UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 20-F
[_] REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES
EXCHANGE ACT OF 1934
OR
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the Fiscal year ended December 31, 2000
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER ___________
VIRYANET LTD.
(Exact Name of Registrant as specified in its charter)
______________________
STATE OF ISRAEL
(Jurisdiction of incorporation or organization)
5 KIRYAT HAMADA STREET
SCIENCE BASED INDUSTRIES CAMPUS
P.O. BOX 23052
HAR HOTZVIM, JERUSALEM
ISRAEL 91230
(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 N/A
- ---------------------------- ------------------------------------------
Securities registered or to be registered pursuant to Section 12(g) of the Act:
Ordinary shares, par value NIS 0.1 per share
- -------------------------------------------------------------------------------
(Title of Class)
Securities for which there is a reporting obligation pursuant to Section 15(d)
of the Act:
N/A
- -----------------------------------------------------------------
(Title of Class)
Indicate the number of outstanding shares of each of issuer's classes of capital
or common stock as of the close of the period covered by the annual report:
As of December 31, 2000, the Registrant had outstanding 21,664,673 ordinary
shares.
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes: [X] No: [_]
Indicate by check mark which financial statement item the Registrant has elected
to follow:
Item 17 [_] Item 18 [X]
TABLE OF CONTENTS
PAGE
----
PART I............................................................................... 1
Item 1. Identity of Directors, Senior Management and Advisors.................... 1
Item 2. Offer Statistics and Expected Timetable.................................. 1
Item 3. Key Information.......................................................... 2
Selected Financial Data................................................ 2
Capitalization and Indebtedness........................................ 3
Reasons for the Offer and Use of Proceeds.............................. 3
Risk Factors........................................................... 3
Item 4. Information on our Company............................................... 12
History and Development................................................ 12
Business Overview...................................................... 12
Organizational Structure............................................... 16
Property, Plant and Equipment.......................................... 16
Item 5. Operating and Financial Review and Prospects............................. 17
Operating Results...................................................... 19
Liquidity and Capital Resources........................................ 22
Research and Development, Patents and Licenses, etc.................... 25
Trend Information...................................................... 25
Item 6. Directors, Senior Management and Employees............................... 26
Directors and Senior Management........................................ 26
Compensation........................................................... 28
Board Practices........................................................ 29
Employees.............................................................. 32
Share Ownership........................................................ 32
Item 7. Major Shareholders and Related Party Transactions........................ 36
Major Shareholders..................................................... 36
Related Party Transactions............................................. 38
Interests of Experts and Counsel....................................... 41
Item 8. Financial Information.................................................... 41
Consolidated Statements and Other Financial Information................ 41
Significant Changes.................................................... 41
Item 9. The Offer and Listing.................................................... 42
Market Price Information............................................... 42
Markets on Which our Ordinary Shares Trade............................. 42
Item 10. Additional Information................................................... 42
Share Capital.......................................................... 42
Memorandum and Articles of Association................................. 42
Material Contracts..................................................... 44
Exchange Controls...................................................... 44
Taxation............................................................... 45
Item 11. Quantitative and Qualitative Disclosures about Market
Risk................................................................... 54
Item 12. Description of Securities other than Equity Securities................... 54
Part II.............................................................................. 54
Item 13. Defaults, Dividend Arrearages and Delinquencies........................ 54
Item 14. Material Modifications to the Rights of Security Holders and
Use of Proceeds........................................................ 54
Part III............................................................................. 55
Item 17. Financial Statements................................................... 55
Item 18. Financial Statements................................................... 55
Item 19. Exhibits............................................................... 56
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
Unless the context otherwise requires, all reference in this annual report
to "ViryaNet," "we," "our," "us" and the "Company" refer to ViryaNet Ltd. and
its consolidated subsidiaries. Reference to "dollars" or $ are to United States
dollars.
Matters discussed in this document may constitute forward-looking
statements. The Private Securities Litigation Reform Act of 1995 provides safe
harbor protections for forward-looking statements in order to encourage
companies to provide prospective information about their businesses.
Forward-looking statements include statements concerning plans, objectives,
goals, strategies, future events or performance, and underlying assumptions and
other statements, which are other than statements of historical facts.
We desire to take advantage of the safe harbor provisions of the Private
Securities Litigation Reform Act of 1995 and we are including this cautionary
statement in connection with this safe harbor legislation. This document and any
other written or oral statements made by us or on our behalf may include
forward-looking statements, which reflect our current views with respect to
future events and financial performance. The words "believe," "expect,"
"anticipate," "intend," "estimate," "forecast," "project" and similar
expressions identify forward-looking statements.
The forward-looking statements in this document are based upon various
assumptions, many of which are based, in turn, upon further assumptions,
including without limitation, management's examination of historical operating
trends, data contained in our records and other data available from third
parties. Although we believe that these assumptions were reasonable when made,
because these assumptions are inherently subject to significant uncertainties
and contingencies which are difficult or impossible to predict and are beyond
our control, we cannot assure you that we will achieve or accomplish these
expectations, beliefs or projections. In addition to these important factors and
matters discussed elsewhere herein and in the documents incorporated by
reference herein, important factors that, in our view, could cause actual
results to differ materially from those discussed in the forward-looking
statements, including the achievement of the anticipated levels of
profitability, growth, cost, the timely development and acceptance of new
products, the impact of competitive pricing, the impact of general business and
global economic conditions and other important factors described from time to
time in the reports filed by us with the Securities and Exchange Commission.
Except to the extent required by law, neither we, nor any of our respective
agents, employees or advisors intends or has any duty or obligation to
supplement, amend, update or revise any of the forward-looking statements
contained or incorporated by reference in this document.
PART I
ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISORS
Not applicable.
ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE
Not applicable.
1
ITEM 3. KEY INFORMATION
Selected Consolidated Financial Data
The tables that follow present portions of our financial statements and are
not complete. You should read the following selected financial data with our
consolidated financial statements, notes to our consolidated financial
statements and Operating and Financial Review and Prospects section included in
this annual report. Historical results are not necessarily indicative of any
results to be expected in any future period.
We derived the selected consolidated statements of operations data below
for the years ended December 31, 1998, 1999 and 2000, and the selected
consolidated balance sheet data as of December 31, 1999 and 2000, from our
audited consolidated financial statements, which are included elsewhere in this
annual report. These consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United States
("GAAP"). We derived the consolidated statements of operations data for the
years ended December 31, 1996 and 1997 and the selected consolidated balance
sheet data as of December 31, 1996, 1997 and 1998 from audited consolidated
financial statements that are not included in this annual report.
Summary Consolidated Financial Information
Year Ended December 31,
--------------------------------------------
1996 1997 1998 1999 2000
---- ---- ---- ---- ----
(in thousands, except per share data)
Statement of Operations Data:
Revenues:
Software licenses............................................. $ 916 $ 1,067 $ 1,801 $ 4,269 $ 17,027
Maintenance and services...................................... 10,547 12,400 11,724 11,533 10,080
------- ------- -------- --------- --------
Total revenues.............................................. 11,463 13,467 13,525 15,802 27,107
Cost of revenues:
Software licenses............................................. 120 106 146 952 938
Maintenance and services...................................... 6,342 8,817 9,709 9,978 7,857
------- ------- -------- --------- --------
Total cost of revenues...................................... 6,462 8,923 9,855 10,930 8,795
Gross profit.................................................... 5,001 4,544 3,670 4,872 18,312
------- ------- -------- --------- --------
Operating expenses:
Research and development, net................................. 953 3,443 5,322 6,865 7,224
Sales and marketing, net...................................... 1,124 3,329 8,862 13,537 16,385
General and administrative.................................... 2,049 2,403 2,602 3,518 3,857
Amortization of deferred stock compensation (1)............... -- 12 250 798 1,104
------- ------- -------- --------- --------
Total operating expenses.................................... 4,126 9,187 17,036 24,718 28,570
Operating income (loss)......................................... 875 (4,643) (13,366) (19,846) (10,258)
Financial income (expenses), net................................ (105) (85) 234 (565) 26
Financial expenses related to amortization of beneficial
conversion feature and compensation related to warrants
to investors in convertible loan (*) -- -- -- -- (16,556)
------- ------- -------- --------- --------
Net income (loss)............................................... $ 770 $(4,728) $(13,132) $ (20,411) $(26,788)
======= ======= ======== ========= ========
Preferred shares deemed dividend................................ $ $ (116) $ (61) $ (303) $ --
======= ======= ======== ========= ========
Net income (loss) to shareholders of ordinary shares............ $ 770 $(4,844) $(13,193) $ (20,744) $(26,788)
------- ------- ------- --------- --------
Basic net earnings (loss) per share............................. $ 0.31 $ (1.91) $ (5.16) $ (7.74) $ (3.34)
Diluted net earnings (loss) per share........................... $ 0.23 $ (1.91) $ (5.16) $ (7.74) $ (3.34)
------- ------- -------- --------- --------
(1) Amortization of deferred stock compensation relates to the
following:
Cost of revenues............................................. -- -- -- $ 16 $ 4
Research and development, net................................ -- -- -- 391 --
Sales and marketing.......................................... -- -- $ 120 39 207
General and administrative................................... -- $ 12 130 352 893
------- ------- -------- --------- --------
-- $ 12 $ 250 $ 798 $ 1,104
======= ======= ======== ========= ========
2
December 31,
------------------
1996 1997 1998 1999 2000
------ ------ ----- ------ -------
(in thousands)
Balance Sheet Data:
Cash and cash equivalents................................ $ 905 $ 817 $ 554 $ 1,886 $ 21,838
Working capital (deficit)................................ 1,425 (519) (2,343) (11,305) 21,126
Total assets............................................. 8,699 7,333 8,638 8,692 34,840
Long-term loan, including current
maturities............................................... 671 133 62 11
Convertible debentures................................... -- -- -- -- --
Shareholders" equity (deficiency)........................ 1,569 69 (1,452) (10,555) 23,181
_______________________
(*) Financial expenses related to beneficial conversion feature of convertible
debentures and detachable warrants were recorded at the time of our initial
public offering in September, 2000, due to the discounted conversion feature of
the convertible debentures which converted into ordinary shares at that time.
Capitalization and Indebtedness
Not applicable.
Reasons for the Offer and Use of Proceeds
Not applicable.
Risk Factors
Risk Relating to Our Business
We have a history of losses and our recent financial results have been lower
than expected.
We incurred net losses of approximately $4.7 million in 1997, $13.1 million
in 1998, $20.4 million in 1999 and $26.8 million in 2000. As of December 31,
2000, we had an accumulated deficit of approximately $74.9 million. As a result,
we will need to generate significant revenues to achieve and maintain
profitability. Our revenue for the first quarter ended March 31, 2001 was $4.6
million, as compared to $8.2 million for the fourth quarter ended December 31,
2000, and was below the Company's expectations. This revenue shortfall was due
primarily to customers and prospective customers, especially in the
telecommunications area, experiencing issues related to current adverse economic
conditions that are causing them to defer their technology purchasing. We expect
that revenue growth during the remainder of 2001 will be at lower rates than in
previous years. Such continued adverse economic conditions could cause our
revenues to continue to decrease and make it more difficult for us to reach
profitability.
We have a limited operating history in our current principal market, which will
make it difficult or impossible for you to predict our future results of
operations.
We began operations in March 1988 as a general software services company. In
1995, we changed our strategic focus to the development of service delivery
chain management applications, including our product first internet-based
service community management product, Service Suite. We did not introduce
ViryaNet Service Hub until the fourth quarter of 1999. Each of these changes has
required us to adjust our business processes and make a number of significant
personnel additions and changes. Historically, most of our revenues were
generated from our services activities. Substantially all of our revenues in
1998, 1999 and 2000 were generated from our service delivery chain management
applications, including Service Suite. We anticipate that the substantial
majority of our revenues in the near future will be generated from transactions
which will include the ViryaNet Service Hub and related products. Our prospects
must be considered in light of the risks and difficulties frequently encountered
by companies dependent upon operating revenues from a new product line in an
emerging and rapidly evolving market. Because of our limited experience in our
principal market and with our principal product, we cannot provide assurance
that our strategy for operating in that market or selling that product will be
successful. Our historical results of operations should not serve as indications
of future performance.
3
We may experience significant fluctuations in our quarterly results, which makes
it difficult for investors to make reliable period-to-period comparisons and may
contribute to volatility in the market price for our ordinary shares.
Our quarterly revenues, gross profits and results of operations have
fluctuated significantly in the past and we expect them to continue to fluctuate
significantly in the future. The following events may cause fluctuations:
. changes in demand or timing of orders, especially large orders, for our
products and services;
. timing of product releases;
. the dollar value and timing of contracts;
. delays in implementation;
. changes in the proportion of service and license revenues;
. price and product competition;
. increases in selling and marketing expenses, as well as other operating
expenses;
. technological changes;
. adverse economic conditions and currency fluctuations; and
. consolidation of our clients.
A substantial portion of our expenses, including most product development
and selling and marketing expenses, must be incurred in advance of when revenue
is generated. If our projected revenue does not meet our expectations, we are
likely to experience an even larger shortfall in our operating profit relative
to our expectations. As a result, we believe that period-to-period comparisons
of our historical results of operations are not necessarily meaningful and that
you should not rely on them as an indication for future performance. Also, it is
possible that our quarterly results of operations may be below the expectations
of public market analysts and investors. If this happens, the price of our
ordinary shares will likely decrease.
Historically, our revenues have been concentrated in a few large orders and a
small number of customers and our business could be adversely affected if we
lose a key customer.
A significant portion of our revenues each year has been derived from large
orders from a small number of clients. In 1998, 1999 and 2000, we derived 55%,
55% and 9% of our revenues from two customers, Sun Microsystems and GE Medical,
who are shareholders or warrant holders. In 1999, 71% of our revenues were
derived from four customers, including Sun Microsystems and GE Medical, and no
one customer accounted for more than 33% of our revenues. In 2000, two customers
each accounted for approximately 11% or more of our revenues, and represented an
aggregate of 23% of our total revenues. We do not expect that these customers
will represent a substantial percentage of our revenues in the future. However,
we do expect that a significant portion of our future revenues will continue to
be derived from a relatively small number of customers. We cannot assure you
that other customers will purchase our products and services in the future. The
loss of key customers or the occurrence of significant reductions in sales from
a key customer would cause our revenues to decrease and make it more difficult
for us to reach profitability.
Our sales cycle is variable and sometimes long and involves significant
resources on our part, but may never result in actual sales.
Our sales cycle from our initial contact with a potential customer to the
signing of a license agreement has historically been lengthy and is variable. We
generally must educate our potential customers about the use and benefit of our
products and services, which can require the investment of significant time and
resources. The purchasing decisions of our customers are subject to the
uncertainties and delays of the budgeting, approval and competitive evaluation
processes that typically accompany significant capital expenditures. Any delays
in sales could cause our operating results to vary widely. If our sales cycle
shortens, our quarterly operating results may become less predictable and may
fluctuate more
4
widely than in the past. A number of companies decide which products to buy
through a request for proposal process. In those situations, we run the risk of
investing significant resources in a proposal, only to lose to our competition.
Since we have historically depended upon Service Suite applications, the failure
of these products in the marketplace in the future could adversely affect our
revenues.
Our future success depends on market acceptance of our new ViryaNet Service
Hub internet-based products, as well as continued acceptance of our Service
Suite and related applications. We have licensed applications to only a small
number of clients. If our products do not achieve or maintain market acceptance
or if our competitors release new products that achieve quicker market
acceptance, have more advanced features, offer better performance or are more
price competitive, license revenues for our products may not grow and may even
decline.
If we are unable to accurately predict and respond to market developments or
demands, our business will be adversely affected.
The market for internet-based service community platforms has only recently
begun to develop and is rapidly evolving. This makes it difficult to predict
demand and market acceptance for our products. We cannot guarantee that the
market for our internet-based products will grow or that our products will
become widely accepted. If the market for our internet-based products does not
develop as quickly as we expect or if our internet-based products are not
accepted by clients, our future revenues and profitability will be adversely
affected. Changes in technologies, industry standards, the regulatory
environment, client requirements and new product introductions by existing or
future competitors could render our existing products obsolete and unmarketable,
or require us to develop new products. A significant increase in the number of
clients, or a significant increase in our development of new product offerings,
or both, could require us to expend significant amounts of money, time and other
resources to meet the demand. This could strain our personnel and financial
resources.
If we fail to achieve or improve our margins on service revenues in the future,
our results of operations could suffer.
Our margins on service revenues have declined from 17% in 1998 to 13% in
1999. Our margins on service revenues improved to 22% in 2000, but this trend
may not continue. This decrease in 1999 was primarily caused by the additional
costs associated with our transition from providing customization services to
our major clients to providing implementation services to a larger number of
clients. To improve our margins, we are working on increasing our service
revenues and decreasing our cost of service revenues. Failure to improve our
margins on service revenues could cause our business to be less profitable.
If we fail to expand our relationships with third parties, we may be unable to
increase our revenues.
To focus more effectively on our core business of developing and licensing
software solutions, we need to establish relationships with third parties that
can provide implementation and consulting services to our customers. Third-party
implementation and consulting firms can also be influential in the choice of
service community management solutions by new customers. If we cannot establish
and maintain effective, long-term relationships with implementation and
consulting providers, or if these providers do not meet the needs or
expectations of our customers, we may be unable to increase our revenues and our
business could be seriously harmed. As a result of the limited resources and
capacities of many third-party implementation providers, we may be unable to
attain sufficient focus and resources from the third-party providers to meet all
of our customers' needs, even if we establish relationships with these third
parties. If sufficient resources are unavailable, we will be required to provide
these services internally, which could limit our ability to expand our base of
customers. A number of our competitors have significantly more established
relationships with these third parties and, as a result, these third parties may
be more likely to recommend competitors' products and services rather than our
own. Even if we are successful in developing relationships with third-party
implementation and consulting providers, we will be subject to significant risk
as we cannot control the level and quality of service provided by third-party
implementation and consulting partners.
Undetected defects may increase our costs and impair the market acceptance of
our products and technology.
Our software products are complex and may contain undetected defects,
particularly when first introduced or when new versions or enhancements are
released. Testing of our products is particularly challenging because it is
difficult to simulate the wide variety of client environments into which our
products are deployed. Despite testing conducted by us and our clients, we have
in the past shipped product releases with some defects, some customers have
cited possible defects, and have otherwise discovered other defects in our
products after their commercial shipment. Our products are frequently
5
critical to our clients' operations. As a result, our clients and potential
clients have a greater sensitivity to product defects than do clients of
software products generally.
Defects may be found in current or future products and versions after the
start of commercial shipment. This could result in:
. a delay or failure of our products to achieve market acceptance;
. adverse client reaction;
. negative publicity and damage to our reputation;
. diversion of resources; and
. increased service and maintenance costs.
Defects could also subject us to legal claims. Although our license
agreements contain limitation of liability provisions, these provisions may not
be sufficient to protect us against these legal claims. The sale and support of
our products may also expose us to product liability claims.
Decisions by clients to develop their own service management solutions or
greater market acceptance of our competitors' products could result in reduced
revenues or gross margins.
The market for third-party internet-based service community platforms is
relatively immature, but has begun to develop rapidly and competition is
intense. This market and the market for service management solutions is
fragmented and stratified. We compete for the business of global or nationwide
organizations that seek to support complex and sophisticated products across a
variety of industries.
Our competitors may be in a better position to devote significant resources
to the development, promotion and sale of their products, and to respond more
quickly to new or emerging technologies and changes in client requirements.
Current and potential competitors have established or may establish cooperative
relationships among themselves or with third parties to increase their ability
to successfully market their products. We also expect that competition will
increase as a result of consolidations in the industry. As we develop new
products, we may begin to compete with companies with which we have not
previously competed. We cannot assure you that competition will not result in
price reductions for our products and services, fewer client orders, reduced
gross margins or loss of market share, any of which could materially adversely
affect our business, financial condition and results of operations.
We rely on software from third parties. If we cannot continue using that
software, we would have to spend additional capital to redesign our existing
software.
We integrate various third-party software products as components of our
products. Our business would be disrupted if functional versions of this
software were either no longer available to us or no longer offered to us on
commercially reasonable terms. In either case, we would be required to spend
additional capital to either redesign our software to function with alternate
third-party software or develop these components ourselves. We might be forced
to limit the features available in our current or future product offerings and
the commercial release of our products could be delayed.
We may be unable to expand our sales, marketing and support organizations which
may hinder our ability to grow and meet customer demands.
We need to substantially expand our direct and indirect sales and marketing
operations to increase market awareness and sales of our products. We may also
need to increase our technical and customer support staff to support new clients
and the expanding needs of existing clients. Qualified individuals are in great
demand throughout the software industry and there is intense competition for
qualified personnel. Competition for qualified people may lead to increased
labor and personnel costs. If we do not succeed in retaining our personnel or in
attracting new employees, our business could suffer significantly.
6
If we are unable to attract, train and retain qualified personnel, we may not be
able to achieve our objectives and our business could be harmed.
As our business continues, we will need to hire additional qualified
engineering, administrative, operational, sales and technical support personnel.
The process of locating, training and successfully integrating qualified
personnel into our operations can be lengthy and expensive. We may not be able
to compete effectively for the personnel we need. Many members of our senior
management, including our chief executive officer, chief operating officer and
chief financial officer, were only recently hired. Our future success depends on
our ability to absorb and retain senior employees and to attract, motivate and
retain highly qualified professional employees. Competition for these employees
is intense in both Israel and the United States. Any loss of members of senior
management or key technical personnel, or any failure to attract or retain
highly qualified employees as needed, could materially adversely affect our
ability to carry out our business plan.
We may be unable to adequately protect our proprietary rights, which may limit
our ability to compete effectively.
Our success and ability to compete are substantially dependent upon our
internally developed technology. Other than our trademarks, most of our
intellectual property consists of proprietary or confidential information that
is not subject to patent or similar protection. We filed a provisional patent
application covering some of our technologies for creating and supporting
service communities on the internet. In December 2000, we filed the patent
application detailing the claims regarding some our technologies for creating
and supporting service communities on the internet. In general, we have relied
on a combination of technical leadership, trade secret, copyright and trademark
law and nondisclosure agreements to protect our proprietary know-how.
Unauthorized third parties may attempt to copy or obtain and use the technology
protected by those rights. Any infringement of our intellectual property could
have a material adverse effect on our business, financial condition and results
of operations. Policing unauthorized use of our products is difficult and
costly, particularly in countries where the laws may not protect our proprietary
rights as fully as in the United States.
We have received a notice from a third party alleging that our use of the
ViryaNet Service Hub name infringes on this third party's trademark rights. We
have responded and denied this claim and we are currently negotiating with such
third party. We cannot predict whether this dispute will settle successfully,
whether this third party would prevail in any claims brought against us, whether
other third parties will assert claims of infringement against us, or whether
any past or future assertions or prosecutions will harm our business. If we are
forced to defend against this claim or any other claims, whether they are with
or without merit or determined in our favor, then we may face costly litigation,
diversion of management resources or, if any claims prevail, damages or
significant increases in development or marketing costs.
We have placed, and in the future may place, our software in escrow. The
software may, under specified circumstances, be made available to our clients.
We have provided our software directly to clients. This may increase the
likelihood of misappropriation or other misuse of our software.
Substantial litigation over intellectual property rights exists in the
software industry. We expect that software products may be increasingly subject
to third-party infringement claims as the functionality of products in different
industry segments overlaps. We believe that many industry participants have
filed or intend to file patent and trademark applications covering aspects of
their technology. We cannot be certain that they will not make a claim of
infringement against us based on our products and technology. Any claims, with
or without merit, could:
. be expensive and time-consuming to defend;
. cause product shipment and installation delays;
. divert management's attention and resources; or
. require us to enter into royalty or licensing agreements to obtain the
right to use a necessary product or component.
Royalty or licensing agreements, if required, may not be available on acceptable
terms, if at all. A successful claim of product infringement against us and our
failure or inability to license the infringed or similar technology could have a
material adverse effect on our business, financial condition and results of
operations.
7
Marketing and distributing our products outside of the United States may require
increased expenses and greater exposure to risks that we may not be able to
successfully address.
We market and sell our products and services in the United States, United
Kingdom, Israel and Japan. We received 26% of our total revenues in 1998, 24% of
our total revenues in 1999 and 25% of our total revenues in 2000 from sales to
customers located outside of the United States. The expansion of our existing
operations and entry into additional international markets will require
significant management attention and financial resources. We have limited
experience in developing localized versions of our products and marketing and
distributing our products outside of the United States. We are subject to a
number of risks customary for international operations, including:
. changing product and service requirements in response to the formation
of economic and marketing unions, including the European Economic
Union;
. economic or political changes in international markets;
. greater difficulty in accounts receivable collection and longer
collection periods;
. unexpected changes in regulatory requirements;
. difficulties and costs of staffing and managing foreign operations;
. the uncertainty of protection for intellectual property rights in some
countries;
. multiple and possibly overlapping tax structures; and
. currency and exchange rate fluctuations.
We are likely to require additional financing and may not be able to raise
additional financing on favorable terms or at all.
We currently anticipate that our current cash and cash equivalents will be
sufficient to meet our anticipated needs for our business operations through at
least the next 12 months. Subsequently, we are likely to require additional
funding for our business operations and can provide no assurance that we will be
able to raise such additional funding on favorable terms or at all. If we raise
additional funds through the issuance of equity or convertible debt securities,
the percentage ownership of our stockholders will be reduced, and these newly-
issued securities may have rights, preferences or privileges senior to those of
existing stockholders. We cannot assure you that additional financing will be
available on terms favorable to us, or at all. If adequate funds are not
available or are not available on acceptable terms, our ability to fund our
operations, take advantage of unanticipated opportunities, develop or enhance
our site content, features or services, or otherwise respond to competitive
pressures would be significantly limited.
The market price of our ordinary shares may be volatile and you may not be able
to resell your shares at or above the price you paid, or at all.
The stock market in general has recently experienced extreme price and
volume fluctuations. The market prices of securities of technology companies,
particularly internet-related companies, have been extremely volatile, and have
experienced fluctuations that have often been unrelated or disproportionate to
the operating performance of those companies. These broad market fluctuations
could adversely affect the market price of our ordinary shares. The market price
of the ordinary shares may fluctuate substantially due to a variety of factors,
including:
. any actual or anticipated fluctuations in our financial condition and
operating results;
. public announcements concerning us or our competitors, or the
internet industry;
. the introduction or market acceptance of new service offerings by us
or our competitors;
. changes in security analysts' financial estimates;
8
. changes in accounting principles;
. sales of our ordinary shares by existing shareholders; and
. the loss of any of our key personnel.
In the past, securities class action litigation has often been brought
against companies following periods of volatility in the market prices of their
securities. We may be the target of similar litigation in the future. Securities
litigation could result in substantial costs and divert our management's
attention and resources, which could cause serious harm to our business.
Future sales of our ordinary shares in the public market or issuances of
additional securities could cause the market price for our ordinary shares to
fall.
As of March 15, 2001, we had 21,709,673 ordinary shares outstanding and have
reserved an additional 6,400,000 ordinary shares for issuance under our option
plans and outstanding warrants, with an additional 1,000,000 ordinary shares for
issuance under our option plans pending shareholder approval. If a large number
of our ordinary shares are sold, the price of our ordinary shares would likely
decrease.
We may continue to issue warrants to some of our customers, and the issuance
of these securities could be dilutive to our shareholders. These warrants will
be valued using the Black-Scholes method when they are issued, and we will
reflect appropriate charges in our financial statements at that time.
Our executive officers, directors and affiliated entities will be able to
influence matters requiring shareholder approval and they may disapprove actions
that you voted to approve.
As of March 15, 2001, our executive officers, directors and entities
affiliated with them, in the aggregate, beneficially owned approximately 25% of
our outstanding ordinary shares. These shareholders, if acting together, will be
able to significantly influence all matters requiring approval by our
shareholders, including the election of directors and the approval of mergers or
other business combination transactions
Any future acquisitions of companies or technologies may distract our management
and disrupt our business.
We may acquire or make investments in complementary businesses,
technologies, services or products if appropriate opportunities arise. We may
engage in discussions and negotiations with companies about our acquiring or
investing in those companies' businesses, products, services or technologies. We
cannot make assurances that we will be able to identify future suitable
acquisition or investment candidates, or if we do identify suitable candidates,
that we will be able to make the acquisitions or investments on commercially
acceptable terms or at all. If we acquire or invest in another company, we could
have difficulty assimilating that company's personnel, operations, technology or
products and service offerings into our own. The key personnel of the acquired
company may decide not to work for us. These difficulties could disrupt our
ongoing business, distract our management and employees, increase our expenses
and adversely affect our results of operations. We may incur indebtedness or
issue equity securities to pay for any future acquisitions. The issuance of
equity securities could be dilutive to our existing shareholders. We do not have
any agreement to enter into any material investment or acquisition transaction.
Risks Related to the Internet
Our business is dependent on the internet and if clients do not continue to use
the internet, our business will suffer.
Our market is relatively new and rapidly evolving. Our future success will
depend on the acceptance by clients of the internet and business-to-business
internet solutions as an integral part of their business model. Demand for and
market acceptance of recently introduced services are each subject to a high
level of uncertainty. If use of the internet does not continue to develop, or
develops more slowly than expected, we may not be able to execute our business
plan successfully.
9
The level of demand and acceptance of internet business-to-business services
may not increase for a number of reasons, including:
. inadequate network infrastructure and congestion of traffic on the
internet;
. actual or perceived lack of security of information;
. inconsistent quality of service;
. lack of availability of cost-effective, high-speed service;
. lack of access and ease of use;
. excessive governmental regulation; and
. uncertainty over intellectual property ownership.
We cannot assure you that the internet infrastructure will be able to
support expected growth or that the performance and reliability of the internet
will not decline as a result of this growth. Many internet sites have
experienced a variety of interruptions in their service as a result of outages
and other delays occurring throughout the internet network infrastructure. If
these outages or delays frequently occur in the future, internet usage could
grow more slowly than anticipated or even decline.
If acceptance and growth of the internet as a medium for business-to-
business commerce does not continue, our business strategy may not be successful
because there may not be a continuing market demand for our services. Any well-
publicized compromise of security could deter businesses from using the internet
to conduct transactions that involve transmitting confidential information.
Computer viruses that spread over the internet could disable or damage the
systems we develop for our clients. Decreased internet traffic as a result of
general security concerns or viruses could cause companies to reduce their
amount of technology spending, which could hurt our results of operations.
Risks Related to Our Location in Israel
It may be difficult to effect service of process and enforce judgments against
directors, officers and experts in Israel.
We are organized under the laws of the State of Israel. Many of our
executive officers and directors and some of the experts named in this annual
report are nonresidents of the United States, and a substantial portion of our
assets and the assets of these persons are located outside the United States.
Therefore, it may be difficult to enforce a judgment obtained in the United
States against us or any of those persons. It may also be difficult to enforce
civil liabilities under United States federal securities laws in actions
instituted in Israel.
Political, economic and military conditions in Israel could negatively impact
our business.
Our principal research and development facilities are located in Israel. We
are directly influenced by the political, economic and military conditions
affecting Israel. 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, which varies in degree and intensity, has caused
security and economic problems in Israel. Any major hostilities involving Israel
or the interruption or curtailment of trade between Israel and its present
trading partners could adversely affect our operations. We cannot assure you
that ongoing or revived hostilities related to Israel will not have a material
adverse effect on us or our business and on our share price. Several Arab
countries still restrict business with Israeli companies and these restrictions
may have an adverse impact on our operating results, financial condition or the
expansion of our business. We could be adversely affected by restrictive laws or
policies directed towards Israel and Israeli businesses. Despite the progress
towards peace between Israel and its Arab neighbors, the future of these peace
efforts is uncertain. In addition, since October 2000, there has been a
significant increase in violence, primarily in the West Bank and Gaza Strip.
Generally, all male adult citizens and permanent residents of Israel under
the age of 51 are, unless exempt, obligated to perform up to 36 days of military
reserve duty annually. Additionally, all Israeli residents of this age are
subject to being
10
called to active duty at any time under emergency circumstances. Many of our
officers and employees are currently obligated to perform annual reserve duty.
Although we have operated effectively under these requirements since we began
operations, we cannot assess the full impact of these requirements on our
workforce or business if political and military conditions should change, and we
cannot predict the effect on us of any expansion or reduction of these
obligations.
We may be adversely affected if the rate of inflation in Israel exceeds the rate
of devaluation of the new Israeli shekel against the dollar.
Most of our revenues are in dollars or are linked to the dollar, while a
substantial portion of our expenses, principally salaries and the related
personnel expenses, are in new Israeli shekels, or NIS. As a result, we are
exposed to the risk that the rate of inflation in Israel will exceed the rate of
devaluation of the NIS in relation to the dollar or that the timing of this
devaluation lags behind inflation in Israel. This would have the effect of
increasing the dollar cost of our operations. In 1998, the rate of devaluation
of the NIS against the dollar exceeded the rate of inflation, a reversal from
prior years. However, in 1999 and in 2000, while the rate of inflation was low,
there was a devaluation of the dollar against the NIS. We cannot predict any
future trends in the rate of inflation in Israel or the rate of devaluation of
the NIS against the dollar. If the dollar cost of our operations in Israel
increases, our dollar-measured results of operations will be adversely affected.
The tax benefits available to us from government programs may be discontinued or
reduced at any time, which would likely increase our taxes.
We have received grants in the past and receive tax benefits under Israeli
government programs. To maintain our eligibility for these programs and
benefits, we must continue to meet specified conditions, including making
specified investments in fixed assets from our equity. Some of these programs
restrict our ability to manufacture particular products or transfer particular
technology outside of Israel. If we fail to comply with these conditions in the
future, the benefits received could be canceled and we could be required to
refund any payments previously received under these programs or pay increased
taxes. The government of Israel has reduced the benefits available under these
programs recently and these programs and tax benefits may be discontinued or
reduced in the future. In May 2000, the Israeli government approved in principle
a tax reform proposal that would reduce or eliminate some of these benefits in
the future. Legislation will be required to implement these changes, and we are
not certain whether legislation will be enacted. If these tax benefits and
programs are terminated or reduced, we could pay increased taxes in the future,
which could decrease our profits.
Our United States investors could suffer adverse tax consequences if we are
characterized as a passive foreign investment company.
We cannot assure you that we will not be treated as a passive foreign
investment company in 2001 or in future years. We would be a passive foreign
investment company if (i) 75% or more of our gross income in a taxable year,
including the pro rata share of the gross income of any company, US or foreign,
in which we are considered to own 25% of the shares by value, is passive income,
or (ii) at least 50% of the average value (or possibly the adjusted bases of our
assets in particular circumstances) of our assets, including the pro rata share
of the assets of any company in which we are considered to own 25% of the shares
by value, in a taxable year produce, or are held for the production of, passive
income. Passive income includes interest, dividends, royalties, rents and
annuities. If we are or become a passive foreign investment company, many of you
will be subject to adverse tax consequences, including:
. taxation at the highest ordinary income tax rates in effect during
your holding period on some distributions on our ordinary shares and
gain from the sale or other disposition of our ordinary shares;
. paying interest on taxes allocable to prior periods; and
. no increase in the tax basis of our ordinary shares to fair market
value at the date of your death.
11
ITEM 4. INFORMATION ON OUR COMPANY
History and Development
Both our legal and commercial name is ViryaNet Ltd. We were incorporated
and registered in Israel on March 13, 1988 under the Israeli Companies Ordinance
- -- 1984, as a private limited company, under the name R.T.S. Relational
Technology Systems Ltd. We changed our name to RTS Business Systems Ltd. on
September 7, 1997 and to RTS Software Ltd. February 1, 1998. On April 12, 2000,
we changed our name to ViryaNet Ltd. The principal legislation under which we
operate is the Israeli Companies Law - 1999.
Our registered office is located at 5 Kiryat Hamada Street, Science Based
Industries Campus, P.O. Box 23052, Har Hotzvim, Jerusalem, 91230, Israel and our
telephone number is 972-2-581-1462. We have appointed our United States
subsidiary, ViryaNet, Inc., located at 2 Willow Street, Southborough,
Massachusetts 01745-1027 as our agent for service of process.
In 1995, we introduced Service Suite, a collection of four client/server-
based field service management applications. From 1995 to 1999, we focused on
selling these enterprise solutions to global, enterprise 1000 organizations.
With the Service Suite applications, organizations were able to better manage
their supply chain, contracts, workforce and repair businesses.
During the fourth quarter of 1999, we introduced ViryaNet Service Hub, an
internet-architected service business platform, on which service organizations
integrate their service applications and databases and interact with the various
members of their service community, including mobile field engineers, customers,
partners and vendors.
We transferred the functionalities found in our Service Suite applications
to the ViryaNet Service Hub platform. We also introduced new capabilities into
the product, taking advantage of the flexibility, ease of use and pervasive
adoption of the internet.
We market our new internet-based solution primarily to the
telecommunication, utilities, high technology, and industrial automation
industries. ViryaNet Service Hub focuses on helping these organizations better
manage their workforce as part of their total operational support systems
initiatives. Our new ViryaNet Service Hub for wireless workforce management
solution gained early acceptance by the service industry, winning a "best-of-
show" product award at the Field Service Solutions 2000 conference.
Since ViryaNet Service Hub's introduction, we have issued three major
enhancement releases. Our latest version, ViryaNet Service Hub 4, was released
on January 2, 2001.
Our principal capital expenditures for each of fiscal 2000, 1999 and 1998
have been for computer equipment and software, for which we spent approximately
$1.8 million, $0.8 million and $0.5 million in each respective year.
Business Overview
We develop, market and support software products that provide companies
with wireless workforce management solutions for their service communities.
Service communities encompass all participants in the service management and
delivery process, including service organizations, their field engineers,
customers, partners, vendors and suppliers. To capitalize on the opportunity
offered by the internet, service organizations need solutions that support
complex service delivery requirements while enabling collaboration of the
service community to achieve high-quality and cost effective service delivery.
Our solution is designed to meet the needs of service organizations of
companies with service commitments, as well as third-party service providers who
fulfill these commitments on an outsourced basis, by offering real-time
12
management and collaboration of the entire service community. Our solutions
include workforce management, service level agreement management, customer self-
service, repair return automation and auction-based procurement and
replenishment.
We have developed and sold a suite of flexible and scalable software
products for the management of service operations in organizations. These
service delivery chain management products, called Service Suite, help
organizations that provide field service to customers, develop proposals for and
track commitments under service contracts, manage inventory and field service
personnel, follow customer calls and generate accurate and detailed bills.
Service Suite customers of these products include EMC Corporation, GE Medical
Systems and Sun Microsystems.
Products
ViryaNet Service Hub
ViryaNet Service Hub, which was introduced in the fourth quarter of 1999,
is a business-to-business internet platform for service communities. ViryaNet
Service Hub unites an organization's service applications and allows its entire
service community - including customers, operations managers, field engineers,
suppliers, and subcontractors to conduct work and share information on service
related matters. Each component of ViryaNet Service Hub shares a consistent,
easy-to-use, browser-based graphical user interface. The components share a
common underlying technology architecture and a common data model that allows
them to work together and share information. The components are also universally
accessible, allowing employees to work anywhere using desktop or mobile
computers, mobile telephones, personal digital assistants (PDAs) or other
handheld devices.
As the ViryaNet application platform, ViryaNet Service Hub supports a
robust suite of ViryaNet solutions that improve an organization's service
delivery and enhance its revenue opportunities such as management of service
contracts, entitlement tracking, availability of service or spare parts,
inventories, shipping, call dispatch and tracking, administration of field
service personnel, repair depot operations, pricing and invoicing.
ViryaNet Service Hub contains the following key elements:
Service Portal
--------------
Service Portal is a personalized gateway that allows internal users as well
as customers, field employees and external partners, suppliers and vendors to
interface with ViryaNet Service Hub using the internet. Service Portal, when
used with the other components of ViryaNet Service Hub, allows users to access
service information in real time, share documents, collaborate with other users
and obtain service. Service Portal is designed to be seamlessly integrated with
other corporate portals of an organization. Service Portal allows the creation
of users' profiles and includes a registration process that enables ViryaNet
Service Hub to categorize the user and determine for security and efficiency
purposes the scope of access and use of the system that is permitted for that
user. Commonly used internet-based collaboration capabilities, including chat,
forums and customer feedback are facilitated through Service Portal. Using a
standard browser, each user can configure a customized display of active
monitors, graphs and notification queues. A user can subscribe to a variety of
information sources from enterprise knowledge bases and receive updates on a
timely basis.
mService Gateway
---------------
mService Gateway provides mobile users, like field engineers, with remote
access to ViryaNet Service Hub and its applications and data. With mService
Gateway, field engineers can acknowledge being dispatched to a customer service
location through a variety of mobile devices like PalmOS and WindowsCE personal
digital assistants, web-enabled telephones, and I-mode Docomo telephones, which
are dominant in Japan. Once dispatched, engineers can view their work orders,
report work that they have done on service requests, create part activity
reports, create new tasks to be performed in the context of a request, request
that assistance be provided to complete the new tasks and create new service
requests. These actions can be sent to the ViryaNet Service Hub through the
mService Gateway if the mobile device has an internet connection. If the device
has no immediately-available internet connection, the transactions can be stored
locally and transferred to the ViryaNet Service Hub through the mService Gateway
the next time the device is connected to the internet. Through our arrangement
with AvantGo, a provider of mobile infrastructure software and services, we plan
to resell the AvantGo Enterprise product integrated with mService Gateway. This
bundled solution is designed to enable field service technicians to remotely
process data from a wide range of enterprise applications using a variety of
wireless and remote devices that support the AvantGo browser.
13
Service Intelligence
--------------------
Service Intelligence allows users to analyze service operations and
facilitates the production of related reports. Service Intelligence is based on
a collection of key performance indicators that track data on the basis of
criteria like financial trends, service performance, service rates, revenue and
cost per product type. It further allows companies to define their own
performance indicators, monitors and reports, and create graphs and charts. For
each key performance indicator and monitor, a user can determine the data
thresholds that the system must control and the alerts or messages that the
system must send out to appropriate members of the service community.
Service Engine
--------------
Service Engine contains the shared business definitions and rules used by
Service Suite, Service Process and Service Intelligence.
Integration Server
------------------
Integration Server uses application program interfaces (APIs) that
integrate ViryaNet Service Hub with the customer's other applications, including
enterprise resource planning (ERP) applications, customer relationship
management (CRM) applications, data warehouses and other commonly used service
applications. Through Integration Server, users of ViryaNet Service Hub can
directly access applications and databases required to provide comprehensive
customer service.
We have used our generic APIs to build specific interfaces to industry-
leading applications from such vendors as MetaSolv Software, Remedy and
ClickSoftware.
Service Process
---------------
Service Process includes a set of applications, created using Java
technology, which is based on our extensive knowledge of commonly used service
business processes. Applications available today include:
. Wireless WorkForce Management, which provides service processes to
accommodate an organization's full range of workforce activities, from
the receipt of the service request and deployment and monitoring of
field staff, to the collection of vital service data and closing of
the work order; and
. Mobile FE, which works with the wireless support of mService Gateway
to extend workforce management to mobile field engineers using
wireless devices like mobile computers, mobile telephones and PDAs.
Service Suite
-------------
We also provide a suite of client-server enterprise applications for
managing service delivery, which enables service organizations to automate many
of the processes required for service fulfillment. These applications include:
. Service Contract, which provides comprehensive and flexible contract
management;
. Depot Repair, which manages high volume depot repair operations; and
. Service Supply Chain, which manages the service logistics
infrastructure.
Each module within Service Suite can be installed independently or with
other elements of ViryaNet Service Hub. These modules were designed to work in
either a traditional client/server environment or an internet architecture.
Products Under Development
--------------------------
We are in the process of developing the following functionality for
ViryaNet Service Hub:
. Improving support for application service providers to allow the
service organization of multiple companies to be deployed from a
single ViryaNet Service Hub installation. This functionality has been
designed and will be
14
implemented later in 2001. We expect that this effort will not require
significant development resources before its commercial release.
. Extending our service process to include new return material
authorization (RMA) and repair functionality, based upon our
capability and functionality found in the ViryaNet Service Suite
product.
. Extending our concept of managing service communities to service
trading web sites. These trading web sites will enable vendors to bid
for services and parts in auctions. We plan to integrate services from
those sites into our customer's business processes, as well as
participate in the formation of service web trading communities. We
expect that this effort will not require significant development
resources before its commercial release.
Since the introduction of ViryaNet Service Hub in the fourth quarter
of 1999, we have licensed our internet-based solution to, among others, BGE
HOME, Broadwing, ITC Deltacom, Symbol, Teraoka Seiko, Citizens Communications
and Switch and Data Facilities Corporation.
During the year, we formed strategic alliances with world-class system
integration, consulting, and reseller organizations, such as Cap Gemini Ernst &
Young, Akili, CTG, Omron Alphatec and ClickSoftware, leveraging their industry
presence and complementing our own direct sales channels.
Our revenues are derived mainly from the licensing of our software and
from maintenance and services which we provide. The following table describes,
for the periods indicated, the percentage of revenues represented by each of the
items on our consolidated statements of operations:
Year Ended December 31,
1998 1999 2000
-------- ------- ------
Revenues:
Software licenses...................... 13.3% 27.0% 62.8%
Maintenance and services............... 86.7 73.0 37.2
----- ----- -----
Total revenues....................... 100.0 100.0 100.0
The following table summarizes the revenues from our products and services
by country, stated as a percentage of total revenues for the periods indicated.
Year Ended December 31,
Country 1998 1999 2000
------- ---- ---- ----
United States 74% 76% 75%
United Kingdom 22 19 6
Japan 4 5 19
--- --- ---
Total 100% 100% 100%
=== === ===
We target companies in the high technology, telecommunications, utilities
and industrial automation industries that have extensive service commitments and
complex products, strong commitments to customer satisfaction and an internet
presence.
We have a number of aggressive marketing programs to increase our market
presence and awareness of our product benefits. We also emphasize and use a
variety of lead generation programs. Our goal in 2001 is to broaden our
awareness to other industries. Within some of the industries listed, we also
plan on introducing our solution offering to organizations which employ between
25 and 100 field engineers.
Our sales and marketing staff consists of professionals in a variety of
fields, including marketing and media relations, direct sales, technical sales
consultants, product management, advertising and business management consulting.
As of December 31, 2000, we employed 52 sales, marketing and business
development personnel. The majority of our sales personnel operate through our
United States subsidiary and the balance operate through our United Kingdom and
Japan subsidiaries. Our United Kingdom subsidiary is responsible for sales and
marketing in Europe.
15
Although the majority of our sales have resulted from using our own
marketing lead generation and direct sales, we have entered into several
marketing partnership agreements with Akili, Cap Gemini Ernst & Young, Omron
Alphatec, CTG, MetaSolv and Symbol.
Cap Gemini Ernst & Young, Akili, Omron Alphatec, and CTG provide consulting
and implementation services; MetaSolv provides order management and service
fulfillment solutions; and Symbol provides handheld computers and scanner
devices.
We expect to benefit from marketing programs and leads generated by these
partners, as well as cooperation from the sales forces of these partners in
sales opportunities identified by them. We intend to expand our marketing and
implementation capacity through the use of third parties, including systems
integrators, vendors of complementary products and providers of service
applications. By employing third parties in the marketing and implementation
process, we expect to enhance sales by taking advantage of the market presence
of these third parties and devote more resources to making additional sales and
reduce the cost of each sale.
We also intend to explore and establish indirect sales channels through
relationships with additional resellers who offer complementary products and
application service providers. Resellers will be primarily used to sell special
versions of our product configured for specific market targets, to be combined
with their complementary products.
Application service providers will be used to provide our product to
customers who wish to avoid the initial cost of our product combined with the
required hardware platforms and infrastructure investments. Through an
application service provider, customers will be billed a monthly rental or
subscription fee. We believe that this application service provider channel will
be effective for reaching segments of the market for which the higher costs of a
direct sales channel are not appropriate.
We have created an alliances and partnership team to work with our business
partners, including systems integrators, complementary product vendors and
application service providers.
Organizational Structure
We are organized under the laws of the State of Israel. We are the parent
company of our wholly owned operating subsidiaries which are specified in the
table below.
Name of Subsidiary Country of Incorporation
ViryaNet Inc. United States of America
ViryaNet Europe Ltd. United Kingdom
ViryaNet Japan Japan
Property, Plants and Equipment
We do not own any real property. Our engineering and research and
development facilities are located in Jerusalem, Israel, where we occupy
approximately 16,950 square feet. The premises are leased under a lease
agreement which will terminate on December 31, 2002 with total annual rent of
approximately $276,200.
Our subsidiary located in the United States leases approximately 13,807
feet in Southborough, Massachusetts which is utilized primarily for
administrative, marketing, sales, service and technical support purposes. We
relocated our United States headquarters to Southborough, Massachusetts in May
2000. The premises are leased under a lease agreement which will expire in 2005
with total annual rent of approximately $331,000. In addition, our subsidiary
located in the United States leases an aggregate of 2000 square feet of office
space in Atlanta, Georgia, Plano, Texas, Dublin, California, and Huntington
Beach, California primarily used for sales purposes, which expire at various
dates through 2002 with a total annual rent of approximately $190,000. Our
subsidiary located in the United Kingdom leases approximately 2734 square feet
in Hemel Hempsted, under a lease agreement which will expire in December 2006
with a total annual rent of approximately $71,000, and our subsidiary in Japan
leases approximately 2110 square feet under a lease agreement which will expire
on June 30, 2001 with a total annual rent of $94,000 approximately.
16
We believe that these facilities are adequate to serve our current needs.
However, if we expand our operations in the future, we may need additional space
in Israel and abroad.
ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS
YOU SHOULD READ THE FOLLOWING DISCUSSION AND ANALYSIS IN CONJUNCTION WITH ITEM 3
"SELECTED FINANCIAL DATA" AND OUR CONSOLIDATED FINANCIAL STATEMENTS AND NOTES
THERETO INCLUDED ELSEWHERE IN THIS ANNUAL REPORT. IN ADDITION TO HISTORICAL
INFORMATION, THE FOLLOWING DISCUSSION CONTAINS CERTAIN FORWARD-LOOKING
STATEMENTS THAT INVOLVE KNOWN AND UNKNOWN RISKS AND UNCERTAINTIES, SUCH AS
STATEMENTS OF OUR PLANS, OBJECTIVES, EXPECTATIONS AND INTENTIONS. SEE
"CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS."
Overview
We develop, market and support wireless workforce management solutions for
field service communities. These solutions enable field service organizations to
schedule and dispatch field service personnel efficiently; capture and record
logistics and labor activity; and monitor, report, and measure this activity
meeting an organization's installation, preventative maintenance, and break-fix
obligations. Our wireless workforce management solution supports wireless
devices over standard wireless networks.
We were founded in 1988. Through 1997, we generated revenue primarily from
the sale of customized systems for customer service and product support and
related services, and invested relatively few resources in developing software
products. In the first quarter of 1997, we began to develop standardized service
delivery chain management software. During 1997 and 1998, we intensified our
research and development activities and, in the second quarter of 1998, we
commercially released our service delivery chain management product, Service
Suite. Concurrently with the release, we began to build our direct sales force
and expand our marketing activities. In the fourth quarter of 1999, we
introduced our initial internet-based product, ViryaNet Service Hub.
Where We Derive Our Revenues
We derive revenues from licenses of our software products and from related
services, which include implementation, consulting, customer customization and
integration, post-contract customer support and training. Our products are
typically licensed directly to customers for a perpetual term. Before the first
quarter of 2000, all of our license revenues were derived from licenses of
Service Suite products. In the first quarter of 2000, we also started to
recognize revenues relating to licenses and implementation of ViryaNet Service
Hub. We bill customers according to contract terms. Amounts collected from
customers in excess of revenues recognized are recorded as deferred revenue.
How We Recognize Revenue
We recognize license and services revenues on contracts involving
significant implementation or customization by us using the percentage-of-
completion method. We classify revenue from these arrangements as license and
service revenues based on the estimated fair value of each element. Provision
for estimated contract losses are recognized in the period in which the loss
becomes probable and can be reasonably estimated. License revenues on contracts
that do not involve significant implementation or customization by us are
recognized, under Statement of Position No. 97-2, when persuasive evidence of an
arrangement exists, the fee is fixed and determinable, collection is probable
and delivery has occurred. Where software arrangements involve multiple
elements, revenue is allocated to each element based on vendor-specific
objective evidence of the relative fair values of each element in the
arrangement. Our vendor-specific objective evidence used to allocate the sales
price to professional services and maintenance is based on the price charged
when these elements are sold separately. License revenues are recorded based on
the residual method according to SOP 98-9, Modification of SOP 97-2, Software
Revenue Recognition, for certain transactions. Under the residual method,
revenue is recognized for the delivered elements when (1) there is vendor-
specific objective evidence of the fair values of all the undelivered elements,
(2) vendor-specific objective evidence of fair value does not exist for one or
more of the delivered elements in the arrangement, and (3) all revenue
recognition criteria of the amended SOP 97-2 are satisfied. Under the residual
method, any discount in the arrangement is allocated to the delivered element.
17
Service revenues from professional services and training are recognized as
these services are performed. Service revenues from post-contract maintenance
services are recognized pro-rata over the contractual support term, generally
one year.
Effective January 1, 2000, we adopted the new guidelines on revenue
recognition as described in Staff Accounting Bulletin No. 101 "Revenue
Recognition in Financial Statement" of the Securities and Exchange Commission
(the "SEC") in December 1999. This adoption did not have a significant effect on
our consolidated results of operations or financial position.
How We Sell Our Products
We sell our products through our direct sales force, and expand our sales
efforts through relationships with system integrators and vendors of
complementary products. Our revenues are derived from customers in the United
States, United Kingdom, Japan and Israel. We price our products based on the
market conditions in each jurisdiction where we operate.
A significant portion of our revenues has been derived from a small number
of relatively large companies. For the years 1998, 1999, and 2000 respectively,
we derived 55%, 55% and 9% of our revenues from two customers, Sun Microsystems
and GE Medical, who are shareholders or warrant holders. In 1999, 71% of our
revenues were derived from four clients, including Sun Microsystems and GE
Medical, and no one customer accounted for more than 33% of our revenues. In
2000, two customers each accounted for approximately 11% of our revenue and
represented an aggregate of 23% of our total revenues. We do not expect that
these customers will represent a substantial percentage of our revenues in the
future. However, we do expect that a significant portion of our future revenues
will continue to be derived from a relatively small number of customers. We
expect this portion to decrease as a percentage of our total revenues.
Our Reporting Currency
Our reporting currency is the United States dollar. Transactions and
balances of subsidiaries whose functional currency is not the dollar have been
translated to dollars under the principles described in Financial Accounting
Standards Board Statement No. 52. Assets and liabilities have been translated at
period-end exchange rates. Results of operations have been translated at average
exchange rates. As the exchange gains and losses arising from these translations
are immaterial, they are recorded as financial expenses.
Stock-Based Compensation
Through December 31, 2000, we have recorded unearned stock compensation
related to stock option grants to our employees and consultants totaling $2.8
million, of which $0.6 million remains to be amortized through 2005. This amount
represents the difference between the exercise price and the estimated fair
value of our ordinary shares on the date these stock options were granted. This
amount is included as a component of shareholders' equity and is being amortized
by charges to operations over the vesting period of the options, consistent with
the method described in Accounting Principles Board Opinion No. 25 and Statement
of Financial Accounting Standards No. 123 and EITF 96-18. We recorded
amortization of unearned stock compensation of $250,000, $798,000 and $1,104,000
in 1998, 1999, and 2000, respectively. The amortization of stock compensation is
classified as a separate component of operating expenses in our consolidated
statement of operations.
Initial Public Offering and Private Placements
In September 2000, we completed our initial public offering. In this
offering, we raised gross proceeds of $32 million, issuing 4 million ordinary
shares at a price of $8 per share.
In February and March 2000, some of our shareholders loaned us an aggregate
of $5.0 million. These convertible loans converted into the convertible
debentures issued in April 2000 as described below. These shareholders were also
issued warrants to purchase up to an aggregate of 124,999 ordinary shares at an
exercise price of $4.56 per share. The warrants, which may be exercised until
the earlier of five years from the date of issuance, a merger of ViryaNet, or
the sale of all or substantially all of our shares or assets were valued at
$505,000. In April 2000, we issued convertible debentures to three additional
investors in an aggregate amount of $11.0 million.
18
All of the convertible debentures bore annual interest at the London
interbank offered rate plus 2%. On the date of our initial public offering, all
of the convertible debentures, including unpaid interest, were automatically
converted into 3,343,885 ordinary shares reflecting a conversion price of $4.80
per share, a discount of 40% of the price per share of the initial public
offering. In September 2000, we recorded a one-time financing expense of
approximately $16.6 million.
Operating Results
The following table describes, for the periods indicated, the percentage of
revenues represented by each of the items on our consolidated statements of
operations:
Year Ended December 31,
----------------------
1998 1999 2000
------- -------- -------
Revenues:
Software licenses......................... 13.3% 27.0% 62.8%
Maintenance and services.................. 86.7 73.0 37.2
------- -------- -------
Total revenues.......................... 100.0 100.0 100.0
Cost of revenues:
Software licenses......................... 1.1 6.0 3.5
Maintenance and services.................. 71.8 63.1 28.9
------- -------- -------
Total costs of revenues................. 72.9 69.1 32.4
Gross profit................................. 27.1 30.9 67.6
Operating expenses:
Research and development, net............. 39.3 43.4 26.7
Sales and marketing....................... 65.5 85.7 60.4
General and administrative................ 19.2 22.3 14.2
Amortization of deferred stock
compensation............................ 1.8 5.0 4.1
------- -------- -------
Total operating expenses................ 125.8 156.4 105.4
Operating loss............................... (98.7) (125.5) (37.8)
Financial income (expenses), net............. 1.7 (3.6) 0.1
------- -------- -------
Financial expenses related to beneficial
conversion feature of convertible
debenture................................. (61.1)
-------
Net loss..................................... (97.0) (129.2) (98.8)
======= ======== =======
Preferred shares deemed dividend............. (0.5) (1.9) -
======= ======== =======
Net loss to shareholders of ordinary
shares.................................... (97.5)% (131.1)% (98.8)%
------- -------- -------
Geographic Distribution
While our products are sold in specified countries, the implementation of
these products may be performed for global clients on a worldwide basis. The
following table summarizes the revenues from our products and services by
country, stated as a percentage of total revenues for the periods indicated.
Year Ended December 31,
-----------------------
Country 1998 1999 2000
- ------- ---- ---- ----
United States................ 74% 76% 75%
United Kingdom............... 22 19 6
Japan........................ 4 5 19
---- ---- ----
Total........................ 100% 100% 100%
---- ---- ----
19
Comparison of Fiscal Years Ended December 31, 1999 and 2000
Revenues
Total revenues increased 72% from $15.8 million in 1999 to $27.1 million in
2000.
Software Licenses. Software licenses revenues consist of licenses of our
software as well as third-party software. Third-party software consists of
software that is either embedded in our software or enhances the functionality
of our software. We resell third-party software to our customers at margins that
are lower than margins that we earn on our software. Software licenses revenues
increased 299% from $4.3 million in 1999 to $17.0 million in 2000. This increase
was primarily attributable to software licenses revenues recognized from
contracts with five customers that accounted for $8.6 million of revenues and
additional customers that accounted for the remainder of the revenues.
Maintenance and Services. Maintenance and services revenues consist of
consulting, implementation, customization and integration, post-contract
customer maintenance, and training. Our maintenance and services revenues
decreased 13% from $11.5 million in 1999 to $10.1 million in 2000. This decrease
was primarily due to a reduction in customization and implementation services of
approximately $1.9 million from 1999 to 2000. This decrease was partially offset
by increases in maintenance revenues of approximately $500,000. Maintenance and
services revenues comprised 73% of our revenues in 1999 and 37% in 2000. This
decrease was a result of our efforts to increase sales of software licenses and
because the implementation of our products requires less customization.
Cost of Revenues
Total cost of revenues decreased 20% from $10.9 million in 1999 to $8.8
million in 2000.
Software Licenses. Cost of software licenses revenues consists primarily of
payments to third parties for our reselling of their software. Software licenses
costs decreased 1% from $952,000 in 1999 to $938,000 in 2000. Cost of software
licenses as a percentage of revenues from software licenses declined from 22% in
1999 to 6% in 2000. This decline was primarily due to a contract with one client
in 1999 that involved an unusually large component of third-party software.
Maintenance and Services. Cost of maintenance and services revenues
consists primarily of salaries and facility costs. Maintenance and service costs
decreased 21% from $10.0 million in 1999 to $7.9 million in 2000. This decrease
resulted primarily from streamlining of support and training personnel.
Maintenance and services costs as a percentage of related maintenance and
services revenues was 87% in 1999 and 78% in 2000. The decrease in maintenance
and services costs as a percentage of maintenance and services revenues resulted
primarily from the personnel reductions which we implemented in the fourth
quarter of 1999. While we expect that we will incur maintenance and services
costs in 2001 higher than the levels expended in 2000, we also expect to adjust
these expenses according to the needs of our business.
Operating Expenses
Research and Development, Net. Research and development, net includes costs
relating to the development of our products. These costs consist primarily of
employee salaries and benefits, facilities costs, and the cost of consulting
resources that supplement our internal development team. Due to the relatively
short time between the date our products achieve technological feasibility and
the date they generally become available to customers, costs subject to
capitalization under SFAS No. 86 have been immaterial and have been expensed as
incurred. Research and development, net expenses increased 5% from $6.9 million
in 1999 to $7.2 million in 2000. This increase was attributable to the increase
of personnel costs due to the hiring of new personnel for our ongoing
development efforts. We expect that we will continue to devote substantial
resources to research and development. While we expect that we will incur
research and development expenses in 2001 similar to the levels expended in
2000, we also expect to adjust these expenses according to the needs of our
business.
Sales and Marketing. Sales and marketing expenses consist of salaries,
commissions, field office expenses, travel and entertainment, promotional
expenses, and facility costs. Sales and marketing expenses increased 21% from
$13.5 million in 1999 to $16.4 million in 2000. This increase of $2.9 million
was attributable to increase in personnel costs of
20
$1.3 million and increase in marketing programs that amounted to $1.6 million.
While we expect that we will incur sales and marketing expenses in 2001 similar
to the levels expended in 2000, we also expect to adjust these expenses
according to the needs of our business.
General and Administrative. General and administrative expenses consist of
salaries for administrative, executive and finance personnel, information system
costs, professional services, and allocated facilities costs. These costs
increased 10% from $3.5 million in 1999 to $3.9 million in 2000. This increase
was attributable to increases in personnel expenses. While we expect that we
will incur general and administrative expenses in 2001 similar to the levels
expended in 2000, we also expect to adjust these expenses according to the needs
of our business.
Amortization of Stock-Based Compensation. Amortization of stock-based
compensation includes the amortization of unearned employee stock-based
compensation and expenses for stock granted to consultants in exchange for
services. Stock-based compensation expense is amortized over the vesting
schedule of the option, typically four years, using the straight line approach.
With the grant of some stock options, we recorded aggregate unearned stock-based
compensation expense of $2.8 million through December 31, 2000. Stock-based
compensation included in operating expenses totaled $798,000 in 1999 and $1.1
million in 2000.
Financial Income and Financial Expenses. Net financial expenses were
$565,000 in 1999 compared to net financial income of $26,000 in 2000. In 1999
and 2000, financial expenses were $641,000 and $589,000 respectively and
financial income was $76,000 and $615,000 respectively. The interest expense
resulted from interest expenses from the use of bank lines of credit and the
interest income resulted from interest earned on our cash and cash equivalents'
balances.
Comparison of Fiscal Years Ended December 31, 1998 and 1999
Revenues
Total revenues increased 17% from $13.5 million in 1998 to $15.8 million in
1999.
Software Licenses. Software licenses revenues increased 137% from $1.8
million in 1998 to $4.3 million in 1999. This increase was primarily
attributable to software licenses revenues recognized from contracts with two
major customers that accounted for $3.0 million in 1999 compared to $424,000 in
1998. For the years 1998 and 1999 respectively, revenues from licenses of third-
party software were 16% and 30% of total software licenses revenues.
Maintenance and Services. Our maintenance and services revenues decreased
2% from $11.7 million in 1998 to $11.5 million in 1999. The reason for the
decrease was a reduction in customization services of $1.9 million from 1998 to
1999. This decrease was offset by increases in revenues from other professional
services generated by the implementation of our software and by increases in
maintenance revenues. Service revenues from the implementation of our software
and post-contract maintenance increased by $1.7 million from 1998 to 1999.
Maintenance and services revenues comprised 87% of our revenues in 1998 and 73%
in 1999. This decrease was a result of our efforts to increase sales of software
licenses and limit the scope of projects involving significant customization.
Cost of Revenues
Total cost of revenues increased 11% from $9.9 million in 1998 to $10.9
million in 1999.
Software Licenses. Software licenses costs increased 552% from $146,000 in
1998 to $952,000 in 1999. This increase was primarily due to a contract with one
client in 1999 that involved a large component of third-party software.
Maintenance and Services. Maintenance and service costs increased 3% from
$9.7 million in 1998 to $10.0 million in 1999. This increase resulted primarily
from hiring and training additional consulting, support and training personnel
to support our growing client base. Maintenance and services costs as a
percentage of related maintenance and services revenues was 83% in 1998 and 87%
in 1999. The increase in maintenance and services costs as a percentage of
maintenance and services revenues resulted primarily from the additional costs
of our transition from providing customization services to two major clients to
providing implementation services to a larger number of clients.
21
Operating Expenses
Research and Development, Net. Research and development expenses increased
29% from $5.3 million in 1998 to $6.9 million in 1999. This increase in research
and development expenses was attributable to the increase of personnel costs due
to the hiring of new personnel for our ongoing development efforts.
Sales and Marketing. Sales and marketing expenses increased 53% from $8.9
million in 1998 to $13.5 million in 1999. The increase of $4.6 million for 1999
compared to 1998 was attributable to a $3.6 million increase in personnel
expenses and a $1.0 million increase in marketing costs.
General and Administrative. General and administrative costs increased 35%
from $2.6 million in 1998 to $3.5 million in 1999. This increase was
attributable to increases of $810,000 in personnel expenses and $230,000 in
professional services expenses.
Amortization of Stock-Based Compensation. Stock-based compensation included
in operating expenses totaled $250,000 in 1998 and $798,000 in 1999.
Financial Income and Financial Expenses. Financial income was $234,000 in
1998 compared to a financial expense of $565,000 in 1999. The financial income
in 1998 consists of interest income due to higher average cash and cash
equivalent and short-term investment balances over the period and higher income
from foreign currency re-measurement. The increase in financial expenses in 1999
resulted from interest expenses incurred from our bank lines of credit.
Liquidity and Capital Resources
How We Have Financed Our Business
We have primarily financed our operations through placements of our
ordinary and preferred shares and convertible debentures. Through December 31,
2000, gross proceeds from private placements of ordinary and preferred shares
and convertible debentures totaled $54.1 million. In September 2000, we
completed our initial public offering in which we raised gross proceeds of $32
million. At the initial public offering, all the preferred shares were converted
into ordinary shares. To a lesser extent, we have financed our operations
through short-term bank facilities and other financing arrangements. In March
1999 and January 2000, we issued warrants to purchase an aggregate of 286,956
ordinary shares to a subsidiary of Bank Hapoalim, at exercise prices ranging
from $4.60 to $5.75 per share. The warrants contained a cashless exercise
feature and were exercised by the bank at the time of the initial public
offering. During the first four months of 2000, we sold an aggregate of $16.0
million in principal amount of convertible debentures, bearing interest at the
London interbank offered rate plus 2%, payable on a quarterly basis starting in
April 2001. $5.0 million of the $16.0 million was received in February and March
2000 and $11.0 million was received in April 2000. On the date of our initial
public offering, all of the convertible debentures, including unpaid interest,
were automatically converted into 3,343,885 ordinary shares reflecting a
conversion price of $4.80 per share, a discount of 40% of the price per share of
the initial public offering.
Cash
As of December 31, 2000, we had cash and cash equivalents of $21.8 million
and we had a working capital of $21.1 million. As of December 31, 2000 we did
not have any long-term borrowings.
Net cash used in operating activities was $9.4 million in 1998, $13.1
million in 1999, and, $15.8 million in 2000. Net cash used in investing
activities was $944,000 in 1998, $931,000 in 1999 and $2.2 million in 2000.
Investing activities consisted primarily of purchases of computers and software.
Net cash provided by financing activities was $10.1 million in 1999, $15.4
million in 1999, and $38.2 million in 2000. Net cash provided by financing
activities consists primarily of net proceeds from the issuances of preferred
and ordinary shares as well as long term convertible debentures and, in 1999,
from a net increase in our short-term bank line of credit of $5.1 million. In
2000, the financing activities included a net decrease in our short-term bank
line of credit in the amount of $5.1 million.
22
Lines of Credit
As of December 31, 2000, we had a line of credit with Bank Hapoalim that
allowed us to borrow up to an aggregate of $6.0 million until March 31, 2001. In
April 2001, Bank Hapoalim agreed to extend the line of credit until March 31,
2002. We agreed to grant Bank Hapoalim a warrant to purchase our ordinary
shares, at an aggregate exercise price of $300,000. The fair value of such
warrant is approximately $150,000, which shall be accounted for as a cost of the
line of credit and will be amortized over a one year period. During April 2001,
we drew an aggregate of $2 million from Bank Hapoalim on account of such credit
line. Borrowings under the line of credit with Bank Hapoalim are in United
States dollars and bear interest annually at the London interbank offered rate
plus 1.5%. All borrowings under the line of credit with Bank Hapoalim are
secured by a lien on our assets. Except as specified above, borrowings under the
lines are not limited by the amount of our assets and do not require us to meet
financial ratios or tests. As of April 30, 2001, we had $2,090,000 of
outstanding indebtedness under our line of credit.
Operating Leases
Payments under non-cancelable operating lease agreements for facilities and
other equipment expire on various dates through 2006, resulting in aggregate
lease expenses ranging from $939,000 in 2001 to $69,000 in 2006.
Future Cash Needs
We expect that operating expenses and capital expenditures will continue to
be a material use of our cash resources. We may utilize cash resources to fund
acquisitions or investments in other businesses, technologies, or product lines.
We believe that our working capital is sufficient for our anticipated needs for
the next 12 months.
Research and Development Grants
We conduct our research and development activities primarily at our
principal offices in Israel. Our research and development efforts have been
financed, in part, through grants from the office of the chief scientist of
Israel. Under these grants, royalties are payable to the Israeli government,
generally at the rate of 3% during the first three years, 4% over the following
three years, and 5% in the seventh year and future years, on the revenues
derived from products developed by us according to those programs. The maximum
aggregate royalties will not exceed 100%, 150% in some circumstances, of the
dollar-linked value of the total grant received. During 1996, we paid all
royalties due to the office of the chief scientist amounting to a total of
$676,000. Therefore, we are under no further obligation to pay royalties to the
office of the chief scientist on the sale of products funded by the office of
the chief scientist. The government of Israel does not own proprietary rights in
the technology developed using its funding and there is no restriction on the
export of the products manufactured using the technology. Some restrictions on
the technology do apply, however, including the obligation to manufacture the
product based on the technology in Israel and to obtain the office of the chief
scientist's consent for the transfer of the technology to a third party. These
restrictions continue to apply to us although we have paid the full amount of
royalties payable under these grants. If the office of the chief scientist
consents to the manufacture of the products outside Israel, the regulations
allow the office of the chief scientist to require the payment of increased
royalties, ranging from 120% to 300% of the amount of the office of the chief
scientist grant, depending on the percentage of foreign manufacture. If the
chief scientist consents to the manufacture of our products outside Israel, we
cannot assure you that we will not be required to pay the office of the chief
scientist additional royalties.
In 1998, we received a grant from the United States-Israel Binational
Industrial Research and Development Foundation for a development project on our
Service Suite line of products conducted by us and a United States partner.
Under the terms of this grant, we are obligated to pay to the foundation
royalties of 3% to 5% of the revenues derived from sales of products developed
in this project, up to an aggregate amount equal to 100-150% of the grant,
linked to the dollar and to the U.S. consumer price index. The cumulative amount
of grants recognized was $330,000 as of December 31, 2000.
Effects of Currency Fluctuations
Revenues generated and costs incurred outside of the United States are
generally denominated in non-dollar currencies. For the years 1998, 1999 and
2000 respectively, 26%, 24% and 25% of our revenues were denominated in
non-dollar currencies. Costs not effectively denominated in United States
dollars are translated to United States dollars, when recorded, at the
prevailing exchange rates for the purposes of our financial statements.
Consequently, fluctuations in the
23
rates of exchange between the dollar and non-dollar currencies will affect our
results of operations. An increase in the value of a particular currency
relative to the dollar will increase the dollar reporting value for transactions
in that particular currency, and a decrease in the value of that currency
relative to the dollar will decrease the dollar reporting value for those
transactions. This effect on the dollar reporting value for transactions is
generally only partially offset by the impact that currency fluctuations may
have on costs. In 1998, we had net income due to currency fluctuations of
$275,000. In 1999 we had a net loss of $47,000 and in 2000 there was no income
or loss due to currency fluctuations. We generally do not engage in currency
hedging transactions to offset the risks with variations in currency exchange
rates. Consequently, significant foreign currency fluctuations and other foreign
exchange risks may have a material adverse effect on our business, financial
condition and results of operations.
Impact of Inflation
Since our revenues are generated in United States dollars and currencies
other than New Israeli Shekels (NIS), and a substantial portion of our expenses
is incurred and will continue to be incurred in NIS, we are exposed to risk by
the amount that the rate of inflation in Israel exceeds the rate of devaluation
of the NIS in relation to the dollar and other currencies or if the timing of
the devaluation lags behind inflation in Israel. In 1994, 1995 and 1996, the
inflation rate in Israel exceeded the rate of devaluation of the NIS against the
dollar and other currencies. This trend was reversed during 1997 and 1998. In
1999 and 2000, while the rate of inflation was low, there was a devaluation of
the dollar against the NIS. We generally do not engage in any hedging or other
transactions intended to manage risks relating to foreign currency exchange rate
or interest rate fluctuations. We also do not own any market risk sensitive
instruments. However, we may in the future undertake hedging or other
transactions or invest in market risk sensitive instruments if we determine that
it is necessary to offset these risks.
Effective Corporate Tax Rate
Our tax rate will reflect a mix of the United States and the United Kingdom
statutory tax rates on our United States and United Kingdom income and the
Israeli tax rate discussed below. We expect that most of our taxable income will
be generated in Israel. Israeli companies are generally subject to income tax at
the rate of 36%. The majority of our income, however, is derived from our three
investment programs with approved enterprise status under the law for the
encouragement of capital investments and is eligible for some tax benefits.
Under our first investment program, we will enjoy a reduced tax rate of
10-25% during a period of seven years in which this investment program produces
taxable income depending on foreign investment. Under our other two investment
programs we will enjoy a tax exemption on income derived during the first ten
years in which these investment programs produce taxable income, provided that
we do not distribute the income as dividends. All of these tax benefits are
subject to various conditions and restrictions.
As of December 31, 2000, we had net operating loss carryforwards for tax
reporting purposes of approximately $28.8 million in the United States, $5.5
million in Israel, $11.4 million in the United Kingdom and $600,000 in Japan. In
the United States, the internal revenue code limits the use in any future period
of net operating loss carryforwards following a significant change in ownership
interests. Since we have incurred tax losses through December 31, 2000, we have
not used these net operating losses.
Adaptation to New Euro Currency
In January 1999, a new currency called the euro was introduced in Austria,
Belgium, Finland, France, Germany, Italy, Luxembourg, the Netherlands, Portugal,
the Republic of Ireland and Spain. By June 30, 2002, at the latest, all
participating European Monetary Union countries are expected to be operating
with the euro as their single currency. Computer systems and software products
will need to be designed or modified to accept the euro currency and, during the
transitional phase, may need to accept both the euro and local currencies.
Conversion to the euro will require restructuring of databases and internal
accounting systems and the conversion of historical data. We believe that all
products offered by us are adapted to the euro. Since the introduction of the
euro we have not experienced any difficulties or complaints from the adaptation
of our products to the euro. However, we did not contact our clients or
suppliers to determine their preparedness for the adoption of the euro.
We have not incurred any material expenses from the adaptation of our
products to the euro and we do not expect to incur any expenses from future
adaptation to the euro. However, we cannot assure you that our products or
software provided to our clients by other vendors, or developed internally by
our clients, will ensure an errorless transition to the euro. Even if our
products and services satisfy these requirements, the products and services
provided to our clients by other
24
software vendors or developed internally by our clients may not be euro
compliant and may disrupt our clients' ability to use our products.
Research and Development
We believe that our future success depends, to a significant extent, on our
ability to maintain and extend our technological leadership through our research
and development activities. We employ product managers in our research and
development activities. These managers provide a critical interface between our
research scientists and client needs and industry developments. This interface
helps focus our research and development personnel on developing market-driven
applications. By using information provided by our product managers, we can also
manage our research and development resources to address perceived market
trends.
Our research and development expenditures for 1998, 1999, and 2000 were
$5.3 million, $6.9 million and $7.2 million respectively. We will continue to
devote substantial resources to research and development. Part of our funding
for research and development activity has in the past come from various Israeli
government programs.
Trend Information
For information about our expectations regarding our future cost of
revenues, future operating expenses and liquidity and capital resources, please
see the discussion under the "Risk Factors" section of Item 3 and the "Operating
Results" section and the "Liquidity and Capital Resources" section of Item 5.
25
ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES
Directors and Senior Management
Name Age Position
---- --- --------
Samuel I. HaCohen 43 Chairman of the Board of Directors
Winfried A. Burke 53 President and Chief Executive Officer
Vladimir Morgenstern 43 Executive Vice President, Corporate Program
and Director
Menachem Ish-Shalom 41 Chief Operating Officer
Albert A. Gabrielli 42 Chief Financial Officer
Ron Ben-Natan 33 Senior Vice President of Engineering and Chief
Technology Officer
John L. Sherry III 45 Senior Vice President of Worldwide Marketing
and Business Development
Jeffrey Galin, Sr. 33 Senior Vice President of Worldwide Sales
Amnon Shoham 43 Director
Jay B. Morrison 52 Director
Steven N. Baloff 44 Director
Lawrence W. Hambly 54 Director
Hillel Milo 49 Director
Samuel I. HaCohen co-founded ViryaNet in March 1988. Since March 1988, Mr.
HaCohen has served as our chairman of the board of directors. From March 1988
until February 2001, Mr. HaCohen served as our chief executive officer and as
the chairman of the board of directors. Before co-founding ViryaNet, Mr. HaCohen
held senior systems management positions in John Bryce Systems Ltd., a software
company, and the Hadassah Hospital, Jerusalem. Mr. HaCohen holds a Bachelor of
Science degree in computer science and statistics from the Hebrew University of
Jerusalem and has completed all course work for a Master of Science in
statistics from the Hebrew University of Jerusalem.
Winfried A. Burke joined us in October 1999 as our senior vice president of
worldwide marketing. From October 2000 until February 2001, Mr. Burke served as
our president and chief operating officer. In February 2001, Mr. Burke was
appointed chief executive officer. Since February 2001, Mr. Burke has served as
chief executive officer and president of ViryaNet. From January 1999 until
October 1999, Mr. Burke served as vice president of sales and marketing for
ViewSoft, a software company. From July 1997 until December 1998, Mr. Burke
served as general manager of North American operations and vice president of
worldwide channels and strategic alliances at Gentia Software, a software
company. From August 1994 until July 1997, Mr. Burke was a merger and
acquisition consultant. From 1991 until 1994, Mr. Burke served as vice president
of sales and marketing for Oberon Software. Mr. Burke has also held various
positions in product management, marketing and sales at Prime Computer, Apollo,
Sequoia and Wang. He began his career as a software engineer at the
Massachusetts Institute of Technology Instrumentation Laboratory, Draper
Laboratory, where he worked on the Apollo and Space Shuttle projects, followed
by software development assignments at the Massachusetts Institute of Technology
Lincoln Laboratory and Data General. Mr. Burke holds a Bachelor of Science in
computer science from the Massachusetts Institute of Technology.
Vladimir Morgenstern co-founded ViryaNet with Mr. HaCohen. He has served as
one of our directors since July 1999. Since November 1999, Mr. Morgenstern has
served as our executive vice president, corporate program. He served as our
technical manager and chief technology officer from March 1988 until November
1999. He has served as our director since July 1999. Before co-founding
ViryaNet, Mr. Morgenstern held senior systems management positions in John Bryce
Systems Ltd. and the Hadassah Hospital, Jerusalem. Mr. Morgenstern holds a
Bachelor of Science degree in physics from Vilnius University in Lithuania and
has completed all course work for a Master of Science in applied mathematics.
Menachem Ish-Shalom has served as our chief operating officer since
February 2001 and served as executive vice president of world-wide operations
from November 2000 until February 2001. Mr. Ish-Shalom served as vice president
of customer care and billing at Amdocs from April 2000 until November 2000. From
May 1989 until April 2000, Mr. Ish-Shalom was employed at ViryaNet and served in
a number of senior management positions, including research and development
manager, general manager of Israeli operations, and executive vice president of
engineering. Mr. Ish-Shalom holds a Bachelor of Science in computer science from
the Hebrew University of Jerusalem.
Albert A. Gabrielli has served as our chief financial officer since April
2001. From August 2000 until March 2001, Mr. Gabrielli served as the chief
financial officer of Ziplink, a provider of wholesale internet connectivity
services. From October 1999 until July 2000, he served as Vice President,
Finance for Ziplink. From August 1998 until August 1999, Mr.
26
Gabrielli served as Vice President, Finance, Enterprise Data Product Group for
Nortel Networks, a telecommunication networking company. From June 1998 until
August 1998, he served as Vice President, Finance, Internet/Telecommunications
and Enterprise Product Group for Bay Networks, a telecommunication networking
company. From July 1995 until June 1998, he served in a number of senior
management positions with Bay Networks. From 1982 until July 1995 Mr. Gabrielli
was employed at Digital Equipment Corporation in a variety of finance and
finance management roles, supporting professional services, data networking, and
systems integration businesses. Mr. Gabrielli received his Bachelor of Science
in economics and finance from Bentley College.
Ron Ben-Natan has served as our chief technology officer since November
1999 and has served as senior vice president of engineering since February 2000.
From June 1998 to November 1999, Mr. Ben-Natan served as our vice president
product development. From July 1995 to June 1998, Mr. Ben-Natan served as the
chief technology officer of Entity Object Technology, a software consulting
company he co-founded. Mr. Ben-Natan holds a Doctor of Philosophy in computer
sciences from the Hebrew University of Jerusalem.
John L. Sherry, III joined us in March 2001 as our senior vice president of
worldwide marketing and business development. From July 1999 to February 2001,
Mr. Sherry served as vice president of marketing for Excelergy Corporation, a
software provider to the restructuring energy industry. From January 1996 to
July 1999, Mr. Sherry served as executive director of marketing for Kenan
Systems (now Lucent Software Products Group), a provider of billing and customer
care software to the telecommunications industry. From June 1983 to January
1996, Mr. Sherry served in a wide variety of product marketing and senior
management roles for the IBM Corporation. Mr. Sherry holds a Bachelor of Science
in applied mathematics from Brown University and a Master of Business
Administration from the Harvard Business School.
Jeffrey Galin, Sr. has served as our Senior Vice President of Worldwide
Sales since November 2000. Prior to November 2000, he served in senior sales
management positions since joining us in August 1997, including director of
eastern regional sales beginning in August 1997 and Vice President of North
American Sales beginning in January 1999. In November 2000, Mr Galin was
appointed Senior Vice President of Worldwide Sales. Before joining us, Mr. Galin
served as vice president of sales at Precise Software Solutions, where he was
responsible for managing the sales effort of a SQL tuning technology for Oracle
databases. In addition, from 1994 to 1995, Mr. Galin served as regional manager,
eastern United States, for Mercury Interactive, a provider of Web performance
management solutions based in Sunnyvale, California. Mr. Galin holds a Bachelor
of Arts degree in finance and legal studies from the University of
Massachusetts, Amherst.
Amnon Shoham has served as one of our directors since October 1996. Mr.
Shoham is the managing director of Cedar (Israel) Financial Advisors Ltd., a
position he has held since 1997. From 1993 to 1997, Mr. Shoham served as a
managing partner of Star Ventures in Israel. Mr. Shoham serves as a director on
the board of directors of Jacada, a software company. Mr. Shoham holds a
Bachelor of Arts in law from the University of Tel Aviv.
Jay B. Morisson has served as one of our directors since October 1996. Dr.
Morisson is the founder and managing general partner of Newbury Ventures, a
United States venture capital firm established in 1992. Dr. Morisson is a
general partner of Jerusalem Pacific Ventures (1994), one of our shareholders.
Before 1992, Dr. Morisson held a number of positions with Govett & Co. and
European International Fund Management Company, including the positions of chief
financial officer and president of its venture capital subsidiary. Dr. Morisson
serves as a director of Fundtech, a software company and of several privately
held technology companies. He holds undergraduate and master's degrees in
operational research from Ohio State University and a doctorate in business
administration from the Haas School of Business at the University of California
at Berkeley.
Steven N. Baloff has served as one of our directors since October 1996. Mr.
Baloff has served as a managing director and general partner of Advanced
Technology Ventures, a United States venture capital firm, since 1996. Before
joining Advanced Technology Ventures, from 1989 to 1995 Mr. Baloff served as
president and chief executive officer of Worldview Systems, an electronic travel
industry information service. Mr. Baloff holds a Bachelor of Arts in economics
from Harvard College and a Master of Business Administration from Stanford
University.
Lawrence W. Hambly has served as one of our directors since August 1998.
Since March 1993, Mr. Hambly has served as executive vice president of the
Enterprise Services Division of Sun Microsystems, a manufacturer of networked
computing systems. Since April 1990, Mr. Hambly has been a corporate executive
officer of Sun Microsystem and a member of Sun Microsystem's executive
management group. From April 1990 to March 1993, Mr. Hambly served as vice
president of worldwide marketing of computer systems at Sun Microsystems. From
June 1988 to April 1990, Mr. Hambly
27
served as vice president of Sun Microsystem's Federal Systems Division. Before
joining Sun Microsystems, Mr. Hambly served in field sales, sales management,
and engineering positions with Symbolics, Data General, General Research,
Logicon and Rockwell International. Mr. Hambly holds a Bachelor of Science
Degree in physics from Montana State University and a Master of Science in
physics from California State University.
Hillel Milo has served as one of our directors since June 2000. Since 1995,
he has been the chief executive officer of Clal Venture Capital Fund Limited
Partnership. In 1997, he co-founded Infinity Venture Capital Fund Limited
Partnership and served as its chief executive officer until June 1999. From 1993
to 1994, Mr. Milo was the co-founder and the general partner of the Walden
Israel venture capital fund. Previously, Mr. Milo served as a director and
executive officer in a privately-owned European financial and industrial
investment company. Mr. Milo serves on the board of directors of Breezecom, a
manufacturer of wireless access products, and Radvision, a developer of internet
and network based communications products. Mr. Milo has a Bachelor of Science in
mechanical engineering and a Master of Arts in management science from the
University of Alabama.
Compensation
We have entered into employment agreements with Messrs. HaCohen,
Morgenstern, Burke, Ish-Shalom, Gabrielli, Sherry and Galin. These employment
agreements contain various provisions, including provisions relating to
assignment of intellectual property rights to us, non-competition and
confidentiality and are in effect until terminated by either party upon advance
notice of either 30 or 60 days or under specified circumstances under the terms
of the particular agreement. The employment agreement entered into with Messrs.
Ish-Shalom, Burke, Gabrielli and Sherry contain similar terms as those contained
in the agreements with Messrs. HaCohen, Morgenstern and Galin except that (i)
Mr. Ish-Shalom's agreement may be terminated by us without cause under the
circumstance provided under his employment agreement, upon advance notice of 6
months, and may be terminated by Mr. Ish-Shalom upon advance notice of 60 days,
and (ii) Messrs. Burke, Gabrielli and Sherry are entitled to 6 months of
severance, including benefits, in the event we terminate their respective
employment without cause, under the circumstances provided in each of their
employment agreements. We have also entered into executive incentive bonus plans
with these executives. These plans provide for quarterly bonus payments upon
achievement by us of targeted levels in specific business performance
categories.
The aggregate remuneration we paid for the year ended December 31, 2000 to
our directors and executive officers as a group was $2,565,756 in salaries,
fees, commissions and bonuses. Included in this amount is remuneration to two of
our former executive officers. This amount includes $39,709 set aside or accrued
to provide for pension, retirement or similar benefits provided to our directors
and executive officers.
Other than Mr. Samuel HaCohen, who is entitled to receive the benefits
specified in his employment agreement, our directors who are not executive
officers do not receive cash compensation for their service on the board of
directors or any board committee. However, all non-management directors are
reimbursed for their expenses for each board meeting attended, and with respect
to our external directors, such reimbursement is made in accordance with the
applicable provisions of the Israeli law. For additional information, please see
the discussion under the heading "External Directors". During fiscal 2000,
options to purchase 700,000 ordinary shares were granted to our directors and
executive officers. Included in this amount are options to purchase 450,000
ordinary shares granted to one of our former executive officers, of which
300,000 were canceled upon the termination of his employment with us. The
weighted average exercise price of these outstanding options was $7.75 per
share, with vesting over two to four years. All options were issued pursuant to
the 1999 Stock Option and Incentive Plans (the "Option Plan"). In addition, the
board of directors has approved, subject to shareholders approval, the grant of
options to purchase 75,000 ordinary shares to Mr. HaCohen. For additional
information please see discussion under the heading "Option Plans".
28
Board Practices
The following table sets forth certain information concerning our current
directors and executive officers:
Commencement Termination/Renewal
Name Current Office(s) Held of Office Date of Office
- -------------------------------------------------------------------------------------------------------------
Samuel I. HaCohen Chairman of the Board of March 1998 Annual Meeting 2001
Directors
Winifried A. Burke President October 2000 Not applicable
Chief Executive Officer February 2001 Not applicable
Vladimir Morgenstern Director July 1999 Annual Meeting 2001
Executive Vice November 1999 Not applicable
President, Corporate
Program
Menachem Ish-Shalom Chief Operating Officer November 2000 Not applicable
Albert A. Gabrielli Chief Financial Officer April 2001 Not applicable
Ron Ben-Natan Senior Vice President of February 2000 Not applicable
Engineering
Chief Technology Officer November 1999 Not applicable
Jeffrey Galin, Sr. Senior Vice President of November 2000 Not applicable
Worldwide Sales
John L. Sherry III Senior Vice President of March 2001 Not applicable
Worldwide Marketing and
Business Development
Amnon Shoham (1)(2) Director October 1996 Annual Meeting 2001
Jay B. Morisson (1) Director October 1996 Annual Meeting 2001
Steven N. Baloff (2) Director October 1996 Annual Meeting 2001
Lawrence W. Hambly Director October 1998 Annual Meeting 2001
Hillel Milo (1) Director June 2000 Annual Meeting 2001
- ---------------------------------
(1) Member of Audit Committee
(2) Member of Compensation Committee
Our Articles of Association provide that directors are elected at our
annual general meeting of the shareholders by a vote of the holders of a
majority of the voting power represented at that meeting. Each director, except
for the external directors as described below, holds office until the next
annual general meeting of the shareholders. All our executive officers are
elected by the board of directors and serve until their respective successor
have been duly elected or qualified or their positions are vacated by
resignation or otherwise.
29
External Directors
Israeli Companies Law
We are subject to the provisions of the new Israeli Companies Law, 5759-
1999 (the "Companies Law"), which became effective on February 1, 2000 and
supersedes most of the provisions of the Israeli Companies Ordinance, New
Version, 5743-1983.
Who May Be Appointed
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. 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 or person
controlling the company or any entity controlled by the company or by a
controlling shareholder of the company. The term affiliation includes:
. an employment relationship;
. a business or professional relationship maintained on a regular basis;
. control; and
. service as an office holder.
Conflicts of Interest
No person can serve as an external director if the person's position or
other business creates, or may create, conflicts of interests with the person's
responsibilities as an external director or may impair his ability to serve as
an external director. Until the lapse of two years from termination of office of
an external director, for any reason, a company may not engage such former
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.
How External Directors Are Elected
External directors are generally elected by a majority vote at a
shareholders' meeting, provided that either:
. the majority of the shares voted at the meeting, including at least
one third of the shares of non-controlling shareholders or their
representatives voted at the meeting, vote in favor of the election;
or
. 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 shareholders approval, until the
completion of such director's original nomination period, in accordance with
such regulations. Messrs. Shoham and Morisson were designated by our Board of
Directors as our external directors in accordance with such regulations.
Term of Service
The initial term of an external director is three years and may be extended
by the shareholders for an additional three years. If, when we elect an external
director, all of our directors are of the same gender, then the next external
director must
30
be of the other gender. Each committee exercising powers of the board of
directors is required to include at least one external director.
Independent Directors
The ordinary shares offered in our initial public offering are listed for
quotation on the Nasdaq National Market and are subject to the rules of the
Nasdaq National Market applicable to quoted companies. Under the Nasdaq rules,
we are required to appoint a minimum of three independent directors. The
independence standard under the Nasdaq rules excludes any person who is a
current or former employee of a company as well as the immediate family members
of an executive officer of a company. Messrs. Milo, Morisson and Shoham serve as
independent directors and meet the independence standard of the Nasdaq rules.
Board Committees
Our board of directors has formed an audit committee, an executive
committee and a compensation committee. The audit committee exercises the powers
of the board of directors for our accounting, reporting and financial control
practices. Our executive committee is responsible for managing our daily
operations and acting on behalf of our board of directors in exigent
circumstances. Our compensation committee sets the annual compensation for our
executive officers and, to the extent permitted under the Companies Law,
administers our option plans. Messrs. Milo, Morisson and Shoham are members of
our audit committee. Messrs. Baloff, HaCohen, Morisson and Shoham are members of
our executive committee. Messrs. Shoham and Baloff are members of our
compensation committee.
Audit Committee
Nasdaq Rules and Israeli Companies Law
Under the Nasdaq rules, we are required to form an audit committee
consisting of at least three independent directors, all of whom are financially
literate and one of whom has accounting or related financial management
expertise. The responsibilities of the audit committee under the Nasdaq rules
include evaluating the independence of a company's outside auditors. Our current
audit committee complies with the Nasdaq rules. Under the Companies Law, the
board of directors of any company that is required to nominate external
directors must also appoint an audit committee. The Companies Law requires that
the audit committee be comprised of at least three directors, including all of
the external directors, but excluding:
. a chairman of the board of directors;
. a controlling shareholder or the relative of a controlling
shareholder; or
. any director employed by the company, or who provides services to the
company on a regular basis.
Role of Audit Committee
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 suggest appropriate course of action. The
approval of the audit committee is required to engage in specified actions and
transactions with office holders, controlling shareholders and third parties in
which office holders and controlling shareholders have a personal interest.
Conflicts of Interest
An audit committee of a public company may not approve an action or a
transaction with an interested party, an office holder, a controlling
shareholder, or an entity in which they have a personal interest unless at the
time of approval the two external directors are serving as members of the audit
committee and at least one of the external directors was present at the meeting
in which an approval was granted. Our external directors are members of our
audit committee.
31
Employees
As of December 31, 2000, we had 83 employees in Israel, 87 in the United
States, 18 in the United Kingdom and 7 in Japan. Of our 195 employees, 61 were
engaged in research and development, 52 in sales, marketing and business
development, 51 in professional services and technical support and 26 in
finance, administration and operations. None of our employees is represented by
a labor union.
We are not a party to any collective bargaining agreement with our
employees. However, some provisions of the collective bargaining agreement
between the Histadrut, the General Federation of Labor in Israel, and the
Coordination Bureau of Economic Organizations, including the Industrialists'
Association of Israel, are applicable to our Israeli employees under expansion
orders of the Israeli Ministry of Labor and Welfare. These provisions
principally concern the length of the work day and the work week, minimum wages
for workers, contributions to pension funds, insurance for work-related
accidents, procedures for dismissing employees and determination of severance
pay. Under these provisions, the wages of most of our employees are
automatically adjusted based on changes in the Israeli consumer price index. The
amount and frequency of these adjustments are modified occasionally. We consider
our relationship with our employees to be good and have never experienced a
strike or work stoppage.
We have to comply with various labor and immigration laws throughout the
world, including laws and regulations in Israel, the United States, the United
Kingdom and Japan. Compliance with these laws has not been a material burden for
us. If the number of our employees increases over time, our compliance with
these regulations could become more burdensome.
Share Ownership
As of March 15, 2001, the aggregate number of our ordinary shares
beneficially owned by our directors and executive officers was 10,504,195,
including options and warrants to purchase up to 2,405,834 ordinary shares which
are exercisable or will become exercisable within 60 days of March 15, 2001,
including options to purchase up to 500,000 ordinary shares issued to two of our
former executive officers. As of March 15, 2001, options to purchase up to
2,859,250 ordinary shares granted to our directors and executive officers,
including two of our former executive officers, under our option plans were
outstanding. The weighted average exercise price of these options was $4.43 per
share. Of these options, options to purchase 2,240,708 ordinary shares are
exercisable or will become exercisable within 60 days of March 15, 2001.
As of March 15, 2001, there were approximately 75 shareholders of record. We
believe that shares of our ordinary shares held in bank, money management
institution and brokerage house "nominee" names account for at least an
estimated 1075 additional beneficial owners.
The following table summarizes information about the beneficial ownership of
our outstanding ordinary shares and the options as of March 15, 2001 for each
our director and executive officer.
Beneficial Ownership of Percent Options to Purchase
Name(1) Ordinary Shares(2) of Class (3) Ordinary Shares
Samuel I. HaCohen 725,298 (4) 3.3% 545,000(5)
Winfried A. Burke 269,100 (6) 1.2% 425,000 (7)(8)
Vladimir Morgenstern 598,419 (9) 2.7% 433,000 (10)
Menachem Ish-Shalom * * 171,250 (11)
Ron Ben-Natan * * 300,000 (12)
Jeffrey Galin * * 265,000 (13)
Amnon Shoham * * 80,000 (14)
Jay B. Morisson 1,089,988 (15) 5.0% 30,000 (16)
Steven N. Baloff 2,045,478 (17) 9.4% 30,000 (18)
Lawrence W. Hambly 265,625 (19) 1.2% 50,000 (20)
Hillel Milo 4,475,704(21) 20.6% 30,000(22)
Yoram Bibring (23) 350,000 (24) 1.6% 350,000 (25)
Ethan Allen (26) * * 150,000 (27)
(*) Less than 1% of our ordinary shares.
(1) Does not include John L. Sherry III, who joined us as Senior Vice President
of Worldwide Marketing and Business Development on March 28, 2001 and also
does not include Albert A. Gabrielli, who joined us as Chief Financial
Officer
32
on April 9, 2001. As of May 1, 2001, Mr. Sherry and Mr. Gabrielli do not
beneficially own any ordinary shares and do not own any options to purchase
ordinary shares.
(2) Beneficial ownership by a person assumes exercise of all options and
warrants beneficially owned by such person that are currently exercisable
or are exercisable within 60 days of March 15, 2001. Unless otherwise noted
or except to the extent authority is shared by spouses under applicable
law, all persons referred to above have sole voting and sole investment
power over their respective ordinary shares.
(3) The percentages shown are based on (i) 21,709,673 ordinary shares
outstanding on March 15, 2001 and (ii) shares of ordinary shares issuable
upon the exercise of all options and warrants beneficially owned by such
persons that are currently exercisable or are exercisable within 60 days of
such date.
(4) Includes 264,320 ordinary shares, warrants to purchase 3,478 ordinary
shares exercisable within 60 days of March 15, 2001, and options to
purchase 457,500 ordinary shares exercisable within 60 days of March 15,
2001. The exercise price of the warrants to purchase 3,478 ordinary shares
ranges between $0.61 and $5.75 per share. The exercise price of the options
to purchase 457,500 ordinary shares ranges between $0.61 and $5.75 per
share.
(5) The exercise price of the options ranges between $0.61 and $5.75 per share.
Such options expire between 2005 and 2008. The board of directors has
approved, subject to shareholders approval, an additional grant of options
to purchase 75,000 ordinary shares at an exercise price of $1 per share,
which expire in 2008.
(6) Includes 6,600 ordinary shares and options to purchase 262,500 ordinary
shares exercisable within 60 days of March 15, 2001. The exercise price of
the options ranges between $5.75 and $8.
(7) The exercise price of the options ranges between $5.75 and $8 per share.
Such options expire in 2008.
(8) Does not include an additional grant of options to purchase 350,000
ordinary shares, approved by the Board of Directors in April 2001. The
exercise price of such options is $0.72 per share. Such options expire in
2008. Of such options, options to purchase 116,667 ordinary shares are
exercisable within 60 days of March 15, 2001. All such options shall be
characterized as issued under our 1999 Stock Option and Incentive Plan upon
shareholder approval of the reservation of additional ordinary shares to be
issued under our 1999 Stock Option and Incentive Plan or upon availability
of additional ordinary shares reserved for issuance under our 1999 Stock
Option and Incentive Plan. See the discussion regarding the 1999 Stock
Option and Incentive Plan under the section "Option Plans".
(9) Includes 227,919 ordinary shares and options to purchase 370,500 ordinary
shares exercisable within 60 days of March 15, 2001. The exercise price of
the options to purchase 370,500 ordinary shares ranges between $0.61 and
$5.75 per share.
(10) The exercise price of the options ranges between $0.61 and $5.75 per share.
Such options expire between 2005 and 2008. See the discussion regarding the
1999 Stock Option and Incentive Plan under the section "Option Plans".
(11) The exercise price of the options ranges between $0.61 and $2.30 per share.
Such options expire between 2005 and 2006.
(12) The exercise price of the options ranges between $3.20 and $11 per share.
Such options expire between 2007 and 2008.
33
(13) The exercise price of the options ranges between $2.30 and $11 per share.
Such options expire between 2006 and 2008.
(14) The exercise price of the options ranges between $2.30 and $5.75 per share.
Such options expire between 2005 and 2008.
(15) Includes options to purchase 30,000 ordinary shares exercisable by Jay
Morisson within 60 days of March 15, 2001, and 1,051,174 ordinary shares
held by Jerusalem Pacific Ventures and warrants to purchase 8,814 ordinary
shares exercisable within 60 days March 15, 2001, which Dr. Morisson, the
fund manager of Jerusalem Pacific Ventures, may be considered to
beneficially own, although he disclaims beneficial ownership of these
ordinary shares. The exercise price of the options to purchase 30,000
ordinary shares is $5.75 per share, and the exercise price of the warrants
to purchase 8,814 ordinary shares ranges between $0.025 and $4.56 per
share.
(16) The exercise price of the option is $5.75 per share. Such options expire in
2008.
(17) Includes options to purchase 30,000 ordinary shares exercisable by Mr.
Baloff within 60 days of March 15, 2001, and 1,967,514 ordinary shares held
by Advanced Technology Ventures and warrants to purchase 47,964 ordinary
shares exercisable within 60 days of March 15, 2000, which Mr. Baloff, the
managing director and general partner of Advanced Technology Ventures, may
be considered to beneficially own, although he disclaims beneficial
ownership of these ordinary shares. The exercise price of the options to
purchase 30,000 ordinary shares is $5.75 per share and the exercise price
of the warrants to purchase 47,964 ordinary shares ranges between $0.025
and $5.75 per share.
(18) The exercise price of the option is $5.75 per share. Such options expire in
2008.
(19) Includes options to purchase 40,625 ordinary shares exercisable within 60
days of March 15, 2001. The exercise price of the options is $3.20 and
225,000 ordinary shares held by Sun Microsystems which Mr. Hambly, an
officer of Sun Microsystems, may be considered to beneficially own although
he disclaims beneficial ownership of these ordinary shares.
(20) The exercise price of such options is $3.20 per share. Such options expire
in 2007.
(21) Includes options to purchase 15,000 ordinary shares exercisable by Mr. Milo
within 60 days of March 15, 2000, the exercise price of which is $8 per
share and which expire in 2008, and (i) 753,814 ordinary shares and
warrants to purchase 15,833 ordinary shares exercisable within 60 days of
March 15, 2001 held by Clal Venture Capital Fund L.P. ("CVC"), the exercise
price of which ranges between $0.025 and $4.56 per share, (ii) 805,000
ordinary shares and warrants to purchase 15,833 ordinary shares exercisable
within 60 days of March 15, 2001 held by Clalit Capital Fund L.P.
("Clalit"), the exercise price of which ranges between $0.025 and $4.56 per
share, (iii) 1,398,510 ordinary shares and warrants to purchase 36,602
ordinary shares exercisable within 60 days of March 15, 2001 held by Clal
Industries and Investments Ltd. ("Clal Industries"), the exercise price of
which is $5.75 per share, and (iv) 1,398,510 ordinary shares and warrants
to purchase 36,602 ordinary shares exercisable within 60 days of March 15,
2001 held by Clal Electronics Industries Ltd. ("Clal Electronics"), the
exercise price of which is $5.75 per share. Mr. Milo, the Chief Executive
of CVC, may be considered to beneficially own the ordinary shares and
warrants held by CVC, Clalit, Clal Industries and Clal Electronics,
although he disclaims beneficial ownership of these shares.
(22) The exercise price of such options is $8 per share. Such options expire in
2008.
(23) As of April 9, 2001, Mr. Bibring no longer serves as our Chief Financial
Officer.
(24) Includes only options to purchase ordinary shares exercisable within 60
days of March 15, 2001. The exercise price of the options to purchase
350,000 ordinary shares ranges between $1 and $5.75 per share.
(25) The exercise price of the options ranges between $1 and $5.75 per share.
Such options expire between 2007 and 2008.
34
reservation of additional ordinary shares to be issued under our 1999 Stock
Option and Incentive Plan. See the discussion regarding the 1999 Stock
Option and Incentive Plan under the section "Option Plans".
(26) As of October 31, 2000, Mr. Allen resigned and no longer serves as our
Chief Operating Officer and President.
(27) The exercise price of such options is $5.75 per share. Such options expire
on December 31, 2001.
Option Plans
We maintain four option plans, the 1996 Stock Option and Incentive Plan,
the 1997 Stock Option and Incentive Plan, the 1998 Stock Option and Incentive
Plan and the 1999 Stock Option and Incentive Plan.
The purpose of the option plans is to afford an incentive to our officers,
directors, employees and consultants, or any of our subsidiaries, to acquire a
proprietary interest in us, to continue as officers, directors, employees and
consultants, to increase their efforts on behalf of ViryaNet and to promote the
success of our business.
The 1996 Stock Option and Incentive Plan
In 1996, we adopted the 1996 Stock Option and Incentive Plan and reserved
1,400,000 ordinary shares for issuance to employees. As of March 15, 2001,
options to purchase 1,068,920 ordinary shares were outstanding under the 1996
Stock Option and Incentive Plan. In 2000, the 30,865 additional ordinary shares
that were available for grants of additional options were transferred to the
1999 Stock Option and Incentive Plan. The exercise price of options granted
under the 1996 Stock Option and Incentive Plan range from $0.61 to $1.00.
The 1997 Stock Option and Incentive Plan
In 1997, we adopted the 1997 Stock Option and Incentive Plan and reserved
options to purchase an aggregate of 500,000 ordinary shares. As of March 15,
2001, options to purchase 189,975 ordinary shares were outstanding under the
1997 Stock Option and Incentive Plan. In 2000, the 230,125 additional ordinary
shares that were available for grants of additional options were transferred to
the 1999 Stock Option and Incentive Plan. The exercise price of the options
granted under the 1997 Stock Option and Incentive Plan is $2.30.
The 1998 Stock Option and Incentive Plan
In 1998, we adopted the 1998 Stock Option and Incentive Plan and reserved
options to purchase an aggregate of 1,500,000 ordinary shares to employees. As
of March 15, 2001, options to purchase 785,500 ordinary shares were outstanding
under the 1998 Stock Option and Incentive Plan. In 2000, the 705,000 additional
ordinary shares that were available for grants of additional options were
transferred to the 1999 Stock Option and Incentive Plan. The exercise price of
the options granted under the 1998 Stock Option and Incentive Plan range from
$1.00 to $3.90.
The 1999 Stock Option and Incentive Plan
In 1999, we adopted the 1999 Stock Option and Incentive Plan and reserved
options to purchase an aggregate of 3,000,000 ordinary shares to employees and
transferred an additional 965,990 ordinary shares to the 1999 Stock Option and
Incentive Plan from the 1996 Stock Option and Incentive Plan, the 1997 Stock
Option and Incentive Plan and the 1998 Stock Option and Incentive Plan. As of
March 15, 2001, options to purchase 3,774,305 ordinary shares were outstanding
under the 1999 Stock Option and Incentive Plan and 187,935 additional ordinary
shares were available for grants of additional options. The exercise price of
the options granted under the 1999 Stock Option and Incentive Plan range from
$2.57 to $12.00.
On October 30, 2000, our board of directors authorized, subject to
shareholder approval, the reservation of options to purchase an additional
1,000,000 ordinary shares to employees, for an aggregate of 4,000,000 ordinary
shares to be granted under the 1999 Stock Option and Incentive Plan.
35
In December 2000, the board of directors approved the grant of additional
options to purchase an aggregate of 75,000 ordinary shares to Mr. HaCohen
subject to shareholder approval.
Administration of Our Option Plans
Our option plans are administered by the board of directors. Under the
option plans, options to purchase our ordinary shares may be granted to our
officers, directors, employees or consultants or our subsidiaries. Under the
option plans, the exercise price of options shall be determined by the committee
but may not be less than NIS 0.1. The vesting schedule of the options is also
determined by the committee but generally the options vest over a four year
period. Each option granted under the option plans is exercisable until seven
years from the date of the grant of the option. The 1996 Stock Option and
Incentive Plan, the 1997 Stock Option and Incentive Plan, the 1998 Stock Option
and Incentive Plan and the 1999 Stock Option and Incentive Plan will expire on
December 31, 2005, 2006, 2007 and 2008 respectively.
ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS
Major Shareholders
The following table summarizes information about the beneficial
ownership of our outstanding ordinary shares as of March 15, 2001 for each
person or group that we know owns more than 5% of our ordinary shares.
We determine beneficial ownership of shares under the rules of the
Securities and Exchange Commission and include any ordinary shares over which a
person exercises sole or shared voting or investment power, or of which a person
has the right to acquire ownership at any time within 60 days of March 15, 2001.
Except as otherwise indicated, and subject to applicable community property
laws, the persons named in the table have sole voting and investment power for
all ordinary shares held by them. Applicable percentage ownership in the
following table is based on 21,709,673 ordinary shares outstanding as of March
15, 2001.
Ordinary Shares
---------------
Beneficially Owned
------------------
Name and Address Number Percent of Class
- ---------------- ------ ----------------
The Clal Group (1)..................................... 4,460,704 20.4%
Kiriat Atidim
Ramat Hachayal
P.O. Box 61581, Tel Aviv 58177,
Israel
Advanced Technology Ventures IV L.P. (2)............... 2,015,478 9.3%
485 Ramona Street, Suite 200
Palo Alto, CA 94301
United States
SVM Star Ventures Management GmbH No. 3 (3)............ 1,904,999 8.8%
Possartsrassa 9
D-81679 Munich, Germany
GE Capital Equity Holdings, Inc. (4)................... 1,780,242 8.1%
120 Long Ridge Road
Stamford, CT 06927
United States
36
The Gilde IT Fund B.V.(5).............................. 1,257,927 5.8%
Newtonlann 91, PO Box 85067
3508 AB Utrecht
The Netherlands
Deer IV & Co. LLC (6).................................. 1,139,452 5.2%
1400 Old Country Road
Suite 407
Westbury, NY 11590
United States
(1) Includes:
. 753,814 ordinary shares and warrants to purchase 15,833 ordinary
shares exercisable within 60 days of March 15, 2001 held by Clal
Venture Capital Fund L.P.;
. 805,000 ordinary shares and warrants to purchase 15,833 ordinary
shares exercisable within 60 days of March 15, 2001 held by Clalit
Capital Fund L.P.;
. 1,398,510 ordinary shares and warrants to purchase 36,602 ordinary
shares exercisable within 60 days of March 15, 2001 held by Clal
Industries and Investments Ltd.; and
. 1,398,510 ordinary shares and warrants to purchase 36,602 ordinary
shares exercisable within 60 days of March 15, 2001 held by Clal
Electronics Industries Ltd.
(2) Includes warrants to purchase 47,964 ordinary shares exercisable within 60
days of March 15, 2001 held by Advanced Technology Ventures IV L.P.
Advanced Technology Ventures IV, L.P., ATV Associates IV, L.P., Jos C.
Henkens, Pieter J. Schiller and Steven N. Baloff share voting and
dispositive power over 2,064,386 ordinary shares. Each of the reporting
persons expressly disclaim beneficial ownership of any ordinary shares of
ViryaNet, except to the extent of any pecuniary interest therein and
except in the case of Advanced Technology Ventures IV, L.P. for the
2,064,386 shares which it holds of record.
(3) Includes:
. 413,572 ordinary shares held by STAR Management of Investments (1993)
Limited Partnership;
. 333,141 ordinary shares held by SVE STAR Ventures Enterprises No. III,
a German civil law partnership (with limitation of liability);
. 27,858 ordinary shares held by SVE STAR Ventures Enterprises No. IIIA,
a German civil law partnership (with limitation of liability);
. 146,585 ordinary shares held by SVM STAR Ventures
Managementgesellschaft GmbH Nr. 3 & Co. Beteiligungs KG;
. 650,771 ordinary shares held by SVE STAR Ventures Enterprises No. V, a
German civil law partnership (with limitation of liability); and
. 333,072 ordinary shares held by SVM STAR Ventures Management GmbH No.
3. SVM STAR Ventures Management GmbH No. 3 has the sole power to vote
or direct the vote of the ordinary shares held by the STAR entities
and is therefore considered the beneficial owner of the shares
beneficially held by SVE STAR Ventures Enterprises No. III, SVE STAR
Ventures Enterprises No. IIIA, SVM STAR Ventures Management
gesellschaft GmbH No. 3 & Co. Beteiligungs KG, and SVE STAR Ventures
Enterprises No. V. SVM STAR Venture Capital Management Ltd. has the
sole power to vote or direct the vote of the ordinary shares held by
STAR Management of Investments (1993) Limited Partnership and is
therefore considered the beneficial owner of the shares beneficially
held by STAR Management of Investments (1993) Limited Partnership. Dr.
Meir Barel is the principal shareholder and sole director of SVM STAR
Ventures Management GmbH No. 3 and SVM STAR Venture Capital Management
Ltd., and may be considered to be the beneficial owner of all of the
ordinary shares beneficially held by the Star entities, but Dr. Barel
disclaims beneficial ownership of these ordinary shares except to the
extent of any pecuniary interest in these ordinary shares.
(4) Includes warrants to purchase 87,657 ordinary shares exercisable within 60
days of March 15, 2000, held by GE Capital Equity Holdings, Inc. ("GE
Holdings") and warrants to purchase 50,000 ordinary shares exercisable
within 60 days of March 15, 2001 held by General Electric Medical Systems,
a division of General Electric Corporation. GE Holdings shares voting power
and dispositive
37
power over 1,730,241 ordinary shares with General Electric Capital
Corporation ("GE Capital"). General Electric Company shares voting and
dispositive power over 50,000 ordinary shares with GE Holdings and GE
Capital. General Electric Capital Services, Inc. and General Electric
Company expressly disclaim beneficial ownership of the ordinary shares
owned by GE Holdings. Each of GE Holdings, GE Capital and General Electric
Capital Services, Inc. expressly disclaims beneficial ownership of the
ordinary shares owned by General Electric Company.
(5) Gilde Investment Management BV, Gilde IT Fund BV, A. A. den Heijer and B.
T. Molenaar share voting and dispositive power over 1,247,386 ordinary
shares of ViryaNet.
(6) Includes:
. 587,943 ordinary shares and warrants to purchase 15,716 exercisable
within 60 days of March 15, 2001 held by Bessemer Venture Partners IV
L.P. ("BVP IV");
. 427,051 ordinary shares and warrants to purchase 10,793 exercisable
within 60 days of March 15, 2001 held by Bessec Ventures IV L.P.
("Bessec IV"); and
. 97,076 ordinary shares and warrants to purchase 873 exercisable within
60 days of March 15, 2001 held by Bessemer Venture Investors L.P.
("BVI L.P".).
Deer IV & Co. LLC is the general partner of each of BVP IV, Bessec IV and
BVI L.P. (collectively the "Bessemer Entities"). Deer IV & Co. LLC may be
considered to be the beneficial owner of all of the ordinary shares
beneficially held by the Bessemer Entities, but Deer IV & Co. LLC disclaims
beneficial ownership of these ordinary shares except to the extent of any
pecuniary interest therein.
Our major shareholders do not have different voting rights.
Related Party Transactions
Registration Rights
Pursuant to the 2000 Amendment and Restatement to the Investors Rights
Agreement among us and certain shareholders entered into on April 5, 2000, we
have granted registration rights to some of our shareholders and warrant
holders.
As of March 15, 2001, holders of 15,486,831 ordinary shares and
warrants to purchase 498,064 ordinary shares have the right, after one year from
our initial public offering and only under certain circumstances, to require us
to register their ordinary shares for sale. As of March 15, 2001, holders of
16,778,880 ordinary shares and warrants and options to purchase 1,584,542
ordinary shares shall have the right, under certain circumstances, to register
their ordinary shares for sale, if we propose to register any of our securities
for sale. Holders of 16,778,880 ordinary shares and warrants to purchase
1,584,542 ordinary shares will have the right only under certain circumstances
to require us to register their ordinary shares for resale to the public
provided that the aggregate offering price to the public will be at least $5
million, or $1 million if the registration is filed on Form F-3. We will not be
required to complete more than six of these registrations.
Convertible Debentures Financing
In February and March 2000, some of our shareholders loaned ViryaNet an
aggregate of $5 million. These convertible loans converted into the convertible
debentures issued later in April 2000 as described below. These shareholders
were also issued warrants to purchase up to an aggregate of 124,999 ordinary
shares at an exercise price of $4.56 per share. The warrants may be exercised
until the earlier of 5 years from the date of issuance, a merger of ViryaNet or
the sale of all or substantially all of our shares or assets. In April 2000, we
issued convertible debentures to three additional investors in an aggregate
amount of $11.0 million.
All of the convertible debentures bore annual interest rates at the
London interbank offered rate plus 2%. The convertible debentures, including
unpaid interest, were automatically converted into ordinary shares upon the
completion of our initial public offering at a conversion price of $4.80 per
share reflecting a discount of 40% of the price per share in our initial public
offering. Investors owning ten percent or more of our shares and officers who
were issued shares upon the conversion of the convertible debentures include:
38
Number of Ordinary Shares issued upon
-------------------------------------
Investor Conversion of Convertible Debentures
-------- ------------------------------------
Advanced Technology Ventures Group... 134,534
The Clal Group....................... 1,460,320
GE Capital Equity Holdings........... 124,319
Purchases in Our Initial Public Offering
In the framework of our initial public offering, the Clal group purchased
1,000,000 of the 4,000,000 ordinary shares which were offered at our the initial
public offering price, $8.00 per share. Immediately following our initial public
offering, the Clal group beneficially owned 4,279,704 ordinary shares, or 19.7%
of our outstanding capital stock.
Exercise of Warrants
Concurrently with our initial public offering, warrants to purchase up to
2,115,143 ordinary shares were exercised into 1,349,210 ordinary shares, at an
exercise price ranging from $2 to $5.75 per share, of which warrants to purchase
up to 1,154,090 were exercised according to a cashless exercise feature and the
remaining 195,120 were exercised for an aggregate amount of $585,360. Investors
owning ten percent or more of our shares who exercised warrants in that
transaction and the number of ordinary shares issued upon the exercise of such
warrants include:
Number of Ordinary Shares
-------------------------
Investor
--------
The Star Group....................... 189,277
Advanced Technology Ventures Group... 186,200
The Clal Group....................... 189,580
Loan and amounts granted to Officers
In June 1999, the board of directors granted Mr. HaCohen a loan in the
amount of $100,000. The loan was approved by the shareholders in June 2000. The
loan bears 6.5% annual interest. As of March 15, 2001, the outstanding loan
amount was $111,100.
In November 2000, the board of directors granted a bonus to Mr. HaCohen in
the amount of $90,000 for work performed in connection with our initial public
offering. This bonus is subject to shareholder approval. To date, we have paid
Mr. HaCohen $58,230. In the event that shareholder approval is not obtained, Mr.
HaCohen shall return such amount plus interest equaling the Israeli Consumer
Price Index plus 4%. As of March 15, 2001, $59,271 would be required to be
returned to us in the event that shareholder approval is not obtained.
Exculpation, Insurance and Indemnification of Directors and Officers
Under the Companies Law, an Israeli company may not exempt an office holder
from liability for a breach of his duty of loyalty, but may exempt in advance an
office holder from his liability to the company, in whole or in part, for a
breach of his 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 for acts which he performed in his capacity as an
office holder in relation to:
. a breach of his duty of care to us or to another person;
. a breach of his duty of loyalty to us, provided that the office holder
acted in good faith and had reasonable cause to assume that his act
would not prejudice our interests; or
. a financial liability imposed upon him in favor of another person.
39
Indemnification of Office Holders
Our Articles of Association provide that we may indemnify an office holder
against:
. a financial liability imposed on him in favor of another person by any
judgment, including a settlement or an arbitrator's award approved by a
court concerning an act performed in his capacity as an office holder;
. reasonable litigation expenses, including attorneys' fees, expended by
the office holder or charged to him by a court in proceedings we institute
against him, instituted on our behalf, or instituted by another person, in
each case relating to an act performed in his capacity as an office holder;
and
. reasonable litigation expenses relating to an act performed in his
capacity as an office holder, including attorneys' fees, expended by the
office holder or charged to him by a court in a criminal proceeding from
which he was acquitted, or a criminal proceeding in which he was convicted
for a criminal offense that does not require proof of intent.
Our Articles of Association also include:
. authorization to undertake, in advance, to indemnify an office holder,
provided that the undertaking is limited to specified events which the
board of directors believes are anticipated and limited in amount
determined by the board of directors to be reasonable under the
circumstances; and
authorization to indemnify retroactively an office holder.
Limitations on Insurance and Indemnification
The Companies Law provides that a company may not indemnify an office holder
nor enter into an insurance contract which would provide coverage for any
monetary liability incurred as a result of:
. a breach by the office holder of his 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;
. a breach by the office holder of his duty of care if the breach was done
intentionally or recklessly;
. any act or omission done with the intent to derive an illegal personal
benefit; or
. any fine levied against the office holder.
Under the Companies Law, indemnification of, and procurement of insurance
coverage for, our office holders must be approved by our audit committee and our
board of directors and, in specified circumstances, by our shareholders.
We have agreed to indemnify our office holders under indemnification
agreements with each office holder. We have also exempted and agreed to
indemnify our office holders from liabilities resulting from acts performed by
them in their capacity as an officer holder to the maximum extent permitted
under the Companies Law. We have obtained directors and officers liability
insurance for the benefit of our office holders.
Other Clients
From January 1, 2000 through December 31, 2000, we issued to some of our
clients warrants to purchase an aggregate of 357,450 ordinary shares. The
exercise price of these warrants ranges from $2.57 to $11 per share.
Concurrently with and immediately after our initial public offering,
warrants to purchase 450,000 ordinary shares, which were granted between 1996
through 1999, were exercised on a cashless basis. The exercise price of these
warrants ranged from $2.00 to $5.75 per share.
40
Interests of Experts and Counsel
Not applicable.
ITEM 8. FINANCIAL INFORMATION
Consolidated Statements and Other Financial Information
See Item 18 "Financial Statement" and included herein by reference.
Legal Proceedings
In December 1999, our former vice president of marketing and sales filed an
action in Israel against us and Mr. HaCohen seeking damages in the amount of up
to $1,364,000. The former employee alleges wrongful denial of his right to
exercise options, loss of compensation, including options to purchase shares
granted to him by his previous employer, severance payment and other social
benefits, as well as damage to his reputation.
In March 2000, we filed a statement of defense and counter action against
the former employee seeking damages in the amount of approximately $970,000. We
alleged that the former employee has acted in bad faith, breached his fiduciary
duty and did not perform his duties as required.
In October 2000, this former employee filed a Response Statement to the
counter action. This matter was referred by the Jerusalem District Labor Court
to a mediation procedure, which is currently pending.
We are unable to determine with any certainty the ultimate outcome of the
litigation and/or mediation procedure and its effect on our business, financial
condition and results of operations. We intend to vigorously defend this action.
We have received a notice from a third party alleging that our use of the
Service Hub name infringes on this third party's trademark rights. We have
responded and denied this claim and we are currently negotiating a settlement
agreement with such third party. We cannot predict whether this dispute will
settle successfully, whether this third party would prevail in any claims
brought against us, whether other third parties will assert claims of
infringement against us, or whether any past or future assertions or
prosecutions will harm our business. If we are forced to defend against this
claim or any other claims, whether they are with or without merit or determined
in our favor, then we may face costly litigation, diversion of management
resources or, if any claims prevail, damages or significant increases in
development or marketing costs.
Dividend Distribution Policy
We have never declared or paid dividends to our shareholders and we do not
intend to pay dividends in the future. We anticipate that we will retain all of
our future earnings for use in the expansion and operation of our business and,
therefore, do not expect to pay any dividends in the future.
Significant Changes
Not applicable.
41
ITEM 9. THE OFFER AND LISTING
Market Price Information
The annual high and low reported sale prices for our ordinary shares were
9.375 and 2.563 respectively. Through March 31, 2001, the high and low reported
sales prices for our ordinary shares were as follows:
Period High Low
------ ---- ---
Year ending December 31, 9.375 2.563
2000
Fourth Quarter, ending 8.625 2.563
December 31, 2000
Third Quarter, ending 9.375 8.063
September 30, 2000
Most Recent 6 months High Low
-------------------- ---- ---
March 2001 2.563 1.00
February 2001 4.125 2.625
January 2001 3.875 2.750
December 2000 5.375 2.563
November 2000 6.500 4.625
October 2000 8.625 5.875
Markets on Which Our Ordinary Shares Trade
Our ordinary shares have been listed on the Nasdaq National Market since
September 19, 2000, under the symbol "VRYA". Prior to September 19, 2000, there
was no public market for our ordinary shares.
ITEM 10. ADDITIONAL INFORMATION
Share Capital
Not applicable.
Memorandum and Articles of Association
Company's objectives
The Company's objectives, as set forth in section 3 of our Articles of
Association, are to carry on any business and do any act which is not prohibited
by law. We may also make contributions of reasonable sums to worthy purposes
even if such contributions are not made on the basis of business considerations.
42
Directors
Any director is entitled to vote in a meeting of our board of directors,
except that a director who has a personal interest in an "extraordinary
transaction" (as defined below) which is considered at a meeting of our board of
directors may not be present at this meeting or vote on this matter. An
"extraordinary transaction" is defined in the Companies Law as a transaction
that is either (i) not in the ordinary course of business; (ii) not on market
terms; or (iii) that is likely to have a material impact on the company's
profitability, assets or liabilities.
Until otherwise decided by our board of directors, a quorum at a meeting of
our board of directors shall be constituted by the presence in person, by
alternate or by telephone or similar communication equipment, of a majority of
the directors then in office who are lawfully entitled to participate and vote
at the meeting. If within one-half an hour (or within such longer time not
exceeding one (1) hour as the Chairman of the meeting may decide) from the time
appointed for the holding of the board meeting, a quorum is not present, the
board meeting shall stand adjourned to the same day in the next week at the same
time and place (unless such day shall fall on a public holiday either in Israel
or the United States, in which case the meeting will be adjourned to the first
day, not being a Friday, Saturday or Sunday, which follows such public holiday).
If, at such adjourned board meeting, a quorum is not present within half an hour
from the time appointed for holding the meeting, the directors present, in
person, by alternate or by telephone or similar communication equipment who are
lawfully entitled to participate and vote at such meeting, shall be a quorum.
Our business is managed by the board of directors, which may exercise all
such company powers and perform on our behalf all such acts as may be exercised
and performed by us as are not by the Companies Law or by our Articles of
Association required to be exercised or done by us through a general meeting of
our shareholders. Our Articles of Association provides that the board of
directors may from time to time, at its discretion, cause us to borrow or secure
the payment of any sum or sums of money for the Company's purposes, and may
secure or provide for the repayment of such sum or sums in such manner, at such
times and upon such terms and conditions as it deems fit, and, in particular, by
the issuance of bonds, perpetual or redeemable debentures, debenture stock, or
any mortgages, charges, or other securities on the undertaking or the whole or
any part of our property, both present and future, including its uncalled or
called but unpaid capital for the time being.
There is no age limit as to the ability of individuals to serve as members
of our board of directors.
A director is not required to hold our shares as a condition to his
nomination or election as our director.
Rights attached to our shares
All dividends shall be declared by our board of directors and paid in
proportion to the amount paid up on account of the nominal value of the ordinary
shares in respect of which the dividend is being paid. As regards to ordinary
shares not fully paid throughout the period in respect of which the dividend is
paid, dividends in respect thereto shall be apportioned and paid pro rata
according to amounts deemed under our Articles of Association to be paid up on
account of the nominal value of such shares during any portion or portions of
the period in respect of which the dividend is paid.
Under our Articles of Association, every shareholder who is present, in
person, by proxy, or by written ballot or is deemed under the Companies Law to
be present at a general meeting of the shareholders, shall be entitled to one
vote for each ordinary share of which he is the holder,
The distribution of dividends is under the discretion of our board of
directors, which is under no obligation to distribute dividends to our
shareholders out of the Company's profits.
Upon liquidation, all available surplus after payments of all debts shall
be distributed to our shareholders on a pro-rata basis.
Changes of rights attached to our shares
Changes to the rights attached to our ordinary shares require the approval
of shareholders present, in person, by proxy, or by written ballot, or deemed
under the Companies Law to be present, holding greater than fifty percent (50%)
of the total voting power attached to the ordinary shares whose holders were
present, in person, by proxy, or by written ballot, or deemed under the
Companies Law to be present, at such general meeting, and voted thereon. If, at
any time, the share capital of the Company is divided into different classes of
shares, the right attached to any class (unless otherwise provided by the terms
of issue of the shares of that class) may be varied only upon consent of a
separate general meeting of the
43
holders of the shares of that class and the provisions of our Articles of
Association relating to general meetings shall apply to every such separate
general meeting. The enlargement of an authorized class of shares, or the
issuance of additional shares thereof out of the authorized and unissued share
capital, shall not be deemed to vary, modify or abrogate the rights attached to
previously issued shares of such class or of any other class of shares.
General Meetings
We are required to hold an annual general shareholders meeting once in
every calendar year within a period of not more than fifteen (15) months after
the last preceding annual general shareholders meeting. All general shareholders
meetings other than annual general shareholders meeting are deemed to be
extraordinary shareholders meeting. Our board of directors may call for a
general meeting whenever it sees fit, and, under the Companies Law, is required
to call a general meeting upon a demand in writing by (i) a shareholder or
shareholders holding at least 5% of the outstanding shares and 1% of the voting
rights in the company, or (ii) a shareholder or shareholders holding at least 5%
of the voting rights in the company. Subject to applicable law and regulations,
prior notice of at least 21 days of any general shareholders meeting, specifying
the place, date and hour of the meeting, shall be given to the shareholders of
the Company. No business shall be transacted at any general shareholders meeting
unless a quorum is present when the meeting proceeds to business. For all
purposes, the quorum shall not be less than two (2) shareholders present in
person, or by proxy, or deemed by the Companies Law, to be present at such
meeting, holding, in the aggregate, at least, thirty-three and one-third percent
(33 1/3%) of the voting rights in our issued share capital. If, within half an
hour from the time appointed for the meeting, a quorum is not present (or within
such longer time not exceeding one (1) hour as the Chairman of the meeting may
decide), the meeting, if convened upon the requisition of the shareholders,
shall be dissolved; in any other case, it shall stand adjourned to the same day
in the next week at the same place and time (unless such day shall fall on a
public holiday either in Israel or the United States, in which case the meeting
will be adjourned to the first day, not being a Friday, Saturday or Sunday,
which follows such public holiday), or any other day, hour and/or place as the
directors shall notify the shareholders. If a quorum is not present at the
second meeting within half an hour from the time appointed for the meeting, any
two shareholders present personally or by proxy or any other valid instrument
shall constitute a quorum, and shall be entitled to deliberate and to resolve in
respect of the matters for which the meeting was convened.
Ownership of our shares
Our Articles of Association and the laws of the State of Israel do not
restrict in anyway the ownership or voting of our shares by non-residents of
Israel.
Change of Control
Our Articles of Association do not contain specific provisions intended to
delay, defer or prevent a change of control.
Material Contracts
We have not entered into any material contracts other than in the ordinary
course of business and other than those discussed in the Property, Plant and
Equipment section and the Lines of Credit section under Item 4 "Information on
our Company" and in the Related Party Transactions section under Item 7 "Major
Shareholders and Related Party Transactions".
Exchange Controls
Until May 1998, Israel imposed restrictions on transactions in foreign
currency. These restrictions affected our operations in various ways, and also
affected the right of non-residents of Israel to convert into foreign currency
amounts they received in Israeli currency, such as the proceeds of a judgment
enforced in Israel. Despite these restrictions, foreign investors who purchased
shares with foreign currency were able to repatriate in foreign currency both
dividends (after deduction of withholding tax) and the proceeds from the sale of
the shares. In 1998, the Israeli currency control regulations were liberalized
significantly, as a result of which Israeli residents generally may freely deal
in foreign currency and non-residents of Israel generally may freely purchase
and sell Israeli currency and assets. There are currently no Israeli currency
control restrictions on remittances of dividends on the ordinary shares or the
proceeds from the sale of the shares; however, legislation remains in effect
pursuant to which currency controls can be imposed by administrative action at
any time.
44
Neither our Memorandum of Association nor our Articles of Association nor
the laws of the State of Israel restrict in any way the ownership or voting of
ordinary shares by non-residents of Israel.
Taxation
United States Federal Income Tax Consideration
The following discussion describes the material United States federal
income tax consequences to a person from the purchase, ownership, and
disposition of our ordinary shares. The following discussion is based on the
internal revenue code, current and proposed treasury regulations, judicial
decisions and published positions of the internal revenue service, all as in
effect on the date of this form, and all of which are subject to change,
possibly with retroactive effect. This discussion does not address all aspects
of United States federal income taxation that may be relevant to a person based
on particular circumstances. For example, the following discussion does not
address the United States federal income tax consequences of the purchase,
ownership and disposition of the ordinary shares if the person:
. controls or owns, directly, indirectly or through attribution 10% or
more of our shares by vote or value;
. is a broker-dealer, insurance company, tax-exempt organization, or
financial institution;
. holds ordinary shares as part of an integrated investment comprised of
ordinary shares and one or more other positions; or
. has a functional currency that is not the United States dollar.
The following discussion also does not address any aspect of state, local
or non-United States tax laws or any aspect of United States estate or gift
taxation and does not address aspects of United States federal income taxation
applicable to United States holders holding options, warrants or other rights to
acquire our ordinary shares, or who otherwise receive our ordinary shares as
compensation. Further, this summary generally considers only United States
holders that hold their ordinary shares as capital assets and does not consider
the tax treatment of holders who are partnerships or who hold ordinary shares
through a partnership or other pass-through entity. This discussion also assumes
that we will not be treated as a controlled foreign corporation. Under the
internal revenue code, a controlled foreign corporation generally means any
foreign corporation if, on any day during its taxable year, more than fifty
percent of either the total combined voting power of all classes of stock of the
corporation entitled to vote, or the total value of the stock of the corporation
is owned, directly, indirectly or by attribution, by United States persons who,
in turn, own directly, indirectly or by attribution, ten percent or more of the
total combined voting power of all classes of stock of the corporation entitled
to vote. This discussion does not apply to any person which is not a United
States holder or to any person which holds shares other than ordinary shares.
For purposes of this discussion, a person is a United States holder if such
person holds ordinary shares and if such person is:
. a citizen or resident of the United States;
. a partnership or a corporation or other entity taxable as a
corporation organized under the laws of the United States or of any
state of the United States or the District of Columbia;
. an estate the income of which is includible in gross income for United
States federal income tax purposes regardless of source; or
. a trust, if a United States court is able to exercise primary
supervision over its administration and one or more United States
persons have the authority to control all of its substantial
decisions.
You should be aware that this summary is not a comprehensive description of
all the tax considerations that may be relevant to your purchase, ownership or
disposition of our ordinary shares. United States holders of our ordinary shares
are advised to consult their own tax advisors concerning the United States
federal, state and local tax consequences, as well as the tax consequences in
Israel and other jurisdictions, of the purchase, ownership and disposition of
our ordinary shares in their particular situations.
45
Distributions
We have never paid dividends, and do not intend to pay dividends in the
future. In general, and subject to the discussion below, if we do make a
distribution on the ordinary shares, the distribution will be treated as a
dividend for United States federal income tax purposes to the extent of our
current and accumulated earnings and profits, as calculated under United States
federal income tax principles. If the amount of the distribution exceeds our
earnings and profits, the excess will first be treated as a non-taxable return
of a United States holder's tax basis in the ordinary shares that reduces that
United States holder's tax basis dollar-for-dollar, and then as gain from the
constructive disposition of the ordinary shares.
The amount received by a United States holder that is treated as a dividend
for United States federal income tax purposes:
. will be includible in the United States holder's gross income;
. will be subject to tax at the rates applicable to ordinary income; and
. will not qualify for the dividends received deduction applicable in
some cases to United States corporations.
The amount of dividend income will include the amount of Israeli taxes, if
any, withheld by us on the dividends we paid, as described below in this filing
under Israeli Taxation and Investment Programs. Thus, if withholding taxes are
imposed, a United States holder will be required to report income in an amount
greater than the cash or the value of other property it receives on the ordinary
shares. However, a United States holder may be eligible to claim as a credit
against its United States federal income tax liability the amount of tax
withheld by us on the dividends we paid.
The amount of foreign income taxes which may be claimed as a credit in any
year is subject to complex limitations and restrictions, which must be
determined on an individual basis by each United States holder. In general, the
total amount of allowable foreign tax credits in any year cannot exceed the pre-
credit United States tax liability for the year attributable to each of nine
categories of foreign source taxable income. Dividends received by a United
States holder on stock of a foreign corporation, such as our ordinary shares,
are generally treated as foreign source income within the category of passive
income for this purpose, but are subject to being reclassified as United States
source income in specific circumstances. Because distributions in excess of our
current and accumulated earnings and profits generally will not give rise to
foreign source income, a person may be unable to claim a foreign tax credit for
Israeli withholding tax imposed on the excess amount unless, subject to
applicable limitations, such person has other foreign source income. A United
States holder's foreign tax credit may be further limited or restricted based on
that United States holder's particular circumstances, including the length of
time the United States holder owned our ordinary shares and whether the
alternative minimum tax provisions of the internal revenue code apply. If a
United States holder's foreign tax credit is restricted in one taxable year, the
excess foreign tax credit generally can be carried back for two taxable years
and forward for five taxable years, subject to the limitations described above.
If a United States holder receives a dividend in NIS or other non-United
States currency, the amount of the distribution for United States federal income
tax purposes will be the United States dollar value of the distribution
determined by the spot rate of exchange on the date the distribution is
received, or is treated as received. A United States holder will have a tax
basis in the foreign currency for United States federal income tax purposes
equal to the United States dollar value of the foreign currency as determined
under the preceding sentence. A United States holder generally will recognize
exchange gain or loss upon the subsequent disposition of the foreign currency
equal to the difference between the amount realized on the disposition and the
United States holder's tax basis in the foreign currency. The gain or loss
generally will be ordinary gain or loss and will generally be treated as United
States source gain or loss for United States federal income tax purposes.
Alternatively, a United States holder may elect to claim a United States
federal income tax deduction for the Israeli tax paid or withheld, but only for
a taxable year in which the United States holder elects to deduct all foreign
income taxes. A non-corporate United States holder, however, may not elect to
deduct Israeli taxes if that United States holder does not itemize deductions.
Because the tax rules that limit the availability or use of foreign tax
credits are complex, we are unable to provide United States holders with any
assurance as to the effect of limitations on United States foreign tax credits
and deductions
46
for foreign taxes, and United States holders should consult with, and rely
solely upon, their personal tax advisors with respect to such matters.
Sale, Exchange or Other Disposition
Subject to the discussion below, a United States holder generally will
recognize capital gain or loss for United States federal income tax purposes
upon the sale or other disposition of the United States holder's ordinary shares
equal to the difference between the amount realized on the sale or other
disposition and the United States holder's tax basis in its ordinary shares. The
capital gain or loss will be long-term capital gain or loss if the ordinary
shares have been held for more than one year at the time of sale or other
disposition. In general, any gain or loss recognized by a United States holder
on the sale or other disposition of ordinary shares will be United States source
income or loss for foreign tax credit purposes. In some cases, however, losses
upon the sale or other disposition of ordinary shares may be required to be
allocated to foreign source income.
Personal Holding Companies
A foreign corporation may be classified as a personal holding company for
United States federal income tax purposes if both of the following two tests are
satisfied:
. if at any time during the last half of the company's taxable year,
five or fewer individuals without regard to their citizenship or
residency actually or constructively own, under attribution rules,
more than 50% of the stock of the corporation by value; and
. 60% or more of the foreign corporation's gross income derived from
United States sources or effectively connected with a United States
trade or business, as specifically adjusted, is from passive sources
like dividends and royalty payments.
A personal holding company generally is taxed at a rate of 39.6% of
undistributed personal holding company income, which is generally calculated
based on the corporation's taxable income, after making adjustments including
deducting dividends paid and income taxes. We cannot provide any assurance that
either test will not be satisfied in 2001 or future years because it is
difficult to make accurate predictions of future income and the amount of stock
an individual will actually or constructively own in us.
Foreign Personal Holding Companies
A foreign corporation will be classified as a foreign personal holding
company for United States federal income tax purposes if both of the following
two tests are satisfied:
. five or fewer individuals who are United States citizens or residents
actually or constructively own, under attribution rules, more than 50%
of all classes of the corporation's stock measured by voting power or
value at any time during the corporation's taxable year; and
. the corporation receives at least 60%, 50% if previously a foreign
personal holding company, of its gross income regardless of source, as
specifically adjusted, from passive sources.
If a corporation is classified as a foreign personal holding company, a
portion of its undistributed foreign personal holding company income, as defined
for United States federal income tax purposes, would be imputed to all of its
shareholders who are United States holders on the last day of the corporation's
taxable year, or, if earlier, the last day on which the United States ownership
test set forth above is met. The imputed income would be taxable as a dividend,
even if no cash dividend is actually paid. United States holders who dispose of
their shares before that date would not be subject to United States federal
income tax under these rules. We cannot provide any assurance that we will not
qualify as a foreign personal holding company in 2001 or future years because it
is difficult to make accurate predictions of future income and the amount of
stock a United States citizen or resident will actually or constructively own in
us.
47
Foreign Investment Companies
A foreign corporation may be classified as a foreign investment company if,
at any time during a taxable year when 50% or more by vote or value of the
corporation's outstanding stock is owned, directly or indirectly, by United
States holders, it is:
. registered under the Investment Company Act of 1940 as a management
company or unit investment trust; or
. engaged, or holding itself out as being engaged, primarily in the
business of investing, reinvesting, or trading in securities,
commodities, or any interest, including a futures or forward contract
or option, in securities or commodities.
In general, if a corporation is classified as a foreign investment company
at any time during the period a United States holder holds the corporation's
stock, any gain from the sale or exchange, or distribution treated as an
exchange, of stock in that corporation by the United States holder will be
taxable as ordinary income to the extent of the United States holder's ratable
share of the corporation's accumulated earnings and profits. We cannot provide
any assurance that we will not qualify as a foreign investment company in 2001
or future years because it is difficult to make accurate predictions of the
amount of stock United States holders will directly or indirectly own in us.
Passive Foreign Investment Company Rules
In general, a foreign corporation will be a passive foreign investment
company if:
. 75% or more of its gross income, including the pro rata share of the
gross income of any United States or foreign company in which the
corporation is considered to own 25% or more of the shares by value,
in a taxable year is passive income; or
. at least 50% of the average value of the assets of the corporation,
including the pro rata share of the assets of any United States or
foreign company in which the corporation is 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 the foreign corporation
is a publicly traded corporation for its entire taxable year, this 50%
test is based on the average value of its assets. This 50% test may
instead be based on the adjusted bases of the foreign corporation's
assets, rather than value, if the foreign corporation is not a
publicly traded corporation for a portion of its taxable year and
either the foreign corporation is a controlled foreign corporation or
elects to use the adjusted bases of its assets for purposes of this
test.
If we were a passive foreign investment company, and a United States holder
did not make a qualifying election either to treat us as a qualified electing
fund or mark our shares to market:
. excess distributions by us to a United States holder would be taxed in
a special way. Excess distributions are amounts received by a United
States holder concerning our ordinary shares in any taxable year that
exceed 125% of the average distributions received by the United States
holder from us in the shorter of either the three previous years or
the United States holder's holding period for ordinary shares before
the current taxable year. Excess distributions must be allocated
ratably to each day that a United States holder has held our ordinary
shares. A United States holder must include amounts allocated to the
current taxable year and to pre-passive foreign investment company
years in its gross income as ordinary income for the current taxable
year. A United States holder must pay tax on amounts allocated to each
prior taxable year for which we were a passive foreign investment
company at the highest rate in effect for that year on ordinary income
and the tax is subject to an interest charge at the rate applicable to
deficiencies for income tax.
. the entire amount of gain that is recognized by a United States holder
upon the sale or other disposition of ordinary shares will also be
considered an excess distribution and will be subject to tax as
described above.
. if a corporation is a passive foreign investment company, a United
States holder who acquires ordinary shares in the corporation from a
decedent who was a United States shareholder is denied the normally
available step-up in the tax basis of the ordinary shares to fair
market value at the date of death and instead will hold the ordinary
shares with a tax basis equal to the decedent's basis, if lower than
the fair market value. A United States holder cannot avoid this
result, however, by electing to mark our ordinary shares to market.
48
If a United States holder has made a qualified electing fund election for
all taxable years during which the United States holder owned our ordinary
shares and we were a passive foreign investment company, the passive foreign
investment company rules described above will not apply to the United States
holder. Instead, a United States holder of a qualified electing fund is required
for each taxable year to include in income a pro rata share of the ordinary
earnings of the qualified electing fund as ordinary income and a pro rata share
of the net capital gain of the qualified electing fund as long-term capital
gain, subject to a separate election to defer payment of taxes and incur an
interest charge. The qualified electing fund election is made on a
shareholder-by-shareholder basis and can be revoked only with the consent of the
internal revenue service. A United States holder generally makes a qualified
electing fund election by obtaining and retaining the passive foreign investment
company annual information statement, attaching a completed internal revenue
service Form 8621 to a timely filed United States federal income tax return and
by filing the form with the internal revenue service center in Philadelphia,
Pennsylvania. Even if a qualified electing fund election is not made, a
shareholder in a passive foreign investment company who is a United States
holder generally must file a completed internal revenue service Form 8621 every
year.
A United States holder of publicly traded passive foreign investment
company stock could elect to mark the stock to market annually and generally
could be subject to specific rules for each of the United States holder's
taxable years, including:
. if the fair market value of the United States holder's passive foreign
investment company stock exceeds the United States holder's adjusted
tax basis in that stock as of the close of the United States holder's
taxable year, the United States holder will recognize the amount of
the excess as ordinary income;
. if the fair market value of the United States holder's passive foreign
investment company stock is less than the United States holder's
adjusted tax basis in that stock as of the close of the United States
holder's taxable year, the United States holder may recognize the
amount of the difference as ordinary loss. Losses would be allowed
only for the amount of net gain previously included by the United
States holder under the election for prior taxable years; and
. if the United States holder has elected to mark our ordinary shares to
market for all taxable years during which the United States holder
owned our ordinary shares and we were a passive foreign investment
company, the passive foreign investment company rules generally will
not apply to the United States holder.
United States holders who hold ordinary shares during a period when we are
a passive foreign investment company will be subject to the preceding rules,
even if we cease to be a passive foreign investment company, subject to
exceptions for United States holders who made a qualified electing fund
election. United States holders are urged to consult their tax advisors about
the passive foreign investment company rules, including the specific rules and
requirements applicable to making qualified electing fund and other elections.
Status of ViryaNet as a Passive Foreign Investment Company
Although we do not reasonably believe we will be a passive foreign
investment company in 2001, we cannot provide any assurance that we will not
qualify as a passive foreign investment company in 2001 or in future years.
Passive foreign investment company status is determined as of the end of each
taxable year and is dependent upon a number of factors, including the value of a
corporation's assets and the amount and type of its gross income. The
determination of whether we are or will become a passive foreign investment
company will be affected by how rapidly we use our cash and investment assets in
our business. Also, a significant decline in the market price of our ordinary
shares may result in our being classified as a passive foreign investment
company.
Backup Withholding and Information Reporting
Dividends on our ordinary shares, and payments of the proceeds of a sale of
our ordinary shares, paid within the United States or through certain United
States-related financial intermediaries are subject to information reporting and
may be subject to backup withholding at a 31% rate unless (i) the payor is
entitled to, and does in fact, presume the United States holder of our ordinary
shares is a corporation or other exempt recipient or (ii) the United States
holder provides a taxpayer identification number on a properly completed Form W-
9 and certifies that no loss of exemption from backup withholding has occurred.
The amount of any backup withholding will be allowed as a credit against a
United States holder's United States federal income tax liability and may
entitle that United States holder to a refund, provided that required
information is furnished to the internal revenue service.
49
Israeli Taxation and Investment Programs
The following is a summary of the principal tax laws applicable to
companies in Israel, with special reference to their effect on us, and Israeli
government programs benefiting us. This section also contains a discussion of
Israeli tax consequences to you if you acquire ordinary shares of our company.
This summary does not discuss all the acts of Israeli tax law that may be
relevant to you in light of your personal investment circumstances or if you are
subject to special treatment under Israeli law. To the extent that the
discussion is based on new tax legislation which has not been subject to
judicial or administrative interpretation, we cannot assure you that the views
expressed in this discussion will be accepted by the tax authorities. The
discussion should not be understood as legal or professional tax advice and is
not exhaustive of all possible tax considerations.
You are urged to consult your own tax advisors about the Israeli or other
tax consequences of the purchase, ownership and disposition of our ordinary
shares, including, in particular, the effect of any foreign, state or local
taxes.
General Corporate Tax Structure
The general corporate tax rate in Israel is 36%. However, the effective tax
rate payable by a company which derives income from an approved enterprise may
be considerably less.
Law for the Encouragement of Industry, Taxes, 1969
We qualify as an industrial company under the Law for the Encouragement of
Industry (Taxes), 1969, otherwise known as the industry encouragement law. A
company qualifies as an industrial company under the industry encouragement law
if it resides in Israel and at least 90% of its income in a given tax year,
exclusive of income from specified loans, marketable securities, capital gains,
interest and dividends, is derived from an industrial enterprise owned by us. An
industrial enterprise is defined as an enterprise whose major activity in a
given tax year is industrial manufacturing.
Under the industry encouragement law, an industrial company is entitled to
deduct the purchase price of know how, patents or rights over a period of eight
years beginning with the year in which the rights were first used.
The tax laws and regulations dealing with the adjustment of taxable income
for inflation in Israel also provide that industrial enterprises, like ours, 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 operated and range from 20% to 40% on a straight-line basis, or
from 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, which are
applied on a straight-line basis.
Industrial enterprises which are approved enterprises can also choose
between
. the special rates referred to above; and
. accelerated rates of depreciation applied on a straight-line basis on
property and equipment, generally ranging from 200% on equipment to
400% of the ordinary depreciation rates on buildings during the first
five years of service of the assets subject to a ceiling of 20% per
year on depreciation of buildings.
Qualification as an industrial company under the industrial encouragement
law is not conditioned upon the receipt of prior approval from any Israeli
government authority. No assurance can be given that we will continue to qualify
as an industrial company or will in the future be able to avail ourselves of any
benefits available to companies so qualifying.
Law for the Encouragement of Capital Investments, 1959
The Law for Encouragement of Capital Investments, 1959, which is referred
to below as the capital investments law, provides that capital investments in a
production facility or other eligible assets may, upon application to the
Israeli Investment Center of the Ministry of Industry and Commerce, be
designated as an approved enterprise. Each certificate of approval for an
approved enterprise relates to a specific investment program in the approved
enterprise, delineated both by the financial scope of the investment and by the
physical characteristics of the facility or the asset. An approved enterprise is
entitled to benefits, including Israeli government cash grants and tax benefits.
50
Tax Benefits
Taxable income derived from an approved enterprise is subject to a reduced
corporate tax rate of 25%. That income is eligible for further reductions in tax
rates depending on the percentage of the foreign investment in our share capital
and the percentage of our combined share and loan capital owned by non-Israeli
residents. The tax rate is 20% if the foreign investment is 49% or more but less
than 74%, 15% if the foreign investment is 74% or more but less than 90% and 10%
if the foreign investment is 90% or more. The lowest level of foreign investment
during the year will be used to determine the relevant tax rate for that year.
These tax benefits described above are granted for a limited period of time and
begin when a company is operational and profitable. The benefits are granted for
up to 7 years, or 10 years for a company that has 25% or more of its shares
owned by non-Israeli shareholders, from the first year in which the approved
enterprise has taxable income, other than income subject to capital gains tax.
The period of benefits may not, however, exceed the lesser of 12 years from the
year in which the production began or 14 years from the year of receipt of
approved enterprise status.
An approved enterprise approved after April 1, 1986 may elect to forego any
entitlement to the grants otherwise available under the capital investments law
or may participate in an alternative benefits program, under which the
undistributed income from the approved enterprise is fully exempt from corporate
tax for a defined period of time. The period of tax exemption ranges between two
and ten years, depending upon the location within Israel of the approved
enterprise and the type of the approved enterprise. Alternatively, approved
enterprises approved after January 1, 1997 in national priority region A may
elect to receive grants and a two-year tax exemption for undistributed profits
derived from the approved enterprise program. We cannot assure you that the
current benefit programs will continue to be available or that we will continue
to qualify for benefits under the current programs.
We have three approved enterprise programs under the capital investments
law, which entitle us to some tax benefits. The tax benefit period for these
programs has not yet begun. We have elected to participate in a government grant
approved enterprise program and have received grants from the investment center.
Income derived from the government grant approved enterprise program is subject
to a reduced tax rate of 10% to 25% (depending on the percentage of foreign
investment in us) for a period of seven years starting on the first year in
which we generate taxable income from the approved enterprise. We have elected
to participate in two additional alternative benefit programs. Income derived
from our alternative benefit programs is exempt from tax for a period of ten
years, starting in the first year in which we generate taxable income from the
approved enterprise.
If dividends are paid out of tax-exempt profit derived from our approved
enterprise, we will be liable for corporate tax on the gross amount of
distributed profits before company tax at the rate that would have been applied
if we had not elected the alternative tax benefit. This rate is generally 10% to
25%, depending on the percentage of a company's shares held by foreign
shareholders. We will also be required to withhold on behalf of the dividend
recipients 15% of the amount distributed as dividends. Cash dividends paid by an
Israeli company are normally subject to a withholding tax, except for dividends
that are paid to an Israeli company, in which case no tax is withheld unless the
dividend is paid from earnings from an approved enterprise. Since we have
received some benefits under Israeli laws relating to approved enterprises,
payment of dividends may subject us to some Israeli taxes to which we would not
otherwise be subject.
The Israeli government has discussed reducing the benefits available to
companies under the capital investments law. The termination or substantial
reduction of any of the benefits available under the capital investments law
could materially impact the cost of future investments by us.
Each application to the investment center is reviewed separately, and a
decision about whether or not to approve the application is based on the then
prevailing criteria in the capital investments law, on the specific objectives
of the applicant company in the application and on financial criteria of the
applicant company. We cannot assure you that any application will be approved.
The benefits available to an approved enterprise are conditional upon the
fulfillment of conditions stipulated in the capital investments law and its
regulations and the criteria in the specific certificate of approval, as
described above. If these conditions are violated, in whole or in part, we would
be required to refund the amount of tax benefits and linkage differences to the
Israeli consumer price index and interest. We believe that our approved
enterprise programs operate in compliance with all of these conditions and
criteria.
Taxation Under Inflationary Conditions
The Income Tax, Inflationary Adjustment, Law, 1985, which is referred to
below as the inflationary adjustments law, attempts to overcome some of the
problems presented to a traditional tax system by an economy experiencing rapid
inflation, which was the case in Israel at the time the law was enacted.
Generally, the inflationary adjustments law provides significant tax
adjustments, based on net equity less fixed assets, to depreciation methods and
tax loss carry forwards to
51
compensate for loss of value resulting from an inflationary economy. Our taxable
income is subject to the provisions of this law.
The inflationary adjustments law allows foreign-invested companies, which
maintain their accounts in dollars in compliance with regulations published by
the Israeli minister of finance to deviate from the principles of the
inflationary adjustments law. These companies may either base their tax returns
on their operating results as reflected in the dollar financial statements or
adjust their tax returns based on exchange rate changes rather than changes in
the Israeli consumer price index. For these purposes, a foreign-invested company
is a company more than 25% of whose share capital and of whose combined share
and loan capital is held by persons who are not residents of Israel. A company
that elects to measure its results for tax purposes based on the dollar exchange
rate cannot change that election for a period of three tax years following the
election. We believe that we qualify as a foreign investment company within the
meaning of the inflationary adjustment law. We have not yet elected to measure
our results for tax purposes based on the dollar exchange rate, but may do so in
the future, during a 30-day period in the beginning of each tax year.
Tax Benefits of Research and Development
Israeli tax law permits, under some conditions, a tax deduction in the year
incurred for expenditures, including capital expenditures, in scientific
research and development projects, if the expenditures are approved by the
relevant government ministry and if the research and development is for the
promotion of the enterprise and is carried out by, or on behalf of, a company
seeking the deduction.
Some of our research and development programs have been approved by the
chief scientist and we have been able to deduct, for tax purposes, a portion of
our research and development expenses net of the grants received. Other research
and development expenses that are not approved may be deducted for tax purposes
in 3 equal installments during a 3-year period.
Committee on the Reform of Taxes on Income
On May 7, 2000, the Israeli government approved the recommendations of the
public committee on the reform of taxes on income, to broaden the categories of
taxable income and to change the tax rates imposed on employment income.
The committee recommended to:
. impose an estate and gift tax;
. impose a tax upon capital gains at a rate of up to 25% for
individuals, including capital gains derived from the sale of
shares in Israeli publicly traded companies;
. impose a tax upon all income of Israeli residents regardless of the
territorial source of income;
. increase the tax rate from zero to 10% on the exempt period under
the alternative package of benefits for approved enterprises under
the Law for the Encouragement of Capital Investments, 1959; and
. cancel the preferred benefits granted to companies with foreign
investment.
Legislation will be required to implement these changes, and the enactment of
that legislation is uncertain. The termination or reduction of these tax
benefits and programs could harm our business, financial condition and results
of operations.
Withholding and Capital Gains Taxes Applicable to Non-Israeli Shareholders
Nonresidents of Israel are subject to income tax on income accrued or
derived from sources in Israel or received in Israel. These sources of income
include passive income like dividends, royalties and interest, as well as non-
passive income from business conducted or services rendered in Israel. We are
generally required to withhold income tax at the rate of 25%, 15% for dividends
generated by an approved enterprise, on all distributions of dividends.
Israeli law imposes a capital gains tax on the sale of securities and other
capital assets. The regular rate applicable to corporations is 36% and the
maximum rate applicable to individuals is 50%. Under current law, however, sales
of our ordinary shares are exempt from Israeli capital gains tax for so long as:
52
. the shares are quoted on Nasdaq or listed on a stock exchange in a
designated country like the United States; and
. we qualify as an industrial company or industrial holding company.
A nonresident of Israel who receives interest, dividend or royalty income
derived from or accrued in Israel, from which tax was withheld at the source, is
generally exempt from the duty to file tax returns in Israel on this income,
provided the income was not derived from a business conducted in Israel by the
nonresident during an accrued period of more than 180 days in the relevant tax
year and the nonresident does not have any other non-passive income from sources
within Israel.
The convention between the United States and the government of the State of
Israel on taxes on income, which shall be referred to as the treaty, is
generally effective as of January 1, 1995.
Under the treaty, the following entities or individuals generally are exempt
from Israeli capital gains tax on income derived from the sale, exchange or
disposition of ordinary shares if these entities or individuals own, directly or
indirectly, less than 10% of the voting power in our Company during the twelve
month period preceding the sale, exchange or disposition of their ordinary
shares:
. individuals that are residents of the United States;
. corporations, or entities taxable as corporations, that are not
residents of Israel and that are organized under the laws of the United
States or of any state of the United States or the District of Columbia;
and
. other entities, to the extent that the other entities' income is taxable
in the United States as the income of residents of the United States.
The application of the treaty provisions applying to dividends and capital
gains described above and below is conditioned upon the fact that this income is
not effectively connected with a permanent establishment maintained by the non-
Israeli residents in Israel. Under the treaty, a permanent establishment
generally means a fixed place of business through which industrial or commercial
activity is conducted, directly or indirectly through agents.
Unless an exemption applies under domestic Israeli law, residents of the
United States who own the requisite 10% or more of our outstanding voting shares
are subject to Israeli tax on any gain realized on the sale, exchange or
disposition of those shares but would generally be permitted under the treaty to
claim a credit for those taxes against the United States income tax imposed on
any gain from the sale, exchange or disposition, subject to the limitations
applicable to foreign tax credits.
Under the treaty, the maximum tax on dividends paid to a holder of ordinary
shares who is a resident of the United States under the treaty generally is 25%.
However, dividends generally paid to a United States corporation by an Israeli
company that does not enjoy the benefits of an approved enterprise will
generally be subject to a 12.5% dividend withholding tax if:
. the recipient corporation owns at least 10% of the outstanding voting
shares of the Israeli company during the portion of the current taxable
year and during the whole of the prior taxable year of the Israeli
company preceding the date of the dividend; and
. not more than 25% of the gross income of the Israeli company during the
prior taxable year of the Israeli company preceding the date of the
dividend consists of interest or dividends.
If the Israeli company is entitled to the Israeli tax benefits applicable to
an approved enterprise and the requirements listed above are met, the
withholding tax rate on dividends paid to a United States corporation is 15%.
53
Documents on Display
The documents concerning ViryaNet referred to in this document and required
to be made available to the public are available at our offices located at 5
Kiryat Hamada Street, Science Based Industries Campus, Har Hotzvim, Jerusalem,
Israel 91230.
ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Revenues generated and costs incurred outside of the United States are
generally denominated in non-dollar currencies. Costs not effectively
denominated in United States dollars are translated to United States dollars,
when recorded, at the prevailing exchange rates for the purposes of the our
financial statements. Consequently, fluctuations in the rates of exchange
between the dollar and non-dollar currencies will affect our results of
operations. An increase in the value of a particular currency relative to the
dollar will increase the dollar reporting value for transactions in that
particular currency, and a decrease in the value of that currency relative to
the dollar will decrease the dollar reporting value for those transactions. This
effect on the dollar reporting value for transactions is generally only
partially offset by the impact that currency fluctuations may have on costs. We
do not generally engage in currency hedging transactions to offset the risks
associated with variations in currency exchange rates. Consequently, significant
foreign currency fluctuations and other foreign exchange risks may have a
material adverse effect on our business, financial condition and results of
operations. Since the our revenues are generated in United States dollars and
currencies other than NIS, and a substantial portion of our expenses are
incurred and will continue to be incurred in NIS, we are exposed to risk by the
amount that the rate of inflation in Israel exceeds the rate of devaluation of
the NIS in relation to the dollar and other currencies or if the timing of the
devaluation lags behind inflation in Israel. We do not engage in any hedging or
other transactions intended to manage risks relating to foreign currency
exchange rate or interest rate fluctuations. We also does not own any market
risk sensitive instruments. However, we may in the future undertake hedging or
other transactions or invest in market risk sensitive instruments if we
determine that it is necessary to offset these risks.
ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES
Not applicable.
PART II
ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES
None.
ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF
PROCEEDS
Use of Proceeds
On September 19, 2000, we commenced an initial public offering of 4,000,000
of our ordinary shares, pursuant to our final prospectus dated September 19,
2000 (the "Prospectus"). The Prospectus was contained in our Registration
Statement on Form F-1, which was declared effective by the Securities and
Exchange Commission (SEC File No. 333-42158) on September 19, 2000. The initial
public offering closed on September 22, 2000 upon the sale of 4,000,000 ordinary
Shares to the underwriters. Chase Securities Inc., Salomon Smith Barney, Inc.,
and Dain Rauscher Incorporated acted as the representatives of the underwriters
in the initial public offering.
The aggregate offering price of the initial public offering to the public
was $32,000,000, with proceeds to us, after deduction of the underwriting
discount, of $29,760,000 (before deducting offering expenses payable by us).
54
From September 19, 2000, through December 31, 2000, the aggregate amount of
expenses incurred by us in connection with the issuance and distribution of
ordinary shares offered and sold in the initial public offering was
approximately $5,995,000, including $2,240,000 in underwriting discounts and
commissions, $288,000 in payments to directors and officers and $3,467,000 in
other expenses.
The net proceeds to us from the initial public offering, after deducting
underwriting discounts and commissions and other expenses, were approximately
$26,005,000.
From September 19, 2000, through December 31, 2000, the amount of net
offering proceeds used for purchase of equipment and software was approximately
$1,302,000, for repayment of indebtedness approximately $2,104,000, and for
working capital approximately $7,281,000. We invested the balance of net
proceeds of approximately $15,318,000 primarily in short term deposits.
PART III
ITEM 17. FINANCIAL STATEMENTS
Not applicable.
ITEM 18. FINANCIAL STATEMENTS
See the Index to Consolidated Financial Statements and related Financial
Statements accompanying this report beginning page F-1.
55
ITEM 19. EXHIBITS
--------
Item 19. Exhibits.
Exhibit
Number Description of Document
3.1 Memorandum of Association of Registrant (English translation) dated
March 8, 1988 filed as Exhibit 3.1 to the Company's Registration
Statement on Form F-1, No. 333-42158 and incorporated herein by
reference.
3.2 Amended Articles of Association of Registrant filed as Exhibit 3.2 to
the Company's Registration Statement on Form F-1, No. 333-42158 and
incorporated herein by reference.
4.1 Specimen of ordinary share certificate filed as Exhibit 4.1 to the
Company's Registration Statement on Form F-1, No. 333-42158 and
incorporated herein by reference.
4.2 Amended Articles of Association of Registrant (included at Exhibit
3.2) filed as Exhibit 4.2 to the Company's Registration Statement on
Form F-1, No. 333-42158 and incorporated herein by reference.
10.1 1996 stock option plan filed as Exhibit 10.1 to the Company's
Registration Statement on Form F-1, No. 333-42158 and incorporated
herein by reference.
10.2 1997 stock option plan filed as Exhibit 10.2 to the Company's
Registration Statement on Form F-1, No. 333-42158 and incorporated
herein by reference.
10.3 1998 stock option plan filed as Exhibit 10.3 to the Company's
Registration Statement on Form F-1, No. 333-42158 and incorporated
herein by reference.
10.4 1999 stock option plan filed as Exhibit 10.4 to the Company's
Registration Statement on Form F-1, No. 333-42158 and incorporated
herein by reference.
10.5 The 2000 Amendment and Restatement to the Investors Rights Agreement
among ViryaNet and the Investors dated April 5, 2000 filed as Exhibit
10.5 to the Company's Registration Statement on Form F-1, No. 333-
42158.
10.6 Warrant issued by ViryaNet to Hapoalim Nechasim (Menayot) Ltd. to
purchase 217,391 ordinary shares filed as Exhibit 10.10 to the
Company's Registration Statement on Form F-1, No. 333-42158 and
incorporated herein by reference.
10.7 Warrant issued by ViryaNet to Hapoalim Nechasim (Menayot) Ltd. to
purchase approximately 69,565 ordinary shares filed as Exhibit 10.11
to the Company's Registration Statement on Form F-1, No. 333-42158
and incorporated herein by reference.
10.8 Form of warrant issued by ViryaNet to customers prior to July 1, 2000
to purchase ordinary shares filed as Exhibit 10.12 to the Company's
Registration Statement on Form F-1, No. 333-42158 and incorporated
herein by reference.
10.9 Lease for approximately 16,950 square feet of office space in
Jerusalem, Israel filed as Exhibit 10.14 to the Company's
Registration Statement on Form F-1, No. 333-42158 and incorporated
herein by reference.
10.11 Lease for approximately 13,807 square feet in Southborough,
Massachusetts filed as Exhibit 10.15 to the Company's Registration
Statement on Form F-1, No. 333-42158 and incorporated herein by
reference.
10.12 Form of Indemnification Agreement entered into with directors and
officers of Company filed as Exhibit 10.16 to the Company's
Registration Statement on Form F-1, No. 333-42158 and incorporated
herein by reference.
10.13 Form of warrant issued by ViryaNet to customers after July 1, 2000 to
purchase ordinary shares filed as Exhibit 10.17 to the Company's
Registration Statement on Form F-1, No. 333-42158 and incorporated
herein by reference.
21.1 Subsidiaries of the Registrant filed as Exhibit 21.1 to the Company's
Registration Statement on Form F-1, No. 333-42158 and incorporated
herein by reference.
23.1 Consent of Kost, Forer & Gabbay, a member of Ernst and Young
International and incorporated herein by reference.
56
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the Registrant
certifies that it has reasonable grounds to believe that it meets all of the
requirements for filing on Form 20-F and has duly caused this Form 20-F to be
signed on its behalf by the undersigned, thereunto duly authorized, in the City
of Southborough, Massachusetts, on this 9th day of May, 2001.
VIRYANET LTD.
By: /s/ Winfried A. Burke
-------------------------------------
Winfried A. Burke
President and Chief Executive Officer
57
VIRYANET LTD. AND ITS SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
AS OF DECEMBER 31, 2000
IN U.S. DOLLARS
INDEX
Page
----------------
Report of Independent Auditors F-2
Consolidated Balance Sheets F-3 - 4
Consolidated Statements of Operations F-5
Statements of Changes in Shareholders' Equity (Deficiency) F-6 - 7
Consolidated Statements of Cash Flows F-8 - 9
Notes to Consolidated Financial Statements F-10 - 32
- - - - - - - - - - -
[LOGO] ERNST & YOUNG . Kost Forer & Gabbay . Phone: 972-3-6232525
3 Aminadav St. Fax: 972-3-5622555
Tel-Aviv 67067, Israel
REPORT OF INDEPENDENT AUDITORS
To the shareholders of
VIRYANET LTD.
We have audited the accompanying consolidated balance sheets of
ViryaNet Ltd. ("the Company") and its subsidiaries as of December 31, 1999 and
2000, 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 December 31, 2000. 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 the 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 December 31, 1999 and 2000,
and the consolidated results of their operations and cash flows for each of the
three years in the period ended December 31, 2000, in conformity with accounting
principles generally accepted in the United States.
Tel-Aviv, Israel KOST FORER & GABBAY
February 12, 2001 A Member of Ernst & Young International
F-2
VIRYANET LTD. AND ITS SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
U.S. dollars in thousands
December 31,
--------------------------------
1999 2000
-------- ---------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 1,886 $ 21,838
Restricted cash (Note 3) 96 -
Trade receivables (net of allowance for doubtful
accounts - $ 28 in 1999 and $ 37 in 2000) 2,755 3,510
Unbilled receivables 708 2,680
Other accounts receivable and prepaid expenses (Note 4) 902 2,960
-------- ---------
Total current assets 6,347 30,988
-------- ---------
SEVERANCE PAY FUND 854 945
-------- ---------
PROPERTY AND EQUIPMENT, NET (Note 5) 1,491 2,907
-------- ---------
$ 8,692 $ 34,840
======== =========
The accompanying notes are an integral part of the consolidated financial
statements.
F-3
VIRYANET LTD. AND ITS SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
U.S. dollars in thousands (except share data)
December 31,
----------------------------
1999 2000
-------- ---------
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIENCY)
CURRENT LIABILITIES:
Short-term bank credit (Note 6) $ 5,283 $ 145
Current maturities of long-term loans 11 -
Trade payables 1,303 2,449
Deferred revenues 7,150 1,956
Other accounts payable and accrued expenses (Note 7) 3,905 5,312
-------- ---------
17,652 9,862
-------- ---------
ACCRUED SEVERANCE PAY 1,595 1,797
-------- ---------
COMMITMENTS AND CONTINGENT LIABILITIES (Note 8)
SHAREHOLDERS' EQUITY (DEFICIENCY) Share capital (Note 9):
Preferred shares of NIS 0.1 par value
Authorized: 13,100,000 shares as of December 31, 1999
and no shares as of December 31, 2000; Issued and outstanding:
10,146,387 shares as of December 31, 1999 and no shares as of
December 31, 2000; 294 -
Ordinary shares of NIS 0.1 par value
Authorized: 6,900,000 shares as of December 31, 1999 and
35,000,000 shares as of December 31, 2000; Issued and outstanding:
2,700,640 shares as of December 31, 1999 and 21,664,672 shares as
of December 31, 2000; 103 610
Additional paid-in capital 37,728 98,328
Deferred stock compensation (603) (604)
Accumulated other comprehensive loss - (288)
Accumulated deficit (48,077) (74,865)
-------- ---------
Total shareholders' equity (deficiency) (10,555) 23,181
-------- ---------
$ 8,692 $ 34,840
======== =========
The accompanying notes are an integral part of the consolidated financial
statements.
F-4
VIRYANET LTD. AND ITS SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
U.S. dollars in thousands (except share and per shares data)
Year ended December 31,
--------------------------------------------------
1998 1999 2000
----------- ------------- -------------
Revenues (Note 11a and 11b):
Software licenses $ 1,801 $ 4,269 $ 17,027
Maintenance and services 11,724 11,533 10,080
---------- ----------- -----------
Total revenues 13,525 15,802 27,107
---------- ----------- -----------
Cost of revenues:
Software licenses 146 952 938
Maintenance and services 9,709 9,978 7,857
---------- ----------- -----------
Total cost of revenues 9,855 10,930 8,795
---------- ----------- -----------
Gross profit 3,670 4,872 18,312
---------- ----------- -----------
Operating expenses:
Research and development, net (Note 12a) 5,322 6,865 7,224
Sales and marketing 8,862 13,537 16,385
General and administrative 2,602 3,518 3,857
Amortization of deferred stock compensation 250 798 1,104
---------- ----------- -----------
Total operating expenses 17,036 24,718 28,570
---------- ----------- -----------
Operating loss (13,366) (19,846) (10,258)
Financial income (expenses), net (Note 12b) 234 (565) 26
Financial expenses related to amortization of beneficial
conversion feature and compensation related to warrants to
investors in convertible loan (Notes 10d, 10c1d) - - (16,556)
---------- ----------- -----------
Net loss $ (13,132) $ (20,411) $ (26,788)
========== =========== ===========
Preferred shares deemed dividend (61) (303) -
========== =========== ===========
Net loss to shareholders of ordinary shares $ (13,193) $ (20,714) $ (26,788)
========== =========== ===========
Basic and diluted net loss per share $ (5.16) $ (7.74) $ (3.34)
========== =========== ===========
Weighted average number of shares used in computing basic
and diluted net loss per ordinary shares 2,554,654 2,676,212 8,029,785
========== =========== ===========
(1) Stock based compensation relates to the following:
Cost of revenues $ - $ 16 $ 4
Research and development, net - 391 -
Sales and marketing 120 39 207
General and administrative 130 352 893
---------- ----------- -----------
Total $ 250 $ 798 $ 1,104
========== =========== ===========
The accompanying notes are an integral part of the consolidated financial
statements.
F-5
VIRYANET LTD. AND ITS SUBSIDIARIES
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (DEFICIENCY)
U.S. dollars in thousands (except share data)
Additional Deferred
Preferred Ordinary Preferred Ordinary paid-in stock
shares shares shares shares capital compensation
----------- ----------- ----------- ---------- ------------ ---------------
(Share data)
-------------------------
Balance as of January 1, 1998 4,601,740 2,517,520 $ 146 $ 101 $ 14,356 $ -
Issuance of ordinary shares, net - 46,870 - *) - -
Issuance of preferred shares, net 3,717,950 - 103 - 11,036 -
Exercise of stock options, net - 148,315 - 3 95 -
Conversion of ordinary shares 87,565 (87,565) 2 (2) - -
Investor relationship type of expenses - - - - 124 -
Deferred stock compensation - - - - 510 (510)
Amortization of deferred
stock compensation and
compensation related to
options granted to consultants - - - - - 250
Net loss - - - - - -
---------- --------- ------ ------ --------- ----------
Total comprehensive loss
Balance as of December 31, 1998 8,407,255 2,625,140 251 102 26,121 (260)
Issuance of preferred shares, net 1,739,132 - 43 - 9,796 -
Receivables on account of shares - - - - (100) -
Exercise of stock options, net - 75,500 - 1 72 -
Issuance of warrants to customers - - - - 500 -
Deferred stock compensation - - - - 1,141 (1,141)
Amortization of compensation
related to warrants to bank - - - - 198 -
Amortization of deferred
stock compensation and
compensation related to
options granted to consultants - - - - - 798
Net loss - - - - - -
---------- --------- ------ ------ --------- ----------
Total comprehensive loss
Balance as of December 31, 1999 10,146,387 2,700,640 294 103 37,728 (603)
---------- --------- ------ ------ --------- ----------
Accumulated Total
other Total shareholders'
comprehensive Accumulated comprehensive equity
loss deficit loss (deficiency)
------------- ------------ ------------- ---------------
Balance as of January 1, 1998 $ - $ (14,534) $ - $ 69
Issuance of ordinary shares, net - - - -
Issuance of preferred shares, net - - - 11,139
Exercise of stock options, net - - - 98
Conversion of ordinary shares - - - -
Investor relationship type of expenses - - - 124
Deferred stock compensation - - - -
Amortization of deferred
stock compensation and
compensation related to
options granted to consultants - - - 250
Net loss - (13,132) (13,132) (13,132)
------- ----------- ---------- ---------
Total comprehensive loss $ (13,132)
==========
Balance as of December 31, 1998 - (27,666) $ - (1,452)
Issuance of preferred shares, net - - - 9,839
Receivables on account of shares - - - (100)
Exercise of stock options, net - - - 73
Issuance of warrants to customers - - - 500
Deferred stock compensation - - - -
Amortization of compensation
related to warrants to bank - - - 198
Amortization of deferred
stock compensation and
compensation related to
options granted to consultants - - - 798
Net loss - (20,411) (20,411) (20,411)
------- ----------- ---------- ---------
Total comprehensive loss $ (20,411)
==========
Balance as of December 31, 1999 - (48,077) (10,555)
------- ----------- ---------
*) Less than $1,000
The accompanying notes are an integral part of the consolidated financial
statements.
F-6
VIRYANET LTD. AND ITS SUBSIDIARIES
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (DEFICIENCY)
U.S. dollars in thousands (except share data)
Additional Deferred
Preferred Ordinary Preferred Ordinary paid-in stock
shares shares shares shares capital compensation
----------- ----------- ----------- ---------- ------------ ---------------
(Share data)
-------------------------
Balance as of December 31, 1999 10,146,387 2,700,640 $ 294 $ 103 $ 37,728 $ (603)
Conversion of preferred shares (10,146,387) 10,146,387 (294) 294 - -
Issuance of ordinary shares, net - 4,000,000 - 98 25,526 -
Conversion of long-term loan, net - 3,343,885 - 82 15,969 -
Amortization of beneficial
conversion feature - - - - 16,051 -
Exercise of warrants, net - 1,349,210 - 30 555 -
Exercise of stock options, net - 124,550 - 3 183 -
Amortization of compensation
related to warrants to
investors in convertible loans - - - - 505 -
Issuance of warrants to customers - - - - 333 -
Compensation related to warrants
to bank - - - - 254 -
Amortization of compensation
related to warrants to third party - - - - 119 -
Deferred stock compensation - - - - 1,105 (1,105)
Amortization of deferred
stock compensation and
compensation related to options
granted to consultants - - - - - 1,104
Comprehensive loss:
Foreign currency translation
adjustment - - - - - -
Net loss - - - - - -
------------ ----------- ------- ------- --------- --------
Total comprehensive loss
Balance as of December 31, 2000 - 21,664,672 $ - $ 610 $ 98,328 $ (604)
============ =========== ======= ======= ========= ========
Accumulated Total
other Total shareholders'
comprehensive Accumulated comprehensive equity
loss deficit loss (deficiency)
------------- ------------ -------------- ---------------
Balance as of December 31, 1999 $ - $ (48,077) $ - $ (10,555)
Conversion of preferred shares - - - -
Issuance of ordinary shares, net - - - 25,624
Conversion of long-term loan, net - - - 16,051
Amortization of beneficial
conversion feature - - - 16,051
Exercise of warrants, net - - - 585
Exercise of stock options, net - - - 186
Amortization of compensation
related to warrants to
investors in convertible loans - - - 505
Issuance of warrants to customers - - - 333
Compensation related to warrants
to bank - - - 254
Amortization of compensation
related to warrants to third party - - - 119
Deferred stock compensation - - - -
Amortization of deferred
stock compensation and
compensation related to options
granted to consultants - - - 1,104
Comprehensive loss:
Foreign currency translation
adjustment (288) - (288) (288)
Net loss - (26,788) (26,788) (26,788)
------ ---------- ---------- ---------
Total comprehensive loss ==========
Balance as of December 31, 2000 $ (288) $ (74,865) $ (27,076) $ 23,181
====== ========== =========
*) Less than $1,000
The accompanying notes are an integral part of the consolidated financial
statements.
F-7
VIRYANET LTD. AND ITS SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
U.S. dollars in thousands
Year ended December 31,
----------------------------------------------
1998 1999 2000
---------- ---------- -----------
Cash flows from operating activities:
- ------------------------------------
Net loss $ (13,132) $ (20,411) $ (26,788)
Adjustments to reconcile net loss to
net cash used in operating activities:
Depreciation 555 758 900
Increase in accrued severance pay, net 135 209 111
Amortization of deferred stock compensation and
compensation related to options granted to consultants 250 798 1,104
Amortization of compensation related to warrants to bank - 198 254
Amortization of compensation related to warrants to
third party - - 119
Investor relationship type of expenses 124 - -
Amortization of beneficial conversion feature - - 16,051
Amortization of compensation related to warrants to
investors in convertible loans - - 505
Marketable securities, net 1,133 881 -
Decrease (increase) in trade receivables and
unbilled receivables (2,154) 531 (2,687)
Decrease (increase) in other accounts receivable
and prepaid expenses (335) 241 (2,041)
Increase (decrease) in trade payables 656 (314) 1,057
Increase (decrease) in deferred revenues 1,515 3,955 (5,252)
Increase in other accounts payable and accrued expenses 1,856 39 875
Others 11 19 -
---------- ---------- -----------
Net cash used in operating activities (9,386) (13,096) (15,792)
---------- ---------- -----------
Cash flows from investing activities:
- ------------------------------------
Purchase of property and equipment (968) (923) (2,330)
Proceeds from sale of property and equipment 24 88 28
Investment in restricted cash - (96) -
Proceeds from restricted cash - - 96
---------- ---------- -----------
Net cash used in investing activities (944) (931) (2,206)
---------- ---------- -----------
The accompanying notes are an integral part of the consolidated financial
statements.
F-8
VIRYANET LTD. AND ITS SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
U.S. dollars in thousands
Year ended December 31,
-------------------------------------------------
1998 1999 2000
--------------- --------------- -------------
Cash flows from financing activities:
- ------------------------------------
Short-term bank credit, net (1,427) 5,098 (5,138)
Proceeds from issuance of share capital and exercise of stock
options, net 11,562 9,812 42,968
Issuance of warrants to customers - 500 333
Principal payment of long-term loans (67) (51) (11)
-------- -------- ---------
Net cash provided by financing activities 10,068 15,359 38,152
-------- -------- ---------
Effect of exchange rate on cash and cash equivalents - - (202)
-------- -------- ---------
Increase (decrease) in cash and cash equivalents (262) 1,332 19,952
Cash and cash equivalents at the beginning of the year 816 554 1,886
-------- -------- ---------
Cash and cash equivalents at the end of the year $ 554 $ 1,886 $ 21,838
======== ======== =========
Supplemental disclosure of cash flows activities:
- ------------------------------------------------
Cash paid during the year for
Interest $ 94 $ 237 $ 180
======== ======== =========
Supplemental disclosure of non-cash investing and financing activities:
- ----------------------------------------------------------------------
Accrued expenses related to issuance expenses $ - $ - $ (521)
======== ======== =========
The accompanying notes are an integral part of the consolidated financial
statements.
F-9
VIRYANET LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1:- GENERAL
a. ViryaNet Ltd., an Israeli corporation (the "Company"), was
established in 1988. The Company develops, markets and supports
software products, which provide business-to-business internet
solutions and related services that enable service organizations
and their field engineers, customers, partners, vendors and
suppliers to collaborate in a single environment called a
service community.
ViryaNet Ltd. has three wholly-owned subsidiaries: in the United
States ("ViryaNet US") in the United Kingdom ("ViryaNet UK") and
in Japan ("ViryaNet Japan").
The Company's sales are made in the United States, the United
Kingdom and Japan. As for major customers, see Note 11b.
b. In March 1998, the Company established a subsidiary in Japan
("ViryaNet Japan"). Until October 1999, the Company owned 95% of
this Company. In October 1999, the Company purchased the
remaining 5% of the share capital of the Japanese subsidiary in
exchange for 40,000 warrants to purchase ordinary shares of the
Company at an exercise price of $5.75. In connection with the
acquisition, the Company recorded goodwill in the amount of
$100,000. Since it was immaterial, the goodwill was fully
amortized in 1999.
c. On September 19, 2000, the Company completed its Initial Public
Offering ("IPO"). Since then, the ordinary shares have been
traded on the NASDAQ in the U.S. (see Note 9a2).
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES
The consolidated financial statements have been prepared in
accordance with generally accepted accounting principles 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 affect
the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those
estimates.
b. Financial statements in United States dollars:
All of the Company's and ViryaNet US's sales are made in
U.S. dollars ("dollars"). In addition, a substantial
portion of the costs of the Company and ViryaNet US are
incurred in dollars. Since the dollar is the primary
currency of the economic environment in which the
Company and its U.S. subsidiary operate, the dollar is
their functional and reporting currency.
Accordingly, monetary accounts maintained in currencies
other than the dollar are remeasured into dollars using
the foreign currency exchange rate at balance sheet
date, in accordance with Statement No. 52 of the
Financial Accounting Standard Board ("FASB") "Foreign
Currency Translation". Operational transactions and non-
monetary balance sheet accounts are measured and
recorded at the rate in effect at the date of the
transaction. The effects of foreign currency
remeasurement are reported in the statement of
operations as financial income or expenses, as
appropriate.
The functional currency of ViryaNet UK and ViryaNet
Japan has been determined to be their local currency.
Assets and liabilities are translated at the year-end
exchange rate and statement of operations items are
translated at the average rate prevailing during the
year. The resulting translation adjustments are
F-10
VIRYANET LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
reported as a component of accumulated other comprehensive loss in
shareholders' equity (deficiency).
c. Principles of consolidation:
The consolidated financial statements include the accounts of
ViryaNet Ltd. and its subsidiaries. Intercompany balances and
transactions have been eliminated in consolidation.
d. Cash equivalents:
Cash equivalents are short-term, highly liquid investments that
are readily convertible to cash, and originally purchased with
maturities of three months or less.
e. Marketable securities:
In accordance with Statement of Financial Accounting Standards No.
115, "Accounting for Certain Investments in Debt and Equity
Securities" ("SFAS 115"), the Company has classified its
marketable debt into a trading category. Under SFAS 115,
marketable securities classified as trading securities are stated
according to the quoted market prices as of balance sheet date.
Gain and losses (realized and unrealized) related to trading
securities as well as interest on such securities are included as
financial income, or expenses as appropriate. All marketable debts
were sold prior to December 1999.
f. Property and equipment:
These assets 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
depreciation rates:
%
-------------------------
Computers, peripheral equipment and software 33
Office furniture and equipment 6 - 25
Motor vehicles 15
Leasehold improvements are depreciated over term of the related lease
periods.
The Company and its subsidiaries periodically assess the
recoverability of the carrying amount of property and equipment
and provide for any possible impairment loss based upon the
difference between the carrying amount and fair value of such
assets in accordance with SFAS No. 121 "Accounting for Impairment
of Long-Lived Assets and for Long-Lived Assets to be Disposed of".
As of December 31, 2000, no impairment losses have been
identified.
g. Income taxes:
The Company accounts for income taxes in accordance with Statement
of Financial Accounting Standards (SFAS) 109, "Accounting for
Income Taxes". This statement prescribes the use of the liability
method whereby deferred tax asset and liability account balances
are determined based on the differences between 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.
F-11
VIRYANET LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
h. Revenue recognition:
Effective January 1, 2000, the Company adopted new guidance on
revenue recognition as is described in Staff Accounting Bulletin
No. 101 "Revenue Recognition in Financial Statement" of the
Securities and Exchange Commission (the "SEC") in December 1999.
The adoption did not have a significant effect on the
consolidated results of operations or financial position.
The Company generates revenues from licensing the rights to use
its software products directly to end-users. The Company also
generates revenues from sales of professional services, including
consulting, customization, implementation, training and
maintenance.
Revenues from other software license that require significant
customization, integration and installation are recognized, based
on SOP 81-1 "Accounting for Performance of Construction- Type and
Certain Production-Type Contract" using contract accounting on a
percentage of completion method based on the relationship of
actual costs incurred to total costs estimated to be incurred
over the duration of the contract. 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 contract. As of December 31, 2000 no
such estimated losses were identified.
Revenues from software license agreements are recognized, in
accordance with Statement Of Position (SOP) 97-2 "Software
Revenue Recognition" (as amended), when persuasive evidence of an
agreement exists, delivery of the software has occurred, the fee
is fixed or determinable and collectability is probable.
The Company has entered into software license agreements with
customers whereby, upon entering into these agreements, the
Company granted warrants to these customers and expects to do so
in the future. In such cases, the Company deducts the fair value
of these warrants from the related software revenues and
amortizes the fair value over the period the related revenues are
recognized. The fair value of these warrants is determined using
the Black-Scholes option pricing model (see also Note 9c3).
When software arrangements involve multiple elements, revenue is
allocated to each element based on vendor-specific objective
evidence ("VSOE") of the relative fair values of each element in
the arrangement. The Company's VSOE used to allocate the sales
price to professional services and maintenance is based on the
price charged when these elements are sold separately. License
revenues are recorded based on the residual method, in accordance
with SOP 98-9, "Modification of SOP 97-2, Software Revenue
Recognition, with respect to certain transactions". Under the
residual method, revenue is recognized for the delivered elements
when (1) there is VSOE of the fair values of all the undelivered
elements, (2) VSOE of fair value does not exist for one or more
of the delivered elements in the arrangement, and (3) 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.
Service revenues which include fees for consulting,
implementation, customization and training services, are
recognized as work is performed. Maintenance revenues are
recognized ratably over the term of the maintenance agreement,
which, in most cases, is one year.
Deferred revenues include amounts received for which revenues
have not been recognized.
i. Research and development costs:
Research and development costs are charged to the statement of
operations as incurred. Statement of Financial Accounting
Standards (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 any material costs between the completion of the
working model and the point at which the product is ready for
general release. Therefore, through December 31, 2000, the
Company has charged all software development costs to research
and development expenses, in the period incurred.
F-12
VIRYANET LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
j. Royalty-bearing grants:
Royalty-bearing grants from Binational Industrial Research and
Development Foundation ("BIRD-F") for funding of approved
research projects are recognized at the time the Company is
entitled to such grants on the basis of the related costs
incurred and were netted from research and development costs
(see Note 12a).
k. Concentrations of credit risk:
Financial instruments that potentially subject the Company to
concentrations of credit risk consist principally of cash and
cash equivalents, restricted cash and trade receivables. The
Company's cash and cash equivalents and restricted cash are
held in deposits with major banks in Israel, the United States,
the United Kingdom and Japan. 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 deposits. The Company's trade receivables
are derived from sales to large and solid organizations located
mainly in the United States, United Kingdom and Japan. The
Company performs ongoing credit evaluations of its customers
and to date has not experienced any material losses. An
allowance for doubtful accounts is determined with respect to
accounts that are doubtful of collection.
The Company has no significant off-balance sheet concentration
of credit-risk such as foreign exchange contracts, option
contracts or other foreign hedging arrangements.
l. Accounting for stock-based compensation:
The Company has elected to follow Accounting Principles Board
Opinion No. 25 "Accounting for Stock Issued to Employees" ("APB
25") and Interpretation No. 44 "Accounting for Certain
Transactions Involving Stock Compensation" ("FIN 44") in
accounting for its employee stock option plans. Under APB 25,
when the exercise price of the Company's share options is less
than the market price of the underlying shares on the date of
grant, compensation expense is recognized. The pro forma
disclosures required by SFAS No. 123 "Accounting for Stock-
Based Compensation" ("SFAS 123"), are provided in Note 9b3.
The Company applies SFAS 123 and EITF 96-18 "Accounting for
Equity Instruments that are Issued to Other than Employees for
Acquiring, or in Conjunction with Selling, Goods or Services"
with respect to options issued to non-employees. SFAS 123
requires use of an option valuation model to measure the fair
value of the options on the date of grant.
m. Basic and diluted net loss per share:
Basic and diluted net income (loss) per share is presented in
accordance with SFAS No. 128, "Earnings per Share" ("SFAS
128"), for all years presented. Basic net income (loss) per
share has been calculated using the weighted-average number of
ordinary shares outstanding during the year. Diluted net income
per share is calculated based on the weighted average number of
ordinary shares outstanding during each year, plus the weighted
average number of dilutive potential ordinary shares considered
outstanding during the year.
All convertible preferred shares, convertible debentures,
outstanding stock options, and warrants have been excluded from
the calculation of the diluted net loss per ordinary share
because all of these securities are anti-dilutive for all
periods presented. The total weighted average number of shares
related to the outstanding options, preferred shares and
warrants excluded from the calculations of diluted net loss per
share were 13,430,880, 17,413,758 and 7,610,192, for the years
ended December 31, 1998, 1999 and 2000, respectively.
n. Severance pay:
The Company's liability for severance pay is calculated
pursuant to 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. One year after
commencement of employment with the Company, employees are
entitled to one month's salary for each year of employment or a
portion thereof. The Company's liability for all of its
employees, is
F-13
VIRYANET LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 are based on the cash surrendered value of
these policies, and include immaterial profits.
Severance expenses for the years ended December 31, 1998, 1999
and 2000 amounted to approximately $734,000, $1,070,000 and
$543,000, respectively.
o. Fair value of financial instruments:
The following methods and assumptions were used by the Company
in estimating its fair value disclosures for financial
instruments:
Cash and cash equivalents, restricted cash, trade receivables,
short term bank credit, current maturities of long-term loans
and trade payables - the carrying amounts of these items
approximate their fair value due to the short-term maturity of
such instruments.
p. Future adoption of new accounting standard:
In June 1998, the Financial Accounting Standards Board issued
Statement No. 133, "Accounting for Derivative Instruments and
Hedging Activities", as amended, which is required to be
adopted in years beginning after June 15, 2000. Because the
Company does not use derivatives, management does not
anticipate that the adoption of the new Statement will have an
effect on earnings or the financial position of the Company.
NOTE 3:- RESTRICTED CASH
As of December 31, 1999, the Company recorded a fixed charge on the
short-term bank deposit in order to secure a bank line of credit,
which was removed during the year 2000.
NOTE 4:- OTHER ACCOUNTS RECEIVABLE AND PREPAID EXPENSES
December 31,
-----------------------------
1999 2000
------- --------
U.S. dollars in thousands
-----------------------------
Prepaid expenses $ 534 $ 2,218
Employees 91 107
Government authorities 78 218
Other 199 417
------- --------
$ 902 $ 2,960
======= ========
F-14
VIRYANET LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 5:- PROPERTY AND EQUIPMENT
December 31,
-----------------------------
1999 2000
-------- --------
U.S. dollars in thousands
-----------------------------
a. Cost:
Computers, peripheral equipment and software $ 2,858 $ 4,658
Office furniture and equipment 707 997
Motor vehicles 170 260
Leasehold improvements 196 228
-------- --------
3,931 6,143
-------- --------
Accumulated depreciation:
Computers, peripheral equipment and software 1,890 2,434
Office furniture and equipment 342 563
Motor vehicles 67 69
Leasehold improvements 141 170
-------- --------
2,440 3,236
-------- --------
Depreciated cost $ 1,491 $ 2,907
======== ========
b. As for charges, See Note 8c.
NOTE 6:- SHORT-TERM BANK CREDIT
In 1999 the Company had authorized credit lines from several banks in
the amount of $4,303,000, of which $303,000 is denominated in NIS and
bears interest at the rate of prime plus 1% and $4,000,000 is
denominated in dollars and bears interest at LIBOR plus 1.5%.
In January 2000, the Company had authorized an additional $2,000,000
credit line for one year. Dollar-denominated borrowings bear interest
at an annual rate of LIBOR plus 1.5%, and NIS-denominated credit
lines from Bank Hapoalim bear interest of prime plus 1%. The credit
facility is secured by a floating charge on all of the Company's
assets.
The weighted average interest rate on the credit lines as of December
31, 2000 and 1999 was approximately 11.2% and 8%, respectively.
In connection with the credit lines, the Company granted warrants to
Bank Hapoalim (see also Note 9c2b).
F-15
VIRYANET LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 7:- OTHER ACCOUNTS PAYABLE AND ACCRUED EXPENSES
December 31,
--------------------------------
1999 2000
------------- --------------
U.S. dollars in thousands
--------------------------------
Accrued expenses $ 769 $ 2,292
Employees and payroll accruals 2,855 2,574
Others 281 446
--------- ---------
$ 3,905 $ 5,312
========= =========
NOTE 8: - COMMITMENTS AND CONTINGENT LIABILITIES
a. Royalty commitments:
Under the Company's research and development agreements
with BIRD-F and pursuant to applicable laws, the Company is
required to pay royalties at the rate of 3%-5% of sales of
products developed with funds provided by BIRD-F, up to an
amount equal to 100%-150% of BIRD-F research and
development grants (linked to the dollar and to the U.S.
Consumer Price Index) related to such projects.
As of December 31, 2000, the Company had an outstanding
contingent obligation to pay royalties in the amount of
$330,000.
b. Lease commitments:
The Company and its subsidiaries rent their facilities
under various operating lease agreements, which expire on
various dates, the latest of which is in 2006.
Future minimum rental payments under non-cancelable
operating leases are as follows:
U.S. dollars
Year ended December 31, in thousands
--------------------------------- ----------------
2001 $ 939
2002 799
2003 530
2004 505
2005 170
2006 69
--------
$ 3,012
========
Total rent expenses for the years ended December 31, 1998,
1999 and 2000 were approximately $955,000, $1,078,000 and
$1,100,000, respectively.
F-16
VIRYANET LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
c. Charges and guarantees:
Various computers, peripheral equipment and motor vehicles
of the Company are pledged as fixed charges in favor of
various banks and financial institutions. The Company also
has a floating charge on all of its assets in favor of a
bank.
The Company obtained bank guarantees in the amount of
$71,000 in order to secure a leasing agreement.
d. Litigation:
In December 1999, the Company's former vice president of
sales and marketing filed an action against the Company and
Company's Chief Executive Officer seeking damages in the
amount of approximately $1,364,000. The former employee
alleges wrongful denial of his right to exercise options,
loss of compensation including options to purchase shares
granted to him by his previous employer, severance payment
and other social benefits as well as damage to his
reputation.
In March 2000, the Company filed a counter action against
this former employee seeking damages in the amount of
approximately $970,000. The Company alleged that the former
employee has acted in bad faith, breached his fiduciary
duties towards the Company and did not perform his duties
as required.
The Company's management and its legal advisors are unable
to determine the ultimate outcome of the litigation and its
effect on the Company's business, operating results and
financial condition and, accordingly, no provisions were
made.
NOTE 9:- SHARE CAPITAL
a. Composition of share capital:
Authorized shares Issued and outstanding shares
--------------------------- -----------------------------
December 31, December 31,
--------------------------- -----------------------------
1999 2000 1999 2000
---------- ---------- ----------- ------------
Shares of NIS 0.1 par
value:
Ordinary shares (1)(2) 6,900,000 35,000,000 2,700,640 21,664,672
Preferred "A" shares (3) 6,133,330 - 3,951,740 -
Preferred "B" shares (3) 866,670 - 650,000 -
Preferred "C-1" shares (3) 4,000,000 - 3,805,515 -
Preferred "C-2" shares (3) 2,100,000 - 1,739,132 -
---------- ---------- ---------- ----------
20,000,000 35,000,000 12,847,027 21,664,672
========== ========== ========== ==========
(1) The ordinary shares confer upon the holders the
right to receive notice to participate and vote in
general meetings of the Company, and the right to
receive dividends, if declared.
(2) Upon the IPO, the Company issued 4,000,000 ordinary
shares of $8.00 per share in consideration of net
proceeds of $25,624.
(3) All preferred shares were automatically converted
into ordinary shares at the time of the IPO.
F-17
VIRYANET LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
b. Stock options:
1. Under the Company's 1996, 1997, 1998 and 1999 Stock
Option Plans ("the Plans"), options may be granted
to officers, directors, employees and consultants of
the Company or its subsidiaries.
2. Pursuant to the Plans, the Company reserved for
issuance 1,400,000, 500,000, 1,500,000 and 3,000,000
ordinary shares, respectively.
As of December 31, 2000 an aggregate to 187,935
ordinary shares of the Company were still available
for future grant.
3. Each option granted under the Plans is exercisable
until the earlier of seven years from the date of
the grant of the option or the expiration dates of
the respective option plans. The 1996, 1997, 1998
and 1999 option plans will expire on December 31,
2005, 2006, 2007, and 2008, respectively. The
exercise price of the options granted under the
Plans may not be less than the nominal value of the
shares into which such options are exercised. The
options vest primarily over four years. Any options
which are canceled or not exercised before
expiration become available for future grants.
4. During 2000, the Company decided to extend the
exercise period for certain grants. The extension
was accounted for in accordance with FIN 44, by
applying a new measurement date, which resulted in
no additional compensation expenses.
5. In October 2000, the Company decided to increase the
number of shares reserved for issuance under the
1999 Stock Option Plan by additional 1,000,000
ordinary shares, subject to shareholders' approval.
6. A summary of the Company's share option activity
(except options to consultants) under the Plans is
as follows:
Year ended December 31,
------------------------------------------------------------------------
1998 1999 2000
------------------------ ---------------- ---------------------
Weighted Weighted Weighted
Number average Number average Number average
of exercise of exercise of exercise
options price options price options price
-------- --------- -------- --------- -------- --------
Outstanding-
beginning of the year 1,963,720 $ 1.10 2,869,970 $ 2.20 4,655,250 $ 4.02
Granted 1,332,000 3.35 2,810,480 5.53 1,847,975 6.80
Exercised (148,315) 0.66 (75,500) 0.96 (124,550) 1.49
Forfeited (277,435) 0.81 (949,700) 3.21 (890,575) 5.31
--------- ------ --------- ------ --------- ------
Outstanding - end
of the year 2,869,970 $ 2.20 4,655,250 $ 4.02 5,488,100 $ 4.78
========== ====== ========= ====== ========= ======
Options exercisable 1,335,901 $ 1.40 1,570,076 $ 2.74 2,088,040 $ 3.60
=========== ====== ========= ====== ========= ======
F-18
VIRYANET LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The options outstanding as of December 31, 2000, have been separated into
ranges of exercise price, as follows:
Options Weighted Weighted
outstanding average Weighted Options average
Ranges of as of remaining average exercisable at exercise price
Exercise December 31, contractual life exercise December 31, of exercisable
price 2000 Years price 2000 options
------------ ------------ ---------------- -------- -------------- --------------
$ 0.61 948,220 2.34 $ 0.65 897,481 $ 0.66
2.3 - 2.57 644,400 5.76 2.48 300,975 2.39
3.2 - 3.90 665,500 4.32 3.51 432,250 3.50
5.75 2,441,730 5.83 5.75 1,149,500 5.75
8 347,000 6.64 8.00 58,542 8.00
10 - 12 441,250 6.49 11.02 41,292 11.16
------------ ------------ ---------------- ------- -------------- --------------
$ 0.61 - 12 5,488,100 $ 4.78 2,880,040 $ 3.60
============ ============ ================ ======= ============== ==============
The Company recorded deferred compensation for options issued with an
exercise price below the fair value of the ordinary shares. Deferred
compensation is amortized and recorded as compensation expense ratably over
the vesting period of the option. Compensation expenses of approximately
$104,000, $618,000 and $967,000 were recognized during the years ended
December 31, 1998, 1999 and 2000, respectively.
F-19
VIRYANET LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Under SFAS No. 123, "Accounting for Stock-Based Compensation"
("SFAS No. 123"), pro forma information regarding net loss and net
loss per share is required for grants issued after December 1994,
and has been determined as if the Company had accounted for its
employee share options under the fair value method of SFAS No.
123. The fair value for these options was estimated at the grant
date using a Black-Scholes option pricing model with the following
weighted-average assumptions for 1998, 1999 and 2000: risk-free
interest rates of 5.5%, 5.75% and 5.75% respectively, dividend
yields of 0% for each year, volatility factors of the expected
market price of the Company's Ordinary shares of 0.5, 0.5 and
0.84, respectively, and a weighted-average expected life of the
options of approximately 3.5, 3.4 and 3 years, respectively.
The weighted average fair values of options granted for the years
ended December 31, 1998, 1999 and 2000 were:
exercise price on the grant date that:
----------------------------------------------------------------
Equals market price Exceeds market price
---------------------------- ----------------------------
Year ended December 31, Year ended December 31,
---------------------------- ----------------------------
1998 1999 2000 1998 1999 2000
------- -------- ------- ------- ------- -------
Weighted average exercise prices $ 3.30 $ 5.75 $ 5.24 $ 3.90 $ - $ 8
======= ======= ======= ======= ======= =======
Weighted average fair values on grant date $ 1.37 $ 2.74 $ 0.49 $ 1.12 $ - $ 10.15
======= ======= ======= ======= ======= =======
Is less than market price
-------------------------------
Year ended December 31,
-------------------------------
1998 1999 2000
------- ------- -------
Weighted average exercise prices $ 3.20 $ 4.18 $ 5.17
======== ======= =======
Weighted average fair values on grant date $ 1.75 $ 3.04 $ 5.09
======== ======= =======
Because changes in the subjective input assumptions can materially
affect affect the fair value estimate, it is management's opinion
that the existing option pricing models do not necessarily provide
a reliable single measure of the fair value of its employee stock
options.
Pro forma information under SFAS No. 123 is as follows:
Year ended December 31,
-----------------------------------------------
1998 1999 2000
----------- ------------ -----------------
U.S. dollars in thousands, except per share data
------------------------------------------------
Net loss to shareholders of ordinary shares as reported $ (13,193) $ (20,714) $ (26,788)
========== ========== ==========
Pro forma net loss to shareholders of ordinary shares $ (13,491) $ (21,079) $ (28,885)
========== ========== ==========
Pro forma basic and diluted net loss per ordinary share $ (5.28) $ (7.87) $ (3.60)
========== ========== ==========
F-20
VIRYANET LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7. Options issued to consultants:
a) The Company's outstanding options to consultants as of December 31,
2000, are as follows:
Options for Exercise
ordinary price Options Exercisable
Issuance date shares per share exercisable through
---------------- ------------ ------------ ------------ --------------
December 1996 250,000 $ 1.00 250,000 (*)
March 1998 5,000 $ 3.20 2,500 February 2002
September 1998 40,000 $ 3.75 40,000 January 2001
November 1998 10,000 $ 3.75 10,000 December 2006
November 1998 45,000 $ 1.00 45,000 December 2006
November 1999 12,000 $ 5.75 12,000 November 2006
July 2000 2,000 $ 11.00 2,000 July 2007
December 2000 11,600 $ 2.57 11,600 December 2007
------- -------- -------- -------------
Total 375,600 373,100
======= ========
(*) The options are exercisable through December 2001. If not
exercised, they are automatically renewed for one
additional year, each time, for up to seven years, through
December 2006. The exercise price will be increased by 6%
compounded each year.
b) The Company had accounted for its options to consultants under the
fair value method of SFAS No. 123 and EITF 96-18. The fair value
for these warrants was estimated using a Black-Scholes option
pricing model with the following weighted-average assumptions for
1998, 1999 and 2000: risk-free interest rates of 5.5%, 5.75% and
5.75%, respectively, dividend yields of 0% for each year,
volatility factors of the expected market price of the Company's
ordinary shares of 0.5, 0.5 and 0.84, respectively, and a weighted-
average expected life of the options of approximately 3.5, 2.1 and
2 years, respectively.
c) In connection with the grant of stock options to consultants, the
Company recorded deferred stock compensation totaling $276,000
through December 31, 2000. Compensation expenses of approximately
$146,000, $80,000 and $32,000 were recognized during the years
ended December 31, 1998, 1999 and 2000, respectively.
F-21
VIRYANET LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
c. Warrants:
1. Warrants issued to investors:
a) As part of the investment agreement in 1996,
the Company issued to certain investors
warrants to purchase 1,375,110 Series A
Convertible preferred shares at an exercise
price of $3.00 of which warrants to purchase
216,670 shares were converted in December
1996 into warrants to purchase 216,670 Series
B non-voting preferred shares. Upon the IPO,
195,120 warrants were exercised in
consideration of $585,000 and 1,179,990
warrants were exercised into 737,494 A
preferred shares, by way of cashless
exercise.
b) As part of the investment agreement in
February 1998, the Company issued to the
shareholders warrants to purchase 31,794
convertible Series C-1 preferred shares at an
exercise price equal to the par value of the
shares. The Company recorded in 1998 investor
relationship type expenses in the amount of
$124,000. This transaction was accounted for
according to EITF 98-5 "Accounting for
Convertible Securities with Beneficial
Conversion Features on Contingent Adjustable
Conversion Ratios" (EITF 98-5) and APB 14
"Accounting for Convertible Debt and Debt
Issued with Stock Purchase Warrants" ("APB
14"). The fair value of this warrant was
determined using the Black-Scholes pricing
model, assuming a risk free rate of 5.5%, a
volatility factor of 0.5, dividend yields of
0% and an expected life of two years. The
warrants have no expiration date. Upon the
IPO, 3,077 warrants were exercised into 3,077
Series C-1 preferred shares, by way of
cashless exercise.
c) As part of the investment agreement in June
1999, the Company issued to certain Series C-
2 preferred shares investors detachable
warrants to purchase 347,826 Series C-2
preferred shares at an exercise price of
$5.75. The warrants contain a cashless
exercise feature and expire upon the earlier
of June 2004 or a merger or sale of all or
substantially all of the Company's assets or
issued and outstanding share capital. The
cashless exercise feature allows the holder
to convert the warrant into ordinary shares
without the payment of any exercise price.
The number of shares issuable upon exercise
is determined by subtracting the exercise
price of the warrant from the aggregate
market value of the underlying shares, and
then dividing such amount by the market value
of an ordinary share. The Company recorded a
deemed dividend at the amount of $303,000.
This transaction was accounted for according
to EITF 98-5 and APB 14. The fair value of
this warrant was determined using the Black-
Scholes pricing model, assuming a risk free
interest of 5.75%, a volatility factor of 0.5
dividend yields of 0% and an expected life of
warrants of six months.
F-22
VIRYANET LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
d) The Company granted to the investors in the
convertible loan 124,999 warrants at an
exercise price equal to 95% of the conversion
price per share determined in the IPO. The
warrants are exercisable upon the IPO (see
also Note 9d).
In connection with these warrants, the
Company recorded financial expensesof
$505,000, which was fully amortized over the
life period of the convertible debentures.
This transaction was accounted for according
to Accounting Principles Board Opinion No.
14, "Accounting for Convertible Debt and Debt
Issued with Stock Purchase Warrants" ("APB
14"). The fair value of these warrants was
determined using the Black-Scholes pricing
model, assuming a risk free interest rate of
5.75%, a volatility factor of 0.5, dividend
yields of 0% and an expected life of six
months.
2. Warrants issued for financing transactions:
a) In connection with a credit line from Bank
Hapoalim, the Company issued in March 1999 to
a subsidiary of Bank Hapoalim, a warrant to
purchase ordinary shares of the Company
having an aggregate market value at the date
of exercise of $1,250,000 in exchange for
$1,000,000 in cash. The warrant contained a
cashless exercise feature where the Company
issued ordinary shares having an aggregate
market value of $250,000 at the time of
exercise. Upon the IPO, the warrants were
exercised into 92,391 ordinary shares, by way
of cashless exercise.
The fair value of the warrant is
approximately $250,000, which has been
accounted for as a cost of the line of credit
and was amortized ratably over a one year
period. The Company recorded $198,000 in 1999
and $52,000 in 2000 as compensation expense
and included these amounts in financial
expenses (see Note 12b).
b) In connection with the additional credit line
received in January 2000, the Company issued
to a subsidiary of Bank Hapoalim, a warrant
to purchase an additional 69,565
ordinaryshares of the Company against payment
of $400,000. The warrants contained a
cashless exercise feature and was exercised
into 19,565 ordinary shares upon the IPO.
The Company recorded a compensation of
approximately $202,000, which was amortized
ratably over a period of one year and
included in the financial expenses (see Note
12b). This transaction was accounted for
according to APB 14.
The fair value of this warrant was determined
using the Black-Scholes pricing model,
assuming a risk free interest rate of 5.75%,
a volatility factor of 0.5, dividend yields
of 0% and an expected life of the warrant of
one year.
F-23
VIRYANET LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3. Warrants issued to customers:
a) In 1996, the Company entered into software
license agreements with two customers, one of
them a related party. In connection with
these agreements, the Company issued warrants
to purchase 300,000 and 100,000 ordinary
shares at an exercise of $2.00 and $3.00 per
share, respectively. At the grant date, the
fair value of these warrants was estimated as
$168,000 and was deducted from software
revenues and amortized over the period such
related revenue was recognized (1996 and
1997). The fair value of these warrants was
determined using Black-Scholes pricing model,
assuming a risk free rate 6.0%, a volatility
factor 0.5, dividend yields of 0% and an
expected life of the warrants of five years.
The warrants were exercised into 287,500
ordinary shares, by way of cashless exercise.
b) In 1999, the Company entered into software
license agreements with certain customers,
one of them a related party. In connection
with these agreements, the Company issued
warrants expiring three years from the date
of the agreements to purchase 150,000
ordinary shares at an exercise price of $5.75
per share, and to purchase 50,000 ordinary
shares at an exercise price of $5.75 in
consideration of $125,000. At the grant date,
the fair value of the warrants was estimated
as $500,000 of which $375,000 was deducted
from software revenues and amortized over the
period such related revenue was recognized.
The fair value of these warrants was
determined using the Black-Scholes pricing
model, assuming a risk free rate of 5.75%, a
volatility factor of 0.50, dividend yields of
0% and an expected life of the warrants of 3
years. The Company recorded proceeds from
issuance of warrants in the amount of
$500,000. Since the IPO, the warrants are
exercisable. Upon the IPO 500,000 warrants
were exercised into 14,063 ordinary shares,
by way of cashless exercise.
c) In 2000, the Company issued warrants to
various customers to purchase 214,850
ordinary shares at exercise prices ranging
from $2.57 to $11 per share with a weighted
average exercise price of $8.59. These
customer warrants have expiration dates
ranging from two to three years from the
execution date of each customer's respective
software license agreement. The estimated
aggregate fair value of the warrants, based
on the fair value of each of the warrants on
their respective grant date, is $449,190. The
fair value of each of these warrants is
determined using the Black-Scholes pricing
model, assuming a risk free interest rate of
5.75%, a volatility factor ranging from 0.5
to 0.84 dividend, yields of 0% and an
expected life of two to three years. The
Company recorded proceeds from issuance of
warrants in the amount of $333,000. The
Company deducted $333,000 from software
revenues and amortized it over the period
when such revenue was recognized.
These transactions were accounted for
according to EITF 96-18.
F-24
VIRYANET LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4. Warrants to Third Party:
During 2000, the Company granted to a third party,
with respect to marketing services, a warrant to
purchase 47,600 ordinary shares at an exercise price
ranging from $2.57 to $12. At the grant date, the
fair value of the warrant was determined using the
Black and Scholes pricing model assuming a risk free
rate of 5.75%, a volatility factor ranging from 0.5
to 0.84, dividend yield of 0% and an expected life
of two to three years. In relation to the warrants,
the Company recorded $119,000 as sales and marketing
expenses. These transactions were accounted for
according to EITF 96-18.
d. Convertible debentures:
In February and March 2000, the Company entered into
convertible loan agreements with existing shareholders in
the aggregate amount of approximately $5.0 million. These
convertible loans were then converted into convertible
debentures upon the issuance of April 2000, as described
below. In April 2000, the Company entered into a
convertible debenture agreement ("agreement") with
additional investors in the aggregate amount of
approximately $11.0 million. The debentures were
denominated in dollars and bore annual interest at the rate
of LIBOR plus 2%, payable quarterly, commencing in April
2001.
Upon the IPO, the debentures were automatically converted
into 3,343,885 ordinary shares equal to $16 million
principal amount and the $51,000 unpaid accrued interest,
divided by the IPO price discounted by 40%.
Upon the IPO and in relation to the conversion, the Company
recorded $16 million of financial expenses in accordance
with to EITF 98-5 "Accounting for Convertible Securities
with Beneficial Conversion Features or Contingent
Adjustable Conversion Ratios".
In respect to warrants issued to investors in the
convertible debentures (see Note 9c1d.)
e. Deemed dividend:
In 1998 the Company converted 87,565 ordinary shares to
preferred shares. Since the Company's preferred shares have
preference rights, the Company recorded deemed dividend at
the amount of $61,000, which were calculated as the
difference between the fair value of the preferred shares
and the fair value of the ordinaryshares at the date of
conversion (see also Note 9c1c). The deemed dividend
increases the loss applicable to ordinary shares in the
calculation of basic and diluted net loss per share for the
year ended December 31, 1998, without any effect on total
shareholders' equity (deficiency).
f. 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.
F-25
VIRYANET LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 10: - TAXES ON INCOME
a. Tax benefits under the Law for the Encouragement of Capital
Investments, 1959 ("the law"):
The Company's production facilities have been granted an
"Approved Enterprise" status under the law, for three
separate investment programs which were approved in
February 1989, March 1995 and April 1998.
According to the provisions of the law, income derived
from the February 1989 program during a period of seven
years from the year in which it first earns taxable income
is subject to reduced corporate tax of 10% - 25%, based on
the percentage of foreign ownership.
According to the provisions of the law, the Company has
elected for its other two investment programs the
"alternative system of benefits" (the waiver of grants in
return for a tax exemption). Accordingly, income derived
from these programs will be tax-exempt for a period of ten
years commencing with the year in which it first earns
taxable income.
For the second investment program, the Company elected to
enjoy a Government guaranteed long-term loan plan along
with the tax exemption. These loans were repaid by the
Company in January 1997.
The period of tax benefits described above is subject to
limits of 12 years from the commencement of production, or
14 years from the approval date, whichever is earlier.
Accordingly, the period of the benefit relating to these
investment programs will expire between 2003 to 2012.
As the Company currently has no taxable income, the
benefits have not yet utilized for all three programs.
The tax-exempt income attributable to the "Approved
Enterprise" can be distributed to shareholders without
subjecting the Company to taxes only upon the complete
liquidation of the Company. If the retained tax-exempt
income is distributed in a manner other than in the
complete liquidation of the Company, it would be taxed at
the corporate tax rate applicable to such profits as if the
Company had not chosen the alternative tax benefits
(currently - 20%). The Company"s Board of Directors has
determined that such tax exempted income will not be
distributed as dividends.
In the event of failure to comply with the conditions
stipulated by the above law and the instruments of approval
for the specific investments in "approved enterprises",
maintaining the development and production nature of its
facilities, and financing of at least 30% of the investment
program by equity, it may be subject to corporate tax in
Israel at the regular corporation tax rate of 36% and may
be required to refund the amount of the benefits, in whole
or in part, including interest.
The law also grants entitlement to claim accelerated
depreciation on equipment used by the "Approved Enterprise"
during five tax years.
Income from sources other than the Approved Enterprise,
during the benefit period, will be subject to tax at
regular rates (36%).
F-26
VIRYANET LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
b. Tax benefits under the Law for the Encouragement of
Industry (Taxes), 1969:
The Company is an "industrial company", as defined by this
law and, as such, is entitled to certain tax benefits,
mainly accelerated depreciation of machinery and equipment,
as prescribed by regulations published under the
Inflationary Adjustments Law, the right to claim public
issuance expenses in three equal annual installments. The
Company has not yet utilized this tax benefit.
c. Measurement of results for tax purposes under the Income
Tax Law (Inflationary Adjustments), 1985:
Results for tax purposes are measured in real terms of
earnings in NIS after certain adjustments for increases in
the Israeli Consumer Price Index (CPI). As explained in
Note 2b, the financial statements are presented in U.S.
dollars. The difference between the annual change in the
CPI and in the NIS/dollar exchange rate causes a difference
between taxable income and the pre-tax income presented in
the financial statements. In accordance with paragraph 9(f)
of SFAS No. 109, the Company has not provided deferred
income taxes on this difference between the reporting
currency and the tax bases of assets and liabilities.
d. Net operating losses carryforwards:
The Company has accumulated losses for tax purposes as of
December 31, 2000, in the amount of approximately
$5,471,000 which may be carried forward and offset against
taxable income in the future for an indefinite period.
Through December 31, 2000, ViryaNet UK had accumulated
losses for income tax purposes of approximately $11,416,000
and that can be carried forward and offset against taxable
income in the future for an indefinite period.
Through December 31, 2000, ViryaNet Japan had accumulated
losses for income tax purposes of approximately $600,000
that can be carried forward and offset against taxable
income for 10 years and expire from 2008 to 2009.
Through December 31, 2000, ViryaNet US had U.S. federal net
operating loss carryforwards for income tax purposes of
approximately $28,800,000, that can be carried forward and
offset against taxable income for 15 years and expire from
2009 to 2014.
Utilization of U.S. net operating losses may be subject to
substantial annual limitations 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.
F-27
VIRYANET LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
e. 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 liabilities and assets are as follows:
U.S. dollars in thousands
---------------------------
Year ended
December 31,
---------------------------
1999 2000
------------- ---------
US, net operating loss carryforwards $ 6,440 $ 10,010
UK, net operating loss carryforwards 3,240 3,425
Japan, net operating loss carryforwards 432 216
Other reserve and allowances 331 72
-------- ---------
Total deferred tax
assets before valuation allowance 10,443 13,723
Valuation allowance (10,443) (13,723)
-------- ---------
Net deferred tax assets $ - $ -
-------- ---------
ViryaNet UK, ViryaNet US and ViryaNet Japan have provided
valuation allowances on deferred tax assets resulting from tax
loss carryforwards and other temporary differences, since they
have a history of losses over the past years. Management
currently believes that it is more likely than not that the
deferred tax regarding the loss carryforwards and other
temporary differences will not be realized.
f. Pre-tax loss:
Year ended December 31,
--------------------------------------------------
1998 1999 2000
-------------- ------------- --------------
U.S. dollars in thousands
--------------------------------------------------
Domestic $ 6,774 $ 3,165 $ 17,833
Foreign 6,358 17,246 8,955
--------- ---------- ---------
$ 13,132 $ 20,411 $ 26,788
========= ========== =========
F-28
VIRYANET LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 11: - SEGMENTS, CUSTOMERS AND GEOGRAPHIC INFORMATION
a. Summary information about geographical destinations:
The Company manages its business on a basis of one
reportable segment. See Note 1a for a brief description of
the Company's business and follows the requirements of SFAS
No. 131 "Disclosures About Segments of an Enterprise and
Relation Information".
The Company attributes revenues from external customers, on
the basis of the location of end customer.
The following presents total revenues and long-lived assets
for the year ended December 31, 1998, 1999 and 2000:
Year ended Year ended Year ended
December 31, 1998 December 31, 1999 December 31, 2000
------------------------- ------------------------ -------------------------
Total Long-lived Total Long-lived Total Long-lived
revenues assets revenues assets revenues assets
----------- ------------ ---------- ---------- ---------- ------------
U.S. dollars in thousands
-------------------------------------------------------------------------------
Israel $ - $ 844 $ - $ 713 $ - $ 935
United States 10,021 436 11,998 617 20,280 1,842
United Kingdom 2,958 125 3,054 101 1,739 80
Japan 546 28 750 60 5,088 50
---------- ---------- -------- --------- ---------- ----------
$ 13,525 $ 1,433 $ 15,802 $ 1,491 $ 27,107 $ 2,907
========== ========== ======== ========= ========== ==========
b. Major customers data (percentage of total revenues):
Year ended December 31,
----------------------------------------------------------------
1998 1999 2000
--------------- ------------------ -------------------
%
----------------------------------------------------------------
Customer A 41 22 5
Customer B 14 33 4
Customer C 15 5 1
Customer D 10 11 1
Customer E - 3 12
Customer F - 2 11
F-29
VIRYANET LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 12: - SELECTED STATEMENTS OF OPERATIONS DATA
a. Research and development expenses:
Year ended December 31,
--------------------------------------------------
1998 1999 2000
-------------- -------------- ---------------
U.S. dollars in thousands
--------------------------------------------------
Total cost $ 5,652 $ 6,865 $ 7,224
Less - grants and participation 330 - -
-------- -------- --------
$ 5,322 $ 6,865 $ 7,224
======== ======== ========
b. Financial income (expenses), net:
Financial expenses:
Interest $ 76 $ 340 $ 221
Loss from marketable securities 189 - -
Other expenses 72 56 66
Foreign currency translation differences - 47 48
Amortization of deferred compensation
of options to Bank Hapoalim - 198 254
-------- -------- --------
337 641 589
-------- -------- --------
Financial income:
Interest 296 69 541
Gain from marketable securities - 7 -
Other income - - 74
Foreign currency translation
differences 275 - -
-------- -------- --------
571 76 615
-------- -------- --------
$ 234 $ (565) $ 26
======== ======== ========
NOTE 13:- RELATED PARTY TRANSACTIONS
a. In September 1995, the Company entered into a sales
software license and development services agreement with
Sun Microsystems Inc. ("SUN"). As part of the agreement,
SUN was granted a warrant to purchase 300,000 of the
Company's preferred shares at an exercise price of $2.00
per share. The Company accounted for these warrants in
accordance with the requirements set forth in FAS-123 which
amounted to an expense of $168,000, which was deducted from
the revenues in 1996 and 1997. The fair value of this
warrant was determined using Black-Scholes pricing model
assuming a risk free rate 6.0%, a volatility factor 0.5,
dividend yields of 0% and an expected life of the warrant
of 5 years. Such agreement was amended in December 1998.
According to this amendment, the Company provided
additional software license sales and development services.
In September 2000 and upon the IPO, the warrants were
exercised into 225,000 preferred shares, by way of cashless
exercise.
F-30
VIRYANET LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The president of enterprise services of SUN is a member of the
Company's Board of Directors.
b. In April 1998, the Company signed a share purchase
agreement with GE Capital Equity Holdings Inc. ("GE"), a
subsidiary of General Electric. As of December 31, 1999, GE
held 11.8% of the Company's outstanding shares. In June
1998, the Company entered into a software license and
support agreement with GE Medical Systems Inc. ("GE
Medical"), another subsidiary of General Electric. Under
the agreement the Company granted GE Medical a non
exclusive license to use certain of the Company's products.
Pursuant to the amendment to this agreement. The Company
obliged to provide GE, until December 31, 2001, with
maintenance and support services including future upgrades
and enhancements. The Company also granted GE 50,000
warrants at an exercise price of $5.75, exercisable until
December 2002. The Company accounted for those warrants in
accordance with the requirements set forth in FAS 123 which
amounted to an expense of $125,000, which was deducted from
the revenues in 1999. The fair value of this warrant was
determined using Black-Scholes pricing model assuming a
risk free rate 5.75%, a volatility factor of 0.5, dividend
yields of 0% and an expected life of the warrants of 3
years.
c. The balances with and the revenues derived from these
related parties were as follows:
1. Balances with related parties:
December 31,
-------------------------------------
1999 2000
------------------ ----------------
U.S. dollars in thousands
-------------------------------------
Trade receivables:
Sun MicroSystems Inc.(*) $ 546 $ 74
========= ========
GE Medical Systems Inc. (*) $ 1,083 $ 40
========= ========
Deferred revenues:
Sun MicroSystems Inc. (*) $ 289 $ -
========= ========
GE Medical Systems Inc. (*) $ 31 $ 600
========= ========
(*) The balance is unlinked and bears no interest.
2. Revenues from related parties:
Year ended December 31,
--------------------------------------------------
1998 1999 2000
-------------- -------------- ---------------
U.S. dollars in thousands
--------------------------------------------------
Sun MicroSystems Inc. $ 5,548 $ 3,553 $ 1,257
======== ======== ========
GE Medical Systems Inc. $ 1,872 $ 5,251 $ 1,162
======== ======== ========
F-31
VIRYANET LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
d. On June 30, 1999, the Company issued to its chairman of the
Board of Directors 17,390 Series C-2 preferred shares in
consideration of $100,000 which the Company loaned to him,
repayable not later than June 30, 2002 and bear annual
interest at the rate of 6.5%. The debt is secured by the
shares. In December 2000, the Company decided to grant to
its chairman of the Board of Directors options to purchase
75,000 ordinary shares at an exercise price of $1.00 per
share. The grant is subject to shareholders approval.
F-32