UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 20-F
(Mark One)
[_] REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES
EXCHANGE ACT OF 1934
OR
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL YEAR ENDED JANUARY 31, 2004
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _______________ TO _______________
Commission File number 1-14842
E-SIM LTD.
(Exact name of Registrant as specified in its charter)
ISRAEL
(Jurisdiction of incorporation or organization)
19 HARTUM STREET, JERUSALEM 91450, ISRAEL
(Address of principal executive offices)
Securities registered or to be registered pursuant to Section 12(b) of the Act.
<Table>
<Caption>
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
------------------- -----------------------------------------
None None
</Table>
Securities registered or to be registered pursuant to Section 12(g) of the Act.
ORDINARY SHARES, NIS 0.1 PAR VALUE PER SHARE
(Title of Class)
Securities for which there is a reporting obligation pursuant to Section 15(d)
of the Act.
NONE
(Title of Class)
Indicate the number of outstanding shares of each of the issuer's classes of
capital or common stock as of the close of the period covered by the annual
report:
19,823,595 ORDINARY SHARES, NIS 0.1 PAR VALUE PER SHARE
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
[X] Yes [_] No
Indicate by check mark which financial statement item the registrant has elected
to follow.
[_] Item 17 [X] Item 18
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INTRODUCTION
Unless otherwise indicated, as used in this annual report, the terms "e-SIM,"
"we," "us" and "our," mean e-SIM Ltd. and its consolidated subsidiaries.
This annual report includes "forward-looking statements," within the meaning of
the Private Securities Litigation Reform Act of 1995, with respect to our
business, financial condition and results of operations. Statements that use the
terms "believe," "anticipate," "expect," "plan," "intend," "estimate,"
"anticipate," "project" and similar expressions in the affirmative and the
negative are intended to identify forward-looking statements. These statements
reflect our current views with respect to future events and are based on current
assumptions, expectations, estimates and projections about our business and the
markets in which we operate and are subject to risks and uncertainties. Actual
events (including our results) could differ materially from those anticipated in
these forward-looking statements as a result of various factors, including the
risks discussed in "Item 3. Key Information--Risk Factors" and elsewhere in this
annual report. Except as required by applicable law, including the securities
laws of the United States, we do not undertake any obligation nor intend to
update or revise any forward-looking statements, whether as a result of new
information, future events or otherwise.
All references in this annual report to dollars or $ are to U.S. dollars and all
references to NIS are to new Israeli shekels. The representative rate of
exchange of the NIS to the dollar as published by the Bank of Israel for January
31, 2004 was NIS 4.483 per $1.00.
For the purposes of this annual report, references to the years 1999, 2000,
2001, 2002 and 2003 mean our fiscal years ended on January 31 of the following
year.
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TABLE OF CONTENTS
<Table>
<Caption>
PAGE
PART I ............................................................... 1
Item 1 IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS ....... 1
Item 2 OFFER STATISTICS AND EXPECTED TIMETABLE ..................... 1
Item 3 KEY INFORMATION ............................................. 1
Item 4 INFORMATION ON THE COMPANY .................................. 21
Item 5 OPERATING AND FINANCIAL REVIEW AND PROSPECTS ................ 37
Item 6 DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES .................. 55
Item 7 MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS ........... 73
Item 8 FINANCIAL INFORMATION ....................................... 76
Item 9 THE OFFER AND LISTING ....................................... 78
Item 10 ADDITIONAL INFORMATION ...................................... 80
Item 11 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK .............................................. 97
Item 12 DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES ...... 98
PART II ............................................................. 98
Item 13 DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES ............. 98
Item 14 MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY
HOLDERS AND USE OF PROCEEDS .............................. 98
Item 15 CONTROLS AND PROCEDURES ..................................... 98
Item 16 [RESERVED] .................................................. 99
Item 16A AUDIT COMMITTEE FINANCIAL EXPERT ............................ 99
Item 16B CODE OF ETHICS .............................................. 99
Item 16C PRINCIPAL ACCOUNTANT FEES AND SERVICES ...................... 100
Item 16D EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT
COMMITTEES ............................................... 101
Item 16E REPURCHASE OF EQUITY SECURITIES BY THE ISSUER AND
AFFILIATED PURCHASERS .................................... 101
PART III ............................................................. 101
Item 17 FINANCIAL STATEMENTS ........................................ 101
Item 18 FINANCIAL STATEMENTS ........................................ 101
Item 19 EXHIBITS .................................................... 101
</Table>
<Page>
PART I
ITEM 1
IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS
Not applicable.
ITEM 2
OFFER STATISTICS AND EXPECTED TIMETABLE
Not applicable.
ITEM 3
KEY INFORMATION
(A) SELECTED FINANCIAL DATA
We have derived the selected consolidated financial data set forth below as of
January 31, 2003 and January 31, 2004 and for the years ended January 31, 2002,
January 31, 2003 and January 31, 2004 from the audited consolidated financial
statements and related notes included elsewhere in this annual report. We have
derived the selected consolidated financial data as of January 31, 2000, January
31, 2001 and January 31, 2002 and for the years ended January 31, 2000 and
January 31, 2001 from audited consolidated financial statements that are not
included in this annual report. We prepare our consolidated financial statements
in accordance with generally accepted accounting principles in the United
States, or U.S. GAAP. The selected consolidated financial data set forth below
should be read together with and are qualified by reference to "Item 5.
Operating and Financial Review and Prospects" and our consolidated financial
statements and related notes, included elsewhere in this annual report.
1
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CONSOLIDATED STATEMENTS OF OPERATIONS DATA:
<Table>
<Caption>
YEAR ENDED JANUARY 31,
------------------------------------------------------------------------
2000 2001 2002 2003 2004
------------ ------------ ------------ ------------ ------------
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
Revenues:
Products ........................... $ 4,243 $ 6,818 $ 3,031 $ 3,304 $ 1,819
Services ........................... 1,796 3,063 2,005 2,916 2,682
------------ ------------ ------------ ------------ ------------
6,039 9,881 5,036 6,220 4,501
------------ ------------ ------------ ------------ ------------
Cost of revenues:
Products ........................... 358 383 169 267 122
Services ........................... 1,201 1,735 1,776 1,663 1,983
------------ ------------ ------------ ------------ ------------
1,559 2,118 1,945 1,930 2,105
------------ ------------ ------------ ------------ ------------
Gross profit .......................... 4,480 7,763 3,091 4,290 2,396
------------ ------------ ------------ ------------ ------------
Operating expenses:
Product development ................ 725 2,475 - - -
Web-site development ............... 570 800 - - -
Research and development, net ...... 2,244 2,774 2,610 1,464 1,560
Selling, marketing, general and
administrative, net ............. 6,576 8,751 7,854 4,261 3,635
Restructuring and impairment of
web-site development costs ..... - - 910 - -
------------ ------------ ------------ ------------ ------------
Total operating expenses .............. 10,115 14,800 11,374 5,725 5,195
------------ ------------ ------------ ------------ ------------
Operating loss ........................ 5,635 7,037 8,283 1,435 2,799
Financial expenses (income), net ...... (236) (230) 210 (9) 1,343
Other expenses, net ................... - 730 426 94 -
------------ ------------ ------------ ------------ ------------
Loss before taxes on income ........... 5,399 7,537 8,919 1,520 4,142
Taxes on income ....................... 51 56 62 199 106
============ ============ ============ ============ ============
Net loss .............................. $ 5,450 $ 7,593 $ 8,981 $ 1,719 $ 4,248
============ ============ ============ ============ ============
Basic and diluted net loss per
share ................................. $ 0.52 $ 0.65 $ 0.77 $ 0.15 $ 0.36
============ ============ ============ ============ ============
Weighted average number of shares
used in computing basic and diluted
net loss per share .................... 10,455,766 11,642,687 11,663,170 11,665,359 11,963,056
============ ============ ============ ============ ============
</Table>
2
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CONSOLIDATED BALANCE SHEET DATA:
<Table>
<Caption>
AS OF JANUARY 31,
---------------------------------------------------
2000 2001 2002 2003 2004
-------- ------- -------- -------- --------
(IN THOUSANDS)
Cash and cash equivalents ................. $ 12,618 $ 6,683 $ 1,305 $ 627 $ 238
Total assets .............................. 17,123 13,454 *4,807 *3,851 2,370
Working capital (deficit) ................. 11,909 5,774 (4,075) (3,464) (5,014)
Short-term bank credit and
current maturities of long-term
bank loans ............................. 262 218 3,360 2,084 242
Current maturities of convertible
bank loans ............................. - - 840 690 -
Convertible loan from a related
party .................................. - - - 190 -
Other convertible loan, net ............... - - - - 73
Long-term bank loans, net of
current maturities and
convertible loans ...................... 18 2,486 - - 2,413
Long term convertible bank loans .......... - - - - 641
Shareholders' equity (deficiency) ......... $ 13,064 $ 5,721 $ (3,275) $ (4,891) $ (6,652)
</Table>
(*) Reclassified
(B) CAPITALIZATION AND INDEBTEDNESS
Not applicable.
(C) REASONS FOR THE OFFER AND USE OF PROCEEDS
Not applicable.
(D) RISK FACTORS
YOU SHOULD CAREFULLY CONSIDER THE FOLLOWING RISK FACTORS AND OTHER INFORMATION
INCLUDED IN THIS ANNUAL REPORT. THE RISKS AND UNCERTAINTIES DESCRIBED BELOW ARE
NOT THE ONLY ONES WE FACE. ADDITIONAL RISKS AND UNCERTAINTIES THAT WE ARE
PRESENTLY NOT AWARE OF, OR THAT WE CURRENTLY DEEM IMMATERIAL, MAY ALSO ARISE.
OUR BUSINESS, FINANCIAL CONDITION AND RESULTS OF OPERATIONS COULD BE MATERIALLY
ADVERSELY AFFECTED BY ANY OF THESE KNOWN OR UNKNOWN RISKS. WE MAY NOT
SUCCESSFULLY ADDRESS ANY OF THESE RISKS. IN THE EVENT THAT ONE OR MORE OF THE
RISKS SET FORTH BELOW OCCURS, OUR SHARE PRICE COULD DECREASE AND YOU MAY LOSE
ALL OR PART OF YOUR INVESTMENT.
3
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WE HAVE FUTURE CAPITAL NEEDS AND THE AVAILABILITY OF ADDITIONAL FINANCING ON
FAVORABLE TERMS OR AT ALL IS UNCERTAIN. As of July 15, 2004, we had cash and
cash equivalents of approximately $0.5 million (including an investment of
$2,487,500 received from certain investors in May and June 2004, as discussed
below) and borrowing capacity of approximately $0.9 million under our existing
credit line. The conditions under which we may utilize this credit line are
discussed below and in "Item 5. Operating and Financial Review and Prospects -
Liquidity and Capital Resources". Our ability to generate revenues and manage
costs as anticipated may be adversely affected by a variety of factors,
including those discussed in this Risk Factors section. If we are unable to
generate sufficient revenues from operations, if our expenses are higher than
anticipated or if acceleration of our bank loans is demanded by the lenders upon
the occurrence of an event of default under the loan agreements, we would be
required to seek to raise additional capital through public or private debt or
equity issuances. Events of default under our loan agreements include, among
others, non-payment of scheduled principal and interest payments, our
liquidation or the occurrence of events after January 31, 2005, in the case of
one of the banks extending us loans (in respect of $500,000 of our total debt to
that bank prior to that date), and after August 14, 2005, in the case of the
other bank, that the banks believe harm or might harm our ability to perform our
obligations under the loan agreements. Additional debt or equity financing,
whether obtained through public or private debt or equity financing, may not be
available when needed or may not be available on terms acceptable to us. In
addition, if additional funds are raised through the issuance of equity
securities, the net tangible book value per share may decrease, the percentage
ownership of our then current shareholders may be diluted and such new equity
securities may have rights, preferences or privileges senior or more
advantageous to those of the holders of our ordinary shares. If additional
financing is not available when needed, our business and financial condition
will be materially adversely affected, we may be forced to discontinue
operations or to pursue a sale of our company or a substantial part of our
assets on terms, which if available at all, may not be favorable to us or our
shareholders.
IF OUR SHAREHOLDERS DO NOT APPROVE AN EQUITY INVESTMENT IN RESPECT OF CERTAIN
INTERESTED PARTY INVESTORS, WE WILL BE REQUIRED TO REPAY THE INVESTED FUNDS AND
MAY NOT HAVE SUFFICIENT CASH TO DO SO. In May and June 2004, we entered into an
equity investment agreement, referred to as the Investment Agreement, with
certain investors, including Marc Belzberg, our chairman, chief executive
officer and one of our major shareholders, Gibralt, a party controlled by Samuel
Belzberg, one of our directors and Marc Belzberg's father, and Lisa Belzberg,
Marc Belzberg's sister and Samuel Belzberg's daughter. These members of the
Belzberg family, or the Belzberg Family, invested $1,500,000 in return for
3,000,000 of our ordinary shares, at a price of $0.50 per ordinary share. The
Belzberg Family also received warrants to purchase 750,000 of our ordinary
shares, at an exercise price of $0.75 per share. Each of the warrants is
immediately exercisable in full and has a five-year term. The transaction was
approved by our board of directors and audit committee. The investment by the
Belzberg Family is also subject to shareholder approval since they are "related
parties" according to the Israeli Companies Law, 5759-1999, or the Companies
Law. We plan to submit the transaction for shareholder approval at our next
general meeting of shareholders, where it must be approved by a majority which
includes at least one-third of our shareholders present at the meeting and
voting on the transaction who are not related parties, unless our shareholders
who are not related parties and who vote against the resolution do not represent
more than one percent of our total outstanding voting rights. This transaction
may not be approved by our shareholders. According to the terms of the
Investment Agreement, if our shareholders do not approve the investment by
November 10, 2004, the Investment Agreement in respect of the Belzberg Family
will be null and void and we will be obligated to repay such funds together with
accrued interest at a rate equal to the six-month LIBOR prevailing on May 10,
2004. Each of Marc Belzberg, Gibralt and Lisa Belzberg has agreed that,
notwithstanding the foregoing, we will not be required to repay these funds to
them until August 31, 2005, if doing so would affect our ability to continue
operations as a going concern. If our shareholders do not approve the
transaction, and consequently we will be required to repay the invested amount
to the Belzberg Family by August 31, 2005, we will be required to raise
additional capital through public or private debt or equity issuances.
Additional debt or equity financing, whether obtained through public or private
debt or equity financing, may not be available when needed or may not be
available on terms acceptable to us. In addition, if additional funds are raised
through the issuance of equity securities, the net tangible book value per share
may decrease, the percentage ownership of our then current shareholders may be
diluted and such new equity securities may have rights, preferences or
privileges senior or more advantageous to those of the holders of our ordinary
shares. If additional financing is not available when needed, our business and
financial condition will be materially adversely affected, we may be forced to
discontinue operations or to pursue a sale of our company or a substantial part
of our assets on terms, which if available at all, may not be favorable to us or
our shareholders.
4
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WE MAY NOT HAVE SUFFICIENT CASH ON HAND TO MAKE THE PAYMENTS THAT WILL BE DUE ON
OUR OUTSTANDING BANK LOANS BEGINNING FEBRUARY 28, 2005. In February, May and
July 2004, we entered into agreements amending certain provisions of our prior
agreements with certain banks. As part of these amendments, the scheduled
maturity of the loans the banks provided to us was extended. As of July 15, 2004
our debt to the banks was an aggregate of approximately $1.5 million, which sum
does not include borrowing capacity of approximately $0.9 million under our
existing credit line with one of these banks which has not been utilized as of
the date of this annual report. Pursuant to the amended terms of the agreements,
we are required to repay monthly principal payments to these banks beginning
February 28, 2005. The banks can demand acceleration of payment of the loans
prior to the agreed payment dates upon the occurrence of an event of default
under the loan agreements, such as non-payment of scheduled principal and
interest payments, our liquidation or the occurrence of events after January 31,
2005 in the case of one of the banks extending us loans (in respect of $500,000
of our total debt to that bank prior to that date) and after August 14, 2005 in
the case of the other bank that the banks believe harm or might harm our ability
to perform our obligations under the loan agreements. We may not have sufficient
cash on hand to make principal or interest payments when due, or if acceleration
is demanded by the banks. If we are unable to make principal or interest
payments when due, our business and financial condition will be materially
adversely affected. The banks have a security interest in our right to receive
revenues pursuant to agreements with two major customers and in the event of a
default under the terms of the agreements, the revenues from these customers
would not be available to us and our business will be materially adversely
affected. In any such event, we may be forced to discontinue operations or to
pursue a sale of our company or a substantial part of our assets on terms, which
if available at all, may not be favorable to our shareholders. Additional debt
or equity financing to repay these loans, whether obtained through public or
private debt or equity financing, may not be available when needed or may not be
available on terms acceptable to us. In addition, if additional funds are raised
through the issuance of equity securities, the net tangible book value per share
may decrease, the percentage ownership of our then current shareholders may be
diluted and such new equity securities may have rights, preferences or
privileges senior or more advantageous to those of the holders of our ordinary
shares.
5
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WE HAVE A HISTORY OF LOSSES AND MAY NOT ACHIEVE PROFITABILITY. We began
operations in 1991 as a software consulting company and began commercial
shipment of our initial Rapid software products in 1994. We incurred significant
operating and net losses in every fiscal year since our inception and expect to
continue to incur losses in the future. While in 2002 our revenues increased to
$6.2 million, a 24% increase compared with $5.0 million in 2001, our revenues in
2003 were $4.5 million, representing a 28% decrease compared to 2002. As of
January 31, 2004, we had an accumulated deficit of $42 million. Our net losses
for 2003 were $4.2 million, an increase of 147% compared with net losses of $1.7
million for 2002. We expect net cash outflows and net operating losses will
continue through at least the end of 2004 and may continue thereafter. We cannot
assure you that we will be able to achieve or sustain profitability. In order to
do so, we will need to significantly increase our revenues and appropriately
control our expenses.
Our future prospects should be considered in light of the challenges frequently
encountered by companies in new and rapidly evolving industries. These
challenges include establishing and increasing market acceptance of our products
and systems, responding effectively to competitive pressures, offering high
quality customer service and support, introducing, on a timely basis, advanced
versions of, and enhancements to, our existing products and successfully
marketing and supporting these advanced versions and enhancements. We may not be
able to satisfactorily address these risks cost-efficiently or at all.
THE PROPORTION OF OUR REVENUES DERIVING FROM SERVICES HAS INCREASED AT THE
EXPENSE OF REVENUES DERIVING FROM SALES OF PRODUCTS. IF THIS TREND CONTINUES, IT
MAY ADVERSELY AFFECT OUR GROSS MARGINS AND PROFITABILITY. Our revenues from the
sale of products decreased to approximately $1.8 million in 2003 from
approximately $3.3 million in 2002 and approximately $3.0 million in 2001. Our
revenues from services decreased in 2003 to approximately $2.7 million from
approximately $2.9 million in 2002, a decrease from approximately $2.0 million
in 2001. Our gross margin from products is higher than our gross margin from
services, since our cost of services, which includes expenses of salaries and
related benefits of the employees engaged in providing the services, is
relatively higher than our cost of products. If this trend continues, our gross
margins and profitability may be adversely affected.
WE ARE HEAVILY RELIANT ON THE SALE OF ONE FAMILY OF PRODUCTS TO ONE MARKET.
Sales and services related to the RapidPLUS product family have accounted for
substantially all of our revenue. If sales of the RapidPLUS family products
decline, or fail to grow, or the profit margin on these products decreases
significantly, our business, financial condition and results of operations will
be materially and adversely affected. In addition, while in the past we offered
our products to a wide range of customers, since we changed our business model
our target market has been narrowed to include only wireless handset platform
developers, handset manufacturers and mobile carriers. If we are not successful
in penetrating this market and selling our products, our business, financial
condition and results of operations will be materially and adversely affected.
IF WE FAIL TO TIMELY COMPLETE THE DEVELOPMENT AND INTRODUCTION OF NEW PRODUCTS,
OUR RESULTS OF OPERATIONS WILL SUFFER. Growth in our sales and revenues is
dependent, to a significant extent, upon the commercial success and market
acceptance of our products. To this end, we are involved in the development and
introduction of new products and applications and advanced versions and
enhancements to our existing products. A number of risks are inherent in this
process, and we may not successfully complete the development or introduction of
these products and applications. The development of new technologies and
products is complex and uncertain, and requires close collaboration and
continued technological advancement involving multiple hardware and software
design teams within our company, our customers and outside suppliers of key
components. These factors may result in a failure to introduce new products and
applications, and advanced versions of, and enhancements to, our existing
products in a timely manner, if at all. In the past, we have, on occasion,
experienced delays in the release of new products and product enhancements,
including new modules. If we fail to timely complete the development and
introduction of new products and applications, and advanced versions of, and
enhancements to, our existing products, our results of operations will suffer.
6
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WE ARE SUBJECT TO RISKS OF TECHNOLOGICAL CHANGE AND NEED TO DEVELOP NEW PRODUCTS
AND APPLICATIONS AND NEW VERSIONS OF, AND ENHANCEMENTS TO, OUR EXISTING
PRODUCTS. The market for our products is characterized by rapid technological
developments, evolving industry standards, swift changes in customer
requirements, computer operating environments and software applications, and
frequent new product introductions and enhancements. To succeed, we believe we
must:
o anticipate and timely respond to changes in the market for our
products and customer expectations;
o meet changing and increasing customer expectations;
o continue to enhance our existing products;
o develop and introduce in a timely manner new products and applications
and new versions of, and enhancements to, our existing products
incorporating technological advances; and
o comply with emerging industry standards.
Our products may become obsolete if we fail to successfully anticipate or react
to change. To the extent that one or more of our current or new competitors
introduces products that more effectively address customer needs, our business,
financial condition and results of operations could be materially adversely
affected. In addition, negative reviews or other adverse publicity of our new or
existing products could have a material adverse effect on our revenues
In 2001 we effected a corporate restructuring, which included a reduction of our
research and development expenses during 2001 and the first quarter of 2002 by
approximately 50%, primarily by reducing our research and development staff.
Although we have increased our research and development staff since then, we
still have fewer research and development employees than we had prior to the
restructuring. We believe that, to date, these cutbacks have not adversely
affected our ability to introduce new products and applications and new versions
of, and enhancements to, our existing products and the timing of their
introduction. However, the reduction in research and development costs may
affect our future revenues and impair our ability to compete in the markets in
which we operate in the future. As part of the restructuring, we decided not to
proceed with the development of a new product designed to be a new version of
our RapidPLUS toolset, and, instead, have relied upon the knowledge gained in
the course of development to introduce new modules and versions of our existing
RapidPLUS toolset. Although we believe this is a prudent and cost-effective
approach to advancing the development of our products, we cannot be sure that
these new modules and versions will be sufficiently advanced technologically,
gain market acceptance or provide the same long-term return as a new version of
our RapidPLUS toolset would be expected to.
7
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WE HAVE SIGNIFICANT FLUCTUATIONS IN OUR BUSINESS AND OUR RESULTS OF OPERATIONS
ARE UNPREDICTABLE. We have experienced, and expect to continue to experience,
significant quarterly and annual variations in our results of operations. These
variations in our results of operations may make it difficult for investors to
make reliable period-to-period comparisons of our performance or predictions as
to our future performance and may contribute to volatility in our share price.
These variations result from a variety of factors, including:
o the strength of the market for technology products generally;
o the timing, composition and size of orders from our customers (which
may be impacted by a variety of factors affecting our customers and
not directly related to our products and services);
o market acceptance of our products;
o the various types of distribution channels we employ, including direct
sales and sales through distributors;
o the timing of new enhancement or product announcements by us and our
competitors;
o our ability to continue to develop, introduce and deliver new and
enhanced products on a timely basis and in a cost effective manner;
o our ability to offer new products at competitive prices;
o our ability to anticipate customer needs and demand;
o delays in the implementation of our solutions by customers;
o changes in the proportion of service and product revenues;
o price and product competition;
o increases in selling and marketing expenses, as well as other
operating expenses;
o technological changes;
o political instability in the Middle East;
o consolidation of our clients;
o currency exchange rate fluctuations and economic conditions in the
geographical areas in which we operate; and
8
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o the availability of funds to finance implementation of our business
plan.
Moreover, our revenues in each quarter are derived primarily from a few large
orders, some of which are from new customers. For example, single orders were
responsible for 37%, 30%, 23% and 21% of revenues in the first, second, third
and fourth quarters of 2003, respectively. The deferral or loss of one or more
significant sales could materially affect our operating results in any fiscal
quarter, especially if there are significant sales and marketing expenses
associated with the deferred or lost sales. Conversely, if we obtain large
orders in a particular quarter, our revenues and the rate of growth of our
revenues for that quarter may reach levels that may not be sustained in
subsequent quarters. Consequently, our inability to obtain large orders from our
customers or delays in the shipment of, or payment for, any such order could
significantly impact our quarterly results. Conversely, a significant increase
in the number of our customers or in our development of new product offerings,
or both, could require us to expend significant amounts of money, time and other
resources to meet the demand. This could strain our personnel and financial
resources.
In addition, future results of operations may fall below the expectations of our
investors, which would likely cause the trading price of our ordinary shares to
decline. Our expense levels are based, in part, on our expectations of future
revenues. If our revenues are below expectations, our results of operations are
likely to be adversely affected. Net income may decline due to decreased
revenues because we may not be able to promptly reduce expenses correspondingly
to the decrease in revenues. In light of the above, we believe that our business
activity and results of operations in any quarter are not necessarily indicative
of any longer trends in our business and it may be difficult for investors to
evaluate our prospects. You should not rely on period-to-period comparisons of
our financial results to predict our future performance.
HISTORICALLY, OUR REVENUES HAVE BEEN CONCENTRATED IN A FEW LARGE ORDERS AND A
SMALL NUMBER OF CUSTOMERS AND OUR BUSINESS COULD BE ADVERSELY AFFECTED IF WE
LOSE A KEY CUSTOMER. A significant portion of our revenues each year has been
derived from large orders from a small number of clients. In 2001, five
customers accounted for 45% of our revenues, in 2002 four customers accounted
for 52% of our revenues and in 2003, five customers accounted for 60% of our
revenues. Although we endeavor to broaden our client base, we expect that a
significant portion of our future revenues will continue to be derived from a
relatively small number of customers. The loss of key customers or significant
reductions in revenues generated from a key customer would cause our revenues to
decline and make it more difficult for us to achieve or sustain profitability.
WE DEPEND ON CERTAIN KEY TECHNICAL, DEVELOPMENT AND MANAGEMENT PERSONNEL. THE
LOSS OF THE SERVICES OF THESE EMPLOYEES AND OUR FAILURE TO HIRE NEW CAPABLE
EMPLOYEES AND REPLACE EMPLOYEES WHO LEAVE US WOULD HAVE A MATERIAL ADVERSE
EFFECT ON OUR RESULTS. Our future performance depends, to a significant extent,
upon the continued service of our key technical, development and management
personnel. Competition for these employees can be intense, especially in a
number of our key markets and locations, primarily in Israel. The process of
locating, training and successfully integrating qualified personnel into our
operations can be lengthy and expensive. The market for the qualified personnel
we require is very competitive because of the limited number of people available
with the necessary technical and sales skills and understanding of our products
and technology. We may not be able to compete effectively for the personnel we
need. The loss of the services of certain of these individuals would have a
material adverse effect on our results. None of our employees has a long-term
employment contract. Our future success also depends on our ability to continue
to attract, train and retain highly qualified technical, development and sales
and marketing personnel and we may not be able to attract, train or retain such
personnel. If we are unable to hire and integrate such personnel on a timely
basis in the future, our business, financial condition and results of operations
could be materially adversely affected.
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WE ARE SUBJECT TO COMPETITION IN THE MMI, EMBEDDED SYSTEM APPLICATION SOFTWARE
DEVELOPMENT AND INTERNET MARKETS, AND MANY OF OUR COMPETITORS HAVE LONGER
OPERATING HISTORIES, GREATER NAME RECOGNITION, ACCESS TO LARGER CUSTOMER BASES
AND SIGNIFICANTLY GREATER FINANCIAL, TECHNICAL, MARKETING AND SALES RESOURCES
THAN WE DO. The wireless handset man machine interface, or MMI, market and the
embedded systems software development industry are both highly competitive and
characterized by rapidly advancing technology. We expect competition to increase
in the future. We believe that the principal competitive factors in this
industry are technological innovation, functionality, reliability, service,
reputation, pricing and the ability to provide integrated solutions.
In order to maintain and improve our position in both the wireless handset MMI
market and the embedded software systems industry, we must continue to enhance
our existing products and to develop new products and applications and product
and application extensions. The reduction in 2001 in the number of our research
and development employees may adversely affect our ability to compete with our
competitors by introducing to the market new products and applications and new
versions of, and enhancements to, existing products in a timely manner or at
all.
We believe that the main competition in the wireless handset MMI market is from
companies that sell the MMI as part of a wider suite of integrated products,
including wireless handset platform vendors who have their own in-house MMI
solution, such as Infineon Technologies AG, Agere Systems, Inc. and Skyworks
Solutions, Inc. and companies that provide core software for wireless handsets
and MMI solutions, such as TTPCom and Cybelius Software Oy.
We believe that the principal competition for our products in the embedded
systems market comes from embedded systems applications software development
solutions that are developed in-house by our customers or potential customers,
rather than those purchased from independent software vendors like us. Many
organizations that develop their software solutions in-house have better
familiarity with their systems and substantial internal programming resources
with the capability to develop specific solutions for their needs. A customer's
decision to use our products may involve a fundamental shift in the software
development process used by that customer. Consequently, we must persuade many
potential customers to replace their in-house solutions, into which substantial
resources have been invested, with our products. We also compete with other
independent software vendors who provide products addressing certain stages of
the development cycle for products incorporating embedded systems applications
software. Software providers competing with our products at various stages of
the embedded systems applications software development cycle include Cats, Inc.,
Altia, Inc., Virtual Prototypes, Inc., ZipC, Inc. and Gaio, Inc.
In the Internet market there are technologies currently available that compete
with LiveProducts and which are difficult to compete with, such as Macromedia's
Flash and ShockWave Director. Current and potential competitors may develop
products that may be more effective than our current or future products and our
technologies and products may be rendered obsolete by such developments.
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Many of our existing and potential competitors have longer operating histories,
greater name recognition, access to larger customer bases and significantly
greater financial, technical, marketing and sales resources than we do. Many of
our competitors have well-established relationships with our current and
potential customers and have extensive knowledge of our target markets. As a
result, they may be able to adapt more quickly to new or emerging technologies
and changes in customer requirements or to devote greater resources to the
promotion and sale of their products than us.
We expect to face increasing competitive pressures from both current and future
competitors. Competitive pressures in our markets could cause us to reduce the
prices of our products, which would result in reduced gross profits. We believe
that our ability to compete successfully will depend on a number of factors both
within and outside our control, including price, quality, availability, customer
service and support, breadth of product line, product performance and features,
rapid time-to-market delivery capabilities, reliability, timing of new product
introductions by us, our customers and our competitors, and the ability of our
customers to obtain financing. We may not have the financial resources,
technical expertise, or marketing, sales, distribution, and customer service and
support capabilities to compete successfully against our current and future
competitors. If we fail to compete successfully, our business, financial
condition and results of operations will be materially adversely affected.
WE ARE SUBJECT TO CERTAIN RISKS RELATING TO THE MARKETING OF OUR MMI SOLUTION TO
WIRELESS HANDSET PLATFORM VENDORS, WIRELESS HANDSET MANUFACTURES AND MOBILE
CARRIERS. In 2003 we changed our business strategy to improve our operating
results. Our strategy is no longer based upon reliance on our traditional
distributors in the embedded systems market, many of whom were among our largest
customers. Instead, we currently concentrate our efforts on establishing
long-term distribution contracts with wireless handset platform vendors and
direct licensing and development contracts with these vendors and with wireless
handset manufacturers and mobile carriers.
Our revenue model is based upon receipt of a royalty stream from the embedding
of our MMI reference design and MicroKernels in handset products sold by
wireless handset manufacturers or mobile carriers. We may not be successful in
marketing our MMI solution to wireless handset platform vendors, wireless
handset manufacturers or mobile carriers. Our wireless handset platform vendor
distributors may be unsuccessful in distributing our MMI solution to their
customers. Furthermore, the wireless handset manufacturers or mobile carriers
may not succeed in marketing the handset units containing our MMI solution.
Additionally, the financial condition of any of such wireless handset platform
under distributors, wireless handset manufactures and mobile carriers could
suffer from material adverse changes, which could result in a decrease in orders
of our products. In any of the situations described above, our revenues will
suffer and our results of operations will be materially adversely affected.
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WE ARE EXPOSED TO RISKS ASSOCIATED WITH INTERNATIONAL SALES, WHICH HAVE
ACCOUNTED FOR 70.4%, 96.1% AND 98.9% OF OUR REVENUES FOR 2003, 2002 AND 2001,
RESPECTIVELY. A key component of our strategy is to continue to expand
operations in existing international markets outside of Israel, and to enter new
international markets. Substantially all of our sales have been made and are
expected to continue to be made, directly or indirectly, in the international
markets, with sales in the U.S., Japan, the Far East (excluding Japan) and
Europe representing 16.3%, 9.2%, 11.9% and 33.0%, respectively, of our total
revenue for 2003; 20.9%, 44.9%, 10.4% and 19.9%, respectively, of our total
revenues for 2002; and 25.0%, 28.2%, 32.2% and 13.5%, respectively, of our total
revenues for 2001. We currently maintain direct sales and service offices or
personnel in the U.S. and Japan and have distributors and resellers in Europe
and the Far East. A substantial portion of our revenues has been made, and is
expected to continue to be made, in the U.S., the Far East and Europe, although
the relative amount of sales in each of these markets may change. For additional
information see note 13b to our consolidated financial statements, included
elsewhere in this annual report.
There are certain risks inherent in doing business in international markets,
including:
o difficulties in collecting accounts receivable, including royalties;
o foreign currency risks;
o financial and political instability;
o longer payment cycles;
o lack of acceptance of products not adapted for the local market;
o cultural differences in the conduct of business;
o difficulties in protecting intellectual property rights;
o difficulties in staffing and managing foreign operations;
o withholding taxes restricting the repatriation of earnings;
o unexpected changes in regulatory requirements;
o burdens of complying with a wide variety of foreign laws; and
o tariffs and other trade barriers.
Any of these factors could adversely affect the success of our international
operations. In some markets, adaptation of our products to the local culture,
language and requirements is critical for local market acceptance of our
products and market penetration. We may incur substantial costs and experience
delays in adapting our products for local markets, and any adapted product may
not achieve market acceptance or generate significant revenues. One or more of
these factors may have a material adverse effect on our business, financial
condition and results of operations.
OUR BUSINESS AND FINANCIAL CONDITION COULD BE NEGATIVELY IMPACTED BY THE
FINANCIAL INSTABILITY OF OUR CUSTOMERS, DUE TO OUR DEPENDENCY ON THE SUCCESS OF
SUCH CUSTOMERS IN SELLING THEIR PRODUCTS IN WHICH OUR RAPID PRODUCTS ARE
EMBEDDED. We sell our products and provide services to wireless handset platform
solutions vendors, wireless handset manufactures and embedded systems
manufacturers and distributors located around the world based on pre-qualified
payment terms. Financial difficulties of a customer could cause us a credit risk
relating to that customer's receivables. Our inability to collect on our trade
accounts receivable from any one of these customers could have a material
adverse effect on our business and financial condition.
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WE HAVE RISKS RELATING TO THE LONG SALES CYCLE FOR OUR RAPID PRODUCTS. IN
ADDITION, WE ONLY RECOGNIZE REVENUES AFTER OUR CUSTOMERS AND THEIR CUSTOMERS ARE
SUCCESSFUL IN SELLING THEIR PRODUCTS IN WHICH OUR RAPID PRODUCTS ARE EMBEDDED,
AND THEREFORE THE RECEIPT BY US OF REVENUES IS DEPENDENT ON THE SUCCESS OF OUR
CUSTOMERS AND THEIR CUSTOMERS IN SELLING SUCH PRODUCTS. A decision to use our
Rapid products often entails a fundamental change in a customer's product
engineering methods, and replacement of all or a significant part of a
customer's in-house solutions. Consequently, we devote significant marketing
efforts to educating potential customers about the benefits of adopting the
Rapid methodology. In addition, using RapidPLUS CODE (the code generation module
of our RapidPLUS product) involves taking a risk of embedding machine-generated
code in the embedded product. Consequently, customers need to be confident that
the generated code functions correctly and efficiently. Moreover, pursuant to
our new business model, an increasing portion of our revenues is expected to
consist of royalties received by us from the sale by our customers - wireless
handset platform vendors - of their own products in which our MicroKernel
software is embedded, rather than from the sale of Rapid PLUS licenses. Under
this new model, we will only be entitled to receive royalties after such vendors
complete the manufacturing of the wireless platforms and sell it to handset
manufacturers, who will then develop, manufacture and sell the handsets. As a
result of this sales chain, we are exposed to risks relating to our customers'
and their customers' volume of sales and their promptness in collecting payments
on such sales and then paying us royalties. If our customers fail to
successfully sell their products in which our Rapid applications are embedded,
we will not recognize revenues, although we will incur costs and expenses
relating to the development, support, marketing and sale of such applications.
In light of the need to educate a customer about the benefits of the Rapid
products and convince customers of the reliability of our code generation
capability, the critical role software development plays in the customer's
business, the significant costs involved in implementing our products on a large
scale within that business and our dependency on sales by our customers and
their customers to end users, our sales cycle is relatively long. For sales of
our Rapid products directly to wireless handset platform vendors, the sales
cycle is typically approximately nine to twelve months (but we do not recognize
revenues from royalties until such platform vendors sell their product to
handset manufacturers, who then sell the handsets to the end users). For sales
of our Rapid products to wireless handset manufacturers, the sales cycle is
typically six to nine months. Because we do not recognize revenues until the
handsets are sold to end users, any significant marketing expenses that we incur
before we receive any revenues generated as a result of these efforts (primarily
research and development and technical support expenses), would have a material
adverse effect on our business, financial condition and results of operations.
The length of the sales cycles may continue to increase in light of the more
conservative spending by many customers and potential customers due to current
market conditions, and may therefore result in a delay in the recognition and
receipt by us of revenues, which may adversely affect our profitability and
financial position.
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WE ARE SUBJECT TO RISKS OF PRODUCT DEFECTS AS WELL AS OTHER POTENTIAL LIABILITY.
As a result of their complexity, software products, including those we develop
and market, may contain undetected errors or compatibility problems,
particularly when first introduced or when new versions of, and enhancement to,
our existing products are released. Errors may not be detected in new products
or applications or in new versions of, or enhancements to, our existing products
after they have been shipped, despite our testing as well as the testing and use
by current and potential customers. These errors could result in the loss of, or
delay in, market acceptance of our products, which could have a material adverse
effect on our business, financial condition and results of operations.
The use of our products for applications in markets where the failure of our
products could cause substantial property damage or personal injury could
subject us to significant product liability claims. In addition, our products
may be used for applications in mission-critical business systems where the
failure of our products could result in substantial economic loss. Our license
and other agreements with our customers typically contain provisions designed to
limit our exposure to potential product liability and other claims. However, the
limitation of liability provisions contained in our agreements are not effective
in all circumstances and in all jurisdictions. Although we have not experienced
any product liability or economic loss claims to date, the conduct of our
business entails the risk of such claims. We carry insurance against product
liability risks and errors or omissions coverage, but our insurance coverage may
not continue to be available to us on commercially reasonable terms or at all,
and even if available, may be insufficient to cover certain liabilities.
In addition, product liability claim or claim for economic loss brought against
us in excess of, or outside the limits of, our insurance coverage, or a product
recall involving our software, could have a material adverse effect on our
business, financial condition and results of operations.
WE DEPEND ON CERTAIN PROPRIETARY TECHNOLOGY AND WE CANNOT ASSURE YOU THAT WE
WILL BE ABLE TO PROTECT OUR PROPRIETARY RIGHTS. Our success is dependent, to a
significant extent, upon our proprietary technology. To protect our proprietary
rights, we rely on a combination of copyright, trademark, patent and trade
secret laws, together with non-disclosure and other contractual confidentiality
procedures, which provide only limited protection. We have registered patents in
the United States, Israel, Taiwan and China and have filed patent applications,
which are currently pending, in Europe, India, Japan, Hong Kong, South Korea,
and Canada in respect of certain aspects of our core technology, and intend to
file additional applications in certain other countries. These new patents may
not be issued or if issued, these patents may be challenged or invalidated, or
may not be of sufficient scope or strength to provide us with meaningful
protection or commercial advantage. As part of our confidentiality procedures,
we generally enter into non-disclosure agreements with our employees,
consultants, distributors and development partners that limit access to, and
distribution of, our software, documentation and other proprietary information.
Despite our efforts to protect our proprietary rights, it may be possible for
unauthorized parties to copy our products or to reverse engineer or obtain and
use information that we regard as proprietary. In addition, the laws of some
foreign countries do not protect our proprietary rights as fully as do the laws
of the United States or Israel. Our efforts to protect our proprietary rights
may not be adequate and our competitors may independently develop technologies
that are substantially equivalent or superior to our technologies.
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WE DEPEND ON THIRD-PARTY PROPRIETARY TECHNOLOGY. We rely, and expect to continue
to rely, on certain software that we license from third parties, including
software that is integrated with internally developed software and used in our
products to perform key functions. Some of this software may be required to
complete the development of products that we intend to offer in the future.
These third-party providers may not remain in business or continue to support
their technology and their technology may not otherwise be available to us on
commercially reasonable terms. The loss of, or inability to maintain or obtain
any of, software licenses we rely upon could result in delays or cancellations
in product shipments until equivalent software can be identified and licensed or
developed and integrated with our products. Any such delay or cancellation could
have a material adverse affect on our business, financial condition and results
of operations.
WE COULD BECOME SUBJECT TO LITIGATION REGARDING ALLEGED INFRINGEMENT OF
THIRD-PARTY INTELLECTUAL PROPERTY RIGHTS, WHICH COULD SERIOUSLY HARM OUR
BUSINESS, AND AS A RESULT OF SUCH LITIGATION WE MAY HAVE TO SEEK LICENSES FOR
THE USE OF THIRD PARTIES' INTELLECTUAL PROPERTY RIGHTS, WHICH MAY NOT BE
AVAILABLE TO US ON REASONABLE TERMS OR AT ALL. Third parties have in the past
asserted, and may in the future assert against us, claims that we have violated
a patent or infringed a copyright, trademark or other proprietary right
belonging to them. For instance, in 2002, one of our competitors alleged that
certain features of our RapidPLUS Express breach that party's copyright, a claim
we believe to be without merit and which has not been pursued by that
competitor. In addition, based on the size and sophistication of our competitors
and the history of rapid technological change in our industry, we anticipate
that several competitors may have intellectual property rights that could relate
to our products. Therefore, we may need to litigate to defend against claims of
infringement or to determine the validity or scope of the proprietary rights of
others. Similarly, we may need to litigate to enforce or uphold the validity of
our patents, trademarks and other intellectual property rights. Other actions
may involve ownership disputes over our intellectual property or the
misappropriation of our trade secrets or proprietary technology. As a result of
these actions, we may have to seek licenses for the use of third parties'
intellectual property rights. These licenses may not be available to us on
reasonable terms or at all. In addition, if we decide to litigate these claims,
the litigation could be expensive and time consuming and could result in court
orders preventing us from selling our then-current products or from operating
our business. Any infringement claim, regardless of merit, could result in the
expenditure of significant financial and managerial resources and harm our
business, financial condition and results of operations.
WE MAY PURSUE ACQUISITIONS THAT PRESENT RISKS AND THAT MAY NOT BE SUCCESSFUL. IN
ADDITION, EVEN IF WE ARE ABLE TO IDENTIFY FUTURE SUITABLE ACQUISITION OR
INVESTMENT CANDIDATES, WE CANNOT MAKE ASSURANCES THAT WE WILL BE ABLE TO MAKE
THE ACQUISITIONS OR INVESTMENTS ON COMMERCIALLY ACCEPTABLE TERMS OR AT ALL. In
the future, we may pursue acquisitions to enhance our technology and diversify
our product and service offerings and customer base or for other strategic
purposes. We have a limited history of making acquisitions and we cannot be
certain that any future acquisitions will be successful. Even if we are able to
identify future suitable acquisition or investment candidates, we cannot make
assurances that we will be able to make the acquisitions or investments on
commercially acceptable terms or at all. If we acquire or invest in another
company, we could have difficulty assimilating that company's personnel,
operations, technology or products and service offerings into our own. The key
personnel of the acquired company may decide not to work for us. These
difficulties could disrupt our ongoing business, distract our management and
employees, increase our expenses and adversely affect our results of operations.
In addition, we may incur indebtedness or issue equity securities to pay for any
future acquisitions. The issuance of equity securities could be dilutive to our
existing shareholders.
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INFLATION AND CURRENCY FLUCTUATIONS MAY ADVERSELY AFFECT OUR RESULTS. We may be
adversely affected if the rate of inflation in Israel exceeds the rate of
devaluation of the NIS against the dollar.
Most of our revenues are generated in dollars and a substantial portion of our
expenses is incurred in NIS. The dollar cost of our operations in Israel is
influenced by the extent to which any increase in the rate of inflation in
Israel is not offset, or is offset on a lagging basis, by a devaluation of the
NIS in relation to the dollar.
The deflation rate in Israel was 2.3% in 2003, while the NIS appreciated against
the dollar by 6.9%. As a result, we experienced an increase in the dollar costs
of our operations in Israel in 2003, primarily because substantially all our
revenues are received in dollars while salaries in Israel are paid in NIS and
constitute a significant portion of our expenses.
We cannot assure that we will not be materially and adversely affected in the
future if the rate of inflation in Israel exceeds the devaluation of the NIS
against the U.S. dollar or if the timing of this devaluation lags behind
increases in inflation in Israel.
We do not currently engage in any hedging arrangements to offset risks
associated with fluctuations in foreign currency exchange rates, but may do so
in the future. As a result, price and exchange rate instability could have a
material adverse effect on our business, financial condition and results of
operations.
WE MAY NOT SATISFY THE REQUIREMENTS FOR QUOTATION ON THE OTC BULLETIN BOARD
SERVICE. IF OUR SHARES ARE REMOVED FROM THE OTCBB, IT WOULD BE MORE DIFFICULT
FOR OUR SHAREHOLDERS TO DISPOSE OF OR PURCHASE OUR SHARES AND OUR ABILITY TO
RAISE FUNDS THROUGH THE ISSUANCE OF EQUITY SECURITIES WOULD BE MATERIALLY
ADVERSELY AFFECTED. In February 2002, our ordinary shares were delisted from the
NASDAQ National Market as a result of our failure to meet NASDAQ's continued
listing requirements. Trading in our ordinary shares is currently conducted on
the Over the Counter Bulletin Board, or the OTCBB. If we cannot satisfy OTCBB's
requirements for quotation, it may remove our ordinary shares from its service.
To continue to be quoted on the OTCBB, we must remain current in our filings
with the Securities and Exchange Commission, or the Commission and must have a
market maker for our stock. We may not be able to continue to satisfy these or
other quotation requirements in the future. If this occurs, our ordinary shares
may be removed from the OTCBB. As a result, an investor would likely find it
significantly more difficult to dispose of, or to obtain accurate quotations as
to the value of, our ordinary shares and the prices of our ordinary shares may
be lower than those that might otherwise be available through the OTCBB. In
addition, if our ordinary shares are removed from the OTCBB, our ability to
raise funds through the issuance of equity securities would be materially
adversely affected.
THE PRICE OF OUR ORDINARY SHARES IS HIGHLY VOLATILE. The price of our ordinary
shares fluctuates significantly. For example, the price has ranged from $38 per
share in March 2000 to $0.07 per share in October 2002. On January 30, 2004, the
price was $0.84 per share. During the year ended January 31, 2004, our trading
volume was, on average, only 19,575 ordinary shares per day, which has increased
the volatility of the trading price of our shares
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Prices of our ordinary shares may fluctuate in response to a number of events
and factors, including:
o quarterly variations in our results of operations;
o changes in our operating expense level or losses;
o performance of technology companies generally;
o new products, services and strategic developments by us or our
competitors;
o announcements of innovations;
o changes in financial estimates and recommendations by securities
analysts with respect to our company, companies engaged in a similar
business or technology companies generally;
o general stock market conditions, particularly with respect to
technology companies;
o general conditions of the economies of the countries in which we
operate; and
o outbreaks or escalation of hostilities or terrorist incidents in
Israel or elsewhere in the world.
Any of these events may cause our share price to decline, which may adversely
affect our business and financing opportunities.
A substantial portion of our expenses, including most product development,
selling and marketing expenses, must be incurred before revenue is generated. If
our projected revenue does not meet our expectations, we are likely to
experience a shortfall in our projected operating results. As a result, we
believe that period-to-period comparisons of our historical results of
operations are not necessarily meaningful and that you should not rely on them
as an indication of future performance. Also, our quarterly results of
operations have, on separate occasions, been below the expectations of public
market analysts and investors and the price of our ordinary shares subsequently
decreased. If this happens in the future, the price of our ordinary shares will
likely decrease again.
In addition, global stock markets have recently experienced and may continue to
experience significant price decreases and price and volume fluctuations, which
have particularly affected the market prices of the stocks of high technology
companies, Internet-related companies and Israeli companies, including us.
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FUTURE SALES OF OUR ORDINARY SHARES IN THE PUBLIC MARKET AND LOW TRADING VOLUME
COULD ADVERSELY AFFECT OUR SHARE PRICE. As of July 15, 2004 we had 21,798,595
ordinary shares issued and outstanding, which does not include an aggregate of
3,000,000 ordinary shares issuable to the Belzberg Family upon receipt of
shareholder approval. Pursuant to the terms of the Investment Agreement, we
intend to apply for the registration of an aggregate of 6,218,750 ordinary
shares issued or issuable under the Investment Agreement (which includes an
aggregate of 3,750,000 ordinary shares and ordinary shares underlying warrants
immediately exercisable in full and with a five-year term issuable to the
Belzberg Family upon receipt of shareholder approval and 2,468,750 ordinary
shares and ordinary shares underlying warrants held by certain other
warrant-holders). In addition, we intend to apply for registration of
approximately 6,045,312 ordinary shares, 6,111,112 ordinary shares underlying
warrants and 1,005,654 ordinary shares underlying convertible loans held by
parties who have exercised rights to request that we include their shares in any
registration statement that we file. Registration of these shares would
generally result in these shares becoming freely tradable without restriction
immediately upon the effectiveness of such registration. Future sales of these
shares, or the perception that these sales could occur, could adversely affect
the market price of our shares. In addition, during the 12-month period ending
on July 15, 2004, we experienced a low trading volume of our ordinary shares
(consisting of a daily average of approximately 23,043 shares), and if one or a
small number of parties buys or sells a large number of our ordinary shares, we
may experience volatility in our share price and our share price may be
adversely affected.
IF WE ARE CHARACTERIZED AS A PASSIVE FOREIGN INVESTMENT COMPANY, OUR U.S.
SHAREHOLDERS MAY SUFFER ADVERSE TAX CONSEQUENCES. If, for any taxable year, our
passive income, or our assets that produce passive income, exceed specified
levels, we may be characterized as a passive foreign investment company, or
PFIC, for U.S. federal income tax purposes. This characterization could result
in adverse U.S. tax consequences for our U.S. shareholders, which may include
having gains realized on the sale of our ordinary shares treated as ordinary
income, rather than as capital gains income, and having potentially punitive
interest charges apply to the proceeds of sales of our ordinary shares. We
believe we were not a PFIC for our fiscal year ended January 31, 2004. However,
the tests for determining PFIC status are applied annually and it is difficult
to make accurate predictions of future income and assets, which are relevant to
this decision. Accordingly, we may have been, for the fiscal year ended January
31, 2004, or may become in the future, a PFIC. For a more detailed discussion of
the consequences of our being classified as a PFIC, see "Item 10.E. Additional
Information-Taxation-United States Federal Income Tax Considerations."
WE ARE SUBJECT TO RISKS ASSOCIATED WITH JOINT DEVELOPMENT PROJECTS. In the past
we have joined other companies in joint development projects, and we may
continue to do so in the future. We undertake certain risks when we enter these
joint development projects. These risks include:
o loss of control over the development of aspects of the jointly developed
product;
o loss of control over timing of any module/product introduction and
availability; and
o disputes concerning rights with respect to any technology used or developed
in the joint development process.
In addition, our joint development activities may not result in new products or
enhancements and any products or enhancements developed may not be commercially
successful.
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IF OUR SHAREHOLDER APPROVE A RECENT INVESTMENT IN US BY CERTAIN RELATED PARTIES,
OUR CHIEF EXECUTIVE OFFICER AND CHAIRMAN OF THE BOARD OF DIRECTORS AND HIS
AFFILIATES WILL BENEFICIALLY OWN MORE THAN 60% OF OUR ORDINARY SHARES, AND WILL
THEREFORE BE ABLE TO EXERCISE CONTROL OVER ALL MATTERS REQUIRING SHAREHOLDER
APPROVAL, INCLUDING THE ELECTION OF DIRECTORS AND APPROVAL OF SIGNIFICANT
CORPORATE TRANSACTIONS. Assuming shareholder approval of the new investment
noted above by certain related parties, as of July 15, 2004, our directors,
executive officers and principal shareholders and their affiliates beneficially
owned approximately 65.6% of our outstanding ordinary shares. Assuming such
shareholder approval, the Belzberg Family will beneficially own, immediately
following such approval, more than 60% of our ordinary shares. As a result, the
Belzberg Family will be able to exercise control over all matters requiring
shareholder approval, including the election of directors and approval of
significant corporate transactions. Such concentration of ownership could delay
or prevent proxy contests, mergers, tender offers, open-market purchase programs
or other purchases of our ordinary shares that might otherwise give you the
opportunity to realize a premium over the then-prevailing market price of our
ordinary shares. This concentration of ownership may also adversely affect our
share price. See "Item 7. Major Shareholders and Related Party Transactions."
WE ARE LOCATED IN THE STATE OF ISRAEL, WHICH ENTAILS VARIOUS SPECIAL RISKS. We
are incorporated under the laws of the State of Israel, and our principal
offices, manufacturing and research and development facilities are located in
Israel. Although most of our revenues are currently derived from sales made to
customers outside Israel, we are nonetheless influenced by political, economic
and military conditions affecting Israel. Any major hostilities involving Israel
or the interruption or curtailment of trade between Israel and its present
trading partners could have a material adverse effect on our operations. Since
September 2000, there has been an escalation of violence in the West Bank and
Gaza Strip and increased terrorist activity within Israel, causing a
deceleration of the Israeli economy. Furthermore, several countries restrict
business with Israeli companies. We could be adversely affected by further
set-backs to the peace process in the Middle East or by restrictive laws or
policies directed toward Israel or Israeli businesses.
We benefit from programs sponsored by the Government of Israel for the support
of research and development and marketing, as well as favorable tax rates
available to "Approved Enterprises" in Israel. To be eligible for these programs
and tax benefits, we must continue to meet certain conditions, including
reaching certain revenue and export levels. If we fail to meet these conditions
in the future, we could be required to refund tax benefits that we expect to
receive. In addition, the Government of Israel has reduced the benefits
available under a number of government sponsored programs and has indicated its
intention to further reduce benefits in the future.
The termination or adverse modification of these programs or our inability to
take advantage of them would cause the costs of our operations in Israel to
materially increase and result in an adverse effect on the results of our
operations as a whole. To the extent that we increase our activities outside of
Israel, which could result from, among other things, future acquisitions, these
increased activities generally will not be eligible for benefit programs
sponsored by the State of Israel. Accordingly, the effective cost of our future
research and development activities in particular, and our operations in
general, could significantly increase.
Additionally, all nonexempt male adult citizens of Israel are obligated to
perform military reserve duty. Some of our officers and employees are currently
obligated to perform annual reserve duty. Furthermore, all these persons are
subject to being called to active duty at any time under emergency
circumstances. Although we have operated without any material disruption under
these requirements since we began operations, we cannot assess the full impact
of these requirements on our workforce or business if conditions should change,
and we cannot predict the effect on us of any expansion or reduction of these
obligations.
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PROVISIONS OF ISRAELI LAW COULD DELAY, PREVENT OR MAKE DIFFICULT A CHANGE OF
CONTROL AND THEREFORE DEPRESS THE PRICE OF OUR SHARES. The Companies Law
generally requires that a merger be approved by the board of directors and a
majority of the shares voting on the proposed merger. Unless a court rules
otherwise, the merger will not be deemed approved if a majority of the shares
held by parties other than the other party to the merger (or by any person who
holds 25% or more of the shares or the right to appoint 25% or more of the
directors of the other party) vote against the merger. Upon the request of any
creditor of a party to the proposed merger, a court may delay or prevent the
merger if it concludes that there is a reasonable concern that, as a result of
the merger, the surviving company will be unable to satisfy its obligations.
Finally, a merger may not be completed unless at least 70 days have passed since
the filing of the merger proposal with the Israeli Registrar of Companies.
In certain circumstances an acquisition of shares in a public company must be
made by means of a tender offer if, as a result of the acquisition, the
purchaser would become a 25% or 45% shareholder of the company (unless there is
already a 25% or a majority shareholder of the company, respectively). If, as a
result of an acquisition, the acquirer would hold more than 90% of a company's
shares, the acquisition must be made by means of a tender offer for all of the
shares. The described restrictions could prevent or make more difficult an
acquisition of our company, which could depress our share price.
Also, Israel tax law treats some acquisitions, such as stock-for-stock exchanges
between an Israeli company and a foreign company, less favorably than U.S. tax
laws. For example, Israeli tax law may, under certain circumstances, subject a
shareholder who exchanges his ordinary shares for shares in another corporation,
to taxation prior to the sale of the shares received in such stock-for-stock
swap.
IT MAY BE DIFFICULT TO ENFORCE A U.S. JUDGMENT AGAINST US, AND OUR OFFICERS AND
DIRECTORS NAMED IN THIS ANNUAL REPORT, TO ASSERT U.S. SECURITIES LAWS CLAIMS IN
ISRAEL AND TO SERVE PROCESS ON SUBSTANTIALLY ALL OF OUR OFFICERS AND DIRECTORS.
We are incorporated in Israel. Most of our executive officers and directors
named in this annual report are nonresidents of the United States, and a
substantial portion of the assets of these persons are located outside the
United States. It may be difficult for an investor, or any other person or
entity, to enforce a U.S. court judgment based upon the civil liability
provisions of U.S. federal securities laws in an Israeli court or to effect
service of process upon these persons. Additionally, it may be difficult for an
investor, or any other person or entity, to enforce civil liabilities under U.S.
federal securities laws in original actions instituted in Israel.
YOUR RIGHTS AND RESPONSIBILITIES AS A SHAREHOLDER WILL BE GOVERNED BY ISRAELI
LAW AND DIFFER IN SOME RESPECTS FROM THE RIGHTS AND RESPONSIBILITIES OF
SHAREHOLDERS UNDER U.S. LAW. We are incorporated under Israeli law. The rights
and responsibilities of holders of our ordinary shares are governed by our
memorandum of association, our articles of association and by Israeli law. These
rights and responsibilities differ in some respects from the rights and
responsibilities of shareholders in typical U.S. corporations. In particular, a
shareholder of an Israeli company has a duty to act in good faith toward the
company and other shareholders and to refrain from abusing his power in the
company, including, among other things, in voting at the general meeting of
shareholders on certain matters. See "Item 6. Management - Board Practices -
Approval of Specified Related Party Transactions Under Israeli Law - Shareholder
Duties" for additional information concerning this duty.
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ITEM 4
INFORMATION ON THE COMPANY
(A) HISTORY AND DEVELOPMENT OF THE COMPANY
e-SIM Ltd., formerly known as Emultek Ltd., was incorporated as a corporation
under the laws of the State of Israel in 1989, and commenced operations in 1991
as a software development and consultation company.
Our corporate headquarters are located at 19 Hartum Street, Jerusalem, 91450
Israel, and our telephone number is 972-2-587-0770. Our research and development
department is located in Teradion, Israel. Some of our simulation development
services are provided by a sub-contractor located in Bangalore, India. In 1996
we established a wholly-owned subsidiary in the United States, e-SIM, Inc., a
Delaware corporation. e-SIM, Inc.'s address is 225 S. Lake Avenue, suite 300,
Pasadena, CA 91101 and its telephone number is (626) 584-7810. In 1998, we
established a wholly-owned subsidiary in Japan, e-SIM Japan Ltd., which has an
office in Tokyo. In 1999, we established a wholly-owned subsidiary in France,
e-SIM Europe SARL. On February 1, 2003, e-SIM Europe SARL ceased operations.
We completed our initial public offering in July 1998, and began trading on the
American Stock Exchange. Our name was changed from Emultek Ltd. to e-SIM Ltd. in
June 1999. In March 2000, we changed our listing to the NASDAQ National Market,
or NASDAQ, and our ordinary shares were traded on NASDAQ under the symbol
"ESIM." In February 2002, our ordinary shares were delisted by NASDAQ as a
result of our failure to meet NASDAQ's continued listing requirements. Trading
in our ordinary shares is currently conducted in the over-the-counter market, or
the OTCBB, under the symbol "ESIM.OB".
In 1998, we changed our fiscal year, and since then our fiscal year ends on
January 31, instead of December 31.
Our first product, Rapid, was released in 1992 as a software tool that enables
customers to create simulations for a variety of products. Leveraging the
simulation technology utilized in Rapid, we developed RapidSimulation, which was
first released in early 1994. RapidSimulation enabled developers of embedded
systems software to use a visual and intuitive, object-based process to create
simulated computer prototypes of their products that are fully functional,
interactive and behaviorally identical to the products represented.
RapidSimulation was also used as a development product in computer based
training, or CBT, for generating interactive simulations of embedded systems.
In September 1997, we broadened our product line by introducing RapidPLUS, a
software development product that consists of a suite of integrated modules,
each of which supports a different stage of the embedded systems' life cycle. In
March 1998, we further expanded RapidPLUS by introducing a module to
automatically generate efficient and compact source code for applications
software directly from the simulated prototype. This module was developed with
the assistance of, and partial funding by, Motorola, Inc. RapidSimulation has
been integrated into RapidPLUS and is no longer offered as a separate product.
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In 1999, we began providing web-based product simulations built with RapidPLUS
for electronics companies. Our simulation technology generates animated
interactive virtual models that accurately simulate real products with
interactive walk-through features that allow for step-by-step use of the product
for e-commerce, marketing, customer support, Internet or Intranet use. These
simulations, named "LiveProducts," are used for product launches, promotion,
web-based customer support, as well as training for sales and support forces and
customers. The LiveProducts are typically bundled in our "LiveManuals" product
that includes a web-based user manual and interactive live feature
demonstrations. The terms "LiveManuals" and "LiveProducts" are sometimes used
interchangeably.
In 1999, we established LiveManuals.com, which was planned to be a web-site
where consumers could try out consumer electronic products before purchase,
receive instructions on how to use the products, and manage their customer
service needs, such as ordering repairs or purchasing service contracts from
third parties. The LiveManuals technology was used to prepare on-line simulation
based user manuals. We have ceased maintaining this web-site because we no
longer regard it as a source of revenue or a marketing tool.
In addition to providing customers with finished product simulations, in 2000,
we began licensing the right to use the LiveProducts-generating technology to
prepare simulations. The technology license grants the customer the right to use
the technology in a limited geographic area for creating LiveProducts, either
for their own use or for third parties.
In 2001, we began marketing our LiveProduct generation technology as RapidPLUS
Web Studio (which had existed since 1999 but was not offered until 2001), an
additional module to the RapidPLUS family of products. RapidPLUS Web Studio
allows our customers to generate their own LiveProducts simulations. As part of
the RapidPLUS Web Studio package, our customers receive the Scenario Authoring
Tool, or SAT, which allows them to create interactive feature demonstrations for
the generated LiveProducts.
In the second half of 2001 and first quarter of 2002, we effected a major
restructuring of our corporate activities. As part of this restructuring, we
merged our Software Tools division and LiveProducts division, closed offices in
the U.S., France and Sweden and relocated our Japanese offices to a customer's
facilities. We reduced our staff in all categories, particularly from the former
LiveProducts division, whose sales and marketing department was eliminated
entirely and whose responsibilities were taken over by other existing staff. In
addition, we significantly reduced our research and development department. The
restructuring led to a significant cost saving and reduction in our losses.
In 2001, we revised our product-packaging program and made it modular. This
allows our customers to choose only those modules they require and reduces the
initial purchase price for new users of our products. Under this program,
RapidPLUS DOC is sold as the base product, to which our customers may choose to
add a C code generator to create RapidPLUS CODE or a Java code generator to
create the RapidPLUS Web Studio product. In 2002, we added a new product and
module to the RapidPLUS family, called RapidPLUS Xpress. RapidPLUS Xpress is an
easy to learn tool that enables non-technical designers of user interfaces to
easily design product simulations and generate graphic diagrams from them.
Originally sold either as a stand-alone tool or as an add-on to RapidPLUS DOC,
RapidPLUS Xpress is now available only in the latter option.
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During 2002 and 2003, we changed our business model from the development of a
generic MMI tool for embedded systems to the development of an MMI solution
specifically for the wireless market. We also shifted from relying on our
traditional distributors in the embedded systems market, many of whom were among
our largest customers, to establishing long-term distribution contracts with
wireless handset platform vendors and direct licensing and development contracts
with these vendors and with wireless handset manufacturers and mobile carriers.
Wireless handset platform vendors, handset manufacturers and mobile carriers are
generally interested in the ease of use of wireless or mobile handsets by
consumers. Development of the interface between the consumer and the handset
product, known as the man machine interface, or MMI, requires software
development, which can be facilitated by software development tools and a basic
application that can be customized to meet the needs of each vendor,
manufacturer or carrier. We offer this market software development tools and a
basic application, known as the MMI reference design, which can be customized to
create the MMI application for the customer's handset.
In 2003, we began offering our MMI reference design as a separate product. Our
business model for this sector is based upon the licensing of our RapidPLUS
development tools, our MMI reference design, our MicroKernel (the proprietary
software component located in the micro processing unit of the handset and on
which the code for the MMI generated by RapidPLUS can be run), and customization
tools, and provision of customization, training, development and consulting
services. We regard this package of software tools, products, applications and
services as our MMI solution, which can be tailored to the needs of each
customer.
The revenues we derive from contracts with wireless handset platform vendors and
with wireless handset manufacturers and mobile carriers are comprised of license
fees relating to the licensing of our RapidPLUS tools, license fees for our MMI
reference designs, royalty fees relating to the licensing of our MMI reference
designs and MicroKernels and service revenue from customization, training,
development and consulting services. Under our new business model, we expect to
receive a royalty payment for each handset into which one of our MMI reference
designs or MicroKernel is integrated. As part of this strategy, distribution of
certain of our products is currently conducted by the handset platform vendors
who are our customers, who then will either offer to their customers - the
handset manufacturers - our MMI solution as part of their platform offering to
the handset manufacturers or refer such customers to us directly. We believe
this strategy will result in a long-term recurring stream of revenues and that
our platform vendors will be able to market our MMI solution to a range of
handset manufacturers, thus saving us significant marketing expenses. To date,
we have attracted new customers through this strategy. As a result of our new
strategy, our sales through our traditional distributors, including distributors
who were major clients, have significantly declined. In addition, because we are
only now beginning to receive revenues from our MMI solution, our overall
revenues in 2003 have declined compared with 2002.
CAPITAL EXPENDITURES
For a description of our principal capital expenditures, please see note 4 to
our consolidated financial statements, included elsewhere in this annual report.
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(B) BUSINESS OVERVIEW
We offer an MMI solution for wireless handset platform vendors, handset
manufacturers and mobile carriers. Based on our proprietary technology, our MMI
solution allows our customers to more easily and quickly develop the MMI of a
new handset that they intend to introduce. Until recently, the handset industry
was vertically integrated, so that the leading handset vendors controlled
materially all aspects of the industry, including the technology assets,
engineering capabilities, production, branding, distribution and support. This
market is now evolving such that the different stages of the development,
production and sales process are being conducted by different companies. In
recent years, we have witnessed a new trend pursuant to which the global handset
supply chain has been transformed from a traditional "vertical" structure, in
which original equipment manufacturers designed, manufactured and distributed
mobile handsets, to a more complex "horizontal" model in which a variety of
different participants produce the handset. In the current wireless handset
market, handset platform vendors, who are usually semi-conductor manufacturers,
often provide the handsets' main electronic and software components to wireless
handset manufacturers in the form of a standardized platform known as a
reference platform. These vendors are interested in providing their
manufacturing customers a reference platform which has been tested and
integrates a variety of components that the manufacturer can customize and
develop in a rapid and simple manner to commence manufacturing. Our MMI
reference design and the accompanying customization and development tools can be
part of the reference platform, thus providing platform vendors with a modular,
customizable, pre-integrated MMI solution that they can, in turn, provide to
their customers. This can add value to their product, differentiate them from
platform vendors who do not have an effective MMI solution, and assist their
platforms to be more quickly and effectively deployed in the market with less
risk.
Our offering for the wireless handset market is comprised of the following
components, which are either licensed as stand-alone products or services or as
part of an MMI solution:
o the RapidPLUS product, which enables the customer to develop and
simulate MMIs, as well as to generate code and documentation;
o the MMI reference design, which is customizable, modular and scalable;
o the Rapid MicroKernel, which is a software component located in the
micro processing unit of the handset, on which the code for the MMI
generated by RapidPLUS can be run; and
o customization tools to customize the MMI reference design during
development or in the post-development stage. These customization
tools do not require use of any programming language, and can
therefore be used by a wider range of application developers. These
tools are usually offered together with the MMI reference design.
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As part of our offering, we also provide our customers with consulting and
engineering services, as well as training and support for their staff and
customers. We also resell certain third party applications, which
complement our product line. Notable examples are Motorola's WAP Browser
and MMS Client that we distribute under an agreement with Motorola's
Semiconductor Products Sector. In April 2004, Motorola's Semiconductor
Products Sector was reorganized and its activities were transferred to a
subsidiary of Motorola, Inc. named Freescale Semiconductor, Inc., or
Freescale.
While our main efforts are now dedicated to the expansion of our business in the
wireless handset markets, we continue our traditional business of providing
simulation-based technology for use in the design, development, documentation,
promotion, customer support and training of other interactive electronics
products and systems. Our RapidPLUS product line allows our customers to use
on-screen, graphically accurate and behaviorally complete simulations they
created of their products to help improve these products, reduce the time and
cost involved in bringing them to market, effectively train sales and support
personnel, reduce the cost and complexity of customer support, and provide a
low-cost and efficient method of reaching target consumers.
RAPIDPLUS
RapidPLUS is a suite of integrated software tools. RapidPLUS provides a means of
quickly and easily creating product simulations. The RapidPLUS toolset is sold
in several packages, including RapidPLUS Xpress, RapidPLUS/CODE, RapidPLUS/DOC,
RapidCBT and RapidPLUS Web Studio. Each of these packages serves a different
part of the product's life cycle, based on the initial product simulation. The
packages and their content may change from time to time based on our business
and technological considerations.
The RapidPLUS modules are used throughout the product's life cycle as follows:
PRODUCT DESIGN. RapidPLUS DOC is used to create virtual prototypes of user
interface for new products in order to visualize, communicate and improve the
product's design. Customers can test new design alternatives, ensure their
designs are complete and consistent, and communicate their concepts with other
parts of the organization or external bodies, before developing and
manufacturing the product.
DOCUMENTATION. RapidPLUS DOC is used to generate technical documentation from
the prototype/simulation. This documentation includes functional and graphic
information about the product, and can be updated automatically when changes are
made to the prototype/simulation. The documentation can serve as a specification
to engineers and as a basis for user manuals.
CODE GENERATION. Using RapidPLUS CODE, users can generate compact and efficient
C code from the prototype, to be used as the MMI of their product's software,
and which can be linked to other software modules. Changes in the
simulation/prototype are immediately reflected in the generated code. To run on
the customer's product, the generated code requires a software component, which
we call a MicroKernel, located in the micro processing unit of the product. This
MicroKernel needs to be "ported" to the specific hardware and software
environment (processor, operating system and other software modules) that exists
on the product. Typically, for a fee we provide our customers with this porting
service.
In addition to licensing the RapidPLUS CODE software tool, we charge our
customers a licensing fee for each customer product shipped embedded with the
MicroKernel.
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MMI REFERENCE DESIGN
We license the MMI reference design to wireless handset platform vendors,
handset manufacturers and mobile carriers as a basic application, which can be
customized to create the MMI application for the customer's handset. As a key
element of our wireless handset MMI solution, the MMI reference design provides
the blueprint for the eventual creation of the user interface of the wireless
handset. The MMI reference design is a modular, customisable, scalable and
open-source full MMI application, which can be adapted and further developed by
use of RapidPLUS to add further functionality as may be required by the
customer. Embedding the MMI reference design in the platform that is offered to
the wireless handset manufacturers can add value to their product, differentiate
them from platform vendors who do not have an effective MMI solution, and assist
their platforms to be more quickly and effectively deployed in the market with
less risk.
CUSTOMIZATION TOOLS
We license a set of customization tools to wireless handset platform vendors,
handset manufacturers and mobile carriers, who may use such tools to customize
the MMI reference design to the demands of their customers. These tools are
usually offered together with the MMI reference design.
LIVEPRODUCTS AND LIVEMANUALS
We provide technology and services to deliver product simulations and electronic
manuals over the Internet. LiveProducts are animated interactive virtual models
that accurately simulate real products with interactive walk-through features
that allow for step-by-step use of the product for e-commerce, marketing,
customer support, Internet or Intranet use.
When a LiveProduct is bundled into a LiveManual, as is typically the case, it
provides a web-based user manual and interactive live feature demonstrations.
PRINCIPAL MARKETS
We target the following markets:
WIRELESS HANDSET PLATFORM, HANDSET MANUFACTURING MARKET AND MOBILE CARRIES
Our MMI solution targets as its main market the wireless handset platform,
handset manufacturing industries and mobile carriers. We believe the potential
for our MMI solution in this market is growing primarily due to the change in
the nature of the wireless handset manufacturing industry. For a discussion of
the changes that have recently occurred in this market and the presently
anticipated trends, see "Business Overview". The MMI is becoming a significant
part of the platform offering which wireless handset platform vendors seek to
market to handset manufacturers, since the development of an MMI by wireless
handset manufacturers is difficult and time consuming. Furthermore, we believe
the MMI can be a major differentiator between different brands. Our MMI
reference design and the accompanying customization and development tools can be
part of the reference platform, thus providing platform vendors with a modular,
customizable, pre-integrated MMI solution that they can, in turn, provide to
their customers. This can add value to their product, differentiate them from
platform vendors who do not have an effective MMI solution, and assist their
platforms to be more quickly and effectively deployed in the market with less
risk.
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Our strategy for this market currently focuses our sales, marketing and research
and development on wireless handset platform vendors and handset manufacturers.
We are developing a base of strategic clients for long-term relationships in
which we develop and customize an MMI for the strategic client's particular
needs. For example, in 2002 we entered into an agreement with Freescale,
providing Freescale with the right to use RapidPLUS as the user interface
component for its wireless platforms and chipset reference designs, and to
resell RapidPLUS to manufacturer customers. Freescale sells a wireless platform
that includes hardware, software and tools that enable manufacturer customers to
quickly create wireless handsets. Freescale provides its customers with a
reference design for a complete handset. The user interface of this reference
design has been created using RapidPLUS. Freescale offers its customers
RapidPLUS Code as a tool for user interface development and customization of the
reference design. Motorola has sold this platform to a number of companies that
have chosen to use RapidPLUS to develop the user interfaces of their cellular
phones, including, but not limited to, TCL Telecom, RTX Telecom, Elcoteq Network
Corporation and Eastern Telecom. In addition to revenues from the licensing of
the RapidPLUS software as a development tool, in the first quarter of 2004, we
began to receive royalty revenue from the inclusion of our MicroKernels in the
platforms that Freescale has sold to its customers. In October 2002, we entered
into an agreement with IXI Mobile (R&D) Ltd., creator of the Personal Mobile
Gateway, to develop an MMI for the reference design of the user interface of
some of IXI's products, and to include RapidPLUS as part of its standard
software development environment, known as IXI-Studio.
In December 2003, we entered into an agreement with Texas Instruments France
S.A., or TI, to develop an MMI application for a new wireless platform.
In April 2004, we entered into an agreement with an additional strategic
customer, Sasken Communication Technologies Ltd., a provider of
telecommunications software solutions, for the bundling of our MMI solution into
their mobile software solutions to their customers.
In each of the three contracts discussed above, we receive revenue from
licensing our RapidPLUS software, MMI reference design, customization tools and
MicroKernels. The amount of revenue to be earned will be dependent on the
success of our customers in marketing their platform reference design, with our
MMI solution, to their customers.
In addition to our strategic customers, we are also focusing our efforts on a
series of strategic relationships with hardware providers, third-party
application vendors, and other software vendors in the wireless handset market
whereby we pre-integrate our MMI solutions with their hardware or their
applications or conduct joint marketing activities. For example, in November
2003, we entered into an agreement with Freescale to bundle their Mobile
Internet Browser (MIB) and their MultiMedia Messaging System (MMS) client into
our MMI solution and become a reseller for them. We have also established joint
marketing relationships with Intel, Inc., TransChip, Inc., Emblaze Semiconductor
Ltd. and Renesas Technology Corp.
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EMBEDDED SYSTEMS SOFTWARE MARKET
Most electronics products today incorporate embedded systems. Embedded systems
consist of microprocessors and related software, incorporated within electronics
products, which are dedicated to performing specific tasks quickly and reliably.
Consumer electronics products are becoming increasingly complex as manufacturers
design these products with increasing numbers of features and capabilities. The
complexity of electronics products makes it more difficult for a manufacturer to
support the entire life cycle of these products, from design through sales and
customer support. Many of the factors driving changes in the wireless platform
and handset manufacturing markets, such as pressure to lower development costs
and reduce time to market, increased design complexity and limited engineering
resources, apply to the manufacture of electronic products incorporating
increasingly complex embedded systems.
In 2003, our sales efforts in this market, both through distributors and
directly to embedded system manufacturers, decreased as a result of the changed
focus in our business model to wireless handset platform vendors, wireless
handset manufacturers and mobile carriers.
INTERNET BASED CUSTOMER SUPPORT, TRAINING AND E-COMMERCE
As discussed in "History and Development of the Company", in 1999, we began
providing web-based product simulations built with RapidPLUS for electronics
companies and established a web-site known as LiveManuals.com. We market our
LiveProducts and LiveManuals solutions to consumer electronics manufacturers,
retailers and wireless carriers as well as licensing our LiveProducts technology
to third parties who will themselves produce LiveProducts or LiveManuals for
their customers in different geographic areas. In 2003, we produced LiveProducts
for leading companies, including Nikon Corporation, Samsung Telecommunications
America, L.P., Sprint PCS and Panasonic Consumer Electronics Company. Several of
these customers were repeat users of our products and services. We had revenues
from our Internet based activities of approximately $49,000, $392,000, $684,000,
$1,027,000 and $418,000 in 1999, 2000, 2001, 2002 and 2003, respectively.
The significant drop in revenues in 2003 was the result of our decision to focus
our sales efforts on the wireless handset market and our reevaluation of the
potential revenues to be earned by our Internet based activities.
In order to provide our customers with LiveProduct simulations, in 1999 we
established a simulation development facility in Bangalore, India with a local
sub-contractor. The sub-contractor was responsible for obtaining facilities and
all necessary equipment, as well as hiring qualified personnel required to
develop simulations for our LiveProducts customers. All personnel were employed
directly by the sub-contractor, except for a supervisor of the project who was
employed directly by us. We paid the sub-contractor a monthly fee based on the
number and type of personnel employed in that period by the sub-contractor to
work exclusively on our projects. In December 2003, as a result of the decreased
demand for our LiveProducts, the terms of our relationship with the Indian
sub-contractor were changed and now provide that any work done for us at its
facility is paid on a per-project basis and not for a monthly fee. Personnel of
the sub-contractor are no longer dedicated to work exclusively on our
simulations and we no longer employ the project supervisor.
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TECHNOLOGY
RAPIDPLUS
RapidPLUS simulation, development and code generation technology relies on the
following principles:
o Statecharts programming, which are used to define the logical behavior of
the system;
o Component-based (or object) technology, which is used to describe the
different graphic and functional elements of the system;
o Simulation technology, which provides the capability to instantly visualize
and test a handset's MMI application on a PC and view each change
immediately after it is made; and
o Code generation technology, which generates compact, efficient and easily
integrated C code from the simulation into the target environment.
MMI REFERENCE DESIGN
Our MMI reference design incorporates several advanced technologies, including
modular architecture, windowing system, application manager, data-driven menus,
layouts and graphic resources.
RESEARCH AND DEVELOPMENT
We believe that our technology is a core strength and that our ability to
enhance our existing products and applications, develop and introduce new
products and applications on a timely basis, maintain technological
competitiveness and meet customer requirements is essential to our future
success. Accordingly, we devote, and intend to continue to devote, a significant
portion of our personnel and financial resources to research and development of
our core technology and to customer projects developed based on this technology.
While we had reduced the number of research and development employees in the
course of our restructuring efforts in 2002, we have recently increased our
research and development force by hiring seven additional software developers
and two product testers, representing an increase of 53% in the size of our
research and development staff following the restructuring. In addition, in
order to successfully develop new and enhanced products, we seek to develop and
maintain close relationships with customers and remain responsive to their
needs.
Our core technology, products and applications are developed in our research and
development facility in Israel. Product development teams include experts in
computer science, electronic engineering, advanced mathematical techniques,
computer graphics, physics and other fields. Our research and development
efforts have been financed primarily by revenues and cash flows from operations,
equity investments, borrowings from banks and other parties and governmental and
other grants, such as the programs sponsored by the Office of the Chief
Scientist and the Israeli-U.S. Bi-national Industrial Research and Development
Foundation, or BIRD Foundation.
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As of July 15, 2004, our research and development department consisted of 18
software developers, five product testers, one technical writer, one systems
manager, one general assistant and our Vice President of Research and
Development. The research and development department is divided into two major
teams: RapidPLUS core technology, including code generation, and LiveManuals,
each headed by a team manager who reports to our Vice President of Research and
Development. In addition, we employ a Chief Scientist who reports directly to
our Chief Executive Officer and is responsible for the planning and design of
future architecture and development of our products, based on requirements
defined by our marketing department. We have ISO 9001:2000 and ISO 9000-3
certification, which enables us to expand our marketing efforts to those
customers and governmental authorities who require that certification.
GOVERNMENT AND OTHER GRANTS
Generally, grants from the Office of the Chief Scientist constitute up to 50% of
certain research and development expenses for the development of products
intended for export. Under the terms of the Office of the Chief Scientist for
participation in these programs, a royalty at a rate of 3.5% to 5% of the sales
of products developed in, and related revenues generated by, a project funded by
the Office of the Chief Scientist must be paid as sales of these products
commence. The royalty payments end when 100% to 150% of the grant is repaid in
NIS linked to the dollar and bearing interest at the rate of six-month LIBOR.
The obligation to pay these royalties is contingent upon actual sales of the
products and in the absence of sales, no royalty payment is required. Through
January 31, 2004, we obtained grants from the Office of the Chief Scientist in
the aggregate amount of approximately $1.8 million for certain of our research
and development projects and paid or accrued royalties to the Office of the
Chief Scientist in the aggregate amount of approximately $1.5 million. As of
January 31, 2004, the aggregate amount of the contingent obligation to the
Office of the Chief Scientist was approximately $394,000.
Since March 1998, the Israeli Government, through the Fund for Encouragement of
Marketing Activities Abroad has awarded us grants related to our foreign
marketing expenses. These grants are awarded for specific expenses we incur in
our foreign marketing activities, based on expenses reported to the Fund for
Encouragement of Marketing Activities Abroad. All marketing grants received from
the Fund for Encouragement of Marketing Activities Abroad are linked to the
dollar and are repayable in the form of royalty payments in the amount of 4% of
any increase in export sales we realize up to the total amount of grants we
receive. If we do not achieve an increase in export sales, we have no obligation
to pay any royalties or return any funds received through these grants. All
payments are linked to the dollar and bear interest at a rate of six-month
LIBOR.
Through January 31, 2004, we obtained grants in the aggregate of $778,000 from
the Fund for Encouragement of Marketing Activities Abroad and have paid or
accrued royalties in the amount of $272,000. As of January 31, 2004, the
aggregate amount of the contingent obligation to the Fund for Encouragement of
Marketing Activities Abroad was $506,000.
Some of the accrued royalties to the Office of the Chief Scientist and the Fund
for Encouragement of Marketing Activities Abroad were not paid when due. In
December 2003, we reached a settlement regarding payments to the Office of the
Chief Scientist and the Fund for Encouragement of Marketing Activities Abroad.
This settlement was renegotiated in January 2004. For additional information
concerning the terms of this renegotiated settlement, see "Item 5. Operating and
Financial Review and Prospects - Research and Development, Patents and
Licenses - Research and Development Grants."
30
<Page>
Terms of Israeli Government grants also require that the research and
development be conducted by the applicant for the grant as specified in the
application and that the manufacturing of products developed with Israeli
Government grants be performed in Israel, unless special approval has been
granted. Separate Israeli Government consent is required to transfer to third
parties technologies developed through projects in which the Government
participates. These restrictions, however, do not apply to exports from Israel
of products developed using these technologies. Because the Government of Israel
has from time to time revised its policies regarding the availability of grants,
the Israeli Government's support of research and development may not continue.
Through January 31, 2004, we received grants in the aggregate amount of
approximately $394,000 from the BIRD Foundation. We are obligated to pay
royalties to the BIRD Foundation on the proceeds from sales of products,
referred to as the development packages, resulting from the research and
development which the BIRD Foundation funded. The payments are of $250 for each
development package per license and $2,500 for each development package of
products per site. The total amount of the royalties may not exceed 150% of the
grants received. All the payments are linked to the dollar and the U.S. Consumer
Price Index.
Through January 31, 2004, we paid or accrued royalties to the BIRD Foundation in
the aggregate amount of approximately $210,000. As of January 31, 2004, the
aggregate amount of the contingent obligation to the BIRD Foundation was
approximately $381,000.
REVENUE SOURCES
We generate revenue from RapidPLUS license fees, MMI reference design license
fees, professional service fees, LiveManuals development fees, support contracts
fees, runtime licensing fees and right to use fees. We are beginning to generate
revenue from fees related to sales of mobile handsets embedded with our state
machine MicroKernel. The contracts we have entered into with wireless platform
vendors and handset manufacturers are structured so that runtime licensing fees
will become a significant revenue stream if sales by the customer are
successful.
RAPIDPLUS LICENSE FEES
RapidPLUS license fees are generated by license agreements providing our
customers with the right to use our RapidPLUS products on a non-exclusive basis,
including our RapidPLUS CODE, RapidPLUS DOC, RapidPLUS Web Studio, RapidPLUS
Xpress and RapidCBT.
MMI REFERENCE DESIGN LICENSE FEES
We typically charge an up-front fee to each customer who licenses our MMI
reference designs or one of their derivatives. This fee is in addition to the
royalty fee we charge for embedding the MMI reference design or MicroKernel with
the customer's product, as described below.
RUNTIME LICENSING FEES
We charge runtime license fees for the embedding of our MMI reference designs or
MicroKernel in each product sold by a customer. MicroKernel Code generated by
RapidPLUS/Code requires the state machine MicroKernel to run in the embedded
application. This method of charging is common in our industry.
31
<Page>
PROFESSIONAL SERVICE FEES
Our technical services team generates revenue from MMI contract development and
consulting and from the mentoring and training of users of our products. Charges
are based on price lists, specific contracts or per-period fees.
LIVEMANUALS DEVELOPMENT FEES
We sell our customers simulations of their products for fees that depend on the
complexity of the product and the simulation. Together with these simulations,
we also offer our customers additional items such as electronic user manuals. We
refer to these combined simulations and user manuals as LiveProducts or
LiveManuals.
SUPPORT CONTRACTS FEES
With license agreements for our RapidPLUS products, customers typically purchase
a one-year service agreement that provides them with customer support and
enables them to receive periodic updates and new releases of the licensed
products. The customer may elect to renew the agreement each year.
RIGHT TO USE FEES
Customers who use RapidPLUS simulations over the web typically are required to
pay us a fee for the right to use them. We charge these fees either on a
one-time basis per each web-site on which the simulations are deployed or on an
annual basis permitting unlimited use. Our revenues from these fees are not
significant.
SALES AND MARKETING
Our sales are based on a global sales organization with a mixture of direct and
indirect sales. We have subsidiaries, primarily engaged in sales and service, in
the U.S. and Japan. As part of our restructuring, which commenced in the second
quarter of 2001, we significantly reduced our sales and marketing staff in the
U.S., Japan and Europe. Our U.S. staff had been primarily involved in the sales
and marketing of LiveManuals and our LiveManuals.com web-site. As we have ceased
to invest in the LiveManuals.com web-site, much of this staff was no longer
required and was let go. We closed our European office, in France, in 2002. We
have redeployed our international sales force and assigned some of our staff
involved in sales in Asia also to take responsibility for European sales.
We continue to have several distribution agreements in the U.S., Europe and
Asia, on exclusive and non-exclusive bases. In 2002, we entered into agreements
with Freescale and with IXI Mobile (R&D) Ltd. providing them with various
rights, including the right to license RapidPLUS and MicroKernels to customers
who acquire their products or services. A similar agreement was entered into in
2003 with Texas Instruments. Distributors are supported and trained by our local
and Israel-based personnel. In many cases we actively participate in the sale
processes of our distributors. We seek to combine the expertise of our personnel
and knowledge of the product and the target markets with the local distributor's
knowledge and contacts with the local market, as well as their familiarity with
the local business culture.
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The following table sets forth sales by our principal distributors as
percentages of our total revenues for the years ended January 31, 2002, 2003 and
2004:
<Table>
<Caption>
YEAR ENDED JANUARY 31,
----------------------
NAME OF DISTRIBUTOR 2002 2003 2004
- ------------------------------- ---- ---- ----
Freescale ..................... 5% 5% 8%
Yamagata ...................... 6% 33% 1%
Nippon Systemware ............. 1% 8% 1%
Virtual Products
International .............. 6% 3% 1%
Tatung ........................ 13% 1% -
Kobe Steel .................... 15% - -
</Table>
The decrease in sales to distributors is primarily attributable to the
implementation of our current business model pursuant to which we devote most of
our resources and focus our efforts on sales to wireless handset platform
vendors and wireless handset manufacturers. As a result, we devote fewer
resources compared with prior years to sales to distributors in the embedded
systems markets. While we have entered into agreements with distributors in the
wireless handset platform market, such as Freescale, these agreements, which are
more focused on long term future royalty streams, have yet to result in
significant revenues. In 2003, most of our revenues were derived from direct
sales of products and services to our customers.
Our revenues are mainly derived from licensing our products and providing
maintenance and service. The following table presents the sources of our
revenues by category of activity for the years ended January 31, 2002, 2003 and
2004:
<Table>
<Caption>
YEAR ENDED JANUARY 31,
---------------------------
2002 2003 2004
------- ------- -------
(IN THOUSANDS)
Revenues:
Products $ 3,031 $ 3,304 $ 1,819
Services 1,322 1,889 2,264
LiveProducts 683 1,027 418
------- ------- -------
Total $ 5,036 $ 6,220 $ 4,501
</Table>
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<Page>
The following table presents total revenues attributed to geographic segments
based on the location of the customers for the years ended January 31, 2002,
2003 and 2004 and long-lived assets as of January 31, 2002, 2003 and 2004:
<Table>
<Caption>
2002 2003 2004
------------------ ----------------- -----------------
LONG- LONG- LONG-
TOTAL LIVED TOTAL LIVED TOTAL LIVED
REVENUES ASSETS REVENUES ASSETS REVENUES ASSETS
-------- ------- -------- ------ -------- ------
(IN THOUSANDS)
Israel .......... $ 55 $ 780 $ 240 $ 469 $ 1,333 $ 399
Far East* ........ 1,622 - 649 - 535 -
Japan ........... 1,421 32 2,794 30 414 20
U.S. ............ 1,258 252 1,297 35 732 21
Europe .......... 680 14 1,240 - 1,487 -
------- ------- ------- ----- ------- -----
Total............ $ 5,036 $ 1,078 $ 6,220 $ 534 $ 4,501 $ 440
======= ======= ======= ===== ======= =====
</Table>
* Excluding Japan
The following table represents our main customers, by percentage of revenues for
the years ended January 31, 2002, 2003 and 2004:
<Table>
<Caption>
YEAR ENDED JANUARY 31,
----------------------
CUSTOMER 2002 2003 2004
- ------------------------------ ---- ---- ----
IXI .......................... - 2% 28%
Texas Instruments ............ - - 10%
Alcatel ...................... - 4% 9%
Freescale .................... 5% 5% 8%
Panasonic .................... 3% 6% 5%
Yamagata ..................... 6% 33% 1%
Nippon Systemware ............ 1% 8% 1%
Virtual Products
International ............. 6% 3% 1%
Tatung ....................... 13% 1% -
Kobe Steel ................... 15% - -
</Table>
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<Page>
DEPENDENCE ON THIRD PARTY RIGHTS
We rely, and expect to continue to rely, on certain software that we license
from third parties, including software that is integrated with internally
developed software and used in our products to perform key functions. Some of
this software may be required to complete the development of products that we
intend to offer in the future. These third-party providers may not remain in
business or continue to support their technology and their technology may not
otherwise be available to us on commercially reasonable terms.
COMPETITION
The wireless handset MMI market is a competitive one. Our main competition in
this market comes from companies that sell the MMI as part of a wider suite of
integrated products. Among these are semiconductor vendors who have their own
in-house MMI solution, such as Infineon Technologies AG, Agere Systems, Inc. and
Skyworks Solutions, Inc. There are also companies that provide core software for
wireless devices, such as protocol stacks that also provide an MMI solution.
Most notable of these is TTPCom. A potential direct competitor is Cybelius
Software Oy, with its Maestro prototyping and code generation solution.
We believe that the principal competition for our products in the embedded
systems market comes from embedded systems applications software development
solutions that are developed in-house by our customers or potential customers
rather than those purchased from independent software vendors like us. Software
providers competing with our products at various stages of the embedded systems
applications software development cycle include Cats. Inc., Altia, Inc., Virtual
Prototypes, Inc., ZipC, Inc., Cybelius Software Oy and Gaio, Inc.
Because we have derived most of our revenues from sales of and services related
to the RapidPLUS family of products, the effects of competition are more intense
than if we had a broader product offering.
The Internet market is also highly competitive and is characterized by rapid
technological change and intense competition. There are technologies currently
available that compete with LiveProducts and which are difficult to compete
with, such as Macromedia's Flash and ShockWave Director. Current and potential
competitors may develop products that may be more effective than our current or
future products and our technologies and products may be rendered obsolete by
such developments.
(C) ORGANIZATIONAL STRUCTURE
We have three wholly-owned subsidiaries:
o e-SIM, Inc., incorporated under the laws of the State of Delaware and
responsible for sales, marketing and technical support in the U.S.;
o e-SIM Japan Ltd., incorporated under the laws of Japan and responsible for
sales, marketing and technical support in Japan; and
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<Page>
o e-SIM Europe SARL, incorporated under the laws of France. This subsidiary
ceased operations in February 1, 2003.
(D) PROPERTY, PLANTS AND EQUIPMENT
We currently lease a facility consisting of approximately 7,494 square feet in
Teradion, Israel. The annual lease payment is approximately $24,000. The lease
expires in December 2005.
Our headquarters and executive offices are located in a facility consisting of
approximately 5,745 square feet in Jerusalem, Israel. The annual lease payment
is approximately $71,000. The lease expires in March 2006.
In 2003, we decided to close our U.S. offices and subleased our facilities until
the expiration of the lease period in August 2003. Our U.S. employees currently
work from home. We do not presently lease or rent any facilities in the U.S.
Our Japanese subsidiary currently uses a facility consisting of approximately
435 square feet belonging to our customer Yamagata Printing Co. Ltd. in Tokyo,
Japan under an agreement that expires in December 2005, for which it pays no
rent but reimburses Yamagata Printing Co. Ltd. for all expenses incurred, which
are approximately $3,800 per year.
We believe that our current space is adequate for our current requirements and
that additional space will be available upon reasonable terms, if needed.
As of July 15, 2004, we leased 33 cars for 36 months each. Termination of the
lease for each car is subject to payment of a fine of three-months' fees under
that lease. Our average monthly lease payment per car is $600 and the sum of our
annual lease payments for cars for the year ended January 31, 2004 was
approximately $240,000.
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<Page>
ITEM 5
OPERATING AND FINANCIAL REVIEW AND PROSPECTS
(A) OPERATING RESULTS
OVERVIEW
Our primary business is providing MMI solutions for wireless handset platform
vendors, handset manufacturers and mobile carriers. We believe that our MMI
reference design and line of RapidPLUS development tools, in addition to our
customization, training, development and consulting services, allow our
customers to more easily and quickly develop the MMI for the new handsets they
plan to introduce to the market, thus making us a comprehensive service provider
in the field of MMI for the wireless handset market. While we no longer focus on
the embedded systems market, which was our traditional line of business, we
still derive significant revenues from this market, although we expect such
revenues to decrease in the future. In addition, we also derive revenues from
the sales of LiveProducts; we do not anticipate such revenues to increase in the
future.
We experienced a decrease in our revenues in 2003 as a result of changing our
business strategy. Our strategy is no longer based upon reliance on our
traditional distributors in the embedded systems market, many of whom were among
our largest customers. Instead, we currently concentrate our efforts on
establishing long-term distribution contracts with wireless handset platform
vendors and direct licensing and development contracts with these vendors and
with wireless handset manufacturers and mobile carriers. The revenues we derive
from these contracts are comprised of license fees relating to the licensing of
our RapidPLUS tools, license fees for our MMI reference designs, royalty fees
relating to the licensing of our MMI reference designs and MicroKernels and
service revenue from customization, training, development and consulting
services. Under this new business model, we expect to receive a royalty payment
for each handset into which one of our MMI reference designs or MicroKernel is
integrated. As part of this strategy, distribution of certain of our products is
currently conducted by the handset platform vendors who are our customers, who
then will either offer to their customers - the handset manufacturers - our MMI
solution as part of their platform offering to the handset manufacturers or
refer such customers to us directly. We believe this strategy will result in a
long-term recurring stream of revenues and that our platform vendors will be
able to market our MMI solution to a range of handset manufacturers, thus saving
us significant marketing expenses. To date, we have attracted new customers
through this strategy. As a result of the changed strategy, our sales through
our traditional distributors, including distributors who were major clients,
have significantly declined. In addition, because we are only now beginning to
receive revenues from our MMI solution, our overall revenues in 2003 have
declined compared with 2002.
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<Page>
CRITICAL ACCOUNTING POLICIES
The discussion and analysis of our financial condition and results of operation
are based on our consolidated financial statements, which have been prepared in
conformity with U.S. GAAP. The preparation of these financial statements
requires us to make estimates and judgments that affect the reported amounts of
assets, liabilities, revenues and expenses, and related disclosure of contingent
assets and liabilities. We evaluate these estimates on an on-going basis. We
base our estimates on our historical experience and on various other assumptions
that we believe to be reasonable under the circumstances, the results of which
form the basis for making judgments about the carrying amount values of assets
and liabilities that are not readily apparent from other sources. Actual results
may differ from these estimates under different assumptions or conditions. Under
U.S. GAAP, when more than one accounting method or policy or its application is
generally accepted, our management selects the accounting method or policy that
it believes to be most appropriate in the specific circumstances. Our management
considers some of these accounting policies as critical. A critical accounting
policy is an accounting policy that management believes is both most important
to the portrayal of our financial condition and results and requires
management's most difficult subjective or complex judgment, often as a result of
the need to make accounting estimates about the effect of matters that are
inherently uncertain. While our significant accounting policies are discussed in
note 2 to our consolidated financial statements, included elsewhere in this
annual report, we believe the following accounting policies to be critical:
REVENUE RECOGNITION
We derive our revenues from license fees of our products, maintenance and
support, royalties and from rendering services including consulting, software
customization, implementation, and training. We sell our products through our
direct sales force and indirectly through resellers (both of which are
considered end-users). We also generate revenues from providing full electronic
product simulation, and from fees deriving from usage of the simulation.
We account for software sales in accordance with Statement of Position 97-2,
"Software Revenue Recognition," as amended, or SOP 97-2. SOP 97-2 generally
requires that revenue earned on software arrangements involving multiple
elements is to be allocated to each element based on the relative fair value of
the elements. In addition, we have adopted Statement of Position 98-9,
"Modification of SOP 97-2, Software Revenue Recognition with Respect to Certain
Transactions," or SOP 98-9, for all transactions entered into after January 1,
2000. SOP 98-9 requires that revenue be recognized under the "residual method"
when Vendor Specific Objective Evidence, or VSOE, of Fair Value, as defined in
SOP 97-2, exists for all undelivered elements and VSOE does not exist for all of
the delivered elements. Under the residual method, any discount in the
arrangement is allocated to the delivered elements. Determination of the
probability of collection is based upon management's judgments regarding the
payment of fees for services rendered and products delivered. This determination
is based on management's periodic assessment of the credit worthiness and other
known factors of its customers and distributors. In judging the probability of
collection of software license fees we continuously monitor collection and
payments from our customers and maintain a provision for estimated credit losses
based upon our historical experience and any specific customer collection issues
that we have identified. In connection with customers with whom we have no
previous experience, we may utilize independent resources to evaluate the
creditworthiness of those customers. We perform on-going credit evaluations of
our customers and adjust credit limits based upon payment history and the
customer's current creditworthiness, as determined by our review of their
current credit information. If the financial situation of any of our customers
were to deteriorate, resulting in an impairment of their ability to pay the
indebtedness they incur with us, additional allowances may be required. In
addition, if management's assessment as to the credit worthiness of our customer
does not properly reflect the actual collection, the revenue recognized for any
reporting period could be adversely affected.
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<Page>
Revenue from license fees is recognized when persuasive evidence of an
agreement exists, delivery of the product has occurred, no significant
obligations with regard to implementation remain, the fee is fixed or
determinable, and collection is probable and no further obligations exist.
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 and support) is determined based on a renewal ratio and
the price charged for the undelivered element when sold separately.
Revenues from consulting services and training included in multiple element
arrangements are recognized at the time such services are rendered.
We are entitled to royalties upon some of the licensing agreements for the
software tools and to fees upon usage of the product simulation by the end
users. Revenues from royalties and usage fees are recognized when such revenues
are reported to us.
Revenues from license fees that involve significant customization and
implementation of the Company's software to customer specifications are
recognized in accordance with Statement of Position 81-1 "Accounting for
Performance of Construction -Type and Certain Production - Type Contracts," or
SOP 81-1, using contract accounting on a percentage of completion method over
the period from signing of the license through to completion in accordance with
the "Input Method". The amount of revenue recognized is based on the total
license fees under the license agreement and the percentage to completion
achieved. The percentage to completion is measured by monitoring progress using
records of actual time incurred to date in the project compared to the total
estimated project requirement, which corresponds to the costs related to earned
revenues. Estimates of total project requirements are based on prior experience
of customization, delivery and acceptance of the same or similar technology and
are reviewed and updated regularly by management.
A provision for estimated losses on uncompleted contracts is recorded in the
period in which such losses are first determined, in the amount of the estimated
loss for the entire contract. As of January 31, 2004, no such estimated losses
were identified.
In transactions where a customer's contractual terms include a provision for
customer acceptance, revenues are recognized when such acceptance has been
obtained.
Deferred revenue includes unearned amounts received under maintenance and
support contracts, and amounts received from customers but not recognized as
revenue.
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<Page>
ALLOWANCE FOR DOUBTFUL ACCOUNTS AND PROVISION FOR BAD DEBTS.
We continuously monitor collection and payment from our customers and maintain
allowances for doubtful accounts and for estimated losses resulting from the
inability of our customers to make required payments. We have provided for these
allowances based on assumptions relating to the financial condition of our
customers in accordance with our management's estimates and historical
experience, plus an additional general reserve of 3%. If the financial condition
of our customers were to deteriorate, resulting in an impairment of their
ability to make payments, additional allowances may be required, the extent of
which is inherently uncertain. Our trade receivables are mainly derived from
sales to customers located primarily in Europe, Israel, the Far East and the
United States. We perform ongoing credit evaluation of our customers.
We generally do not require collateral. However, in certain circumstances, we
may require letters of credit, other collateral or additional guarantees.
CONTINGENCIES
We are, from time to time, subject to proceedings and other claims related to
vendors and other matters. We are required to assess the likelihood of any
outcomes to these matters as well as potential ranges of probable losses. A
determination of the amount of reserves required, if any, for these
contingencies is made after careful analysis of each individual issue. The
required reserves may change in the future due to new developments in each
matter or changes in approach such as a change in settlement strategy in dealing
with these matters.
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<Page>
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, line items from our
consolidated statements of operations for the three most recent years:
<Table>
<Caption>
YEAR ENDED JANUARY 31,
-----------------------------------------------
2002 2003 2004
------------ ------------ ------------
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
Revenues:
Products ........................................ $ 3,031 $ 3,304 $ 1,819
Services ........................................ 2,005 2,916 2,682
------------ ------------ ------------
5,036 6,220 4,501
------------ ------------ ------------
Cost of revenues:
Products ........................................ 169 267 122
Services ........................................ 1,776 1,663 1,983
------------ ------------ ------------
1,945 1,930 2,105
------------ ------------ ------------
Gross profit ....................................... 3,091 4,290 2,396
------------ ------------ ------------
Operating expenses:
Research and development, net ................... 2,610 1,464 1,560
Selling, marketing, general and administrative,
net .......................................... 7,854 4,261 3,635
Restructuring and impairment of
web-site development costs .................... 910 - -
------------ ------------ ------------
Total operating expenses ........................... 11,374 5,725 5,195
------------ ------------ ------------
Operating loss ..................................... 8,283 1,435 2,799
Financial expenses (income), net ................... 210 (9) 1,343
Other expenses, net ................................ 426 94 -
------------ ------------ ------------
Loss before taxes on income ........................ 8,919 1,520 4,142
Taxes on income .................................... 62 199 106
------------ ------------ ------------
Net loss ........................................... $ 8,981 $ 1,719 $ 4,248
============ ============ ============
Basic and diluted net loss per share ............... $ 0.77 $ 0.15 $ 0.36
============ ============ ============
Weighted average number of shares used in
computing basic and diluted net loss per share .. 11,663,170 11,665,359 11,963,056
============ ============ ============
</Table>
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<Page>
The following table sets forth, for the periods indicated, line items from our
consolidated statements of operations as percentages of our revenues for the
three most recent years:
<Table>
<Caption>
YEAR ENDED JANUARY 31,
-----------------------
2002 2003 2004
----- ----- -----
Revenues:
Products ............................... 60.2% 53.1% 40.4%
Services ............................... 39.8% 46.9% 59.6%
----- ----- -----
100.0% 100.0% 100.0%
----- ----- -----
Cost of revenues:
Products ............................... 3.4% 4.3% 2.7%
Services ............................... 35.2% 26.7% 44.1%
----- ----- -----
38.6% 31.0% 46.8%
----- ----- -----
Gross profit .............................. 61.4% 69.0% 53.2%
----- ----- -----
Operating expenses:
Research and development, net .......... 51.8% 23.5% 34.7%
Selling, marketing, general and
administrative, net ................. 156.0% 68.5% 80.8%
Restructuring and impairment of
web-site development costs .......... 18.1% - -
----- ----- -----
Total operating expenses .................. 225.9% 92.0% 115.5%
----- ----- -----
Operating loss ............................ 164.5% 23.0% 62.3%
Financial expenses (income), net .......... 4.2% (0.1)% 29.8%
Other expenses, net ....................... 8.4% 1.5% -
----- ----- -----
Loss before taxes on income ............... 177.1% 24.4% 92.1%
Taxes on income ........................... 1.2% 3.2% 2.4%
===== ===== =====
Net loss .................................. 178.3% 27.6% 94.5%
===== ===== =====
</Table>
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GEOGRAPHIC DISTRIBUTION
The following table sets forth, for the periods indicated, the percentage of
total consolidated revenues derived from each of the regions identified:
<Table>
<Caption>
YEAR ENDED JANUARY 31,
----------------------
REGION 2002 2003 2004
- --------- ---- ---- ----
Israel 1% 4% 30%
Far East* 32% 10% 12%
Japan 28% 45% 9%
U.S. 25% 21% 16%
Europe 14% 20% 33%
</Table>
* Excluding Japan
2003 COMPARED WITH 2002
REVENUES. Revenues for 2003 decreased 28% to $4.5 million, compared with $6.2
million in 2002. Product revenues for 2003 decreased by 45% to $1.8 million,
compared with $3.3 million in 2002. This decrease is primarily attributable to
our new business strategy focused on long-term contracts and royalty payments in
the wireless handset market which we are only now beginning to receive. Revenues
from services decreased by 8% in 2003 to $2.7 million, compared with $2.9 in
2002. The decrease in revenues from services was primarily attributable to a
decrease of 59% in revenues from Live Products which were $418,000 in 2003
compared with $1.0 million in 2002. This decrease is primarily attributable to
changes in our business model resulting in a shift of our focus to MMI solutions
in the wireless handset market. The decrease in revenues from Live Products was
partially offset by a 24% increase in consulting and support services, which
were $2.3 million in 2003, compared with $1.9 million in 2002. This increase was
primarily attributable to consulting and support services provided to leading
wireless handset platform vendors, some of whom became our customers in 2003.
COST OF REVENUES. Cost of revenues consisted primarily of the salaries of our
technical support staff, expenses incurred in connection with our sub-contractor
for the development of LiveProduct simulations provided to our customers,
royalties to the Office of the Chief Scientist and the cost of freight, software
production, manuals and packaging. Cost of product revenues decreased 54% in
2003 to $122,000, compared with $267,000 in 2002. This decrease is primarily
attributable to the decrease in product revenues. Cost of service revenues
increased by 19% to $2.0 million for 2003, compared with $1.7 million for 2002.
This increase is primarily attributable to the costs associated with additional
technical staff hired in 2003. Overall, cost of revenues as a percentage of
revenues increased from 31% in 2002 to 47% in 2003. This increase was primarily
attributable to the decrease in our revenues.
RESEARCH AND DEVELOPMENT EXPENSES, NET. Research and development expenses, net,
consisted primarily of salaries and other related expenses for research and
development personnel, as well as the cost of facilities and depreciation of
capital expenditures. Research and development expenses, net increased 7% to
$1.6 million for 2003, compared with $1.5 million for 2002. This increase is
attributable to the increase in research and development staff. Research and
development expenses, net increased as a percentage of revenues to 35% for 2003,
compared with 24% for 2002. This increase was primarily attributable to the
decrease in our revenues.
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SELLING, MARKETING, GENERAL AND ADMINISTRATIVE EXPENSES, NET. Selling,
marketing, general and administrative expenses, net, decreased in 2003 by 15% to
$3.6 million, compared with $4.3 million in 2002. The decrease is primarily
attributable to staff reductions, closure of certain of our offices outside of
Israel and related expenses. Selling and marketing expenses, net, consisted
primarily of salaries for sales personnel, expenses related to our subsidiaries,
costs of travel, advertising and promotional activities, and royalties paid for
governmental grants and to the BIRD Foundation. Selling and marketing expenses,
net, decreased by 33% to $1.8 million for 2003, compared with $2.7 million for
2002. This decrease was primarily attributable to the reduction in our sales and
marketing staff and related expenses. Selling and marketing expenses, net,
decreased as a percentage of revenues to 40% in 2003 from 43% in 2002. General
and administrative expenses consisted primarily of costs associated with
management compensation, professional fees and office expenses. General and
administrative expenses increased 17% to $1.8 million for 2003, compared with
$1.6 million for 2002. This increase was primarily attributable to a repricing
of options issued as compensation, increased legal fees and lease expenses.
OPERATING LOSS. Our operating loss increased by 95% to $2.8 million for 2003,
compared with $1.4 million for 2002. As a percentage of revenues, operating loss
increased to 62% for 2003 from 23% for 2002. Although operating expenses
decreased to $5.2 million in 2003 from $5.7 million in 2002, this trend was
offset by the decrease in revenues and has resulted in an increase in operating
loss. This increase in the amount of our operating loss and as a percentage of
our revenues is primarily attributable to the new business strategy focused on
long-term contracts and royalties that has caused a decrease in our revenues.
FINANCIAL EXPENSES (INCOME), NET. In 2003, financial expenses, net was
approximately $1.3 million, compared with financial income, net of $9,000 in
2002. Financial expenses, net consist primarily of a non-cash conversion of a
convertible loan, interest expenses on loans and lines of credit, and expenses
resulting from foreign currency exchange rate differences. This change is
attributable to a non-cash conversion expense, in an amount of $1 million,
resulting from conversion of a loan made by Smithfield, as discussed in "-
Liquidity and Capital Resources," adverse foreign currency exchange rate
differences of approximately $33,000 in 2003 compared with gains of
approximately $224,000 in 2002 and approximately $288,000 in interest rate
payments on loans in 2003 compared with approximately $215,000 in 2002.
OTHER EXPENSES, NET. In 2003, other expenses, net were $0, compared with $94,000
in 2002, which were attributable to sales of certain fixed assets and a
write-off expense related to obsolete property and equipment.
TAXES ON INCOME. Taxes on income decreased 47% to $106,000 in 2003, compared
with $199,000 in 2002. This difference is primarily attributable to a
withholding tax paid as a result of a single transaction in 2003. Taxes on
income decreased as a percentage of revenues to 2.4% in 2003, compared to 3.2%
in 2002.
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2002 COMPARED WITH 2001
REVENUES. Revenues increased 24% to $6.2 million in 2002, compared with $5.0
million in 2001. While product revenues for 2002 increased by 9% to $3.3
million, compared with $3.0 million in 2001, revenues from services increased by
45% to $2.9 million, compared with $2 million in 2001. Revenues from services
related to software sales for 2002 increased by 43% to $1.9 million, compared
with $1.3 million in 2001. This increase was primarily attributable to a large
project we entered into with a leading wireless platform vendor. Revenues from
Live Products services for 2002 increased by 50% to $1 million, compared with
$684,000 in 2001, as a result of new orders received from new and existing
customers. The increase in product revenues in 2002 is primarily attributable to
increased product sales to one of our major customers.
COST OF REVENUES. Cost of revenues consisted primarily of salaries of our
technical support staff, expenses incurred in connection with our Indian
sub-contractor for the development of LiveProduct simulations provided to our
customers, royalties to the Office of the Chief Scientist and the cost of
freight, software production, manuals and packaging. Cost of product revenues
increased 58% to $267,000 in 2002, compared with $169,000 in 2001. The increase
of cost of product revenues is primarily attributable to the increase in the
cost of manuals, packaging, freight and royalties to the Office of the Chief
Scientist. Cost of service revenues decreased by 6% to $1.7 million for 2002,
compared with $1.8 million in 2001. The decrease in cost of services revenues is
primarily attributable to a decrease of 47% in services for software-related
sales to $533,000 in 2002 from $997,000 in 2001, mainly due to the decrease in
our technical support staff. This decrease was partially offset by an increase
in costs of services in Live Products by 45% to $1.1 million in 2002, compared
with $778,000 in 2001 due to an increase in Live Products sales. Overall, cost
of revenues as a percentage of revenues decreased from 38.6% in 2001 to 31.0% in
2002.
RESEARCH AND DEVELOPMENT EXPENSES, NET. Research and development expenses, net,
consisted primarily of salaries and other related expenses for research and
development personnel, as well as the cost of facilities and depreciation of
capital expenditures. Research and development expenses, net of grants from the
Office of the Chief Scientist decreased 44% to $1.5 million for 2002, compared
with $2.6 million for 2001. This decrease was primarily attributable to the
downsizing of our research and development staff in 2002, and was partially
offset by the lack of funding from the Office of the Chief Scientist in 2002,
compared with grants of $427,000 obtained in 2001. Research and development
expenses, net decreased as a percentage of revenues to 24% for 2002, compared
with 52% for 2001.
SELLING, MARKETING, GENERAL AND ADMINISTRATIVE EXPENSES, NET. Selling,
marketing, general and administrative expenses, net, decreased in 2002 by 46% to
$4.3 million, compared with $7.9 million in 2001. The decrease is primarily
attributable to the restructuring plan that we implemented beginning in 2001 and
which included staff reductions, closure of offices outside Israel and related
expenses. Selling and marketing expenses, net, consisted primarily of salaries
for sales personnel, expenses related to our subsidiaries, costs of travel,
advertising and promotional activities, and royalties paid for governmental
grants and to the BIRD Foundation. Selling and marketing expenses, net,
decreased by 53% to $2.7 million for 2002, compared with $5.7 million for 2001.
This decrease was primarily attributable to the reduction in sales and marketing
staff and related expenses. Selling and marketing expenses, net, decreased as a
percentage of revenues to 43% in 2002 from 113% in 2001. General and
administrative expenses, net, consisted primarily of costs associated with
management compensation, professional fees and office expenses. General and
administrative expenses decreased 28% to $1.6 million for 2002, compared with
$2.2 million for 2001. This decrease was primarily attributable to a reduction
in salaries, legal fees and lease expenses.
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RESTRUCTURING AND IMPAIRMENT OF WEB-SITE DEVELOPMENT COSTS. In the first quarter
of 2001, we embarked on a significant restructuring effort. Since the
restructuring entailed a reduction of approximately 60% of our workforce, most
of the costs associated with the restructuring consisted of severance payments
and other benefits to former employees and payments for vacant office space,
amounting to $309,000. In 2002 we incurred no further costs related to
restructuring.
In 2001 we determined that the costs we incurred in developing our
LiveManuals.com web-site were not recoverable and therefore we wrote off the net
value of the investment in the web-site, which was $601,000. There were no
further expenses related to the web-site development in 2002.
For further information on impairment of web-site development costs, see note 2h
to our consolidated financial statements, included elsewhere in this annual
report.
OPERATING LOSS. Our operating loss decreased by 82% to $1.4 million for 2002,
compared with $8.3 million for 2001. As a percentage of revenues, operating loss
decreased to 23% for 2002 from 164.5% for 2001. This decrease in the amount of
our operating loss and as a percentage of our revenues is primarily attributable
to our increased revenues and to the decrease in operating expenses and costs
resulting from our corporate restructuring.
FINANCIAL EXPENSES (INCOME), NET. In 2002 financial income, net was
approximately $9,000, compared with financial expenses, net of $210,000 in 2001.
Financial expenses (income), net consist primarily of interest expenses on loans
and lines of credit, interest earned on deposits and gain or expense resulting
from foreign currency exchange rate differences. The change from financial
expense to financial income in 2002 is primarily attributable to favorable
foreign exchange rate differences, partially offset by interest expenses on
loans and lines of credit.
OTHER EXPENSES, NET. In 2002 other expenses, net consisted of loss and expense
incurred in connection with sales of certain fixed assets and a write-off
expense related to obsolete property and equipment. In 2001 other expenses, net
consisted of a write-off expense related to the impairment of an investment.
Accordingly, other expenses, net decreased by 78% in 2002 to $94,000, compared
with $426,000 in 2001.
TAXES ON INCOME. Taxes on income increased 220% to $199,000 in 2002, compared
with $62,000 in 2001, an increase primarily attributable to withholding tax paid
as a result of a single transaction. Taxes on income increased as a percentage
of revenues to 3% in 2002, compared to 1% in 2001.
IMPACT OF INFLATION AND CURRENCY FLUCTUATIONS
Most of our revenues are generated in dollars and a substantial portion of our
expenses is incurred in NIS. The dollar cost of our operations in Israel is
influenced by the extent to which any increase in the rate of inflation in
Israel is not offset, or is offset on a lagging basis, by a devaluation of the
NIS in relation to the dollar.
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The inflation rate in Israel was 3.1% in 2001 and 5.6% in 2002 and the deflation
rate was 2.3% in 2003. In 2001 and 2002, the devaluation of the NIS against the
dollar was 11.2% and 4.6%, respectively. In 2003, revaluation of the NIS against
the dollar was 6.9%. As a result, we experienced an increase in the dollar costs
of our operations in Israel in 2003, as opposed to a decrease in our dollar
costs in 2001 and 2002, primarily because substantially all our revenues are
received in dollars while salaries in Israel are paid in NIS and constitute a
significant portion of our expenses. However, these fluctuations did not
materially affect our results of operations.
We do not currently engage in any hedging arrangements to offset risks
associated with fluctuations in foreign currency exchange rates, but may do so
in the future. As a result, price and exchange rate instability could have a
material adverse effect on our business, financial condition and results of
operations.
CONDITIONS IN ISRAEL
We are incorporated under the laws of the State of Israel, and our principal
offices, manufacturing and research and development facilities are located in
Israel. Although most of our revenues are currently derived from sales made to
customers outside Israel, we are nonetheless influenced by political, economic
and military conditions affecting Israel. Any major hostilities involving Israel
or the interruption or curtailment of trade between Israel and its present
trading partners could have a material adverse effect on our operations. Since
September 2000, there has been an escalation of violence in the West Bank and
Gaza Strip and increased terrorist activity within Israel, causing a
deceleration of the Israeli economy. Furthermore, several countries restrict
business with Israeli companies. We could be adversely affected by further
set-backs to the peace process in the Middle East or by restrictive laws or
policies directed toward Israel or Israeli businesses.
Additionally, all nonexempt male adult citizens of Israel are obligated to
perform military reserve duty. Some of our officers and employees are currently
obligated to perform annual reserve duty. Furthermore, all these persons are
subject to being called to active duty at any time under emergency
circumstances. Although we have operated without any material disruption under
these requirements since we began operations, we cannot assess the full impact
of these requirements on our workforce or business if conditions should change,
and we cannot predict the effect on us of any expansion or reduction of these
obligations.
(B) LIQUIDITY AND CAPITAL RESOURCES
We have funded our operations primarily through public and private sales of
equity securities, sales of products and services, borrowings from banks and
other parties, and, to a lesser extent, through research and development grants
from the Office of the Chief Scientist and the BIRD Foundation and grants from
the Fund for Encouragement of Marketing Activities Abroad (See "- Research and
Development, Patents and Licenses" and "- Marketing Grants" below). Cash and
cash equivalents and short-term deposits were $1.3 million, $0.6 million and
$0.2 million as of January 31, 2002, January 31, 2003 and January 31, 2004,
respectively. Net cash used in operating activities was $6.7 million, $127,000
and $1.2 million in 2001, 2002, and 2003, respectively. Our capital expenditures
since inception have been related primarily to computers, equipment, renovations
of facilities and vehicles, and were approximately $147,000, $63,000 and
$163,000 in 2001, 2002 and 2003, respectively.
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On January 31, 2004 and July 15, 2004, we had approximately $3.3 million and
$1.5 million, respectively, of bank loans outstanding, which included $641,000
and $883,000, respectively of convertible bank loans. The latter amount is
convertible at an average share price of $1.96. In addition, as of July 15,
2004, we had an unutilized credit line of $0.9 million from the Israel Discount
Bank Ltd., or Discount Bank, which may be drawn upon, provided we are not in
default under our loan agreement with this bank. All the bank loans and any
utilized portion of the credit line bear interest at a weighted average rate of
three-month LIBOR plus 3.5% linked to the dollar.
In February, May and July, 2004, we entered into agreements amending certain
provisions of our prior agreements with Discount Bank and with the Industrial
Development Bank of Israel Ltd., or the Development Bank. As part of these
amendments, the scheduled maturity of the loans the banks provided to us was
extended. Discount Bank agreed that beginning February 28, 2005, we will be
required to repay the outstanding balance of the loan as of that date, including
any portion of the $0.9 million credit line we may draw prior to that date, in
36 equal monthly payments of principal and interest. As of July 15, 2004, the
outstanding balance of the loan extended to us by Discount Bank was $611,000.
Development Bank was paid $400,000 in respect of its outstanding loans using
proceeds received in the new equity investment we completed in June 2004,
discussed below, and $71,000 in overdue payments of principal and interest and
has reduced the outstanding balance of the loan by an additional $400,000. The
remaining outstanding balance, which was $902,000 on July 15, 2004, is to be
repaid in 48 equal monthly payments of principal beginning March 1, 2005, with
interest to continue to be paid on a monthly basis. As part of these amendments,
it was agreed with the banks that we raise additional equity, a condition we met
by entering into the investment agreements in May and June 2004, discussed
below. The banks also received additional rights to purchase our ordinary shares
by way of conversion of a portion of the loans as follows: (1) Discount Bank
received the right to purchase 75,000 ordinary shares at a price per share of
$0.85; and (2) Development Bank received the right to purchase 110,000 ordinary
shares at a price per share of $0.90 and 110,000 ordinary shares at a price per
share of $0.70.
All our bank loans are secured by substantially all of our assets. In addition,
the banks hold a security interest on our right to receive revenues pursuant to
agreements with two major customers. The banks can demand acceleration of
payment of the loans prior to the agreed payment dates upon the occurrence of an
event of default under the loan agreements, such as non-payment of scheduled
principal and interest payments, our liquidation or the occurrence of events
after January 31, 2005 in the case of one of the banks extending us loans (in
respect of $500,000 of our total debt to that bank prior to that date) and after
August 14, 2005 in the case of the other bank, that the banks believe harm or
might harm our ability to perform our obligations under the loan agreements. In
addition, under our agreements with these banks, until at least one half of the
outstanding principal amount of the loans has been repaid, we may not make any
cash payment of management fees to any shareholder holding, directly or
indirectly, 5% or more of our shares, or to any related party of such
shareholder, including, without limitation, Yozma Hofsheet Ltd., to whom we
presently owe management fees.
We also had an interest-free, unsecured $100,000 convertible loan payable to
Vertical Ventures, LLC, or Vertical Ventures, convertible into our ordinary
shares at a price per share of $0.18 until August 1, 2004, the maturity date of
this loan. Pursuant to the terms of the agreement, upon conversion of the entire
loan amount into our ordinary shares, Vertical Ventures receives a warrant to
purchase 555,556 additional ordinary shares at an exercise price of $0.54 per
share. The loan agreement allowed us to require the conversion of the loan, at
the exercise price of $0.18 per share, at any time following an equity raising
of at least $1,000,000 prior to August 1, 2004. On July 29, 2004, we notified
Vertical Ventures that we were requiring them to convert the entire loan amount
into 555,556 of our ordinary shares and receive a warrant, as per the loan
agreement.
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In July 2003, we entered into a convertible loan agreement with Smithfield
Investments B.V., or Smithfield, an entity controlled by Marc Belzberg, pursuant
to which Smithfield agreed to lend us an aggregate of $1 million maturing on
August 1, 2004 and bearing no interest. Until that date, Smithfield had the
right to convert the principal amount of the loan into our ordinary shares at a
price per share of $0.18. In addition, upon conversion of the entire loan amount
into our ordinary shares, Smithfield was to receive a warrant to purchase
5,555,556 ordinary shares at an exercise price per share of $0.54. On January
31, 2004, Smithfield converted the loan into 5,555,556 ordinary shares and was
issued a warrant pursuant to the terms of the agreement.
In May and June 2004, we entered into an equity investment agreement with Marc
Belzberg, his sister, Lisa Belzberg, Gibralt, and certain other investors who
are not related parties, pursuant to which they purchased an aggregate of
4,975,000 of our ordinary shares for $2,487,500, or $0.50 per share. These
investors also received warrants to purchase 1,243,750 of our ordinary shares,
at $0.75 per share. Each of the warrants is immediately exercisable in full and
has a five-year term. The transaction was approved by our board of directors and
audit committee. If approved by our board of directors, we will issue an
additional 48,750 ordinary shares and warrants to purchase 12,188 ordinary
shares at an exercise price of $0.75 per share as finder's fees associated with
the transaction. The purchase by the members of the Belzberg Family of 3,000,000
ordinary shares and warrants to purchase an additional 750,000 ordinary shares
is subject to shareholder approval. We plan to submit the transaction for
approval at our next general meeting of shareholders, where it must be approved
by a majority which includes at least one-third of our shareholders present at
the meeting and voting on the transaction who are not related parties, unless
our shareholders who are not related parties who vote against the resolution do
not represent more than one percent of our total voting rights. According to the
terms of the investment agreement, if our shareholders do not approve the
investment by November 10, 2004, the investment agreement with the Belzberg
Family will be null and void and we will be obligated to repay the amount
invested by them together with accrued interest at a rate equal to the six-month
LIBOR prevailing on May 10, 2004. Each of Marc Belzberg, Gibralt and Lisa
Belzberg has agreed that, notwithstanding the foregoing, we will not be required
to repay these funds to them until August 31, 2005, if doing so would affect our
ability to continue operations as a going concern.
As of July 15, 2004, we had cash and cash equivalents of $0.5 million (after
giving effect to the equity investment of $2,487,500 discussed above), which
represents an increase in our cash and cash equivalents of $238,000 as of
January 31, 2004 and a decrease in our cash and cash equivalents of $798,000 as
of June 30, 2003 and $627,000 as of January 31, 2003. These funds are held
primarily in dollars, but also in NIS, Euros and Pounds Sterling. We believe
that these funds, together with borrowing capacity of approximately $0.9 million
under our existing credit line, anticipated revenues and cash flows from our
operations (including collection of trade receivables) will be sufficient for
our requirements for the next twelve months. If this working capital becomes
insufficient to meet our requirements in the course of the next twelve months or
thereafter, we will attempt to obtain additional loans or issue additional
securities. We cannot assure you that we will be able to obtain additional
financing on terms acceptable to us, if at all. Our ability to generate revenues
and manage costs as anticipated may be adversely affected by a variety of
factors, including those discussed under "Item 3. Key Information -Risk
Factors." If we are unable to generate sufficient revenues from operations, or
if acceleration of our bank loans is demanded by the lenders, or if our expenses
are higher than anticipated, we may be required to seek to raise additional
capital through public or private debt or equity issuances. Additional debt or
equity financing, whether obtained through public or private debt or equity
financing, may not be available when needed or may not be available on terms
acceptable to us. In addition, if additional funds are raised through the
issuance of equity securities, the net tangible book value per share may
decrease, the percentage ownership of our then current shareholders may be
diluted and such new equity securities may have rights, preferences or
privileges senior or more advantageous than those of the holders of our ordinary
shares. If additional financing is not available when needed, our business and
financial condition will be materially adversely affected, we may be forced to
discontinue operations or to pursue a sale of our company or a substantial part
of our assets on terms, which if available at all, may not be favorable to us or
our shareholders.
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(C) RESEARCH AND DEVELOPMENT, PATENTS AND LICENSES
RESEARCH AND DEVELOPMENT GRANTS
We participate in programs sponsored by the Israeli Government for the support
of research and development activities. Through January 31, 2004, we had
obtained grants from the Office of the Chief Scientist aggregating $1.8 million
for certain of our research and development projects. We are obligated to pay
royalties to the Office of the Chief Scientist at the rate of 3.5% to 5% of the
sales of the products and other related revenues generated from these projects,
up to an amount equal to 100% to 150% of the grants received in NIS, linked to
the dollar and bearing interest at a rate equal to six-month LIBOR. The
obligation to pay these royalties is contingent on actual sales of these
products and generation of related revenues and in the absence of such sales or
related revenues no payment is required. Through January 31, 2004, we have paid
or accrued royalties to the Office of the Chief Scientist in the aggregate
amount of $1.5 million. As of January 31, 2004, our aggregate contingent
liability to the Office of the Chief Scientist was $394,000. Some of the accrued
royalties in the amount of $469,000 were not paid when due. In December 2003, we
reached a settlement regarding payments to the Office of the Chief Scientist and
the Fund for the Encouragement of Marketing Activities Abroad, discussed below.
Under the terms of the settlement for the return of overdue payments to the
Office of the Chief Scientist for research and development grants and for
marketing grants received from the Fund for the Encouragement of Marketing
Activities, discussed below, we will make quarterly payments of $50,000 over a
three-year period beginning May 2004, of which $30,000 will be earmarked for the
repayment of research and development grants and $20,000 for marketing grants.
We have also agreed to pay royalties of 5% of revenues exceeding certain
specified revenue levels. 60% of the royalty payments will be earmarked for the
repayment of research and development grants and 40% for repayment of marketing
grants received by us from the Fund for the Encouragement of Marketing
Activities Abroad, discussed below. We will not be required to pay royalties on
revenues up to such specified revenue levels earned after January 1, 2004 until
November 2005, following which we will repay the royalties accrued on such
revenues in quarterly installments until May 2007. We will pay any royalties
accrued on revenues after November 2005 on an on-going basis in accordance with
the standard payment requirements of the Office of the Chief Scientist.
We also participated in a program sponsored by the BIRD Foundation, pursuant to
which a portion of our development expenses was funded. Through January 31,
2004, we obtained grants in the aggregate amount of $394,000 from the BIRD
Foundation. We are obligated to pay royalties to the BIRD Foundation on the
proceeds from sales of products resulting from the research and development
funded by the BIRD Foundation. The total amount of the royalties may not exceed
150% of the grants received. All the payments are linked to the dollar.
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Through January 31, 2004, we paid or accrued royalties to the BIRD Foundation in
the aggregate amount of $210,000. As of January 31, 2004, the aggregate amount
of the contingent obligation to the BIRD Foundation was $381,000.
Our research and development expenses, net, during the three most recent years,
consisted of the following:
<Table>
<Caption>
YEAR ENDED, JANUARY 31,
---------------------------
2002 2003 2004
------- ------- -------
(IN THOUSANDS)
Total costs $ 3,037 $ 1,464 $ 1,560
Less - grants and participations (427) - -
Total Expenses, net $ 2,610 $ 1,464 $ 1,560
======= ======= =======
</Table>
MARKETING GRANTS
In March 1998, the Israeli Government, through the Fund for the Encouragement of
Marketing Activities Abroad, awarded us grants relating to our foreign marketing
expenses. These grants are awarded for specific expenses we incurred in
connection with our foreign marketing activities, based upon expenses we
reported to the Fund for the Encouragement of Marketing Activities Abroad. All
marketing grants received from the Fund for the Encouragement of Marketing
Activities Abroad are linked to the dollar and are repayable in the form of
royalty payments in the amount of 4% (plus interest at the rate of six-month
LIBOR) of any increase in export sales realized by us up to the total amount of
grants we received. If we do not achieve an increase in export sales, we have no
obligation to pay any royalties or to return any funds received through these
grants. All payments are linked to the dollar.
Through January 31, 2004, we obtained grants in the aggregate amount of $778,000
from the Fund for the Encouragement of Marketing Activities Abroad and have paid
or accrued royalties in the amount of $272,000. The aggregate amount of the
income-contingent obligation to the Fund for the Encouragement of Marketing
Activities was $506,000. As discussed above, some of the accrued royalties in
the amount of $218,000 were not paid when due. In December 2003 and as part of
the settlement with the Office of the Chief Scientist discussed above, we
reached a settlement regarding payments to the Fund for the Encouragement of
Marketing Activities whereby accrued royalties shall be repaid by us in
quarterly installments of $20,000 between May 2004 and April 2007. We have also
agreed to pay royalties of 5% of revenues exceeding certain specified revenue
levels. 60% of the royalty payments will be earmarked for the repayment of
research and development grants received from the Office of the Chief Scientist
discussed above and 40% for repayment of marketing grants. We will not be
required to pay royalties on revenues up to such specified revenue levels earned
after January 1, 2004, until November 2005, following which we will repay the
royalties accrued on such revenues in quarterly installments until May 2007. We
will pay any royalties accrued on revenues after November 2005 on an on-going
basis in accordance with the standard payment requirements of the Fund for the
Encouragement of Marketing Activities Abroad.
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(D) TREND INFORMATION
1. We have experienced, and expect to continue to experience,
significant quarterly and annual variations in our results of operations. These
variations result from a variety of factors, including the timing, composition
and size of orders from our customers, market acceptance of our products, the
success of our distribution channels, competitive pressures, and other factors.
In particular, our revenues in each quarter are derived primarily from a fairly
small number of large orders, some of which are from new customers. The deferral
or loss of one or more significant sales could materially affect our operating
results in any fiscal quarter, especially if there are significant sales and
marketing expenses associated with the deferred or lost sales. Conversely, if we
obtain large orders in a particular quarter, our revenues and the rate of growth
of our revenues for that quarter may reach levels that may not be sustained in
subsequent quarters.
2. In the current wireless handset market, handset platform vendors,
who are usually semi-conductor manufacturers, often provide the main electronic
and software components of the handset to handset manufacturers in the form of a
standardized platform known as a reference platform. These vendors are
interested in providing their manufacturing customers a reference platform which
has been tested and integrates a variety of components that the manufacturer can
customize and develop in a rapid and simple manner to commence manufacturing.
Our MMI reference design and the accompanying customization and development
tools that go along with it can be part of the reference platform, thus
providing platform vendors with a modular, customizable, pre-integrated MMI
solution that they can, in turn, provide to their customers. This can add value
to their product, differentiate them from platform vendors who do not have an
effective MMI solution, and assist their platforms to be more quickly and
effectively deployed in the market with less risk.
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Until recently, the handset industry was vertically integrated, so that the
leading handset vendors controlled materially all aspects of the industry,
including the technology assets, engineering capabilities, production, branding,
distribution and support. We believe that a new trend is emerging in this
market, pursuant to which some of the leading wireless handset platform vendors
are outsourcing several stages of the development, production and sales process
of their products. The wireless handset platform vendors, who are usually
semi-conductor manufacturers, often provide the main electronic and software
components of the handset to handset manufacturers in the form of a standardized
platform known as a reference platform. These vendors are interested in
providing their manufacturing customers a reference platform which has been
tested and integrates a variety of components that the manufacturer can
customize and develop in a rapid and simple manner to commence manufacturing.
Our MMI reference design and the accompanying customization and development
tools can be part of the reference platform, thus providing platform vendors
with a modular, customizable, pre-integrated MMI solution that they can, in
turn, provide to their customers. This can add value to their product,
differentiate them from platform vendors who do not have an effective MMI
solution, and assist their platforms to be more quickly and effectively deployed
in the market with less risk. Therefore, in 2003, we changed our business
strategy to meet this new trend. We decided to focus mainly on the wireless
handset market and, in this market, to offer complete, market-specific MMI
solutions, rather than just customization tools. Our strategy is no longer based
upon reliance on our traditional distributors in the embedded systems market,
many of whom were among our largest customers. Instead, we currently concentrate
our efforts on establishing long-term distribution contracts with wireless
handset platform vendors and direct licensing and development contracts with
these vendors and with wireless handset manufacturers and mobile carriers. The
revenues we derive from these contracts are comprised of license fees relating
to the licensing of our RapidPLUS tools, license fees for our MMI reference
designs, royalty fees relating to the licensing of our MMI reference designs and
MicroKernels and service revenue from customization, training, development and
consulting services. Under this new business model, we expect to receive a
royalty payment for each handset into which one of our MMI reference designs or
MicroKernel is integrated. As part of this strategy, distribution of certain of
our products is currently conducted by the handset platform vendors who are our
customers, who then will either offer to their customers - the handset
manufacturers - our MMI solution as part of their platform offering to the
handset manufacturers or refer such customers to us directly. We believe this
strategy will result in a long-term recurring stream of revenues and that our
platform vendors will be able to market our MMI solution to a range of handset
manufacturers, thus saving us significant marketing expenses. To date, we have
attracted new customers through this strategy. In order to do so, we have
increased our technical staff. As a result of the changed strategy, our sales
through our traditional distributors, including distributors who were major
clients, have significantly declined. In addition, because we are only now
beginning to receive revenues from our MMI solution, our overall revenues in
2003 have declined compared with 2002.
3. Our future success is dependant on the growth and development of the
wireless handset market, which may not continue to change at the rate and in the
direction which we currently anticipate, if at all. In addition, as discussed
above, we currently rely on our wireless handset platform vendor customers to
distribute our products. These customers may not be able to build and market
platforms effectively and, thus, successfully market our products. For a
discussion of the development of the wireless handset market, see "Item 4(B) -
Business Overview". For additional information concerning our anticipated
liquidity and capital resources, see "- Liquidity and Capital Resources."
4. We believe that the MMI is becoming a significant part of the
platform offering which wireless handset platform vendors seek to market to the
handset manufacturers, as creation of an MMI by the manufacturer is difficult
and time consuming. Furthermore, we believe the MMI can be a major
differentiator between different brands. We believe the main forces driving the
rapid changes in the wireless handset platform and handset manufacturing market
are currently as follows:
o pressure to lower development costs;
o pressure to reduce time to market;
o increased complexity of design;
o lack of available engineering talent;
o increased competition; and
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o value proposition being highest for software content and lower for hardware
features.
As a result of these factors, we believe that platform vendors, handset
manufacturers and mobile carriers, who do not necessary have particular
expertise in the development of an MMI, will increasingly seek assistance
developing an MMI solution to be embedded into the products they sell. Our MMI
reference design and the accompanying customization and development tools that
go along with it can be part of the reference platform, thus providing platform
vendors with a modular, customizable, pre-integrated MMI solution that they can,
in turn, provide to their customers.
(E) OFF-BALANCE SHEET ARRANGEMENTS
We have no material off-balance sheet arrangements.
(F) TABULAR DISCLOSURE OF CONTRACTUAL OBLIGATIONS
The following table summarizes our contractual obligations as of January 31,
2004:
<Table>
<Caption>
PAYMENT DUE BY PERIOD
-------------------------------------------------------
LESS THAN MORE THAN
TOTAL 1 YEAR 1-3 YEARS 3-5 YEARS 5 YEARS
------- --------- --------- --------- ---------
(IN THOUSANDS)
Long-Term Debt
Obligations............... $ 4,000 $ 409 $ 3,169 $ 422 -
Capital Lease
Obligations .............. 53 10 36 7 -
Operating Lease
Obligations .............. 197 95 102 - -
Other Long-Term
Liabilities .............. 1,105 1,105
------- ----- ------- ----- -------
$ 5,355 $ 514 $ 3,307 $ 429 $ 1,105
======= ===== ======= ===== =======
</Table>
Long-term debt consists of bank loans and the amount due to the Government of
Israel pursuant to the Office of the Chief Scientist and BIRD Foundation
arrangements discussed in "- Research and Development, Patents and Licenses-
Research and Development Grants" and arrangements with the Fund for the
Encouragement of Marketing Activities Abroad discussed in "- Research and
Development, Patents and Licenses- Marketing Grants." Capital lease obligations
represent a vehicle finance-leasing purchase. Operating lease obligations
represent rental leases. Other long-term liabilities represent our liability for
employee severance pay. The foregoing table does not include amounts that we
will be required to repay to the Belzberg Family in the event that our
shareholders do not approve the investment they made in us in May 2004, as
discussed in "- Liquidity and Capital Resources."
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ITEM 6
DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES
(A) DIRECTORS AND SENIOR MANAGEMENT
Our directors and executive officers, their ages and positions are as follows:
<Table>
<Caption>
NAME AGE POSITION
- ----------------------------- --- ------------------------------------------
Marc Belzberg ............... 49 Chairman of the Board of Directors and Chief
Executive Officer
Yaron Eldad ................. 39 Chief Operating Officer, Chief Financial Officer and
Secretary
Uri Yaffe ................... 40 Senior Vice President, Corporate Sales
Frederick Rotbart ........... 54 Chief Scientist
Avi Hitelman ................ 48 Vice President, Research and Development
Reuven Kleinman ............. 45 Vice President, Marketing and Business Development
Nir Gazit ................... 41 Vice President, Technical Services
Samuel Belzberg (2) ......... 75 Director
Amir Galili (1) (2) ......... 50 Director
John McDonald ............... 74 Director and Vice Chairman
Kim Campbell (1)(3) ......... 57 Director*
Ayelet Tal (1)(2)(3) ........ 36 Director
</Table>
(1) Member of the Audit Committee
(2) Member of the Compensation Committee
(3) External Director (as required under Israeli law)
* Ms. Campbell was appointed to a three-year term of office on July 13, 2001 and
her term of office has thus expired. Our board of directors has recommended to
our shareholders that Ms. Campbell be reappointed to the board of directors as
an external director at the next general meeting of shareholders, which we
intend to hold by November 2004.
MARC BELZBERG has served as the Chairman of the Board of Directors since 1993
and Chief Executive Officer since 1998. Mr. Belzberg also served as our
President from 1993 to March 2001. Mr. Belzberg is also a director of the
Jerusalem Post Charity Fund and a director of Smithfield Investments B.V., a
privately-held company engaged in investments. Mr. Belzberg is the worldwide
chairman of the Bnei Akiva youth movement, chairman of the Foundation of Jewish
Renaissance and chairman of the OneFamily Fund. Prior to joining us, Mr.
Belzberg was the first president of First City Capital Corporation from 1983 to
1990 and was a private investor from 1990 to 1993. Mr. Belzberg received an
M.B.A. from New York University and a B.A. from Yeshiva University. Mr. Belzberg
is the son of Samuel Belzberg, a Director of our company.
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YARON ELDAD has served as our Chief Financial Officer since 1995, as our
Secretary since 1996 and as our Chief Operating Officer since 2002. Prior to
joining our company, Mr. Eldad had an independent auditing practice from 1994 to
1995. Mr. Eldad was employed by Nissan Caspi CPA from 1993 to 1994, and by
Shekhter & Maas CPA from 1991 to 1993, both of which are private auditing firms
in Israel. Mr. Eldad received an M.B.A. from the Hebrew University and a B.A. in
economics and accounting from Ben Gurion University and is a Certified Public
Accountant in Israel.
URI YAFFE was appointed our Senior Vice President of Corporate Sales in 1999.
Prior to that appointment, Mr. Yaffe served as our European Managing Director
from 1998 to 1999. Prior to joining us, from 1992 to 1997, Mr. Yaffe managed the
Debriefing, Command and Control Business Unit at BVR Technologies, which
develops, manufactures and markets advanced computer-based training, simulation
and analysis systems for military applications. Mr. Yaffe received a BSC in
Business Management from New Haven University.
FREDERICK ROTBART is one of the founders of our company and has served as our
Chief Scientist since 1991. Prior to joining us, Dr. Rotbart was an independent
software consultant working primarily for Wang Computers Inc. from 1989 to 1990.
Dr. Rotbart received a Ph.D. in theoretical physics from Tel Aviv University.
AVI HITELMAN has served as our Vice President of Research and Development since
1996. Prior to joining us, Mr. Hitelman served as team leader at Elbit Computer
Ltd. from 1982 to 1987 and as Project Manager from 1990 to 1995, and as a
software team leader at Techlogic Ltd. from 1987 to 1990. Mr. Hitelman received
an M.S. in electrical engineering from the Technion - Israel Institute of
Technology.
REUVEN KLEINMAN has served as our Vice President of Marketing and Business
Development since January 1999. From 1995 to 1999, he served as Product
Marketing Manager and Director of Business Development. From 1990 to 1995, Mr.
Kleinman was Chief Executive Officer of Galcon and GalTech in Kibbutz Kfar Blum.
Mr. Kleinman holds a BSC with honors in physics and computer science from Tel
Aviv University.
NIR GAZIT has served as our Vice President of Technical Services since June
1999. He joined our company in 1994 and served as Support and Application
engineer until 1996. At that time he was promoted to Director of Customer
Support until 1999. Mr. Gazit holds a B.A. in Industrial Engineering from Tel
Aviv University.
SAMUEL BELZBERG has been a Director since October 1997. Mr. Belzberg has served
as President of Bel-Fran Investments Ltd. (a private investment company) since
1968, President and Chief Executive Officer of Gibralt Holdings Ltd. (a personal
investment company), which is a shareholder of ours, since 1995, Chairman of
Balfour Holdings, Inc. (a real estate development company) since 1992 and a
Director of Smithfield Investments B.V. He also founded First City Financial
Corporation. Mr. Belzberg serves as a director of Education Lending, Inc., a
company involved in student loans. Mr. Belzberg received a B.A. in commerce from
the University of Alberta, Edmonton and an honorary Ph.D. from Simon Fraser
University. He was awarded the Order of Canada in 1989, promoted to Officer of
the Order of Canada in 2002 and received the Governor General Award of Canada in
1992. Mr. Belzberg is the father of Marc Belzberg, our Chairman of the Board and
Chief Executive Officer.
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AMIR GALILI is one of the founders of our company and has served as a Director
since 1991, as our Chief Executive Officer from 1991 to 1993, and as Vice
President, Training, Support and Applications from 1993 to 1997. Mr. Galili
resigned from his Vice President position on March 31, 1997. Since July 1997,
Mr. Galili has served as Chairman of the Board of Directors and Chief Executive
Officer of Trivnet Ltd., a software company. Prior to founding e-SIM, Mr. Galili
worked at Elbit Ltd. and was involved in the development of the Lavi fighter
plane project at Israel Aircraft Industries from 1985 to 1987. Mr. Galili
received a B.Sc. in electronics and an M.B.A. from Tel Aviv University.
JOHN MCDONALD has served as Vice Chairman of the Board of Directors since 1999.
Mr. McDonald is the retired President of Casio, Inc. and is currently a
management and marketing consultant. Mr. McDonald joined Casio in 1975 as
President of Casio Europe and Managing Director of its United Kingdom
Subsidiary. Mr. McDonald served as President of Casio from 1978 to 1999. Mr.
McDonald holds a B.A. in English from Brooklyn College.
KIM CAMPBELL joined our Board of Directors in 2001. Ms. Campbell served as
Canada's nineteenth Prime Minister, in 1993, and has held cabinet portfolios as
Minister of Justice, Attorney General, Minister of National Defense and
Veterans' Affairs, and Minister of State for Indian Affairs and Northern
Development. Ms. Campbell served as Consul General of Canada in Los Angeles from
1996 to 2000. She is Chair Emerita of the Council of Women World Leaders and
President of the International Women's Forum. Ms Campbell is Secretary General
of the Club of Madrid, an organization of former presidents and prime ministers
who work to foster emerging democracies. She is also a Lecturer in Public Policy
at the John F. Kennedy School of Government at Harvard University.
AYELET TAL joined our Board of Directors in 2003. From 1996 to 2002, Ms. Tal
served as Vice President of Finance and Corporate Controller of Check Point
Software Technologies Ltd., an Israeli security software company. From 1991 to
1996, Ms. Tal served as an audit manager at Deloitte Touche Israel. Ms. Tal
holds a B.A. in Accounting and Economics from Bar-Ilan University.
Except for Messrs. M. Belzberg, Rotbart, S. Belzberg and Galili, as of July 15,
2004, none of our directors or executive officers owned more than one percent of
the outstanding ordinary shares. For information as to the share ownership of
our directors and executive officers, see "- Share Ownership".
There is no arrangement or understanding with any major shareholders, customers,
suppliers or others pursuant to which any of the persons referred to above was
selected as a director or member of our senior management.
(B) COMPENSATION
The following table sets forth the aggregate compensation paid to, or accrued on
behalf of, all our directors and officers as a group for the year ended January
31, 2004.
<Table>
<Caption>
SALARIES, DIRECTORS' FEES, PENSION, RETIREMENT
COMMISSIONS AND BONUSES AND SIMILAR BENEFITS
-------------------------- --------------------
All directors and officers as a
group (12 persons)(1) $ 1,090,000 $ 160,000
</Table>
(1) Includes a management fee payable to an affiliate of Samuel Belzberg.
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Our directors who are not executive officers or external directors, namely
Messrs. S. Belzberg, Galili and McDonald, currently do not receive cash
compensation for their services on the board of directors or any of its
committees. However, we granted five non-executive directors options to purchase
ordinary shares. As of January 31, 2004, these directors held options to
purchase an aggregate of 315,000 ordinary shares at exercise prices ranging from
$0.02 to $0.70 per share. We may in the future grant additional options or other
compensation to non-executive directors. All of the non-executive directors are
reimbursed for their expenses for each meeting of board of directors attended.
Pursuant to the Israeli Companies Law, annual compensation of the external
directors is subject to regulations promulgated under the Companies Law. These
regulations provide mandatory minimum and maximum rates of compensation for
external directors, based on the company's net worth. We have fixed the annual
compensation for external directors at the minimum amount permitted by the
Israeli regulations.
The following table sets forth certain information pertaining to all of our
directors and officers as a group, who held office at any time during the period
indicated, concerning (i) options granted by us, (ii) options exercised, and
(iii) options unexercised as of January 31, 2004:
<Table>
<Caption>
FEBRUARY 1, 2003-
JANUARY 31, 2004
-----------------
OPTIONS GRANTED
Number of ordinary shares .................................. 1,726,719
Weighted average exercise price per ordinary share ......... $ 0.49
Weighted average remaining exercise period ................. 6.03 years
OPTIONS EXERCISED
Number of ordinary shares .................................. 430,308
Weighted average exercise price per ordinary share ......... $ 0.08
UNEXERCISED OPTIONS
Number or ordinary shares .................................. 3,106,430
Weighted average exercise price per ordinary share ......... $ 0.24
Weighted average remaining exercise period ................. 5.93 years
</Table>
(C) BOARD PRACTICES
APPOINTMENT OF DIRECTORS AND TERMS OF OFFICE
Our directors, other than our external directors, are elected by our
shareholders at an annual general shareholders' meeting and hold office until
the next annual general shareholders' meeting which is required to be held at
least once in every calendar year, but not more than fifteen months after the
last preceding annual general shareholders' meeting. Until the next annual
general shareholders' meeting, shareholders may elect new directors to fill
vacancies in, or increase the number of, members of the board of directors in a
special meeting of the shareholders. Our board of directors may appoint any
person as a director temporarily to fill any vacancy created in the board of
directors. Any director so appointed may hold office until the first general
shareholders' meeting convened after the appointment and may be re-elected. The
appointment and terms of office of all our executive officers are determined by
our board of directors, except that the appointment of the chairman of the board
of directors, the chief executive officer and the president must also be
approved by the shareholders. The terms of office of the directors must be
approved, under the Companies Law, by the audit committee, the board of
directors and the shareholders.
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We are subject to the provisions of the Companies Law, which became effective on
February 1, 2000 superseding most of the provisions of the Israeli Companies
Ordinance (New Version), 5743-1983. The Minister of Justice has adopted
regulations exempting companies, like us, whose shares are traded outside of
Israel from some provisions of the Companies Law.
None of our directors has the right to receive any benefit upon termination of
his or her office. None of our directors has a service contract with us. For
information regarding the arrangements pursuant to which Marc Belzberg provides
services to us on behalf of Yozma Hofsheet Ltd., see "Item 7. Major Shareholders
and Related Party Transactions - Related Party Transactions - Interests of
Management in Certain Transactions."
EXTERNAL DIRECTORS
Under the Companies Law, companies incorporated under the laws of Israel whose
shares have been offered to the public in or outside of Israel are required to
appoint two external directors. The Companies Law provides that a person may not
be appointed as an external director if the person or the person's relative,
partner, employer or any entity under the person's control, has, as of the date
of the person's appointment to serve as external director, or had, during the
two years preceding that date, any affiliation with the company, any entity
controlling the company or any entity controlled by the company or by this
controlling entity. The term affiliation includes:
o an employment relationship;
o a business or professional relationship maintained on a regular basis;
o control; and
o service as an office holder.
No person can serve as an external director if the person's position or other
business creates, or may create, conflict of interests with the person's
responsibilities as an external director. Until the lapse of two years from
termination of office, a company may not engage an external director to serve as
an office holder and cannot employ or receive services from that person, either
directly or indirectly, including through a corporation controlled by that
person.
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External directors are to be elected by a majority vote at a shareholders'
meeting, provided that either (1) the majority of shares voted at the meeting,
including at least one-third of the shares of non-controlling shareholders voted
at the meeting, vote in favor of the election; or (2) the total number of shares
of non-controlling shareholders voted against the election of the external
director does not exceed one percent of the aggregate voting rights in the
company. However, under regulations promulgated under the Companies Law, the
board of directors of companies whose shares are traded outside of Israel may
determine that a director, who was appointed before February 1, 2000 and
complies with the non-affiliation requirements of an external director, will be
designated as an external director, without shareholder approval, until the
completion of that director's original nomination period, in accordance with
such regulations.
The initial term of an external director is three years and may be extended for
an additional three years. Each committee of our board of directors is required
to include at least one external director and our audit committee is required to
include both external directors. Until July 13, 2004, Ms. Kim Campbell and Ms.
Ayelet Tal served as our external directors. Ms. Campbell was appointed for a
three-year term at our annual general meeting of shareholders held on July 13,
2001 and her term of office has thus expired. Our board of directors has
recommended that she be reappointed to a further term of three years at our next
annual meeting of shareholders, which we intend to hold before November 2004.
Ms. Tal's appointment for a three-year term as our other external director was
approved by shareholders at our last annual general meeting held in September
2003.
AUDIT COMMITTEE
Under the Companies Law, the board of directors of any company that is required
to nominate external directors must also appoint an audit committee, comprised
of at least three directors including all of the external directors, but
excluding a:
o chairman of the board of directors; and
o controlling shareholder or his or her relative and any director
employed by the company or who provides services to the company on a
regular basis.
The role of the audit committee is to identify and examine deficiencies in the
business management of the company in consultation with the internal auditor and
the company's independent accountants and to suggest appropriate courses of
action. In addition, the approval of the audit committee is required to effect
certain specified actions and transactions with office holders and interested
parties. The audit committee is responsible for supervising the activities of
the internal auditor.
An interested party is defined in the Companies Law as a 5% or greater
shareholder, any person or entity who has the right to designate one or more
directors or the general manager of the company or any person who serves as a
director or as a general manager.
An audit committee may not approve an action or a transaction with an interested
party or with an office holder unless at the time of approval the two external
directors are serving as members of the audit committee, at least one of whom
was present at the meeting in which an approval was granted.
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Under the provisions of the Sarbanes-Oxley Act of 2002 (the "SARBANES-OXLEY
ACT"), the audit committee is responsible for the appointment, compensation,
retention and oversight of the work of a company's independent auditors.
However, under Israeli law, the appointment of external auditors requires the
approval of the shareholders of the company and compensation of external
auditors must be approved by either shareholders or the board of directors.
Pursuant to Israeli law, our articles of association determine that the
compensation of the external auditors must be approved by our board of
directors. Accordingly, the appointment of the external auditors will be
required to be approved and recommended to the shareholders by the audit
committee and approved by the shareholders. The compensation of the external
auditors will be required to be approved by the audit committee and recommended
to and approved by the board of directors.
In addition, under the Sarbanes-Oxley Act, the audit committee is responsible,
among other things, for the following:
o Assisting the board of directors in monitoring our financial
statements, the effectiveness of our internal controls and
establishing procedures for handling complaints regarding our
accounting practices;
o Engaging outside advisors;
o Reviewing and discussing with management and the independent auditors
the company's quarterly financial statements (including the
independent auditors' review of the quarterly financial statements)
prior to any required submission to shareholders, the Commission, any
stock exchange or the public;
o Reviewing and discussing with management and the independent auditors
the company's annual audited financial statements prior to any
required submission to shareholders, the Commission, any stock
exchange or the public;
o Recommending to the board of directors, if appropriate, that the
company's annual audited financial statements be included in the
company's annual report;
o Reviewing and discussing with management all disclosures made by the
company concerning any material changes in the financial condition or
operations of the company;
o Reviewing disclosures made to the audit committee by the company's
chief executive officer and chief financial officer during their
certification process for the company's annual report about any
significant deficiencies in the design or operation of internal
controls or material weaknesses therein and any fraud involving
management or other employees who have a significant role in the
company's internal controls; and
o Reviewing and approving all related-party transactions.
Our board of directors has established an audit committee, which currently
consists of Ms. Tal and Mr. Galili, but which also included Ms. Campbell until
the expiration of her term of office on July 13, 2004. Our board of directors
has recommended that Ms. Campbell be reappointed to a further term of three
years at our next annual meeting of shareholders, which we intend to hold before
November 2004. If her appointment is approved by our shareholders, Ms. Campbell
will serve on the audit committee. Our board of directors has appointed Mr.
McDonald to serve on the audit committee until the reappointment of Ms. Campbell
as external director by our shareholders. Our board of directors has determined
that Ms. Tal is an "audit committee financial expert" as defined by applicable
SEC rules. See "Item 16A. Audit Committee Financial Expert".
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The composition of our audit committee satisfies the requirements of the
Companies Law and applicable SEC rules.
COMPENSATION COMMITTEE
Our Compensation Committee reviews and, when required, approves policies under
which compensation is awarded to certain of our executive officers and
directors. The members of our Compensation Committee are Messrs. Samuel Belzberg
and Galili and Ms. Tal.
INTERNAL AUDITOR
Under the Companies Law, the board of directors must also appoint an internal
auditor proposed by the audit committee. The role of the internal auditor is to
examine whether the company's actions comply with the law and orderly business
procedure. Under the Companies Law, the internal auditor may not be an
interested party, an office holder, or an affiliate, or a relative of an
interested party, an office holder or affiliate, nor may the internal auditor be
the company's independent accountant or its representative. Daniel Shapira,
Certified Public Accountant (Israel), currently serves as our Internal Auditor.
APPROVAL OF SPECIFIED RELATED PARTY TRANSACTIONS UNDER ISRAELI LAW
FIDUCIARY DUTIES OF OFFICE HOLDERS
The Companies Law imposes a duty of care and a duty of loyalty on all office
holders of a company, including directors and executive officers. The duty of
care requires an office holder to act with the level of care with which a
reasonable office holder in the same position would have acted under the same
circumstances. The duty of care includes a duty to use reasonable means to
obtain:
o information on the appropriateness of a given action brought for his or her
approval or performed by him or her by virtue of his or her position; and
o any other important information pertaining to the previous actions.
The duty of loyalty of an office holder includes a duty to:
o refrain from any conflict of interest between the performance of his or her
duties in the company and his or her personal affairs;
o refrain from any activity that is competitive with the company;
o refrain from usurping any business opportunity of the company to receive a
personal gain for himself or herself or others; and
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o disclose to the company any information or documents relating to a
company's affairs which the office holder has received due to his or her
position as an office holder.
Under the Companies Law, the board of directors must approve all compensation
arrangements of office holders who are not directors. Directors' compensation
arrangements also require audit committee approval before board approval and
shareholder approval. Pursuant to regulations promulgated under the Companies
Law in 2002, directors' compensation arrangements no longer require shareholder
approval if the audit committee and board of directors determine that these
compensation arrangements are solely for the benefit of the company. The
Companies Law requires that an office holder of a company promptly disclose any
personal interest that he or she may have and all related material information
known to him or her, in connection with any existing or proposed transaction by
the company. A personal interest of an office holder includes an interest of a
company in which the office holder is, directly or indirectly, a 5% or greater
shareholder, director or general manager, or in which he or she has the right to
appoint at least one director or the general manager. In the case of an
extraordinary transaction, the office holder's duty to disclose applies also to
a personal interest of the office holder's relative. The office holder must also
disclose any personal interest held by the office holder's spouse, siblings,
parents, grandparents, descendants, spouse's descendants and the spouses of any
of the foregoing. Under Israeli law, an extraordinary transaction is a
transaction:
o other than in the ordinary course of business;
o other than on market terms; or
o that is likely to have a material impact on the company's profitability,
assets or liabilities.
Under the Companies Law, once an office holder complies with the above
disclosure requirement, the board of directors may approve a transaction between
the company and an office holder, or a third party in which an office holder has
a personal interest, unless the articles of association provide otherwise. A
transaction that is adverse to the company's interest cannot be approved.
If a transaction is an extraordinary transaction, both the audit committee and
the board of directors must approve the transaction. Under specific
circumstances, shareholder approval may also be required. An office holder who
has a personal interest in a matter, which is considered at a meeting of the
board of directors or the audit committee, may not be present at this meeting or
vote on this matter.
DISCLOSURE OF PERSONAL INTERESTS OF A CONTROLLING SHAREHOLDER
Under the Companies Law, the disclosure requirements that apply to an office
holder also apply to a controlling shareholder of a public company. A
controlling shareholder includes a shareholder who holds 25% or more of the
voting rights in a public company if no other shareholder owns more than 50% of
the voting rights in the company. Extraordinary transactions with a controlling
shareholder or in which a controlling shareholder has a personal interest, and
the terms of compensation of a controlling shareholder who is an office holder,
require the approval of the audit committee, the board of directors and the
shareholders of the company. Shareholder approval must include either:
o at least one-third of the shares held by shareholders who have no personal
interest in the transaction and are present and voting, in person, by proxy
or by written ballot, at the meeting; or
o a majority of the voting power present and voting, provided that the
shareholders who have no personal interest in the transaction who vote
against the transaction do not represent more than one percent of the total
voting rights in the company.
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For information concerning the direct and indirect personal interests of certain
of our office holders and principal shareholders in certain transactions with
us, see "Item 7. Major Shareholders and Related Party Transactions."
The Companies Law requires that every shareholder who participates, either by
proxy or in person, in a vote regarding a transaction with a controlling
shareholder, indicate whether or not that shareholder has a personal interest in
the vote in question, the failure of which results in the invalidation of that
shareholder's vote.
However, under the Companies Regulations (Relief with respect to Related Party
Transactions), 5760-2000, and subsequent amendments thereto, promulgated
pursuant to the Companies Law, each of the following transactions between a
company and its controlling shareholder(s) do not require shareholder approval:
o an extension of the term of an existing related party transaction, provided
that the original transaction was duly approved in accordance with the
applicable provisions of the Companies Law or the Israeli Securities Law
and regulations under these laws;
o a transaction that has been approved by the audit committee and the board
of directors as being solely for the benefit of the company;
o a transaction between the company and its controlling shareholder(s)
directly or with any other person when a controlling shareholder has a
personal interest in the transaction, provided that the audit committee and
the board of directors approve the transaction and determine that the
transaction is in accordance with the terms defined in a duly approved
framework transaction. A framework transaction is a transaction that
defines general terms under which the company may, in the ordinary course
of business, enter into transactions of a similar type;
o a transaction between the company and its controlling shareholder(s) or
with any other person when a controlling shareholder has a personal
interest in the transaction, for the purpose of entering into, or
submitting an offer for, a joint transaction of the company and such
controlling shareholder or related party with a third party, provided that
the audit committee and the board of directors have approved the
transaction and that the terms of the transaction in relation to the
company are not materially different from those relating to the controlling
shareholder(s) or a corporation in its or their control, taking into
account their proportionate participation in the transaction; or
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o a transaction between companies that are controlled by the same controlling
shareholder or between the company and its controlling shareholder(s) or
between the company and any other person when a controlling shareholder has
a personal interest in the transaction, provided that for each public
company involved, its audit committee and its board of directors find that
the transaction is in accordance with market terms, in the ordinary course
of business and is not detrimental to the welfare of the company.
Pursuant to these regulations, compensation arrangements between a publicly held
company and its controlling shareholder(s) serving as director(s) do not require
shareholder approval if the following conditions are met:
o the compensation arrangements are approved by the audit committee and the
board of directors as being solely for the benefit of the company;
o the compensation arrangements do not commit the company to more than an
aggregate of NIS 25,000 in expenditures and provided such arrangements are
limited to no more than two years; and
o The compensation awarded to the controlling shareholder is identical to the
compensation of the external directors or other directors and does not
exceed the maximum amount permitted to be paid to external directors by
Israeli regulations.
SHAREHOLDER DUTIES
Under the Israeli Companies Law, a shareholder has a duty to act in good
faith toward the company and other shareholders and to refrain from abusing
his power in the company, including, among other things, in voting at the
general meeting of shareholders on the following matters:
o an amendment to the company's articles of association;
o an increase of the company's authorized share capital;
o a merger; or
o an interested party transaction that require shareholder approval.
The Companies Law provides that a shareholder shall refrain from oppressing
other shareholders. In addition, any controlling shareholder, any shareholder
who knows that he or she possesses power to determine the outcome of a
shareholder vote, and any shareholder who, pursuant to the provisions of a
company's articles of association, has the power to appoint or prevent the
appointment of an office holder in the company, or has any other power over the
company, is under a duty to act with fairness towards the company. A breach of
the above duty of fairness will be considered as a breach of the fiduciary duty
of an office holder as described above.
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EXEMPTION, INSURANCE AND INDEMNIFICATION OF DIRECTORS AND OFFICERS
Under the Companies Law, an Israeli company may not exempt an office holder from
liability with respect to a breach of his or her duty of loyalty, but may exempt
in advance an office holder from his or her liability to the company, in whole
or in part, with respect to a breach of his or her duty of care.
OFFICE HOLDER INSURANCE
Our articles of association provide that, subject to the provisions of the
Companies Law, we may enter into a contract for the insurance of the liability
of any of our office holders with respect to:
o a breach of his or her duty of care to us or to another person;
o a breach of his or her fiduciary duty to us, provided that the office
holder acted in good faith and had reasonable cause to assume that his or
her act would not prejudice our interests;
o a financial liability imposed upon him or her in favor of another person
concerning an act performed by him or her in his or her capacity as an
office holder; or
o any other incident for which it is or shall be permitted to insure the
liability of an office holder.
INDEMNIFICATION OF OFFICE HOLDERS
Our articles of association provide that we may indemnify an office holder
against:
o a monetary liability imposed on him or her in favor of another person
pursuant to a judgment, including a judgment given in a settlement or an
arbitrator's award approved by the court concerning an act performed in his
or her capacity as an office holder;
o reasonable litigation expenses, including legal fees, incurred by an office
holder or which he or she is ordered to pay by a court, in proceedings we
institute against him or instituted on our behalf or by another person, or
in a criminal charge from which he or she was acquitted, or a criminal
charge in which he or she was convicted for a criminal offense that does
not require proof of intent, in each case relating to an act performed in
his or her capacity as an office holder; and
o any other obligation or expense for which it is or shall be permitted to
indemnify a director or an officer.
The Companies Law provides that a company may exempt an office holder
prospectively from liability, in whole or in part, for damage resulting from a
breach of his or her duty of care towards the company, if its articles of
association so provide. On July 13, 2001, our shareholders approved new articles
of association enabling us to provide our office holders with prospective
indemnification in accordance with the Companies Law.
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LIMITATIONS ON INSURANCE AND INDEMNIFICATION
The Companies Law provides that a company may not indemnify an office holder nor
enter into an insurance contract that would provide coverage for any monetary
liability incurred as a result of any of the following:
o a breach by the office holder of his or her duty of loyalty unless the
office holder acted in good faith and had a reasonable basis to believe
that the act would not prejudice the company;
o a breach by the office holder of his or her duty of care if the breach was
done intentionally or recklessly;
o any act or omission done with the intent to derive an illegal personal
benefit; or
o any fine levied against the office holder as a result of a criminal
offense.
Under the Companies Law, the shareholders of a company may include in its
articles of association either of the following provisions:
o a provision authorizing the company to grant in advance an undertaking to
indemnify an office holder, provided that the undertaking is limited to
specified classes of events which the board of directors deems foreseeable
at the time of grant and is limited to an amount determined by the board of
directors to be reasonable under the circumstances; or
o a provision authorizing the company to retroactively indemnify an office
holder.
Each of the foregoing provisions is included in our articles of association that
have been approved by our shareholders.
In addition, under the Companies Law, indemnification of, and procurement of
insurance coverage for, our office holders must be approved by our audit
committee and board of directors and, in specified circumstances, by our
shareholders.
Our shareholders have approved an indemnification of our directors to the
maximum extent permitted by the Companies Law and exculpation of the directors
from all liability for damage resulting from any director's breach of care
towards us, pursuant to the provisions of the articles of association. We have
acquired directors' and officers' liability insurance covering the officers and
directors of the Company for certain claims.
ALTERNATE DIRECTORS
The Companies Law allows for the appointment of alternate directors if the
company's articles so provide. Our articles of association include provisions
for the appointment of alternate directors, subject to certain provisions of the
Companies Law. Alternate directors appointed by our directors may not already be
directors and may serve in such capacity on behalf of only one director at a
time. Although alternate directors have all the rights and obligations of the
appointing directors, they may not in turn appoint alternates for themselves,
nor do they have standing at any meeting of the board of directors or committee
thereof while the appointing director is present. Without derogating from the
relevant provisions of the Companies Law, alternate directors are solely
responsible for their own acts and defaults, and are not deemed agents of their
appointing directors. None of our directors have appointed alternate directors.
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(D) EMPLOYEES
As of January 31, 2004, we had 57 employees worldwide, of whom 15 were employed
in technical support and shipping, 22 in research and development, 4 in
simulation development, 9 in sales and marketing and 7 in corporate management,
finance and general administration. Of these employees, 52 were employed in
Israel, 3 in the U.S., 1 in Europe and 1 in Japan. In addition, until December
2003, our Indian sub-contractor employed approximately 25 employees who were
engaged solely in producing simulations for us. However, the arrangement has
been changed and any work for us in India is done on a per-project basis and
accordingly no employees of the sub-contractor are dedicated solely to us.
As of January 31, 2003, we had 54 employees worldwide, of whom 13 were employed
in technical support and shipping, 18 in research and development, 6 in
simulation development, 10 in sales and marketing and 7 in corporate management,
finance and general administration. Of these employees, 42 were employed in
Israel, 4 in the U.S., 3 in Europe and 5 in Japan. In addition to our employees,
our Indian sub-contractor employed, as of June 30, 2003 approximately 27
employees who were engaged solely in producing simulations for us.
As of January 31, 2002, we had 53 employees worldwide, of whom 11 were employed
in technical support and shipping, 17 in research and development, 5 in
simulation development, 12 in sales and marketing and 8 in corporate management,
finance and general administration. Of these employees, 38 were employed in
Israel, 7 in the U.S., 4 in Europe and 4 in Japan. In addition to our employees,
our Indian sub-contractor employed, as of July 31, 2002, approximately 45
employees who were engaged solely in producing simulations for us.
Our employees are not party to any collective bargaining agreement. We are,
however, subject to certain labor-related statutes, and to certain provisions of
collective bargaining agreements between the Histadrut (General Federation of
Labor in Israel) and the Coordinating Bureau of Economic Organizations
(including the Industrialists' Association), which are applicable to our Israeli
employees by virtue of expansion orders of the Israeli Ministry of Labor and
Welfare. These statutes and provisions principally concern the length of the
work day, minimum daily wages for professional workers, contributions to pension
funds, insurance for work-related accidents, procedures for dismissing
employees, determination of severance pay, annual vacation, sick pay and other
conditions of employment. We generally provide our employees with benefits and
working conditions beyond the required minimum.
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We have written employment agreements, which include non-competition and
confidentiality provisions, with all our key employees. The employment
agreements with each of the executive officers require the employee to dedicate
his or her full working time to his or her duties at our company and provide for
an indefinite term of employment that continues until terminated by either us or
the employee, subject to applicable notice periods. The agreements specify the
employee's compensation package, which typically consist of a base salary (which
for Israeli employees is linked to changes in the Israeli Consumer Price Index,
or CPI), certain life and disability insurance benefits and pension plan
benefits, participation in a professional advancement fund and the use of a
company car. Officers are eligible to receive a bonus and stock options from us
based upon certain criteria and limits established by us.
Israeli law generally requires the payment by employers of severance pay upon
the retirement or death of an employee or upon termination of employment by the
employer without due cause and, under certain circumstances, upon voluntary
termination by the employee. We currently fund our ongoing severance obligations
by making monthly payments to approved severance funds or insurance policies.
However, as of January 31, 2004, we had accrued a liability on our books in the
amount of $1,105,000 in respect of severance pay obligations that is partly
funded through insurance policies in the amount of $714,000. See note 2p to our
consolidated financial statements, included elsewhere in this annual report. In
addition, according to the National Insurance Law, Israeli employees and
employers are required to pay specified sums to the National Insurance
Institute, which is similar to the U.S. Social Security Administration. Since
January 1, 1995, such amounts also include payments for national health
insurance. The payments to the National Insurance Institute are approximately
14.5% of wages (up to a specified amount), of which the employee contributes
approximately 66% and the employer contributes approximately 34% (including
national health tax). The majority of our permanent Israeli employees are
covered by life and pension insurance policies providing customary benefits to
employees, including retirement and severance benefits. We contribute 13.33% to
15.83% of base wages (depending on the employee) to such plans and permanent
employees contribute 5% of base wages. We consider our relationship with our
employees to be good and have never experienced a material labor dispute, strike
or work stoppage.
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(E) SHARE OWNERSHIP
The following table sets forth certain information regarding beneficial
ownership of our ordinary shares by our directors and officers as of July 15,
2004. The voting rights of our officers and directors do not differ from the
voting rights of other holders of ordinary shares.
<Table>
<Caption>
NUMBER OF PERCENTAGE OF
ORDINARY SHARES ORDINARY SHARES
NUMBER OF BENEFICIALLY BENEFICIALLY
ORDINARY PERCENTAGE OF OWNED OWNED
SHARES OUTSTANDING ASSUMING ASSUMING
BENEFICIALLY ORDINARY SHAREHOLDER SHAREHOLDER
Names OWNED (1) SHARES (2)(3) APPROVAL (1)(4) APPROVAL (2)(4)
------------ ------------- --------------- ---------------
Marc Belzberg (5) .......... 14,336,916 52.3% 15,586,916 50.9%
Yaron Eldad ................ * * * *
Fredrick Rotbart ........... 513,958 2.4% 513,958 2.1%
Avi Hitelman ............... * * * *
Reuven Kleinman ............ * * * *
Nir Gazit .................. * * * *
Uri Yaffe .................. * * * *
Samuel Belzberg (6) ........ 1,618,566 7.4% 2,868,566 11.4%
Amir Galili ................ 1,002,515 4.6% 1,002,515 4.0%
John McDonald .............. * * * *
Kim Campbell ............... * * * *
Ayelet Tal ................. * * * *
</Table>
* Less than one percent of our outstanding ordinary shares.
(1) Except as otherwise noted and pursuant to applicable community property
laws, each person named in the table has sole voting and investment power
with respect to all ordinary shares listed as owned by such person. Shares
beneficially owned include shares that may be acquired pursuant to the
exercise of options that are exercisable within 60 days of July 15, 2004.
(2) Ordinary shares deemed beneficially owned by virtue of the right of any
person or group to acquire such shares within 60 days of July 15, 2004, are
treated as outstanding only for the purposes of determining the percent
owned by such person or group.
(3) The percentages shown are based on 21,798,595 ordinary shares issued and
outstanding as of July 15, 2004.
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(4) The percentages shown are based on 24,798,595 ordinary shares assuming
shareholder approval of the May 2004 Investment Agreement with respect to
shares and warrants purchased by Marc Belzberg, Gibralt, a company
controlled by Samuel Belzberg as discussed in note (6) below, and Lisa
Belzberg.
(5) Marc Belzberg's beneficial interest is held directly and through
Smithfield. Assuming shareholder approval of the Investment Agreement, Mr.
Belzberg will be issued 1,000,000 ordinary shares and a warrant to purchase
an additional 250,000 ordinary shares directly. Mr. Belzberg has also been
issued, in his capacity as one of our directors, options to purchase 41,000
of our ordinary shares exercisable within 60 days. Smithfield is a wholly
owned subsidiary of Bellevue Investments N.V., referred to as Bellevue.
Salomon Spira, the father-in-law of Marc Belzberg, holds all of the voting
rights and 10% of the economic rights (E.G., rights to distributions and
liquidation proceeds) of Bellevue. Marc Belzberg holds 90% of the economic
rights (but none of the voting rights) of Bellevue. Smithfield holds
8,740,360 ordinary shares and warrants currently exercisable to purchase
5,555,556 ordinary shares.
(6) Includes 66,000 ordinary shares underlying currently exercisable options.
Except for such options, Samuel Belzberg's beneficial interest is held
through Gibralt, which is controlled by him. He is the father of Marc
Belzberg.
As a group, officers and directors hold options to purchase an aggregate of
3,106,430 ordinary shares at exercise prices ranging from $0.02 to $0.70 per
share. The weighted average exercise price of these options is $0.31 per share
and their expiration date range from June 2005 to December 2013.
OPTION PLANS
In June 1996, our board of directors approved the grant of options to a number
of officers, directors and employees, specifying the basic terms of the options
granted and providing that these options shall be subject to a stock option
plan, referred to as the 1996 Option Plan, to be established at a later date. In
July 1997, the board of directors approved the 1996 Option Plan and adopted our
1997 Employee and Director Stock Option Plan, referred to as the 1997 Option
Plan, and in September 1999 adopted the 1999 Option Plan. In December 2003, our
board of directors adopted the 2003 Israeli Share Option Plan, referred to as
the 2003 Option Plan, designed to comply with Section 102 of Israeli Income Tax
Ordinance (New Version), 1961, or the Tax Ordinance, and enable us, and grantees
under this plan, to benefit from Section 102 of the Tax Ordinance. The purpose
of these option plans is to enable us to attract and retain qualified officers,
directors and employees and to motivate these persons with an equity
participation in our company.
In September 2002, following the decline of the price of our ordinary shares on
the OTCBB, our board of directors resolved to reprice 1,071,328 options
previously granted to our employees with exercise prices ranging from $0.14 to
$22.50 to the nominal value of the shares, NIS 0.10. Of the resulting
compensation expenses of $126,000, $63,000 was recognized in the year ended
January 31, 2003 and $42,000 was recognized in the year ended January 31, 2004.
In September 2003, following the further decline of the price of our ordinary
shares on the OTCBB, our shareholders resolved, based on the recommendation of
the board of directors and the audit committee, to reprice 174,000 options
previously granted to our directors with exercise prices ranging from $0.14 to
$6.50 per ordinary share to $0.02 per ordinary share. In respect of this
repricing, we incurred a compensation expense of $45,600. For further
information, see note 10d to our consolidated financial statements. The
discussion of our options plans below includes the prices of our share options
following the repricing.
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In September 2003, our board of directors resolved to increase the number of
ordinary shares purchasable under the 1999 Option Plan from 1,800,000 to
2,113,366. Options to purchase the additional 313,360 ordinary shares were
issued in September 2003, at an exercise price of $0.26 per share.
GENERAL. The 1996 Option Plan authorizes the issuance of options to purchase an
aggregate of 339,985 ordinary shares, all of which options have been granted to
officers, directors and employees with exercise prices ranging from $0.02 to
$2.12 per share. Options to acquire 103,715 ordinary shares are currently
outstanding under the 1996 Option Plan.
The 1997 Option Plan authorizes the issuance of options to purchase an aggregate
of 1,042,446 ordinary shares, all of which options have been granted to
officers, directors and employees with exercise prices ranging from $0.02 to
$6.50 per share. Options to acquire 753,681 ordinary shares are currently
outstanding under the 1997 Option Plan.
The 1999 Option Plan authorizes the issuance of options to purchase an aggregate
of 2,113,366 ordinary shares, of which options to acquire 1,773,817 ordinary
shares are currently outstanding and have been granted to officers, directors
and employees with exercise prices ranging from $0.02 to $1.33 per share.
The 2003 Option Plan authorizes the issuance of options to purchase an aggregate
of 8,000,000 ordinary shares, of which options to acquire 1,212,807 ordinary
shares are currently outstanding and have been granted to officers, directors
and employees at an exercise price of $0.70.
Upon the occurrence of any ordinary share split, reverse ordinary share split,
recapitalization or rights offerings or other substantially similar corporate
transaction or event, we shall make such equitable changes or adjustments
necessary to the number of shares subject to each outstanding option in order to
prevent dilution or enlargement of the optionees' rights.
ADMINISTRATION. The Option Plans are administered by our board of directors,
which is authorized, among other things, to determine the number of ordinary
shares to which an option may relate and the terms, conditions and restrictions
of the options, to determine whether, to what extent and under what
circumstances an option may be settled, cancelled, forfeited, exchanged or
surrendered, to construe and interpret the Option Plans and any options, to
prescribe, amend and rescind rules and regulations relating to the Option Plans,
and to make all other determinations deemed necessary or advisable for the
administration of the Option Plans.
VESTING PERIODS. Although the terms of individual options may differ, typically
the options vest in equal portions over a four-year period, commencing one year
after the date of grant. The options granted under the Option Plans are
generally exercisable for four years after vesting, subject to the grantee
remaining employed by us. Any options which are forfeited or cancelled before
expiration become available for future grants.
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AMENDMENT AND TERMINATION OF THE OPTION PLANS. We may, at any time in our sole
and absolute discretion, suspend or terminate the Option Plans or revise or
amend them in any respect; provided, however, that no amendment, construction,
interpretation or other determination by us under the Option Plans, or any other
action or inaction us of any kind, shall adversely affect an optionee's rights
under any outstanding option without the consent of that optionee.
ITEM 7
MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS
(A) MAJOR SHAREHOLDERS
The following table sets forth certain information regarding ownership of our
ordinary shares as of July 15, 2004, for each person known by us to own
beneficially more than 5% of our outstanding ordinary shares. The voting rights
of our major shareholders do not differ from the voting rights of other holders
of ordinary shares.
<Table>
<Caption>
PERCENTAGE
NUMBER OF OF ORDINARY
ORDINARY SHARES SHARES
NUMBER OF BENEFICIALLY BENEFICIALLY
ORDINARY PERCENTAGE OF OWNED OWNED
SHARES OUTSTANDING ASSUMING ASSUMING
BENEFICIALLY ORDINARY SHAREHOLDER SHAREHOLDER
NAME AND ADDRESS OWNED (1) SHARES (2)(3) APPROVAL (1)(4) APPROVAL (4)
---------------------------- ------------ ------------- --------------- ------------
Marc Belzberg (5) .......... 14,336,916 52.3% 15,586,916 50.9%
Samuel Belzberg (6) ........ 1,618,566 7.4% 2,868,566 11.4%
Solomon Spira (7) .......... 14,334,127 52.4% 14,334,127 47.2%
Lisa Belzberg .............. - - 1,250,000 5.0%
</Table>
(1) Except as otherwise noted and pursuant to applicable community property
laws, each person named in the table has sole voting and investment power
with respect to all ordinary shares listed as owned by such person. Shares
beneficially owned include shares that may be acquired pursuant to the
exercise of options that are exercisable within 60 days of July 15, 2004.
(2) Ordinary shares deemed beneficially owned by virtue of the right of any
person or group to acquire such shares within 60 days of July 15, 2004, are
treated as outstanding only for the purposes of determining the percent
owned by such person or group.
(3) The percentages shown are based on 21,798,595 ordinary shares issued and
outstanding as of July 15, 2004.
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(4) The percentages shown are based on 24,798,595 outstanding ordinary shares
assuming shareholder approval of the May 2004 Investment Agreement with
respect to shares and warrants purchased by Marc Belzberg, Gibralt, a
company controlled by Samuel Belzberg as discussed in note (6) below, and
Lisa Belzberg.
(5) Marc Belzberg's beneficial interest is held directly and through
Smithfield. Assuming shareholder approval of the Investment Agreement, Mr.
Belzberg will be issued 1,000,000 ordinary shares and a warrant to purchase
an additional 250,000 ordinary shares directly. Mr. Belzberg has also been
issued, in his capacity as one of our directors, options to purchase 41,000
of our ordinary shares exercisable within 60 days. Smithfield is a wholly
owned subsidiary of Bellevue. Solomon Spira, the father-in-law of Marc
Belzberg, holds all of the voting rights and 10% of the economic rights
(E.G., rights to distributions and liquidation proceeds) of Bellevue. Marc
Belzberg holds 90% of the economic rights (but none of the voting rights)
of Bellevue. Smithfield holds 8,740,330 ordinary shares and a warrant
currently exercisable to purchase 5,555,556 ordinary shares.
(6) Includes 66,000 ordinary shares underlying currently exercisable options.
Except for such options, Samuel Belzberg's beneficial interest is held
through Gibralt, which is controlled by him. He is the father of Marc
Belzberg.
(7) Solomon Spira is the father-in-law of Marc Belzberg. Mr. Spira directly
holds 38,241 ordinary shares. His remaining interest is held through
Smithfield, of which he is a controlling shareholder, as described in note
(5) above.
As of July 15, 2004, we had approximately 36 shareholders of record with a
United States address. As of July 15, 2004, these United States record holders
held approximately 10,683,822 ordinary shares, representing approximately 49% of
our then outstanding share capital.
As of July 31, 2003, members of the Belzberg family, including Marc Belzberg,
his father Samuel Belzberg, his sister Lisa Belzberg and his father-in-law
Solomon Spira, held approximately 28.43% of our outstanding shares. Immediately
prior to the Investment Agreement, in May 2004, the Belzberg Family held
approximately 52.12% of our shares. If the Investment Agreement is approved with
respect to Marc Belzberg, Gibralt and Lisa Belzberg, the Belzberg Family will
hold approximately 53.76% of our outstanding ordinary shares.
To the best of our knowledge, we are not directly or indirectly owned or
controlled by another corporation or by any foreign government and currently
there are no arrangements that may, at a subsequent date, result in a change in
our control. Our major shareholders do not have different voting rights with
respect to their shares.
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(B) RELATED PARTY TRANSACTIONS
INVESTMENTS AND LOANS BY RELATED PARTIES
In May and June 2004, we entered into an equity investment agreement with Marc
Belzberg, our chairman, chief executive officer and one of our major
shareholders, his sister, Lisa Belzberg, Gibralt, a party controlled by Samuel
Belzberg, who is a director of our company and the father of Marc Belzberg and
certain other investors who are not related parties, pursuant to which they
purchased an aggregate of 4,975,000 of our ordinary shares for $2,487,500, or
$0.50 per share. These investors also received warrants to purchase 1,243,750 of
our ordinary shares, at $0.75 per share. Each of the warrants is immediately
exercisable in full and has a five-year term. The transaction was approved by
our board of directors and audit committee. The purchase by the members of the
Belzberg Family of 3,000,000 ordinary shares and warrants to purchase an
additional 750,000 ordinary shares is subject to shareholder approval as Marc
Belzberg, Gibralt and Lisa Belzberg are considered related parties under the
Israeli Companies Law. We plan to submit the transaction for approval at our
next general meeting of shareholders, where it must be approved by a majority
which includes at least one-third of our shareholders present at the meeting and
voting on the transaction who are not related parties, unless our shareholders
who are not related parties who vote against the resolution do not represent
more than one percent of our total voting rights. According to the terms of the
investment agreement, if our shareholders do not approve the investment by
November 10, 2004, the investment agreement with the Belzberg Family will be
null and void and we will be obligated to repay the amount invested by them
together with accrued interest at a rate equal to the six-month LIBOR prevailing
on May 10, 2004. Each of Marc Belzberg, Gibralt and Lisa Belzberg has agreed
that, notwithstanding the foregoing, we will not be required to repay these
funds to them until August 31, 2005, if doing so would affect our ability to
continue operations as a going concern.
In July 2003, we entered into a convertible loan agreement with Smithfield, an
entity controlled by Marc Belzberg, pursuant to which Smithfield agreed to lend
us $1 million maturing on August 1, 2004 and bearing no interest. Until that
date, Smithfield had the right to convert the principal amount of the loan into
our ordinary shares at a price per share of $0.18. In addition, upon conversion
of the entire loan amount of into our ordinary shares, Smithfield was to receive
a warrant to purchase 5,555,556 of our ordinary shares at an exercise price per
share of $0.54.
Smithfield is considered a related party, and, therefore, the convertible loan
agreement was brought before, and approved by, our audit committee, board of
directors and shareholders. In January 2004, Smithfield elected to convert the
entire loan amount into a total of 5,555,556 of our ordinary shares and was
issued a warrant pursuant to the terms of the agreement.
In August 2002, we entered into an agreement with Gibralt, pursuant to which
Gibralt agreed to lend us $950,000 at an annual interest rate of 6% maturing on
February 28, 2003. We have repaid $760,000 of the loan to Gibralt. Pursuant to
the agreement, $190,000 of the aggregate principal amount of the loan was not
repaid and Gibralt was granted the right to convert this sum into our ordinary
shares at the price per share of $0.14 for a period of five years from the date
of the loan agreement.
Because Gibralt is considered a related party and the transaction involved a
conversion right of a portion of the loan, the transaction was approved by our
audit committee, board of directors and shareholders, as required by the
Companies Law. In January 2004, Gibralt converted the principal amount of the
loan and accrued interest into 1,458,964 of our ordinary shares.
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INTERESTS OF MANAGEMENT IN CERTAIN TRANSACTIONS
In 1993, we entered into an agreement, pursuant to which Yozma Hofsheet Ltd.,
referred to as Yozma, an Israeli company beneficially owned by Samuel Belzberg,
currently provides us with management and consulting services for a fee which
was initially $10,750 per month, increased by 12% per year. Currently, we are
obliged to pay Yozma $32,643 per month, which sum is presently being accrued.
These services have been provided by Marc Belzberg on behalf of Yozma, or a
predecessor company. Under this agreement, we accrued services fees of $312,000,
$350,000 and $392,000 in 2001, 2002 and 2003, respectively. Yozma waived its
fees for the quarters ended October 31, 2000 and April 30, 2001. Pursuant to
agreements entered into with banks who provided us with loans to extend the
scheduled maturity of the loans and to make certain other changes to the terms,
until at least one half of the outstanding principal of the loans has been
repaid, we have agreed not to pay management fees to Yozma. Yozma has agreed to
these terms. For information relating to the issuance of options to certain of
our directors and officers, see "Item 6. Directors, Senior Management and
Employees - Share Ownership - Option Plans."
(C) INTERESTS OF EXPERTS AND COUNSEL
Not applicable.
ITEM 8
FINANCIAL INFORMATION
(A) CONSOLIDATED STATEMENTS AND OTHER FINANCIAL INFORMATION
The financial statements required by this item are found at the end of this
annual report, beginning on page F-1.
EXPORT SALES
Export sales constitute a significant portion of our sales. In 2003, export
sales were approximately $3.2 million constituting 70.4% of our total sales. For
a more detailed discussion regarding the allocation of our revenues by
geographic regions based on the location of our customers, see "Item4(B)--
Information on the Company--Business Overview--Sales and Marketing."
LEGAL PROCEEDINGS
In January 2002, we terminated a license agreement with Simulis, Inc., which
granted Simulis certain exclusive and non-exclusive rights to market our Rapid
CBT software. Simulis disputed the validity of the termination. We have agreed
with Simulis on certain terms resolving the dispute, subject to certain
conditions that we believe have been met, but a definitive agreement resolving
this matter has not yet been executed. In addition, we have not yet received
certain payments that we believe are due from Simulis pursuant to the terms
agreed to with Simulis, and our ability to collect such amounts from Simulis is
currently unclear. Therefore, we cannot assure you that a definitive agreement
relating to the settlement of this dispute will be ultimately entered into, that
the dispute will be finally and successfully resolved or that we will receive
payments that we believe we are entitled to under the terms agreed to with
Simulis.
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<Page>
In July 2002, we received a claim from Gaio, Inc., one of our principal
competitors in Japan, alleging that certain features of our then newly released
RapidPLUS Express breach Gaio's copyright and demanding that we cease marketing
this product in a version which allegedly breaches its proprietary rights. We
believe the claim to be without merit, have advised Gaio accordingly and have
continued to market the allegedly infringing software. The last communication we
received from Gaio was on January 28, 2003 and they did not respond to our
letter to them from March 6, 2003. We cannot predict at this time whether Gaio
will press its claims, but if it does so, we intend to defend our position
vigorously.
We are currently involved in a dispute with our former landlord at Kiryat Mada
Street, Jerusalem, the Har Hotzvim Property Company Ltd., which is demanding
lease and lease related payments for a certain period prior to our vacating the
premises. We have paid the landlord a certain amount we believe is owed. In
March 2004, the landlord filed a complaint against us in Israel, claiming
approximately $40,000 as damages resulting from the alleged breach of contract,
lease payments and interest. We intend to vigorously defend the claim and
believe it to be without merit. We cannot predict at this time the outcome of
these court proceedings.
We are not currently involved in any other material legal or arbitration
proceedings which may have, or have had in the recent past, a significant effect
on our financial position or profitability.
DIVIDEND POLICY
We have never declared or paid any cash dividend on our ordinary shares. We do
not anticipate paying any cash dividend on our ordinary shares in the
foreseeable future. We currently intend to retain all future earnings to finance
operations and expand our business.
(B) SIGNIFICANT CHANGES
Except as otherwise disclosed in this annual report, no significant change has
occurred since January 31, 2004.
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<Page>
ITEM 9
THE OFFER AND LISTING
(A) OFFER AND LISTING DETAILS
In February 2002, our ordinary shares were delisted from the NASDAQ National
Market as a result of our failure to meet NASDAQ's continued listing
requirements. Trading in our ordinary shares is currently conducted in the
over-the-counter market, on the OTCBB. The following table lists the highest and
lowest closing prices, in dollars, of our ordinary shares for the years
indicated as reported by the American Stock Exchange, the NASDAQ National Market
or the OTCBB (as applicable) for the period during which our ordinary shares
were so traded for each financial year indicated below:
<Table>
<Caption>
YEAR HIGH LOW
---- --------- --------
1999 $ 20.7500 $ 4.6250
2000 $ 38.0000 $ 2.1250
2001 $ 3.0500 $ 0.1800
2002 $ 0.6500 $ 0.0700
2003 $ 1.4900 $ 0.1100
</Table>
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<Page>
The following tables list the high and low closing prices, in dollars, of our
ordinary shares as reported by the NASDAQ National Market or the OTCBB (as
applicable) for each financial quarter of the periods indicated below:
<Table>
<Caption>
2002 HIGH LOW
----------------------- -------- --------
First Quarter $ 0.4500 $ 0.1300
Second Quarter $ 0.6500 $ 0.1400
Third Quarter $ 0.1800 $ 0.0700
Fourth Quarter $ 0.2400 $ 0.1000
<Table>
<Caption>
2003 HIGH LOW
----------------------- -------- --------
First Quarter $ 0.2300 $ 0.1100
Second Quarter $ 0.3600 $ 0.1500
Third Quarter $ 0.6800 $ 0.2300
Fourth Quarter $ 1.4900 $ 0.5000
<Table>
<Caption>
2004 HIGH LOW
----------------------- -------- --------
First Quarter $ 1.0400 $ 0.6500
Second Quarter
(through July 15,
2004) $ 0.7300 $ 0.3700
</Table>
The following table lists the high and low closing prices, in dollars, of our
ordinary shares as reported by the OTCBB for the six most recent months:
<Table>
<Caption>
2004 HIGH LOW
----------------------- -------- --------
January 2004 $ 1.0600 $ 0.7100
February 2004 $ 1.0400 $ 0.8300
March 2004 $ 0.9300 $ 0.7000
April 2004 $ 0.8600 $ 0.6500
May 2004 $ 0.7300 $ 0.6100
June 2004 $ 0.7000 $ 0.5700
July 2004 (through
July 15, 2004) $ 0.6200 $ 0.3700
</Table>
(B) PLAN OF DISTRIBUTION
Not applicable.
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<Page>
(C) MARKETS
On July 7, 1998, we completed our initial public offering, at which time our
ordinary shares began trading on the American Stock Exchange, under the symbol
EMU. In June 1999, we changed our name from Emultek Ltd. to e-SIM Ltd., and our
symbol changed to EIM. In March 2000, we changed our listing to the NASDAQ
National Market under the symbol ESIM. In February 2002, our ordinary shares
were delisted from the NASDAQ National Market as a result of our failure to meet
NASDAQ's continued listing requirements. Trading in our ordinary shares is
currently conducted in the over-the-counter market, on the OTCBB. Our shares
were not traded publicly prior to our initial public offering.
(D) SELLING SHAREHOLDERS
Not applicable.
(E) DILUTION
Not applicable.
(F) EXPENSES OF THE ISSUE
Not applicable.
ITEM 10
ADDITIONAL INFORMATION
(A) SHARE CAPITAL
Not applicable.
(B) MEMORANDUM AND ARTICLES OF ASSOCIATION
SECURITIES REGISTERS
Our transfer agent and register is the American Stock Transfer & Trust Co. and
its address is 59 Maiden Lane, New York, NY 10038.
At our Annual General Meeting of Shareholders on July 13, 2001, we adopted
amended articles of association, which replaced our previous articles of
association in their entirety. The following is a summary of the material
provisions of our articles of association currently in effect and related
provisions of Israeli law. This summary does not purport to be a complete
description and is qualified in its entirety by reference to the complete text
of our articles of association.
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PURPOSES OF THE COMPANY
We are a public company registered under the Israeli Companies Law as e-SIM
Ltd., registration number 52-004343-1. Pursuant to Section 2 of our articles of
association, we may engage in any lawful business or matter that we decide upon.
By resolution and at the sole discretion of our board of directors, we may grant
reasonable contributions and donations for charitable purposes.
DIRECTORS
The Companies Law restricts a director's power to vote on a proposal,
arrangement or contract in which the director is materially interested. A
director who has an interest in a given matter may not participate in a vote on
the matter if the proposal, arrangement or contract at hand constitutes a
transaction that is not in the ordinary course of the company's business, is not
at market conditions or may materially affect the company's profitability,
property or commitments, unless a majority of the company's directors are
materially interested in said proposal, arrangement or contract. In the latter
case, while directors may participate in the vote, the proposal, arrangement or
contract must also be approved at a General Meeting of Shareholders. We are
subject to these provisions of the Companies Law.
Pursuant to the Companies Law, decisions relating to the compensation of the
directors themselves must receive the approval of our Audit Committee prior to
the approval of our the board of directors, and must subsequently be approved by
the General Meeting of Shareholders. We have incorporated these provisions of
the Companies Law into our articles of association and require the approval of
the General Meeting of Shareholders for resolutions concerning remuneration of
our directors.
Our board of directors has the authority to borrow any sum in the manner, time
and conditions that it may deem fit, including the issuing of bonds or
debentures or a series of bonds or debentures, whether secured or non secured,
or subordinate to any mortgage, lien or other security of a factory, or property
of our company, wholly or partially.
We de not have an age limit requirement for our directors, nor do we require
that directors hold any of our shares.
RIGHTS ATTACHED TO SHARES
SHARE CAPITAL
Our registered share capital consists of 70,000,000 ordinary shares, NIS 0.1 par
value. Each of our ordinary shares has equal rights with any other such share,
including voting rights, the right to participate in any distribution to holders
of ordinary shares and any other right provided by the Companies Law to our
ordinary shares. In April 2004, our board of directors recommended that we
effect a reverse stock split of our share capital, resulting in every five
existing ordinary shares be converted into one ordinary share. As directed by
our board of directors, we will submit the proposed reverse stock split for
shareholder approval at our next general meeting of shareholders.
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DIVIDEND RIGHTS
Subject to the provisions of the Companies Law, our board of directors may
decide to distribute interim and final dividends. Any distribution of dividends
must be fixed and paid to shareholders pro rata according to the par value of
the shares, subject to our right to alter our existing share capital and rules
regarding priority. Holders of our ordinary shares are entitled to the full
amount of any cash or share dividend declared, although the board of directors
may deduct any amount payable on our shares, whether or not that amount is yet
due, and such matter would be subject to certain rules prescribed by Israeli
law.
VOTING RIGHTS
Holders of our ordinary shares have one vote for each ordinary share held on all
matters submitted to the vote of shareholders. These voting rights may be
affected by the grant of any special voting rights to the holders of a class of
shares with preferential rights that may be authorized in the future. Other than
external directors, who are elected for a three-year term, our directors are
elected annually by majority vote at our general meeting of shareholders.
LIQUIDATION RIGHTS
In the case of our liquidation, our articles of association provide that share
capital shall be returned and surplus of our assets shall be distributed to our
shareholders pro rate in proportion to the paid-up capital on the par value of
our shares, subject to any provisions of the law concerning liquidation and any
special rights that may be attached to our shares in the future.
CHANGE OF RIGHTS ATTACHED TO SHARES
Pursuant to our articles of associations and subject to the provisions of the
Companies Law, we may change the rights attached to any of our shares, without
prejudice to any special rights previously conferred on the holders of any
existing shares or class of shares, by an ordinary resolution approved by a
simple majority at a General Meeting of Shareholders. If a change entails the
division of our share capital into different classes of shares, the rights
attached to any class, unless otherwise provided by the terms of issue of the
shares of that class, may be varied only with the consent in writing of the
holders of all issued shares of that class, or with the approval of an ordinary
resolution passed at a separate general meeting of the holders of the shares of
the class.
GENERAL MEETINGS
Pursuant to the provisions of the Companies Law, a general meeting of
shareholders must be convened annually, no more than 15 months after the
previous one, and at such place as may be determined by the board of directors.
The board of directors may also convene an extraordinary general meeting as it
decides or upon demand of any two directors or 25% of the directors, whichever
is lower, or of one or more shareholders holding an aggregate of at least 5% of
the company's outstanding shares and at least 1% of the voting rights in the
company or at least 5% of the voting rights in the company. Prior to any general
meeting of shareholders, notice will be given in accordance with the relevant
provisions of the Companies Law and the Israeli Foreign Traded Companies
Regulations.
82
The quorum requirement for our general meeting of shareholders, whether annual
or special, is two members present in person or by proxy and holding or
representing between them at least 33 1/3% of our outstanding issued share
capital. If convened upon request of shareholders, as described above, a meeting
adjourned for lack of quorum shall be dissolved, but in any other case it shall
be adjourned to the same day one week later at the same time and place or to
such day, time and place as the board of directors may, by notice to our
shareholders appoint, subject to the relevant provisions of the Companies Law.
At the adjourned meeting, the business for which the original meeting was called
will be transacted if any two members are present, either in person or by proxy.
Pursuant to our articles of association, at any general meeting of our
shareholders, whether annual or special, resolutions will pass by a simple
majority, including resolutions to further amend our articles of association but
excluding approval of certain transactions, actions and arrangements for which
the Companies Law requires different voting arrangements. See "Item 6.
Directors, Senior Management and Employees-Board Practices-Approval of Specified
Related Party Transactions Under Israeli Law" for a discussion of these special
rules.
LIMITATIONS ON RIGHTS TO OWN SECURITIES
Neither our articles of association nor the laws of the State of Israel restrict
in any way the ownership or voting of shares by non-residents, except with
respect to subjects of countries that are in a state of war with Israel.
PROVISIONS AFFECTING A POTENTIAL CHANGE OF CONTROL
The Companies Law allows for corporate mergers, so long as the merger is
approved both by the board of directors and by the general meeting of
shareholders of each company that is a party to the proposed merger. General
meeting approval of mergers must be by a vote of the majority of the company's
shares, present and voting on the proposed merger. Shares held by the other
party to the merger or by a shareholder who also holds at least 25% of such
party are excluded from voting on a proposed merger.
Pursuant to the Companies Law, a merger does not require court approval, other
than in specified situations. However, the creditors of either party to a
proposed merger may petition the courts to delay or prevent a merger if there is
a reasonable concern that that the surviving company will be unable to meet the
obligations of either party to the merger to their creditors.
Mergers may be completed only after at least 70 days have passed from the time
that a request for the approval of a merger has been filed with the Israeli
Registrar of Companies.
The Companies Law requires that acquisitions of public companies on the open
market must be made by means of a tender offer if, as a result of the
acquisition, the purchaser would hold at least 25% of the target company's
shares, and there is no other shareholder holding at least 25% of the share in
the company. Similarly, if there is no shareholder who holds more than 50% of
the target company's shares, an acquisition that would result in the purchaser
holding more than 45% of the company's shares, must also be conducted via a
tender offer. These rules apply only to the acquisition of companies, not to
mergers, and do not apply to Israeli companies registered for trade outside of
Israel, like us, in certain circumstances.
83
If, following an acquisition of shares, the purchaser would become the holder of
more than 90% of the company's shares, the acquisition must be made by means of
a tender offer for all of the target company's shares. If all shareholders in
the target company except for the holders of shares representing less than 5% of
the company's shares accept the tender offer, the purchaser may acquire all
shares for which the tender offer was made. However, if a tender offer fails to
acquire 95% of the target company, the purchaser may not acquire tendered shares
that would raise the purchaser's holding in the company above 90%.
OWNERSHIP THRESHOLD FOR DISCLOSURE
Our articles of association do not provide for an ownership threshold above
which shareholding must be disclosed. However, pursuant to the provisions of the
Companies Law, we are required to maintain a separate register for shareholders
who hold more than 5% of our shares or voting rights.
CHANGES IN SHARE CAPITAL
As provided by our articles of association, we may change our share capital by
an ordinary resolution approved by the general meeting of shareholders. In
September 2003, our shareholders voted to increase our share capital from
2,000,000 NIS divided into 20,000,000 ordinary shares par value NIS 0.10 each to
7,000,000 NIS divided into 70,000,000 ordinary shares par value NIS 0.10 each.
In April 2004, our board of directors recommended that we effect a reverse stock
split of our share capital, resulting in every five existing ordinary shares
being converted into one ordinary share. At the direction of our board of
directors, we will sumbit the proposed reverse stock split for shareholder
approval at our next general meeting of shareholders.
(C) MATERIAL CONTRACTS
For a summary of our material contracts see "Item 5. Operating and Financial
Review and Prospects - Liquidity and Capital Resources," and "Item 7. Major
Shareholders - Related Party Transactions."
(D) EXCHANGE CONTROLS
The State of Israel's extensive controls on foreign currency, such as the
Currency Control Law of 1978, were lifted, in large part, in May 1998. There
currently are no Israeli currency control restrictions on payments of dividends
on ordinary shares or the proceeds from the sale of ordinary shares. However,
legislation remains in effect pursuant to which currency controls can be imposed
by administrative action at any time.
Under current Israeli regulations, any dividends or other distributions paid in
respect of ordinary shares may be paid in non-Israeli currencies, or, if paid in
Israeli currency, will be freely repatriable in non-Israeli currencies at the
rate of exchange prevailing at the time of the conversion. Because exchange
rates between the NIS and the dollar fluctuate continuously, a U.S. shareholder
will be subject to the risk of currency fluctuations between the dates when
NIS-denominated dividends are declared and paid by us in NIS.
84
(E) TAXATION
MATERIAL UNITED STATES FEDERAL INCOME TAX CONSIDERATIONS
Subject to the limitations described below, the following discussion describes
certain material U.S. federal income tax consequences of the purchase, ownership
and disposition of our ordinary shares to a beneficial owner of ordinary shares
that is (a) an individual who is a citizen or resident of the U.S., (b) a
corporation (or other entity treated as a corporation for U.S. federal tax
purposes) created or organized in the U.S. or under the laws of the U.S. or of
any state thereof or the District of Columbia, (c) an estate, the income of
which is includable in gross income for U.S. federal income tax purposes
regardless of its source; or (d) a trust (i) if a court within the U.S. is able
to exercise primary supervision over the administration of the trust and one or
more U.S. persons have the authority to control all substantial decisions of the
trust or (ii) that has a valid election under applicable U.S. Treasury
Regulations to be treated as a U.S. person, referred to as a "U.S. Shareholder."
This summary does not purport to be a comprehensive description of all of the
U.S. federal income tax considerations that may be relevant to a decision to
hold our ordinary shares and does not apply to specified persons or cover
specified situations. This summary generally considers only U.S. Shareholders
that are the beneficial owners of our ordinary shares that will own ordinary
shares as capital assets. Except to the limited extent discussed below, this
summary does not consider the U.S. tax consequences to a person that is not a
U.S. Shareholder.
This discussion is based on current provisions of the Internal Revenue Code of
1986, as amended, referred to as the Code, current and proposed Treasury
regulations promulgated thereunder, and administrative and judicial decisions as
of the date hereof, all of which are subject to change, possibly on a
retroactive basis. Any such change could affect the continuing validity of this
discussion. This discussion does not address all aspects of U.S. federal income
taxation that may be relevant to any particular shareholder based on such
shareholder's individual circumstances. In particular, this discussion does not
address the potential application of the alternative minimum tax or the U.S.
federal income tax consequences to certain shareholders that are subject to
special treatment, including: broker-dealers; insurance companies; regulated
investment companies; tax-exempt organizations; financial institutions;
"financial services entities"; holders of ordinary shares held as part of a
"straddle," constructive sale," "hedge" or "conversion transaction" with other
investments; holders who own or owned directly, indirectly or by attribution at
least 10% of our voting power; shareholders whose functional currency is not the
U.S. dollar; shareholders who received ordinary shares as compensation for the
performance of services; and shareholders who have elected mark-to-market
accounting.
Additionally, the discussion does not consider the tax treatment of shareholders
that are partnerships or other pass-through entities, or persons who hold
ordinary shares through a partnership or other pass-through entity or the
possible application of U.S. federal gift or estate taxes. In addition, this
discussion does not consider any aspect of state, local or non-U.S. tax laws.
Certain material aspects of U.S. federal income tax relevant to a beneficial
owner other than a U.S. Shareholder, referred to as a Non-U.S. Shareholder, also
are discussed below.
85
EACH INVESTOR IS ADVISED TO CONSULT SUCH PERSON'S OWN TAX ADVISOR WITH RESPECT
TO THE SPECIFIC TAX CONSEQUENCES TO SUCH PERSON OF PURCHASING, HOLDING OR
DISPOSING OF ORDINARY SHARES.
TAXATION OF ORDINARY SHARES
DIVIDENDS. We have never paid cash dividends and we currently do not intend to
pay cash dividends in the foreseeable future. In the event we do pay a dividend
and subject to the discussion below under "-Passive Foreign Investment
Companies," a U.S. Shareholder generally will be required to include in gross
income as ordinary income the amount of any distribution paid on our ordinary
shares (including the amount of Israeli taxes, if any, withheld therefrom) on
the date the distribution is received to the extent that such distributions are
paid out of our current or accumulated earnings and profits as determined for
U.S. federal income tax purposes. Distributions in excess of such earnings and
profits will be applied against and will reduce the U.S. Shareholder's tax basis
in the ordinary shares and, to the extent in excess of such tax basis, will be
treated as gain from a sale or exchange of ordinary shares. See "--Sale of
Exchange of Ordinary Shares." Dividends paid prior to January 1, 2009 to
non-corporate U.S. Shareholders who meet certain eligibility requirements (as
discussed below) qualify for a reduced rate of taxation of 15% or lower if (a)
our ordinary shares are readily tradable on an established securities market in
the U.S., or (b) we qualify for benefits under an income tax treaty, such as the
U.S.-Israel Tax Treaty. It is unclear whether the trading of our ordinary shares
on the OTCBB meets "established securities market" test above.
A U.S. Shareholder would not be entitled to the reduced rate unless the
Shareholder satisfies certain eligibility requirements, including certain
holding period and at risk requirements. In addition, dividends paid with
respect to our ordinary shares will not qualify for the reduced rate if we are a
foreign investment company, a foreign personal holding company, or a passive
foreign investment company or "PFIC", as these terms are defined for U.S.
federal income tax purposes. Due to the nature of our activities, income and
ownership, we do not believe we are a foreign investment company or a foreign
personal holding company nor do we believe we were a PFIC for 2003 and we do not
expect to become a PFIC in the foreseeable future. See the discussions below
under "--Foreign Personal Holding Company" and "--Passive Foreign Investment
Company Considerations" for more information. U.S. Shareholders should consult
their own tax advisors on their eligibility for reduced rates of taxation with
respect to any dividends paid by us.
Distributions of current or accumulated earnings and profits paid by us in NIS
will be includable in the income of a U.S. Shareholder at a U.S. dollar amount
calculated by reference to the spot rate of exchange in effect on the date the
dividend is includible in the income of the U.S. Shareholder, and a U.S.
Shareholder will have a tax basis in such NIS for U.S. federal income tax
purposes equal to such U.S. dollar value, without reduction for any Israeli
taxes withheld at source, regardless of whether the payment is in fact converted
into U.S. dollars on such date. If the U.S. Shareholder converts distributions
paid in NIS into U.S. dollars on the day the dividend is includible in the
income of the U.S. Shareholder, the U.S. Shareholder generally should not be
required to recognize gain or loss arising from exchange rate fluctuations. If
the U.S. Shareholder subsequently converts the NIS, any subsequent gain or loss
in respect of such NIS arising from exchange rate fluctuations will be U.S.
source ordinary exchange income or loss. Distributions of current or accumulated
earnings and profits generally will not qualify for the dividends-received
deduction available to corporations.
86
U.S. Shareholders will have the option of claiming the amount of any Israeli
income taxes withheld at source or paid with respect to dividends either as a
deduction from gross income or as a dollar-for-dollar credit against their U.S.
federal income tax liability. Individuals who do not claim itemized deductions,
but instead utilize the standard deduction, may not claim a deduction for the
amount of the Israeli income taxes withheld, but those individuals may still
claim the amount of such taxes as a credit against their U.S. federal income tax
liability subject to limitations and restrictions discussed below. The amount of
foreign income taxes that may be claimed as a credit in any year is subject to
complex limitations and restrictions, which must be determined on an individual
basis by each shareholder. These limitations include, among others, rules that
limit foreign tax credits allowable with respect to specific classes of income
to the U.S. federal income taxes otherwise payable with respect to each such
class of income. The total amount of allowable foreign tax credits in any year
cannot exceed the regular U.S. tax liability for the year attributable to
foreign source taxable income. Foreign income taxes that may be, or are,
refunded to a U.S. Shareholder may not be claimed as a foreign tax credit.
Special rules apply to foreign tax credits associated with qualified dividend
income. In addition, U.S. Shareholders must meet certain holding period and at
risk requirements in order to claim a credit for foreign taxes. The rules
relating to the determination of the foreign tax credit are complex, and U.S.
Shareholders should consult their own tax advisors to determine whether and to
what extent they would be entitled to such credit.
SALE OR EXCHANGE OF ORDINARY SHARES. Subject to the discussion below under
"-Passive Foreign Investment Companies," upon the sale, exchange or other
disposition of our ordinary shares, a U.S. Shareholder generally will recognize
capital gain or loss in an amount equal to the difference between the amount
realized on the sale or exchange by such U.S. Shareholder and its tax basis in
the ordinary shares, which is usually the U.S. dollar cost of the ordinary
shares. A U.S. Shareholder that uses the cash method of accounting calculates
the U.S. dollar value of the proceeds received on the sale date as of the date
that the sale settles, while a U.S. Shareholder that uses the accrual method of
accounting is required to calculate the value of the proceeds of the sale as of
the "trade date," and therefore, may realize foreign currency gain or loss,
unless such U.S. Shareholder has elected to use the settlement date to determine
its proceeds of sale. If the ordinary shares are publicly traded, a disposition
of the shares will be considered to occur on the "trade date," regardless of the
U.S. Shareholder's method of accounting. The gain or loss realized on the sale,
exchange or other disposition of our ordinary shares will be long-term capital
gain or loss if the U.S. Shareholder has a holding period of more than one year
at the time of such sale or exchange.
Capital gains of non-corporate taxpayers from the sale or exchange of ordinary
shares held more than one year are eligible for reduced rates of taxation
applicable to long-term capital gains. The deductibility of a capital loss
recognized on the sale or exchange of ordinary shares is subject to limitations.
Gain or loss realized by a U.S. Shareholder on a sale or exchange of ordinary
shares generally will be treated as U.S. source income for U.S. foreign tax
credit purposes.
A U.S. Shareholder who receives a foreign currency distribution and converts the
foreign currency into U.S. dollars subsequent to receipt will have foreign
exchange gain or loss based on any appreciation or depreciation in the value of
the foreign currency against the U.S. dollar, which will generally be U.S.
source ordinary income or loss.
87
PASSIVE FOREIGN INVESTMENT COMPANIES
We will be classified as a passive foreign investment company, or PFIC, if 75%
or more of our gross income (including the pro rata share of the gross income of
any company, U.S. or foreign, in which we are considered to own 25% or more of
the shares by value) in a taxable year is passive income. Passive income for
this purpose includes items such as dividends, interest, royalties, rents and
gains from commodities and securities transactions, and the excess of gains over
losses from the disposition of assets that produce passive income.
Alternatively, we will be considered to be a PFIC if at least 50% or more of the
assets (averaged over the year and generally determined based upon fair market
value) of our company (including the pro rata share of the assets of any U.S. or
foreign company in which we are considered to own 25% or more of the shares by
value) in a taxable year are held for the production of, or produce, passive
income. If we are a PFIC, in the absence of an election by a U.S. Shareholder to
treat us as a "qualified electing fund," referred to as a "QEF" election, as
discussed below, certain distributions by us and sale or other disposition of
the ordinary shares at a gain, will be treated for federal income tax purposes
as if the distribution or gain had been recognized ratably over the U.S.
Shareholder's holding period for the ordinary shares. The U.S. Shareholder would
be liable to pay tax at ordinary income tax rates on amounts allocable to the
current year and to years prior to our becoming a PFIC, and with respect to
other years in the U.S. Shareholder's holding period, at the maximum income tax
rates on ordinary income in effect from time to time, plus interest on the tax.
Even if a QEF election is not made, a U.S. Shareholder must file a completed IRS
Form 8621 with the U.S. Shareholder's U.S. federal income tax return each year.
Additionally, if we were to become a PFIC, U.S. Shareholders who acquire
ordinary shares from a decedent would be denied the normally available step-up
of the tax basis for such shares to fair market value at the date of death and
instead would have a tax basis equal to the decedent's basis, if lower. Finally,
if we were a PFIC, dividend distributions on our ordinary shares would not
qualify for reduced rates of taxation.
If a U.S. Shareholder has made a QEF election for all taxable years that such
shareholder has held the ordinary shares and we were a PFIC, distributions and
gain will not be deemed to have been recognized ratably over the taxpayer's
holding period or be subject to an interest charge, gain on the sale of ordinary
shares will be characterized as capital gain and the denial of basis step-up at
death described above will not apply. Instead, a U.S. Shareholder that has made
a QEF election is required for each taxable year to include in income a pro rata
share of the ordinary earnings of the QEF as ordinary income and a pro rata
share of the net capital gain of the QEF fund as long-term capital gain,
regardless of whether we have distributed such earnings or gain.
A U.S. Shareholder of certain publicly traded PFIC stock can elect to mark the
stock to market annually, recognizing as ordinary income or loss each year an
amount equal to the difference as of the close of the taxable year between the
holder's adjusted tax basis in the PFIC stock and its fair market value. Losses
are allowed only to the extent of net mark-to-market gain previously included by
the U.S. Shareholder under the election for prior taxable years. If the
mark-to-market election is made, then the rules set forth above for taxation of
distributions by us and dispositions of ordinary shares at a gain would not
apply for periods covered by the election.
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Based on our estimated gross income, the average value of our gross assets
(determined by reference to the market value of our shares and valuing our
intangible assets using the methods prescribed for publicly traded corporations)
and the nature of our business, we believe that we were not a PFIC for the
taxable year ending January 31, 2004. However, if our stock does not continue to
be traded on the OTCBB we may become a PFIC. Our status in future years will
depend on our assets and activities in those years, although you will be treated
as continuing to own an interest in a PFIC if we are a PFIC in any year while
you own shares unless you make certain elections. We do not anticipate becoming
a PFIC, but, because the market price for our ordinary shares and the amount of
cash we hold are likely to fluctuate, we have no assurance that we will not be
considered a PFIC at any taxable year.
We can give no assurance that we will have timely knowledge of our future status
as a PFIC. In this regard, we do not assume any obligation to make timely
disclosure with respect to such status. Moreover, we do not plan to provide U.S.
Shareholders with the necessary information to make a QEF election.
Consequently, as a practical matter, U.S. Shareholders should assume that they
will not be able to make a QEF election. U.S. Shareholders who hold ordinary
shares during a period when we are a PFIC will be subject to the foregoing
rules, even if we cease to be a PFIC. U.S. Holders are urged to consult their
tax advisors about the PFIC rules, including the consequences to them of making
a mark-to-market election or QEF election with respect to our ordinary shares in
the event that we are treated as a PFIC.
TAX CONSEQUENCES FOR NON-U.S. HOLDERS OF OUR ORDINARY SHARES
Except as described in "--Information Reporting and Backup Withholding," a
Non-U.S. Shareholder of ordinary shares who is a beneficial owner of the
ordinary shares will not be subject to U.S. federal income or withholding tax on
the payment of dividends on, and proceeds from the disposition of, ordinary
shares, unless (a) such item is effectively connected with the conduct by the
Non-U.S. Shareholder of a trade or business in the U.S. and, in the case of a
resident of a country that has a treaty with the U.S., such item is attributable
to a permanent establishment (or, in the case of an individual, a fixed place of
business) in the United States or (b) in the case of capital gain realized by an
individual Non-U.S. Shareholder, the Non-U.S. Shareholder is present in the U.S.
for 183 days or more in the taxable year of the sale and certain other
conditions are met.
INFORMATION REPORTING AND BACKUP WITHHOLDING
U.S. Shareholders generally are subject to information reporting requirements
with respect to dividends paid in the U.S. on our ordinary shares. In addition,
U.S. Shareholders are subject to U.S. backup withholding (currently at a rate of
28%) on dividends paid in the U.S. on ordinary shares unless the U.S.
Shareholder provides an IRS Form W-9, the U.S. shareholder is a corporation or
otherwise establishes an exemption. U.S. Shareholders are subject to information
reporting and backup withholding (currently at a rate of 28%) on proceeds paid
from the sale, exchange, redemption or other disposition of ordinary shares
unless the U.S. Shareholder provides an IRS Form W-9, the U.S. shareholder is a
corporation or otherwise establishes an exemption.
Non-U.S. Shareholders generally are not subject to information reporting or
back-up withholding with respect to dividends paid on, or proceeds upon the
sale, exchange, redemption or other disposition of, ordinary shares, provided
that such Non-U.S. Shareholder provides a taxpayer identification number,
certifies to its foreign status, or otherwise establishes an exemption.
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Backup withholding is not an additional tax. The amount of any backup
withholding will be allowed as a credit against such U.S. Shareholder's or
Non-U.S. Shareholder's United States federal income tax liability and may
entitle such shareholder to a refund, provided that the required information is
furnished to the U.S. Internal Revenue Service.
ISRAELI TAXATION AND INVESTMENT PROGRAMS
The following is a summary of the current tax laws of the State of Israel as
they relate to us and our shareholders, including U.S. and other non-Israeli
shareholders. The following also includes a discussion of certain Israeli
Government programs benefiting various Israeli businesses, including our
company. To the extent that the discussion is based on legislation yet to be
subjected to judicial or administrative interpretation, there can be no
assurance that the views expressed herein will accord with any such
interpretation in the future. This discussion is not intended and should not be
construed as legal or professional tax advice and does not cover all possible
tax considerations. The following summary is included herein for general
information only and is not intended to substitute for careful tax planning.
TAX REFORM
On January 1, 2003, the Law for Amendment of the Income Tax Ordinance (Amendment
No. 132), 5762-2002, known as the Tax Reform, came into effect. As a result of
the Tax Reform, Israeli residents, including companies, are subject to Israeli
tax on income accrued or derived in Israel or abroad. The Tax Reform also
introduced controlled foreign corporation (CFC) rules into the Israeli tax
structure, so that an Israeli individual or company may become subject to
Israeli taxes on certain income of a non-Israeli subsidiary if the subsidiary's
primary source of income is passive income (such as interest, dividends,
royalties, rental income or capital gains). Capital gains taxation was also
substantially changed by the Tax Reform.
GENERAL CORPORATE TAX STRUCTURE
The regular rate of corporate tax to which Israeli companies are subject is 36%.
The government has announced a program to reduce the corporate tax rate to 30%
over a three-year period. Legislation in implement this decision has yet to be
enacted. However, the effective rate of tax payable by a company that is
qualified under Israeli law as an "Industrial Company" and that derives income
from an "Approved Enterprise," as discussed below, may be considerably lower.
See "- Law for the Encouragement of Capital Investments, 1959."
Our effective tax rate was 0% through January 31, 2004. The expiration of the
benefit period under one of our Approved Enterprise programs may have a material
adverse effect on our effective tax rate beginning in the tenth year after we
have taxable profits. The continuation of this tax rate is dependent upon the
receipt of certain approvals from the Israeli Investment Center, a statutory
body made up of representatives of various Israeli Government ministries,
referred to as the Investment Center. See "-Law for the Encouragement of Capital
Investments, 1959."
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LAW FOR THE ENCOURAGEMENT OF INDUSTRY (TAXES), 1969
Pursuant to the Law for the Encouragement of Industry (Taxes), 1969, referred to
as the Industry Law, a company qualifies as an "Industrial Company" if it is
resident in Israel and at least 90% of its income in any tax year, determined in
Israeli currency (exclusive of income from defense loans, capital gains,
interest and dividends) is derived from an "Industrial Enterprise" it owns. An
"Industrial Enterprise" is defined for purposes of the Industry Law as an
enterprise the majority activity of which, in a given tax year, is industrial
production.
We qualify as an Industrial Company. We are therefore entitled to certain tax
benefits, including, among other things, a deduction of the purchase price of
patents or certain other intangible property rights at the rate of 12.5% per
annum and, subject to certain conditions, the right to submit our tax returns on
a consolidated basis. In addition, we, as an Industrial Company may, in certain
cases, deduct the expenses incurred in connection with a public offering at the
rate of 33.3% of such expenses per annum.
Eligibility for benefits under the Industry Law is not contingent upon the
approval of any government agency. There can be no assurance that we will
continue to so qualify, or will be able to avail ourselves of any benefits under
the Industry Law in the future.
LAW FOR THE ENCOURAGEMENT OF CAPITAL INVESTMENTS, 1959
GENERAL
Our production facilities have been granted "Approved Enterprise" status
pursuant to the Israeli Law for the Encouragement of Capital Investments, 1959,
referred to as the Investment Law, which provides certain tax and financial
benefits to investment programs that have been granted such status. The
Investment Law provides that a proposed capital investment in eligible
facilities may, upon application to the Investment Center of the Ministry of
Industry and Commerce of the State of Israel, referred to as the Investment
Center, within the funding limits set by the Israeli Government budget, be
granted the status of an "Approved Enterprise" if such project may promote the
objectives of the Investment Law and it is desirable to encourage the
implementation of the project by the grant of the approval.
The Investment Law provides that capital investments in production facilities
(or other eligible facilities) may, upon application to the Investment Center,
be designated as an Approved Enterprise. Each instrument of approval for an
Approved Enterprise relates to a specific investment program, delineated both by
the financial scope of the investment, including sources of funds, and by the
physical characteristics of the facility or other assets. The tax benefits
available under any instrument of approval relate only to taxable profits
attributable to the specific program and are contingent upon meeting the
criteria set out in the instrument of approval. If, as in our case, (a) only a
part of a company's taxable income is derived from an Approved Enterprise or (b)
a company owns more than one Approved Enterprise, our resulting effective
corporate tax rate represents the weighted combination of the various applicable
rates. A company owning a "mixed enterprise" (I.E., a company the income of
which is derived from both an Approved Enterprise and other sources) generally
may not distribute a dividend that is attributable only to the Approved
Enterprise.
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Subject to certain provisions concerning income and subject to the Alternative
Benefits (hereinafter defined), any distributed dividends are deemed
attributable to the entire enterprise, and the effective tax rate represents the
weighted combination of the various applicable tax rates. A company may elect to
attribute dividends distributed by it only to income not subject to the
Alternative Benefits.
TAX BENEFITS
Income derived from an Approved Enterprise is subject to corporate tax at the
reduced rate of 25% (or lower in the case of a qualified "Foreign Investor's
Company," referred to as a FIC, that is at least 25% owned by non-Israeli
residents) until the earlier of (a) seven or ten, in the case of a FIC,
consecutive years, commencing in the year in which the specific Approved
Enterprise first generates taxable income (which income is not offset by
deductions attributable to other sources), (b) 12 years from the year of
commencement of production or (c) 14 years from the year of approval of the
Approved Enterprise status. A company owning an Approved Enterprise that was
approved after April 1, 1986, may elect to forego the entitlement to grants and
to certain tax benefits otherwise available under the Investment Law, and apply
for an alternative package of tax benefits ("Alternative Benefits"). Under the
Alternative Benefits, undistributed income from the Approved Enterprise is fully
tax-exempt (a "tax exemption") for a defined period. The period of tax exemption
under the Alternative Benefits program ranges between two and ten years,
depending principally upon the geographic location within Israel of the Approved
Enterprise and the type of Approved Enterprise. On expiration of the tax
exemption, the Approved Enterprise is eligible for the beneficial tax rate (25%
or lower in the case of a qualified FIC) for the remainder of the applicable
period of benefits, as described above.
Dividends paid out of income derived from an Approved Enterprise (or out of
dividends received from a company whose income is derived from an Approved
Enterprise) are generally subject to withholding tax at the rate of 15%
(deductible at source). The 15% rate is limited to dividends and distributions
out of income derived during the benefits period and actually paid at any time
up to 12 years thereafter. A company that elects the Alternative Benefits will
be subject to corporate tax at the otherwise applicable rate of 25% (or lower in
the case of a qualified FIC) in respect of the gross amount of the dividend if
it pays a dividend out of income derived by its Approved Enterprise during the
tax-exemption period, in addition to the withholding tax due on the dividend.
The tax exempt income attributable to the "Approved Enterprise" can be
distributed to shareholders without subjecting us to taxes only upon our
complete liquidation. We currently have no plans to distribute dividends.
The tax benefits available to an Approved Enterprise relate only to taxable
income attributable to that specific enterprise and are contingent upon the
fulfillment of the conditions stipulated by the Investment Law, the regulations
published thereunder and the instruments of approval for the specific
investments in the Approved Enterprise. In the event that we fail to comply with
these conditions, the tax and other benefits could be rescinded, in whole or in
part, and we might be required to refund the amount of the canceled benefits,
with the addition of CPI linkage differences and interest. We believe that our
Approved Enterprises have substantially complied with all such conditions. No
assurance can be given that we will continue to so comply or that we qualify as
a FIC.
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FINANCIAL BENEFITS
An Approved Enterprise is also entitled to a grant from the Government of Israel
with respect to investments in certain production facilities located in
designated areas within Israel, provided it did not elect the Alternative
Benefits. Grants are available for enterprises situated in development areas and
for high-technology or skill-intensive enterprises in Jerusalem. The investment
grant is computed as a percentage (up to 20%, depending upon the location and
size of the enterprise) of the original costs of the fixed assets for which
Approved Enterprise status has been granted.
The termination or substantial reduction of any of the benefits available under
the Investment Law could have a material adverse effect on future investments by
us in Israel. As long as we are in compliance with the conditions set forth in
the certificates of approvals granted to it, our income derived from Approved
Enterprise expansion programs will be tax-exempt for the prescribed period and
thereafter will enjoy reduced tax rates, as detailed above.
We were awarded "Approved Enterprise" status by the Israeli Government under the
Investment Law with respect to three investment programs, of which three
programs were completed, one in April 1993, one in March 1998 and another in
December 2003. In September 2003, we were awarded Approved Enterprise status
with respect to a fourth program. The Approved Enterprise status allows us a tax
exemption on undistributed Israeli income for the period of ten years after the
first year that we realize taxable income. As we currently have no taxable
income, these benefits have not yet commenced. With respect to the first two
investment programs, we also elected to receive Government-guaranteed long-term
loans along with the tax exemption. The benefits are conditional upon the
fulfillment of a marketing plan filed by the Company and fulfilling of the
conditions stipulated by the above law, regulations published thereunder and the
instruments of approval for the specific investments in "Approved Enterprises."
In the event of our failure to comply with these conditions, the benefits may be
cancelled and we may be required to refund the amount of the benefits, in whole
or in part, including interest.
The Investment Center of the Ministry of Industry and Commerce bases its
decision as to whether or not to approve an application, on the criteria set
forth in the Investment Law and regulations, the then prevailing policy of the
Investment Center, and the specific objectives and financial criteria of the
applicant. Accordingly, there can be no assurance that any such application will
be approved. In addition, the benefits available to an approved enterprise are
conditional upon the fulfillment of conditions stipulated in the Investment Law
and its regulations and the criteria set forth in the specific certificate of
approval. In the event that a company does not meet these conditions, it would
be required to refund a portion of the benefits already received, with the
addition of interest and penalties.
The Investment Law and regulations prescribing the benefits provide for an
expiration date for the grant of new benefits, which has been extended several
times in the past. The expiration date currently in effect is October 30, 2004,
which may be extended to December 31, 2004 by ministerial decision, and no new
benefits may be granted following that date unless the expiration date is again
extended. In addition, from time to time, the Government of Israel has discussed
reducing the benefits available to companies under the Investment Law. We cannot
assure you that our approved program and the benefits thereunder shall continue
in the future at its current level or at any level. The termination or
substantial reduction of any of the benefits available under the Investment Law
could have a material adverse effect on future investments by us.
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LAW FOR THE ENCOURAGEMENT OF INDUSTRIAL RESEARCH AND DEVELOPMENT, 1984
Under the Law for the Encouragement of Industrial Research and Development,
1984, referred to as the Research Law, and the instructions of the Director
General of the Ministry of Industry and Trade No. 4.4 of January 2, 1994,
research and development programs and the plans for the intermediate stage
between research and development, and manufacturing and sales approved by a
governmental committee of the Office of the Chief Scientist are eligible for
grants of up to 50% of the research and development project's expenditures if
they meet certain criteria. These grants are issued in return for the payment of
royalties at the rate of 3.5%-5% of the sale of products developed with funds
provided by the Office of the Chief Scientist. Total royalties will not exceed
100% (or, in some cases, 150%) of the grants received. Following the full
payment of such royalties, there is no further liability for payment, as long as
the technology and its manufacturing remain in Israel.
The technology developed pursuant to the terms of these grants may not be
transferred to third parties without the prior approval of a governmental
committee under the Research Law. Such approval is not required for the export
of any product resulting from such or research or development. Approval of the
transfer of technology may be granted only if the recipient abided by all the
provisions of the Research Law and regulation promulgated thereunder, including
the restriction on the transfer of known-how and the obligation to pay royalties
in an increased amount, of up to 300% of the grants received. There can be no
assurance that such consent, if requested, will be granted.
We participated in programs sponsored by the Office of the Chief Scientist for
the support of research and development activities. Through January 31, 2003, we
had obtained grants from the Office of the Chief Scientist aggregating
$1,778,000 for certain of our research and development projects. We are
obligated to pay royalties to the Office of Chief Scientist at the rate of
3.5%-5% of the sales of the products and other related revenues developed from
such projects, up to an amount equal to 100%-150% of the grants received.
Through January 31, 2004, we have accrued or paid royalties to the Office of the
Chief Scientist in the aggregate amount of $1.5 million. On January 31, 2003,
the aggregate liability to the Office of the Chief Scientist, which is
contingent on our income, was $394,000. Some of the accrued royalties were not
paid when due In December 2003, we reached a settlement regarding payments to
the Office of the Chief Scientist. For additional information concerning the
terms of this settlement, see "Item 5. Operating and Financial Review and
Prospects - Research and Development, Patents and Licenses - Research and
Development Grants."
TAX BENEFITS AND GRANTS FOR RESEARCH AND DEVELOPMENT
Israeli tax law allows, subject to certain conditions, a tax reduction in the
year incurred for expenditures (including capital expenditures) in scientific
research and development projects, if the expenditures are approved by the
relevant Israeli Government Ministry, determined by the field of research, the
research and development is for the promotion of enterprise, and is carried out
by, or on behalf of, the company seeking the said deduction. Expenditures not so
approved are deductible over a three-year period. However, expenditures from
grants made available to our company by the Israeli Government are not,
according to Israeli law, included in research and development expenses, and are
thus not deductible.
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TAXATION UNDER INFLATIONARY CONDITIONS
The Income Tax (Inflationary Adjustments) Law, 1985, referred to as the
Inflationary Adjustments Law, is intended to neutralize the erosion of capital
investments in business and to prevent tax benefits resulting from deduction of
inflationary expenses. This law applies a supplementary set of inflationary
adjustments to the nominal taxable profits computed under regular historical
cost principles. The Inflationary Adjustments Law introduced a special tax
adjustment for the preservation of equity based on changes in the CPI, whereby
certain corporate assets are classified broadly into fixed (inflation-resistant)
assets and non-fixed assets. Where shareholders' equity, as defined in the
Inflationary Adjustments Law, exceeds the depreciated cost of fixed assets, as
defined in the Inflationary Adjustments Law, a tax deduction that takes into
account the effect of the annual rate of inflation on such excess is allowed (up
to a ceiling of 70% of taxable income for companies in any single year, with the
unused portion carried forward on a linked basis, without limit). If the
depreciated cost of such fixed assets exceeds shareholders' equity, then such
excess, multiplied by the annual inflation rate, is added to taxable income. In
addition, subject to certain limitations, depreciation of fixed assets and
losses carried forward are adjusted for inflation on the basis of changes in the
CPI.
In November 2001, an amendment to the Inflationary Adjustments Law was passed by
the Israeli Knesset, pursuant to which the Minister of Finance, with the
approval of the finance committee of the Knesset, can determine that the
provisions of the Inflationary Adjustments Law, in whole or in part, will not
apply to a tax year if the CPI of that year did not exceed 3%.
Pursuant to the Inflationary Adjustments Law, results for tax purposes are
measured in real terms in accordance with the changes in the CPI, see note 11a
to our consolidated financial statements, included elsewhere in this annual
report. A FIC may, subject to certain conditions, elect to measure results, for
tax purposes, in dollar terms.
One of the net effects of the Inflationary Adjustment Law is that our taxable
income for Israeli corporate tax purposes will be different from our dollar
income reflected in our financial statements, which are based on changes in the
New Israeli Shekel exchange rate with respect to the dollar.
TAXATION OF NON-ISRAELI SHAREHOLDERS ON RECEIPT OF DIVIDENDS
Non-residents of Israel are generally subject to Israeli income tax on the
receipt of dividends paid on the ordinary shares at the rate of 25%, which tax
will be withheld at source. Under the U.S.-Israel Tax Treaty, the maximum tax on
dividends paid to a holder of the ordinary shares who is a U.S. resident is 25%.
However, dividends paid from income derived from our Approved Enterprise are
subject to withholding at the rate of 15%.
CAPITAL GAINS TAXES APPLICABLE TO NON-ISRAELI SHAREHOLDERS
Capital gains from the sale of our ordinary shares by non-Israeli shareholders
are exempt from Israeli taxation. In addition, the US-Israel Tax Treaty exempts
US residents who hold an interest of less than 10% in an Israeli company, and
who held an interest of less than 10% during the 12 months prior to a sale of
their shares, from Israeli capital gains tax in connection with such sale.
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(F) DIVIDENDS AND PAYING AGENTS
Not applicable.
(G) STATEMENT BY EXPERTS
Not applicable.
(H) DOCUMENTS ON DISPLAY
Any statement in this annual report about any of our contracts or other
documents is not necessarily complete. Statements made in this annual report as
to the contents of any contract, agreement or other document are necessarily
summaries of these documents and are qualified in their entirety by reference to
each such contract, agreement or other document that is filed as an exhibit to
this annual report. The exhibits themselves must be reviewed for a complete
description of the contract or document.
We are subject to the information reporting requirements of the Securities and
Exchange Act of 1934, as amended, referred to as the Exchange Act, applicable to
foreign private issuers. As a foreign private issuer, we are exempt from certain
rules and regulations under the Exchange Act prescribing the furnishing and
content of proxy statements, and our officers, directors and principal
shareholders are exempt from the reporting and "short-swing" profit recovery
provisions contained in Section 16 of the Exchange Act, with respect to their
purchase and sale of our ordinary shares. In addition, we are not required to
file reports and financial statements with the Commission as frequently or as
promptly as U.S. companies whose securities are registered under the Exchange
Act. However, we file with the Commission an annual report on Form 20-F
containing financial statements audited by an independent consulting firm. We
also furnish reports on Form 6-K containing unaudited financial information for
the first three quarters of each fiscal year.
You may examine and copy this annual report and any other document we file with
the Commission at the Commission's public reference room at 450 Fifth Street,
N.W., Washington, D.C. 20549. You may also obtain copies of the documents at
prescribed rates by writing to the Public Reference Section of the Commission at
450 Fifth Street, N.W., Washington, D.C. 20549. You may call the Commission at
1-800-SEC-0330 for further information on the operation of the public reference
facilities. The documents concerning us which are referred to in this annual
report may also be examined at our principal executive offices located at 19
Hartum Street, Jerusalem 91450, Israel.
In addition, the Commission maintains an Internet website at http://www.sec.gov
that contains reports, proxy statements, information statements and other
material that are filed through the Commission's Electronic Data Gathering,
Analysis and Retrieval, or EDGAR, system. We began filing our reports through
the EDGAR system in November 2002.
(I) SUBSIDIARY INFORMATION
Not applicable.
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ITEM 11
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk relating to our operations result primarily from changes in interest
rates and foreign currency exchange rate fluctuations, which could impact our
results of operations and financial condition. We seek to manage the exposure to
these market risks through our regular operating and financing activities.
INTEREST RATE RISK
Our interest expenses are sensitive to the LIBOR as our long-term debt bears on
average a quarterly LIBOR plus 3.5% interest rate. As of January 31, 2004, we
had approximately $3.3 million in loans bearing an average interest of LIBOR
plus 3.5% interest rate. Consequently, a 1% increase in interest rates would
cause a net loss of approximately $33,000.
We do not use derivative financial instruments to hedge against such
sensitivities.
FOREIGN CURRENCY RISKS
We are exposed to financial market risk associated with changes in foreign
currency exchange rates. The majority of our revenue is generated in dollars and
the majority of our expenses, however, is incurred in NIS. The dollar cost of
our operations in Israel is influenced by the extent to which any increase in
the rate of inflation in Israel is not offset, or is offset on a lagging basis,
by a devaluation of the NIS in relation to the dollar.
The inflation rate in Israel was (1.9)%, 6.5% and 1.4% in 2003, 2002 and 2001,
respectively. The devaluation of the NIS against the U.S. dollar was (7.5)%,
7.3% and 9.3% in 2003, 2002 and 2001, respectively. Assuming a 10% devaluation
of the U.S. dollar against the NIS, and assuming a maximum deviation of 1% in
inflation, we would experience exchange rate losses of approximately $188,000.
A significant portion of our expenditures is employee compensation-related.
Salaries are paid in NIS and are adjusted for changes in either the CPI or the
Cost of Living Allowance. This increases salary expenses in U.S. dollar terms.
The devaluation/revaluation of the NIS against the U.S. dollar
decreases/increases employee compensation expenditures as expressed in dollars,
proportionally.
Under current conditions, we do not believe that our exposure to interest rate
and foreign currency market risks will have a material impact on our results of
operations in the future. However, if we determine in the future that our
results of operations may be materially adversely affected as a result of our
exposure to such market risks, we may determine to purchase certain financial
instruments in order to hedge against such market risks.
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ITEM 12
DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES
Not applicable.
PART TWO
ITEM 13
DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES
Not applicable.
ITEM 14
MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS
For information concerning certain changes made in July 2001 to our articles of
association that modify the terms of our ordinary shares, see the information
contained in the Current Report on Form 6-K filed with the Commission on July
31, 2001. The revised terms of our ordinary shares are summarized under "Item
10. Additional Information - Memorandum and Articles of Association - Rights
Attached to Shares." For information concerning changes made in September 2003
to our share capital, see "Item 10. Additional Information - Memorandum and
Articles of Association - Changes in Share Capital."
(B), (C), (D) AND (E) Not applicable.
ITEM 15
CONTROLS AND PROCEDURES
(a) We maintain disclosure controls and procedures that are designed to ensure
that information required to be disclosed in our filings under the Securities
Exchange Act of 1934 is recorded, processed, summarized and reported within the
time periods specified in the rules and forms of the Securities and Exchange
Commission. Such information is accumulated and communicated to our management,
including our Chief Executive Officer and Chief Financial Officer, as
appropriate, to allow timely decisions regarding required disclosure. Our
management, including our Chief Executive Officer and Chief Financial Officer,
recognizes that any set of controls and procedures, no matter how well designed
and operated, can provide only reasonable assurance of achieving the desired
control objectives.
98
As of the end of the period covered by this annual report on Form 20-F, we
performed an evaluation, under the supervision and with the participation of our
management, including our Chief Executive Officer and Chief Financial Officer,
of the effectiveness of the design and operation of our disclosure controls and
procedures. Based on such evaluation, our management, including our Chief
Executive Officer and Chief Financial Officer concluded that our disclosure
controls and procedures are effective.
(b) Not applicable.
(c) Not applicable.
(d) There have been no changes in our internal controls over financial reporting
or in other factors that have materially affected, or are reasonably likely to
materially affect, the internal controls over financial reporting subsequent to
the date of their evaluation in connection with the preparation of this annual
report on Form 20-F. Therefore, no corrective actions with regard to significant
deficiencies and material weaknesses required to be were taken.
ITEM 16A
AUDIT COMMITTEE FINANCIAL EXPERT
Our board of directors has determined that Ms. Ayelet Tal, who is a member of
the audit committee, meets the Commission's applicable rules and regulations
regarding an Audit Committee Financial Expert, as such term is defined in the
instructions to paragraph (a) of Item 16A of Form 20-F.
ITEM 16B
CODE OF ETHICS
In May 2004, our board of directors adopted a code of ethics applicable to our
employees, officers and directors, including our principal executive officer,
principal financial officer and principal accounting officers and other
individuals performing similar functions, referred to as the Code of Ethics. The
Code of Ethics is intended to promote honest and ethical conduct and compliance
with the law on the part of all our employees, officers and directors,
particularly those involved in preparing our financial records and statements
submitted to our shareholders and any governmental agency. A copy of the Code of
Ethics will be provided without charge upon written request submitted to our
corporate headquarters at 19 Hartum Street, Jerusalem 91450, Israel, attention:
Controller. No amendments to, or waivers in respect of, the Code of Ethics were
made during the financial year ended January 31, 2004.
99
ITEM 16C
PRINCIPAL ACCOUNTANT FEES AND SERVICES
The table below summarizes the audit fees we and our subsidiaries paid during
each of 2002 and 2003:
YEAR ENDED JANUARY 31,
-----------------
2003 2004
------- -------
Audit Fees (1) $28,500 $22,500
Audit-Related Fees (2) 28,000 30,700
Tax Fees (3) 12,500 -
All Other Fees (4) 2,000 500
------- -------
Total $71,000 $53,700
======= =======
(1) Includes professional services rendered with respect to the audits of our
annual consolidated financial statements, review of consolidated quarterly
financial statements, statutory audits of us and our subsidiaries, consents
and assistance with review of documents filed with the Commission.
(2) Includes consultations concerning financial accounting and reporting
standards.
(3) Includes fees for services related to tax compliance, tax planning and tax
advice.
(4) Includes all other fees for miscellaneous services rendered.
Our audit committee is responsible for the oversight of our independent
auditors' work. The audit committee's policy is to pre-approve all audit and
non-audit services provided by Kost Forer Gabbay & Kasierer, a member of Ernest
& Young Global, or E&Y. These services may include audit services, audit-related
services, tax services and other services, as further described below. The audit
committee sets forth the basis for its pre-approval in detail, listing the
particular services or categories of services which are pre-approved, and
setting forth a specific budget for such services. Additional services may be
pre-approved by the audit committee on an individual basis. Once services have
been pre-approved, E&Y and our management then report to the audit committee on
a periodic basis regarding the extent of services actually provided in
accordance with the applicable pre-approval and regarding the fees for the
services performed.
100
In June 2004, our Audit Committee adopted pre-approval policies and procedures
for audit and non-audit services received from our auditors, which policies and
procedures will apply with respect to our financial statements for the year
ended January 31, 2005.
ITEM 16D
EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES
Not applicable.
ITEM 16E
REPURCHASE OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS
None.
PART III
ITEM 17
FINANCIAL STATEMENTS
We have responded to Item 18 in lieu of this Item.
ITEM 18
FINANCIAL STATEMENTS
The financial statements required by this item are found at the end of this
annual report, beginning on page F-1.
ITEM 19
EXHIBITS
The exhibits filed with or incorporated into this annual report are listed in
the index of exhibits below.
EXHIBIT NO. DESCRIPTION
1.1 Memorandum of Association of the Registrant (together with an English
translation thereof) (incorporated by reference to Exhibit 3.1 to the
Registration Statement on Form F-1 (Registration No. 333-8830))
1.2 Articles of Association of the Registrant, as amended (incorporated by
reference to Exhibit 1.2 to the annual report on Form 20-F filed with
the Commission on July 31, 2001)
101
4.1 Consulting Agreement, dated August 7, 1997, between the Registrant and
Yozma Hofsheet Ltd. (incorporated by reference to Exhibit 10.3 to the
Registration Statement on Form F-1 (Registration No. 333-8830))
4.2 1996 and 1997 Stock Option Plans of the Registrant (incorporated by
reference to Exhibit 10.7 to the Registration Statement on Form F-1
(Registration No. 333-8830))
4.3 1999 Share Option Plan of the Registrant (incorporated by reference to
Exhibit 4.3 to the annual report on Form 20-F filed with the
Commission on July 31, 2001)
4.4* 2003 Israeli Share Option Plan of the Registrant
4.5 Agreement of General Business Conditions, dated November 30, 2000,
between the Registrant and Industrial Development Bank of Israel Ltd.
(incorporated by reference to Exhibit 4.4 to the annual report on Form
20-F filed with the Commission on July 31, 2001)
4.6 Agreement, dated November 30, 2000, between the Registrant and
Industrial Development Bank of Israel Ltd. (incorporated by reference
to Exhibit 4.5 to the annual report on Form 20-F filed with the
Commission on July 31, 2001)
4.7 Debenture, dated November 30, 2000, in favor of Industrial Development
Bank of Israel Ltd., (incorporated by reference to Exhibit 4.6 to the
annual report on Form 20-F filed with the Commission on July 31, 2001)
4.8* Convertible Debenture, dated November 30, 2000, in favor of Industrial
Development Bank of Israel Ltd.
4.9 Debenture, dated September 19, 2000, in favor of Israel Discount Bank
Ltd. (incorporated by reference to Exhibit 4.7 to the annual report on
Form 20-F filed with the Commission on July 31, 2001)
4.10 Convertible Debenture, dated September 19, 2000, in favor of Israel
Discount Bank Ltd. (incorporated by reference to Exhibit 4.8 to the
annual report on Form 20-F filed with the Commission on July 31, 2001)
4.11 Credit Agreement, dated September 19, 2000, in favor of Israel
Discount Bank Ltd. (incorporated by reference to Exhibit 4.9 to the
annual report on Form 20-F filed with the Commission on July 31, 2001)
4.12 Amendment to Additional Conditions for Granting Credits, dated August
13, 2002, between the Registrant and Industrial Development Bank of
Israel Ltd. (incorporated by reference to Exhibit 4.10 to the annual
report on Form 20-F filed with the Commission on August 15, 2002)
4.13 Amendment to Convertible Debenture, dated August 13, 2002, in favor of
Industrial Development Bank of Israel Ltd. (incorporated by reference
to Exhibit 4.11 to the annual report on Form 20-F filed with the
Commission on August 15, 2002)
4.14 Amendment to Additional Conditions for Granting Credits, dated August
13, 2002, between the Registrant and Israel Discount Bank Ltd.
(incorporated by reference to Exhibit 4.12 to the annual report on
Form 20-F filed with the Commission on August 15, 2002)
4.15 Amendment to Convertible Debenture, dated August 13, 2002, in favor of
Israel Discount Bank Ltd. (incorporated by reference to Exhibit 4.13
to the annual report on Form 20-F filed with the Commission on August
15, 2002)
102
4.16 Agreement dated August 14, 2002 between the Registrant and Gibralt
Capital (incorporated by reference to Exhibit 4.14 to the annual
report on Form 20-F filed with the Commission on August 15, 2002)
4.17 Amendment to Additional Conditions for Granting Credits, dated July
30, 2003, between the Registrant and Industrial Development Bank of
Israel Ltd. (incorporated by reference to Exhibit 4.15 to the annual
report on Form 20-F filed with the Commission on July 31, 2003)
4.18 Amendment to Additional Conditions for Granting Credits, dated July
30, 2003, between the Registrant and Israel Discount Bank Ltd.
(incorporated by reference to Exhibit 4.16 to the annual report on
Form 20-F filed with the Commission on July 31, 2003)
4.19 Loan agreement, dated July 31, 2003, between the Registrant and
Smithfield Investments B.V. (incorporated by reference to Exhibit 4.17
to the annual report on Form 20-F filed with the Commission on July
31, 2003)
4.20* Loan agreement, dated July 31, 2003, between the Registrant and
Vertical Ventures, LLC
4.21* Amendment of Additional Conditions for Granting Credits - Amendment
No. 3, dated February 15, 2004, between the Registrant and Industrial
Development Bank of Israel Ltd.
4.22* Amendment No. 2 to Convertible Debenture, dated February 15, 2004,
between the Registrant and Industrial Development Bank of Israel Ltd.
4.23* Amendment No. 3 to Convertible Debenture, dated May 2, 2004, between
the Registrant and Industrial Development Bank of Israel Ltd.
4.24* Amendment No. 4 to Convertible Debenture, dated May 2, 2004, between
the Registrant and Industrial Development Bank of Israel Ltd.
4.25* Second Amendment to Convertible Debenture, dated February 9, 2004,
between the Registrant and Israel Discount Bank Ltd.
4.26* Amendment of Additional Conditions for Granting Credits, dated
February 9, 2004, between the Registrant and Israel Discount Bank Ltd.
4.27* Share purchase agreement, dated as of June 4, 2004, between the
registrant and certain purchasers named therein (including form of
warrant issued to such investors).
4.28* Agreement dated December 3, 1999, between the Registrant and
Smithfield Investments B.V.
4.29* Amendment of Additional Conditions for Granting Credits, dated July
28, 2004, between the Registrant and Israel Discount Bank Ltd.
4.30* Amendment No. 1 to Debenture, dated July 28, 2004, between the
Registrant and Israel Discount Bank Ltd.
4.31* Amendment Number 5 to Additional Conditions for Granting Credits,
dated July 28, 2004, between the Registrant and Industrial Development
Bank of Israel Ltd.
4.32* Amendment No. 1 to Debenture, dated July 28, 2004, between the
Registrant and Industrial Development Bank of Israel Ltd.
103
8 List of Subsidiaries (incorporated by reference to Exhibit 8 to the
annual report on Form 20-F filed with the Commission on July 31, 2001)
12.1* Certification of Chief Executive Officer of the Registrant pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002.
12.2* Certification of Chief Financial Officer of the Registrant pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002.
13.1* Certification of Chief Executive Officer pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
13.2* Certification of Chief Financial Officer pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
14.1* Consent of Kost Forer Gabbay & Kasierer, a member of Ernst & Young
Global
- ----------
* Filed herewith.
104
SIGNATURES
The registrant hereby certifies that it meets all of the requirements for filing
on Form 20-F and it has duly caused and authorized the undersigned to sign this
annual report on its behalf.
BY: /s/ Marc Belzberg
---------------------
Name: Marc Belzberg
Title: Director and Chief Executive Officer
Dated: July 30, 2004
<Page>
E-SIM LTD. AND ITS SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
AS OF JANUARY 31, 2004
IN U.S. DOLLARS
INDEX
<Table>
<Caption>
PAGE
---------
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM F-2
CONSOLIDATED BALANCE SHEETS F-3 - F-4
CONSOLIDATED STATEMENTS OF OPERATIONS F-5
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (DEFICIENCY) F-6
CONSOLIDATED STATEMENTS OF CASH FLOWS F-7
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS F-8 - F-35
</Table>
- - - - - - - -
<Page>
ERNST & YOUNG o KOST FORER GABBAY & KASIERER o Phone: 972-3-6232525
3 Aminadav St. Fax: 972-3-5622555
Tel-Aviv 67067, Israel
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
TO THE SHAREHOLDERS OF
E-SIM LTD.
We have audited the accompanying consolidated balance sheets of e-SIM Ltd.
(the "Company") and its subsidiaries as of January 31, 2003 and 2004, and the
related consolidated statements of operations, changes in shareholders' equity
(deficiency) and cash flows for each of the three years in the period ended
January 31, 2004. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
the Company and its subsidiaries as of January 31, 2003 and 2004, and the
consolidated results of their operations and cash flows for each of the three
years in the period ended January 31, 2004, in conformity with U.S. generally
accepted accounting principles.
Tel-Aviv, Israel KOST FORER GABBAY & KASIERER
March 15, 2004 A Member of Ernst & Young Global
F-2
<Page>
E-SIM LTD. AND ITS SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
<Table>
<Caption>
JANUARY 31,
------------------
2003 2004
-------- -------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 627 $ 238
Trade receivables (net of allowance for doubtful accounts of $ 123 and
$16 as of January 31, 2003 and 2004, respectively) 1,594 568
Other accounts receivable and prepaid expenses *) 434 347
-------- -------
Total current assets 2,655 1,153
-------- -------
SEVERANCE PAY FUND 598 714
-------- -------
LONG-TERM PREPAID EXPENSES 64 63
-------- -------
PROPERTY AND EQUIPMENT, NET 534 440
-------- -------
Total assets $ 3,851 $ 2,370
======== =======
</Table>
*) Reclassified.
The accompanying notes are an integral part of the consolidated financial
statements.
F-3
<Page>
E-SIM LTD. AND ITS SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE DATA)
<Table>
<Caption>
JANUARY 31,
---------------------
2003 2004
--------- ---------
LIABILITIES AND SHAREHOLDERS' DEFICIENCY
CURRENT LIABILITIES:
Short-term bank credit $ 14 $ 1
Current maturities of long-term bank loans 2,070 241
Current maturities of convertible bank loans 690 -
Trade payables 630 796
Convertible loan from a related party 190 -
Other convertible loan, net - 73
Employees and payroll accruals 643 778
Deferred revenues 1,265 766
Accrued expenses and other liabilities *) 617 458
--------- ---------
Total current liabilities 6,119 3,113
--------- ---------
LONG-TERM LIABILITIES:
Long-term bank loans - 2,413
Long term convertible bank loans - 641
Related parties 1,659 1,251
Capital lease obligation, net of current maturities - 43
Royalties to Government authorities *) 95 456
Accrued severance pay 869 1,105
--------- ---------
Total long-term liabilities 2,623 5,909
--------- ---------
SHAREHOLDERS' DEFICIENCY:
Ordinary shares - NIS 0.1 par value:
20,000,000 and 70,000,000 shares authorized as of January 31, 2003
and 2004, respectively; 11,665,359 and 19,823,595 shares issued
and outstanding as of January 31, 2003 and 2004, respectively 356 539
Additional paid-in capital 32,666 34,890
Receipts on account of shares 5 -
Deferred stock compensation (63) (21)
Accumulated other comprehensive income (loss) (7) 36
Accumulated deficit (37,848) (42,096)
--------- ---------
Total shareholders' deficiency (4,891) (6,652)
--------- ---------
Total liabilities and shareholders' deficiency $ 3,851 $ 2,370
========= =========
</Table>
*) Reclassified
The accompanying notes are an integral part of the consolidated financial
statements.
F-4
<Page>
E-SIM LTD. AND ITS SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE AND PER SHARE DATA)
<Table>
<Caption>
YEAR ENDED JANUARY 31,
------------------------------------------
2002 2003 2004
------------ ------------ ------------
Revenues:
Products $ 3,031 $ 3,304 $ 1,819
Services 2,005 2,916 2,682
------------ ------------ ------------
5,036 6,220 4,501
------------ ------------ ------------
Cost of revenues:
Products 169 267 122
Services 1,776 1,663 1,983
------------ ------------ ------------
1,945 1,930 2,105
------------ ------------ ------------
Gross profit 3,091 4,290 2,396
------------ ------------ ------------
Operating expenses:
Research and development, net 2,610 1,464 1,560
Selling, marketing, general and administrative, net 7,854 4,261 3,635
Restructuring and impairment of capitalized web-site
development costs 910 - -
------------ ------------ ------------
Total operating expenses 11,374 5,725 5,195
------------ ------------ ------------
Operating loss 8,283 1,435 2,799
Financial expenses (income), net 210 (9) 1,343
Other expenses, net 426 94 -
------------ ------------ ------------
Loss before taxes on income 8,919 1,520 4,142
Taxes on income 62 199 106
------------ ------------ ------------
Net loss $ 8,981 $ 1,719 $ 4,248
============ ============ ============
Basic and diluted net loss per share $ 0.77 $ 0.15 $ 0.36
============ ============ ============
Weighted average number of shares used in computing
basic and diluted net loss per share 11,663,170 11,665,359 11,963,056
============ ============ ============
</Table>
The accompanying notes are an integral part of the consolidated financial
statements.
F-5
<Page>
E-SIM LTD. AND ITS SUBSIDIARIES
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (DEFICIENCY)
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE DATA)
<Table>
<Caption>
ORDINARY SHARE CAPITAL ADDITIONAL RECEIPTS ON DEFERRED
---------------------- PAID-IN ACCOUNT OF STOCK
SHARES AMOUNT CAPITAL SHARES COMPENSATION
---------- ------ ---------- ----------- ------------
Balance as of February 1, 2001 11,659,372 $ 356 $ 32,531 $ - $ -
Exercise of options 5,987 *) - 9 - -
Comprehensive loss:
Net loss - - - - -
Foreign currency translation adjustments - - - - -
---------- ------ -------- ---- ------
Total comprehensive loss
Balance as of January 31, 2002 11,665,359 356 32,540 - -
Exercise of options - *) - - 5 -
Deferred stock compensation in respect of
repriced options - - 126 - (126)
Amortization of deferred stock
compensation for repriced options - - - - 63
Comprehensive loss:
Net loss - - - - -
Foreign currency translation adjustments - - - - -
---------- ------ -------- ---- ------
Total comprehensive loss
Balance as of January 31, 2003 11,665,359 356 32,666 5 (63)
Exercise of options 486,401 11 27 (5) -
Stock compensation in respect of repriced
options - - 46 - -
Amortization of deferred stock
compensation for repriced options - - - - 42
Compensation in respect of convertible
loans - - 1,070 - -
Conversion of convertible loans from related
parties into Ordinary shares 7,014,519 157 1,047 - -
Conversion of convertible bank loans into
Ordinary shares 657,316 15 34 - -
Comprehensive loss: - - - - -
Net loss - - - - -
Foreign currency translation adjustments - - - - -
---------- ------ -------- ---- ------
Total comprehensive loss
Balance as of January 31, 2004 19,823,595 $ 539 $ 34,890 $ - $ (21)
========== ====== ======== ==== ======
F-6A
<Caption>
ACCUMULATED TOTAL
OTHER TOTAL SHAREHOLDERS'
COMPREHENSIVE ACCUMULATED COMPREHENSIVE EQUITY
INCOME (LOSS) DEFICIT LOSS (DEFICIENCY)
------------- ----------- ------------- -------------
Balance as of February 1, 2001 $ (18) $ (27,148) $ 5,721
Exercise of options - - 9
Comprehensive loss:
Net loss - (8,981) $ (8,981) (8,981)
Foreign currency translation adjustments (24) - (24) (24)
----- --------- -------- --------
Total comprehensive loss $ (9,005)
========
Balance as of January 31, 2002 (42) (36,129) (3,275)
Exercise of options - - 5
Deferred stock compensation in respect of
repriced options - - -
Amortization of deferred stock
compensation for repriced options - - 63
Comprehensive loss:
Net loss - (1,719) $ (1,719) (1,719)
Foreign currency translation adjustments 35 - 35 35
----- --------- -------- --------
Total comprehensive loss $ (1,684)
========
Balance as of January 31, 2003 (7) (37,848) (4,891)
Exercise of options - - 33
Stock compensation in respect of repriced
options - - 46
Amortization of deferred stock
compensation for repriced options - - 42
Compensation in respect of convertible
loans - - 1,070
Conversion of convertible loans from related
parties into Ordinary shares - - 1,204
Conversion of convertible bank loans into
Ordinary shares - - 49
Comprehensive loss: - -
Net loss - (4,248) $ (4,248) (4,248)
Foreign currency translation adjustments 43 - 43 43
----- --------- -------- --------
Total comprehensive loss $ (4,205)
========
Balance as of January 31, 2004 $ 36 $ (42,096) $ (6,652)
===== ========= ========
</Table>
*) Represents an amount lower than $1.
The accompanying notes are an integral part of the consolidated financial
statements.
F-6B
<Page>
E-SIM LTD. AND ITS SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
<Table>
<Caption>
YEAR ENDED JANUARY 31,
--------------------------------
2002 2003 2004
--------- --------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (8,981) $ (1,719) $ (4,248)
Adjustments required to reconcile net loss to net cash used in operating activities:
Depreciation and amortization 653 403 234
Amortization of deferred stock compensation - 63 88
Impairment of long-term investment and capitalized website development
costs 1,027 - -
Amortization of compensation in respect of convertible loans - - 1,042
Loss on sale of property and equipment 46 94 -
Accrued interest on long-term liability - - 97
Increase (decrease) in accrued severance pay, net (9) (79) 120
Increase (decrease) in royalties to OCS and marketing fund - *) 95 (167)
Decrease (increase) in trade receivables 1,541 (246) 1,026
Decrease (increase) in other accounts receivable and prepaid expenses
including long-term 234 *) (27) 87
Increase (decrease) in trade payables (1,017) (328) 166
Increase (decrease) in accrued expenses and other liabilities *) (71) *) 9 359
Increase in related parties *) 256 *) 569 353
Increase (decrease) in employees and payroll accruals *) (359) *) 123 135
Increase (decrease) in deferred revenues *) (58) *) 916 (499)
--------- --------- --------
Net cash used in operating activities (6,738) (127) (1,207)
--------- --------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (147) (63) (163)
Proceeds from sale of property and equipment 32 50 23
--------- --------- --------
Net cash used in investing activities (115) (13) (140)
--------- --------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Exercise of options 9 - 33
Receipts on account of shares - 5 -
Short-term bank credit, net (196) 10 (13)
Proceeds from long-term bank loans 1,710 - 984
Proceeds from loan from a related party - 760 -
Principal payments of loan from a related party - - (760)
Proceeds from convertible loan from a related party - 190 1,100
Principal payments of long-term bank loans (18) (1,436) (483)
Proceeds from capital lease obligation - - 59
Principal payments of capital lease - - (6)
--------- --------- --------
Net cash provided by (used in) financing activities 1,505 (471) 914
--------- --------- --------
Effect of exchange rate changes on cash and cash equivalents (30) (67) 44
--------- --------- --------
Decrease in cash and cash equivalents (5,378) (678) (389)
Cash and cash equivalents at the beginning of the year 6,683 1,305 627
--------- --------- --------
Cash and cash equivalents at the end of the year $ 1,305 $ 627 $ 238
========= ========= ========
NON-CASH ACTIVITIES:
Conversion of convertible loan from related parties $ - $ - $ 1,204
========= ========= ========
Conversion of convertible bank loans $ - $ - $ 49
========= ========= ========
Sale of property and equipment $ - $ 66 $ -
========= ========= ========
Property and equipment capital lease obligation $ - $ - $ 53
========= ========= ========
Deferred compensation in respect of a convertible loan from related party $ - $ - $ 27
========= ========= ========
Issuance of shares $ - $ - $ 5
========= ========= ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOWS ACTIVITIES -
Cash paid during the year for interest $ 99 $ 119 $ 218
========= ========= ========
Cash paid during the year for taxes $ 59 $ 37 $ 18
========= ========= ========
</Table>
*) Reclassified
The accompanying notes are an integral part of the consolidated financial
statements.
F-7
<Page>
E-SIM LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS
NOTE 1:- GENERAL
a. e-SIM Ltd. (together with its subsidiaries, the "Company") was
incorporated in 1989 in Israel and commenced operations in 1991.
In January 1996, e-SIM Inc. a wholly-owned subsidiary of e-SIM
Ltd. was incorporated in the State of Delaware and commenced
operations. In November 1998, e-SIM Japan Ltd., a wholly-owned
subsidiary of e-SIM Ltd., was incorporated in Tokyo, Japan and
commenced operations in February 1999. These subsidiaries
coordinate the activities of the Company's direct and indirect
sales in the U.S., the Far East and Europe. In August 1999, e-SIM
Europe SARL, a wholly-owned subsidiary of e-SIM Ltd., was
incorporated in France and commenced operations. On February 1,
2003, e-SIM Europe SARL ceased operations.
The Company is a provider of MMI (man machine interface) software
solutions for wireless platform vendors, handset manufacturers
and mobile carriers. The company's solution includes development
tools, MMI applications and professional services. The Company
operates in the wireless handset markets and continues to provide
simulation-based technology for use in the design, development,
documentation, promotion, customer support and training of other
interactive electronic products and systems.
b. As for major customers, see Note 13c.
c. Restructuring costs:
During the second quarter of 2001, the Company's Board of
Directors approved a cost reduction plan. The cost reduction plan
provides for the termination of up to 74 employees and was
accounted for in accordance with Emerging Issues Task Force No.
94-3, "Liability Recognition for Certain Employee Termination
Benefits and Other Costs to Exit an Activity (Including Certain
Costs Incurred in a Restructuring)" ("EITF No. 94-3") and Staff
Accounting Bulletin No. 100, "Restructuring and Impairment
Charges" ("SAB No. 100"). The terminations resulted from the
Company's strategy to reduce costs and achieve profitability.
Restructuring charges of $309,000 were expensed during the year
ended January 31, 2002. This charge is comprised of $272,000
relating to involuntary employee terminations and $37,000
relating to other exit costs. As of January 31, 2002, all of the
restructuring costs were paid in cash.
F-8
<Page>
E-SIM LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES
The consolidated financial statements have been prepared in accordance
with accounting principles generally accepted in the United States
("U.S. GAAP").
a. Use of estimates:
The preparation of financial statements in conformity with
generally accepted accounting principles requires management to
make estimates and assumptions that effect the amounts reported
in the financial statements and accompanying notes. Actual
results could differ from those estimates.
b. Financial statements in U.S. dollars:
A majority of e-SIM Ltd.'s revenues is generated in U.S. dollars
("dollar"). In addition, a substantial portion of e-SIM Ltd.'s
costs is incurred in dollars. e-SIM Ltd.'s management believes
that the dollar is the primary currency of the economic
environment in which e-SIM Ltd. operates. Thus, the functional
and reporting currency of e-SIM Ltd. is the dollar. Accordingly,
monetary accounts maintained in currencies other than the dollar
are remeasured into U.S. dollars in accordance with Statement No.
52 of the Financial Accounting Standard Board, "Foreign Currency
Translation" ("SFAS No. 52"). All transaction gains and losses of
the remeasurement of monetary balance sheet items are reflected
in the statements of operations as financial income or expenses,
as appropriate.
The financial statements of certain subsidiaries whose functional
currency has been determined to be their local currency, have
been translated into U.S. dollars. All balance sheet accounts
have been translated using the exchange rates in effect on 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 accumulated other comprehensive income (loss) in
shareholders' deficiency.
c. Principles of consolidation:
The consolidated financial statements include the accounts of
e-SIM Ltd. and its wholly-owned subsidiaries. Intercompany
balances and transactions have been eliminated upon
consolidation.
d. Cash equivalents:
Cash equivalents include short-term highly liquid investments
that are readily convertible to cash purchased with maturities of
three months or less, at the date acquired.
F-9
<Page>
E-SIM LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)
e. Property and equipment:
Property and equipment are stated at cost, net of accumulated
depreciation. Depreciation is calculated by the straight-line
method over the estimated useful lives of the assets, at the
following annual rates:
<Table>
Computers and peripheral equipment 33%
Office furniture and equipment 6% - 20%
Motor vehicles (included under a capital lease) 15%
Leasehold improvements Over the term of the lease
</Table>
f. Impairment of long-lived assets to be disposed of:
The Company's long-lived assets are reviewed for impairment, in
accordance with Statement of Financial Accounting Standards No.
144, "Accounting for the Impairment and the Disposal of
Long-Lived Assets", whenever events or changes in circumstances
indicate that the carrying amount of an asset may not be
recoverable. Recoverability of assets to be held and used is
measured by a comparison of the carrying amount with the future
undiscounted cash flows expected to be generated by the assets.
If such assets are considered to be impaired, the impairment to
be recognized is measured by the amount by which the carrying
amount exceeds the fair value of the assets. Assets to be
disposed of are reported at the lower of the carrying amount or
fair value less costs to sell. As of January 31, 2004, no
impairment losses have been identified.
g. Revenue recognition:
The Company derives its revenues from license fees of its
products, maintenance and support, royalties and from rendering
services including consulting, software customization,
implementation, and training. The Company sells its products
through its direct sales force and indirectly through resellers,
which are considered end-users. The Company also generates
revenues from providing full electronic product simulation, and
from fees deriving from usage of the simulation.
The Company accounts for software sales in accordance with
Statement of Position 97-2, "Software Revenue Recognition", as
amended ("SOP 97-2"). SOP 97-2 generally requires that revenue
earned on software arrangements involving multiple elements are
to be allocated to each element based on the relative fair value
of the elements. In addition, the Company has adopted Statement
of Position 98-9, "Modification of SOP 97-2, Software Revenue
Recognition with Respect to Certain Transactions, "("SOP 98-9")
for all transactions entered into after January 1, 2000. SOP 98-9
requires that revenue be recognized under the "residual method"
when Vendor Specific Objective Evidence ("VSOE") of Fair Value
exists for all undelivered elements and VSOE does not exist for
all of the delivered elements and all other SOP 97-2 criteria are
met. Under the residual method any discount in the arrangement is
allocated to the delivered elements.
F-10
<Page>
E-SIM LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)
Revenue from license fees is recognized when persuasive evidence
of an agreement exists, delivery of the product has occurred, the
fee is fixed or determinable, collection is probable and no
further obligations exist.
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 and
support) is determined based on a renewal ratio and the price
charged for the undelivered element when sold separately.
Revenues from consulting services and training included in
multiple element arrangements are recognized at the time such
services are rendered.
The Company is entitled to royalties upon some of the licensing
agreements for the software tools and to fees upon usage of the
product simulation by the end-users. Revenues from royalties and
usage fees are recognized when such revenues are reported to the
Company.
Revenues from license fees that involve significant customization
and implementation of the Company's software to customer specific
specifications are recognized in accordance with Statement of
Position 81-1 "Accounting for Performance of Construction -Type
and Certain Production -Type Contracts" ("SOP 81-1"), using
contract accounting on a percentage of completion method, over
the period from signing of the license through to completion in
accordance with the "Input Method". The amount of revenue
recognized is based on the total license fees under the license
agreement and the percentage to completion achieved. The
percentage to completion is measured by monitoring progress using
records of actual time incurred to date in the project compared
to the total estimated project requirement, which corresponds to
the costs related to earned revenues. Estimates of total project
requirements are based on prior experience of customization,
delivery and acceptance of the same or similar technology and are
reviewed and updated regularly by management.
A provision for estimated losses on uncompleted contracts is
recorded in the period in which such losses are first determined,
in the amount of the estimated loss for the entire contract. As
of January 31, 2004, no such estimated losses were identified.
In transactions where a customer's contractual terms include a
provision for customer acceptance, revenues are recognized when
such acceptance has been obtained.
Deferred revenue includes unearned amounts received under
maintenance and support contracts, and amounts received from
customers but not recognized as revenue.
F-11
<Page>
E-SIM LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)
h. Capitalized web-site development costs:
During 2000, the Company adopted the provision of the Emerging
Issue Task Force ("EITF") consensus No. 00-2, "Accounting for Web
Site Development Costs", which provides guidance on what types of
costs associated with website development should be capitalized
or expensed. The Company developed an Internet website,
Livemanuals.com, and began the application phase of this software
system. During 2000, the Company capitalized $ 721,000 of
development costs related to internal use software. Such
capitalized amounts were amortized, on a straight-line basis,
over a three-year period, until the second quarter of 2001.
During the second quarter of 2001, the Company determined that
the costs incurred in developing the Livemanuals.com website were
not recoverable. Therefore $ 601,000, which represents the net
value of the investment in the web-site, was written off.
i. Research and development costs:
Statement of Financial Accounting Standards No. 86, "Accounting
for the Costs of Computer Software to be Sold, Leased or
Otherwise Marketed" ("SFAS No. 86"), requires capitalization of
certain software development costs subsequent to the
establishment of technological feasibility.
Based on the Company's product development process, technological
feasibility is established upon completion of a working model.
The Company does not incur material costs between the completion
of the working model and the point at which the products are
ready for general release. Therefore, research and development
costs are charged to the statement of operations as incurred.
j. Advertising expenses:
Advertising expenses are charged to the statement of operations
as incurred. Advertising expenses amounted to $ 325,000, $ 41,000
and $ 42,000, for the years ended January 31, 2002, 2003 and
2004, respectively.
k. Income taxes:
The Company accounts for income taxes in accordance with
Statement of Financial Accounting Standards No. 109, "Accounting
for Income Taxes" ("SFAS No. 109"). This Statement prescribes the
use of the liability method, whereby deferred tax assets and
liability account balances are determined based on differences
between the financial reporting and tax bases of assets and
liabilities and are measured using the enacted tax rates and laws
that will be in effect when the differences are expected to
reverse. The Company provides a valuation allowance, if
necessary, to reduce deferred tax assets to their estimated
realizable value.
F-12
<Page>
E-SIM LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)
l. Warranty costs:
The Company provides its customers with a warranty of up to 90
days from the shipment date. The Company's liability is to
replace the licensed software or to make a reasonable effort to
correct any defect in the licensed software. No provision for
warranty costs was recorded in the financial statements due to
immateriality.
m. Concentrations of credit risk:
Financial instruments that potentially subject the Company to
concentrations of credit risk consist primarily of cash and cash
equivalents and trade receivables.
Cash and cash equivalents are invested in major banks in the
U.S., Europe, Japan and Israel. Such deposits in the United
States may be in excess of insured limits and are not insured in
other jurisdictions. Management believes that the financial
institutions that hold the Company's investments are financially
sound, and, accordingly, minimal credit risk exists with respect
to these investments.
The trade receivables of the Company are mainly derived from
sales to customers located primarily in the United States, the
Far East, Europe and Israel. The Company performs ongoing credit
evaluation of its customers and to date has not experienced any
material losses. An allowance for doubtful accounts is determined
with respect to those amounts that the Company has determined to
be doubtful of collection, plus a 3% general allowance. The
Company does not generally require collateral. However, in
certain circumstances, the Company may require letters of credit,
other collateral or additional guarantees.
The Company has no significant off-balance-sheet concentration of
credit risk, such as foreign exchange contracts, options
contracts or other foreign hedging arrangements.
n. Accounting for stock-based compensation:
The Company has elected to follow Accounting Principles Board
Opinion No. 25, "Accounting for Stock Options Issued to
Employees" ("APB No. 25"), and FASB Interpretation No. 44,
"Accounting of Certain Transactions Involving Stock Compensation"
("FIN 44"), in accounting for its employee stock options plans.
Under APB No. 25, when the exercise price of an employee stock
option is equivalent to or above the market price of the
underlying stock on the date of grant, no compensation expense is
recognized.
Under Statement of Financial Accounting Standards No. 148,
"Accounting for Stock-Based Compensation - Transition and
Disclosure" ("SFAS No. 148"), that amended Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" ("SFAS No. 123"), pro forma information regarding
net income (loss) and net earnings (loss) per share is required
and has been determined as if the Company had accounted for its
employee stock options under the fair value method of SFAS No.
123.
F-13
<Page>
E-SIM LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)
The fair value for options granted in the years ended January 31,
2002, 2003 and 2004 is amortized over their vesting period and
estimated at the date of grant using a Black-Scholes options
pricing model with the following weighted average assumptions:
<Table>
<Caption>
YEAR ENDED JANUARY 31
-----------------------------------
2002 2003 2004
---------- ---------- ---------
Dividend yield 0% 0% 0%
Expected volatility 1.698 1.595 1.329
Risk-free interest 2% 1.5% 3.66%
Expected life of up to 4.61 years 5.75 years 6.3 years
</Table>
Pro forma information under SFAS 123, is as follows:
<Table>
<Caption>
YEAR ENDED JANUARY 31,
------------------------------------
2002 2003 2004
-------- -------- --------
IN THOUSANDS (EXCEPT PER SHARE DATA)
------------------------------------
Net loss as reported $ (8,981) $ (1,719) $ (4,248)
Add: stock-based employee compensation
intrinsic value - 63 88
Deduct: stock based employee compensation -
fair value (1,443) (288) (258)
-------- -------- --------
Pro forma net loss $(10,424) $ (1,944) $ (4,418)
======== ======== ========
Basic and diluted net loss per share as reported $ (0.77) $ (0.15) $ (0.36)
======== ======== ========
Pro forma basic and diluted net loss per share $ (0.89) $ (0.17) $ (0.37)
======== ======== ========
</Table>
o. Royalty bearing grants:
Royalty-bearing grants from the Government of Israel for funding
approved research and development projects and from the
Bi-National Industrial Research and Development Fund ("BIRD-F")
are recognized at the time the Company is entitled to such
grants, on the basis of the costs incurred and included as a
deduction of research and development costs. Research and
development grants recognized amounted to $ 427,000, $ 0 and $ 0
for the years ended January 31, 2002, 2003 and 2004,
respectively.
F-14
<Page>
E-SIM LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)
The Company also obtained grants from the Government of Israel,
through the Fund for Encouragement of Foreign Marketing
Activities. Such grants were recognized at the time the Company
was entitled to such grants on the basis of the related costs
incurred, and are presented as a deduction of selling and
marketing expenses.
p. Severance pay:
The Company's liability for severance pay is 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, if they
have been employed by the Company for at least one year. The
Company's liability for all of its employees in Israel is fully
provided by monthly deposits with insurance policies and by an
accrual. The value of these policies is recorded as an asset in
the Company's balance sheet.
The deposited funds include profits accumulated up to the balance
sheet date. The deposited funds may be withdrawn only upon the
fulfillment of the obligation pursuant to 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.
Severance expenses for the years ended January 31, 2002, 2003 and
2004, were approximately $ 494,000, $ 323,000 and $ 308,000,
respectively.
q. Fair value of financial instruments:
The following methods and assumptions were used by the Company in
estimating its fair value disclosures for financial instruments:
The carrying amounts of cash and cash equivalents, trade
receivables, trade payables, related party payables and
short-term bank credit approximate their fair value due to the
short-term maturity of such instruments.
The carrying amounts of the Company's long-term bank loans,
convertible bank loans, convertible loans from a related party
and other convertible loan approximate their fair value. Fair
value was estimated using discounted cash flow analyses, based on
the Company's incremental borrowing rates for similar types of
borrowing arrangements.
F-15
<Page>
E-SIM LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)
r. Basic and diluted net loss per share:
Basic net loss per share is computed based on the weighted
average number of Ordinary shares outstanding during each year.
Diluted net loss per share is computed based on the weighted
average number of Ordinary shares outstanding during each year,
plus dilutive potential Ordinary shares considered outstanding
during the year, in accordance with Statement of Financial
Accounting Standard No. 128, "Earnings Per Share" ("SFAS No.
128").
All convertible loans and outstanding stock options have been
excluded from the calculation of the diluted net loss per share
because all such securities are anti-dilutive for all periods
presented.
The total weighted average number of shares related to
convertible loans and stock options outstanding excluded from the
calculation of diluted net loss per share was 1,919,231,
4,259,823 and 10,110,231 for the years ended January 31, 2002,
2003 and 2004, respectively.
s. Reclassification:
Certain amounts from prior years have been reclassified to
conform to the current year's presentation. The reclassification
had no effect on previously reported net loss, shareholder's
deficiency or cash flows.
t. Impact of recently issued accounting standards:
In January 2003, the FASB issued Interpretation No. 46,
"Consolidation of Variable Interest Entities" ("FIN 46"). The
objective of FIN 46 is to improve financial reporting by
companies involved with variable interest entities. A variable
interest entity is a corporation, partnership, trust, or any
other legal structure used for business purposes that either (a)
does not have equity investors with voting rights or (b) has
equity investors that do not provide sufficient financial
resources for the entity to support its activities. FIN 46
requires a variable interest entity to be consolidated by a
company if that company is subject to a majority of the risk of
loss from the variable interest entity's activities or entitled
to receive a majority of the entity's residual returns or both.
FIN 46 also requires disclosures about variable interest entities
that the company is not required to consolidate but in which it
has a significant variable interest. The consolidation
requirements of FIN 46 apply immediately to variable interest
entities created after January 31, 2003. The consolidation
requirements apply to older entities in the first fiscal year or
interim period ending after March 15, 2004. Certain of the
disclosure requirements apply in all financial statements issued
after January 31, 2003, regardless of when the variable interest
entity was established. As of January 31, 2004, the Company does
not expect the adoption of FIN 46 to have a material impact on
its consolidated financial statements.
F-16
<Page>
E-SIM LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS
NOTE 3:- OTHER RECEIVABLES AND PREPAID EXPENSES
<Table>
<Caption>
JANUARY 31,
-----------------
2003 2004
-------- ------
IN THOUSANDS
-----------------
Government authorities $ 84 $ 86
Prepaid expenses 140 106
Employees 13 -
Grants to be received *) 182 59
Other 15 96
-------- -----
$ 434 $ 347
======== =====
</Table>
*) Reclassified.
NOTE 4:- PROPERTY AND EQUIPMENT
a. Composition of property and equipment is as follows:
<Table>
Cost:
Computers and peripheral equipment $ 1,923 $ 1,992
Office furniture and equipment 445 466
Motor vehicles (1) 271 281
Leasehold improvements 265 276
------- -------
2,904 3,015
Less - accumulated depreciation 2,370 2,575
------- -------
Depreciated cost $ 534 $ 440
======= =======
</Table>
(1) The Company leases several motor vehicles under a capital
lease.
b. Depreciation expenses for the years ended January 31, 2002, 2003
and 2004 were $ 593,000, $ 403,000 and $ 234,000, respectively.
c. As for charges, see Note 9c.
NOTE 5:- SHORT-TERM BANK CREDIT
As of January 31, 2003 and 2004, the Company had short-term revolving
credit in the amount of $14,000 and $ 1,000, respectively. The
weighted average interest rates as of January 31, 2003 and 2004, were
10.35% and 10.38%, respectively.
F-17
<Page>
E-SIM LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS
NOTE 6:- ACCRUED EXPENSES AND OTHER LIABILITIES
<Table>
<Caption>
JANUARY 31,
----------------
2003 2004
-------- -----
IN THOUSANDS
----------------
Royalties to the OCS and the Marketing Fund $ *) 527 $ 200
Government authorities *) 43 105
Other 47 153
-------- -----
$ 617 $ 458
======== =====
</Table>
*) Reclassified.
NOTE 7:- FINANCING ARRANGEMENTS
<Table>
<Caption>
WEIGHTED AVERAGE WEIGHTED AVERAGE
INTEREST RATE CONVERSION PRICE
FOR THE YEAR ENDED PER SHARE
JANUARY 31, AS OF JANUARY 31, JANUARY 31,
------------------ ----------------- -----------------
2003 2004 2003 2004 2003 2004
------- -------- ------- ------- ------- -------
IN THOUSANDS
-----------------
Bank loans, linked to 5.12% 5.12% $ - $ - $ 2,070 $ 2,654
the U.S. dollar (See a
below)
Convertible bank loans,
linked to the U.S.
dollar (see b. below) 5.12% 5.12% $ 3.85 $ 4.14 690 641
Loans from related
parties, linked to the
U.S. dollar (see c
below) 6% 6% $ - $ - 786 -
Convertible loans from
related parties, linked
to the U.S. dollar (see
c below) 6% 6% $ 0.14 $ 0.14 190 -
Other convertible loan
net linked to the U.S.
dollar (see d. below) - - $ 0.18 $ 0.18 - 73
------- -------
Total financing
arrangements $ 3,736 $ 3,368
======= =======
</Table>
F-18
<Page>
E-SIM LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS
NOTE 7:- FINANCING ARRANGEMENTS (CONT.)
a. Long-term bank loans:
During September and November 2000, the Company entered into two
long-term loan agreements with two Israeli banks, according to
which the Company received an amount of $ 4,200,000 to be repaid
within two years.
In August 2002 and 2003, the Company entered into agreements with
these two banks amending certain provisions of the agreements
governing the abovementioned loans and extending the scheduled
maturity of the loans. The 2003 amendments provide for the
repayment of the loans in 12 monthly installments of principal
and interest in the amount of $80,000. The unpaid balance of the
loans is due on August 31, 2004.
The amendments had no accounting implications due to
immateriality, in accordance with Emerging Issues Task Force No.
96-19 "Debtor's Accounting for a Modification or Exchange of Debt
Instruments" ("EITF No. 96-19").
The banks hold a security interest on the Company's right to
receive revenues pursuant to agreements with two major customers
and can demand payment of the loans prior to the maturity date
upon the occurrence of an event of default set forth in the loan
agreements, such as non-payment of scheduled principal and
interest installments or the Company's liquidation.
In addition, until at least one half of the outstanding principal
of the loans has been repaid, the Company has undertaken not to
make any cash payments of management fees to any shareholder
holding, directly or indirectly, 5% or more of its shares.
In February, March and July 2004, the Company reached an
agreement with the banks, regarding extension of the loans and
reduction in debt (See Note 15a).
b. Convertible bank loans:
In connection with the credit line agreements, the Company
entered into convertible loan agreements, in the amount of $
690,000, to be converted into Ordinary shares of the Company,
with an average conversion price of $ 3.85 per share.
In consideration for the extension of the long-term bank loans in
2002 and 2003, the terms of the convertible debentures issued to
the banks have been amended to grant them the right to convert a
portion of the loan into an additional aggregate number of
699,920 Ordinary shares at the market price of the Company's
Ordinary shares on the date of the 2002 amendments which was $
0.14 per share. (See Note 15a).
F-19
<Page>
E-SIM LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS
NOTE 7:- FINANCING ARRANGEMENTS (CONT.)
In December 2003, the banks converted some of the loans into the
Company's Ordinary shares as follows: one of the banks purchased
307,356 Ordinary shares of the Company by way of a cashless
exercise, and the other bank purchased 349,960 Ordinary shares of
the Company at a price per share of $0.14.
Upon the closing of the agreements, in accordance with EITF No.
98-5, "Accounting for Convertible Securities with Beneficial
Conversion Features or Contingently Adjustable Conversion Ratios"
("EITF No. 98-5"), the Company recorded a one-time interest
expense in the amount of approximately $ 43,000, which represents
the theoretically most beneficial conversion feature to the
holder of the note measured at the issuance date of the note that
is also the commitment date. In addition, upon the 2002 and 2003
amendments of the agreements, and in accordance with EITF No.
98-5 and EITF No. 00-27, "Application of EITF No. 98-5 to Certain
Convertible Investments", ("EITF No. 00-27") the Company has
recorded interest expenses in the amount of $ 0 and $ 14,000 in
the years ended January 31, 2003 and 2004, respectively.
c. Loans and convertible loans from related parties:
(1) In August 2002, the Company entered into an agreement with
Gibralt Holdings Ltd. ("Gibralt"), a related party that
agreed to lend the Company $ 950,000 until February 28,
2003. The loan was secured by a $ 1 million account
receivable, payable on February 28, 2003. The Company
granted the related party a security interest in the account
receivable to secure the loan. The loan bears interest at
the rate of 6% per annum. In addition, if on the due date
the repayment of the loan would result in the Company having
cash and cash equivalent reserves of less than $ 1 million,
the related party agreed to extend the date for repayment of
a portion of the loan in an amount equal to the difference
between $ 1 million and the cash and cash equivalents at
that date, until the earlier of August 15, 2003 or the date
when the cash and cash equivalents equal $ 1 million.
According to the agreement, Gibralt received the right to
convert up to $ 190,000 of the aggregate principle amount of
the loan into Ordinary shares at the price per share on the
date the loan was made at any time for a period of five
years from such date with 30 days notice before conversion.
By April 30, 2003, $ 760,000 of the loan was repaid to
Gibralt. On January 18, 2004, Gibralt converted the
remaining loan amount of $190,000, plus interest, into
1,458,964 Ordinary shares of the Company.
F-20
<Page>
E-SIM LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS
NOTE 7:- FINANCING ARRANGEMENTS (CONT.)
(2) In July 2003, the Company entered into a convertible loan
agreement with Smithfield Investments B.V. ("Smithfield"),
an entity controlled by Marc Belzberg, the Company's
Chairman, Chief Executive Officer and one of its major
shareholders. Pursuant to the agreement, Smithfield agreed
to lend the Company an amount of $ 1 million maturing on
August 1, 2004 and bearing no interest. Until that date,
Smithfield was given the right to convert the principal
amount of the loan into the Company's Ordinary shares at a
price per share of $ 0.18. In addition, upon conversion of
the entire loan amount into the Company's Ordinary shares,
Smithfield was to receive a warrant to purchase $3,000,000
worth of Ordinary shares at an exercise price per share of $
0.54. The transaction was approved by the Company's Board of
Directors, audit committee and general meeting of
shareholders.
In January 2004, Smithfield converted the loan into
5,555,556 Ordinary shares and therefore has received the
right to purchase additional shares as noted.
In accordance with EITF No. 98-5 and EITF No. 00-27, the
Company has recorded interest expenses in the amount of $
553,000, representing the theoretical most beneficial
conversion feature to Smithfield at the commitment date, and
additional interest expenses in the amount of $ 447,000,
representing the compensation related to the warrant.
d. Other convertible loans:
In July 2003, the Company signed a convertible loan agreement in
the amount of $ 100,000, maturing on August 1, 2004 and bearing
no interest. Until that date, the lender may convert the
principal amount of the loan into the Company's Ordinary shares
at a price per share of $ 0.18. In addition, upon conversion of
the entire loan amount into the Company's Ordinary shares, the
lender shall receive a warrant to purchase $ 300,000 worth of
Ordinary shares at an exercise price per share of $ 0.54. As of
January 31, 2004, the loan was not converted.
Under the provisions of EITF No. 98-5 and EITF No. 00-27, the
Company is required to record the theoretically most beneficial
feature to the lender at the commitment date. The beneficial
conversion feature amounts to $ 56,000 and is expensed to the
statement of operations over the loan period. In the year ended
January 31, 2004, the Company recorded financial expenses in the
amount of $ 27,000. In addition, upon conversion of the loan, the
Company shall record compensation expenses in the amount of $
44,000 in respect of the warrants.
F-21
<Page>
E-SIM LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS
NOTE 8:- CAPITAL LEASE OBLIGATION
The liabilities are repayable in monthly payments over a period of
five years, starting July 2003.
<Table>
<Caption>
WEIGHTED JANUARY 31,
AVERAGE 2004
INTEREST ------------
RATE IN THOUSANDS
-------- ------------
Capital lease obligations 7% $ 53
====
Aggregate annual maturities of long-term debt are as follows:
First year (current maturities) $ 10
----
Second year 11
Third year 12
Fourth year 13
Fifth year 7
----
43
----
$ 53
====
</Table>
NOTE 9:- COMMITMENTS AND CONTINGENT LIABILITIES
a. Lease commitments:
The Company leases its facilities under various operating lease
agreements, which expire on various dates. Future minimum annual
payments under non-cancelable operating leases are as follows:
<Table>
<Caption>
YEAR ENDED JANUARY 31 IN THOUSANDS
--------------------- ------------
2005 $ 95
2006 93
2007 9
-----
$ 197
=====
</Table>
Rent expenses for the years ended January 31, 2002, 2003 and
2004, were $ 410,000, $ 273,000 and $ 184,000, respectively.
b. Guarantees:
The Company has provided bank guarantees in favor of its lessors
in Israel in the amount of $ 27,000.
F-22
<Page>
E-SIM LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS
NOTE 9:- COMMITMENTS AND CONTINGENT LIABILITIES (CONT.)
c. Charges:
The Company recorded a fixed charge on its property and equipment
and a floating charge on all of its assets in favor of banks as
collateral for bank loans.
d. Legal proceedings:
In August 2002, a Japanese competitor alleged that the Company is
violating its sale rights by using certain of its components in
one of the Company's products. The Company received no
communication or further allegations from this competitor in the
course of 2003. While the Company, after consulting with its
legal advisor, is unable to predict the ultimate outcome of this
claim, it believes such a claim is without merit and intends to
defend itself. As a result, no provision was recorded in these
financial statements.
The Company is currently involved in a dispute with its former
landlord in Israel, who is demanding lease and lease-related
payments for a certain period prior to the Company's vacating the
premises. The Company has paid the landlord a certain amount it
believes is owed, but in March 2004 the landlord filed a suit
against the Company, claiming approximately $ 40,000 for the
alleged breach of contract, rental fees and interest. The Company
has filed a defense in which it denies the former landlord's
claims. The Company cannot predict at this time the outcome of
these court proceedings. As a result, no provision was recorded
in these financial statements.
e. Royalties:
(i) e-SIM Ltd. participates in programs sponsored by the
Government of Israel for the support of research and
development activities. Through January 31, 2004, e-SIM Ltd.
obtained grants from the Office of the Chief Scientist
("OCS") in the aggregate amount of $ 1,780,000 for certain
of e-SIM Ltd.'s research and development projects. e-SIM
Ltd. is obligated to pay royalties to the OCS at a rate of
3.5% to 5% of the sales of the products and other related
revenues generated by such projects, up to an amount equal
to 100% - 150% of the grants received, in NIS linked to the
U.S. dollar and bearing interest at a rate equal to
six-month LIBOR. The obligation to pay these royalties is
contingent on actual sales of the products or the generation
of such other related revenue and, in the absence of such
sales or related revenues, no payment is required.
Through January 31, 2004, e-SIM Ltd. has paid or accrued
royalties to the OCS aggregating to the amount of $
1,508,000. As of January 31, 2004, the aggregate amount of
the contingent obligation to the OCS is $ 394,000.
F-23
<Page>
E-SIM LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS
NOTE 9:- COMMITMENTS AND CONTINGENT LIABILITIES (CONT.)
Since March 1998, the Israeli Government, through the Fund
for Encouragement of Marketing Activities Abroad (the
"Fund"), has awarded e-SIM Ltd. grants related to its
foreign marketing expenses. These grants are awarded for
specific expenses incurred by e-SIM Ltd. in its foreign
marketing activities, based upon such expenses reported by
e-SIM Ltd. to the Fund. All marketing grants received from
the Fund are linked to the U.S. dollar and are repayable in
the form of royalty payments in the amount of 4% of any
increase in export sales realized by e-SIM Ltd. up to the
total amount of grants received by e-SIM Ltd. If e-SIM Ltd.
does not achieve an increase in export sales, it has no
obligation to pay any royalties or to return any funds
received through these grants. All payments are linked to
the U.S. dollar and bear interest at the rate of six-month
LIBOR.
Through January 31, 2004, e-SIM Ltd. obtained grants in an
aggregate amount of $ 778,000 from the Fund and has paid or
accrued royalties in the amount of $ 272,000. The aggregate
amount of the contingent obligation to the Fund was
$ 506,000.
In January 2004, the Company reached a settlement regarding
royalty payments to the Government of Israel. The terms of
the settlement for the return of overdue payments to the OCS
for research and development grants and for marketing
grants from the Fund for the Encouragement of Marketing
Activities are as follows: The Company shall pay quarterly
payments of $30,000 and $20,000 to the OCS and to the Fund
for the Encouragement of Foreign Marketing Activities,
respectively, beginning from May 2004 and continuing for
three years thereafter. The Company has also agreed to pay
5% of the revenues exceeding certain projected sales
presented. The Company will not be required to pay ongoing
royalties until November 2005, following which accrued
ongoing royalties will be repaid in quarterly installments
until May 2007.
(ii) e-SIM Ltd. participated in a program sponsored by the
Israeli-U.S. Binational Industrrial Research and Development
Foundation (BIRD-F), pursuant to which a portion of e-SIM
Ltd.'s development expenses was funded. Through January 31,
2004, e-SIM Ltd. obtained grants aggregating to the amount
of $ 394,000 from BIRD-F. e-SIM Ltd. is obligated to pay
royalties to BIRD-F on the proceeds from sales of products
("the development packages") resulting from the research and
development which BIRD-F funded. The payments are of $ 250
for each development package per license and $ 2,500 for
each development package per site.
The total amount of the royalties may not exceed 150% of the
grants received. All the payments are linked to the U.S.
dollar and the U.S. Consumer Price Index.
Through January 31, 2004, e-SIM Ltd. paid or accrued
royalties to BIRD-F in the aggregate amount of $ 210,000. As
of January 31, 2004, the aggregate amount of the contingent
obligation to BIRD-F was $ 381,000.
F-24
<Page>
E-SIM LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS
NOTE 10:- SHAREHOLDERS' DEFICIENCY
a. Ordinary shares:
Ordinary shares confer upon their holders voting rights, the
right to receive cash dividends if declared and the right to
share in excess assets upon liquidation of the Company.
b. Share issuance:
In July 1998, the Company consummated an initial public offering
of 2,150,000 Ordinary shares in which the shares were listed for
trade on the American Stock Exchange ("AMEX"). On March 14, 2000,
the Company changed the listing for the trading of its shares
from the AMEX to the NASDAQ National Market System ("NASDAQ").
On February 8, 2002, the Company's shares were de-listed by the
NASDAQ as a result of the Company's failure to meet NASDAQ's
continued listing requirements. Trading in the Company's shares
is currently conducted on the over-the-counter Bulletin Board
("OTCBB").
c. Stock Option Plan:
Under the Company's 1996, 1997, 1999 and 2003 Stock Option Plans
("the Plans"), options may be granted to key officers, directors
and employees of the Company.
Pursuant to the Plans, the Company reserved for issuance
11,495,797 Ordinary shares. As of January 31, 2004, 6,820,735
Ordinary shares of the Company are still available for future
grant.
Each option granted under the Plans is exercisable until the
earlier of seven years from the date of grant of the option or
the expiration dates of the respective option plans. The 1996,
1997, 1999 and 2003 option plans will expire on January 31, 2006,
2007, 2008 and 2009, respectively. The exercise price of the
options granted under the plans may not be less than the nominal
value of the shares into which such options are exercised. The
options vest primarily over four years. Any options, which are
canceled or forfeited before expiration, become available for
future grants.
F-25
<Page>
E-SIM LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS
NOTE 10:- SHAREHOLDERS' DEFICIENCY (CONT.)
A summary of the grants under the Plans is as follows:
<Table>
<Caption>
YEAR ENDED JANUARY 31,
-------------------------------------------------------------------
2002 2003 2004
-------------------- --------------------- --------------------
WEIGHTED WEIGHTED WEIGHTED
AMOUNT AVERAGE AMOUNT AVERAGE AMOUNT AVERAGE
OF EXERCISE OF EXERCISE OF EXERCISE
OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE
--------- -------- ---------- -------- --------- --------
Outstanding at the
beginning of year 1,337,149 $ 7.513 1,707,493 $ 4.17 2,397,625 $ 0.32
Granted 1,054,235 $ 1.379 1,184,661 $ 0.143 2,127,719 $ 0.51
Exercised (5,987) $ 1.598 - $ - (486,401) $ 0.08
Repriced:
Cancelled - $ - (1,071,328) $ 4.44 - $ -
Granted - $ - 1,071,328 $ 0.02 - $ -
Forfeited (677,904) $ 6.446 (494,529) $ 3.657 (194,923) $ 0.42
--------- ---------- ---------
Outstanding at the
end of the year 1,707,493 $ 4.17 2,397,625 $ 0.32 3,844,020 $ 0.36
========= ======= ========== ======= ========= ======
Exercisable
options at the
end of the year 797,283 $ 4.955 958,698 $ 0.65 898,960 $0.196
========= ======= ========== ======= ========= ======
</Table>
The options outstanding as of January 31, 2004 have been
separated into ranges of exercise prices as follows:
<Table>
<Caption>
OPTIONS
OUTSTANDING WEIGHTED OPTIONS
AS AVERAGE EXERCISABLE WEIGHTED
OF JANUARY REMAINING WEIGHTED AS OF AVERAGE
EXERCISE 31, CONTRACTUAL AVERAGE JANUARY 31, EXERCISE
PRICE 2004 LIFE EXERCISE PRICE 2004 PRICE
----------- ----------- ----------- -------------- ----------- --------
AMOUNT YEARS AMOUNT
----------- ----------- -----------
$ 0.02-0.18 1,693,700 6.016 $ 0.08 719,798 $ 0.054
$ 0.25-0.27 874,910 6 $ 0.26 - $ -
$ 0.31-0.54 1,235,410 6.3324 $ 0.706 179,162 $ 0.7617
$ 1.63-6.5 40,000 1.48 $ 3.456 - $ -
-------- -------
3,844,020 6.067 $ 0.36 898,960 $ 0.196
========= ===== ====== ======= =======
</Table>
Where the Company has recorded deferred compensation for options
issued with an exercise price below the fair value of the
Ordinary shares, the deferred compensation is amortized and
recorded as compensation expenses ratably over the vesting period
of the options. See d below regarding compensation expenses.
F-26
<Page>
E-SIM LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS
NOTE 10:- SHAREHOLDERS' DEFICIENCY (CONT.)
The weighted average fair values of options granted for the years
ended January 31, 2002, 2003 and 2004 were:
<Table>
<Caption>
YEAR ENDED JANUARY 31,
--------------------------------------------------------------------
2002 2003 2004
-------------------- --------------------- ---------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE WEIGHTED AVERAGE WEIGHTED AVERAGE WEIGHTED
EXERCISE AVERAGE EXERCISE AVERAGE EXERCISE AVERAGE
PRICE FAIR VALUE PRICE FAIR VALUE PRICE FAIR VALUE
-------- ---------- -------- ---------- -------- ----------
Options granted at exercise
price that is:
Less than market price at
date of grant $ - $ - $ 0.02 $ 0.18 $ 0.11 $ 0.13
====== ====== ====== ====== ====== ======
Equal to market price at
date of grant $ 0.95 $ 0.89 $ 0.14 $ 0.12 $ 0.51 $ 0.47
====== ====== ====== ====== ====== ======
Exceeds market price at
date of grant $ 1.51 $ 1.08 $ 0.20 $ 0.13 $ - $ -
====== ====== ====== ====== ====== ======
</Table>
d. Repricing of options:
On September 11, 2002, 1,071,328 previously granted options with
exercise prices ranging from between $ 0.14 - $ 22.5 were
repriced downward to the nominal value of the shares into which
such options are exercisable, resulting in a new measurement date
and total compensation expenses of $ 126,000 of which $ 63,000
was recognized in the year ended January 31, 2003 and $ 42,000
was recognized in the year ended January 31, 2004 for the portion
already vested. The balance will be amortized over the remaining
vesting period.
On September 18, 2003, 174,000 previously granted options with
exercise prices ranging from between $ 0.14 - $ 6.5 were repriced
downward to the nominal value of the shares into which such
options are exercisable, resulting in a new measurement date and
total compensation expenses of $ 46,000 which were recognized
immediately as the options were fully vested.
e. Dividends:
In the event that cash dividends are declared in the future, such
dividends will be paid in NIS. The Company does not intend to pay
cash dividends in the foreseeable future.
F-27
<Page>
E-SIM LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS
NOTE 11:- INCOME TAXES
a. Measurement of taxable income under the Income Tax Law
(Inflationary Adjustments), 1985:
Results for tax purposes are measured in terms of earnings in NIS
after certain adjustments for increases in Israel's Consumer
Price Index. As explained in Note 2b, the financial statements of
the Company are presented in U.S. dollars. The difference between
the annual change in Israel's Consumer Price Index and in the
NIS/dollar exchange rate causes a further difference between
taxable income and the income before taxes shown in the financial
statements. In accordance with paragraph 9(f) of SFAS No. 109,
the Company has not provided for deferred income taxes on the
difference between the functional currency and the tax bases of
assets and liabilities.
b. Tax benefits under the Law for the Encouragement of Capital
Investments, 1959 ("the law"):
e-SIM Ltd.'s production facilities in Israel have been granted
"Approved Enterprise" status by the Israeli Government under the
above law with respect to four investment programs, of which
three programs were completed, one in April 1993, another in
March 1998 and a third in December 2003. The Company has not yet
completed its investments under the fourth program, which was
approved in September 2003. The Approved Enterprise status allows
e-SIM Ltd. a tax exemption on undistributed Israeli income for a
period of 10 years after the first year in which it realizes
taxable income. As the Company currently has no taxable income,
these benefits have not yet commenced. By January 31, 2004 e-SIM
Ltd. has received final approval for the investment programs that
ended in April 1993, March 1998 and December 2003.
The entitlement to the above benefits is conditional upon e-SIM
Ltd.'s fulfillment of 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 e-SIM Ltd. may be required to refund the amount of
the benefits, in whole or in part, including interest. As of
January 31, 2004, management believes that e-SIM Ltd. is meeting
all of the aforementioned conditions.
In the event of the distribution of cash dividends from income
that is tax exempt as mentioned above, e-SIM Ltd. would have to
pay income tax at the rate of 25% on the amount distributed. The
tax exempt income attributable to the Approved Enterprise can be
distributed to shareholders without subjecting e-SIM Ltd. to
taxes only upon the complete liquidation of e-SIM Ltd. The
Company currently has no plans to distribute dividends.
As prescribed in the law, e-SIM Ltd. is entitled to claim
accelerated depreciation on equipment used in an Approved
Enterprise during five tax years.
In Israel, income from sources other than an Approved Enterprise
is taxed at the regular corporate tax rate of 36%.
F-28
<Page>
E-SIM LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS
NOTE 11:- INCOME TAXES (CONT.)
c. Tax benefits under Israel's Law for the Encouragement of Industry
(Taxation), 1969:
e-SIM Ltd. is an "Industrial Company" under the Law for the
Encouragement of Industry (Taxation), 1969, and, as such, is
entitled to certain tax benefits, including accelerated rates of
depreciation over a period of three years.
d. Israeli tax reform:
On January 1, 2003, a comprehensive tax reform took effect in
Israel. Pursuant to the reform, resident companies are subject to
Israeli tax on income accrued or derived both in Israel or
abroad.
In addition, the concept of "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.
e. Net operating losses carryforwards:
e-SIM Ltd. has accumulated tax losses in Israel as of January 31,
2004, in the amount of approximately $ 19,791,000, which may be
carried forward and offset against taxable income in the future
for an indefinite period.
Through January 31, 2004, e-SIM Inc. had U.S. federal net
operating tax loss carryforwards of approximately $ 12,324,000
that can be carried forward and offset against taxable income for
15 to 20 years, and expire from 2011 to 2021. Utilization of U.S.
net operating losses may be subject to the substantial annual
limitation due to the "change in ownership" provisions of the
Internal Revenue Code of 1986 and similar state provisions. The
annual limitation may result in the expiration of net operating
losses before utilization.
F-29
<Page>
E-SIM LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS
NOTE 11:- INCOME TAXES (CONT.)
f. Deferred income taxes:
Deferred income taxes reflect the net tax effects of temporary
differences between the carrying amounts of assets and
liabilities for financial reporting purposes and the amounts used
for income tax purposes. Significant components of the Company's
deferred tax assets are as follows:
<Table>
<Caption>
JANUARY 31,
--------------------
2003 2004
-------- ---------
IN THOUSANDS
--------------------
Net operating losses carryforward $ 9,759 $ 11,562
Reserves and allowances 190 268
-------- ---------
Net deferred tax asset before valuation allowance 9,949 11,830
Valuation allowance (9,949) (11,830)
-------- ---------
Net deferred tax asset $ - $ -
======== =========
</Table>
The Company has provided valuation allowances against the full
amount of the tax benefits in the accompanying consolidated
financial statements due to its history of losses and the current
concern regarding its ability to realize these deferred tax
assets in the future. Management currently believes that it is
more likely than not that the deferred taxes in respect to the
carryforward tax losses and other temporary differences will not
be realized in the foreseeable future.
During the year ended January 31, 2004, the Company increased its
valuation allowance by approximately $ 1,881,000.
g. Losses before taxes on income:
<Table>
<Caption>
YEAR ENDED JANUARY 31,
---------------------------
2002 2003 2004
------- ------- -------
IN THOUSANDS
---------------------------
Domestic $ 5,420 $ 387 $ 3,520
Foreign 3,499 1,133 622
------- ------- -------
$ 8,919 $ 1,520 $ 4,142
======= ======= =======
</Table>
F-30
<Page>
E-SIM LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS
NOTE 12:- RELATED PARTY TRANSACTIONS
a. In 1993, the Company entered into an agreement to pay management
fees to a company controlled by a principal shareholder in a
monthly amount of $ 11,000 that increases at a rate of 12% per
annum. The Company believes that the management fees are
comparable to fees that would have been charged by an unrelated
party. At January 31, 2004, the unpaid balance of such fees was $
1,251,000.
b. Transactions with related parties are as follows:
<Table>
<Caption>
YEAR ENDED JANUARY 31,
----------------------
2002 2003 2004
------ ----- -----
IN THOUSANDS
----------------------
Management fees $ 312 $ 350 $ 392
===== ===== =====
</Table>
c. See Note 7c for additional transactions with related parties.
NOTE 13:- REPORTABLE SEGMENTS
a. The Company follows Statement of Financial Accounting Standards
No. 131, "Disclosure About Segments of an Enterprise and Related
Information" ("SFAS No. 131"). Since February 1, 1999, the
Company's management differentiates between its Software Tools
segment and LiveProducts segment. The Software Tools segment
markets, licenses and supports its RapidPLUS software tools, and
provides training and consulting services to designers of
consumer and industrial electronics products. The LiveProducts
segment markets, licenses and produces full electronic product
simulations.
The total revenues are attributed to geographic areas based on
the location of the end customer.
F-31
<Page>
E-SIM LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS
NOTE 13:- REPORTABLE SEGMENTS (CONT.)
The following data presents the selected statements of operations data
and long-lived assets of the Company's operating segments for the
years ended January 31, 2002, 2003 and 2004:
<Table>
<Caption>
YEAR ENDED JANUARY 31,
----------------------------------------------------------------------------------------------
2002 2003 2004
----------------------------- ----------------------------- ------------------------------
SOFTWARE LIVE SOFTWARE LIVE SOFTWARE LIVE
TOOLS PRODUCTS TOTAL TOOLS PRODUCTS TOTAL TOOLS PRODUCTS TOTAL
-------- -------- ------- -------- -------- ------- -------- -------- --------
IN THOUSANDS
----------------------------------------------------------------------------------------------
Revenues $ 4,352 $ 684 $ 5,036 $ 5,193 $ 1,027 $ 6,220 $ 4,083 $ 418 $ 4,501
------- ------- ------- ------- ------- ------- ------- ------ -------
Cost of revenues:
Products 169 - 169 267 - 267 122 - 122
Services 999 777 1,776 533 1,130 1,663 1,232 751 1,983
------- ------- ------- ------- ------- ------- ------- ------ -------
1,168 777 1,945 800 1,130 1,930 1,354 751 2,105
------- ------- ------- ------- ------- ------- ------- ------ -------
Gross profit (loss) 3,184 (93) 3,091 4,393 (103) 4,290 2,729 (333) 2,396
------- ------- ------- ------- ------- ------- ------- ------ -------
Operating expenses:
Research and development, net 1,044 1,566 2,610 1,222 242 1,464 1,439 121 1,560
Selling, marketing, general and
administrative, net 3,962 3,892 7,854 3,347 914 4,261 3,312 323 3,635
Restructuring and impairment of
website development costs 90 820 910 - - - - - -
------- ------- ------- ------- ------- ------- ------- ------ -------
Total operating expenses 5,096 6,278 11,374 4,569 1,156 5,725 4,751 444 5,195
------- ------- ------- ------- ------- ------- ------- ------ -------
Operating loss before financial and
other expenses, net $ 1,912 $ 6,371 8,283 $ 176 $ 1,259 1,435 $ 2,022 $ 777 2,799
======= ======= ======= ======= ======= ======
Financial and other expenses, net 636 85 1,343
------- ------- -------
Loss before taxes on income 8,919 1,520 4,142
Taxes on income 62 199 106
------- ------- -------
Net loss $ 8,981 $ 1,719 $ 4,248
======= ======= =======
</Table>
F-32
<Page>
E-SIM LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS
NOTE 13:- REPORTABLE SEGMENTS (CONT.)
<Table>
<Caption>
JANUARY 31, 2003 JANUARY 31, 2004
--------------------------- ---------------------------
SOFTWARE LIVE SOFTWARE LIVE
TOOLS PRODUCTS TOTAL TOOLS PRODUCTS TOTAL
-------- -------- ----- -------- -------- -----
IN THOUSANDS IN THOUSANDS
--------------------------- ---------------------------
Long-lived assets $ 456 $ 78 $ 534 $ 397 $ 43 $ 440
===== ==== ===== ===== ==== =====
</Table>
b. Summary information about geographic areas:
The following presents total revenues for the years ended January
31, 2002, 2003 and 2004, and long-lived assets as of January 31,
2002, 2003 and 2004:
<Table>
<Caption>
2002 2003 2004
--------------------- --------------------- ---------------------
TOTAL LONG-LIVED TOTAL LONG-LIVED TOTAL LONG-LIVED
REVENUES ASSETS REVENUES ASSETS REVENUES ASSETS
-------- ---------- -------- ---------- -------- ----------
IN THOUSANDS
---------------------------------------------------------------------
Israel $ 55 $ 780 $ 240 $ 469 $ 1,333 $ 399
Far East *) 1,622 - 649 - 535 -
Japan 1,421 32 2,794 30 414 20
U.S.A 1,258 252 1,297 35 732 21
Europe 680 14 1,240 - 1,487 -
------- ------- ------- ----- ------- -----
$ 5,036 $ 1,078 $ 6,220 $ 534 $ 4,501 $ 440
======= ======= ======= ===== ======= =====
</Table>
*) Excluding Japan.
c. Major customer data by percentage of total revenues:
<Table>
<Caption>
YEAR ENDED JANUARY 31,
----------------------
2002 2003 2004
---- ---- ----
Customer A - 2.4% 28%
== === ==
Customer B - - 10%
== === ==
</Table>
F-33
<Page>
E-SIM LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS
NOTE 14:- SELECTED STATEMENTS OF OPERATIONS DATA
a. Research and development expenses, net:
<Table>
<Caption>
YEAR ENDED JANUARY 31,
---------------------------
2002 2003 2004
------- ------- -------
IN THOUSANDS
---------------------------
Total costs $ 3,037 $ 1,464 $ 1,560
Less - grants and participations (427) - -
------- ------- -------
$ 2,610 $ 1,464 $ 1,560
======= ======= =======
b. Selling, marketing, general and
administrative expenses, net:
Total costs $ 7,857 $ 4,219 $ 3,645
Less - grants net of royalties to the Fund (3) 42 (10)
------- ------- -------
$ 7,854 $ 4,261 $ 3,635
======= ======= =======
c. Financial expenses (income):
Financial expenses:
Interest and other $ 272 $ 231 $ 288
Amortization of deferred stock
compensation and compensation in
respect of convertible loans - - 1,130
Foreign currency translation adjustments 68 - -
------- ------- -------
340 231 1,418
------- ------- -------
Financial income:
Interest on deposits and other (130) (16) (6)
Foreign currency translation adjustments - (224) (69)
------- ------- -------
(130) (240) (75)
------- ------- -------
$ 210 $ (9) $ 1,343
======= ======= =======
</Table>
F-34
<Page>
E-SIM LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS
NOTE 15:- SUBSEQUENT EVENTS (UNAUDITED)
a. Bank loans:
In February, May and July 2004, the Company entered into
agreements amending certain provisions of its prior agreements
with the Israel Discount Bank Ltd., or Discount Bank, and with
the Industrial Development Bank of Israel Ltd., or the
Development Bank. As part of these amendments, the scheduled
maturity of the loans the banks provided to the Company was
extended. Discount Bank agreed that beginning February 28, 2005,
the Company will be required to repay the outstanding balance of
the loan as of that date, including any portion of the $0.9
million credit line it may draw upon prior to that date, in 36
equal monthly payments of principal and interest. As of July 15,
2004, the outstanding balance of the loan extended to the Company
by Discount Bank was $611,000. Development Bank was paid $400,000
in respect of its outstanding loans using proceeds received in
the new equity investment the Company completed in June 2004,
discussed below, and $71,000 in overdue payments of principal and
interest and has reduced the outstanding balance of the loan by
an additional $400,000. The remaining outstanding balance, which
was $902,000 on July 15, 2004, is to be repaid in 48 equal
monthly payments of principal beginning March 1, 2005 with
interest to continue to be paid on a monthly basis. As part of
these amendments, it was agreed with the banks that the Company
raise additional equity, a condition it met by entering into the
investment agreements in May and June 2004, discussed below. The
banks also received additional rights to purchase the Company's
ordinary shares by way of conversion of a portion of the loans as
follows: (1) Discount Bank received the right to purchase 75,000
ordinary shares at a price per share of $0.85; and (2)
Development Bank received the right to purchase 110,000 ordinary
shares at a price per share of $0.90 and 110,000 ordinary shares
at a price per share of $0.70.
b. Investment agreement:
In May and June 2004, the Company entered into an equity
investment agreement with certain investors, some of whom are
related parties of the Company, pursuant to which they purchased
an aggregate of 4,975,000 of the Company's ordinary shares for
$2,487,500, or $0.50 per share. These investors also received
warrants to purchase 1,243,750 of the Company's ordinary shares,
at $0.75 per share. The transaction was approved by the Company's
board of directors and audit committee. The purchase by the
related parties of 3,000,000 ordinary shares in the amount of
$1,500,000 and warrants to purchase an additional 750,000
ordinary shares is subject to shareholder approval. The Company
plans to submit the transaction for approval at its next general
meeting of shareholders. According to the terms of the investment
agreement, if the Company's shareholders do not approve the
investment by November 10, 2004, the investment agreement with
the related parties will be null and void and the Company will be
obligated to repay the amount invested by them together with
accrued interest at a rate equal to the six-month LIBOR
prevailing on May 10, 2004. Each of related parties has agreed
that, notwithstanding the foregoing, the Company will not be
required to repay these funds to them until August 31, 2005, if
doing so would affect the Company's ability to continue
operations as a going concern.
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F-35
EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION
1.1 Memorandum of Association of the Registrant (together with an English
translation thereof) (incorporated by reference to Exhibit 3.1 to the
Registration Statement on Form F-1 (File No. 333-8830))
1.2 Articles of Association of the Registrant, as amended (incorporated by
reference to Exhibit 1.2 to the annual report on Form 20-F filed with
the Commission on July 31, 2001)
4.1 Consulting Agreement, dated August 7, 1997, between the Registrant and
Yozma Hofsheet Ltd. (incorporated by reference to Exhibit 10.3 to the
Registration Statement on Form F-1 (File No. 333-8830))
4.2 1996 and 1997 Stock Option Plans of the Registrant (incorporated by
reference to Exhibit 10.7 to the Registration Statement on Form F-1
(File No. 333-8830))
4.3 1999 Share Option Plan of the Registrant (incorporated by reference to
Exhibit 4.3 to the annual report on Form 20-F filed with the
Commission on July 31, 2001)
4.4* 2003 Israeli Share Option Plan of the Registrant
4.5 Agreement of General Business Conditions, dated November 30, 2000,
between the Registrant and Industrial Development Bank of Israel Ltd.
(incorporated by reference to Exhibit 4.4 to the annual report on Form
20-F filed with the Commission on July 31, 2001)
4.6 Agreement, dated November 30, 2000, between the Registrant and
Industrial Development Bank of Israel Ltd. (incorporated by reference
to Exhibit 4.5 to the annual report on Form 20-F filed with the
Commission on July 31, 2001)
4.7 Debenture, dated November 30, 2000, in favor of Industrial Development
Bank of Israel Ltd. (incorporated by reference to Exhibit 4.6 to the
annual report on Form 20-F filed with the Commission on July 31, 2001)
4.8* Convertible Debenture, dated November 30, 2000, in favor of Industrial
Development Bank of Israel Ltd.
4.9 Debenture, dated September 19, 2000, in favor of Israel Discount Bank
Ltd. (incorporated by reference to Exhibit 4.7 to the annual report on
Form 20-F filed with the Commission on July 31, 2001)
4.10 Convertible Debenture, dated September 19, 2000, in favor of Israel
Discount Bank Ltd. (incorporated by reference to Exhibit 4.8 to the
annual report on Form 20-F filed with the Commission on July 31, 2001)
4.11 Credit Agreement, dated September 19, 2000, in favor of Israel
Discount Bank Ltd. (incorporated by reference to Exhibit 4.9 to the
annual report on Form 20-F filed with the Commission on July 31, 2001)
4.12 Amendment to Additional Conditions for Granting Credits, dated August
13, 2002, between the Registrant and Industrial Development Bank of
Israel Ltd. (incorporated by reference to Exhibit 4.10 to the annual
report on Form 20-F filed with the Commission on August 15, 2002)
4.13 Amendment to Convertible Debenture, dated August 13, 2002, in favor of
Industrial Development Bank of Israel Ltd. (incorporated by reference
to Exhibit 4.11 to the annual report on Form 20-F filed with the
Commission on August 15, 2002)
4.14 Amendment to Additional Conditions for Granting Credits, dated August
13, 2002, between the Registrant and Israel Discount Bank Ltd.
(incorporated by reference to Exhibit 4.12 to the annual report on
Form 20-F filed with the Commission on August 15, 2002)
4.15 Amendment to Convertible Debenture, dated August 13, 2002, in favor of
Israel Discount Bank Ltd. (incorporated by reference to Exhibit 4.13
to the annual report on Form 20-F filed with the Commission on August
15, 2002)
4.16 Agreement dated August 14, 2002 between the Registrant and Gibralt
Capital (incorporated by reference to Exhibit 4.14 to the annual
report on Form 20-F filed with the Commission on August 15, 2002)
4.17 Amendment to Additional Conditions for Granting Credits, dated July
30, 2003, between the Registrant and Industrial Development Bank of
Israel Ltd. (incorporated by reference to Exhibit 4.15 to the annual
report on Form 20-F filed with the Commission on July 31, 2003)
4.18 Amendment to Additional Conditions for Granting Credits, dated July
30, 2003, between the Registrant and Israel Discount Bank Ltd.
(incorporated by reference to Exhibit 4.16 to the annual report on
Form 20-F filed with the Commission on July 31, 2003)
4.19 Loan agreement dated, July 31, 2003, between the Registrant and
Smithfield Investments B.V. (incorporated by reference to Exhibit 4.17
to the annual report on Form 20-F filed with the Commission on July
31, 2003)
4.20* Loan agreement, dated July 31, 2003, between the Registrant and
Vertical Ventures, LLC
4.21* Amendment of Additional Conditions for Granting Credits - Amendment
No. 3, dated February 15, 2004, between the Registrant and Industrial
Development Bank of Israel Ltd.
4.22* Amendment No. 2 to Convertible Debenture, dated February 15 2004,
between the Registrant and Industrial Development Bank of Israel Ltd.
4.23* Amendment No. 3 to Convertible Debenture, dated May 2, 2004, between
the Registrant and Industrial Development Bank of Israel Ltd.
4.24* Amendment No. 4 to Convertible Debenture, dated May 2, 2004, between
the Registrant and Industrial Development Bank of Israel Ltd.
4.25* Second Amendment to Convertible Debenture, dated February 9, 2004,
between the Registrant and Israel Discount Bank Ltd.
4.26* Amendment of Additional Conditions for Granting Credits, dated
February 9, 2004, between the Registrant and Israel Discount Bank Ltd.
4.27* Share purchase agreement dated as of June 4, 2004 between the
registrant and certain purchasers named therein (including form of
warrant issued to such investors).
4.28* Agreement dated December 3, 1999, between the Registrant and
Smithfield Investments B.V.
4.29* Amendment of Additional Conditions for Granting Credits, dated July
28, 2004, between the Registrant and Israel Discount Bank Ltd.
4.30* Amendment No. 1 to Debenture, dated July 28, 2004, between the
Registrant and Israel Discount Bank Ltd.
4.31* Amendment Number 5 to Additional Conditions for Granting Credits,
dated July 28, 2004, between the Registrant and Industrial Development
Bank of Israel Ltd.
4.32* Amendment No. 1 to Debenture, dated July 28, 2004, between the
Registrant and Industrial Development Bank of Israel Ltd.
8 List of Subsidiaries (incorporated by reference to Exhibit 8 to the
annual report on Form 20-F filed with the Commission on July 31, 2001)
12.1* Certification of Chief Executive Officer of the Registrant pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002.
12.2* Certification of Chief Financial Officer of the Registrant pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002.
13.1* Certification of Chief Executive Officer pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
13.2* Certification of Chief Financial Officer pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
14.1* Consent of Kost Forer Gabbay & Kasierer, a member of Ernst & Young
Global
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* Filed herewith.