FILED PURSUANT TO RULE 424(b)(3)
REGISTRATION STATEMENT NO. 333-120159
PROSPECTUS
[SUPERCOM LOGO]
6,341,713 ORDINARY SHARES
SuperCom Ltd. is registering 6,341,713 ordinary shares for sale by selling
shareholders. We will pay all expenses of registering the securities. We will
not receive any proceeds from the sale of ordinary shares by the selling
shareholders. Our ordinary shares are traded on the OTC Bulletin Board under the
symbol "SPCBF.OB". Our ordinary shares also are listed on Euronext Brussels
under the symbol "SUP". On November 5, 2004, the last reported sale price of our
ordinary shares on the OTC Bulletin Board was $2.40. On November 5, 2004, the
last reported sale price of our ordinary shares on Euronext Brussels was
(euro)1.99 per share, equivalent to $2.57 per share, calculated using the
exchange rate of $1.2938 per Euro on such date.
---------------
INVESTING IN OUR SECURITIES INVOLVES RISKS.
SEE "RISK FACTORS" BEGINNING ON PAGE 6.
---------------
THE SECURITIES AND EXCHANGE COMMISSION AND STATE SECURITIES REGULATORS
HAVE NOT APPROVED OR DISAPPROVED THESE SECURITIES, OR DETERMINED IF THIS
PROSPECTUS IS TRUTHFUL OR COMPLETE. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
---------------
The date of this prospectus is November 8, 2004.
You should rely only on the information contained or incorporated by
reference in this prospectus. We have not authorized anyone to provide you with
information different from that contained in this prospectus. We are not making
an offer of these securities in any state where the offer is not permitted. You
should not assume that the information provided by this prospectus is accurate
as of any date other than the date on the front of this prospectus. Our
business, financial condition, results of operations and prospects may have
changed since then. In this prospectus, "SuperCom," "we," "us" and "our" refer
to SuperCom Ltd. (unless the context otherwise requires).
---------------
TABLE OF CONTENTS
Page
Prospectus Summary...........................................................1
Risk Factors.................................................................6
Cautionary Note Regarding Forward-Looking Statements........................16
Use of Proceeds.............................................................16
Dividend Policy.............................................................16
Exchange Rate Information...................................................16
Current Outstanding Share Capital...........................................17
Capitalization..............................................................18
Price Range of Ordinary Shares..............................................19
Selected Consolidated Financial Data........................................20
Management's Discussion and Analysis of Financial Condition and Results
of Operations.............................................................22
Business....................................................................35
Management..................................................................51
Certain Relationships and Related Party Transactions........................58
Principal Shareholders......................................................59
Description of Share Capital................................................60
Selling Shareholders........................................................62
Plan of Distribution........................................................65
Memorandum and Articles of Association......................................66
Description of Ordinary Shares..............................................70
Shares Eligible for Future Sale.............................................73
Conditions in Israel........................................................74
Taxation....................................................................76
Enforceability of Civil Liabilities.........................................80
Legal Matters...............................................................81
Experts.....................................................................81
Where You Can Find More Information.........................................81
Index......................................................................F-1
-i-
PROSPECTUS SUMMARY
This summary highlights selected information contained elsewhere in
this prospectus. This summary may not contain all of the information that you
should consider before buying ordinary shares in this offering. You should
carefully read this entire prospectus, including "Risk Factors" and our
consolidated financial statements, before making an investment decision.
We are a smart card technology company that designs, develops and
markets advanced smart card technologies and products for the governmental and
commercial secured identification markets. With an embedded microcontroller,
smart cards have the unique ability to store large amounts of data, perform
on-card functions, such as encryption, and interact intelligently with a smart
card reader. Smart cards connect to a smart card reader through either direct
physical contact or a remote contactless radio frequency interface. We function
as a "one stop" technological integration and support source for smart card
system integrators, utilizing our know-how and technologies. We develop and
market a wide range of complementary technologies and solutions for the smart
card market, including customizable smart cards, smart card-related products,
proprietary smart card production technologies, and advanced identification, or
ID, technologies, complemented by brand protection and authentication
technologies.
Since 1994, our technologies and products have been included in several
large governmental projects worldwide, such as the Hong Kong government passport
project, the United Kingdom passport project and the Ukraine passport project.
We believe that our extensive product line and experience, combined with our
growth strategy in governmental projects and commercial solutions, position us
for further growth. We cannot assure you however, that such growth will be
achieved.
Beginning in the fourth quarter of 2001, we completely reorganized our
operational and strategic structure. This reorganization included an in-depth
analysis of our technologies, products, applications, target markets, business
and marketing strategies, as well as instituting aggressive cost-cutting
measures. As a result of this process, we decided to focus on what we believed
to be our core strengths:
o Smart card technology integration know-how;
o High security solution integration;
o Proprietary smart card technologies and products;
o Expertise in multi-application smart cards; and
o Extensive experience with the government ID market.
Our objective is to become a leading provider of high-end smart card
systems by marketing our extensive technological know-how, advanced technologies
and value-added products and applications for government and commercial smart
cards in the secured identification and access control markets, worldwide. While
we intend to continue to participate in governmental ventures, we also plan to
increase our sales efforts in the private commercial market through our
distribution channels, including our recently entered into distribution
arrangements with Clinton Electronics Corporation, TransTech Systems, Inc.,
Laminex, Inc. and Eastern DataComm.
We will seek to market our products and proprietary technologies to
position us as:
o A horizontal smart card technology provider and integrator with the
ability to respond to complex security and multi-application smart
card system challenges; and
o A provider of a combination of unique and traditional smart cards
and complementary smart card-related products, which, as applicable,
will be sold "off-the-shelf" as complete solutions.
-1-
There can be no assurance as to whether we shall achieve our objective,
as to the degree of our success in growth in the commercial market or as to
whether we shall achieve the desired position.
Our executive offices are located at Millennium Bldg., 3 Tidhar St.,
P.O.B. 2094, Raanana, Israel and our telephone number is (011) +972-9-7750800.
Our website is located at http://www.supercomgroup.com. The information
contained on our website is not intended to be a part of this prospectus.
-2-
THE OFFERING
Ordinary shares which may be sold
by selling shareholders .......... 6,341,713 ordinary shares, including
2,312,298 ordinary shares issuable upon
exercise of warrants
Ordinary shares to be outstanding
after the offering................ 16,996,287 ordinary shares, excluding (i)
the ordinary shares issuable as of the date
of this prospectus upon exercise of options,
and (ii) 2,312,298 ordinary shares issuable
upon effectiveness of the registration
statement of which this prospectus forms a
part and upon exercise of warrants. We have
outstanding options to purchase 2,172,878
ordinary shares, 1,602,194 of which are
currently exercisable. In addition, we
authorized grants of options to employees
and officers, under our option plan, with an
exercise price of $0.85, to purchase an
aggregate of 1,400,000 shares, which remains
subject to all required approvals under
Israeli law.
Use of proceeds................... We will not receive any proceeds from the
sales described in this prospectus. We will
bear the expenses related to the
registration of the ordinary shares.
OTC Bulletin Board Symbol......... SPCBF.OB
Euronext Brussels Symbol.......... SUP
The number of ordinary shares to be outstanding after this offering
does not include, as of October 28,2004:
3,572,878 ordinary shares reserved for issuance upon exercise of (i)
outstanding options to purchase 2,172,878 ordinary shares at a weighted
average exercise price of $ 0.97 per share and (ii) authorized grants
of options to employees and officers, under our option plan, with an
exercise price of $0.85, to purchase an aggregate of 1,400,000 shares,
which remains subject to all required approvals under the Israeli law.
As used in this prospectus:
o all references to "New Shekels" or "NIS" are to the lawful currency
of Israel;
o all references to "Euros", "EUR" or "(euro)" are to the lawful
currency of the European Union; and
o all references to "dollars" or "$" are to the lawful currency of the
United States.
-3-
SUMMARY CONSOLIDATED FINANCIAL DATA
The following is a summary of financial data included elsewhere in the
prospectus. You should read the following data with the more detailed
information contained in "Selected Consolidated Financial Data," "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
our consolidated financial statements and related notes appearing elsewhere in
this prospectus.
SUMMARY OF CONSOLIDATED FINANCIAL DATA
YEAR ENDED DECEMBER 31,
---------------------------------------------
Audited
(IN THOUSANDS OF U.S. DOLLARS, EXCEPT PER SHARE DATA)
*1999 *2000 *2001 2002 2003
SUMMARY OF STATEMENT OF OPERATIONS:
Revenues 3,894 3,062 6,889 8,027 7,244
Cost of Revenues 1,956 1,756 2,574 1,830 3,102
----- ----- ----- ----- -----
Gross Profit 1,938 1,306 4,315 6,197 4,142
----- ----- ----- ----- -----
Operating Expenses:
Research and Development 1,975 2,477 1,225 1,334 918
Selling and Marketing 1,588 4,180 4,628 2,828 3,026
General and Administrative 2,990 3,385 3,604 1,988 1,829
----- ----- ----- ----- -----
Total Operating Expenses 6,553 10,042 9,457 6,150 5,773
----- ------ ----- ----- -----
Operating Income (Loss) (4,615) (8,736) (5,142) 47 (1,631)
Financial Income (Expenses), Net 545 744 123 (35) (233)
OTHER INCOME (EXPENSES), NET (5) (1,688) (241) 6,203 (83)
--- -------- ----- ----- ----
Income Loss before Taxes on Income (4,075) (9,680) (5,260) 6,215 (1,947)
Income Taxes 6 2 -- -- --
Equity in Earnings (Loss) of an Affiliated
Company, Net of taxes 18 19 -- (38) (48)
-- -- -- ---- ----
Net Income (Loss) from continuing operations (4,063) (9,663) (5,260) 6,177 (1,995)
======= ======= ======= ===== =======
Loss from discontinued operations 97 1,276 1,288 427 --
Net income (loss) $(4,160) $ (10,939) $ (6,548) $ 5,750 $ (1,995)
======== ========== ========= ======= =========
PER SHARE DATA:
Basic and Diluted earning (loss) from continuing
operations (0.34) $(0.76) $(0.42) $0.49 $(0.15)
Basic and Diluted earning (loss) from discontinued
operations $(0.01) $(0.1) $(0.1) $(0.04) $ --
Basic and Diluted earning (loss) per share
$(0.35) $(0.86) $(0.52) $ 0.45 $(0.15)
SUMMARY OF BALANCE SHEET DATA:
Cash and Cash Equivalents 5,295 8,565 274 4,567 1,912
Bank deposit 13,068 -- 100 1,196
Marketable debt securities -- -- -- 609 117
Trade receivables 225 161 573 2,202 1,808
Inventories 1,079 2,832 3,777 3,144 3,236
Total Current Assets 20,883 12,887 6,006 11,092 9,630
TOTAL ASSETS 21,941 15,219 8,531 13,756 12,434
Total Current Liabilities 1,583 4,016 4,226 3,468 4,199
Accrued Severance Pay 705 858 442 362 436
TOTAL SHAREHOLDERS' EQUITY 19,653 10,345 3,863 9,497 7,612
-4-
SUMMARY OF CONSOLIDATED FINANCIAL DATA
THREE MONTHS SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
------------------ -----------------
Unaudited Unaudited
(IN THOUSANDS OF U.S. DOLLARS, EXCEPT PER SHARE DATA)
2003 2004 2003 2004
SUMMARY OF STATEMENT OF OPERATIONS:
Revenues 1,021 1,173 3,905 2,484
Cost of Revenues 447 738 1,504 1,564
------ ------ ------ ------
Gross Profit 574 435 2,401 920
------ ------ ------ ------
Operating Expenses:
Research and Development 229 183 465 377
Selling and Marketing 260 572 1,547 1,129
General and Administrative 438 441 939 944
------ ------ ------ ------
Total Operating Expenses 927 1,196 2,951 2,450
------ ------ ------ ------
Operating Income (Loss) (353) (761) (550) (1,530)
Financial Income (Expenses), Net (131) (70) (146) (77)
OTHER INCOME (EXPENSES), NET (11) (49) (41) (53)
----- ------ ----- -----
Income Loss before Taxes on Income (495) (880) (737) (1,660)
Income Taxes -- -- -- --
Equity in Earnings (Loss) of an Affiliated
Company, Net of taxes -- -- -- --
-- -- -- --
Net Income (Loss) from continuing operations (495) (880) (737) (1,660)
====== ======= ====== ======
Loss from discontinued operations -- -- -- --
Net income (loss) $(495) $(880) $(737) $(1,660)
====== ====== ====== =======
PER SHARE DATA:
Basic and Diluted earning (loss) from continuing
operations $(0.04) $(0.07) $(0.06) $(0.13)
Basic and Diluted earning (loss) from discontinued
operations $-- $-- $-- $--
Basic and Diluted earning (loss) per share
$(0.04) $(0.07) $(0.06) $(0.13)
SUMMARY OF BALANCE SHEET DATA:
Cash and Cash Equivalents 3,932 1,528 3,932 1,528
Bank deposit 791 601 791 601
Marketable debt securities 274 -- 274 --
Trade receivables 3,851 1,798 3,851 1,798
Inventories 2,898 2,836 2,898 2,836
Total Current Assets 12,255 8,076 12,255 8,076
TOTAL ASSETS 14,776 11,032 14,776 11,032
Total Current Liabilities 5,253 3,626 5,253 3,626
Accrued Severance Pay 392 465 392 465
TOTAL SHAREHOLDERS' EQUITY 8,786 6,756 8,786 6,756
-5-
RISK FACTORS
This offering involves a high degree of risk. You should carefully
consider the following risks together with the other information in this
prospectus before deciding to invest in our ordinary shares. If any of the
following risks actually occur, our business, financial condition and results of
operations could be materially and adversely affected. In that case, the trading
price of our ordinary shares could decline, and you may lose all or part of your
investment. The risks described below are not necessarily in order of degree or
magnitude of risk.
WE HAVE A HISTORY OF OPERATING LOSSES AND NEGATIVE CASH FLOWS AND MAY NOT BE
PROFITABLE IN THE FUTURE.
We have incurred substantial losses and negative cash flows
since our inception. We had an accumulated deficit of approximately $19,902,000
at June 30, 2004. We had an accumulated deficit of approximately $18,242,000 at
December 31, 2003. Although we generated net income of approximately $5,750,000
for the year ended December 31, 2002, such net income was generated primarily
from the sale of our equity ownership in our former subsidiary InkSure. We
incurred losses of approximately $1,995,000 and $6,548,000 for the years ended
December 31, 2003 and 2001, respectively. We expect to have net operating losses
and negative cash flows for the foreseeable future, and expect to spend
significant amounts of capital to enhance our products and services, develop
further sales and operations, and fund expansion. As a result, we will need to
generate significant revenue to achieve profitability. Even if we do achieve
profitability, we may not be able to sustain or increase profitability on a
quarterly or annual basis.
Part of our operating expense levels are based on internal forecasts
for future demand and not on firm customer orders for products or services. Our
results may be affected by fluctuating demand for our products and services from
one quarter to the next and by increases in the costs of components and raw
materials acquired from suppliers.
WE WILL FACE A NEED FOR ADDITIONAL CAPITAL AND MAY NEED TO CURTAIL OUR
OPERATIONS IF IT IS NOT AVAILABLE.
We believe that our current cash and cash equivalents, in addition to
our revenues generated from our business operations, will satisfy our operating
capital needs for at least the next 12 months based upon our currently
anticipated business activities. However, we may need additional capital even
within the next 12 months if we undertake large projects or have a delay in one
of our anticipated projects. Our need for additional capital to finance our
operations and growth will be greater should, among other things, our revenue or
expense estimates prove to be incorrect. We may not be able to obtain additional
financing in sufficient amounts or on acceptable terms when needed, which would
force us to curtail our operations or not pursue opportunities which present
themselves.
WE DERIVE A SUBSTANTIAL PORTION OF OUR REVENUE FROM A SMALL NUMBER OF CUSTOMERS,
AND THE REDUCTION OF SALES TO ANY ONE OF THOSE CUSTOMERS COULD ADVERSELY IMPACT
OUR OPERATING RESULTS BY CAUSING A DROP IN REVENUES.
We depend on a limited number of customers for a substantial portion of
our revenue. During the years ended December 31, 2003, 2002 and 2001, we derived
66%, 73%, and 70%, respectively, of our consolidated net revenue for that year
from four individual customers. In 2003, our customers Ministry of Internal
Affairs of Ukraine, Intercomsoft China travel CHK and China travel holding
accounted for 27%, 16% 12% and 11%, respectively, of our consolidated net
revenues. A substantial reduction in sales to any of our significant customers
would adversely affect our business unless we were able to replace the revenue
we received from those customers, which replacement we may not be able to do.
During 2002, we began the delivery of the first phase of the Ukraine ID
smart card project pursuant to Contract No.10/82, dated April 9, 2002 (the
"Contract") between SuperCom and the Ministry of Internal Affairs of Ukraine
(the "Ministry") and generated revenues of $2,100,000. During 2003,we generated
an aggregate of $1,970,000 in revenues from this project. In April 2004, we were
informed by the International Commercial Arbitration Court at the Ukrainian
Chamber of Commerce and Industry ("Arbitration Court") that the Department for
Resources Supply of the Ministry had filed with the Arbitration Court a
statement of claim to declare the Contract as void due to defaults in the tender
proceedings under which the Contract had been awarded to SuperCom. On July 22,
2004 we were informed by the law firm representing us in the arbitration
proceedings that on July 19, 2004, the Arbitration Court issued a negative award
declaring the Contract as void. We strongly believe that the award is wrong due
to many defaults that occurred in the arbitration proceedings and we intend to
challenge the validity of the award in the civil courts of Ukraine. We are not
anticipating any revenues from this project during the year 2004 and the
following years, which represented approximately $13,300,000 of anticipated
revenues for the remainder of the term through 2006.
-6-
WE DERIVE A SUBSTANTIAL PORTION OF OUR REVENUE FROM A SMALL NUMBER OF CUSTOMERS,
AND THE LOSS OF ANY ONE OF THOSE CUSTOMERS COULD ADVERSELY IMPACT OUR OPERATING
RESULTS BY CAUSING A DROP IN REVENUES.
We depend on a limited number of customers for a substantial portion of
our revenue. The termination or non-renewal of any significant contract upon
expiration, would adversely affect our business unless we were able to replace
the revenue we received from those customers, which replacement we may not be
able to do.
OUR RELIANCE ON THIRD PARTY TECHNOLOGIES, RAW MATERIALS AND COMPONENTS FOR THE
DEVELOPMENT OF SOME OF OUR PRODUCTS AND OUR RELIANCE ON THIRD PARTIES FOR
MANUFACTURING MAY DELAY PRODUCT LAUNCH, IMPAIR OUR ABILITY TO DEVELOP AND
DELIVER PRODUCTS OR HURT OUR ABILITY TO COMPETE IN THE MARKET.
Most of our products integrate third-party technology that we license
and/or raw materials and components that we purchase or otherwise obtain the
right to use, including: operating systems, microchips, security and
cryptography technology for card operating systems, which prevents unauthorized
parties from tampering with our cards, and dual interface technology, which
enables cards to operate in both contact and contactless mode. Our ability to
purchase and license new technologies and components from third parties is and
will continue to be critical to our ability to offer a complete line of products
that meets customer needs and technological requirements. We may not be able to
renew our existing licenses or be able to purchase components and raw materials
on favorable terms, or at all. If we lose the rights to a patented technology,
we may need to stop selling or may need to redesign our products that
incorporate that technology, and we may lose the potential competitive advantage
such technology gave us. In addition, competitors could obtain licenses for
technologies for which we are unable to obtain licenses, and third parties may
develop or enable others to develop a similar solution to security issues,
either of which events could adversely affect our results of operations. Also,
dependence on the patent protection of third parties may not afford us any
control over the protection of the technologies upon which we rely. If the
patent protection of any of these third parties were compromised, our ability to
compete in the market also would be impaired.
DELAYS IN DELIVERIES FROM OUR SUPPLIERS OR DEFECTS IN GOODS OR COMPONENTS
SUPPLIED BY OUR VENDORS COULD CAUSE OUR REVENUES AND GROSS MARGINS TO DECLINE.
We rely on a limited number of vendors for certain components for the
products we are supplying. Any undetected flaws in components supplied by our
vendors could lead to unanticipated costs to repair or replace these parts. We
currently purchase some of our components from a single supplier to take
advantage of volume discounts which presents a risk that the components may not
be available in the future on commercially reasonable terms or at all. Although
we believe that there are additional suppliers for the equipment and supplies
that we require, we may not be able to make such alternative arrangement
promptly. If one of our suppliers were unable to meet our supply demands and we
could not quickly replace the source of supply, it could cause a delay of
receipt of revenues and damage to our business reputation.
OUR INABILITY TO MAINTAIN AND DEVELOP NEW STRATEGIC RELATIONSHIPS WITH PRIMARY
INTEGRATORS FOR GOVERNMENTAL SECURED ID AND PASSPORT PROJECTS COULD IMPACT OUR
ABILITY TO OBTAIN OR SELL OUR PRODUCTS, AND PREVENT US FROM GENERATING SALES
REVENUES.
We obtain and sell many of our products through strategic alliance and
supplier agreements in which we act as subcontractors or suppliers to the
primary integrator or contractor, including China Travel Service (Holdings) H.K.
Ltd. in Hong Kong for the Hong Kong passport and China re-entry card projects
and Intercomsoft in Moldova for the Moldova national documentation project. The
loss of any of our existing strategic relationships, or the inability to create
new strategic relationships in the future, could adversely affect our ability to
develop and sell our products.
We sometimes depend upon our strategic partners to market our products
and to fund and perform their obligations as contemplated by our agreements with
them. We do not control the time and resources devoted by our partners to these
activities. These relationships may not continue or may require us to spend
significant financial, personnel and administrative resources from time to time.
We may not have the resources available to satisfy our commitments, which may
adversely affect our strategic relationships.
If alliance or supplier agreements are cancelled, modified or delayed,
if alliance or supplier partners decide not to purchase our products or to
purchase only limited quantities of our products, or if we are unable to enter
into additional alliance or supplier agreements, our ability to produce and sell
our products and to generate sales revenues could be adversely affected.
-7-
OUR DEPENDENCE ON THIRD PARTY DISTRIBUTORS, SALES AGENTS, AND VALUE-ADDED
RESELLERS COULD RESULT IN MARKETING AND DISTRIBUTION DELAYS WHICH WOULD PREVENT
US FROM GENERATING SALES REVENUES.
We market and sell some of our products using a network of distributors
covering several major world regions, including the United States. We are
currently engaged in discussions with other potential distributors, sales
agents, and value-added resellers. Such arrangements may never be finalized and,
if finalized, such arrangements may not increase our revenues or enable us to
achieve profitability.
Our ability to terminate a distributor who is not performing
satisfactorily may be limited. Inadequate performance by a distributor would
adversely affect our ability to develop markets in the regions for which the
distributor is responsible and could result in substantially greater
expenditures by us in order to develop such markets. Our operating results will
be highly dependent upon: (i) our ability to maintain our existing distributor
arrangements; (ii) our ability to establish and maintain coverage of major
geographic areas and establish access to customers and markets; and (iii) the
ability of our distributors, sales agents, and value-added resellers to
successfully market our products. A failure to achieve these objectives could
result in lower revenues.
THIRD PARTIES COULD OBTAIN ACCESS TO OUR PROPRIETARY INFORMATION OR COULD
INDEPENDENTLY DEVELOP SIMILAR TECHNOLOGIES BECAUSE OF THE LIMITED PROTECTION FOR
OUR INTELLECTUAL PROPERTY AND SUCH ACTIONS WOULD ENABLE THIRD PARTIES TO COMPETE
MORE EFFECTIVELY WITH US AND, ACCORDINGLY, THESE ACTIONS WOULD HAVE A HARMFUL
EFFECT ON OUR OPERATIONS.
Despite the precautions we take, third parties may copy or obtain and
use our proprietary technologies, ideas, know-how and other proprietary
information without authorization or may independently develop technologies
similar or superior to our technologies. In addition, the confidentiality and
non-competition agreements between us and most of our employees, distributors
and clients may not provide meaningful protection of our proprietary
technologies or other intellectual property in the event of unauthorized use or
disclosure. If we are not able to defend successfully our industrial or
intellectual property rights, we might lose rights to technology that we need to
develop our business, which may cause us to lose potential revenues, or we might
be required to pay significant license fees for the use of such technology. To
date, we have relied primarily on a combination of patent, trade secret and
copyright laws, as well as nondisclosure and other contractual restrictions on
copying, reverse engineering and distribution to protect our proprietary
technology. We currently have three registered patents in Israel, one in Europe,
one in the United States, one in Hong Kong, one in Ukraine and two patent
applications pending in the United States and Europe and other jurisdictions for
technology related to our smart card technology. We may not be issued patents
based on our patent applications. Any inability to protect intellectual property
rights in our technology could enable third parties to compete more effectively
with us and/or could reduce our ability to compete. In addition, these efforts
to protect our intellectual property rights could require us to incur
substantial costs even when our efforts are successful.
In addition, the laws of certain foreign countries may not protect our
intellectual property rights to the same extent as do the laws of Israel or the
United States. Our means of protecting our intellectual property rights in
Israel, the United States or any other country in which we operate may not be
adequate to fully protect our intellectual property rights. For instance, the
intellectual property rights of our Asian subsidiary, SuperCom Asia Pacific Ltd.
may not be fully protected by the laws of Hong Kong and the People's Republic of
China, or PRC. The PRC does not yet possess a comprehensive body of intellectual
property laws. As a result, the enforcement, interpretation and implementation
of existing laws, regulations or agreements may be sporadic, inconsistent and
subject to considerable discretion. The PRC's judiciary has not had sufficient
opportunity to gain experience in enforcing laws that exist, leading to a higher
than usual degree of uncertainty as to the outcome of any litigation. As the
legal system develops, entities such as the Company may be adversely affected by
new laws, changes to existing laws (or interpretations thereof) and preemption
of provincial or local laws by national laws. Even when adequate law exists in
the PRC, it may not be possible to obtain speedy and equitable enforcement of
the law.
WE MAY FACE HARMFUL CLAIMS OF INFRINGEMENT OF PROPRIETARY RIGHTS, WHICH COULD
REQUIRE US TO DEVOTE SUBSTANTIAL TIME AND RESOURCES TOWARD MODIFYING OUR
PRODUCTS OR OBTAINING APPROPRIATE LICENSES.
There is a risk that our products infringe the proprietary rights of
third parties. On August 8, 2003, we received a letter stating that we may be
infringing certain patents of third parties with respect to our hot lamination
process for plastic cards. We reviewed the claims made in the letter and we do
not believe that our products or technology infringes such parties' patents or
any other third party's patents. Since the initial letter, we received another
letter dated July 13, 2004 from the same party requesting that we respond to
-8-
their claim and stating that attractive licenses are available. To date, no
infringement claims have been filed against us. We believe that hot lamination
of plastic cards is a widely known process that is used by most card
manufacturers. Even if it were determined that we are infringing such third
party's patents, we feel that we could use another process to laminate plastic
cards and our business would not be materially affected.
Regardless of whether our products infringe on proprietary rights of
third parties, infringement or invalidity claims may be asserted or prosecuted
against us and we could incur significant expenses in defending them. If any
infringement claims or actions are successfully asserted against us, we may be
required to discontinue the use of certain processes, cease the manufacture, use
and sale of infringing products and services, expend significant resources to
develop non infringing technology, modify our products and services or seek
licenses for these intellectual property rights. We may not be able to modify
our products or obtain licenses on commercially reasonable terms, in a timely
manner or at all. Our failure to do so could adversely affect our business by
preventing us from selling some or all of our products. Adverse or protracted
litigation or the failure to obtain necessary licenses or other rights could
increase our expenses, as well as delay our increasing revenues, due to the
possible devotion of significant financial and human resources in defending such
litigation.
A SECURITY BREACH OF OUR INTERNAL SYSTEMS OR THOSE OF OUR CUSTOMERS COULD HARM
OUR BUSINESS BY ADVERSELY AFFECTING THE MARKET'S PERCEPTION OF OUR PRODUCTS AND
SERVICES THEREBY CAUSING OUR REVENUES TO DECLINE.
For us to penetrate further the marketplace, the marketplace must be
confident that we provide effective security protection for national identity
and other secured ID documents and cards. Although we have not experienced any
act of sabotage or unauthorized access by a third party of our software or
technology to date, if an actual or perceived breach of security occurs in our
internal systems or those of our customers, regardless of whether we caused the
breach, it could adversely affect the market's perception of our products and
services. This could cause us to lose customers, resellers, alliance partners or
other business partners thereby causing our revenues to decline. If we or our
customers were to experience a breach of our internal systems, our business
could be severely harmed by adversely affecting the market's perception of our
products and services.
WE MAY BE EXPOSED TO SIGNIFICANT LIABILITY FOR ACTUAL OR PERCEIVED FAILURE TO
PROVIDE REQUIRED PRODUCTS OR SERVICES WHICH COULD DAMAGE OUR REPUTATION AND
ADVERSELY AFFECT OUR BUSINESS BY CAUSING OUR REVENUES TO DECLINE AND OUR COSTS
TO RISE.
Products as complex as those we offer may contain undetected errors or
may fail when first introduced or when new versions are released. Despite our
product testing efforts and testing by current and potential customers, it is
possible that errors will be found in new products or enhancements after
commencement of commercial shipments. The occurrence of product defects or
errors could result in adverse publicity, delay in product introduction,
diversion of resources to remedy defects, loss of or a delay in market
acceptance, or claims by customers against us, or could cause us to incur
additional costs or lose revenues, any of which could adversely affect our
business.
Because our customers rely on our products for critical security
applications, we may be exposed to claims for damages allegedly caused to a
customer as a result of an actual or perceived failure of our products. An
actual or perceived breach of security systems of one of our customers,
regardless of whether the breach is attributable to our products or solutions,
could adversely affect our business reputation. Furthermore, our failure or
inability to meet a customer's expectations in the performance of our services,
or to do so in the time frame required by the customer, regardless of our
responsibility for the failure, could result in a claim for substantial damages
against us by the customer, discourage other customers from engaging us for
these services, and damage our business reputation.
We currently carry product liability insurance, errors and omissions
for high-technology companies insurance and insurance to guard against losses
caused by employees' dishonesty. We believe that this insurance coverage is
comparable to that of other similar companies in our industry. However, that
insurance may not continue to be available to us on reasonable terms or in
sufficient amounts to cover one or more large claims, or the insurer may
disclaim coverage as to any future claim. We do not maintain insurance coverage
for employee errors or security breaches, nor do we maintain specific insurance
coverage for any interruptions in our business operations. The successful
assertion of one or more large claims against us that exceed available insurance
coverage, or changes in our insurance policies, including premium increases or
the imposition of large deductibles or co-insurance requirements, could
adversely affect our business by increasing our costs.
OUR EFFORTS TO EXPAND OUR INTERNATIONAL OPERATIONS ARE SUBJECT TO A NUMBER OF
RISKS, ANY OF WHICH COULD ADVERSELY REDUCE OUR FUTURE INTERNATIONAL SALES.
-9-
Most of our business to date has been in jurisdictions other than the
United States and we plan to increase our international sales outside of the
United States. Our inability to obtain or maintain federal or foreign regulatory
approvals relating to the import or export of our products on a timely basis
could adversely affect our ability to expand our international business.
Additionally, our international operations could be subject to a number of
risks, any of which could adversely affect our future international sales,
including:
o increased collection risks;
o trade restrictions;
o export duties and tariffs;
o uncertain political, regulatory and economic developments;
o inability to protect our intellectual property rights;
o very aggressive competitors;
o lower gross margins in commercial sales in Hong Kong and China;
o business development in Hong Kong and China is time consuming and
risky due to the uncertain political, regulatory and legal
environment; and
o currency issues.
In addition, in many countries the national security organizations
require our employees to obtain clearance before such employees can work on a
particular transaction. Failure to receive, or delays in the receipt of,
relevant foreign qualifications also could have a material adverse effect on our
ability to obtain sales at all or on a timely basis. Additionally, as foreign
government regulators have become increasingly stringent, we may be subject to
more rigorous regulation by governmental authorities in the future. If we fail
to adequately address any of these regulations, our business will be harmed.
THE MARKETS THAT WE TARGET FOR A SUBSTANTIAL PART OF OUR FUTURE GROWTH ARE IN
VERY EARLY STAGES OF DEVELOPMENT, AND IF THEY DO NOT DEVELOP OUR BUSINESS MIGHT
NOT GROW AS MUCH OR AS PROFITABLY AS WE HOPE.
Many of the markets that we target for our future growth are currently
small or non-existent and need to develop if we are to achieve our growth
objectives. If some or all of these markets do not develop, or if they develop
more slowly than we anticipate, then we will not grow as quickly or profitably
as we hope. For example, we are developing smart card products and services for
the national government ID market. Smart card technology has not been widely
adopted by national governments until recently, largely due to the cost of the
necessary infrastructure and the relatively limited capabilities of previous
microchips. We are investing in identification and security networks products
and services, but so far we have not deployed our systems on a widespread basis.
In 2003, our revenues from the government market totaled approximately
$5,500,000 compared to $1,800,000 from the commercial market. Although we
believe the government market is critical to our success in the short term, we
believe that both the government and commercial markets will be critical to our
long-term future success. The development of these markets will depend on many
factors that are beyond our control, including the factors that are discussed in
these Risk Factors.
IF SMART CARD AND HIGHLY SECURED DOCUMENT TECHNOLOGY IS NOT ADOPTED IN
GOVERNMENT AND INDUSTRY ORGANIZATIONS, WE MAY LOSE SOME OF OUR EXISTING
CUSTOMERS AND OUR BUSINESS MIGHT NOT GROW AS MUCH OR AS PROFITABLY AS WE HOPE.
Our ability to grow depends significantly on whether governmental and
industrial organizations adopt smart card technology as part of their new
standards. If these organizations do not adopt smart card and highly secured
document technology, then we might not be able to penetrate some of the new
markets we are targeting, or we might lose some of our existing customer base.
In order for us to achieve our growth objectives, smart card technology
must be adopted in a variety of areas, including:
-10-
o bank credit and debit card systems, which in most countries have
traditionally relied on magnetic stripe cards as their principal
technology;
o computer equipment, which must include smart card readers as
standard equipment if the use of smart cards for Internet and other
applications is to become common;
o widely used digital signature information technology security
systems;
o national identity card programs, which are considering smart cards
with biometric technology;
o government issued passports and ID cards which include contactless
smart card chips, which has been recently recommended as the new
standard by International Committee of Aviation Organizations;
o transportation applications using cards as method of payment; and
o access control in such fields as education and health care.
Any or all of these areas may not adopt smart card technology.
WE NEED TO DEVELOP OUR POSITION AS A PROVIDER OF SOFTWARE, SYSTEMS AND SERVICES
TO EARN HIGH MARGINS FROM OUR TECHNOLOGY AND, IF WE ARE UNABLE TO DEVELOP SUCH
POSITION, OUR BUSINESS WILL NOT BE AS PROFITABLE AS WE HOPE, IF PROFITABLE AT
ALL.
The increasing sophistication of smart card technology places a premium
on providing innovative software systems and services to customers, in addition
to manufacturing and supplying smart cards. While we have had some early success
positioning ourselves as a provider of services and systems, may not continue to
be successful with this strategy and we may not be able to capture a significant
share of the market for the sophisticated services and systems that we believe
are likely to produce attractive margins in the future. A significant portion of
the value of smart card technology lies in the development of operating systems
and applications that will permit the use of smart cards in new markets. In
contrast, the margins involved in manufacturing and selling smart cards can be
relatively small, and might not be sufficient to permit us to earn an attractive
return on our development investments.
IF WE ARE UNABLE TO KEEP UP WITH RAPID CHANGES IN SMART CARD TECHNOLOGY, OUR
EXISTING PRODUCTS AND SERVICES COULD BECOME OBSOLETE AND OUR REVENUES WILL
DECLINE.
The market for our products and services is marked by rapid
technological change, frequent new product introductions and smart card
technology enhancements, uncertain product life cycles, changes in customer
demands and evolving industry standards. New products and services based on new
or improved technologies or new industry standards can render existing products
and services obsolete and unmarketable. To succeed, we will need to enhance our
current products and service offerings and develop new products and services on
a timely basis to keep pace with developments related to smart card technology
and to satisfy the increasingly sophisticated requirements of our customers. Any
delays in developing and releasing enhanced or new products and services or in
keeping pace with continuous technological change may cause us to lose our
existing customer base.
The process of developing our products and services is extremely
complex and requires significant continuing development efforts. Our investments
in research and development have been considerable and may increase in the
future. In order to earn an adequate return on these investments, we need to
expand our sales significantly. We may not achieve our development objectives or
expand our sales.
THE TIME FROM OUR INITIAL CONTACT WITH A CUSTOMER TO A SALE IS LONG AND SUBJECT
TO DELAYS, WHICH COULD RESULT IN THE POSTPONEMENT OF OUR RECEIPT OF REVENUES
FROM ONE ACCOUNTING PERIOD TO THE NEXT, INCREASING THE VARIABILITY OF OUR
RESULTS OF OPERATIONS AND CAUSING SIGNIFICANT FLUCTUATIONS IN OUR REVENUE FROM
QUARTER TO QUARTER.
The period between our initial contact with a potential customer and
the purchase of our products and services is often long and subject to delays
associated with the budgeting, approval and competitive evaluation processes
that frequently accompany significant capital expenditures, particularly by
governmental agencies. The typical sales cycle for our government customers has
-11-
to date ranged from three to 24 months and the typical sales cycle for our
commercial customers has ranged from one to six months. A lengthy sales cycle
may have an impact on the timing of our revenue, which may cause our quarterly
operating results to fall below investor expectations. We believe that a
customer's decision to purchase our products and services is discretionary,
involves a significant commitment of resources, and is influenced by customer
budgetary cycles. To successfully sell our products and services, we generally
must educate our potential customers regarding their use and benefits, which can
require significant time and resources. This significant expenditure of time and
resources may not result in actual sales of our products and services.
OUR MARKETS ARE HIGHLY COMPETITIVE AND COMPETITION COULD HARM OUR ABILITY TO
SELL PRODUCTS AND SERVICES AND COULD REDUCE OUR MARKET SHARE.
The market for smart card and secured document products and services is
intensely competitive. We expect competition to increase as the industry grows
and as smart card technology begins to converge with the information technology
industry. We may not be able to compete successfully against current or future
competitors. We face competition from technologically sophisticated companies,
many of which have substantially greater technical financial, and marketing
resources than us. In some cases, we compete with entities that have
pre-existing relationships with potential customers. As the national
documentation production market expands, we expect additional competitors to
enter the market.
Some of our competitors and potential competitors have larger technical
staffs, larger customer bases, more established distribution channels, greater
brand recognition and greater financial, marketing and other resources than we
do.
Our competitors may be able to develop products and services that are
superior to our products and services, that achieve greater customer acceptance
or that have significantly improved functionality as compared to our existing
and future smart card products and services. In addition, our competitors may be
able to negotiate strategic relationships on more favorable terms than we are
able to negotiate. Many of our competitors may also have well established
relationships with our existing and prospective customers. Increased competition
may result in our experiencing reduced margins, loss of sales or decreased
market shares.
WE RELY ON THE SERVICES OF CERTAIN EXECUTIVE OFFICERS AND KEY PERSONNEL, THE
LOSS OF WHOM COULD ADVERSELY AFFECT OUR OPERATIONS BY CAUSING A DISRUPTION TO
OUR BUSINESS.
Our future success depends largely on the efforts and abilities of our
executive officers and senior management and other key employees, including
technical and sales personnel. The loss of the services of any of these persons
could disrupt our business until replacements, if available, can be found. We do
not maintain any key-person insurance for any of our employees.
OUR ABILITY TO REMAIN COMPETITIVE DEPENDS IN PART ON ATTRACTING, HIRING AND
RETAINING QUALIFIED TECHNICAL PERSONNEL AND, IF WE ARE NOT SUCCESSFUL IN SUCH
HIRING AND RETENTION, OUR BUSINESS COULD BE DISRUPTED.
Our future success depends in part on the availability of qualified
technical personnel, including personnel trained in software and hardware
applications within specialized fields. As a result, we may not be able to
successfully attract or retain skilled technical employees, which may impede our
ability to develop, install implement and otherwise service our software and
hardware systems and to efficiently conduct our operations.
The information technology and network security industries are
characterized by a high level of employee mobility and the market for technical
personnel remains extremely competitive in certain regions, including Israel.
This competition means there are fewer highly qualified employees available to
hire, the costs of hiring and retaining such personnel are high and highly
qualified employees may not remain with our Company once hired. Furthermore,
there may be pressure to provide technical employees with stock options and
other equity interests in our Company, which may dilute our earnings (loss) per
share.
Additions of new personnel and departures of existing personnel,
particularly in key positions, can be disruptive, might lead to additional
departures of existing personnel and could have a material adverse effect on our
business, operating results and financial condition.
OUR PLANNED GROWTH WILL PLACE SIGNIFICANT STRAIN ON OUR FINANCIAL AND MANAGERIAL
RESOURCES AND MAY NEGATIVELY AFFECT OUR RESULTS OF OPERATIONS AND ABILITY TO
GROW.
-12-
Our ability to manage our growth effectively will require us:
o to continue to improve our operations, financial and management
controls, reporting systems and procedures;
o to train, motivate and manage our employees; and
o as required, to install new management information systems.
Our existing management and any new members of management may not be
able to augment or improve existing systems and controls or implement new
systems and controls in response to anticipated future growth. If we are
successful in achieving our growth plans, such growth is likely to place a
significant burden on the operating and financial systems, resulting in
increased responsibility for our senior management and other personnel.
SOME OF OUR PRODUCTS ARE SUBJECT TO GOVERNMENT REGULATION OF RADIO FREQUENCY
TECHNOLOGY WHICH COULD CAUSE A DELAY OR INABILITY TO INTRODUCE SUCH PRODUCTS IN
THE UNITED STATES AND OTHER MARKETS.
The rules and regulations of the United States Federal Communications
Commission or, the "FCC" limit the radio frequency used by and level of power
emitting from electronic equipment. Our readers, controllers and other radio
frequency technology scanning equipment are required to comply with these FCC
rules which may require certification, verification or registration of the
equipment with the FCC. Certification and verification of new equipment requires
testing to ensure the equipment's compliance with the FCC's rules. The equipment
must be labeled according to the FCC's rules to show compliance with these
rules. Testing, processing of the FCC's equipment certificate or FCC
registration, and labeling may increase development and production costs and
could delay introduction of our verification scanning device and next generation
radio frequency technology scanning equipment into the U.S. market. Electronic
equipment permitted or authorized to be used by the FCC through our
certification or verification procedures must not cause harmful interference to
licensed FCC users, and it is subject to radio frequency interference from
licensed FCC users. Selling, leasing or importing non compliant equipment is
considered a violation of FCC rules and federal law and violators may be subject
to an enforcement action by the FCC. Any failure to comply with the applicable
rules and regulations of the FCC could have a material adverse effect on our
business, operating results and financial by increasing our costs due to
compliance and/or limit our sales in the United States.
CONDITIONS IN ISRAEL AFFECT OUR OPERATIONS IN ISRAEL AND MAY LIMIT OUR ABILITY
TO SELL OUR PRODUCTS AND SERVICES.
We are incorporated under Israeli law and our manufacturing facility
and research and development facility will continue to be located in Israel.
Political, economic and military conditions in Israel will, accordingly,
directly affect our operations. Since the establishment of the State of Israel
in 1948, a number of armed conflicts have taken place between Israel and its
Arab neighbors and a state of hostility, varying in degree and intensity, has
led to security and economic problems for Israel. Despite negotiations to effect
peace between Israel and its Arab neighbors, the future of these peace efforts
is uncertain. Since October 2000, there has been a significant increase in
violence primarily in the West Bank and Gaza Strip, negotiations between Israel
and the Palestinian Authority have ceased from time to time and there has been
increased military activity characterized by some as war. More recently,
violence has spread to Jerusalem and areas near Tel Aviv. Furthermore, several
countries still restrict trade with Israeli companies, which may limit our
ability to make sales, or purchase components from, in those countries. Any
future armed conflict, political instability, continued violence in the region
or restrictions could have a material adverse effect on our business, operating
results and financial condition.
OUR OPERATIONS COULD BE DISRUPTED AS A RESULT OF THE OBLIGATION OF MANAGEMENT OR
KEY PERSONNEL TO PERFORM MILITARY SERVICE IN ISRAEL.
Generally, all nonexempt male adult citizens and permanent residents of
Israel are obligated to perform annual military reserve duty and are subject to
being called for active duty at any time under emergency circumstances.
Currently, Israeli law requires most male Israeli citizens to perform military
reserve duty annually until the age of 45. Generally, between five and ten,
representing approximately 8% to 15%, of our officers and employees are at any
one time obligated to perform annual reserve duty. We believe that a maximum of
approximately 15% of our employees at any one time could be called for active
duty under emergency circumstances. While we have operated effectively under
these requirements since our incorporation, we cannot predict the full impact of
such conditions on us in the future, particularly if emergency circumstances
-13-
occur. If many of our employees are called for active duty, our operations in
Israel and our business, results and financial condition may be adversely
affected.
FLUCTUATIONS IN THE EXCHANGE RATE BETWEEN THE UNITED STATES DOLLAR AND FOREIGN
CURRENCIES MAY AFFECT OUR OPERATING RESULTS.
We incur expenses for our operations in Israel in New Israeli Shekels
(NIS) and translate these amounts into United States dollars for purposes of
reporting consolidated results. As a result, fluctuations in foreign currency
exchange rates may adversely affect our expenses and results of operations, as
well as the value of our assets and liabilities. Fluctuations may adversely
affect the comparability of period-to-period results. In addition, we hold
foreign currency balances, primarily NIS, that will create foreign exchange
gains or losses, depending upon the relative values of the foreign currency at
the beginning and end of the reporting period, affecting our net income and
earnings per share. Although we may use hedging techniques in the future (which
we currently do not use), we may not be able to eliminate the effects of
currency fluctuations. Thus, exchange rate fluctuations could have a material
adverse impact on our operating results and stock price. In addition, future
currency exchange losses may increase if we become subject to exchange control
regulations restricting our ability to convert local currencies into United
States dollars or other currencies.
WE ARE EXPOSED TO SPECIAL RISKS IN FOREIGN MARKETS WHICH MAY MAKE IT DIFFICULT
IN SETTLING TRANSACTIONS AND THEREBY FORCE US TO CURTAIL OUR BUSINESS
OPERATIONS.
In conducting our business in foreign countries, we are subject to
political, economic, legal, operational and other risks that are inherent in
operating in other countries. For instance, business development in Hong Kong
and China is time consuming and risky due to the uncertain political, regulatory
and legal environment. Other risks inherent to operating in other countries
include range from difficulties in settling transactions in emerging markets to
possible nationalization, expropriation, price controls and other restrictive
governmental actions. We also face the risk that exchange controls or similar
restrictions imposed by foreign governmental authorities may restrict our
ability to convert local currency received or held by it in their countries into
United States dollars or other currencies, or to take those dollars or other
currencies out of those countries.
OUR SHAREHOLDERS MAY FACE DIFFICULTIES IN THE ENFORCEMENT OF CIVIL LIABILITIES
AGAINST SUPERCOM LTD. AND ITS OFFICERS AND DIRECTORS.
Certain of our directors and our professional advisors are residents of
Israel or otherwise reside outside of the United States. SuperCom Ltd. is
incorporated under Israeli law and its principal office and facilities are
located in Israel. All or a substantial portion of the assets of such persons
are or may be located outside of the United States. It may be difficult to
effect service of process within the United States upon us or upon any such
directors or professional advisors or to realize in the United States upon
judgments of United States' courts predicated upon civil liability of SuperCom
Ltd. or such persons under United States federal securities laws. We have been
advised by our Israeli counsel that there is doubt as to whether Israeli courts
would (i) enforce judgments of United States' courts obtained against SuperCom
Ltd. or such directors or professional advisors predicated solely upon the civil
liabilities provisions of United States' federal securities laws, or (ii) impose
liabilities in original actions against SuperCom Ltd. or such directors and
professional advisors predicated solely upon such United States' laws. However,
subject to certain time limitations, Israeli courts will enforce foreign
(including United States) final executory judgments for liquidated amounts in
civil matters, obtained after due trial before a court of competent jurisdiction
which recognizes similar Israeli judgments, provided that (1) due process has
been observed, (2) such judgments or the execution thereof are not contrary to
Israeli law, public policy, security or sovereignty, (3) such judgments were not
obtained by fraud and do not conflict with any other valid judgment in the same
matter between the same parties and (4) an action between the same parties in
the same matter is not pending in any Israeli court at the time the law suit is
instituted in the foreign court.
WE ARE UNLIKELY TO PAY DIVIDENDS FOR THE FORESEEABLE FUTURE.
We distributed a cash dividend to our shareholders on one occasion on
August 26, 1997 in the aggregate amount of NIS 1 million and prior to that
dividends in the form of bonus shares were distributed on two other occasions.
We do not expect to declare or pay cash dividends in the foreseeable future and
currently intend to retain future earnings, if any, to finance the growth and
development of our business.
WITH OUR COMMON SHARES BEING TRADED ONLY ON THE OTC BULLETIN BOARD OR ON THE
"PINK SHEETS" IN THE UNITED STATES, THE LIQUIDITY OF OUR COMMON SHARES IN THE
UNITED STATES MAY BE LIMITED.
-14-
Our ordinary shares trade on the Euronext Brussels stock market and are
quoted on the OTC Bulletin Board in the United States. If we were unable to have
a quotation of our ordinary shares on the OTC Bulletin Board System, our shares
will only be traded on the "pink sheet" market. Stocks in the OTC Bulletin Board
or in the "pink sheet" market ordinarily have much lower trading volume than in
other markets, such as the Nasdaq SmallCap Market or the Nasdaq National Market.
Very few market makers take interest in shares traded over-the-counter, and
accordingly the markets for such shares are less orderly than is usual for
Nasdaq stocks. As a result of the low trading volumes ordinarily obtained in OTC
Bulletin Board and "pink sheet" markets, sales of our ordinary shares in any
significant amount could not be absorbed without a dramatic reduction in price.
Moreover, thinly traded shares in the OTC Bulletin Board and in the "pink sheet"
markets are more susceptible to trading manipulations than is ordinarily the
case for more actively traded shares.
"PENNY STOCK" RULES MAY MAKE BUYING OR SELLING OUR ORDINARY SHARES DIFFICULT,
SEVERELY LIMITING THE MARKET PRICE OF OUR ORDINARY SHARES AND THE LIQUIDITY OF
OUR SHARES IN THE UNITED STATES.
Trading in our ordinary shares will most likely be subject to the
"penny stock" regulations adopted by the U.S. Securities and Exchange
Commission. These regulations generally define a "penny stock" to be any equity
security that has a market price of less than $5.00 per share, subject to
certain exceptions. These rules require that any broker-dealer who recommends
our securities to persons other than prior customers and accredited investors,
must, prior to the sale, make a special written suitability determination for
the purchaser and receive the purchaser's written agreement to execute the
transaction. Unless an exception is available, the regulations require delivery,
prior to any transaction involving a "penny stock," of a disclosure schedule
explaining the penny stock market and the risks associated with trading in the
penny stock market. In addition, broker-dealers must disclose commissions
payable to both the broker-dealer and registered representative and current
quotations for the securities they offer. The additional burdens imposed upon
broker-dealers by such requirements may discourage broker-dealers from effecting
transactions in our stock, which could severely limit their market price and the
liquidity of our stock.
BEING A FOREIGN PRIVATE ISSUER EXEMPTS US FROM CERTAIN SECURITIES AND EXCHANGE
COMMISSION REQUIREMENTS.
We are a foreign private issuer within the meaning of rules promulgated
under the Securities Exchange Act of 1934 (the "Exchange Act"). As such, we are
exempt from certain provisions applicable to United States public companies
including:
o the rules under the Exchange Act requiring the filing with the
Commission of quarterly reports on Form 10-Q or current reports on
Form 8-K;
o the sections of the Exchange Act regulating the solicitation of
proxies, consents or authorizations in respect of a security
registered under the Exchange Act;
o the provisions of Regulation FD aimed at preventing issuers from
making selective disclosures of material information;
o the sections of the Exchange Act requiring insiders to file public
reports of their stock ownership and trading activities and
establishing insider liability for profits realized from any
"short-swing" trading transaction (i.e., a purchase and sale, or
sale and purchase, of the issuer's equity securities within less
than six months);
Because of these exemptions, investors are not afforded the same
protections or information generally available to investors holding shares in
public companies organized in the United States.
-15-
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
Certain statements in "Summary" and under the captions "Risk Factors,"
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," "Business" and elsewhere in this prospectus constitute
"forward-looking statements" within the meaning of the U.S. Private Securities
Litigation Reform Act of 1995. These forward-looking statements are not
historical facts, but rather are based on our current expectations, estimates
and projections about our industry, our beliefs and assumptions. Words including
"may," "could," "would," "will," "anticipates," "expects," "intends," "plans,"
"projects," "believes," "seeks," "estimates," and similar expressions are
intended to identify forward-looking statements. These statements are not
guarantees of future performance and are subject to certain risks, uncertainties
and other factors, some of which are beyond our control, are difficult to
predict and could cause actual results to differ materially from those expressed
or forecasted in the forward-looking statements. We caution you not to place
undue reliance on these forward-looking statements, which reflect our
management's view only as of the date of this prospectus. We are not obligated
to update these statements or publicly release the result of any revisions to
them to reflect events or circumstances after the date of this prospectus or to
reflect the occurrence of unanticipated events. For purposes of this "Risk
Factors" section, when we state that a risk, uncertainty or problem may, could
or would have "a material adverse effect on our business" or words to that
effect, we mean that the risk, uncertainty or problem may, could or would have a
"material adverse effect on the business, result of operations, financial
condition, cash flow or prospects of our company."
USE OF PROCEEDS
We will not receive any proceeds from the sale of the ordinary shares
by the selling shareholders.
DIVIDEND POLICY
The payment of future dividends will be dependent on our earnings, our
financial situation and cash requirements, general business conditions in the
markets in which we operate, legal, tax and regulatory considerations and other
factors. We have never declared or paid any dividends, and we currently intend
to retain all available earnings generated by our operations for the development
and growth of our business.
EXCHANGE RATE INFORMATION
For a discussion of the impact of exchange rate fluctuations on our
business, financial condition and results of operations, see "Risk Factors--
Fluctuations in the exchange rate between the United States dollar and foreign
currencies may affect our operating results." and "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
We incur expenses for our operations in Israel in New Israeli Shekels
(NIS) and translate these amounts into United States dollars for purposes of
reporting consolidated results. On December 31, 2003, the exchange rate between
the NIS and the U.S. dollar was NIS 4.379 = US$ 1.00 and the exchange rate
between the NIS and the euro was NIS 5.5331 = 1.00 euro. The following table
shows for the periods and dates indicated, certain information concerning the
representative US dollar exchange rate for translating NIS as determined by the
Bank of Israel for the years ended December 31, 1999 through 2003.
Exchange Rate
Year At End of Period Average Rate (1) High Low
- ----------------------------------------------------------------------------
1999 4.15 4.14 4.29 4.01
2000 4.04 4.08 4.20 3.97
2001 4.416 4.205 4.416 4.041
2002 4.737 4.738 4.991 4.437
2003 4.379 4.5483 4.924 4.283
(1) The average of the daily exchange rates during the year.
-16-
The following table shows the high and low exchange rates for the previous six
months:
Period High Low
- ------ ---- ---
Apr. 2004 4.599 4.515
May 2004 4.634 4.555
June 2004 4.552 4.49
July 2004 4.527 4.471
August 2004 4.555 4.454
September 2004 4.526 4.478
October 2004 4.481 4.432
On November 1, 2004, the exchange rate between the NIS and the U.S. dollar was
NIS 4.441 = $1 US.
CURRENT OUTSTANDING SHARE CAPITAL
Our capital stock consists of 26,500,000 ordinary shares, NIS 0.01 par
value, authorized. As of the date hereof, we had 16,996,287 ordinary shares
outstanding, which are all fully paid. We also have outstanding warrants to
purchase an aggregate of 2,312,298 ordinary shares and outstanding options to
purchase an aggregate of 2,172,878 ordinary shares, 1,602,194 of which are
currently exercisable. In addition, we authorized grants of options to employees
and officers, under our option plan, with an exercise price of $0.85, to
purchase an aggregate of 1,400,000 shares, which remains subject to all required
approvals under Israeli law.
-17-
CAPITALIZATION
The table below sets forth our total indebtedness in US dollars and
capitalization as of December 31, 2003, June 30, 2004 and our pro forma as
adjusted capitalization as of June 30, 2004 after giving effect to all
transactions since June 30, 2004. You should read this table in conjunction with
the audited consolidated financial statements and accompanying notes included in
this prospectus.
OUTSTANDING AS AT
DECEMBER 31, JUNE 30, JUNE 30,
2003 2004 2004
Actual Actual As adjusted
Audited Unaudited Unaudited
(IN THOUSANDS OF US DOLLARS)
-----------------------------------
Liabilities
Total bank debt including current
portion ............................. 2,318 1,926 1,926
Warrants .............................. 0 0 197
Shareholders' Equity
Ordinary Shares
(Authorized: 26,500,000) ........... 40 41 50
Additional paid-in-capital ......... 25,814 25,856 28,183
Deferred compensation .............. 0 (14) (14)
Receipt on account of shares ....... 0 775 0
-----------------------------------
Deficit ............................ (18,242) (19,902) (19,902)
-----------------------------------
Total Shareholders' Equity .............. 7,612 6,756 8,317
===================================
The following table sets forth our total capitalization as adjusted after giving
effect to all transactions after June 30, 2004.
- -------------------------- ------------------------ ---------------------- ------------------------- ------------------------
NUMBER OF ORDINARY SHARE CAPITAL NUMBER OF WARRANTS NUMBER OF OPTIONS*
SHARE (IN THOUSANDS)
- -------------------------- ------------------------ ---------------------- ------------------------- ------------------------
AS OF JUNE 30, 2004 12,966,872 $ 41 -- 2,172,878
- -------------------------- ------------------------ ---------------------- ------------------------- ------------------------
ISSUANCE OF SHARES AND
WARRANTS IN PRIVATE
PLACEMENTS 4,029,415 $ 9 2,312,298 --
- -------------------------- ------------------------ ---------------------- ------------------------- ------------------------
AS ADJUSTED AS OF JUNE
30, 2004 16,996,287 $ 50 2,312,298 2,172,878*
- -------------------------- ------------------------ ---------------------- ------------------------- ------------------------
* In addition, we authorized grants of options to employees and officers, under
our option plan, with an exercise price of $0.85, to purchase an aggregate of
1,400,000 shares, which remains subject to all required approvals under Israeli
law.
-18-
PRICE RANGE OF ORDINARY SHARES
Currently, the principal trading market for our ordinary shares is the
Euronext Brussels stock market.
The following table sets forth, for the periods indicated, the reported
high and low quoted closing prices of our ordinary shares, on the Euronext
Brussels stock market since October 23, 2003 and Nasdaq Europe for the periods
indicated. Our ordinary shares began trading on Nasdaq Europe on April 23, 1999.
On October 29, 2004, the closing price of our ordinary shares on Euronext
Brussels was (euro)1.60 per share, equivalent to $2.04 per share.
FISCAL YEAR ENDED:
---------------------- ----------------- ----------------- ----------------- ----------------- -----------------
DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31,
2003 2002 2001 2000 1999
---------------------- ----------------- ----------------- ----------------- ----------------- -----------------
High ($) 0.75 0.565 1.6 6.95 3.0
---------------------- ----------------- ----------------- ----------------- ----------------- -----------------
Low ($) 0.28 0.10 0.25 1.8 3.0
---------------------- ----------------- ----------------- ----------------- ----------------- -----------------
The following table sets forth for the most recent full financial years
and any subsequent period: the high and low market prices for each full
financial quarter:
QUARTER ENDED:
------------ ----------- ----------- ---------- ------------ ------------ ----------- ----------- ------------
SEPTEMBER JUNE MARCH DECEMBER SEPTEMBER JUNE 30, MARCH 31, DECEMBER
30, 2004 30, 2004 31, 2004 31, 2003 30, 2003 2003 2003 31, 2002
------------ ----------- ----------- ---------- ------------ ------------- ----------- ----------- -----------
High ($) 1.042 1.205 0.730 0.75 0.665 0.525 0.675 0.55
------------ ----------- ---------- ------------ ------------- ----------- ----------- ----------- -----------
Low ($) 0.791 0.616 0.546 0.28 0.29 0.3088 0.38 0.10
------------ ----------- ---------- ------------ ------------- ----------- ----------- ----------- -----------
------------ ---------- ------------
SEPTEMBER JUNE
30, 2002 30, 2002
------------ ---------- ------------
High ($) 0.535 0.565
------------ ---------- ------------
Low ($) 0.12 0.275
------------ ---------- ------------
The following table sets forth for the most recent six months: the high
and low market prices for each month:
- ---------- -------------- -------------- -------------- ----------- ------------ ------------
October 2004 September 2004 August 2004 July 2004 June 2004 May 2004
- ---------- -------------- ------------ --------------- ----------- ------------ ------------
High ($) 2.663 0.857 0.945 1.04 1.2 0.960
- ---------- -------------- ------------ ------------ ----------- ------------ ------------
Low ($) 0.819 0.791 0.797 0.855 0.83 0.770
- ---------- -------------- ------------ ------------ ----------- ------------ ------------
-19-
SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data as of December 31,
2002 and 2003 and for the years ended December 31, 2001, 2002 and 2003 have been
derived from our audited consolidated financial statements. These financial
statements have been prepared in accordance with generally accepted accounting
principles in the United States, or U.S. GAAP, and audited by Kost, Forer,
Gabbay & Kasierer, a member of Ernst & Young Global. The consolidated selected
financial data as of December 31, 1999, 2000 and 2001 and for the years ended
December 31, 1999 and 2000 have been derived from other consolidated financial
statements not included in this prospectus and have also been prepared in
accordance with U.S. GAAP and audited by Kost, Forer, Gabbay & Kasierer, a
member of Ernst & Young Global. The consolidated selected financial data as of
June 30, 2004, and 2003 are unaudited. The selected consolidated financial data
set forth below should be read in conjunction with and are qualified by
reference to "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and the consolidated financial statements and notes
thereto and other financial information included elsewhere in this prospectus.
SUMMARY OF CONSOLIDATED FINANCIAL DATA
YEAR ENDED DECEMBER 31,
---------------------------------------------
(IN THOUSANDS OF U.S. DOLLARS, EXCEPT PER SHARE DATA)
*1999 *2000 *2001 2002 2003
SUMMARY OF STATEMENT OF OPERATIONS:
Revenues 3,894 3,062 6,889 8,027 7,244
Cost of Revenues 1,956 1,756 2,574 1,830 3,102
----- ----- ----- ----- -----
Gross Profit 1,938 1,306 4,315 6,197 4,142
----- ----- ----- ----- -----
Operating Expenses:
Research and Development 1,975 2,477 1,225 1,334 918
Selling and Marketing 1,588 4,180 4,628 2,828 3,026
General and Administrative 2,990 3,385 3,604 1,988 1,829
----- ----- ----- ----- -----
Total Operating Expenses 6,553 10,042 9,457 6,150 5,773
----- ----- ----- ----- -----
Operating Income (Loss) (4,615) (8,736) (5,142) 47 (1,631)
Financial Income (Expenses), Net 545 744 123 (35) (233)
OTHER INCOME (EXPENSES), NET (5) (1,688) (241) 6,203 (83)
----- ----- ----- ----- -----
Income Loss before Taxes on Income (4,075) (9,680) (5,260) 6,215 (1,947)
Income Taxes 6 2 -- -- --
Equity in Earnings (Loss) of an Affiliated
Company, Net of taxes 18 19 -- (38) (48)
----- ----- ----- ----- -----
Net Income (Loss) from
continuing operations (4,063) (9,663) (5,260) 6,177 (1,995)
======= ======= ======= ===== =======
Loss from discontinued operations 97 1,276 1,288 427 --
Net income (loss) $ (4,160) $ (10,939) $ (6,548) $ 5,750 $ (1,995)
========= ========== ========= ======= =========
PER SHARE DATA:
Basic and Diluted earning (loss)
from continuing operations (0.34) $(0.76) $(0.42) $0.49 $(0.15)
Basic and Diluted earning (loss)
from discontinued operations $(0.01) $(0.1) $(0.1) $(0.04) $--
Basic and Diluted earning (loss)
per share $(0.35) $(0.86) $(0.52) $0.45 $(0.15)
-20-
SUMMARY OF BALANCE SHEET DATA:
Cash and Cash Equivalents 5,295 8,565 274 4,567 1,912
Bank deposit 13,068 -- 100 1,196
Marketable debt securities -- -- -- 609 117
Trade receivables 225 161 573 2,202 1,808
Inventories 1,079 2,832 3,777 3,144 3,236
Total Current Assets 20,883 12,887 6,006 11,092 9,630
TOTAL ASSETS 21,941 15,219 8,531 13,756 12,434
Total Current Liabilities 1,583 4,016 4,226 3,468 4,199
Accrued Severance Pay 705 858 442 362 436
TOTAL SHAREHOLDERS' EQUITY 19,653 10,345 3,863 9,497 7,612
SUMMARY OF CONSOLIDATED FINANCIAL DATA
THREE MONTHS SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
------------------ ---------------------
Unaudited Unaudited
(IN THOUSANDS OF U.S. DOLLARS, EXCEPT PER SHARE DATA)
2003 2004 2003 2004
SUMMARY OF STATEMENT OF OPERATIONS:
Revenues 1,021 1,173 3,905 2,484
Cost of Revenues 447 738 1,504 1,564
------ ------ ------ ------
Gross Profit 574 435 2,401 920
------ ------ ------ ------
Operating Expenses:
Research and Development 229 183 465 377
Selling and Marketing 260 572 1,547 1,129
General and Administrative 438 441 939 944
------ ------ ------ ------
Total Operating Expenses 927 1,196 2,951 2,450
------ ------ ------ ------
Operating Income (Loss) (353) (761) (550) (1,530)
Financial Income (Expenses), Net (131) (70) (146) (77)
OTHER INCOME (EXPENSES), NET (11) (49) (41) (53)
----- ------ ------ ------
Income Loss before Taxes on Income (495) (880) (737) (1,660)
Income Taxes -- -- -- --
Equity in Earnings (Loss) of an Affiliated
Company, Net of taxes -- -- -- --
-- -- -- --
Net Income (Loss) from continuing operations (495) (880) (737) (1,660)
====== ====== ====== ======
Loss from discontinued operations -- -- -- --
Net income (loss) $(495) $(880) $(737) $(1,660)
====== ====== ====== =======
PER SHARE DATA:
Basic and Diluted earning (loss) from continuing
operations $(0.04) $(0.07) $(0.06) $(0.13)
Basic and Diluted earning (loss) from discontinued
operations $-- $-- $-- $--
Basic and Diluted earning (loss) per share
$(0.04) $(0.07) $(0.06) $(0.13)
SUMMARY OF BALANCE SHEET DATA:
Cash and Cash Equivalents 3,932 1,528 3,932 1,528
Bank deposit 791 601 791 601
Marketable debt securities 274 -- 274 --
Trade receivables 3,851 1,798 3,851 1,798
Inventories 2,898 2,836 2,898 2,836
Total Current Assets 12,255 8,076 12,255 8,076
TOTAL ASSETS 14,776 11,032 14,776 11,032
Total Current Liabilities 5,253 3,626 5,253 3,626
Accrued Severance Pay 392 465 392 465
TOTAL SHAREHOLDERS' EQUITY 8,786 6,756 8,786 6,756
-21-
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following section should be read in conjunction with the audited
financial statements and notes thereto for the year ended December 31, 2003, and
the financial years ended December 31, 2003 and 2002, which have been prepared
in accordance with U.S. GAAP and which are included in this prospectus. Some of
the statements contained in this section constitute forward-looking statements.
These statements relate to future events or to our future financial performance
and involve known and unknown risks, uncertainties and other factors that may
cause our actual results, levels of activity, performance or achievements to be
materially different from any future results, levels of activity, performance or
achievements express or implied by such forward-looking statements.
OVERVIEW
We were incorporated under the laws of the State of Israel in 1988.
From our incorporation until 1999, we were a development-stage company primarily
engaged in research and development, establishing relationships with suppliers
and potential customers and recruiting personnel. During the fiscal year ended
December 31, 2002, we completed our reorganization plan which began in 2001.
According to such plan, we decided to focus our marketing and sales efforts on
the commercial market with a new line of products, including SmartGate 2400,
EduGate, DynaGate and Flight Gate, while still maintaining our business in the
governmental market.
During 2002, we began the delivery of the first phase of the Ukraine ID
smart card project pursuant to Contract No. 10/82, dated April 9, 2002 (the
"Contract") between SuperCom and the Ministry of Internal Affairs of Ukraine
(the "Ministry") and generated revenues of $2.1 million. During 2003, we
generated an aggregate of $1.97 million in revenues from this project. In April
2004, we were informed by the International Commercial Arbitration Court at the
Ukrainian Chamber of Commerce and Industry ("Arbitration Court") that the
Department for Resources Supply of the Ministry had filed with the Arbitration
Court a statement of claim to declare the Contract as void due to defaults in
the tender proceedings under which the Contract had been awarded to SuperCom. On
July 22, 2004 we were informed by the law firm representing us in the
arbitration proceedings that on July 19, 2004, the Arbitration Court issued a
negative award declaring the Contract as void. We strongly believe that the
award is wrong due to many defaults that occurred in the arbitration proceedings
and we intend to challenge the validity of the award in the civil courts of
Ukraine. We are not anticipating any revenues from this project during the year
2004 and the following years, representing the loss of approximately $13,300,000
of anticipated revenues for the remainder of the term through 2006. If we are
not able to replace this revenue with revenue from other projects, we expect
that our total revenues will decrease and our net loss will increase in 2004.
During fiscal 2002, we sold our equity interest in our subsidiary,
InkSure Technologies, Inc., or InkSure, for which we received aggregate proceeds
of approximately $6,600,000 from the sale of shares.
In October 2004, the United States Government Printing Office (GPO)
informed us that our proposal as a prime contractor for the integration of smart
card technology in the US new electronic passports has been accepted for award.
In addition, our proposal as a sub-contractor with a leading American system
integrator corporation has also been accepted for award in this project.We
believe that this project will be the largest and most advanced smart passport
project in the world to date. The US authorities have announced multiple awards
for the implementation of the project that will include the production of smart
inlay for the new passports with a sophisticated chip containing personal
identification such as biometric data. This type of passport will be difficult
to forge and will replace the traditional passport that contained a printed
personal photograph and was considered to be easy to falsify. The scope of the
project based on the RFP is estimated at 50 million passports over the following
five years.
In this project, we will supply the smart card technology that we have
developed over recent years, including the smart chip with an operating system
and antenna that is embedded in the passport. Our advanced technology meets the
new strict international standards (ISO and ICAO) and the high requirements for
travel documents set forth by the United States authorities in this tender.
We expect that the award of the tender will positively influence our
business in the coming years. We cannot currently estimate the impact on our
results of operations. We expect that the final order for 2005 pursuant to the
project will be received prior to the end of the year. Thus, we do not expect to
start generating substantial revenues from this project until the first quarter
of 2005.
-22-
REVENUES
The primary products that we sell are smart card systems, smart card
production machines and raw materials used for the production of smart cards and
secured ID cards. We derive the majority of our revenues during the first two
years of an agreement with a customer. This revenue is generated by the delivery
of the data collection and document production systems. Following delivery of
such systems, the majority of revenues generated from the agreement results from
ongoing deliveries of raw materials for use with the installed systems. We also
typically generate additional revenues from maintenance fees.
Our systems are tailored to meet the specific needs of our customers.
In order to satisfy these needs, the terms of each agreement, including the
duration of the agreement and prices for our products and services differ from
agreement to agreement.
Additional revenue is generated through licensing technology, mostly
with commercial customers.
OPERATING EXPENSES
Our costs associated with a particular project may vary significantly
depending on the specific requirements of the customer and the terms of the
agreement, as well as on the extent of the technology licensing. As a result,
our gross profits from each project may vary significantly.
Our research and development expenses consist of salaries, raw material
and equipment costs, as well as financing research and development operations in
subsidiaries.
NET INCOME
Our operating results are significantly affected by, among other
things, the timing of contract awards and performance of agreements. As a
result, our revenues and income may fluctuate substantially from quarter to
quarter, and comparisons over longer periods of time may be more meaningful. Our
operating results are not seasonal because contracts are awarded and performed
throughout the year. The nature of our expenses (including cost of revenues) are
mainly fixed or semi-fixed and any fluctuation in revenues will generate a
significant variation in gross profit and net income.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of financial statements requires us to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
the disclosure of contingent liabilities at the date of the financial statements
and the reported amounts of revenues and expenses during the reporting period.
On an ongoing basis, we evaluate our estimates and judgments, including those
related to revenue recognition, allowance for bad debts, and valuation of
inventories and impairment of long-lived assets.
We base our estimates and judgments on historical experience and on
various other factors that we believe to be reasonable under the circumstances,
the results of which form the basis for making judgments about the carrying
values of assets and liabilities that are not readily apparent from other
sources. Under different assumptions or conditions, actual results may differ
from these estimates.
Our discussion and analysis of our financial condition and results of
operations are based on our consolidated financial statements, which have been
prepared in accordance with generally accepted accounting principles in the
United States ("US GAAP"). Our significant accounting principles are presented
within Note 2 to our Consolidated Financial Statements. While all the accounting
policies impact the financial statements, certain policies may be viewed to be
critical. These policies are those that are most important to the portrayal of
our financial condition and results of operations. Actual results could differ
from those estimates. Management believes that the significant accounting
policies which affect its more significant judgments and estimates used in the
preparation of the consolidated financial statements and are the most critical
to aid in fully understanding and evaluating our reported results include the
following:
o Revenue recognition
o Allowance for doubtful accounts
o Inventory valuation
o Impairment of long-lived assets
o Contingencies
-23-
REVENUE RECOGNITION AND ALLOWANCE FOR DOUBTFUL ACCOUNTS
We generate revenues primarily from governmental projects sales and
commercial sales. We recognize revenues in respect of products when, among other
things, we have delivered the goods being purchased and we believe
collectability to be reasonably assured. We do not grant a right of return to
our customers. We perform ongoing credit evaluations of our customers' financial
condition and we require collateral as deemed necessary. An allowance for
doubtful accounts is determined with respect to those accounts that we have
determined to be doubtful of collection. If the financial condition of our
customers were to deteriorate, resulting in an impairment of their ability to
make payments, additional allowances would be required.
INVENTORIES VALUATION
At each balance sheet date, we evaluate our inventory balance for
excess quantities and obsolescence. This evaluation includes analyses of sales
levels by product line and projection of future demand. In addition, we write
off inventories that we considered obsolete. Remaining inventory balances are
adjusted to the lower of the cost or market value. If future demand or market
conditions are less favorable than our projections, additional inventory
write-downs may be required and would be reflected in cost of sales in the
period the revision is made.
IMPAIRMENT OF LONG-LIVED ASSETS
Long-lived assets are reviewed for impairment in accordance with
Statement of Financial Accounting Standard No. 144 "Accounting for the
Impairment or Disposal of Long-Lived Assets" whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. Recoverability of the carrying amount of assets to be held and used
is measured by a comparison of the carrying amount of an asset to the future
undiscounted cash flows expected to be generated by the assets. If such assets
are considered to be impaired, the impairment to be recognized is measured by
the amount by which the carrying amount of the assets exceeds the fair value of
the assets. Assets to be disposed of are reported at the lower of the carrying
amount or fair value less selling costs.
The determination of the value of such long-lived and intangible assets
requires management to make assumptions regarding estimated future cash flows
and other factors to determine the fair value of the respective assets. If these
estimates or the related assumptions change in the future, we could be required
to record impairment charges. Any material change in our valuation of assets in
the future and any consequent adjustment for impairment could have a material
adverse impact on our future reported financial results.
CONTINGENCIES
From time to time, we are defendant or plaintiff in various legal
actions, which arise in the normal course of business. We are required to assess
the likelihood of any adverse judgments or outcomes to these matters as well as
potential ranges of probable losses. A determination of the amount of reserves
required for these contingencies, if any, which would be charged to earnings, is
made after careful and considered analysis of each individual action together
with our legal advisors. The required reserves may change in the future due to
new developments in each matter or changes in circumstances, such as a change in
settlement strategy. A change in the required reserves would affect our earnings
in the period the change is made.
RESULTS OF OPERATIONS
The following table sets forth selected consolidated income statement
data for SuperCom for each of the three years ended December 31, 2001, 2002 and
2003 expressed as a percentage of total revenues. Figures may not add up due to
rounding.
-24-
- ------------------------------------------------------------------------------------------------------
2001 2002 2003
- ------------------------------------------------------------------------------------------------------
Revenues 100% 100% 100%
- ------------------------------------------------------------------------------------------------------
Cost of revenues 37.4 22.8 42.8
- ------------------------------------------------------------------------------------------------------
Gross profit 62.6 77.2 57.2
- ------------------------------------------------------------------------------------------------------
Operating expenses:
- ------------------------------------------------------------------------------------------------------
Research and development 17.8 16.6 12.7
- ------------------------------------------------------------------------------------------------------
Selling and marketing, net 67.2 35.2 41.8
- ------------------------------------------------------------------------------------------------------
General and administrative 52.3 24.8 25.2
- ------------------------------------------------------------------------------------------------------
Total operating expenses 137.3 76.6 79.7
- ------------------------------------------------------------------------------------------------------
Operating income (loss) (74.7) 0.6 (22.5)
- ------------------------------------------------------------------------------------------------------
Financial income (expenses), net 1.8 (0.4) (3.2)
- ------------------------------------------------------------------------------------------------------
Other income (expenses), net (3.5) 77.3 (1.1)
- ------------------------------------------------------------------------------------------------------
Income (loss) before income taxes (76.4) 77.5 (26.8)
- ------------------------------------------------------------------------------------------------------
Equity in losses of affiliates and impairment, net of taxes -- (0.5) (0.7)
- ------------------------------------------------------------------------------------------------------
Net income (loss) from continuing operations (76.4) 77.0 (27.5)
- ------------------------------------------------------------------------------------------------------
Loss from discontinued operations 18.7 5.3 --
- ------------------------------------------------------------------------------------------------------
Net income (loss) 95.1% 71.7% (27.5)
- ------------------------------------------------------------------------------------------------------
OPERATING RESULTS
THREE MONTHS ENDED JUNE 30, 2004 COMPARED TO THREE MONTHS ENDED JUNE 30, 2003
REVENUES
Our revenues for the three months ending June 30, 2004 were USD
1,173,000 compared to USD 1,021,000 during the three months ending June 30,
2003, representing an increase of 15%. The increase in revenues for the three
months ending June 30, 2004 was primarily due to the increase in commercial
sales in the revenues for the three months ending June 30, 2004.
GROSS PROFIT
Gross profit for the three months ending June 30, 2004 was USD 435,000
compared to a gross profit of $574,000 for the three months ending June 30,
2003. The gross profit margin for the three months ending June 30, 2004
decreased by 19% (versus gross profit margin of 56% for the three months ending
June 30, 2003). The decrease in gross profit was primarily due to an increase in
commercial systems volume, which carry lower margins.
NET LOSS
Our net loss for the tree months ending June 30, 2004 was USD 880,000
compared to a net loss of USD 495,000 for the tree months ending June 30, 2003.
This increase was primarily due to a decrease in gross profit margins and to a
increase in selling and marketing expenses due to the expansion of selling and
marketing activities in the USA commercial and governmental activity.
EXPENSES
Research and development expenses for the tree months ending June 30,
2004 totaled USD 183,000 compared to USD 229,000 for the three months ending
June 30, 2003, representing a decrease of 20%. This decrease is mainly due to
technology and products advanced maturity.
Sales and marketing expenses for the three months ending June 30, 2004
totaled USD 572,000 compared to USD 260,000 in 2003, which represents an
increase of 120%. This increase in sales and marketing expenses for the three
months ending June 30, 2004 was primarily due to the expansion of marketing
activities related to commercial and governmental activity in the US market.
-25-
General and administrative expenses for the three months ending June
30, 2004 totaled USD 441,000 compared to USD 438,000 in 2003, representing an
increase of 1%.
SIX MONTHS ENDED JUNE 30, 2004 COMPARED TO SIX MONTHS ENDED JUNE 30, 2003
REVENUES
Our revenues for the six months ending June 30, 2004 were USD 2,484,000
compared to USD 3,905,000 during the six months ending June 30, 2003,
representing a decrease of 36%. The decrease in revenues for the six months
ending June 30, 2004 was primarily due to the inclusion of a governmental
project in the revenues for the three months ending March 31, 2003.
GROSS PROFIT
Gross profit for the six months ending June 30, 2004 was USD 920,000
compared to a gross profit of $2,401,000 for the six months ending June 30,
2003. The gross profit margin for the six months ending June 30, 2004 decreased
by 24% (versus gross profit margin of 61% for the six months ending March 31,
2003). The decrease in gross profit was primarily due to a decrease in the
above-mentioned governmental project revenues, which carried higher margins and
to an increase in commercial systems volume, which carry lower margins.
NET LOSS
Our net loss for the six months ending June 30, 2004 was USD 1,660,000
compared to a net loss of USD 737,000 for the six months ending June 30, 2003.
This increase was primarily due to a decrease in revenues and the gross profit
margins due to the above-mentioned governmental project and increase of net loss
in 2nd quarter as mentioned above.
EXPENSES
Research and development expenses for the six months ending June 30,
2004 totaled USD 377,000 compared to USD 465,000 for the six months ending June
30, 2003, representing a decrease of 19%.
Sales and marketing expenses for the six months ending June 30, 2004
totaled USD 1,129,000 compared to USD 1,547,000 in 2003, which represents a
decrease of 27%. This decrease in sales and marketing expenses for the six
months ending June 30, 2004 was primarily due to the decrease in sales and
marketing expenses related to the above-mentioned governmental project revenues
deducted by the expansion of marketing activities related to commercial and
governmental activity in the US market.
General and administrative expenses for the six months ending June 30,
2004 totaled USD 944,000 compared to USD 939,000 in 2003, representing an
increase of 1%.
YEAR ENDED DECEMBER 31, 2003 COMPARED TO YEAR ENDED DECEMBER 31, 2002
REVENUES
Our revenues in 2003 were $7,244,000 compared to $8,027,000 in 2002, a
decrease of 9%. The decrease was primarily due to the inclusion of InkSure's
revenues ($1,884,000) in the 2002 results of operations. Not including InkSure's
results of operations for 2002, revenues would have increased to $7,244,000 from
$6,143,000, representing an increase of 18%. This increase was primarily due to
the implementation of a new 5-year governmental project in Africa, plus the
expansion in the commercial markets systems and their implementation during
2003. The primary increase in commercial revenues has come from the United
States, Asia Pacific and the Israeli commercial markets by the sale of our
automatic production line, SmartGate, EduGate and DynaGate systems. Our revenues
in the fourth quarter of 2003 included $536,000 of revenue related to the sale
of a production line to a customer, who is also a distributor of our products in
the United States, which is to be paid to us over a period of four years.
GROSS PROFIT
-26-
Our gross profits in 2003 were $4,142,000 compared to gross profits of
$6,197,000 in 2002, a decrease of 33%. The gross profit margin for the year 2003
decreased by 20% as compared to 77% in 2002. The decrease in our 2003 gross
profit was primarily due to the inclusion of InkSure's gross profit ($1,613,000)
in the 2002 results of operations. Not including InkSure's results of operations
for 2002, gross profit would have decreased to $4,142,000 from $4,584,000,
representing a decrease of 9%. This decrease was primarily due to an increase in
the volume of commercial systems, which carries lower margins.
NET INCOME
Our net loss in 2003 was $1,995,000 compared to a net income of
$5,750,000 in 2002 ($6,203,000 booked as other income originated from the
divestment of the InkSure shares and net income of InkSure's activities in the
amount of $294,000). This was primarily due to a decrease in gross profit
margins and an increase in our sales and marketing expenses in the United States
and Israeli markets, as well as in the international governmental project
market. Not including InkSure's influences on 2002 net income, 2003 net loss
would have increased to $1,995,000 from $747,000, representing an increase of
167%. This increase in our net loss was primarily due to a decrease in gross
profit margins and an increase in our sales and marketing expenses in the United
States and Israeli markets as well as our management's decision to increase our
doubtful accounts by $700,000. Such net provision of $700,000 for doubtful
accounts results from the aggregate amount of $2,133,000 owed by the Ukraine
government reduced by the elimination of our obligation to pay commissions to
the consultants that mediated this agreement in the amount of $1,400,000.
EXPENSES
Our research and development expenses in 2003 were $918,000 compared to
$1,334,000 in 2002, a decrease of 31%. The decrease in the research and
development expenses was primarily due to the inclusion of InkSure's research
and development expenses ($330,000) in the 2002 results of operations. Not
including InkSure's results of operations for 2002, research and development
expenses would have decreased to $918,000 from $1,004,000, representing a
decrease of 9%.
Our selling and marketing expenses in 2003 were $3,026,000 compared to
$2,828,000 in 2002, an increase of 7%. The increase in the selling and marketing
expenses was due to the inclusion of InkSure's selling and marketing expenses
($788,000) in the 2002 results of operations. Not including InkSure's results of
operations for 2002, selling and marketing expenses would have increased to
$3,026,000 from $2,040,000, representing an increase of 48%. The increase was
primarily due to a net impact of $700,000 relating to the Ukraine project
implementation (such net impact of $700,000 results from the aggregate amount of
$2,133,000 owed by the Ukraine government reduced by the elimination of our
obligation to pay commissions to the consultants that mediated this agreement in
the amount of $1,400,000) and the expansion of marketing activities related to
commercial activity in the US and the Israeli markets.
Our general and administrative expenses in 2003 were $1,829,000
compared to $1,988,000 in 2002, a decrease of 8%. The decrease in the general
and administrative expenses was primarily due to the inclusion of InkSure's
general and administrative expenses ($189,000) in the 2002 results of
operations. Not including InkSure's results of operations for 2002, general and
administrative expenses would have increase to $1,829,000 from $1,799,000,
representing an increase of 2%.
Our operating expenses in 2003 were $5,773,000 compared to $6,150,000
in 2002, a decrease of 6%. The decrease in operating expenses was primarily due
to the inclusion of InkSure's operating expenses ($1,307,000) in the 2002
results of operations. Not including InkSure's results of operations for 2002,
operating expenses would have increase to $5,773,000 from $4,843,000,
representing an increase of 19%. This increase was primarily due to the
above-mentioned increase in selling and marketing expenses.
YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31, 2001
REVENUES
Our revenues in 2002 were $8,027,000 compared to $6,889,000 in 2001, an
increase of 17%. The increase was primarily due to a growth in international
governmental projects. The delivery of the first phase of the Ukraine ID project
was a major element of this growth. We also launched a new series of commercial
access control products, including the SmartGate 2400 system. This was part of
our new commercial marketing strategy to supplement our on-going governmental
projects.
-27-
GROSS PROFIT
Our gross profits in 2002 were $6,197,000 compared to gross profits of
$4,315,000 in 2001, an increase of 44%. The gross profit margin for the year
2002 increased by 14% as compared to 63% in 2001. The increase in our 2002 gross
profit was primarily due to high gross profits resulting from the delivery of
the first phase of the Ukraine ID project and from a one-time increase of raw
materials sales with high gross margins sold in 2002 compared to 2001.
NET INCOME
Our net income in 2002 was $5,750,000 compared to a net loss of
$6,548,000 in 2001. This increase was primarily due to our divestment of InkSure
for an aggregate consideration of $6,600,000. Commencing with the quarter ended
June 30, 2002, the financial results of InkSure are not included in our
financial statements. For the fiscal years 2002, 2001 and 2000, InkSure's
operations generated revenues of $1,880,000, $1,760,000 and $140,000,
respectively.
EXPENSES
Our research and development expenses in 2002 were $1,334,000 compared
to $1,225,000 in 2001, an increase of 9%. The increase in the research and
development expenses was mainly due to the intensive research and development
activities pursued by InkSure.
Our selling and marketing expenses in 2002 were $2,828,000 compared to
$4,628,000 in 2001, a decrease of 39%. The decrease in the selling and marketing
expenses was primarily as a result of InkSure and another of our subsidiary's,
SuperCom SmartCards Inc. reduced expenses in connection with its efforts to
penetrate new markets in the United States and Europe which have been cut back
since the fourth quarter of 2001.
Our general and administrative expenses in 2002 were $1,988,000
compared to $3,604,000 in 2001, a decrease of 45%. The decrease in the general
and administrative expenses was due to our cost-cutting plan that resulted in
increased efficiency.
Our operating expenses in 2002 were $6,150,000 compared to $9,460,000
in 2001, a decrease of 35%. The decrease in operating expenses was primarily due
to our reduction of general and administrative expenses and the exclusion of
InkSure's financial results from our financial reports. The decrease in general
and administrative expenses was due to a cost-cutting plan that resulted in
increased efficiency.
DISCONTINUED OPERATIONS
As part of our reorganization plan, we have made a decision to focus on
our core business and to shut down all operations not included in our core
business that result in losses. As a result, we closed SuperCom SmartCards Inc.,
Genodus Inc. and its subsidiary; and Kromotec Inc. and its subsidiary. Loss from
discontinued operations for 2002 totaled $427,000, compared to $1,288,000 for
2001.
LIQUIDITY AND CAPITAL RESOURCES
Net cash used in operating activities from continuing operations for
the three months ended June 30, 2004 was $803,000 compared to $547,000 used
during the three months ended June 30, 2003, an increase of $256,000 or 47%.
This increase was primarily as a result of an increase in loss from operational
activities.
Net cash provided by investing activities during the three months ended
June 30, 2004 was $415,000 compared to $19,000 used in investing activities
during the three months ended June 30, 2003, an increase of $434,000. This
increase was primarily due to an investment of $604,000 in short term bank
deposits during the three months ended June 30, 2004, an increase of $56,000 in
restricted cash deposits during the three months ended June 30, 2004 and to
increase of $ 87,000 in Purchase of property and equipment during the three
months ended June 30, 2004.
-28-
Net cash provided by financing activities during the three months ended
June 30, 2004 was $844,000 compared to $663,000 provided during the three months
ended June 30, 2003, an increase of $181,000. This increase was primarily due to
$ 775,000 proceeds from payables on account of shares during the three months
ended June 30, 2004 and to a decrease of $562,000 in net bank credit provided
during the three months ended June 30, 2004.
Net cash used in operating activities from continuing operations for
the six months ended June 30, 2004 was $1,433,000 compared to $894,000 used
during the six months ended June 30, 2003, an increase of $539,000 or 60%. This
increase was primarily as a result of an increase in loss from operational
activities.
Net cash provided by investing activities during the six months ended
June 30, 2004 was $667,000 compared to $501,000 used in investing activities
during the six months ended June 30, 2003, an increase of $1,168,000. This
increase was primarily due to an investment of $595,000 in short term bank
deposits during the six months ended June 30, 2004 compared to proceeds of $
791,000 from short term deposit during the six months ended June 30, 2004, an
increase of $262,000 in restricted cash deposits during the six months ended
June 30, 2004 and to increase of $ 226,000 in Purchase of property and equipment
during the six months ended June 30, 2004.
Net cash provided by financing activities during the six months ended
June 30, 2004 was $382,000 compared to $760,000 provided during the six months
ended June 30, 2003, a decrease of $378,000. This decrease was primarily due to
$ 775,000 proceeds from payables on account of shares during the six months
ended June 30, 2004 and $155,000 reimbursement of net bank credit during the six
months ended June 30, 2004 compared to $935,000 investment in net bank credit
provided during the six months ended June 30, 2003.
Net cash used in operating activities from continuing operations for
the period ended December 31, 2003 was $2,152,000 compared to $1,876,000 during
the period ended December 31, 2002, an increase of $276,000 or 15%. This
increase was primarily as a result of an increase in loss from operational
activities. In additional to loss from operational activities, our net cash used
in operating activities in the period ended December 31, 2003 and in the period
ended December 31, 2002 was influenced by the increases in our accounts
receivable balances during the year 2002 due to long term credit sales. In
addition, during the year 2003 our revenues included $536,000 of revenues
related to the sale of a production line to a customer which is to be paid to us
over a period of four years. This transaction has increased the cash used in
operating activities as compared to our loss from operational activities during
the year 2003.
Net cash used in investing activities during the period ended December
31, 2003 was $1,539,000 compared to $5,596,000 provided by investing activities
during the period ended December 31, 2002, a decrease of $7,135,000. This
decrease was primarily due to an investment of $1,196,000 in short term bank
deposits during the period ended December 31, 2003 and to $4,352,000 proceeds
from the sale of the shares of our subsidiary Inksure during the period ended
December 31, 2002.
Net cash provided by financing activities during the period ended
December 31, 2003 was $1,036,000 compared to $574,000 during the period ended
December 31, 2002, an increase of $462,000. This increase was primarily due to
an increase in net bank credit provided during the period ended December 31,
2003.
As of December 31, 2003, our cash, short-term deposits, and marketable
debt securities totaled $3,225,000, compared to $5,176,000 as of December 31,
2002.
Since May 1999, we have funded operations primarily through cash
generated from our initial public offering on Nasdaq Europe in April 1999, which
resulted in total net proceeds of approximately $23,600,000 (before offering
expenses), our sale of shares of our subsidiary, InkSure, and, to a lesser
extent, borrowings from financial institutions. As of December 31, 2003, our
principal source of liquidity was $3,225,000 of cash, cash equivalents and
marketable securities. As of December 31, 2003, we had $2,318,000 of debt
outstanding relating to obligations under our credit facility and an obligation
for severance pay to Israeli employees of $436,000 of which $333,000 is provided
by monthly deposits with severance pay funds, insurance policies and by an
accrual. As of December 31, 2003, our accumulated net deficit was $18,242,000.
-29-
In April 1999, we entered into an underwriting agreement to sell
2,526,316 ordinary shares plus an additional 631,579 ordinary shares offered by
selling shareholders at an offering price of $10.00 per share for gross proceeds
to us of approximately $25,300,000. The gross proceeds were offset by
underwriting fees of $1,700,000 and offering expenses of $1,250,000 so that we
received net proceeds of $22,350,000 from this public offering.
We anticipate that our capital resources for 2004 and 2005 will come
primarily from credit facilities and private placements. During June and July,
2004, the Company received aggregate gross proceeds of $1,225,000 from a private
placement of 1,558,826 ordinary shares and five-year warrants to purchase
623,535 ordinary shares at an exercise price of $1.10 per share. In connection
with the private placement, our placement advisors received warrants to purchase
77,941 ordinary shares at an exercise price of $1.10 per share.
In August and September 2004, we received gross proceeds of $2,200,000
from a private placement to accredited investors of 2,470,589 ordinary shares
and five-year warrants to purchase 988, 234 ordinary shares at an exercise price
of $1.10 per share. In connection with the private placement, our placement
agent received warrants to purchase 177,882 ordinary shares at an exercise price
of $1.10 per share and 444,706 ordinary shares at an exercise price of $ 0.85
per share. All of such warrants issued in this private placement except 444,706
warrants with an exercise price of$0.85, may be called by us at a redemption
price of $.01 per warrant at any time after the closing price (or closing bid
price) of our ordinary shares on an U.S. stock exchange, Nasdaq or the OTC
Bulletin Board is equal to or greater than $2.50 per share for 10 out of any 15
consecutive trading days.
Our budget relies on our existing projects and estimated commercial
revenues. We project that our expenses for 2004 will be higher than our
revenues. As we reach the desired level of technology advancement in our
products, we anticipate that no major expenses will be needed in connection with
research and development efforts. As of December 31, 2003, we had credit lines
from several banks in the aggregate amount of $ 1,957,000 (including long-term
loans credit lines in the amount of $719,000 of which $628,000 was used), of
which $1,238,000 is denominated in NIS and bears interest at the rate of Prime,
in the range of +1% to +3%, and $ 719,000 is denominated in dollars and bears
interest at the rate of LIBOR in the range of +2.5% to +3.2%.
The weighted average interest rate on the credit lines as of December
31, 2002 and 2003 was approximately 11.71% and 7.7%, respectively.
In addition, we received from a bank short-term loans in the amount of
$ 500,000 in order to secure an agreement with a customer. The average interest
rate on the loans as of December 31, 2003, was approximately 5.7%.
We had an unused credit facility in the amount of approximately
$139,000 as of December 31, 2003 (there is no fee for the unused portion of the
credit facility).
Since the quarter ended December 31, 2001, we have continued to
implement our comprehensive cost-cutting plan, including the reorganization of
our headquarters and our subsidiaries, the freezing of non-profitable
activities, and staff reductions. The first results from this cost-cutting plan
were visible in the fiscal quarter ended December 31, 2001 and have continued in
2002 and in 2003.
We believe that our existing capital resources will be sufficient to
fund our planned operations through at least the next twelve months. We will be
required to raise additional funds to meet our long-term planned goals. We
intend to consider other alternatives for financing, which may include public or
private equity financings. There can be no assurance that such additional
financing, if at all available, can be obtained on terms acceptable to us. If we
are unable to obtain such additional financing, future operations will need to
be scaled back further or discontinued.
QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISKS
The primary objective of our investment activities is to preserve
principal while at the same time maximizing the income we receive from
investments without significantly increasing risk. Some of the securities in
which we may invest may be subject to market risk. This means that a change in
prevailing interest rates and foreign currency rates against the NIS may cause
the value of the investment to fluctuate. For example, if we purchase a security
that was issued with a fixed interest rate and the prevailing interest rate
later rises, the value of our investment will probably decline. To minimize this
risk, we intend to maintain our portfolio of cash equivalents and short-term
investments in a variety of securities, including U.S. dollars, NIS bank
deposits, money market funds and government and non-government debt securities.
In general, money market funds are not subject to market risk because the
interest paid on such funds fluctuates with the prevailing interest rate.
-30-
Our financial market risk includes risks related to international
operations and related foreign currencies. We anticipate that sales outside of
North America will continue to account for a significant portion of our
consolidated revenue in 2003. To date, most of our sales have been valued in
U.S. dollars. In future periods, we expect our sales to be principally valued in
U.S. dollars, eliminating foreign currency exchange risk.
We value expenses of some of our international operations, such as
Israel and Hong Kong, in each country's local currency and therefore are subject
to foreign currency exchange risk. However, through December 31, 2003, we have
not experienced any significant negative impact on our operations as a result of
fluctuations in foreign currency exchange rates, although we have incurred a
loss of $98,000 in the year ended December 31, 2003 due to fluctuations in
foreign exchange rates. We do not use financial instruments to hedge operating
expenses in Israel or Hong Kong that are valued in local currency. We intend to
continue to assess the need to utilize financial instruments to hedge currency
exposures on an ongoing basis.
We do not use derivative financial instruments for speculative trading
purposes, nor do we hedge our foreign currency exposure to offset the effects of
changes in foreign exchange rates.
Our exposure to market risks for changes in interest rates relates
primarily to our credit facility. At December 31, 2003, our financial market
risk related to this debt was immaterial. Our general policy is to limit the
risk of principal loss and ensure the safety of invested funds by limiting
market and credit risk.
IMPACT OF INFLATION AND CURRENCY FLUCTUATIONS
Because the majority of our revenue is paid in or linked to the U.S.
dollar, we believe that inflation and fluctuation in the NIS/U.S. dollar
exchange rate has no material effect on our revenue. However, a portion of the
cost of our Israeli operations, mainly personnel and facility-related, is
incurred in NIS. Because some of our costs are in NIS, inflation in Israel and
U.S. dollar exchange rate fluctuations do have some impact on expenses and, as a
result, on net income. Our NIS costs, as expressed in U.S. dollars, are
influenced by the extent to which any increase in the rate of inflation in
Israel is not offset, or is offset on a delayed basis, by a devaluation of the
NIS in relation to the U.S. dollar.
In 2003, the rate of evaluation of the NIS against the U.S. dollar was
7.5% and the rate of deflation was 2%. It is unclear what the
devaluation/evaluation rate will be in the future, and we may be materially
adversely affected if inflation in Israel exceeds the devaluation of the NIS
against the U.S. dollar, or if the timing of the devaluation lags behind
increases in 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. At December 31, 2003, we did not own any market risk sensitive
instruments except for our revolving line of credit. However, we may in the
future undertake hedging or other similar transactions or invest in market risk
sensitive instruments if management determines that it is necessary or advisable
to offset these risks.
RESEARCH AND DEVELOPMENT
Our past research and development efforts have helped us to achieve our
goal of offering our customers a complete line of products and solutions. As a
result of our past efforts, we reduced the number of employees in our research
and development activities to ten people as of December 31, 2003. We spent $1.2
million, $1.3 million and $0.9 million on research and development in 2001, 2002
and 2003, respectively. These amounts were spent on the development or
improvement of our technologies and products, primarily in the areas of an
automatic contactless smart card production line, data capture, management
software, population registry software packages, security printing, contactless
smart cards and document authentication. We will continue to research and
develop new security and identification features through laser printing and
pre-printing, create new personalization methods for contactless smart cards,
develop a range of smart card applications and continue to develop our automatic
contactless smart card production line. There can be no assurance that we can
achieve any or all of our research and development goals.
TREND INFORMATION
-31-
INDUSTRY TRENDS
The increased demand for better security systems and services has
positively affected trends within the industry. Access and asset control are now
a leading security concerns in commercial and governmental enterprises. This has
created an increasing demand, both for physical security access to buildings and
logical security access to corporate networks. Our contactless smart cards
provide an optimal solution to these problems as they deliver stronger
authentication of network users and they store personal data for highly secure
physical access control.
Another major trend is the widespread deployment of smart credentials and
travel documents. From among the three main credentials (e-passport, ID card,
drivers' license) currently in use on a governmental level, the electronic smart
passport is posed to be the frontrunner and leads the way for the others. As a
global credential, it is the only one based on international standards and will
therefore most likely serve as the base from which the standards of other
credentials on national, local and commercial levels will be derived.
MARKET AND OPERATIONAL TRENDS
Our quarterly operations results may be subject to significant
fluctuations due to several factors. Some of these factors are based primarily
on the timing of large orders, which represent a significant percentage of our
revenues, customer budget cycles and impact on the timing for buying decisions,
competitive pressures, the ability of our partners, distributors and system
integrators to become effective in selling and marketing our products, as well
as other factors.
During 2003, we have seen an increase in the percentage of revenue
derived from the development of our partnerships, distribution and systems
integration network. We expect to continue to benefit from marketing programs
and leads generated by this network, as well as sales opportunities identified
by them. We intend to expand our marketing and implementation capacity through
these third parties, including 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 their
market presence.
During the six months ended June 30, 2004, we have observed a slight
increase in our production. We have also observed a considerable increase in
marketing leads from our growing partnerships, distributions and systems
integration network, and a particular interest by government customers in
electronic passports (e-passports).
A significant portion of our 2004 revenues to date have been derived
from our governmental projects and the remainder have been derived from
commercial products. Historically, our revenues have been concentrated in a few
large orders and in a relatively small number of customers, a trend that has
been increasing over time and a trend that we expect to continue to influence
our revenues.
Due to the arbitration proceeding with the Ukraine Chamber of Commerce
relating to our agreement with the Ukraine Ministry of Internal Affairs, we are
not anticipating any revenues from this project during the year 2004 or beyond.
During 2003, we generated an aggregate of $1.97 million in revenues from this
project. If we are not able to replace this revenue with revenue from other
projects, we expect our revenues to decrease and our net loss to increase in
2004 See the paragraph headed risks "We derive a substantial portion of our
revenue from a small number of customers..." in the Risk Factors set forth in
Item 3 above.
We have observed an increase in orders for access control networks in
the first half of 2004 compared with 2003. Since the end of 2003, the selling
prices of our commercial products have been slightly increased. Commercial
product inventory has been reduced without replenishing the stock, while other
inventory levels have remained the same.
For information about our expectations regarding future cost of
revenues, future operating expenses and liquidity and capital resources, please
refer to the "Risk Factors, "Operating Results" section and the "Liquidity and
Capital Resources" section of "Management Discussion and Analysis of Financial
Condition and Results of Operations.".
Our development and marketing efforts for the solution and product
platforms are aimed at addressing several systems and service trends that we see
developing in the industry:
-32-
In 2003, the ICAO (International Civil Aviation Organization) mandated
the inclusion of biometric authentication technology in passports. We believe
that the e-passport trend, from our point of view, should have an apparent
impact on our operations during the next few years. As we have developed a
flexible end-to-end solution for electronic passports, we believe that this
trend will significantly affect our business forecast, as well as influence
vertical markets in the smart card industry. Our combined experience in passport
application projects worldwide and our position as a leading smart card inlay
manufacturer provides us with what we believe is an advantage. We are currently
aggressively bidding on a number of large projects and expect to achieve fair
results.
As a result of these trends and combined with our core strengths, we
are focusing on products and solutions that have been indicated to be
significantly influential in the present and future markets. We expect that the
2004 revenues will be primarily derived from:
o Smart passport technologies;
o High security solution integration;
o Expertise in multi-application smart cards, integration know-how;
and
o Extensive experience with the government ID market.
RECENT DEVELOPMENTS AND OUTLOOK
We expect revenues to continue to be derived from one-time sales and
recurring fees, sales of high-end solutions, sales of products, consumables and
technology. Sales are expected to continue through OEM partnerships and
continual upgrades, maintenance and support will continue to be provided to
customers.
For 2004, we anticipate that through the distribution and systems'
integration network implemented this year, and the recognition of our technology
and backlog, we will meet our strategic business plan and have the opportunity
to emerge as a key player in governmental and commercial markets.
Due to the arbitration proceeding with the Ukraine Chamber of Commerce
relating to our agreement with the Ukraine Ministry of Internal Affairs, we are
not anticipating any revenues from this project during the year 2004 or beyond.
During 2003, we generated an aggregate of $1.97 million in revenues from this
project. If we are not able to replace this revenue with revenue from other
projects, we expect our revenues to decrease and our net loss to increase in
2004. See the paragraph headed risks "We derive a substantial portion of our
revenue from a small number of customers..." in the Risk Factors set forth in
this prospectus.
In October 2004, the United States Government Printing Office (GPO)
informed us that our proposal as a prime contractor for the integration of smart
card technology in the US new electronic passports has been accepted for award.
In addition, our proposal as a sub-contractor with a leading American system
integrator corporation has also been accepted for award in this project. In this
project, we will supply the smart card technology that we have developed over
recent years, including the smart chip with an operating system and antenna that
is embedded in the passport. Our advanced technology meets the new strict
international standards (ISO and ICAO) and the high requirements for travel
documents set forth by the United States authorities in this tender. We expect
that the award of the tender will positively influence our business in the
coming years. We cannot currently estimate the impact on our results of
operations. We expect that the final order for 2005 pursuant to the project will
be received prior to the end of the year. Thus, we do not expect to start
generating substantial revenues from this project until the first quarter of
2005.
OFF-BALANCE SHEET ARRANGEMENTS
We do not have any material off-balance sheet transactions and we are
not party to any material off-balance sheet transactions.
CONTRACTUAL OBLIGATIONS
The following table summarizes our contractual obligations and
commitments as of December 31, 2003 that will require significant cash outlays
in the future:
- ----------------------------------------------------------------------------------------------------------------
CONTRACTUAL OBLIGATIONS TOTAL 2004 2005 2006 2007 AND
BEYOND
- ----------------------------------------------------------------------------------------------------------------
Long term debt $ 628,000 $ 441,000 $ 187,000
- ----------------------------------------------------------------------------------------------------------------
Capital Lease Obligations
- ----------------------------------------------------------------------------------------------------------------
Operating Leases $ 1,032,000 $ 370,000 $ 354,000 $ 308,000
- ----------------------------------------------------------------------------------------------------------------
Unconditional Purchase Obligations
- ----------------------------------------------------------------------------------------------------------------
Total Contractual Cash Obligations $ 1,660,000 $ 811,000 $ 541,000 $ 308,000
- ----------------------------------------------------------------------------------------------------------------
-33-
Long-term debt consists of amounts due to loans from banks, which is described
in Item 18, note 8 to the financial statements included in this prospectus.
Operating lease obligations represent commitments under several lease agreements
for our facilities and the facilities of certain subsidiaries. Total contractual
cash obligations represent outstanding commitments for loans from banks and
lease agreement for facilities. We are not a party to any capital leases.
NEW ACCOUNTING PRONOUNCEMENTS
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities," which addresses significant issue
regarding the recognition, measurement, and reporting of costs associated with
exit and disposal activities, including restructuring activities. SFAS No. 146
requires that costs associated with exit or disposal activities be recognized
when they are incurred rather than at the date of a commitment to an exit or
disposal plan. SFAS No. 146 is effective for all exit or disposal activities
initiated after December 31, 2002. We do not expect the adoption of SFAS No. 146
to have a material impact on our results of operations or financial position.
In November 2002, the FASB issued FASB Interpretation No. 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others, an interpretation of FASB
Statements No. 5, 57, and 107 and Rescission of FASB Interpretation No. 34"
("FIN No. 45"). FIN No. 45 elaborates on the disclosures to be made by a
guarantor in its interim and annual financial statements about its obligations
under certain guarantees that it has issued.
FIN No. 45 also clarifies that a guarantor is required to recognize, at
the inception of a guarantee, a liability for the fair value of the obligation
undertaken in issuing the guarantee. FIN No. 45 does not prescribe a specific
approach for subsequently measuring the guarantor's recognized liability over
the term of the related guarantee. It also incorporates, without change, the
guidance in FASB Interpretation No. 34, "Disclosure of Indirect Guarantees of
Indebtedness of Others," which is being superseded. The disclosure provisions of
FIN No. 45 are effective for financial statements of interim or annual periods
that end after December 15, 2002 and the provisions for initial recognition and
measurement are effective on a prospective basis for guarantees that are issued
or modified after December 31, 2002, irrespective of a guarantor's year-end. We
do not expect the adoption of FIN No. 45 to have a material impact on our
results of operations or financial position.
In November 2002, the Emerging Issues Task Force (EITF) of the FASB
reached a consensus on EITF issue No. 00-21, "Accounting for Revenue
Arrangements with Multiple Element Deliverables." The issue addresses how to
account for arrangements that may involve multiple revenue-generating
activities, i.e., the delivery or performance of multiple products, services,
and/or rights to use assets. In applying this guidance, separate contracts with
the same party, entered into at or near the same time, will be presumed to be a
package, and the consideration will be measured and allocated to the separate
units based on their relative fair values. This consensus guidance will be
applicable to agreements entered into in quarters beginning after June 15, 2003.
The adoption of EITF issue No. 00-21 did not have a material impact on
our result of operations or financial position.
In December 2003, the FASB issued additional guidance clarifying the
provisions of FASB Interpretation No. 46, Consolidation of Variable Interest
Entities, an Interpretation of ARB No. 51 ("FIN 46-R"). FIN 46-R provides a
deferral of FIN 46 for certain entities until after March 15, 2004. FIN 46
requires certain variable interest entities to be consolidated by the primary
beneficiary of the entity if the equity investors in the entity do not have the
characteristics of a controlling financial interest or do not have sufficient
equity at risk for the entity to finance its activities without additional
subordinated financial support from other parties. We do not expect the adoption
of FIN 46 to have a material impact on our consolidated financial statements.
-34-
BUSINESS
HISTORY AND DEVELOPMENT OF SUPERCOM LTD.
SuperCom Ltd. was incorporated in Israel, as a company limited by
shares, on July 4, 1988 under the name "SuperCom Ltd." pursuant to the
provisions of the then current Israeli Companies Ordinance. The legislative
framework within which we now operate is the Israeli Companies Law, 5759-1999
(the "Companies Law"), which became effective on February 1, 2000, and the
Israeli Companies Ordinance (New Version) 1983, as amended (the "Companies
Ordinance").
SuperCom Ltd. became a publicly-traded company on Nasdaq Europe on
April 19,1999. On October 23,2003, following the closing of the Nasdaq Europe
stock market, we transferred the listing of our shares to Euronext Brussels New
Market under the symbol "SUP".
From our incorporation in 1988 until 1999, we were a development-stage
company primarily engaged in research and development, establishing
relationships with suppliers and potential customers and recruiting personnel.
During the fiscal year ended December 31, 2002, we completed our reorganization
plan which began in 2001. According to such plan, we decided to focus our
marketing and sales efforts on the commercial market with a new line of
products, including SmartGate 2400, EduGate, ynaGate and Flight Gate, while
still maintaining our business in the governmental market.
In December 2002, we discontinued the operations of two subsidiaries,
Genodous Inc. and Kromotek, Inc., and disposed of all assets related to such
subsidiaries. The operations and cash flows of those two subsidiaries have been
eliminated from our operations. We have no intention of continuing our activity
in such subsidiaries. Our plan of discontinuance involved (i) termination of all
employees related to those subsidiaries, including payment of all statutory and
contractual severance sums, by the end of the fourth quarter of 2002, and (ii)
disposal of the equipment owned by such subsidiaries.
During the period from January 1, 2003 to December 31, 2003, our
capital expenditures totaled approximately $87,000 (compared to $73,000 during
2002 and $1,891,000 during 2001), of which approximately $78,000 (compared to
$69,000 during 2002 and $1,719,000 during 2001) was expended at or upon
SuperCom's facilities in Israel, and approximately $9,000(compared to $4,000
during 2002 and $172,000 during 2001) was expended upon various facilities of
SuperCom's subsidiaries outside Israel. Of these expenditures, approximately
$66,000 during 2003 (compared to $33,000 during 2002 and $1,741,000 during 2001)
was for capital equipment and leasehold improvements and the balance of
approximately $21,000 (compared to $40,000 during 2002 and $150,000 during 2001)
was related to information technology.
On Novenber 17, 2003, we purchased the remaining 20% of the shares that
we did not own of SuperCom Asia Pacific from the minority shareholder in
consideration for approximately $70,000.
All of the above expenditures were paid from cash generated from our
initial public offering.
During fiscal 2002, we sold in three separate transactions with third
party purchasers our equity interest in our subsidiary, InkSure Technologies,
Inc., or InkSure, for which we received aggregate proceeds of approximately
$6,600,000 from the sale of its shares. During 2003, we did not make any
significant capital divestitures nor are any such divestitures in progress.
Other than further capital expenditures of the types and consistent with the
amounts described above, there are no significant capital expenditures in
progress by us.
On May 6, 2003, we announced that we has executed a letter of intent
which sets forth the preliminary terms and conditions of a proposed merger
transaction between us and PerfectData Corporation, a US public "shell" company.
In connection with the merger, our shareholders were to exchange their shares of
capital stock for shares of common stock of PerfectData Corporation. On October
24, 2003, PerfectData filed with the Securities and Exchange Commission its
Registration Statement on Form S-4 regarding the proposed merger transaction
between us and PerfectData. On January 20, 2004, we and Perfect Data announced
that they were mutually terminating the merger agreement and related agreements.
Our head office and principal place of business is located at
Millennium Bldg., 3 Tidhar St., P.O.B. 2094, Raanana 43665 Israel, and our
telephone number is +972-9-7750800. Our internet address is
http://www.supercomgroup.com.
-35-
Our agent for SEC matters in the United States is SuperCom, Inc., whose
address is: 245 5th Avenue, Suite 2103, New York, NY 10016-8728.
For information concerning our capital expenditures and methods of
financing, see "Management's Discussion and Analysis of Financial Condition and
Results of Operations."
BUSINESS OVERVIEW
We are a smart card technology company that designs, develops and
markets advanced smart card technologies and products for the governmental and
commercial secured identification markets. With an embedded microcontroller,
smart cards have the unique ability to store large amounts of data, perform
on-card functions, such as encryption, and interact intelligently with a smart
card reader. Smart cards connect to a smart card reader through either direct
physical contact or a remote contactless radio frequency interface. We function
as a "one stop" technological integration and support source for smart card
system integrators, utilizing our know-how and technologies. We develop and
market a wide range of complementary technologies and solutions for the smart
card market, including customizable smart cards, smart card-related products,
proprietary smart card production technologies, and advanced identification, or
ID, technologies, complemented by brand protection and authentication
technologies.
Since 1994, our technologies and products have been included in several
large governmental projects worldwide, such as the Hong Kong government passport
project, the United Kingdom passport project and the Ukraine passport project.
We believe that our extensive product line and experience, combined with our
growth strategy in governmental projects and commercial solutions, position us
for further growth. We cannot assure you, however, that such growth will be
achieved.
Beginning in the fourth quarter of 2001, we completely reorganized our
operational and strategic structure. This reorganization included an in-depth
analysis of our technologies, products, applications, target markets, business
and marketing strategies, as well as instituting aggressive cost-cutting
measures. As a result of this process, we decided to focus on what we believed
to be our core strengths:
o Smart card technology integration know-how;
o High security solution integration;
o Proprietary smart card technologies and products;
o Expertise in multi-application smart cards; and
o Extensive experience with the government ID market.
Our objective is to become a leading provider of high-end smart card
systems by marketing our extensive technological know-how, advanced technologies
and value-added products and applications for government and commercial smart
cards in the secured identification and access control markets, worldwide. While
we intend to continue to participate in governmental ventures, we also plan to
increase our sales efforts in the private commercial market through our
distribution channels, including our recently entered into distribution
arrangements with Clinton Electronics Corporation, TransTech Systems, Inc.,
Laminex, Inc. and Eastern DataComm.
We will seek to market our products and proprietary technologies to
position us as:
o A horizontal smart card technology provider and integrator with the
ability to respond to complex security and multi-application smart
card system challenges; and
o A provider of a combination of unique and traditional smart cards
and complementary smart card-related products, which, as
applicable, will be sold "off-the-shelf" as complete solutions.
There can be no assurance as to whether we shall achieve our objective, as to
the degree of our success in growth in the commercial market or as to whether we
shall achieve the desired position.
-36-
THE MARKET
OUR MARKET OPPORTUNITY
Many industries are rapidly adopting smart cards due to their enhanced
security features. One reason for this move is the ability to use smart cards
for multiple purposes. In today's world, mobile phones are used not only for
communication, but also for mobile commerce. Credit cards are used as loyalty
cards and as a means of authenticating e-commerce transactions. Transportation
payment cards at once support multiple transportation providers and function as
debit cards for select retailers. Smart cards can carry personal information for
identification purposes, biometric data for physical access control, and digital
signatures for network security.
A smart card is a card that stores information on an integrated circuit
chip embedded within the card, rather than on a magnetic stripe on the surface.
While a typical magnetic stripe card stores approximately 212 bytes of
information, generally consisting of limited data, a smart card can store 64
kilobytes or more of information, which is many times more than a traditional
magnetic stripe credit card. Additionally, the integrated circuit within a smart
card serves as a central processing unit which, combined with its memory
capacity, facilitates the use of encryption applications, which secure data and
value exchanges within networks and the Internet. Smart cards also permit
bi-directional authentication, which means that in addition to authenticating
the identity of the user, the card can authenticate the validity of the intended
party or device prior to exchanging information or value.
Due to the need for more secure identification and authentication, and
the ability to incorporate multi-application features, there has been a shift
towards adapting high-end smart card systems in both governmental and commercial
market segments. Governments are seeking to move away from their traditional
paper-based identification systems, and commercial entities are also shifting
their secured systems away from basic, low memory single application cards.
The demand for increasingly complicated smart card systems with novel
technological abilities, combined with increased pressure for cost-effective
systems, has fostered the emergence of multiple entrants in the smart card
market, each specializing in specific aspects of smart card production, software
or technology. However, the complexity and sheer volume of these specialized
providers have generated an outcome opposite to the market's needs. This
specialization has required a growing number of entities to become involved in a
single project, thereby causing longer timelines, higher costs, and less
optimized solutions.
SECURITY, COST REDUCTION AND SMART CARDS
Governments and commercial entities control and mass-produce various
types of identification documents and cards, such as passports, visas, drivers'
licenses, and national or contactless smart cards. Such documents and cards
generally provide their owners with the ability to exercise special rights,
obtain benefits, effect commercial transactions, or cross otherwise restricted
borders. As a result of their importance, identification cards and related
documents are often forged or altered. The costs associated with such fraud, for
both victims and law enforcement agents, are significant. Consequently,
governments and commercial organizations are seeking solutions that will
heighten security, reduce costs associated with forged or fraudulent
identification documentation and enable cost-effective production of secure and
durable documentation.
TECHNOLOGICAL DEVELOPMENTS
As an additional means of detecting fraud, identification systems
increasingly use biometric data, which are unique biological characteristics
such as fingerprints and facial images, to verify personal identity and other
personal information, such as medical and financial information. For example, in
our Philippines passport project, our identification system includes a person's
fingerprint as verification of a person's identity. The inclusion of this
information in cards or documents for on-line or real-time verification is
particularly important for identification cards as they are often used in
commercial transactions.
POLITICAL DEVELOPMENTS
-37-
The growth in the national identification documentation market has been
fueled by geopolitical developments including the disintegration of several
federal states (such as the former Soviet Union), the subsequent emergence of
newly independent nations, and the creation of regional communities (such as the
European Union). These political developments have created significant
opportunities as an increasing number of governments are seeking to create
digital population registry databases and cost-effective, secure and durable
national identification documentation. Over the past year, we have submitted a
number of proposals to governments, including the Israeli and Ethiopian
governments, to spearhead national identification documentation projects. Since
the events of September 11, 2001, we have observed increased interest in
government ID projects. Governments that had previously planned to change their
national ID documents delayed implementation until 2003 or 2004 in order to
establish an identification system with a higher degree of security.
AUTHENTICATION AND SECURITY OF DOCUMENTS
Today, with the help of advanced printing technologies, counterfeiters
can produce most of the current identification documents that exist in the
world. The events of September 11, 2001 revealed to governments and security
agencies worldwide that one way to fight terrorism is to require national ID
documents with a high level of security. Our printing production and security
technologies provide governments and their law enforcement agencies advanced and
highly secure ID documents that help reduce and detect counterfeited ID
documents.
OUR STRATEGY
We are a provider of high-end smart card systems and secured ID
document technologies. We believe that the government and commercial sectors are
moving towards the more functional and broader applications that a smart card
solution can provide over traditional methods. We are positioning ourselves to
become a key player in government and commercial smart card markets as a result
of our ability to function as a one-stop shop for cost-effective high-end smart
card systems. Our objective is to become a market leader in the development and
marketing of our advanced smart card technologies and value-added related
products and applications for contactless smart card and ID markets worldwide.
We intend to achieve our goal by:
o Focusing on both government and commercial customers;
o Leveraging our technological competence and reputation;
o Focusing on the smart card business;
o Focusing research and development on adapting our current
technology achievements to market demands;
o Increasing sales and marketing resources; and
o Seeking partnerships with other relevant companies.
There can be no assurance that we shall achieve our goal, whether in whole
or in part.
EXTEND TECHNOLOGICAL RECOGNITION
We believe that our customized systems, proprietary printing and
production technologies, software packages and integration capabilities will
enable us to position ourselves as a key technological player in the secured
identification document/card market. There can be no assurance, however, that we
shall become such a key technological player.
LEVERAGE TECHNOLOGY/KNOW-HOW INTO COMPLEMENTARY MARKETS
We intend to leverage our core technologies and know-how in order to
respond to the needs of existing and potential customers. These technologies
involve document authentication and registry database systems. We intend to
tailor our marketing and sales efforts so as to integrate such technologies into
the actual solutions offered to our governmental and commercial customers. There
can be no assurance, however, that we shall be successful in these efforts.
-38-
EXPANSION OF THE CONTACTLESS SMART CARD BUSINESS
We believe that the picture identification contactless smart card
represents the next generation of national identification documentation and
anticipate increasing demand for this technology from our existing and potential
customer base. We have positioned ourselves to service this demand through the
development of our smart card production line technology. We intend to become a
key player in the supply of contactless smart cards to the governmental and
commercial markets, and are consequently investing in research and development
to enhance our contactless smart card technologies in order to satisfy end-user
requirements. There are two aspects of the expanding commercial market: (i) new
applications and (ii) replacement of low-end magnetic stripe cards with
contactless smart cards with security features. There can be no assurance that
we shall become a key player in the governmental and commercial smart card
markets.
LEVERAGE PUBLIC SECTOR EXPERTISE INTO COMMERCIAL APPLICATIONS
We believe that significant commercial possibilities exist for our
secure and durable document/card production solutions. We have completed the
process of leveraging our expertise to the production of picture identification
contactless smart cards, and now provide solutions for commercial applications
with requirements similar to those in the public sector, such as private or
corporate identification cards, medical cards and benefits administration.
PENETRATING NEW MARKETS
We intend to increase our penetration of existing markets by leveraging
our current products and systems to new applications and new vertical markets,
which can be used to produce various types of documents and cards. We will also
seek to leverage our existing relationships and established reputation in new
markets. We have initiated entry into geographic markets upon which we have not
traditionally focused, such as the United States. There can be no assurance,
however, that our efforts will achieve their objectives.
RESEARCH AND DEVELOPMENT
Our past research and development efforts have helped us to achieve the
goal of offering our customers a complete line of products and solutions. As a
result of our past efforts, we reduced the number of employees in our research
and development activities to ten people as of December 31, 2003. We spent $1.2
million, $1.3 million and $0.9 million on research and development in, 2001,
2002 and 2003, respectively. These amounts were spent on the development or
improvement of our technologies and products, primarily in the areas of an
automatic contactless smart card production line, data capture, management
software, population registry software packages, security printing, contactless
smart cards and document authentication. We will continue to research and
develop new security and identification features through laser printing and
pre-printing, create new personalization methods for contactless smart cards,
develop a range of smart card applications and continue to develop our automatic
contactless smart card production line. There can be no assurance that we can
achieve any or all of our research and development goals.
PRODUCTS AND NEW TECHNOLOGY
Since our inception in 1988, we have been involved in the development
of advanced technologies for the national documentation market. In view of the
increasing demand for identification cards that are based on contactless
smartcard technologies, we have developed a fully automated production line for
picture identification contactless smart cards. We also offer to our customers
raw materials and maintenance and service agreements. In 2002, we decided to
focus on the commercial market through several new applications. Today, we have
two major groups of solutions for our customers that are organized as separate
marketing divisions:
o Our ID and smart card division provides ID solutions for governments
and contactless smart card production facilities for the
governmental markets; and
o Our commercial marketing division focuses on our commercial
applications such as SmartGate 2400, Power Reader and EduGate in the
United States and Asia Pacific.
CONTACTLESS SMART CARDS
-39-
Our contactless smart cards are customizable, machine-readable smart
cards designed for a broad range of commercial and governmental applications.
From traditional ID documents to modern e-commerce cards, our contactless smart
cards carry large quantities of data, securely stored in a sealed microchip and
are read using our Smart Card Reader. The cards come in different sizes and can
incorporate virtually any chip on the market. For increased durability, the
cards are constructed from Teslin (R), an ultra-thin material that resists
abrasion. The cards are suitable for many existing and future applications, such
as e-identity verification, contactless credit cards, loyalty cards, health
cards, financial sector cards, transportation cards and others. Currently, our
customers are using the cards as loyalty cards as part of our Edugate and
Smartgate systems and as financial sector cards.
We have designed and developed what we believe are unique technologies
for the production of our proprietary contactless smart card. The smart card is
a pre-fabricated multi-layered Teslin (R) and polyester card that contains a
radio frequency antenna and a programmable memory chip. Each smart card is
personalized, including the initialization of its memory chip, in order to
produce a particular contactless smart card. The design of the contactless smart
card minimizes the number of steps necessary to produce smart cards because our
proprietary printing technology allows customers to print directly onto multiple
pages of the smart card. The smart card uses read/write memory chips supplied by
third parties with a capacity that ranges from one to eight kilobytes and
contains an installed "on-board" operating system. This allows customers to
re-program the chip following initialization, thereby adding, removing or
updating applications and data without the need to replace the chip.
We have also developed the contactless smart card Production Line 1000
(SPPL 1000), a technology designed for the mass production of secure and durable
picture identification contactless smart cards. The SPPL 1000-A automated smart
card inlet production line produces the inlet that contains the chip and an
antenna that carries the secure, personalized data in the finished card, which
is the core of the contactless smart card. Producing a continuous reel of
inlets, the SPPL 1000-A increases throughput and reduces waste. Utilizing our
universal chip packaging, it can accommodate virtually any chip on the market.
Our SPPL 1000-B automated contactless smart card and pouch production
line produces the highly durable casing for our inlet: either the finished,
personalized smart card or our card-base or our pouch. The SPPL 1000-B uses
pre-printed ultra-strong Teslin (R) pages to produce high quality color smart
cards laminated with additional protective layers of polyester. The SPPL 1000-B
accepts continuous reels of our smart card inlets, thereby maximizing
flexibility and cost efficiency.
CONTACTLESS SMART CARD READER/WRITER - 5600 SERIES
Our Contactless Smart Card Readers/Writers are devices that transfer
data to and from contactless smart cards. Our Contactless Smart Card
Readers/Writers are easily integrated with devices such as vending machines,
access gates and hand-held terminals. Unlike readers/writers that require direct
contact between the card and reader, SuperCom Contactless Smart Card
Readers/Writers operate by radio frequency technology, which allows the
transmission of data by simply holding the card near the reader. The ability to
read cards without physical contact speeds reaction time and prolongs the life
of both the smart card and the reader/writer. In addition, given that the 5600
Series Reader/Writer has no moving parts, maintenance and cost of ownership is
considerably reduced.
SMART CARD 8500 SERIES
Our Smart Card 8500 Series offers more features than our other smart
cards. These smart cards are color personalized, highly durable, and may be
produced at remote issuing stations by customers using our equipment. In
addition, the 8500 Series' smart cards are designed to meet size and thickness
standards regardless of the size of the chip the customer chooses. The 8500
Series' smart cards may incorporate a variety of security features such as ID
pictures and holograms, hidden features detectable by ultraviolet lamps or
two-dimensional bar-code readers, and proprietary features that require special
forensic equipment for authentication. Customers can select the security level
required for each card, creating customized security solutions for different ID
types.
SECURITY PRINTING
We have developed fully automated production lines that allow for rapid
mass production of generic pouches and personalized cards. Our ability to
produce generic pouches is important because such pouches may be personalized
-40-
through our proprietary transfer printing technology at a later stage. This
provides customers with the option to decentralize the mass production of cards
by manufacturing pouches in a centralized location and distributing them to
sites (such as regional documentation issuing sites or embassies) where the
pouch is personalized and the final card is produced.
TRANSFER PROCESS PRINTING
Our proprietary transfer printing technology, which is patented in five
jurisdictions, including the United States, Europe and Hong Kong, allows us to
print captured data on booklets and pouches regardless of the size, design,
type, thickness or lamination method used. This technology offers the customer
the option of combining the security of personalized pouches and pre-sewn
laminated booklets with the durability of laser printing in a cost-effective
manner. The ability to affix data on any size pouch or booklet provides us with
a competitive advantage as governments often purchase quantities of different
types of blank passport booklets and pouches in bulk and desire the ability to
produce durable passports and similar documents in various formats while
utilizing their entire existing stock of booklets and cards. Our technology
allows the printing of personalized data on multiple passport pages in the same
step. This allows additional security data to be included in a passport without
incurring a substantial increase in the cost of producing each booklet.
TESLIN PRINTING
A growing segment of the national identification documentation market
uses Teslin (R) as its primary printing substrate. Teslin (R) is a polymer that
was developed and patented in the United States by PPG Industries. We purchase
all of the Teslin (R) used in our business from PPG Industries. Teslin (R) has
been identified by the identification documentation production industry as a
potential substrate because of its high absorption level, attractive print
stability, and plastic-like flexibility and durability. Teslin (R), however, is
extremely sensitive to high temperatures. This renders useless any conventional
printing technique based on extreme heat, such as laser printing. In addition,
Teslin (R) is not receptive to ink jet printing. The practice adopted by the
national identification production industry is to use thick pieces of Teslin (R)
coated with various chemicals in order to increase its resistance to heat. This
process, however, makes the cards more vulnerable to damage, thus vitiating the
very attractiveness of Teslin (R). We offer our customers the ability to print
on Teslin (R) using high quality color laser printers. Our use of laser printing
provides us with an important competitive advantage given that laser printing
can retain functional stability for up to 10 years, as opposed to ink jet or
thermal transfer technology printing, which are generally stable for only two to
five years.
Our solution features a production process in which laser printing is
controlled by proprietary software rather than the typical heat and pressure
process. This solution makes laser printing possible on extremely thin layers of
uncoated Teslin (R), which maximizes durability while minimizing the possibility
of forgery or tampering. We also utilize our Teslin (R) printing capability for
the production of picture identification contactless smart cards in order to
make such cards significantly more durable.
SOFTWARE PACKAGES
Our software packages are designed for data collection and management,
and capturing and encoding various types of data in a personal digitized file.
This facilitates control over the data printing process and storage of digitized
files at either a remote site or central registry. The packages can handle all
types of data ranging from images captured through live video, photo or color
scanning to biometric information, including palm geometry, fingerprints and
facial recognition. The packages are configurable with all types of database
software, can be used with all commercially available platforms, including
mainframe computers and UNIX servers, can support multiple document types and
printers and can operate in Windows 98, Windows 2000, Windows XP and Windows NT
environments.
Our proprietary software integrates these data capture technologies
with a PC-based workstation in a modular configuration, allowing for the easy
establishment and operation of multiple data collection stations and provision
of customer-specific solutions. In addition, our software enables data capture
workstation operators to control the image capture process exclusively through
the keyboard and to calibrate multiple units of image capture equipment through
one centralized workstation.
RAW MATERIALS
-41-
We sell specially designed kits containing the raw materials necessary
to produce some of our products, including silicon sheets, polyethylene
terephthalate (PET) and Teslin (R). Among the raw materials we sell are
plastics, various printing substrates, toners and printing drums. Although not
all of these materials incorporate our technologies, they include components
necessary for the operation of certain of our systems. In some cases, our
customer agreements require that customers purchase raw materials from us for
the production of documents and cards exclusively for the term of the agreement.
COMMERCIAL PRODUCTS
EDUGATE
EduGate is an access control and attendance system designed to combat
school truancy. The system allows school personnel to record and automatically
report students' entry or exit by using a system of smart cards and smart card
readers while a remote central computer compiles data about students'
attendance. An optional feature is PhoneGate, an automated system that contacts
parents by email or text messaging if their child is absent from school.
DYNAGATE
DynaGate is a portable smart card reader and data collection device
that can also be integrated into our EduGate system. It utilizes the Dynamic
Access Control (DAC) concept (patent pending in the United States and Israel) to
enable school personnel to check, record and automatically report a student's
entry or exit using a specially designed mobile reader. The school's main
management system records activity and automatically notifies parents of their
child's absence from school.
SMARTGATE 2400
Security and identification authorization are important concerns for
businesses and individuals alike. SmartGate 2400 is an integrated solution for
these concerns, providing secured access control to targeted environments using
contactless smart cards, controllers and readers. These units are programmed
according to client specifications and carry an array of personalization and
security features. The multi-application system can be integrated into a variety
of environments, including office buildings, residential buildings, nursing
homes, hospitals, universities and schools.
NEW TECHNOLOGIES
Through our involvement in the national identification documentation
market, we have identified features that require new technologies that are
complementary to our core technologies, primarily for document authentication
and population registry systems. Magna is our comprehensive, web-based
population registration and document issuance system that we market to
businesses and government offices. An off-the-shelf software solution, Magna
features generic core technology, intuitive modular structure and easy-to-use
tools. Magna enables customization without dependency on technical experts as
well as allowing controlled, seamless integration with existing legacy systems.
CUSTOMERS AND PROJECTS
Passports And ID Card, Africa
In April 2003, we entered into an agreement with the Security,
Immigration and Refugees Affaires Authority of an African country in connection
with passports and other travel documentation project in such African country.
The agreement has a term of five years. Pursuant to the agreement, we will
supply the customer with equipment and raw materials necessary for the
production of passports and other travel documents as required from time to time
under the agreement. Pursuant to the agreement, the customer is required to pay
us for the equipment and the raw materials that we supply in the aggregate
amount of US $1.6 million. During 2003, we generated $536,000 in revenues
pursuant to this agreement.
Passports and Id Smart Cards, Ukraine
In September 1999, a consortium led by us was awarded a contract from
the Ukrainian government for a national passport and ID smart card project. Over
the course of the project, we were engaged to supply technology, production
-42-
equipment and raw materials for the issuance of passports and ID smart cards. In
April 2001, we signed the first phase of this agreement, which provided the
Ukrainian government with a central production system for issuing Ukrainian
passports and finished the initial implementation phase. During 2002, we began
the delivery of the first phase of the Ukraine ID smart card project and
generated revenues of $2.1 million. During 2003, we generated an aggregate of
$1.97 million in revenues from this project.
In April 2004, we were informed by the International Commercial Arbitration
Court at the Ukrainian Chamber of Commerce and Industry ("Arbitration Court")
that the Department for Resources Supply of the Ministry had filed with the
Arbitration Court a statement of claim to declare the Contract as void due to
defaults in the tender proceedings under which the Contract had been awarded to
SuperCom. On July 22, 2004 we were informed by the law firm representing us in
the arbitration proceedings that on July 19, 2004, the Arbitration Court issued
a negative award declaring the Contract as void. We strongly believe that the
award is wrong due to many defaults that occurred in the arbitration proceedings
and we intend to challenge the validity of the award in the civil courts of
Ukraine. We are not anticipating any revenues from this project during the year
2004 and the following years.
National Documentation, Moldova
In August 1995, we entered into an agreement with Intercomsoft Ltd., an
Irish company, or Intercomsoft, which was subsequently amended on May 5, 1998
and July 22, 1998, in connection with a national documentation project in
Moldova. The agreement has a term of ten years. Pursuant to the agreement, we
will supply Intercomsoft with equipment and raw materials necessary for the
production of passports, drivers' licenses, vehicle registrations,
identification cards and other documents, as required from time to time under an
agreement between Intercomsoft and the Ministry of Internal Affairs of Moldova,
or MIAM. Pursuant to the agreement, Intercomsoft is required to pay us for the
equipment and raw materials that we supply to Intercomsoft. In addition, we are
entitled to 25% of Intercomsoft's gross profits from the sale of ID
documentation to the MIAM. In addition, Trimol Group Inc., a publicly traded
company in the United States and the parent company of Intercomsoft, issued
125,000 Trimol shares to us as partial consideration for the equipment supplied
and the other undertakings. In 2002, we generated revenues of $1.5 million
pursuant to this agreement. During 2003, we generated $1,184,000 in revenues
pursuant to this agreement.
Passports, Hong Kong
In September 1996, SuperCom Asia Pacific Ltd., or SuperCom Asia
Pacific, as of December 31, 2003, our 100%-owned subsidiary, entered into an
agreement with China Travel Service (Holdings) H.K. Ltd., or CTSH, which
supplies passports to the Hong Kong government. Pursuant to the agreement,
SuperCom Asia Pacific, as subcontractor, is obligated to provide CTSH with all
the equipment and raw materials required for the production of passports in Hong
Kong. The agreement provides for payments for equipment and raw materials
purchased plus annual fees for maintenance after the first 12 months. In
September 1999, the parties signed a supplementary agreement whereby they agreed
to extend the agreement for an additional term of three years through December
31, 2003. In September 2003, the parties signed a supplementary agreement
whereby they agreed to extend the agreement for an additional term of one year
through December 31, 2004. In 2002, we generated revenues of $615,000 pursuant
to this agreement. During 2003, we generated $811,000 in revenues pursuant to
this agreement.
Hong Kong - China Re-Entry Cards
In 1996, SuperCom Asia Pacific entered into an agreement with China
Travel Services (CHK) Ltd., or CTS, which is responsible for the supply of Hong
Kong - China re-entry cards to the Hong Kong government. According to the
agreement, SuperCom Asia Pacific, as subcontractor, will provide CTS with all
the equipment and raw material necessary for the production of the Hong Kong -
China re-entry cards. The agreement provides for payment of equipment and raw
materials plus annual maintenance fees after the first 12 months. The term of
the agreement is five years with a five-year renewal option and can be
terminated for cause. In 2002, we generated revenues of $931,000 pursuant to
this agreement. During 2003, we generated $879,000 in revenues pursuant to this
agreement.
In December 1999, the parties signed a supplementary agreement in which
they agreed to maintain the unit price of raw materials for an additional period
of three years starting on January 1, 2000, provided that CTS will maintain
during that term a minimum annual order of raw materials of 1,000,000 units per
year.
Passports, United Kingdom
-43-
In December 1997, we entered into an agreement with the Stationary
Office Limited, or TSO, an English company, which was awarded a ten-year
agreement in June 1997 to supply passports to the United Kingdom Passport
Agency. Pursuant to the agreement, we, as subcontractor, will supply TSO with
equipment and training for the production of passports at TSO's central facility
in Manchester, England and at six regional offices of the United Kingdom
Passport Agency. In addition, TSO has the option to purchase raw materials from
us at prices specified in the agreement. The TSO agreement may be terminated for
cause and upon termination of TSO's agreement with the Passport Agency. In 2002,
we generated revenues of $285,000 pursuant to this agreement. During 2003, we
generated revenues of $140,000 pursuant to this agreement.
SALES AND MARKETING
We sell our systems and products worldwide through distribution
channels that include direct sales and traditional distributor or reseller
sales. We have approximately 27 employees directly engaged in the sale,
distribution and support of our products and are represented by seven
independent distributors and resellers with which we have distribution
agreements. We are implementing a U.S. and European penetration plan, geared at
establishing a strong U.S. and European sales and marketing presence and
strategic partnerships. We expect these efforts to lead to a strong project flow
and increased product sales, and we anticipate that by 2006 nearly a majority of
all of our overall revenues will come from U.S.-based projects. However, we
cannot assure you that we will meet this objective.
Our resellers sell our systems and products to business enterprises,
healthcare and educational institutions and government agencies and act as the
initial customer service contact for the systems and products they sell. We
establish relationships with resellers through written agreements that provide
prices, discounts and other material terms and conditions under which the
reseller is eligible to purchase our systems and products for resale. These
agreements generally do not grant exclusivity to the resellers.
During 2003, we signed distribution agreements with three U.S.
distributors: TransTech Systems, Inc., Laminex Inc. and Clinton Electronics
Corporation, providing us with what we believe to be, but cannot assure you will
be, complete nationwide sales, distribution and support coverage for our systems
and products for the U.S. market.
SALES ANALYSIS
SALES BY GEOGRAPHIC DESTINATION:
The following table provides a breakdown of total revenue by geographic
market (all amounts in thousands of US dollars):
YEAR 2001 2002 2003
--------------------------------------------------
Eastern Europe $1,749 $3,680 $3,154
Western Europe 322 319 161
Far East 2,240 1,942 2,067
Africa 0 0 536
Middle East 326 228 498
North America 2,241 581 828
South America 10 5 0
Asia 1 1,272 0
--------------------------------------------------
TOTAL $6,889 $8,027 $7,244
==================================================
CUSTOMER SERVICE
We believe that customer support plays a significant role in our sales
and marketing efforts and in our ability to maintain customer satisfaction,
which is critical to our efforts to build our reputation and permit us to grow
in both new and existing markets. In addition, we believe that the customer
interaction and feedback involved in our ongoing support functions provide us
with information on customer needs that contributes to our product development
efforts. We generally provide maintenance services under our agreements pursuant
-44-
to terms that are according to each particular agreement. We provide service
either through customer training, local third-party service organizations, our
subsidiaries, or our personnel, including appropriate personnel sent from our
headquarters in Israel. We generally provide our customers with a warranty for
our products varying in length from 12 to 36 months. Costs incurred annually by
SuperCom for product warranties have to date been insignificant; however, there
can be no assurance that these costs will not increase significantly in the
future.
MANUFACTURING
Our manufacturing operations consist primarily of materials planning
and procurement, quality control of components, kit assembly and integration,
final assembly, and testing of fully-configured systems. A significant portion
of our manufacturing operations consists of the integration and testing of
off-the-shelf components. All of our products and systems, whether or not
manufactured by us, undergo several levels of testing, including configuration
to customer orders and testing with current release software, prior to delivery.
Certain components, such as printers and digital cameras, are purchased
and then integrated by us into a data capture workstation. We perform a
significant amount of primary assembly of our printers. We contract with
manufacturers to produce less technologically sensitive and complex features of
our printers to our specifications.
In addition, we purchase raw materials such as Teslin, silicon, toners
and certain security features, used by our customers in the production of ID
documents from third parties. While third parties process many of the materials
according to our specifications, we carry out the finishing and packaging of the
consumable materials.
We do not have minimum supply commitments from our vendors and
generally purchase components on a purchase order basis. Although we generally
use standard raw materials and components for our systems, some of the key raw
materials or components are available only from a single source, such as Teslin,
which is only available from PPG Industries, or from limited sources, including
various chips and toners. Even where multiple sources are available, we
typically obtain components and raw materials from only one vendor to ensure
high quality, prompt delivery and low cost. If one of our suppliers were unable
to meet our supply demands and we could not quickly replace the source of
supply, it could have a material adverse effect on our business, operating
results and financial condition, for reasons including a delay of receipt of
revenues and damage to our business reputation. We have, however, identified
alternate sources of supply for most of our components and raw materials. We
believe that our open systems architecture facilitates the substitution of
components when this becomes necessary or desirable.
COMPETITION
The market for our products and services is extremely competitive. Our
management expects this competition to intensify as the markets in which our
products and services compete continue to develop. We face competition from
technologically sophisticated companies, many of which have substantially
greater technical, financial, and marketing resources. In some cases, we compete
with entities that have pre-existing relationships with potential customers. As
the national documentation production market expands, we expect additional
competitors to enter the market. However, to date we have been able to compete
because our products combine technologies and features that provide customers
with a complete and comprehensive solution. There can be no assurance, however,
that other companies will not offer similar products in the future.
In the passport production and national identification card markets, we
compete with local governments and government-owned or private sector security
printing companies. These companies have either adapted new printing
technologies to the passport production market or use the same technologies as
we do. These companies include Canadian Bank Notes; Thomas De la Rue, a publicly
held English company; Giesecke & Devrient GmbH, a German company; 3M Inc., a
publicly-held American company; Setec Oy, a Finnish company that produces
passports using laser engraving technology; Toppan, a Japanese company that
manufactures laser printers; and American Banknote Corporation. We are able to
compete to date on the basis of, among other things, our ability to produce
national identification cards of any size that feature high-speed laser printing
on Teslin (R) and polyester, which provides enhanced security and significant
durability. There can be no assurance, however, that other companies will not
offer similar products in the future.
-45-
We also compete with system integrators such as EDS, Unisys, Siemens,
TRW, Lockheed-Martin and IBM, which act as prime integrators in connection with
government agreements. These system integrators, however, sometimes act as our
partners when we participate in consortiums led by, or including, one or more of
these system integrators.
In projects where customers require biometric data collection
technology, we compete with automatic fingerprint identification system, or AFIS
providers such as Lockheed-Martin, Printrak International (Motorola), TRW,
Cogent Technology, Sagem Morpho of France and NEC of Japan. AFIS suppliers tend
to position themselves as prime integrators on turnkey projects. We have
developed integration capabilities with AFIS systems and can print encrypted
AFIS data onto our national identification cards and passports.
In the emerging market for contactless smart cards for use in national
documentation systems, we compete with companies such as Schlumberger, Gempluss
and Orga Cards, which supply smart cards for commercial applications using
polyvinylchloride, or PVC, and other material platforms; Giesecke & Devrient
Oberthur, which supplies smart cards; ODS Landis & Gyr and Maurer, a German
company, which produces laser engraved polycarbonate cards; Nova Card and
Amatech, German companies, and Austrian Cards, an Austrian company, which also
se antenna winding technology, PET cards and sell contactless production
equipment; Muhlbauer and Meltzer, German companies which are competitors in
manufacturing contactless equipment; and Bull and De La Rue, which is engaged in
the business of printing money, passport and other secured documents.
INTELLECTUAL PROPERTY
Our ability to compete is dependent on our ability to develop and
maintain the proprietary aspects of our technology. We rely on a combination of
trademark, copyright, trade secret and other intellectual property laws,
employee and third-party nondisclosure agreements, licensing and other
contractual arrangements and have also applied for patent protection to protect
our proprietary technology and intellectual property. These legal protections
afford only limited protection for our proprietary technology and intellectual
property.
In addition, the laws of certain foreign countries may not protect our
intellectual property rights to the same extent as do the laws of Israel or the
United States. For instance, the intellectual property rights of our Asian
subsidiary, SuperCom Asia Pacific Ltd. may not be fully protected by the laws of
Hong Kong and the People's Republic of China.
PATENTS
We currently have three registered patents in Israel, one in Europe,
one in the United States, one in Hong Kong, one in Ukraine and two patent
applications pending in the United States and Europe and other jurisdictions for
technology related to our smart card technology. We intend to file additional
patent applications when and if appropriate. There is no guarantee that patents
will arise from our applications or, if patents do arise, that we will be
afforded proprietary protection should claims arise.
In addition, we recognize that our existing patents provide us only
limited protection. Moreover, not all countries provide legal protection of
proprietary technology to the same extent. There can be no assurance that the
measures taken by us to protect our proprietary technologies are or will be
sufficient to prevent misappropriation of our technologies or portions thereof
by unauthorized third parties or independent development by others of similar
technologies or products. In addition, regardless of whether our products
infringe on proprietary rights of third parties, infringement or invalidity
claims may be asserted or prosecuted against us and we could incur significant
expenses in defending them. Our costs could also increase if we have to pay
license fees as a result of these claims.
LICENSES
We license technology and software, such as operating systems and
database software from third parties for incorporation into our smart card
systems and products and we expect to continue to enter into these types of
agreements for future products. Our licenses are either perpetual or for
specific terms.
GOVERNMENT REGULATION
Some of our contracts relate to projects that have elements that are
classified for national security reasons. Although most of our contracts are not
themselves classified, persons with high security clearances are often required
to perform portions of the contracts. We believe that our employment of
-46-
personnel with high security clearances is helpful in obtaining such contracts.
Doing business with governments is complex and requires the ability to comply
with intricate regulations and satisfy periodic audits.
Our smart card readers must comply in the United States with the
regulations of the Federal Communications Commission, or the FCC, which may
require certification, verification or registration of the equipment with the
FCC. Certification and verification of new equipment requires testing to ensure
the equipment's compliance with the FCC's rules. In addition, the equipment must
be labeled according to the FCC's rules to show compliance with these rules.
Electronic equipment permitted or authorized to be used by the FCC through our
certification or verification procedures must not cause harmful interference to
licensed FCC users, and it is subject to radio frequency interference from
licensed FCC users. To date, our smart card readers have complied with the
regulations of the FCC; however, there can be no assurance that they will
continue to do so in the future.
LEGAL PROCEEDINGS
Other than as described below, there are no materials pending legal
proceedings in which we are a party or of which our property is subject.
In April 2004, we were informed by the International Commercial
Arbitration Court at the Ukrainian Chamber of Commerce and Industry
("Arbitration Court") that the Department for Resources Supply of the Ministry
had filed with the Arbitration Court a statement of claim to declare the
Contract No. 10/82, dated April 9, 2002 between SuperCom and the Ministry of
Internal Affairs of Ukraine as void due to defaults in the tender proceedings
under which the Contract had been awarded to SuperCom. On July 22, 2004 we were
informed by the law firm representing us in the arbitration proceedings that on
July 19, 2004, the Arbitration Court issued a negative award declaring the
Contract as void. We strongly believe that the award is wrong due to many
defaults that occurred in the arbitration proceedings and we intend to challenge
the validity of the award in the civil courts of Ukraine. We are not
anticipating any revenues from this project during the year 2004 and the
following years.
On November 10, 2003, Supercom Slovakia, a subsidiary (66%) of Supercom
Ltd., received an Award by the International Arbitral Centre of the Austrian
Federal Economic Chamber ("IAC"), in the case against the Ministry of Interior
of the Slovak Republic which refers to the agreement on delivery of Technology,
Cooperation and Services signed on March 17, 1998. Upon the Arbitral Award, the
Ministry of Interior of the Slovak Republic has been ordered to pay Supercom
Slovakia the amount of SKK 80,000,000 (Approximately US $2.27 million). In
addition, the Ministry of Interior of the Slovak Republic has been ordered to
pay the costs of arbitration in the amount of EUR 42,716 and Supercom Slovakia's
legal fees in the amount of EUR 63,611. The Ministry of Interior of the Slovak
Republic has the right to appeal in the Austrian Courts within 3 months from the
date of this award on only legal procedures. We have begun the enforcement
procedure of the arbitral award and in parallel, we have indirectly received
information that the Ministry of Interior of the Slovak Republic has filed an
appeal.
On July 14, 2003, Mr. Yaacov Pedhatzur, an Israeli citizen filed a
complaint against us, in the Magistrate's Court of Tel Aviv, Israel. The
plaintiff claims that we owe him NIS 250,000 (Approximately US $54,550) in
commissions allegedly due for his part in establishing business connections for
us in Eastern Asia during the years 1993-1998. We plan to contest this claim.
On December 12, 1999, Secu-Systems filed a lawsuit with the District
Court in Tel-Aviv-Jaffa jointly and severally against us and InkSure Ltd. (a
former subsidiary, which is currently a subsidiary of InkSure Technologies,
Inc.) seeking a permanent injunction and damages. The plaintiff asserted in its
suit that the printing method applied to certain products that have been
developed by InkSure Ltd. constitutes inter alia: (a) the breach of a
confidentiality agreement between the plaintiff and us; (b) unjust enrichment of
us and InkSure Ltd; (c) breach of fiduciary duties owed to the plaintiff by us
and InkSure Ltd., and (d) a tort of misappropriation of trade secrets and damage
to plaintiff's property. Secu-Systems, based on such allegations, asked the
court to order the Company and InkSure to: (i) cease any activity which involves
the plaintiff's confidential information; (ii) furnish the plaintiff with a
certified report detailing all profits derived by us and InkSure Ltd. from such
activity; (iii) pay the plaintiff an amount equal to all such profits, and (iv)
pay the plaintiff additional damages in the amount of NIS 100,000.
Alternatively, the plaintiff asked the court to declare that the above-mentioned
products are owned by the plaintiff and InkSure in equal parts and that the
plaintiff is entitled to 50% of all profits derived therefrom, in which case,
the plaintiffs asked that we and InkSure allocated 50% of the profits from the
printing method at issue.
-47-
Based upon the facts known to us and those provided by InkShure Ltd.
and our legal advisors advice which is based, inter-alia, on said facts, our
management is of the opinion that, the prospects are favorable that the court
will not grant the permanent injunction or award damages of a substantial amount
in connection with the litigation. Accordingly, our management did not provide
for such potential liability.
RECENT DEVELOPMENTS
During June and July, 2004, the Company received aggregate gross
proceeds of $1,225,000 from a private placement of 1,558,826 ordinary shares and
five-year warrants to purchase 623,535 ordinary shares at an exercise price of
$1.10 per share. In connection with the private placement, our placement
advisors received warrants to purchase 77,941 ordinary shares at an exercise
price of $1.10 per share.
In August and September 2004, we received gross proceeds of $2,200,000
from a private placement to accredited investors of 2,470,589 ordinary shares
and five-year warrants to purchase 988, 234 ordinary shares at an exercise price
of $1.10 per share. In connection with the private placement, our placement
agent received warrants to purchase 177,882 ordinary shares at an exercise price
of $1.10 per share and 444,706 ordinary shares at an exercise price of $ 0.85
per share. All of such warrants issued in this private placement except 444,706
warrants with an exercise price of$0.85, may be called by us at a redemption
price of $.01 per warrant at any time after the closing price (or closing bid
price) of our ordinary shares on an U.S. stock exchange, Nasdaq or the OTC
Bulletin Board is equal to or greater than $2.50 per share for 10 out of any 15
consecutive trading days.
Esther Koren Dalal resigned as a member of our Board of Directors
effective July 14, 2004 due to personal reasons. Ms. Michal Brikman was
subsequently appointed to our Board of Directors as an External Director which
was approved by our shareholders at a special general shareholder meeting on
October 28, 2004. In addition, we intend to appoint Ms. Brikman to the audit
committee.
In October 2004, the United States Government Printing Office (GPO)
informed us that our proposal as a prime contractor for the integration of smart
card technology in the US new electronic passports has been accepted for award.
In addition, our proposal as a sub-contractor with a leading American system
integrator corporation has also been accepted for award in this project. In this
project, we will supply the smart card technology that we have developed over
recent years, including the smart chip with an operating system and antenna that
is embedded in the passport. Our advanced technology meets the new strict
international standards (ISO and ICAO) and the high requirements for travel
documents set forth by the United States authorities in this tender.
ORGANIZATIONAL STRUCTURE
The diagram below shows SuperCom Ltd.'s holdings in its subsidiaries and
affiliates as of June 30, 2004:
-------------
SuperCom Ltd.
-------------
|
|
----------------------------------------------------------
| | | |
|100% | 100% |66% 40% |
| | | |
- ----------------- --------- ------------- -------------
SuperCom SuperCom, SuperCom CT
Asia Pacific Ltd. Inc. Slovakia A.S. CardTech Ltd.
- ----------------- --------- ------------- -------------
As part of our reorganization plan, we have made a strategic decision
to focus on our core business and shut down all operations that are not a part
thereof. As a result, we liquidated Genodus Inc. and its subsidiary; Kromotech
Inc. and its subsidiary, both of which developed technology used in our
-48-
business, which we currently own, and sold all of our equity in InkSure
Technologies, Inc. and its subsidiaries.
SUPERCOM ASIA PACIFIC LIMITED ("SAP")
SAP, registered in Hong Kong, is responsible for our sales and marketing efforts
in the Far East. SAP was 80% owned by us and 20% by Chandler Technology Limited,
a company owned by SAP's former managing director, Thomas Chan. On November 17,
2003 we entered into an agreement with Chandler Technology Limited for
purchasing Chandler Technology's shares in SAP. SAP is currently 100% owned by
us.
C.T. CARD TECH TECHNOLOGIES (1994) LTD. ("CT CARD TECH")
CT Card Tech, incorporated in Israel in 1994, is responsible for our sales and
marketing activities in the former Soviet Union (other than the Ukraine and
Moldova). CT Card Tech is 40% owned by us and 60% owned by CT Card Tech's
managing director.
SUPERCOM SLOVAKIA A.S. ("SUPERCOM SLOVAKIA")
SuperCom Slovakia, incorporated in Slovakia, was established to implement a
national documentation project in the Republic of Slovakia. SuperCom Slovakia is
66% owned by us and 34% owned by EIB Group a.s., a privately held Czech company.
SUPERCOM, INC.
SuperCom, Inc., incorporated in Delaware, is responsible for our sales and
marketing efforts in the United States. SuperCom, Inc. is 100% owned by us.
PROPERTY, PLANTS AND EQUIPMENT
We do not own any real estate property.
We currently lease approximately 1,844 square meters of facilities In
Ra'anana, Israel. Our principal management, administration and marketing
activities occupy approximately 600 square meters on the site. Our principal
engineering, research and development and manufacturing activities occupy
approximately 1244 square meters on the site. Such manufacturing activities
consist of the production of smart cards and assembly lines for our smart card
products and secured documents solutions. The lease for substantially all of
this space expires in August 2005. We sublet space in this facility to CT Card
Tech, one of our subsidiaries. Other than the space we sublease, we utilize the
full capacity of our facilities in Ra'anana.
SuperCom Asia Pacific's leases approximately 200 square meters of
office space in Hong Kong, and SuperCom, Inc. leases approximately 200 and 30
square meters of office space in New York and Washington, D.C., respectively.
All of such leased properties in Hong Kong and the United States consist of
office space for management, administrative and marketing activities.
The total annual rental fee for 2001, 2002 and 2003 was US$ 571,000,
US$ 414,121 and US$ 311,804, respectively, and was linked to the Consumer Price
Index in the United States. The total annual lease commitments for 2004 are
US$370,000.
All assets are held in the name of SuperCom Ltd. and its subsidiaries.
The following table details our fixed assets as of December 31, 2003:
DECEMBER 31,
-----------------------------
2002 2003
------------ ------------
COST: (IN THOUSANDS OF US DOLLARS)
Computers and peripheral equipment $ 2,287 $ 2,281
Office furniture and equipment 410 408
Leasehold improvements 1,027 1,107
------------ ------------
3,724 3,796
------------ ------------
ACCUMULATED DEPRECIATION:
Computers and peripheral equipment 1,423 1,412
Office furniture and equipment 164 192
Leasehold improvements 257 516
------------ ------------
1,844 2,120
------------ ------------
Depreciated cost $ 1,880 $ 1,676
============ ============
-49-
Depreciation expenses for the years ended December 31, 2001, 2002 and
2003 were $ 372,000, $ 442,000 and $ 371,000, respectively.
EMPLOYEES
As of June 30, 2004 and December 31, 2003, we had 63 and 59 full-time
employees, respectively. The following table describes our employees and the
employees of our subsidiaries by department.
DEC. 31, DEC. 31, DEC. 31, JUNE 30,
2001 2002 2003 2004
-------- -------- -------- -------
Research, Development & Manufacturing 34 25 21 23
Marketing and Sales 13 15 27 29
Administration 12 11 11 11
-- -- -- --
TOTAL 59 51 59 63
SuperCom's Israeli employees are not part of a collective bargaining
agreement. However, in Israel we are subject to certain labor statutes, and to
certain provisions of collective bargaining agreements between the Histadrut,
the General Federation of Labor in Israel, and the Coordinating Bureau of
Economic Organizations, including the Industrialists' Association. These are
applicable to our Israeli employees by virtue of expansion orders of the Israeli
Ministry of Labor and Welfare. These statutes and provisions principally concern
the length of the workday, minimum daily wages for professional workers,
procedures for dismissing employees, determination of severance pay, annual and
other vacations, sick pay and other conditions for employment. We provide our
employees with benefits and working conditions that comply with the required
minimum. In addition, all employees in Israel under collective bargaining
agreements and expansion orders are entitled to automatic adjustment of wages
relative to increases in the Consumer Price Index in Israel. The amount and
frequency of these adjustments are modified from time to time.
Generally, all male adult citizens and permanent residents of Israel
under the age of 54 are, unless exempt, obligated to perform up to 30 days of
military reserve duty annually. Additionally, all such residents are subject to
being called to active duty at any time under emergency circumstances. Some of
our officers and employees are currently obligated to perform annual reserve
duty. While we have operated effectively under these requirements since we began
operations, no assessment can be made as to the full impact of such requirements
on our workforce or business if conditions should change, and no prediction can
be made as to the effect on us of any expansion of such obligations.
All of our employees have entered into confidentiality agreements. We
have also granted certain employees options to purchase shares of our ordinary
shares under our option plan. We consider our relationship with our employees to
be a good one and have never experienced a strike or work stoppage.
Our ability to succeed depends, among other things, upon our continuing
ability to attract and retain highly qualified managerial, technical,
accounting, sales and marketing personnel.
-50-
MANAGEMENT
GENERAL
We are managed by our Board of Directors that, pursuant to our Articles of
Association, must be comprised of between two and eight members. Members are
elected for a term ending at our next annual general meeting of shareholders.
The Board of Directors elects one of its members to serve as the Chairman.
The Board of Directors is composed as follows (as of the date of this
prospectus):
- -------------------------------------------------------------------------------
NAME AGE POSITION
- -------------------------------------------------------------------------------
Eli Rozen 50 Director, Chairman of the Board
- -------------------------------------------------------------------------------
Avi Landman 50 Director
- -------------------------------------------------------------------------------
Menachem Meron 75 Director
- -------------------------------------------------------------------------------
Avi Elkind 50 External Director
- -------------------------------------------------------------------------------
Michal Brikman 35 External Director
- -------------------------------------------------------------------------------
ELI ROZEN is one of our co-founders and serves as a director and our Chairman of
the Board of Directors. Mr. Rozen has served as the Chairman since 2000. In
1988, Mr. Rozen joined Electrocard Ltd., our predecessor, and served as the
General Manager and a director until our establishment in 1988. From 1988 until
2000, he served as our Chief Executive Officer and President. Mr. Rozen has a
B.S. in Industrial Engineering and Management from the Israel Institute of
Technology.
AVI LANDMAN is one of our co-founders and serves as a member of the Board of
Directors and as the Research Manager. Prior to joining us in 1988, Mr. Landman
worked as a computer engineer at Gal Bakara Ltd. and prior to that as an
electrical engineer at Eltam Ltd. Mr. Landman has a Bachelor of Science degree
in Computer Engineering from the Israel Institute of Technology - the "Technion
".
AVI ELKIND, an external Director, became a member of the Board of Directors on
July 25, 2000 and is a member of the remuneration committee as well as the audit
committee. Since 1999, Mr. Elkind has been Chairman and Chief Executive Officer
of E.A. Elkind Ltd. Prior to that, from 1997 to 1999, he was the Chief Financial
Officer of Pelephone Communication Ltd. Mr. Elkind graduated from Hebrew
University of Jerusalem in where he holds degrees in Social Studies and
Economics, Business Administration and International Affairs.
MENACHEM MERON became a member of the Board of Directors on July 25, 2000. Since
1968, Mr. Meron has been managing director of IFTIC Ltd., a consulting firm. Mr.
Meron serves as a director with the Polar Investment Company Ltd., Magal
Securities Systems Ltd. and Paz Lubricants & Chemicals Ltd.
MICHAL BRIKMAN, an external Director, became a member of the Board of Directors
on October 28, 2004. Ms. Brikman is a Certified Public Accountant with extensive
management and accounting experience. In addition to her appointment to
SuperCom's Board of Director, she also serves on the Board of other public
companies in Israel. Ms. Brikman received her Masters in Finance from Baruch
College in New York City and later relocated to Israel.
EXECUTIVE OFFICERS AND KEY EMPLOYEES
Our executive officers and certain key employees who are not also directors
are:
- --------------------------------------------------------------------------------
NAME AGE POSITION
- --------------------------------------------------------------------------------
Avi Schechter 39 President, Chief Executive Officer
- --------------------------------------------------------------------------------
Eli Basson 43 Vice President IPS (Int'l Project Solutions) Division
- --------------------------------------------------------------------------------
Eyal Tuchman 36 Vice President, Chief Financial Officer
- --------------------------------------------------------------------------------
-51-
Avi Schechter, President And Chief Executive Officer, is SuperCom's Chief
Executive Officer and President. Mr. Schechter has been our Chief Executive
Officer and President since 2001. Mr. Schechter has many years of commercial and
managerial experience. From March 2001 to November 2001, he served as the Chief
Executive Officer of Genodus Inc., one of SuperCom's subsidiaries. Mr. Schechter
was in charge of developing a generic platform that pioneered a simplified and
complete implementation of a multitude of Enterprise Application Integration
projects. Prior to joining Genodus, from November 1998 to February 2001, he was
the Chief Executive Officer of E-com Global Electronic Commerce, a subsidiary of
the Aurec group. Prior to that, Mr. Schechter was the Chief Executive Officer of
Tikal Ltd., a service company, which provides medical information for insurance
companies. He holds a B.A. in Economics and Sociology from Bar-Ilan University
and an M.S. in Information Systems from Recanati School of Business, Tel-Aviv
University.
Eli Basson, Vice President Ips (Int'l Project Solutions) Division. Mr. Basson
entered his position after serving as the Chief Executive Officer of Genodus,
Inc. from December 1999 to March 2001. Before joining Genodus, Basson served as
our Vice President of Research & Development and Operations. From July 1994 to
July 1997, he was Vice President of Customer Support for Eldor Computers, and
from December 1992 to July 1994, he was Deputy Vice President of Customer
Support and Response Center Manager at Orbotech (USA). Basson holds a Masters of
Science in Management from Lesley College and a B.S. in Electrical Engineering
from the Technion Israel Institute of Technology.
Eyal Tuchman, CPA, Vice President, Corporate Finance And Chief Financial
Officer, Mr. Tuchman has years of experience in accounting and finance in
publicly traded companies. Prior to joining us in 2002, he served as Chief
Financial Officer of Magam Group, a company traded on the Tel-Aviv Stock
Exchange, from 1996 to 2002, and before that, was a Senior Auditor at Kessleman
& Kessleman (today, PriceWaterhouseCoopers), one of the top five CPA firms in
Israel. Mr. Tuchman holds a B.A. in Economics & Accounting from Ben Gurion
University, as well as a C.P.A.
COMPENSATION OF DIRECTORS AND OFFICERS
The aggregate amount of compensation paid by us to our board members
and the following executive officers: (i) President and Chief Executive Officer;
(ii) Vice President, Projects and Chief Operating Officer; (iii) Chairman of the
Board of Directors; (iv) Vice President, Business Development and Marketing and
(v) Vice President, Corporate Finance and Chief Financial Officer (collectively,
the "Named Executive Officers") for the years ended December 31, 2003 was
approximately US $706,904.
The following table summarizes the compensation paid by us in U.S.
dollars to our board members and executive officers in 2003 and share options
granted thereto in 2003:
Base Salary $660,000
Other Benefits 47,000
--------
Total $707,000
========
Number of Share Options 870,981
The following table sets forth, with respect to each of our directors,
all remuneration paid by us during the fiscal year ended December 31, 2003:
- ----------------------------------------------------------------------------------------------------------------------
NAME TITLE BASE FEE ($) BENEFITS ($) TOTAL ($)
- ----------------------------------------------------------------------------------------------------------------------
Eli Rozen Chairman of the Board and 144,000 3,000 147,000
Board Member
- ----------------------------------------------------------------------------------------------------------------------
Avi Landman Board Member 73,000 14,000 87,000
- ----------------------------------------------------------------------------------------------------------------------
Avi Elkind Board Member 7,260 - 7,260
- ----------------------------------------------------------------------------------------------------------------------
Menahem Meron Board Member 16,800 - 16,800
- ----------------------------------------------------------------------------------------------------------------------
On January 26, 2003, at a special general meeting, our shareholders
approved the grant to each of our directors who is not an external director,
commencing on October 1, 2002, a monthly $1,000 fee participation remuneration
-52-
per meeting of the Board of Directors, provided however, that each of the
directors who is not an external director shall be entitled to an aggregate sum
of monthly remuneration and participation remuneration of not more than $18,000
per year.
As of March 31, the Company had set aside approximately $332,000 to
provide pension, retirement or similar benefits for its management.
OPTION/SAR GRANTS DURING THE YEAR ENDED DECEMBER 31, 2003
During the year ended December 31, 2003, no options were granted to the
Executive Officers.
AGGREGATED OPTION/SAR EXERCISES DURING THE YEAR ENDED DECEMBER 31, 2003
AND FINANCIAL YEAR-END OPTION/SAR VALUES
The following table sets out (i) the number of Ordinary Shares issued
to the Named Executive Officers upon the exercise of options during the year
ended December 31, 2003 and the aggregate value realized upon such exercises;
and (ii) the number and value of unexercised options held by the Named Executive
Officers as at December 31, 2003:
- -------------------------------------------------------------------------------------------------------------------------
NAME AND POSITION SECURITIES AGGREGATE VALUE UNEXERCISED VALUE OF UNEXERCISED
IN-THE-MONEY
OPTIONS/SARS OPTIONS/SARS AT
ACQUIRED ON AT FY-END (#) FY-END ($)
EXERCISE REALIZED EXERCISABLE/ EXERCISABLE/
(#) ($) UNEXERCISABLE UNEXERCISABLE (1)
- -------------------------------------------------------------------------------------------------------------------------
Avi Schechter - President, Chief
Executive Officer - - 140,000 29,400
- -------------------------------------------------------------------------------------------------------------------------
Eyal Tuchman - Vice President,
Chief Financial Officer - - 50,000 10,500
- -------------------------------------------------------------------------------------------------------------------------
Eli Basson - Vice President,
Research and Development and Chief
Operating Officer 74,078 7,408 5,922 1,244
- -------------------------------------------------------------------------------------------------------------------------
(1) Based on the closing price of our ordinary shares on the Euronext Brussels
New Market of $0.6318 on December 31, 2003.
BOARD PRACTICES
Our Board of Directors and senior management consider good corporate
governance to be central to our effective and efficient operations. The
following table lists our directors, the positions they hold with us and the
dates the directors were first elected or appointed:
- --------------------------------------------------------------------------------
NAME POSITION TERM
- --------------------------------------------------------------------------------
Eli Rozen Director, Chairman of the Board 1988
- --------------------------------------------------------------------------------
Avi Landman Director 1988
- --------------------------------------------------------------------------------
Menachem Meron Director July 25, 2000
- --------------------------------------------------------------------------------
Avi Elkind External Director July 25, 2000
- --------------------------------------------------------------------------------
Michal Brikman External Director October 28, 2004
- --------------------------------------------------------------------------------
Our Articles of Association provide that the minimum number of members
of the Board of Directors is two and the maximum number is eight. The Board of
Directors is presently comprised of four members, one of whom was appointed as
an external director under the provisions of the Companies Law (discussed below)
by the shareholders at our 2003 Annual General Meeting of Shareholders. All
directors hold office until their successors are elected at the next annual
general meeting of shareholders.
Under the Companies Law and the regulations promulgated pursuant
thereto, Israeli public companies, namely companies whose shares have been
offered to the public, or that are publicly traded are required to appoint at
least two natural persons as "external directors". A person may not be appointed
as an external director if the person, or a relative, partner or employer of the
-53-
person, or any entity under the person's control, has or had, on or within the
two years preceding the date of the person's appointment to serve as an external
director, any affiliation with the company to whose board the external director
is proposed to be appointed, with the controlling shareholder of such company or
with any entity controlling or controlled by such company or by the controlling
shareholder of such 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 (which term includes a director).
In addition, no person may serve as an external director if the
person's position or other business activities create, or may create, a conflict
of interest with the person's responsibilities as an external director or
interfere with the person's ability to serve as an external director or if the
person is a member or employee of the Israel Securities Authority or of an
Israeli stock exchange. If, at the time of election of an external director, all
other directors are of the same gender, the external director to be elected must
be of the other gender.
Each committee of a company's board of directors that has the authority
to exercise powers of the board of directors is required to include at least one
external director and its audit committee must include all external directors.
External directors are elected at the general meeting of shareholders
by a simple majority, provided that the majority includes at least one-third
of the shareholders who are not controlling shareholders, who are present and
voting, or that the non-controlling shareholders who vote against the election
hold one percent or less of the voting power of the company. Notwithstanding
the above, regulations under the Companies Law provide that with respect to
companies such as us, whose shares are traded on a stock exchange outside of
Israel, the board of directors may determine that a director appointed prior
to February 1, 2000 (the effective date of the Companies Law), who meets the
above qualifications, be deemed an external director even if the person served
as a director when the Companies Law became effective. In such case
shareholder approval is not required.
At our 2003 Annual General Meeting held on June 30, 2003, Esther Koren
and Avi Elkind were each re-elected to serve as external directors for an
additional term of three years ending on June 30, 2006. However, Esther Koren
resigned as a member of our Board of Directors due to personal reasons effective
July 14, 2004. Ms. Michal Brikman was subsequently appointed to our Board of
Directors as an External Director which was approved by our shareholders at a
special general shareholder meeting on October 28, 2004. In addition, we intend
to appoint Ms. Brikman to the audit committee.
Under the Companies Law, an external director cannot be dismissed from
office unless: (i) the board of directors determines that the external director
no longer meets the statutory requirements for holding the office, or that the
external director has breached the external director's fiduciary duties and the
shareholders vote, by the same majority required for the appointment, to remove
the external director after the external director has been given the opportunity
to present his or her position; (ii) a court determines, upon a request of a
director or a shareholder, that the external director no longer meets the
statutory requirements of an external director or that the external director has
breached his or her fiduciary duties to the company; or (iii) a court
determines, upon a request of the company or a director, shareholder or creditor
of the company, that the external director is unable to fulfill his or her duty
or has been convicted of specified crimes.
BOARD COMMITTEES
We currently have the following committees:
AUDIT COMMITTEE
The Companies Law requires public companies to appoint an audit
committee comprised of at least three directors, including all of the external
directors, and further stipulates that the chairman of the board of directors of
a public company, any director employed by or providing other services on a
regular basis to the company and the controlling shareholder or any relative of
the controlling shareholder of such company may not be members of the audit
committee of the company. We have an audit committee (the "Audit Committee"), a
majority of whose members, including the Chairman, satisfy the criteria of
independence as required by Euronext Rules. The functions of the Audit Committee
include, among others, reviewing and evaluating the results and scope of the
audit and other services provided by our independent accountants. In addition,
tasks include reviewing our accounting principles and system of internal
auditing controls and approving actions or transactions requiring Audit
Committee approval under the Companies Law, the Articles of Association and the
Euronext Rules. The Audit Committee is comprised of Mr. Avi Elkind and Mr.
Menachem Meron. Prior to her resignation, Esther Koren had been a member of the
Audit Committee. Following the shareholders meeting in accordance with the
applicable provisions of the Companies Law, we intend to replace Ms. Koren with
-54-
Ms. Michal Brikman, an external director that satisfies the criteria of
independence as required by Euronext Rules.
REMUNERATION COMMITTEE
We have a remuneration committee (the "Remuneration Committee"), a
majority of whose members, including the Chairman, satisfy the criteria of
independence required by Euronext Rules. Under the Companies Law, the
Remuneration Committee may only make recommendations to the Board of Directors
concerning the grant of options and may need to seek the approval of the Audit
Committee, the Board of Directors and the shareholders for certain compensation
decisions. The Remuneration Committee is responsible for making recommendations
on remuneration of Named Executive Officers and the implementation of the
Employee Share Option Plan. The Named Executive Officers and our senior officers
are paid fairly and commensurably with their contributions to furthering our
strategic direction and objectives. We also grant stock options to our officers,
directors and employees from time to time in accordance with our stock option
plan. The Remuneration Committee is comprised of Avi Elkind and Menachem Meron.
Prior to her resignation, Esther Koren had been a member of the Remuneration
Committee. Following the shareholders meeting in accordance with the applicable
provisions of the Companies Law, we intend to replace Ms. Koren with an external
director that satisfies the criteria of independence as required by Euronext
Rules within the next 60 days.
EMPLOYMENT AGREEMENTS, TERMINATION OF EMPLOYMENT AND CHANGE-IN-CONTROL
ARRANGEMENTS
We have employment agreements with the following executive officers and
directors:
Avi Schechter's consulting/services agreement, dated July 1, 2002,
provides for his services as our President and Chief Executive Officer until
terminated by either party as described below. The agreement provides for an
annual salary of $179,822. In addition, we provide Mr. Schechter with the use of
an automobile, mobile telephone and regular telephone. Either party may
terminate the employment agreement without cause upon 90 days' prior notice or
we may terminate it upon 30 days' notice for cause. In the event of Mr.
Schechter's termination in connection with a change of control, he is entitled
to receive his salary for 180 days. During 2002, we granted Mr. Schechter
options to purchase an aggregate of 140,000 ordinary shares at an exercise price
of $0.42 per share.
Eyal Tuchman's employment agreement, dated July 1, 2002, provides for
his employment as our Vice President, Corporate Finance and Chief Financial
Officer until terminated by either party as described below. The agreement
provides for an annual salary of $97,780, plus a bonus as determined by the
board of directors. In addition, we provide Mr. Tuchman with the use of an
automobile and mobile telephone. Either party may terminate the employment
agreement without cause upon 90 days' prior notice or we may terminate it
immediately for cause. During 2002, we granted Mr. Tuchman an option to purchase
50,000 ordinary shares at an exercise price of $0.42 per share.
Eli Basson's employment agreement, dated July 28, 1997, provides for
his employment as our Vice President and Chief Operating Officer until
terminated by either party as described below. The agreement provides for an
annual salary of $113,668. Either party may terminate the employment agreement
without cause upon 90 days' prior notice or we may terminate it upon two weeks'
prior notice for cause. During 2002, we granted Mr. Basson an option to purchase
17,764 ordinary shares at an exercise price of $0.42 per share.
Eli Rozen's (Director) consulting/services agreement, dated October 1,
2001, provides for his employment as our Chairman of the Board of Directors
until terminated by either party as described below. The agreement provides for
an annual salary of $110,400. In addition, we provide Mr. Rozen with the use of
an automobile and mobile telephone and regular telephone. Either party may
terminate the employment agreement without cause upon 60 days' prior notice or
we may terminate it upon 30 days' notice for cause. During 2003, we granted Mr.
Rozen an option to purchase 720,981 ordinary shares at an exercise price of
$0.42 per share.
Avi Landman's (Director) consulting/services agreement, dated October
1, 2001, provides for his employment as our Research Manager until terminated by
either party as described below. The agreement provides for an annual salary of
$55,200. Either party may terminate the employment agreement without cause upon
60 days' prior notice or we may terminate it upon 30 days' notice for cause.
-55-
SHARE OWNERSHIP
The following table shows the number of Ordinary Shares and options to purchase
Ordinary Shares beneficially owned by each director and the Named Executive
Officers as of October 1, 2004.
- -----------------------------------------------------------------------------------------------------------------
NAME ORDINARY % OF OUTSTANDING OPTIONS EXERCISE PRICE EXPIRATION DATE
SHARES HELD ORDINARY SHARES OUTSTANDING
DIRECTLY AND AS OF APRIL 30,
BENEFICIALLY 2004
- -----------------------------------------------------------------------------------------------------------------
Eli Rozen 2,425,359 18.7% 720,981 $ 0.42 27, January, 2013
- -----------------------------------------------------------------------------------------------------------------
Avi Landman 2,345,764 18.09% 50,000 $ 0.42 27, January, 2013
- -----------------------------------------------------------------------------------------------------------------
Menachem Meron - - 50,000 $ 0.42 7, October 2012
- -----------------------------------------------------------------------------------------------------------------
Avi Elkind - - 50,000 $ 0.42 30, June 2013
- -----------------------------------------------------------------------------------------------------------------
Avi Schechter - - 70,000 $ 0.42 1, January 2012
70,000 $ 0.42 17, March 2012
150,000 $ 0.42 25, April 2014
- -----------------------------------------------------------------------------------------------------------------
Eyal Tuchman - - 50,000 $ 0.42 20, June 2012
75,000 $ 0.42 25, April 2014
- -----------------------------------------------------------------------------------------------------------------
Eli Basson - - 5,922 $ 0.42 17, March 2012
75,000 $ 0.52 25, April 2014
- -----------------------------------------------------------------------------------------------------------------
All of our Ordinary Shares have identical voting rights.
STOCK OPTION PLAN
On February 14, 1999, the Board of Directors adopted, and our
shareholders subsequently approved, the 1999 Employee Stock Option Plan, which
was amended and restated in March 2002 and November 2003 (the "Option Plan").
The Option Plan is intended to provide incentives to our employees, officers,
directors and/or consultants by providing them with the opportunity to purchase
our Ordinary Shares. Under the Option Plan, options to purchase an aggregate of
up to the number of our authorized ordinary shares (26,500,000) may, from time
to time, be awarded to any employee, officer, director and/or consultant. The
Option Plan is, subject to the provisions of the Companies Law, administered by
the Remuneration Committee, and is designed: (i) to comply with Section 102 of
the Tax Ordinance or any provision which may amend or replace it and rules
promulgated thereunder and to enable us and grantees thereunder to benefit from
Section 102 of the Tax Ordinance and the Commissioner's Rules; and (ii) to
enable us to grant options and issue shares outside the context of Section 102
of the Tax Ordinance. Options become exercisable ratably over a period of three
to five years, commencing with the date of grant. The options generally expire
no later than 10 years from the date of grant. Any options, which are forfeited
or canceled before expiration, become available for future grants.
During 2003, options to purchase a total of $1,005,981, $151,646 and
200,533 Ordinary Shares (having respective weighted exercise prices of $0.42,
$0.72 and $0.42 per share) were awarded, cancelled and exercised, respectively,
under this Plan. As of March 31, 2004, under this Plan, options to purchase a
total of 2,172,878 Ordinary Shares and having a weighted average exercise price
of $0.975 per share, were outstanding.
As a result of an amendment to Section 102 of the Tax Ordinance as part
of the 2003 Israeli tax reform, and pursuant to an election made by us
thereunder, capital gains derived by optionees arising from the sale of shares
pursuant to the exercise of options granted to them under Section 102 after
January 1, 2003, will generally be subject to a flat capital gains tax rate of
25%. Previously, such gains were taxed as salary income at the employee's
marginal tax rate (which could be up to 50%). However, as a result of this
election, we will no longer be allowed to claim as an expense for tax purposes
the amounts credited to such employees as a benefit when the related capital
gains tax is payable by them, as we had previously been entitled to do under
Section 102. For certain information as to the Israeli tax reform, see
"Taxation." (1)
A summary of our stock option activity, and related information is as
follows:
-56-
YEAR ENDED DECEMBER 31,
------------------------------------------------------------------------------
2001 2002 2003
------------------------- ------------------------- -------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
NUMBER OF EXERCISE NUMBER OF EXERCISE NUMBER OF EXERCISE
OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE
------------ ----------- ------------ ----------- ----------- ------------
Outstanding at 768,410 $ 4.30 543,495 $ 5.19 880,712 $2.88
beginning of year
Granted 65,000 0.42 443,081 0.42 1,005,981 0.42
Exercised - - - - (200,533) 0.42
Canceled and
forfeited (289,915) 3.36 (105,864) 4.41 (151,646) 0.72
------------ ------------ -----------
Outstanding at end of year 543,495 $ 5.19 880,712 $ 2.88 1,534,514 1.8
============ =========== ============ =========== =========== ============
Exercisable at end of year 329,842 $ 5.58 478,714 $ 4.32 1,082,846 1.91
============ =========== ============ =========== =========== ============
The options outstanding as of December 31, 2003, have been separated into ranges
of exercise price as follows:
OPTIONS WEIGHTED OPTIONS
OUTSTANDING AVERAGE WEIGHTED EXERCISABLE WEIGHTED
AS OF REMAINING AVERAGE AS OF AVERAGE
EXERCISE DECEMBER 31, CONTRACTUAL EXERCISE DECEMBER 31, EXERCISE
PRICE 2003 LIFE (YEARS) PRICE 2003 PRICE
- -------------------- --------------- -------------- -------------- ----------------- --------------
$ 0.42 1,303,781 8.95 $0.42 869,314 $ 0.42
$ 2.00 15,000 2 2.0 9,000 $ 2.0
$ 4.00 - $ 6.00 18,670 0.5 5.09 16,180 $ 5.25
$ 8.00 - $ 9.60 197,063 0.2 8.14 188,352 $ 8.52
--------------- -----------------
1,534,514 1.8 1,082,846 $ 1.91
=============== ============== ================= ==============
-57-
CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS
On September 1, 2001, we entered into an agreement with our 40%-owned
subsidiary CT Card Tech pursuant to which we have agreed to sub-lease office
space in our Rannana, Israel facility to CT Card Tech and to provide CT Card
Tech with certain additional services in consideration for a monthly payment of
$1,000. In November 2003, CT Card Tech surrendered a portion of its office
space, which reduced the monthly payment to US$ 500.
On March 7, 2000 we entered into an agreement with IFTIC Ltd., or
IFTIC, a company registered in Israel and 50%-owned by Menachem Meron, a member
of our board of directors. Under the terms of the agreement, IFTIC provides us
with market promotion and management services for a minimum fee of $2,500 per
month for the first 10 hours and an additional fee of 1.5% of sales initiated
from new customers first introduced by Mr. Meron. During 2003, we paid $16,800
pursuant to this agreement.
On October 1, 2001, we entered into a consulting agreement with Phinal
Ltd, a company owned by our chairman of the Board of Directors and a principal
shareholder, Eli Rozen. In consideration of these services, we have undertaken
to pay Mr. Rozen $10,500 per month plus car expenses. During 2003, we paid an
aggregate of $126,000 pursuant to this agreement.
On October 1, 2001, we entered into a consulting agreement with Ashland
Investments Ltd., or Ashland, a company owned by Avi Landman, a current member
of our board of directors, one of our co-founders and a principal shareholder.
In consideration of these services, we have undertaken to pay Mr. Landman $4,600
per month. In addition, we provide Mr. Landman with the use of an automobile and
mobile telephone. During 2003, we paid Ashland $55,200 pursuant to this
agreement.
During 2002, Avi Landman, one of our co-founders, received $152,442 as
back compensation in connection with salary and social benefits for the period
he served as an employee in connection with the termination of his employment
agreement.
On October 1, 2001, we entered into a consulting agreement with J.R.
Hagran Ltd., a company owned by one of our co-founders Jacob Hassan. In
consideration for these services, we have undertaken to pay Mr. Hassan $4,600
per month plus car expenses. During 2003, we paid J.R. Hagran Ltd. an aggregate
of $55,200 pursuant to this agreement.
During 2002, one of our co-founders, Jacob Hassan, received $154,000 as
back compensation in connection with salary and social benefits for the period
he served as an employee in connection with the termination of his employment
Agreement.
-58-
PRINCIPAL SHAREHOLDERS
The following table lists the beneficial ownership of our securities as
of October 15, 2004 and as adjusted to reflect the sale of ordinary shares in
this offering by:
o each person known by us to be the beneficial owner of more than 5%
of the outstanding shares of any class of our securities,
o each of our directors and executive officers individually, and
o all of our executive officers and directors as a group:
Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission and generally includes voting or investment
power with respect to securities. The principal address of our directors and
executive officers listed below (all but Jacob Hassan) is c/o SuperCom Ltd.,
Millennium Bldg., 3 Tidhar St., P.O.B. 2094, Raanana, Israel. We believe that
all persons named in the table have sole voting and sole investment power with
respect to all shares beneficially owned by them. All figures include ordinary
shares issuable upon the exercise of options or warrants exercisable within 60
days of October 28, 2004 and deemed to be outstanding and beneficially owned by
the person holding those options or warrants for the purpose of computing the
percentage ownership of that person, but are not deemed to be outstanding for
the purpose of computing the percentage ownership of any other person.
NUMBER OF SHARES PERCENTAGE OF
BENEFICIALLY SHARES
NAME OF BENEFICIAL OWNER OWNED OUTSTANDING
- ------------------------ ---------------- -------------
Eli Basson(1) 94,450 *
Jacob Hassan(2) 2,346,358 13.8%
Avi Landman(3) 2,379,098 13.97%
Menahem Meron(4) 33,333 *
Eli Rozen(5) 3,129,674 17.68%
Avi Schechter(6) 200,000 *
Eyal Tuchman(7) 75,000 *
Avi Elkind(8) 33,333 *
Michal Brikman 0 0
All directors and executive 5,944,888 32.76%
officers as a group (8 persons)(9)
- ----------
* Represents beneficial ownership of less than 1% of outstanding ordinary
shares.
(1) Includes options to purchase 80,922 ordinary shares which are currently
exercisable or exercisable within 60 days of the date hereof.
(2) Mr. Hassan's address is 21 Shnat Hayovel, Hod Hasharon , Israel.
(3) Includes (a) options to purchase 33,334 ordinary shares which are
currently exercisable or exercisable within 60 days of the date hereof
and (b) 500,000 shares owned by Ashland Investments LLC, a limited
liability company owned by Mr. Landman.
(4) Includes options to purchase 33,333 ordinary shares which are currently
exercisable or exercisable within 60 days of the date hereof. Mr. Meron
is one of our current directors.
(5) Includes options to purchase 704,315 ordinary shares which are
currently exercisable or exercisable within 60 days of the date hereof.
(6) Includes options to purchase 190,000 ordinary shares which are
currently exercisable or exercisable within 60 days of the date hereof.
(7) Includes options to purchase 75,000 ordinary shares which are currently
exercisable or exercisable within 60 days of the date hereof.
(8) Includes options to purchase 33,333 ordinary shares which are currently
exercisable or exercisable within 60 days of the date hereof.
(9) Includes options to purchase 1,150,236 ordinary shares which are
currently exercisable or exercisable within 60 days of the date hereof.
-59-
DESCRIPTION OF SHARE CAPITAL
Set forth below is a summary of certain in formation relating to our
share capital and of certain provisions of our Articles of Association and
Israeli law. This summary does not purport to be complete. It is qualified in
its entirety by reference to the Articles of Association and Israeli law in
effect at the date of this prospectus.
AUTHORIZED AND ISSUED SHARE CAPITAL
Our capital stock consists of 26,500,000 ordinary shares, NIS 0.01 par
value, authorized. As of October 15, 2004, we had 16,996,287 ordinary shares
outstanding, which are all fully paid. As of December 31, 2003, there were
12,906,872 outstanding ordinary shares, and as of January 1, 2003, we had
12,706,339 outstanding ordinary shares.
CHANGES IN ISSUED SHARE CAPITAL
The following sets forth the changes in our issued share capital
occurring during the least three years:
January 1, 2001 to December 31, 2001
As of January 1, 2001, there were 12,706,339 ordinary shares
outstanding. There were no changes in issued share capital during 2001.
January 1, 2002 to December 31, 2002
As of January 1, 2002, there were 12,706,339 ordinary shares
outstanding. There were no changes in issued share capital during 2002.
We divested our investment (100% of the shares) in our subsidiary
InkSure Technologies, Inc. (formerly known as InkSure, Inc.) in three parts. Due
to such divestments, we had a gain in the aggregate amount of $6,423,000. The
details of such divestitures are as follows:
During March 2002, we divested part of our investment in InkSure
Technologies Inc. to Elad Ink, a privately held investment company. Under the
terms of the transaction, we sold 1,141,553 shares in the subsidiary for
$1,000,000.
During May 2002, we divested another part of our investment in InkSure
to ICTS Information Systems BV, a member of the ICTS group (NASDAQ: ICTS). Under
the terms of the transaction, we sold 782,771 shares in the subsidiary for
$1,000,000. As a result of these divestitures, we had gains net of expenses in
the amount of $1,936,000.
On October 2, 2002, we divested the remaining investment in InkSure
Technologies Inc. to ICTS Information Systems BV. Under the terms of the
transaction, we sold 3,075,676 shares in InkSure for $ 4,583,000.
January 1, 2003 to December 31, 2003
As of January 1, 2003, there were 12,706,339 ordinary shares
outstanding.
During December 2003, 200,533 of our outstanding stock options were exercised
and such ordinary shares issued upon exercise have been listed on Euronext
Brussels New Market.
January 1, 2004 to August 31, 2004
As of January 1, 2004, there were 12,906,872 ordinary shares
outstanding.
During February 2004, 60,000 shares were issued to an employee upon
exercise pursuant to the option plan.
-60-
During June and July, 2004, the Company received aggregate gross
proceeds of $1,225,000 from a private placement of 1,558,826 ordinary shares and
five-year warrants to purchase 623,535 ordinary shares at an exercise price of
$1.10 per share. In connection with the private placement, our placement
advisors received warrants to purchase 77,941 ordinary shares at an exercise
price of $1.10 per share. These securities were issued in reliance upon an
exemption from registration set forth in Regulation S of the Securities Act of
1933, as amended.
In August and September 2004, we received gross proceeds of $2,200,000
from a private placement to accredited investors of 2,470,589 ordinary shares
and five-year warrants to purchase 988, 234 ordinary shares at an exercise price
of $1.10 per share. In connection with the private placement, our placement
agent received warrants to purchase 177,882 ordinary shares at an exercise price
of $1.10 per share and 444,706 ordinary shares at an exercise price of $ 0.85
per share. All of such warrants issued in this private placement except 444,706
warrants with an exercise price of $0.85, may be called by us at a redemption
price of $.01 per warrant at any time after the closing price (or closing bid
price) of our ordinary shares on an U.S. stock exchange, Nasdaq or the OTC
Bulletin Board is equal to or greater than $2.50 per share for 10 out of any 15
consecutive trading days. These securities were issued in reliance upon an
exemption from registration set forth in Section 4(2) of the Securities Act of
1933, as amended, and Rule 506 of Regulation D promulgated thereunder.
As of October 18, 2004, there were 16,996,287 ordinary shares
outstanding.
WARRANTS, OPTIONS AND OTHER CONVERTIBLE OBLIGATIONS
Stock Options
As at October 15, 2004, we had outstanding options to purchase an
aggregate of 2,172,878 ordinary shares. In addition, we authorized grants of
options to employees and officers, under our option plan, with an exercise price
of $0.85, to purchase an aggregate of 1,400,000 shares, which remains subject to
all required approvals under Israeli law. Under our Stock Option Plan, we may
issue options to purchase up to our authorized number of Ordinary Shares. As at
December 31, 2003, 1,534,514 options had been granted, with exercise prices
ranging from $0.42 to $9.64. The exercise price of each option granted may not
be less than the market price of our Ordinary Shares at the time of the grant
and no option may have a term exceeding 10 years. Please refer to the section
entitled "Stock Option Plan" for further information with respect to our Option
Plan, including information with respect to option grants, exercises and
cancellations during the last three years.
Warrants
As described above, during June and July, 2004, the Company received
aggregate gross proceeds of $1,225,000 from a private placement of 1,558,826
ordinary shares and five-year warrants to purchase 623,535 ordinary shares at an
exercise price of $1.10 per share. In connection with the private placement, our
placement advisors received warrants to purchase 77,941 ordinary shares at an
exercise price of $1.10 per share.
In August and September 2004, we received gross proceeds of $2,200,000
from a private placement to accredited investors of 2,470,589 ordinary shares
and five-year warrants to purchase 988, 234 ordinary shares at an exercise price
of $1.10 per share. In connection with the private placement, our placement
agent received warrants to purchase 177,882 ordinary shares at an exercise price
of $1.10 per share and 444,706 ordinary shares at an exercise price of $ 0.85
per share. All of such warrants issued in this private placement except 444,706
warrants with an exercise price of $0.85, may be called by us at a redemption
price of $.01 per warrant at any time after the closing price (or closing bid
price) of our ordinary shares on an U.S. stock exchange, Nasdaq or the OTC
Bulletin Board is equal to or greater than $2.50 per share for 10 out of any 15
consecutive trading days.
-61-
SELLING SHAREHOLDERS
This prospectus covers offers and sales of the following ordinary shares:
o 1,558,826 ordinary shares issued in connection with a private placement
completed on July 15, 2004.
o 623,535 ordinary shares issuable upon the exercise of warrants having
an exercise price of $1.10 per share that were issued in connection
with a private placement completed on July 15, 2004.
o 2,470,589 ordinary shares issued in connection with a private placement
completed on September 10, 2004.
o 988,234 ordinary shares issuable upon the exercise of warrants having
an exercise price of $1.10 per share that were issued in connection
with a private placement completed on September 10, 2004.
o 444,706 ordinary shares issuable upon the exercise of warrants having
an exercise price of $0.85 per share and 177,882 ordinary shares
issuable upon the exercise of warrants having an exercise price of
$1.10 per share that were issued to Broadband Capital LLC as a portion
of the placement agent fee issued in connection with a private
placement completed on September 10, 2004.
o 75,000 ordinary shares issuable upon the exercise of warrants having an
exercise price of $1.10 per share that were issued to Meitav Capital
Ltd. as a portion of the placement agent fee issued in connection with
a private placement completed on July 15, 2004.
o 2,941 ordinary shares issuable upon the exercise of warrants having an
exercise price of $1.10 per share that were issued to Max Tech Ltd. as
a portion of the placement agent fee issued in connection with a
private placement completed on July 15, 2004.
The following table provides information on the selling shareholders, their
current beneficial ownership of our securities, the number of ordinary shares
offered for each shareholder's account, and the amount and percentage of their
beneficial ownership after this offering, assuming they sell all of the offered
shares. "Beneficial ownership" here means direct or indirect voting or
investment power over outstanding shares and shares which a person has the right
to acquire now or within 60 days after the date of this prospectus. The table
also includes ordinary shares issuable upon exercise of the warrants described
above.
The information in the table was provided by the selling shareholders,
reports furnished to us under rules of the SEC and our share ownership records,
as of the date of this prospectus. Except as noted in the footnotes, no selling
shareholder has had, within the past three years, any position, office or other
material relationship with us or any of our predecessors or affiliates. The
calculation of the percentage of ordinary shares beneficially owned after the
offering is based on 16,996,287 ordinary shares outstanding as of October 18,
2004.
% OF COMMON
SHARES STOCK
SHARES BENEFICIALLY BENEFICIALLY BENEFICIALLY
- -------------------------------- OWNED BEFORE OWNED AFTER OWNED AFTER
NAME OF SELLING STOCKHOLDER THE OFFERING SHARES OFFERED THE OFFERING THE OFFERING
- -------------------------------- ------------------- -------------- ------------- ------------
Jeffrey Carter 82,353(1) 82,353(1) 0 -
Donald Zoltan 82,353(2) 82,353(2) 0 -
Daniel and Clare Lange 82,353(3) 82,353(3) 0 -
Edwin Bindseil 164,706(4) 164,706(4) 0 -
Russell and Setsuko Trimble 164,706(5) 164,706(5) 0 -
Longview Fund LP (44) 494,117(6) 494,117(6) 0 -
Charles Bradley 82,353(7) 82,353(7) 0 -
Ethan Benovitz 123,529(8) 123,529(8) 0 -
Selwyn Partners LP 164,706(9) 164,706(9) 0 -
Victor M. Dandridge III 41,177(10) 41,177(10) 0 -
Jack and Monika Berg 164,706(11) 164,706(11) 0 -
Leviticus Partners LP 988,235(12) 988,235(12) 0 -
Tibo Markovitch 32,942(13) 32,942(13) 0 -
Meitav Gemel Ltd. 247,058(14) 247,058(14) 0 -
-62-
% OF COMMON
SHARES STOCK
SHARES BENEFICIALLY BENEFICIALLY BENEFICIALLY
- -------------------------------- OWNED BEFORE OWNED AFTER OWNED AFTER
NAME OF SELLING STOCKHOLDER THE OFFERING SHARES OFFERED THE OFFERING THE OFFERING
- -------------------------------- ------------------- -------------- ------------- ------------
Y.A.Z. Investments & Assets Ltd. (43) 247,058(15) 247,058(15) 0 -
Moshe Nodelman 82,354(16) 82,354(16) 0 -
Inventech Investment Ltd. 49,412(17) 49,412(17) 0 -
Adina Grinfeld 41,177(18) 41,177(18) 0 -
Amotz Raz 41,177(19) 41,177(19) 0 -
Yehuda Biron 41,177(20) 41,177(20) 0 -
Ester Orkovi 82,354(21) 82,354(21) 0 -
Abraham Peer 123,529(22) 123,529(22) 0 -
Meir Schonherz 41,177(23) 41,177(23) 0 -
Provident Fund Of The Employees Of The
Hebrew University Of Jerusalem I.N.T. 82,354(24) 82,354(24) 0 -
Abraham Peer 164,706(25) 164,706(25) 0 -
Abraham Grinfeld 82,354(26) 82,354(26) 0 -
Ester Dodkewitz 164,706(27) 164,706(27) 0 -
Meitav Gemel Ltd. 329,412(28) 329,412(28) 0 -
Meitav Investment Management and
Securities Advisors Ltd 164,706(29) 164,706(29) 0 -
Glomare BV 82,354(30) 82,354(30) 0 -
Orkobi Avishai 41,177(31) 41,177(31) 0 -
Orkobi Avishai 41,177(32) 41,177(32) 0 -
Kabuki Partners ADP, G.P. 329,412(33) 329,412(33) 0 -
Corsair Capital Partners 100 L.P. (34) 57,646(35) 57,646(35) 0 -
Corsair Capital Investors, Ltd. (34) 16,471(36) 16,471(36) 0 -
Corsair Capital Partners L.P. (34) 420,000(37) 420,000(37) 0 -
Michael Rapp (39) (40) 427,983(38) 427,983(38) 0 -
Philip Wagenheim (39) (40) 104,283(38) 104,283(38) 0 -
Karl Brenza (39) (40) 31,129(38) 31,129(38) 0 -
Broadband Capital Management LLC (40)(41) 31,130(38) 31,130(38) 0 -
Jeffrey Meshel (39) (40) 28,063(38) 28,063(38) 0 -
Meitav Capital Ltd. (42) 37,500(38) 37,500(38) 0 -
Goldhar Corporate Finance Ltd (42) 37,500(38) 37,500(38) 0 -
Max Tech Ltd. (42) 2,941(38) 2,941(38) 0 -
- --------------
*Less than one percent.
(1) Includes 23,529 ordinary shares underlying warrants which are currently
exercisable.
(2) Includes 23,529 ordinary shares underlying warrants which are currently
exercisable.
(3) Includes 23,529 ordinary shares underlying warrants which are currently
exercisable.
(4) Includes 47,059 ordinary shares underlying warrants which are currently
exercisable.
(5) Includes 47,059 ordinary shares underlying warrants which are currently
exercisable
(6) Includes 141,176 ordinary shares underlying warrants which are currently
exercisable.
(7) Includes 23,529 ordinary shares underlying warrants which are currently
exercisable.
-63-
(8) Includes 35,294 ordinary shares underlying warrants which are currently
exercisable.
(9) Includes 47,059 ordinary shares underlying warrants which are currently
exercisable.
(10) Includes 11,765 ordinary shares underlying warrants which are currently
exercisable.
(11) Includes 47,059 ordinary shares underlying warrants which are currently
exercisable.
(12) Includes 282,353 ordinary shares underlying warrants which are currently
exercisable.
(13) Includes 9,412 ordinary shares underlying warrants which are currently
exercisable.
(14) Includes 70,588 ordinary shares underlying warrants which are currently
exercisable.
(15) Includes 70,588 ordinary shares underlying warrants which are currently
exercisable.
(16) Includes 23,530 ordinary shares underlying warrants which are currently
exercisable.
(17) Includes 14,118 ordinary shares underlying warrants which are currently
exercisable.
(18) Includes 11,765 ordinary shares underlying warrants which are currently
exercisable.
(19) Includes 11,765 ordinary shares underlying warrants which are currently
exercisable.
(20) Includes 11,765 ordinary shares underlying warrants which are currently
exercisable.
(21) Includes 23,530 ordinary shares underlying warrants which are currently
exercisable.
(22) Includes 35,294 ordinary shares underlying warrants which are currently
exercisable.
(23) Includes 11,765 ordinary shares underlying warrants which are currently
exercisable.
(24) Includes 23,530 ordinary shares underlying warrants which are currently
exercisable.
(25) Includes 47,059 ordinary shares underlying warrants which are currently
exercisable.
(26) Includes 23,530 ordinary shares underlying warrants which are currently
exercisable.
(27) Includes 47,059 ordinary shares underlying warrants which are currently
exercisable.
(28) Includes 94,118 ordinary shares underlying warrants which are currently
exercisable.
(29) Includes 47,059 ordinary shares underlying warrants which are currently
exercisable.
(30) Includes 23,530 ordinary shares underlying warrants which are currently
exercisable.
(31) Includes 11,765 ordinary shares underlying warrants which are currently
exercisable.
(32) Includes 11,765 ordinary shares underlying warrants which are currently
exercisable.
(33) Includes 94,118 ordinary shares underlying warrants which are currently
exercisable.
(34) Jay Petschek and Steven Major share voting and investment power over the
securities.
(35) Includes 16,470 ordinary shares underlying warrants which are currently
exercisable.
(36) Includes 4,706 ordinary shares underlying warrants which are currently
exercisable.
(37) Includes 120,000 ordinary shares underlying warrants which are currently
exercisable.
(38) Comprised solely of ordinary shares underlying warrants which are currently
exercisable.
(39) Employee or principal of Broadband Capital Management LLC, a broker/dealer,
that acted as placement agent for our private placement of ordinary shares
and warrants consummated in August and September 2004. Michael Rapp is the
Managing Member of, and has voting and/or investment control over,
Broadband Capital Management LLC.
(40) Represents shares issuable upon exercise of warrants issued to Broadband
Capital Management LLC as partial compensation for serving as a placement
agent in our September 2004 private placement.
(41) Michael Rapp has voting and/or investment control over this selling
shareholder.
(42) Represents shares issuable upon exercise of warrants issued as partial
compensation for serving as a placement agent in our July 2004 private
placement.
-64-
(43) Mr. Yehuda Zadke has voting and/or investment control over this selling
shareholder.
(44) Peter T. Bent, Chairman of the General Partner, Viking Asset Management,
LLC, has voting and/or investment control over this selling shareholder.
PLAN OF DISTRIBUTION
We have registered the shares on behalf of the selling shareholders.
For the purposes herein, the term "selling shareholder" includes donees,
pledgees, transferees or other successors-in-interest selling shares of common
stock received after the date of this prospectus from a selling shareholder as a
gift, pledge, corporate dividend, partnership or limited liability company
distribution or other transfer. We are bearing all costs relating to the
registration of the shares, other than fees and expenses, if any, of counsel or
other advisors to the selling shareholders. Any commissions, discounts, or other
fees payable to broker-dealers in connection with any sale of the shares will be
borne by the selling shareholders. The selling shareholders may offer their
shares at various times in one or more of the following transactions, or in
other kinds of transactions:
o transactions on the Over-The-Counter Bulletin Board or on any
national securities exchange or U.S. inter-dealer system of a
registered national securities association on which the ordinary
shares may be listed or quoted at the time of sale;
o in private transactions;
o in connection with short sales of our shares;
o by pledge to secure debts and other obligations;
o in connection with the writing of non-traded and exchange-traded
call options, in hedge transactions and in settlement of other
transactions;
o in standardized or over-the-counter options; or
o in a combination of any of the above transactions.
The selling shareholders also may resell all or a portion of the shares
in open market transactions in reliance on Rule 144 under the Securities Act, if
they meet the criteria and conform to the requirements of that rule.
The selling shareholders may sell their shares at quoted market prices,
at prices based on quoted market prices, at negotiated prices or at fixed
prices. The selling shareholders may use broker-dealers to sell their shares. If
this happens, broker-dealers may either receive discounts or commissions from
the selling shareholders, or they may receive commissions from purchasers of
shares for whom they acted as agents.
The selling shareholders and any broker-dealers or agents that
participate with the selling shareholders in the sale of shares may be
"underwriters" within the meaning of the Securities Act. Any commissions
received by broker-dealers or agents on the sales and any profit on the resale
of shares purchased by broker-dealers or agents may be deemed to be underwriting
commissions or discounts under the Securities Act.
Under the rules and regulations of the SEC, any person engaged in the
distribution or the resale of our shares may not simultaneously buy, bid for or
attempt to induce any other person to buy or bid for our common stock in the
open market for a period of two business days prior to the commencement of the
distribution. The rules and regulations under the Securities Exchange Act of
1934 may limit the timing of purchases and sales of shares of our common stock
by the selling shareholders.
-65-
MEMORANDUM AND ARTICLES OF ASSOCIATION
We are a public company organized in the State of Israel under the
Israeli Companies Law. We are registered with the Registrar of Companies of the
State of Israel and we have been assigned company number 52-00-4407-4.
Set forth below is a summary of certain provisions of our Memorandum of
Association (the "Memorandum"), the Articles of Association (the "Articles") and
the Companies Law. This description does not purport to be complete and is
qualified in its entirety by reference to the full text of the Memorandum and
Articles and by Israeli law filed as exhibits to our registration statement on
Form 20-F.
Objects Of The Company
Pursuant to Section 2 of the Memorandum, the principal object for which
we were established is to engage in the development, manufacture, implementation
and marketing of computerized systems in general and computerized systems for
producing tags, computerized photograph databases for the purpose of
identification and for issuing various certificates in particular; consultation
in the above fields; development, manufacture, implementation and marketing of
any product based on the knowledge and expertise of the parties; and the
purchase, sale, import, export and implementation of any action required to
realize the above objectives.
Directors
Our Articles provide that the number of directors serving on the board
shall be not less than two but shall not exceed eight. Our directors, other than
external directors, are elected at the annual shareholders meeting to serve
until the next annual meeting or until their earlier death, resignation,
bankruptcy, incapacity or removal by resolution of the general shareholders
meeting. Directors may be re-elected at each annual shareholders meeting. The
board may appoint additional directors (whether to fill a vacancy or create new
directorship) to serve until the next annual shareholders meeting, provided,
however, that the board shall be entitled to act in every matter so long as the
number of its members is not less than the quorum required at the time for
meetings of the board. If the number of members of the board decreases below
said quorum, the board will not be entitled to act except in order to fill
vacant positions on the board or to call a general meeting of the shareholders.
Our officers serve at the discretion of the board.
The board of directors may meet and adjourn its meetings according to
our needs. A meeting of the board may be called at the request of each director.
The quorum required for a meeting of the board consists of at least two
directors constituting a majority of directors. The adoption of a resolution by
the board requires approval by a simple majority of the directors present at a
meeting in which such resolution is proposed. In lieu of a board meeting a
resolution may be adopted in writing by all directors, and a meeting may also be
held through any communications means, provided however that all participants
may hear each other simultaneously.
Subject to the Companies law, the board may appoint a committee of the
board and delegate to such committee all or any of the powers of the board, as
it deems appropriate. The board may, at any time, amend, restate or cancel the
delegation of any of its powers to any of its committees. Under the Companies
Law the board of directors must appoint an audit committee, comprised of at
least three directors and including all of the external directors. The function
of the audit committee is to review irregularities in the management of our
business and recommend remedial measures. The committee is also required, under
the Companies Law, to approve certain related party transactions. The board has
appointed an internal audit committee which has three members and a remuneration
committee which has three members.
Fiduciary Duties Of Officers
The Companies Law codifies the fiduciary duties that "office holders,"
including directors and executive officers, owe to a company. An office holder's
fiduciary duties consist of a duty of care and a duty of loyalty. The duty of
loyalty includes avoiding any conflict of interest between the office holder's
position in the company and his personal affairs, avoiding any competition with
the company, avoiding exploiting any business opportunity of the company in
order to receive personal advantage for himself or others, and revealing to the
company any information or documents relating to the company's affairs which the
office holder has received due to his position as an office holder.
Approval Of Certain Transactions
-66-
Under the Companies Law, all arrangements as to compensation of office
holders who are not directors, or controlling parties, require approval of the
board of directors. Arrangements regarding the compensation of directors also
require internal audit committee and shareholder approval.
The Companies Law requires that an office holder of the company
promptly disclose any personal interest that he or she may have and all related
material information known to him or her, in connection with any existing or
proposed transaction by the company. In addition, if the transaction is an
extraordinary transaction as defined under Israeli law, the office holder must
also disclose any personal interest held by the office holder's spouse,
siblings, parents, grandparents, descendants, spouse's descendants and the
spouses of any of the foregoing. In addition, the office holder must also
disclose any interest held by any corporation in which the office holder is a 5%
or greater shareholder, director or general manager or in which he or she has
the right to appoint at least one director or the general manager. An
extraordinary transaction is defined as a transaction other than in the ordinary
course of business, otherwise than on market terms, or that is likely to have a
material impact on the company's profitability, assets or liabilities.
In the case of a transaction which is not an extraordinary transaction,
after the office holder complies with the above disclosure requirement, only
board approval is required unless the articles of association of the company
provide otherwise. The transaction must not be adverse to the company's
interest. Furthermore, if the transaction is an extraordinary transaction, then,
in addition to any approval stipulated by the articles of association, it also
must be approved by the company's audit committee and then by the board of
directors, and, under certain circumstances, by a meeting of the shareholders of
the company. An office holder who has a personal interest in a matter that is
considered at a meeting of the board of directors or the audit committee may not
be present at the deliberations or vote on this matter. If a majority of the
directors has a personal interest in a transaction with us, such directors may
be present at the deliberations and vote in this matter, and shareholder
approval of the transaction is required.
The Companies Law applies the same disclosure requirements to a
controlling shareholder of a public company, which includes a shareholder that
holds 25% or more of the voting rights if no other shareholder owns more than
50% of the voting rights in the company. Extraordinary transactions with a
controlling shareholder or in which a controlling shareholder has a personal
interest, and the terms of compensation of a controlling shareholder who is an
office holder, require the approval of the audit committee, the board of
directors and the shareholders of the company by simple majority, provided that
either such majority vote must include at least one-third of the shareholders
who have no personal interest in the transaction and are present at the meeting
(without taking into account the votes of the abstaining shareholders), or that
the total shareholdings of those who have no personal interest in the
transaction who vote against the transaction represent no more than one percent
of the voting rights in the company.
In addition, a private placement of securities that will increase the
relative holdings of a shareholder that holds five percent or more of the
company's outstanding share capital (assuming the exercise or conversion of all
securities held by such person that are exercisable for or convertible into
shares) or voting rights or that will cause any person to become, as a result of
the issuance, a holder of more than five percent of the company's outstanding
share capital or voting rights, requires approval by the board of directors and
the shareholders of the company. However, if the receiving party is not a
director in the company, its CEO, or a controlling shareholder, and will not
become a controlling shareholder as a result of the private placement,
shareholder approval is not required if the allotted securities amount to twenty
percent or less, of the company's outstanding voting rights before the
allotment. Since our shares are traded and were offered to the public only
outside of Israel, and as long as our shares are not offered to the public or
registered for trade in Israel, we are exempted from these limitations
concerning private placements.
Under the Companies Law and as long as our Articles are not amended to
determine otherwise,, certain resolutions, such as resolutions regarding
mergers, and windings up, require approval of the holders of 75% of the shares
represented at the meeting and voting thereon.
Duties of Shareholders
Under the Companies Law, a shareholder has a duty to act in good faith
and in a customary way towards the company and other shareholders and to refrain
from abusing his or her power in the company including, among other things, when
voting in a general meeting of shareholders on the following matters:
o any amendment to the articles of association;
o an increase of the company's authorized share capital;
-67-
o a merger; or
o approval of interested party transactions which require shareholder
approval.
In addition, any controlling shareholder, any shareholder who knows
that it possesses power to determine the outcome of a shareholder vote and any
shareholder who, pursuant to the provisions of a company's articles of
association, has the power to appoint or prevent the appointment of an office
holder in the company, is under a duty to act with fairness towards the company.
The Companies Law does not describe the substance of this duty but provides that
a breach of his or her duty is tantamount to a breach of fiduciary duty of an
officer of the company.
EXEMPTION, INSURANCE AND INDEMNIFICATION OF DIRECTORS AND OFFICERS
Exemption of Office Holders
Under the Companies Law, an Israeli company may not exempt an office
holder from liability for breach of his duty of loyalty, but may exempt in
advance an office holder from liability to the company, in whole or in part, for
a breach of his duty of care, provided the articles of association of the
company allow it to do so. Our Articles allow us to exempt our office holders
entirely and in advance from liability to any damage suffered as a result of
this breach of duty of care towards us.
Office Holder Insurance
Our Articles 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 any act done by him or her by virtue of being an office
holder, in respect of any of the following:
o a breach of duty of care towards us or any other person,
o a breach of fiduciary obligations towards us, provided that the
office holder acted in good faith and had reasonable grounds to
assume that his or her act would not be to our detriment, or
o a financial liability imposed on him or her in favor of another
person.
Indemnification of Office Holders
Our Articles provide that we may indemnify an office holder, post
factum, for the following cases of liability and expenses incurred by him or her
as a result of an act done by him or her by virtue of being an office holder :
o a monetary liability imposed on him or her in favor of another
person pursuant to a judgment, including a settlement judgment or an
arbitrator award approved by a, and
o reasonable litigation expenses, including attorneys' fees, incurred
by the office holder or imposed on him or her by a court, in a
proceeding brought against him by or on our behalf or by another
person, or in a criminal proceeding from which he or she were
acquitted, or in a criminal proceeding in which he or she were
convicted for a criminal offense that does not require evidence of
criminal mens rea.
We have obtained directors and officers liability insurance for the
benefit of our office holders.
Limitations on Exemption, Insurance and Indemnification
The Israeli Companies Law provides that a company may not exempt or
indemnify an office holder, or enter into an insurance contract, which would
provide coverage for any monetary liability incurred as a result of any of the
following:
o a breach by the office holder of his or her duty of loyalty towards
the company unless, with respect to insurance coverage, the office
holder acted in good faith and had a reasonable basis to believe that
the act would not prejudice the company;
-68-
o a breach by the office holder of his or her duty of care if the
breach was done intentionally or recklessly;
o any act or omission done with the intent to derive an illegal
personal benefit; or
o any fine levied against the office holder.
Required Approvals
In addition, under the Companies Law, any exemption of, indemnification
of, or procurement of insurance coverage for, our office holders must be
approved by our audit committee and our board of directors and, if the
beneficiary is a director, an additional approval by our shareholders is
required.
-69-
DESCRIPTION OF ORDINARY SHARES
As of October 29, 2004, our authorized share capital consists of
26,500,000 ordinary shares, nominal value of NIS 0.01 per share, of which
16,996,287 are issued and outstanding, not including shares issuable upon
exercise of warrants or options.
The ownership or voting of ordinary shares by non-residents of Israel
is not restricted in any way by our articles of association or the laws of the
State of Israel
DIVIDEND AND LIQUIDATION RIGHTS
We have not declared a dividend since August 27, 1997 and we do not
anticipate any dividend declaration in the foreseeable future. Dividends may
only be paid out of our profits legally available for distribution under the
Companies Law (the "Profits Criteria"), and provided that there is no reasonable
concern that such payment will prevent us from satisfying our existing and
foreseeable obligations as they become due. In addition, a competent court may
approve, as per a motion to be filed by a company in accordance with the
Companies Law requirements, a payment which does not meet the Profit Criteria,
provided that the court was convinced that there is no reasonable concern that
such payment will prevent the company from satisfying its existing and
foreseeable obligations as they become due.
In accordance with our articles of association, a dividend shall be
proposed by the board of directors and shall be payable only after the same has
been approved by ordinary resolution of the shareholders meeting, but no such
resolution shall provide for the payment of an amount exceeding the amount
proposed by the board of directors.
Subject to the rights of the holders of shares as to dividends, any
dividend paid by us shall be allocated among the members entitled thereto in
proportion to the sum paid up or credited as paid up on account of the nominal
value of their respective holding of the shares in respect of which such
dividend is being paid, without taking into account the premium paid up for the
shares.
In the event of our liquidation, after satisfaction of all liabilities
to creditors and subject to the rights of the holders of shares with special
rights upon liquidation, if any, our assets available for distribution will be
distributed to our shareholders in proportion to the nominal value of their
respective holding of the shares in respect of which such distribution is being
made.
PREEMPTIVE RIGHTS
Under the Companies Law, unless the articles of association provide
otherwise, shareholders in public companies such as ours do not have preemptive
rights. Since such right is not provided by our articles of association, our
shareholders do not have a right to purchase shares in a new issue before they
are offered to third parties. As a result, our shareholders could experience
dilution of their ownership interest if we decide to raise additional funds by
issuing more shares and these shares are purchased by third parties.
VOTING, SHAREHOLDERS' MEETINGS AND RESOLUTIONS
The Companies Law permits a corporation to allocate different voting
rights to different classes of shares. We have currently only one class of
shares (ordinary shares) and under the articles of association the holder of our
ordinary shares has one vote for each ordinary share held by him of record on
all matters submitted to a vote of shareholders. However, by a resolution
approved by 75% of the voting power represented and voting in a general meeting,
we may provide for shares with preferred or deferred rights, including in regard
to voting rights. The quorum required for a general meeting of shareholders
consists of two or more shareholders present, in person or by proxy, and holding
shares conferring in the aggregate at least 33.33% of the voting power. A
meeting adjourned for lack of a quorum shall take place 21 days following the
date of a notice of a reconvened meeting issued by us at the same time and place
or any time and place as our board of directors designated in the said notice.
At such adjourned meeting, any two members present in person or by proxy shall
constitute a quorum.
Under the Companies Law, unless otherwise provided in the articles of
association or by applicable law, shareholders' resolutions require the approval
of a simple majority. Our articles of association provide that: (1) ordinary
resolution shall be deemed adopted if approved by the holders of the majority of
-70-
the voting power represented at the meeting and voting thereon; and (2) special
or extraordinary resolution shall be deemed adopted if approved by the holders
of not less than 75% of the voting power represented at the meeting and voting
thereon. The Companies Law provides that Israeli companies such as our, which
were incorporated prior to the effectiveness of the Companies Law (February 1,
2000) may amend its articles of association by a resolution at a general meeting
adopted by the holders of 75% of the voting rights present, unless the articles
were amended by a 75% majority to determined otherwise. Our articles of
association have not been amended to determine otherwise.
Under the Companies Law, a shareholder has a duty to act in good faith
towards the company and other shareholders while exercising his or her right and
duties and refrain from abusing his power in the company, including, among other
things, when voting in the general meeting of shareholders on the following
matters: (i) an amendment to the articles of association; (ii) an increase of
the corporation's authorized share capital; (iii) a merger; or (iv) approval of
certain acts and transactions, including interested party transactions, that
require shareholder approval, as specified in the Companies Law. In addition,
any controlling shareholder, any shareholder who knows that it possesses the
power to determine the outcome of a shareholders' meeting and any shareholder
that, under the provisions of the articles of association, has the power to
appoint or prevent the appointment of an officer in the company or another power
toward the company, is under a duty to act in fairness towards the company.
The Companies Law provides that the approval of the following
transaction requires the approval of the shareholders following the approval of
such transaction by the audit committee and by the board of directors: (i)
transaction of the company with a director regarding the term of his tenure,
including his compensation; (ii) an extraordinary transaction (i.e., a
transaction not in the ordinary course of business, not on market terms, or that
is likely to have a material impact on the company's profitability, assets or
liabilities) of a public company, such as ours, with a controlling shareholder,
as such term is defined in the Companies Law, or an extraordinary transaction of
the company with a third party in which a controlling shareholder has a personal
interest and any transaction of the company with a controlling shareholder which
is an office holder in the company or its employee, regarding the terms of his
tenure or employment (an "Extraordinary Transaction of a Public Company with a
Controlling Shareholder"). Any shareholder participating in a meeting in which
an Extraordinary Transaction of a Public Company with a Controlling Shareholder
is being discussed, has to notify the company, before the voting thereon,
whether he has any personal interest in the approval of the said transaction. An
Extraordinary Transaction of a Public Company with a Controlling Shareholder
which is not approved in accordance with the abovementioned requirements shall
have no effectiveness toward the company and toward the controlling shareholder.
The abovementioned requirements are subject to certain exemptions as may be set
forth in regulation promulgated under the Companies Law.
TRANSFER OF SHARES AND NOTICES
Fully paid ordinary shares are issued in the name of the shareholder
and are transferable under our articles of association unless the transfer is
restricted or prohibited by Israeli law or the rules of a stock exchange on
which the shares are traded. Under our articles of association, no transfer of
shares shall be registered unless proper writing or instrument of transfer has
been submitted to us or to our transfer agent, together with an evidence of
title as the board of directors may reasonably require.
Under regulations promulgated under the Companies Law an Israeli public
company whose shares are traded outside of Israel, such as ours, has to publish
a notice of meetings of shareholders, in accordance with the laws of the country
in which its shares are listed for trading, and if such laws do not provide
regulations for this matter, then the publication shall be as provided by the
company from time to time.
SPECIAL NOTIFICATION DUTIES
In accordance with our articles of association, any natural or legal
person who acquires or disposes of, directly or indirectly, shares of our
company, is obliged to notify us on a form prescribed by the market authority of
Euronext Brussels within 5 days from the date of such transaction, in any event
that the proportion of shares held by such person following the transaction
exceeds or falls below 5% of our outstanding shares or any multiple thereof.
ANTI-TAKEOVER PROVISIONS UNDER ISRAELI LAW
Tender Offer. A person wishing to acquire shares of a publicly traded
Israeli company and who would as a result of such acquisition hold more than 90%
-71-
of the company's issued and outstanding share capital or class of shares, is
required by the Companies Law to make a tender offer to acquire all of the
issued and outstanding shares or class of shares of the company. The acquirer is
entitled to acquire all such shares if the holdings of the shareholders who have
not accepted the offer are less than 5% of the issued share capital or the
relevant class of shares. In any event that the tender offer was not accepted
(i.e., the holdings of the shareholders who have not accepted the offer was not
less than 5%) the acquirer may not acquire shares of the company from
shareholders who accepted the tender offer if following such acquisition the
acquirer would then hold more than 90% of the company's issued and outstanding
share capital or the relevant class of shares.
In addition, a shareholder holding more than 90% of the company's
shares or class of shares is prevented from purchasing additional shares as long
as he holds such amount of shares. Any shares acquired in violation of the
foregoing requirement will not grant any rights to their holder and shall be
deemed "dormant" shares.
The Companies Law provides that an acquisition of shares of a public
company must be made by means of a special tender offer if as a result of the
acquisition the purchaser will hold 25% or more of the voting power ("25%
Shareholder") if there is no other 25% Shareholder. Similarly, the Companies Law
provides that an acquisition of shares in a public company must be made by means
of a special tender offer if as a result of the acquisition the purchaser will
hold more than 45% of the voting power, if there is no other shareholder who
holds more than 50% of the voting power. Regulations promulgated under the
Companies Law provide that the special tender offer requirements described in
this paragraph do not apply to companies whose shares are listed for trading
outside of Israel if, according to the laws of the country in which the shares
are traded, including the rules and regulations of the stock exchange on which
the shares are traded, either:
o there is a limitation on the acquisition of any level of control of
the company; or
o the acquisition of any level of control must be by means of a tender
offer to the public.
Merger. Under the Companies Law, merger transactions must be approved
by the board of directors and by a majority at the shareholders meeting of each
company which is party to such merger transactions. However, the Companies Law
further provides that with respect to companies such as ours, which were
incorporated prior to the effectiveness of the Companies Law and which did not
amend their articles of association by a 75% majority to state otherwise, the
approval of a merger requires a resolution adopted by the holders of 75% of the
present and voting shareholders.
In addition, the Companies Law provides that if one party to the
merger, or any person or entity holding, directly or indirectly, 25% or more of
either the voting power or the right to appoint a director of such party to the
merger, holds shares of the other merging company, then a majority of the
shareholders who are present at the meeting of such other merging comany, other
than the first merging company, or any person or entity holding 25% or more of
either the voting power of the right to appoint a director of the first merging
company or any one acting on his/her behalf, including family members or
entities under his/her control, must not have objected to the merger. The
Companies Law does not require court approval of a merger, but a court may
substitute its approval for the requisite class approvals or for the above
requisite unrelated shareholder approval if requested to do so by the holders of
at least 25% of the voting rights of a merging company.
Upon the request of a creditor of either party to the proposed merger,
the court may delay or prevent the merger if it concludes that there exists a
reasonable concern that, as a result of the merger, the surviving company will
be unable to satisfy the obligations of any of the parties to the merger. In
addition, a merger may not be executed unless at least 70 days have passed from
the time that a merger proposal of the merging companies has been filed with the
Israeli Registrar of Companies.
Tax Law. Israeli tax law treats specified acquisitions, including a
share-for-share swap between an Israeli company and a foreign company, less
favorably than does United States tax law. For example, Israeli tax law may
subject a shareholder who exchanges ordinary shares in an Israeli company for
shares in a foreign company to immediate taxation. Please see "Taxation."
OTHER ANTI-TAKEOVER PROVISIONS
We are also subject to the tender offer provisions of the U.S.
Securities Exchange Act.
EXCHANGE CONTROLS
-72-
Pursuant to a general permit issued in 1998 by the Israeli Controller
of Foreign Exchange under the Currency Control Law, 1978 (the "Currency Control
Law"), there are virtually no restrictions on foreign exchange in the State of
Israel, except for certain reporting obligations.
TRANSFER AGENT, REGISTRAR AND PAYING AGENT
The transfer agent and registrar for our ordinary shares in the United
States is American Stock Transfer & Trust Company. Its address is 59 Maiden
Lane, New York, New York 10038. Our paying agent in Belgium is Leleux Associated
Brokers S.A.
LISTING
Our ordinary shares are traded publicly on the Euronext Brussels New
Market under the symbol "SUP". Our ordinary shares are traded publicly in the
United States on the Over-the-Counter Bulletin Board under the symbol
"SPCBF.OB". Any new share issued by us must be admitted for listing on Euronext
Brussels before such shares can be traded on Euronext Brussels.
SHARES ELIGIBLE FOR FUTURE SALE
Sales of substantial amounts of our ordinary shares in the public
market following this offering, or the perception that such sales may occur,
could adversely affect the prevailing market price of our ordinary shares or
adversely affect our ability to raise additional equity capital in the future
and on terms favorable to us or at all.
Assuming no exercise of outstanding options or warrants, we will have
an aggregate of 16,996,287 ordinary shares outstanding as of the date of this
prospectus. Of these shares, 4,029,415 ordinary shares registered in this
offering generally will be freely tradable without restriction or further
registration under the Securities Act. An additional 2,312,298 ordinary shares
registered in this offering that will be issued upon the exercise of warrants or
shares issuable upon the effectiveness of the registration statement of which
this prospectus forms a part of, will be freely tradable when issued without
restriction or future registration under the Securities Act.
The remaining 12,966,872 ordinary shares are eligible for resale in
the United States without registration pursuant to section 4(1) of the
Securities Act, unless held by "affiliates," as that term is defined in Rule 144
under the Securities Act, who may sell only the volume of shares described below
and whose sales would be subject to additional restrictions described below. We
expect to file a registration statement on Form S-8 covering the options issued
under our Stock Option Plan which would cause the shares issued upon exercise of
options issued under the Plan to be freely tradable. We have also registered all
of our issued and outstanding ordinary shares under the Securities Exchange Act.
In general, under Rule 144 as currently in effect, a person, or group
of persons whose shares are required to be aggregated, who has beneficially
owned shares that are restricted securities as defined in Rule 144 for at least
one year is entitled to sell, within any three-month period, a number of shares
that does not exceed the greater of:
o 1% of the then outstanding shares of our ordinary shares; or
o the average weekly trading volume in our ordinary shares on the Over-
the-Counter Bulletin Board during the four calendar weeks preceding
the filing of a notice on Form 144 with respect to such sale;
provided that requirements concerning availability of public information, manner
of sale and notice of sale are satisfied. In addition, a person who is not
deemed to have been an affiliate at any time during the three months preceding a
sale and who has beneficially owned the shares proposed to be sold for at least
two years would be entitled to sell these shares under Rule 144(k) without
regard to the requirements described above. To the extent that shares were
acquired from one of our affiliates, a person's holding period for the purpose
of effecting a sale under Rule 144 would commence on the date of transfer from
the affiliate.
RULE 701
In general, any of our employees, officers or directors, as well as
bona fide consultants or advisors, who before we became subject to the reporting
requirements of the Securities Exchange Act purchased our ordinary shares
pursuant to a written compensatory benefit plan or contract, are entitled to
-73-
rely on the resale provisions of Rule 701. Those provisions permit
non-affiliates to sell such shares without having to comply with the public
information, holding period, volume limitation or notice provisions of Rule 144
and permit affiliates to sell such shares without having to comply with the Rule
144 holding period restrictions, in each case commencing 90 days after the date
that we became subject to the reporting requirements of the Securities Exchange
Act.
RULE 904
Rule 904 of Regulation S under the Securities Act provides that shares
owned by any person, other than persons deemed to be affiliates by virtue of
their significant shareholdings in our company, may be sold without registration
outside the United States, provided the sale is accomplished in an offshore
transaction, and no directed selling efforts are made, as those terms are
defined in Regulation S, subject to certain other conditions. In general, this
means that the shares, including "restricted" shares and shares held by our
directors and officers who do not own a significant percentage of the shares,
may be sold without registration in the United States or otherwise outside the
United States.
OPTIONS
We expect to file a registration statement on Form S-8 under the
Securities Act to register the ordinary shares issuable under our Stock Option
Plan. The registration statement on Form S-8 will become effective automatically
upon filing. As of October 18, 2004, options to purchase 2,172,878 ordinary
shares were issued and outstanding under the Stock Option Plan, of which options
to purchase 1,602,194 ordinary shares had vested and had not been exercised. In
addition, we authorized grants of options to employees and officers, under our
option plan, with an exercise price of $0.85, to purchase an aggregate of
1,400,000 shares, which remains subject to all required approvals under Israeli
law. Ordinary shares issued upon exercise of a share option and registered under
the Form S-8 registration statements will, subject to the vesting provisions and
securities law volume limitations applicable to our affiliates, be available for
sale in the public markets upon the expiration or release from the terms of any
applicable lock-up agreements.
CONDITIONS IN ISRAEL
We are incorporated under the laws of and our principal offices and
research and development facilities are located in the State of Israel.
Accordingly, we are directly affected by political, military and economic
conditions in Israel. Our operations would be materially adversely affected if
major hostilities involving Israel occur, Israel's political or economic
conditions deteriorate or trade between Israel and its present trading partners
is curtailed.
POLITICAL AND MILITARY CONDITIONS
Since the establishment of the State of Israel in 1948, a number of
armed conflicts have taken place between Israel and its Arab neighbors and a
state of hostility, varying from time to time in intensity and degree, has led
to security and economic problems for Israel. Additionally, from time to time
since December 1987, Israel has experienced civil unrest, primarily in the West
Bank and Gaza Strip administered by Israel since 1967. A peace agreement between
Israel and Egypt was signed in 1979, a peace agreement between Israel and Jordan
was signed in 1994 and, since 1993,several agreements between Israel and
Palestinian representatives have been signed pursuant to which certain
territories in the West Bank and Gaza Strip were handed over to Palestinian
administration. The implementation of these agreements with the Palestinian
representatives has been subject to difficulties and delays and a resolution of
all of the differences between the parties remains uncertain. In addition, since
October 2000, there has been a substantial deterioration in the relationship
between Israel and the Palestinian Authority and a significant increase in
violence in the West Bank and Gaza Strip. During 2002, violence intensified
between Palestinians and Israelis and Israel has undertaken military actions in
the West Bank and the Gaza Strip. In May 2000, Israeli forces withdrew from
southern Lebanon. As of the date hereof, Israel has not entered into any peace
agreement with Syria or Lebanon. We cannot predict whether any other agreements
will be entered into between Israel and its neighboring countries, whether a
final resolution of the area's problems will be achieved, the nature of any
resolution of this kind, or whether the current civil unrest will continue and
to what extent this unrest will have an adverse impact on Israel's economic
development, on our operations in the future and on our share price.
Despite the progress towards peace between Israel and its Arab
neighbors, certain countries, companies and organizations continue to
participate in a boycott of Israeli firms and others doing business in Israel or
with Israeli companies. Although we are precluded from marketing our products to
these countries, we believe that in the past the boycott has not had a material
-74-
adverse effect on us. However, restrictive laws, policies or practices directed
towards Israel or Israeli businesses could have an adverse impact on the
expansion of our business.
Generally, all male adult citizens and permanent residents of Israel
under the age of 48 are, unless exempt, obligated to perform up to 37 days of
military reserve duty annually. Additionally, all residents of this age are
subject to being called to active duty at any time under emergency
circumstances. Most of our male officers and employees are currently obligated
to perform annual reserve duty. Although we have operated effectively under
these requirements, we cannot assess the full impact of these requirements on
our workforce or business if conditions should change, and no prediction can be
made as to the effect on us of any expansion of these obligations.
ECONOMIC CONDITIONS
Israel's economy has been subject to numerous destabilizing factors,
including rampant inflation in the early to mid-1980s, low foreign exchange
reserves, fluctuations in world commodity prices, military conflicts and civil
unrest. The Israeli Government has, for these and other reasons, intervened in
various sectors of the economy by utilizing, among other means, fiscal and
monetary policies, import duties, foreign currency restrictions and control of
wages, prices and foreign currency exchange rates. In 1998, the Israeli currency
control regulations were liberalized significantly, as a result of which Israeli
residents may deal in foreign currency and non-residents of Israel may purchase
and sell Israeli currency and assets. The Israeli Government has periodically
changed its policies in all these areas. There are currently no Israeli currency
control restrictions on remittances of dividends on ordinary shares or proceeds
from the sale of shares. However, there remains in effect legislation pursuant
to which currency controls can be imposed by administrative action at any time.
In addition, Israeli residents are required to file reports on certain types of
actions or transactions.
TRADE RELATIONS
Israel is a member of the United Nations, the International Monetary
Fund, the International Bank for Reconstruction and Development and the
International Finance Corporation. Israel is a member of the World Trade
Organization and is signatory to the General Agreement on Tariffs and Trade,
which provides for the reciprocal lowering of trade barriers among its members.
In addition, Israel has been granted preferences under the Generalized System of
Preferences from the United States, Australia, Canada and Japan. These
preferences allow Israel to export the products covered by such programs either
duty-free or at reduced tariffs.
Israel and the European Economic Community, now known as the European
Union, concluded a Free Trade Agreement in July 1975 which confers certain
advantages with respect to Israeli exports to most European countries and
obligates Israel to lower its tariffs with respect to imports from these
countries over a number of years. In 1985, Israel and the United States entered
into an agreement to establish a free trade area. The free trade area has
eliminated all tariff and certain non-tariff barriers on most trade between the
two countries. On January 1, 1993, an agreement between Israel and the European
Free Trade Association, which includes Norway, Switzerland, Iceland and
Liechtenstein, established a free-trade zone between Israel and those nations.
In November 1995, Israel entered into a new agreement with the European Union
that redefines rules of origin and makes other improvements, such as providing
for Israel to become a member of the research and technology programs of the
European Union. In recent years, Israel has established commercial and trade
relations with a number of other nations, including Russia, China, India, Turkey
and other nations in Eastern Europe and Asia.
-75-
TAXATION
ISRAELI TAX CONSIDERATIONS
The following is a summary of the material aspects of the current tax
structure applicable to companies in Israel and their effect on us. To the
extent that the following discussion is based on new or existing tax or other
legislation that has not been subject to judicial or administrative
interpretation, there can be no assurance that the views expressed herein will
be accepted by the tax or other authorities in question. This discussion is not
intended, nor should it be construed, as legal or professional tax advice and it
is not exhaustive of all possible tax considerations.
WE URGE PROSPECTIVE PURCHASERS OF ORDINARY SHARES TO CONSULT THEIR OWN
TAX ADVISORS AS TO THE ISRAELI OR OTHER TAX CONSEQUENCES OF THE PURCHASE,
OWNERSHIP AND DISPOSITION OF ORDINARY SHARES, INCLUDING, IN PARTICULAR, THE
EFFECT OF ANY FOREIGN, STATE OR LOCAL TAXES.
Taxation of Capital Gains Applicable to Israeli and Non-Israeli Shareholders
Israeli law generally imposes a capital gains tax on the sale of any
capital assets by residents of Israel, as defined for Israeli tax purposes, and
on the sale of assets located in Israel, including shares in Israeli companies,
by both residents and non-residents of Israel, unless a specific exemption is
available or unless a tax treaty between Israel and the shareholder's country of
residence provides otherwise. The law distinguishes between real gain and
inflationary surplus. The inflationary surplus is a portion of the total capital
gain which is equivalent to the increase of the relevant asset's purchase price
which is attributable to the increase in the Israeli consumer price index or, in
certain circumstances, a foreign currency exchange rate, between the date of
purchase and the date of sale. The real gain is the excess of the total capital
gain over the inflationary surplus.
Pursuant to the Tax Reform, generally, capital gains tax is imposed on
Israeli residents at a rate of 15% on real gains derived on or after January 1,
2003, from the sale of shares in Israeli companies publicly traded on Nasdaq or
on a recognized stock exchange (Euronext Brussels New Market) or regulated
market in a country that has a treaty for the prevention of double taxation with
Israel. This tax rate is contingent upon the shareholder not claiming a
deduction for financing expenses in connection with such shares, and does not
apply to: (i) the sale of shares to a relative (as defined in the Tax Reform);
(ii) the sale of shares by dealers in securities; (iii) the sale of shares by
shareholders that report in accordance with the Inflationary Adjustments Law; or
(iv) the sale of shares by shareholders who acquired their shares prior to an
initial public offering (that are subject to a different tax arrangement). The
tax basis of shares acquired prior to January 1, 2003 will be determined in
accordance with the average closing share price in the three trading days
preceding January 1, 2003. However, a request may be made to the tax authorities
to consider the actual adjusted cost of the shares as the tax basis if it is
higher than such average price.
In December 2003, regulations promulgated pursuant to the Tax Reform
were amended so that, in certain circumstances, capital gains derived from the
sale and subsequent (same day) repurchase of shares traded on the TASE or from
shares of Israeli companies publicly traded on a recognized stock exchange or
regulated market in a country that has a treaty for the prevention of double
taxation with Israel, may be taxed at a rate equal to the withholding tax rate
applicable to revenues derived from such sale. In accordance with an
announcement published by the Israeli Income Tax Commission, the withholding tax
rate applicable to the sale of such shares until the end of 2003 tax year, which
was equal at such time to 1% of the revenues generated in their sale, was
determined as the final tax rate applicable to such sale. The amended
regulations also determined that the day of such sale and repurchase shall be
considered the new date of purchase of such shares. The foregoing was not
applicable to: (i) dealers in securities; (ii) shareholders that report in
accordance with the Inflationary Adjustments Law; (iii) shareholders who
acquired their shares prior to an initial public offering; (iv) in some cases,
shareholders that received their shares within the framework of an
employer-employee relationship; or (v) shareholders claiming a deduction for
financing expenses in connection with such shares. The regulations further
provided that with respect to shares of Israeli companies traded on a stock
exchange outside of Israel, the market price determined at the close of the
trading day preceding the day of the sale and repurchase of such shares, shall
constitute the new tax basis for any future sale of such shares.
Non-Israeli residents are exempt from Israeli capital gains tax on any
gains derived from the sale of shares publicly traded on a the TASE, provided
such gains did not derive from a permanent establishment of such shareholders in
Israel, and are exempt from Israeli capital gains tax on any gains derived from
the sale of shares of Israeli companies publicly traded on a recognized stock
-76-
exchange (Euronext Brussels New Market) or regulated market outside of Israel,
provided however that such capital gains are not derived from a permanent
establishment in Israel and provided that such shareholders did not acquire
their shares prior to an initial public offering. However, non-Israeli
corporations will not be entitled to such exemption if an Israeli resident (i)
has a controlling interest of 25% or more in such non-Israeli corporation, or
(ii) is the beneficiary or is entitled to 25% or more of the revenues or profits
of such non-Israeli corporation, whether directly or indirectly.
In some instances where SuperCom shareholders may be liable to Israeli
tax on the sale of their ordinary shares, the payment of the consideration may
be subject to the withholding of Israeli tax at the source. Pursuant to the
Convention Between the government of the United States of America and the
government of Israel with Respect to Taxes on Income, as amended (the
"U.S.-Israel Tax Treaty") the sale, exchange or disposition of ordinary shares
by a person who (i) holds the ordinary shares as a capital asset, (ii) qualifies
as a resident of the United States within the meaning of the U.S.-Israel Tax
Treaty and (iii) is entitled to claim the benefits afforded to such person by
the U.S.-Israel Tax Treaty, generally, will not be subject to the Israeli
capital gains tax unless such Treaty U.S. Resident holds, directly or
indirectly, shares representing 10% or more of our voting power during any part
of the 12-month period preceding such sale, exchange or disposition, subject to
certain conditions, or the capital gains from such sale, exchange or disposition
can be allocated to a permanent establishment in Israel. In this case, the sale,
exchange or disposition of ordinary shares would be subject to Israeli tax, to
the extent applicable; however, under the U.S.-Israel Tax Treaty, such Treaty
U.S. Resident would be permitted to claim a credit for such taxes against the
U.S. federal income tax imposed with respect to such sale, exchange or
disposition, subject to the limitations in U.S. laws applicable to foreign tax
credits. The U.S.-Israel Tax Treaty does not relate to U.S. state or local
taxes.
Income Taxes on Dividend Distribution to Non-Israeli Shareholders
Individuals who are non-residents of Israel are subject to a graduated
income tax on income derived from sources in Israel. These sources of income
include passive income, including dividends, royalties and interest, as well as
non-passive income from services provided in Israel. Upon a distribution of a
dividend, other than bonus shares (stock dividends), income tax is generally
withheld at the rate of 25% (or 15% in the case of dividends distributed from
taxable income derived from an Approved Enterprise), unless a different rate is
provided in a treaty between Israel and the shareholder's country of residence.
The withheld tax is the final tax in Israel on dividends paid to non-residents
who do not conduct a business in Israel. See "U.S.-Israel Tax Treaty".
A non-resident of Israel who has dividend income derived from or
accrued in Israel, from which tax was withheld at source, is generally exempt
from the duty to file tax returns in Israel in respect of such income, provided
such income was not derived from a business conducted in Israel by the taxpayer
and the non-resident has no other sources of income in Israel.
Residents of the United States generally will have withholding tax in
Israel deducted at source. As discussed below, they may be entitled to a credit
or deduction for United States federal income tax purposes in the amount of the
taxes withheld, subject to detailed rules contained in United States tax
legislation.
U.S.-Israel Tax Treaty
The Treaty is generally effective as of January 1, 1995. Under the
Treaty, the maximum Israeli tax and withholding tax on dividends paid to a
holder of Ordinary Shares who is a Treaty U.S. Resident (as defined below) is
generally 25%. However, pursuant to the Approved Enterprise Law, dividends
distributed by an Israeli company and derived from the income of an Approved
Enterprise during the applicable benefits period will generally be subject to a
reduced 15% dividend withholding tax rate. The Treaty further provides that a
12.5% Israeli dividend withholding tax will apply to dividends paid to a United
States corporation owning 10% or more of an Israeli company's voting shares
during, in general, the current and preceding tax year of the Israeli company.
The lower 12.5% rate applies only on dividends distributed from income not
derived from an Approved Enterprise in the applicable period and does not apply
if the company has certain amounts of passive income.
Pursuant to the Treaty, the sale, exchange or disposition of Ordinary
Shares by a person who qualifies as a resident of the United States within the
meaning of the Treaty and who is entitled to claim the benefits afforded to such
residents under the Treaty (a "Treaty U.S. Resident") generally will not be
subject to the Israeli capital gains tax unless such Treaty U.S. Resident holds,
directly or indirectly, shares representing 10% or more of the voting power of
the Company during any part of the 12-month period preceding such sale, exchange
-77-
or disposition subject to certain conditions. A sale, exchange or disposition of
Ordinary Shares by a Treaty U.S. Resident who holds, directly or indirectly,
shares representing 10% or more of the voting power of the Company at any time
during such preceding 12-month period would not be exempt under the Treaty from
such Israeli tax; however, under the Treaty, such Treaty U.S. Resident would be
permitted to claim a credit for such taxes against United States federal income
tax imposed on any gain from such sale, exchange or disposition, under the
circumstances and subject to the limitations specified in the Treaty.
Israel presently has no estate or gift tax.
General Corporate Tax Structure
The general corporate tax rate in Israel is currently 36%. The
effective tax rate payable by a company that derives income from an "Approved
Enterprise," however, may be considerably less. See "Law for the Encouragement
of Capital Investments, 1959" below.
Law for the Encouragement of Industry (Taxes), 1969
Under the Law for the Encouragement of Industry (Taxes), 1969 (the
"Industry Encouragement Law"), a company qualifies as an "Industrial Company" if
it is a resident in Israel and at least 90% of its income in a given tax year
(exclusive of certain income) is derived from Industrial Enterprises which was
defined as an enterprise whose major activity in a particular tax year is
industrial manufacturing. The Company currently qualifies as such.
A qualifying Industrial Company is entitled to deduct the purchase
price of know-how and patents and is also entitled to deduct expenses of issuing
publicly traded shares.
Additionally, under certain income tax regulations, Industrial
Companies qualify for special accelerated depreciation rates. An Industrial
Company owning an Approved Enterprise (see "Law for the Encouragement of Capital
Investments, 1959" below) may choose between the above depreciation rates and
the depreciation rules available to Approved Enterprises.
Qualification as an Industrial Company is not conditional upon the
receipt of prior approval from any Israeli Government authority. No assurance
can be given that the Company will continue to qualify as an Industrial Company
or will in the future be able to avail itself of any benefits available to
companies so qualifying.
Law for the Encouragement of Capital Investment, 1959
The Law for the Encouragement of Capital Investment, 1959 (the
"Investment Law") provides that capital investment in a production facility (or
other eligible assets) may, upon application to the Israeli Investment Center,
be designated as an "Approved Enterprise". Each certificate of approval for an
Approved Enterprise relates to a specific investment program, delineated both by
the financial scope of the investment and by the physical characteristics of the
facility or the asset. A company having an Approved Enterprise is entitled to
certain benefits, including Israeli Government cash grants and tax benefits.
Each application for an investment program is evaluated by the Investment Center
and there can be no assurance that any such application will be approved. The
Company currently has three Alternative Benefits Programs under the Investment
Law, which entitle the Company to certain tax benefits. The benefits available
to a company having an Approved Enterprise are conditional upon the fulfillment
of certain conditions stipulated in the Investment Law and its regulations and
the criteria set forth in the specific certificate of approval. The Company
believes its Approved Enterprises operate in substantial compliance with all
such conditions and criteria.
UNITED STATES FEDERAL INCOME TAX CONSIDERATIONS
The following general discussion sets forth the material United States
federal income tax consequences that are applicable to the following persons who
invest in Ordinary Shares and hold such Ordinary Shares as capital assets ("U.S.
Shareholders"): (a) individuals who are citizens or residents (as specifically
defined for U.S. federal income tax purposes) of the United States; (b)
corporations (or entities treated as corporations for U.S. tax purposes) created
or organized in the United States or under the laws of the United States or of
any state thereof; and (c) estates or trusts the income of which is subject to
United States federal income taxation regardless of its source. This discussion
does not deal with: (i) all aspects of U.S. federal income taxation that may be
-78-
relevant to particular U.S. Shareholders based on their particular circumstances
(including potential application of the alternative minimum tax); (ii) certain
U.S. Shareholders subject to special treatment under the U.S. federal income tax
laws such as broker-dealers, insurance companies, tax-exempt organizations,
financial institutions, taxpayers whose functional currency is not the Dollar,
or foreign individuals or entities; (iii) U.S. Shareholders owning directly or
by attribution 10% or more of the Ordinary Shares; or (iv) any aspect of state,
local or non-United States tax laws. Additionally, the following discussion does
not consider the tax treatment of persons who hold Ordinary Shares through a
partnership or other pass-through entity.
The summary of United States income tax laws set out below is based on
the Internal Revenue Code of 1986, as amended, Treasury regulations, judicial
decisions and published positions of the Internal Revenue Service (the "IRS") as
of the date hereof and is subject to any changes occurring in the United States
law after that date, which changes could be retroactive.
Dividends Paid on Shares
Distributions on Ordinary Shares paid (before reduction for Israeli
withholding taxes) out of the Company's current or accumulated earnings and
profits, as determined for U.S. federal income tax purposes, will be dividends
and will be includible in a U.S. Shareholder's ordinary income when received.
Under recently enacted legislation, dividends received by an individual taxpayer
during taxable years before 2009 will be taxed at a maximum rate of 15%,
provided the taxpayer has held the stock for more than 60 days during the
120-day period beginning 60 days before the ex-dividend date and certain other
conditions are satisfied. Dividends received by an individual taxpayer for
taxable years after 2008 will be subject to tax at ordinary income rates. The
dividend will not be eligible for the dividends-received deduction generally
allowed to U.S. corporations.
The amount of any dividend paid in Israeli currency will equal the
Dollar value of the Israeli currency received calculated by reference to the
exchange rate in effect on the date the dividend is received by the U.S.
Shareholder, regardless of whether the Israeli currency is converted into
Dollars. If the Israeli currency received as a dividend is not converted into
Dollars on the date of receipt, the U.S. Shareholder will have a basis in the
Israeli currency equal to the Dollar value on the date of receipt. Any gain or
loss realized on a subsequent conversion or other disposition of the Israeli
currency will be treated as ordinary income or loss, and generally will be
income or loss from sources within the United States for U.S. foreign tax credit
purposes.
To the extent that the amount of any distribution exceeds the Company's
current and accumulated earnings and profits for a taxable year, the
distribution will first be treated as a tax-free return of capital to the extent
of the U.S. Shareholder's basis, and any excess will be treated as capital gain.
Such distributions would not give rise to income from sources outside the United
States.
Credit for Israeli Taxes Withheld
U.S. Shareholders may be entitled to deduct, or claim a U.S. foreign
tax credit for, Israeli taxes that are withheld on dividends received, subject
to applicable limitations in the Code. Dividends will be income from sources
outside the United States and generally will be "passive income" or "financial
services income" for purposes of computing the U.S. foreign tax credit allowable
to a U.S. Shareholder. The rules governing the U.S. foreign tax credit are
complex, and additional limitations on the credit apply to individuals receiving
dividends eligible for the 15% maximum tax rate on dividends described above.
Disposition of Ordinary Shares
A U.S. Shareholder will generally recognize capital gain or loss upon
the sale or exchange of Ordinary Shares in an amount equal to the difference
between the amount realized and the U.S. Shareholder's tax basis in the Ordinary
Shares. Such gain or loss will be long-term capital gain or loss if the U.S.
Shareholder's holding period exceeds one year, and otherwise will be short-term
capital gain or loss. Certain limitations apply to the deductibility of capital
losses by both corporate and non-corporate taxpayers. Gain or loss from the
sale, exchange or other disposition of Ordinary Shares will generally be treated
as from U.S. sources for U.S. foreign tax credit purposes. However, pursuant to
the Treaty, such gain or loss may be foreign source in certain circumstances.
See "U.S.-Israel Tax Treaty". U.S. Shareholders should consult their own tax
advisors regarding the treatment of any foreign currency gain or loss on any
Israeli currency received in respect of the sale, exchange or other disposition
of Ordinary Shares.
-79-
Passive Foreign Investment Company
A "passive foreign investment company" ("PFIC") is defined as any
foreign corporation at least 75% of whose consolidated gross income for the
taxable year is passive income, or at least 50% of the value of whose
consolidated assets is attributable to assets that produce or are held for the
production of passive income. For this purpose, passive income generally
includes dividends, interest, royalties, rents, annuities and the excess of
gains over losses from the disposition of assets which produce passive income.
The Company believes that it is not and has not been a PFIC for United States
federal income tax purposes, and the Company expects that it will not become a
PFIC. If the Company were to become a PFIC, then all U.S. Shareholders would be
required either: (i) to include in their taxable income certain undistributed
amounts of the Company's income if a qualified electing fund election has been
made; or (ii) to pay an interest charge together with tax calculated at maximum
ordinary income rates on certain "excess distributions" (defined to include gain
on the sale of Ordinary Shares). In addition, if the Company is a PFIC,
individual U.S. Shareholders will not be eligible for the 15% maximum tax rate
on dividends described above.
Backup Withholding and Information Reporting
A non-corporate U.S. Shareholder may, under certain circumstances, be
subject to information reporting requirements and "backup withholding" at a rate
currently equal to 28% on cash payments in the United States of dividends on,
and the proceeds of disposition of, Ordinary Shares. Backup withholding will
apply only if a U.S. Shareholder: (a) fails to furnish its social security or
other taxpayer identification number ("TIN") within a reasonable time after the
request therefor; (b) furnishes an incorrect TIN; (c) is notified by the IRS
that it has failed properly to report payments of interest and dividends; or (d)
under certain circumstances, fails to certify, under penalty of perjury, that it
has furnished a correct TIN and has not been notified by the IRS that it is
subject to backup withholding for failure to report interest and dividend
payments. U.S. Shareholders should consult their tax advisors regarding their
qualification for exemption, if applicable. The amount of backup withholding
from a payment to a U.S. Shareholder generally will be allowed as a credit
against such U.S. Shareholder's federal income tax liability and may entitle
such U.S. Shareholder to a refund, provided that the required information is
furnished to the IRS.
THE ABOVE DESCRIPTION IS NOT INTENDED TO CONSTITUTE A COMPLETE
ANALYSIS OF ALL TAX CONSEQUENCES RELATING TO THE OWNERSHIP OR DISPOSITION OF OUR
ORDINARY SHARES BY A UNITED STATES HOLDER. YOU SHOULD CONSULT YOUR OWN TAX
ADVISOR CONCERNING THE TAX CONSEQUENCES OF YOUR PARTICULAR SITUATION, AS WELL AS
ANY TAX CONSEQUENCES THAT MAY ARISE UNDER THE LAWS OF ANY STATE, LOCAL, FOREIGN,
OR OTHER TAXING JURISDICTION.
ENFORCEABILITY OF CIVIL LIABILITIES
We are incorporated under the laws of the State of Israel. Service of
process upon our directors and executive officers and the Israeli experts named
in this prospectus, substantially all of whom reside outside the United States,
will be difficult to obtain within the United States. Furthermore, because
substantially all of our assets and substantially all of our directors and
officers are located outside the United States, any judgment obtained in the
United States against us or any of our directors and officers or the Israeli
experts named in the prospectus, will be difficult to collect outside those
countries.
We have been informed by our legal counsel in Israel that there is
doubt as to the enforceability of civil liabilities under the Securities Act and
the Securities Exchange Act in original actions instituted in Israel. However,
subject to certain time limitations, Israeli courts generally enforce a final
executory judgment of a foreign court in civil matters including judgments based
upon the civil liability provisions of the Securities Act and the Securities
Exchange Act or the Belgian securities laws and including a monetary or
compensatory judgment in a non-civil matter, provided that:
o the judgments are obtained after due process before a court of competent
jurisdiction, according to the laws of the state in which the judgment is
given and the rules of private international law currently prevailing in
Israel;
o the foreign court is not prohibited by law from enforcing judgments of
Israeli courts;
o adequate service of process has been effected and the defendant has had a
reasonable opportunity to be heard and to present his evidence;
o the judgments and the enforcement of the civil liabilities are not
contrary to the law, public policy, security or sovereignty of the State
of Israel;
-80-
o the judgments were not obtained by fraud and do not conflict with any
other valid judgment in the same matter between the same parties;
o an action between the same parties in the same matter is not pending in
any Israeli court at the time the lawsuit is instituted in the foreign
court; and
o the obligations under the judgment are enforceable according to the laws
of the State of Israel.
We have irrevocably appointed SuperCom, Inc. as our agent solely to
receive service of process in any action against us in any United States federal
court or the courts of the State of New York arising out of this offering.
Foreign judgments enforced by Israeli courts will be payable in
Israeli currency, which can then be converted into non-Israeli currency and
transferred out of Israel. The usual practice in an action before an Israeli
court to recover an amount in a non-Israeli currency is for the Israeli court to
render judgment for the equivalent amount in Israeli currency at the rate of
exchange in force on the date thereof, but the judgment debtor may make payment
in foreign currency. Pending collection, the amount of the judgment of an
Israeli court stated in Israeli currency ordinarily will be linked to the
Israeli consumer price index plus interest at the annual statutory rate set by
Israeli law prevailing at that time. Judgment creditors must bear the risk of
unfavorable exchange rate movement.
LEGAL MATTERS
The validity of the ordinary shares offered in this offering and
certain other matters in connection with this offering relating to Israeli law
will be passed upon for us by Yossi Avraham & Co., Tel Aviv, Israel. Certain
legal matters in connection with this offering relating to United States law
will be passed upon for us by Mintz Levin Cohn Ferris Glovsky and Popeo PC, New
York, New York.
EXPERTS
The consolidated financial statements of SuperCom Ltd. as of December
31, 2003 and 2002, and for each of the fiscal years ended December 31, 2003,
2002 and 2001, included in this registration statement have been audited by
Kost, Forer, Gabbay & Kaiserer, a member of Ernst & Young Global, independent
auditors, as stated in their reports appearing herein, which, as to the years
2002 and 2003 are based in part on the reports of BDO McCabe Lo Company
independent auditors, and have been so included in reliance upon the reports of
such firm given upon their authority as experts in accounting and auditing.
The financial statements of SuperCom Asia Pacific have been audited by
BDO McCabe Lo & Company, independent certified public accountants, to the extent
and for the periods set forth in their report appearing in the Registration
Statement, and is included in reliance upon such report given upon the authority
of said firm as experts in auditing and accounting
WHERE YOU CAN FIND MORE INFORMATION
We have filed a registration statement on Form F-1, including the
exhibits and schedules thereto, with the Securities and Exchange Commission, or
SEC, under the Securities Act, and the rules and regulations thereunder, for the
registration of the ordinary shares that are being offered by this prospectus.
This prospectus does not include all of the information contained in the
registration statement. You should refer to the registration statement and its
exhibits for additional information. Whenever we make reference in this
prospectus to any of our contracts, agreements or other documents, the
references are not necessarily complete and you should refer to the exhibits
attached to the registration statement for copies of the actual contract,
agreements or other document.
We are subject to the informational requirements of the Securities
Exchange Act, applicable to foreign private issuers. We, as a "foreign private
issuer," are exempt from the rules under the Securities Exchange Act prescribing
certain disclosure and procedural requirements for proxy solicitations, and our
officers, directors and principal shareholders are exempt from the reporting and
-81-
"short-swing" profit recovery provisions contained in Section 16 of the
Securities Exchange Act, with respect to their purchases and sales of shares. In
addition, we are not required to file annual, quarterly and current reports and
financial statements with the SEC as frequently or as promptly as United States
companies whose securities are registered under the Securities Exchange Act.
However, we will file with the SEC, within 180 days after the end of each fiscal
year, an annual report on Form 20-F containing financial statements audited by
an independent accounting firm. We will also furnish quarterly reports on Form
6-K containing unaudited interim financial information for the first three
quarters of each fiscal year, within 60 days after the end of such quarter.
You may read and copy any document we file or furnish with the SEC at
reference facilities at 450 Fifth Street, NW, Washington, DC 20549. You may also
obtain copies of the documents at prescribed rates by writing to the Public
Reference Section of the SEC at 450 Fifth Street, NW, Washington, DC 20549.
Please call the SEC at 1-800-SEC-0330 for further information on the operation
of the public reference facilities. You can review our SEC filings and the
registration statement by accessing the SEC's internet site at
http://www.sec.gov.
Documents may also be inspected at the National Association of
Securities Dealers, Inc., 1735 K street, N.W., Washington D.C. 20006.
-82-
SUPERCOM LTD. AND ITS SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
AS OF DECEMBER 31, 2003
IN U.S. DOLLARS
INDEX
PAGE
--------
REPORTS OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM..................F-2
CONSOLIDATED BALANCE SHEETS...............................................F-4
CONSOLIDATED STATEMENTS OF OPERATIONS.....................................F-6
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY.............................F-7
CONSOLIDATED STATEMENTS OF CASH FLOWS.....................................F-8
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS...............................F-10
- - - - - - - - - - - - - - - - - - - - -
F-1
REPORT OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
TO THE SHAREHOLDERS OF
SUPERCOM LTD.
We have audited the accompanying consolidated balance sheets of
Supercom Ltd. ("the Company") and its subsidiaries as of December 31, 2002 and
2003, and the related consolidated statements of operations, changes in
shareholders' equity and cash flows for each of the three years in the period
ended December 31, 2003. Our audits also included financial statement schedule
listed in Item 19 of the Company's 20-F. These financial statements and schedule
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements and schedule based on our
audits. We did not audit the financial statements of "Supercom Asia Pacific
Limited" a subsidiary, the financial statements of which reflect total assets of
5.7% of the consolidated assets as of December 31, 2003, and total revenues of
29% of the consolidated revenues for the year then ended. Those statements were
audited by other auditors whose report has been furnished to us, and our
opinion, insofar as it relates to the data included for this subsidiary, is
based solely on the report of the other auditors.
We conducted our audits in accordance with auditing standards of the
Public Company Accounting Oversight Board in the United States. Those standards
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by management, as well
as evaluating the overall financial statement presentation. We believe that our
audits and the report of the other auditors provide a reasonable basis for our
opinion.
In our opinion, based on our audits and the report of the other
auditors, 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, 2002 and 2003, and the
consolidated results of their operations and cash flows for each of the three
years in the period ended December 31, 2003, in conformity with accounting
principles generally accepted in the United States. Additionally, in our
opinion, the related financial statement schedule when considered in relation to
the basic financial statements and schedule taken as a whole, presents fairly in
all material respects the information set forth therein.
Tel-Aviv, Israel KOST FORER GABBAY & KASIERER
March 22, 2004 A Member of Ernst & Young Global
- --------------------------------------------------------------------------------
F-2
[LOGO] [LETTERHEAD of
BDO McCabe Lo & Company
CERTIFIED PUBLIC ACCOUNTANTS
8TH FLOOR, WING ON CENTRE
111 CONNAUGHT ROAD CENTRAL
HONG KONG
TELEPHONE: (852) 2541-5041
FACSIMILE: (852) 2815-2239]
Report of Independent Registered Public Accounting Firm
TO THE BOARD OF DIRECTORS OF
SUPERCOM ASIA PACIFIC LIMITED
We have audited the accompanying consolidated balance sheets of SuperCom Asia
Pacific Limited and its subsidiary (collectively "the Company") as of December
31, 2003 and 2002, and the related consolidated statements of operations,
stockholders' deficit and cash flows for the years ended December 31, 2003 and
2002. 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 audit.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board in the United States. Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial positions of the
Company as of December 31, 2003 and 2002 and the consolidated results of their
operations and cash flows for the years ended December 31, 2003 and 2002, in
conformity with accounting principles generally accepted in the United States of
America.
BDO McCabe Lo & Company
HONG KONG, FEBRUARY 10, 2004
F-3
SUPERCOM LTD. AND ITS SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
DECEMBER 31,
--------------------
2002 2003
------- -------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 4,567 $ 1,912
Restricted cash deposits 53 681
Short-term deposit -- 1,196
Marketable debt securities 609 117
Trade receivables (net of allowance for doubtful accounts of
$ 1,200 and $ 3,333 as of December 31, 2002 and 2003,
respectively) 2,202 1,808
Other accounts receivable and prepaid expenses 517 680
Inventories 3,144 3,236
-------- --------
TOTAL current assets 11,092 9,630
-------- --------
LONG-TERM INVESTMENTS:
Long-term trade receivables -- 364
Investment in an affiliate and others 323 275
Severance pay fund 288 333
-------- --------
611 972
-------- --------
PROPERTY AND EQUIPMENT, NET 1,880 1,676
-------- --------
OTHER ASSETS 173 156
-------- --------
$13,756 $12,434
======== ========
The accompanying notes are an integral part of the consolidated financial
statements.
F-4
SUPERCOM LTD. AND ITS SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE DATA
DECEMBER 31,
-----------------------
2002 2003
-------- --------
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Short-term bank credit and current maturities of long-term loan $ 851 $ 2,131
Trade payables 691 1,085
Employees and payroll accruals 192 161
Accrued expenses and other liabilities 1,734 822
-------- --------
TOTAL current liabilities 3,468 4,199
-------- --------
LONG-TERM LIABILITIES:
Long-term loan, net of current maturities 429 187
Accrued severance pay 362 436
-------- --------
TOTAL long-term liabilities 791 623
-------- --------
COMMITMENTS AND CONTINGENT LIABILITIES
SHAREHOLDERS' EQUITY:
Share capital:
Ordinary shares of NIS 0.01 par value -
Authorized: 26,500,000 shares as of December 31, 2002 and
2003; Issued and outstanding: 12,706,339 and 12,906, 872
shares as of December 31, 2002 and 2003, respectively 40 40
Additional paid-in capital 25,730 25,814
Deferred stock compensation (26) --
Accumulated deficit (16,247) (18,242)
-------- --------
TOTAL shareholders' equity 9,497 7,612
-------- --------
$ 13,756 $ 12,434
======== ========
The accompanying notes are an integral part of the consolidated financial
statements.
F-5
SUPERCOM LTD. AND ITS SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARES DATA
YEAR ENDED
DECEMBER 31,
----------------------------------------------
2001 2002 2003
------------ ------------ ------------
Revenues $ 6,889 $ 8,027 $ 7,244
Cost of revenues 2,574 1,830 3,102
------------ ------------ ------------
Gross profit 4,315 6,197 4,142
------------ ------------ ------------
Operating expenses:
Research and development 1,225 1,334 918
Selling and marketing, net 4,628 2,828 3,026
General and administrative 3,604 1,988 1,829
------------ ------------ ------------
TOTAL operating expenses 9,457 6,150 5,773
------------ ------------ ------------
Operating income (loss) (5,142) 47 (1,631)
Financial income (expenses), net 123 (35) (233)
Other income (expenses), net (241) 6,203 (83)
------------ ------------ ------------
Income (loss) before income taxes (5,260) 6,215 (1,947)
Equity in losses of affiliates and
impairment, net of taxes -- (38) (48)
------------ ------------ ------------
Net income (loss) from continuing
operations (5,260) 6,177 (1,995)
Loss from discontinued operations 1,288 427 --
------------ ------------ ------------
Net income (loss) $ (6,548) $ 5,750 $ (1,995)
============ ============ ============
Net earnings (loss) per share:
Basic and diluted earnings (loss) from
continuing operations $ (0.42) $ 0.49 $ (0.15)
============ ============ ============
Basic and diluted loss from
discontinued operations $ (0.10) $ (0.04) $ --
============ ============ ============
Basic and diluted net earnings (loss)
per share $ (0.52) $ 0.45 $ (0.15)
============ ============ ============
Weighted average number of Ordinary
shares outstanding 12,706,339 12,706,339 12,718,426
============ ============ ============
The accompanying notes are an integral part of the consolidated financial
statements.
F-6
SUPERCOM LTD. AND ITS SUBSIDIARIES
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AMOUNT
OTHER TOTAL
NUMBER OF ADDITIONAL DEFERRED ACCUMULATED TOTAL SHARE-
ORDINARY SHARE PAID-IN STOCK COMPREHENSIVE ACCUMULATED COMPREHENSIVE HOLDERS'
SHARES CAPITAL CAPITAL COMPENSATION INCOME (LOSS) DEFICIT INCOME (LOSS) EQUITY
---------- ------- ---------- ------------ ------------- ----------- ------------- --------
Balance as of January 1, 2001 12,706,339 $ 40 $25,752 $(114) $ 116 $(15,449) $10,345
Forfeiture of stock options -- -- (22) 22 -- -- --
Deferred stock compensation -- -- 219 (219) -- -- --
Amortization of deferred
stock compensation -- -- -- 66 -- -- 66
Net loss -- -- -- -- -- (6,548) $(6,548) (6,548)
---------- ------ --------- ------------ ------------- ----------- ------------- --------
Total comprehensive loss $(6,548)
=======
Balance as of December 31,
2001 12,706,339 40 25,949 (245) 116 (21,997) 3,863
Forfeiture of stock options
held by Inksure's employees -- -- (219) 219 -- -- --
Other comprehensive income:
Functional currency
adjustment due to sale of
Inksure -- -- -- -- (116) -- $ (116) (116)
Net income -- -- -- -- -- 5,750 5,750 5,750
---------- ------ --------- ------------ ------------- ----------- ------- --------
Total comprehensive income $ 5,634
=======
Balance as of December 31,
2002 12,706,339 40 25,730 (26) -- (16,247)
9,497
Exercise of stock options 200,533 *)-- 84 -- -- -- -- 84
Amortization of stock
compensation -- -- -- 26 -- -- 26
Net loss -- -- -- (1,995) $(1,995) (1,995)
---------- ------ --------- ------------ ------------- ----------- ------- ---------
Total comprehensive loss $(1,995)
=======
Balance as of December 31,
2003 12,906,872 $ 40 $25,814 -- -- $(18,242) $7,612
========== ====== ========= ============ ============= ========== =========
*) Less than $ 1.
The accompanying notes are an integral part of the consolidated financial
statements.
F-7
SUPERCOM LTD. AND ITS SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
YEAR ENDED DECEMBER 31,
----------------------------------------
2001 2002 2003
-------- -------- -------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $(6,548) $ 5,750 $(1,995)
Loss for the period from discontinued operations 1,288 427 --
-------- -------- --------
Net income (loss) from continuing operations (5,260) 6,177 (1,995)
Adjustments to reconcile net income (loss) to net cash used in
operating activities:
Depreciation and amortization 372 442 371
Equity in losses of an affiliates, net -- 38 --
Accrued severance pay, net (288) (20) 29
Amortization of deferred stock compensation 66 -- 26
Decline in market value below cost of marketable debt securities -- -- 52
Decrease (increase) in trade receivables (412) (2,061) 30
Decrease (increase) in other accounts receivable and prepaid expen 272 (153) (79)
Increase in inventories (945) (217) (92)
Increase (decrease) in trade payables (312) (355) 394
Decrease in employees and payroll accruals (14) (341) (31)
Increase (decrease) in accrued expenses and other liabilities (390) 881 (912)
Loss on sale of property and equipment 511 209 5
Accumulated interest on marketable debt securities -- (1) --
Gain on issuance of subsidiary's shares -- (1,802) --
Gain on sale of subsidiary's shares -- (1,936) --
Accumulated interest on long-term loan -- -- 2
Write-off of investment in an affiliate -- -- 48
Gain on sale of subsidiary -- (2,685) --
-------- -------- --------
Net cash used in operating activities (6,400) (1,824) (2,152)
Adjustments to reconcile net loss to net cash used in operating
activities from discontinued operations 122 375 --
Net cash used in operating activities from discontinued operations (1,166) (52) --
-------- -------- --------
Net cash used in operating activities of continuing operations (7,566) (1,876) (2,152)
-------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sale of property and equipment 719 14 2
Purchase of property and equipment (1,891) (73) (87)
Proceeds from short-term deposit -- 100 --
Investment in short-term deposits (100) -- (1,196)
Proceeds from sale of subsidiary -- 4,352 --
Investment in marketable debt securities -- (908) --
Proceeds from redemption of marketable debt securities -- 362 440
Restricted cash deposits -- (53) (628)
Realization of investment in a subsidiary -- (58) --
Proceeds from issuance of shares in Inksure -- 230 --
Proceeds from sale of subsidiary's shares -- 1,630 --
Net cash used for investment activities from discontinued
operations (549) -- --
Investment in other assets -- -- (70)
-------- -------- --------
Net cash provided by (used in) investing activities (1,821) 5,596 (1,539)
-------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Short-term bank credit, net 1,076 (192) 1,196
Proceeds from long-term loan -- 850 250
Principal payment of long-term loan -- (64) (410)
Net cash provided by (used in) financing activities from discontinued
operations 20 (20) --
-------- -------- --------
Net cash provided by financing activities 1,096 574 1,036
-------- -------- --------
Increase (decrease) in cash and cash equivalents (8,291) 4,294 (2,655)
Less - increase (decrease) in cash and cash equivalents from
discontinued operations 11 (1) --
Cash and cash equivalents at the beginning of the year 8,554 274 4,567
-------- -------- --------
Cash and cash equivalents at the end of the year $ 274 $ 4,567 $ 1,912
======== ======== ========
SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING ACTIVITIES:
Receivables on account of shares $ -- $ -- $ 84
======== ======== ========
The accompanying notes are an integral part of the consolidated financial
statements.
F-8
SUPERCOM LTD. AND ITS SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
YEAR ENDED DECEMBER 31,
----------------------------------------
2001 2002 2003
-------- -------- -------
SUPPLEMENTAL DISCLOSURE OF CASH FLOWS INFORMATION:
Cash paid during the year for:
Interest $ 75 $ 60 $ 135
======== ======== ========
SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING
ACTIVITIES:
Transfer of inventory to property and equipment $ -- $ 789 $ --
======== ======== ========
The accompanying notes are an integral part of the consolidated financial
statements.
F-9
SUPERCOM LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
NOTE 1:- GENERAL
a. Supercom Ltd. ("the Company") was established in 1988 in
Israel and has been listed for trade since October 23, 2003
on Euronext Brussels New Market, under the symbol SUP (see
Note 17b).
The Company is a technology integrator and provider of
high-end smartcard systems. The Company functions as a
"one-stop" technological integration and support source for
system integrators, utilizing its unique know-how and
technologies. The Company is also a developer and provider
of a wide-range of complementary technologies and solutions
for the smartcard market. The Company develops and markets
innovative smartcards, smartcard-related products,
proprietary smartcard production technologies and advanced
identification technologies, complemented by brand
protection and authentication technologies. The Company
also sells specially designed kits containing the raw
materials necessary to produce cards and smartcards.
The Company sells its products through centralized
marketing offices in distinct world regions. The Company
has a subsidiary in Hong-Kong, Supercom Asia Pacific
Limited; in which the Company holds 100% of the shares, and
in the United States SuperCom Inc. that was established by
the Company during 2003 in order to market commercial and
governmental contactless smart cards and readers in the
United States.
b. Concentration of risk that may have a significant impact on
the Company:
The Company derived most of its revenues from several major
customers (see Note 14).
The Company purchases certain raw materials used in its
products from a sole supplier. Although there are only a
limited number of manufacturers of those particular raw
materials, management believes that other suppliers could
provide similar components on comparable terms without
affecting operating results.
c. Sale of Inksure Technologies Inc.:
During March 2002, the Company divested part of its
investment in InkSure Technologies Inc. (a subsidiary), to
Elad Ink, a privately held investment company. Under the
terms of the transaction, the Company sold 1,141,553 shares
in the subsidiary for $ 1,000 for cash consideration. As a
result of this transaction, the Company's ownership
interest in Inksure was diluted from 88% to 60%.
During May 2002, the Company divested part of its
investment in InkSure Technologies Inc. (a subsidiary), to
ICTS Information Systems BV, a member of the ICTS group
F-10
(NASDAQ: ICTS). Under the terms of the transaction, the
Company sold 782,771 shares in the subsidiary for $1,000
for cash consideration. As a result of this transaction,
the Company's ownership interest in Inksure was diluted
from 60% to approximately 48%.
As a result of those divestitures, the Company realized
gains net of expenses in the amount of $ 1,936.
In July 5, 2002, Inksure Technologies Inc. issued 3,850,945
Ordinary shares to a private investor. As a result, the
Company's equity ownership interest in Inksure was diluted
from 50% to 30%. Therefore, after July 5, 2002, the Company
didn't have control over the operating and financial
results of Inksure and ceased the consolidation of
Inksure's results from this date. Commencing July 5, 2002
the investment in Inksure was accounted under the equity
method of accounting.
In September 2002,Inksure Technologies Inc. issued 310,560
Ordinary shares to a private investor which decreased the
Company's ownership in Inksure to 29%. As a result of the
foregoing sales, the Company had gains net of expenses in
the amount of $ 1,802.
F-11
SUPERCOM LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
NOTE 1:- GENERAL (CONT.)
On October 2, 2002, the Company divested its remaining
investment in InkSure Technologies Inc., to ICTS
Information Systems BV. Under the terms of the transaction,
the Company sold 3,075,676 shares in InkSure for $ 4,583 in
cash consideration.
The following is a summarized information for Inksure
Technologies Inc for a period of three months ended
September 30, 2002.
Current assets $ 5,686
Non-current assets 866
Current liabilities 643
Long-term liabilities 78
Revenues 803
Gross profit 682
Net loss 122
d. Discontinued operations:
In December 2002, the Company discontinued the operations
of two subsidiaries, ("Genodous Inc." and "Kromotek, Inc.")
and disposed of all assets related to them. The operations
and cash flows of those two subsidiaries have been
eliminated from the operations of the Company. The Company
has no intention of continuing the activities of the
subsidiaries. The Company's plan for discontinuing the
operations of the subsidiaries involved (i) termination of
all employees related to those subsidiaries, including
payment of all statutory and contractual severance
payments, by the end of the fourth quarter of 2002, and
(ii) disposal of the equipment.
The discontinuance of operations of the subsidiaries was
accounted for in accordance with Statement of Financial
Accounting Standard No. 144, "Accounting for the Impairment
or Disposal of Long- Lived Assets" ("SFAS No. 144").
As a result of the above, the results of operations of the
two subsidiaries were reported separately as discontinued
operations in the statement of operations for the years
ended December 31, 2001, 2002 and 2003, respectively, and
are summarized as follows:
F-12
YEAR ENDED
DECEMBER 31,
----------------------------------
2001 2002 2003
------ ------ ------
Revenues $ 373 $ -- $ --
Operating expenses:
Research and development 1,063 132 --
Selling and marketing, net 113 46 --
General and administrative 497 -- --
------ ------ ------
Total operating loss 1,300 178 --
Financial income 12 -- --
Other expenses -- 249 --
------ ------ ------
Net loss $1,288 $ 427 $ --
====== ====== ======
e. The Company management has decided to increase its doubtful
accounts in an aggregate amount of $ 2,133 due to the debt
of the Ukraine Government (see Note 10f).
F-13
SUPERCOM LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES
The consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the
United States.
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 U.S. dollars:
A majority of the sales of the Company and its
subsidiaries' is made in U.S. dollars. In addition, a
substantial portion of the costs of the Company and its
subsidiaries' is incurred in dollars.
Company's management believes that the dollar is the
currency of the primary economic environment in which the
Company and its subsidiaries operate. Thus, the functional
and reporting currency of the Company and its subsidiaries
is the U.S. dollar.
Accordingly, monetary accounts maintained in currencies
other than the dollar are remeasured into U.S. dollars in
accordance with Statement No. 52 of the Financial
Accounting Standards Board ("FASB") "Foreign Currency
Translation". All transaction gains and losses from the
remeasurement of monetary balance sheet items are reflected
in the statements of operations as financial income or
expenses as appropriate.
Through 1999, the financial statements of a subsidiary,
whose functional currency was not the U.S. dollar, have
been translated into U.S. dollars, in accordance with
Statement of Financial Accounting Standards ("SFAS") 52,
"Foreign Currency Translation". All balance sheet accounts
have been translated using the exchange rates in effect at
the balance sheet date. Statement of operations amounts
have been translated using the average exchange rate for
the year. The resulting aggregate translation adjustments
are reported as a component of other comprehensive income
(loss). Starting January 1, 2000, the U.S. dollar became
the functional currency of the subsidiary.
c. Principles of consolidation:
The consolidated financial statements include the accounts
of the Company and its majority of wholly-owned
subsidiaries (unless the minority shareholders have certain
approval or veto rights) in Israel, the United States and
Hong-Kong. Intercompany transactions and balances have been
eliminated upon consolidation.
d. Cash equivalents:
The Company considers highly liquid investments originally
purchased with maturities of three months or less to be
cash equivalents.
F-14
SUPERCOM LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)
e. Restricted cash:
Restricted cash is primarily invested in certificates of
deposit, which mature within one year and is used to secure
an agreement with a customer or a bank.
f. Short-term deposits:
The Company classifies deposits with maturities of more
than three months and less than one year as short-term
deposits. The short-term deposits are presented at their
cost.
g. Marketable securities:
The Company accounts for investments in debt securities in
accordance with Statement of Financial Accounting Standard
No. 115, "Accounting for Certain Investments in Debt and
Equity Securities" ("SFAS No. 115"). Management determines
the appropriate classification of its investments in debt
and equity securities at the time of purchase and
reevaluates such determinations at each balance sheet date.
Debt securities are classified as held-to-maturity when the
Company has the positive intent and ability to hold the
securities to maturity and are stated at amortized cost.
The amortized cost of held-to-maturity securities is
adjusted for amortization of premiums and accretion of
discounts to maturity. Such amortization, accretion,
decline in value judged to be other than temporary and
interest are included in financial income, net. At December
31, 2003 and 2002, marketable debt securities were
designated as held-to-maturity.
According to Staff Accounting Bulletin No. 59 ("SAB 59"),
management is required to evaluate each period whether a
security's decline in value is other than temporary. The
Company considers fair value below cost for two consecutive
quarters to be other than a temporary impairment.
Due to a permanent decline in the value of marketable debt
securities, the Company recorded an impairment of its
investments in those securities. (See Note 3).
h. Inventories:
Inventories are stated at the lower of cost or market
value. Inventory write-offs are provided to cover risks
arising from slow-moving items or technological
obsolescence. Cost is determined as follows:
Raw materials, parts and supplies - using the moving
"average cost" method.
Work-in-progress - represents the manufacturing costs.
Finished products - on the basis of direct manufacturing
costs, with the addition of allocable, indirect
manufacturing costs.
F-15
SUPERCOM LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)
i. Investment in an affiliate and majority owned subsidiary:
The investment in a company, over which the Company can
exercise significant influence, over operating and
financial policies of the investee (generally, entities in
which the Company holds 20% to 50% of ownership or voting
rights) is presented using the equity method of accounting.
The investment in a majority-owned company is represented
using the equity method of accounting due to the
participation rights that the minority has. (See Note 5)
j. Property and equipment:
Property and equipment are stated at cost, net of
accumulated depreciation. Depreciation is computed using
the straight-line method, over the estimated useful lives,
at the following annual rates:
%
--------------------
Computers and peripheral equipment 6 - 33
Office furniture and equipment 6 - 20
Leasehold improvements Over the term of the
lease
The Company's long-lived assets and certain identifiable
intangibles are reviewed for impairment in accordance with
Statement of Financial Accounting Standard No. 144,
"Accounting for the Impairment or Disposal of Long-Lived
Assets" ("SFAS No. 144") whenever events or changes in
circumstances indicate that the carrying amount of an asset
may not be recoverable. Recoverability of assets to be held
and used is measured by a comparison of the carrying amount
of an asset to the future undiscounted cash flows expected
to be generated by the assets. If such assets are
considered to be impaired, the impairment to be recognized
is measured by the amount by which the carrying amount of
the assets exceeds the fair value of the assets. Assets to
be disposed of by sale are reported at the lower of the
carrying amount or fair value less costs to sell.
k. Accrued severance pay:
The liabilities of the Company and its Israeli subsidiaries
for severance pay are calculated pursuant to Israel's
Severance Pay Law based on the most recent salary of the
employees multiplied by the number of years of employment
as of the balance sheet date. Employees are entitled to one
month's salary for each year of employment, or a portion
thereof. The Company's liability for all its employees is
fully provided by monthly deposits with severance pay
funds, 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
Israel's Severance Pay Law or labor agreements. The value
of the deposited funds is based on the cash surrendered
value of these policies and includes immaterial profits.
F-16
SUPERCOM LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)
Severance expenses (revenues) for the years ended December
31, 2001, 2002 and 2003 amounted to $ (41), $ 88 and $ 153,
respectively.
l. Intangible assets:
Intangible assets acquired on or after July 1, 2001, should
be amortized over their useful lives using a method of
amortization that reflects the pattern in which the
economic benefits of the intangible assets are consumed or
otherwise used up, in accordance with SFAS No. 142.
The Company's identifiable intangibles are reviewed for
impairment in accordance with SFAS No. 144 whenever events
or changes in circumstances indicate that the carrying
amount of an asset may not be recoverable. Recoverability
of assets to be held and used is measured by a comparison
of the carrying amount of an asset to the future
undiscounted cash flows expected to be generated by the
assets. If such assets are considered to be impaired, the
impairment to be recognized is measured by the amount by
which the carrying amount of the assets exceeds the fair
value of the assets.
m. Revenue recognition:
The Company and its subsidiaries generate their revenues
from the sale of products, maintenance, training,
installation and royalties. The sale of products involves
the sale of the Smartcard System and raw materials. The
Company sells its products through centralized marketing
offices in distinct world regions.
Product sales of smartcard systems, contactless smart card
Production Line 1000 (SPPL 1000), and raw materials are
recognized in accordance with Staff Accounting Bulletin No.
101, "Revenue Recognition in Financial Statements" ("SAB
No. 101") when persuasive evidence of an agreement exists,
delivery of the product has occurred, the fee is fixed or
determinable, collectability is probable, and
inconsequential or perfunctory performance obligations
remain. In agreements for which the customer requires an
acceptance provision, the Company and its subsidiaries
defer the recognition of revenues until the receipt of the
acceptance confirmation.
In December 2003, the SEC issued Staff Accounting Bulletin
("SAB") No. 104, "Revenue Recognition," ("SAB No. 104")
which revises or rescinds certain sections of SAB No. 101,
"Revenue Recognition," in order to make this interpretive
guidance consistent with current authoritative accounting
and auditing guidance and SEC rules and regulations. The
changes noted in SAB No. 104 did not have a material effect
on the Company's consolidated results of operations,
consolidated financial position or consolidated cash flows.
In November 2002, Emerging Issues Task Force ("EITF")
reached a consensus on Issue No. 00-21, "Revenue
Arrangements with Multiple Deliverables, " EITF Issue No.
00-21 provides guidance on how to account for arrangements
that involve the delivery or performance of multiple
products, services and/or rights to use assets. The
provisions of EITF Issue No. 00-21 applied to revenue
arrangements entered into in fiscal periods beginning after
June 15, 2003.
F-17
SUPERCOM LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)
Additionally, companies were applied the consensus guidance
in this issue to all existing arrangements as the
cumulative effect of a change in accounting principle in
accordance with APB Opinion No. 20, "Accounting Changes".
The adoption of EITF Issue No. 00-21 did not have a
material impact on the Company's financial position, cash
flows or results of operations.
The Company does not provide a right of return to its
customers.
Maintenance and support revenue included in multiple
element arrangements is deferred and recognized on a
straight-line basis over the term of the maintenance and
support agreement. The VSOE of fair value of the
undelivered elements (maintenance, support and services) is
determined based on time and material basis. Revenues from
consumables are recorded upon shipment.
The Company is entitled to royalties upon the sales of
smartcard systems that are recognized when they are
reported to the Company.
Deferred revenues and customer advances include amounts
received from customers for which revenues have not been
recognized.
n. Research and development costs
Smart-Card systems research and development costs are
charged to the statement of operations as incurred.
Research and development costs incurred in the process of
software production before establishment of technological
feasibility, are charged to expenses as incurred. Costs of
the production of a product master incurred subsequent to
the establishment of technological feasibility are
capitalized according to the principles set forth in SFAS
No. 86 "Accounting for the Costs of Computer Software to be
Sold, Leased or Otherwise Marketed". Based on the Company's
product development process, technological feasibility is
established upon completion of a detailed program design or
a working model.
Costs incurred by the Company between completion of the
detailed program design and the point at which the product
is ready for general release have been capitalized.
Capitalized software development costs will be amortized on
a product-by-product basis commencing with general product
release by the greater of the amount computed using: (i)
the ratio that current gross revenues from sales of the
software bear to the total of current and anticipated
future gross revenues from sales of that software, or (ii)
the straight-line method over the estimated useful life of
the software product (three years).
The Company assesses the recoverability of this intangible
asset on a regular basis by determining whether the
amortization of the asset over its remaining life can be
recovered through undiscounted future operating cash flows
from the specific software product sold. Based on its most
recent analyses, management believes that no impairment of
capitalized software development costs exists as of
December 31, 2003.
F-18
SUPERCOM LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE DATA
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)
o. Income taxes:
The Company and its subsidiaries account 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 differences between the financial
reporting and tax bases of assets and liabilities and are
measured using the enacted tax rates and laws that will be
in effect when the differences are expected to reverse. The
Company and its subsidiaries provide a valuation allowance,
if necessary, to reduce deferred tax assets to their
estimated realizable value.
p. Concentrations of credit risk:
Financial instruments that potentially subject the Company
to concentrations of credit risk consist principally of
cash and cash equivalents, marketable securities and trade
receivables. The Company's trade receivables are derived
from sales to customers located primarily in Europe
(including Eastern Europe), South-East Asia, England,
Turkey, the United States and Israel. Management believes
that its credit risk is moderated by the diversity of its
customers and geographic sales areas. The Company performs
ongoing credit evaluations of its customer's financial
conditions. The allowance for doubtful accounts is
determined with respect to specific debts that the Company
has determined to be doubtful of collection.
Cash and cash equivalents and marketable debt securities
are deposited with major banks in Israel, Hong-Kong and the
United States. Management believes that the financial
institutions that hold the Company's investments are
financially sound, and accordingly, minimal credit risk
exists with respect to these investments.
The Company's marketable debt securities include
investments in securities of U.S. corporations. Minimal
credit risk exists with respect to these marketable debt
securities.
The Company has no significant off-balance-sheet
concentration of credit risk such as foreign exchange
contracts, option contracts or other foreign hedging
arrangements.
q. Basic and diluted net earnings (loss) per share:
Basic net earnings (loss) per share is computed based on
the weighted average number of Ordinary shares outstanding
during each year. Diluted net earnings (loss) per share is
computed based on the weighted average number of Ordinary
shares outstanding during each year, plus the dilutive
potential stock options outstanding during the year, in
accordance with FASB Statement No. 128, "Earnings Per
Share".
All outstanding stock options have been excluded from the
calculation of the diluted net earnings (loss) per share
because all such securities are anti-dilutive for all
periods presented. The number of outstanding options was
543,495, 880,712 and 1,534,514, for the years ended
December 31, 2001, 2002 and 2003, respectively.
F-19
SUPERCOM LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE DATA
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)
r. Fair value of financial instruments:
The following methods and assumptions were used by the
Company and its subsidiaries in determining their fair
value disclosures for financial instruments:
At December 31, 2003 and 2002, the carrying amounts of cash
and cash equivalents, restricted cash deposits, short-term
deposits, trade receivables, other accounts receivable,
trade payables, short-term bank credit and other accounts
payable approximate their fair value due to the short-term
maturity of such instruments. The fair value for marketable
securities is based on quoted market prices.
The carrying amount of the Company's long-term loan
approximates its fair value. The fair value was estimated
using discounted cash flows analyses, using current
interest rates for loans or similar terms and maturities.
s. Accounting for stock-based compensation:
The Company has elected to account for stock-based
compensation in accordance with the provisions of
Accounting Principles Board Opinion No. 25 ("APB-25"),
"Accounting for Stock Issued to Employees". Under APB-25,
when the exercise price of the Company's stock options is
equal or higher than the market price of the underlying
shares on the date of grant, no compensation expense is
recognized.
Under Statement of Financial Accounting Standard No. 123,
pro forma information regarding net income and income per
share is required, 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 of these options is amortized over their
vesting period and estimated at the date of grant using a
Black-Scholes option pricing model with the following
weighted-average assumptions for 2001, 2002 and 2003:
risk-free interest rate of 3%, 4% and 3%, respectively,
with a dividend yielded of 0% for each year, volatility
factors of the expected market price of the Company's
Ordinary shares of 1.44, 0.515 and 1.642, respectively, and
a weighted-average expected life of the option of five
years for each year.
F-20
SUPERCOM LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE DATA
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)
The following table summarizes relevant information as to
reported results under the Company's intrinsic value method
of accounting for stock awards, with supplemental
information as if the fair value recognition provisions of
SFAS No. 123, "Accounting for Stock Based Compensation,"
had been applied:
Pro forma information under SFAS 123:
YEAR ENDED DECEMBER 31,
---------------------------------------
2001 2002 2003
------- ------- -------
Net income (loss) from continuing operations as
reported $(5,260) $ 6,177 (1,995)
Deduct: Stock based compensation expenses
determined under fair value based method 297 256 280
Add: stock based compensation expenses included
in reported net income (loss) 66 -- 26
------- ------- -------
Pro forma net income (loss) from continuing
operations $(5,491) $ 5,921 $(2,249)
======= ======= =======
Basic and diluted net earnings (loss) per share
from continuing operations as reported $ (0.42) $ 0.49 $ (0.15)
======= ======= =======
Pro forma basic and diluted net earnings (loss)
from continuing operations $ (0.43) $ 0.47 $ (0.17)
======= ======= =======
Net loss from discontinuing operations as
reported $(1,288) $ (427) $ --
Deduct: Stock based compensation expenses
determined under fair value based method -- -- $ --
Add: stock based compensation expenses included
in reported net income (loss) -- -- $ --
------- ------- -------
Pro forma net loss from discontinuing operations $(1,288) $ (427) $ --
======= ======= =======
Pro forma basic and diluted loss from
discontinuing operations $ (0.10) $ (0.04) $ --
======= ======= =======
Net income (loss) as reported $(6,548) $ 5,750 $(1,995)
Deduct: Stock based compensation expenses
determined under fair value based method 297 256 280
Add: stock based compensation expenses included
in reported net income (loss) 66 -- 26
-------- ------- --------
Pro forma net income (loss) $(6,779) $ 5,494 $(2,249)
======= ======= =======
Basic and diluted net earnings (loss) per share
as reported $ (0.52) $ 0.45 $ (0.15)
======= ======= =======
Pro forma basic and diluted loss $ (0.54) $(0.434) $ (0.17)
======= ======= =======
t. Non-royalty-bearing grants:
The Company received non-royalty-bearing grants from the
Fund for Encouragement of Marketing Activity. These grants
are recognized at the time the Company is entitled to such
grants on the basis of the costs incurred and included as a
reduction in sales and marketing expenses.
F-21
u. Advertising costs:
The Company expenses advertising costs as incurred.
Advertising expenses for the years ended December 31, 2001,
2002 and 2003 were approximately $295, $48 and $ 58,
respectively.
v. Recently issued accounting pronouncements:
In November 2002, the FASB issued FASB Interpretation No.
45, "Guarantor's Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness
of Others, An Interpretation of FASB Statements No. 5, 57,
and 107 and Rescission of FASB Interpretation No. 34" ("FIN
No. 45"). FIN No. 45 elaborates on the disclosures to be
made by a guarantor in its interim and annual financial
statements about its obligations under certain guarantees
that it has issued. It also clarifies that a guarantor is
required to recognize, at the inception of a guarantee, a
liability for the fair value of the obligation undertaken
in issuing the guarantee. FIN No. 45 does not prescribe a
specific approach for subsequently measuring the
guarantor's recognized liability over the term of the
related guarantee. It also incorporates, without change,
the guidance in FASB Interpretation No. 34, "Disclosure of
Indirect Guarantees of Indebtedness of Others," which is
being superseded. The disclosure provisions of FIN No. 45
are effective for financial statements of interim or annual
periods that end after December 15, 2002, and the
provisions for initial recognition and measurement are
effective on a prospective basis for guarantees that are
issued or modified after December 31, 2002, irrespective of
a guarantor's year-end. The adoption of FIN No. 45 did not
have a material impact on the results of operations or
financial position of the Company.
In December 2003, the FASB issued additional guidance
clarifying the provisions of FASB Interpretation No. 46,
Consolidation of Variable Interest Entities, an
Interpretation of ARB No. 51 ("FIN 46-R"). FIN 46-R
provides a deferral of FIN 46 for certain entities until
after March 15, 2004. FIN 46 requires certain variable
interest entities to be consolidated by the primary
beneficiary of the entity if the equity investors in the
entity do not have the characteristics of a controlling
financial interest or do not have sufficient equity at risk
for the entity to finance its activities without additional
subordinated financial support from other parties. The
Company believes that the adoption of this standard will
have no material impact on its consolidated financial
statements.
NOTE 3: MARKETABLE DEBT SECURITIES
The following is a summary of held-to-maturity securities:
AMORTIZED UNREALIZED ESTIMATED
COST GAINS (LOSSES) FAIR VALUE
- --------------------------------------------------------------------------------
2002 2003 2002 2003 2002 2003
- --------------------------------------------------------------------------------
Corporate obligations
$ 609 $ 117 $ (15) $ (12) $ (594) $ (105)
================================================================================
F-22
All marketable debt securities will be redeemed by January 15,
2004. In the fourth quarter of 2003, due to a permanent decline in
value for some of the securities, the Company recorded an
impairment of its investment in those securities. The impairment
was in the amount of $ 52.
NOTE 4:- INVENTORIES
DECEMBER 31,
-------------------------
2002 2003
----------- -----------
Raw materials, parts and supplies $ 962 $ 1,662
Finished products 2,182 1,574
----------- -----------
$ 3,144 $ 3,236
=========== ===========
NOTE 5:- INVESTMENT IN AFFILIATES AND OTHERS
a. The Company holds 40% of an affiliate, which serves as a
regional marketing office responsible for marketing in the
former Soviet territories (excluding Ukraine and Moldavia).
During 2003, the affiliate downsized all of its operation,
and the Company decided to write-off its entire investment
in the affiliate in the amount of $ 48.
b. In December 1997, the Company established Supercom Slovakia
in equal parts with another investor as a result of a
transaction with the Slovakian ministry of interior.
In March 2000, the Company purchased an additional 16% of
Supercom Slovakia, at the nominal value of $1, and granted
to the third party a loan in the amount of $ 275, bearing
interest of 0.7% per month for any amounts outstanding.
This interest is compounded to the outstanding principal of
the loan and will be repaid under the same conditions of
the loan.
The third party has an option to buy back 16% of the
shares, for $ 1, subsequent to repayment of the loan to the
Company.
The Company currently owns 66% of Supercom Slovakia's
outstanding shares. The Company has accounted for this
investment using the equity method of accounting, due to
the minority interest participation rights. (See also Note
10c).
F-23
SUPERCOM LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 6:- PROPERTY AND EQUIPMENT
DECEMBER 31,
----------------
2002 2003
------ ------
Cost:
Computers and peripheral equipment $2,287 $2,281
Office furniture and equipment 410 408
Leasehold improvements 1,027 1,107
------ ------
3,724 3,796
------ ------
Accumulated depreciation:
Computers and peripheral equipment 1,423 1,412
Office furniture and equipment 164 192
Leasehold improvements 257 516
------ ------
1,844 2,120
------ ------
Depreciated cost $1,880 $1,676
====== ======
Depreciation expenses for the years ended December 31, 2001, 2002
and 2003 are $ 372, $ 442 and $ 371, respectively.
NOTE 7:- OTHER ASSETS
On November 17, 2003, the Company purchased 20% of the remaining
shares of Supercom Asia Pacific from the minority in consideration
of $ 70.
The acquisition was accounted for under the purchase method of
accounting. Accordingly, the consideration of $ 70 was attributed
to customer related intangible assets.
DECEMBER 31,
------------
2002 2003
---- ----
Customer related intangible assets $ -- $ 70
Capitalized software production costs, net
(see Note 2n) 173 86
---- ----
$173 $156
==== ====
F-24
SUPERCOM LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 8:- BANK CREDIT
a. As of December 31, 2003, the Company had credit lines from
several banks in the aggregate amount of $ 1,957 (including
long-term loans credit lines in the amount of $ 719, of
which the amount of $ 628 was used), of which $ 1,238 is
denominated in NIS and bears interest at the rate of Prime,
plus an additional 1% - 3%, and $ 719 is denominated in
dollars and bears interest at the rate of LIBOR plus 2.5%
-3.2%.
The weighted average interest rate on the credit lines as
of December 31, 2002 and 2003 was approximately 11.71% and
approximately 7.7%, respectively.
In addition, the Company received short-term loans from a
bank in the amount of $ 500, under certain conditions (see
Note 10e). The average interest rate on the loans as of
December 31, 2003, was approximately 5.7%.
The Company had an unused credit facility in the amount of
approximately $ 139 as of December 31, 2003 (there is no
fee for the unused portion of the credit facility).
B. LONG-TERM LOANS:
DECEMBER 31,
------------
2002 2003
---- ----
Banks $786 $628
Less - current maturities of long-term loans 357 441
---- ----
$429 $187
==== ====
The loans bear annual average interest at the rate of LIBOR
+2.8%.
NOTE 9:- ACCRUED EXPENSES AND OTHER LIABILITIES
Customer advances $ 140 $ 166
Deferred revenues 304 437
Accrued expenses 259 171
Commissions 960 --
Other 71 48
------ ------
$1,734 $ 822
====== ======
F-25
SUPERCOM LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 10:- COMMITMENTS AND CONTINGENT LIABILITIES
a. Lease commitments:
The Company's facilities and those of certain subsidiaries
are rented under several operating lease agreements for
periods ending in 2006.
Future minimum lease commitments under non-cancelable
operating leases for the years ended December 31, are as
follows:
2004 $ 370
2005 354
2006 308
-------
$ 1,032
=======
Rent expenses for the years ended December 31, 2001, 2002
and 2003, were approximately $ 571, $ 414 and $ 312,
respectively.
b. Guarantees:
1. The Company obtained bank guarantees in the amount of $
60, in order to secure the Company's lease and, as a
condition for those guarantees, the Company deposited $
60 with the bank. The Company provided a guarantee in
favor of Bank Hapoalim Ltd. in the amount of $ 450, for
debt and other obligations. The Company provided bank
guarantees in the amount of $ 91, in order to secure
other obligations.
2. The Company mortgaged its deposits in the amount of $
183 in Israel Discount Bank Ltd. in favor of the bank,
and an amount of $ 117 in favor of Bank Otsar Ha-Hayal
Ltd.
3. In order to secure an agreement with a customer, the
Company obtained short-term loans in the amount of $
500 and provided bank guarantees in the amounts of $
158 and $ 156, which were deposited by the Company.
c. Litigations
1. On January 19, 2000, Supercom Slovakia, a 66% owned
subsidiary of the Company, filed a claim against the
ministry of interior of the Republic of Slovakia for
the breach of the delivery of technology, co-operation
and services agreement. The Company requests
performance of the agreement. On November 17, 2003, the
arbitration procedure was finalized and the ministry of
interior of Slovakia has been ordered to pay Supercom
Slovakia the amount of SKK 80,000 (approximately US$
2,270 as of December 31, 2003) plus an average interest
F-26
rate of 16.4% from March 1999. In addition, the
Slovakian ministry of interior has been ordered to pay
the costs of arbitration in the amount of(euro)42,716
and Supercom Slovakia's legal fees in the amount
of(euro)63,611. The Slovakian ministry of interior has
the right to appeal in the Austrian Courts within three
months from the date of this award on only legal
procedures. The company has begun the enforcement
procedure of the arbitral award and correspondingly,
indirectly received information that the Slovakian
ministry of interior has filed an appeal.
2. On December 12, 1999, Secu-Systems filed a lawsuit with
the District Court in Tel-Aviv-Jaffa jointly and
severally against the Company and InkSure Ltd. (a
former subsidiary) seeking a permanent injunction and
damages. The plaintiff asserted in its suit that the
printing method applied to certain products that have
been developed by InkSure Ltd. constitutes inter alia:
(a) the breach of a confidentiality agreement between
the plaintiff and the Company; (b) unjust enrichment of
the Company and InkSure Ltd; (c) breach of fiduciary
duties owed to the plaintiff by the Company and InkSure
Ltd., and (d) a tort of misappropriation of trade
secrets and damage to plaintiff's property.
Secu-Systems, based on such allegations, asked the
court to order the Company and InkSure to: (i) cease
any activity which involves the plaintiff's
confidential information; (ii) furnish the plaintiff
with a certified report detailing all profits derived
by the Company and InkSure Ltd. from such activity;
(iii) pay the plaintiff an amount equal to all such
profits, and (iv) pay the plaintiff additional damages
in the amount of NIS 100,000. Alternatively, the
plaintiff asked the court to declare that the
above-mentioned products are owned by the plaintiff and
InkSure in equal parts and that the plaintiff is
entitled to 50% of all profits derived therefrom, in
which case, the plaintiffs asked that the Company and
InkSure allocated 50% of the profits from the printing
method at issue.
Based upon the facts known to the Company and those
provided by InkShure Ltd. and the Company's legal
advisors advise which is based, inter-alia, on said
facts, the Company's management is of the opinion that,
the prospects are favorable that the court will not
grant the permanent injunction or award damages of a
substantial amount in connection with the litigation.
Accordingly, the management of the Company did not
provide for such potential liability.
3. On July 14, 2003, an Israeli agent ("the claimant")
filed a lawsuit with the District Court in
Tel-Aviv-Jaffa against the Company and its chairman of
the Board of Directors; the claimant claims that the
Company owes him NIS 250,000 (approximately $ 54,550)
in commissions allegedly due for his part in
F-27
establishing business connections for the Company in
Eastern Asia during the years 1993-1998. The Company
plans to contest this claim.
The Company's management and its legal advisors cannot
assess at this stage the outcome of this claim.
4. During March 2004, the Company was informed indirectly
that the Ministry of Ukraine has filed a claim in order
to declare the agreement that was signed between the
parties on April 9, 2002, void due to errors in the
tender procedures under which the contract had been
awarded to the Company. The Company is currently
investigating the claim. During 2002, the Company began
the delivery of the first phase pursuant to this
agreement and generated revenues of $2,100. During
2003, the Company generated an aggregate of $ 1,970, in
revenues from this project.
The Company's management has decided to increase its
allowance for doubtful accounts in an aggregate amount
of $ 2,133 due to the Ukraine government debt to the
Company. In addition, the Company has reduced its
obligation to pay commissions to the distributor that
mediated this agreement.
The Company does not anticipate any revenues from this
project during 2004. The management believes that the
claim has no merits and intends to vigorously defend
the validity of the contract.
F-28
SUPERCOM LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 11:- 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
status as an "Approved Enterprise", under the law, for
three separate investment programs that were approved in
July 1992, October 1994 and March 1996.
Since the Company is operating more than one approved
enterprise and since the Company is not entitled to tax
benefits on part of its taxable income that is taxed at the
rate of 36%, under the abovementioned law, its effective
tax rate will be the result of a weighted combination of
the various applicable rates and tax exemptions. The
computation is made in respect of income derived from each
project, on the basis of formulas specified by law and
approvals.
The entitlement to the above benefits is conditional upon
the Company fulfilling the conditions stipulated by the
above law, regulations published thereunder and the letters
of approval for the specific investments in "approved
enterprises". In the event of failure to comply with these
conditions, the benefits may be canceled and the Company
may be required to refund the amount of the benefits, in
whole or in part, including interest. As of December 31,
2003, management believes that the Company is meeting all
of the aforementioned conditions.
The tax-exempt profits that will be earned by the Company's
"Approved Enterprises" can be distributed to shareholders'
without tax liability to the Company only upon the complete
liquidation of the Company. If these retained tax-exempt
profits are distributed in a manner other than in the
complete liquidation of the Company, they would be taxed at
the corporate tax rate applicable to such profits as if the
Company had not elected the alternative system of benefits
(currently 25% for an "Approved Enterprise"). The Company's
Board of Directors has determined that such tax-exempt
income will not be distributed as dividends.
The period of tax benefits, detailed above, is subject to
limits of 12 years from the commencement of production, or
14 years from the approval date, whichever is earlier.
The law also grants entitlement to claim accelerated
depreciation on buildings, machinery and equipment used by
the "Approved Enterprise", during the first five tax years.
Should the Company derive income from sources other than an
"Approved Enterprise" during the relevant period of
benefits, such income will be taxable at regular corporate
tax rate of 36%.
b. Tax benefits under the Law for the Encouragement of
Industry (Taxation), 1969:
F-29
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,
the right to claim public issuance expenses and
amortization of patents and other intangible property
rights as a deduction for tax purposes.
c. Measurement of results for tax purposes under the Income
Tax Law (Inflationary Adjustments), 1985.
Results for tax purposes are measured in terms of earnings
in NIS after certain adjustments for increase in Israel's
Consumer Price Index ("CPI"). As explained in Note 2b, the
financial statements are measured in U.S. dollars. The
difference between the annual change in Israel's CPI and in
the NIS/dollar exchange rate causes a further difference
between taxable income and the income before taxes shown in
the financial statements. In accordance with paragraph 9(f)
of SFAS No. 109, the Company has not provided deferred
income taxes on this difference between the functional
currency and the tax bases of assets and liabilities.
F-30
SUPERCOM LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 11:- TAXES ON INCOME (CONT.)
d. Israeli tax reform:
On January 1, 2003, the Law for Amendment of the Income Tax
Ordinance (Amendment No. 132) 2002, known as the tax
reform, became effective. The tax reform changed Israel's
tax system from one on a territorial basis into that of a
personal basis.
In addition, the concept of a "controlled foreign
corporation" was introduced, according to which an Israeli
company may become subject to Israeli taxes on certain
income of a non-Israeli subsidiary if the subsidiary's
primary source of income is passive income (such as
interest, dividends, royalties, rental income or capital
gains). The tax reform also substantially changed the
system of taxation of capital gains. Management of the
Company does not expect that the tax reform will have any
significant impact on the Company's activities.
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 deferred tax assets of the Company and
its subsidiaries' are as follows:
DECEMBER 31,
-------------------
2002 2003
------- -------
Operating loss carryforward $ 3,256 $ 2,338
Reserves and allowances 290 828
------- -------
Net deferred tax asset before valuation
allowance 3,546 3,166
Valuation allowance (3,546) (3,166)
------- -------
Net deferred tax asset $ -- $ --
======= =======
Deferred income taxes consist of the
following:
Domestic $ 2,640 $ 2,971
Valuation allowance (2,640) (2,971)
------- -------
Foreign 906 195
Valuation allowance (906) (195)
------- -------
$ -- $ --
======= =======
The Company and its subsidiaries have provided valuation
allowances of $ 3,166 in respect of deferred tax assets
resulting from tax loss carryforwards and other temporary
differences. Management currently believes that since the
Company and its subsidiaries have a history of losses the
deferred tax assets will not be realized in the foreseeable
future.
F-31
SUPERCOM LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 11:- TAXES ON INCOME (CONT.)
f. Net operating losses carryforward:
Supercom Ltd. has accumulated losses for tax purposes as of
December 31, 2003, in the amount of approximately $ 9,737,
which may be carried forward and offset against taxable
income in the future for an indefinite period.
Supercom's subsidiaries - in the United States and Hong
Kong, have estimated total available carryforward tax
losses of $ 9 and $ 1,070, respectively, which are
available to offset against future taxable income, if any,
in the future for an indefinite period in Hong Kong and
expiring in 2019 in the United States.
Utilization of U.S. net operating losses may be subject to
a substantial annual limitation due to the "change in
ownership" provisions of the Internal Revenue Code of 1986
and similar state provisions. The annual limitation may
result in the expiration of net operating losses before
utilization.
g. Income (loss) from continuing operations before taxes on
income consists of the following:
YEAR ENDED DECEMBER 31,
-------------------------------
2001 2002 2003
------- ------- -------
Domestic $(3,330) $ 5,614 $(1,902)
Foreign (1,930) 601 (45)
------- ------- -------
$(5,260) $ 6,215 $(1,947)
======= ======= =======
h. Reconciliation of the theoretical tax expense (benefit) to
the actual tax expense (benefit):
A reconciliation of theoretical tax expense, assuming all
income is taxed at the statutory rate applicable to the
income of companies in Israel (36% for each of the years
ended December 31, 2001, 2002 and 2003, respectively), and
the actual tax expense, is as follows:
F-32
YEAR ENDED DECEMBER 31,
---------------------------------
2001 2002 2003
------- ------- -------
Income (loss) from continuing operations before
taxes on income, as reported in the
consolidated statements of operations $(5,260) $ 6,215 $(1,947)
======= ======= =======
Statutory tax rate in Israel 36% 36% 36%
======= ======= =======
Theoretical tax expenses (benefit) $(1,894) $ 2,237 $ (701)
Carryforward losses and other deferred taxes
for which a full valuation allowance was
recorded 1,894 (2,237) 701
Taxes due to a subsidiary -- -- --
------- ------- -------
Actual income tax $ -- $ -- $ --
======= ======= =======
F-33
SUPERCOM LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 12:- SHARE CAPITAL
a. Shareholders' rights:
The Ordinary shares confer upon the holders the right to
receive notice to participate and vote in the general
meetings of the Company, and the right to receive
dividends, if declared.
b. Stock options:
1. On February 14, 1999, the Board of Directors adopted
the 1999 Employee Stock Option Plan that was amended
and restated in March 2002 (the "Option Plan").
Under the Option Plan, 1,000,000 shares have been
reserved for issuance.
Options become exercisable ratably over a period of
three to five years, commencing with the date of
grant. The options generally expire no later than 10
years from the date of grant. Any options, which are
forfeited or canceled before expiration, become
available for future grants.
On January 26, 2003, at the general meeting, it was
resolved to grant an option to acquire up to 50,000
shares of the Company to each of the directors of
the Company, who are not outside directors. The
exercise price under the terms of such options is $
0.42 per share.
It was also approved to grant an option to acquire
up to 670,981 shares of the Company (the "Option")
to Mr. Eli Rozen in lieu of his rights due to the
termination of his employment. The exercise price
under the terms of the Option is $ 0.42 per share.
In December 2003, employees of the Company exercised
their options into Ordinary shares in consideration
of $ 84.
On November 13, 2003, the Board of Directors
approved to reprice 136,919 options to two senior
employees from $ 4.02 per share to $ 0.42, the
options vest over five equal portions each over a 12
month period, with the first portion vesting on
February 2, 1999. The employees exercised the
options and, as a result, the Company did not record
any compensation expenses.
F-34
SUPERCOM LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 12:- SHARE CAPITAL (CONT.)
2. A summary of the Company's stock option activity,
and related information is as follows:
YEAR ENDED DECEMBER 31
---------------------------------------------------------------------------
2001 2002 2003
------------------- ----------------------- -----------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
NUMBER OF EXERCISE NUMBER OF EXERCISE NUMBER OF EXERCISE
OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE
--------- -------- ---------- -------- ---------- --------
Outstanding at 768,410 $ 4.3 543,495 $ 5.19 880,712 $ 2.88
beginning of year
Granted 65,000 $ 0.42 443,081 $ 0.42 1,005,981 $ 0.42
Exercised -- $ -- -- $ -- (200,533) $ 0.42
Canceled and forfeited (289,915) $ 3.36 (105,864) $ 4.41 (151,646) $ 0.72
--------- ---------- ----------
Outstanding at end of year
543,495 $ 5.19 880,712 $ 2.88 1,534,514 $ 1.8
========= ======== ========== ======== ========== ========
Exercisable at end of year
329,842 $ 5.58 478,714 $ 4.32 1,082,846 $ 1.91
========= ======== ========== ======== ========== ========
Compensation expenses recognized by the Company
related to its share-based employee compensation
awards was $ 66, $ 0 and $ 26 for the years ended
December 31, 2001, 2002 and 2003, respectively.
The options outstanding as of December 31, 2003,
have been separated into ranges of exercise price as
follows:
OPTIONS WEIGHTED OPTIONS
OUTSTANDING AVERAGE WEIGHTED EXERCISABLE WEIGHTED
AS OF REMAINING AVERAGE AS OF AVERAGE
EXERCISE DECEMBER 31, CONTRACTUAL EXERCISE DECEMBER 31, EXERCISE
PRICE 2003 LIFE (YEARS) PRICE 2003 PRICE
- -------------------- --------------- -------------- -------------- ----------------- --------------
$ 0.42 1,303,781 8.95 $ 0.42 869,314 $ 0.42
$ 2.00 15,000 2 $ 2.0 9,000 $ 2.0
$ 4.00 - $ 6.00 18,670 0.5 $ 5.09 16,180 $ 5.25
$ 8.00 - $ 9.60 197,063 0.2 $ 8.14 188,352 $ 8.52
----------- -----------
1,534,514 $ 1.8 1,082,846 $ 1.91
=========== ======== =========== ==========
c. 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-35
SUPERCOM LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 13:- RELATED PARTY TRANSACTIONS
a. On October 1, 2001, the Company entered into a consulting
agreement with a company owned by the Chairman of the Board
of Directors who is one of the co-founders of the Company.
In consideration of these services, the Company has
undertaken to pay $ 10.5 per month plus motor vehicle
expenses. During 2003, the Company paid $ 126, pursuant to
this agreement.
b. On October 1, 2001, the Company entered into a consulting
agreement with a company owned by a member of the Company's
Board of Directors, one of the Company's co-founders and a
principal shareholder.
In consideration of these services, the Company has
undertaken to pay $ 4.6 per month plus motor vehicle
expenses. During 2003, the Company paid $ 55, pursuant to
this agreement.
c. On October 1, 2001, the Company entered into a consulting
agreement with a company owned by one of the co-founders of
the Company.
In consideration for these services, the Company has
undertaken to pay $ 4.6 per month plus motor vehicle
expenses. During 2003, the Company paid $ 55, pursuant to
this agreement.
d. On September 1, 2001, the Company entered into an agreement
with its 40% affiliate, pursuant to which the Company
agreed to sub-lease office space in the Raanana, Israel
facility to CT Card Tech and to provide CT Card Tech with
certain additional services in consideration of a monthly
payment of $ 1. In November 2003, CT Card Tech surrendered
a portion of its office space, which reduced the monthly
payment to $ 0.5.
e. On March 7, 2000, the Company entered into an agreement
with IFTIC Ltd., a company registered in Israel and
wholly-owned by a member of the Company's Board of
Directors. Under the terms of the agreement, IFTIC provides
the Company with market promotion and management services
for a minimum fee of $ 2.5 per month for the first 10 hours
and an additional fee of 1.5% of sales initiated from new
customers first introduced by the member of the Board. The
Company paid IFTIC approximately $ 17 in 2003.
f. During 2002, Avi Landman, one of the Company's co-founders,
received $152,442 as back compensation in connection with
salary and social benefits for the period he served as an
employee in connection with the termination of his
employment agreement.
NOTE 14:- SEGMENTS, CUSTOMERS AND GEOGRAPHIC INFORMATION
F-36
a. Summary information about geographic areas:
The Company manages its business on the basis of one
reportable segment (see Note 1 for a brief description of
the Company's business) and follows the requirements of
SFAS 131, "Disclosures About Segments of an Enterprise and
Related Information".
The following is a summary of operations within geographic
areas, based on the location of its customers:
YEAR ENDED DECEMBER 31,
----------------------------------------------------------------------------------
2001 2002 2003
--------------------------- ------------------------- -------------------------
TOTAL LONG-LIVED TOTAL LONG-LIVED TOTAL LONG-LIVED
REVENUES ASSETS REVENUES ASSETS REVENUES ASSETS
---------- ----------- ---------- ----------- ---------- ---------
Ukraine $ -- $ -- $2,120 $ -- $1,970 $ --
Moldova 1,075 -- 1,554 -- 1,184 --
Eastern Europe 674 -- 6 -- -- --
Hong-Kong 2,212 144 1,942 58 2,067 28
England 213 -- 285 -- 154 --
Israel 327 1,493 229 1,822 460 1,647
Turkey -- -- 1,272 -- -- --
United States 2,241 120 581 -- 828 1
Africa -- -- -- -- 536 --
Other 147 106 38 -- 45 --
------ ------ ------ ------ ------ ------
$6,889 $1,863 $8,027 $1,880 $7,244 $1,676
====== ====== ====== ====== ====== ======
F-37
b. Summary of operations based on products and services:
YEAR ENDED DECEMBER 31,
--------------------------
2001 2002 2003
------ ------ ------
SPPL 1000 $4,606 $2,080 $ 551
Raw materials and equipment -- 4,879 6,116
License fee 1,667 446 --
Maintenance 616 622 577
------ ------ ------
$6,889 $8,027 $7,244
====== ====== ======
NOTE 14:- SEGMENTS, CUSTOMERS AND GEOGRAPHIC INFORMATION (CONT.)
c. Major customers data as a percentage of total sales:
YEAR ENDED DECEMBER 31,
------------------------------------------
2001 2002 2003
------------ ------------ ------------
Customer A -- 26% 27%
============ ============ ============
Customer B 16% 19% 16%
============ ============ ============
Customer C -- 16% --
============ ============ ============
Customer D 17% 12% 12%
============ ============ ============
Customer E -- *) -- 11%
============ ============ ============
Customer F 23% *) -- --
============ ============ ============
Customer G 14% -- --
============ ============ ============
*) Less than 10%.
F-38
NOTE 15:- FINANCIAL INCOME (EXPENSES), NET
YEAR ENDED DECEMBER 31,
---------------------------------
2001 2002 2003
----- ----- -----
Financial expenses:
Interest, bank charges and fees $(116) $(119) $(207)
Foreign currency translation -- -- (98)
----- ----- -----
(116) (119) (305)
----- ----- -----
Financial income:
Foreign currency translation 108 50 --
Interest 131 34 72
----- ----- -----
239 84 72
----- ----- -----
$ 123 $ (35) $(233)
===== ===== =====
NOTE 16:- OTHER INCOME (EXPENSES), NET
Loss on sale of property and equipment, net $ (511) $ (209) $ (5)
Decline in market value of held-to-maturity securities -- -- (52)
Gain on sale of subsidiary's shares 250 1,936 --
Gain on sale of a subsidiary -- 2,685 --
Gain on issuance of subsidiary's shares -- 1,802 --
Other 20 (11) (26)
------- ------- -------
$ (241) $ 6,203 $ (83)
======= ======= =======
F-39
NOTE 17:- SIGNIFICANT EVENTS
a. On May 6, 2003, the Company announced that it had executed
a letter of intent which sets forth the preliminary terms
and conditions of a proposed merger between the Company and
PerfectData Corporation. In connection with the merger, the
shareholders of the Company were to exchange their shares
in the Company for shares of Common stock of PerfectData.
On October 24, 2003, Perfect Data has filed with the
Securities and Exchange Commission its Registration
Statement on Form S-4 regarding the proposed merger between
the Company and Perfect Data.
On January 20, 2004, the Company and Perfect Data announced
that their merger agreement and related agreements have
been terminated according to the terms of the agreements.
b. On October 23, 2003, the Company transferred the listing of
its Ordinary shares to the Euronext Brussels New Market,
under the symbol SUP and has requested the delisting from
NASDAQ Europe following the announcement by NASDAQ Europe
that it will be discontinuing its operations by the end of
November 2003. The delisting was effected at the close of
business on November 27, 2003.
- - - - - - - - - - -
AUDITORS
THE CONSOLIDATED FINANCIAL STATEMENTS OF THE COMPANY, INCLUDING THE NOTES
THERETO, AS OF AND FOR THE YEARS ENDED 31 DECEMBER, 2001, 2002 AND 2003,
INCLUDED IN ITEM 18 OF THIS REGISTRATION FORM, HAVE BEEN PREPARED IN ACCORDANCE
WITH U.S. GAAP AND HAVE BEEN AUDITED BY KOST, FORER GABBAY & KASIERER, A MEMBER
OF ERNST & YOUNG GLOBAL, INDEPENDENT PUBLIC ACCOUNTANTS, LOCATED AT 3 AMINADAV
STREET, TEL AVIV, ISRAEL. THE CONSOLIDATED FINANCIAL STATEMENTS HAVE BEEN
INCLUDED IN THIS ANNUAL REPORT IN RELIANCE UPON THE REPORT OF KOST, FORER GABBAY
& KASIERER, GIVEN ON THE AUTHORITY OF THAT FIRM AS EXPERTS IN AUDITING AND
ACCOUNTING.
DIRECTORS & SENIOR EXECUTIVES OF THE ISSUER
F-40
SUPERCOM LTD. AND ITS SUBSIDIARIES
INTERIM CONSOLIDATED FINANCIAL STATEMENTS
AS OF JUNE 30, 2004
IN U.S. DOLLARS
UNAUDITED
INDEX
PAGE
---------
CONSOLIDATED BALANCE SHEETS F-42
CONSOLIDATED STATEMENTS OF OPERATIONS F-44
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY F-45
CONSOLIDATED STATEMENTS OF CASH FLOWS F-46
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS F-47
---------
F-41
SUPERCOM LTD. AND ITS SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
- --------------------------------------------------------------------------------
U.S. dollars in thousands
DECEMBER 31, JUNE 30,
2003 2004
------------------- -------------------
UNAUDITED
-------------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 1,912 $ 1,528
Restricted cash deposits 681 434
Short-term deposit 1,196 601
Marketable debt securities 117 -
Trade receivables (net of allowance for doubtful accounts of
$ 3,333 as of December 31, 2003 and June 30, 2004) 1,808 1,798
Other accounts receivable and prepaid expenses 680 879
Inventories 3,236 2,836
------------------- -------------------
Total current assets 9,630 8,076
------------------- -------------------
LONG-TERM INVESTMENTS:
Long term trade receivables 364 305
Investment in an affiliate and others 275 275
Severance pay fund 333 356
------------------- -------------------
972 936
------------------- -------------------
PROPERTY AND EQUIPMENT, NET 1,676 1,886
------------------- -------------------
OTHER ASSETS 156 134
------------------- -------------------
$ 12,434 $ 11,032
=================== ===================
The accompanying notes are an integral part of the consolidated financial
statements.
F-42
CONSOLIDATED BALANCE SHEETS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AMOUNTS
DECEMBER 31, JUNE 30,
2003 2004
------------------- -------------------
UNAUDITED
-------------------
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Short-term bank credit and current maturities of long-term loan $ 2,131 $ 1,741
Trade payables 1,085 1,033
Employees and payroll accruals 161 192
Accrued expenses and other liabilities 822 660
------------------- -------------------
Total current liabilities 4,199 3,626
------------------- -------------------
LONG-TERM LIABILITIES:
Long-term loan, net of current maturities 187 185
Accrued severance pay 436 465
------------------- -------------------
Total long-term liabilities 623 650
------------------- -------------------
SHAREHOLDERS' EQUITY:
Share capital:
Ordinary shares of NIS 0.01 par value -
Authorized: 26,500,000 shares at December 31, 2003 and June 30, 2004;
Issued and outstanding: 12,906,872 and 12,966,872 shares at December
31, 2003 and June 30, 2004, respectively 40 41
Additional paid-in capital 25,814 25,856
Deferred stock compensation - (14)
Receipt on account of shares - 775
Accumulated deficit (18,242) (19,902)
------------------- -------------------
Total shareholders' equity 7,612 6,756
------------------- -------------------
$ 12,434 $ 11,032
=================== ===================
The accompanying notes are an integral part of the consolidated financial
statements.
F-43
CONSOLIDATED STATEMENTS OF OPERATIONS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE DATA)
SIX MONTHS ENDED THREE MONTHS ENDED
JUNE 30, JUNE 30,
-------------------------------- -------------------------------
2003 2004 2003 2004
---------------- --------------- --------------- ---------------
UNAUDITED
-----------------------------------------------------------------
Revenues $ 3,905 $ 2,484 $ 1,021 $ 1,173
Cost of revenues 1,504 1,564 447 738
---------------- --------------- --------------- ---------------
Gross profit 2,401 920 574 435
---------------- --------------- --------------- ---------------
Operating expenses:
Research and development 465 377 229 183
Selling and marketing 1,547 1,129 260 572
General and administrative 939 944 438 441
---------------- --------------- --------------- ---------------
Total operating expenses 2,951 2,450 927 1,196
---------------- --------------- --------------- ---------------
Operating loss (550) (1,530) (353) (761)
Financial expenses, net 146 77 131 70
Other expenses, net 41 53 11 49
---------------- --------------- --------------- ---------------
Net loss $ (737) $ (1,660) $ (495) $ (880)
================ =============== =============== ===============
Basic and diluted net loss per share $ (0.06) $ (0.13) $ (0.04) $ (0.07)
================ =============== =============== ===============
Weighted average number of Ordinary shares used in
computing basic and diluted net loss per share 12,706,339 12,949,070 12,706,339 12,966,872
================ =============== =============== ===============
The accompanying notes are an integral part of the consolidated financial
statements.
F-44
SUPERCOM LTD. AND ITS SUBSIDIARIES
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
RECEIPT
ON
NUMBER OF ADDITIONAL DEFERRED ACCOUNT TOTAL
ORDINARY SHARE PAID-IN STOCK ACCUMULATED OF SHAREHOLDERS'
SHARES CAPITAL CAPITAL COMPENSATION DEFICIT SHARES EQUITY
---------- ------- ---------- ------------ ----------- -------- -------------
Balance as of January 1, 2004 12,906,872 40 25,814 - (18,242) 7,612
Deferred stock compensation - - 19 (19) - - -
Conversion of loan to ordinary
shares, net 60,000 1 23 - - - 24
Amortization of deferred stock
compensation - - - 5 - - 5
Receipt on account of shares - - - - - 775 775
Net loss - - - - (1,660) - (1,660)
---------- ------- ---------- ------------ ----------- -------- -------------
Balance as of June 30, 2004 12,966,872 $ 41 $ 25,856 $ (14) $ (19,902) $ 775 $ 6,756
========== ======= ========== ============ =========== ======== =============
The accompanying notes are an integral part of the consolidated financial
statements.
F-45
SUPERCOM LTD. AND ITS SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
SIX MONTHS ENDED
JUNE 30,
-------------------------------------
2003 2004
---------------- ---------------
UNAUDITED
--------------------------------------
Cash flows from operating activities:
Net loss $ (737) $ (1,660)
Adjustments to reconcile net loss to net cash used
in operating activities:
Depreciation and amortization 189 167
Accrued severance pay, net 10 6
Amortization of deferred stock compensation 26 5
Decrease (increase) in trade receivables (1,649) 69
Decrease (increase) in other accounts receivable
and prepaid expenses 76 (199)
Decrease in inventories 246 330
Increase (decrease) in trade payables 294 (52)
Increase in employees and payroll accruals 42 56
Increase (decrease) in accrued expenses and other
liabilities 603 (162)
Others 6 7
---------------- ---------------
Net cash used in operating activities (894) (1,433)
---------------- ---------------
Cash flows from investing activities:
Proceeds from sale of property and equipment 1 -
Purchase of property and equipment (31) (285)
Short-term deposits matured - 595
Investment in short-term deposits (791) -
Proceeds from redemption of marketable debt
securities 335 110
Restricted cash deposits, net (15) 247
---------------- ---------------
Net cash provided by (used in) investing activities (501) 667
---------------- ---------------
Cash flows from financing activities:
Short-term bank credit, net 768 (555)
Receipt of long-term loan 167 400
Issuance expenses related to conversion of loan into
shares - (1)
Receipt of proceeds on account of shares - 775
Repayment of long-term loan (175) (237)
---------------- ---------------
Net cash provided by financing activities 760 382
---------------- ---------------
Decrease in cash and cash equivalents (635) (384)
Cash and cash equivalents at the beginning of the
period 4,567 1,912
---------------- ---------------
Cash and cash equivalents at the end of the period $ 3,932 $ 1,528
================ ===============
Supplemental disclosure of cash flows information:
Cash paid during the period for:
Interest $ 37 $ 69
================ ===============
Supplemental disclosure of non-cash activities:
Transfer of inventory to property and equipment $ - $ 70
================ ===============
Conversion of loan to ordinary shares $ - $ 25
================ ===============
The accompanying notes are an integral part of the consolidated financial
statements.
F-46
NOTE 1:- GENERAL
The accompanying unaudited interim consolidated financial
statements have been prepared in accordance with generally
accepted accounting principles in the United States for interim
financial statements. Accordingly, they do not include all the
information and footnotes required by generally accepted
accounting principles in the United States for complete financial
statements. In the opinion of management, all adjustments
(consisting of normal recurring accruals) considered necessary for
a fair presentation have been included. Operating results for the
periods presented are not necessarily indicative of the results
that may be expected for the year ended December 31, 2004. These
financial statements should be read in conjunction with the
Company's annual audited financial statements and accompanying
notes as of December 31, 2003, included in this Registration
Statement.
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES
a. The significant accounting policies applied in the annual
financial statements of the Company as of December 31,
2003, are applied consistently in these financial
statements.
b. Accounting for stock-based compensation: (4)
The Company elected to follow Accounting Principles Board
Opinion No. 25, ("APB 25") "Accounting for Stock Issued to
Employees" and FASB Interpretation No. 44, "Accounting for
Certain Transactions Involving Stock Compensation" in
accounting for its employee stock option plans. According
to APB 25, compensation expense is measured under the
intrinsic value method, whereby compensation expense is
equal to the excess, if any, of the quoted market price of
the stock over the exercise price at the grant date of the
award.
F-47
U.S. DOLLARS IN THOUSANDS, (EXCEPT PER SHARE DATA)
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)
The following pro forma information presents the effect on
the consolidated stock-based employee compensation expense,
consolidated net loss and loss per share as if the fair
value based method provided under SFAS No. 123 had been
applied to all outstanding awards in each reported period.
SIX MONTHS ENDED THREE MONTHS ENDED
JUNE 30, JUNE 30,
--------------------------- ------------------------------
2003 2004 2003 2004
------------- ----------- ------------ -------------
UNAUDITED UNAUDITED
--------------------------- ------------------------------
Net loss as reported $ (737) $ (1,660) $ (495) $ (880)
Deduct: Stock based compensation
expenses determined under fair
value based method (253) (154) (28) (45)
Add: stock based compensation
expenses included in reported
net loss 26 5 1 1
------------- ----------- ------------ -------------
Pro forma net loss $ (964) $ (1,809) $ (522) $ (924)
============= =========== ============ =============
Basic and diluted net loss per
share, as reported $ (0.06) $ (0.13) $ (0.04) $ (0.07)
============= =========== ============ =============
Pro forma basic and diluted net loss
per share $ (0.08) $ (0.14) $ (0.04) $ (0.07)
============= =========== ============ =============
F-48
U.S. DOLLARS IN THOUSANDS
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)
The fair value for these options was estimated at the
date of grant using a Black-Scholes option-pricing model
with the following weighted-average assumptions:
SIX MONTHS ENDED THREE MONTHS ENDED
JUNE 30, JUNE 30,
------------------------------ -------------------------------
2003 2004 2003 2004(*)
--------------- -------------- -------------- ---------------
UNAUDITED UNAUDITED
------------------------------ -------------------------------
Risk free interest rates 1% 3.35% 1% -
Dividend yields - - - -
Volatility 1.642 1.092 1.642 -
Expected life 5 5 5 -
(*) No options were granted during the period.
The Black-Scholes option valuation model was developed
for use in estimating the fair value of traded options
which have no vesting restrictions and are fully
transferable. In addition, option valuation models require
the input of highly subjective assumptions including the
expected stock price volatility. Because the Company's
employee stock options have characteristics significantly
different from those of traded options, and because changes
in the subjective input assumptions can materially affect
the fair value estimate, in management's opinion, the
existing models do not necessarily provide a reliable
single measure of the value of its employee stock options.
For purposes of pro forma disclosures, the estimated fair
value of the options is amortized to expense over the
options' vesting period by the straight line method.
NOTE 3:- INVENTORIES
DECEMBER 31, JUNE 30,
----------------------------------------
2003 2004
--------------- -----------------
Raw materials, parts and supplies 1,662 1,262
Finished products 1,574 1,574
--------------- -----------------
$ 3,236 $ 2,836
=============== =================
F-49
U.S. DOLLARS IN THOUSANDS, (EXCEPT SHARE AND PER SHARE DATA)
NOTE 4: - SIGNIFICANT EVENTS
a. During June and July 2004, the Company received aggregate
gross proceeds of $1,225 from a private placement of
1,441,178 Ordinary shares and five-year warrants to
purchase 360,296 Ordinary shares at an exercise price of
$1.10 per share. In connection with the private placement,
the Company's placement advisors received fully exercisable
warrants to purchase 72,058 Ordinary shares with the same
terms as above. As of the balance sheet date the Company
has received $ 775 out of the total proceeds. The amount
received was presented in shareholders equity as a receipt
on account of shares.
b. During August and September 2004, the Company received
gross proceeds of $2,200 from a private placement of
2,588,237 ordinary shares and five-year warrants to
purchase 1,251,473 ordinary shares at an exercise price of
$1.10 per share. In connection with the private placement,
the Company's placement agent received fully exercisable
warrants to purchase 183,765 ordinary shares at an exercise
price of $1.10 per share and 444,706 ordinary shares at an
exercise price of $ 0.85 per share. All of such warrants
issued in this private placement, except the 444,706
warrants with the exercise price of $0.85, may be called by
the Company at a redemption price of $0.01 per warrant at
any time after the closing price (or closing bid price) of
the Company's ordinary shares on the U.S. stock exchange,
Nasdaq or the OTC Bulletin Board is equal to or greater
than $2.50 per share for 10 out of any 15 consecutive
trading days.
According to the Subscription Agreement,the Company has
agreed to file a registration statement on Form F-1 with
respect to the resale of the securities issued,not later
than 45 days following the date of the completion of the
placement (completion date) and to have such registration
statement declared effective by the SEC within 135 days
after the completion date. In addition the Company agreed
to cause the registration Statement to remain effective
until the date which is the earlier of (a) at such time
that all the securities issued are sold or (b) at such time
as all the securities issued may be sold pursuant to Rule
144(k) under the 1933 Act. In the event that the Company
does not comply with the aforementioned agreements
)"Registration Default"(, it will be required to pay the
investors a penalty equal to one half percent of the gross
proceeds received for all or part of each 30-day period
during which the Registration Default remains uncured.
F-50
U.S. DOLLARS IN THOUSANDS,
NOTE 5: - CONTINGENT LIABILITIES
There were no material changes in the status of the Company's
contingent liabilities as described in the Company's annual
financial statements except as mentioned in par. 1 below, the
details of which are as follows:
1. In April 2004, the Company was informed by the
International Commercial Arbitration Court at the Ukrainian
Chamber of Commerce and Industry ("Arbitration Court") that
the Department for Resources Supply of the Ministry had
filed with the Arbitration Court a statement of claim to
declare the agreement between the Company and the Ukraine
government (the "Contract") as void due to defaults in the
tender proceedings under which the Contract had been
awarded to SuperCom. On July 22, 2004 the Company was
informed by the law firm representing the Company in the
arbitration proceedings that on July 19, 2004, the
Arbitration Court issued a negative award declaring the
Contract as void. The Company strongly believes that the
award is wrong due to many defaults that occurred in the
arbitration proceedings and it intends to challenge the
validity of the award in the civil courts of Ukraine. The
Company does not anticipate any revenues from this project
during the year 2004 and the following years.
2. On January 19, 2000, Supercom Slovakia, a 66% owned
subsidiary of the Company, filed a claim against the
ministry of interior of the Republic of Slovakia for the
breach of the delivery of technology, co-operation and
services agreement. The Company requests performance of the
agreement. On November 17, 2003, the arbitration procedure
was finalized and the ministry of interior of Slovakia has
been ordered to pay Supercom Slovakia the amount of SKK 80
thousands (approximately US$ 2,270 as of June 30, 2004)
plus an average interest rate of 16.4% from March 1999. In
addition, the Slovakian ministry of interior has been
ordered to pay the costs of arbitration in the amount of
(euro) 43 thousands and Supercom Slovakia's legal fees in
the amount of (euro) 64 thousands. The Slovakian ministry
of interior has the right to appeal in the Austrian Courts
within three months from the date of this award. The
company has begun the enforcement procedure of the arbitral
award and correspondingly, indirectly received information
that the Slovakian ministry of interior has filed an
appeal.
F-51
U.S. DOLLARS IN THOUSANDS,
NOTE 5: - CONTINGENT LIABILITIES (CONT.)
3. On December 12, 1999, Secu-Systems filed a lawsuit with the
District Court in Tel-Aviv-Jaffa against the Company and
InkSure Ltd. (a former subsidiary) seeking a permanent
injunction and damages. The plaintiff asserted in its suit
that the printing method applied to certain products that
have been developed by InkSure Ltd. constitutes inter alia:
(a) the breach of a confidentiality agreement between the
plaintiff and the Company; (b) unjust enrichment of the
Company and InkSure Ltd; (c) breach of fiduciary duties
owed to the plaintiff by the Company and InkSure Ltd., and
(d) a tort of misappropriation of trade secrets and damage
to plaintiff's property. Secu-Systems, based on such
allegations, asked the court to order the Company and
InkSure to: (i) cease any activity which involves the
plaintiff's confidential information; (ii) furnish the
plaintiff with a certified report detailing all profits
derived by the Company and InkSure Ltd from such activity;
(iii) pay the plaintiff an amount equal to all such
profits, and (iv) pay the plaintiff additional damages in
the amount of NIS 100 thousands. Alternatively, the
plaintiff asked the court to declare that the
above-mentioned products are owned by the plaintiff and
InkSure in equal parts and that the plaintiff is entitled
to 50% of all profits derived therefrom, in which case, the
plaintiffs asked that the Company and InkSure allocate 50%
of the profits from the printing method at issue.
Based upon the facts known to the Company and those
provided by InkSure Ltd. and the Company's legal advisors
advise which is based, inter-alia, on said facts, the
Company's management is of the opinion that, the prospects
are favorable that the court will not grant the permanent
injunction or award damages of a substantial amount in
connection with the litigation. Accordingly, the management
of the Company did not provide for such potential
liability.
4. On July 14, 2003, an Israeli agent ("the claimant") filed a
lawsuit with the District Court in Tel-Aviv-Jaffa against
the Company and its chairman of the Board of Directors; the
claimant claims that the Company owes him NIS 250 thousands
(approximately $ 55) in commissions allegedly due for his
part in establishing business connections for the Company
in Eastern Asia during the years 1993-1998. The Company
plans to contest this claim. The Company's management and
its legal advisors cannot assess at this stage the outcome
of this claim.
F-52
6,341,713 ORDINARY SHARES
[LOGO OMITTED]
----------
PROSPECTUS
----------
NOVEMBER 8, 2004
All dealers that buy, sell or trade our ordinary shares, whether or not
participating in this offering, may be required to deliver a prospectus.