevent dilution or enlargement of the optionees' rights.
Administration. The Option Plans are administered by our board of directors,
which is authorized, among other things, to determine the number of ordinary
shares to which an option may relate and the terms, conditions and restrictions
of the options, to determine whether, to what extent and under what
circumstances an option may be settled, cancelled, forfeited, exchanged or
surrendered, to construe and interpret the Option Plans and any options, to
prescribe, amend and rescind rules and regulations relating to the Option Plans,
and to make all other determinations deemed necessary or advisable for the
administration of the Option Plans.
Vesting Periods. Although the terms of individual options may differ, typically
the options vest in equal portions over a four-year period, commencing one year
after the date of grant. The options granted under the Option Plans are
generally exercisable for four years after vesting, subject to the grantee
remaining employed by us. Any options which are forfeited or cancelled before
expiration become available for future grants.
Amendment and Termination of the Option Plans. We may, at any time in our sole
and absolute discretion, suspend or terminate the Option Plans or revise or
amend them in any respect; provided, however, that no amendment, construction,
interpretation or other determination by us under the Option Plans, or any other
action or inaction us of any kind, shall adversely affect an optionee's rights
under any outstanding option without the consent of that optionee.
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ITEM 7
MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS
(A) MAJOR SHAREHOLDERS
The following table sets forth certain information regarding ownership of our
ordinary shares as of July 31, 2003, for each person known by us to own
beneficially more than 5% of our outstanding ordinary shares. The voting rights
of our major shareholders do not differ from the voting rights of other holders
of ordinary shares.
NUMBER OF ORDINARY PERCENTAGE OF ORDINARY
SHARES BENEFICIALLY SHARES BENEFICIALLY
NUMBER OF ORDINARY PERCENTAGE OF OWNED ASSUMING OWNED ASSUMING
SHARES BENEFICIALLY OUTSTANDING ORDINARY SHAREHOLDER SHAREHOLDER
NAME AND ADDRESS OWNED (1) SHARES (2)(3) APPROVAL (4) APPROVAL (4)
- ---------------- --------- ------------- ------------ ------------
Marc Belzberg (5).............. 3,200,805 27.4% 14,311,916 62.8%
Samuel Belzberg (6)............ 134,602 1.1% 1,491,745 11.4%
Amir Galili.................... 977,515 8.4% 977,515 8.4%
Solomon Spira (7).............. 3,223,016 27.6% 14,334,127 62.9%
Uri Binyamini.................. 609,900 5.2% 609,900 5.2%
* Less than one percent of the outstanding ordinary shares.
(1) Except as otherwise noted and pursuant to applicable community property
laws, each person named in the table has sole voting and investment
power with respect to all ordinary shares listed as owned by such
person. Shares beneficially owned include shares that may be acquired
pursuant to options that are exercisable within 60 days of July 31,
2003.
(2) Ordinary shares deemed beneficially owned by virtue of the right of any
person or group to acquire such shares within 60 days of July 31, 2003,
are treated as outstanding only for the purposes of determining the
percent owned by such person or group.
(3) The percentages shown are based on 11,665,359 ordinary shares issued and
outstanding as of July 31, 2003.
(4) Assumes (i) shareholder approval of the July 2002 convertible loan
agreement with Gibralt, which is controlled by Samuel Belzberg, and the
July 2003 convertible loan agreement with Smithfield, which is
controlled by Marc Belzberg and Solomon Spira, as discussed in note (5)
below and (ii) conversion in full of all outstanding convertible loans
into our ordinary shares.
72
(5) Marc Belzberg's beneficial interest is held through Smithfield.
Smithfield is a wholly owned subsidiary of Bellevue. Salomon Spira, the
father-in-law of Marc Belzberg, holds all of the voting rights and 10%
of the economic rights (e.g., rights to distributions and liquidation
proceeds) of Bellevue. Marc Belzberg holds 90% of the economic rights
(but none of the voting rights) of Bellevue. Smithfield holds 3,184,805
ordinary shares. The shares held by Smithfield include 220,000 shares
purchased by Smithfield from a third party in April, 2001.
(6) Samuel Belzberg's beneficial interest is held through Gibralt, which is
controlled by him. He is the father of Marc Belzberg.
(7) Solomon Spira is the father-in-law of Marc Belzberg. His interest is
held through Smithfield, of which he is a controlling shareholder, as
described in note (5) above.
As of June 30, 2003, we had approximately 39 shareholders of record with a
United States address. As of June 30, 2003, these United States record holders
held approximately 9,266,524 ordinary shares, representing approximately 79.4%
of our then outstanding share capital.
To the best of our knowledge, we are not directly or indirectly owned or
controlled by another corporation or by any foreign government and currently
there are no arrangements that may, at a subsequent date, result in a change in
our control.
(B) RELATED PARTY TRANSACTIONS
LOANS BY RELATED PARTIES
In July, 2003, we entered into a convertible loan agreement with Smithfield, an
entity controlled by Marc Belzberg, our chairman, chief executive officer and
one of our major shareholder, pursuant to which Smithfield agreed to lend us $1
million maturing on August 1, 2004 and bearing no interest. Until that date,
Smithfield may convert the principal amount of the loan into our ordinary shares
at a price per share of $0.18. In addition, if Smithfield elects to convert the
entire loan amount into our ordinary shares, it will receive a warrant to
purchase $3,000,000 worth of our ordinary shares at a price per share of $0.54.
According to the terms of the convertible loan agreement, we will have the right
to compel Smithfield to convert the loan in its entirety into our ordinary
shares if we consummate an equity investment of at least $1 million.
Since Smithfield is considered a related party, the transaction is subject to
the approval of our audit committee, board of directors and shareholders. The
transaction has been approved by our board of directors and audit committee. The
transaction also requires shareholder approval for an increase in our authorized
share capital. We plan to submit the transaction and the increase in our
authorized share capital for shareholder approval at our next general meeting of
shareholders. We cannot assure you the transaction will be approved. However,
Smithfield has agreed that if our shareholders do not approve this transaction
or the increase in share capital, it will provide the amount of the investment
as a loan, if failure to provide it would affect our ability to continue
operations as a going concern.
In August 2002, we entered into an agreement with Gibralt, a party controlled by
Samuel Belzberg, who is a director of our company and the father of Marc
Belzberg, our chairman, chief executive officer and one of our major
73
shareholders, pursuant to which Gibralt agreed to lend us $950,000 at an annual
interest rate of 6% maturing on February 28, 2003. We have repaid $760,000 of
the loan to Gibralt. As per the agreement, $190,000 of the aggregate principal
amount of the loan was not repaid. Pending shareholder approval Gibralt will
have the right to convert this sum into our ordinary shares at the price per
share of $0.14 for a period of five years from the date of the loan agreement.
Since Gibralt is considered a related party and the transaction involves a
conversion right of a portion of the loan, the transaction is subject to the
approval of our audit committee, board of directors and shareholders. Although
the transaction was properly approved by our audit committee and board of
directors, it is still pending shareholder approval. We plan to submit the
transaction to our shareholders for approval at our upcoming general meeting of
shareholders. We cannot assure you that the transaction will be approved. In the
event that our shareholders do not approve the transaction, we will be required
to repay the balance the loan amounting to $190,000 in cash.
INTERESTS OF MANAGEMENT IN CERTAIN TRANSACTIONS
In 1993, we entered into an agreement, pursuant to which Yozma Hofsheet Ltd.,
referred to as Yozma, an Israeli company beneficially owned by Samuel Belzberg,
currently provides us with management and consulting services for a fee which
was initially $10,750 per month, increased by 12% per year. Currently, we are
obliged to pay Yozma $29,811 per month, which sum is presently being accrued.
These services have been provided by Marc Belzberg on behalf of Yozma, or a
predecessor company. Under this agreement we accrued services fees of $207,000,
238,000 and $350,000 in 2000, 2001 and 2002, respectively. Yozma waived its fees
for the quarters ended October 31, 2000 and April 30, 2001. Pursuant to
agreements entered into with banks who provided us with short-term and
convertible loans to extend the scheduled maturity of the loans and to make
certain other changes to the terms, until at least one half of the outstanding
principal of the loans has been repaid, we have undertaken with the banks not to
make any cash payment of management fees to Yozma. Yozma has agreed to these
terms. For issuance of options to certain of our directors and officers, see
"Item 6. Directors, Senior Management and Employees - Share Ownership - Option
Plans."
(C) INTERESTS OF EXPERTS AND COUNSEL
Not applicable.
ITEM 8
FINANCIAL INFORMATION
(A) CONSOLIDATED STATEMENTS AND OTHER FINANCIAL INFORMATION
The financial statements required by this item are found at the end of this
annual report, beginning on page F-1.
74
EXPORT SALES
Export sales constitute a significant portion of our sales. In 2002, export
sales were approximately $6.0 million constituting 96.1% of our total sales. For
a more detailed discussion regarding the allocation of our revenues by
geographic regions based on the location of our customers, see "Item
4--Information on the Company--Business Overview--Sales and Marketing."
LEGAL PROCEEDINGS
In January 2002, we terminated a license agreement with Simulis, Inc., which
granted Simulis certain exclusive and non-exclusive rights to market our Rapid
CBT software. Simulis has disputed the validity of the termination. In August
2002, we agreed with Simulis on certain terms resolving the dispute, subject to
certain conditions that we believe have been met. A definite agreement resolving
this matter has been prepared but not yet executed. In addition, we have not
received any payments due from Simulis pursuant to our understanding for over
four months and our ability to collect the amounts from Simulis is currently
unclear. Therefore, we cannot assure you that definitive agreements will be
ultimately entered into and that the dispute will be finally and successfully
resolved.
We have received a claim from Gaio, Inc., one of our principal competitors in
Japan, alleging that certain features of our newly released RapidPLUS version 7
breach its copyright and demanding that we cease marketing this product in a
version which allegedly breaches its proprietary rights. We believe the claim to
be without merit, and intend to defend it vigorously. However, we cannot predict
at this time the outcome of Gaio's claims.
We are currently involved in a dispute with our former landlord at Kiryat Mada
Street, Jerusalem, the Har Hotzvim Property Company Ltd., who alleges that in
November 2002 we reached an oral agreement to continue and lease their
facilities. In addition, the landlord demands lease and lease related payments
for a certain period prior to our vacating the premises. We have paid the
landlord a certain amount we believe is owed and are currently involved in
discussions concerning the balance claimed. We cannot predict at this time the
outcome of these discussions.
We are not currently involved in any other material legal or arbitration
proceedings which may have, or have had in the recent past, a significant effect
on our financial position or profitability.
DIVIDEND POLICY
We have never declared or paid any cash dividend on our ordinary shares. We do
not anticipate paying any cash dividend on our ordinary shares in the
foreseeable future. We currently intend to retain all future earnings to finance
operations and expand our business.
(B) SIGNIFICANT CHANGES
Except as otherwise disclosed in this annual report, no significant change has
occurred since January 31, 2003.
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ITEM 9
THE OFFER AND LISTING
(A) OFFER AND LISTING DETAILS
In February 2002, our ordinary shares were delisted from the NASDAQ National
Market as a result of our failure to meet NASDAQ's continued listing
requirements. Trading in our ordinary shares is currently conducted in the
over-the-counter market, on the OTCBB. The following table lists the high and
low closing prices, in dollars, of our ordinary shares for the years indicated
as reported by the American Stock Exchange, the NASDAQ National Market or the
OTCBB (as applicable) for the period during which our ordinary shares were so
traded for each financial year indicated below:
YEAR HIGH LOW
---- ---- ---
1998 $7.0625 $1.4375
1999 $20.7500 $4.6250
2000 $38.0000 $2.1250
2001 $3.0500 $0.1800
2002 $0.6500 $0.0700
The following tables list the high and low closing prices, in dollars, of our
ordinary shares as reported by the NASDAQ National Market or the OTCBB (as
applicable) for each full financial quarter of the periods indicated below:
2001 HIGH LOW
---- ---- ---
First Quarter $2.7500 $0.6563
Second Quarter $3.0500 $1.5700
Third Quarter $1.9500 $0.1800
Fourth Quarter $0.5000 $0.2100
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2002 HIGH LOW
---- ---- ---
First Quarter $0.4500 $0.1300
Second Quarter $0.6500 $0.1400
Third Quarter $0.1800 $0.0700
Fourth Quarter $0.2400 $0.1000
2003 HIGH LOW
---- ---- ---
First Quarter $0.2300 $0.1100
Second Quarter (through July 15,
2003) $0.3600 $0.1700
The following table lists the high and low closing prices, in dollars, of our
ordinary shares as reported by the OTCBB for the six most recent months:
2003 HIGH LOW
---- ---- ---
January $0.1300 $0.1100
February $0.1300 $0.1100
March $0.2300 $0.1100
April $0.2200 $0.1100
May $0.3600 $0.1500
June $0.3100 $0.1700
July (through July 15, 2003) $0.2700 $0.1900
(B) PLAN OF DISTRIBUTION
Not applicable.
(C) MARKETS
On July 7, 1998, we completed our initial public offering, at which time our
ordinary shares began trading on the American Stock Exchange, under the symbol
EMU. In June 1999, we changed our name from Emultek Ltd. to e-SIM Ltd., and our
symbol changed to EIM. In March 2000, we changed our listing to the NASDAQ
National Market under the symbol ESIM. In February 2002, our ordinary shares
were delisted from the NASDAQ National Market as a result of our failure to meet
NASDAQ's continued listing requirements. Trading in our ordinary shares is
currently conducted in the over-the-counter market, on the OTCBB. Our shares
were not traded publicly prior to our initial public offering.
(D) SELLING SHAREHOLDERS
Not applicable.
77
(E) DILUTION
Not applicable.
(F) EXPENSES OF THE ISSUE
Not applicable.
ITEM 10
ADDITIONAL INFORMATION
(A) SHARE CAPITAL
Not applicable.
(B) MEMORANDUM AND ARTICLES OF ASSOCIATION
SECURITIES REGISTERS
Our transfer agent and register is the American Stock Transfer & Trust Co. and
its address is 59 Maiden Lane, New York, NY 10038.
At our Annual General Meeting of Shareholders on July 13, 2001, we adopted
amended articles of association, which replaced our previous articles of
association in their entirety. The following is a summary of the material
provisions of our articles of association currently in effect and related
provisions of Israeli law. This summary does not purport to be a complete
description and is qualified in its entirety by reference to the complete text
of our articles of association.
PURPOSES OF THE COMPANY
We are a public company registered under the Israeli Companies Law as e-SIM
Ltd., registration number 52-004343-1. Pursuant to Section 2 of our articles of
association, we may engage in any lawful business or matter that we decide upon.
By resolution and at the sole discretion of our board of directors, we may grant
reasonable contributions and donations for charitable purposes.
DIRECTORS
The Companies Law restricts a director's power to vote on a proposal,
arrangement or contract in which the director is materially interested. A
director who has an interest in a given matter may not participate in a vote on
the matter if the proposal, arrangement or contract at hand constitutes a
transaction that is not in the ordinary course of the company's business, is not
at market conditions or may materially affect the company's profitability,
property or commitments, unless a majority of the company's directors are
materially interested in said proposal, arrangement or contract. In the latter
case, while directors may participate in the vote, the proposal, arrangement or
78
contract must also be approved at a General Meeting of Shareholders. We are
subject to these provisions of the Companies Law.
Pursuant to the Companies Law, decisions relating to the compensation of the
directors themselves must receive the approval of our Audit Committee prior to
the approval of our the board of directors, and must subsequently be approved by
the General Meeting of Shareholders. We have incorporated these provisions of
the Companies Law into our articles of association and require the approval of
the General Meeting of Shareholders for resolutions concerning remuneration of
our directors.
Our board of directors has the authority to borrow any sum in the manner, time
and conditions that it may deem fit, including the issuing of bonds or
debentures or a series of bonds or debentures, whether secured or non secured,
or subordinate to any mortgage, lien or other security of a factory, or property
of our company, wholly or partially.
We de not have an age limit requirement for our directors, nor do we require
that directors hold any of our shares.
RIGHTS ATTACHED TO SHARES
SHARE CAPITAL
Our registered share capital consists of 20,000,000 ordinary shares, NIS 0.1 par
value. Each of our ordinary shares has equal rights with any other such share,
including voting rights, the right to participate in any distribution to holders
of ordinary shares and any other right provided by the Companies Law to our
ordinary shares.
DIVIDEND RIGHTS
Subject to the provisions of the Companies Law, our board of directors may
decide to distribute interim and final dividends. Any distribution of dividends
must be fixed and paid to shareholders pro rata according to the par value of
the shares, subject to our right to alter our existing share capital and rules
regarding priority. Holders of our ordinary shares are entitled to the full
amount of any cash or share dividend declared, although the board of directors
may deduct any amount payable on our shares, whether or not that amount is yet
due, and such matter would be subject to certain rules prescribed by Israeli
law.
VOTING RIGHTS
Holders of our ordinary shares have one vote for each ordinary share held on all
matters submitted to the vote of shareholders. These voting rights may be
affected by the grant of any special voting rights to the holders of a class of
shares with preferential rights that may be authorized in the future. Other than
external directors, who are elected for a three-year term, our directors are
elected annually by majority vote at our general meeting of shareholders.
LIQUIDATION RIGHTS
In the case of our liquidation, our articles of association provide that share
capital shall be returned and surplus of our assets shall be distributed to our
shareholders pro rate in proportion to the paid-up capital on the par value of
our shares, subject to any provisions of the law concerning liquidation and any
special rights that may be attached to our shares in the future.
79
CHANGE OF RIGHTS ATTACHED TO SHARES
Pursuant to our articles of associations and subject to the provisions of the
Companies Law, we may change the rights attached to any of our shares, without
prejudice to any special rights previously conferred on the holders of any
existing shares or class of shares, by an ordinary resolution approved by a
simple majority at a General Meeting of Shareholders. If a change entails the
division of our share capital into different classes of shares, the rights
attached to any class, unless otherwise provided by the terms of issue of the
shares of that class, may be varied only with the consent in writing of the
holders of all issued shares of that class, or with the approval of an ordinary
resolution passed at a separate general meeting of the holders of the shares of
the class.
GENERAL MEETINGS
Pursuant to the provisions of the Companies Law, a General Meeting of
Shareholders must be convened annually, no more than 15 months after the
previous one, and at such place as may be determined by the board of directors.
The board of directors may also convene an extraordinary general meeting as it
decides or upon demand of any two directors or 25% of the directors, whichever
is lower, or of one or more shareholders holding an aggregate of at least 5% of
the company's outstanding shares and at least 1% of the voting rights in the
company or at least 5% of the voting rights in the company. Prior to any General
Meeting of Shareholders, notice will be given in accordance with the relevant
provisions of the Companies Law and the Israeli Foreign Traded Companies
Regulations.
The quorum requirement for our General Meeting of Shareholders, whether annual
or special, is two members present in person or by proxy and holding or
representing between them at least 33 1/3% of our outstanding issued share
capital. If convened upon request of shareholders, as described above, a meeting
adjourned for lack of quorum shall be dissolved, but in any other case it shall
be adjourned to the same day one week later at the same time and place or to
such day, time and place as the board of directors may, by notice to our
shareholders appoint, subject to the relevant provisions of the Companies Law.
At the adjourned meeting, the business for which the original meeting was called
will be transacted if any two members are present, either in person or by proxy.
Pursuant to our articles of association, at any General Meeting of our
shareholders, whether annual or special, resolutions will pass by a simple
majority, including resolutions to further amend our articles of association but
excluding approval of certain transactions, actions and arrangements for which
the Companies Law requires different voting arrangements. See "Item 6.
Directors, Senior Management and Employees-Board Practices-Approval of Specified
Related Party Transactions Under Israeli Law" for a discussion of these special
rules.
LIMITATIONS ON RIGHTS TO OWN SECURITIES
Neither our articles of association nor the laws of the State of Israel restrict
in any way the ownership or voting of shares by non-residents, except with
respect to subjects of countries that are in a state of war with Israel.
80
PROVISIONS AFFECTING A POTENTIAL CHANGE OF CONTROL
The Companies Law allows for corporate mergers, so long as the merger is
approved both by the board of directors and by the general meeting of
shareholders of each company that is a party to the proposed merger. General
meeting approval of mergers must be by a vote of the majority of the company's
shares, present and voting on the proposed merger. Shares held by the other
party to the merger or by a shareholder who also holds at least 25% of such
party are excluded from voting on a proposed merger.
Pursuant to the Companies Law, a merger does not require court approval, other
than in specified situations. However, the creditors of either party to a
proposed merger may petition the courts to delay or prevent a merger if there is
a reasonable concern that that the surviving company will be unable to meet the
obligations of either party to the merger to their creditors.
Mergers may be completed only after at least 70 days have passed from the time
that a request for the approval of a merger has been filed with the Israeli
Registrar of Companies.
The Companies Law requires that acquisitions of public companies on the open
market must be made by means of a tender offer if, as a result of the
acquisition, the purchaser would hold at least 25% of the target company's
shares, and there is no other shareholder holding at least 25% of the share in
the company. Similarly, if there is no shareholder who holds more than 50% of
the target company's shares, an acquisition that would result in the purchaser
holding more than 45% of the company's shares, must also be conducted via a
tender offer. These rules apply only to the acquisition of companies, not to
mergers, and do not apply to Israeli companies registered for trade outside of
Israel, like us, in certain circumstances.
If, following an acquisition of shares, the purchaser would become the holder of
more than 90% of the company's shares, the acquisition must be made by means of
a tender offer for all of the target company's shares. If all shareholders in
the target company except for the holders of shares representing less than 5% of
the company's shares accept the tender offer, the purchaser may acquire all
shares for which the tender offer was made. However, if a tender offer fails to
acquire 95% of the target company, the purchaser may not acquire tendered shares
that would raise the purchaser's holding in the company above 90%.
OWNERSHIP THRESHOLD FOR DISCLOSURE
Our articles of association do not provide for an ownership threshold above
which shareholding must be disclosed. However, pursuant to the provisions of the
Companies Law, we are required to maintain a separate register for shareholders
who hold more than 5% of our shares or voting rights.
CHANGES IN SHARE CAPITAL
As provided by our articles of association, we may change our share capital by
an ordinary resolution approved by the General Meeting of Shareholders.
81
(C) MATERIAL CONTRACTS
For a summary of our material contracts see "Item 5. Operating and Financial
Review and Prospects - Liquidity and Capital Resources," and "Item 7. Major
Shareholders - Related Party Transactions."
(D) EXCHANGE CONTROLS
The State of Israel's extensive controls on foreign currency, such as the
Currency Control Law of 1978, were lifted, in large part, in May 1998. There
currently are no Israeli currency control restrictions on payments of dividends
on ordinary shares or the proceeds from the sale of ordinary shares. However,
legislation remains in effect pursuant to which currency controls can be imposed
by administrative action at any time.
Under current Israeli regulations, any dividends or other distributions paid in
respect of ordinary shares may be paid in non-Israeli currencies, or, if paid in
Israeli currency, will be freely repatriable in non-Israeli currencies at the
rate of exchange prevailing at the time of the conversion. Because exchange
rates between the NIS and the dollar fluctuate continuously, a U.S. shareholder
will be subject to the risk of currency fluctuations between the dates when
NIS-denominated dividends are declared and paid by us in NIS.
(E) TAXATION
UNITED STATES FEDERAL INCOME TAX CONSIDERATIONS
Subject to the limitations described below, the following discussion describes
the material U.S. federal income tax consequences to a beneficial owner of
ordinary shares that is (a) a citizen or resident of the U.S., (b) a corporation
(or other entity treated as a corporation for U.S. federal tax purposes) created
or organized in the U.S. or under the laws of the U.S. or of any state, (c) an
estate, the income of which is includable in gross income for U.S. federal
income tax purposes regardless of its source or (d) a trust if a court within
the U.S. is able to exercise primary supervision over the administration of the
trust and one or more U.S. persons have the authority to control all substantial
decisions of the trust, referred to as a "U.S. Shareholder."
This summary is for general information purposes only and does not purport to be
a comprehensive description of all of the U.S. federal income tax considerations
that may be relevant to a decision to hold ordinary shares. This summary
generally considers only U.S. Shareholders that are the beneficial owners of the
ordinary shares that will own ordinary shares as capital assets. Except to the
limited extent discussed below, this summary does not consider the U.S. tax
consequences to a person that is not a U.S. Shareholder.
This discussion is based on current provisions of the Internal Revenue Code of
1986, as amended, referred to as the Code, current and proposed Treasury
regulations promulgated thereunder, and administrative and judicial decisions as
of the date hereof, all of which are subject to change, possibly on a
retroactive basis. This discussion does not address all aspects of U.S. federal
income taxation that may be relevant to any particular shareholder based on such
shareholder's particular circumstances (including potential application of the
alternative minimum tax), U.S. federal income tax consequences to certain
shareholders that are subject to special treatment (such as taxpayers who are
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broker-dealers, insurance companies, tax-exempt organizations, financial
institutions, or "financial services entities"); holders of securities held as
part of a "straddle," "hedge" or "conversion transaction" with other
investments; holders who own or owned directly, indirectly or by attribution at
least 10% of our voting power; taxpayers whose functional currency is not the
U.S. dollar; taxpayers who received ordinary shares as compensation; taxpayers
who have elected mark-to-market accounting; and certain expatriates or former
long-term residents of the U.S.
Additionally, the discussion does not consider the tax treatment of persons who
hold ordinary shares through a partnership or other pass-through entity or the
possible application of U.S. federal gift or estate taxes. In addition, this
discussion does not consider any aspect of state, local or non-U.S. tax laws.
Certain material aspects of U.S. federal income tax relevant to a beneficial
owner other than a U.S. Shareholder, referred to as a Non-U.S. Shareholder, also
are discussed below.
EACH INVESTOR IS ADVISED TO CONSULT SUCH PERSON'S OWN TAX ADVISOR WITH RESPECT
TO THE SPECIFIC TAX CONSEQUENCES TO SUCH PERSON OF PURCHASING, HOLDING OR
DISPOSING OF ORDINARY SHARES.
TAXATION OF ORDINARY SHARES
Dividends. We have never paid cash dividends and we currently do not intend to
pay cash dividends in the foreseeable future. In the event we do pay a dividend
and subject to the discussion below under "-Passive Foreign Investment
Companies," a U.S. Shareholder generally will be required to include in gross
income as ordinary income the amount of any distribution paid on the ordinary
shares (including the amount of Israeli taxes, if any, withheld therefrom) on
the date the distribution is received to the extent that such distributions are
paid out of our current or accumulated earnings and profits as determined for
U.S. federal income tax purposes. Distributions in excess of such earnings and
profits will be applied against and will reduce the U.S. Shareholder's tax basis
in the ordinary shares and, to the extent in excess of such tax basis, will be
treated as gain from a sale or exchange of ordinary shares. See "--Sale of
Exchange of Ordinary Shares." Distributions of current or accumulated earnings
and profits generally will not qualify for the dividends-received deduction
available to corporations. Under recently-enacted U.S. federal income tax
legislation, an individual U.S. holder's "qualified dividend income" is
currently subject to tax at reduced rates not exceeding 15%. For this purpose,
"qualified dividend income" generally includes dividends paid by a foreign
corporation if either (a) the stock of such corporation with respect to which
the dividends are paid is readily tradable on an established securities market
in the U.S., or (b) such corporation is eligible for benefits of a comprehensive
income tax treaty with the U.S. which includes an information exchange program
and is determined to be satisfactory by the U.S. Secretary of the Treasury.
Dividends paid by a foreign corporation will not qualify for the reduced rates,
however, if such corporation is treated, for the tax year in which the dividend
is paid or the preceding tax year, as a "foreign investment company," a "foreign
personal holding company" or a "passive foreign investment company" for U.S.
federal income tax purposes. We do not currently believe that we would be
classified as a "foreign investment company," a "foreign personal holding
company" or a "passive foreign investment company" for U.S. federal income tax
purposes. However, see the discussion under "--Passive Foreign Investment
Companies" below. Accordingly, dividend distributions with respect to our
ordinary shares should be treated as "qualified dividend income" so long as our
ordinary shares are traded on the OTCBB or we satisfy the treaty related
requirements above and thus should be eligible for the reduced tax rates.
Taxpayers must satisfy certain holding period requirements in order to be
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eligible for the reduced rates for qualified dividend income. Distributions of
current or accumulated earnings and profits paid in NIS will be includable in
the income of a U.S. Shareholder in a U.S. dollar amount calculated by reference
to the exchange rate in effect on the day they are considered to be received by
the U.S. Shareholder, without reduction for any Israeli taxes withheld at
source, regardless of whether the payment is in fact converted into U.S. dollars
on such date. A U.S. Shareholder who receives a foreign currency distribution
and converts the foreign currency into U.S. dollars subsequent to receipt will
have foreign exchange gain or loss based on any appreciation or depreciation in
the value of the foreign currency against the U.S. dollar, which will generally
be U.S. source ordinary income or loss.
U.S. Shareholders who are subject to withholding tax in Israel may generally be
entitled to a credit or deduction for U.S. Federal income tax purposes in the
amount of the taxes withheld, subject to certain conditions and limitations. The
total amount of allowable foreign tax credits in any year generally cannot
exceed regular U.S. tax liability for the year attributable to certain foreign
source income. A U.S. Shareholder will be denied a foreign tax credit with
respect to Israeli income tax withheld from dividends received to the extent
such U.S. Shareholder has not held the ordinary shares for a minimum period or
to the extent such U.S. Shareholder is under an obligation to make certain
related payments with respect to substantially similar or related property.
Distributions of current or accumulated earnings and profits will generally be
foreign source passive income for U.S. foreign tax credit purposes. Special
rules may apply to the foreign tax credit computations associated with qualified
dividend income, discussed above.
Sale or Exchange of Ordinary Shares. Subject to the discussion below under
"-Passive Foreign Investment Companies," upon the sale or exchange of ordinary
shares, a U.S. Shareholder generally will recognize capital gain or loss in an
amount equal to the difference between the amount realized on the sale or
exchange by such U.S. Shareholder and its tax basis in the ordinary shares,
which is usually the U.S. dollar cost of the ordinary shares. A U.S. Shareholder
that uses the cash method of accounting calculates the U.S. dollar value of the
proceeds received on the sale date as of the date that the sale settles, while a
U.S. Shareholder that uses the accrual method of accounting is required to
calculate the value of the proceeds of the sale as of the "trade date," and
therefore, may realize foreign currency gain or loss, unless such U.S.
Shareholder has elected to use the settlement date to determine its proceeds of
sale. If the ordinary shares are publicly traded, a disposition of the shares
will be considered to occur on the "trade date," regardless of the U.S.
Shareholder's method of accounting. The gain or loss realized on the sale or
exchange of ordinary shares will be long-term capital gain or loss if the U.S.
Shareholder has a holding period of more than one year at the time of such sale
or exchange.
Capital gains of non-corporate taxpayers from the sale or exchange of ordinary
shares held more than one year are eligible for reduced rates of taxation
applicable to long-term capital gains. The deductibility of a capital loss
recognized on the sale or exchange of ordinary shares is subject to limitations.
Gain or loss realized by a U.S. Shareholder on a sale or exchange of ordinary
shares generally will be treated as U.S. source income for U.S. foreign tax
credit purposes.
A U.S. Shareholder who receives a foreign currency distribution and converts the
foreign currency into U.S. dollars subsequent to receipt will have foreign
exchange gain or loss based on any appreciation or depreciation in the value of
the foreign currency against the U.S. dollar, which will generally be U.S.
source ordinary income or loss.
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PASSIVE FOREIGN INVESTMENT COMPANIES
We will be a passive foreign investment company, or PFIC, if 75% or more of our
gross income (including the pro rata share of the gross income of any company,
U.S. or foreign, in which we are considered to own 25% or more of the shares by
value) in a taxable year is passive income. Alternatively, we will be considered
to be a PFIC if at least 50% or more of the assets (averaged over the year and
generally determined based upon fair market value) of our company (including the
pro rata share of the assets of any U.S. or foreign company in which we are
considered to own 25% or more of the shares by value) in a taxable year are held
for the production of, or produce, passive income. If we are a PFIC, U.S.
shareholder, in the absence of an election by such U.S. Shareholder to treat us
as a "qualified electing fund," referred to as a "QEF" election, as discussed
below, upon certain distributions by us and upon sale or other disposition of
the ordinary shares at a gain, as if the distribution or gain had been
recognized ratably over the taxpayer's holding period for the ordinary shares.
The U.S. Shareholder would be liable to pay tax at ordinary income tax rates on
amounts allocable to the current year and to years prior to our becoming a PFIC,
and with respect to other years in the U.S. Shareholder's holding period, at the
maximum income tax rates on ordinary income in effect from time to time, plus
interest on the tax. Even if a QEF election is not made, a U.S. Shareholder must
file a completed IRS Form 8621 with the U.S. Shareholder's U.S. federal income
tax return each year. Additionally, if we were to become a PFIC, U.S.
Shareholders who acquire ordinary shares from a decedent would be denied the
normally available step-up of the tax basis for such shares to fair market value
at the date of death and instead would have a tax basis equal to the decedent's
basis, if lower.
If a U.S. Shareholder has made a QEF election for all taxable years that such
shareholder has held the ordinary shares and we were a PFIC, distributions and
gain will not be deemed to have been recognized ratably over the taxpayer's
holding period or be subject to an interest charge, gain on the sale of ordinary
shares will be characterized as capital gain and the denial of basis step-up at
death described above will not apply. Instead, a U.S. Shareholder that has made
a QEF election is required for each taxable year to include in income a pro rata
share of the ordinary earnings of the QEF as ordinary income and a pro rata
share of the net capital gain of the QEF fund as long-term capital gain,
regardless of whether we have distributed such earnings or gain.
A U.S. Shareholder of certain publicly traded PFIC stock can elect to mark the
stock to market annually, recognizing as ordinary income or loss each year an
amount equal to the difference as of the close of the taxable year between the
holder's adjusted tax basis in the PFIC stock and its fair market value. Losses
are allowed only to the extent of net mark-to-market gain previously included by
the U.S. Shareholder under the election for prior taxable years. If the
mark-to-market election is made, then the rules set forth above for taxation of
distributions by us and dispositions of ordinary shares at a gain would not
apply for periods covered by the election.
We believe that we were not a PFIC for our fiscal year which commenced February
1, 2002. However, the tests for determining PFIC status are applied annually and
it is difficult to make accurate predictions of future income and assets, which
are relevant to this determination. Accordingly, there can be no assurance that
we will not become a PFIC.
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We can give no assurance that we will have timely knowledge of our future status
as a PFIC. In this regard, we do not assume any obligation to make timely
disclosure with respect to such status. Moreover, we do not plan to provide U.S.
Shareholders with the necessary information to make a QEF election.
Consequently, as a practical matter, U.S. Shareholders should assume that they
will not be able to make a QEF election. U.S. Shareholders who hold ordinary
shares during a period when we are a PFIC will be subject to the foregoing
rules, even if we cease to be a PFIC. U.S. Holders are urged to consult their
tax advisors about the PFIC rules, including the consequences to them of making
a mark-to-market election or QEF election with respect to our ordinary shares in
the event that we are treated as a PFIC.
NON-U.S. HOLDERS OF ORDINARY SHARES
Except as described in "--Information Reporting and Backup Withholding," a
Non-U.S. Shareholder of ordinary shares who is a beneficial owner of the
ordinary shares will not be subject to U.S. federal income or withholding tax on
the payment of dividends on, and proceeds from the disposition of, ordinary
shares, unless (a) such item is effectively connected with the conduct by the
Non-U.S. Shareholder of a trade or business in the U.S. and, in the case of a
resident of a country that has a treaty with the U.S., such item is attributable
to a permanent establishment (or, in the case of an individual, a fixed place of
business) in the United States or (b) in the case of capital gain realized by an
individual Non-U.S. Shareholder, the Non-U.S. Shareholder is present in the U.S.
for 183 days or more in the taxable year of the sale and certain other
conditions are met.
INFORMATION REPORTING AND BACKUP WITHHOLDING
U.S. Shareholders generally are subject to information reporting requirements
with respect to dividends paid in the U.S. on ordinary shares. In addition, U.S.
Shareholders are subject to U.S. backup withholding (currently at a rate of 28%)
on dividends paid in the U.S. on ordinary shares unless the U.S. Shareholder
provides an IRS Form W-9 or otherwise establishes an exemption. U.S.
Shareholders are subject to information reporting and backup withholding
(currently at a rate of 28%) on proceeds paid from the sale, exchange,
redemption or other disposition of ordinary shares unless the U.S. Shareholder
provides an IRS Form W-9 or otherwise establishes an exemption.
Non-U.S. Shareholders generally are not subject to information reporting or
back-up withholding with respect to dividends paid on, or proceeds upon the
sale, exchange, redemption or other disposition of, ordinary shares, provided
that such Non-U.S. Shareholder provides a taxpayer identification number,
certifies to its foreign status, or otherwise establishes an exemption.
Backup withholding is not an additional tax. The amount of any backup
withholding will be allowed as a credit against such U.S. Shareholder's or
Non-U.S. Shareholder's United States federal income tax liability and may
entitle such shareholder to a refund, provided that the required information is
furnished to the U.S. Internal Revenue Service.
ISRAELI TAXATION AND INVESTMENT PROGRAMS
The following is a summary of the current tax laws of the State of Israel as
they relate to us and our shareholders, including U.S. and other non-Israeli
shareholders. The following also includes a discussion of certain Israeli
Government programs benefiting various Israeli businesses, including our
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company. To the extent that the discussion is based on legislation yet to be
subjected to judicial or administrative interpretation, there can be no
assurance that the views expressed herein will accord with any such
interpretation in the future. This discussion is not intended and should not be
construed as legal or professional tax advice and does not cover all possible
tax considerations. The following summary is included herein for general
information only and is not intended to substitute for careful tax planning.
TAX REFORM
On January 1, 2003, the Law for Amendment of the Income Tax Ordinance (Amendment
No. 132), 5762-2002, known as the Tax Reform, came into effect.
The Tax Reform, aimed at broadening the categories of taxable income and
reducing the tax rates imposed on employment income, introduced the following,
among other things:
o Reduction of the tax rate levied on capital gains (other than
gains deriving from the sale of listed securities) derived after
January 1, 2003, to a general rate of 25% for both individuals
and corporations;
o Imposition of Israeli tax on all income of Israeli residents,
individuals and corporations, regardless of the territorial
source of income, including income derived from passive sources
such as interest, dividends and royalties;
o Introduction of controlled foreign corporation (CFC) rules into
the Israeli tax structure, so that an Israeli individual or
company may become subject to Israeli taxes on certain income of
a non-Israeli subsidiary if the subsidiary's primary source of
income is passive income (such as interest, dividends, royalties,
rental income or capital gains);
o Imposition of capital gains tax at a rate of 15% on real capital
gains realized by individuals as of January 1, 2003, from the
sale of shares of publicly traded Israeli companies (such gain
was previously exempt from capital gains tax in Israel in certain
circumstances). For information with respect to the applicability
of Israeli capital gains taxes on the sale of our ordinary
shares, see "Capital Gains Tax and Taxation Of Dividends" below;
o Imposition of a 10-15% tax on savings;
o Introduction of a new regime for the taxation of shares and
options issued to employees and officers (including directors),
including a reduction in taxes on gains from exercise of options;
and
o Introduction of tax at a rate of 25% on dividends paid by one
Israeli company to another (which are generally not subject to
tax), if the source of such dividend is income that was derived
outside of Israel.
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As most of the measures in the Tax Reform came into effect as of January 1,
2003, there are no tax effects on us as a result of the reform for the year
2002. We cannot yet predict the full effect of the new measures on either the
company or our shareholders.
GENERAL CORPORATE TAX STRUCTURE
The regular rate of corporate tax to which Israeli companies are subject is 36%.
However, the effective rate of tax payable by a company that is qualified under
Israeli law as an "Industrial Company" and that derives income from an "Approved
Enterprise," as further discussed below, may be considerably lower. See "Law for
the Encouragement of Capital Investments, 1959."
Our effective tax rate was 0% through January 31, 2003. The expiration of the
benefit period under one of our Approved Enterprise programs may have a material
adverse effect on our effective tax rate beginning in the tenth year after we
have taxable profits. The continuation of this tax rate is dependent upon the
receipt of certain approvals from the Israeli Investment Center, a statutory
body made up of representatives of various Israeli Government ministries,
referred to as the Investment Center. See "-Law for the Encouragement of Capital
Investments 1959."
LAW FOR THE ENCOURAGEMENT OF INDUSTRY (TAXES), 1969
Pursuant to the Law for the Encouragement of Industry (Taxes), 1969, referred to
as the Industry Law, a company qualifies as an "Industrial Company" if it is
resident in Israel and at least 90% of its income in any tax year, determined in
Israeli currency (exclusive of income from defense loans, capital gains,
interest and dividends) is derived from an "Industrial Enterprise" it owns. An
"Industrial Enterprise" is defined for purposes of the Industry Law as an
enterprise the majority activity of which, in a given tax year, is industrial
production.
We qualify as an Industrial Company. We are therefore entitled to certain tax
benefits, including, among other things, a deduction of the purchase price of
patents or certain other intangible property rights at the rate of 12.5% per
annum and, subject to certain conditions, the right to submit our tax returns on
a consolidated basis. In addition, we, as an Industrial Company may, in certain
cases, deduct the expenses incurred in connection with a public offering at the
rate of 33.3% of such expenses per annum.
The tax laws and regulations dealing with the adjustment of taxable income for
local inflation provide that Industrial Enterprises, such as us, are eligible
for special rates of depreciation deductions. These rates vary in the case of
plant and machinery according to the number of shifts in which the equipment is
being operated and generally range from 20% to 40% on a straight-line basis, and
30% to 50% on a declining balance basis for equipment first put into operation
on or after June 1, 1989 (instead of the regular rates that are applied on a
straight-line basis). An Industrial Company may claim 150% of such rates with
respect to equipment first put into operations during the years 1992, 1993 and
1994. Moreover, Industrial Enterprises that are Approved Enterprises can choose
between (a) the special depreciation rates referred to above or (b) accelerated
regular rates of depreciation applied on a straight-line basis in respect of
property and equipment, generally ranging from 200% (in respect of equipment) to
400% (in respect of buildings) of the ordinary depreciation rates during the
first five years of service of these assets, provided that the depreciation on a
building may not exceed 20% per annum.
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Eligibility for benefits under the Industry Law is not contingent upon the
approval of any government agency. There can be no assurance that we will
continue to so qualify, or will be able to avail ourselves of any benefits under
the Industry Law in the future.
LAW FOR THE ENCOURAGEMENT OF CAPITAL INVESTMENTS, 1959
GENERAL
Our production facilities have been granted "Approved Enterprise" status
pursuant to the Israeli Law for the Encouragement of Capital Investments, 1959,
referred to as the Investment Law, which provides certain tax and financial
benefits to investment programs that have been granted such status. The
Investment Law provides that a proposed capital investment in eligible
facilities may, upon application to the Investment Center of the Ministry of
Industry and Commerce of the State of Israel, referred to as the Investment
Center, within the funding limits set by the Israeli Government budget, be
granted the status of an "Approved Enterprise" if such project may promote the
objectives of the Investment Law and it is desirable to encourage the
implementation of the project by the grant of the approval. These objectives are
to attract capital to Israel and encourage economic initiative and investments
of foreign and local capital in order to (a) develop the Israeli economy's
productive capacity, utilize its resources and economic potential efficiently
and maximize the productive capacity of existing enterprises; (b) improve
Israel's balance of payments by reducing imports and increasing exports; and (c)
assist in the absorption of immigration, distribute the population over the area
of the country and create sources of employment.
The Investment Law provides that capital investments in production facilities
(or other eligible facilities) may, upon application to the Investment Center,
be designated as an Approved Enterprise. Each instrument of approval for an
Approved Enterprise relates to a specific investment program, delineated both by
the financial scope of the investment, including sources of funds, and by the
physical characteristics of the facility or other assets. The tax benefits
available under any instrument of approval relate only to taxable profits
attributable to the specific program and are contingent upon meeting the
criteria set out in the instrument of approval. If, as in our case, (a) only a
part of a company's taxable income is derived from an Approved Enterprise or (b)
a company owns more than one Approved Enterprise, our resulting effective
corporate tax rate represents the weighted combination of the various applicable
rates. A company owning a "mixed enterprise" (i.e., a company the income of
which is derived from both an Approved Enterprise and other sources) generally
may not distribute a dividend that is attributable only to the Approved
Enterprise.
Subject to certain provisions concerning income and subject to the Alternative
Benefits (hereinafter defined), any distributed dividends are deemed
attributable to the entire enterprise, and the effective tax rate represents the
weighted combination of the various applicable tax rates. A company may elect to
attribute dividends distributed by it only to income not subject to the
Alternative Benefits.
TAX BENEFITS
In Israel, income derived by companies is generally taxed at the regular
corporate tax rate of 36%. However, income derived from an Approved Enterprise
is subject to corporate tax at the reduced rate of 25% (or lower in the case of
a qualified "Foreign Investor's Company," referred to as a FIC, that is at least
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25% owned by non-Israeli residents) until the earlier of (a) seven or ten, in
the case of a FIC, consecutive years, commencing in the year in which the
specific Approved Enterprise first generates taxable income (which income is not
offset by deductions attributable to other sources), (b) 12 years from the year
of commencement of production or (c) 14 years from the year of approval of the
Approved Enterprise status. A company owning an Approved Enterprise that was
approved after April 1, 1986 may elect to forego the entitlement to grants and
to certain tax benefits otherwise available under the Investment Law, and apply
for an alternative package of tax benefits ("Alternative Benefits"). Under the
Alternative Benefits, undistributed income from the Approved Enterprise is fully
tax-exempt (a "tax exemption") for a defined period. The period of tax exemption
under the Alternative Benefits program ranges between two and ten years,
depending principally upon the geographic location within Israel of the Approved
Enterprise and the type of Approved Enterprise. On expiration of the tax
exemption, the Approved Enterprise is eligible for the beneficial tax rate (25%
or lower in the case of a qualified FIC) for the remainder of the applicable
period of benefits, as described above.
Dividends paid out of income derived from an Approved Enterprise (or out of
dividends received from a company whose income is derived from an Approved
Enterprise) are generally subject to withholding tax at the rate of 15%
(deductible at source). The 15% rate is limited to dividends and distributions
out of income derived during the benefits period and actually paid at any time
up to 12 years thereafter. A company that elects the Alternative Benefits will
be subject to corporate tax at the otherwise applicable rate of 25% (or lower in
the case of a qualified FIC) in respect of the gross amount of the dividend if
it pays a dividend out of income derived by its Approved Enterprise during the
tax-exemption period, in addition to the withholding tax due on the dividend.
The tax exempt income attributable to the "Approved Enterprise" can be
distributed to shareholders without subjecting us to taxes only upon our
complete liquidation. We currently have no plans to distribute dividends.
The tax benefits available to an Approved Enterprise relate only to taxable
income attributable to that specific enterprise and are contingent upon the
fulfillment of the conditions stipulated by the Investment Law, the regulations
published thereunder and the instruments of approval for the specific
investments in the Approved Enterprise. In the event that we fail to comply with
these conditions, the tax and other benefits could be rescinded, in whole or in
part, and we might be required to refund the amount of the canceled benefits,
with the addition of CPI linkage differences and interest. We believe that our
Approved Enterprises have substantially complied with all such conditions. No
assurance can be given that we will continue to so comply or that we qualify as
a FIC.
FINANCIAL BENEFITS
An Approved Enterprise is also entitled to a grant from the Government of Israel
with respect to investments in certain production facilities located in
designated areas within Israel, provided it did not elect the Alternative
Benefits. Grants are available for enterprises situated in development areas and
for high-technology or skill-intensive enterprises in Jerusalem. The investment
grant is computed as a percentage (up to 20%, depending upon the location and
size of the enterprise) of the original costs of the fixed assets for which
Approved Enterprise status has been granted. For programs approved prior to
December 31, 1996, an Approved Enterprise could be entitled to State-guaranteed
loans from banks and other financial institutions, of up to 66.67% of approved
project expenditures (in lieu of Government grants), whether or not the
Alternative Benefits are elected. As of January 31, 2003 the Company had no such
outstanding guaranteed loans.
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The termination or substantial reduction of any of the benefits available under
the Investment Law could have a material adverse effect on future investments by
us in Israel. As long as we are in compliance with the conditions set forth in
the certificates of approvals granted to it, our income derived from Approved
Enterprise expansion programs will be tax-exempt for the prescribed period and
thereafter will enjoy reduced tax rates, as detailed above.
We were awarded "Approved Enterprise" status by the Israeli Government under the
Investment Law with respect to three investment programs, of which two programs
were completed, one in April 1993, and the other in March 1998. The Approved
Enterprise status allows us a tax exemption on undistributed Israeli income for
the period of ten years after the first year that we realize taxable income. As
we currently have no taxable income, these benefits have not yet commenced. With
respect to the first two investment programs, we also elected to receive
Government-guaranteed long-term loans along with the tax exemption. We have not
received final approval for the investment programs that ended in April 1993 and
March 1998. The benefits are conditional upon the fulfillment of a marketing
plan filed by the Company and fulfilling of the conditions stipulated by the
above law, regulations published thereunder and the instruments of approval for
the specific investments in "Approved Enterprises." In the event of our failure
to comply with these conditions, the benefits may be cancelled and we may be
required to refund the amount of the benefits, in whole or in part, including
interest. In March 1998, we applied for approval to commence a third program,
for which we received approval in November 1998.
The Investment Center of the Ministry of Industry and Commerce bases its
decision as to whether or not to approve an application, on the criteria set
forth in the Investment Law and regulations, the then prevailing policy of the
Investment Center, and the specific objectives and financial criteria of the
applicant. Accordingly, there can be no assurance that any such application will
be approved. In addition, the benefits available to an approved enterprise are
conditional upon the fulfillment of conditions stipulated in the Investment Law
and its regulations and the criteria set forth in the specific certificate of
approval. In the event that a company does not meet these conditions, it would
be required to refund a portion of the benefits already received, with the
addition of interest and penalties. From time to time, the Government of Israel
has discussed reducing the benefits available to companies under the Investment
Law. We cannot assure you that our approved program and the benefits thereunder
shall continue in the future at its current level or at any level. The
termination or substantial reduction of any of the benefits available under the
Investment Law could have a material adverse effect on future investments by us.
LAW FOR THE ENCOURAGEMENT OF INDUSTRIAL RESEARCH AND DEVELOPMENT, 1984
Under the Law for the Encouragement of Industrial Research and Development,
1984, referred to as the Research Law, and the instructions of the Director
General of the Ministry of Industry and Trade No. 4.4 of January 2, 1994,
research and development programs and the plans for the intermediate stage
between research and development, and manufacturing and sales approved by a
governmental committee of the Office of the Chief Scientist are eligible for
grants of up to 50% of the research and development project's expenditures if
they meet certain criteria. These grants are issued in return for the payment of
royalties at the rate of 3.5%-5% of the sale of products developed with funds
provided by the Office of the Chief Scientist. Total royalties will not exceed
100% (or, in some cases, 150%) of the grants received. Following the full
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payment of such royalties, there is no further liability for payment, as long as
the technology and its manufacturing remain in Israel.
The technology developed pursuant to the terms of these grants may not be
transferred to third parties without the prior approval of a governmental
committee under the Research Law. Such approval is not required for the export
of any product resulting from such or research or development. Approval of the
transfer of technology may be granted only if the recipient abided by all the
provisions of the Research Law and regulation promulgated thereunder, including
the restriction on the transfer of known-how and the obligation to pay royalties
in an increased amount, of up to 300% of the grants received. There can be no
assurance that such consent, if requested, will be granted.
We participated in programs sponsored by the Office of the Chief Scientist for
the support of research and development activities. Through January 31, 2003, we
had obtained grants from the Office of the Chief Scientist aggregating
$1,778,000 for certain of our research and development projects. We are
obligated to pay royalties to the Office of Chief Scientist at the rate of
3.5%-5% of the sales of the products and other related revenues developed from
such projects, up to an amount equal to 100%-150% of the grants received.
Through January 31, 2003, we have accrued or paid royalties to the Office of the
Chief Scientist in the aggregate amount of $1,279,000. On January 31, 2003, the
aggregate liability to the Office of the Chief Scientist, which is contingent on
our income, was $621,000. Some of the accrued royalties were not paid when due
In January 2003, we reached a settlement regarding payments to the Office of the
Chief Scientist. For additional information concerning the terms of this
settlement, see "Item 5. Operating And Financial Review And Prospects - Research
and Development, Patents and Licenses - Research and Development Grants."
TAX BENEFITS AND GRANTS FOR RESEARCH AND DEVELOPMENT
Israeli tax law allows, subject to certain conditions, a tax reduction in the
year incurred for expenditures (including capital expenditures) in scientific
research and development projects, if the expenditures are approved by the
relevant Israeli Government Ministry, determined by the field of research, the
research and development is for the promotion of enterprise, and is carried out
by, or on behalf of, the company seeking the said deduction. Expenditures not so
approved are deductible over a three-year period. However, expenditures from
grants made available to our company by the Israeli Government are not,
according to Israeli law, included in research and development expenses, and are
thus not deductible.
TAXATION UNDER INFLATIONARY CONDITIONS
The Income Tax (Inflationary Adjustments) Law, 1985, referred to as the
Inflationary Adjustments Law, is intended to neutralize the erosion of capital
investments in business and to prevent tax benefits resulting from deduction of
inflationary expenses. This law applies a supplementary set of inflationary
adjustments to the nominal taxable profits computed under regular historical
cost principles. The Inflationary Adjustments Law introduced a special tax
adjustment for the preservation of equity based on changes in the CPI, whereby
certain corporate assets are classified broadly into fixed (inflation-resistant)
assets and non-fixed assets. Where shareholders' equity, as defined in the
Inflationary Adjustments Law, exceeds the depreciated cost of fixed assets, as
defined in the Inflationary Adjustments Law, a tax deduction that takes into
account the effect of the annual rate of inflation on such excess is allowed (up
to a ceiling of 70% of taxable income for companies in any single year, with the
92
unused portion carried forward on a linked basis, without limit). If the
depreciated cost of such fixed assets exceeds shareholders' equity, then such
excess, multiplied by the annual inflation rate, is added to taxable income. In
addition, subject to certain limitations, depreciation of fixed assets and
losses carried forward are adjusted for inflation on the basis of changes in the
CPI.
In November 2001, an amendment to the Inflationary Adjustments Law was passed by
the Israeli Knesset, pursuant to which the Minister of Finance, with the
approval of the finance committee of the Knesset, can determine that the
provisions of the Inflationary Adjustments Law, in whole or in part, will not
apply to a tax year if the CPI of that year did not exceed 3%.
Pursuant to the Inflationary Adjustments Law, results for tax purposes are
measured in real terms in accordance with the changes in the CPI, see note 11 to
our consolidated financial statements, included elsewhere in this annual report.
A FIC may, subject to certain conditions, elect to measure results, for tax
purposes, in dollar terms.
One of the net effects of the Inflationary Adjustment Law is that our taxable
income for Israeli corporate tax purposes will be different from our dollar
income reflected in our financial statements, which are based on changes in the
New Israeli Shekel exchange rate with respect to the dollar.
CAPITAL GAINS TAX AND TAXATION OF DIVIDENDS
Israeli law imposes a capital gains tax on the sale of capital assets located in
Israel, including shares in Israeli companies, by both residents and
non-residents of Israel unless a specific exemption is available or unless a tax
treaty between Israel and the shareholder's country of residence provides
otherwise. The law distinguishes between real gain and inflationary surplus. The
inflationary surplus is a portion of the total capital gain that is equivalent
to the increase of the relevant asset's purchase price which is attributable to
the increase in the Israeli consumer price index between the date of purchase
and the date of sale. The real gain is the excess of the total capital gain over
the inflationary surplus. Capital gains (other than gains deriving from the sale
of listed securities) derived after January 1, 2003 are taxed at a rate of 25%
for both individuals and corporations. Regarding assets acquired prior to
January 1, 2003, the tax rate of 25% will apply to a proportionate part of the
gain in accordance with the holding periods of the Asset, before and after
January 1, 2003 on a linear basis.
Prior to the Tax Reform, with certain exceptions for sales of shares owned prior
to our initial public offering, sales of our ordinary shares by individuals were
generally exempted from Israeli capital gains tax.
Pursuant to the Tax Reform, generally, capital gains tax is imposed at a rate of
15% on real gains derived on or after January 1, 2003, from the sale of shares
in companies (i) publicly traded on the Tel Aviv Stock Exchange ("TASE") or;
(ii) (subject to a necessary determination by the Israeli Minister of Finance)
Israeli companies publicly traded on a recognized stock exchange or regulated
market outside of Israel (such as us). This tax rate is contingent upon the
shareholder not claiming a deduction for financing expenses and does not apply
to: (i) dealers in securities; (ii) shareholders that report in accordance with
the Inflationary Adjustment Law; or (iii) shareholders who acquired their shares
prior to an initial public offering (that are subject to a different tax
arrangement). The tax basis of shares acquired prior to January 1, 2003 will be
93
determined in accordance with the average closing share price in the three
trading days preceding January 1, 2003. However, a request may be made to the
tax authorities to consider the actual adjusted cost of the shares as the tax
basis if it is higher than such average price.
Non-Israeli residents are exempt from Israeli capital gains tax on any gains
derived from the sale of shares publicly traded on the TASE, and are exempt from
Israeli capital gains tax on any gains derived from the sale of shares of
Israeli companies publicly traded on a recognized stock exchange or regulated
market outside of Israel, provided that such capital gains are not derived from
a permanent establishment in Israel and that such shareholders did not acquire
their shares prior to an initial public offering. However, non-Israeli
corporations will not be entitled to such exemption if an Israeli resident (i)
has a controlling interest of 25% or more in such non-Israeli corporation, or
(ii) is the beneficiary of or is entitled to 25% or more of the revenues or
profits of such non-Israeli corporation, whether directly or indirectly.
In any event, the provisions of the Tax Reform shall not effect the exemption
from capital gains tax for gains accrued before January 1, 2003, as described
above.
In some instances where our shareholders may be liable to Israeli tax on the
sale of their ordinary shares, the payment of the consideration may be subject
to the withholding of Israeli tax at the source.
On the distribution of dividends other than bonus shares (stock dividends),
income tax is generally withheld at source at the rate of 25% (or 15% in the
case of dividends paid out of income derived from Approved Enterprises; see
"--Law for the Encouragement of Capital Investments, 1959"), unless a double
taxation treaty is in effect between Israel and the shareholder's country of
residence that provides for a lower tax rate in Israel on dividends. The
Convention between the State of Israel and the Government of the U.S. relating
to relief from double taxation, referred to as the Treaty, provides for a
maximum tax of 25%, on dividends paid to a resident of the U.S. or 15% in the
case of dividends paid out of the profits of an Approved Enterprise. See
"--U.S.-Israel Tax Treaty." Where the recipient of the dividend is a U.S.
corporation owning 10% or more of the voting stock of the paying corporation and
the dividend is not paid from the profits of an Approved Enterprise, Israeli tax
withheld may not exceed 12.5%, subject to certain conditions.
U.S.-ISRAEL TAX TREATY
Under the Treaty, the maximum tax on dividends paid to a holder of ordinary
shares who qualifies as a resident of the U.S. within the meaning of the Treaty
and who is entitled to claim the benefits afforded to such residents, referred
to as a Treaty U.S. Resident, will be 25%; as noted above, however, under the
Investment Law and the Treaty, dividends generated by an Approved Enterprise are
taxed at the rate of 15%. The Treaty further provides that a 12.5% Israeli
dividend withholding tax would apply to dividends paid to a U.S. corporation
owning 10% or more of an Israeli company's voting stock for, in general, the
current and preceding tax years of the Israeli company provided certain
requirements are met. The lower 12.5% rate applies only to dividends from income
not derived from an Approved Enterprise in the applicable period and does not
apply if we have certain amounts of passive income. Residents of the U.S. who
are subject to withholding tax in Israel may generally be entitled to a credit
94
or deduction for U.S. federal income tax purposes in the amount of the taxes
withheld, subject to the conditions and limitations set forth in applicable U.S.
tax legislation. See "-U.S. Federal Income Tax Considerations."
Pursuant to the Treaty and subject to certain conditions and limitations
provided for therein, the sale, exchange or disposition of ordinary shares by a
Treaty U.S. Resident will not be subject to the Israeli capital gains tax unless
such Treaty U.S. Resident holds, directly or indirectly, shares representing 10%
or more of our voting power during any part of the 12-month period preceding
such sale, exchange or disposition. A sale, exchange or disposition of ordinary
shares by a Treaty U.S. Resident who holds, directly or indirectly, shares
representing 10% or more of our voting power at any time during such preceding
12-month period would be subject to such Israeli tax; however, under the Treaty,
such Treaty U.S. Resident would be permitted to claim a credit for such taxes
against the U.S. income tax imposed on any gain from such sale, exchange or
disposition, subject to the limitations applicable to foreign tax credits.
(F) DIVIDENDS AND PAYING AGENTS
Not applicable.
(G) STATEMENT BY EXPERTS
Not applicable.
(H) DOCUMENTS ON DISPLAY
Any statement in this annual report about any of our contracts or other
documents is not necessarily complete. If the contract or document is filed as
an exhibit to this annual report, the contract or other document is deemed to
modify the description contained in this annual report. The exhibits themselves
must be reviewed for a complete description of the contract or document.
We are subject to the information reporting requirements of the Securities and
Exchange Act of 1934, as amended, referred to as the Exchange Act, applicable to
foreign private issuers. As a foreign private issuer, we are exempt from certain
rules and regulations under the Exchange Act prescribing the furnishing and
content of proxy statements, and our officers, directors and principal
shareholders are exempt from the reporting and "short-swing" profit recovery
provisions contained in Section 16 of the Exchange Act, with respect to their
purchase and sale of our ordinary shares. In addition, we are not required to
file reports and financial statements with the Commission as frequently or as
promptly as U.S. companies whose securities are registered under the Exchange
Act. However, we file with the Commission an annual report on Form 20-F
containing financial statements audited by an independent consulting firm. We
also furnish reports on Form 6-K containing unaudited financial information for
the first three quarters of each fiscal year.
You may examine and copy this annual report and any other document we file with
the Commission at the Commission's public reference room at 450 Fifth Street,
N.W., Washington, D.C. 20549. You may also obtain copies of the documents at
prescribed rates by writing to the Public Reference Section of the Commission at
450 Fifth Street, N.W., Washington, D.C. 20549. You may call the Commission at
1-800-SEC-0330 for further information on the operation of the public reference
95
facilities. The documents concerning us which are referred to in this annual
report may also be examined at our principal executive offices located at 19
Hartum Street, Jerusalem, Israel.
In addition, the Commission maintains an Internet website at http://www.sec.gov
that contains reports, proxy statements, information statements and other
material that are filed through the Commission's Electronic Data Gathering,
Analysis and Retrieval, or EDGAR, system. We began filing our reports through
the EDGAR system in November 2002.
(I) SUBSIDIARY INFORMATION
Not applicable.
ITEM 11
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk relating to our operations result primarily from changes in
interest rates and foreign currency exchange rate fluctuations.
INTEREST RATE RISK
Our interest expenses are sensitive to the LIBOR as some of our loans bear a
LIBOR based interest rate.
We do not use derivative financial instruments.
The table below details the balance and interest rates of our loans outstanding
as of January 31, 2003:
AVERAGE
BALANCE INTEREST RATE FAIR VALUE
------- ------------- ----------
Liabilities
Bank loans $ 866,000 LIBOR +3%* $ 866,000
1,894,000 5.81% 1,894,000
---------- ----------
Total $2,760,000 $2,760,000
* As of January 31, 2003 one month LIBOR for dollar loans was approximately
1.81%.
FOREIGN CURRENCY RISKS
We are exposed to financial market risk associated with changes in foreign
currency exchange rates. The majority of our revenue is transacted in dollars
and the majority of our expenses, however, is denominated in NIS. The dollar
cost of our operations in Israel is influenced by the extent to which any
increase in the rate of inflation in Israel is not offset, or is offset on a
lagging basis, by a devaluation of the NIS in relation to the dollar.
96
ITEM 12
DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES
Not applicable.
PART TWO
ITEM 13
DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES
Not applicable.
ITEM 14
MATERIAL MODIFICATIONS OF THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS
(A)
For information concerning certain changes made in July 2001 to our articles of
association which modify the terms of our ordinary shares, see the information
contained in the Current Report on Form 6-K filed with the Commission on July
31, 2001. The revised terms of our Ordinary Shares are summarized under "Item 10
- - Additional Information - Memorandum and Articles of Association - Rights
Attached to Shares."
(B), (C) AND (D) Not applicable.
(E) USE OF PROCEEDS
The effective date of the registration statement (Registration No. 333-8830) for
our initial public offering of our ordinary shares was July 7, 1998. The
offering commenced on July 7, 1998 and terminated after the sale of all the
securities registered on or about July 10, 1998. The managing underwriters of
the offering were Gruntal & Co. L.L.C. and Everen Securities Inc. In the
offering, we registered 2,150,000 ordinary shares and sold these ordinary shares
for an aggregate offering price of approximately $15 million, reflecting a price
per share of $7. In connection with the offering, we incurred expenses of
approximately $2 million, which included underwriting discounts and commissions
and other expenses such as filing fees relating to the registration statement
and the American Stock Exchange, and accounting, legal, printing, engraving and
miscellaneous expenses. None of these payments was made, directly or indirectly,
to any of our directors or officers, or their associates, any persons owning 10%
97
or more of any class of our equity securities, or to any of our affiliates. The
net proceeds that we received as a result of the offering were approximately $13
million.
Through January 31, 2000, proceeds from the offering were used as follows:
Long-Term Bank Loan Repayment $ 800,667
Repayment of Shareholder's Loan 94,742
Repayment of Industrial Finance
Company Loan 1,266,091
Payment of Management Fees 1,030,057
Repayment of Short-Term Bank Loans 387,613
Purchase of Fixed Assets 973,909
Operating Activities $ 8,478,699
The foregoing table represents the application of all of the proceeds from the
offering.
Except for the repayment of the shareholder's loan to an affiliate of Marc
Belzberg and the payment of management fees to an affiliate of Samuel Belzberg,
each as described in "Item 7. Major Shareholders and Related Party Transactions
- - Major Shareholders" and "Item 7. Major Shareholders and Related Party
Transactions - Related Party Transactions - Interests of Management in Certain
Transactions" and as set forth above, none of the net proceeds was paid,
directly or indirectly, to any of our directors or officers, or their
associates, any persons owning 10% or more of any class of our equity
securities, or to any of our affiliates.
ITEM 15
CONTROLS AND PROCEDURES
(a) We maintain disclosure controls and procedures that are designed to ensure
that information required to be disclosed in our filings under the Securities
Exchange Act of 1934 is recorded, processed, summarized and reported within the
periods specified in the rules and forms of the Securities and Exchange
Commission. Such information 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. Our
management, including our Chief Executive Officer and Chief Financial Officer,
recognizes that any set of controls and procedures, no matter how well designed
and operated, can provide only reasonable assurance of achieving the desired
control objectives.
Within 90 days prior to the filing date of this annual report on Form 20-F, we
have carried out an evaluation, under the supervision and with the participation
of our management, including our Chief Executive Officer and Chief Financial
Officer, of the effectiveness of the design and operation of our disclosure
98
controls and procedures. Based on such evaluation, our Chief Executive Officer
and Chief Financial Officer concluded that our disclosure controls and
procedures are effective.
(b) There have been no significant changes in our internal controls or in other
factors that could significantly affect the internal controls subsequent to the
date of their evaluation in connection with the preparation of this annual
report on Form 20-F.
ITEM 16
[RESERVED]
PART THREE
ITEM 17
FINANCIAL STATEMENTS
We have responded to Item 18 in lieu of this Item.
ITEM 18
FINANCIAL STATEMENTS
The financial statements required by this item are found at the end of this
annual report, beginning on page F-1.
ITEM 19
EXHIBITS
The exhibits filed with or incorporated into this annual report are listed in
the index of exhibits below.
EXHIBIT NO. DESCRIPTION
----------- -----------
1.1 Memorandum of Association of the Registrant (together with
an English translation thereof) (incorporated by reference
to Exhibit 3.1 to the Registration Statement on Form F-1
(File No. 333-8830))
1.2 Articles of Association of the Registrant, as amended
(incorporated by reference to Exhibit 1.2 to the annual
report on Form 20-F filed with the Commission on July 31,
2001)
4.1 Consulting Agreement, dated August 7, 1997, between the
Registrant and Yozma Hofsheet Ltd. (incorporated by
reference to Exhibit 10.3 to the Registration Statement on
Form F-1 (File No. 333-8830))
99
4.2 1996 and 1997 Stock Option Plans of the Registrant
(incorporated by reference to Exhibit 10.7 to the
Registration Statement on Form F-1 (File No. 333-8830))
4.3 1999 Share Option Plan of the Registrant (incorporated by
reference to Exhibit 4.3 to the annual report on Form 20-F
filed with the Commission on July 31, 2001)
4.4 Agreement of General Business Conditions, dated November
30, 2000, between the Registrant and Industrial
Development Bank of Israel Ltd. (incorporated by reference
to Exhibit 4.4 to the annual report on Form 20-F filed
with the Commission on July 31, 2001)
4.5 Agreement, dated November 30, 2000, between the Registrant
and Industrial Development Bank of Israel Ltd.
(incorporated by reference to Exhibit 4.5 to the annual
report on Form 20-F filed with the Commission on July 31,
2001)
4.6 Debenture, dated November 30, 2000, in favor of Industrial
Development Bank of Israel Ltd. (incorporated by reference
to Exhibit 4.6 to the annual report on Form 20-F filed
with the Commission on July 31, 2001)
4.7 Debenture, dated September 19, 2000, in favor of Israel
Discount Bank Ltd. (incorporated by reference to Exhibit
4.7 to the annual report on Form 20-F filed with the
Commission on July 31, 2001)
4.8 Convertible Debenture, dated September 19, 2000, in favor
of Israel Discount Bank Ltd. (incorporated by reference to
Exhibit 4.8 to the annual report on Form 20-F filed with
the Commission on July 31, 2001)
4.9 Credit Agreement, dated September 19, 2000, in favor of
Israel Discount Bank Ltd. (incorporated by reference to
Exhibit 4.9 to the annual report on Form 20-F filed with
the Commission on July 31, 2001)
4.10 Amendment to Additional Conditions for Granting Credits,
dated August 13, 2002, between the Registrant and
Industrial Development Bank of Israel Ltd. (incorporated
by reference to Exhibit 4.10 to the annual report on Form
20-F filed with the Commission on August 15, 2002)
4.11 Amendment to Convertible Debenture, dated August 13, 2002,
in favor of Industrial Development Bank of Israel Ltd.
(incorporated by reference to Exhibit 4.11 to the annual
report on Form 20-F filed with the Commission on August
15, 2002)
4.12 Amendment to Additional Conditions for Granting Credits,
dated August 13, 2002, between the Registrant and Israel
Discount Bank Ltd. (incorporated by reference to Exhibit
4.12 to the annual report on Form 20-F filed with the
Commission on August 15, 2002)
4.13 Amendment to Convertible Debenture, dated August 13, 2002,
in favor of Israel Discount Bank Ltd. (incorporated by
reference to Exhibit 4.13 to the annual report on Form
20-F filed with the Commission on August 15, 2002)
4.14 Agreement dated August 14, 2002 between the Registrant and
Gibralt Capital (incorporated by reference to Exhibit 4.14
to the annual report on Form 20-F filed with the
Commission on August 15, 2002)
4.15* Amendment to Additional Conditions for Granting Credits,
dated July 30, 2003, between the Registrant and Industrial
Development Bank of Israel Ltd.
100
4.16* Amendment to Additional Conditions for Granting Credits,
dated July 30, 2003, between the Registrant and Israel
Discount Bank Ltd.
4.17* Agreement, dated July 31, 2003, between the Registrant and
Smithfield Investments B.V.
8 List of Subsidiaries (incorporated by reference to Exhibit
8 to the annual report on Form 20-F filed with the
Commission on July 31, 2001)
12.1* Consent of Kost Forer & Gabbay, a member of Ernst & Young
Global
12.2* Certificate of Chief Executive Officer pursuant to 18
U.S.C. Section 1350, As Adopted Pursuant To Section 906 Of
The Sarbanes-Oxley Act of 2002.
12.3* Certificate of Chief Financial Officer pursuant to 18
U.S.C. Section 1350, As Adopted Pursuant To Section 906 Of
The Sarbanes-Oxley Act of 2002.
- -----------------
* Filed herewith.
101
SIGNATURES
The registrant hereby certifies that it meets all of the requirements for filing
on Form 20-F and it has duly caused and authorized the undersigned to sign this
annual report on its behalf.
BY: /s/ Marc Belzberg
-------------------------------------------
Name: Marc Belzberg
Title: Director and Chief Executive Officer
Dated: July 31, 2003
CERTIFICATIONS
I, Marc Belzberg, certify that:
1. I have reviewed this annual report on Form 20-F of e-SIM Ltd.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a. designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this annual report is being prepared;
b. evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
c. presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a. all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b. any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal controls
or in other factors that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: July 31, 2003
/s/ Marc Belzberg
Marc Belzberg
Chief Executive Officer
2
CERTIFICATIONS
I, Yaron Eldad, certify that:
1. I have reviewed this annual report on Form 20-F of e-SIM Ltd.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a. designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this annual report is being prepared;
b. evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
c. presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a. all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b. any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal controls
or in other factors that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: July 31, 2003
/s/ Yaron Eldad
Yaron Eldad
Chief Financial Officer
2
E-SIM LTD. AND ITS SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
AS OF JANUARY 31, 2003
IN U.S. DOLLARS
INDEX
PAGE
--------------
REPORT OF INDEPENDENT AUDITORS F-2
CONSOLIDATED BALANCE SHEETS F-3 - F-4
CONSOLIDATED STATEMENTS OF OPERATIONS F-5
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (DEFICIENCY) F-6
CONSOLIDATED STATEMENTS OF CASH FLOWS F-7
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS F-8 - F-33
- - - - - - - -
ERNST & YOUNG
REPORT OF INDEPENDENT AUDITORS
TO THE SHAREHOLDERS OF
E-SIM LTD.
We have audited the accompanying consolidated balance sheets of e-SIM
Ltd. ("the Company") and its subsidiaries as of January 31, 2002 and 2003, and
the related consolidated statements of operations, changes in shareholders'
equity (deficiency) and cash flows for each of the three years in the period
ended January 31, 2003. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with auditing standards
generally accepted in the 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 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 consolidated financial
position of the Company and its subsidiaries as of January 31, 2002 and 2003,
and the consolidated results of their operations and cash flows for each of the
three years in the period ended January 31, 2003, in conformity with accounting
principles generally accepted in the United States.
Tel-Aviv, Israel /s/ KOST FORER & GABBAY
March 12, 2003 A Member of Ernst & Young Global
F-2
E-SIM LTD. AND ITS SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
JANUARY 31,
-----------------------------------
2002 2003
--------------- ----------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 1,305 $ 627
Trade receivables (net of allowance for doubtful accounts of
$ 138 and $ 123 as of January 31, 2002 and 2003, respectively) 1,343 1,594
Other receivables and prepaid expenses 351 252
--------------- ----------------
Total current assets 2,999 2,473
--------------- ----------------
SEVERANCE PAY FUND 466 598
--------------- ----------------
LONG-TERM PREPAID EXPENSES 72 64
--------------- ----------------
PROPERTY AND EQUIPMENT, NET 1,078 534
--------------- ----------------
$ 4,615 $ 3,669
=============== ================
The accompanying notes are an integral part of the consolidated financial
statements.
F-3
E-SIM LTD. AND ITS SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE DATA)
JANUARY 31,
-----------------------------------
2002 2003
--------------- ----------------
LIABILITIES AND SHAREHOLDERS' DEFICIENCY
CURRENT LIABILITIES:
Short-term bank credit $ 4 $ 14
Current maturities of long-term bank loans 3,356 2,070
Current maturities of convertible bank loans 840 690
Trade payables 977 630
Related parties 529 1,659
Convertible loan from a related party - 190
Employees and payroll accruals 535 643
Deferred revenues 349 1,265
Accrued expenses and other liabilities 484 239
--------------- ----------------
Total current liabilities 7,074 7,400
--------------- ----------------
LONG-TERM LIABILITIES:
Royalties to OCS and Marketing Fund - 291
Accrued severance pay 816 869
--------------- ----------------
Total long-term liabilities 816 1,160
--------------- ----------------
SHAREHOLDERS' DEFICIENCY:
Ordinary shares - NIS 0.1 par value:
20,000,000 shares authorized as of January 31, 2002 and 2003;
11,665,359 shares issued and outstanding as of January
31, 2002 and 2003 356 356
Additional paid-in capital 32,540 32,666
Receipts on account of shares - 5
Deferred stock compensation - (63)
Accumulated other comprehensive loss (42) (7)
Accumulated deficit (36,129) (37,848)
--------------- ----------------
Total shareholders' deficiency (3,275) (4,891)
--------------- ----------------
$ 4,615 $ 3,669
=============== ================
The accompanying notes are an integral part of the consolidated financial
statements.
F-4
E-SIM LTD. AND ITS SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE AND PER SHARE DATA)
YEAR ENDED JANUARY 31,
-----------------------------------------------------------
2001 2002 2003
----------------- ---------------- ----------------
Revenues:
Products $ 6,818 $ 3,031 $ 3,304
Services 3,063 2,005 2,916
----------------- ---------------- ----------------
9,881 5,036 6,220
----------------- ---------------- ----------------
Cost of revenues:
Products 383 169 267
Services 1,735 1,776 1,663
----------------- ---------------- ----------------
2,118 1,945 1,930
----------------- ---------------- ----------------
Gross profit 7,763 3,091 4,290
----------------- ---------------- ----------------
Operating expenses and costs:
Product development 2,475 - -
Web-site development 800 - -
Research and development, net 2,774 2,610 1,464
Selling, marketing, general and administrative, net 8,751 7,854 4,261
Restructuring and impairment of website development - 910 -
----------------- ---------------- ----------------
Total operating expenses 14,800 11,374 5,725
----------------- ---------------- ----------------
Operating loss 7,037 8,283 1,435
Financial expenses (income), net (230) 210 (9)
Other expenses, net 730 426 94
----------------- ---------------- ----------------
Loss before taxes on income 7,537 8,919 1,520
Taxes on income 56 62 199
----------------- ---------------- ----------------
Net loss $ 7,593 $ 8,981 $ 1,719
================= ================ ================
Basic and diluted net loss per share $ 0.65 $ 0.77 $ 0.15
================= ================ ================
Weighted average number of shares used in computing basic
and diluted net loss per share 11,642,687 11,663,170 11,665,359
================= ================ ================
The accompanying notes are an integral part of the consolidated financial
statements.
F-5
E-SIM LTD. AND ITS SUBSIDIARIES
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (DEFICIENCY)
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE DATA)
ORDINARY SHARE CAPITAL ADDITIONAL RECEIPTS ON DEFERRED
----------------------------- PAID-IN ACCOUNT OF STOCK
SHARES AMOUNT CAPITAL SHARES COMPENSATION
-------------- ------------- ------------- -------------- -----------------
Balance as of February 1, 2000 11,326,765 $ 348 $ 30,303 $ 2,000 $ (26)
Issuance of shares, net 250,000 6 2,012 (2,000) -
Exercise of options 70,927 2 173 - -
Exercise of warrants 11,680 *) - - - -
Amortization of beneficial conversion
feature - - 43 - -
Amortization of deferred stock
compensation - - - - 26
Comprehensive loss:
Net loss - - - - -
Other comprehensive loss -
Foreign currency translation
adjustments - - - - -
-------------- ------------- ------------- -------------- -----------------
Total comprehensive loss
Balance as of January 31, 2001 11,659,372 356 32,531 - -
Exercise of options 5,987 *) - 9 - -
Comprehensive loss:
Net loss - - - - -
Other comprehensive loss -
Foreign currency translation
adjustments - - - - -
-------------- ------------- ------------- -------------- -----------------
Total comprehensive loss
Balance as of January 31, 2002 11,665,359 356 32,540 - -
Exercise of options - - - 5 -
Deferred stock compensation in respect
of repriced options - - 126 - (126)
Amortization of deferred stock
compensation on repriced options - - - - 63
Comprehensive loss:
Net loss - - - - -
Other comprehensive income (loss)
Foreign currency translation
adjustments - - - - -
-------------- ------------- ------------- -------------- -----------------
Total comprehensive loss
Balance as of January 31, 2003 11,665,359 $ 356 $ 32,666 $ 5 $ (63)
============== ============= ============= ============== =================
*) Represents an amount lower than $1.
The accompanying notes are an integral part of the consolidated financial
statements.
** TABLE CONTINUED... **
F-6-A
ACCUMULATED TOTAL
OTHER TOTAL SHAREHOLDERS'
COMPREHENSIVE ACCUMULATED COMPREHENSIVE EQUITY
LOSS DEFICIT LOSS (DEFICIENCY)
------------------- ---------------- ------------------- ----------------
Balance as of February 1, 2000 $ (6) $ (19,555) $ 13,064
Issuance of shares, net - - 18
Exercise of options - - 175
Exercise of warrants - - -
Amortization of beneficial conversion
feature - - 43
Amortization of deferred stock
compensation - - 26
Comprehensive loss:
Net loss - (7,593) $ (7,593) (7,593)
Other comprehensive loss -
Foreign currency translation
adjustments (12) - (12) (12)
------------------- ---------------- ------------------- ----------------
Total comprehensive loss $ (7,605)
===================
Balance as of January 31, 2001 (18) (27,148) 5,721
Exercise of options - - 9
Comprehensive loss:
Net loss - (8,981) $ (8,981) (8,981)
Other comprehensive loss -
Foreign currency translation
adjustments (24) - (24) (24)
------------------- ---------------- ------------------- ----------------
Total comprehensive loss $ (9,005)
===================
Balance as of January 31, 2002 (42) (36,129) (3,275)
Exercise of options - - 5
Deferred stock compensation in respect
of repriced options - - -
Amortization of deferred stock
compensation on repriced options - - 63
Comprehensive loss:
Net loss - (1,719) $ (1,719) (1,719)
Other comprehensive income (loss)
Foreign currency translation
adjustments 35 - 35 35
------------------- ---------------- ------------------- ----------------
Total comprehensive loss $ (1,684)
===================
Balance as of January 31, 2003 $ (7) $ (37,848) $ (4,891)
=================== ================ ================
*) Represents an amount lower than $1.
The accompanying notes are an integral part of the consolidated financial
statements.
** TABLE COMPLETE **
F-6-B
E-SIM LTD. AND ITS SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
YEAR ENDED JANUARY 31,
-----------------------------------------------------
2001 2002 2003
--------------- --------------- ---------------
Cash flows from operating activities:
Net loss $ (7,593) $ (8,981) $ (1,719)
Adjustments required to reconcile net loss to net cash used in operating
activities:
Depreciation and amortization 668 653 403
Amortization of deferred stock compensation 26 - 63
Impairment of long-term investment and website development costs 730 1,027 -
Amortization of beneficial conversion feature 43 - -
Loss on sale of property and equipment 16 46 94
Accrued interest on long-term investment (7) - -
Accrued severance pay, net 103 (9) (79)
Royalties to OCS and marketing fund - - 291
Decrease (increase) in trade receivables (783) 1,541 (246)
Decrease (increase) in other receivables and prepaid expenses including
long-term (196) 234 155
Increase (decrease) in trade payables 1,178 (1,017) (328)
Increase (decrease) in related parties, employees and payroll accruals,
deferred revenues and accrued expenses and other liabilities 260 (232) 1,239
--------------- --------------- ---------------
Net cash used in operating activities (5,555) (6,738) (127)
--------------- --------------- ---------------
Cash flows from investing activities:
Purchase of property and equipment (826) (147) (63)
Investment in long-term investment (1,229) - -
Proceeds from sale of property and equipment 21 32 50
Investment in website development costs (721) - -
--------------- --------------- ---------------
Net cash used in investing activities (2,755) (115) (13)
--------------- --------------- ---------------
Cash flows from financing activities:
Issuance of shares, net (47) 9 -
Receipts on account of shares - - 5
Short-term bank credit, net - (196) 10
Proceeds from long-term bank loans 2,000 1,710 -
Proceeds from loan from a related party - - 760
Proceeds from convertible loan from a related party - - 190
Proceeds from convertible bank loans 500 - -
Principal payments of long-term bank loans, net (76) (18) (1,436)
--------------- --------------- ---------------
Net cash provided by (used in) financing activities 2,377 1,505 (471)
--------------- --------------- ---------------
Effect of exchange rate changes on cash and cash equivalents (2) (30) (67)
--------------- --------------- ---------------
Decrease in cash and cash equivalents (5,935) (5,378) (678)
Cash and cash equivalents at the beginning of the year 12,618 6,683 1,305
--------------- --------------- ---------------
Cash and cash equivalents at the end of the year $ 6,683 $ 1,305 $ 627
=============== =============== ===============
Non-cash activities:
Issuance expenses $ 50 $ - $ -
=============== =============== ===============
Sale of property and equipment $ - $ - $ 66
=============== =============== ===============
Supplemental disclosure of cash flows activities -
Cash paid during the year for interest $ 200 $ 99 $ 119
=============== =============== ===============
Cash paid during the year for taxes $ 65 $ 59 $ 37
=============== =============== ===============
The accompanying notes are an integral part of the consolidated financial
statements.
F-7
E-SIM LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 1:- GENERAL
a. e-SIM Ltd. (together with its subsidiaries - "the
Company") was incorporated in 1989 in Israel and commenced
operations in 1991. In January 1996, e-SIM Inc. a
wholly-owned subsidiary of e-SIM Ltd. was incorporated in
the State of Delaware and commenced operations. In
November 1998, e-SIM Japan Ltd., a wholly-owned subsidiary
of e-SIM Ltd., was incorporated in Tokyo, Japan and
commenced operations in February 1999. In August 1999,
e-SIM Europe SARL, a wholly-owned subsidiary of e-SIM
Ltd., was incorporated in France and commenced operations.
These subsidiaries coordinate the activities of the
Company's direct and indirect sales in the U.S., the Far
East and in Europe. During 2002 the European subsidiary
suspended its operations.
The Company is a provider of advanced simulation
technology for use in the development, promotion and
support of wireless consumer and industrial electronic
products. The Company supports the entire life cycle of
these products and divides its activities into two
segments. The Software Tools (formerly known as Embedded
System) segment provides simulation technology for the
design of the user interfaces for consumer electronics
products. The Company's patent-pending statechart
technology allows manufacturers to automatically generate
compact C code that can be embedded directly into consumer
and industrial electronic products. The technology is also
capable of automatically generating specifications and
user manuals. The LiveProducts segment produces product
simulations for delivery on the Web that allow consumers
to operate virtual simulations of electronic products over
the Web.
The Company has an accumulated deficit of approximately $
38 million and negative cash flows from operating
activities for the year ended January 31, 2003, of
approximately $ 127,000. The Company will need to obtain
additional funds in order to continue its operations as a
going concern. The Company's management believes that
sufficient funds will be available through 2003.
b. As for major customers, see Note 13c.
c. Restructuring costs:
During the second quarter of 2001, the Company's Board of
Directors approved a cost reduction plan. The cost
reduction plan provides for the termination of up to
approximately seventy four employees accounted for in
accordance with Emerging Issues Task Force No. 94-3,
"Liability Recognition for Certain Employee Termination
Benefits and Other Costs to Exit an Activity (Including
Certain Costs Incurred in a Restructuring)" ("EITF No.
94-3") and Staff Accounting Bulletin No. 100,
"Restructuring and Impairment Charges" ("SAB No. 100").
The terminations resulted from the Company's strategy to
reduce costs and achieve profitability. Restructuring
charges of $309,000 were expensed during the year ended
January 31, 2002. This charge is comprised of $272,000
relating to involuntary employee terminations and $37,000
relating to other exit costs. As of January 31, 2002, all
of the restructuring costs were paid in cash.
F-8
E-SIM LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES
The consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the
United States ("U.S. GAAP").
a. Use of estimates:
The preparation of financial statements in conformity with
generally accepted accounting principles requires
management to make estimates and assumptions that effect
the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those
estimates.
b. Financial statements in U.S. dollars:
A majority of e-SIM Ltd.'s revenues is generated in U.S.
dollars ("dollar"). In addition, a substantial portion of
e-SIM Ltd.'s costs is incurred in dollars. e-SIM Ltd.'s
management believes that the dollar is the primary
currency of the economic environment in which e-SIM Ltd.
operates. Thus, the functional and reporting currency of
e-SIM Ltd. is the dollar. Accordingly, monetary accounts
maintained in currencies other than the dollar are
remeasured into U.S. dollars in accordance with Statement
No. 52 of the Financial Accounting Standard Board "Foreign
Currency Translation" ("SFAS No. 52"). All transaction
gains and losses of the remeasurement of monetary balance
sheet items are reflected in the statements of operations
as financial income or expenses as appropriate.
The financial statements of certain subsidiaries, whose
functional currency has been determined to be their local
currency, have been translated into U.S. dollars. All
balance sheet accounts have been translated using the
exchange rates in effect at the balance sheet date.
Statements of operations amounts have been translated
using the average exchange rate for the year. The
resulting aggregate translation adjustments are reported
as a component of shareholders' equity (deficiency) in
accumulated other comprehensive income (loss).
c. Principles of consolidation:
The consolidated financial statements include the accounts
of e-SIM Ltd. and its wholly-owned subsidiaries.
Intercompany balances and transactions have been
eliminated upon consolidation.
d. Cash equivalents:
Cash equivalents include short-term highly liquid
investments that are readily convertible to cash,
originally purchased with maturities of three months or
less.
e. Investment in a company:
Investments in privately held companies in which the
Company does not have the ability to exercise significant
influence over operating and financial policies of the
investees, are presented at cost. The carrying value is
periodically reviewed by management. If this review
indicates that the cost is not recoverable, the carrying
value is reduced to its estimated fair value.
F-9
E-SIM LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)
During March 2000, e-Sim Ltd. entered into a Letter of
Intent (the "LOI") with a company engaged in the
development of technology complementary to e-Sim Ltd's
LiveProducts business, relating to a possible acquisition
of the target company by e-Sim Ltd. shares. As part of the
LOI, e-Sim Ltd. invested $ 1 million, which represented
approximately 2.75% of the equity stock in the said
company. In addition, e-Sim Ltd. provided the said company
with several loans in a total amount of $149,000, which
bear annual interest of 12% to be repaid in three
installments starting from October 31, 2000 through
December 15, 2000. As of January 31, 2002 none of the
installments were repaid.
e-Sim Ltd.'s management decided to write off the
investment in the said company, since certain
circumstances such as the global decrease in valuation of
similar technology companies and current information about
the prospects of the said company including capital
raising possibilities, indicated that all the carrying
amount of the investment may not be recoverable. The
impairment had been recorded as other expenses in the
statements of operations. During the years ended January
31, 2001 and 2002, the impairment expenses were $ 730,000
and $ 426,000 respectively.
f. Property and equipment:
Property and equipment are stated at cost, net of
accumulated depreciation. Depreciation is calculated by
the straight-line method over the estimated useful lives
of the assets, at the following annual rates:
Computers and peripheral equipment 33%
Office furniture and equipment 6 - 20%
Motor vehicles 15%
Leasehold improvements Over the term of the lease
g. Impairment of long-lived assets to be disposed:
The Company's long-lived assets are reviewed for
impairment, in accordance with Statement of Financial
Accounting Standards No. 144 "Accounting for the
Impairment and the Disposal of Long-Lived Assets,"
whenever events or changes in circumstances indicate that
the carrying amount of an asset may not be recoverable.
Recoverability of assets to be held and used is measured
by a comparison of the carrying amount with the future
undiscounted cash flows expected to be generated by the
assets. If such assets are considered to be impaired, the
impairment to be recognized is measured by the amount by
which the carrying amount exceeds the fair value of the
assets. Assets to be disposed of are reported at the lower
of the carrying amount or fair value less costs to sell.
As of January 31, 2003, no impairment losses have been
identified.
F-10
E-SIM LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)
h. Revenue recognition:
The Company has derived its revenues from license fees for
its products, maintenance and support, royalties and from
rendering consulting services including implementation,
and training. The Company sells its products through its
direct sales force and indirectly through resellers (both
of which are considered end-users). The Company also
generates revenues from providing full product simulation
for delivery over the Internet and Intranet, and from fees
deriving from usage of the simulation.
The Company implements Statement of Position (SOP) 97-2,
"Software Revenue Recognition", as amended. Revenues from
software arrangements are recognized upon delivery of the
product, when no future obligation exists, when collection
is probable, the product fee is otherwise fixed or
determinable and persuasive evidence of an arrangement
exists. The Company does not grant a right of return to
its customers. SOP 97-2 requires revenue earned on
software arrangements involving multiple elements to be
allocated to each element based on the relative fair value
of the elements. The Company has also adopted SOP 98-9,
"Modification of SOP 97-2, Software Revenue Recognition
with Respect to Certain Transactions," for all
transactions entered into after January 1, 2000.
The Company's Vendor Specific Objective Evidence ("VSOE")
used to allocate the sales price to maintenance and
support, consulting services including implementation and
training is based on a renewal ratio and the price charged
when these elements are sold separately. SOP 98-9 requires
that revenue be recognized under the "residual method"
when (1) VSOE of fair value exists for all undelivered
elements and no VSOE exists for all of the delivered
elements, and (2) all revenue recognition criteria of SOP
97-2, as amended, are satisfied. Under the residual
method, any discount in the arrangement is allocated to
the delivered element.
Maintenance and support revenues included in multiple
element arrangements are deferred and recognized on a
straight-line basis over the term of the maintenance and
support agreement.
The Company is entitled to royalties upon some of the
licensing agreements for the software tools. Royalties are
recognized when such royalties are reported to the Company
or at such time when a buyout agreement is signed with the
end customer.
Revenues from consulting services, implementation, and
training included in multiple element arrangements are
recognized at the time such services are rendered.
Revenues from product simulation are recognized in
accordance with SOP No. 81-1 "Accounting for Performance
of Construction Type and Certain Production Type
Contracts", using contract accounting on a percentage of
completion method based on basis of units of work
completed. A provision for estimated losses on uncompleted
contracts is recorded in the period in which such losses
are first identified, in the amount of the estimated loss
on the entire
F-11
E-SIM LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)
contract. As of January 31, 2003, no such estimated losses
were identified. Estimated gross profit or loss from
long-term contracts may change due to changes in estimates
resulting from differences between actual performance and
original forecasts. Such changes in estimated gross profit
are recorded in results of operations when they are
reasonably determinable by management, on a cumulative
catch-up basis.
The Company is entitled to usage fees upon licensing of
the product simulation to the end users. Revenues from
usage fees are recognized when such revenues are reported
to the Company or at such time when a buyout agreement is
signed with the end customer.
In contracts in which acceptance by the customer of
particular aspects of the transaction is required, the
Company defers revenues dependent upon such acceptance
until the acceptance is confirmed.
Deferred revenue includes unearned amounts received under
maintenance and support contracts, and amounts received
from customers but not recognized as revenues.
i. Website development costs:
During 2000, the Company adopted the provision of the
Emergency Issue Task Force ("EITF") consensus No. 00-2
"Accounting for Web Site Development Costs" which provides
guidance on what types of costs associated with website
development should be capitalized or expensed. The Company
has developed an Internet website and began the
application phase of this software system. During 2000,
the Company capitalized $ 721,000 of development costs
related to internal use software. Such capitalized amounts
were amortized, on a straight-line basis, over a
three-year period, until the second quarter of 2001.
During the second quarter of 2001, the Company determined
that the costs incurred in developing the Livemanuals.com
website were not recoverable. Therefore $ 601,000, which
represents the net value of the investment in the
web-site, was written off.
j. Research and development costs:
Statement of Financial Accounting Standards No. 86 ("SFAS
No. 86") "Accounting for the Costs of Computer Software to
be Sold, Leased or Otherwise Marketed", requires
capitalization of certain software development costs
subsequent to the establishment of technological
feasibility.
Based on the Company's product development process,
technological feasibility is established upon completion
of a working model. The Company does not incur material
costs between the completion of the working model and the
point at which the products are ready for general release.
Therefore, research and development costs are charged to
the statement of operations as incurred.
F-12
E-SIM LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)
k. Advertising expenses:
Advertising expenses are charged to the statement of
operations as incurred. Advertising expenses amounted to $
459,000, $ 325,000 and $ 41,000 for the years ended
January 31, 2001, 2002 and 2003, respectively.
l. Income taxes:
The Company accounts for income taxes in accordance with
Statement of Financial Accounting Standards No. 109,
"Accounting for Income Taxes" ("SFAS No. 109"). This
statement prescribes the use of the liability method
whereby deferred tax assets and liability account balances
are determined based on differences between the financial
reporting and tax bases of assets and liabilities and are
measured using the enacted tax rates and laws that will be
in effect when the differences are expected to reverse.
The Company provides a valuation allowance, if necessary,
to reduce deferred tax assets to their estimated
realizable value.
m. Warranty costs:
The Company provides its customers with a warranty of up
to 90 days from the shipment date. The Company's liability
is to replace the licensed software or to make a
reasonable effort to correct any defect in the licensed
software. No provision for warranty costs was recorded in
the financial statements due to immateriality.
n. Concentrations of credit risk:
Financial instruments that potentially subject the Company
to concentrations of credit risk consist primarily of cash
and cash equivalents and trade receivables.
Cash and cash equivalents are invested in major banks in
the U.S., Europe, Japan and Israel. Such deposits in the
United States may be in excess of insured limits and are
not insured in other jurisdictions. Management believes
that the financial institutions that hold the Company's
investments are financially sound, and accordingly,
minimal credit risk exists with respect to these
investments.
The trade receivables of the Company are mainly derived
from sales to customers located primarily in the United
States, the Far East and Europe. The Company performs
ongoing credit evaluation of its customers. An allowance
for doubtful accounts is determined with respect to those
amounts that the Company has determined to be doubtful of
collection plus a 3% general allowance. The Company
generally does not require collateral; however, in certain
circumstances, the Company may require letters of credit,
other collateral or additional guarantees.
The Company has no significant off-balance-sheet
concentration of credit risk such as foreign exchange
contracts, options contracts of other foreign hedging
arrangements.
F-13
E-SIM LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)
o. Accounting for stock-based compensation:
The Company has elected to follow Accounting Principles
Board Opinion No. 25, "Accounting for Stock Options Issued
to Employees" ("APB No. 25"), and FASB interpretation No.
44 "Accounting of Certain Transactions Involving Stock
Compensation" ("FIN 44") in accounting for its employee
stock options plans. Under APB No. 25, when the exercise
price of the Company's stock options is less than the
market price of the underlying shares on the date of the
grant, compensation expense is recognized over the vesting
period of the options.
Under Statement of Financial Accounting Standards No. 148
"Accounting for Stock-Based Compensation - Transition and
Disclosure ("SFAS No. 148") that amended Statement of
Financial Accounting Standards No. 123 "Accounting for
Stock-Based Compensation" ("SFAS No. 123"), pro forma
information regarding net income (loss) and net earnings
(loss) per share is required and has been determined as if
the Company had accounted for its employee stock options
under the fair value method of SFAS No. 123. The fair
value for these options was estimated at the date of
grant, using the Black-Scholes Option Valuation Model,
with the following weighted-average assumptions for the
years ended January 31, 2001, 2002 and 2003: expected
volatility of 1.379, 1.698 and 1.595, respectively;
risk-free interest rates of 6%, 2% and 1.5% respectively,
dividend yields of 0% for each year, and a
weighted-average expected life of the option of 4.77, 4.61
and 5.75 years, respectively.
The following table illustrates the effect on the net loss
and net loss per share, assuming that the Company had
applied the fair value recognition provision of SFAS No.
123 on its stock-based employee compensation:
YEAR ENDED JANUARY 31,
------------------------------------------------------
2001 2002 2003
--------------- ---------------- ---------------
Net loss as reported $ (7,593) $ (8,981) $ (1,719)
Add: total stock-based employee compensation expense
determined under fair value based method (1,145) (1,443) (225)
--------------- ---------------- ---------------
Pro forma net loss $ (8,738) $ (10,424) $ (1,944)
=============== ================ ===============
Pro forma basic and diluted net loss per share $ (0.75) $ (0.89) $ (0.17)
=============== ================ ===============
p. Royalty bearing grants:
Royalty-bearing grants from the Government of Israel for
funding approved research and development projects and
from the Bi-National Industrial Research and Development
Fund ("BIRD-F") are recognized at the time the Company is
entitled to such grants, on the basis of the costs
incurred and included as a deduction of research and
development costs. Research and development grants
recognized amounted to $ 238,000, $ 427,000 and $ 0 for
the years ended January 31, 2001, 2002 and 2003,
respectively.
F-14
E-SIM LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)
The Company also obtained grants from the Government of
Israel, through the Fund for Encouragement of Marketing
Activities Abroad. Such grants are recognized at the time
the Company is entitled to such grants on the basis of the
related costs incurred, and are presented as a deduction
of selling and marketing expenses. Marketing grants
amounted to $ 180,000, $ 0 and $ 0 for the years ended
January 31, 2001, 2002 and 2003, respectively.
q. Severance pay:
The Company's liability for severance pay is calculated
pursuant to the Israeli severance pay law based on the
most recent salary of the employees multiplied by the
number of years of employment, as of the balance sheet
date. Employees are entitled to one month's salary for
each year of employment, or a portion thereof, if they
have been employed by the Company for at least one year.
The Company's liability for all of its employees in
Israel, is fully provided by monthly deposits with
insurance policies and by an accrual. The value of these
policies is recorded as an asset in the Company's balance
sheet.
The deposited funds include profits accumulated up to the
balance sheet date. The deposited funds may be withdrawn
only upon the fulfillment of the obligation pursuant to
Israeli severance pay law or labor agreements. The value
of the deposited funds is based on the cash surrendered
value of these policies, and includes immaterial profits.
Severance expenses for the years ended January 31, 2001,
2002 and 2003, were approximately $ 308,000, $ 494,000 and
$ 322,910, respectively.
r. Fair value of financial instruments:
The following methods and assumptions were used by the
Company in estimating its fair value disclosures for
financial instruments:
The carrying amounts of cash and cash equivalents, trade
receivables, trade payables related party payables and
short-term bank credit approximate their fair value due to
the short-term maturity of such instruments.
The carrying amounts of the Company's long-term bank
loans, convertible loans and convertible loans from a
related party approximate their fair value. Fair value was
estimated using discounted cash flow analyses, based on
the Company's incremental borrowing rates for similar
types of borrowing arrangements.
s. Basic and diluted net loss per share:
Basic net earnings (loss) per share is computed based on
the weighted average number of Ordinary shares outstanding
during each year. Diluted net earnings (loss) per share is
computed based on the weighted average number of Ordinary
shares outstanding during each year, plus dilutive
potential ordinary shares considered outstanding during
the year, in accordance with Statement of Financial
Accounting Standard No. 128, "Earnings Per Share" ("SFAS
No. 128").
F-15
E-SIM LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)
All convertible loans and outstanding stock options have
been excluded from the calculation of the diluted net loss
per share because all such securities are anti-dilutive
for all periods presented.
The total weighted average number of shares related to
convertible loans and stock options outstanding excluded
from the calculation of diluted net loss per share was
1,931,509, 1,919,231 and 4,259,823 for the years ended
January 31, 2001, 2002 and 2003, respectively.
t. Reclassification:
Certain amounts from prior years have been reclassified to
conform to the current year's presentation. The
reclassification had no effect on previously reported net
loss, shareholder's equity or cash flows.
u. Impact of recently issued accounting standards:
In April 2002, the FASB issued SFAS No. 145, "Rescission
of SFAS No. 4, 44 and 64, Amendment of SFAS No. 13, and
Technical Corrections," which rescinds SFAS No. 4,
"Reporting Gains and Losses from Extinguishment of Debt,"
and an amendment of that Statement, and SFAS No. 64,
"Extinguishments of Debt Made to Satisfy Sinking-Fund
Requirements." SFAS No. 145 amends SFAS No. 44,
"Accounting for Intangible Assets for Motor Carriers."
SFAS No. 145 amends SFAS No. 13, "Accounting for Leases,"
to eliminated an inconsistency between the required
accounting for sale-leaseback transactions and the
required accounting for certain lease modifications that
have economic effects that are similar to sale-leaseback
transactions. SFAS No. 145 also amends other existing
authoritative pronouncements to make various technical
corrections, clarify meanings, or describe their
applicability under changed conditions. SFAS No. 145 is
effective for fiscal years beginning May 15, 2002. The
Company does not expect the adoption of SFAS No. 145 will
have a material impact on its results of operations or
financial position.
In November 2002, the FASB issued Interpretation No. 45
("FIN No. 45"), "Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees
of Indebtedness of Others, an Interpretation of SFAS No.
5, 57 and 107 and Rescission of FASB Interpretation No. 34
("FIN No. 34"). FIN No. 45 elaborates on the disclosures
to be made by a guarantor in its interim and annual
financial statements about its obligations under certain
guarantees that it has issued. It also clarifies that a
guarantor is required to recognize, at the inception of a
guarantee, a liability for the fair value of the
obligation undertaken in issuing the guarantee. FIN No. 45
does not prescribe a specific approach for subsequently
measuring the guarantor's recognized liability over the
term of the related guarantee. It also incorporates,
without change, the guidance in FIN No. 34, "Disclosure of
Indirect Guarantees of Indebtedness to Others," which is
being superseded. The disclosure provisions of FIN No. 45
are effective for financial statements of interim or
annual periods that end after December 15, 2002 and the
provisions for initial recognition and measurement are
effective on a prospective basis for guarantees that are
issued or modified after December 31, 2002, irrespective
of a guarantor's year-end. The Company does not expect the
adoption of FIN No. 45 to have a material impact on
results of operations or financial position.
F-16
E-SIM LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)
In January 2003, the FASB issued Interpretation No. 46,
Consolidation of Variable Interest Entities ("FIN 46").
The objective of FIN 46 is to improve financial reporting
by companies involved with variable interest entities. A
variable interest entity is a corporation, partnership,
trust, or any other legal structure used for business
purposes that either (a) does not have equity investors
with voting rights or (b) has equity investors that do not
provide sufficient financial resources for the entity to
support its activities. FIN 46 requires a variable
interest entity to be consolidated by a company if that
company is subject to a majority of the risk of loss from
the variable interest entity's activities or entitled to
receive a majority of the entity's residual returns or
both. FIN 46 also requires disclosures about variable
interest entities that the company is not required to
consolidate but in which it has a significant variable
interest. The consolidation requirements of Interpretation
46 apply immediately to variable interest entities created
after January 31, 2003. The consolidation requirements
apply to older entities in the first fiscal year or
interim period beginning after June 15, 2003. Certain of
the disclosure requirements apply in all financial
statements issued after January 31, 2003, regardless of
when the variable interest entity was established. As of
January 1, 2003, the Company has not yet determined what
effect, if any, FIN 46 will have on its consolidated
financial statements.
NOTE 3:- OTHER RECEIVABLES AND PREPAID EXPENSES
JANUARY 31,
-----------------------------------
2002 2003
--------------- ----------------
IN THOUSANDS
-----------------------------------
Government authorities $ 17 $ 84
Prepaid expenses 250 140
Employees 81 13
Other 3 15
--------------- ----------------
$ 351 $ 252
=============== ================
NOTE 4:- PROPERTY AND EQUIPMENT, NET
a. Comprised as follows:
Cost:
Computers and peripheral equipment $ 2,224 $ 1,923
Office furniture and equipment 549 445
Motor vehicles 387 271
Leasehold improvements 344 265
--------------- ---------------
3,504 2,904
Less - accumulated depreciation 2,426 2,370
--------------- ---------------
Depreciated cost $ 1,078 $ 534
=============== ===============
F-17
E-SIM LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 4:- PROPERTY AND EQUIPMENT, NET (CONT.)
b. Depreciation expenses for the years ended January 31,
2001, 2002 and 2003 were $ 608,000, $ 593,000 and $
403,000, respectively.
c. As for charges, see Note 9c.
NOTE 5:- SHORT-TERM BANK CREDIT
As of January 31, 2002 and 2003, the Company had
short-term revolving credit in the amount of $ 4,000 and
$14,000, respectively. The weighted average interest rates
as of January 31, 2002 and 2003, were 13.0% and 10.35%
respectively.
NOTE 6:- ACCRUED EXPENSES AND OTHER LIABILITIES
JANUARY 31,
-----------------------------------
2002 2003
---------------- ---------------
IN THOUSANDS
-----------------------------------
Government authorities, net of grants to be received $ 189 $ 192
Other 295 47
---------------- ---------------
$ 484 $ 239
================ ===============
NOTE 7:- LONG-TERM BANK LOANS
During September and November 2000, the Company entered
into two long-term loan agreements with two Israeli banks,
according to which the Company is entitled to aggregate
loans in the amount of up to $ 4,200,000 to be repaid
within two years.
In August 2002, the Company entered into agreements with
the two banks, to extend the scheduled maturity of the
above-mentioned loans and to make certain other changes to
the terms. Pursuant to the amended terms, the Company will
repay the loans in monthly payments consisting of
principal and interest in an aggregate amount of $ 70,000
per month, and the monthly payment will be increased in
any quarter in which the Company's revenues exceed $ 2
million. The unpaid balance of the loans will become due
on August 31, 2003, unless the banks at that time, at
their sole discretion, agree to extend the payment date.
The banks can demand prior payment of the loans upon the
occurrence of an event of default, such as non-payment of
installments, liquidation of the Company or if the banks
deem that events have occurred that harm or might harm the
Company's ability to perform its commitments to the banks.
In addition, until at least one half of the outstanding
principal of the loans has been repaid, the Company has
undertaken not to make any cash payments of management
fees to any shareholder holding, directly or indirectly,
5% or more of its shares.
F-18
E-SIM LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 7:- LONG-TERM BANK LOANS (CONT.)
The banks can demand a prior payment of the loan upon the
occurrence of an event of default, such as non-payment of
installment, liquidation of the Company or if the banks
deem that events have occurred that harm or might harm the
Company's ability to perform its commitments to the banks.
As of January 31, 2003, the Company utilized an amount of
$ 2,760,000, out of which an amount of $ 690,338, is a
convertible loan (see Note 8).
The Company had an unused credit facility in the amount of
approximately $ 1,097,656 as of January 31, 2003.
In July 2003, the Company reached an agreement with the
banks, regarding extension of the loans (See Note 15).
WEIGHTED AVERAGE
INTEREST RATE
FOR THE YEAR ENDED
JANUARY 31, JANUARY 31,
------------------------------------ -----------------------------------
2002 2003 2002 2003
---------------- ----------------- ---------------- ----------------
IN THOUSANDS
-----------------------------------
Loans linked to the U.S. dollar 5.37% 5.31% $ 3,356 $ 2,070
Loan linked to the Israeli Consumer Price
Index ("CPI") - -
---------------- ----------------
3,356 2,070
Less - current maturities 3,356 2,070
---------------- ----------------
$ - -
================ ================
NOTE 8:- CONVERTIBLE BANK LOANS AND CONVERTIBLE LOANS FROM A RELATED
PARTY
a. In connection with the credit line agreements (see Note
7), the Company entered into convertible loan agreements,
in the amount of $ 690,338, to be converted into Ordinary
shares of the Company, with an average conversion price of
$ 3.85 per share.
In consideration for the extension of the long-term bank
loans in 2002, the terms of the convertible debentures
issued to the banks have been amended to grant them the
right to convert a portion of the loan into an additional
aggregate number of 349,960 Ordinary shares at the market
price of the Company's Ordinary shares on the date of the
agreement. The banks will have the right to purchase
additional Ordinary shares, if the term of the loans is
extended, at the same terms after August 31, 2003 (see
Note 15).
F-19
E-SIM LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 8:- CONVERTIBLE BANK LOANS AND CONVERTIBLE LOANS FROM A RELATED
PARTY (CONT.)
As of January 31, 2003, the convertible loans that are
linked to the U.S. dollar consisted of the following:
INTEREST CONVERSION EXPIRATION
ISSUANCE DATE AMOUNT RATE PRICE DATE
------------------------------------------ ---------------- ------------ ---------------- -------------------
a. September 2000 $ 221,344 4.81% $ 4 August 2003
b. November 2000 200,000 5.81% $ 4.21 August 2003
c. March 2001 120,000 5.81% $ 4.21 August 2003
d. April 2001 100,000 5.81% $ 4.21 August 2003
e. August 2002 24,497 5.81% $ 0.14 August 2003
f. August 2002 24,497 4.81% $ 0.14 August 2003
----------------
Balance as of January 31, 2003 $ 690,338
Less - current maturities 690,338
----------------
$ -
================
As of January 31, 2003, none of the convertible loans were
converted into Ordinary shares, and all of the convertible
loans were presented as current liabilities.
Upon the closing of the agreement which was signed in
September, 2000, the Company was required according to
EITF 98-5 "Accounting for Convertible Securities with
Beneficial Conversion Features or Contingently Adjustable
Conversion Ratios ("EITF 98-5") to record a one-time
interest expense in the amount of approximately $ 43,000
which represents the theoretical most beneficial
conversion feature to the holder of the note measured at
the issuance date of the note that is also the commitment
date. In addition, upon the amendment of the agreement, no
interest expenses were recorded in accordance with EITF
98-5 and EITF 00-27, "Application of EITF 98-5 to Certain
Convertible Investments".
b. In August 2002, the Company entered into a loan agreement
with Gibralt, a related party (see Note 12). According to
the loan agreement, Gibralt may choose to convert up to $
190,000 aggregate principal amount of the loan into
Ordinary shares at the price per share on the date the
loan was made at any time for a period of five years from
such date with 30 days notice before conversion.
The transaction was approved by the Company's audit
committee and board of directors and will be brought to
the shareholders for approval at the next annual general
meeting of the Company.
As of January 31, 2003, no portion of the loan has been
repaid or converted (see Note 12c).
INTEREST CONVERSION EXPIRATION
ISSUANCE DATE AMOUNT RATE PRICE DATE
---------------------------------------- --------------- --------------- ---------------- -----------------------
September 2002 $ 190,000 6% 0.14 September 2007
===============
F-20
E-SIM LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 9:- COMMITMENTS AND CONTINGENT LIABILITIES
a. Lease commitments:
The Company rents its facilities under various operating
lease agreements, which expire on various dates. Future
minimum annual payments under non-cancelable operating
leases are as follows:
YEAR ENDED JANUARY 31: IN THOUSANDS
------------------------------- -------------------
2004 $ 154
2005 94
2006 92
2007 10
-------------------
$ 350
===================
Rent expenses for the years ended January 31, 2001, 2002
and 2003, were $ 526,000 $ 410,000 and $ 273,000
respectively.
b. Guarantees:
The Company has provided bank guarantees in favor of its
lessors in Israel in the amount of $ 16,000.
c. Charges:
The Company recorded a fixed charge on its property and
equipment and a floating charge on all of its assets in
favor of banks as collateral for bank loans.
d. Legal proceedings:
In August 2002, the Company has been alleged by a Japanese
competitor of the Company that the Company is violating
its sale rights in using certain components in one of the
Company's products. While the Company, with the advise of
its legal advisor, is unable to predict the ultimate
outcome of this claim, it believes such claims are without
merit and intends to defend itself. As a result, no
provision was recorded in these financial statements.
The Company is currently involved in a dispute with its
former landlord in Israel, who alleges that in November
2002 the Company reached an oral agreement to continue and
lease their facilities. In addition, the landlord demands
lease and lease related payments for a certain period
prior to the Company's vacating the premises. The Company
has paid the landlord a certain amount it believes is owed
and is currently involved in discussions concerning the
balance claimed. The Company cannot predict at this time
the outcome of these discussions
F-21
E-SIM LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 9:- COMMITMENTS AND CONTINGENT LIABILITIES (CONT.)
e. Royalties:
(i) e-SIM Ltd. participates in programs sponsored
by the Government of Israel for the support of
research and development activities. Through
January 31, 2003, e-SIM Ltd. obtained grants
from the office of the Chief Scientist ("OCS")
aggregating to the amount of $ 1,777,000 for
certain of e-SIM Ltd.'s research and
development projects. e-SIM Ltd. is obligated
to pay royalties to the OCS, at a rate of 3.5%
to 5% of the sales of the products and other
related revenues generated by such projects, up
to an amount equal to 100% - 150% of the grants
received, in NIS linked to the U.S. dollar and
bear interest at the rate of six months libor.
The Company is obligated to repay the
Government of Israel for grants received only
to the extent that there are sales of the
funded products.
Through January 31, 2003, e-SIM Ltd. has paid
or accrued royalties to the OCS aggregating to
the amount of $ 1,279,000. As of January 31,
2003, the aggregate amount of the contingent
obligation to the OCS was $ 621,000.
Since March 1998, the Israeli Government,
through the Fund for Encouragement of Marketing
Activities Abroad ("the Fund"), has awarded
e-SIM Ltd. grants related to its foreign
marketing expenses. These grants are awarded
for specific expenses incurred by e-SIM Ltd. in
its foreign marketing activities, based upon
such expenses reported by e-SIM Ltd. to the
Fund. All marketing grants received from the
Fund are linked to the U.S. dollar and are
repayable in the form of royalty payments in
the amount of 4% (plus interest at the rate of
six-month LIBOR) of any increase in export
sales realized by e-SIM Ltd. up to the total
amount of grants received by e-SIM Ltd. If
e-SIM Ltd. does not achieve an increase in
export sales, it has no obligation to pay any
royalties or to return any funds received
through these grants. All payments are linked
to the U.S. dollar and bear interest in the
rate of 6 months libor.
Through January 31, 2003, e-SIM Ltd. obtained
grants in the aggregate to $ 778,000 from the
Fund and has paid or accrued royalties in the
amount of $ 282,000. The aggregate amount of
the contingent obligation to the Fund was $
496,000.
In January 2003, the Company reached a
settlement regarding payments to the Office of
the Chief Scientist ("OCS"). The terms of the
settlement for the return of overdue payments
to the OCS for research and development grants
and for marketing grants from the Fund for the
Encouragement of Marketing Activities,
discussed below, are as follows: a single
payment of $ 30,000 made in February 2003, four
quarterly payments of $ 30,000 commencing April
30, 2003, a payment of $ 45,000 in April 2004
and a payment of $ 50,000 in July 2004. The
Company has also agreed to pay 5% of revenues
exceeding certain projected sales presented.
The Company will not be required to pay
on-going royalties until July 2004, at which
time it will negotiate the payment terms of the
remaining debt with the OCS. Of the funds paid
to the OCS according to the new payment
schedule, two-thirds will be for research and
development grants and the other third for
marketing grants from the Fund for the
Encouragement of Marketing Activities.
F-22
E-SIM LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 9:- COMMITMENTS AND CONTINGENT LIABILITIES (CONT.)
(ii) e-SIM Ltd. also participates in a program
sponsored by the Israel - U.S. Binational
Industrial Research and Development foundation
("BIRD-F"), pursuant to which a portion of
e-SIM Ltd.'s development expenses was funded.
Through January 31, 2003, e-SIM Ltd. obtained
grants aggregating to the amount of $ 394,000
from BIRD-F. e-SIM Ltd. is obligated to pay
royalties to BIRD-F on the proceeds from sales
of products ("the development packages")
resulting from the research and development
which BIRD-F funded. The payments are of $ 250
for each development package per license and $
2,500 for each development package of products
per site.
The total amount of the royalties may not
exceed 150% of the grants received. All the
payments are linked to the U.S. dollar and the
U.S. Consumer Price Index.
Through January 31, 2003, e-SIM Ltd. paid or
accrued royalties to BIRD-F in the aggregate
amount of $ 201,000. As of January 31, 2003,
the aggregate amount of the contingent
obligation to BIRD-F was $ 389,000.
NOTE 10:- SHAREHOLDERS' EQUITY (DEFICIENCY)
a. Ordinary shares:
Ordinary shares confer upon their holders voting rights,
the right to receive cash dividends if declared and the
right to share in excess assets upon liquidation of the
Company.
b. Share issuance:
1. In July 1998, the Company consummated an
initial public offering ("IPO") of 2,150,000
Ordinary shares in which the shares were listed
for trade on the American Stock Exchange
("AMEX"). On February 19, 2000, the Company
changed the listing for the trading of its
shares from the AMEX to the NASDAQ National
Market System.
On February 8, 2002, the Company's shares were
de-listed by the NASDAQ, as a result of the
Company's failure to meet NASDAQ requirements
for either the minimum of $ 10,000,000
shareholders' equity or the minimum $ 4,000,000
in net tangible assets. Trading in the
Company's shares is currently conducted in the
over-the-counter Bulletin Board ("OTCBB").
2. During December 1999, the Company entered into
Securities Purchase Agreements ("the
Agreements") with a group of private investors,
pursuant to which, the Company issued during
1999, 875,000 Ordinary shares to the investors
for a consideration of $ 7,000,000, and 250,000
Ordinary shares were issued during 2000, for a
consideration of $ 2,000,000 which was paid
during 1999, and was presented as receipts on
account of shares.
F-23
E-SIM LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 10:- SHAREHOLDERS' EQUITY (DEFICIENCY) (CONT.)
c. Stock Option Plan:
In 1996, 1997 and 1999, the Company adopted the 1996, 1997
and 1999 Share Option Plans ("the Plans") for the granting
of options to key employees, officers and directors to
purchase ordinary shares of the Company. Under the terms
of the plan, options generally become exercisable, over a
four-year period, after which they expire. Any options,
that are forfeited or canceled before expiration, become
available for future grants.
Pursuant to the Plans, the Company reserved for issuance
3,182,431 Ordinary shares. As of January 31, 2003, an
aggregate of 440,164 Ordinary shares of the Company are
still available for future grant.
A summary of grants under the Plans is as follows:
YEAR ENDED JANUARY 31,
----------------------------------------------------------------------------------------------
2001 2002 2003
------------------------------ ------------------------------- -------------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
AMOUNT PRICE AMOUNT PRICE AMOUNT PRICE
-------------- --------------- --------------- -------------- --------------- ---------------
Outstanding at the 1,279,518 $ 5.514 1,337,149 $ 7.513 1,707,493 $ *) 4.17
beginning of year
Granted 551,235 $ 11.995 1,054,235 $ 1.379 1,184,661 $ 0.143
Exercised (70,927) $ 2.471 (5,987) $ 1.598 - $ -
Repriced:
Old exercise price - - - - (1,071,328) $ 4.44
New exercise price - - - - 1,071,328 $ 0.02
Forfeited (422,677) $ 9.425 (677,904) $ 6.446 (494,529) $ 3.657
-------------- --------------- ---------------
Outstanding at the end
of the year 1,337,149 $ 7.513 1,707,493 $ 4.17 2,397,625 $ 0.32
============== =============== =============== =============== =============== ===============
Exercisable options at
the end of the year 540,282 $ 5.293 797,283 $ 4.955 958,698 $ 0.65
============== =============== =============== =============== =============== ===============
Where the Company has recorded deferred compensation for
options issued with an exercise price below the fair value
of the Ordinary shares, the deferred compensation is
amortized and recorded as compensation expense ratably
over the vesting period of the options. Compensation
expense of approximately $ 26,000, $ 0 and $ 0 were
recognized during the years ended January 31, 2001, 2002
and 2003, respectively (see Note 10d).
The options outstanding as of January 31, 2003 have been
separated into ranges of exercise prices as follows:
OPTIONS
OPTIONS WEIGHTED AVERAGE EXERCISABLE
OUTSTANDING AS REMAINING WEIGHTED AVERAGE AS OF WEIGHTED
EXERCISE OF JANUARY 31, CONTRACTUAL LIFE EXERCISE PRICE JANUARY 31, AVERAGE
PRICE 2003 2003 EXERCISE PRICE
------------------ ------------------ ------------------ ------------------ ---------------- ----------------
AMOUNT YEARS AMOUNT
------------------ ------------------ ----------------
$ 0.02 1,060,824 9.63 $ 0.02 531,994 $ 0.02
$ 0.1-$ 0.14 990,097 5.92 $ 0.14 80,000 $ 0.14
$ 0.20 150,000 1.42 $ 0.2 150,000 $ 0.2
$ 1.5 - $ 1.63 113,162 2.08 $ 1.53 113,162 $ 1.53
$ 2.12 33,542 1.58 $ 2.12 33,542 $ 2.12
$ 6.5 50,000 2.73 $ 6.5 50,000 $ 6.5
------------------ ----------------
2,397,625 6.97 $ 0.32 958,698 $ 0.65
================== ================== ================== ================ ================
F-24
E-SIM LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 10:- SHAREHOLDERS' EQUITY (DEFICIENCY) (CONT.)
The weighted average fair values of options granted for
the years ended January 31, 2001, 2002 and 2003 were:
YEAR ENDED JANUARY 31,
----------------------------------------------------------------------------------
2001 2002 2003
--------------------------- ------------------------------------------------------
WEIGHTED WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE WEIGHTED AVERAGE WEIGHTED
EXERCISE AVERAGE EXERCISE AVERAGE EXERCISE AVERAGE
PRICE FAIR VALUE PRICE FAIR VALUE PRICE FAIR VALUE
------------- ------------- ------------ -------------- ------------ -------------
Options granted at exercise price
that is:
Less than market price at date
of grant $ 6.78 $ 6.24 $ - $ - $ 0.02 $ 0.18
============= ============= =========== =============== ============ =============
Equal to market price at date $ 10.80 $ 9.56 $ 0.95 $ 0.89 $ 0.14 $ 0.12
of grant
============= ============= =========== =============== ============ =============
Exceeds market price at date
of grant $ 13.50 $ 11.71 $ 1.51 $ 1.08 $ 0.20 $ 0.13
============= ============= =========== =============== ============ =============
d. Repricing of options:
On September 11, 2002, 1,071,328 previously granted
options with exercise prices ranging between $ 0.14 - $
22.5 were re-priced downward to the nominal value of the
shares into which such options are exercisable, resulting
in a new measurement date and total compensation expenses
of $ 126,000 of which $ 63,000 was recognized in the year
ended January 31, 2003 for the portion already vested and
the balance will be amortized over the remaining vesting
period.
e. Dividends:
In the event that cash dividends are declared in the
future, such dividends will be paid in NIS. The Company
does not intend to pay cash dividends in the foreseeable
future.
NOTE 11:- INCOME TAXES
a. Measurement of taxable income under the Income Tax Law
(Inflationary Adjustments), 1985:
Results for tax purposes are measured in terms of earnings
in NIS after certain adjustments for increases in the CPI.
As explained in Note 2b, the financial statements of the
Company are presented in U.S. dollars. The difference
between the annual change in the Israeli Consumer Price
Index and in the NIS/dollar exchange rate causes a further
difference between taxable income and the income before
taxes shown in the financial statements. In accordance
with paragraph 9(f) of SFAS No. 109, the Company has not
provided for deferred income taxes on the difference
between the functional currency and the tax bases of
assets and liabilities.
F-25
E-SIM LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 11:- INCOME TAXES (CONT.)
b. Tax benefits under the Law for the Encouragement of
Capital Investments, 1959:
e-SIM Ltd.'s production facilities in Israel have been
granted "Approved Enterprise" status by the Israeli
Government under the Law for the Encouragement of Capital
Investments, 1959 ("the Investment Law") with respect to
three investment programs, of which two programs were
completed, one in April 1993, and the other in March 1998.
The Approved Enterprise status allows e-SIM Ltd. a tax
exemption on undistributed Israeli income for a period of
10 years after the first year in which it realizes taxable
income. As the Company currently has no taxable income,
these benefits have not yet commenced. With respect to the
first two investment programs, e-SIM Ltd. also elected to
receive government-guaranteed long-term loans along with
the tax exemption. e-SIM Ltd. has not received final
approval for the investment programs that ended in April
1993 and March 1998.
The entitlement to the above benefits is conditional upon
e-SIM Ltd. fulfillment of the conditions stipulated by the
above law, regulations published thereunder and the
instruments 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
e-SIM Ltd. may be required to refund the amount of the
benefits, in whole or in part, including interest. As of
January 31, 2003, management believes that e-SIM is
meeting all of the aforementioned conditions.
In March 1998, e-SIM Ltd. applied for approval to commence
a third program, which it obtained in November 1998. As of
January 31, 2003, the third program has been concluded,
but has yet to receive final approval.
During 2002, e-SIM Ltd. applied for approval to commence a
fourth program. The program was approved, but has yet to
be concluded.
In the event of the distribution of cash dividends from
income that is tax exempt as mentioned above, e-SIM Ltd.
would have to pay income tax at the rate of 25% on the
amount distributed. The tax exempt income attributable to
the "Approved Enterprise" can be distributed to
shareholders without subjecting e-SIM Ltd. to taxes only
upon the complete liquidation of e-SIM Ltd. The Company
currently has no plans to distribute dividends.
By right of this law, e-SIM Ltd. is entitled to claim
accelerated depreciation on equipment used in the
"Approved Enterprise" during five tax years.
In Israel, income from sources other than the "Approved
Enterprise" is taxed at the regular corporate tax rate of
36%.
e-SIM Ltd. has to fulfill the conditions detailed in the
"Approved Enterprise" programs, which include an
obligation to invest certain amounts in fixed assets, an
obligation to finance a percentage of the investment in
fixed assets by its shareholders' equity and achieving
sales targets.
F-26
E-SIM LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 11:- INCOME TAXES (CONT.)
c. Tax benefits under Israel's Law for the Encouragement of
Industry (Taxation), 1969:
e-SIM Ltd. is an "Industrial Company" under the Law for
the Encouragement of Industry (Taxation), 1969, and as
such, is entitled to certain tax benefits, including
accelerated rates of depreciation over a period of three
years.
d. Israeli tax reform:
On July 24, 2002, Amendment 132 to the Israeli Income Tax
Ordinance ("the Amendment") was approved by the Israeli
parliament and came into effect on January 1, 2003. The
principal objectives of the Amendment were to broaden the
categories of taxable income and to reduce the tax rates
imposed on employees income.
The material consequences of the Amendment applicable to
the Company include, among other things, imposing tax upon
all income of Israel residents, individuals and
corporations, regardless of the territorial source of
income and certain modifications in the qualified taxation
tracks of employee stock options.
e. Tax assessments:
In March 2003, the Company received tax assessments
through 2001.
f. Net operating losses carryforwards:
Following the above tax assessments, e-SIM Ltd. has
accumulated tax losses in Israel as of January 31, 2003,
in the amount of approximately $ 14,791,000, which may be
carried forward and offset against taxable income in the
future for an indefinite period.
Through January 31, 2003, e-SIM Inc. had U.S. federal net
operating tax loss carryforwards of approximately $
12,318,000 that can be carried forward and offset against
taxable income for 15 to 20 years from 2011-2021.
Utilization of U.S. net operating losses may be subject to
the substantial annual limitation due to the "change in
ownership" provisions of the Internal Revenue Code of 1986
and similar state provisions. The annual limitation may
result in the expiration of net operating losses before
utilization.
g. Deferred income taxes:
Deferred income taxes reflect the net tax effects of
temporary differences between the carrying amounts of
assets and liabilities for financial reporting purposes
and the amounts used for income tax purposes. Significant
components of the Company's deferred tax assets are as
follows:
F-27
E-SIM LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 11:- INCOME TAXES (CONT.)
JANUARY 31,
-----------------------------------
2002 2003
--------------- ---------------
IN THOUSANDS
-----------------------------------
Net operating losses carryforward $ 10,999 $ 9,759
Reserves and allowances 304 190
--------------- ---------------
Net deferred tax asset before valuation allowance 11,303 9,949
Valuation allowance (11,303) (9,949)
--------------- ---------------
Net deferred tax asset $ - $ -
=============== ===============
The Company has provided valuation allowances against the
full amount of the tax benefits in the accompanying
consolidated financial statements due to its history of
losses and the current concern regarding its ability to
realize these deferred tax assets in the future.
Management currently believes that it is more likely than
not that the deferred taxes regarding the losses
carryforward and other temporary differences will not be
realized in the foreseeable future.
f. Losses before taxes on income:
YEAR ENDED JANUARY 31,
------------------------------------------------------
2001 2002 2003
------------------------------------------------------
IN THOUSANDS
------------------------------------------------------
Domestic $ 2,483 $ 5,420 $ 387
Foreign 5,054 3,499 1,133
--------------- --------------- ---------------
$ 7,537 $ 8,919 $ 1,520
=============== =============== ===============
During the year ended January 31, 2003, the Company
decreased its valuation by approximately $ 1,354,000.
NOTE 12:- RELATED PARTY TRANSACTIONS
a. In 1993, the Company entered into an agreement to pay
management fees to a company controlled by a principal
shareholder in a monthly amount of $ 11,000 that increases
at a rate of 12% per annum. The Company believes that the
management fees are comparable to fees that would have
been charged by an unrelated party. At January 31, 2003,
the balance of such fees was $ 859,000.
b. Transactions with related parties are as follows:
YEAR ENDED JANUARY 31,
------------------------------------------------------
2001 2002 2003
--------------- --------------- ---------------
IN THOUSANDS
------------------------------------------------------
Management fees $ 207 $ 238 $ 350
=============== =============== ===============
The principal shareholder waived the fee for the first
quarter of 2001.
F-28
E-SIM LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 12:- RELATED PARTY TRANSACTIONS (CONT.)
c. In August 2002, the Company entered into an agreement with
a related party which agreed to lend the Company $ 950,000
until February 28, 2003. The loan was secured by a $ 1
million account receivable, which was payable on February
28, 2003. The Company granted the related party a security
interest in the account receivable to secure the loan. The
loan bears interest at the rate of 6% per annum. In
addition, if on the due date the repayment of the loan
would result in the Company having cash and cash
equivalent reserves of less than $ 1 million, the related
party has agreed to extend the date for repayment of a
portion of the loan in an amount equal to the difference
between $ 1 million and the cash and cash equivalents at
that date, until the earlier of August 15, 2003 or the
date when the cash and cash equivalents equal $ 1 million
(see Note 15).
As of January 31, 2003, none of the loan was repaid by the
Company to the related party and none of the convertible
portion of the loan was converted by Gibralt. By April 30,
2003, $ 760,000 of the loan was repaid.
NOTE 13:- REPORTABLE SEGMENTS
a. The Company follows Statement of Financial Accounting
Standards No. 131, "Disclosure About Segments of an
Enterprise and Related Information" ("SFAS No. 131").
Since February 1, 1999, the Company's management
differentiates between its Software Tools segment and
LiveProducts segment. The Software Tools segment markets,
licenses and supports its RapidPLUS software tools, as
well as providing training and consulting services, to
designers of consumer and industrial electronics products.
The LiveProducts segment markets, licenses and produces
full product simulations for delivery over the Internet
and Intranet, and is establishing its own comprehensive
Web-site for supporting consumer electronics products.
The accounting policies of the segments are the same as
those described in the summary of significant accounting
policies (see Note 2). The Company evaluates performance
based on profit or loss from operations before financial
expenses.
The Company attributes revenues based on the end
customers' location.
F-29
E-SIM LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 13:- REPORTABLE SEGMENTS (CONT.)
The following data presents the selected statements of
operations data and assets of the Company's operating
segments for the years ended January 31, 2001, 2002 and
2003:
YEAR ENDED JANUARY 31,
------------------------------------------------------------------------------------------------
2001 2002
----------------------------------------------- -----------------------------------------------
SOFTWARE LIVE SOFTWARE LIVE
TOOLS PRODUCTS TOTAL TOOLS PRODUCTS TOTAL
--------------- --------------- --------------- --------------- --------------- ---------------
IN THOUSANDS
------------------------------------------------------------------------------------------------
Revenues $ 9,489 $ 392 $ 9,881 $ 4,352 $ 684 $ 5,036
--------------- --------------- --------------- --------------- --------------- ---------------
Cost of revenues:
Products 383 - 383 169 - 169
Services 1,475 260 1,735 999 777 1,776
--------------- --------------- --------------- --------------- --------------- ---------------
1,858 260 2,118 1,168 777 1,945
--------------- --------------- --------------- --------------- --------------- ---------------
Gross profit (loss) 7,631 132 7,763 3,184 (93) 3,091
--------------- --------------- --------------- --------------- --------------- ---------------
Operating expenses and costs:
Product development - 2,475 2,475 - - -
Website development - 800 800 - - -
Research and development, net 1,387 1,387 2,774 1,044 1,566 2,610
Selling, marketing, general
and administrative, net 5,318 3,433 8,751 3,962 3,892 7,854
Restructuring and impairment of
website development - - - 90 820 910
--------------- --------------- --------------- --------------- --------------- ---------------
Total operating expenses 6,705 8,095 14,800 5,096 6,278 11,374
--------------- --------------- --------------- --------------- --------------- ---------------
Operating loss (income) before
financial expenses, net $ (926) $ 7,963 7,037 $ 1,912 $ 6,371 8,283
=============== =============== =============== ===============
Financial expenses, net and other
expenses 500 636
--------------- ---------------
Net loss before taxes on income 7,537 8,919
Taxes on income 56 62
--------------- ---------------
Net loss $ 7,593 $ 8,981
=============== ===============
** TABLE CONTINUED... **
F-30-A
YEAR ENDED JANUARY 31,
-------------------------------------------------
2003
-------------------------------------------------
SOFTWARE LIVE
TOOLS PRODUCTS TOTAL
--------------- --------------- ---------------
IN THOUSANDS
-------------------------------------------------
Revenues $ 5,193 $ 1,027 $ 6,220
--------------- --------------- ---------------
Cost of revenues:
Products 267 - 267
Services 533 1,130 1,663
--------------- --------------- ---------------
800 1,130 1,930
--------------- --------------- ---------------
Gross profit (loss) 4,393 (103) 4,290
--------------- --------------- ---------------
Operating expenses and costs:
Product development - - -
Website development - - -
Research and development, net 1,222 242 1,464
Selling, marketing, general
and administrative, net 3,347 914 4,261
Restructuring and impairment of
website development - - -
--------------- --------------- ---------------
Total operating expenses 4,569 1,156 5,725
--------------- --------------- ---------------
Operating loss (income) before
financial expenses, net $ 176 $ 1,259 1,435
=============== ===============
Financial expenses, net and other
expenses 85
---------------
Net loss before taxes on income 1,520
Taxes on income 199
---------------
Net loss $ 1,719
===============
** TABLE COMPLETE **
F-30-B
E-SIM LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 13:- REPORTABLE SEGMENTS (CONT.)
JANUARY 31, 2002 JANUARY 31, 2003
----------------------------------------------- -----------------------------------------------
SOFTWARE LIVE SOFTWARE LIVE
TOOLS PRODUCTS TOTAL TOOLS PRODUCTS TOTAL
--------------- -------------- -------------- --------------- --------------- ---------------
IN THOUSANDS IN THOUSANDS
----------------------------------------------- -----------------------------------------------
Long-lived assets $ 806 $ 272 $ 1,078 $ 456 $ 78 $ 534
=============== ============== ============== =============== =============== ===============
b. Summary information about geographic areas:
The following presents total revenues attributed to
geographic information based on the location of the
customers for the years ended January 31, 2001, 2002 and
2003, and long-lived assets as of January 31, 2001, 2002
and 2003:
2001 2002 2003
------------------------------- ------------------------------ -------------------------------
TOTAL LONG-LIVED TOTAL LONG-LIVED TOTAL LONG-LIVED
REVENUES ASSETS REVENUES ASSETS REVENUES ASSETS
--------------- --------------- -------------- -------------- --------------- ---------------
IN THOUSANDS
------------------------------------------------------------------------------------------------
Israel $ 70 $ 1,045 $ 55 $ 780 $ 240 $ 469
Far east *) 1,367 - 1,622 - 649 -
Japan 4,255 49 1,421 32 2,794 30
U.S.A. 2,725 1,130 1,258 252 1,297 35
Europe 1,464 43 680 14 1,240 -
--------------- --------------- -------------- -------------- --------------- ---------------
$ 9,881 $ 2,267 $ 5,036 $ 1,078 $ 6,220 $ 534
=============== =============== ============== ============== =============== ===============
*) Excluding Japan.
c. Major customer data by percentage of total revenues:
YEAR ENDED JANUARY 31,
------------------------------------------------------
2001 2002 2003
--------------- --------------- ----------------
Customer A 28% 1% 8%
=============== =============== ================
Customer B 5% 15% -
=============== =============== ================
Customer C 11% - 1%
=============== =============== ================
Customer D - 13% 1%
=============== =============== ================
Customer E 7% 6% 33%
=============== =============== ================
F-31
E-SIM LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 14:- SELECTED STATEMENTS OF OPERATIONS DATA
a. Research and development, net:
YEAR ENDED JANUARY 31,
------------------------------------------------------
2001 2002 2003
--------------- ---------------- ---------------
IN THOUSANDS
------------------------------------------------------
Total costs $ 3,012 $ 3,037 $ 1,464
Less - grants and participations (238) (427) -
--------------- ---------------- ---------------
$ 2,774 $ 2,610 $ 1,464
=============== ================ ===============
b. Selling, marketing, general and administrative:
Total costs $ 8,738 $ 7,857 $ 4,219
Less - grants net of royalties to the fund 13 (3) 42
--------------- ---------------- ---------------
$ 8,751 $ 7,854 $ 4,261
=============== ================ ===============
c. Financial expenses (income):
Financial expenses:
Interest and other $ 157 $ 272 $ 231
Amortization of beneficial conversion feature 43 - -
Foreign currency translation adjustments 46 68 -
--------------- ---------------- ---------------
246 340 231
--------------- ---------------- ---------------
Financial income:
Interest on deposits and other (476) (130) (16)
Foreign currency translation adjustments - - (224)
--------------- ---------------- ---------------
(476) (130) (240)
--------------- ---------------- ---------------
$ (230) $ 210 $ (9)
=============== ================ ===============
.
NOTE 15:- SUBSEQUENT EVENTS (UNAUDITED)
a. In July 2003, the Company reached an agreement with the
banks, in respect to the long-term bank loans (see Note
7), regarding the extension of the scheduled maturity of
the loans to August 31, 2004 and increasing the minimum
monthly payments of principal and interest to $ 80,000 per
month (subject to increase if the Company's revenues
exceed certain specified amounts). In addition, the
Company granted these banks liens on its right to receive
revenues pursuant to agreements with two major customers.
The banks can demand payment of the loans prior to the
maturity date upon the occurrence of an event of default
under the loan agreements, such as non-payment of
scheduled principal and interest payments, liquidation of
the company or occurrence of events that the banks believe
harm or might harm the Company's ability to perform its
obligations under the loan agreements. In addition, under
the Company's agreements with these banks, until at least
one half of the outstanding principal of the loans has
been repaid, the Company may not make any cash payment of
management fees to any shareholder holding, directly or
indirectly, 5% or more of the Company's shares, or to any
related party of such shareholder.
F-32
E-SIM LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 15:- SUBSEQUENT EVENTS (UNAUDITED) (CONT.)
b. In July 2003, the Company entered into a convertible loan
agreement with Smithfield Investments B.V.("Smithfield"),
an entity controlled by Marc Belzberg, the Company's
chairman, chief executive officer and a major shareholder,
pursuant to which Smithfield agreed to lend the Company $1
million until August 1, 2004 and bearing no interest.
Until that date, Smithfield may convert the sum of the
loan into the Company's ordinary shares at the price per
share of $0.18. In addition, if Smithfield elects to
convert the entire loan amount into the Company's ordinary
shares, it will receive a warrant to purchase $3,000,000
worth of the Company's ordinary shares at a price per
share of $0.54. According to the terms of the convertible
loan agreement, the Company will have the right to force
Smithfield to convert the loan in its entirety into equity
if the Company effects an equity raising in the amount of
at least $1,000,000. The transaction was approved by the
Company's board of directors and audit committee and is
subject to shareholder approval. The transaction is also
subject to the Company's shareholders' approval of the
increase of the Company's authorized share capital. The
Company plans to submit the transaction and the increase
of its share capital to its shareholders for approval at
the next general meeting of the Company's shareholders.
The Company cannot assure whether the transaction or the
increase of share capital will be approved. However,
Smithfield has agreed that in the event that the
shareholders do not approve this transaction or the share
capital increase, it will provide the amount of the
investment as a loan, if failure to provide it would
affect the Company's ability to continue operations as a
going concern.
- - - - - - -
F-33
EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION
----------- -----------
1.1 Memorandum of Association of the Registrant (together with
an English translation thereof) (incorporated by reference
to Exhibit 3.1 to the Registration Statement on Form F-1
(File No. 333-8830))
1.2 Articles of Association of the Registrant, as amended
(incorporated by reference to Exhibit 1.2 to the annual
report on Form 20-F filed with the Commission on July 31,
2001)
4.1 Consulting Agreement, dated August 7, 1997, between the
Registrant and Yozma Hofsheet Ltd. (incorporated by
reference to Exhibit 10.3 to the Registration Statement on
Form F-1 (File No. 333-8830))
4.2 1996 and 1997 Stock Option Plans of the Registrant
(incorporated by reference to Exhibit 10.7 to the
Registration Statement on Form F-1 (File No. 333-8830))
4.3 1999 Share Option Plan of the Registrant (incorporated by
reference to Exhibit 4.3 to the annual report on Form 20-F
filed with the Commission on July 31, 2001)
4.4 Agreement of General Business Conditions, dated November
30, 2000, between the Registrant and Industrial
Development Bank of Israel Ltd. (incorporated by reference
to Exhibit 4.4 to the annual report on Form 20-F filed
with the Commission on July 31, 2001)
4.5 Agreement, dated November 30, 2000, between the Registrant
and Industrial Development Bank of Israel Ltd.
(incorporated by reference to Exhibit 4.5 to the annual
report on Form 20-F filed with the Commission on July 31,
2001)
4.6 Debenture, dated November 30, 2000, in favor of Industrial
Development Bank of Israel Ltd. (incorporated by reference
to Exhibit 4.6 to the annual report on Form 20-F filed
with the Commission on July 31, 2001)
4.7 Debenture, dated September 19, 2000, in favor of Israel
Discount Bank Ltd. (incorporated by reference to Exhibit
4.7 to the annual report on Form 20-F filed with the
Commission on July 31, 2001)
4.8 Convertible Debenture, dated September 19, 2000, in favor
of Israel Discount Bank Ltd. (incorporated by reference to
Exhibit 4.8 to the annual report on Form 20-F filed with
the Commission on July 31, 2001)
4.9 Credit Agreement, dated September 19, 2000, in favor of
Israel Discount Bank Ltd. (incorporated by reference to
Exhibit 4.9 to the annual report on Form 20-F filed with
the Commission on July 31, 2001)
4.10 Amendment to Additional Conditions for Granting Credits,
dated August 13, 2002, between the Registrant and
Industrial Development Bank of Israel Ltd. (incorporated
by reference to Exhibit 4.10 to the annual report on Form
20-F filed with the Commission on August 15, 2002)
4.11 Amendment to Convertible Debenture, dated August 13, 2002,
in favor of Industrial Development Bank of Israel Ltd.
(incorporated by reference to Exhibit 4.11 to the annual
report on Form 20-F filed with the Commission on August
15, 2002)
4.12 Amendment to Additional Conditions for Granting Credits,
dated August 13, 2002, between the Registrant and Israel
Discount Bank Ltd. (incorporated by reference to Exhibit
4.12 to the annual report on Form 20-F filed with the
Commission on August 15, 2002)
4.13 Amendment to Convertible Debenture, dated August 13, 2002,
in favor of Israel Discount Bank Ltd. (incorporated by
reference to Exhibit 4.13 to the annual report on Form
20-F filed with the Commission on August 15, 2002)
4.14 Agreement dated August 14, 2002 between the Registrant and
Gibralt Capital (incorporated by reference to Exhibit 4.14
to the annual report on Form 20-F filed with the
Commission on August 15, 2002)
4.15* Amendment to Additional Conditions for Granting Credits,
dated July 30], 2003, between the Registrant and
Industrial Development Bank of Israel Ltd.
4.16* Amendment to Additional Conditions for Granting Credits,
dated July 30, 2003, between the Registrant and Israel
Discount Bank Ltd.
4.17* Agreement dated, July 31, 2003, between the Registrant and
Smithfield Investments B.V.
8 List of Subsidiaries (incorporated by reference to Exhibit
8 to the annual report on Form 20-F filed with the
Commission on July 31, 2001)
12.1* Consent of Kost Forer & Gabbay, a member of Ernst & Young
Global
12.2* Certificate of Chief Executive Officer pursuant to 18
U.S.C. Section 1350, As Adopted Pursuant To Section 906 Of
The Sarbanes-Oxley Act of 2002.
12.3* Certificate of Chief Financial Officer pursuant to 18
U.S.C. Section 1350, As Adopted Pursuant To Section 906 Of
The Sarbanes-Oxley Act of 2002.
- -------------------
* Filed herewith.