AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON MARCH 30, 2006
================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 20-F
[_] REGISTRATION STATEMENT PURSUANT TO SECTION 12(B) OR (G) OF THE SECURITIES
EXCHANGE ACT OF 1934
OR
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2005
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ________ TO ________
OR
[_] SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
DATE OF EVENT REQUIRING THIS SHELL COMPANY REPORT ________
COMMISSION FILE NUMBER 0-28878
TEFRON LTD.
(Exact name of Registrant as specified in its charter)
ISRAEL
(Jurisdiction of incorporation or organization)
IND. CENTER TERADYON, P.O. BOX 1365, MISGAV 20179, ISRAEL
(Address of principal executive offices)
Securities registered or to be registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
- ---------------------------- ---------------------------------------------
ORDINARY SHARES, NEW YORK STOCK EXCHANGE
NIS 1.0 PAR VALUE PER SHARE
Securities registered or to be registered pursuant to Section 12(g) of the Act:
NONE
(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:
18,012,976 ORDINARY SHARES, NIS 1.0 PAR VALUE PER SHARE
Indicate by check mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act.
YES [_] NO [X]
If this report is an annual or transition report, indicate by check mark if the
registrant is not required to file reports pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934.
YES [_] NO [X]
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [_]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
one):
LARGE ACCELERATED FILER [_] ACCELERATED FILER [_] NON-ACCELERATED FILER [X]
Indicate by check mark which financial statement item the registrant has elected
to follow.
ITEM 17 [_] ITEM 18 [X]
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Sections 12, 13, or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court.
YES [_] NO [_]
NOT APPLICABLE
ii
TABLE OF CONTENTS
Page
PART I 3
ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS 3
ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE 3
ITEM 3. KEY INFORMATION 3
A. Selected Financial Data 3
B. Capitalization and Indebtedness 4
C. Reasons for the Offer and Use of Proceeds 4
D. Risk Factors 4
ITEM 4. INFORMATION ON THE COMPANY 15
A. History and Development of the Company 15
B. Business Overview 17
C. Organizational Structure 27
D. Property, Plants and Equipment 27
ITEM 4A UNRESOLVED STAFF COMMENTS 29
ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS 30
ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES 45
A. Directors and Senior Management 45
B. Compensation 48
C. Board Practices 50
D. Employees 53
E. Share Ownership 54
ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS 57
A. Major Shareholders 57
B. Related Party Transactions 58
C Interests of Experts and Counsel 61
ITEM 8. FINANCIAL INFORMATION 61
ITEM 9. THE OFFER AND LISTING 62
A. Offer and Listing Details 62
B. Plan of Distribution 63
C. Markets 63
D. Selling Shareholders 63
E. Dilution 63
F. Expenses of the Issue 63
ITEM 10. ADDITIONAL INFORMATION 63
A. Share Capital 63
B. Memorandum and Articles of Association 63
C. Material Contracts 66
D. Exchange Controls 77
E. Taxation 77
F. Dividends and Payment Agents 81
G. Statements by Experts 81
H. Documents on Display 81
I. Subsidiary Information 82
ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 82
ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES 83
iii
PART II 84
ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES 84
ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS
AND USE OF PROCEEDS 84
ITEM 15. CONTROLS AND PROCEDURES 84
ITEM 16. [RESERVED] 84
ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT 84
ITEM 16B. CODE OF ETHICS 84
ITEM 16C. ACCOUNTANTS' FEES AND SERVICES 84
ITEM 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT
COMMITTEES 85
ITEM 16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND
AFFILIATED PURCHASERS 86
PART III 86
ITEM 17. FINANCIAL STATEMENTS 86
ITEM 18. FINANCIAL STATEMENTS 86
ITEM 19. EXHIBITS 87
iv
INTRODUCTION
As used in this Annual Report on Form 20-F, references to "we", "our",
"us", "Tefron" or the "Company" are references to Tefron Ltd., a company
organized under the laws of the State of Israel, and its wholly-owned
subsidiaries, unless indicated otherwise.
Our consolidated financial statements have been prepared in United States
dollars and in accordance with accounting principles generally accepted in the
United States, or U.S. GAAP. See Note 2 of the Notes to our Consolidated
Financial Statements. All references in this Annual Report to "U.S. dollars,"
"dollars" or "$" are to United States dollars and all references in this Annual
Report to "NIS" or "shekels" are to New Israeli Shekels. Unless otherwise
indicated, and when no date is specified, NIS amounts have been translated into
U.S. dollars at NIS 4.603 to $1.00, the representative rate of exchange
published by the Bank of Israel, the Israeli central bank, for December 31,
2005. The representative exchange rate between the NIS and the dollar as
published by the Bank of Israel for March 24, 2006 was NIS 4.681 to $1.00.
All references in this Annual Report to "Victoria's Secret" are both to the
Victoria's Secret stores and Victoria's Secret Catalog owned and operated by
Intimate Brands, Inc., a subsidiary of The Limited, Inc., and to Mast Industries
Inc., a wholly-owned subsidiary of The Limited, which imports and distributes
women's intimate apparel and related products on behalf of Victoria's Secret
stores, Victoria's Secret Catalog, Cacique and Abercrombie & Fitch. All
references in this Annual Report to "Warnaco/Calvin Klein" are to Warnaco Inc.,
the owner worldwide of the Calvin Klein trademarks, rights and business for
women's intimate apparel and men's underwear. All references in this Annual
Report to "Nike" are to Nike, Inc.
FORWARD-LOOKING STATEMENTS
This Annual Report contains forward-looking statements within the meaning
of the U.S. Securities Act of 1933, as amended, the U.S. Securities Exchange Act
of 1934, as amended, and the safe harbor provisions of the United States Private
Securities Litigation Reform Act of 1995. These forward-looking statements
involve risks and uncertainties and relate to our future plans, objectives,
expectations and intentions. The use of words such as "may," "will," "expect,"
"anticipate," "intend," "plan," "estimate," "believe," "continue" or other
similar expressions often identify forward-looking statements but are not the
only way we identify these statements. These forward-looking statements reflect
our current expectations and assumptions as to future events that may not prove
to be accurate.
We cannot guarantee that the forward-looking statements described in this
Annual Report will transpire. Our actual results are subject to a number of
risks and uncertainties and could differ materially from those discussed in
these statements. Factors that could contribute to these differences include,
but are not limited to, those discussed under "Item 3. Key Information," "Item
4. Information on the Company" and "Item 5. Operating and Financial Review and
Prospects" and elsewhere in this Annual Report. The uncertainties that may cause
differences include, but are not limited to:
o our customers' continued purchase of our products in the same volumes
or on the same terms;
o the cyclical nature of the clothing retail industry;
o the competitive nature of the markets in which we operate, including
the ability of our competitors to enter into and compete in the
seamless market in which we operate;
o the potential adverse effect on our business resulting from our
international operations, including increased custom duties and import
quotas (e.g., in China, where we manufacture for our swimwear
division).
1
o the potential adverse effect on our future operating efficiency
resulting from our expansion into new product lines with more
complicated products and different raw materials;
o the purchase of new equipment that may be necessary as a result of our
expansion into new product lines;
o our dependence on our suppliers for our machinery and the maintenance
of our machinery;
o the fluctuating costs of raw materials;
o our dependence on subcontractors in connection with our manufacturing
process;
o our failure to generate sufficient cash from our operations to pay our
debt;
o fluctuations in inflation and currency rates; and
o the limitations and restrictions imposed by our substantial debt
obligations.
In addition, you should note that our past financial and operational
performance is not necessarily indicative of future financial and operational
performance. We undertake no obligation to update any forward-looking
statements, whether as a result of new information, future events or otherwise.
2
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
3A. SELECTED FINANCIAL DATA
The following selected financial data as of December 31, 2004 and 2005 and
for each of the three years ended December 31, 2003, 2004 and 2005 have been
derived from, and should be read in conjunction with, our consolidated financial
statements and notes thereto appearing elsewhere in this Annual Report. The
selected financial data as of December 31, 2001, 2002 and 2003 and for each of
the years ended December 31, 2001 and December 31, 2002 have been derived from
our audited financial statements not included in this Annual Report.
YEAR ENDED DECEMBER 31,
2001 2002 2003 2004 2005
--------- --------- --------- --------- ---------
(In thousands, except per share data)
STATEMENT OF INCOME DATA:
Sales, net $ 188,949 $ 190,305 $ 163,086 $ 182,819 $ 205,585
Cost of sales 169,173 151,385 139,422 159,937 166,217
Restructuring costs -- 1,550 -- -- --
--------- --------- --------- --------- ---------
Gross profit 19, 776 37, 370 23,664 22,882 39,368
Selling, general and administrative
expenses 20,140 18,358 20,323 22,387 19,837
Impairment and other expenses related
to the put option exercise -- -- -- -- 6,073
Restructuring costs -- 3,793 -- -- --
--------- --------- --------- --------- ---------
Operating income (loss) (364) 15,219 3,341 495 13,458
Financing expenses, net 9,396 5,457 5,628 5,212 4,371
Other income (expenses), net (843) (2,293) 228 -- 409
--------- --------- --------- --------- ---------
Income (loss) before taxes on income (10,603) 7,469 (2,059) (4,717) 9,496
Taxes on income (tax benefit) (837) 4,979 (424) 203 7,818
--------- --------- --------- --------- ---------
Income (loss) after income
Taxes (9,766) 2,490 (1,635) (4,920) 1,678
Equity in losses of an affiliate
company (240) (1,172) (183) -- --
Minority interest in losses
(earnings) of a subsidiary . -- (822) (2,550) (1,945) 1,615
Pre-acquisition loss of subsidiary
since April 1, 2003 through May
5, 2003 -- -- (85) -- --
--------- --------- --------- --------- ---------
Income (loss) before cumulative
effect of change in accounting
principles (10,006) 496 (4,453) (6,865) 3,293
Cumulative effect of change in
accounting principle -- (17,994) -- -- --
--------- --------- --------- --------- ---------
Net income (loss) (10,006) (17,498) (4,453) (6,865) 3,293
Basic and diluted net earnings (loss)
per share:
Basic net earnings (losses) per share
before cumulative effect of
change in accounting
principles (0.81) 0.04 (0.36) (0.44) 0.19
========= ========= ========= ========= =========
Loss per share from cumulative effect
of change in accounting principle -- (1.45) -- -- --
========= ========= ========= ========= =========
Basic net earnings (losses) per share
basic (0.81) (1.41) (0. 36) (0.44) 0.19
--------- --------- --------- --------- ---------
Diluted net earnings (losses) per
share (0.81) (1.41) (0. 36) (0.44) 0.18
--------- --------- --------- --------- ---------
Weighted average number of shares
used for computing basic
earnings (losses) per share 12,412 12,410 12,412 15,604 17,719
--------- --------- --------- --------- ---------
Weighted average number of shares
used for computing diluted
earnings (losses) per
share 12,412 12,410 12,412 15,604 18,543
========= ========= ========= ========= =========
3
AT DECEMBER 31,
-----------------------------------------------------------------------------
2001 2002 2003 2004 2005
--------- --------- --------- --------- ---------
(in thousands)
Cash and cash equivalents $ 5,078 $ 6,742 $ 5,747 $ 3,558 $ 8,201
Working capital (deficit) (6,958) (6,167) (14,524) (8,441) 8,777
Total assets 229,065 197,743 201,591 191,531 185,880
Total debt(1) 131,609 98,890 99,124 78,507 66,370
Shareholders' equity 58,588 41,108 36,655 46,744 54,685
Share Capital 5,575 5,575 5,575 6,583 6,810
Additional paid in capital 62,810 62,810 62,810 79,243 83,069
- ----------
(1) Total debt consists of total bank debt, other loans received and
capital lease obligations.
3B. CAPITALIZATION AND INDEBTEDNESS
Not Applicable.
3C. REASONS FOR THE OFFER AND USE OF PROCEEDS
Not Applicable.
3D. RISK FACTORS
WE DEPEND ON A SMALL NUMBER OF PRINCIPAL CUSTOMERS WHO HAVE IN THE
PAST BOUGHT OUR PRODUCTS IN LARGE VOLUMES. WE CANNOT ASSURE THAT THESE
CUSTOMERS OR ANY OTHER CUSTOMER WILL CONTINUE TO BUY OUR PRODUCTS IN THE
SAME VOLUMES OR ON THE SAME TERMS.
4
Our sales to Victoria's Secret accounted for approximately 38.2% of our
total sales in 2003, 38.5% of our total sales in 2004 and 33.7% of our total
sales in 2005. Our sales to Nike accounted for approximately 3.2% of our total
sales in 2003, 6.8% of our total sales in 2004 and 21.5% of our total sales in
2005. Our sales to Target, Banana Republic and The Gap, J.C. Penny, Calvin Klein
and Cardinal Healthcare accounted in the aggregate for approximately 32.5% of
our total sales in 2003, 35.3% of our total sales in 2004 and 27.2% of our total
sales in 2005. We do not have long-term purchase contracts with our customers,
and our sales arrangements with our customers do not have minimum purchase
requirements. We cannot assure that Victoria's Secret, Nike, Target, Banana
Republic and The Gap, J.C Penny, Calvin Klein or Cardinal Healthcare or any
other customer will continue to buy our products at all or in the same volumes
or on the same terms as they have in the past. Their failure to do so may
significantly reduce our sales. In addition, we cannot assure that we will be
able to attract new customers.
Cardinal Healthcare is a customer of our subsidiary, Alba Health LLC, or
AlbaHealth, and accounted for approximately 8.5% of our sales in 2005. We have
delivered a notice to exercise our option to require AlbaHealth to purchase our
ownership interest in AlbaHealth, and we are in the process of negotiating the
final terms of the purchase. Upon the completion of this transaction, Cardinal
Healthcare will no longer be a customer of ours. See "Item 10. Additional
Information - 10C. Material Contracts - AlbaHealth Option Agreement."
A material decrease in the quantity of sales made to our principal
customers, a material adverse change in the terms of such sales or a material
adverse change in the financial conditions of our principal customers could
significantly reduce our sales.
OUR PRINCIPAL CUSTOMERS ARE IN THE CLOTHING RETAIL INDUSTRY, WHICH IS
SUBJECT TO SUBSTANTIAL CYCLICAL VARIATIONS. OUR REVENUES WILL DECLINE
SIGNIFICANTLY IF OUR PRINCIPAL CUSTOMERS DO NOT CONTINUE TO BUY OUR
PRODUCTS IN LARGE VOLUMES DUE TO AN ECONOMIC DOWNTURN.
Our customers are in the clothing retail industry, which is subject to
substantial cyclical variations and is affected strongly by any downturn in the
general economy. A downturn in the general economy, a change in consumer
purchasing habits or any other events or uncertainties that discourage consumers
from spending, could have a significant effect on our customers' sales and
profitability. Such downturns, changes, events or uncertainties could result in
our customers having larger inventories of our products than expected. These
events could result in decreased purchase orders from us in the future, which
would significantly reduce our sales and profitability. For example, the
difficult global economic environment and the continuing soft retail market
conditions in the world and specifically in the U.S. both before and especially
after the events of September 11, 2001 were reflected in disappointing clothing
retail sales in the year 2001 compared to the same period in the year 2000, and
consequently decreased our order backlog and production levels. A prolonged
economic downturn could harm our financial condition.
THE CLOTHING RETAIL INDUSTRY IS SUBJECT TO CHANGES IN FASHION
PREFERENCES. IF TEFRON AND ITS CUSTOMERS MISJUDGE A FASHION TREND OR THE
PRICE AT WHICH CONSUMERS ARE WILLING TO PAY FOR OUR PRODUCTS, OUR REVENUES
COULD BE ADVERSELY AFFECTED.
The clothing retail industry is subject to changes in fashion preferences.
We design and manufacture products based on our and our customers' judgment as
to what products will appeal to consumers and what price consumers would be
willing to pay for our products. We may not be successful in accurately
anticipating consumer preferences and the prices that consumers would be willing
to pay for our products. If we are not successful, our customers may reduce the
volume of their purchases from us and/or the prices at which we sell our
products will decline, in either case resulting in reduced revenues.
5
OUR MARKETS ARE HIGHLY COMPETITIVE AND SOME OF OUR COMPETITORS HAVE
NUMEROUS ADVANTAGES OVER US; WE MAY NOT BE ABLE TO COMPETE SUCCESSFULLY.
We compete directly with a number of manufacturers of intimate apparel,
swimwear and active-wear, many of which have a lower cost-base than Tefron,
longer operating histories, larger customer bases, greater geographical
proximity to customers and significantly greater financial and marketing
resources than we do. Increased competition, direct or indirect, could reduce
our revenues and profitability through pricing pressure, loss of market share
and other factors. We cannot assure that we will be able to compete successfully
against existing or new competitors, as the market for our products evolves and
the level of competition increases. Moreover, our competitors, especially those
from the Far East, have established relationships with our customers, which has
caused an erosion of prices of some of the products of our Cut & Sew Division;
current or future relationships between our existing and prospective
competitors, especially from the Far East, with existing or potential customers,
could materially affect our ability to compete. In addition, we cannot assure
that our customers will not seek to manufacture our products through alternative
sources and thereby eliminate the need to purchase our products. See "Item 4.
Information on the Company - 4B. Business Overview - Competition."
Our customers operate in an intensely competitive retail environment. In
the event that any of our customers' sales decline for any reason, whether or
not related to us or to our products, our sales to such customers could be
materially reduced.
In addition, our competitors may be able to purchase seamless knitting
machines and other equipment similar to, but less expensive than, the Santoni
knitting machines we use to knit garments in our Hi-Tex manufacturing process.
By reducing their production cost, our competitors may lower their selling
prices. If we are forced to reduce our prices and we cannot reduce our
production costs, it will cause a reduction in our profitability. Furthermore,
if there is a weak retail market or a downturn in the general economy,
competitors may be pressured to sell their inventory at substantially depressed
prices. A surplus of intimate apparel at significantly reduced prices in the
marketplace would significantly reduce our sales.
WE FACE SEVERAL RISKS, INCLUDING POLITICAL, ECONOMIC, SOCIAL, CLIMATIC
RISKS, ASSOCIATED WITH INTERNATIONAL BUSINESS.
Approximately 92% of our sales in 2004 and in 2005 were made to customers
in North America, and we intend to continue to expand our sales to customers in
the United States and Europe. In addition, a substantial majority of our raw
materials are purchased outside of Israel. Furthermore, a substantial majority
of our sewing operation is performed in Jordan, and products, equipment and
machinery of ours are situated in Jordan for that purpose. Our international
sales and purchases are affected by costs associated with shipping goods and
risks inherent in doing business in international markets, including:
o changes in regulatory requirements;
o export restrictions, tariffs and other trade barriers;
o quotas imposed by international agreements between the United States
and certain foreign countries;
o currency fluctuations;
o longer payment cycles;
o difficulties in collecting accounts receivable;
o political instability, hostility and seasonal reductions in business
activities; and
o strikes and general economic problems.
Any of these risks could have a material adverse effect on our ability to
deliver or receive goods on a competitive and timely basis and on our results of
operations. We cannot assure that we will not encounter significant difficulties
in connection with the sale or procurement of goods in international markets in
the future or that one or more of these factors will not significantly reduce
our sales and profitability. See "Item 4. Information on the Company - 4B.
Business Overview - Manufacturing and Production."
6
In addition, we may enter into joint ventures with third parties or
establish operations outside of Israel that will subject us to additional
operating risks. These risks may include diversion of management time and
resources and the loss of management control over such operations and may
subject us to the laws of such jurisdiction. Due to commercial disputes that
arose between us and the other shareholder of our subsidiary that managed
operations in Madagascar, we no longer have production activities in Madagascar.
In the context of these commercial disputes, the court appointed a liquidator to
sell the company and to use the proceeds to pay third party creditors. We don't
currently expect to incur material additional costs in connection with the court
procedure, although we cannot be certain.
In addition to our production facilities in Israel, we currently have
production facilities in Jordan, we have relationships with manufacturers in
China and Cambodia and we are in the process of shifting additional sewing
production out of Israel to benefit from lower labor costs.
Our ability to benefit from the lower labor costs will depend on the
political, social and economic stability of these countries and in the Middle
East and Africa in general. We cannot assure that the political, economic or
social situation in these countries or in the Middle East and Africa in general
will not have a material adverse effect on our operations, especially in light
of the potential for hostilities in the Middle East. The success of the
production facilities also will depend on the quality of the workmanship of
laborers and our ability to maintain good relations with such laborers, in these
countries. We cannot guarantee that our operations in China, Cambodia, Jordan or
any newer locations outside of Israel will be cost-efficient or successful.
OUR EXPANSION INTO NEW PRODUCT LINES WITH MORE COMPLICATED PRODUCTS
AND DIFFERENT RAW MATERIALS REDUCED OUR OPERATING EFFICIENCY DURING 2003
AND 2004. WE MAY ALSO FACE OPERATING EFFICIENCY DIFFICULTIES IN THE FUTURE.
During 2003, 2004 and 2005, we invested significant efforts to develop and
expand new product lines, including active-wear products and swimwear, to
diversify our product line and our client base. The manufacturing of new, more
complicated products with different raw materials reduced our operating
efficiency in 2003 and 2004. Although our operating efficiency improved in 2005,
our continued efforts to develop and expand new product lines may result in
additional reductions in operating efficiency in the future.
OUR EXPANSION INTO NEW PRODUCT LINES, IN PARTICULAR ACTIVE-WEAR
BUSINESS PRODUCTS, INVOLVES THE MANUFACTURE OF NEW PRODUCTS, WHICH HAS AND
MAY REQUIRE US TO PURCHASE ADDITIONAL MACHINERY ADAPTED TO MANUFACTURE SUCH
PRODUCTS. THE ADDITIONAL CAPITAL EXPENDITURES INCURRED IN CONNECTION WITH
THESE PURCHASES MAY REDUCE OUR FUTURE CASH FLOW.
During 2003, 2004 and 2005 we invested significant efforts to develop and
expand our new product lines, in particular active-wear products, to diversify
our product line and our client base. Active-wear products that we manufacture
are made in bigger sizes than intimate apparel, both because our active-wear
products are intended for both men and women, and because our active-wear
products involve the manufacture of more tops. As a result, we have purchased
and may need to purchase additional knitting machines and other equipment
adapted to manufacture our new product lines. In addition, the manufacture of
active-wear products at times requires equipment with new technologies. The
additional capital expenditures that may be incurred in connection with these
purchases may reduce our future cash flow.
WE DEPEND ON OUR SUPPLIERS FOR MACHINERY AND THEIR MAINTENANCE. WE MAY
EXPERIENCE DELAYS OR ADDITIONAL COSTS SATISFYING OUR PRODUCTION
REQUIREMENTS DUE TO OUR RELIANCE ON THESE SUPPLIERS.
We purchase machinery and equipment used in our Hi-Tex manufacturing
process from a sole supplier. If our supplier is not able to provide us with
maintenance, additional machinery or equipment as needed, we might not be able
to maintain or increase our production to meet any demand for our products.
7
OUR RESULTS OF OPERATIONS WOULD BE MATERIALLY AND ADVERSELY AFFECTED
IN THE EVENT WE ARE UNABLE TO OPERATE OUR PRINCIPAL PRODUCTION FACILITIES
IN SEGEV, ISRAEL.
All of our manufacturing with respect to our Seamless Division, which
includes the major portion of our manufacture of all of our active-wear
products, is located in a complex of production facilities located in Segev,
Israel. These facilities also contain a significant portion of our machinery and
equipment, including Santoni machines and adaptations and configurations that we
have made to the machinery and equipment, as well as infrastructure that we have
built tailored to our needs. We have no effective back-up for these operations
and, in the event that we are unable to use the production facilities located in
Segev, Israel as a result of damage or for any other reason, our ability to
manufacture a major portion our products and our relationships with customers
could be significantly impaired and this would materially and adversely affect
our results of operation.
WE ARE SUBJECT TO FLUCTUATING COSTS OF RAW MATERIALS.
We use cotton yarn, lycra, spandex, various polymeric yarn and elastic as
primary materials for manufacturing our products. Our financial performance
depends, to a substantial extent, on the cost and availability of these raw
materials. The capacity, supply and demand for such raw materials are subject to
cyclical and other market factors and may fluctuate significantly. As a result,
our cost in securing raw materials is subject to substantial increases and
decreases over which we have no control except by seeking to time our purchases
of cotton and polymeric yarns, which are our principal raw materials, to take
advantage of favorable market conditions. For example, in 2004 and 2005 the cost
of synthetic fibers increased due to rising energy costs, and there may be a
similar increase in 2006. We cannot assure that we will be able to pass on to
customers the increased costs associated with the procurement of raw materials.
Moreover, there has in the past been, and there may in the future be, a time lag
between the incurrence of such increased costs and the transfer of such
increases to customers. To the extent that increases in the cost of raw
materials cannot be passed on to customers or there is a delay in passing on the
increased costs to customers, we are likely to experience an increase in the
cost of raw materials which may materially reduce our margin of profitability.
WE DEPEND ON SUBCONTRACTORS IN CONNECTION WITH OUR MANUFACTURING
PROCESS, IN PARTICULAR THE DYEING AND FINISHING PROCESS; WE MAY EXPERIENCE
DELAYS OR ADDITIONAL COSTS SATISFYING OUR PRODUCTION REQUIREMENTS AND WE
MAY BE PREVENTED FROM MEETING OUR CUSTOMERS' ORDERS DUE TO OUR RELIANCE ON
THESE SUBCONTRACTORS.
We depend on subcontractors who render services to us that are an integral
part of our manufacturing process, and in particular sewing services. If such
subcontractors do not render the required services, we may experience delays or
additional costs to satisfy our production requirements. We depend on a
subcontractor who performs a major part of the dyeing and finishing of our
Hi-Tex manufacturing process, which is an essential part of our manufacturing
process. If that subcontractor breaches its commitments toward us or is
otherwise not able to supply the required services, we would have difficulty
meeting our customer orders until we find an alternative source.
AN INCREASE IN THE MINIMUM WAGE IN ISRAEL MAY ADVERSELY AFFECT OUR
OPERATING RESULTS.
Many of our employees earn the minimum wage payable under law. The current
minimum monthly wage is approximately NIS 3,335. Recently, the leader of a major
opposition party in Israel has advocated increasing the minimum wage. An
increase in the minimum wage will increase our labor costs, and unless we can
obtain alternative labor in lower cost markets, this increase could adversely
affect our operating results.
8
WE REQUIRE A SIGNIFICANT AMOUNT OF CASH TO SATISFY OUR DEBT
OBLIGATIONS. IF WE FAIL TO GENERATE SUFFICIENT CASH FLOW FROM OPERATIONS,
WE MAY NEED TO RENEGOTIATE OR REFINANCE OUR DEBT, OBTAIN ADDITIONAL
FINANCING, POSTPONE CAPITAL EXPENDITURES OR SELL ASSETS.
We depend mainly on cash generated from operating activities to make
payments on our debts. The cash generated by operating activities was
approximately $6.9 million and $20.8 million in 2004 and 2005, respectively. We
cannot assure that we will generate sufficient cash flow from operations to make
the scheduled payments on our debt. We have repayment obligations on our
long-term debt of approximately $7.6 million in 2006 and $11.4 million in 2007
and the balance of $29.7 million from 2008 until 2012. These amounts do not
include any repayment obligations under our short-term bank credit and revolving
credit facility in the amount of approximately $17.7 million as of December 31,
2005. Our ability to meet our debt obligations will depend on whether we can
successfully implement our strategy, as well as on economic, financial,
competitive and technical factors. Some of the factors are beyond our control,
such as economic conditions in the markets where we operate or intend to
operate, changes in our customers' demand for our products, and pressure from
existing and new competitors.
If we cannot generate sufficient cash flow from operations to make
scheduled payments on our debt obligations, we may need to renegotiate the terms
of our debt, refinance our debt, obtain additional financing, delay planned
capital expenditures or sell assets. Our ability to renegotiate the terms of our
debt, refinance our debt or obtain additional financing will depend on, among
other things:
o our financial condition at the time;
o restrictions in agreements governing our debt; and
o other factors, including market conditions.
If our lenders decline to renegotiate the terms of our debt in these
circumstances, the lenders could declare all amounts borrowed and all amounts
due to them under the agreements due and payable. If we are unable to repay the
debt in these circumstances, the lenders could foreclose on our assets that are
subject to liens and sell our assets to satisfy the debt. See "Item 5. Operating
and Financial Review and Prospects" and "Item 10. Additional Information -10C
Material Contracts - Credit Agreement."
OUR BUSINESS MAY BE IMPACTED BY INFLATION AND NIS AND EURO EXCHANGE
RATE FLUCTUATIONS.
Exchange rate fluctuations between the U.S. dollar and the NIS and between
the Euro and the U.S. dollar, and inflation in Israel, may negatively affect our
earnings. A substantial majority of our revenues and a substantial portion of
our expenses are denominated in U.S. dollars, and we expect that a portion of
our revenues in 2006 will be denominated in Euros. However, a significant
portion of the expenses associated with our Israeli operations, including
personnel and facilities-related expenses, are incurred in NIS. Consequently,
inflation in Israel will have the effect of increasing the dollar cost of our
operations in Israel, unless it is offset on a timely basis by a devaluation of
the NIS relative to the U.S. dollar. We cannot predict any future trends in the
rate of inflation in Israel or the rate of devaluation of the NIS against the
U.S. dollar. In addition, we are exposed to the risk of appreciation of the NIS
vis-a-vis the U.S. dollar. This appreciation would cause an increase in our NIS
expenses as recorded in our U.S. dollar denominated financial reports even
though the expenses denominated in NIS will remain unchanged. In addition,
exchange rate fluctuations in currency exchange rates in countries other than
Israel where we operate and do business may also negatively affect our earnings.
See "Item 11. Quantitative and Qualitative Disclosures about Market Risk -
Foreign Currency Risk."
9
OUR DEBT OBLIGATIONS MAY HINDER OUR GROWTH AND PUT US AT A COMPETITIVE
DISADVANTAGE.
We have a considerable amount of bank debt mainly as a result of our
acquisition of Alba in December 1999 and the investments made in our Hi-Tex
Division. As of December 31, 2005, we had approximately $48.7 million of long
term loans outstanding (including current maturities of $7.6 million) and
approximately $17.7 million in short-term bank credit. Our substantial debt
obligations could have important consequences. For example, they could:
o require us to use a substantial portion of our operating cash flow to
repay the principal and interest on our loans, which would reduce
funds available to grow and expand our business, invest in machinery
and equipment and for other purposes;
o place us at a competitive disadvantage compared to our competitors
that have less debt;
o make us more vulnerable to economic and industry downturns and reduce
our flexibility in responding to changing business and economic
conditions;
o limit our ability to pursue business opportunities; and
o limit our ability to borrow money for operations or capital in the
future.
Because a significant portion of our loans bear interest at floating rates,
an increase in interest rates could reduce our profitability. A ten percent
interest rate change on our floating interest rate long-term loans outstanding
at December 31, 2005, would have an annual impact of approximately $0.3 million
on our interest cost. See "Item 5. Operating and Financial Review and Prospectus
- - Liquidity and Capital Resources" and "Item 11. Quantitative and Qualitative
Disclosures about Market Risk."
DUE TO RESTRICTIONS IN OUR LOAN AGREEMENTS, WE MAY NOT BE ABLE TO
OPERATE OUR BUSINESS AS WE DESIRE.
Our loan agreements contain a number of conditions and limitations on the
way in which we can operate our business, including limitations on our ability
to raise debt, sell or acquire assets and pay dividends. Our loan agreements
also contain various covenants which require that we maintain certain financial
ratios related to shareholder's equity and operating results. These limitations
and covenants may force us to pursue less than optimal business strategies or
forgo business arrangements which could have been financially advantageous to us
and our shareholders. See "Item 5. Operating and Financial Review and Prospects
- - Liquidity and Capital Resources."
Our failure to comply with the covenants and restrictions contained in our
loan agreements could lead to a default under the terms of these agreements. For
instance, during 2004, our subsidiary, AlbaHealth, failed to comply with certain
financial covenants contained in its credit facility with General Electric
Capital Corporation, or GE Capital, including a minimum EBITDA requirement.
However, GE Capital agreed to waive certain financial covenant defaults that
occurred during 2004 and to amend certain of the financial covenant provisions
of the AlbaHealth credit facility. During the second quarter of 2005, AlbaHealth
again failed to comply with a certain financial covenant in the credit facility.
On October 10, 2005, AlbaHealth signed an amendment to its credit facility,
under which the covenant defaults were waived and the Company was provided with
more favorable credit facility terms. See "Item 10. Additional Information -
10C. Material Contracts - AlbaHealth Credit Agreement" for a description of the
revised terms of the AlbaHealth credit facility. We have delivered a notice to
exercise our option to require AlbaHealth to purchase our ownership interest in
AlbaHealth, and we are in the process of negotiating the final terms of the
purchase. See "Item 10. Additional Information - 10C. Material Contracts -
AlbaHealth Option Agreement."
If a default occurs and we are unable to renegotiate the terms of our debt,
the lenders could declare all amounts borrowed and all amounts due to them under
the agreements due and payable. If we are unable to repay the debt, the lenders
could foreclose on our assets that are subject to liens and sell our assets to
satisfy the debt. If AlbaHealth is unable to repay its debt, the lenders could
foreclose on its assets that are subject to liens and sell its assets to satisfy
the debt. See "Item 10. Additional Information - 10C. Material Contracts -
Credit Agreement."
10
WE ARE AFFECTED BY CONDITIONS TO, AND POSSIBLE REDUCTION OF,
GOVERNMENT PROGRAMS AND TAX BENEFITS.
We benefit from certain Israeli Government programs and tax benefits,
particularly as a result of the "Approved Enterprise" status of substantially
all of our existing production facilities in Israel. As a result of our
"Approved Enterprise" status, we have been able to receive significant
investment grants with respect to our capital expenditures. In addition,
following our exhaustion of our net operating loss carry forwards, we have been
able to benefit from a reduced tax rate of 25% on earnings derived from these
investments for which the benefit period has not expired. To maintain
eligibility for these programs and tax benefits, we must continue to meet
certain conditions, including making certain specified investments in fixed
assets and conducting our operations in specified "Approved Enterprise" zones in
Israel. If we fail to meet such conditions in the future, we could be required
to refund tax benefits and grants already received, in whole or in part, with
interest linked to the Consumer Price Index, or CPI, in Israel from the date of
receipt. We have granted a security interest over all of our assets to secure
our obligations to fulfill these conditions.
The Government of Israel has reduced the available amount of investment
grants from up to 38% of eligible capital expenditures in 1996 to up to 24% of
eligible capital expenditures (for projects not exceeding investments of 140
million shekels that are submitted in any year) and up to 20% of eligible
capital expenditures (for projects exceeding investments of 140 million shekels
that are submitted in any year) since 1997. There can be no assurance that the
Israeli Government will not further reduce the availability of investment
grants. The termination or reduction of certain programs and tax benefits,
particularly benefits available to us as a result of the "Approved Enterprise"
status of some of our existing facilities in Israel, would increase the costs of
acquiring machinery and equipment for our production facilities and increase our
effective tax rate which, in the aggregate, could significantly reduce our
profitability. In addition, income attributed to certain programs is tax exempt
for a period of two years and is subject to a reduced corporate tax rate of 10%
- - 25% for an additional period of five to eight years, based on the percentage
of foreign investment in the Company. We cannot assure that we will obtain
approval for additional Approved Enterprises, or that the provisions of the Law
for the Encouragement of Capital Investments, 1959, as amended, will not change
or that the 25% foreign investment percentage will be reached for any subsequent
year. See "Item 4. Information on the Company - 4B. Business Overview - Israeli
Investment Grants and Tax Incentives."
We also benefit from exemptions from customs duties and import quotas due
to our locations in Israel and Jordan (Qualified Industrial Zone), and the free
trade agreements Israel maintains with the United States, Canada, the European
Union, or EU, and the European Free Trade Association, or EFTA. If there is a
change in such benefits or if other countries enter into similar agreements and
obtain similar benefits or if any such agreements were terminated, our
profitability may be reduced.
OUR ANNUAL AND QUARTERLY OPERATING RESULTS MAY VARY WHICH MAY CAUSE
THE MARKET PRICE OF OUR ORDINARY SHARES TO DECLINE.
We may experience significant fluctuations in our annual and quarterly
operating results which may be caused by, among other factors:
o the timing, size and composition of orders from customers;
o varying levels of market acceptance of our products;
o the timing of new product introductions by us, our customers or their
competitors;
o economic conditions in the geographical areas in which we operate or
sell products; and
o operating efficiencies.
11
When we establish a relationship with a new customer, initial sales to such
customer are often in larger quantities of goods (to build its initial
inventory) than may be required to replenish such inventory from time to time
afterwards. As a result, after a customer builds its initial inventory, our
sales to such customer may decrease. We cannot assure that our sales to any of
our customers will continue at the current rate. See "Item 5. Operating and
Financial Review and Prospects."
Our operations are affected by our principal customers' businesses, which
businesses are subject to substantial cyclical variations. If demand for our
products is significantly reduced, our profits will be reduced, and we may
experience slower production, lower plant and equipment utilization and lower
fixed operating cost absorption.
Additionally, if, in any year, there is a significant number of Christian,
Druse, Jewish or Muslim holidays in a particular quarter, we will have fewer
days of operation which will result in lower levels of production and sales
during such quarter. In certain years, a significant number of such holidays
have occurred during the second quarter, but the dates of many of those holidays
are based on the lunar calendar and vary from year to year.
IF OUR ORDINARY SHARES ARE DELISTED FROM THE NEW YORK STOCK EXCHANGE,
THE LIQUIDITY AND PRICE OF OUR ORDINARY SHARES AND OUR ABILITY TO ISSUE
ADDITIONAL SECURITIES MAY BE SIGNIFICANTLY REDUCED.
In order to maintain the listing of our ordinary shares on The New York
Stock Exchange, or NYSE, we are required to meet specified maintenance
standards. In addition, the NYSE has amended its continued listing criteria to
require, among other things, either a minimum stockholders' equity of $75
million or a minimum market capitalization of $75 million. As of December 31,
2005, our market capitalization was $156.2 million, and we had stockholders'
equity of $54.7 million.
In the event we fail to meet any current or revised listing criteria of the
NYSE, our ordinary shares may be delisted from trading on the NYSE. We cannot
assure that we will meet all NYSE criteria in the future. Delisting of our
ordinary shares would result in limited availability of market price information
and limited news coverage. In addition, delisting could diminish investors'
interest in our ordinary shares as well as significantly reduce the liquidity
and price of our ordinary shares. Delisting may also make it more difficult for
us to issue additional securities or secure additional financing.
On September 28, 2005, our shares also began trading on the Tel Aviv Stock
Exchange, or TASE. Under the Israeli Securities Law of 1968, in the event that
within 12 months after we were initially listed for trading on TASE, we are
delisted from trading on the NYSE, then within two months of such delisting, we
will also be delisted from trading on TASE. If, however, prior to the expiration
of such two months period we register our shares for trading on TASE by
publishing a prospectus, our shares will not be delisted for trading on TASE.
WE MAY NOT BE ABLE TO PROTECT OUR INTELLECTUAL PROPERTY.
Our success is substantially dependent upon the adaptations and
configurations we make to the machinery and equipment that we purchase and upon
the manufacturing technologies, methods and techniques that we have developed
for our exclusive use. Only a part of the adaptations, configurations,
technologies or techniques used in our manufacturing process is patented.
Moreover, we purchase our machinery and equipment from third parties and we
cannot assure that a competitor will not adapt, configure or otherwise utilize
machinery or equipment in substantially the same manner as we do. In addition,
our subcontractors have access to proprietary information, including regarding
our manufacturing processes, and from time to time we also lend machinery and
equipment to subcontractors, and there is a possibility that subcontractors may
breach their confidentiality undertakings toward us. Any replication of our
manufacturing process by an existing or future competitor may significantly
reduce our sales and profitability.
12
WE FACE POTENTIAL COMPETITION BY OUR FORMER EMPLOYEES.
Our trade secrets are well known to some of our employees. In the event one
or more of our current or former employees exploit our trade secrets in
violation of their non-competition and confidentiality obligations, we may be
adversely affected in the competitive market and in our relationships with our
customers and suppliers.
WE FACE POTENTIAL CONFLICTS OF INTEREST CAUSED BY INVESTOR INFLUENCE.
Our principal shareholders have a great deal of influence over the
constitution of our Board of Directors and over matters submitted to a vote of
the shareholders. As of March 15, 2006, Norfet, Limited Partnership had voting
power over approximately 28.44% of the outstanding ordinary shares of Tefron. In
addition, as of March 15, 2006 and based on available public information, Meir
Shamir, one of our directors, owned approximately 40.02% in Mivtach-Shamir,
which at such date was an approximately 34.45% holder in Norfet. As a result,
the corporate actions of Tefron may be significantly influenced by Mr. Shamir.
Furthermore, as of March 15, 2006, Ishay Davidi, the Chairman of our Board of
Directors, served as CEO of FIMI 2001 Ltd., which controls the general partner
of Norfet, one of the Norfet limited partners (which is managed by FIMI 2001
Ltd.) as well as the other Norfet limited partners by virtue of an irrevocable
power of attorney. As a result, the corporate actions of Tefron may be
significantly influenced by Mr. Davidi.
As of March 15, 2006, Arie Wolfson, one of our directors, had direct voting
power (through Arwol Holdings Ltd. an Israeli company wholly owned by Mr.
Wolfson) over approximately 24.11% of the outstanding ordinary shares of Tefron,
not including options to acquire 225,000 ordinary shares of Tefron that have
already vested. Mr. Wolfson is also the Chairman and a significant shareholder
of Macpell Industries Ltd., an Israeli company that owned approximately 18.38%
of the outstanding ordinary shares of Tefron as of March 15, 2006. The
controlling shareholders of Macpell have entered into a shareholders' agreement
regarding corporate actions of Macpell, including the process by which Macpell
votes its ordinary shares of Tefron to elect our Directors. As a result, the
corporate actions of Tefron may be influenced significantly by Mr. Wolfson and
by the other controlling shareholders of Macpell.
In connection with the acquisition of Tefron ordinary shares by Norfet,
Limited Partnership from the Company, Arwol Holdings Ltd. and Macpell, each of
Norfet, Arwol and Macpell agreed to vote all of the Tefron ordinary shares owned
or controlled by each of them for the election to the Company's nine-member
Board of Directors of: (i) two members plus one independent director and one
external director nominated by Norfet, Limited Partnership, (ii) two members
plus one independent director and one external director nominated by Arwol and
Macpell, and (iii) the Company's chief executive officer.
We are party to consulting and management services agreements with each of
(i) Mr. Wolfson and a company controlled by him and (ii) Norfet, pursuant to
which each of them agreed to provide consultancy and management services to
Tefron. We also lease various properties from affiliates of Macpell. See "Item
6. Directors, Senior Management and Employees - 6A. Directors and Senior
Management," "Item 7. Major Shareholders and Related Party Transactions," and
Note 17 of the Notes to the Consolidated Financial Statements.
Israeli law imposes procedures, including, for certain material
transactions, a requirement of shareholder approval, as a precondition to
entering into interested party transactions. These procedures may apply to
transactions between Macpell and us and between Norfet and us. However, we
cannot assure that we will be able to avoid the possible detrimental effects of
any such conflicts of interest by complying with the procedures mandated by
Israeli law. See "Item 6. Directors, Senior Management and Employees - 6A.
Directors and Senior Management," "- 6C. Board Practices," and "Item 7. Major
Shareholders and Related Party Transactions."
13
WE ARE SUBJECT TO VARIOUS RISKS RELATING TO OPERATIONS IN ISRAEL.
We are incorporated under the laws of, and our main offices and
manufacturing facilities are located in, the State of Israel. We are directly
influenced by the political, economic and security conditions in Israel. Since
the establishment of the State of Israel in 1948, a number of armed conflicts
have taken place between Israel and its Arab neighbors and a state of hostility,
varying in degree and intensity, has led to security and economic concerns for
Israel. Any major hostilities involving Israel, the interruption or curtailment
of trade between Israel and its trading partners or a significant downturn in
the economic or financial condition of Israel could have a material adverse
effect on our operations. Since October 2000, there has been a deterioration in
the relationship between Israel and the Palestinians which has resulted in
increased violence. The future effect of this deterioration and violence on the
Israeli economy and our operations is unclear. We cannot assure that ongoing or
revived hostilities or other factors related to Israel will not have a material
adverse effect on us or our business.
Generally, all male adult citizens and permanent residents of Israel under
the age of 54, unless exempt, are obligated to perform up to 36 days of annual
military reserve duty. Additionally, all such residents are subject to being
called to active duty at any time under emergency circumstances. Some of our
officers and employees are currently obligated to perform annual reserve duty.
No assessment can be made as to the full impact of such requirements on our
workforce or business, and no prediction can be made as to the effect of any
expansion or reduction of such military obligations on our business. See "Item
4. Information on the Company - 4B. Business Overview - Conditions in Israel."
During 2004, a general strike at Israel's ports caused a shortage of raw
materials and resulted in a loss to the Company of sales of approximately $2.5
million. This shortage also resulted in a decrease in production volume and an
increase in operating costs, which affected our ability to achieve greater
operating efficiencies. Although Israel's Ministry of Finance, the Histadrut
(General Federation of Labor in Israel), and the Israel Ports Authority signed
an agreement in February 2005 which is intended to ensure five years without
labor strikes, a further strike or labor disruption at Israel's ports may occur
and have an adverse effect on us or our business.
14
ITEM 4. INFORMATION ON THE COMPANY
4A. HISTORY AND DEVELOPMENT OF THE COMPANY
Tefron Ltd. was incorporated under the laws of the State of Israel on March
10, 1977. Our principal executive offices are located at Ind. Center Teradyon,
P.O. Box 1365, Misgav 20179, Israel and our telephone number is 972-4-9900-881.
We are subject to the provisions of the Israeli Companies Law, 1999. Our agent
for service of process in the United States is CSC Corporation Service Company,
2711 Centerville Rd. Suite 400, Wilmington, DE 19808.
Below is a summary of significant events in our development:
1990 First bodysize cotton panty with applicated elastics
1997 Formation of Hi-Tex Founded by Tefron Ltd. and production of
first seamless panty.
Initial public offering of our shares on the NYSE.
1998 Acquisition of a dyeing and finishing facility to achieve greater
vertical integration of our business.
1999 Acquisition of Alba, a manufacturer of seamless apparel and
healthcare products. The main purpose of the acquisition of Alba
was to acquire additional production capacity, a presence in the
United States, direct store distribution capacity, a broader
customer base and incremental revenues.
2001 Initial significant shifting of sewing production to Jordan.
2001 Launch of a turn around program, including significant cost
reduction, downsizing and consolidation of operations.
2002 Reorganization of Alba, including a spin-off of the Health
Product Division and the formation of the AlbaHealth joint
venture with a strategic investor, and the initial consolidation
of the seamless production activity in Hi-Tex in Israel which was
completed in the second quarter of 2003.
2003 Acquisition of all of the outstanding ordinary shares of Macro
Clothing Ltd., an entity that manufactures, markets and sells
swimsuits and beachwear.
Implementation of strategic steps to expand our product line,
including active-wear products, to diversify our product line and
client base.
15
FEB.-APRIL 2004 Closing of equity investments with two groups of investors
in the aggregate amount of $20 million.
OCTOBER 2004 Launch of a new business division, Sports Innovation
Division, or SID, which is devoted to our growing US
customers base in the sport active wear market.
SEPTEMBER 2005 Registration of our shares for trading on the TASE (in
addition to the listing on the NYSE).
DECEMBER 2005 Our delivery of a notice to exercise our option to require
AlbaHealth to purchase our ownership interest in AlbaHealth.
We are in the process of negotiating the final terms of the
purchase.
JANUARY 2006 Closing of a public auction of ordinary shares and option
certificates on the TASE for aggregate net proceeds of $13.9
million (not including proceeds that may be received upon
exercise of any option certificates).
ALBAHEALTH LLC
FORMATION OF ENTITY. On September 6, 2002, Alba entered into a contribution
agreement with Encompass Group, L.L.C., an experienced manufacturer and marketer
of numerous health products, and GE Capital, as a result of which Encompass and
GE Capital acquired a portion of AlbaHealth's Products Division which from then
became operated through a newly formed Delaware limited liability company,
AlbaHealth.
Under the terms of the contribution agreement, Alba contributed to
AlbaHealth substantially all of the assets related to its Health Products
Division, together with the associated liabilities, including bank debt of $28
million secured by such assets, in exchange for a 48.325% ownership interest in
AlbaHealth. Encompass contributed $12 million in cash to the capital of
AlbaHealth in exchange for a 48.325% ownership interest, and GE Capital
contributed $1 million in cash in exchange for a 3.35% ownership interest. In
addition, GE Capital provided AlbaHealth with a $18.0 million credit facility.
For information concerning the AlbaHealth credit agreement, see "Item 10.
Additional Information - 10C. Material Contracts - AlbaHealth Credit Agreement."
Under the terms of the Contribution Agreement, the parties agreed that Alba
will maintain a majority position on the board of managers of AlbaHealth so long
as it holds at least 40% of the interest of AlbaHealth. In addition, the
Contribution Agreement provides for certain limitations on the ability of the
parties to transfer their interests in AlbaHealth.
PUT OPTION AGREEMENT. The parties to the Contribution Agreement are also
parties to a Put Option Agreement under which each of Alba and GE Capital has an
option to require AlbaHealth to purchase all, but not less than all, of such
party's ownership interest in AlbaHealth. In December 2005, we delivered a
notice of exercise to require AlbaHealth to purchase our ownership interest in
AlbaHealth, and we are in the process of negotiating the final terms of the
purchase. Closing is subject to satisfaction of various conditions. See "Item
10. Additional Information - 10C. Material Contracts - AlbaHealth Option
Agreement."
CAPITAL EXPENDITURES
Our capital expenditures for fixed assets (net of grants from the
Government of the State of Israel) were $4.8 million, $7.8 million, and $2.1
million, for the years ended December 31, 2005, 2004, and 2003, respectively.
The 2005 expenditures were primarily made in Israel to purchase new dyeing and
finishing machines, sewing machines and other equipment. See Consolidated
Statements of Cash Flows in the Consolidated Financial Statements.
16
Our current capital expenditures include investments in equipment,
machinery and leasehold improvements in our facilities in Israel and Jordan. See
Note 6 of the Notes to the Consolidated Financial Statements. We expect to incur
capital expenses primarily to acquire new knitting and finishing machines, and
other equipment for our Hi-Tex Division and to shift more of the sewing
production of our Hi-Tex division out of Israel to Jordan to take advantage of
lower labor costs.
As of the date of this Annual Report, we estimate that our capital
expenditures for 2006 (net of grants from the Government of the State of Israel)
will be approximately $8 million. We expect to finance these investments
primarily from cash generated from operations and from the proceeds of our
January 2006 equity offering in Israel. However, the actual amount of our
capital expenditures will depend on a variety of factors, including general
economic conditions, changes in demand for our products, increase in the sales
growth of our new products, the risks and uncertainties involved in doing
business in Jordan and our ability to generate sufficient cash from operations.
See "Item 3. Key Information - 3D. Risk Factors."
4B. BUSINESS OVERVIEW
OVERVIEW
We manufacture intimate apparel, active-wear and swimwear sold throughout
the world by such name-brand marketers as Victoria's Secret, Nike, Target,
Warnaco/Calvin Klein, The Gap, Banana Republic, Mervyn's, Puma, Patagonia,
Adidas, Reebok and other well known American retailers and designer labels.
Through the utilization of manufacturing technologies and techniques developed
or refined by us, we are able to mass-produce quality garments featuring unique
designs tailored to our customers' individual specifications. Our product line
includes knitted briefs, bras, tank tops, boxers, leggings, crop, T-shirts,
daywear, nightwear, bodysuits, swim-wear, beach-wear, active-wear and
accessories. Our Healthcare Division manufactures and sells a range of textile
healthcare products. These products include: slip resistant footwear;
anti-embolism stockings and compression therapy systems, an intermittent
pneumatic compression device; sterile wound dressings; and XX-Span(R) dressing
retainers, an extensible net tubing designed to hold dressings in place without
the use of adhesive tape. In December 2005, we exercised our option under the
AlbaHealth Put Option Agreement to sell our ownership interest in AlbaHealth,
and we are in the process of negotiating the final terms of the purchase. See
"Item 10. Additional Information - 10C. Material Contracts - AlbaHealth Option
Agreement."
We seek to apply our manufacturing technologies and techniques to meet the
fashion and merchandising needs of our customers. With product innovation made
possible by our manufacturing capabilities, we invest our marketing efforts to
become a principal supplier to a more select customer base, representing some of
the leaders in the intimate apparel and active-wear industries. As a result of
this strategy, we successfully entered the United States market for quality,
competitively priced intimate apparel and active-wear.
We are known for the technological innovation of our Hi-Tex manufacturing
process. Our Hi-Tex manufacturing process was implemented as part of our
strategy to streamline our manufacturing process and improve the design and
quality of our products. The Hi-Tex manufacturing process involves the
utilization of a single machine that transforms yarn directly into a nearly
complete garment, replacing the knitting, cutting, and significant sewing
functions which, in traditional manufacturing, are performed sequentially on
separate machines at separate workstations. Following this single-machine
operation, all the Hi-Tex manufacturing process requires to complete the garment
is dyeing and a reduced amount of sewing and finishing. Our Hi-Tex manufacturing
process enables us to produce a substantially wider range of fabrics, styles and
product lines, resulting in a consistently high level of comfort, quality and
durability. Our fabric engineering, product design and the comfort of our
products provide us with an opportunity to expand our sales of active-wear
products.
17
We believe that our collaboration with our customers in the design and
development of our products strengthens our relationships with our customers and
improves the quality of our products. We began our relationship with Victoria's
Secret in 1991, with Banana Republic and The Gap in 1993, with Warnaco/Calvin
Klein in 1994 and with Nike and J.C. Penny in 2000. In 2000, we also began our
relationship with Target, which was an existing customer of Alba Waldensian,
Inc., which name was changed to Tefron USA, Inc., or Alba. These customers
accounted for approximately 71.3% and 73.9% of our total sales in 2004 and in
2005, respectively. We enjoy several strategic advantages by reason of our
location in Israel and Jordan. Israel is one of the few countries in the world
that has free trade agreements with the United States, Canada, the European
Union, or EU, and the European Free Trade Association, or EFTA. These agreements
permit us to sell our products in the United States, Canada and the member
countries of the EU and the EFTA free of customs duties and import quotas. Due
to our locations in Israel and in Jordan we benefit from exemptions from customs
duties and import quotas. We also currently benefit from substantial investment
grants and tax incentives provided by the Government of Israel and from the
availability in Israel of both skilled engineers and relatively inexpensive
unskilled workers. See "- Israeli Investment Grants and Tax Incentives" and "-
Conditions in Israel -Trade Agreements."
PRODUCTS
In close collaboration with our customers, we design and manufacture
intimate apparel, active-wear and swimwear. Through our efficient capability, we
produce garments made of cotton and synthetic fibers for large-volume marketers
who, in recent years, have increased retail consumer interest for quality
intimate apparel and active-wear at affordable prices. We believe that our
advanced technology and manufacturing processes enable us to deliver intimate
apparel and active-wear that is comfortable to wear, fits well, fashionable,
made of high-quality fabric and difficult to imitate. Our product line includes
knitted briefs, bras, tank tops, boxers, leggings, crop, T-shirts, daywear,
nightwear, bodysuits, swim-wear, beach-wear, active-wear, and accessories.
AlbaHealth manufactures and sells healthcare products. These products
include: anti-embolism stockings and compression therapy systems, an
intermittent pneumatic compression device, both of which are designed to improve
circulation and reduce the incidence of deep vein thrombosis; sterile wound
dressings, such as pre-saturated gauze, petrolatum and xeroform gauze,
non-adhering dressings and gauze strips; and XX-Span(R) dressing retainers, an
extensible net tubing designed to hold dressings in place without the use of
adhesive tape. All dressing products are used in wound care therapy. Other
healthcare products include slip-resistant patient treads, which are knitted
soft patient footwear with slip-resistant soles to help prevent patient falls
while keeping feet warm even while in bed, oversized socks and knitted cuffs. In
2005, footwear products represented approximately 49.0% of the sales of
AlbaHealth.
The principal market for our products is the United States. For a breakdown
of our sales by geographic area and operating segments, see Note 16 of the Notes
to the Consolidated Financial Statements.
MANUFACTURING AND PRODUCTION
We have developed manufacturing innovations for various stages of the
production process, including improvements in the knitting of fabric as well as
the cutting and sewing of individual garments. Our manufacturing technologies
and techniques allow us to provide our customers with mass-produced quality
merchandise at competitive prices. In May 1997, we introduced our Hi-Tex
manufacturing process which consolidates a large portion of the production steps
into a single machine, the Santoni knitting machine, and has enabled us to
produce a substantially wider range of fabrics, styles and product lines at a
consistently higher level of comfort, quality and durability. The Santoni
Knitting machines are seamless knitting machines that use state-of-the-art
computer controlled circular knitting technology.
We manufacture products only to fill firm orders and therefore maintain
limited inventory of finished goods. Customers typically send projected product
requirements to us between six and 12 months in advance of the delivery
requirements and place firm orders between three and six months prior to the
desired delivery date. This lead time allows us to coordinate raw material
procurement with its usage and to adjust production levels in order to meet
demand.
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We currently produce intimate apparel and active-wear products in different
style, color and yarn combinations. We manufacture cotton knit products using
our advanced proprietary manufacturing techniques and also produce fine products
from synthetic fibers, including micro-fibers, using our cut-and-sew
manufacturing process and our highly automated Hi-Tex manufacturing process.
MANUFACTURING PROCESS
We utilize vertically integrated production processes and automated
production techniques. These processes involve the following steps:
o PRODUCT DESIGN - Traditionally, manufacturers produce several samples
of a garment from which apparel marketers can select. In contrast, our
sophisticated technology enables us to collaborate with our customers
earlier in the design process to develop customized garments. In
addition, we work independently to develop new products, to increase
sales to existing customers and to exploit market opportunities and
increase penetration where it can establish a competitive advantage.
o RAW MATERIAL DEVELOPMENT - After a design is developed, raw materials
for the production of the product are purchased. Our raw materials
include cotton yarns, blends of cotton and synthetic yarn (e.g.,
cotton-spandex, cotton-lycra and cotton-viscose), micro-fiber nylons
and blends of micro-fiber nylon with lycra/spandex and elastic. We
purchase our raw materials from several international and domestic
suppliers and historically have not experienced any difficulty in
obtaining raw materials to meet production requirements. Raw materials
are generally purchased against actual orders, although we have a
policy of maintaining a minimum level of those raw materials that are
in repeated demand. From time to time, when market conditions are
favorable, we have entered into contracts with various suppliers of
basic yarns for delivery over a period of three to six months.
o KNITTING (ONLY CUT & SEW) - Our Cut & Sew Division knitting facility
located adjacent to our principal manufacturing facility in Segev,
Israel, currently supplies substantially all of our fabric needs in
Israel. This facility utilizes advanced and automated technology to
knit tubular fabric, including bodysize fabrics. Bodysize fabrics,
which are required for bodysize garments, enable maximum use of fabric
and minimize waste during cutting. We operate 115 automatic knitting
machines, which have capacity to produce approximately 300 tons of
fabric per month (depending on the type of fabric). During 2005, we
produced approximately 85 tons of fabric per month.
o DYEING AND FINISHING - Our Cut & Sew Division's dyeing and finishing
facility can satisfy a significant portion of its dyeing and finishing
needs in-house. The remainder is outsourced to dyeing and finishing
subcontractors in Israel. Our Hi-Tex Division subcontracts almost all
of its dyeing and finishing needs. We have established testing
procedures which examine all fabric upon return to us to ensure the
color consistency, stability and durability of our dyed fabric.
o CUTTING (ONLY CUT & SEW) - Traditionally, manufacturers manually cut
multiple layers of fabric on a cutting table. To modernize the
production process, manufacturers have used computerized, automatic
cutting equipment. We use both this equipment and highly advanced
machines that automatically and continuously lay and cut tubular
knitted fabric to specified sizes, minimizing fabric waste and the
amount of sewing required, which results in a more consistent and
comfortable garment.
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o SEWING (ONLY CUT & SEW) - Cut fabrics are sewn to complete the
garment, including the addition of accessories such as elastic waist
and leg bands as well as labels. Working with computerized equipment
and robotics, our employees sew garments with far greater precision
than if sewn entirely by hand. To accommodate short-term increased
capacity requirements, we have the ability to utilize subcontractors
to perform a portion of the sewing process. Our Cut & Sew Division
operates a sewing facility in Jordan and also subcontracts sewing in
Israel, China and Jordan.
o TESTING AND QUALITY CONTROL - We place significant emphasis on quality
control and uses quality assurance teams at each stage of the
manufacturing process.
HI-TEX MANUFACTURING PROCESS
In an effort to streamline and automate the manufacturing process further,
we developed the Hi-Tex manufacturing process, which utilizes state-of-the-art
technology that eliminates most stages of the manufacturing process while
increasing efficiency, consistency and quality. We have successfully combined
existing hosiery and apparel technologies to create this new manufacturing
process. The Hi-Tex process includes the utilization of a single machine, the
Santoni knitting machine, that transforms yarn directly into a nearly complete
garment, replacing the knitting, cutting, sewing and accessorizing functions
which, in traditional manufacturing, are performed sequentially on separate
machines at separate workstations. Following this single-machine operation, all
the Hi-Tex process requires to complete the garment is dyeing and a limited
amount of sewing and finishing, which are conducted using our proprietary
techniques. In addition to providing a higher level of manufacturing efficiency,
Hi-Tex has enabled us to produce a substantially wider range of fabrics, styles
and product lines at a consistently higher level of comfort, quality and
durability. This is made possible, in large part, because the Hi-Tex process
knits a garment directly, rather than cutting it from fabric, allowing for the
production of any size, pattern or design with even greater precision than
previously available.
The Hi-Tex manufacturing process is currently being used to produce
knit-to-size intimate apparel, active-wear and outerwear. We operate our Hi-Tex
knitting process in our principal production facilities in Segev, Israel. We
operate our Hi-Tex sewing process in one sewing facility in Israel and also
subcontract sewing in Israel and in Jordan. See "Item 4. Information on the
Company - 4D. Property, Plants and Equipment." At December 31, 2005, we had a
total of 751 fully equipped Santoni Knitting machines at the Hi-Tex facilities
in Israel. We also have 145 fully equipped Santoni Knitting machines at Alba in
Valdese, North Carolina, which are currently not operated but may be transferred
to other manufacturing facilities at our discretion.
We believe that the Hi-Tex manufacturing process represents an innovative
combination of cutting-edge technology and technical expertise and has further
strengthened our reputation within the industry as a leader in automated
manufacture and design. In addition, with both the Hi-Tex manufacturing process
and the traditional cut-and-sew process, we are able to produce garments made
from synthetic fibers in addition to existing lines of cotton products. We
specialize in developing and using performance yarns. The Hi-Tex manufacturing
process was developed in-house through the adaptation and configuration of
machinery and equipment purchased from third parties. Although developed for its
exclusive use, only a part of these adaptations and configurations is patented.
Alba's health products, now produced by AlbaHealth, are manufactured at its
Rockwood, Tennessee plant and by subcontractors in the United States, Mexico and
Sri Lanka.
SALES AND MARKETING
Our marketing strategy focuses on selling quality knitted products to large
U.S. marketers of intimate apparel, active-wear and swimwear. We market our
products directly to major retailers, which sell them under their own labels and
to several companies that market nationally advertised brands. We have sales
offices which are located in Portland, Oregon and in Israel.
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We see the active-wear market as an added opportunity to promote our
innovative production and design capabilities. Our office in Portland, Oregon
serves to advance our active-wear sales, to strengthen the communication with
our active-wear customers, and to improve our services. In addition, we have
dedicated a separate development and sales team in Israel for the active-wear
customers.
Products of AlbaHealth for use in hospitals are marketed to major
distributors by AlbaHealth's sales representatives. These products are sold both
under private label and AlbaHealth's own label.
INTELLECTUAL PROPERTY
Only a part of the adaptations, configurations, technologies or techniques
used in our manufacturing process is patented. See "Item 3. Key Information -
3D. Risk Factors - We may not be able to protect our intellectual property."
However, we have obtained patents for certain aspects of our manufacturing
process and for certain of our products, such as the "millennium bra", the
"bonded bra" and the "ultrasonic bra", whose fabric is joined without sewing.
Alba holds several patents relating to our products and AlbaHealth holds
several patents relating to healthcare products, including patents for processes
which make it possible to knit bras and various functional features in bras and
panties on seamless knitting equipment. AlbaHealth also holds a patent for a
device used to warm wet dressings as well as a patent for a process covering the
manufacture of dressings.
We emphasize the development of new technologies that will enable the
manufacture of products that have an advantage over the products currently
existing in the market.
SEASONALITY
Although our operations are affected by the substantial cyclical variations
of our principal customers' businesses, downturns in the general economy, a
change in consumer purchasing habits and other events, we have not identified a
clear seasonal pattern to our general business, other than with respect to our
swimwear products. In the swimwear segment, most of our sales are consummated
between December and May.
CUSTOMERS
Our customers represent some of the leading marketers of intimate apparel
and active-wear in the world. More than 68% of our sales in 2005 were derived
from the worldwide sale of our products to our four largest apparel customers,
Victoria's Secret, Nike, Target, and Banana Republic and The Gap. In 2005, we
strengthened our business relationships with our active-wear customers, such as
Nike, Patagonia, Reebok, Puma, Adidas and others.
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The following table outlines the dollar amount and percentage of total
sales to our customers:
CUSTOMER 2003 2004 2005
------------------- -------------------- -------------------
(Dollars in millions)
Victoria's Secret (1) $ 62.2 38.2% $ 70.4 38.5% $ 69.3 33.7%
Nike $ 5.3 3.2% $ 12.4 6.8% $ 44.1 21.5%
Target $ 14.8 9.1% $ 24.4 13.4% $ 18.5 9.0%
Cardinal Healthcare (2) $ 17.8 10.9% $ 16.9 9.2% $ 17.5 8.5%
The Gap/Banana Republic $ 9.2 5.6% $ 11.5 6.3% $ 9.2 4.5%
Others $ 53.8 33.0% $ 47.2 25.8% $ 47.0 22.8%
Total $163.1 100.0% $182.8 100.0% $205.6 100%
- --------------------------------------------------------------------------------
(1) Includes sales to Mast Industries, Inc. on behalf of Victoria's Secret,
Victoria's Secret Catalog, Cacique and Abercrombie & Fitch.
(2) Customer of AlbaHealth, our subsidiary.
We established our relationship with our largest customer, Victoria's
Secret, in 1991. Currently, we manufacture underwear, nightwear, loungewear,
bodysuits and bras for Victoria's Secret. We continue to seek to expand and
strengthen our relationship with Victoria's Secret by providing the retailer
with a continuing line of new products. However, we cannot assure that
Victoria's Secret will continue to buy our products in the same volumes or on
the same terms as they did in the past. For instance, during the past few years
we have been asked by Victoria's Secret to reduce the prices of Victoria's
Secret's Logo program. See "Item 3. Key Information - 3D. Risk Factors - We
depend on a small number of principal customers who have in the past purchased
our products in large volumes. We cannot assure that these customers or any
other customer will continue to buy our products in the same volumes or on the
same terms."
We began our working relationship with Nike in 2000. Currently, we supply
them with active-wear for men and women.
We began our relationship with Target in 2000, which was an existing
customer of Alba. Currently, we supply them with underwear for men and women,
and active-wear products.
We began our working relationship with Banana Republic and The Gap in 1993.
Currently, we supply Banana Republic and The Gap with underwear and sleepwear.
We also gained as a customer Allegiance Healthcare Corporation,
subsequently acquired by Cardinal Healthcare, through our acquisition of Alba at
the end of 1999. Cardinal acquires a range of medical products from AlbaHealth.
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When we establish a relationship with a new customer in the normal course
of business, our initial sales to that customer are typically in larger
quantities of goods (to build the customer's initial inventory) than may be
required to replenish such inventory from time to time thereafter. After a
customer builds its initial inventory, the rate of growth of our sales to the
customer may decrease. The volume of products ordered by customers are subject
to the cyclical variations in their business. See "Item 3. Key Information - 3D.
Risk Factors."
We depend on a small number of principal customers. Our principal customers
are in the retail industry, which is subject to substantial cyclical variations.
Our annual and quarterly results may vary which may cause our profits and/or the
market price of our Ordinary Shares to decline. Consequently, there can be no
assurance that sales to current customers will continue at the current rate.
BACKLOG
Our backlog of orders during 2005 ranged from $45.8 million to $64.2
million, as compared to a range of $48.6 million to $85.8 million during 2004.
This backlog is comprised of firm orders that represent the average production
volume mainly for the subsequent three to five months. Backlog data and any
comparison thereof as of different dates may not necessarily indicate future
sales.
ISRAELI INVESTMENT GRANTS AND TAX INCENTIVES
The Israeli government has established investment and tax incentive
programs for enterprises that invest and do business in Israel. Israeli
government support is provided primarily to industrial and tourism companies
that help fulfill certain economic objectives of the Israeli government, such as
creating employment in selected locations in Israel, competing in international
markets, utilizing innovative technologies, producing value-added products and
generating income in foreign currency. To date, we have enjoyed Israeli
government grants with respect to such programs for significant amounts of our
capital expenditures. Such grants were available from 1997 to 2001 for an amount
equal to 24% of the eligible annual capital expenditures for projects not
exceeding investments of NIS140 million in any year, and for an amount equal to
20% of the eligible annual capital expenditures for projects exceeding
investments of NIS140 million. Following the exhaustion of our net operating
loss carry forwards in 1997, we began to benefit from certain tax incentives as
a result of the Approved Enterprise status of certain of our facilities.
Approved Enterprises related to investment programs from January 1997 onwards in
designated areas which include the location of our primary plants are exempt
from tax for the first two years of the Benefit Period commencing in the first
year in which the taxable income is generated.
LAW FOR THE ENCOURAGEMENT OF CAPITAL INVESTMENTS, 1959
PRIOR TO AMENDMENT IN APRIL 2005
The Law for Encouragement of Capital Investments, 1959, or the Investment
Law, provides that a capital investment in eligible facilities may, upon
application to the Investment Center, be designated as an "Approved Enterprise."
Each certificate of approval for an Approved Enterprise relates to a specific
investment program delineated both by its financial scope, including its capital
sources, and by its physical characteristics, e.g., the equipment to be
purchased and utilized pursuant to the program. The tax benefits derived from
any such certificate of approval relate only to taxable income attributable to
the specific Approved Enterprise.
Each application to the Investment Center is reviewed separately, and a
decision as to whether or not to approve such application is based upon, among
other things, the then-prevailing criteria set forth in the Investment Law, on
the specific objectives of the applicant company set forth in such application
and on certain financial criteria of the applicant company. Accordingly, there
can be no assurance that any such application will be approved.
Taxable income of a company derived from an Approved Enterprise designated
as such after July 30, 1978 is subject to corporate tax at the maximum rate of
25% for the "Benefit Period," a period of seven years commencing on the latest
of the year of operation or in the year in which the Approved Enterprise first
generated taxable income (limited to 12 years from commencement of production or
14 years from the date of approval, whichever is earlier) and, under certain
circumstances (as further detailed below), extending to a maximum of ten years
from the commencement of the Benefit Period. In the event that a company is
operating under more than one approval or that its capital investments are only
partly approved, referred to as a "Mixed Enterprise", its effective corporate
tax rate is the result of a weighted combination of the various applicable
rates.
23
We currently have plants which have been granted Approved Enterprise status
in conformity with the Investment Law. In accordance with this law, the income
from the Approved Enterprises during the Benefit Period will be subject to a
reduced tax rate of 25% (for Letters of Approval received before 1997) or 2
years of tax exemption and a reduced tax rate for the remainder of the benefits
period (for Letters of Approval received after 1997). A company with foreign
investment in excess of 25% at the time an approval is granted is entitled to a
Benefit Period of ten years from such approval. In addition, the tax rate
benefit is reduced even further in correspondence with the increase in the
foreign ownership percentage The proportion of foreign investment is measured
annually based on the lowest level of foreign investment during the year. Our
effective tax rate for accounting purposes for income derived from Approved
Enterprises during 2005, based on its percentage of foreign investment in 2005,
was 25%. Due to accumulated losses and other factors, we did not pay tax on this
income during 2005.
The Benefit Period for our first Approved Enterprises has ended and as
such, income attributable to these enterprises are taxed at a rate of 31%, the
regular Israeli corporate tax rate in 2006. Shareholders are subject to a 15%
Israeli tax (withheld at source) on dividends distributed out of income of
Approved Enterprises and a 20% (25% if the recipient of the dividends holds an
interest in the company of more than 10% during the 12 months prior to a
dividend distribution), Israeli tax (unless treaties for the prevention of
double taxation state otherwise) on dividends distributed from other sources of
income. Tax-exempt income attributable to the "Approved Enterprise" cannot be
distributed to shareholders without subjecting the Company to taxes except upon
complete liquidation of the Company. If such retained tax-exempt income is
distributed in a manner other than upon the complete liquidation of the Company,
it would be taxed at the reduced corporate tax rate applicable to such profits
(between 10%-25%). The Company currently does not have profits that can be
distributed as dividends under Israeli Law.
The Investment Law also provides that an Approved Enterprise is entitled to
accelerated depreciation on its property and equipment that are included in an
approved investment program. We have not utilized this benefit as we have
received preferable depreciation rights pursuant to other taxation laws.
Grants and certain other incentives received by a company in accordance
with the Investment Law remain subject to final ratification by the Investment
Center, such ratification being conditional upon fulfillment of all terms of the
approved program.
The benefits available to an Approved Enterprise are conditional upon the
fulfillment of certain conditions stipulated in the Investment Law and its
regulations and the criteria set forth in the specific certificate approval, as
described above. In the event that these conditions are not satisfied, in whole
or in part, we would be required to refund the amount of tax benefits, with the
addition of the Israeli CPI, linkage adjustment and interest. We have recorded
floating charges on all of our assets to secure our obligation to fulfill these
conditions. We believe that our Approved Enterprises operate in substantial
compliance with all such conditions and criteria. However, the shifting of the
sewing operations from Israel to Jordan may require an adjustment to the terms
of the certificate approval; otherwise, our operations may not be in compliance
with the approval's terms.
TAX BENEFITS UNDER AN AMENDMENT THAT BECAME EFFECTIVE ON APRIL 1, 2005
A recent amendment to the Investment Law, which has been officially
published as of April 1, 2005 has significantly changed the provisions of the
law. The amendment sets forth the scope of enterprises which may qualify as a
Privileged Enterprise (under the amendment, the designation is Priviliged
Enterprise rather than Approved Enterprise) by setting forth criteria for
qualification of a company, such as provisions generally requiring that at least
25% of the Approved Enterprise's income will be derived from export and under
the alternative package of benefits will invest a minimum qualifying investments
in productive assets.
24
We will continue to enjoy our current tax benefits in accordance with the
provisions of the Investment Law prior to its revision, but if we are granted
any new benefits in the future, they will be subject to the provisions of the
amended Investment Law. The amendment will be relevant to us only for new
programs of ours, if any, commencing in 2007 and thereafter.
There can be no assurance that we will satisfy the above conditions in the
future or that we will be entitled to any additional benefits under the
Investment Law. In addition, it is possible that we may not be able to operate
in a way that maximizes utilization of the benefits under the Investment Law.
LAW FOR THE ENCOURAGEMENT OF INDUSTRY (TAXES), 1969
We currently qualify as an "Industrial Company" within the definition of
the Law for the Encouragement of Industry (Taxes), 1969, or the Industry
Encouragement Law. According to the Industry Encouragement Law, an Industrial
Company is a company resident in Israel, at least 90% of the income of which, 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" owned by it. An Industrial Enterprise is defined as an enterprise
whose major activity in a given tax year is industrial production activity.
The following tax benefits are available to Industrial Companies:
(a) deduction of purchases of know-how and patents over an eight-year
period for tax purposes;
(b) an election under certain conditions to file a consolidated tax return
with certain Israeli industrial subsidiaries;
(c) accelerated depreciation rate on equipment and buildings; and
(d) expenses related to a public offering are deductible in equal amounts
over three years.
Eligibility for the benefits under the Industry Encouragement Law is not
subject to receipt of prior approval from a governmental authority. No assurance
can be given that we will continue to qualify as an Industrial Company or that
the benefits described above will be available in the future.
COMPETITION
The intimate apparel and active-wear markets are highly competitive. Our
products compete with products of other manufacturers in Israel, Europe, the
United States, South and Central America and Asia. Competition in our markets is
generally based on price, quality and customer service.
Although we have invested in Santoni knitting machines to manufacture our
seamless products, a competitor of the Santoni brand could manufacture similar
machines at lower prices, thereby increasing the competition we would face in
the intimate apparel and active-wear markets. See "Item 3. Key Information - 3D.
Risk Factors - Our markets are highly competitive and some of our competitors
have numerous advantages over us; we may not be able to compete successfully."
In addition, we benefit from Israel's status as one of the few countries in
the world that currently has free trade agreements with the United States,
Canada, the EU and the EFTA which permit us to sell its products in the United
States, Canada and the member countries of the EU and the EFTA free of customs
duties and imports quotas. Finally, government incentives that reduce the cost
to us of our equipment may not be available in other countries. We are also able
to sell our products manufactured at our facilities in Jordan free from customs
duties and import quotas to the United States and Europe under certain
conditions. We may also elect to manufacture products in Egypt and sell them
free from customs duties and import quotas to the United States under certain
conditions.
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CONDITIONS IN ISRAEL
We are incorporated under the laws of, and many of our offices and
manufacturing facilities are located in, the State of Israel. Accordingly, we
are directly affected by political, security and economic conditions in Israel.
Our operations would be materially adversely affected if major hostilities
involving Israel should occur or if trade between Israel and its present trading
partners should be curtailed.
POLITICAL CONDITIONS IN ISRAEL
Since the establishment of the State of Israel in 1948, a number of armed
conflicts have taken place between Israel and its Arab neighbors and a state of
hostility, varying from time to time in intensity and degree, has led to
security and economic concerns for Israel. A peace agreement between Israel and
Egypt was signed in 1979, and a peace agreement between Israel and Jordan was
signed in 1994. However, as of the date hereof, Israel has not entered into any
peace agreement with Syria or Lebanon. No prediction can be made as to whether
any other agreements will be entered into between Israel and its neighboring
countries, whether a final resolution of the area's problems will be achieved,
the nature of any such resolution or whether civil unrest will resume and to
what extent such unrest would have an adverse impact on Israel's economic
development or on our operations in the future.
There is substantial uncertainty about how or whether any peace process
will develop or what effect it may have upon us. Since October 2000, there has
been a substantial deterioration in the relationship between Israel and the
Palestinians which has resulted in increased violence. The future effect of this
deterioration and violence on the Israeli economy and our operations is unclear.
Ongoing violence between Israel and its Arab neighbors and Palestinians may have
a material adverse effect on our business, financial condition or results of
operations.
Certain countries, companies and organizations continue to participate in a
boycott of Israeli firms. We do not believe that the boycott has had a material
adverse effect on us, but there can be no assurance that restrictive laws,
policies or practices directed towards Israel or Israeli businesses will not
have an adverse impact on our business.
Generally, all male adult citizens and permanent residents of Israel under
the age of 54, unless exempt, are obligated to perform up to 36 days of annual
military reserve duty. Additionally, all such residents are subject to being
called to active duty at any time under emergency circumstances. Some of our
officers and employees are currently obligated to perform annual reserve duty.
While we have operated effectively under these requirements since we began
operations, no assessment can be made as to the full impact of such requirements
on our workforce or business, and no prediction can be made as to the effect on
us of any expansion or reduction of such obligations.
ECONOMIC CONDITIONS IN ISRAEL
Israel's economy has been subject to numerous destabilizing factors,
including a period of rampant inflation in the early to mid-1980s, low foreign
exchange reserves, fluctuations in world commodity prices, military conflicts
and civil unrest. The Israeli government has, for these and other reasons,
intervened in various sectors of the economy employing, among other means,
fiscal and monetary policies, import duties, foreign currency restrictions and
control of wages, prices and foreign currency exchange rates. The Israeli
government has periodically changed its policies in all these areas.
26
TRADE AGREEMENTS
Israel is a member of the United Nations, the International Monetary Fund,
the International Bank for Reconstruction and Development, and the International
Finance Corporation. Israel is a signatory to the General Agreement on Tariffs
and Trade, or GATT, which provides for the reciprocal lowering of trade barriers
among its members. In addition, Israel has been granted preferences under the
Generalized System of Preferences from the United States, Australia, Canada and
Japan. These preferences allow Israel to export the products covered by such
program either duty-free or at reduced tariffs. Israel became associated with
the European Economic Community (now known as the European Union) in a Free
Trade Agreement concluded in 1975, which confers certain advantages with respect
to Israeli exports to most European countries and obligates Israel to lower its
tariffs with respect to imports from those countries over a number of years.
In 1985, Israel and the United States entered into an agreement to
establish a Free Trade Area that has eliminated all tariff and certain
non-tariff barriers on most trade between the two countries. On January 1, 1993,
an agreement between Israel and the EFTA established a free trade zone between
Israel and the EFTA nations. In recent years, Israel has established commercial
and trade relations with a number of other nations (including the People's
Republic of China, Russia, India and other nations in Asia and Eastern Europe)
with which Israel had not previously had such relations.
In January 1995, the GATT members entered into an agreement with respect to
Textile and Clothing. According to this agreement, all non-tariff barriers were
gradually decreased since the date of the agreement until their full omission on
January 1, 2005. In 2004, in expectation of this change, the United States
decided to extend the period of barriers relating to products exported from
China.
Israel is a party to Qualified Industrial Zones agreements - since 1998
with Jordan and the United States, and since December 2004, with Egypt and the
United States. These agreements enable us to execute part of our manufacturing
process in defined zones in Jordan or in Egypt, under the terms of these
agreements, and enjoy exemption from U.S. custom duties and quotas once exported
to the United States.
U.S. GOVERNMENT REGULATION
Alba is subject to various United States regulations relating to the
maintenance of safe working conditions and manufacturing practices. In addition,
certain of the products manufactured by AlbaHealth are subject to the
requirements of the U.S. Food and Drug Administration with respect to
environmentally controlled facilities. Management believes that it is currently
in compliance with all such regulations.
4C. ORGANIZATIONAL STRUCTURE
Our significant subsidiaries consist of the following wholly-owned
subsidiaries: (i) Hi-Tex Founded by Tefron Ltd., a company incorporated under
the laws of the State of Israel, (ii) Marco Clothing Ltd. a company formed under
the laws of Israel, (iii) Alba Waldensian, Inc., which name was changed to
Tefron USA, Inc. and which holds a 48.325% interest in AlbaHealth, a Delaware
limited liability company, and (iv) El-Masira Textile Company Ltd., a company
incorporated under the laws of Jordan.
4D. PROPERTY, PLANTS AND EQUIPMENT
ISRAEL
As of December 31, 2005, we maintained manufacturing and administrative
facilities at the following sites in Israel and Jordan:
27
APPROX.
SQUARE NUMBER OF LEASE
FACILITY IN ISRAEL FOOTAGE EMPLOYEES EXPIRATION(1) FUNCTION
- ------------------ ------- --------- ------------- --------
Petach Tikva 7600 7 2008 Management offices
Segev: Central Factory -
Tefron (2) (3) 83,000 169 2006 Knitting cutting, sewing,
packaging, storage and
administrative functions
Segev: Central Factory -
Hi-Tex 1 (2) (3) 143,000 347 2011 Knitting, sewing, packaging,
storage and administrative
functions
Segev: Central Factory -
Hi-Tex 2 (2) (3) 178,000 371 2012 Knitting, sewing, packaging
and storage
Holon - Macro Center 12000 68 2009 Sewing and administrative
functions
Yarka 23,000 339 2012 Sewing and packaging
Segev: Central Factory - New -Net 37,000 -- 2006 Storage
Netanya: Dyeing Factory 68,000 50 2009 Dyeing and finishing
Segev: Delivery Warehouse (2) (3) 65,000 10 2012 Warehouse for finished
products
FACILITY IN JORDAN
Irbid (5) 147,000 502 2006(4) Sewing and packaging factory
(1) Including any renewal options.
(2) We lease this property from a subsidiary of Macpell.
(3) Not including an additional option for a 15 year lease exercisable
every three years on 90 days' prior advance notice.
(4) The agreement is renewable, at our option, every year.
(5) Includes free land lease of 78,000 square feet.
Our Hi-Tex 1, Hi-Tex 2, Central Factory and Delivery Warehouse facilities
in Segev, Israel, are leased from a subsidiary of Macpell. See "Item 7. Major
Shareholders and Related Party Transactions - 7B. Related Party Transactions -
Relationships and Transactions with Macpell - Lease Arrangement."
For a description of our plans regarding our facilities, see Note 6 of the
Notes to the Consolidated Financial Statements.
We believe that our existing facilities in Israel and Jordan are
well-maintained, in good operating condition and provide adequate space for our
current level of operations as well as for a significant increase in sales
volume. We further believe that our facilities and operations are in substantial
compliance with current Israeli governmental regulations regarding safety,
health and environmental pollution. We have not generally experienced difficulty
in complying with these regulations and such compliance has not had a material
adverse effect on our capital expenditures, earnings or competitive position.
28
UNITED STATES
As of December 31, 2005, Alba maintained manufacturing and administrative
facilities at the following sites in the United States:
APPROX. NUMBER OF
FACILITY IN UNITED STATES SQUARE FOOTAGE EMPLOYEES FUNCTION
- ------------------------- -------------- --------- --------
Valdese, NC - Alba 157,000 9 Warehouse (Consumer Products)
Rockwood, TN (AlbaHealth) 245,940 231 Knitting, Yarn Processing & Finishing (Health Products)
Valdese, NC - Offices 52,000 13 Corporate headquarters
New York City - Offices 3,200 3 Sales Offices and Showroom
Portland, OR- Offices 2,029 4 Sales Offices and Showroom
We also own two facilities in Valdese, NC (of approximately 178,300 and
81,000 square feet, respectively), which are currently unused. We are exploring
opportunities to sell or lease these facilities. See Note 6 of the Notes to the
Consolidated Financial Statements.
The lease of Alba's office in Portland, Oregon expired in February 2006 and
the office was vacated.
All plants are of brick and steel construction, and most areas have been
air-conditioned. Since April 2005, we are leasing for seven years 2000 square
feet at 150 West 30th Street New York, NY. The remainder of Alba's physical
properties are held in fee simple. Alba's physical properties are subject to a
lien pursuant to a credit agreement entered into in connection with the
acquisition of Alba. See "Item 10. Additional Information - 10C. Material
Contracts - Credit Agreement." We believe our existing facilities in the United
States are well-maintained, in good operating condition and provide adequate
space for Alba's current level of operations as well as for a significant
increase in sales volume.
We further believe that Alba is in substantial compliance with present
United States federal, state and local regulations regarding the discharge of
materials into the environment. Capital expenditures required to be made in
order to achieve such compliance have had no material adverse effect upon Alba's
earnings or the competitive position of Alba. We believe that continued
compliance will not require material expenditures.
ITEM 4A. UNRESOLVED STAFF COMMENTS
Not Applicable.
29
ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS
GENERAL
OUR BUSINESS; DEVELOPMENTS
We manufacture intimate apparel, active-wear and swim-wear sold throughout
the world by name-brand marketers as well as well known American retailers and
designer labels. Our product line includes knitted briefs, bras, tank tops,
boxers, leggings, crop, T-shirts, daywear, nightwear, bodysuits, swim-wear,
beach wear, active-wear, and accessories.
We have three divisions: Seamless (also called Hi-Tex), Cut & Sew and
Healthcare. Our Seamless Division, which manufactures intimate apparel and
active-wear products, generated approximately 53.4% of our revenues during 2005.
Our Cut & Sew Division, which manufactures intimate apparel, active-wear and
swim-wear products, generated approximately 29.9% of our revenues during 2005.
Our Healthcare Division generated approximately 16.7% of our revenues during
2005. We have delivered a notice to exercise our option to require AlbaHealth to
purchase our ownership interest in AlbaHealth, and we are in the process of
negotiating the final terms of the purchase. See "Item 10. Additional
Information - 10C. Material Contracts - AlbaHealth Option Agreement."
Our Hi-Tex manufacturing process involves a vertically integrated
production process, from the design of the product to the knitting, dyeing and
sewing of the product. However, our Hi-Tex manufacturing process utilizes
state-of-the-art technology that eliminates a significant number of stages of
the manufacturing process while enabling our Hi-Tex Division to produce a
substantially wider range of fabrics, styles and product lines at a consistently
high level of comfort, quality and durability. The Hi-Tex manufacturing process
was developed in-house through the adaptation and configuration of machinery and
equipment purchased from third parties. Although developed for our exclusive
use, most of these adaptations and configurations are not patented. The
manufacturing for our Hi-Tex Division takes place mainly in Israel, where we
operated approximately 751 fully equipped Santoni knitting machines as of
December 31, 2005.
Our Cut & Sew manufacturing process also involves a vertically integrated
production process. We are involved in all steps in the process, from the design
of the product to the knitting, dyeing, cutting and sewing of the product. The
knitting, dyeing and cutting processes for our intimate apparel and active-wear
products of our Cut & Sew Division take place in Israel and most of the sewing
for these products takes place in Jordan. Our swimwear products are produced
mainly in the Far East.
Our Healthcare Division manufactures a range of textile healthcare
products, which are manufactured in the United States, Mexico and Sri Lanka.
2005 DEVELOPMENTS
In 2005, we benefited from our strategy, begun at the end of 2002, to
transform from an intimate apparel company with one anchor customer to a more
diversified active-wear, swimwear and intimate apparel company with a
diversified customer base. Our expansion into active-wear and swim-wear has
provided us with an opportunity to increase our sales to a more diverse customer
base, including Nike, Reebok, Puma, Target, Swimwear Anywear and others. During
2005, our sales of active-wear and swim-wear products accounted for
approximately 33.9% of our overall sales, while during 2004 sales of these
products accounted for approximately 16.6% of our overall sales.
The growth in our sales during 2005 was due mainly to the significant
growth in sales of active-wear, and in particular sales to Nike for their Nike
Pro category. We are looking to further expand our relationship with Nike. We
intend to broaden our product lines while entering into new categories and
increase the visibility of our Engineered For Performance EFP(TM) technology.
30
While our transformation to a more diversified company initially reduced
operating efficiency in our Seamless division as we manufactured new, more
complicated active-wear and swim-wear products with different raw materials,
during 2005 we improved our operating efficiency. This improved efficiency
contributed to our higher operating and net profit during 2005. We intend to
work to maintain these efficiency levels as we expand our product lines and
manufacture other new, more complicated active-wear and swim-wear products,
although we cannot guarantee that we will be able to do so.
The cost structure of our Cut & Sew manufacturing process for intimate
apparel and active-wear products, which takes place principally in Israel and
Jordan, continues to be higher than the cost structure of many of our
competitors in the Far East, Egypt and Mexico. This competition, mainly for the
sale of intimate apparel products, has caused an erosion of our prices. We are
endeavoring to move portions of the Cut & Sew manufacturing process for intimate
apparel and active-wear products from Israel and Jordan to Egypt and the Far
East to benefit from the lower labor costs in those locations.
Our Cut & Sew manufacturing process for swim-wear products continues to
takes place principally in the Far East to keep costs low. We are endeavoring to
move the rest of the local production to subcontractors in the Far East.
In addition, the strengthening of the U.S. dollar compared to the NIS and
Euro in 2005 also positively affected our operating income in 2005.
CURRENCY; REVENUES; RAW MATERIALS
The currency of the primary economic environment in which our business is
conducted is the U.S. dollar. Consequently, we use the dollar as our functional
currency. Transactions and balances denominated in dollars are presented at
their dollar amounts. Transactions and balances in other currencies are
converted into dollars in accordance with the principles set forth in Statement
No. 52 of the Financial Accounting Standards Board and resulting gains and
losses are included in the statement of income. The financial information below
reflects our operations on a consolidated basis.
Substantially all of our revenues are derived from the sale of our
products, primarily in the United States. We recognize revenues from the sale of
our products upon shipment. Our payment terms vary based on customer and length
of relationship. We do not have any long-term supply obligations.
We purchase our raw materials from several international and domestic
suppliers and historically have not experienced any difficulty in obtaining raw
materials to meet production requirements. Raw materials are generally purchased
against actual orders, although we have a policy of maintaining a minimum level
of those raw materials that are in repeated demand. From time to time, when
market conditions are favorable, we have entered into contracts with various
suppliers of basic cotton for delivery over a period of three to six months.
SIGNIFICANT ACCOUNTING POLICIES
We prepare our consolidated financial statements in conformity with
accounting principles generally accepted in the U.S. As such, we are required to
make certain estimates, judgments and assumptions that we believe are reasonable
based upon the information available at the time they are made. These estimates,
judgments and assumptions affect the reported amounts of assets and liabilities
as of the date of the financial statements, as well as the reported amounts of
expenses during the periods presented.
31
Our management believes the significant accounting policies which affect
management's more significant estimates, judgments, and assumptions used in the
preparation of the Company's consolidated financial statements and which are the
most critical to aid in fully understanding and evaluating the Company's
reported financial results include the following:
o Inventory valuation
o Property, plant and equipment
o Goodwill
o Income taxes and valuation allowance
INVENTORY VALUATION
At each balance sheet date, we evaluate our inventory balance for excess
quantities and obsolescence. We estimate the excess inventory of products and
raw materials which are not designated for existing or projected orders as well
as inventory that is not of saleable quality, estimate their market value and
reduce their carrying value accordingly. Misjudgement in planning inventory
level or in the assessment of the market value of the excess raw materials and
products may require us to record inventory mark downs that would be reflected
in cost of sales in the period the revision is made.
PROPERTY, PLANT AND EQUIPMENT
Our property, plant and equipment are reviewed for impairment in accordance
with Statement of Financial Accounting Standard No. 144 "Accounting for the
Impairment or Disposal of Long-Lived Assets", whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. Recoverability of assets to be held and used is measured by a
comparison of the carrying amount of an asset to the future undiscounted cash
flows expected to be generated by the assets. If such assets are considered to
be impaired, the impairment to be recognized is measured by the amount by which
the carrying amount of the assets exceeds the fair value of the assets. Assets
to be disposed of are reported at the lower of the carrying amount or fair value
less costs to sell.
GOODWILL
Goodwill represents excess of the costs over the net assets of businesses
acquired. Goodwill that arose from acquisitions prior to July 1, 2001 was
amortized until December 31, 2001 on a straight-line basis over forty years.
Under Statement of Financial Accounting Standard No. 142, goodwill acquired in a
business combination for which date is on or after July 1, 2001 shall not be
amortized.
SFAS No. 142 requires goodwill to be tested for impairment on adoption and
at least annually thereafter or between annual tests in certain circumstances,
and written down when impaired, rather than being amortized as previous
accounting standards required. Goodwill attributable to each of the reporting
units is tested for impairment by comparing the fair value of each reporting
unit with its carrying value.
The carrying value of goodwill recorded in our financial statement is
related to the AlbaHealth reporting unit. In preparation of the financial
statements for the year 2005, we completed our most recent review performed by
an independent expert of this reporting unit, which determined that its fair
value is lower than its carrying value, and therefore an impairment of $5.7
million was required in the recorded goodwill for this period to adjust it to
its determined fair value. The review process uses the income method and is
based on a discounted future cash flow approach that uses estimates for cash
flow, growth of sales, taxes, profits and cost of capital, among others, for the
AlbaHealth reporting unit as well the anticipated amount to be received by
Tefron in connection with the exercise of its put option. We have delivered a
notice to exercise our option to require AlbaHealth to purchase our ownership
interest in AlbaHealth, and we are in the process of negotiating the final terms
of the purchase. See "Item 10. Additional Information - 10C. Material Contracts
- - AlbaHealth Option Agreement." We may incur additional charges for the
impairment of goodwill in the future if the sale of our interest in AlbaHealth
is not completed and AlbaHealth fails to meet our assumed cash flow, growth of
sales and profits, or if interest rates significantly increase.
32
INCOME TAXES AND VALUATION ALLOWANCE
The Company and its subsidiaries account 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 financial reporting and tax bases of assets and
liabilities and are measured using the enacted tax rates and laws that will be
in effect when the differences are expected to reverse. The Company and its
subsidiaries provide a valuation allowance, if necessary, to reduce deferred tax
assets to their estimated realizable value.
We must assess the likelihood that we will be able to recover our deferred
tax assets. We review the balance of deferred taxes in relation to our
anticipated profits and if we estimate that it is not likely that our
anticipated profits will materialize, we record a valuation allowance against
the deferred tax assets accordingly. A future decrease in our profits or
anticipated profits may result in an additional adjustment to the carrying
amount of our deferred taxes.
In addition, the calculation of our tax liabilities involves dealing with
uncertainties in the application of complex tax regulations, particularly under
the Investment Law. We estimate our tax liabilities under the various investment
programs under the Investment Law based on a complex mix of factors, including
our estimates of our future growth of revenues, the particular investment
program under which revenue will be generated and the location where such
revenues will be generated. We may need to record a charge for tax if our
estimates are inaccurate or if we experience changes due to off-shoring certain
of our production processes.
OPERATING RESULTS
The following table sets forth our results of operations expressed as a
percentage of total sales for the periods indicated:
YEAR ENDED DECEMBER 31,
2003 2004 2005
----- ----- -----
Sales, net 100.0% 100.0% 100%
Cost of sales 85.5 87.5 80.9
----- ----- -----
Gross profit 14.5 12.5 19.1
Selling, general and administrative
expenses 12.5 12.2 9.6
----- ----- -----
Impairment and other expenses related to the put
option exercise -- -- 3.0
----- ----- -----
Operating income before financing
expenses 2.0 0.3 6.5
Financing expenses, net (3.5) (2.9) (2.1)
Other income 0.1 -- 0.2
----- ----- -----
Income (loss) before taxes on income (1.3) (2.6) 4.6
Taxes on income (tax benefit) (0.3) 0.1 3.8
----- ----- -----
Income (loss) after taxes on income (1.0) (2.7) 0.8
Equity in losses of affiliated company (0.1) -- --
Minority interest in losses (earnings) to a
subsidiary (1.6) (1.1) 0.8
----- ----- -----
Net income (loss) (2.7) (3.8) 1.6
===== ===== =====
33
YEAR ENDED DECEMBER 31, 2005 COMPARED TO YEAR ENDED DECEMBER 31, 2004
SALES
CONSOLIDATED. Sales for the year ended December 31, 2005 were $205.6
million, a 12.5% increase compared to sales of $182.8 million for the year ended
December 31, 2004. Our sales of intimate apparel decreased 14.1% from $118.2
million in 2004 to $101.6 million in 2005, our sales of active-wear products
increased 158.4% from $20.1 million in 2004 to $52.0 million in 2005, our sales
of swim-wear increased 72.7% from $10.3 million in 2004 to $17.8 million in 2005
and our sales of health care products remained at the same level of $34.2
million as last year. Below is a table that describes our 2004 and 2005 sales of
intimate apparel, active-wear and swimwear products:
SALES
--------------------------------------------------------------------------------------
2004 2005
-------------------------------------- ---------------------------------------
(Dollars in thousands)
CUT & SEW SEAMLESS TOTAL CUT & SEW SEAMLESS TOTAL
--------- -------- ----- --------- -------- -----
Intimate Apparel $ 47,351 $ 70,889 $118,240 $ 37,564 $ 64,061 $101,625
Active-wear 7,646 12,459 20,105 6,140 45,821 51,961
Swimwear 10,275 -- 10,275 17,750 - 17,750
Total 65,272 83,348 148,620 61,454 109,882 171,336
AlbaHealth 34,199 34,249
Total with AlbaHealth 182,819 205,585
SEAMLESS. Sales for the year ended December 31, 2005 for this segment
were $109.9 million, a 31.8% increase compared to sales of $83.3 million
for the year ended December 31, 2004. This increase in sales was mainly due
to the growth in sales of our active-wear seamless products, and in
particular in sales to Nike for their Nike Pro category.
CUT & SEW. Sales for the year ended December 31, 2005 for this segment
were $61.5 million, a 5.8% decrease compared to sales of $65.3 million for
the year ended December 31, 2004. This decrease in sales was mainly due to
a decrease of 20.7% of our sales of intimate apparel products from $47.4
million in 2004 to $37.6 million in 2005, which was partially offset by an
increase of 72.7% in our sales of swim-wear products from $10.3 million in
2004 to $17.8 million in 2005. In order to improve the price
competitiveness of our intimate apparel products, we are endeavoring to
transfer the related manufacturing process from Israel and Jordan to Egypt
and the Far East to benefit from the lower labor costs in those locations.
HEALTHCARE. Sales for the year ended December 31, 2005 for this
segment were $34.2 million, same amount as compared to the sales for the
year ended December 31, 2004.
COST OF SALES
Cost of sales consists primarily of materials, various salaries and related
expenses, subcontracting expenses and other overhead expenses related to our
manufacturing operations. Cost of sales increased by 3.9% to $166.2 million in
2005 as compared to $159.9 million in 2004, primarily due to the increase in
sales. As a percentage of sales, cost of sales decreased to 80.9% in 2005 as
compared to 87.5% in 2004. This improvement in gross profit percentage was due
to the increased contribution of higher margin products and the improved
operating efficiencies in our Seamless and Cut & Sew segments. These efficiency
measures included, among others, increased production and quality performance
and further transfer of sewing capacity to Jordan.
34
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses consist primarily of costs
relating to salaries to employees engaged in sales, marketing, distribution,
administration and management activities, freight and other administrative
costs. Selling, general and administrative expenses decreased by 11.4% to $19.8
million in 2005 as compared to $22.4 million in 2004. This decrease was
primarily due to a reduction in air freight expenses due to improved deliveries
to our customers and to a reduction of general and administrative payroll
expenses. As a percentage of sales, selling, general and administrative expenses
decreased from 12.2% in 2004 to 9.6% in 2005. This was primarily due to the
increase in sales volume and the factors mentioned above.
OPERATING INCOME
CONSOLIDATED. Operating income for the year ended December 31, 2005 was
$13.5 million (6.5% of sales), compared to operating income of $0.5 million
(0.3% of sales) for the year ended December 31, 2004. This increase in operating
income was due to the increase in gross profit and decrease in selling, general
and administrative expenses as discussed above.
SEAMLESS. Operating income for the year ended December 31, 2005 for
this segment was $12.8 million (11.6% of sales), compared to operating loss
of $8.2 million ((9.9)% of sales) for the year ended December 31, 2004.
This improvement was due to the increased contribution of higher margin
products, increased production volume, improvement in production and
quality performance, further transfer of sewing capacity to Jordan and a
decrease in freight expenses.
CUT & SEW. Operating income for the year ended December 31, 2005 for
this segment was $2.9 million (4.7% of sales), compared to operating income
of 3.5 million (5.4% of sales) for the year ended December 31, 2004. The
decrease resulted primarily from a decrease in sales to a major intimate
apparel customer due to strengthened price competition.
HEALTHCARE. Operating loss for the year ended December 31, 2005 for
this segment was $2.2 million (including impairment and other expenses
related to the put option exercise in the amount of $6.1 million), compared
to operating income of $5.2 million for the year ended December 31, 2004.
This decrease was mainly due to the effect of the put option exercise
described above.
FINANCING EXPENSES, NET
Financing expenses decreased to $4.4 million in 2005 as compared to $5.2
million in 2004. This decrease was mainly due to the strengthening of the U.S
dollar as compared to the NIS and the EUR. This decrease was partly offset by an
increase in interest expenses on our loans and credit lines due to an increase
in LIBOR rates.
INCOME TAXES
Tax expense for 2005 was $7.8 million (including tax expense of $3.5
million related to the put option exercise in Alba Health), as compared to tax
expense of $0.2 million for 2004. The main reasons for this increase were (i)
the increase in pretax profit which was $9.5 million in 2005 (including
impairment and other expenses related to the put option exercise in the amount
of $6.1 million) compared to a pretax loss of $4.7 million in the year 2004 and
(ii) the effect of the put option exercise described above.
35
YEAR ENDED DECEMBER 31, 2004 COMPARED TO YEAR ENDED DECEMBER 31, 2003
SALES
CONSOLIDATED. Sales for the year ended December 31, 2004 were $182.8
million, 12.1% increase compared to sales of $163.1 million for the year ended
December 31, 2003. Our sales of intimate apparel increased 8.5% from $109.0
million in 2003 to $118.2 million in 2004, our sales of active-wear products
increased 66.6% from $12.1 million in 2003 to $20.1 million in 2004 and our
sales of Swim-wear increased 175.4% from $3.7 million in 2003 to $10.3 million
in 2004. Below is a table that describes our 2003 and 2004 sales of intimate
apparel, active-wear and swimwear products:
SALES
---------------------------------------------------------------------------------
2003 2004
----------------------- ---------------------- ---------------------
(Dollars in thousands)
CUT & SEW SEAMLESS TOTAL CUT & SEW SEAMLESS TOTAL
--------- -------- ----- --------- -------- -----
Intimate Apparel 48,044 60,954 108,998 47,351 70,889 118,240
Active-wear 1,638 10,433 12,071 7,646 12,459 20,105
Swimwear 3,731 -- 3,731 10,275 -- 10,275
Total 54,413 71,387 124,800 65,272 83,348 148,620
Alba Health -- -- 38,286 -- -- 34,199
Total with AlbaHealth -- -- 163,086 -- -- 182,819
SEAMLESS. Sales for the year ended December 31, 2004 for this segment
were $83.8 million, a 16.8% increase compared to sales of $71.4 million for
the year ended December 31, 2003. This increase in sales was due to a
greater demand for intimate apparel products and the increase of sales of
our more diverse selection of active wear products to a more diverse
customer base.
CUT & SEW. Sales for the year ended December 31, 2004 for this segment
were $65.3 million, a 20.0% increase compared to sales of $54.4 million for
the year ended December 31, 2003. This increase in sales was due primarily
to an increase in sales of our more diverse selection of swimwear and
active-wear products to a more diverse customer base.
HEALTHCARE. Sales for the year ended December 31, 2004 for this
segment were $34.2 million, a 10.7% decrease compared to the sales of $38.3
million for the year ended December 31, 2003. This decrease was mainly due
price erosion caused by competition from producers in the Far East.
COST OF SALES
Cost of sales consists primarily of materials, various salaries and related
expenses, subcontracting expenses and other overhead expenses related to our
manufacturing operations. Cost of sales increased by 14.7% to $159.9 million in
2004 as compared to $139.4 million in 2003 primarily due to the increase in
sales. As a percentage of sales, cost of sales increased to 87.5% in 2004 as
compared to 85.5% in 2003 primarily due to the operating inefficiencies referred
to above and the reevaluation of the NIS compared to the United States dollar.
Although we believe that our efficiency will improve as we continue to
manufacture our new product lines, we cannot assure that we will be able to
return to our previous efficiency levels in the future.
36
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses consist primarily of costs
relating to salaries to employees engaged in sales, marketing, distribution,
administration and management activities, freight and other administrative
costs. Selling, general and administrative expenses increased by 10.2% to $22.4
million in 2004 as compared to $20.3 million in 2003. This increase is primarily
due to an increase in sales, an increase in air freight charges of due to delays
in supplying orders to customers resulting from the operating inefficiencies
referred to above, an expense resulting from the grant of options to the
company's CEO and an impairment of property and equipment held for sale in North
Carolina. As a percentage of sales, selling, general and administrative expenses
decreased from 12.5% in 2003 to 12.2% in 2004.
OPERATING INCOME
CONSOLIDATED. Operating income for the year ended December 31, 2004 was
$495,000 (0.3% of sales), compared to operating income of $3.3 million (2.0% of
sales) for the year ended December 31, 2003. This decrease in operating income
was due to the increase in cost of sales and selling, general and administrative
expenses discussed above.
SEAMLESS. Operating loss for the year ended December 31, 2004 for this
segment was $8.2 million (9.8% of sales), compared to operating loss of
$4.1 million (5.7% of sales) for the year ended December 31, 2003. This
increase in operating loss was due primarily to operating inefficiencies
and increase in freight charges due to delays in supplying orders to
customers.
CUT & SEW. Operating income for the year ended December 31, 2004 for
this segment was $3.5 million (5.4% of sales), compared to operating income
of $0.7 million (as restated) (1.3% of sales) for the year ended December
31, 2003. The increase in operating income resulted primarily from a
significant increase in sales and gross profit of our swimwear products and
increase in sales of active wear products. This increase was offset by
price erosion of an intimate apparel project to a major customer due to
competition.
HEALTHCARE. Operating income for the year ended December 31, 2004 for
this segment was $5.2 million, 22.1% decrease from the operating income of
$6.7 million for the year ended December 31, 2003. This decrease was mainly
due price erosion caused by competition from producers in the Far East.
FINANCING EXPENSES, NET
Financing expenses decreased slightly to $5.2 million in 2004 as compared
to $5.6 million in 2003. This decrease was mainly due to decrease in interest
expenses caused by reduction of $20 million in the amount of bank debt, capital
lease and other loans from proceeds of issuance of shares in April 2004. This
decrease was partly offset by an increase in bank charges due to our increased
use of letters of credit, mainly with new customers.
INCOME TAXES
Tax expense for 2004 was $0.2 million as compared to tax benefit of $0.4
million for 2003. In 2004, we reduced our deferred taxes in Alba by $0.6 million
as a result of an adjustment of our expected utilization of deferred taxes in
light of expected future earnings and recorded additional expenses of $0.4
million due to tax assessment by the Israeli tax authorities regarding tax
returns for the years 1997-2000.
37
LIQUIDITY AND CAPITAL RESOURCES
2005 SOURCES AND USES OF CASH
During 2005, we generated approximately $20.8 million in cash from
operating activities. This cash flow was used to repay a net amount of $3.6
million of short term bank loans and credit lines, $8.5 million of long term
bank loans and capital leases and to invest $5.3 million in fixed assets. During
2005, we received government grants in the approximate amount of $0.5 million,
received proceeds of $0.6 million from the Company's insurance policy for
equipment damage and proceeds of $0.5 million from sales of property and
equipment. At December 31, 2005, we had cash and cash equivalents of $8.2
million, as compared to $3.6 million at the end of the previous year. The main
capital investment in fixed assets in 2006 is expected to be made in favor of
acquiring additional santoni machines to support the anticipated growth of our
seamless segment.
Cash provided by operating activities is net income (loss) adjusted for
certain non-cash items and changes in assets and liabilities. For 2005, cash
provided by operating activities was $20.8 million, compared to $6.9 million in
2004, while our net income increased in 2005 to $3.3 million compared to a net
loss of $6.9 million in 2004. During 2005, the majority of our increase in cash
flow as compared to 2004 was mainly due to an increase in our net income
(excluding the non cash expenses).
CONTRACTUAL AND OTHER COMMITMENTS
We have various commitments primarily related to long-term debt, capital
lease obligations and short-term debt. The following tables provide details
regarding our contractual cash obligations and other commercial commitments
subsequent to December 31, 2005:
CONTRACTUAL OBLIGATIONS (1)(2) TOTAL 2006 2007 2008 2009-2010 2011 +
- ------------------------------ ----- ---- ---- ---- --------- ------
Long-Term Bank Debt $48.7 $7.6 $11.4 $5.9 $10.1 $13.7
Capital Lease Obligations -- -- -- -- -- --
Other Long-Term
Obligations (3) -- -- -- -- -- --
TOTAL CONTRACTUAL CASH
OBLIGATIONS 48.7 7.6 11.4 5.9 10.1 13.7
OTHER COMMERCIAL COMMITMENTS TOTAL AMOUNTS AVAILABLE 2005(4)
- ---------------------------- ----------------------- -------
Lines of Credit $17.2 $17.2
Short Term Bank Debt $ 3.5 $ 0.5
Guarantees/Letters of Credit $ 5.5 $ 2.5
TOTAL COMMERCIAL COMMITMENTS $26.2 $20.2
These credit line facilities are not limited in time.
(1) Contractual obligations are defined as agreements for finance purposes
that are enforceable and legally binding on Tefron and that specify all
significant terms, including fixed or minimum quantities to be purchased, and
the approximate timing of the transaction. Because our purchase orders are based
on our current manufacturing needs, our agreements for the purchase of raw
materials and other goods and services are not included in the table above.
38
(2) This table does not include payments of interest on our long-term bank
debt or on our short-term bank debt, due to its variable nature. Interest on our
long-term bank debt ranges from three-month LIBOR plus 2% to three-month LIBOR
plus 2.75%, and interest on our short-term bank debt ranges from LIBOR plus 1.5%
to LIBOR plus 2.75%. As of March 15, 2006, the three-month LIBOR was 4.5%.
(3) This table does not include deferred tax obligations of $9.1 million
and accrued severance pay, net, in the amount of $2.1 million. We do not know in
what year these long-term obligations will be payable.
(4) These credit lines facilities are revolving every year.
LOAN FACILITIES
At December 31, 2005, outstanding borrowings from banks and other financial
institutions totaled $66.4 million, comprised of $48.7 million of long
term-debt, including current maturities of $7.6 million, and $17.7 million of
short-term debt. The bank loans bear interest at LIBOR plus 1.5% to 2.75% and
are scheduled to mature during the next seven years.
Long-term loans include a term loan facility of our subsidiary, Alba (now
called Tefron USA Inc.), with Bank Hapoalim B.M. and Israel Discount Bank of New
York entered into in connection with the acquisition of Alba, in the outstanding
amount of $22.4 million payable in 32 quarterly installments commencing March
15, 2005 through December 15, 2012.
The term loan facility and a short-term related revolving credit facility
are secured by a floating lien on all the personal property of Alba and its
subsidiaries, pledges of all non-margin stock of Alba owned by our U.S.
subsidiary, Tefron U.S. Holdings Corp., and all subsidiary stock then owned by
Alba, and guaranties made by us, Hi-Tex Founded by Tefron Ltd. and by Tefron
U.S. Holdings Corp.
Long-term loans also include a long-term loan facility between us and
Hi-Tex Founded by Tefron Ltd., with Bank Hapoalim B.M. and Israel Discount Bank
Ltd. in the outstanding amount of $19.5 million payable in 32 quarterly
installments commencing March 31, 2005 and terminating December 31, 2012. The
term loan facility and a related short-term revolving credit facility are
secured by a floating lien on all the personal property of Tefron and Hi-Tex.
The bank loan agreements contain various covenants which require, among
other things, that we maintain certain financial ratios related to shareholders'
equity and operating results. In addition, the terms prohibit us and Alba from
incurring certain additional indebtedness, limit certain investments, advances
or loans and restrict substantial asset sales, cash dividends and other payments
to shareholders of us and of Alba. These covenants and restrictions could hinder
us in operations and growth.
On September 9, 2002, we formed a new entity, AlbaHealth, with Encompass
Group, LLC, a Delaware limited liability company, and GE Capital, a Delaware
corporation, to operate Alba's health products business. In connection with the
transaction, Alba contributed substantially all of the assets of its Health
Products Division (together with associated liabilities, including certain
existing bank indebtedness) to the capital of AlbaHealth in exchange for a
48.325% ownership interest in AlbaHealth. Encompass and GE Capital contributed
cash to the capital of AlbaHealth in the amount of $12 million and $1 million,
respectively, in exchange for a 48.325% and 3.35% ownership interest in
AlbaHealth, respectively. Following the transaction, we repaid $28 million of
the long term loan facility with Bank Hapoalim B.M. and Israel Discount Bank of
New York.
We have delivered a notice to exercise our option to require AlbaHealth to
purchase our ownership in AlbaHealth under the Put Option Agreement with
AlbaHealth, Encompass Group, L.L.C. and GE Capital, and we are in the process of
negotiating the final terms of the purchase. Pursuant to an Obligation Letter in
April 2004, Tefron, Hi-Tex and Alba undertook to Bank Hapoalim B.M. and Israel
Discount Bank Ltd. to pay 50% of the net proceeds that would result from our
subsidiary, Alba, (i) exercising its right, to require AlbaHealth to purchase
all of Alba's ownership interest in AlbaHealth or (ii) otherwise selling its
interest in AlbaHealth, on account of their loans to Tefron, Hi-Tex and Alba.
See "Item 10. Additional Information - 10C Material Contracts - AlbaHealth
Option Agreement."
39
In connection with the formation of AlbaHealth, AlbaHealth entered into a
credit agreement with GE Capital, amended in October 2005, which contains a term
loan facility in the outstanding principal amount of $6.75 million as of
December 31, 2005, and also contains a revolving loan facility of up to $3.0
million. The proceeds from the term loan facility and the revolving loan
facility were and are to be used, among other purposes, to repay amounts due to
the Bank Hapoalim B.M. and Israel Discount Bank of New York and for working
capital purposes. The October 2005 Amendment provides that the balance of the
term loan facility now amortizes as follows: (i) four consecutive quarterly
installments on the first day of January, April, July, and October from January
1, 2006 through October 1, 2006, each in the amount of $312,500 and (ii) three
consecutive quarterly installments on January 1, 2007, April 1, 2007 and July 1,
2007, each in the amount of $375,000. The final installment will be due on
September 6, 2007 and will be in the amount of $4,375,000 or, if different, the
remaining principal balance of the loan.
The credit agreement contains various covenants which require, among other
things, that we maintain certain financial ratios. During 2004, AlbaHealth
failed to comply with certain financial covenants contained in its credit
facility with the bank lender. However, the bank agreed to waive the covenant
defaults that occurred during 2004 and to amend certain of the financial
covenant provisions of the cedit facility. During the second quarter of 2005,
the subsidiary again failed to comply with a certain financial covenant in the
credit facility. On October 1, 2005, the Company signed an amendment to the
credit agreement under which the bank agreed again to waive the covenants
defaults and provide the Company with more favorable credit facility terms. See
"Item 10. Additional Information - 10C. Material Contracts - AlbaHealth Credit
Agreement" for more information regarding this credit facility.
Under the terms of an existing agreement, Alba provides certain management
services to AlbaHealth in return for an annual fee of approximately $800,000 for
the first year ending on September 6, 2003, which amount was to be increased at
a rate of 4% per annum for each additional year of the term. Following the first
increase of 4%, it was agreed to keep the fee unchanged at $832,000. While
AlbaHealth is unable to satisfy the conditions of its obligation to purchase our
ownership interest, the terms of the Put Option Agreement provide that Alba will
no longer receive these management fees from AlbaHealth, although we may
continue to receive a portion of these fees for a period of time as part of our
agreement to sell our AlbaHealth interest to AlbaHealth.
Our short-term debt in the amount of approximately $17.7 million consists
of one-year revolving credit facilities with various expiration dates during
2006. We expect that the one-year revolving credit facilities will be renewed
beyond their respective expiration dates. However, the lenders under such
revolving credit facilities are under no obligation to renew such facilities. In
the event that these facilities are not renewed, we may be unable to repay
outstanding amounts, and the lenders may, as a result, declare all amounts
borrowed to be due and payable. A default under the revolving credit facilities
may also trigger a default under the long-term loan facilities described above.
40
EQUITY FINANCINGS
On April 22, 2004, we issued to Norfet, Limited Partnership, or Norfet,
controlled by FIMI Opportunity Fund and certain other co-investors,
approximately 3.53 million ordinary shares at a base price of $4.25 per share
and to a group of investors represented by Mr. Zvi Limon, or Leber,
approximately 1.07 million of our ordinary shares at a base price of $4.65 per
share. See "Item 10. Additional Information - C. Material Agreements - FIMI
Agreements". We applied most of the aggregate amount of $19.7 million from these
investments to repay short-term debt. On April 5, 2005 we issued, with no
further consideration, additional shares to Norfet and Leber according to share
purchase price adjustment mechanisms included in the investments agreements with
these investors. Also, on March 9, 2004, we announced that we had entered into
an equity line credit facility with Brittany Capital Management Ltd., or
Brittany, an entity advised by Southridge Capital Management LLC. Under the
agreement, we have an option to call funds of up to the lesser of $15 million or
2,470,021 ordinary shares (equal to 19.9% of our outstanding share capital on
the day we signed the agreement) over a three-year period expiring at the end of
October 2007. Under the financing facility, we will be entitled to issue shares
to Brittany from time to time, at our own election, subject to certain minimum
and maximum limitations, but in no event will Brittany be obligated to own more
than 4.99% of our ordinary shares at any one time. The price to be paid by
Brittany will be at a discount of 6% to the market price of our ordinary shares
(as calculated under the agreement) during a period prior to the issuance of the
shares. Before drawing on the equity line, we must satisfy certain closing
conditions, including the effectiveness of a registration statement that we must
file relating to the shares to be issued to Brittany. See "Item 10. Additional
Information - C. Material Agreements - Equity Line Credit Facility ".
On January 10, 2006, we completed a public auction of our ordinary shares
and Option Certificates (Series 1) in Israel. A total of 100,000 units,
consisting of 18 Shares and six Option Certificates each, were issued in the
offering at a price of NIS 701.64 (approximately $151.48) per unit. Each Option
Certificate is exercisable into one Share until January 9, 2007 at an exercise
price of $9.49 per Share. Our total net proceeds from the offering were
approximately $13.9 million, not including the proceeds that we may receive from
any exercise of Option Certificates. The shares and the Option Certificates are
listed for trading on the Tel Aviv Stock Exchange.
OUTLOOK
We currently believe that our cash flow from ongoing operations, our
available bank credit and proceeds from equity financings will be sufficient to
finance all of our ongoing costs and our planed investment in our business
through 2006. We are looking to further expand our relationship with Nike and
increase our sales of swim-wear products. We intend to broaden our product lines
while entering into new categories and increase the visibility of our Engineered
For Performance EFPTM technology. However, we may not generate sufficient cash
from operations to finance our ongoing costs and service our high level of debt.
See "Item 3. Key Information - 3D. Risk Factors," in particular "- We depend on
a small number of principal customers who have in the past bought our products
in large volumes," "Our principal customers are in the retail industry, which is
subject to substantial cyclical variations," "Our expansion into new product
lines with more complicated products and new raw materials reduced our operating
efficiency during 2003 and 2004. We may also face operating efficiency
difficulties in the future," and "- Our markets are highly competitive and some
of our competitors have numerous advantages over us; we may not be able to
compete successfully." In the event sufficient cash from operations is not
generated, we may need to renegotiate the terms of the debt, refinance the debt,
obtain additional financing, postpone capital expenditures or sell assets .In
these circumstances, if the lenders decline to renegotiate the terms of the
debt, the lenders could declare all amounts borrowed to be due and payable. If
we are unable to repay the debt, the lenders could foreclose on our assets that
are subject to liens and sell the assets to satisfy the debt. See "Item 3. Key
Information - 3D. Risk Factors - Our debt obligations may hinder our growth and
put us at a competitive disadvantage," "We require a significant amount of cash
to pay our debt " and "Due to restrictions in our loan agreements, we may not be
able to operate our business as we desire." See "Item 10. Additional Information
- - 10C. Material Contracts - Credit Agreement."
DESIGN AND DEVELOPMENT OF PRODUCTS
Our design and development of products department continually strives to
improve technologies and products and develop new lines of products. We estimate
that we invested approximately $4 million to $4.5 million in 2003, $4.4 million
to $4.9 million in 2004, and $4.8 million to $5.0 million in 2005 on design and
development of products, including Alba.
41
IMPACT OF INFLATION AND CURRENCY FLUCTUATIONS
Because most of our revenues in the foreseeable future are expected to
continue to be generated in U.S. dollars, and in 2006 we expect to generate a
portion of our revenues in Euro, and a significant portion of our expenses are
expected to continue to be incurred in NIS, we are exposed to the risk of
appreciation of the NIS vis-a-vis the U.S. dollar. Part of our expenses are
executed in Euro, and therefore we are also exposed to the risk of appreciation
of the Euro vis-a-vis the U.S dollar. This appreciation would cause an increase
in our NIS or Euro expenses as recorded in our U.S. dollar denominated financial
reports even though the expenses denominated in NIS or Euro will remain
unchanged. A portion of our NIS denominated expenses is linked to changes in the
Israeli cost of living index, a portion is linked to increases in NIS payments
under collective bargaining agreements and a portion is unlinked.
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 (or is not) offset, or
is offset on a lagging basis, by the devaluation of the NIS in relation to the
dollar. Unless inflation in Israel is offset by a devaluation of the NIS, such
inflation will have a negative effect on our profitability because we receive
most of our payments in dollars or dollar-linked NIS, but incur a portion of our
expenses in NIS and NIS linked to the CPI. See "Item 11. Quantitative and
Qualitative Disclosures about Market Risk - Foreign Currency Risk" and
"-Interest Rate Risk."
In 2002, 2004 and 2005, the rate of devaluation of the NIS vis-a-vis the
dollar exceeded the inflation rate in Israel. During 2002, 2004 and 2005, the
rate of inflation was 6.5%, 1.2% and 2.4%, respectively, while NIS devalued
against the U.S. dollar by 7.3%, (1.6)% and 6.9% in 2002, 2004 and 2005,
respectively. During 2003, the rate of inflation was (1.9)%, while NIS
appreciated against the U.S. dollar by 7.6%. However, to the extent in the
future that the rate of inflation in Israel exceeds the rate of devaluation of
the NIS in relation to the dollar or if the timing of such devaluation lags
behind inflation in Israel, we may be adversely affected.
A devaluation of the NIS in relation to the dollar would have the effect of
decreasing the dollar value of any assets or receivables denominated in NIS
(unless such receivables are linked to the dollar). Such a devaluation would
also have the effect of reducing the dollar amount of any of our expenses or
liabilities which are denominated in NIS (unless such expenses or payables are
linked to the dollar). Conversely, any increase in the value of the NIS in
relation to the dollar will have the effect of increasing the dollar value of
any of our unlinked NIS assets and the dollar amounts of any of our unlinked NIS
liabilities and expenses. During 2005, we incurred expenses of approximately
$0.8 million due to the appreciation of the NIS in relation to the dollar and
approximately $0.2 million due to the appreciation of the Euro in relation to
the dollar. This appreciation may continue in 2006.
Because exchange rates between the NIS and the dollar fluctuate
continuously (albeit with a historically declining trend in the value of the
NIS), exchange rate fluctuations and especially larger periodic devaluations
will have an impact on our profitability and on period-to-period comparisons of
our results. This impact is recorded in our consolidated financial statements in
accordance with applicable accounting principles. We may from time to time
utilize derivative financial instruments to manage risk exposure to fluctuations
in foreign exchange rates. We do not engage in any speculative or profit
motivated hedging activities. See "Item 3. Key Information - 3D. Risk Factors.
Since most of our revenues are generated in U.S. dollars and a large part of our
expenses are in Israeli currency, we are subject to fluctuations in inflation
and currency rates."
EFFECTIVE CORPORATE TAX RATE
The taxable income of Israeli corporations is generally subject to
corporate tax at the statutory rate of 31% in 2006. The rate was 34% for 2005,
and is scheduled to decline 29% in 2007, 27% in 2008, 26% in 2009 and 25% in
2010 and thereafter. However, most of our manufacturing facilities in Israel
have been granted Approved Enterprise status under the Investment Law, and
consequently income derived from such facilities is eligible, subject to
compliance with certain requirements, for certain tax benefits beginning when
such facilities first generate taxable income. We have derived most of our
income from our Approved Enterprise facilities. Subject to compliance with
applicable requirements, income derived from our Approved Enterprise facilities
will be subject to corporate tax at a rate of 25% for the earlier between: (i)
10 years beginning in the year that we had taxable income, (ii) 12 years from
commencement of production, or (iii) 14 years from the date of approval.
42
In addition, should the percentage of foreign investment exceed 25%,
Approved Enterprises would qualify for reduced tax rates for an additional three
years beyond the initial seven-year period. The benefit period under each of our
Approved Enterprises will in any event expire 14 years following the date of the
approval of such Approved Enterprise by the Investment Center or 12 years after
production commences, whichever is earlier. In the event that the percentage of
foreign investment is between 49% and 74%, we would be subject to a corporate
tax rate of 20% on income derived from our Approved Enterprises. The proportion
of foreign investment is measured annually based on the lowest level of foreign
investment during the year. In addition, pursuant to the Investment Law,
Approved Enterprises related to investment programs from January 1997 onwards in
designated areas which include the location of our primary plants are exempt
from tax for the first two years of the Benefit Period commencing in the first
year in which taxable income is generated.
There can be no assurance that we will obtain approval for additional
Approved Enterprises, or that the provisions of the Investment Law will not
change, or that the above-mentioned foreign investment in our shares will be
reached for any subsequent year. See "Item 3. Key Information - 3D. Risk Factors
- - We are affected by conditions to and possible reduction of government programs
and tax benefits."
GOVERNMENT PROGRAMS
We benefit from certain Israeli government programs, particularly as a
result of the Approved Enterprise status of substantially all of our existing
production facilities in Israel. This status has enabled us to receive
investment grants with respect to certain of our capital expenditures. The
Government of Israel has reduced the investment grants available to us from 38%
of eligible annual capital expenditures in 1996 to 24% of eligible annual
capital expenditures (for projects not exceeding investments of 140 million NIS
in any year) since 1997. Commencing in 2001, such investment grants were reduced
by the Government of Israel to 20% of eligible annual capital expenditures.
There can be no assurance that the Israeli government will not further reduce
such investment grants. The termination or reduction of certain programs
(particularly benefits available to us as a result of the Approved Enterprise
status of certain of our facilities) would increase the costs of acquiring
machinery and equipment for its production facilities which could have a
material adverse effect on us. See "Item 3. Key Information - 3D. Risk Factors -
We are affected by conditions to and possible reduction of government programs
and tax benefits."
EXCHANGE RATES
The following table sets forth the representative rates of exchange
published by the Bank of Israel based on US dollar- NIS transactions for the
periods and dates indicated.
YEAR ENDED DECEMBER 31, AVERAGE RATE HIGH LOW PERIOD END
- ----------------------- ------------ ---- --- ----------
(NIS PER $1.00)
2001 4.21 4.42 4.04 4.42
2002 4.74 4.99 4.44 4.74
2003 4.54 4.92 4.28 4.38
2004 4.48 4.63 4.31 4.31
2005 4.49 4.74 4.30 4.60
The following table sets forth certain information concerning the
representative rate of exchange between the NIS and the US dollar, as published
for the months October 2005 through March 2006.
43
MONTH AVERAGE RATE HIGH LOW PERIOD END
- ----- ------------ ---- --- ----------
(NIS PER $1.00)
October 2005 4.62 4.65 4.59 4.64
November 2005 4.70 4.74 4.64 4.66
December 2005 4.61 4.66 4.58 4.60
January 2006 4.62 4.66 4.58 4.66
February 2006 4.70 4.73 4.66 4.71
March (through March 24, 2006) 4.70 4.72 4.66 4.68
On March 24, 2006, the representative rate of exchange between the NIS and
the US dollar was NIS 4.681 per $1.00, as published by the Bank of Israel.
Changes in the exchange rate between the NIS and the USD could materially affect
our financial results.
TREND INFORMATION. We have seen a significant improvement in the operating
efficiency in our Seamless Division during 2005, although we cannot assure that
we will be able to maintain our current efficiency levels in the future. For
more information, see " - General - 2004 Developments."
We have also experienced erosion in prices of our Cut & Sew intimate
apparel products and decrease in, sales of these products, that may continue in
the future.
OFF-BALANCE SHEET ARRANGEMENTS. We have no off-balance sheet arrangements
that have or are reasonably likely to have a current or future effect on our
financial condition, revenues or expenses, results of operations, liquidity,
capital expenditures or capital resources that are material to investors, except
for foreign exchange hedging contracts. See "Item 11. Quantitative and
Qualitative Disclosures About Market Risk - Foreign Currency Risk.".
44
ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES
6A. Directors and Senior Management
The following table sets forth certain information concerning our current
directors, senior management and key employees as of March 15, 2006
NAME AGE POSITION
- ---- --- --------
Ishay Davidi 44 Chairman of the Board
Yosef Shiran 44 Chief Executive Officer and Director
Arie Wolfson 44 Director
Micha Korman 51 Director
Meir Shamir 55 Director
Shirith Kasher 38 Director
Avi Zigelman 49 Director
Arie Arieli 55 External Director
Yacov Elinav 61 External Director
Asaf Alperovitz 36 Chief Financial Officer
Amit Tal 40 Vice President of Sales and Marketing
Itamar Harchol 47 Chief Technology Officer
Anat Barkan 39 Manager of Human Resources
Amit Eshet 44 Supply Chain Manager
David Gerbi 56 Hi-Tex Division Manager
Ilan Gilboa 39 Cut & Sew Division Manager
Ronny Grundland 52 Swimwear Division Manager
Michal Baumwald Oron 33 Company Secretary and Legal Counsel
ISHAY DAVIDI has served as Chairman of the Board of Directors since
November 2005 and served as a director of the Company since June 2005. Mr.
Davidi serves as a CEO of each of First Israel Mezzanine Investors Ltd. and FIMI
2001 Ltd., the managing general partners of the partnerships constituting the
FIMI Private Equity Funds. Mr. Davidi also serves as a chairman of Tadir
(Precision Products) 1993 Ltd, and as a director at Lipman Electronic
Engineering Ltd, Caesarea Creation Industries Ltd, Medtechnica Ltd, Tedea
Development & Automation Ltd, TAT Technologies Ltd and Formula Systems, Ltd. Mr.
Davidi was also the former CEO of the Tikvah VC Fund. Mr. Davidi holds a B.Sc in
Industrial and Management Engineering from Tel Aviv University and an MBA from
Bar Ilan University.
YOSEF SHIRAN has served as Chief Executive Officer and a Director of Tefron
since January 2001. Prior to joining Tefron, Mr. Shiran was the general manager
of Technoplast Industries, an injection molding and extrusion company, from 1995
to 2000. Mr. Shiran has over 14 years of management experience. Mr. Shiran holds
a B.Sc. degree in Industrial Engineering from Ben-Gurion University and a
masters degree in Business Administration from Bar Ilan University.
ARIE WOLFSON joined Tefron in 1987 and served as Chairman of the Board of
Directors from August 2002 until November 2005. He also served as Chairman of
the Board of Directors from 1997 to 2000, and as President from 1993 to 2000.
Mr. Wolfson served as Chief Financial Officer from 1988 to 1990 and Assistant to
the Chief Executive Officer from 1990 to 1993. Mr. Wolfson has also served as
Chairman of Macpell Industries Ltd., a principal shareholder in Tefron, since
1998 and served as Chief Executive Officer of Macpell from 1998 until March
2003. Mr. Wolfson is a graduate of High Talmudical Colleges in the United States
and in Israel.
MEIR SHAMIR was elected as a director of the Company on March 31, 2004 and
has been the Chairman of Mivtach Shamir Holdings Ltd., an investment company
traded on the TASE, since 1992. Mr. Shamir also serves as a director of each of
the following companies, as well as of other private companies: Lipman
Electronic Engineering Ltd, a manufacturer of electronic clearance systems and
Digal Investments and Holdings Ltd, a real estate holding company traded on the
TASE.
45
MICHA KORMAN has served as a director of the Company since October 2002.
Mr. Korman leads the improving, recovery and rehabilitation process for
companies. Mr. Korman held various senior management positions in the Company
from 1991 until 2003. From October 2000, he served as the Executive Vice
President of the Company. Prior to that, Mr. Korman was Chief Financial Officer
of the Company from 1991 to September 2000. Prior to joining the Company, Mr.
Korman held various senior financial and management positions with companies in
the hi-tech, beverage and food and communication industries. Mr. Korman holds a
Bachelor's degree in Economics, a Business Administration degree from Bar-Ilan
University and an LL.B degree from Kiryat Ono College.
SHIRITH KASHER was elected as a director of the Company on March 31, 2004
and is the CEO of Telem Ltd. From 2001 to March 31, 2005, Ms. Kasher was the
General Counsel and Secretary of The Israel Phoenix Assurance Company Ltd. and
the General Counsel of Atara Investment Company Ltd. and Atara Technology
Ventures Limited (both from the Phoenix Group). From 1997 to 2000, Ms. Kasher
worked at S. Horowitz & Co., first as an Articled Clerk and then as an Advocate.
Ms. Kasher holds a B.Sc. and an LLB, from Tel Aviv University and is admitted to
practice law in Israel.
AVI ZIGELMAN was elected as a director of the Company on June 28, 2005.
Since 2004 Mr. Zigelman is a financial advisor and serves as a director in the
following companies: Plastro Irrigation 1971 Ltd., Phoenix Gemel Ltd., Fox Vizel
Ltd., DCL Technologies Ltd., Bram Industries Ltd and Abe Trans Ltd, Migdal
Capital Markets (1965) Ltd., Gindi Towers Investments Ltd., Milomor Trade &
Communication Ltd. and 3 Pen Technologies Ltd. Since 2000 Mr. Zigelman is a
member of the Professional Committee of the Israeli Accounting Policy Institute.
Between 1996 and 2003, Mr. Zigelman served as a Partner, Head of Professional
Practice Department of KPMG Somekh Chaikin accounting firm, and Mr. Zigelman
holds an M.A. in Business Economics, specialization in Finance, with honors, B.A
in Accounting and Economics, Economics with honors, and Post degree Accounting
Studies, with honors, - all from Tel-Aviv University. Mr. Zigelman is a
Certified Public Accountant.
ARIE ARIELI has served as an External Director of Tefron since July 2000.
Since 1988, Mr. Arieli has been the legal counsel for the Israel Phoenix
Insurance Company. Mr. Arieli has served as Director of the Public for Offer
Commercial Centers Ltd. between 1993 and 1998 and is currently serving as an
External Director for Amit Profitable Company for the Management of Pensions and
Compensation Ltd. and for Master-Bit, the Israeli Students Insurance Agency Ltd.
YACOV ELINAV has served as an External Director of Tefron since 2004.
Between 1991 and July 2003, Mr. Elinav was a member of the Board of Management
of Bank Hapoalim B.M. Mr. Elinav also serves as Chairman of the Board of Diur
B.P. Ltd. and as a Chairman of the Board of DS Securities Investment Ltd. and is
a director of Mivnei Ta'asia Ltd., Middle East Tube Ltd. and other entities and
is an external director of Office Textile Ltd. Mr. Elinav formerly served as a
director of other prominent Israeli companies.
ASAF ALPEROVITZ joined Tefron in June 2005 as Chief Financial Officer. Mr.
Alperovitz has held several management positions, including that of Chief
Financial Officer of Corigin Ltd., an enterprise software company from 2003
until 2005. Prior to that, Mr. Alperovitz worked as the Head of Israeli Desk and
as High-Technology Senior Manager for Ernst & Young in both Israel and
California. Mr. Alperovitz holds a Bachelor's degree in Accounting and Economics
and a Master in Business Administration from Tel-Aviv University and is a
Certified Public Accountant.
AMIT TAL has served as Vice President of Sales and Marketing at Tefron
since 2005 and was marketing director at Tefron from 2001 to 2005. Before
joining Tefron, Mr. Tal was a business unit manager for a large textile firm.
Mr. Tal holds a B.A. in economics and marketing as well as a Masters in Business
Administration.
46
ITAMAR HARCHOL joined Tefron in March 2003 as Chief Technology Officer.
Prior to joining Tefron, from the beginning of 2001 to February 2003, Mr.
Harchol served as the Engineering Manager of Tamuz, a manufacturer of electronic
packaging, between 1998 and 2001 he was Products Manager for the automotive
industry in Ortal Dye Casting and prior to that, between 1994 and 1997, he
served as the Engineering Manager of Inbar Reinforced Polyester which is a
plastic manufacturer of composite materials products. Mr. Harchol holds a degree
of mechanical engineering from the Nazareth College.
ANAT BARKAN joined Tefron in 2005 as Human Resource Manager. Prior to
joining Tefron, Ms. Barkan served as Human Resource manager in several
companies, including Golan Plastic Products from 2001 until 2005 and in
Glidat-Strauss Ltd. from 1995 until 2001. Ms. Barkan holds a Bachelor's degree
in Political Science and Sociology from Haifa University, a Master in Business
Administration from the Hebrew University and a degree in Organizational
Consulting from Haifa University.
AMIT ESHET joined Tefron in February 2001 and has served as Hi-Tex division
manager since July 2004 and as Supply Chain manager since March 2005. Prior to
that, he served as manager quality assurance of Hi-Tex division. Mr. Eshet
served as manager in several industrial corporations. Mr. Eshet holds a B.Sc
degree in Industrial Engineering from the Technion in Haifa.
DAVID GERBI joined Tefron as Hi-Tex Managing director in February 2005.
David has a vast experience in management positions in the textile industry. Mr.
Gerbi served in Nilit Ltd. from 1977 to 1985 as a production manager in the
Textile Division, from 1985 to 1994 as a plant manager in Delta socks division,
from 1997 to 1999 established and managed his own private textile factory,
between 1999 to 2002 served as Delta sporting managing director, and From 2002
to 2005 was a country manager for Sara Lee in Turkey. Mr. Gerbi holds a degree
in practical engineer from Ort and a Bachelor's degree in sociology and state
studies form Haifa University.
ILAN GILBOA joined Tefron as manager of Tefron's cut & sew division in
March 2003. Prior to joining Tefron, Mr. Gilboa served from 1996 to February
2003 in Kulicke & Soffa Israel, a leading supplier of semiconductor assembly and
test innerconnect equipment, materials and technologies, first as a manager of
industrial engineering and last as vice president of operations and as such, was
responsible for the construction of K&S's new industrial facility in China. Mr.
Gilboa holds a B.Sc and M.Sc degree in industrial engineering from the Technion
in Haifa.
RONNY GRUNDLAND joined Tefron in May 2003, following the acquisition of
Macro Clothing Ltd, and has served since then as a Head of Tefron Swimwear
Division. Prior to that Mr. Grundland served since 1995 until 2003 as the
general manager of Macro, since 1993 until 1995 he served as general manger of
Macpell Industries, Ltd. jointly with another and as its marketing manager,
since 1990 until 1992 Mr. Grundland served as an organizational advisor to
textile companies in Israel and Europe, and since 1980 until 1989 he served as a
production and operational manager in Gotex, Ltd. Mr. Grundland holds a B.Sc
degree in industrial Engineering form the Technion- the technologic institution
to Israel.
MICHAL BAUMWALD ORON joined Tefron in 2003 and has served as the company
secretary and legal counsel since August 2004. Prior to joining Tefron, Ms. Oron
served as a lawyer and as legal counsel in a law firm, in private practice and
in the IDF. Ms. Oron holds an LLB from Tel-Aviv University and an LLM from
Bar-Ilan University and was admitted to practice law in Israel in 1996.
MACPELL SHAREHOLDERS' AGREEMENT
The Macpell Shareholders Agreement relates, among other things, to the
election of Directors of Tefron. The agreement provides, among other things,
that subject to the agreement of the shareholders in Tefron, the distribution of
the directors on Tefron's Board of Directors will reflect the direct and
indirect holdings in Tefron (including through Macpell) of the parties to the
agreement. See "Item 7 - Major Shareholders and Related Party Transactions - 7B.
- - Related Party Transaction - Relationships and Transactions with Macpell -
Macpell Shareholders' Agreement."
47
MACPELL-ARWOL- NORFET AGREEMENT
Arwol, Macpell and Norfet are parties to an agreement pursuant to which
they agreed to vote all of Tefron ordinary shares owned or controlled by each of
them for the election to Tefron's Board of Directors of: (i) three members (of
whom at least one will be female and at least one will qualify as an
"independent director" under the NYSE rules) plus, subject to applicable law -
one external director, that shall be nominated by Norfet, (ii) three members (of
whom at least one will qualify as an independent director and a financial expert
under the NYSE rules) plus, subject to applicable law, one external director,
that shall be nominated by Arwol and Macpell, and (iii) Tefron's chief executive
officer. Ishay Davidi, Meir Shamir, Shirith Kasher and Yacov Elinav were
nominated to the Board by Nofet, and Arie Wolfson, Micha Korman, Avi Zigelman
and Arie Arieli were nominated to the Board by Arwol and Macpell. See "Item 10.
Additional Information - C. Material Agreements - FIMI Agreements - Macpell
Agreement" for a description of the agreement between Arwol, Macpell and Norfet,
Limited Partnership regarding the election of members to Tefron's Board of
Directors.
6B. COMPENSATION
The aggregate direct remuneration paid to all Directors and senior
management as a group for services in all capacities for the year ended December
31, 2005 was approximately $1.6 million, of which $104,000 was paid to Directors
in their capacities as Directors. This amount does not include approximately
$20,000 which was set aside or accrued for vacation and recuperation pay. No
amounts were set aside or accrued to provide pension, retirement or similar
benefits. The amount does not include any amounts expended by us for automobiles
made available to our officers, expenses (including business travel and
professional and business association dues and expenses) reimbursed to officers
and other fringe benefits commonly reimbursed or paid by companies in Israel and
$146,000 in management fees paid to Norfet and $241,000 in management fees paid
to New York Delights, a company wholly owned by Arie Wolfson.
In 2005, we granted options for 210,000 Ordinary Shares under the Share
Option Plan, of which 165,000 were granted to Directors and senior managers.
Such options have an average exercise price of $6.34 per share and expire in
2015. Options for 23,000 Ordinary Shares under the Share Option Plan expired or
were cancelled during 2005.
EMPLOYMENT AGREEMENTS
CHIEF EXECUTIVE OFFICER
Under the terms of our management services agreement with Mr. Yosef Shiran,
our Chief Executive Officer, and with an entity controlled by him , referred to
in this Annual Report as the Management Agreement, we pay to the entity
controlled by Mr. Shiran: (i) compensation for management services in the amount
of $26,663 plus NIS 2,065 per month, plus VAT as applicable by law, (ii)
reimbursement of any and all reasonable direct expenses including telephone,
cellular phone and vehicle expenses and (iii) an annual grant that will not be
higher than 2.5% of Tefron's Net Profit, as defined in the Management Agreement,
and not lower than 1.5% of such Net Profit. In any case that the Audit Committee
shall determine that the annual grant should be higher than 1.5% of the Net
Profit, its decision will be subject to approvals of both the Board of Directors
and the General Meeting of the Shareholders of Tefron, unless such approvals
will no longer be required under applicable law. In March 2004, the Tefron
shareholders approved that, upon the closing of the transactions with Norfet,
Limited Partnership described in "Item 10. Additional Information - C. Material
Agreements - FIMI Agreements", the Management Agreement will be amended and
accordingly, from that date onwards the annual grant will be 2% of the Company's
Net Profits, as defined under the Management Agreement.
48
In addition, in 2001, we granted to Mr. Shiran options to purchase 300,000
Ordinary Shares at an exercise price per share of $3.56. These options are
subject to the terms and conditions of our 1997 Share Option Plan. In 2002, we
granted to Mr. Shiran options to purchase 15,000 Ordinary Shares with an
exercise price per share of $3.59. These options are subject to the terms and
conditions of our 1997 Share Option Plan. In March 2004, the Tefron shareholders
approved the grant to Mr. Shiran of options to purchase 650,000 Ordinary Shares
at an exercise price of $ 4.25 per share. These options were issued upon the
closing of the transactions with Norfet, Limited Partnership described in "Item
10. Additional Information - C. Material Agreements - FIMI Agreements". These
options were issued in accordance with our 1997 Share Option Plan. As of
December 31, 2005, 325,000 of these options have vested and the remaining
325,000 options will vest, subject to relevant tax laws, from January 2006 until
December 31, 2007 in the amount of 13,542 options each month.
In the event the Management Agreement is terminated by us without "cause"
or by Mr. Shiran, Mr. Shiran will be entitled to exercise the options he would
otherwise be entitled to exercise as of such date for a period ending 36 months
after such termination. Notwithstanding the foregoing, in the event we terminate
the Management Agreement because of a "Change in Control", Mr. Shiran will be
entitled to exercise all of the 650,000 options not exercisable at the time of
termination. In such a case, Mr. Shiran will be entitled to exercise these
options within 30 days of the termination date. For the purpose of this grant,
"Change of Control" means: if none of (i) FIMI Opportunity Fund, L.P. (and its
affiliates and investors, including FIMI Israel Opportunity Fund, Limited
Partnership), or FIMI; (ii) "Arwol"; and (iii) Macpell, will be party to the
shareholder agreement dated March 17, 2004 between such parties (described in
"Item 10. Additional Information - C. Material Contracts - FIMI Agreements -
Macpell Agreement"), or will otherwise effectively have Control of the Company.
For that purpose, the term "Control" shall have the meaning given to that term
(in Hebrew: "Shlita") in Section 1 of the Securities Law, 1968.
AGREEMENT WITH ARIE WOLFSON
Under the terms of our consulting and management services agreement with
Mr. Arie Wolfson, a Director of the Company, and with a company controlled by
him, referred to herein as the Consulting Agreement, we pay to the company
controlled by Mr. Wolfson: (1) compensation for consulting services in the
amount of $15,000 per month, plus 41% cost (equivalent to the cost we would have
paid for a similar senior management wage), (2) reimbursement of vehicle
expenses, (3) reimbursement of out-of-pocket expenses, and (4) reimbursement of
other standard expenses customarily provided to persons serving in such capacity
in Israel. These payments replace payments made until 2002 to Macpell in the
amount of $20,000 per month. In addition, the consulting and management services
agreement includes non-competition clauses.
In addition, we have granted to Mr. Wolfson options to purchase 225,000
Ordinary Shares at an exercise price per share of $3.50. Such options were
issued in accordance with our 1997 Share Option Plan and, subject to relevant
tax laws, all of the 225,000 options are exercisable.
Pursuant to the terms of the agreement between Norfet, Limited Partnership
and the Company, on March 31, 2004, the general meeting of shareholders of the
Company approved an amendment to the Consulting Agreement which provides that as
of the date on which Mr. Wolfson ceases to act as chairman of the board of
directors of the Company, and for so long as Mr. Wolfson continues to provide
consulting services to the Company, the annual amounts payable pursuant to the
Consulting Agreement will be reduced from $253,800 to $120,000 per annum, each
plus VAT. See "Item 10. Additional Information - 10C. Material Contracts - FIMI
Agreements".
FORMER PRESIDENT
Under the terms of a retirement agreement we executed with Mr. Rabinowicz
on January 10, 2005, we paid Mr. Rabinowicz from January 10, 2005 through
September 30, 2005 monthly compensation in the amount of $20,000, employee
benefits such as vacation, educational fund, sick leave, and management and
disability insurance contributions and provision of a vehicle. Options granted
to Mr. Rabinowicz will be effective and exercisable until January 2, 2007. The
retirement agreement also includes non-competition clauses.
49
DEFERRED SHARES
In 1996, we issued 2,250 Ordinary B Shares each to Sigi Rabinowicz and Arie
Wolfson in consideration for NIS 2,250 and services rendered to us in their
capacities as executive officers. Pursuant to our Articles of Association, the
Ordinary B Shares automatically converted into Deferred Shares upon consummation
of the initial public offering. The Deferred Shares are non-transferable and
entitle their holders, upon the liquidation of the company, to the par value of
the shares but to no voting, dividend or any other rights. During September
2005, the Board of Directors canceled all the Deferred Shares.
6C. BOARD PRACTICES
Each Director, other than the External Directors, is generally elected by a
vote at the Annual General Meeting of shareholders and serves for a term of one
year or until the following Annual General Meeting. Each External Director is
elected to serve for a period of three years from the date of the Annual General
Meeting. Each office holder will serve until his or her removal by the Board of
Directors or resignation from office.
Under an amendment to the Israeli Companies Law, each Israeli public
company is required to determine, no later than April 19, 2006, the minimum
number of directors with "accounting and financial expertise" that such company
believes is appropriate in light of the particulars of such company and its
activities. A director with "Accounting and Financial Expertise" is a person
that, due to education, experience and qualifications, is highly skilled and has
an understanding of business-accounting issues and financial statements in a
manner that enables him/her to understand in depth the company's financial
statements and stimulate discussion regarding the manner of presentation of the
financial data.
INDEPENDENT/EXTERNAL DIRECTORS
ISRAELI COMPANIES LAW REQUIREMENTS
We are subject to the provisions of the Israeli Companies Law, 1999 which
requires that we have at least two External Directors. Under a recent amendment
to the Companies Law, at least one of the external directors is required to have
Financial Expertise and the other External Directors are required to have
Professional Expertise. A director has "Professional Expertise" if he or she
satisfies ONE of the following:
(i) the director holds an academic degree in one of these areas:
economics, business administration, accounting, law or public
administration;
(ii) the director holds an academic degree or has other higher
education, all in the main business sector of the company or in a relevant
area for the board position; or
(iii) the director has at least five years' experience in one or more
of the following (or a combined five years' experience in at least two or
more of these: (a) senior management position in a corporation of
significant business scope; (b) senior public office or senior position in
the public sector; or (c) senior position in the main business sector of
the company.
The above qualifications do not apply to external directors appointed prior
to January 19, 2006, such as our external directors. However, an external
director may not be appointed to an additional term unless: (i) such director
has "Accounting and Financial Expertise"; or (ii) he or she has "Professional
Expertise", and on the date of appointment for another term there is another
external director who has "Accounting and Financial Expertise" and the number of
"Accounting and Financial Experts" on the board of directors is at least equal
to the minimum number determined appropriate by the board of directors.
This recent amendment does not apply to External Directors who were
appointed before January 19, 2006 (such as our External Directors).
50
Under the Companies Law, a person may not be appointed as an External
Director if he or his relative, partner, employer or any entity under his
control has or had during the two years preceding the date of appointment 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: an employment relationship, a business or professional relationship
maintained on a regular basis, control, and 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, conflicts of interest 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.
Under the Companies Law, External Directors must 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 who are participating in the voting at the meeting
in person or by proxy, vote in favor of the election; or (2) the total number of
shares voted against the election of the external director does not exceed one
percent of the aggregate voting rights in the company. The initial term of an
External Director is three years, which term may be extended for an additional
three years. Each committee of a company's board of directors must include at
least one External Director, and all External Directors must serve on the audit
committee. The Company's External Directors are currently Arie Arieli and Yacov
Elinav.
NEW YORK STOCK EXCHANGE REQUIREMENTS
The Company is subject to the rules of the New York Stock Exchange
applicable to listed companies that are foreign private issuers. Under such NYSE
rules, each member of the Company's audit committee must be independent. See "-
Audit Committee" below for a description of the independence standards under the
NYSE rules as applicable to foreign private issuers.
AUDIT COMMITTEE
NYSE REQUIREMENTS. Under NYSE rules as applicable to foreign private
issuers, we are required to have an audit committee that satisfies the
independence requirements of Rule 10A-3 of the U.S. Securities Exchange Act of
1934, as amended.
The requirements implement two basic criteria for determining independence:
(i) audit committee members would be barred from accepting, directly or
indirectly, any consulting, advisory or other compensatory fee from the issuer
or any subsidiary of the issuer, other than in the member's capacity as a member
of the board of directors and any board committee, and (ii) audit committee
members may not be an "affiliated person" of the issuer or any subsidiary of the
issuer apart from his or her capacity as a member of the board and any board
committee.
The SEC has defined "affiliate" for non-investment companies as "a person
that directly, or indirectly through one or more intermediaries, controls, or is
controlled by, or is under common control with, the person specified. "The term
"control" is intended to be consistent with the other definitions of this term
under the U.S. Securities Exchange Act of 1934, as "the possession, direct or
indirect, of the power to direct or cause the direction of the management and
policies of a person, whether through the ownership of voting securities, by
contract, or otherwise."
Among the roles of the audit committee is to be directly responsible for
the oversight of the work of any registered public accounting firm engaged for
the purpose of preparing or issuing an audit report or performing other audit,
review or attest services for Tefron, and each such registered public accounting
firm must report directly to the audit committee.
COMPANIES LAW REQUIREMENTS. 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 the chairman of the board of directors, a
controlling shareholder and any director employed by the company or who provides
services to the company on a regular basis.
51
Among the roles of the audit committee is to examine flaws in the business
management of the company, in consultation with the internal auditor and the
company's independent accountants, and suggest appropriate course of action. The
audit committee also determines whether to approve certain actions and
transactions with related parties. Arrangements regarding compensation of
directors require the approval of the audit committee, the board of directors
and the shareholders.
QUALIFICATIONS OF OTHER DIRECTORS
Under a recent amendment to the Companies Law, the Board is required to
determine the minimal number of board member that would be required to have
Financial Expertise. This requirement is subject to regulations to be
promulgated in which the term Financial Expertise would be defined. On March 8,
2006 the Board determined that at least two members of the board would be
required to have Financial Expertise. The Board believes it complies with such
requirement.
DUTIES OF DIRECTORS
The Companies Law codifies the duty of care and fiduciary duties that an
"Office Holder" (as defined below) owes to a company. An Office Holder's duty of
care and fiduciary duty include avoiding any conflict of interest between the
Office Holder's position in the company and his personal affairs, any
competition with the company, avoiding exploiting any business opportunity of
the company in order to receive personal advantage for himself or others, and
revealing to the company any information or documents relating to the company's
affairs which the Office Holder has received due to his position as an Office
Holder.
An "Office Holder" is defined as a director, managing director, chief
business manager or chief executive officer, executive vice president, vice
president, other manager directly subordinate to the CEO or any other person
assuming the responsibilities of any of the foregoing positions without regard
to such person's title. Under the Companies Law, all arrangements as to
compensation of Office Holders who are not directors and who are not controlling
shareholders require approval of the board of directors, unless the articles of
association provide otherwise. Our articles require that such a transaction
which is not irregular shall be approved by the Board of Directors or by the
Audit Committee or by any other entity authorized by the Board of Directors.
Arrangements regarding the compensation of directors or controlling shareholders
also require the approval of the shareholders.
COMMITTEES
Our Board of Directors has established an Audit Committee, Compensation
Committee and Contributions Committee. The Companies Law restricts the
delegation of powers from the Board of Directors to its committees in certain
manners. The Audit Committee exercises the powers of the Board of Directors with
respect to our accounting, reporting and financial control practices, including
exercising the responsibility, where appropriate, for reviewing potential
conflicts of interest situations. The members of the Audit Committee are Ms.
Kasher and Messrs. Arieli, Elinav and Korman. The Compensation Committee
administers our share option plans. The members of the Compensation Committee
are Mr. Wolfson, Mr. Davidi, Mr. Arieli and Mr. Shiran. The Articles of
Association provide that we may contribute reasonable sums for worthy causes,
even if the contribution is not in the frame of our business considerations. The
Board of Directors has delegated this power to the Contributions Committee. The
members of the Contributions Committee are Messrs. Shiran and Arieli. See "Item
10. Additional Information -10B. Memorandum and Articles of Association - Board
of Directors."
52
6D. EMPLOYEES
At December 31, 2005, we employed 1,373 employees in Israel of whom 565
were salaried employees and 808 were hourly wage employees. At December 31,
2005, we employed 260 employees in the United States through our subsidiary,
Alba, of whom 41 were salaried employees and 219 were hourly wage employees. At
December 31, 2005, El-masira employed 490 employees in Jordan all of them were
salaried employees
At December 31, 2004, we employed 2,082 employees in Israel of whom 469
were salaried employees and 1,613 were hourly wage employees. At December 31,
2004, we employed 301 employees in the United States through our subsidiary,
Alba, of whom 259 were salaried employees and 42 were hourly wage employees. At
December 31, 2004, El-masira employed 440 employees in Jordan all of them were
salaried employees
At December 31, 2003, we employed 2,126 employees in Israel of whom 692
were salaried employees and 1,434 were hourly wage employees. At December 31,
2003, we employed 363 employees in the United States through our subsidiary,
Alba, of whom 48 were salaried employees and 315 were hourly wage employees. At
December 31, 2003, El-masira employed 341 employees in Jordan, all of whom were
salaried employees.
To increase the motivation of the workforce, many factory employees are
eligible for bonuses based upon the number of units such employees produce in
any given day. We believe that relations with our employees are good.
Certain collective bargaining agreements between the Histadrut (General
Federation of Labor in Israel) and the Coordination Bureau of Economic
Organizations (including the Industrialists' Association of Israel, or the
Association) are applicable to our employees in Israel. In addition, a
collective bargaining agreement relating to members of the Association, which
governs employee relations in the textile and clothing industry, applies to most
of our employees in Israel. These agreements concern, among other things, the
maximum length of the work day and the work week, minimum wages, contributions
to a pension fund, insurance for work-related accidents, procedures for
dismissing employees, determination of severance pay and other conditions of
employment. Furthermore, pursuant to certain provisions of such agreements, the
wages of most of our employees are automatically adjusted in accordance with
cost-of-living adjustments, as determined on a nationwide basis and pursuant to
agreements with the Histadrut based on changes in the CPI. The amounts and
frequency of such adjustments are modified from time to time.
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 or, in certain circumstances, by the employee. We currently fund
our ongoing severance obligations by making monthly payments to pension funds,
employee accounts in a provident fund and insurance policies. In addition,
according to the National Insurance Law, Israeli employees and employers are
required to pay specified amounts 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 payable by
employees. The payments to the National Insurance Institute are determined
progressively in accordance with the wages and range from 10.4% to 16.3% of
wages, of which the employer contributes 5.9% of wages, and the employee
contributes the rest. A majority of our permanent employees in Israel are
covered by general and/or individual life and pension insurance policies
providing customary benefits to employees, including retirement and severance
benefits. The employers generally contribute up to 15.8% (depending on the
employee) of base wages to such plans and the permanent employees contribute up
to 5.5% of their base wages.
None of Alba's employees are covered by a collective bargaining agreement.
53
6E. SHARE OWNERSHIP
As of March 15, 2006, the following directors and senior managers
beneficially held the number of Ordinary Shares set forth in the table below.
The information in this table is based on 19,915,563 Ordinary Shares outstanding
as of March 15, 2006. The number of Ordinary Shares beneficially owned by a
person includes Ordinary Shares subject to options held by that person that were
currently exercisable at, or exercisable within 60 days of, March 15, 2006. The
Ordinary Shares issuable under these options are treated as if they were
outstanding for purposes of computing the percentage ownership of the person
holding these options but are not treated as if they were outstanding for the
purposes of computing the percentage ownership outstanding for any other person.
Except as disclosed below, to our knowledge, none of the directors, officers or
key executives listed in the Directors and Senior Management table appearing in
Item 6 above beneficially owns any Ordinary Shares.
% OF ORDINARY
NUMBER OF SHARES
NAME ORDINARY SHARES OUTSTANDING**
- ---- --------------- -------------
Ishay Davidi 5,663,085(5) 28.44%
Yos Shiran 694,172(2) 3.37%
Arie Wolfson 4,856,692(1) 24.11%
Meir Shamir 5,663,085(3) 28.44%
Micha Korman * *
Shirith Kasher * *
Avi Zigelman * *
Arie Arieli * *
Yacov Elinav * *
Amit Tal * *
Itamar Harchol * *
Asaf Alperovitz * *
Anat Barkan * *
David Gerbi * *
Ilan Gilboa * *
Ronny Grundland * *
Michal Baumwald Oron * *
Directors and senior
managers as a
group (17 persons) 11,386,523(4) 54.2%
___________________
* Less than 1% of the outstanding Ordinary Shares.
** Does not take into account 997,400 Ordinary Shares held by a wholly owned
subsidiary of the Company.
(1) Includes (a) 3,660,310 Ordinary Shares held by Macpell, (b) 971,282 Ordinary
Shares held by Arwol Holdings Ltd., (c) 225,000 Ordinary Shares subject to
options exercisable at $3.50 per share (which expire in 2012), and (d) 100
Ordinary Shares held by Mr. Wolfson. Pursuant to Rule 13d-5 of the U.S.
Securities Exchange Act of 1934, as amended, Mr. Wolfson may be deemed to
beneficially own the 3,660,310 Ordinary Shares held by Macpell and the 971,282
Ordinary Shares held by Arwol. See "-6A. Directors and Senior Management -
Macpell Shareholders' Agreement" and "Item 7. Major Shareholders and Related
Party Transactions - 7B. Related Party Transactions - Relationships and
Transactions with Macpell - Macpell Shareholders' Agreement."
54
(2) Consists of 694,172 Ordinary Shares subject to options exercisable at prices
that are between $3.563 and $4.25 per share (which expire between 2011 and
2012).
(3) Consists of 5,663,085 Ordinary Shares held by Norfet, which Mr. Shamir may
be deemed to beneficially own due to his 40% interest in Mivtah-Shamir, which
held an approximately 34.45% interest in Norfet as of December 31, 2005.
(4) Consists of 5,663,085 Ordinary Shares held by Norfet, which Mr. Davidi may
be deemed to beneficially own under U.S securities laws since he serves as CEO
of FIMI 2001 Ltd., which controls the general partner and one of the limited
partners of Norfet and which Meir Shamir may be deemed to beneficially own under
U.S securities laws due to his 40% interest in Mivtah-Shamir, which held an
approximately 34.45% interest in Norfet as of December 31, 2005. Also include
3,660,310 Ordinary Shares held by Macpell of which Arie Wolfson may be deemed to
be beneficial owner under U.S. securities laws due to his beneficial interests
in Macpell and the Macpell Shareholders' Agreement. See "Item 7. Majority
Shareholders and Related Party Transactions - 7B. Related Party Transactions -
Relationships and Transactions with Macpell - Macpell Shareholders' Agreement."
Also includes 971,282 Ordinary Shares held by Arwol of which Arie Wolfson may be
deemed the beneficial owner. Further includes options (exercisable within 60
days) to purchase 1,086,221 Ordinary Shares. The exercise price of these options
ranges from $3.50 to $9.50 per share. These options will expire between 2007 and
2013.
(5) Consists of 5,663,085 Ordinary Shares held by Norfet, which Mr. Davidi may
be deemed to beneficially own under U.S securities laws since he serves as CEO
of FIMI 2001 Ltd., which controls the general partner of Norfet, one of the
Norfet limited partners (which is managed by FIMI 2001 Ltd.) as well as the
other Norfet limited partners by virtue of an irrevocable power of attorney.
SHARE OPTION PLAN
In September 1997, we adopted the Tefron Ltd. 1997 Share Option Plan to
enable us to attract and retain qualified persons as employees, consultants and
directors and to motivate such persons with an equity participation in us.
GENERAL
The Share Option Plan authorizes the issuance of options to purchase
2,712,323 Ordinary Shares. As of March 15, 2006, options to purchase 2,517,054
of such Ordinary Shares had been granted to our senior managers, directors and
employees, of which 1,496,382 options had been granted to our senior managers
and directors as a group. 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. Options granted to our employees shall be issued to a trustee
nominated by the Board of Directors, which trustee shall hold the options, and
any Ordinary Shares issued upon exercise thereof, for the benefit of the
optionees for two years from the date of the grant.
ADMINISTRATION
The Share Option Plan is administered directly by our Board of Directors or
by a committee appointed by the Board of Directors which is authorized, among
other things and, subject to the provisions of the Companies Law, to: (i)
designate participants in the Share Option Plan; (ii) determine the terms and
provisions of the options, including the number of Ordinary Shares to which an
option may relate and the terms, conditions and restrictions thereof; (iii)
accelerate the right of an optionee to exercise any previously granted options;
(iv) construe and interpret the provisions and supervise the administration of
the Share Option Plan; and (v) make all other determinations deemed necessary or
advisable for the administration of the Share Option Plan.
55
VESTING PERIODS
Unless otherwise determined by our Board of Directors and, in the case of
option grants to Directors or an interested party, approved by our shareholders,
one-third of the options granted under the Share Option Plan are exercisable on
each of the first three anniversaries from the date of grant. Unless otherwise
determined by our Board of Directors and, in the case of option grants to
Directors or an interested party, approved by our shareholders, the options
expire on the tenth anniversary from the date of grant, and any additional
options granted in the future shall vest in the same manner over a three-year
period commencing on the date of their grant.
AMENDMENT AND TERMINATION OF THE SHARE OPTION PLAN
We may, at any time and from time to time, amend, alter or discontinue the
Share Option Plan; PROVIDED, HOWEVER, that no amendment or alteration of the
Share Option Plan shall adversely affect an optionee's rights under any
outstanding option without the consent of such optionee.
ACCOUNTING TREATMENT
For a discussion of the accounting treatment of the Share Option Plan, see
Note 2(k) of the Notes to the Consolidated Financial Statements.
AMENDMENT TO THE SHARE OPTION PLAN EFFECTIVE AS OF JANUARY 1, 2003
In December 2002, in order to comply with the new tax rules under the
amended Israeli Income Tax Ordinance [New Version], 1961, our Board approved an
amendment to our Share Option Plan.
The new tax rules enable a company to issue options under three alternative
tracks, which may generally be described as follows: (i) without a trustee,
under which the income will be considered employment income, the income will
continue to be taxed at regular marginal rates of up to the maximal tax rate
plus payments to the National Insurance Institute and payment of health tax, and
no expense is deductible by the employer; (ii) with a trustee under the
employment income track, under which the options are held by a trustee for a
period of twelve months from the end of the tax year in which the grant took
place, the income is considered regular employment income taxed at marginal
rates of up to 50% plus payments to the National Insurance Institute and payment
of health tax, and the employer is entitled to a deductible expense equivalent
to the income attributed to the employee; or (iii) with a trustee under the
capital gains track, under which the options are held by a trustee for a period
of two years from the end of the tax year in which the grant took place, the
income is considered to be a capital gain and is taxable at a reduced rate of
25%, and no expense is deductible by the employer.
On February 27, 2003, in order to enable us to grant options after January
1, 2003, we filed an amendment to the Share Option Plan with the tax authorities
and informed them of our election of the capital gains track (the third
alternative above). In addition, under the amendment to the Share Option Plan,
we may also issue options under the provisions of the tax track without a
trustee under the first alternative. The capital gains track will apply to all
trustee-track options to be granted by us until December 31, 2004. After this
period has ended, we may change our election.
The new rules and the amendment to the Share Option Plan described above
apply only to issuances of options beginning on January 1, 2003 and thereafter.
Options issued before such date will continue to be governed by the law in
effect prior to the amendment.
56
ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS
7A. MAJOR SHAREHOLDERS
Except as noted herein, to our knowledge, we are not directly or indirectly
owned or controlled by another corporation or by any foreign government and no
arrangements exist the operation of which may at a subsequent date result in a
change in control of the company.
The following table sets forth the number of our Ordinary Shares owned by
any person known to us to be the beneficial owner of 5% or more of our Ordinary
Shares as of March 15, 2006. The information in this table is based on
19,915,563 Ordinary Shares outstanding as of such date. The number of Ordinary
Shares beneficially owned by a person includes Ordinary Shares subject to
options held by that person that were currently exercisable at, or exercisable
within 60 days of, March 15, 2006. The Ordinary Shares issuable under these
options are treated as if they were outstanding for purposes of computing the
percentage ownership of the person holding these options but are not treated as
if they were outstanding for the purposes of computing the percentage ownership
outstanding for any other person. None of the holders of the Ordinary Shares
listed in this table have voting rights different from other holders of the
Ordinary Shares.
NAME NUMBER OF SHARES OWNED PERCENT OF ORDINARY SHARES *
- ---- ---------------------- ----------------------------
Norfet, Limited Partnership
c/o Fimi 2001 Ltd.
"Rubinstein House"
37 Begin Rd.
Tel Aviv, Israel 5,663,085 (1) 28.44%
Macpell Industries Ltd.
28 Chida Street
Bnei Brak, Israel 51371 3,660,310 (2) 18.38%
Arie Wolfson 4,856,692 (3) 24.11%
Sigi Rabinowicz 4,051,822 (4) 19.95%
* Does not take into account 997,400 Ordinary Shares held by a wholly-owned
subsidiary of the Company.
(1) Norfet Limited Partnership is an Israeli partnership. As of November 30,
2005, approximately 8.82% of Norfet was held by FIMI Opportunity Fund, LP,
approximately 45.61% of Norfet was held by FIMI Israel Opportunity Fund,
Limited Partnership, approximately 34.45% was held by Mivtach Shamir
Holdings Ltd., approximately 3.45% was held by Migdal Insurance Company,
approximately 6.89% was held by First International Bank of Israel and
approximately 0.786% was held by Zaleznick and Butler. Pursuant to Rule
13d-5 of the U.S Securities Exchange Act, Norfet may also be deemed to
beneficially own the shares held by Macpell and Arwol due to the
shareholders agreement between Arwol, Macpell and Norfet. See "Item 10.
Additional Information - 10C. Material Contracts - FIMI Agreements." In
addition, pursuant to Rule 13d-5, (i) Mr. Ishay Davidi, the Chairman of the
Board of the Company, may be deemed to beneficially own the shares held by
Norfet due to his position as CEO of FIMI 2001 Ltd. and senior partner of
FIMI Israel, Opportunity Fund, Limited Partnership and FIMI Opportunity
Fund, L.P., and (ii) Mr. Meir Shamir, a director in the Company, may be
deemed to beneficially own the shares held by Norfet due to his 40.02%
interest in Mivtah-Shamir.
57
(2) Macpell is an Israeli corporation. As of January 1, 2006, 27.8% of Macpell
are controlled by Arie Wolfson; 25.02% of Macpell are controlled by Sigi
Rabinowicz; and 25.84% of Macpell are controlled by Avi Ruimi, representing
78.7% of Macpell's shares in the aggregate. Pursuant to Rule 13d-5 of the
U.S Securities Exchange Act, Macpell may also be deemed to beneficially own
the shares held by Norfet due to the shareholders agreement between Arwol,
Macpell and Norfet. See "Item 10. Additional Information - 10C. Material
Contracts - FIMI Agreements."
(3) Includes (i) 3,660,310 Ordinary Shares held by Macpell, (ii) 971,282
Ordinary Shares held by Arwol, (iii) 225,000 Ordinary Shares subject to
options exercisable at $3.50 per share (which expire in 2012) and (iv) 100
Ordinary Shares held by Mr. Wolfson. Pursuant to Rule 13d-5 of the U.S.
Securities Exchange Act of 1934, as amended, Mr. Wolfson may be deemed to
beneficially own the 3,660,310 Ordinary Shares held by Macpell due to his
beneficial interest in Macpell and the Macpell Shareholders' Agreement. See
"Item 10. Additional Information - 10C. Material Contracts - FIMI
Agreements."
(4) Consists of (i) 3,660,310 Ordinary Shares held by Macpell, and (ii)
exercisable options to purchase 391,512 Ordinary Shares at prices that are
between $3.50 and $9.50 per share (which expire between 2009 and 2012).
Pursuant to Rule 13d-5 of the U.S. Securities Exchange Act of 1934, as
amended, Mr. Rabinowicz may be deemed to beneficially own the 3,660,310
Ordinary Shares held by Macpell due to his beneficial interest in Macpell
and the Macpell Shareholders' Agreement. See "Item 10. Additional
Information - 10C. Material Contracts - FIMI Agreements."
At March 27, 2006, there were 13 holders of Ordinary Shares of record
registered with a United States mailing address, including banks, brokers and
nominees. These holders of record represented approximately 49.6% of the total
outstanding Ordinary Shares. Because these holders of record include banks,
brokers and nominees, the beneficial owners of these Ordinary Shares may include
persons who reside outside the United States. See "Item 7. Major Shareholders
and Related Party Transactions - 7A. Major Shareholders."
7B. RELATED PARTY TRANSACTIONS
The following discussion includes summaries of the significant terms of
various agreements and transactions. Because these are summaries, they are
qualified by reference to the actual agreements, which are attached as exhibits
to this Annual Report.
The Companies Law requires that certain related party transactions be
approved as provided for in a company's articles of association and, in certain
circumstances, by a company's audit committee or its shareholders. Our Audit
Committee is responsible for reviewing potential conflicts of interest
situations where appropriate.
RELATIONSHIPS AND TRANSACTIONS WITH NORFET
As of March 15, 2006, Norfet owned 5,663,085 Ordinary Shares, which
represented approximately 28.44% of Tefron's outstanding Ordinary Shares.
Substantially all of Norfet is owned by (i) N.D.M.S. Ltd., a company wholly
owned by FIMI Opportunity Fund L.P., (ii) FIMI Israel Opportunity Fund, Limited
Partnership and (iii) Migdal Insurance Company, Mivtach Shamir Holdings Ltd. and
the provident funds of First International Bank of Israel.
Pursuant to a Share Purchase Agreement, dated February 17, 2004, we issued
to Norfet in April 2004, 3,529,412 ordinary shares for a base price of $4.25 per
share and a base aggregate consideration of $15 million. Norfet also acquired an
additional 1,365,000 of our ordinary shares in the aggregate from Arwol and
Macpell pursuant to a separate agreement. Immediately following the closing of
these agreements, Norfet held 4,894,412, or approximately 28.8% of our
outstanding share capital, without taking into account our ordinary shares held
by our wholly-owned subsidiary. In April 2005, due to a purchase price
adjustment agreed to with Norfet instead of the purchase price adjustment
mechanism agreed to in the Share Purchase Agreement, we issued to Norfet an
additional 661,765 ordinary shares, and Arwol transferred 106,908 additional
ordinary shares to Norfet.
58
Under the Share Purchase Agreement, we also agreed to pay Norfet a
management fee of approximately $172,000 plus VAT per annum until our first
annual meeting in 2005 (which took place on June 28, 2005), and $120,000 plus
VAT thereafter.
AGREEMENTS AMONG NORFET, MACPELL AND ARWOL
Under an agreement among Norfet, Macpell and Arwol, the parties agreed to
vote all of Tefron ordinary shares owned or controlled by each of them for the
election to Tefron's Board of Directors of: (i) three members (of whom at least
one will qualify as an "independent director" under the NYSE rules) plus,
subject to applicable law - one external director, that shall be nominated by
Norfet (one of whom shall be a woman), (ii) three members (of whom at least one
will qualify as an independent director and a financial expert under the NYSE
rules) plus, subject to applicable law, one external director, that shall be
nominated by Arwol and Macpell, and (iii) Tefron's chief executive officer.
The Company, Norfet, Arwol and Macpell, together with Leber Partners L.P.,
are also party to a Registration Rights Agreement, dated April 22, 2004, which
replaced the previous Registration Rights Agreements to which some of the
Company and certain of these shareholders had been a party. Please see "Item 10.
Additional Information- 10C. Material Contracts - Leber Partners L.P." for a
more complete description of this agreement. On November 29, 2005, the
Securities and Exchange Commission declared effective a Registration Statement
on Form F-3 covering the resale of 11,521,259 ordinary shares held by the
shareholders party to this agreement.
Please see "Item 10. Additional Information- 10C. Material Contracts - FIMI
Agreements" for a more complete description of these agreements.
RELATIONSHIPS AND TRANSACTIONS WITH MACPELL
As of March 15 2006, Macpell owned 3,660,310 Ordinary Shares, which
represented approximately 18.38% of Tefron's outstanding Ordinary Shares.
Macpell is mainly a holding company that owns various companies, including
Tefron and a partnership that mainly trades in various clothing and apparel
products. Macpell was also engaged in the construction of industrial buildings
mainly intended for the use of the Macpell group.
As of January 1, 2006, 27.8% of Macpell are controlled by Arie Wolfson, one
of our directors; 25.02% of Macpell are controlled by Sigi Rabinowicz; and
25.84% of Macpell are controlled by Avi Ruimi, a former Director of Tefron. The
ordinary shares of Macpell are listed and traded on the Tel Aviv Stock Exchange.
MACPELL SHAREHOLDERS' AGREEMENT
Arwol Holdings Ltd., Riza Holdings Ltd. and Condo Overseas Inc. are parties
to the Macpell Shareholders' Agreement. The agreement provides, among other
things, that subject to the agreement of the shareholders in Tefron, the
distribution of the directors on Tefron's Board will reflect the direct and
indirect holdings in Tefron (including through Macpell) of the parties to the
agreement, subject to certain exceptions. Pursuant to the Macpell Shareholders'
Agreement, the Tefron Ordinary Shares of Macpell held by the parties thereto
will be voted at each meeting of Macpell's shareholders by the trustee in
accordance with the resolution of the shareholders party to the agreement, each
shareholder having one vote for each Macpell share held by such shareholder.
59
The Macpell Shareholders' Agreement contains a right of first refusal in
the event that either party wishes to sell its shares in Macpell, and a
tag-along right if either party finds a buyer outside of the Macpell
Shareholders' Agreement who is willing to purchase the Macpell shares. It also
provides that the parties to the Macpell Shareholders' Agreement shall retain
their ownership of at least 50% of the Macpell shares they own as of the date
the agreement was executed. The Macpell Shareholders' Agreement provides that
the vote of the holders of 75% of the Macpell shares is required for Macpell to
(i) enter another line of business, (ii) merge, consolidate or dispose of any of
its substantial assets, (iii) purchase, lease or acquire another substantial
company, (iv) wind-up Macpell, (v) make decisions regarding the allotment of
Macpell shares and (vi) declare dividends. The Macpell Shareholders' Agreement
specifically permits the sale of Macpell shares by Arwol Holdings Ltd. to Sigi
Rabinowicz or a company controlled by Sigi Rabinowicz, provided that the
transferee agrees to be bound by the terms and conditions of the Macpell
Shareholders' Agreement.
AGREEMENT WITH ARIE WOLFSON
We are party to a consulting and management services agreement with Mr.
Arie Wolfson, a Director of the Company and an indirect holder of 27.84% of
Macpell, and with a company controlled by him. See "Item 6. Directors, Senior
Management and Employees - 6B. Compensation".
RELATIONSHIPS BETWEEN SIGI RABINOWICZ AND SUPPLIERS
We understand that Sigi Rabinowicz, our former president, who also owns a
significant interest in Macpell, began to serve as an agent of some of the
suppliers from whom we regularly purchased materials, and hence may be paid a
commission with respect to such purchases. We believe that our transactions with
these suppliers are in the ordinary course and are on customary terms.
LEASE ARRANGEMENT
On August 12, 1997, we entered into an agreement to lease until 2011
approximately 143,000 square feet of industrial space in a facility (the Hi-Tex
1 facility) adjacent to its current facilities in Segev from a wholly-owned
subsidiary of Macpell (that was recently merged into Macpell) for a current
monthly rent of approximately $73,000. The first rental payment was made upon
entrance into the facility on October 1, 1999. On December 21, 1998, we entered
into an agreement to lease until 2012 approximately 180,000 square feet of
industrial space in a second facility (the Hi-Tex 2 facility) adjacent to our
existing facilities in Segev from the same wholly-owned subsidiary of Macpell
for a monthly rent of approximately $89,000. The first rental payment was made
upon entrance into the facility on March 1, 2000. We conduct our Hi-Tex
manufacturing operations in these facilities. In Segev, we also lease from
Macpell's subsidiary, according to an agreement we entered into on August 16,
1995, a 83,000 square foot facility under a lease that expires in 2006 for a
monthly rent of approximately $48,000 and according to an agreement we entered
into on December 10, 1999 - a 65,000 square foot warehouse under a lease that
expires in 2012 for a monthly rent of approximately $28,000. The rent payable
under these leases is 50% linked to the Israeli and U.S. consumer product index
and 50% to the exchange rate between the NIS and the dollar. These agreements
provide for a 5% increase in monthly rent every 3-5 years. According to the
terms of the lease agreements, we pay the property insurance premiums on these
facilities. There has been a debate whether these agreements were approved as
required by the Companies Law. We have had positive discussions with Macpell in
an effort to resolve the dispute and to reduce our annual payments under these
lease agreements, but we cannot currently assure that we will reach a final
resolution of our dispute. Should we reach a final resolution with Macpell, the
settlement agreement would be subject to approval of our shareholders.
All of these facilities are subject to a long-term lease agreement between
Macpell's subsidiary and the Israel Land Authority. Under the terms of such
lease agreement, Macpell's affiliate was granted a 49-year lease over such
property.
PRODUCTS PURCHASES FROM TEFRON
An affiliate of Macpell purchases from us various products and sells them
in the local Israeli market and abroad. In 2003, our sales to this affiliate
were approximately $1.2 million, in 2004 approximately $0.8 million and in 2005
there was a negligible amount of sales. We believe that the prices of the
products sold to Macpell were no less favorable than those were available to us
from unaffiliated third parties. See Note 17 of the Notes to the Consolidated
Financial Statements.
60
MACRO SHARE PURCHASE AGREEMENT
On March 24, 2003, we entered into a share purchase agreement with Macpell,
and with Mr. Ron Grundland, pursuant to which we agreed to acquire 100% of the
outstanding ordinary shares of Macro Clothing Ltd., upon the satisfaction of
certain conditions, in consideration for the assumption by Tefron of certain
guarantees granted by the sellers in favor of Macro in the aggregate amount of
approximately $530,000, subject to adjustments. Pursuant to the terms of the
agreement, Macpell agreed to pay to us the amount of $300,000 to assume
Macpell's guarantees to the bank. In addition, Macpell agreed to assign to us
its rights to a loan to Macro in the amount of approximately NIS 2.4 million.
Macro manufactures, markets and sells of swimsuits and beachwear.
7C. INTERESTS OF EXPERTS AND COUNSEL.
Not Applicable.
ITEM 8. FINANCIAL INFORMATION
CONSOLIDATED FINANCIAL STATEMENTS
See Item 18.
LEGAL PROCEEDINGS
There are no legal proceedings which may have, or have had in the recent
past, significant effects on the Company's financial position or profitability.
EMPLOYEE CLAIM
In the last few months there have been several meetings and conversations
between the Company and a former employee who had been imprisoned in Egypt for
several years. During February 2006, the former employee sent a letter claiming
that the Company was responsible for his imprisonment due to, among other
things, the Company's failure to warn him about the dangers involved in a trip
to Egypt. The former employee and his family demand that the Company pay them
compensation for his imprisonment in a yet unspecified amount.
DIVIDEND POLICY
Although we have no established dividend policy, in the past we have
distributed dividends to our shareholders from our accumulated earnings. We have
not declared or paid any dividends for the last three fiscal years, but we may
distribute in the future if our Board of Directors so determines.
61
ITEM 9. THE OFFER AND LISTING
9A. OFFER AND LISTING DETAILS
Since the initial public offering of our Ordinary Shares on September 24,
1997, our Ordinary Shares have been traded on the NYSE, under the symbol "TFR."
Prior to the offering, there was no market for our Ordinary Shares.
As reported on the NYSE, the annual high and low sales prices for our
Ordinary Shares were as follows:
HIGH LOW
------ ------
2001 $ 5.44 $ 1.21
2002 $ 4.70 $ 1.15
2003 $ 4.80 $ 3.10
2004 $ 6.30 $ 3.50
2005 $ 8.75 $ 3.84
As reported on the NYSE, the quarterly high and low sales prices for our
Ordinary Shares for the last two years were as follows:
2004 HIGH LOW
---- ------ ------
First quarter $ 6.30 $ 4.31
Second quarter $ 6.00 $ 4.74
Third quarter $ 4.70 $ 3.92
Fourth quarter $ 4.45 $ 3.92
2005
----
First quarter $ 5.35 $ 3.84
Second quarter $ 5.93 $ 4.93
Third quarter $ 7.04 $ 4.96
Fourth quarter $ 8.75 $ 6.20
2006
----
First quarter (through March 24, 2006) $10.70 $ 8.30
As reported on the NYSE, the monthly high and low sales prices for our
Ordinary Shares for the last six months were as follows:
2005 HIGH LOW
---- ------ ------
October $ 6.86 $ 6.20
November $ 8.00 $ 6.77
December $ 8.75 $ 7.82
2006
----
January $10.05 $ 8.41
February $ 9.21 $ 8.30
March (through March 24, 2006) $10.70 $ 8.79
Our shares have been trading on the TASE" since September 28, 2005. As
reported on the TASE, the monthly high and low sales price for our Ordinary
Shares for the last six months were as follows:
62
2005 HIGH LOW
---- --------- ---------
October NIS 32.92 NIS 29.64
November NIS 38.42 NIS 32.18
December NIS 42.12 NIS 34.85
2006
----
January NIS 45.72 NIS 38.62
February NIS 42.56 NIS 39.41
March (through March 24, 2006) NIS 48.15 NIS 41.23
On September 8, 1998, we announced our intention to repurchase through a
stock repurchase program up to one million of our outstanding Ordinary Shares.
As of March 15, 2006, we had repurchased and hold in our treasury 997,400
Ordinary Shares.
9B. PLAN OF DISTRIBUTION
Not Applicable.
9C. MARKETS
Our Ordinary Shares are traded on the NYSE.
9D. SELLING SHAREHOLDERS
Not Applicable.
9E. DILUTION
Not Applicable.
9F. EXPENSES OF THE ISSUE
Not Applicable.
ITEM 10. ADDITIONAL INFORMATION
10A. SHARE CAPITAL
Not Applicable.
10B. MEMORANDUM AND ARTICLES OF ASSOCIATION
SECURITIES REGISTERS
Our transfer agent and register is American Stock Transfer & Trust Company
and its address is 59 Maiden Lane, New York, New York 10038. Section 2 of our
Memorandum of Association provides that our principal objects, among other
things, are to engage in any business connected with manufacturing, processing,
supplying and marketing undergarments, textiles and ready-made clothes. Article
2A of our Articles of Association provides that we may, at any time, carry on
business in any field or type of business permitted to us, whether explicit or
implied, according to our Memorandum of Association.
63
BOARD OF DIRECTORS
The Companies Law requires that certain transactions, actions and
arrangements be approved as provided for in a company's articles of association
and in certain circumstances by the audit committee by the board of directors
itself and by the shareholders. The vote required by the audit committee and the
board of directors for approval of such matters, in each case, is a majority of
the disinterested directors participating in a duly convened meeting.
The Companies Law requires that a member of the board of directors or
senior management of the company promptly disclose any personal interest that he
or she may have (either directly or by way of any corporation in which he or she
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) and all related material information known to him or her,
in connection with any existing or proposed transaction by the company. In
addition, if the transaction is an extraordinary transaction (that is, a
transaction other than in the ordinary course of business, otherwise than on
market terms, or is likely to have a material impact on the company's
profitability, assets or liabilities), the member of the board of directors or
senior management also must disclose any personal interest held by his or her
spouse, siblings, parents, grandparents, descendants, spouse's descendants and
the spouses of any of the foregoing.
Once the member of the board of directors or senior management complies
with the above disclosure requirement, a company may approve the transaction in
accordance with the provisions of its articles of association. If the
transaction is with a third party in which the member of the board of directors
or senior management has a personal interest, the approval must confirm that the
transaction is not adverse to the company's interest. Furthermore, if the
transaction is an extraordinary transaction, then, in addition to any approval
stipulated by the articles of association, it also must be approved by the
company's audit committee and then by the board of directors, and, under certain
circumstances, by a meeting of the shareholders of the company.
Our Articles of Association provide that, subject to the Companies Law, all
actions executed by the Board of Directors or by a committee thereof or by any
person acting as a Director or a member of a committee of the Board of Directors
or by the General Manager will be deemed to be valid even if, after their
execution, it is discovered that there was a certain flaw in the appointment of
such persons or that any one of such persons was disqualified from serving at
his or her office.
Our Articles of Association provide that, subject to the Companies Law, an
officer is entitled to participate and vote in meetings concerning the approval
of actions or transaction in which he or she has a personal interest. Subject to
the Companies Law, a transaction between an officer of Tefron or an entity
controlling Tefron, and us, or a transaction between any other person in which
an officer or an entity controlling the company has a personal interest and us,
and which is not an extraordinary transaction, shall be approved by the Board of
Directors or by the Audit Committee or by any other entity authorized by the
Board of Directors.
Our Articles of Association provide that the Board of Directors may
delegate all of its powers to such committees of the Board of Directors as it
deems appropriate, subject to the provisions of the Companies Law. The Audit
Committee is responsible for reviewing, among other things, potential conflicts
of interest situations where appropriate. See "Item 6. Directors, Senior
Management and Employees - 6C. Board Practices - Committees."
Arrangements regarding compensation of Directors require the approval of
the Audit Committee and the shareholders. The Board of Directors may from time
to time, at its discretion, cause us to borrow or secure the payment of any
money for our purposes, and may secure or provide for the repayment of such
money in the manner as it deems fit.
64
DESCRIPTION OF SECURITIES
We are authorized to issue 49,995,500 Ordinary Shares, par value NIS 1.0
per share, and 4,500 Ordinary B Shares, par value NIS 1.0 per share.
Our Ordinary Shares do not have preemptive rights. The ownership or voting
of Ordinary Shares by nonresidents of Israel or foreign owners is not restricted
or limited in any way by our Memorandum of Association or Articles of
Association, or by the laws of the State of Israel.
TRANSFER OF SHARES AND NOTICES. Fully paid Ordinary Shares are issued in
registered form and may be freely transferred pursuant to our Articles of
Association unless such transfer is restricted or prohibited by another
instrument. Each shareholder of record is entitled to receive at least seven
calendar days' prior notice of an ordinary shareholders' meeting and at least 21
calendar days' prior notice of any shareholders' meeting in which a special or
extraordinary resolution is to be adopted. For purposes of determining the
shareholders entitled to notice and to vote at such meeting, the Board of
Directors may fix the record date not more than 40 nor less than four calendar
days prior to the date of such meeting, nor more than 40 days prior to any other
action.
ELECTION OF DIRECTORS. The Ordinary Shares do not have cumulative voting
rights in the election of Directors. As a result, the holders of Ordinary Shares
that represents more than 50% of the voting power have the power to elect all
the Directors.
DIVIDEND AND LIQUIDATION RIGHTS. Our Ordinary Shares are entitled to the
full amount of any cash or share dividend, if declared. We may declare a
dividend to be paid to the holders of Ordinary Shares according to their rights
and interests in our profits. In the event of our liquidation, after
satisfaction of liabilities to creditors, our assets will be distributed to the
holders of Ordinary Shares in proportion to the nominal value of their
respective holdings. Such right may be affected by the grant of preferential
dividend or distribution rights to the holders of a class of shares with
preferential rights that may be authorized in the future by a special resolution
of our shareholders. Our Board of Directors may declare interim dividends and
propose the final dividend with respect to any fiscal year only out of profits.
Declaration of a final dividend requires approval by an ordinary shareholders'
resolution, which may decrease but not increase the amount proposed by the Board
of Directors. Failure to obtain such shareholder approval does not affect
previously paid interim dividends.
VOTING, SHAREHOLDERS' MEETINGS AND RESOLUTIONS. Holders of Ordinary Shares
have one vote for each Ordinary Share held on all matters submitted to a vote of
shareholders. Such 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. The quorum required for an ordinary meeting of
shareholders consists of at least two shareholders present in person or by proxy
who hold or represent, in the aggregate, at least one-fourth of the voting
rights of the issued share capital. A meeting adjourned for lack of a quorum is
adjourned to the same day in the following week at the same time and place or
any time and place as the Directors designate in a notice to the shareholders.
At such reconvened meeting the required quorum consists of two members present
in person or by proxy who hold or represent, in the aggregate, at least
one-fourth of our voting power.
Annual general meetings of shareholders are held once every year at such
time (within a period of not more than 15 months after the last preceding annual
general meeting) and such place as determined by the board of directors. The
board of directors may call extraordinary general meetings of shareholders and
are obligated to do so upon a written request in accordance with the Companies
Law. The Companies Law provides that an extraordinary general meeting of
shareholder may be called by the board of directors or by a request of two
directors or 25% of the directors in office, or by shareholders holding at least
5% of the issued share capital of the company and at least 1% of the voting
rights, or of shareholders holding at least 5% of the voting rights of the
company.
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An ordinary resolution (such as a resolution for the election of directors,
the declaration of dividends or the appointment of auditors) requires approval
by the holders of a majority of the voting rights represented at the meeting, in
person or by proxy, and voting thereon. A special or extraordinary resolution
(such as a resolution amending our Memorandum of Association or Articles of
Association or approving any change in capitalization, merger, consolidation,
winding-up, or other changes as specified in the Companies Law) requires
approval of the holders of 75% of the voting rights represented at the meeting,
in person or by proxy, and voting thereon. In addition, if our share capital is
divided into different classes of shares, the approval of the holders of 75% of
the issued shares of a particular class or a special resolution passed at a
separate general meeting of the holders of the shares of such class is required
to modify or abrogate the rights attached to such shares.
DEFERRED SHARES. Pursuant to our Articles of Association, our Ordinary B
Shares automatically converted into Deferred Shares upon consummation of our
initial public offering. Subsequent to the conversion, there were 4,500 Deferred
Shares outstanding. During September 2005, the Board of Directors cancelled all
Deferred Shares.
10C. MATERIAL CONTRACTS
Set forth below are summaries of our material contracts. Because these are
summaries, they are qualified by reference to the actual agreements, which are
attached as exhibits to this Annual Report.
ALBAHEALTH OPTION AGREEMENT
In connection with the formation of AlbaHealth (described in "Item 4.
Information on the Company - 4A. History and Development of the Company"), our
subsidiary, Alba, became party to a Put Option Agreement. Pursuant to the
provisions of the Put Option Agreement, for a period of three years commencing
on September 2004 (or, with respect to GE Capital, commencing on such earlier
date as the credit agreement terminates), each of Alba and GE Capital has an
option to require AlbaHealth to purchase all, but not less than all, of such
party's ownership interest in AlbaHealth. The consideration to be paid to Alba
for its interests in AlbaHealth is calculated in accordance with a formula which
takes into account certain factors, such as AlbaHealth's fair value and its net
sales and the date of exercise of the put option. The consideration to be paid
to GE Capital for its interests in AlbaHealth shall be equal to its pro-rata
share of the fair value of AlbaHealth.
Pursuant to the Put Option Agreement, the fair value of AlbaHealth shall be
determined based on a formula which takes into account the difference between
the sum of cash and cash equivalents of AlbaHealth and six times the EBITDA of
AlbaHealth for the preceding year, and the total debt of AlbaHealth at such
time. AlbaHealth's obligation to pay the exercising party its put consideration
is subject to the compliance by AlbaHealth of certain conditions as set forth in
the Put Option Agreement. Pursuant to an amendment to the Put Option Agreement,
dated December 13, 2004, in the event that Alba delivers a "Put Notice" between
July 1, 2005 and December 31, 2005, then for purposes of determining the fair
value of AlbaHealth, AlbaHealth's EBITDA will be deemed to be not less than
$6,434,000 ("Minimum EBITDA") and not more than $6,434,000 plus 50% of the
amount by which the actual EBITDA (as defined in the Put Option Agreement)
exceeds $6,434,000.
Under the terms of a Share Purchase Agreement with Norfet, Limited
Partnership, we agreed to provide Norfet, Limited Partnership with a letter of
undertaking from Alba to exercise its put option in respect of AlbaHealth
immediately following September 2004 as soon as AlbaHealth's EBITDA for four
consecutive quarters equals or exceeds $8 million, subject to certain
conditions. See " - FIMI Agreements - Tefron Agreement" below.
On December 22, 2005, the Company delivered a notice of exercise to
AlbaHealth and the other parties to the Put Option Agreement. Based on recent
negotiations with the other parties, the net proceeds payable to the Company
from the sale of the interest are currently expected to be approximately $11.9
million in cash (net of taxes and payment of $390 to one of AlbaHealth interest
holders, described under "- Proceeds to GE Capital Corporation"). As a result of
the expected exercise of the put option and the annual impairment test of the
goodwill relating to AlbaHealth, the Company recorded an operating loss in the
amount of $6,073 and additional taxes on income of $3,456 (including realization
of deferred taxes in the amount of $2,456). This loss was offset by the minority
interest in the impairment loss amounting to $2,937.
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AlbaHealth generated 19.7% of our total consolidated sales in 2002, 23.5%
of our total consolidated sales in 2003, 18.7% of our total consolidated sales
in 2004 and 16.7% of our total consolidated sales in 2005. AlbaHealth's largest
customer, Cardinal Healthcare, accounted for approximately 10.9% of our total
sales in 2003, 9.2% of our total sales in 2004 and 8.5% of our total sales in
2005.
Upon completion of the transaction, we will fully utilize our aggregate
available carry forward tax losses of approximately $22.2 million, which could
have been utilized to offset against future taxable profits in the United
States.
CONDITIONS TO CLOSING OF PURCHASE OF TEFRON'S OWNERSHIP INTEREST IN
ALBAHEALTH
AlbaHealth's obligation to purchase our ownership interest, and the receipt
of payment by us for our interest, are subject to the satisfaction of the
following conditions: (i) after giving effect to the initial payment to us on
account of our exercise of the option (the "Initial Put Payment"), the fair
value of AlbaHealth's assets exceeds all of its liabilities (subject to certain
exceptions); (ii) both before and after giving effect to a payment of the
consideration to be paid to us on account of our exercise of the option, there
shall not have occurred or be continuing any default or event of default under
the AlbaHealth credit agreement and (iii) financing in an amount sufficient to
fund the Initial Put Payment shall be available (provided that no more than 30%
of the outstanding principal amount of AlbaHealth's bank debt, inclusive of any
new debt to be incurred by AlbaHealth to fund the Initial Put Payment, shall be
subject to interest rates in excess of LIBOR plus 2.75%). There is no assurance
that these conditions will be satisfied. If they are not satisfied, the option
exercise period under the option agreement will be extended accordingly.
Under the terms of the Put Option Agreement, while AlbaHealth is unable to
satisfy the conditions of its obligation to purchase our ownership interest,
AlbaHealth shall be prohibited from making any payments or other distributions
of cash or cash equivalents to any of its members, other than tax distributions
to members in respect of tax obligations of such members as a result of their
ownership of membership interests in AlbaHealth, or the put consideration. Under
the terms of an existing agreement, our subsidiary, Alba, provides certain
management services to AlbaHealth in return for a current annual fee of
approximately $832,000. While AlbaHealth is unable to satisfy the conditions of
its obligation to purchase our ownership interest, the terms of the existing
agreement provide that Alba will no longer receive these management fees from
AlbaHealth.
APPLICATION OF PROCEEDS FROM EXERCISE OF ALBAHEALTH OPTION
PROCEEDS TO BE USED TO PAY BANK LOAN
Pursuant to an Obligation Letter, dated April 22, 2004, Tefron, Hi-Tex and
Alba undertook to Bank Hapoalim B.M. and Israel Discount Bank Ltd. that if and
when our subsidiary, Alba, either (i) exercises its right under its Put Option
Agreement with AlbaHealth, Encompass Group, L.L.C. and GE Capital, to require
AlbaHealth to purchase all of Alba's ownership interest in AlbaHealth or (ii)
otherwise sells its interest in AlbaHealth, then 50% of the net proceeds from
such sale would be paid to Bank Hapoalim B.M. and Israel Discount Bank Ltd. on
account of their loans to Tefron, Hi -Tex and Alba.
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PROCEEDS TO GE CAPITAL
Pursuant to an amendment to the Put Option Agreement, dated December 13,
2004 (the "Put Option Amendment"), AlbaHealth and GE Capital agreed that in the
event Alba delivered a "Put Notice" between July 1, 2005 and December 31, 2005,
then for purposes of determining the fair value of AlbaHealth, AlbaHealth's
EBITDA will be deemed to be not less than $6,434,000, which provided a floor
price for the consideration to be paid to Alba. Pursuant to an agreement with GE
Capital, we agreed to pay GE Capital an amount in order that it would benefit
from this floor price as well (calculated as the amount, if any, by which the
put consideration paid to GE Capital under the Put Option Agreement is less than
it would have been had GE Capital's put consideration also been calculated in
the manner as set forth in the Put Option Amendment). We agreed to pay this
amount to GE Capital only in the event that (i) Alba receives put consideration
from AlbaHealth and (ii) GE Capital delivers its own exercise notice within 30
days of the receipt of Alba's exercise notice. The maximum amount payable by us
under this agreement with GE Capital is approximately $390,000.
We received GE Capital's own exercise notice within 30 days of their
receipt of Alba's exercise notice, and we will be required to pay GE Capital in
the event Alba receives put consideration from AlbaHealth.
FIMI AGREEMENTS
We entered into a Share Purchase Agreement, or the Tefron Agreement, dated
February 17, 2004, with Norfet, Limited Partnership, or the Investor,
substantially all of the interests of which are owned by (i) N.D.M.S. Ltd., a
company wholly owned by FIMI Opportunity Fund, L.P., (ii) FIMI Israel
Opportunity Fund, Limited Partnership and (iii) Migdal Insurance Company, Shamir
Insurers Investment Company and the provident funds of First International Bank
of Israel, pursuant to which we issued to the Investor 3,529,412 Tefron ordinary
shares for a base price of $4.25 per share and a base aggregate consideration of
$15 million. Due to purchase price adjustment provisions in the Tefron
Agreement, Tefron issued to Norfet an additional 661,765 ordinary shares in
April 2005.
In connection with the Tefron Agreement, the Investor also acquired an
additional 1,365,000 Tefron ordinary shares in the aggregate from Arwol and
Macpell pursuant to an Agreement, or the Macpell Agreement, by and among
Macpell, Arwol and the Investor. Following the closing of the Tefron Agreement
and the Macpell Agreement, the Investor held 4,894,412, or approximately 30.7%
of the outstanding share capital of Tefron, without taking into account the
Equity Shares. Due to purchase price adjustment provisions in the Macpell
Agreement, Arwol transferred 106,908 additional ordinary shares to Norfet in
April 2005.
Tefron, the Investor, Arwol and Macpell executed at the closing of the
Tefron Agreement and the Macpell Agreement a Registration Rights Agreement which
replaced the existing Registration Rights Agreement among the Company, Arwol and
Macpell.
Below is a description of the principal terms of these transactions. The
Tefron Agreement, the Registration Rights Agreement, and all transactions
contemplated by such agreements to which Tefron is a party are collectively
referred to as the "FIMI Transactions".
TEFRON AGREEMENT
ISSUE PRICE ADJUSTMENT. Under the terms of the Tefron Agreement, in the
event Tefron's earnings before income tax, depreciation and amortization, or
EBITDA, for 2004 (excluding (i) the EBITDA of AlbaHealth to the extent that it
exceeds zero and (ii) any increase in EBITDA of Alba Waldensian, Inc. as a
result of the exercise of the put option by AlbaHealth described below) as set
forth in Tefron's audited consolidated financial statements for the year ending
on December 31, 2004 is less than $23 million, then the price per share of $4.25
will be adjusted as follows: (i) if Tefron's EBITDA for 2004 was equal to or
less than $16 million, then the share price per share was to be reduced
retroactively by $0.75 (to $3.50), and if the Company's EBITDA for 2004 is
higher than $16 million but lower than $23 million, then the share price
reduction was to be calculated in accordance with the following formula:
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Price Per Share = 4.25 - 0.75*[x]
Where x = [(23,000,000 -2004 EBITDA)/1,000,000]/7]
Tefron had the discretion to decide, in such instances, whether to issue
additional shares or to refund a proportionate part of the consideration paid by
the Investor.
Tefron's EBDITA for 2004 was $11.809 million. and pursuant to an amendment
to the Tefron Agreement signed on March 31, 2005 Tefron issued to Norfet an
additional 661,765 ordinary shares, instead of the adjustment mechanism provided
for in the Tefron Agreement.
Under the terms of the Tefron Agreement, the issue price per share will be
increased in the event that, during the three-year period following the closing
of the Tefron Agreement and the Macpell Agreement, the Investor sells at least
20% of the total number of shares purchased from Tefron and Macpell and Arwol
for cash or publicly traded securities (excluding publicly traded securities in
connection with a merger or reorganization of Tefron), at an average price of at
least $9.22 per share (after adjustments for dividends, share combinations and
splits). The amount of the increase will be equal to the difference between the
average sale price and the threshold of $9.22 (as so adjusted), provided that in
any event, an upwards adjustment will be no more than $0.75 per such sold share.
The amount of any increase is to be paid by the Investor to Tefron on the third
anniversary of the closing of the Tefron Agreement and the Macpell Agreement.
The adjustment mechanism described in the immediately preceding paragraph
will also apply in respect of the four-year period following the closing of the
Tefron Agreement and the Macpell Agreement, but in such event, the Investor
average sale price must exceed $11.60 per share (rather than $9.22 per share)
for the adjustment to apply.
ALBA PUT OPTION. The Tefron Agreement provides that Tefron is required to
provide the Investor with a letter of undertaking from Alba, a wholly owned
subsidiary of Tefron, to exercise its put option in respect of AlbaHealth,
granted pursuant to a Put Option Agreement dated September 6, 2003, as amended
on December 13, 2004, immediately following September 2004 as soon as
AlbaHealth's EBITDA for four consecutive quarters equals or exceeds $8 million.
However, under the agreement Alba will not be required to exercise the put
option for so long as (i) Tefron's total consolidated debt is equal to or is
lower than $50 million (of which no more than $30 million may be long term debt)
and (ii) neither Alba nor Tefron or its subsidiaries is in default under any
financial covenant in loan agreement(s) to which it is a party. In December
2005, we delivered a notice to exercise our option to require AlbaHealth to
purchase our ownership interest in AlbaHealth, and we are in the process of
negotiating the final terms of the purchase.
LIMITS ON EQUITY LINE OF CREDIT. Tefron undertook not to exercise any right
to cause Southridge Capital Markets LLC (or its affiliates) to purchase any of
Tefron's shares without the written consent of the Investor, unless such
issuance is at a price of no less than $4.60 per share or if the issuance is
required in order for Tefron to satisfy covenants relating to shareholders
equity under company loan agreements or if the issuance is required for Tefron
to satisfy certain NYSE listing requirements. Notwithstanding the foregoing,
Tefron may not issue to such third party investor (or its affiliates) an
aggregate sum of more than 12% of Tefron's issued capital without the consent of
the Investor.
APPROVAL OF RELATED AMENDMENTS. For so long as the provisions of the
Macpell Agreement described below under "- Macpell Agreement - Agreements of the
Parties" are in effect, any change in any agreement or arrangement between
Tefron and Arwol, Macpell or Wolfson in effect at the time of closing or the
adoption of any new agreement or arrangement between Tefron and such parties
will require investor's prior approval. Similarly, any amendment to the
management fee arrangement with investor or the adoption of any new agreement or
arrangement between Tefron and the investor will require approval of Macpell and
Arwol.
INCREASE IN SHARES AVAILABLE FOR ISSUANCE UNDER TEFRON LTD. 1997 SHARE
OPTION PLAN. As a result of the transactions contemplated by the Tefron
Agreement, the shareholders of Tefron were asked to increase the plan by 446,274
ordinary shares, which was approved by the shareholders of Tefron on March 31,
2004.
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REGISTRATION RIGHTS AGREEMENT
The Investor entered into a Registration Rights Agreement with Tefron,
Arwol and Macpell on the date of closing with respect to the ordinary shares
that the Investor acquired pursuant to the Tefron Agreement and the Macpell
Agreement replacing the existing Registration Rights Agreement.
The Registration Rights Agreement is substantially the same as the
Registration Rights Agreement approved by the shareholders of Tefron and entered
into by Company, Arwol and Macpell in November 2003, other than (i) the
insertion of a new provision granting to the Investor, Arwol and Macpell the
right, once every 18 months, to request a registration on Form F-3 (short form
registration statement) when the aggregate net proceeds from the sale of such
holders' securities is at least $3,000,000, in which event Tefron would be
obligated keep such registration statement effective so as to permit sale of
ordinary shares pursuant to the Registration Statement for a period of two
years, subject to certain limitations, and (ii) the amendment of an existing
provision granting to the Investor, Arwol and Macpell the right to request a
registration even though Tefron is not eligible to use Form F-3 (short form
registration statement), in which event Tefron would be obligated keep such
registration statement effective so as to permit sale of ordinary shares
pursuant to the Registration Statement for a period of 120 days, subject to
certain limitations.
In connection with the execution of the Share Purchase Agreement with Leber
Partners, L.P., we entered into a Registration Rights Agreement with Leber
Partners, the Investor, Arwol and Macpell which replaced, and is on
substantially the same terms as, the Registration Rights Agreement that we
agreed to execute in connection with the Tefron Agreement. See "- Leber
Partners, L.P. - Registration Rights Agreement."
MACPELL AGREEMENT
At the same time as the Investor proposed to Tefron to enter into the
Tefron Agreement, the Investor proposed to Arwol to purchase from it an
additional amount of approximately 1.365 million Ordinary Shares at the base
price of $5.538 per share, and concomitantly, and as a condition to the said
purchase, to enter into a shareholders agreement. Arwol offered Macpell to join
it and take part in the sale transaction. Under the terms of the Macpell
Agreement among the Investor, Arwol and Macpell, it was agreed that the base
price for purchase of the shares, would be $5.538 per share and the aggregate
purchase price would be $7,559,370.
PURCHASE PRICE ADJUSTMENT. The purchase price of $5.538 per share under the
Macpell Agreement was subject to adjustment downwards or upwards on
substantially the same terms as the adjustment of the issue price under the
Tefron Agreement, as described above; provided that if Tefron's EBITDA for 2004
is between $16 million and $23 million, then the share price reduction was to be
calculated in accordance with the following formula:
Price per share = 5.538 - 0.75*[x]
Where x = [(23,000,000 -2004 EBITDA)/1,000,000]/7]
Tefron's EBITDA for 2004 was $11.809 million, and due to purchase price
adjustment, Arwol transferred 106,908 additional ordinary shares to Norfet in
April 2005, and Macpell elected to pay Norfet cash in lieu of transferring
additional shares to Norfet.
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AGREEMENTS OF THE PARTIES.
COMPOSITION OF THE BOARD OF DIRECTORS. Arwol, Macpell and the Investor
agreed to vote all of Tefron ordinary shares owned or controlled by each of them
for the election to Tefron's Board of Directors of: (i) three members (of whom
at least one will qualify as an "independent director" under the NYSE rules)
plus, subject to applicable law - one external director, that shall be nominated
by the Investor (one of whom shall be a woman), (ii) three members (of whom at
least one will qualify as an independent director and a financial expert under
the NYSE rules) plus, subject to applicable law, one external director, that
shall be nominated by Arwol and Macpell, and (iii) Tefron's chief executive
officer.
CHAIRMAN OF THE BOARD OF TEFRON. Arwol, Macpell and the Investor confirm in
the Macpell Agreement that Arie Wolfson agreed to remain as Chairman of the
Board until Tefron's first Annual General Meeting of Shareholders in calendar
year 2005. Subject to the provisions of applicable law, on or before such
shareholders meeting, Arwol, Macpell and the Investor endeavored to agree on the
identity of the Chairman as of and following such shareholders meeting. The
agreement provided that in the event the parties cannot agree on the identity of
the Chairman, each of Arwol and Macpell (taken as a group) and Norfet will be
entitled to designate the Chairman for an 18 month period, provided that Norfet
would be the first to exercise such right for a period commencing on and as of
the Company's first Annual General Meeting of Shareholders in 2005. In November
2005, Arie Wolfson ceased serving as Chairman of the Board, and Ishay Davidi
began serving as Chairman of the Board.
EXECUTIVE COMMITTEE. Arwol, Macpell and the Investor agreed to appoint an
Executive Committee for advisory purposes, comprised of Messrs. Arie Wolfson and
Ishay Davidi (or, an alternate member appointed by Arwol and Macpell (if Arie
Wolfson cannot fulfill his duties) or an alternative member appointed by the
Investor (if Ishay Davidi cannot fulfill his duties). Decisions of the Executive
Committee do not bind Tefron in any way.
RIGHTS OF FIRST OFFER; TAG-ALONG. The Macpell Agreement contains provisions
which require that if Arwol, Macpell or the Investor wishes to transfer ordinary
shares of Tefron to a third party, it must first make an offer to transfer the
shares the other parties, subject to certain exceptions. The agreement also
gives the right to the offerees to sell certain of their Company ordinary shares
to the proposed purchaser of the ordinary shares rather than accepting the offer
from the transferor. Notwithstanding the foregoing, (i) any transfer of shares
to any direct competitor of Tefron or to any controlling shareholder of a direct
competitor will require consent of the other parties to the agreement and (ii)
each of Arwol and Macpell (as a group) and Norfet may sell Tefron shares, in one
or more instances, constituting in the aggregate less than 2.7% of Tefron's
issued and outstanding share capital.
DRAG ALONG RIGHTS. The Macpell Agreement contains provisions which provide
that if any of Arwol, Macpell or the Investor secures a bona fide offer from any
third party offeror to purchase all of the Ordinary Shares then held by such
party, in cash or publicly traded securities, at a price per share (adjusted for
allocation of dividend, bonus shares, splits etc.) of not less than $10
(provided that such price per share shall not be lower than 80% of the average
of the closing prices of Tefron's shares on the NYSE over the consecutive 60
trading days immediately preceding such sale), and the offeror conditions its
offer on the acquisition of all the shares held by the other two parties to the
Macpell Agreement at such time, such other two parties will be required under
certain conditions to sell all of the shares of Tefron then held by them to such
offeror, at the same price and upon the same terms and conditions as those to
which the sale by the initiator is subject. Notwithstanding the foregoing, in
lieu of selling the shares as described above, the shareholders who receive the
drag along demand may acquire all of the Tefron shares then held by the
initiating shareholder in cash at the price per share and upon the same terms
and conditions as those to which the sale to the offeror would have been
subject.
DISCUSSIONS PRIOR TO MEETINGS. Arwol, Macpell and the Investor agreed in
the Macpell Agreement to meet regularly and in any event prior to each General
Meeting of shareholders of Tefron and to review, discuss and attempt to reach a
unified position with respect to principal issues on the agenda of each such
meeting. The parties clarified that this should not be interpreted as forcing
any party to act or vote according to any position stated at such prior meeting.
DIVIDEND DISTRIBUTION. The parties agreed to formulate a mutually agreeable
dividend distribution policy for Tefron, which policy shall provide for the
distribution of an annual amount, net after taxes (including withholding tax),
of at least $2 million with respect to calendar year 2004, and at least $4.5
million, effective as of calendar year 2005, and they will utilize their best
efforts to cause Tefron to adopt such policy, subject to: (a) the provisions of
applicable law (including NYSE requirements); (b) any undertaking and commitment
made or to be made towards banks and other creditors; (c) the decision of
Tefron's Board of Directors, taking into account Tefron's financial needs,
investments and all other relevant aspects.
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MANAGEMENT FEE. Arwol, Macpell and the Investor agreed in the Macpell
Agreement to vote all of Tefron ordinary shares owned or controlled by them in
order to cause Tefron (i) to pay the Investor (or any of its affiliates) the
Management Fees (described above under "the Tefron Agreement"), and (ii) as of
the date on which Arie Wolfson no longer serves as the Chairman of Tefron's
Board of Directors, to pay Arie Wolfson or his designees for their services to
Tefron, an aggregate annual amount of $120,000.
PURCHASE OF SHARES FROM DISCOUNT INVESTMENT COMPANY, OR DIC. Any party to
the agreement wishing to purchase Company ordinary shares from DIC will be
required to offer to the other parties the right to participate in such
purchase, at the same price per share and upon the same terms and conditions.
TERM OF AGREEMENTS OF THE PARTIES. All agreements of Arwol, Macpell and the
Investor described above under "Agreements of the Parties" above will remain in
effect until the fifth anniversary of the closing of the transactions under the
Macpell Agreement. The Investor will cease to have any rights under these
agreements as of the first date on which it holds less than 10% of Tefron's
issued share capital (on a non-diluted basis), and will cease to have any
obligation under these agreements as of the first date on which the Investor
holds less than 5% of Tefron's issued share capital (on a non-diluted basis).
Each of Arwol and Macpell will cease to have any rights under "Agreements of the
Parties" above as of the first date in which they hold (in the aggregate) less
than 10% of Tefron's issued share capital (on a non-diluted basis), and each of
Arwol and Macpell will cease to have any obligation under these agreements as of
the first date on which such party holds less than 5% of Tefron's issued share
capital (on a non-diluted basis).
LEBER PARTNERS L.P.
SHARE PURCHASE AGREEMENT
We also entered into a Share Purchase Agreement, dated March 3, 2004 with
Leber Partners, L.P., which is a group of investors represented by Mr. Zvi
Limon. The investors invested $5 million in cash in Tefron in exchange for
approximately 1.07 million ordinary shares of Tefron at a base price of $4.65
per share. According to the agreement, the base price per share will be subject
to certain adjustments and may be increased or reduced by up to $0.75 per share.
ISSUE PRICE ADJUSTMENT. The purchase price of $4.65 per share was subject
to adjustment downwards or upwards on substantially the same terms as the
adjustment of the issue price under the Tefron Agreement and the Macpell
Agreement, as described above; provided that if Tefron's EBITDA for 2004 is
between $16 million and $23 million, then the share price reduction was to be
calculated in accordance with the following formula:
Price per share = 4.65 - 0.75*[x]
Where x = [(23,000,000 -2004 EBITDA)/1,000,000]/7]
Tefron EBDITA for 2004 was $11.809 million. Pursuant to an amendment to the
Purchase Agreement signed on March 3, 2004, Tefron issued to Leber an additional
201,613 ordinary shares, instead of the adjustment mechanism provided for in the
Purchase Agreement.
Under the terms of the share purchase agreement, the issue price per share
will be increased in the event that, during the three-year period following the
closing of the agreement, the investors sell for cash or publicly traded
securities (excluding publicly traded securities in connection with a merger or
reorganization of Tefron) at least 20% of the total number of shares they
purchased from Tefron at an average price of at least $9.22 per share (after
adjustments for dividends, share combinations and splits). The amount of the
increase will be equal to the difference between the average sale price and the
threshold of $9.22, provided that in any event, an upwards adjustment will be no
more than $0.75 per such sold share. The amount of any increase is to be paid to
Tefron on the third anniversary of the closing.
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The adjustment mechanism described in the immediately preceding paragraph
will also apply in respect of the four-year period following the closing, but in
such event, the average sale price must exceed $11.60 per share (rather than
$9.22 per share) for adjustment to apply.
REGISTRATION RIGHTS AGREEMENT
In connection with the execution of the Share Purchase Agreement with Leber
Partners, we agreed to enter into a Registration Rights Agreement with Leber
Partners, the Investor under the Tefron Agreement, Arwol and Macpell. This
Registration Rights Agreement replaced, and is on substantially the same terms
as, the Registration Rights Agreement that we agreed to execute in connection
with the Tefron Agreement, other than as provided below. In addition to the
rights to be granted to all of the shareholders that are to be party to the
Registration Rights Agreement, Leber Partners would have the right to request a
registration (even though we would not be eligible to use a short form
registration) of all, but not less than all, of the ordinary shares then held by
Leber Partners, but in any event not less than 500,000 ordinary shares. This
would be below the threshold required for the other shareholders (which would be
a request from holders of at least 25% of the aggregate number of ordinary
shares subject to the agreement at such time to register a minimum of 5% of the
share capital of Tefron then outstanding but not less than 500,000 Ordinary
Shares). Leber Partners also has the right to request a registration of all, but
not less than all, of the ordinary shares then held by it, but in any event not
less than 500,000 ordinary shares. If the Principal Holders intend to distribute
the ordinary shares by means of an underwriting, the underwriter will be
selected by the Company and be reasonably acceptable to Principal Holders of a
majority of the ordinary shares to be registered. Under certain conditions, the
Company may defer registering such ordinary shares for a period not exceeding
180 days. In addition, the Company would have no obligation to register these
shares pursuant to requests once it has effected three effective registrations
pursuant to requests of Principal Holders.
The Principal Holders also have the right, once every 18 months, to request
a registration on Form F-3 (short form registration statement) when the
aggregate net proceeds from the sale of such holders' securities are at least
$3,000,000. In addition, the Principal Holders also have certain rights to
register their ordinary shares for sale at the time the Company registers for
its own account any of its securities in connection with a public offering for
cash (called "piggyback registration").
Under the agreement, the first $50,000 of expenses in connection with
registrations made at the request of one or more Principal Holders will be borne
by the Company, and all expenses in excess of $50,000 will be divided equally
between the Company, on the one hand, and the selling shareholders, on the other
hand. All expenses incurred in connection with "piggyback registrations" will be
borne by the Company, other than underwriting discounts and commissions and
other fees relating to the ordinary shares to be sold for the account of the
Principal Holders.
On November 29, 2005, the Securities and Exchange Commission declared
effective a Registration Statement on Form F-3 covering the resale of 11,521,259
ordinary shares held by the Principal Holders
EQUITY LINE CREDIT FACILITY
On March 9, 2004, we entered into an equity line credit facility with
Brittany, an entity advised by Southridge Capital Management LLC. Under the
agreement, we have an option to call funds of up to the lesser of $15 million or
2,470,021 ordinary shares (equal to 19.9% of our outstanding share capital on
the day we signed the agreement) over a three year period expiring at the end of
October 2007. Under the financing facility, we will be entitled to issue shares
to Brittany from time to time, at our own election, subject to certain minimum
and maximum limitations, but in no event will Brittany be obligated to own more
than 4.99% of our ordinary shares at any one time. The price to be paid by
Brittany will be at a discount of 6% to the market price of our ordinary shares
(as calculated under the agreement) during a period prior to the issuance of the
shares. The "market price" under the agreement is calculated to be the average
of the lowest closing prices for any four trading days (not necessarily
consecutive) during the ten trading day period immediately following the date on
which we deliver a written notice to Brittany setting forth the dollar amount
with respect to which we will require Brittany to purchase our Ordinary Shares.
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Before drawing on the equity line, we must satisfy certain closing
conditions, including the effectiveness of a registration statement that we must
file relating to the shares to be issued to Brittany. In addition, under our
agreement with Norfet, Limited Partnership described above under "- FIMI
Agreements - Tefron Agreement", we require the consent of Norfet for the
issuance of shares under an equity line of credit if such issuance is at a price
of less than $4.6 per share unless the issuance is required in order for us to
satisfy covenants relating to shareholders equity under company loan agreements
or to satisfy certain NYSE listing requirements. Notwithstanding the foregoing,
the issuance under the equity line of an aggregate sum of more than 12% of our
issued capital will also require the consent of Norfet.
To date, we have elected not to draw on our equity line.
OUR CREDIT AGREEMENTS
To finance the acquisition of Alba, AWS, our wholly-owned subsidiary which
merged with and into Alba following our tender offer for Alba, entered into a
credit agreement, dated as of December 13, 1999, with Bank Hapoalim B.M. and the
Israel Discount Bank of New York, as subsequently amended. The Credit Agreement
provided for a tender offer credit facility of up to $70.5 million.
The Credit Agreement also provides for a seven-year term loan facility of
up to $65.5 million, which was drawn down as a single borrowing at the time of
the merger and amortizes in 11 consecutive semi-annual installments commencing
on January 15, 2002. In addition, the Credit Agreement further provides a
one-year revolving loan facility of up to $5 million. The proceeds from the term
loan facility and the revolving loan facility were used to repay the tender
offer credit facility, which was used initially to finance the acquisition of
Alba and to refinance certain indebtedness of Alba.
SECURITY. The term loan facility and the revolving loan facility are
secured by the following:
o a floating lien on all the personal property of Alba and its
subsidiaries,
o pledges of all non-margin stock of Alba owned by Tefron U.S.
Holdings Corp., the parent company of AWS and a wholly-owned
subsidiary of Tefron, and all subsidiary stock then owned by
Alba, and
o guarantees made by Tefron U.S. Holdings Corp. and any
subsidiaries of Alba, and the continuing guaranty of Tefron.
COVENANTS. Under the terms of the Credit Agreement, Alba and its
subsidiaries are restricted from, among other things, the following:
o incurring additional indebtedness, other than certain permitted
indebtedness;
o creating liens other than certain permitted encumbrances;
o creating or assuming any guarantee obligations other than certain
permitted guarantee obligations;
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o merging, consolidating, amalgamating or entering into any other
form of business combination with a third party, or liquidating
or dissolving;
o selling assets, subject to certain exceptions which include sale
of assets in the ordinary course of business or in amounts not
exceeding $250,000 in any twelve-month period;
o declaring or setting aside funds for payment of dividends;
o making capital expenditures, subject to certain exceptions such
as capital expenditures in the ordinary course of business;
o making investments, loans or advances other than as specified; or
o entering into transactions with affiliates unless certain
requirements are satisfied.
The Credit Agreement requires that we maintain certain financial ratios
related to shareholders' equity and operating results. The Credit Agreement also
contains customary events of defaults, including the failure to pay interest or
principal, material breach of any representation or warranty or breach of any
covenant, cross-defaults, bankruptcy, a judgment in excess of $100,000 or a
change in control event relating to Tefron or Alba or its subsidiaries.
Pursuant to the amendment of our Credit Agreement, the repayment schedule
of the loans will be spread over the period from 2005-2012, such that during
each such year from 2005 until 2012 we will be obligated to pay approximately $6
million.
ALBAHEALTH CREDIT AGREEMENT
In connection with the formation of AlbaHealth, AlbaHealth entered into a
credit agreement, dated September 6, 2002, as amended in October 2005 with GE
Capital, pursuant to which GE Capital provided AlbaHealth credit facility of up
to $18 million. The AlbaHealth Credit Agreement provides for a term loan
facility of up to $15 million, which was drawn down as a single borrowing upon
the consummation of such agreement. The original credit agreement provided that
the term loan facility would amortize in 20 consecutive quarterly installments,
however, the October 2005 amendment provides that the balance of the loan
facility as of the date of the Amendment will amortize as follows: (i) four
consecutive quarterly installments on the first day of January, April, July and
October, from January 1, 2006 through October 1, 2006, each in the amount of
$312,500, and (ii) three consecutive quarterly installments on January 1, 2007,
April 1, 2007 and July 1, 2007, each in the amount of $375,000. The final
installment will be due on September 6, 2007 and be in the amount of $4,375,000
or, if different, the remaining principal balance of the term loan.
The AlbaHealth Credit Agreement also provides for a five-year revolving
loan facility of up to $3.0 million. The proceeds from the term loan facility
and the revolving loan facility were and are to be used, among other purposes,
to repay amounts due to the bank lenders under the portion of the Alba Credit
Agreement that was assigned by Alba to AlbaHealth and for working capital
purposes.
SECURITY. The term loan facility and the revolving loan facility are
secured by the following:
o a lien on all of its existing and after-acquired personal and
real property of AlbaHealth, and
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o a first priority security interest over all of the interests in
AlbaHealth held by its members, including Alba, and any
additional indebtedness arising in the future by AlbaHealth or
any of its subsidiaries in favor of such members.
INTEREST RATE. Interest on the revolving credit facility and the term loan
facility shall be paid, at the election of AlbaHealth, at one of the following
rates:
o a floating rate equal to the higher of (i) a base rate quoted by
75% of the largest banks in the U.S. and (ii) the federal funds
rate plus 50 basis points, in each case plus a margin per annum
initially equal to 1.50%; or
o the LIBOR rate plus a margin per annum initially equal to 2.75%.
PREPAYMENT/REPAYMENT. The amounts outstanding under the revolving credit
facility and the term loan facility may be voluntary prepaid by AlbaHealth at
any time, subject to certain limitations and payments of fees. In addition, the
amounts outstanding under the credit facility must be repaid in amounts equal
to:
o 50% of the excess cash flow (as defined in the agreement) for the
preceding year, after the delivery of the annual reports of
AlbaHealth with respect to each year, or, if the leverage ratio
for such preceding year is less then 100%, 25% of the excess cash
flow for such preceding year;
o 75% of the net cash proceeds from issuance of interests in of
AlbaHealth;
o net cash proceeds from the sale of any interests AlbaHealth holds
in any of its subsidiaries; and
o net cash proceeds from certain asset disposals by AlbaHealth.
COVENANTS. Under the terms of the AlbaHealth Credit Agreement, AlbaHealth
and its subsidiaries are restricted from, among other things:
o incurring additional indebtedness, other than certain permitted
indebtedness;
o creating any lien on or with respect to its accounts, properties
or assets except for permitted encumbrances;
o creating or assuming any guarantee obligations other than certain
permitted guarantee obligations;
o merging, consolidating, amalgamating or entering into any other
form of business combination with a third party, or liquidating
or dissolving;
o selling assets, subject to certain exceptions;
o declaring or setting aside funds for payment of dividends or
other similar restricted payments except for permitted payments
and distribution;
o making investments, loans or advances other than as specified;
o entering into transactions with affiliates which are not are not
in the ordinary course of business unless certain requirements
are satisfied; and
o changing its business or altering its capital structure other
than as specified.
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FINANCIAL COVENANTS. The AlbaHealth credit agreement requires AlbaHealth to
comply with certain financial covenants, including with respect to (i) maximum
permitted capital expenditures for each; (ii) minimum annual fixed charge
coverage ratio; (iii) minimum annual EBITDA; and (iv) maximum leverage ratio.
During 2004, AlbaHealth failed to comply with certain financial covenants
contained in the credit agreement, including a minimum EBITDA requirement, and
pursuant to the First Amendment and Waiver to Credit Agreement, GE Capital
agreed to waive certain financial covenant defaults that occurred during 2004
and to amend certain of the financial covenants.
EVENTS OF DEFAULT. The AlbaHealth Credit Agreement contains customary
events of default, including the failure to pay amounts thereunder, breach of
other obligations, any representation and warranty being incorrect or misleading
in any respect, cross-defaults, certain insolvency events or ceasing to carry on
business, change of control of AlbaHealth or any of its subsidiaries, breach of
the contribution agreement and other related agreements, and any default in the
observance or breach of any covenants.
10D. EXCHANGE CONTROLS
Nonresidents of Israel who purchase our Ordinary Shares with U.S. dollars
or other foreign currency will be able to convert dividends (if any) thereon,
and any amounts payable upon the dissolution, liquidation or winding-up of the
affairs of the company, as well as the proceeds of any sale in Israel of the
Ordinary Shares to an Israeli resident, into freely repatriatable dollars, at a
rate of exchange prevailing at the time of conversion, pursuant to regulations,
provided that the Israeli income tax has been withheld with respect to such
amounts, to the extent applicable, or an exemption has been obtained.
10E. TAXATION
The following is a discussion of material United States federal and Israeli
income tax consequences to U.S. Holders (defined below) of Ordinary Shares. This
discussion is based upon existing United States federal and Israeli income tax
laws, including legislation, regulations, administrative rulings and court
decisions, all as in effect on the date of this Annual Report, as well as the
Convention Between the Government of the United States of America and the
Government of the State of Israel With Respect to Taxes on Income (the
"Treaty"). All of these authorities are subject to change (possibly with
retroactive effect) and to differing interpretations.
This summary is for general information only and does not purport to be a
complete analysis of all potential tax consequences of owning Ordinary Shares.
This summary only addresses Ordinary Shares that are held as capital assets
(generally, property held for investment), and does not address all tax
considerations that may be relevant to persons in light of their particular
circumstances, including, for example, persons who hold or at any time have held
(actually or constructively) 10% or more of all classes of voting stock of
Tefron, persons who acquired their Ordinary Shares before the listing of Tefron
shares on the NYSE, persons who acquired their Ordinary Shares pursuant to the
exercise of an employee stock option or otherwise as compensation, and persons
subject to special tax treatment under Israeli or U.S. federal income tax laws,
such as banks and other financial institutions, entities classified as
partnerships for U.S. federal income tax purposes and other pass-through
entities, insurance companies, tax-exempt entities, dealers in securities,
persons holding Ordinary Shares as part of a hedging or conversion transaction
or a straddle, and holders that have a functional currency other than the U.S.
dollar. This summary does not address any aspects of state, local or non-United
States (other than certain Israeli) tax laws, or any estate, gift or other
non-income tax considerations.
For purposes of this discussion, a "U.S. Holder" means a beneficial owner
of Ordinary Shares (i) who is, for U.S. federal income tax purposes:
o a citizen or resident of the United States;
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o a corporation (or another entity taxable as a corporation for U.S.
federal income tax purposes) created or organized in the United States or
under the laws of the United States or any political subdivision thereof;
o an estate, the income of which is subject to U.S. federal income tax
regardless of its source; or
o a trust, if a U.S. court 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, if it was in
existence on August 20, 1996, was treated as a U.S. person on the previous
day and has validly elected to continue to be so treated,
(ii) who is not a resident of Israel for Israeli income tax purposes, and whose
holding of Ordinary Shares is not in any way related to properties or activities
located in Israel, and (iii) who is fully entitled to the benefits of the Treaty
in respect of the Ordinary Shares.
If an entity that is classified as a partnership for U.S. federal tax
purposes holds Ordinary Shares, the U.S. federal income tax treatment of its
partners will generally depend upon the status of the partners and the
activities of the partnership. Entities that are classified as partnerships for
U.S. federal tax purposes and persons holding Ordinary Shares through such
entities should consult their tax advisors about the income and other tax
consequences of purchasing, owning and disposing of the Ordinary Shares.
ALL PERSONS OWNING OR CONSIDERING AN INVESTMENT IN ORDINARY SHARES
(INCLUDING PERSONS THAT ARE RESIDENT OR OTHERWISE TAXABLE IN COUNTRIES OTHER
THAN THE UNITED STATES) ARE STRONGLY URGED TO CONSULT THEIR OWN TAX ADVISORS AS
TO THE PARTICULAR TAX CONSEQUENCES TO THEM OF AN INVESTMENT IN ORDINARY SHARES
UNDER THE TAX LAWS APPLICABLE TO THEM AND ANY POTENTIAL CHANGES IN THE TAX LAWS.
1. CAPITAL GAINS
U.S. FEDERAL INCOME TAX CONSIDERATIONS. Subject to the discussion below
under "Passive Foreign Investment Company Rules," upon the sale or other taxable
disposition of Ordinary Shares, a U.S. Holder generally will recognize capital
gain or loss equal to the difference between the amount realized on the
disposition and such holder's adjusted tax basis in the Ordinary Shares. Such
capital gain or loss will be long-term gain or loss if, at the time of
disposition, the U.S. Holder's holding period in the Ordinary Shares exceeds one
year. Non-corporate taxpayers are subject to lower tax rates on long-term
capital gains. All taxpayers are subject to certain limitations on the deduction
of capital losses.
Subject to complex conditions and limitations, any Israeli capital gains
tax paid with respect to a disposition of Ordinary Shares (see generally the
discussion below under "-Israeli Tax Considerations") will be a foreign income
tax eligible for credit against a U.S. Holder's U.S. federal income tax
liability (or, alternatively, for deduction against income in determining such
tax liability). In general, gain that a U.S. Holder recognizes on the sale or
other disposition of Ordinary Shares will be U.S.-source for purposes of foreign
tax credit limitations, and losses generally will be allocated against U.S.
source income. The rules governing foreign tax credits are complex, and U.S.
Holders should consult their own tax advisors regarding the availability of
foreign tax credits in their particular circumstances.
ISRAELI TAX CONSIDERATIONS. Under regulations promulgated under the Israeli
Tax Ordinance, sales of our ordinary shares until December 31, 2002, were exempt
from Israeli capital gains for individuals and companies on which the provisions
of the income tax law (Inflationary Adjustments), 1985 or the provisions of
Section 130A of the Israeli Tax Ordinance, or the Ordinance, were not imposed,
so long as our ordinary shares were quoted on a stock exchange and we qualified
as an Industrial Company. Notwithstanding the foregoing, until December 31,
2002, dealers in securities in Israel were taxed at regular tax rates applicable
to business income and companies on which the provisions of the income tax law
(Inflationary Adjustments), 1985 or the provisions of Section 130A of the
Ordinance were imposed were taxed at a regular corporate tax rates.
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From January 1, 2003, when Israeli tax reform came into effect, individuals
and companies for which the provisions of the Income Tax Law (Inflationary
Adjustments), 1985 or the provisions of Section 130A of the Israeli Tax
Ordinance are not imposed, are subject to a 15% tax rate on the real capital
gains derived on or after January 1, 2003 from the sale of shares in Israeli
companies publicly traded on a recognized stock exchange.
Under a recent amendment to the Income Tax Ordinance with a retroactive
effect from January 1 2003 and which is effective to sales of shares that occur
on or after January 1, 2006, individuals are subject to a 20% tax rate on the
real capital gains derived on or after January 1, 2003 from the sale of shares.
Substantial individual shareholders (who are defined as shareholders of 10% or
more of the shares of the company in the date of the sale of the shares or on
any date during the 12 months before the sale of the shares) are subject to a
25% tax rate on the real capital gains derived on or after January 1, 2003 from
the sale of shares. Companies on which the provisions of the Income Tax Law
(Inflationary Adjustments), 1985 or the provisions of Section 130A of the
Ordinance were not imposed before January 1, 2006 are subject to 25% tax rate on
real capital gains derived on or after January 1, 2003 from the sale of the
shares. Notwithstanding the above, companies on which the provisions of the
Income Tax Law (Inflationary Adjustments), 1985 or the provisions of Section
130A of the Ordinance were imposed before January 1, 2006 are subject to regular
corporate tax rate on real capital gains derived on the sale of the shares.
Under the Ordinance and the income tax regulations, non-Israeli residents,
who sell shares of an Israeli company publicly traded on a recognized stock
exchange, will be exempt from Israeli capital gains tax if both of the following
conditions are satisfied:
o The capital gain is not attributable to a Permanent Establishment in
Israel; and
o The shares were purchased after the first IPO in the recognized stock
exchange.
In addition, under the Treaty, a U.S. Holder who meets the definition of a
U.S. resident under the Treaty is exempt from Israeli capital gains tax with
respect to a disposition of Ordinary Shares, provided the U.S. Holder holds
shares possessing less than 10% of the voting power in Tefron, and did not hold
shares possessing 10% or more of the voting power in Tefron at any time during
the 12 months prior to the disposition of Ordinary Shares.
2. DISTRIBUTIONS
U.S. FEDERAL INCOME TAX CONSIDERATIONS. Subject to the discussion below
under "Passive Foreign Investment Company Rules," a U.S. Holder generally will
be required to include in gross income, as ordinary dividend income, the amount
of any distributions paid on the Ordinary Shares (including the amount of any
Israeli taxes withheld) to the extent that such distributions are paid out of
Tefron's current or accumulated earnings and profits as determined for U.S.
federal income tax purposes. Distributions in excess of Tefron's earnings and
profits as so determined will be applied against and will reduce the U.S.
Holder's adjusted tax basis in its Ordinary Shares and, to the extent they are
in excess of such tax basis, will be treated as gain from a sale or exchange of
such Ordinary Shares. Subject to certain limitations, "qualified dividend
income" received by a non-corporate taxpayer generally is subject to U.S.
federal income tax at a reduced rate. Dividends paid by Tefron will not qualify
for the dividends-received deduction otherwise available to U.S. corporations.
In the event Tefron pays dividends in a currency other than the U.S.
dollar, such dividends will be includible in the gross income of a U.S. Holder
in a U.S. dollar amount calculated by reference to the exchange rate in effect
on the day they are includible in income by the U.S. Holder (regardless of
whether the U.S. Holder in fact converts the dividends into U.S. dollars). Any
gain or loss resulting from currency exchange fluctuations during the period
from the date the dividend is includible in the income of the U.S. Holder to the
date such foreign currency is disposed of will be treated as ordinary income or
loss.
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Subject to complex conditions and limitations, any Israeli withholding tax
imposed on dividends paid by Tefron (see generally the discussion below under
"-Israeli Tax Considerations") will be a foreign income tax eligible for credit
against a U.S. Holder's U.S. federal income tax liability (or, alternatively,
for deduction against income in determining such tax liability). In general,
dividends generally will be treated as foreign-source passive income or, in the
case of certain U.S. Holders, financial services income, for foreign tax credit
purposes. (U.S. Holders should note that recently enacted legislation eliminates
the "financial services income" category with respect to taxable years beginning
after December 31, 2006. Under this legislation, the foreign tax credit
limitation categories will be limited to "passive category income" and "general
category income.") There are special rules for computing the foreign tax credit
limitation of a taxpayer who receives dividends that are subject to a reduced
rate of tax. The rules governing foreign tax credits are complex, and U.S.
Holders should consult their own tax advisors regarding the availability of
foreign tax credits in their particular circumstances.
ISRAELI TAX CONSIDERATIONS. Non-residents of Israel are subject to Israeli
income tax on income accrued or derived from sources in Israel. Such sources of
income include passive income such as dividends, royalties and interest, as well
as non-passive income from services rendered in Israel. On distributions of
dividends after January 1, 2006, other than bonus shares or stock dividends,
Israeli income tax at the rate of 20% will be withheld on dividends distributed
to Israeli individual shareholders or to non-residents. Substantial individual
shareholders (who are defined as shareholders of 10% or more of the shares of
the company in the date of the sale of the shares or on any date during the 12
months before the sale of the shares) are subject to 25% withholding tax rate
unless a different rate is provided by an applicable treaty. The withholding tax
rate on dividends generated by an Approved Enterprise is 15%.
Under the Treaty, which sets maximum withholding rates on dividends, the
maximum Israeli tax on dividends paid to a holder of Ordinary Shares who
qualifies as a U.S. resident for purposes of the Treaty is generally 25%. This
maximum rate is reduced to 12.5% if the dividends are paid to a U.S. corporation
that holds at least 10% of the voting rights in Tefron and satisfies certain
other requirements.
3. PASSIVE FOREIGN INVESTMENT COMPANY RULES
For U.S. federal income tax purposes, Tefron will be considered a "passive
foreign investment company" (or "PFIC") if (i) 75% or more of our gross income
for the taxable year is passive income (the "income test") or (ii) the average
percentage of our assets (by value) held during the taxable year that produce
passive income (e.g., dividends, interest, royalties, rents and annuities) or
that are held for the production of passive income is at least 50% (the "asset
test"). A corporation that owns, directly or indirectly, at least 25% by value
of the stock of a second corporation must take into account its proportionate
share of the second corporation's income and assets in applying the income test
and the asset test.
Based on current projections concerning the composition of Tefron's income
and assets, Tefron does not believe that it will be treated as a PFIC for its
current or future taxable years. However, because this conclusion is based on
our current projections and expectations as to future business activity, Tefron
can provide no assurance that it will not be treated as a PFIC in respect of its
current or any future taxable years.
If Tefron is treated as a PFIC for any taxable year during which a U.S.
Holder holds Ordinary Shares, then, subject to the discussion of the qualified
electing fund ("QEF") and "mark-to-market" rules below, such U.S. Holder
generally will be subject to a special and adverse U.S. income tax regime with
respect to any gain realized on the disposition of the Ordinary Shares and with
respect to certain "excess distributions" received from Tefron. The adverse tax
consequences include taxation of such gain or excess distribution at
ordinary-income rates and the imposition of an interest charge on tax
liabilities with respect to such gain or excess distributions.
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In some circumstances, a U.S. Holder may avoid certain of the unfavorable
consequences of the PFIC rules by making a QEF election in respect of Tefron. A
QEF election effectively would require an electing U.S. Holder to include in
income currently its pro rata share of the ordinary earnings and net capital
gain of Tefron. However, a U.S. Holder cannot elect QEF status with respect to
Tefron unless Tefron complies with certain reporting requirements and there can
be no assurance that Tefron will provide such information.
A U.S. Holder that holds "marketable" stock in a PFIC may also avoid
certain unfavorable consequences of the PFIC rules by, instead of making a QEF
election, electing to mark the PFIC stock to market at the close of each taxable
year. Tefron expects that the Ordinary Shares will be "marketable" for this
purpose. A U.S. Holder that makes the mark-to-market election will be required
to include in income each year as ordinary income an amount equal to the excess,
if any, of the fair market value of the stock at the close of the year over the
U.S. Holder's adjusted tax basis in the stock. If, at the close of the year, the
U.S. Holder's adjusted tax basis exceeds the fair market value of the stock,
then the U.S. Holder may deduct any such excess from ordinary income, but only
to the extent of net mark-to-market gains previously included in income. Any
gain from the actual sale of the PFIC stock will be treated as ordinary income,
and any loss will be treated as ordinary loss to the extent of net
mark-to-market gains previously included in income.
4. U.S. BACKUP WITHHOLDING AND INFORMATION REPORTING
A U.S. Holder may be subject to U.S. Internal Revenue Service information
reporting and U.S. backup withholding with respect to dividends received with
respect to Ordinary Shares and proceeds from the sale of Ordinary Shares, unless
the U.S. Holder is a corporation or within certain exempt categories and
demonstrates that fact when so required, or (in the case of backup withholding
only) furnishes a correct taxpayer identification number and makes the required
certifications.
U.S. backup withholding is not an additional tax. Any amount withheld under
the backup withholding rules will be allowed as a credit against the U.S.
Holder's U.S. federal income tax liability and may entitle such U.S. Holder to a
refund, provided the required information is timely furnished to the Internal
Revenue Service.
10F. DIVIDENDS AND PAYMENT AGENTS
Not Applicable.
10G. STATEMENTS BY EXPERTS.
Not Applicable.
10H. DOCUMENTS ON DISPLAY
We are currently subject to the information and periodic reporting
requirements of the Securities Exchange Act of 1934, as amended. Our SEC filings
are available for inspection and copying at the public reference facilities
maintained by the Commission in Room 1024, 450 Fifth Street, N.W. Washington,
D.C. 20549, and the Commission's regional offices located in New York, New York
and Chicago, Illinois. Please call the Commission at 1-800-SEC-0330 for further
information on the public reference rooms.
As a foreign private issuer, we are exempt from the rules under the
Securities Exchange Act of 1934, as amended, prescribing the furnishing and
content of proxy statements to shareholders. Because we are a foreign private
issuer, we, our directors and our officers are also exempt from the shortswing
profit recovery and disclosure regime of section 16 of the Exchange Act.
81
10I. SUBSIDIARY INFORMATION
Not Applicable.
ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
FOREIGN CURRENCY RISK
Our operating expenses are influenced by changes in the exchange rates
between the dollar and foreign currencies, especially the NIS. Our operational
expenses increase when the dollar is devalued against such currencies. At
December 31, 2005, our liabilities denominated in foreign currencies in the
amount of $25.2 million represented 19.2% of our total liabilities of $131.1
million. At December 31, 2005, our assets denominated in foreign currencies in
the amount of $7.1 million represented 3.9% of our total assets of $185.9
million. We may from time to time utilize derivative financial instruments to
manage risk exposure to movements in foreign exchange rates. Accordingly, in
2002, a forward exchange contract was designated as hedging instrument. We do
not engage in any speculative or profit motivated forward or derivatives
activities. See "Item 3. Key Information - 3D. Risk Factors" and "Item 5.
Operating and Financial Review and Prospects - Impact of Inflation and Currency
Fluctuations.
Most of our sales are denominated in U.S. dollars, and we incur most of our
expenses in U.S. dollars and in NIS. According to the salient economic factors
indicated in SFAS No. 52, "Foreign Currency Translation," our cash flow, sale
price, sales market, expense, financing and intercompany transactions and
arrangement indicators are predominately denominated in U.S. dollars. In
addition, the U.S. dollar is the primary currency of the economic environment in
which we operate, and thus the U.S. dollar is our functional and reporting
currency.
In our balance sheet, we re-measure into U.S. dollars all monetary accounts
(principally cash and cash equivalents and liabilities) that are maintained in
other currencies. For this re-measurement, we use the foreign exchange rate at
the balance sheet date. Any gain or loss that results from this re-measurement
is reflected in the statement of income as financial income or financial
expense, as appropriate.
We measure and record non-monetary accounts in our balance sheet
(principally fixed assets, prepaid expenses and share capital) in U.S. dollars,
and we do the same with operational accounts. For this measurement, we use the
U.S. dollar value in effect at the date that the asset or liability was
initially recorded in our balance sheet (the date of the transaction).
In managing our foreign exchange risk, from time to time we enter into
various foreign exchange hedging contracts. Our policy is to hedge significant
net exposures in the major foreign currencies in which we operate. We attempt to
limit our exposure resulting from liabilities and anticipated expenses that are
denominated in NIS through forward contracts. We monitor foreign exchange rates
and trends periodically to measure the effectiveness of our foreign currency
hedging. If our forward contracts meet the definition of a hedge and are so
designated, changes in the fair value of the contracts will be:
o offset against changes in the fair value of the hedged assets or
liabilities through earnings, or
o recognized in other comprehensive income until the hedged item is
recognized in earnings.
82
As of December 31, 2005, there were no gains or losses recognized in
earnings for hedge ineffectiveness. As of December 31, 2005, we had outstanding
forward contracts in the amount of $12.5 million. These transactions were for a
period of up to four months. We enter into forward contracts only with
well-established institutions, and therefore we believe that the liabilities
that were owed to us at December 31, 2005 will be realized. In the event that
forward contracts were to become unavailable to us for a period of time and the
dollar were devalued against foreign currencies, our operational expenses would
increase by an amount corresponding to the devaluation of the dollar as a result
of our inability to hedge changes in exchange rates.
INTEREST RATE RISK
Of our dollar-denominated financial liabilities at December 31, 2005, $66.4
million were loans denominated in or linked to the dollar bearing interest at
LIBOR. As a result, our interest expenses are sensitive to changes in LIBOR.
Our dollar-denominated or dollar-linked financial liabilities bear interest
at 1.5% to 2.75% over LIBOR. A hypothetical ten percent shift in interest rates
would result in a decrease (or increase) in net income of approximately $0.3
million.
ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES
Not Applicable.
83
PART II
ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES
None.
ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF
PROCEEDS
14A. TO E. Not Applicable.
ITEM 15. CONTROLS AND PROCEDURES
(a) DISCLOSURE CONTROLS AND PROCEDURES. Our Chief Executive Officer and our
Chief Financial Officer, after evaluating the effectiveness of our disclosure
controls and procedures (as defined in US Exchange Act Rule 13a-15(e)) as of the
end of the period covered by this Annual Report, have concluded that, as of such
date, our disclosure controls and procedures were effective to ensure that
material information relating to the Company was made known to them by others.
(b) INTERNAL CONTROL OVER FINANCIAL REPORTING. There were no changes in our
internal control over financial reporting that occurred during the year ended
December 31, 2004 that have materially affected, or are reasonably likely to
materially affect, our internal control over financial reporting.
ITEM 16. [RESERVED]
16A. AUDIT COMMITTEE FINANCIAL EXPERT
The Board of Directors has determined that Yacov Einav is an "audit
committee financial expert" as defined in Item 16A of Form 20-F. Mr. Einav is an
"independent" director in accordance with applicable NYSE and SEC regulations.
16B. CODE OF ETHICS
We have adopted a code of ethics that applies to our Chief Executive
Officer, Chief Financial Officer, Corporate Controller and employees. This code
of ethics is posted on our website, www.tefron.com, and may be found as follows:
1. From our main web page, first click on the "meet tefron" bar on the
left.
2. Next, click on "code of business ethics" on the bottom.
16C. ACCOUNTANTS' FEES AND SERVICES
The following table presents the aggregate fees for professional services
and other services rendered by Kost, Forer Gabbay & Kasierer in Israel, a member
of Ernest & Young Global, and by McGladrey & Pullen, LLP in the United States to
Tefron in 2005 and 2004.
84
US$ 2005 US$ 2004
-------- --------
Audit Fees (1) $108,000 $126,677
Audit-related Fees (2) $ 53,000 $ 92,000
Tax Fees (3) $ 19,000 $ 63,971
All Other Fees (4) $ 58,200 $ 24,426
TOTAL $238,200 $307,074
Audit Fees consist of fees billed for the annual audit services engagement
and other audit services, which are those services that only the external
auditor can reasonably provide, and include the group audit; statutory audits;
comfort letters and consents; attest services; and assistance with and review of
documents filed with the SEC.
Audit-related Fees consist of fees billed for assurance and related
services that are reasonably related to the performance of the audit or review
of our financial statements or that are traditionally performed by the external
auditor, and include consultations concerning financial accounting and reporting
standards; internal control reviews of new systems, programs and projects;
review of security controls and operational effectiveness of systems; review of
plans and control for shared service centers, due diligence related to
acquisitions; accounting assistance and audits in connection with proposed or
completed acquisitions; and employee benefit plan audits.
Tax Fees include fees billed for tax compliance services, including the
preparation of original and amended tax returns and claims for refund; tax
consultations, such as assistance and representation in connection with tax
audits, tax advice related to mergers and acquisitions, transfer pricing, and
requests for rulings or technical advice from taxing authority.
All Other Fees include fees billed for training; forensic accounting; data
security reviews; treasury control reviews and process improvement and advice;
environmental, sustainability and advisory services.
AUDIT COMMITTEE PRE-APPROVAL POLICIES AND PROCEDURES
Below is a summary of the current Policies and Procedures.
Tefron's audit committee's main role is to assist the Board of Directors in
fulfilling its responsibility for oversight of the quality and integrity of the
accounting, auditing and reporting practices of the Company. The Audit Committee
oversees the appointment, compensation, and oversight of the public accounting
firm engaged to prepare or issue an audit report on the financial statements of
the Company. The audit committee's specific responsibilities in carrying out its
oversight role include the approval of all audit and non-audit services to be
provided by the external auditor and quarterly review the firm's non-audit
services and related fees. These services may include audit services,
audit-related services, tax services and other services, as described above. The
audit committee approves in advance the particular services or categories of
services to be provided to the Company during the following yearly period and
also sets forth a specific budget for such audit and non-audit services.
Additional services may be pre-approved by the audit committee on an individual
basis during the year.
During 2005, none of Audit-related Fees, Tax Fees or Other Fees provided to
us by Kost, Forer Gabbay & Kasierer in Israel or by Ernst & Young or McGladrey &
Pullen, LLP in the United States were approved by the Audit Committee pursuant
to the de minimis exception to the pre-approval requirement provided by
paragraph (c)(7)(i)(C) of Rule 2-01 of Regulation S-X.
16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES.
None.
85
16E. PURCHASES 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
Our Consolidated Financial Statements beginning on pages F-1 through F-35,
as set forth in the following index, are hereby incorporated herein by
reference. These Consolidated Financial Statements are filed as part of this
Annual Report.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
----
Index to Consolidated Financial Statements F-1
Report of Registered Public Accounting Firm F-2
Consolidated Balance Sheets F-3 - F-4
Consolidated Statement of Operations F-5
Consolidated Statement of Changes in Shareholders' Equity F-6
Consolidated Statement of Cash Flows F-7 - F-8
Notes to the Consolidated Financial Statements F-9 - F-35
Report of Independent Auditors for subsidiary of Tefron,
Alba Health LLC, for 2005 Financial Statements F-36
86
ITEM 19. EXHIBITS
1.1. Memorandum of Association of the Company (incorporated by reference to
Exhibit 3.1 to the Company's Registration Statement on Form F-1 (No.
333-7538) filed on August 29, 1997).
1.2. Restated Articles of Association of the Company (incorporated by
reference to Exhibit 1.2 to the Company's Annual Report on Form 20-F
for the fiscal year ended December 31, 2002).
2.1. Form of Credit Agreement, dated as of December 13, 1999, among AWS
Acquisition Corp., Israel Discount Bank of New York and Bank Hapoalim
B.M., New York Branch as Administrative Agent (incorporated by
reference to Exhibit 99(b)(2) to Amendment No. 2 to Schedule 14D-1 in
respect of Alba-Waldensian, Inc. filed by the Company on December 13,
1999).
2.2 Letter, dated March 2, 2004, from Israel Discount Bank Ltd. to the
Company regarding shareholders' equity requirements under the Credit
Agreement (incorporated by reference to Exhibit 2.8 to the Company's
Annual Report on Form 20-F for the fiscal year ended December 31,
2003).
2.3 Letter, dated March 2, 2004, from Bank Hapoalim to the Company
regarding shareholders' equity requirements under the Credit Agreement
(incorporated by reference to Exhibit 2.9 to the Company's Annual
Report on Form 20-F for the fiscal year ended December 31, 2003).
2.4 Letter, dated February 16, 2004, from Israel Discount Bank to the
Company regarding revised repayment schedule and revised shareholders'
equity requirements under the Credit Agreement (incorporated by
reference to Exhibit 2.10 to the Company's Annual Report on Form 20-F
for the fiscal year ended December 31, 2003).
2.5 Letter, dated February 15, 2004, from Bank Hapoalim to the Company
regarding revised repayment schedule under the Credit Agreement
(incorporated by reference to Exhibit 2.11 to the Company's Annual
Report on Form 20-F for the fiscal year ended December 31, 2003).
2.6 Letter, dated March 31, 2004, from Bank Hapoalim to the Company
regarding revised shareholders' equity requirements under the Credit
Agreement (incorporated by reference to Exhibit 2.12 to the Company's
Annual Report on Form 20-F for the fiscal year ended December 31,
2003).
2.7 Sixth Amendment to Credit Agreement, dated December 15, 2004, among
Alba-Waldensian, Inc. and Bank Hapoalim, as Agent and Lender, together
with Term B Notes (incorporated by reference to Exhibit 2.7 to the
Company's Annual Report on Form 20-F for the fiscal year ended
December 31, 2004).
2.8 Credit Agreement, dated September 6, 2002, among AlbaHealth LLC, as
borrower, the other borrower signatory thereto, the lenders signatory,
thereto from time to time, and General Electric Capital Corporation,
as Agent and a Lender. (incorporated by reference to Exhibit 2.8 to
the Company's Annual Report form 20-F for the fiscal year ended
December 31, 2002).
2.9 First Amendment and Waiver to Credit Agreement, dated March 31, 2005,
among AlbaHealth LLC and General Electric Capital Corporation, as
Agent and Lender (incorporated by reference to Exhibit 2.9 to the
Company's Annual Report on Form 20-F for the fiscal year ended
December 31, 2004).
87
2.10 Second Amendment and Waiver to Credit Agreement, dated as of October
1, 2005, among AlbaHealth LLC and General Electric Capital
Corporation, as Agent and Lender.
2.11 Security Agreement, dated as of September 6, 2002, among the Grantor
signatory thereto, from time to time, and General Electric Capital
Corporation, as Agent for the benefit of itself and the lenders from
time to time party to the Credit Agreement (referred to in Exhibit
2.14).
2.12 Borrower Stockholders Pledge Agreement, dated as of September 6, 2002,
by and among the pledgors signatory thereto, from time to time, and
General Electric Capital Corporation, as Agent for the benefit of
itself and the lenders from time to time party to the Credit Agreement
(referred to in Exhibit 2.14).
2.13 Loan Agreement, dated as of December 21, 2004, between Israel Discount
Bank and Hi-Tex Founded by Tefron Ltd (incorporated by reference to
Exhibit 2.12 to the Company's Annual Report on Form 20-F for the
fiscal year ended December 31, 2004).
2.14 Loan Agreement, dated as of December 31, 2004, between Bank Hapoalim
and Hi-Tex Founded by Tefron Ltd (incorporated by reference to Exhibit
2.13 to the Company's Annual Report on Form 20-F for the fiscal year
ended December 31, 2004).
2.15 Loan Agreement, dated as of December 25, 2004, between Israel Discount
Bank and the Company (incorporated by reference to Exhibit 2.14 to the
Company's Annual Report on Form 20-F for the fiscal year ended
December 31, 2004).
2.16 Loan Agreement, dated as of December 31, 2004, between Bank Hapoalim
and the Company (incorporated by reference to Exhibit 2.15 to the
Company's Annual Report on Form 20-F for the fiscal year ended
December 31, 2004).
2.17 The total amount of long-term debt securities of the Company
authorized under any instrument, other than as exhibited hereto, does
not exceed 10% of the total assets of the Company on a consolidated
basis. The Company hereby agrees to furnish to the SEC, upon request,
a copy of any instrument defining the rights of holders of long-term
debt of the Company or of its subsidiaries for which consolidated or
unconsolidated financial statements are required to be filed.
3.1 Shareholders Agreement, dated as of December 28, 1999, between Arwol
Holdings Ltd. and Avi Ruimi (incorporated by reference to Exhibit D to
the General Statement of Beneficial Ownership of the Company on
Schedule 13D filed by Arwol Holdings Ltd., Arie Wolfson, Sigi
Rabinowicz, Riza Holdings Ltd. and Macpell Industries Ltd. on February
17, 2000).
3.2 Agreement, dated February 17, 2004, by and among Arwol Holdings Ltd.,
Macpell Industries Ltd. and Norfet, Limited Partnership (incorporated
by reference to Exhibit 3.4 to the Company's Annual Report on Form
20-F for the fiscal year ended December 31, 2003).
4.1. Agreement and Plan of Merger, dated as of November 8, 1999, by and
among Tefron U.S. Holdings Corp., AWS Acquisition Corp. and
Alba-Waldensian, Inc. (incorporated by reference to Exhibit (c)(1) to
Schedule 14D-1 in respect of Alba-Waldensian, Inc. filed by the
Company on November 12, 1999)
4.2. Employment Agreement, dated as of August 5, 2002, between the Company
and Sigi Rabinowicz (incorporated by reference to Exhibit 4.2 to the
Company's Annual Report on Form 20-F for the fiscal year ended
December 31, 2002).
4.3. Consulting and Management Services Agreement, dated as of August 5,
2002, between the Company, New York Delights Ltd., and Arie Wolfson
(incorporated by reference to Exhibit 4.3 to the Company's Annual
Report on Form 20 F for the fiscal year ended December 31, 2002).
88
4.4. Management and Services Agreement, effective as of July 30, 2003,
between the Company, Yosef Shiran and Shiran & Partners - Consulting,
Entrepreneurship, and Financing (incorporated by reference to Exhibit
4.4 to the Company's Annual Report on Form 20-F for the fiscal year
ended December 31, 2003).
4.5. Lease Agreement dated as of August 12, 1997, between the Company and
New Net Assets (1994) Ltd. and an Assignment Agreement dated as of
December 25, 1998 between the Company and Hi-Tex Founded by Tefron
Ltd. The Company and/or its subsidiary, Hi-Tex Founded by Tefron Ltd.,
have entered in to similar lease agreements with New Net Assets (1994)
Ltd. (incorporated by reference to Exhibit 4.5 to the Company's Annual
Report on Form 20-F for the fiscal year ended December 31, 2001).
4.6 Contribution Agreement, dated as of September 6, 2002, between
AlbaHealth, LLC, Alba-Waldensian, Inc., Encompass Group, L.L.C. and
General Electric Capital Corporation (incorporated by reference to
Exhibit 4.6 to the Company's Annual Report on Form 20-F for the fiscal
year ended December 31, 2002).
4.7 The Limited Liability Company Agreement of AlbaHealth LLC, dated as of
September 6, 2002, by and among AlbaHealth, LLC, Alba-Waldensian,
Inc., Encompass Group, L.L.C. and General Electric Capital Corporation
(incorporated by reference to Exhibit - to the Company's Annual Report
on Form 20-F for the fiscal year ended December 31, 2002).
4.8 Put Option Agreement, dated as of September 6, 2002, as amended as of
December 13, 2004, by and among AlbaHealth, LLC, Alba-Waldensian,
Inc., Encompass Group, L.L.C. and General Electric Capital Corporation
(incorporated by reference to Exhibit 4.8 to the Company's Annual
Report on Form 20-F for the fiscal year ended December 31, 2002).
4.9 Amendment No. 1 to Put Option Agreement, dated as of December 13,
2004, by and among AlbaHealth, LLC, Alba-Waldensian, Inc., Encompass
Group, L.L.C. and General Electric Capital Corporation (incorporated
by reference to Exhibit 4.9 to the Company's Annual Report on Form
20-F for the fiscal year ended December 31, 2004).
4.10 Notice of Exercise under Put Option Agreement, dated December 22, 2005
4.11 Share Purchase Agreement dated February 17, 2004, by and between the
Company and Norfet Limited Partnership, including related Registration
Rights Agreement attached as a schedule (incorporated by reference to
Exhibit 4.9 to the Company's Annual Report on Form 20-F for the fiscal
year ended December 31, 2003).
4.12 Amendment to Purchase Agreement, dated March 31, 2005, by and between
the Company and Norfet Limited Partnership (incorporated by reference
to Exhibit 4.11 to the Company's Annual Report on Form 20-F for the
fiscal year ended December 31, 2004).
4.13 Share Purchase Agreement, made as of March 3, 2004, by and between
Tefron and Leber Partners, L.P, including related Registration Rights
Agreement attached as a schedule (incorporated by reference to Exhibit
4.10 to the Company's Annual Report on Form 20-F for the fiscal year
ended December 31, 2003).
4.14 Amendment to Agreement, dated March 31, 2005, by and between the
Company and Leber Partners, L.P (incorporated by reference to Exhibit
4.13 to the Company's Annual Report on Form 20-F for the fiscal year
ended December 31, 2004).
89
4.15 Private Equity Credit Agreement, dated as of March 9, 2004, by and
between the Company and Brittany Capital Management Limited
(incorporated by reference to Exhibit 4.11 to the Company's Annual
Report on Form 20-F for the fiscal year ended December 31, 2003).
4.16 Registration Rights Agreement, dated as of March 9, 2004, by and
between the Company and Brittany Capital Management Limited
(incorporated by reference to Exhibit 4.12 to the Company's Annual
Report on Form 20-F for the fiscal year ended December 31, 2003).
8.1 List of subsidiaries of the Company.
12.(a).1 Certification by CEO pursuant to Rule 13a-14(a) or Rule 15d-14(a) of
the Securities Exchange Act of 1934, as adopted pursuant to Section
302 of the Sarbanes Oxley Act of 2002.
12.(a).2 Certification by CFO pursuant to Rule 13a-14(a) or Rule 15d-14(a) of
the Securities Exchange Act of 1934, as adopted pursuant to Section
302 of the Sarbanes Oxley Act of 2002.
13.(a).1 Certification of CEO and CFO pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
14.(a).1 Consent of Kost, Forer Gabbay & Kasierer, a member of Ernst &Young
Global.
14.(a).2 Consent of McGladrey & Pullen, LLP.
14.(a).3 Consent of Yoram Eden.
90
TEFRON LTD. AND ITS SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
AS OF DECEMBER 31, 2005
U.S. DOLLARS IN THOUSANDS
INDEX
PAGE
----------
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM F-2
CONSOLIDATED BALANCE SHEETS F-3 - F-4
CONSOLIDATED STATEMENTS OF OPERATIONS F-5
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY F-6
CONSOLIDATED STATEMENTS OF CASH FLOWS F-7 - F-8
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS F-9 - F-35
REPORT OF INDEPENDENT AUDITORS FOR SUBSIDIARY OF
TEFRON, ALBA HEALTH LLC, FOR 2005 FINANCIAL STATEMENTS F - 36
[ERNST & YOUNG LOGO] [X] KOST FORER GABBAY & KASIERER |X| 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
TEFRON LTD.
We have audited the accompanying consolidated balance sheets of Tefron Ltd.
("the Company") and its subsidiaries as of December 31, 2005 and 2004, and the
related consolidated statements of operations, changes in shareholders' equity
and cash flows for each of the three years in the period ended December 31,
2005. 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 did not audit the financial statements of Alba Health LLC ("Alba
Health") a subsidiary, whose statements constitute 21.5% and 23.9% of total
consolidated assets as of December 31, 2005 and 2004, respectively and whose
revenues constitute 16.7%, 18.7% and 23.5% of total consolidated revenues for
the years ended December 31, 2005, 2004 and 2003, respectively. Those statements
were audited by other auditors whose reports have been furnished to us, and our
opinion, insofar as it relates to amounts included for Alba Health, is based
solely on the reports of the other auditors.
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. We were not engaged to
perform an audit of the Company's internal control over financial reporting. Our
audit included consideration of internal control over financial reporting as a
basis for designing audit procedures that are appropriate in the circumstances,
but not for the purpose of expressing an opinion on the effectiveness of the
Company's internal control over financial reporting. Accordingly we express no
such opinion. An audit also includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management and
evaluating the overall financial statement presentation. We believe that our
audits and the reports of the other auditors provide a reasonable basis for our
opinion.
In our opinion, based on our audits and the reports of other auditors, the
consolidated financial statements referred to above present fairly, in all
material respects, the consolidated financial position of the Company and its
subsidiaries as of December 31, 2005 and 2004, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2005, in conformity with accounting principles generally accepted
in the United States.
Tel-Aviv, Israel KOST FORER GABBAY & KASIERER
March 8, 2006 A Member of Ernst & Young Global
F - 2
TEFRON LTD. AND ITS SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
DECEMBER 31,
-----------------------
NOTE 2004 2005
-------- -------- --------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 3,558 $ 8,201
Trade receivables (net of allowances of $ 252 and $ 594 at December
31, 2004 and 2005, respectively) 21,402 30,501
Other accounts receivable and prepaid expenses 4 5,696 4,981
Inventories 5 33,137 29,919
-------- --------
TOTAL current assets 63,793 73,602
-------- --------
DEFERRED TAXES 2,486 -
-------- --------
PROPERTY, PLANT AND EQUIPMENT, NET 6 93,931 86,928
-------- --------
GOODWILL 3 30,743 25,060
-------- --------
DEFERRED LOAN ISSUANCE COSTS 578 290
-------- --------
TOTAL assets $191,531 $185,880
======== ========
The accompanying notes are an integral part of the consolidated financial
statements.
F - 3
TEFRON LTD. AND ITS SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
DECEMBER 31,
--------------------------
NOTE 2004 2005
-------- --------- ---------
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Short-term bank credit 7 $ 21,355 $ 17,713
Current maturities of long-term debt:
Loans from banks and others 9 9,039 7,623
Capital leases 9 206 -
Trade payables 28,991 30,385
Conditional obligation with respect to issuance of shares 11b 3,454 -
Other accounts payable and accrued expenses 8 9,189 9,104
--------- ---------
TOTAL current liabilities 72,234 64,825
--------- ---------
LONG-TERM LIABILITIES:
Loans from banks and others (net of current maturities) 9 47,907 41,034
Deferred taxes 13 5,611 9,116
Accrued severance pay, net 2,744 2,061
--------- ---------
TOTAL long-term liabilities 56,262 52,211
--------- ---------
LIENS, CONTINGENCIES AND COMMITMENTS 10
MINORITY INTEREST 16,291 14,159
--------- ---------
SHAREHOLDERS' EQUITY: 11
Share capital -
Ordinary shares of NIS 1 par value - Authorized: 49,995,500
shares; Issued: 18,014,247 and 19,010,376 shares at
December 31, 2004 and 2005, respectively; Outstanding:
17,016,847 and 18,012,976 shares at December 31, 2004 and 2005,
respectively 6,582 6,810
Deferred shares of NIS 1 par value - Authorized: 4,500 shares;
Issued and outstanding: 4,500 and 0 shares at December 31, 2004
and 2005, respectively 1 -
Additional paid-in capital 79,243 83,069
Deferred stock-based compensation (486) (198)
Less - 997,400 Ordinary shares in treasury, at cost (7,408) (7,408)
Cumulative other comprehensive gain - 307
Accumulated deficit (31,188) (27,895)
--------- ---------
TOTAL shareholders' equity 46,744 54,685
--------- ---------
TOTAL liabilities and shareholders' equity $ 191,531 $ 185,880
========= =========
The accompanying notes are an integral part of the consolidated financial
statements.
F - 4
TEFRON LTD. AND ITS SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
YEAR ENDED DECEMBER 31,
----------------------------------------------------
NOTE 2003 2004 2005
--- ------------ ------------ ------------
Sales, net $ 163,086 $ 182,819 $ 205,585
Cost of sales 12a 139,422 159,937 166,217
------------ ------------ ------------
Gross profit 23,664 22,882 39,368
Selling, general and administrative expenses 20,323 22,387 19,837
Impairment and other expenses related to the put option
exercise 1d - - 6,073
------------ ------------ ------------
Operating income 3,341 495 13,458
Financial expenses, net 12b 5,628 5,212 4,371
Other income 12c 228 - 409
------------ ------------ ------------
Income (loss) before taxes on income (2,059) (4,717) 9,496
Taxes on income (tax benefit) 13 (424) 203 7,818
Equity in losses of affiliated companies (183) - -
Minority interest in losses (earnings) of a subsidiary (2,550) (1,945) 1,615
Pre-acquisition earnings of subsidiary since April 1,
2003 through May 5, 2003 1e (85) - -
------------ ------------ ------------
Net income (loss) $ (4,453) $ (6,865) $ 3,293
============ ============ ============
Basic and diluted net earnings (losses) per share:
Basic net earnings (losses) per share $ (0.36) $ (0.44) $ 0.19
============ ============ ============
Diluted net earnings (losses) per share $ (0.36) $ (0.44) $ 0.18
============ ============ ============
Weighted average number of shares used for computing
basic earnings (losses) per share 12,412,166 15,603,904 17,719,275
============ ============ ============
Weighted average number of shares used for computing
diluted earnings (losses) per share 12,412,166 15,603,904 18,542,618
============ ============ ============
The accompanying notes are an integral part of the consolidated financial
statements.
F - 5
TEFRON LTD. AND ITS SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
CUMULATIVE
ADDITIONAL DEFERRED OTHER
ORDINARY DEFERRED PAID-IN STOCK-BASED COMPREHENSIVE
SHARES SHARES CAPITAL COMPENSATION GAIN
-------- -------- -------- -------- ----------
Balance as of January 1, 2003 $ 5,575 $ 1 $ 62,810 $ - $ -
Net loss - - - - -
-------- -------- -------- -------- ----------
Balance as of December 31, 2003 5,575 1 62,810 - -
Issuance of shares (net of issuance
expenses in the amount of $ 296) 1,007 - 15,393 - -
Deferred stock-based compensation - - 1,040 (1,040) -
Amortization of deferred stock-based
compensation - - - 554 -
Net loss - - - - -
-------- -------- -------- -------- ----------
Balance as of December 31, 2004 6,582 1 79,243 (486) -
Settlement of the conditional obligation
with respect to issuance of shares 200 - 3,254 - -
Exercise of stock options 28 - 428 - -
Cancellation of deferred shares - (1) 1 - -
Deferred stock-based compensation - - 143 (143) -
Amortization of deferred stock-based
compensation - - - 431 -
Comprehensive income:
Unrealized gain on hedging derivative - - - - 307
Net income - - - - -
-------- -------- -------- -------- ----------
Total comprehensive income
Balance as of December 31, 2005 $ 6,810 $ - $ 83,069 $ (198) $ 307
======== ======== ======== ======== ==========
TOTAL
ACCUMULATED COMPREHENSIVE TREASURY
DEFICIT INCOME SHARES TOTAL
-------- ---------- -------- --------
Balance as of January 1, 2003 $(19,870) $ (7,408) $ 41,108
Net loss (4,453) - (4,453)
-------- -------- --------
Balance as of December 31, 2003 (24,323) (7,408) 36,655
Issuance of shares (net of issuance
expenses in the amount of $ 296) - - 16,400
Deferred stock-based compensation - - -
Amortization of deferred stock-based
compensation - - 554
Net loss (6,865) - (6,865)
-------- -------- --------
Balance as of December 31, 2004 (31,188) (7,408) 46,744
Settlement of the conditional obligation
with respect to issuance of shares - - 3,454
Exercise of stock options - - 456
Cancellation of deferred shares - - -
Deferred stock-based compensation - - -
Amortization of deferred stock-based
compensation - - 431
Comprehensive income:
Unrealized gain on hedging derivative - $ 307 - 307
Net income 3,293 3,293 - 3,293
-------- ---------- -------- --------
Total comprehensive income $ 3,600
==========
Balance as of December 31, 2005 $(27,895) $ (7,408) $ 54,685
======== ======== ========
The accompanying notes are an integral part of the consolidated financial
statements.
F - 6
TEFRON LTD. AND ITS SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
YEAR ENDED DECEMBER 31,
------------------------------------------
2003 2004 2005
-------- -------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ (4,453) $ (6,865) $ 3,293
Adjustments to reconcile net income (loss) to net cash provided by
operating activities:
Depreciation, amortization and impairment of property, plant and
equipment 9,005 10,760 10,348
Impairment of goodwill related to the put option exercise - - 5,683
Amortization of deferred stock compensation - 554 431
Loss related to conditional obligation - 150 -
Accrued severance pay, net (692) 380 (588)
Deferred income taxes, net (621) (853) 7,126
Realization of pre-acquisition acquired operating losses - 489 -
Equity in losses of affiliated companies 183 - -
Loss (gain) on disposal of property, plant and equipment, net (199) 28 (409)
Minority interest in earnings (losses) of a subsidiary 2,550 1,945 (1,615)
Pre-acquisition earnings of a subsidiary 85 - -
Decrease (increase) in trade receivables, net (3,006) 3,515 (9,099)
Decrease (increase) in other accounts receivable and prepaid
expenses (469) 65 682
Decrease (increase) in inventories (4,482) (1,461) 3,218
Increase (decrease) in trade payables 3,911 (567) 1,394
Increase (decrease) in other accounts payable and accrued
expenses 1,064 (1,231) 347
-------- -------- --------
Net cash provided by operating activities 2,876 6,909 20,811
-------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property, plant and equipment (3,948) (8,950) (5,255)
Investment grants received 1,868 1,156 452
Investment in affiliated companies (125) - -
Proceeds from sale of property, plant and equipment 499 422 475
Proceeds from the Company's insurance policy for plant and
machinery damage - - 619
Acquisition of Macro Clothing (b) 300 (106) (261)
-------- -------- --------
Net cash used in investing activities (1,406) (7,478) (3,970)
-------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Receipt of long-term bank loans 8,500 - -
Repayment of long-term bank loans and other loans (22,614) (9,854) (8,289)
Payments under capital lease (1,691) (1,488) (206)
Short-term bank credit, net 14,506 (9,276) (3,642)
Dividend paid to minority interest in subsidiary (1,166) (706) (517)
Proceeds from issuance of shares and conditional obligation, net - 19,704 -
Proceeds from exercise of stock options - - 456
-------- -------- --------
Net cash used in financing activities (2,465) (1,620) (12,198)
-------- -------- --------
Increase (decrease) in cash and cash equivalents (995) (2,189) 4,643
Cash and cash equivalents at the beginning of the year 6,742 5,747 3,558
-------- -------- --------
Cash and cash equivalents at the end of the year $ 5,747 $ 3,558 $ 8,201
======== ======== ========
The accompanying notes are an integral part of the consolidated financial
statements.
F - 7
TEFRON LTD. AND ITS SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
YEAR ENDED DECEMBER 31,
---------------------------------------
2003 2004 2005
------- ------- -------
(a) CASH PAID DURING THE YEAR FOR:
Interest $ 3,538 $ 2,809 $ 4,321
======= ======= =======
Income taxes, net of refunds received $ 60 $ 272 $ 204
======= ======= =======
(b) ACQUISITION OF MACRO CLOTHING:
Working capital deficiency, net $ 692 $ - $ -
Property and equipment, net (369) - -
Goodwill (122) (367) -
Accrued severance pay, net 99 - -
------- ------- -------
300 (367) -
------- ------- -------
Accrued payments - 261 (261)
------- ------- -------
$ 300 $ (106) $ (261)
======= ======= =======
(c) SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING
ACTIVITY:
Purchase of property, plant and equipment by credit, net
of investment grants receivable $(2,346) $ (490) $ 1,418
======= ======= =======
The accompanying notes are an integral part of the consolidated financial
statements.
F - 8
TEFRON LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE AND PER SHARE DATA)
NOTE 1:- GENERAL
a. Tefron Ltd, a company organized under the laws of the State of Israel
("the Company") and its subsidiaries are engaged in the design,
manufacture and sale of knitted intimate apparel, swimwear and active
wear, which are manufactured using two different techniques (seamless
and cut and sew) and products for the health care industry (see also
Note 15). The Company's principal market is the United States.
The Company's significant subsidiaries are Hi-Tex, founded by the
Company ("Hi-Tex"), which commenced operations in 1997,
Alba-Waldensian, Inc. ("Alba"), which was purchased in December 1999,
and Macro Clothing Ltd. ("Macro") which was purchased in April 2003.
b. During 2003, 2004 and 2005, 61.4%, 67.9% and 72.7%, respectively, were
derived from the three largest customers all located in the United
States. The Company's arrangements with its customers do not contain
minimum purchase requirements and there can be no assurance that the
principal customers will continue to purchase the Company's products
in the same volumes or on the same terms as they have done in the
past. A material decrease of purchases made by the major customers or
a material adverse change in the terms of such purchases could have a
material adverse effect on the Company's results of operations.
c. In February 2005, a fire damaged the Company's sewing plant in Jordan.
The fire resulted in loss of inventories and raw materials of $ 571,
damages to plant and machinery at cost in the amount of $ 2,558 and
additional costs due to business interruption of $ 591. On September
12, 2005, the Company reached a settlement with the insurance company,
which covered substantially all the losses resulting from the fire,
amounting to $ 3,720, less a $ 250 deductible. Following the
settlement, the Company recorded during the year ended December 31,
2005, a capital gain of $ 378 with respect to the damaged machinery
which was presented as other income and reimbursement for the loss of
inventories and costs due to the business interruption, in the amount
of $ 1,082, which was offset from the cost of sales.
d. Alba Health put option:
The Company has a put option to sell its 48.35% ownership interest in
Alba Health, one of its subsidiaries, to Alba Health. The Company may
exercise this option until September 2007, and the price that would be
paid to the Company will be calculated according to a formula which
determines Alba Health's value based on Alba Health's actual EBITDA,
cash and cash equivalents and total debt. During the period from July
1, 2005 to December 31, 2005, the Company was entitled to use in the
formula a guaranteed EBITDA which is higher than Alba Health's actual
EBITDA. Pursuant to an agreement with one of Alba Health's interest
holders, the Company agreed to pay the holder an amount of $ 390 in
order that it would also benefit from this guaranteed EBITDA.
F - 9
TEFRON LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE AND PER SHARE DATA)
NOTE 1:- GENERAL (CONT.)
On December 22, 2005, the Company delivered a notice of exercise to
AlbaHealth and the other parties to the put option agreement. Based on
recent negotiations with the other parties, the net proceeds payable
to the Company from the sale of the interest are expected to be
approximately $ 11,900 in cash (net of taxes and payment of the $ 390
to one of Alba Health interest holders). As a result of the expected
exercise of the put option and the annual impairment test of the
goodwill related to Alba Health, the Company recorded an operating
loss in the amount of $ 6,073 and additional taxes on income of $
3,456 (including realization of deferred taxes in the amount of $
2,456). This loss was offset by the minority interest in the
impairment loss amounting to $ 2,937.
e. Acquisition of Macro Clothing Ltd. ("Macro"):
In April 2003, the Company agreed to acquire 100% of the outstanding
Ordinary shares of Macro from Macpell Industries Ltd. ("Macpell"). The
closing date of the agreement was May 5, 2003. Macro manufactures,
markets and sells swimsuits and beachwear. The purchase has
diversified the Company's line of products. Pursuant to the terms of
the agreement, the Company assumed certain guarantees to the bank
granted by Macpell in favor of Macro in the aggregate amount of
approximately $ 530 and Macpell paid the Company $ 300 to assume the
aforementioned guarantees. As a result, the Company recorded goodwill
in the amount of $ 122. In addition, Macpell assigned to the Company
its rights to a loan granted to Macro in the amount of approximately $
522. Under the terms of the acquisition agreement, contingent payments
based on certain financial performance criteria amounting to $ 367
were recorded in 2004 out of which $ 106 were paid in 2004 and $ 261
in 2005. As a result, the Company recorded an additional consideration
which increased the purchase price and was allocated to the goodwill.
Since the realization of tax losses derived from pre-acquisition
exceeded the total purchase price, including the total contingent
consideration, the additional consideration and the initial goodwill
allocated in 2003 were recorded as income tax expenses.
The acquisition has been treated using the purchase method of
accounting in accordance with SFAS No. 141, "Business Combination".
The purchase price has been allocated to the assets acquired and to
the assumed liabilities based on their estimated fair value at the
date of acquisition. The excess of the purchase price over the
estimated fair value of the net assets acquired has been recorded as
goodwill.
The operating results of Macro were consolidated for reasons of
convenience effective April 1, 2003. The operating results for the
period prior to the acquisition (from April 1, 2003 through May 5,
2003), amounting to an income of $ 85, were deducted from the
Company's consolidated results of operations. Pro forma information
was not provided due to immateriality.
F - 10
TEFRON LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE AND PER SHARE DATA)
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES
The consolidated financial statements have been prepared in conformity with
accounting principles generally accepted in the United States of America
("U.S. GAAP"). The significant accounting policies followed in the
preparation of the financial statements, applied on a consistent basis,
are:
a. Use of estimates:
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the amounts
reported in the financial statements and accompanying notes. Actual
results could differ from those estimates.
b. Financial statements in U.S. dollars:
The accompanying consolidated financial statements have been prepared
in U.S. dollars, as the currency of the primary economic environment
in which the operations of the Company and its subsidiaries are
conducted is the U.S. dollar. The majority of sales is made in U.S.
dollars, and a significant portion of purchases of materials and
property, plant and equipment is in denominated U.S. dollars. Thus,
the functional and the reporting currency of the Company is the U.S.
dollar.
Accordingly, monetary accounts maintained in currencies other than the
dollar are remeasured into U.S. dollars in accordance with Statement
No. 52 of the Financial Accounting Standards Board ("FASB"), "Foreign
Currency Translation". All transactions gains and losses from the
remeasurement of monetary balance sheet items are reflected in the
statements of operations as financial income or expenses as
appropriate.
c. Principles of consolidation:
The consolidated financial statements include the accounts of the
Company and its subsidiaries. Intercompany balances and transactions
have been eliminated in consolidation.
d. Cash equivalents:
Cash equivalents are short-term highly liquid investments that are
readily convertible to cash with maturities of three months or less
from the date acquired.
e. Inventories:
Inventories are stated at the lower of cost or market value. Inventory
write-offs are provided to cover risks arising from slow-moving items,
discontinued products, and items with a market price that is lower
than cost. Cost is determined as follows:
Raw materials, accessories and packaging materials - using the "moving
average cost" method.
F - 11
TEFRON LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE AND PER SHARE DATA)
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)
Work-in-progress and finished products - using the "moving average
cost" method, based on standard costs which are adjusted to actual
costs.
f. Property, plant and equipment, net:
Property, plant and equipment are stated at cost, net of accumulated
depreciation and investment grants. Investment grants are recorded at
the time the Company is entitled to such grants. Depreciation is
calculated by the straight-line method over the estimated useful lives
of the assets at the following annual rates:
%
------------------
Buildings 2.5
Machinery and equipment 7
Installations and leasehold improvements 5 - 10
Motor vehicles 15
Furniture and office equipment 6 - 25
Leasehold improvements are amortized over the term of the lease,
including reasonably assured renewal options, or the useful lives of
the assets, whichever is shorter. The Company's long-lived assets and
certain identifiable intangibles are reviewed for impairment in
accordance with SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets" whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. Recoverability of assets to be held and used is measured
by a comparison of the carrying amount of an asset to the future
undiscounted cash flows expected to be generated by the assets. If
such assets are considered to be impaired, the impairment to be
recognized is measured by the amount by which the carrying amount of
the assets exceeds the fair value of the assets. Assets to be disposed
of are reported at the lower of the carrying amount or fair value less
costs to sell. The Company recorded impairment losses of $ 771 and $ 0
for the years ended December 31, 2004 and 2005, respectively.
g. Goodwill:
Goodwill is measured as the excess of the cost of an acquired company
over the total of the amounts assigned to tangible and identifiable
intangible assets acquired less liabilities assumed. Goodwill is not
amortized, but rather reviewed for impairment at least annually in
accordance with the provisions of SFAS No. 142.
SFAS No.142 requires goodwill to be tested for impairment on adoption
and at least annually thereafter or between annual tests in certain
circumstances, and written down when impaired, rather than being
amortized as previous accounting standards required. Goodwill
attributable to each of the reporting units is tested for impairment
by comparing the fair value of each reporting unit with its carrying
value. The Company performed annual impairment tests during 2003 and
2004 and no impairment losses were identified. However, the annual
impairment test performed in 2005 resulted in an impairment of $ 5,683
to the goodwill related to Alba Health (see Note 1d).
F - 12
TEFRON LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE AND PER SHARE DATA)
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)
h. Severance pay:
The Company's liability for severance pay in Israel 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. The Company's
liability for all of its Israeli employees, is fully provided by
monthly deposits with insurance policies, pension and severance pay
funds and by an accrual. 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 funds.
Severance pay expenses amounted to $ 357, $ 1,035 and $ 308 for the
years ended December 31, 2003, 2004 and 2005, respectively.
i. Revenue recognition:
Revenues from sales are recognized in accordance with Staff Accounting
Bulletin No. 104, "Revenue Recognition in Financial Statements" ("SAB
No. 104"), when delivery has occurred, persuasive evidence of an
agreement exists, the vendor's fee is fixed or determinable, no
further obligation exists and collectibility is probable.
The Company's subsidiary maintains a provision for rebates, in
accordance with Statement of Financial Accounting Standard No. 48,
"Revenue Recognition When a Right of Return Exists". The provision for
rebates amounted to $ 550, $ 122 and $ 244 for the years ended
December 31, 2003, 2004 and 2005, respectively.
j. Income taxes:
The Company and its subsidiaries account for income taxes in
accordance with Statement of Financial Accounting Standards No.109,
"Accounting for Income Taxes". This Statement prescribes the use of
the liability method whereby deferred tax assets and liability account
balances are determined based on the differences between the financial
reporting and tax bases of assets and liabilities and are measured
using the enacted tax rates and laws that will be in effect when the
differences are expected to reverse. The Company and its subsidiaries
provide a valuation allowance, if necessary, to reduce deferred tax
assets to their estimated realizable value.
k. Stock-based compensation:
The Company has elected to follow Accounting Principles Board Opinion
No.25, "Accounting for Stock Issued to Employees" ("APB 25") and FASB
Interpretation No.44, "Accounting for Certain Transactions Involving
Stock Compensation" ("FIN 44") in accounting for its employee stock
option plans. Under APB 25, when the exercise price of the Company's
share options is higher than or equal to the market price of the
underlying shares on the date of grant, no compensation expense is
recognized.
F - 13
TEFRON LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE AND PER SHARE DATA)
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)
The following pro forma information presents the effect on the
consolidated stock-based employee compensation expense consolidated
net loss and loss per share as of the fair value based method provided
under SFAS No. 123 had been applied to all outstanding awards in each
reported period:
YEAR ENDED DECEMBER 31,
-------------------------------------------------
2003 2004 2005
----------- ----------- ---------
Net income (loss) as reported $ (4,453) $ (6,865) $ 3,293
Add: Stock-based compensation expense included
in the determination of net income (loss) as
reported - 554 431
Deduct: Stock-based compensation expense
determined under fair value method for all
awards (911) (1,359) (888)
----------- ----------- ---------
Pro forma net income (loss) $ (5,364) $ (7,670) $ 2,836
=========== =========== =========
Basic and diluted earnings (loss) per shares
reported:
Basic $ (0.36) $ (0.44) $ 0.19
=========== =========== =========
Diluted $ (0.36) $ (0.44) $ 0.18
=========== =========== =========
Pro forma earnings (loss) per share:
Basic $ (0.43) $ (0.49) $ 0.16
=========== =========== =========
Diluted $ (0.43) $ (0.49) $ 0.15
=========== =========== =========
The fair value for these options was estimated at the date of grant
using a Black-Scholes option-valuation model with the following
weighted-average assumptions:
2003 2004 2005
-------- ------- ---------
Risk-free interest rate 1.5% 2% 4.4%
Expected dividend yield 0% 0% 0%
Expected volatility 94.2% 36% 37%
Expected lives (years) 2 3 3.5
l. Fair value of financial instruments:
The carrying amount reported in the balance sheet for cash and cash
equivalents, trade receivables, short-term bank credit and trade
payables approximates their fair values due to the short-term
maturities of such instruments. Values of long-term loans approximate
their fair values due to the variable interest rates on these loans.
The fair values of capital lease obligations are estimated by
discounting the future cash flows using current interest rates for
leases of similar terms and maturities. The carrying amount of the
capital lease obligations approximates their fair value since such
obligations bear interest at a rate which approximates market rate.
F - 14
TEFRON LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE AND PER SHARE DATA)
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)
m. Basic and diluted earnings (loss) per share:
Basic earnings (loss) per share are computed based on the weighted
average number of Ordinary shares outstanding during the year. Diluted
earnings (loss) per share are computed based on the weighted average
number of Ordinary shares outstanding during the year, plus dilutive
potential Ordinary shares considered outstanding during the year, in
accordance with SFAS No. 128, "Earnings per Share".
n. Concentrations of credit risk:
Financial instruments that potentially subject the Company and its
subsidiaries to concentrations of credit risk consist principally of
cash and cash equivalents and trade receivables. Cash and cash
equivalents are invested mainly in U.S. dollars with major banks in
Israel. Accordingly, the Company's management believes that minimal
credit risk exists with respect to cash and cash equivalents. Trade
receivables are derived from sales to major customers located
primarily in the U.S. The allowance for doubtful accounts comprises
specific accounts the collectibility of which, based upon management's
estimate, is doubtful. The doubtful account expenses for the years
ended December 31, 2003, 2004 and 2005, were $ 27, $ 16 and $ 181,
respectively.
o. Derivatives and hedging:
The Company accounts for derivatives and hedging based on Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS No. 133"). SFAS No. 133
requires the Company to recognize all derivatives on the balance sheet
at fair value. If the derivatives meet the definition of a hedge and
is so designated, changes in the fair value of derivatives will either
be offset against the change in fair value of the hedged assets,
liabilities, or firm commitments through earnings, or recognized in
other comprehensive income until the hedged item is recognized in
earnings. The ineffective portion of a derivative's change in fair
value is recognized in earnings depending on the exposure being
hedged. During 2003, 2004 and 2005 there were no gains or losses
recognized in earnings for hedge ineffectiveness.
In 2005, the Company entered into forward transactions in order to
hedge the variability of anticipated expenses and balances denominated
in new Israeli shekels ("NIS") due to changes of the U.S. dollar
against the NIS. The net loss that resulted from these contracts and
was recognized in earnings during 2005 was $ 145, respectively.
As of December 31, 2005, unrealized gains on hedging derivative
instruments amounted to $ 307. These unrealized gains are included in
accumulated other comprehensive income.
The Company's management believes that since the abovementioned
activities were transacted with well-established institutions, the
liabilities owed to the Company will be fulfilled.
F - 15
TEFRON LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE AND PER SHARE DATA)
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)
p. Impact of recently issued accounting pronouncements:
In November 2004, the FASB issued Statement of Financial Accounting
Standard No. 151, "Inventory Costs, an Amendment of ARB No. 43,
Chapter 4" ("SFAS No. 151"). SFAS No. 151 amends Accounting Research
Bulletin ("ARB") No. 43, Chapter 4, to clarify that abnormal amounts
of idle facility expense, freight handling costs and wasted materials
(spoilage) should be recognized as current-period charges. In
addition, SFAS No.151 requires that the allocation of fixed production
overhead to the costs of conversion be based on the normal capacity of
the production facilities. SFAS No. 151 is effective for inventory
costs incurred during fiscal years beginning after September 15, 2005.
As of December 31, 2005, the Company does not expect that the adoption
of SFAS No. 151 will have a material effect on its financial position
or results of operations.
On December 16, 2004, the Financial Accounting Standards Board (FASB)
issued Statement No. 123 (revised 2004), "Share-Based Payment"
("Statement 123(R)"), which is a revision of FASB Statement No. 123,
"Accounting for Stock-Based Compensation" ("Statement 123").
Generally, the approach in Statement 123(R) is similar to the approach
described in Statement 123. However, Statement 123 permitted, but did
not require, share-based payments to employees to be recognized based
on their fair values while Statement 123(R) requires all share-based
payments to employees to be recognized based on their fair values.
Statement 123(R) also revises, clarifies and expands guidance in
several areas, including measuring fair value, classifying an award as
equity or as a liability and attributing compensation cost to
reporting periods. Statement 123(R) permits public companies to adopt
its requirements using one of two methods:
1. A "modified prospective" method in which compensation cost is
recognized beginning with the effective date (a) based on the
requirements of Statement 123(R) for all share-based payments
granted after the effective date and (b) based on the
requirements of Statement 123 for all awards granted to employees
prior to the effective date of Statement 123(R) that remain
unvested on the effective date.
2. A "modified retrospective" method which includes the requirements
of the modified prospective method described above, but also
permits entities to restate based on the amounts previously
recognized under Statement 123 for purposes of pro forma
disclosures either (a) all prior periods presented or (b) prior
interim periods of the year of adoption.
F - 16
TEFRON LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE AND PER SHARE DATA)
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)
The Company plans to adopt Statement 123(R) using the "modified
prospective" method. The new Standard will be effective for the
Company in the first fiscal year beginning after December 15, 2005. On
March 29, 2005, the SEC published Staff Accounting Bulletin ("SAB")
No. 107, which provides the staff's views on a variety of matters
relating to stock-based payments. SAB 107 requires stock-based
compensation to be classified in the same expense line items as cash
compensation. The Company will adopt Statement 123R and SAB 107 as of
the financial statements of the first quarter of 2006.
In May 2005, the FASB issued Statement of Financial Accounting
Standard No. 154 ("FAS 154"), "Accounting Changes and Error
Corrections" - a replacement of APB No. 20, "Accounting Changes" ("APB
20") and FAS No. 3, "Reporting Accounting Changes in Interim Financial
Statement". FAS 154 provides guidance on accounting for and reporting
of accounting changes and error corrections.
APB 20 previously required that most voluntary changes in accounting
principle be recognized by including in net income of the period of
the change the cumulative effect of changing to the new accounting
principle. FAS 154 requires retrospective application to prior
periods' financial statements of a voluntary change in accounting
principle unless it is impracticable. The amendments are not expected
to have a material impact on the Company's consolidated financial
statements.
q. Reclassification:
Certain prior year amounts were reclassified to conform to current
year financial statement presentation.
NOTE 3:- GOODWILL
Goodwill attributed to operating segments for the years ended December
31, 2004 and 2005 is as follows:
MACRO HEALTHCARE-
CLOTHING USA TOTAL
-------- -------- --------
Balance as of January 1, 2004 $ 122 $ 30,743 $ 30,865
Realization of pre-acquired operating loss (122) - (122)
-------- -------- --------
Balance as of December 31, 2004 - 30,743 30,743
Impairment (see Note 1d) - (5,683) (5,683)
-------- -------- --------
Balance as of December 31, 2005 $ - $ 25,060 $ 25,060
======== ======== ========
F - 17
TEFRON LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE AND PER SHARE DATA)
NOTE 4:- OTHER ACCOUNTS RECEIVABLE AND PREPAID EXPENSES
DECEMBER 31,
-----------------
2004 2005
------- -------
Government authorities:
VAT, customs and other levies recoverable $ 1,509 $ 1,508
Investment grant receivable 1,400 1,130
Income tax advances 175 224
Deferred income taxes (see Note 19) 425 390
Advances to suppliers 491 374
Prepaid expenses 738 898
Other 958 457
------- -------
$ 5,696 $ 4,981
======= =======
NOTE 5:- INVENTORIES
Raw materials, accessories and packaging materials $11,469 $10,578
Work-in progress 11,807 11,166
Finished products 9,861 8,175
------- -------
$33,137 $29,919
======= =======
In the years ended December 31, 2003, 2004 and 2005, the Company
recorded inventory write-downs in the amount of $ 582, $ 969 and $
660, respectively. These write-downs were recorded as cost of sales.
NOTE 6:- PROPERTY, PLANT AND EQUIPMENT, NET
Composition of assets grouped by major classifications, are as
follows:
DECEMBER 31,
---------------------------
2004 2005
--------- ---------
Cost:
Buildings (2) $ 6,933 $ 6,933
Machinery and equipment 178,546 180,979
Installation and leasehold improvements 5,141 5,403
Motor vehicles 611 452
Furniture and office equipment 1,723 2,030
Investment grants (32,957) (33,130)
--------- ---------
159,997 162,667
--------- ---------
Accumulated depreciation:
Buildings 767 942
Machinery and equipment 79,694 88,425
Installation and leasehold improvements 1,908 3,804
Motor vehicles 488 386
Furniture and office equipment 441 1,255
Investment grants (17,232) (19,073)
--------- ---------
66,066 75,739
--------- ---------
Depreciated cost $ 93,931 $ 86,928
========= =========
F - 18
TEFRON LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE AND PER SHARE DATA)
NOTE 6:- PROPERTY, PLANT AND EQUIPMENT, NET (CONT.)
(1) Depreciation and amortization expenses for the years ended December
31, 2003, 2004 and 2005 were $ 8,592, $ 9,348 and $ 10,155,
respectively.
(2) During 2004, the Company had decided to dispose of five idle buildings
of the seamless segment. The buildings were classified as
held-for-sale and are presented in other accounts receivables, in
accordance with Statement of Financial Accounting Standard No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets"
("SFAS No. 144"). Accordingly, these buildings were measured at the
lower of their carrying amount or fair value less costs to sell. In
respect of the above, the Company recorded a loss in the amount of $
771, resulting from the adjustment of the carrying amount of the
buildings to their fair value less costs to sell. In November 2004,
two of the buildings were sold for proceeds of $ 160.
As for liens, see Note 10.
NOTE 7:- SHORT-TERM BANK CREDIT
WEIGHTED AVERAGE
INTEREST RATE
------------------
DECEMBER 31, DECEMBER 31,
------------------ -------------------
2004 2005 2004 2005
------- ------- ------- -------
%
--------------
Loans and bank credit in NIS 6.7 6.5 $21,355 $17,713
======= =======
As for collateral - see Note 10
NOTE 8:- OTHER ACCOUNTS PAYABLE AND ACCRUED EXPENSES
Employees and payroll accruals $ 4,820 $ 3,377
Accrued expenses 2,492 4,077
Equipment suppliers 1,877 650
Short-term deferred taxes - 1,000
------- -------
$ 9,189 $ 9,104
======= =======
F - 19
TEFRON LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE AND PER SHARE DATA)
NOTE 9:- LONG-TERM LOANS
a. Composition:
WEIGHTED AVERAGE
INTEREST RATE
-----------------------
DECEMBER 31, DECEMBER 31,
----------------------- ----------------------
2004 2005 2004 2005
-------- ------- ------- -------
%
----------------------- ------- -------
Loans in U.S. dollars:
Banks (variable interest
LIBOR plus 1.5%-4.5%) 5.4-6.78 5.9-6.8 $56,830 $48,657
Capital lease obligation 7-9 - 206 -
Other 7-9 - 116 -
------- -------
57,152 48,657
------- -------
Less - current maturities:
Loans from banks and others 9,039 7,623
Capital lease obligation 206 -
------- -------
9,245 7,623
------- -------
$47,907 $41,034
======= =======
b. The loans as of December 31, 2005 mature as follows:
DECEMBER 31,
------------------------
2006 (current maturities) $ 7,623
2007 11,422
2008 5,922
2009 and thereafter 23,690
-------
$48,657
=======
c. Upon the closing of the Share Purchase Agreement with the
investor controlled by FIMI (see Note 11), the Company entered
into new financing arrangements with its bank creditors. The new
financing arrangements contain different financial covenants and
ratios from those in the Company's previous bank loan agreements.
As of December 31, 2005, the Company met those covenant criteria.
During 2004, AlbaHealth failed to comply with certain financial
covenants contained in its credit facility with the bank.
However, the bank agreed to waive the covenant defaults that
occurred during 2004 and to amend certain of the financial
covenant provisions of the credit facility. During the second
quarter of 2005, the subsidiary again failed to comply with a
certain financial covenant in the credit facility. On October 1,
2005, the Company signed an amendment to the credit agreement
under which the bank agreed again to waive the covenants defaults
and provide the Company with more favorable credit facility
terms.
d. As for collateral, see Note 10.
F - 20
TEFRON LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE AND PER SHARE DATA)
NOTE 10:- LIENS, CONTINGENCIES AND COMMITMENTS
a. All bank debt is collateralized by a floating charge (a continuing
charge on the Company's present and future assets but permitting the
Company to dispose of such assets in the ordinary course of business)
on all of the assets of the Company and its subsidiaries.
b. In accordance with the provisions of the Law for the Encouragement of
Capital Investments, 1959, the Company and its subsidiaries in Israel
received grants from the State of Israel in respect of investments in
their plants (see Note 13). The conditions in the letters of approval
extending the grants from the State of Israel primarily include the
requirements that the investments be made according to the approved
plan and that at least 30% of the investments be financed by
outstanding share capital. Non-fulfillment of these conditions would
require the refund of the grants linked to the Consumer Price Index in
Israel from the date of receipt plus interest. To guarantee
fulfillment of the conditions for receipt of the grants, the Company
and its subsidiaries have recorded floating charges on all of their
assets in favor of the State of Israel.
c. The facilities of the Company and most of its Israeli subsidiaries are
located in buildings leased for various periods ending between 2006
and 2012. The Company has renewal options for additional periods.
The significant leases are with a related party, a company controlled
by the principal shareholders, ending between 2008 and 2024 (including
renewal options) at an annual rental of $ 2,855. 50% of the basic
rental payments is linked to Israel's CPI and 50% is linked to the
U.S. cost of living index. The remaining lease payments are in, or
linked to, the U.S. dollar.
The aggregate minimum rental, commitments under non-cancelable leases,
based on the above agreements as of December 31, 2005, is as follows:
2006 $ 2,988
2007 2,666
2008 2,383
2009 2,351
2010 and thereafter 5,094
--------
$ 15,482
========
Rental expenses for 2003, 2004 and 2005, amounted to $ 3,121, $ 3,163
and $ 3,345, respectively.
d. Legal proceedings:
There are no material pending legal proceedings.
F - 21
TEFRON LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE AND PER SHARE DATA)
NOTE 11:- SHAREHOLDERS' EQUITY
a. On September 28, 2005, the Company's shares were also listed for trade
on the Tel-Aviv Stock Exchange ("TASE").
b. On April 22, 2004, the transactions pursuant to the Share Purchase
Agreement with a partnership controlled by FIMI Opportunity Fund
("Fimi") and pursuant to the Share Purchase Agreement with Leber
Partners, L.P., a limited partnership ("the Investor") were closed.
Under the agreements, the Company issued 3.53 million and 1.07 million
Ordinary shares of the Company to Fimi and the Investor, respectively,
at a price per share of $ 4.25 and $ 4.65 ("the PPS"), respectively,
for a total cash consideration of $ 15,000 and $ 5,000, respectively.
The number of shares received may be adjusted, based on a certain
formula set forth in the agreement which determines the adjusted price
per share ("adjusted PPS").
In the event that the adjusted PPS is not equal to the PPS, the
Company, at its sole discretion, shall either (i) deliver Fimi and the
Investor, a number of additional Ordinary shares that is equal to the
difference between the number of purchased shares issued and the
number of Ordinary shares that would have been issued to Fimi and the
Investor at the closing date had the original PPS been equal to the
adjusted PPS, or (ii) pay Fimi and the Investor, a cash amount equal
to the difference between the price per share and the adjusted PPS per
each share purchased.
The agreements include two instruments: shares and a conditional
obligation that is freestanding of the shares and can be settled in
shares at the Company's discretion. Therefore the conditional
obligation is a liability and not equity since the value of the payout
is based on the performance condition and not based on the shares. As
a result, the conditional obligation was measured at fair value on
transaction date and on each balance sheet date. The difference
between the initial values assigned to the liability component and the
final payout was charged to the statement of operations.
On March 31, 2005, the Company signed an amendment to the Share
Purchase Agreement with its investors approved by the Company's Board
of Director's on that date. Accordingly, on April 7, 2005, the Company
issued 863,378 Ordinary shares with respect to the conditional
obligation in the amount of $ 3,454 pursuant to a purchase price
adjustment mechanism based on the Company's 2004 EBITDA.
c. Equity credit line:
On March 9, 2004, the Company entered into a Private Equity Credit
Agreement with funds advised by Southridge Capital Management LLC
("Southridge"). Under the agreement, the Company has an option to call
funds from an equity credit line facility provided by Southridge of up
to the lower of $ 15,000 or 19.9% of the Company's outstanding share
capital over the next three years.
F - 22
TEFRON LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE AND PER SHARE DATA)
NOTE 11:- SHAREHOLDERS' EQUITY (CONT.)
Under the financing facility, the Company will be entitled to issue
shares to Southridge from time to time, at its own election, subject
to certain minimum and maximum limitations, but in no event will
Southridge be obligated to own more than 4.99% of the Company's
Ordinary shares at any time. The price to be paid by Southridge will
be at a discount of 6% on the market price of the Company's Ordinary
shares (as calculated under the agreement) during a period prior to
the issuance of the shares. Before drawing on the equity line, the
Company must satisfy certain closing conditions, including the
effectiveness of a registration statement to be filed by the Company,
relating to the shares to be issued to Southridge. As of December 31,
2005, no funds were called.
d. Stock options:
In September 1997, the Company's Board of Directors adopted a Share
Option Plan in which 1,166,049 Ordinary shares were reserved for
issuance to directors, officers and employees of the Company. At
general meetings of shareholders in August 1999, July 2001 and March
2004, it was resolved to increase the number of shares reserved for
issuance under the Share Option Plan by 600,000, 500,000 and 446,274
Ordinary shares, respectively. The options vest over a period of three
to four years and expire after 10 years from the grant date or upon
termination of employment.
On April 22, 2004, upon the completion of the Purchase Agreement
described in a. above, the Company granted the Company's CEO 650,000
options ("the Options"), which may be exercised to purchase up to
650,000 Ordinary shares of the Company, at an exercise price of $ 4.25
per share. The Options vest over four years commencing January 1, 2004
and expire 10 years from the date of the grant. The market price of
the Company's shares on the date of grant was $ 5.85. Accordingly, the
Company recorded compensation expenses of $ 554 and $ 303 in 2004 and
2005, respectively, using the acceleration method according to FIN 28,
"Accounting for Stock Appreciation Rights and Other Variable Stock
Option or Award Plans an interpretation of APB Opinions No. 15 and 25"
("FIN 28"). This expense was presented under general and
administrative expenses.
On August 9, 2005 the Company granted to one of its officers 40,000
options, at an exercise price of $ 5.8 per share, to be vested over
four years. The market price of the Company's shares on the date of
grant was $ 6.23.
Except for these options, all other options are granted with an
exercise price equal to the market value at the date of grant. The
weighted average fair values of the options granted during 2003, 2004
and 2005 were $ 1.67, $ 2 and $ 2.2, respectively.
As of December 31, 2005, 102,518 options were available for future
grants under the aforementioned plan.
F - 23
TEFRON LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE AND PER SHARE DATA)
NOTE 11:- SHAREHOLDERS' EQUITY (CONT.)
A summary of the Company's share option activity under the plan is as
follows:
YEAR ENDED DECEMBER 31,
-----------------------------------------------------------------------------------------
2003 2004 2005
------------------------- ------------------------ ------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
NUMBER EXERCISE NUMBER EXERCISE NUMBER EXERCISE
OF OPTIONS PRICE OF OPTIONS PRICE OF OPTIONS PRICE
---------- ------ ---------- ----- ---------- -----
Options outstanding
at beginning of
year 1,755,874 $ 3.14 1,817,323 $4.54 2,422,805 $4.48
Changes during the
year:
Granted 160,284 $ 3.5 730,000 $4.26 210,000 $6.34
Forfeited or
canceled (98,835) $10.11 (124,518) $4.23 (23,000) $4.16
Exercised - $ - - $ - (132,751) $3.72
---------- ---------- ----------
Options outstanding
at end of year 1,817,323 $ 4.54 2,422,805 $4.48 2,477,054 $4.70
========== ====== ========== ===== ========== =====
Options exercisable
at the end of the
year 1,031,679 $ 5.53 1,422,551 $4.83 1,911,388 $4.70
========== ====== ========== ===== ========== =====
The following table summarizes information about options outstanding
and exercisable at December 31, 2005:
OPTIONS WEIGHTED OPTIONS WEIGHTED AVERAGE
OUTSTANDING WEIGHTED AVERAGE EXERCISABLE EXERCISE
RANGE OF AS OF AVERAGE REMAINING AS OF PRICE OF
EXERCISE DECEMBER 31, EXERCISE CONTRACTUAL DECEMBER 31, OPTIONS
PRICE 2005 PRICE LIFE (YEARS) 2005 EXERCISABLE
- -------------- --------- ------ ---- --------- ------
3.50-4.31 1,984,554 $ 3.76 6.85 1,628,888 $ 3.62
5.82-5.85 150,000 $ 5.83 9.56 - $ 5.83
7.60 60,000 $ 7.63 9.83 - $ 7.63
8.13-9.50 223,500 $ 8.74 3.34 223,500 $ 8.74
15.00 59,000 $15.00 4.46 59,000 $15.00
--------- ---------
2,477,054 1,911,388
========= =========
F - 24
TEFRON LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE AND PER SHARE DATA)
NOTE 12:- SUPPLEMENTARY INFORMATION TO STATEMENTS OF OPERATIONS
YEAR ENDED DECEMBER 31,
---------------------------------------------
2003 2004 2005
--------- --------- ---------
a. Cost of sales:
Materials $ 64,322 $ 80,650 $ 86,138
Salaries and related expenses 39,878 39,536 32,317
Subcontracting 10,673 12,027 15,178
Other production costs 19,141 20,140 21,074
Depreciation 8,048 8,704 9,183
Decrease (increase) in work-in progress and
finished products (2,640) (1,120) 2,327
--------- --------- ---------
$ 139,422 $ 159,937 $ 166,217
========= ========= =========
b. Financial expenses:
Interest on long-term loans $ 3,319 $ 2,657 $ 3,265
Interest on short-term loans 1,042 977 1,202
Interest on tax assessment - - 300
Exchange rate differences, net 682 450 (1,057)
Bank expenses and other, net 585 978 516
Loss from forward exchange transactions - - 145
Loss related to conditional obligation - 150 -
--------- --------- ---------
$ 5,628 $ 5,212 $ 4,371
========= ========= =========
c. Other income:
Capital gain derived from recovery of loss from
insurance company $ - $ - $ 378
Other capital gains 228 - 31
--------- --------- ---------
$ 228 $ - $ 409
========= ========= =========
NOTE 13:- TAXES ON INCOME
a. Reduction in corporate tax rate:
On July 25, 2005, the Knesset (Israeli Parliament) passed the Law for
the Amendment of the Income Tax Ordinance (No. 147), 2005, which
prescribes, among others, a gradual decrease in the corporate tax rate
in Israel to the following tax rates: in 2006 - 31%, in 2007 - 29%, in
2008 - 27%, in 2009 - 26% and in 2010 and thereafter - 25%.
b. Applicable tax laws:
The Company and its subsidiaries in Israel are "industrial companies"
in conformity with the Law for the Encouragement of Industry (Taxes)
1969. The principal benefits to which the companies are entitled under
this Law are accelerated rates of depreciation, consolidated tax
returns and a deduction for tax purposes, over a three year period, of
costs incurred in issuance of shares.
F - 25
TEFRON LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE AND PER SHARE DATA)
NOTE 13:- TAXES ON INCOME
c. Tax benefits under the Law for the Encouragement of Capital
Investments, 1959 ("the Law"):
Certain production facilities in Israel have been granted the status
of "Approved Enterprise" under the Law, for several investment
programs ("the Programs").
In accordance with the Law, the Company and certain subsidiaries in
Israel received grants from the State of Israel in respect of
investments in their plants. The conditions in the letters of approval
extending the grants from the State of Israel primarily include the
requirements that the investments be made according to the approved
plan and that at least 30% of the investments be financed by
outstanding share capital. In addition, income attributed to certain
Programs is tax exempt for a period of two years and is subject to a
reduced corporate tax rate of 10% - 25% for an additional period of
five to eight years, based on the percentage of foreign investment in
the Company.
The duration of tax benefits for each of the Programs is subject to
limitations of the earlier of 12 years from commencement of
investment, or 14 years from receipt of approval, as an "Approved
Enterprise" under the Law.
Tax-exempt income attributable to the "Approved Enterprise" cannot be
distributed to shareholders without subjecting the Company to taxes
except upon complete liquidation of the Company. If such retained
tax-exempt income is distributed in a manner other than upon the
complete liquidation of the Company, it would be taxed at the reduced
corporate tax rate applicable to such profits (between 10%-25%). The
Company currently does not have profit that can be distributed as
dividend under the Israeli Law.
The entitlement to the above benefits is conditional upon the
Company's fulfilling the conditions stipulated by the Law, regulations
published there under and the certificates of approval for the
specific investments in approved enterprises.
Should the Company and its subsidiaries in Israel fail to meet such
requirements in the future, income attributable to its "Approved
Enterprise" programs could be subject to the statutory Israeli regular
corporate tax rate and the Company could be required to refund a
portion of the tax benefits already received, with respect to such
programs. Income from sources other than the "Approved Enterprise" is
subject to tax at regular Israeli corporate tax rate.
On April 1, 2005, an amendment to the Investment Law came into effect
("the Amendment") and has significantly changed the provisions of the
Investment Law. The Amendment limits the scope of enterprises which
may be approved by the Investment Center by setting criteria for the
approval of a facility as a Privileged Enterprise, such as provisions
generally requiring that at least 25% of the Privileged Enterprise's
income will be derived from export. Additionally, the Amendment
enacted major changes in the manner in which tax benefits are awarded
under the Investment Law so that companies no longer require
Investment Center approval in order to qualify for tax benefits.
F - 26
TEFRON LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE AND PER SHARE DATA)
NOTE 13:- TAXES ON INCOME (CONT.)
However, the Investment Law provides that terms and benefits included
in any certificate of approval already granted will remain subject to
the provisions of the law as they were on the date of such approval.
Therefore, the Israeli companies with Approved Enterprise status will
generally not be subject to the provisions of the Amendment. As a
result of the amendment, tax-exempt income generated under the
provisions of the new law, will subject the Company to taxes upon
distribution or liquidation and the Company may be required to record
deferred tax liability with respect to such tax-exempt income. As of
December 31, 2005, the Company did not generate income subject to the
provision of the new law.
d. Taxes on income included in the statements of operations:
YEAR ENDED DECEMBER 31,
---------------------------------------
2003 2004 2005
------- ------- -------
Current taxes $ 197 $ 692 $ 457
Deferred taxes (1) (621) (853) 7,152
Taxes in respect of prior years - 364 209
------- ------- -------
$ (424) $ 203 $ 7,818
======= ======= =======
Domestic $(1,582) $ (476) $ 4,190
Foreign 1,158 679 3,628
------- ------- -------
$ (424) $ 203 $ 7,818
======= ======= =======
(1) Including a deferred tax liability and realization of deferred
tax asset recorded in 2005, in the amount of $ 3,456 as a result
of the expected exercise of the Company's put option in
AlbaHealth (see Note 1d).
F - 27
TEFRON LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE AND PER SHARE DATA)
NOTE 13:- TAXES ON INCOME (CONT.)
e. Effective tax:
Reconciliation between the theoretical tax expense, assuming all
income is taxed at the statutory tax rate applicable to income of the
Company and the actual tax expense as reported in the statement of
operations is as follows:
YEAR ENDED DECEMBER 31,
--------------------------------------------
2003 2004 2005
-------- -------- --------
Income (loss) before taxes, as reported in the
consolidated statements of operations $ (2,059) $ (4,717) $ 9,496
======== ======== ========
Statutory tax rate 36% 35% 34%
======== ======== ========
Provision at the Israeli statutory tax rate $ (741) $ (1,651) $ 3,229
Increase (decrease) in taxes resulting from
"Approved Enterprise" benefits 198 676 (1,297)
Deferred taxes on losses and temporary
differences for which valuation allowance was
provided 533 742 -
Expected realization of foreign subsidiary
for which deferred taxes were not created - - 5,430
Nondeductible expenses 40 88 181
Change in tax rate used for computation of
deferred taxes (469) (83) -
Taxes in respect of prior years - 366 209
Other 15 65 66
-------- -------- --------
Actual tax expenses (benefit) $ (424) $ 203 $ 7,818
======== ======== ========
f. Income (loss) before taxes on income is comprised
as follows:
Israel $ (2,049) $ (5,681) $ 14,410
Foreign (10) 964 (4,914)
-------- -------- --------
Total $ (2,059) $ (4,717) $ 9,496
======== ======== ========
F - 28
TEFRON LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE AND PER SHARE DATA)
NOTE 13:- TAXES ON INCOME (CONT.)
g. Deferred taxes:
Deferred income taxes reflect the net tax effect of temporary
differences between the carrying amounts of assets and liabilities for
financial reporting purposes and the amounts used for income tax
purposes. Significant components of the Company's deferred tax
liabilities and assets are as follows:
DECEMBER 31,
-------------------------
2004 2005
-------- --------
Asset (liability) in respect of:
Property, plant and equipment $(12,982) $(12,898)
Allowances and provisions 1,046 820
Expected realization of foreign subsidiary - (1,000)
Net operating loss carryforward 14,787 3,352
-------- --------
Net deferred tax assets before valuation allowance 2,851 (9,726)
Valuation allowance (1) (5,551) -
-------- --------
Net deferred tax liability $ (2,700) $ (9,726)
======== ========
Presented in balance sheet:
Long-term liability $ (5,611) $ (9,116)
Other liabilities - (1,000)
Long-term assets 2,486 -
Other receivables 425 390
-------- --------
Net deferred tax liability $ (2,700) $ (9,726)
======== ========
Domestic $ (5,141) $ (8,726)
Foreign 2,441 (1,000)
-------- --------
Net deferred tax $ (2,700) $ (9,726)
======== ========
(1) The net change in the total valuation allowance for the years
ended December 31, 2003, 2004 and 2005 is $ 533, $ 1,949 and $
5,551, respectively.
(2) The deferred taxes are computed based on enacted tax rates
expected to apply at the time of reversal (average rate of 22%).
h. As of December 31, 2005 the Company and its Israeli subsidiaries had
an aggregate tax loss carryforward of approximately $ 13,302.
Carryforward tax losses in Israel may be carryforward indefinitely and
may be offset against future taxable income.
As of December 31, 2005, the Company's subsidiary in the U.S. had
estimated aggregate available carryforward tax losses of approximately
$ 22,200, to be offset against future taxable profits, which expire
between 2020 and 2023, and which is expected to be offset against the
gain for tax purposes from the expected exercise of the put option in
AlbaHealth.
F - 29
TEFRON LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE AND PER SHARE DATA)
NOTE 13:- TAXES ON INCOME (CONT.)
i. Final tax assessments:
The Company is currently in the process of tax assessment with
Israel's Tax Authorities for the tax years 1997 to 2000.
NOTE 14:- ACCUMULATED OTHER COMPREHENSIVE INCOME
DECEMBER 31,
------------------------------
2005 2004
-------------- --------------
Unrealized gain from hedging instruments $307 $ -
==== =====
NOTE 15:- EARNINGS (LOSS) PER SHARE
The following table sets forth the computation of basic and diluted
net earnings (loss) per share ("EPS"):
YEAR ENDED DECEMBER 31,
-------------------------------------------------------
2003 2004 2005
------------- ------------- -----------
Net income (loss) $ (4,453) $ (6,865) $ 3,293
============= ============= ===========
Weighted average Ordinary shares outstanding -
Basic EPS 12,412,166 15,603,904 17,719,275
Dilutive effect:
Employee stock options and restricted shares - - 823,343
------------- ------------- -----------
Weighted average Ordinary shares outstanding
Diluted EPS 12,412,166 15,603,904 18,542,618
============= ============= ===========
Basic net earnings (loss) per share $ (0.36) $ (0.44) $ 0.19
============= ============= ===========
Diluted net earnings (loss) per share $ (0.36) $ (0.44) $ 0.18
============= ============= ===========
The total weighted average number of outstanding options and warrants
excluded from the calculation of diluted earnings per share, since
they would have an anti-dilutive effect, were 342,500 for the year
ended December 31, 2005.
In 2003 and 2004, all outstanding stock options were excluded from the
calculation of the diluted net loss per Ordinary share because all
such securities are anti-dilutive.
F - 30
TEFRON LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 16:- SEGMENT REPORTING
a. General information:
The Company has three production lines: Knitted apparel ("Cut and
Sew") Seamless apparel ("Seamless") and health care products. Unlike
the Cut and Sew process, the Seamless process includes the utilization
of a single machine that transforms yarn directly into a nearly
complete garment.
The Company has three reportable segments:
- Intimate apparel and active wear manufactured using the Seamless
process.
- Intimate apparel, active wear and swim wear manufactured using
the Cut and Sew Process, mainly performed in Israel and through
the purchase of finished products in China and Cambodia.
- Health production, located in the U.S. (Healthcare).
The accounting policies of the reportable segments are the same as
those described in Note 2. Selling, general and administrative
expenses are allocated according to management's assessment.
Management evaluates performance based upon operating income (loss)
before interest and income taxes.
F - 31
TEFRON LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 16:- SEGMENT REPORTING (CONT.)
b. Reportable segments:
YEAR ENDED DECEMBER 31, 2005
---------------------------------------------------------
CUT & SEW HEALTHCARE
- ISRAEL SEAMLESS USA CONSOLIDATED
-------- --------- -------- --------
Sales to unaffiliated customers $ 61,454 $ 109,882 $ 34,249 $205,585
======== ========= ======== ========
Impairment and other expenses related to
the put option exercise $ - $ - $ 6,073 $ 6,073
======== ========= ======== ========
Operating income (loss) $ 2,877 $ 12,771 $ (2,190) $ 13,458
======== ========= ========
Financial expenses, net 4,371
Other income, net 409
--------
Income before taxes on income $ 9,496
========
Depreciation and amortization $ 3,082 $ 6,600 $ 666 $ 10,348
======== ========= ======== ========
Identifiable and total assets at
December 31, 2005 $ 37,697 $ 95,552 $ 39,189 $172,438
======== ========= ========
Corporate assets 13,442
--------
Total assets $185,880
========
YEAR ENDED DECEMBER 31, 2004
-----------------------------------------------------------
CUT & SEW HEALTHCARE
- ISRAEL SEAMLESS USA CONSOLIDATED
--------- -------- --------- ---------
Sales to unaffiliated customers $ 65,272 $ 83,348 $ 34,199 $ 182,819
========= ======== ========= =========
Operating income (loss) $ 3,497 $ (8,217) $ 5,215 $ 495
========= ======== =========
Financial expenses, net 5,212
---------
Loss before taxes on income $ (4,717)
=========
Depreciation and amortization $ 2,824 $ 7,478 $ 458 $ 10,760
========= ======== ========= =========
Identifiable and total assets at
December 31, 2004 $ 36,990 $ 98,235 $ 44,243 $ 179,468
========= ======== =========
Corporate assets 12,063
---------
Total assets $ 191,531
=========
F - 32
TEFRON LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 16:- SEGMENT REPORTING (CONT.)
YEAR ENDED DECEMBER 31, 2003
----------------------------------------------------------
CUT & SEW HEALTHCARE
- ISRAEL SEAMLESS USA CONSOLIDATED
--------- -------- -------- ---------
Sales to unaffiliated customers $ 53,413 $ 71,387 $ 38,286 $ 163,086
========= ======== ======== =========
Operating income (loss) $ 704 $ (4,056) $ 6,693 $ 3,341
========= ======== ========
Financial expenses, net 5,628
Other income, net 228
---------
Loss before taxes on income $ (2,059)
=========
Depreciation and amortization $ 2,131 $ 6,452 $ 422 $ 9,005
========= ======== ======== =========
Identifiable and total assets at
December 31, 2003 $ 39,628 $101,202 $ 44,392 $ 185,222
========= ======== ========
Corporate assets 16,369
---------
Total assets $ 201,591
=========
c. The Company's sales by geographic area are as follows:
YEAR ENDED DECEMBER 31,
----------------------------------------
2003 2004 2005
-------- -------- --------
North America $154,696 $168,914 $188,233
Europe 4,350 8,044 11,074
Israel 2,782 2,892 3,865
Other 1,258 2,969 2,413
-------- -------- --------
$163,086 $182,819 $205,585
======== ======== ========
d. Sales to major customers:
YEAR ENDED DECEMBER 31,
----------------------------
2003 2004 2005
---- ---- ----
%
----------------------------
A 38.2 38.5 33.7
B 3.2 6.8 21.5
C 9.1 13.4 9.0
D 10.9 9.2 8.5
---- ---- ----
61.4 67.9 72.7
==== ==== ====
As of December 31, 2004 and 2005, major customer's balances were $
15,106 and $ 16,715, respectively.
F - 33
TEFRON LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 16:- SEGMENT REPORTING (CONT.)
e. The Company's long-lived assets by geographic area are as follows:
DECEMBER 31,
------------------------
2004 2005
-------- --------
Israel $ 79,296 $ 74,812
United States 45,378 37,176
-------- --------
$124,674 $111,988
======== ========
f. Revenues are generated by the following products:
YEAR ENDED DECEMBER 31,
----------------------------------------
2003 2004 2005
-------- -------- --------
Intimate apparel $108,998 $118,240 $101,625
Active wear 12,071 20,105 51,961
Swimwear 3,731 10,275 17,750
Healthcare products 38,286 34,199 34,249
-------- -------- --------
$163,086 $182,819 $205,585
======== ======== ========
NOTE 17:- RELATED PARTIES
Transactions with related parties (shareholders and companies controlled by
shareholders):
YEAR ENDED DECEMBER 31,
---------------------------------------
2003 2004 2005
------- ------- -------
Sales to related parties (1) $ 1,155 $ 796 $ 24
======= ======= =======
Cost of sales (2) (3) $(2,667) $(2,602) $(2,832)
======= ======= =======
Selling, general and administrative expenses (2) $ (703) $ (684) $ (387)
======= ======= =======
(1) Related parties trade receivables in 2004 and 2005 were $ 372 and $
83, respectively.
(2) Related parties trade payables in 2004 and 2005 were $ 52 and $ 174,
respectively.
(3) Including primarily rental payments to a company controlled by
shareholders.
F - 34
TEFRON LTD. AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 18:- SUBSEQUENT EVENTS (UNAUDITED)
On December 27, 2005, Tefron published a prospectus in Israel in connection
with a proposed underwritten offering to the public in Israel either of
Ordinary Shares or of a combination of Ordinary shares and options
excersiable into Ordinary shares. This follows the approval of the
publication of the prospectus by the Israeli Securities Authority and by
the Tel-Aviv Stock Exchange. The offering was made only by Tefron, and not
by any selling shareholder. As a result of the offering completed on
January 10, 2006, the Company raised a net amount of approximately $ 14,000
composed of a combination of 1,800,000 Ordinary shares and 600,000 options
to purchase the Company's Ordinary shares at an exercise price of $ 9.49.
F - 35
[McGladrey & Pullen Logo]
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors
AlbaHealth, LLC
Valdese, North Carolina
We have audited the accompanying balance sheets of AlbaHealth, LLC (the
"Company") as of December 31, 2005 and 2004, and the related statements of
operations, members' equity and cash flows for the years then ended. 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 financial statements referred to above present fairly, in
all material respects, the financial position of AlbaHealth, LLC as of December
31, 2005 and 2004, and the results of its operations and its cash flows for the
years then ended, in conformity with United States generally accepted accounting
principles.
/s/ McGladrey & Pullen, LLP
Charlotte, North Carolina
February 2, 2006
F - 36
SIGNATURES
The Company hereby certifies that it meets all of the requirements for
filing on Form 20-F and that it has duly caused and authorized the undersigned
to sign this annual report on its behalf.
TEFRON LTD.
By: /S/ Yosef Shiran
--------------------
Yosef Shiran
Chief Executive Officer
By: /S/ Asaf Alperovitz
-----------------------
Asaf Alperovitz
Chief Financial Officer
March 30, 2006
EXHIBIT INDEX
1.1. Memorandum of Association of the Company (incorporated by reference to
Exhibit 3.1 to the Company's Registration Statement on Form F-1 (No.
333-7538) filed on August 29, 1997).
1.2. Restated Articles of Association of the Company (incorporated by
reference to Exhibit 1.2 to the Company's Annual Report on Form 20-F
for the fiscal year ended December 31, 2002).
2.1. Form of Credit Agreement, dated as of December 13, 1999, among AWS
Acquisition Corp., Israel Discount Bank of New York and Bank Hapoalim
B.M., New York Branch as Administrative Agent (incorporated by
reference to Exhibit 99(b)(2) to Amendment No. 2 to Schedule 14D-1 in
respect of Alba-Waldensian, Inc. filed by the Company on December 13,
1999).
2.2 Letter, dated March 2, 2004, from Israel Discount Bank Ltd. to the
Company regarding shareholders' equity requirements under the Credit
Agreement (incorporated by reference to Exhibit 2.8 to the Company's
Annual Report on Form 20-F for the fiscal year ended December 31,
2003).
2.3 Letter, dated March 2, 2004, from Bank Hapoalim to the Company
regarding shareholders' equity requirements under the Credit Agreement
(incorporated by reference to Exhibit 2.9 to the Company's Annual
Report on Form 20-F for the fiscal year ended December 31, 2003).
2.4 Letter, dated February 16, 2004, from Israel Discount Bank to the
Company regarding revised repayment schedule and revised shareholders'
equity requirements under the Credit Agreement (incorporated by
reference to Exhibit 2.10 to the Company's Annual Report on Form 20-F
for the fiscal year ended December 31, 2003).
2.5 Letter, dated February 15, 2004, from Bank Hapoalim to the Company
regarding revised repayment schedule under the Credit Agreement
(incorporated by reference to Exhibit 2.11 to the Company's Annual
Report on Form 20-F for the fiscal year ended December 31, 2003).
2.6 Letter, dated March 31, 2004, from Bank Hapoalim to the Company
regarding revised shareholders' equity requirements under the Credit
Agreement (incorporated by reference to Exhibit 2.12 to the Company's
Annual Report on Form 20-F for the fiscal year ended December 31,
2003).
2.7 Sixth Amendment to Credit Agreement, dated December 15, 2004, among
Alba-Waldensian, Inc. and Bank Hapoalim, as Agent and Lender, together
with Term B Notes (incorporated by reference to Exhibit 2.7 to the
Company's Annual Report on Form 20-F for the fiscal year ended
December 31, 2004).
2.8 Credit Agreement, dated September 6, 2002, among AlbaHealth LLC, as
borrower, the other borrower signatory thereto, the lenders signatory,
thereto from time to time, and General Electric Capital Corporation,
as Agent and a Lender. (incorporated by reference to Exhibit 2.8 to
the Company's Annual Report form 20-F for the fiscal year ended
December 31, 2002).
2.9 First Amendment and Waiver to Credit Agreement, dated March 31, 2005,
among AlbaHealth LLC and General Electric Capital Corporation, as
Agent and Lender (incorporated by reference to Exhibit 2.9 to the
Company's Annual Report on Form 20-F for the fiscal year ended
December 31, 2004)..
2.10 Second Amendment and Waiver to Credit Agreement, dated as of October
1, 2005, among AlbaHealth LLC and General Electric Capital
Corporation, as Agent and Lender.
2.11 Security Agreement, dated as of September 6, 2002, among the Grantor
signatory thereto, from time to time, and General Electric Capital
Corporation, as Agent for the benefit of itself and the lenders from
time to time party to the Credit Agreement (referred to in Exhibit
2.14).
2.12 Borrower Stockholders Pledge Agreement, dated as of September 6, 2002,
by and among the pledgors signatory thereto, from time to time, and
General Electric Capital Corporation, as Agent for the benefit of
itself and the lenders from time to time party to the Credit Agreement
(referred to in Exhibit 2.14).
2.13 Loan Agreement, dated as of December 21, 2004, between Israel Discount
Bank and Hi-Tex Founded by Tefron Ltd (incorporated by reference to
Exhibit 2.12 to the Company's Annual Report on Form 20-F for the
fiscal year ended December 31, 2004).
2.14 Loan Agreement, dated as of December 31, 2004, between Bank Hapoalim
and Hi-Tex Founded by Tefron Ltd (incorporated by reference to Exhibit
2.13 to the Company's Annual Report on Form 20-F for the fiscal year
ended December 31, 2004).
2.15 Loan Agreement, dated as of December 25, 2004, between Israel Discount
Bank and the Company (incorporated by reference to Exhibit 2.14 to the
Company's Annual Report on Form 20-F for the fiscal year ended
December 31, 2004).
2.16 Loan Agreement, dated as of December 31, 2004, between Bank Hapoalim
and the Company (incorporated by reference to Exhibit 2.15 to the
Company's Annual Report on Form 20-F for the fiscal year ended
December 31, 2004).
2.17 The total amount of long-term debt securities of the Company
authorized under any instrument, other than as exhibited hereto, does
not exceed 10% of the total assets of the Company on a consolidated
basis. The Company hereby agrees to furnish to the SEC, upon request,
a copy of any instrument defining the rights of holders of long-term
debt of the Company or of its subsidiaries for which consolidated or
unconsolidated financial statements are required to be filed.
3.1. Shareholders Agreement, dated as of December 28, 1999, between Arwol
Holdings Ltd. and Avi Ruimi (incorporated by reference to Exhibit D to
the General Statement of Beneficial Ownership of the Company on
Schedule 13D filed by Arwol Holdings Ltd., Arie Wolfson, Sigi
Rabinowicz, Riza Holdings Ltd. and Macpell Industries Ltd. on February
17, 2000).
3.2 Agreement, dated February 17, 2004, by and among Arwol Holdings Ltd.,
Macpell Industries Ltd. and Norfet, Limited Partnership (incorporated
by reference to Exhibit 3.4 to the Company's Annual Report on Form
20-F for the fiscal year ended December 31, 2003).
4.1. Agreement and Plan of Merger, dated as of November 8, 1999, by and
among Tefron U.S. Holdings Corp., AWS Acquisition Corp. and
Alba-Waldensian, Inc. (incorporated by reference to Exhibit (c)(1) to
Schedule 14D-1 in respect of Alba-Waldensian, Inc. filed by the
Company on November 12, 1999)
4.2. Employment Agreement, dated as of August 5, 2002, between the Company
and Sigi Rabinowicz (incorporated by reference to Exhibit 4.2 to the
Company's Annual Report on Form 20-F for the fiscal year ended
December 31, 2002).
4.3. Consulting and Management Services Agreement, dated as of August 5,
2002, between the Company, New York Delights Ltd., and Arie Wolfson
(incorporated by reference to Exhibit 4.3 to the Company's Annual
Report on Form 20 F for the fiscal year ended December 31, 2002).
4.6. Management and Services Agreement, effective as of July 30, 2003,
between the Company, Yosef Shiran and Shiran & Partners - Consulting,
Entrepreneurship, and Financing (incorporated by reference to Exhibit
4.4 to the Company's Annual Report on Form 20-F for the fiscal year
ended December 31, 2003).
4.7. Lease Agreement dated as of August 12, 1997, between the Company and
New Net Assets (1994) Ltd. and an Assignment Agreement dated as of
December 25, 1998 between the Company and Hi-Tex Founded by Tefron
Ltd. The Company and/or its subsidiary, Hi-Tex Founded by Tefron Ltd.,
have entered in to similar lease agreements with New Net Assets (1994)
Ltd. (incorporated by reference to Exhibit 4.5 to the Company's Annual
Report on Form 20-F for the fiscal year ended December 31, 2001).
4.6 Contribution Agreement, dated as of September 6, 2002, between
AlbaHealth, LLC, Alba-Waldensian, Inc., Encompass Group, L.L.C. and
General Electric Capital Corporation (incorporated by reference to
Exhibit 4.6 to the Company's Annual Report on Form 20-F for the fiscal
year ended December 31, 2002).
4.7 The Limited Liability Company Agreement of AlbaHealth LLC, dated as of
September 6, 2002, by and among AlbaHealth, LLC, Alba-Waldensian,
Inc., Encompass Group, L.L.C. and General Electric Capital Corporation
(incorporated by reference to Exhibit - to the Company's Annual Report
on Form 20-F for the fiscal year ended December 31, 2002).
4.8 Put Option Agreement, dated as of September 6, 2002, as amended as of
December 13, 2004, by and among AlbaHealth, LLC, Alba-Waldensian,
Inc., Encompass Group, L.L.C. and General Electric Capital Corporation
(incorporated by reference to Exhibit 4.8 to the Company's Annual
Report on Form 20-F for the fiscal year ended December 31, 2002).
4.9 Amendment No. 1 to Put Option Agreement, dated as of December 13,
2004, by and among AlbaHealth, LLC, Alba-Waldensian, Inc., Encompass
Group, L.L.C. and General Electric Capital Corporation (incorporated
by reference to Exhibit 4.9 to the Company's Annual Report on Form
20-F for the fiscal year ended December 31, 2004).
4.10 Notice of Exercise under Put Option Agreement, dated December 22, 2005
4.11 Share Purchase Agreement dated February 17, 2004, by and between the
Company and Norfet Limited Partnership, including related Registration
Rights Agreement attached as a schedule (incorporated by reference to
Exhibit 4.9 to the Company's Annual Report on Form 20-F for the fiscal
year ended December 31, 2003).
4.12 Amendment to Purchase Agreement, dated March 31, 2005, by and between
the Company and Norfet Limited Partnership (incorporated by reference
to Exhibit 4.11 to the Company's Annual Report on Form 20-F for the
fiscal year ended December 31, 2004).
4.13 Share Purchase Agreement, made as of March 3, 2004, by and between
Tefron and Leber Partners, L.P, including related Registration Rights
Agreement attached as a schedule (incorporated by reference to Exhibit
4.10 to the Company's Annual Report on Form 20-F for the fiscal year
ended December 31, 2003).
4.14 Amendment to Agreement, dated March 31, 2005, by and between the
Company and Leber Partners, L.P. (incorporated by reference to Exhibit
4.13 to the Company's Annual Report on Form 20-F for the fiscal year
ended December 31, 2004).
4.15 Private Equity Credit Agreement, dated as of March 9, 2004, by and
between the Company and Brittany Capital Management Limited
(incorporated by reference to Exhibit 4.11 to the Company's Annual
Report on Form 20-F for the fiscal year ended December 31, 2003).
4.16 Registration Rights Agreement, dated as of March 9, 2004, by and
between the Company and Brittany Capital Management Limited
(incorporated by reference to Exhibit 4.12 to the Company's Annual
Report on Form 20-F for the fiscal year ended December 31, 2003).
8.1 List of subsidiaries of the Company.
12.(a).1 Certification by CEO pursuant to Rule 13a-14(a) or Rule 15d-14(a) of
the Securities Exchange Act of 1934, as adopted pursuant to Section
302 of the Sarbanes Oxley Act of 2002.
12.(a).2 Certification by CFO pursuant to Rule 13a-14(a) or Rule 15d-14(a) of
the Securities Exchange Act of 1934, as adopted pursuant to Section
302 of the Sarbanes Oxley Act of 2002.
13.(a).1 Certification of CEO and CFO pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
14.(a).1 Consent of Kost, Forer Gabbay & Kasierer, a member of Ernst &Young
Global.
14.(a).2 Consent of McGladrey & Pullen, LLP.
14.(a).3 Consent of Yoram Eden.