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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 20-F
[ ] REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES
EXCHANGE ACT OF 1934
OR
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended DECEMBER 31, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission file number 001-14184
B.O.S. BETTER ONLINE SOLUTIONS LTD.
(Exact name of Registrant as specified in its charter)
ISRAEL
(Jurisdiction of incorporation or organization)
BEIT RABIN, TERADYON INDUSTRIAL PARK, MISGAV, 20179, ISRAEL
(Address of principal executive offices)
Securities registered or to be registered pursuant to Section 12(b) of the Act:
NONE
(Title of each class)
Securities registered or to be registered pursuant to Section 12(g) of the Act:
ORDINARY SHARES, NOMINAL VALUE NIS 4.00 PER SHARE
(Title of Class)
Securities for which there is a reporting obligation pursuant to Section 15(d)
of the Act:
NONE
(Title of Class)
Indicate the number of outstanding shares of each of the issuer's classes of
capital or common stock as of the close of the period covered by the annual
report:
4,737,703 ORDINARY SHARES, NOMINAL VALUE NIS 4.00 PER SHARE, AS OF
DECEMBER 31, 2004
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark which financial statement item the registrant has elected
to follow:
Item 17 [ ] Item 18 [X]
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TABLE OF CONTENTS
PART I......................................................................................... 1
ITEM 1: IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISORS................................... 1
ITEM 2: OFFER STATISTICS AND EXPECTED TIMETABLE................................................. 1
ITEM 3: KEY INFORMATION REGARDING B.O.S. ....................................................... 1
ITEM 4: INFORMATION ON THE COMPANY.............................................................. 14
ITEM 5: OPERATING AND FINANCIAL REVIEW AND PROSPECTS............................................ 29
ITEM 6: DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES.............................................. 41
ITEM 7: MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS....................................... 51
ITEM 8: FINANCIAL INFORMATION................................................................... 55
ITEM 9: THE OFFER AND LISTING................................................................... 55
ITEM 10: ADDITIONAL INFORMATION................................................................. 57
ITEM 11: QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK.............................. 71
ITEM 12: DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES................................. 72
PART II......................................................................................... 73
ITEM 13: DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES........................................ 73
ITEM 14: MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS........... 73
ITEM 15: CONTROLS AND PROCEDURES................................................................ 73
ITEM 16: [RESERVED]............................................................................. 73
ITEM 16A: AUDIT COMMITTEE FINANCIAL EXPERT...................................................... 73
ITEM 16B: CODE OF ETHICS........................................................................ 73
ITEM 16C: PRINCIPAL ACCOUNTANT FEES AND SERVICES................................................ 73
ITEM 16D: EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES............................ 74
ITEM 16E: PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS................ 74
PART III........................................................................................ 75
ITEM 17: FINANCIAL STATEMENTS................................................................... 75
ITEM 18: FINANCIAL STATEMENTS................................................................... 75
ITEM 19: EXHIBITS............................................................................... 75
SIGNATURES...................................................................................... 77
ii
PART I
ITEM 1: IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISORS
Not required.
ITEM 2: OFFER STATISTICS AND EXPECTED TIMETABLE
Not required.
ITEM 3: KEY INFORMATION REGARDING B.O.S.
Unless the context in which such terms are used would require a different
meaning, all references to "BOS", "we", "our" or the "Company" refer to B.O.S.
Better Online Solutions Ltd.
3A. SELECTED CONSOLIDATED FINANCIAL DATA
The consolidated statement of operations data for B.O.S. Better On-Line
Solutions Ltd. set forth below with respect to the years ended December 31,
2004, 2003 and 2002, and the consolidated balance sheet data as of December 31,
2004 and 2003, have been derived from the Consolidated Financial Statements
listed in Item 18, which have been prepared in accordance with generally
accepted accounting principles ("GAAP") in the United States. The consolidated
statement of operations data set forth below with respect to the years ended
December 31, 2001 and 2000, and the consolidated balance sheet data as of
December 31, 2002, 2001 and 2000, have been derived from other consolidated
financial statements not included herein and have been prepared in accordance
with U.S. GAAP. The financial statements for the years ended December 31, 2001,
2002, 2003 and 2004 were audited by Kost, Forer Gabbay & Kasierer, an
independent registered public accounting firm and a member of Ernst & Young
Global, while the financial statements for the year ended December 31, 2000 was
audited by Somekh Chaikin, an independent registered public accounting and
members of KPMG International. The selected consolidated financial data
presented below should be read in conjunction with Item 5: "Operating and
Financial Review and Prospects" and the Notes to the Financial Statements
included in this Form 20-F.
On May 29, 2003, the Company effected a one-for-four reverse stock split. All
share and per share numbers herein reflect adjustments resulting from this
reverse stock split.
1
STATEMENT OF OPERATIONS DATA: (IN US THOUSANDS OF DOLLARS WITH THE EXCEPTION OF
PER SHARE DATA)
YEAR ENDED DECEMBER 31: 2004 2003 2002 2001 2000
----------------------- ----- ----- ----- ----- -----
Revenues 8,282 5,728 9,441 6,042 7,294
Cost of revenues 4,608 1,455 2,300 2,703 2,399
----- ----- ----- ----- -----
GROSS PROFIT 3,674 4,273 7,141 3,339 4,895
OPERATING EXPENSES:
Research and development, net 1,804 1,846 2,182 1,757 2,177
Selling and marketing 1,706 2,178 3,705 4,811 4,185
General and administrative 1,705 1,317 1,697 1,425 2,279
Restructuring costs - 678 - 132 83
----- ----- ----- ----- -----
TOTAL OPERATING EXPENSES 5,215 6,019 7,584 8,125 8,724
OPERATING LOSS: (1,541) (1,746) (443) (4,786) (3,829)
Financial income (expense), net (158) 109 295 427 639
Other income (expenses) - 45 (95) (298) (479)
----- ----- ----- ----- -----
LOSS BEFORE EQUITY IN LOSSES OF
AN AFFILIATED COMPANY (1,699) (1,592) (243) (4,657) (3,669)
Taxes on income (20) - - - -
Equity in losses of an
affiliated company (308) (465) (570) (137) (1,283)
Minority interest in earnings of
a subsidiary (17) - - - -
----- ----- ----- ----- -----
Loss from continuing operations (2044) (2,057) (813) (4,794) (4,952)
Net earning (loss) related to
discontinued operations (9) 2,036 (7,674) (8,313) (2,743)
----- ----- ----- ----- -----
NET LOSS (2,053) (21) (8,487) (13,107) (7,695)
====== === ====== ======= ======
Basic and diluted net loss per
share from continuing
operations $ (0.44) $ (0.56) $ (0.26) $ (1.55) $ (1.66)
======= ======= ======= ======= =======
Basic and diluted net earning
(loss) per share related to
discontinued operations $ 0.00 $ 0.55 $ (2.46) $ (2.68) $ (0.92)
======= ======= ======= ======= =======
Basic and diluted net loss per
share $ (0.44) $ (0.01) $ (2.72) $ (4.23) $ (2.58)
======= ======= ======= ======= =======
Weighted average number of
shares used in computing
basic and diluted net earning
(loss) per share 4,631 3,683 3,117 3,097 2,982
======= ======= ======= ======= =======
2
YEAR ENDED DECEMBER 31,
-------------------------------
BALANCE SHEET HIGHLIGHTED DATA: 2004 2003 2002 2001 2000
------------------------------- ----- ----- ----- ----- -----
Cash and Cash Equivalents 2,578 3,872 5,246 8,325 16,470
Working Capital (*) 5,256 5,082 5,980 7,008 17,378
Total Assets 22,485 14,023 17,192 31,144 46,128
Short-term banks loan and
current maturities of
long-term bank loans and
convertible note 1,997 - - 286 429
Long-term liabilities 3,380 951 794 794 1,049
Minority interest in a
subsidiary 809 - - - -
Shareholders' equity 10,048 10,541 8,015 16,341 29,444
(*)Working capital comprises
of:
Current assets 13,267 7,239 9,525 10,677 20,795
Less: current liabilities 8,011 2,157 3,545 3,669 3,417
----- ----- ----- ----- -----
5,256 5,082 5,980 7,008 17,378
===== ===== ===== ===== ======
3B. CAPITALIZATION AND INDEBTEDNESS
Not applicable
3C. REASONS FOR THE OFFER AND USE OF PROCEEDS
Not applicable
3D. RISK FACTORS
The following factors, in addition to other information contained or
incorporated by reference in this Form 20-F, should be considered carefully.
This report on Form 20-F contains forward-looking statements that are intended
to be, and are hereby identified as, forward looking statements for the purposes
of the safe harbor provisions of the Private Securities Reform Act of 1995.
These statements address, among other things: our strategy; the anticipated
development of our products; our anticipated use of proceeds; our projected
capital expenditures and liquidity; our development of additional revenue
sources; our development and expansion of relationships; the market acceptance
of our products; and our technological advancement. Actual results could differ
materially from those anticipated in these forward-looking statements as a
result of various factors, including all the risks discussed below and elsewhere
in this report.
3
We urge you to consider that statements which use the terms "believe", "do not
believe", "expect", "plan", "intend", "estimate", "anticipate", "projections",
"forecast" and similar expressions are intended to identify forward-looking
statements. These statements reflect our current views with respect to future
events and are based on assumptions and are subject to risks and uncertainties.
Except as required by applicable law, including the federal securities laws of
the United States, we do not intend to update or revise any forward-looking
statements, whether as a result of new information, future events or otherwise.
Market data and forecasts used in this report have been obtained from
independent industry sources. We have not independently verified the data
obtained from these sources and we cannot assure you of the accuracy or
completeness of the data. Forecasts and other forward-looking information
obtained from these sources are subject to the same qualifications and
additional uncertainties accompanying any estimates of future market size.
Risks relating to our business:
OUR SALES IN THE US DEPEND ON ONE MASTER DISTRIBUTOR. IN THE EVENT THAT WE
ENCOUNTER PROBLEMS WORKING WITH THE MASTER DISTRIBUTOR, WE MAY EXPERIENCE AN
INTERRUPTION IN SALES UNTIL AN ALTERNATIVE SOURCE OF DISTRIBUTION CAN BE FOUND,
WHICH MAY HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS.
Up until the fourth quarter of 2002, we marketed our BOScom products in the USA
through a US subsidiary (the BOS US division of PacInfo). Currently, we market
our products in the USA through one master distributor. In 2004, sales of our
BOScom products in the US market accounted for 39% of our sales. In the event
that we encounter problems working with the master distributor, we may
experience an interruption in sales until an alternative source of distribution
can be found, which may have a material adverse effect our business.
IN 2004 WE COMPLETED THE ACQUISITIONS OF MOST OF THE ASSETS OF QUASAR
COMMUNICATION SYSTEMS LTD. (WHICH WERE TRANSFERRED TO OUR SUBSIDIARY, QUASAR
TELECOM (2004) LTD. ("QUASAR TELECOM")) AND A CONTROLLING STAKE OF ODEM
ELECTRONIC TECHNOLOGIES 1992 LTD. ("ODEM"). THE INTEGRATION MAY INTERRUPT THE
ACTIVITIES OF ONE OR MORE OF THE COMBINED COMPANIES AND COULD HAVE AN ADVERSE
EFFECT ON THE BUSINESS, RESULTS OF OPERATIONS, FINANCIAL CONDITION OR PROSPECTS
OF THE COMPANY.
The abovementioned acquisitions involved the integration of companies that had
previously operated independently. The difficulties of combining the companies'
operations included, and continue to be, but are not limited to: the necessity
of coordinating geographically separate organizations and integrating personnel
with diverse business backgrounds, potential difficulties in retaining employees
and the associated adverse effects on relationships with existing partners. The
integration may interrupt the activities of one or more of the combined
company's businesses and may result in the loss of key personnel. This could
have an adverse effect on our business, results of operations, financial
condition or prospects.
WE ARE ENGAGED IN A HIGHLY COMPETITIVE INDUSTRY, AND IF WE ARE UNABLE TO KEEP UP
WITH OR AHEAD OF THE TECHNOLOGY OUR SALES COULD BE ADVERSELY AFFECTED.
ADDITIONALLY, WE ARE FAIRLY NEW PLAYERS IN THE HIGHLY COMPETITIVE VOIP SECTOR,
AND THERE ARE NO ASSURANCES THAT WE WILL BE ABLE TO EFFECTIVELY COMPETE WITH THE
MORE ESTABLISHED BUSINESSES IN THE SECTOR.
IBM sells competing products to our own, and can exercise significant customer
influence and technology control in the IBM host connectivity market. We may
experience increased competition in the future from IBM or other companies,
which may adversely affect our ability to continue to market our products and
services successfully.
We also compete against various companies that offer computer communications
products based on other technologies that in certain circumstances can be
competitive in price and performance to our products. There can be no assurance
that these or other technologies will not capture a significant part of the
existing or potential IBM midrange computer communications market.
4
The market for our products is also characterized by significant price
competition. We may therefore face increasing pricing pressures. There can be no
assurance that competitors will not develop features or functions similar to
those of our products, or that we will be able to maintain a cost advantage or
that new companies will not enter these markets. We believe, however, that our
significant proprietary know-how and experience in emulation technology gives us
long-term advantages.
The VOIP market is very competitive with large companies such as Cisco competing
for the same market segment. There can be no assurance that we will be able to
successfully penetrate the market or realize significant revenues from our line
of products and become profitable.
Some of our current and potential competitors have longer operating histories,
greater name recognition, access to larger customer bases and significantly
greater financial, technical and marketing resources than ours. As a result,
they may be able to adapt more quickly to new or emerging technologies and
changes in customer requirements or to devote greater resources to the promotion
and sale of their products, than us.
IN LATE 2002 WE DECIDED TO WIND UP THE BUSINESS OF OUR SUBSIDIARY, PACIFIC
INFORMATION SYSTEMS, INC. ("PACINFO"), DUE TO ITS SEVERE FINANCIAL SITUATION.
PACINFO HAS ALREADY SETTLED WITH A MAJORITY OF ITS EXTERNAL CREDITORS.
The wind up process was accompanied by settlements with a majority of PacInfo's
creditors, however, there can be no assurance that such a settlement will be
reached with the remainder of the creditors, thus resulting in additional costs
to the Company.
Furthermore, certain actions involving PacInfo, if occurred before the end of
2003, may have triggered a tax event for PacInfo former owners (the "Sellers"),
who sold PacInfo to the Company in 1998. In such event, we may be obligated,
under the purchase agreement, to grant the Sellers a loan on a full recourse
basis for certain tax payments the Sellers may be liable for, currently
estimated at approximately $2 million. The purchase agreement provides that the
Company is to receive a security interest in shares of the Company that the
Sellers hold at the time of the loan with a fair market value as of the date of
the loan of at least 125% of the amount of the loan as security for the
repayment of the loan. In addition, in the event we are required to loan such
sum to the Sellers, we may also be required to reimburse the Sellers for certain
interest on taxes that they may owe. It is possible that the windup of PacInfo
during 2002 and 2003 may have triggered such a tax event for the Sellers, which
would result in our obligation to loan the Sellers such amount and to reimburse
them for interest expenses incidental to the tax event. Such a loan and
reimbursement may have a material adverse affect on our business condition and
results of operations.
IF ACTUAL MARKET CONDITIONS PROVE LESS FAVORABLE THAN THOSE PROJECTED BY
MANAGEMENT, ADDITIONAL INVENTORY WRITE-DOWNS MAY BE REQUIRED
Inventories may be written down for estimated obsolescence based upon
assumptions about future demand and market conditions and could adversely affect
our business condition and results of operations. As of December 31, 2004,
inventory is presented net of $300,000 general provision for technological
obsolescence and slow moving items (see also Note 4 to the Consolidated
Financial Statements).
5
REDUCTION IN CONNECTIVITY FEES MAY ADVERSELY AFFECT OUR SALES OF CELLULAR
COMMUNICATION GATEWAYS.
Our cellular communication gateways, based on the technology we had purchased
from Quasar Communication Systems Ltd. in September 1994, are used, among other
things, to reduce those costs of cellular calls related to the connectivity
between the cellular network and the Public Switched Telephony Network ("PSTN"),
known as connectivity fees. A reduction in such connectivity fees may decrease
the appeal of our cellular communication gateways and adversely affect our
revenues generated by these products.
WE HAVE HAD A HISTORY OF LOSSES AND OUR FUTURE LEVELS OF SALES AND ABILITY TO
ACHIEVE PROFITABILITY ARE UNPREDICTABLE.
We have incurred net losses of approximately $2.1 million in 2004, $21 thousand
in 2003 and $8.5 million in 2002. As of December 31, 2004, we had an accumulated
deficit of approximately $39.1 million. Our ability to maintain and improve
future levels of sales and profitability depends on many factors.
These factors include:
o the continued demand for our existing products;
o our ability to develop and sell new products to meet customer needs;
o management's ability to control costs and successfully implement our
business strategy; and
o our ability to manufacture and deliver products in a timely manner.
There can be no assurance that we will experience any growth in sales or achieve
profitability in the future or that the levels of historic sales or
profitability experienced during previous years will continue in the future or
that our net losses will not increase in the future.
WE DEPEND ON CERTAIN KEY PRODUCTS FOR THE BULK OF OUR SALES AND IF SALES OF
THESE PRODUCTS DECLINE, IT WOULD HAVE A MATERIAL ADVERSE EFFECT ON US.
Our IBM midrange related products account for most of our gross profit. We
anticipate that our IBM midrange related products will continue to account for a
significant portion of our sales and profitability. If sales of our IBM midrange
products were to decline significantly for any reason, or the profit margins on
such products were to decrease significantly for any reason (including in
response to competitive pressures), our financial results would be adversely
affected. Over the past few years there has been a continuous global decrease in
sales and revenues from the connectivity solutions sector (also known as the
legacy family products) (see Item 4B). Although our revenues in this sector have
decreased as a result, in comparison to other players in this field, we have
fared quite well, but there can be no assurance that we will continue to do so.
To reduce the risk of such a decline or decrease due to competitive pressures or
technical obsolescence, we are continually seeking to reduce costs, upgrade and
expand the features of our IBM related products, expand the applications for
which the products can be used and increase marketing efforts to generate new
sales.
Although we are developing and introducing new remote communications products
and increasing our marketing efforts, there can be no assurance that the planned
enhancements or the new developments will be commercially successful, or that we
will be able to increase sales of our IBM midrange products.
IF WE ARE UNSUCCESSFUL IN DEVELOPING AND INTRODUCING NEW PRODUCTS, WE MAY BE
UNABLE TO EXPAND OUR BUSINESS.
The market for some of our products is characterized by rapidly changing
technology and evolving industry standards. The introduction of products
embodying new technology and the emergence of new industry standards can render
existing products obsolete and unmarketable and can exert price pressure on
existing products.
6
We established our subsidiary Lynk, a Division of B.O.S. Ltd., which is now
known as BOScom, for the purpose of developing, manufacturing and marketing new
products for remote networking connectivity and VOIP. However, the VOIP market
has been unstable and vulnerable over the past years, and competing in such a
market may be a risky endeavor. The VOIP market has suffered from low image due
to availability, reliability and quality problems. As such, there can be no
assurance that we will realize significant revenues from products developed and
introduced by BOScom.
Our ability to anticipate changes in technology and industry standards and
successfully develop and introduce new and enhanced products as well as
additional applications for existing products, in each case on a timely basis,
will be critical in our ability to grow and remain competitive. Although these
products are related to, and even incorporate our existing products, there can
be no assurance that we will be able to successfully develop and market any such
new products. If we are unable to develop products that are competitive in
technology and price and responsive to customer needs, for technological or
other reasons, our business will be materially adversely affected.
WE DEPEND ON KEY PERSONNEL AND NEED TO BE ABLE TO RETAIN THEM AND OUR OTHER
EMPLOYEES.
Our success depends, to a significant extent, on the continued active
participation of our executive officers, other members of management and key
technical and sales and marketing personnel. In addition, there is significant
competition for employees with technical expertise in our industry. Our success
will depend, in part on:
o our ability to retain the employees who have assisted in the
development of our products;
o our ability to attract and retain additional qualified personnel to
provide technological depth and support to enhance existing products
and develop new products; and
o our ability to attract and retain highly skilled computer operating,
marketing and financial personnel.
We cannot make assurances that we will be successful in attracting, integrating,
motivating and retaining key personnel. If we are unable to retain our key
personnel and attract additional qualified personnel as and when needed, our
business may be adversely affected.
INDEMNIFICATION OF DIRECTORS AND OFFICERS
The Company has agreements with its directors and senior officers which provide,
subject to Israeli law, for the Company to indemnify these directors and senior
officers for (a) monetary liability imposed upon them in favor of a third party
by a judgment, including a settlement or an arbitral award confirmed by the
court, as a result of an act or omission of such person in his capacity as a
director or officer of the Company, and (b) reasonable litigation expenses,
including attorney's fees, incurred by such a director or officer or imposed on
him by a court, in a proceeding brought against him by or on behalf of the
Company or by a third party, or in a criminal action in which he was acquitted,
or in a criminal action which does not require criminal intent in which he was
convicted, in each case relating to acts or omissions of such person in his
capacity as a director or officer of the Company. Such indemnification may
materially adversely affect our financial condition.
WE MAY BE UNABLE TO EFFECTIVELY MANAGE OUR GROWTH AND EXPANSION, AND AS A
RESULT, OUR BUSINESS RESULTS MAY BE ADVERSELY AFFECTED.
Our goal is to grow significantly over the next few years. The management of our
growth, if any, will require the continued expansion of our operational and
financial control systems, as well as a significant increase in our
manufacturing, testing, quality control, delivery and service capabilities.
These factors could place a significant strain on our resources.
7
Our inability to meet our manufacturing and delivery commitments in a timely
manner (as a result of unexpected increases in orders, for example) could result
in losses of sales, our exposure to contractual penalties, costs or expenses, as
well as damage to our reputation in the marketplace.
Our inability to manage growth effectively could have a material adverse effect
on our business, financial condition and results of operations.
WE HAVE LIMITED EXPERIENCE IN MAKING ACQUISITIONS.
We may wish to pursue the acquisition of businesses, products and technologies
that are complementary to ours. However, to date, our management has had limited
experience in making acquisitions. In June 1998, we acquired PacInfo, which was
based in Portland, Oregon, and in 2001 PacInfo acquired Dean Technologies LLC
("Dean Tech"), which was based in Grapevine, Texas. Both businesses have since
ceased operations. In September 2004, we acquired the majority of the assets of
Quasar Communications Systems Ltd., and in November 2004 we acquired 63.8% of
the outstanding shares of Odem Electronic Technologies 1992 Ltd. from its
existing shareholders. Acquisitions involve a number of other risks, including
the difficulty of assimilating geographically diverse operations and personnel
of the acquired businesses or activities and of maintaining uniform standards,
controls, procedures and policies. There can be no assurance that we will not
encounter these and other problems in connection with any acquisitions we may
undertake. There can be no assurance that we will ultimately be effective in
executing additional acquisitions. Any failure to effectively integrate future
acquisitions could have an adverse effect on our business, operating results or
financial condition.
THE MEASURES WE TAKE IN ORDER TO PROTECT OUR INTELLECTUAL PROPERTY MAY NOT BE
EFFICIENT OR SUFFICIENT.
Our success is dependent upon our proprietary rights and technology. We
currently rely on a combination of trade secret, copyright and trademark law,
together with non-disclosure and invention assignment agreements, to establish
and protect the proprietary rights and technology used in our products. Much of
our proprietary information is not patentable. We generally enter into
confidentiality agreements with our employees, consultants, customers and
potential customers and limit the access to and the distribution of our
proprietary information. Despite these precautions, it may be possible for a
third party to copy or otherwise obtain and use our technology without
authorization, or to develop similar technology independently. We do not believe
that our products and proprietary rights infringe upon the proprietary rights of
others. However, there can be no assurance that any other party will not argue
otherwise. The cost of responding and adequately protecting ourselves against
any such assertion may be material, whether or not the assertion is valid.
Further, the laws of certain countries in which we sell our products do not
protect our intellectual property rights to the same extent as do the laws of
the United States. Substantial unauthorized use of our products could have a
material adverse effect on our business. We cannot make assurances that our
means of protecting our proprietary rights will be adequate or that our
competitors will not independently develop similar technology. Additionally,
there are risks that arise from the use of intranet networks and the Internet.
Although we utilize firewalls and protection software, we cannot be sure that
our proprietary information is secured against penetration. Such penetration, if
occurs, could have an adverse affect on our business.
WE RELY ON CERTAIN KEY SUPPLIERS FOR THE SUPPLY OF COMPONENTS IN OUR PRODUCTS.
We purchase certain components and subassemblies used in our existing products
from a single supplier or a limited number of suppliers. In the event that any
of our suppliers or subcontractors becomes unable to fulfill our requirements in
a timely manner, we may experience an interruption in production until an
alternative source of supply can be obtained, although we are of the opinion
that the level of inventory held by us would probably be sufficient to cover
such a period.
8
FLUCTUATIONS IN OUR OPERATING RESULTS COULD RESULT IN LOWERED PRICES.
Our sales and profitability may vary in any given year, and from quarter to
quarter. In order to increase sales and enter into new markets with new products
we may find it necessary to decrease prices in order to be competitive.
WE HAVE LIMITED CAPITAL RESOURCES AND WE MAY ENCOUNTER DIFFICULTIES RAISING
CAPITAL.
The continued expansion into the Communication and Electronic Components segment
will require additional resources and especially working capital. Our efforts to
obtain a significant credit line from a financial institution have not been
successful, and therefore we plan to raise additional capital and/or to enter
into strategic alliances. However, the Communication market has been unstable
and vulnerable and we may encounter difficulties raising capital. If our efforts
to raise capital do not succeed, our efforts to increase the business and to
compete with our competitors may be seriously jeopardized, thus having a
materially adverse effect on our business.
THERE CAN BE NO ASSURANCE THAT WE WILL NOT BE CLASSIFIED AS A PASSIVE FOREIGN
INVESTMENT COMPANY (A "PFIC").
Based upon its current and projected income, assets and activities, we do not
believe that at this time the Company is a passive foreign investment company (a
"PFIC") for US federal income tax purposes, but there can be no assurance that
we won't be classified as such in the future. Such classification may have grave
tax consequences for US shareholders. One method of avoiding such tax
consequences is by making a "qualified electing fund" election for the first
taxable year in which the Company is a PFIC. However, such an election is
conditioned upon our furnishing US shareholders annually with certain tax
information. We do not presently prepare or provide such information, and such
information may not be available to US shareholders if we are subsequently
determined to be a PFIC.
WE MAY BE REQUIRED TO PAY STAMP TAXES ON DOCUMENTS EXECUTED BY US ON OR AFTER
JUNE 2003.
The Israeli Stamp Tax on Documents Law, 1961, or the "Stamp Tax Law", provides
that certain documents signed by Israeli companies are subject to a stamp tax,
generally at a rate of between 0.4% and 1% of the value of the subject matter of
the applicable document. As a result of an amendment to the Stamp Tax Law that
came into effect in June 2003, the Israeli tax authorities have commenced
enforcement of the provisions of the Stamp Tax Law.
Consequently, we may be liable to pay stamp taxes on some or all of the
documents we have signed since June 2003, which could have a material adverse
effect on our results of operations.
Currently, the Israeli High Court of Justice is considering a petition
concerning the abovementioned amendment to the Stamp Tax Law and the enforcement
actions taken by the Israeli tax authorities. In addition, recently promulgated
regulations provide for a gradual phase-out of the stamp tax by 2008.
WE HAVE SIGNIFICANT SALES WORLDWIDE AND COULD ENCOUNTER PROBLEMS IF CONDITIONS
CHANGE IN THE PLACES WHERE WE MARKET OUR PRODUCTS.
We have sold and intend to continue to sell our products in markets through
distributors in North America, Europe and Asia.
9
A number of risks are inherent in engaging in international transactions,
including -
o international sales and operations being limited or disrupted by
longer sales and payment cycles,
o possible encountering of problems in collecting receivables,
o governmental controls, or export license requirements being imposed,
o political and economic instability in foreign countries,
o trade restrictions or changes in tariffs being imposed, and
o laws and legal issues concerning foreign countries.
If we should encounter such difficulties in conducting our international
operations, it may adversely affect our business condition and results of
operations.
AS PART OF A GLOBAL SLOW DOWN IN TECHNOLOGY MARKETS, TECHNOLOGY-FOCUSED
CORPORATIONS HAVE SUFFERED AND AS A RESULT THEIR SHARES HAVE DECLINED IN VALUE.
Our Company, like other technology companies, has been significantly impacted by
the current market slowdown in the technology industry. Lately, the industry has
been showing initial signs of recovery, however, there can be no assurance that
the technology market will fully recover or that our operating results will not
continue to suffer as a consequence.
INFLATION AND FOREIGN CURRENCY FLUCTUATIONS SIGNIFICANTLY IMPACT ON OUR BUSINESS
RESULTS.
The vast majority of our sales are made in US Dollars and most of our expenses
are in US Dollars and New Israel Shekels ("NIS"). The Dollar cost of our
operations in Israel is influenced by the extent to which any increase in the
rate of inflation in Israel over the rate of inflation in the United States is
offset by the devaluation of the NIS in relation to the Dollar. Our Dollar costs
in Israel will increase if inflation in Israel exceeds the devaluation of the
NIS against the Dollar or if the timing of such devaluations lags behind
inflation rate increases in Israel.
IF WE ARE FORCED TO REPAY OUR SECURED CONVERTIBLE NOTE IN CASH, WE MAY NOT HAVE
ENOUGH CASH TO FUND OUR OPERATIONS AND MAY NOT BE ABLE TO OBTAIN ADDITIONAL
FINANCING.
Our secured convertible term note issued in June 2004, contains certain
provisions and restrictions, which if violated, could result in the full
principal amount together with interest and other amounts becoming immediately
due and payable in cash. If such an event occurred and if the holder of such
note demanded repayment, we might not have the cash resources to repay such
indebtedness when due. The note is repayable in 33 monthly installments
commencing on October 1, 2004, with principal payments which start at $20,000
and increase to $73,600. Subject to certain conditions, the monthly principal
and interest payment on the note may be paid in cash or ordinary shares. If we
make the payments on the note in cash rather than ordinary shares, it would
reduce the amount of cash available to fund operations. Also, in connection with
the issuance of the note, we agreed to certain restrictions upon incurring
additional indebtedness such as in case of certain mergers and acquisitions. The
existence of debt service obligations and the terms and anti-dilution provisions
of the note may limit our ability to obtain additional financing on favorable
terms, or at all.
IF THE INVESTOR IN OUR CONVERTIBLE NOTE FINANCING CONVERTS OR EXERCISES ITS
WARRANTS, OR IF WE ELECT TO PAY PRINCIPAL AND/OR INTEREST ON THE NOTE WITH OUR
ORDINARY SHARES, OUR EXISTING SHAREHOLDERS WILL BE DILUTED. IN ADDITION, SALES
OF SUBSTANTIAL AMOUNTS OF OUR ORDINARY SHARES COULD CAUSE THE MARKET PRICE TO GO
DOWN.
To the extent that the note is converted and/or the warrants that were issued
with the note are exercised, a significantly greater number of our ordinary
shares will be outstanding and the interests of our existing shareholders will
be diluted. If these additional shares are sold into the market, it could
decrease the market price of our ordinary shares and encourage short sales
although the purchaser of the note has agreed to not engage in short sales of
our ordinary shares. Short sales and other hedging transactions could place
further downward pressure on the price of our ordinary shares. We cannot predict
whether or how many of our ordinary shares will become issuable as a result of
these provisions. Additionally, we may elect to make payments of principal of
and interest on the note in ordinary shares, which could result in increased
downward pressure on our share price and further dilution to our existing
shareholders.
10
Risks related to our location in Israel:
POLITICAL, ECONOMIC, AND SECURITY CONDITIONS IN ISRAEL AFFECT OUR OPERATIONS AND
MAY LIMIT OUR ABILITY TO PRODUCE AND SELL OUR PRODUCTS OR PROVIDE OUR SERVICES.
We are incorporated under the laws of the State of Israel, where we also
maintain our headquarters and our principal manufacturing, research and
development facilities. Political, economic, security and military conditions in
Israel directly influence us. We could be adversely affected by 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. The future of the "peace process" with the
Palestinians is uncertain and has deteriorated due to Palestinian violence.
Furthermore, the threat of a large-scale attack by Palestinians on Israeli
civilians and key infrastructure remains a constant fear. The past four years of
renewed terrorist attacks by the Palestinians has severely affected the Israeli
economy in many ways. In addition, several countries still restrict business
with Israel and with companies doing business in Israel. We could be adversely
affected by adverse developments in the "peace process" or by restrictive laws
or policies directed towards Israel or Israeli businesses.
Generally, all nonexempt male adult citizens and permanent residents of Israel,
including some of the our officers and employees, are obligated to perform
military reserve duty annually, and are subject to being called to active duty
at any time under emergency circumstances. While we have operated effectively
under these requirements since its incorporation, we cannot predict the full
impact of such conditions on us in the future, particularly if emergency
circumstances occur. If many of our employees are called for active duty, our
business may be adversely affected.
Additionally, in recent years Israel has been going through a period of
recession in economic activity, resulting in low growth rates and growing
unemployment. Our operations could be adversely affected if the economic
conditions in Israel continue to deteriorate. Also, due to significant economic
reforms proposed by the Israeli government, there have been several general
strikes and work stoppages in 2003 and 2004, affecting all banks, airports and
ports. These strikes have had an adverse effect on the Israeli economy and on
business. Following the passing of laws to implement economic measures, the
Israeli trade unions have threatened further strikes or work stoppages, and
these may have an adverse effect on the Israeli economy and our business.
Furthermore, Israel is a party to certain trade agreements with other countries,
and material changes to these agreements could have an adverse affect on our
business.
IF THE ISRAELI GOVERNMENT PROGRAMS THAT WE BENEFIT FROM ARE REDUCED OR
TERMINATED, OUR COSTS AND TAXES MAY INCREASE.
Under the Israeli Law for Encouragement of Capital Investments, 1959, facilities
that meet certain conditions can apply for "Approved Enterprise" status. This
status confers certain benefits including tax benefits. Our existing facilities
have been designated as Approved Enterprises. If we attain taxable income in
Israel, these tax benefits will help reduce our tax burden.
In addition, in order to maintain our eligibility for the grants and tax
benefits we receive, we must continue to satisfy certain conditions, including
making certain investments in fixed assets and operations and achieving certain
levels of exports. If we fail to satisfy such conditions in the future, we could
be required to refund tax benefits which may have been received with interest
and linkage differences to the Israeli Consumer Price Index.
11
The Israeli Government authorities have indicated that the government may reduce
or eliminate these benefits in the future. A termination or reduction of certain
programs and tax benefits (particularly benefits available to the Company as a
result of the Approved Enterprise status of the Company's facilities and
programs) or a requirement to refund the tax benefits already received, would
have a material adverse effect on the Company's business, operating results and
financial condition.
Under the Law for the Encouragement of Industrial Research and Development, 1984
(the "Research Law"), research and development programs approved by a research
committee appointed by the Israeli Government are eligible for grants in
exchange for payment to the Government of royalties from the sale of products
developed in accordance with the Program. Regulations issued under the Research
Law generally provide for the payment of royalties to the Office of the Chief
Scientist equal to 3.5% of sales of products developed as a result of a research
project so funded until 100% of the dollar-linked grant is repaid. Royalties
payable with respect to grants received under programs approved by the OCS after
January 1, 1999, are subject to interest on the U.S. dollar-linked value of the
total grants received at the annual rate of LIBOR applicable to U.S. dollar
deposits on the date the grants were received.
The Research Law requires that the manufacture of any product developed as a
result of research and development funded by the Israeli Government take place
in Israel. It also provides that know-how from the research may not be
transferred to third parties without the approval of the Israeli Office of the
Chief Scientist in the Ministry of Industry, Trade & Labor.
THE ANTI-TAKEOVER EFFECTS OF ISRAELI LAWS MAY DELAY OR DETER A CHANGE OF CONTROL
OF THE COMPANY.
Under the Israeli Companies Law, a merger is generally required to be approved
by the shareholders and Board of Directors of each of the merging companies.
Shareholder approval isn't required if the company that will not survive is
controlled by the surviving company. Additionally, the law provides some
exceptions to the shareholder approval requirement in the surviving company.
Shares held by a party to the merger and certain of its affiliates are not
counted toward the required approval. If the share capital of the company that
will not be the surviving company is divided into different classes of shares,
the approval of each class is also required. A merger may not be approved if the
surviving company will not be able to satisfy its obligations. At the request of
a creditor, a court may block a merger on this ground. In addition, a merger can
be completed only after all approvals have been submitted to the Israeli
Registrar of Companies, provided that 30 days have elapsed since shareholder
approval was received and 50 days have passed from the time that a proposal for
approval of the merger was filed with the Registrar.
The Israeli Companies Law provides that an acquisition of shares in a public
company must be made by means of a tender offer, if as a result of the
acquisition, the purchaser would become a holder of 25% or more of the voting
power at general meetings, and no other shareholder owns a 25% stake in the
Company. Similarly, the Israeli Companies Law provides that an acquisition of
shares in a public company must be made by means of a tender offer if, as a
result of the acquisition, the purchaser would become a holder of 45% or more of
the voting power at general meetings, unless someone else already holds 45% of
the voting power. An acquisition from a 25% or 45% holder, which turns the
purchaser into a 25% or 45% holder respectively, does not require a tender
offer. An exception to the tender offer requirement may also apply when the
additional voting power is obtained by means of a private placement approved by
the general meeting of shareholders. These rules also do not apply if the
acquisition is made by way of a merger.
12
The Israeli Companies Law provides specific rules and procedures for the
acquisition of shares held by minority shareholders, if the majority shareholder
holds more than 90% of the outstanding shares. Israeli tax law treats specified
acquisitions, including a stock-for-stock swap between an Israeli company and a
foreign company, less favorably than does U.S. tax law.
These laws may have the effect of delaying or deterring a change in control of
the Company, thereby limiting the opportunity for shareholders to receive a
premium for their shares and possible affecting the price that some investors
are willing to pay for the Company's securities.
ALL OF OUR DIRECTORS AND OFFICERS ARE NON-U.S. RESIDENTS AND ENFORCEABILITY OF
CIVIL LIABILITIES AGAINST THEM IS UNCERTAIN.
All of our directors and officers reside outside of the United States. Service
of process upon them may be difficult to effect within the United States.
Furthermore, because the majority of our assets are located in Israel, any
judgment obtained in the United States against us or any of our directors and
officers may not be collectible within the United States.
Risks related to our ordinary shares:
OUR SHARE PRICE HAS BEEN AND MAY CONTINUE TO BE VOLATILE, WHICH COULD RESULT IN
SUBSTANTIAL LOSSES FOR INDIVIDUAL SHAREHOLDERS
The market price of our ordinary shares has been and may continue to be highly
volatile and subject to wide fluctuations. Since January 2004 through May 2005,
the daily closing price of our ordinary shares has ranged from $1.62 to $4.00
per share. We believe that these fluctuations have been in response to a number
of factors including the following, some of which are beyond our control:
o actual or anticipated variations in our quarterly operating results;
o announcements of technological innovations or new products or services
or new pricing practices by us or our competitors;
o increased market share penetration by our competitors;
o announcements by us or our competitors of significant acquisitions,
strategic partnerships, joint ventures or capital commitments;
o additions or departures of key personnel; and
o sales of additional ordinary shares.
In addition, the stock market in general, and stocks of technology companies in
particular, have from time to time experienced extreme price and volume
fluctuations. This volatility is often unrelated or disproportionate to the
operating performance of these companies. These broad market fluctuations may
adversely affect the market price of our ordinary shares, regardless of our
actual operating performance.
THE COMPANY'S SHARES MAY BE DELISTED FROM THE NASDAQ NATIONAL MARKET FOR FAILURE
TO MEET NASDAQ'S REQUIREMENTS.
In late 2002 and early 2003 the Company received notice from the Nasdaq Stock
Market that its ordinary shares were subject to delisting from the Nasdaq
National Market for failure to meet Nasdaq's minimum bid price and shareholders'
equity requirements ($10 million) for continued listing on the National Market.
As a result of the hearing requested by the Company and supplemental information
presented by the Company to the Nasdaq Listing Qualifications Panel by the
Company, the Panel determined to continue the listing of the Company's
securities on the Nasdaq National Market pursuant to a detailed exception to the
Nasdaq National Market Rules, and the Company successfully met all the
conditions set forth in the exception.
13
On August 30, 2004, we received notice from the Nasdaq Stock Market that our
ordinary shares are subject to delisting from the Nasdaq National Market for
failure to meet Nasdaq's minimum market value of publicly held shares
requirement ($5 million) for continued listing on the National Market. On
November 4, 2004 we were notified by Nasdaq that we have regained compliance
with this requirement.
On January 25, 2005, we received notice from the Nasdaq Stock Market that we
were not in compliance with the minimum $10 million shareholders' equity
requirement for continued listing on the National Market. Following that notice,
on January 28, 2005, we received an additional notice indicating that based on
further review of our financial statements as they appeared in our filing on
Form 6-K dated January 10, 2005, it was determined that the shareholders' equity
was $10,601,000 on a pro forma basis as of September 30, 2004. Therefore we were
in compliance with the stockholders' equity requirement for continued listing on
the National Market and the matter had been closed.
However, on June 2, 2005, the Company again received notice from the Nasdaq
Stock Market indicating that based on the results for the period ended March 31,
2005, the shareholders' equity was $9,425,000, and accordingly not in compliance
with the minimum $10,000,000 shareholders' equity requirement for continued
listing on the National Market. Therefore, the Nasdaq Staff is reviewing the
Registrant's eligibility for continued listing on the Nasdaq National Market,
and the Registrant has provided, as requested, its specific plan to achieve and
sustain compliance with the listing requirements.
There can be no assurance that we will be able to meet and continue to meet
these or other Nasdaq requirements to maintain our Nasdaq National Market
listing, in which case we will have the right to apply for a transfer of our
ordinary shares to the Nasdaq Small Cap Market.
ITEM 4: INFORMATION ON THE COMPANY
4A. HISTORY AND DEVELOPMENT OF THE COMPANY
We were incorporated in Israel in 1990 as a private corporation under the
Israeli Companies Ordinance, 1983. We design, integrate and test our products in
our facilities in three locations in Israel. Our headquarters and manufacturing
facilities are located at Teradyon Industrial Zone, Misgav 20179 Israel,
telephone number 972-4-990-7555. The facilities of our subsidiaries (Odem and
Quasar Telecom) are located in the center of Israel.
We are providing solutions that deliver connectivity between systems, systems
and people, and people-to-people. We have enabled customers worldwide to move up
seamlessly to new technologies and capabilities.
In January 2002, the Company changed its organizational structure. As part of
this change, the Company 's marketing, development, production and support
activities were sold to BOScom Ltd. (formerly named Lynk, a Division of B.O.S
Ltd.), an Israeli subsidiary founded in 1995 (and which is a wholly-owned
subsidiary since 2002).
We currently manage our operation through our subsidiaries:
a) BOScom that is engaged in Connectivity Solutions and Communication Solutions
that are based on VoIP technology;
b) Quasar Telecom that is engaged in Communication Solutions that are based on
cellular technology; and
c) Odem that is engaged in the supply of electronic components and solutions.
14
Commencing 2004, the Company manages its business, through its subsidiaries, in
three reportable segments, which consist of Connectivity Solutions,
Communication Solutions and the supply of Electronic Components.
CONNECTIVITY SOLUTIONS focuses on emulation solutions for the popular IBM
iSeries, enabling customers to extend its capabilities and life cycle. Our
server and associated modules empower the iSeries, providing a scaleable
solution for transparent expansion and growth. PrintBOS, an Output Management
solution, provides design, print, distribution and archiving management
solutions that are best-of-breed. PrintBOS enables customers to cut costs,
enhance brand and marketing clout, and direct output to multiple distribution
channels.
COMMUNICATIONS SOLUTIONS provides advanced migration solutions for a full range
of telecom channels, including VoIP and cellular.
ELECTRONIC COMPONENTS are based on Odem Electronic Technologies 1992 Ltd.
("Odem") in which a controlling stake was acquired in 2004. Odem provides
solutions in semiconductors, electronic components, CCD, imaging, networking,
telecom and automation.
We constantly seeks growth opportunities by developing new marketing channels
for our products in North America, Europe and emerging markets in Eastern
Europe, Asia-Pacific and South America. We continues to raise funds from
investors in order to expand operations and capitalize on merger and acquisition
growth opportunities.
In September 2004, the Company entered into an agreement with Quasar
Communication Systems Ltd., an Israeli company engaged in the business of
developing, manufacturing and selling cellular communication gateways, to
purchase the majority of the assets and liabilities of Quasar Communication
Systems for an aggregate consideration of $539,000 by the issuance of 285,000 of
the Company's ordinary shares. The assets and some of the liabilities of Quasar
were transferred into Quasar Telecom (2004) Ltd. ("Quasar Telecom"), a wholly
owned subsidiary of the Company (previously named Boslynk Ltd.). The results of
Quasar Telecom's operations have been included in the consolidated financial
statements since September 28, 2004. The acquisition enables the Company to
continue developing the communication division, while offering to the Company's
clients an extended product line that will enable savings in telecommunication
expenses for enterprise.
We are also the controlling shareholder of Odem, after purchasing on November
18, 2004, 63.8% of Odem's issued and outstanding shares from Odem's existing
shareholders. The consideration for the Odem shares was $2,740,000, comprised of
cash in the amount of $1,971,000 and $769,000 by the issuance of 290,532 of the
Company's ordinary shares (subject to "lock-up" periods of 2 to 4 years). In
addition, Odem's selling shareholders and the Company have certain put and call
options, with respect to all of the remaining Odem shares held by such sellers,
exercisable for a consideration comprised of additional cash and issuance of
additional ordinary shares of the Company. The Company recorded assets and
liability with respect to these options at fair value. The put option liability
will be measured periodically until it expires or exercised and changes in the
fair value will be charged to finance expenses. Odem, an Israeli company, is a
major solution provider and distributor of electronics components and advance
technologies in the Israeli market.
In addition, we have an interest in Surf Communications Solutions Ltd. ("Surf"),
a developer and global supplier of universal access and network convergence
software solutions to the wireline and wireless telecommunications and data
communications industries. In November 2001, the Company invested $1,000,000 as
part of a private placement in Surf. At the same time, the Company converted its
convertible loan in the amount of $1,042,000 (principal and accrued interest)
into Preferred shares in Surf at an exercise price equal to Surf's fair value as
determined in the investment agreement. As a result of this private placement,
the Company's holding in Surf was diluted to 17%. Accordingly, the investment
was accounted based on the cost accounting method.
15
In March 2003, the Company purchased from Catalyst Investments L.P. ("Catalyst")
most of the Surf shares held by Catalyst (191,548 of Catalyst's Preferred C
shares in Surf, and a pro rata share of the Surf Preferred C warrants held by
Catalyst), in consideration of $1,755,000 by the issuance of ordinary shares of
the Company (representing 19.9% of its current outstanding shares pre-issuance,
as a result of which Catalyst held 16.6% of the outstanding Company shares,
after the issuance). The Company has an option to purchase the remaining
Catalyst Preferred C shares in Surf by January 31, 2006, and until such purchase
has voting rights in these Surf shares, in addition to being entitled to profits
resulting from the sale of these shares to a third party. The Company later
assigned these voting rights (see Item 7B). As a result of the transaction with
Catalyst, the Company's holdings in Surf equal 22.5%, and 19.7% of the voting
rights (post-assignment). The Company's investment in Surf is currently
accounted for based on the equity accounting method.
BOScom Ltd.'s subsidiaries are: Better On-Line Solutions Ltd. in the U.K; Better
On-Line Solutions S.A.S. in France; and BOSDelaware, Inc., in the US. During
2003, the operation of BOScom's subsidiaries was ceased (although all
subsidiaries, except for the French one, still exist) and the sales and
marketing in Europe and the United States have since been conducted through
master distributors.
DISCONTINUED OPERATION - COMPUTER NETWORKING:
On June 1, 1998, we acquired 100% of the share capital of PacInfo, a U.S.
corporation which resold, installed and provided computer networking products to
various business entities. In 2001, PacInfo acquired 100% of Dean Tech
Technologies Associates, L.L.C. (Dean Tech). Dean Tech was an IBM Advanced
Business Partner providing complete IT solutions utilizing IBM's
industry-leading eServer pSeries and xSeries lines of servers, as well as IBM
Total Storage Solutions. 100% of our computer networking revenues were derived
from sales to US customers. In the fourth quarter of 2002, Pacinfo's operation
was wound up due to a change in the Company's strategy as a result of Pacinfo's
severe financial situation. Dean Tech has also ceased all operations.
Our U.S. subsidiaries are Lynk USA, Inc., and its subsidiary PacInfo, Inc. Both
are non-operational and commencing the beginning of year 2003 we market our
products in the U.S. through one Master Distributor.
4B. BUSINESS OVERVIEW
INDUSTRY BACKGROUND
The Company manages its business in three reportable segments, which consist of
Connectivity Solutions, Communication Solutions and the supply of Electronic
Components Solutions.
(a) CONNECTIVITY SOLUTIONS
In the 1960s and 1970s, the business computing environment was typically
organized with the mainframe in the data center and minicomputers at the
division or department level. The host mainframe and minicomputers were accessed
by "dumb" terminals at the user level. These host systems featured high
performance and throughput and often ran custom-designed, critical applications
such as organization-wide payroll, general ledger, inventory management and
order processing programs. Because of the importance of the mainframe and
minicomputers as central repositories of corporate data and critical
applications, significant corporate resources were, and continue to be,
dedicated to maintaining this installed hardware and software base. Although
these host systems are capable of supporting enterprise-wide information system
networks, their applications are generally characterized by limited
availability, complex command sequences and character-based user interfaces.
16
With the introduction and proliferation of the personal computers in the 1980s,
a substantial amount of corporate computing power was added to the worker's
desktop, a change facilitated by the availability of increasingly powerful
personal productivity applications such as spreadsheets and word processors.
Personal computers began replacing dumb terminals and, as the business computing
environment became increasingly heterogeneous, organizations found themselves
with significant investments in multiple, but often incompatible, systems each
performing different functions within an organization.
Despite the functionality of personal computers, users still needed access to
certain data and applications residing on host systems. Terminal emulation
hardware and software was developed to provide host connectivity by allowing
personal computers to emulate the dumb terminals they had replaced. Often,
however, these terminal emulation products were complicated, difficult to use
and allowed only a single connection to a single host. In addition, terminal
emulation products made little or no provision for the integration of host data
and applications with personal computers data and applications such as
spreadsheets. Therefore, the full capabilities of the personal computers were
not available to the user when the personal computer was used as a terminal.
In the mid-1980s, the desire of personal computer users to share files and
peripheral devices, and to communicate with other users, led to the widespread
implementation of Local Area Networks. Local Area Networks significantly
expanded an organization's ability to more efficiently connect increased numbers
of its personal computer users to host environments through a "gateway"
dedicated to LAN-to-host communication services. The personal computer software
enabling this LAN-to-host connectivity continued to use terminal emulation
technology.
The emergence of the Internet/intranets in the 1990s has encouraged the
development of numerous new products and services that enable and facilitate
access and connectivity of host computers with computer networks. New IBM
midrange products have expanded capabilities of the iSeries in the area of
electronic commerce.
Continued widespread use of Twinax cable infrastructure has created a need to
develop solutions that can provide these users with such features as e-mail,
networking, and Internet.
An industry trend noticed in the late 1990s was a move to a "thin client"
environment. Larger enterprises use this method as a means to reduce cost of
ownership by employing Microsoft Windows NT/2000 Terminal Servers, which enable
central configuration and user management. Terminals ("thin clients") are
deployed to users throughout the network to provide the requisite connectivity
to host applications. We moved into this arena in early 2003 with a progressive
release program culminating in a full suite of thin clients and Ethernet
terminals. In the first quarter of 2005, we stopped our activities in the thin
client sector and assigned our rights with suppliers to our master distributor
in the U.S., as the profit margin for these products was small, its influence on
our revenues marginal, and the risk significant.
(b) COMMUNICATION SOLUTIONS
In 1995 the first Client VoIP solution was introduced to the market by VocalTec,
an Israeli company that demonstrated telephone calls over the internet. Since
then, in an accelerated mode, the VoIP (Voice over Internet Protocol) and IP
Telephony (Internet Protocol Telephony) have become a market with a turnover of
billions of dollars.
Large companies like Cisco, as well as telephony players such as Lucent, Nortel,
Siemens, Alcatel, Avaya and others are selling VoIP solutions and embedding such
technologies into their product lines.
As broadband connectivity grows in popularity for all organizations, major
savings on calls are a potential reason for migrating traditional calls to VoIP.
Service availability and quality of service (QOS) are two key issues that
enterprises need to address in the Internet architecture to availability and
quality. The incremental cost savings for Internet telephony will depend on the
mix between on-net and off-net calls. Global enterprises with extensive private
voice networks will realize greater savings on global destinations by avoiding
international tariffs.
17
As the accelerated growth and penetration of the cellular communication, there
is an increase demand to extend the PBX functionality and connecting branch
offices with the mobile community via cellular gateways in order to reduce
communication costs among different operators. In September 2004, the Company
purchased most of the assets of Quasar Communication Systems Ltd., an Israeli
company engaged in the business of developing, manufacturing and selling
cellular communication gateways. The acquisition enables the Company to continue
developing the communication division, while offering to the Company's clients
an extended product line that will enable savings in telecommunication expenses
for enterprise.
(c) ELECTRONIC COMPONENTS
Components are the basic building blocks of all electronic products and in the
twenty-first century the end use of electronic products spans virtually all
sectors of the economy. There are three major end uses for electronics
components (a) information technology (IT); (b) industry; and (c) transportation
and consumer goods.
The twentieth century global revolution in electronics contributed to both the
automation of repetitive tasks and the more efficient performance of other
tasks. This revolution began in the late 1940s, followed by advances in
integrated circuit technology in the late 1950s. Since 1960, continuous
improvements in the production of components and subsystems have allowed prices
to decline sharply, while market size increased dramatically.
There are two major groups of components: a large family of active components
and a small group of passive components. Active electronic components are
semiconductor products that supplanted the previous generation of vacuum tube
devices. Passive components can interrupt, resist, or otherwise influence
current flow, but cannot control it. Passive components are capacitors,
resistors, connectors, filters and inductors. In general, the "passives" are
used to enhance or supplement the performance of ICs. The demand for electronic
components is a derived demand. The vast majority of both active and passive
components are installed in "original equipment manufacturer" (OEM) products:
consumer electronics, motor vehicles, telecom equipment, factory automation
systems, military hardware, and other goods.
Since electronic components are so widely installed, their market is affected by
all major macroeconomic variables, such as capital spending, disposable income
and government budgets.
DESCRIPTION OF BUSINESS PRODUCT LINES
(a) CONNECTIVITY SOLUTIONS
The Connectivity Solution product line focuses on emulation solutions for the
popular IBM iSeries servers, enabling customers to vastly extend its
capabilities and life cycle. Its BOSaNOVA products family empower the iSeries,
providing a scaleable solution for transparent expansion and growth.
Connectivity products are based on TCP/IP to Twinax controllers, as well as
iSeries full and rich TCP/IP emulation, that help extend the life cycle of the
organization's iSeries and achieve a rapid ROI. All products are unmatched in
their emulation capabilities, compatibility and transparency
Realizing the changing role of this IBM midrange environment in today's
workplace, our mission is to provide our users with technologically advanced and
cost-efficient solutions for connectivity between them and personal computers
and local area networks, whether local or remote. We sell and support our
products worldwide through distributors, and value-added resellers.
18
Our proprietary products are sold to users of IBM iSeries, which are
predominantly medium to large sized corporations that use large data banks in
their businesses and require the ability to integrate and manipulate the data
into graphics and popular personal computer programs. The target market for our
products is composed of the owners of approximately 500,000 IBM Series servers
and the growing number of users who connect to these computers through the
Internet, intranets and various other connectivity products.
Our main product line is comprised primarily of TCP/IP to Twinax controllers
that allows Legacy Twinax equipment to work locally or remotely via TCP/IP line
to the Series server. In addition we have a line of emulation software, to
simulate a personal computer environment having the same functionality to which
the users are accustomed (i.e. Windows or similar graphical interfaces), while
using a midrange computer. The emulation solutions are offered at two levels -
at the user interface level and at the computer connectivity level. At the user
interface level, our emulation technology allows customers to utilize popular
Windows functions and graphics. At the connectivity level, our connectivity
technology provides personal computers with the ability to act as terminals for
IBM midrange computers either through gateway, Internet or direct connection.
We are using our expertise in the midrange computer environment to develop
Internet/intranet solution products that will enable and enhance connectivity
between IBM iSeries computers and personal computers via the Internet and
intranets.
In 2004, 60% of our sales were attributable to sales of Connectivity solutions
and services.
Below is a description by category of our development activity in the
connectivity product line:
(a1) ISERIES DISPLAY AND PRINTING EMULATION FOR LAN/WAN
In December 1997, we announced our BOSaNOVA transmission control protocol /
internet protocol product, a connectivity tool for organizations with either
local or remote TCP/IP networks (intranet or extranet) of personal computers
using Windows 9x/Me or NT/2000/XP operating systems connected to the iSeries.
Development resources in 1999 were directed toward making TCP/IP connectivity
available for Twinax users. The e-Twinax technology has now been implemented in
products such as the BOSaNOVA Plus, BOSaNOVA TCP/IP, and e-Twin@x Controller,
which made its debut in the middle of 1999, and has been rapidly established as
the remote computer controller of choice.
(a2) BROWSER-BASED WEB-TO-HOST GUI DISPLAY AND PRINTING
In December 1997, we introduced BOSaNOVA WEB, a Java-based application that
provides iSeries web-emulation, allowing organizations to upgrade their iSeries
to enable full web benefits. BOSaNOVA WEB slashes communication costs, ensures a
friendly, transparent work environment, installs rapidly and easily without a
client install and delivers a very fast ROI.
Loaded on a central server and managed by a network supervisor, BOSaNOVA WEB
allows normal user changes to occur hassle-free. Whether moving users to new
workstations, upgrading software, pushing out new applications, or enhancing
security, users simply log on to receive the correct workstation parameters for
their jobs.
The server and users are managed easily and economically via the browser. The
Network Supervisor can change or modify parameters from any enterprise computer
whether internal or external. There is no need to use the server's computer for
changes or upgrades. It is all done seamlessly via the web and from a remote
workstation.
19
Application upgrades and parameter changes are automatically delivered to
end-users as soon as they log on via the browser to the web server integrated
into BOSaNOVA WEB.
BOSaNOVA WEB eliminates the need for both additional "push" software and
expensive technical support at the desktop. Additionally, the client/server
architecture means current cache capabilities can be used, thus enabling
upgrades in real-time.
The client/server architecture allows all internal and external iSeries users to
benefit from the network. Users access the iSeries through the BOSaNOVA web
server which incorporates a web server. The server encodes all transmitted
information, complying with SSL standards, amplified by user verification via a
client certificate.
BOS's Printer Client technology is embedded in BOSaNOVA Web to enable to print
via the web.
(a3) TWINAX-TO-ETHERNET CONTROLLERS
The e-Twin@x Controller, which made its debut in 1999, supplies a secure,
encrypted TN5250e connection to the iSeries over the Internet or WAN, and
provides local or remote Twinax networks with access to LAN resources. The
e-Twin@x Controller allows enterprises to leverage their Twinax investments (in
equipment and cabling) while providing the benefits of a TCP/IP connection.
Dramatic improvements in performance, uptime and cost-efficiency are the result.
A new model, the e-TwinStar, was released in 2002. It features native support
for CAT5 cabling, in the form of built-in RJ45 sockets, saving customers with
this environment the cost of an active star hub.
(a4) SOFTWARE UTILITIES
The PrintBOS Output Management product, which introduced in late 1998 is an
innovative Enterprise Output Management solution answering a growing demand for
central printing and output management solutions in medium and large IT
organizations. PrintBOS is implemented as the central solution for layout
design, printing, faxing, e-mailing, archiving, barcode printing, cheque
printing and secured printing in banks, insurance companies and medium and large
corporations. PrintBOS is also a recognized complementary solution for SAP
layout design and printing and integrates SAP output with other enterprise
software outputs.
PrintBOS was designed for a wide range of operating systems, including mainframe
and UNIX.
PrintBOS customers use it for a variety of documents- from forms, reports,
barcodes and labels to faxes and cheques. PrintBOS transparently intercepts
these print jobs and applies the correct graphic formatting to create the
customer's preferred output. Time and labor-saving, PrintBOS allows employees to
focus on more added-value tasks than output jobs.
(b) COMMUNICATION SOLUTIONS
Our communication products include multi-path, intelligent routing VoIP
gateways, GSM gateways and other cellular gateways. Designed for the corporate
market, these devices enable major reduction of inter-office, long-distance and
cellular-to-line communication costs using VPN, cellular-to-cellular networks or
the public Internet to carry telephone calls.
Additionally, they extend PBX functionality to enterprise branch offices.
Supporting standard protocols, the gateways are built on robust platforms to
allow modular incorporation of value-added applications.
Designed for the enterprise market and OEMs, our Claro VoIP solutions are the
preferred choice for sites requiring from just a few connections to mid-market
sites with hundreds of connections. Our VoIP products are distinguished by their
seamless integration. For end users, this means absolutely no change in their
familiar work environment, eliminating a learning curve. For enterprises, it
translates into a more affordable, attractive investment, as VoIP products fit
in with existing equipment, and demand no changes or additions, delivering
significant, measurable economies of cost.
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The Cellular Gateways Solutions of Quasar Telecom have become an integral part
of the Communication division with their acquisition in 2004 (see Item 4A).
Quasar Telecom's proven cellular technology creates gateways between the
corporate PBX and cellular network to enable cost savings of communication cost.
In 2004, 16% of our sales were attributable to sales of communication products
and services.
(c) ELECTRONIC COMPONENTS
Our subsidiary, Odem, is engaged in solutions of electronic and
electromechanical components and electronic systems for local and international
customers in the defense industry and in the telecommunications and imaging
branches.
Odem, distributes components and represents suppliers in three areas:
o Electronic components
o Information technology hardware
o Image processing products
ELECTRONIC COMPONENTS
Odem imports electronic components and distributes them to the local defense and
civilian electronic industries. It represents suppliers of components in four
categories:
1) Active Components - semiconductors, transistors, detectors, diodes,
integrated circuits, hybrid modems, cellular components, communication ICs,
memories, displays, and LEDS;
2) Passive Components - capacitors, thermistors, varistos, oscillators,
crystals, resistors, C-DC converters, and power supplies;
3) Electro-mechanical Components - relays, connectors, circuit breakers,
filters, transformers, plugs, thermostats, switches, etc.
4) Discontinued Semiconductors- made by Intel, Fairchild, Harris, Microchip,
National, Quality SMC, Texas Instruments, Vantis, Motorola, and more.
INFORMATION TECHNOLOGY
Odem provides full access solutions for IT and telecommunications (LAN/WAN)
applications, selling communication servers, multi-protocol print servers,
server adapters, USB products, switches, fiber optics equipment, ADSL and XDSL
routers, modems, VoIP equipment, ATM devices, and more. During 2004, Odem begun
to provide products and solutions in the filed of RFID (Radio Frequency
Identification Devices), a market that is believed to become an additional
growth engine in the near future.
This identification technology requires a power source at one end only, usually
the scanning device, while the scanned device does not require power source.
These RF based products are currently used in identifying livestock (cattle) and
pets (municipal authorities can read data without physically catching the
animal) and in motor racing, and has a large potential in consumer applications,
such as product marking and automated billing in supermarkets and department
stores.
IMAGE PROCESSING PRODUCTS
Odem markets image processing products, Charge-Coupled-Device (CCD) and CMOS
imaging technologies. The products and technologies Odem markets in this field,
such as CCD & CMOS sensors, line and area scan and camera interface items, are
used in applications of management and quality control in production lines for
products such as semiconductors, PCBs, and textiles.
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In 2004, 23% of our sales were attributable to sales of the Electronic
Components Solutions segment. This rate is expected to grow during 2005 as
Odem's operating results will be fully consolidated.
PRODUCTS
Our product offering is currently comprised of solutions in the fields of
connectivity, communication and electronic components.
(a) CONNECTIVITY SOLUTIONS -
Our products are divided into three areas:
o connectivity emulation solutions,
o gateway/server solutions,
o software utilities solution,
(a1) CONNECTIVITY EMULATION SOLUTIONS
Our emulation products provide personal computer users with easy access to
computer applications and data on IBM midrange computers. These products
establish communications connections between an end user's personal computer or
Local Area Network and IBM midrange computers using TCP/IP, easy-to-use network
or Twinax hardware and software.
Our connectivity emulation products include emulation boards, emulation
software, and controllers as described below:
EMULATION BOARDS
o NATIVE PLUS.
An IBM-compatible Twinax card with 5250 Stealth Technology (TM). This
product does not require a memory segment of the personal computer or
its valuable resources in order to facilitate interaction with the
hardware.
o BOSaNOVA PLUS.
An enhanced version of the Native Plus that includes a Twinax adapter
card with feature-rich 5250 display/printer emulation software for
either DOS, 16- or 32-bit Windows and 32-session APPC display/printer
emulation software. This product is based on an IBM compatible Twinax
card with 5250 Stealth Technology(TM).
EMULATION SOFTWARE
o BOSaNOVA TCP/IP.
A robust client application that provides Windows9x/Me/NT/2000/XP
users on a TCP/IP network with essential iSeries connectivity. The
product includes BOS's rich 5250 emulation, LPD printing capabilities,
file transfer and a remote command facility.
o BOSaNOVA WEB
A Java-based application that provides iSeries users with TN5250e
emulation and printing and SQL-based data transfer on personal
computers via an Internet browser. It is aimed at organizations that
use the Internet and intranet for an increasing number of
applications. BOSaNOVA WEB enables any user equipped with a
Java-enabled Web browser to securely access iSeries applications,
eliminating the need to install and upgrade emulation software on each
of the attached clients, and reducing the maintenance and overhead
usually associated with installation and updating of client
applications for secure communication over traditionally non-secure
TCP/IP networks. BOSaNOVA WEB includes SSL data encryption, IP address
restriction and BOSaNOVA WEB server log-in.
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o BOSaNOVA SECURE
A BOSaNOVA Secure is an all-in-one solution for totally secure iSeries
emulation delivering security from the workstation through the gateway
to the organization level. Secured TN5250 emulation solution for the
Desktop on the TCP/IP net. Implements SSL and SSO (Single Sign ON)
with Kerberos. This outstanding security emulation provides a
comprehensive net security solution, including data on the net. While
current customers can implement the SSL protocol and SSO (Single Sign
ON) add BOSaNOVA Secure to BOSaNOVA TCP/IP, new customers are offered
BOSaNOVA Secure.
(a2) GATEWAY/SERVER SOLUTIONS
Our gateway solutions provide host access to personal computers not directly
connected to the host, either through remote gateways, which allow personal
computer users to receive emulation sessions over telephone lines, or through
Local Area Network gateways, which provide a bridge between the host and all
personal computers on a local area network. Gateways, residing in the same
physical premises as the host and connected to it directly, are connected to the
host on one side, and either Local Area Network or serial communication port on
the user side. Remotely attached gateways replace controllers and primarily
serve users of one remote office or site. Most users at the remote site are
connected through the Local Area Network to the gateway. Remote gateways usually
utilize some sort of System Network Architecture protocol to connect to the
host.
Our gateway/server products include:
o E-TWIN@X CONTROLLER.
This product provides IP over Twinax connection to local and remote
Series, adding the benefits of a Local Area Network to existing Twinax
infrastructure. This product eliminates the difficulty of maintaining
System Network Architecture and Anynet protocols, replacing them with
fast, state-of-the-art Transmission Control Protocol / Internet
Protocol (TCP/IP).
o ADVANCED SERVER FOR SAA.
A gateway package for connecting LAN-based personal computers to IBM
midrange (iSeries) hosts. Advanced Server for SAA is comprised of
server and client workstation software that facilitates communication
between the personal computer and the host, thereby conserving host
resources for more important tasks such as serving more simultaneous
users. The product was introduced to the European market at the end of
1996 and to the US market in the fourth quarter of 1997.
(a3) SOFTWARE UTILITIES SOLUTIONS
A PRINTBOS is an Enterprise Output Management solution answering a growing
demand for central printing and output management solutions in medium and large
IT organizations. PrintBOS is implemented as the central solution for layout
design, printing, faxing, e-mailing, archiving, barcode printing, cheque
printing and secured printing in banks, insurance companies and medium and large
corporations. PrintBOS is also a recognized complementary solution for SAP
layout design and printing and integrates SAP output with other enterprise
software outputs.
23
PrintBOS was designed for a wide range of operating systems, including mainframe
and UNIX.
(b) COMMUNICATION SOLUTIONS -
Our products are divided into two areas:
o VoIP Gateways Solutions
o Cellular Gateways Solutions
(b1) VoIP GATEWAYS SOLUTIONS
o CLARO 3000 GATEWAYS
The Claro 3000 family provides a complete, integrated solution with
the existing telephony network, while supporting ISDN PRI (E1/T1),
ISDN BRI and analog telephony interfaces. Claro gateways provide
superb audio quality in an easy-to-install and maintain affordable
solution. Claro supports ISDN PRI (E1/T1), ISDN BRI and analog
telephony interface. All that needs to be done is to plug the PBX
trunk (PRI E1/T1, BRI or analog lines) into one side of the Claro
gateway, the PSTN Central Office lines into the other, and then
connect the gateway to the IP network. The organization's existing
equipment is fully leveraged, without PBX customization, and without
the expense of additional lines or voice cards. Businesses maximize
savings while guaranteeing clear calls in a no-risk investment that
does not require any changes in current equipment. Best of all,
employees enjoy fully transparent usage: no change in dialing habits
at all. Voice quality is optimized through unique algorithms that
boost Quality of Service to maximize stable clarity. Moreover, Claro
is always up, with instant access to PSTN at any time, and no single
point of failure.
o CLARO 3031 GATEWAYS
Designed for small offices, Claro 3031 is a compact combination call
and data routing solution for remote and branch offices. It transforms
any two-line analog office phone system into a feature-rich converged
voice/fax/data communication network. Claro 3031 delivers superb audio
quality, is easy to install and maintain, and is highly affordable.
Claro 3031 supports LAN switching, WAN routing and VoIP in one
small-footprint package. It guarantees carrier-grade voice quality
connections while maximizing cost-savings, with automatic routing to
PSTN when the IP network cannot deliver the pre-specified quality
level.
o CLARO 2000 GATEWAYS
Claro 2000 family delivers VoIP using existing telephony network,
while providing a solution for termination and origination through the
same gateway. Proprietary quality-boosting algorithms ensure the
highest voice quality, while continuous operations are guaranteed
because there is no single point of failure. In short, these gateways
deliver superb audio quality, are easy to install and maintain, and
are highly affordable. Claro 2010/2020/2050/2060 supports ISDN PRI
(E1/T1) and analog (FXS and FXO) telephony interface.
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o CLARO TO GO
Claro to Go is USB device for IP telephony with analog phones. Now the
user away from the office can enjoy all the savings of IP in a
completely transparent manner. Claro to Go plugs into the USB port of
a PC or laptop on one side, and into any analog telephone on the
other. Digital voice quality is crystal clear. Claro to Go works
seamlessly with other Claro to Go units and Claro IP telephony
gateways, and can take advantage of all their features. Works
seamlessly with gatekeeper and SIP proxies for service providers.
Claro to Go supports Flash to enable supplementary services such as
Call Transfer, Conference Call and Voice Mail call.
(b2) CELLULAR GATEWAYS SOLUTIONS
The CelluLink product line creates a direct connection between the office PBX
and the cellular network. CelluLink enables cost savings, as it eliminates the
interconnection charges between cellular and landline (PTT) networks.
MARKETING, DISTRIBUTION AND SALES
We market our products primarily to medium to large sized corporations through a
combination of direct sales, indirect distribution and original equipment
manufacturers, with our primary focus on resellers and distributors.
In the United States, up until the fourth quarter of 2002, we marketed our
BOScom products through a US subsidiary (the BOS US division of PacInfo). Since
January 2003, we market our products through one Master Distributor located in
Phoenix, Arizona, which coordinates the midrange connectivity-related marketing
efforts of dozens of distributors and resellers, and also offers technical
support and after-sales service. Odem operates in the United States through a
wholly owned company, Rubi-Tech, Inc., located in Sherbourn, Massachusetts.
In Europe, up until the second quarter of 2003, we marketed our BOScom products
through subsidiaries in U.K and France. Currently, we market our products
through local distributors that provide pre and post sales support. Products
sold in the rest of the world are serviced from our headquarters in Israel.
We further rely on peripheral product distributors who offer our products along
with other products for the IBM midrange market. We also rely on value added
resellers who offer system sales and installation which include a variety of our
products. In addition, we heavily depend upon our own marketing resources
operating from Israel.
Our largest customer is our Master Distributor located in Phoenix, Arizona.
We generally do not have any significant backlog because orders are usually
shipped when received.
Our Company's sales do not fluctuate seasonally, with the exception that third
quarter sales are affected by vacations in Europe and the holidays in Israel,
and December and January sales are affected by the Christmas and New Year
festivals.
The following table sets forth our revenues (in thousands of US$) from the
continuing operations, by major geographic area, for the periods indicated
below:
2004 % 2003 % 2002 %
----- --- ----- --- ----- ---
United States 3,252 39% 2,974 52% 4,989 53%
Europe 1,066 13% 1,198 21% 2,148 23%
Israel and others 3,964 48% 1,556 27% 2,304 24%
----- --- ----- --- ----- ---
Total Revenues 8,282 100% 5,728 100% 9,441 100%
===== === ===== === ===== ===
See Note 18b to the Consolidated Financial Statements.
25
MANUFACTURING
Our products are designed, integrated and tested at our facilities in Israel.
The manufacturing is done by Israeli subcontractors using components and
subassemblies supplied by vendors to our specifications. Certain components and
subassemblies used by us in our existing products are purchased from a single
supplier or a limited number of suppliers. Most of the imported components are
purchased in Israel from local representatives of the manufacturers. Some of
them have exclusive representative rights in Israel. In the event that these
suppliers are unable to meet our requirements in a timely manner, we may
experience an interruption in production until an alternative source of supply
can be obtained. We do our best effort to keep sufficient quantities of
components that will enable us to find a second source, when needed. We
generally maintain an inventory of components and subassemblies which we believe
is sufficient to limit the potential for such an interruption. Our current
manufacturing facilities have sufficient capacity to exceed current demand. The
prices of raw materials used in our industry are volatile and availability of
electronic components may vary due to changing demands in the market.
INTELLECTUAL PROPERTY
We currently rely on a combination of trade secrets, copyright and trademark
law, together with non-disclosure agreements and technical measures, to
establish and protect proprietary rights in our products.
We believe that the improvement of existing products, reliance upon trade
secrets and proprietary know-how and the development of new products are
generally as important as patent protection in establishing and maintaining a
competitive advantage. We believe that the value of our products is dependent
upon our proprietary software and hardware remaining "trade secrets" or subject
to copyright protection.
Generally, we enter into non-disclosure and invention assignment agreements with
our employees and subcontractors. However, there can be no assurance that our
proprietary technology will remain a trade secret, or that others will not
develop a similar technology or use such technology in products competitive with
those offered by us.
While our competitive position may be affected by our inability to protect our
proprietary information, we believe that because of the rapid pace of
technological change in the industry, factors such as the technical expertise
and the knowledge and innovative skill of our management and technical
personnel, name recognition, the timeliness and quality of support services
provided by us and our ability to rapidly develop, produce, enhance and market
software products may be more significant in maintaining our competitive
position.
To date, no material claims have been made against us for infringement of
proprietary rights of third parties. There can be no assurance, however, that
third parties will not assert material infringement claims against us in the
future.
As the number of software products in the industry increases and the
functionality of these products further overlaps, we believe that software
programs will increasingly become subject to infringement claims. The cost of
responding to any such assertion may be material, whether or not the assertion
is valid.
COMPETITION
Connectivity Solutions:
The connectivity market is subject to rapidly changing technology and evolving
standards incorporated into personal computers, networks and host computers.
BOS's products compete with products that have already been on the market for a
number of years and manufactured by competitors, most of which have
substantially greater financial, marketing and technological resources and name
recognition than ours.
26
Our competitors include IBM, Perle, Advanced Business Link, IGEL, CLI PowerTerm,
NLynx, NetManage, Attachmate, and Seagull, Adobe, Optio and Formscape.
Communication Solutions:
The Communication industry is highly competitive. Some of the competitors in the
VoIP market include Cisco Systems, Inc., Nortel, Alcatel, Multi-Tech, Mediatrix,
VegaStream and Quintum. There can be no assurance that these or other companies
will not offer lower priced or more sophisticated products than those being
developed or introduced by the Company, and by so doing capture the market for
such products.
Electronic Components Solutions:
The common practice in the industry is that suppliers and manufacturers usually
grant a non-exclusive representation right in a specific territory. As long as
sales reach a reasonable level and the relationship between the parties is good,
the supplier will usually not grant another representation in the agreed
territory.
Although Odem does not posses exclusive representation agreements, in most cases
it does not have a local competitor who distributes components of the same
source.
The number of cases in which territorial-based distributing agreements are
challenged by foreign large distributors, who receive a special discount on
large volume purchases and compete with the local distributor by selling
directly to its customers, is increasing. Still, despite inferiority in pricing,
local distributors have some advantages over such competition by providing close
and continuous technical support, large inventory, a wide spectrum of products
and short reaction time.
Odem currently represents about 30 overseas suppliers, out of which
approximately 20 are electronic components suppliers, 8 market IT equipment, and
2 are suppliers of market image-processing products.
There are more than 200 agents and distributors operating in the electronic
components market in Israel. Five local electronic component distributing
companies - Telsys Ltd., Nisco Projects Ltd., STG Ltd., Semicom Ltd. and Rapac
Electronics Ltd., are publicly traded on the Tel Aviv stock exchange. Other
large and influential companies which are active in the electronic components
market are Eastronics Ltd., STG International Ltd., Chayon Computers Ltd., RDT
Ltd. and Abnet Communications Ltd.
STRATEGY
The Company's strategy is to enable organizations to increase operational
efficiencies while leveraging their existing infrastructure. We will continue to
focus and enhance our existing product lines while continuing to search for
additional growth through merger and acquisitions. As the competitive markets
drive organizations to seek continuous improvements and cost cuts, we believe
that our products can improve the cost effectiveness of customer information
systems and increase user productivity with:
o easy simultaneous access to and use of customer host and LAN-based
computing resources;
o familiar and easy-to-set-up and use communications among personal
computers, LANs and host computers;
o utilities and tools that simplify distributing computing between IBM
midrange host systems and personal computer and LAN systems;
o utilities and tools that improve the appearance and distribution
efficiency of forms throughout the organization; and
o utilities and tools that enhance and preserve customer investment in
equipment and personnel training.
27
The key elements of our strategy are as follows:
o MAXIMIZE EFFICIENCY FOR IBM MIDRANGE MARKET. Through our Connectivity
Solutions division, we intend to expand and support our emulation
product line for IBM midrange computers. This includes continuous
upgrading and improvement of our connectivity emulation products for
direct, gateway and Internet connection, and Windows emulation and
graphics capabilities. We continually upgrade our client software to
ensure its compatibility with each new Windows platform. We intend to
streamline our manufacturing and distribution to better serve our
present client base and access a greater share of the IBM midrange
market. We have already begun to incorporate common components into
our products in an effort to streamline manufacturing and intend to
take steps to improve our destination networks.
o DEVELOP NEW MARKETS AND PRODUCTS FOR OUR COMMUNICATION SOLUTIONS. We
intend to develop and expand into new markets for our communication
products while expanding our communication products offering,
including corporate VOIP infrastructures as well as VOIP solutions for
telephony service providers while merging additional capabilities into
the world of cellular communication gateways.
o CONTINUE TO SEARCH FOR ADDITIONAL COMPANIES TO REPRESENT through our
Electronic Components division.
o EXPAND MARKETING NETWORK. We intend to increase our marketing presence
in the United States, Europe and the Far East, and to expand our
distribution channels in these markets through the use of
acquisitions, additional independent distributors and original
equipment manufacturers as well as our sales representatives.
o ACQUISITION OF COMPLEMENTARY TECHNOLOGIES. We may, from time to time,
make selective acquisitions of complementary technologies that we can
sell through our existing distribution network.
WEB SITE: We maintain a web site where potential customers, investors and others
can obtain the most updated information about our activities, products, press
releases and financial information. Our Web site may be found at
www.boscorporate.com.
EXCHANGE CONTROLS
See Item 10D.
For other government regulations affecting the Company's business, see Item 5,
paragraph entitled 'Grants and Participation'.
4C. ORGANIZATIONAL STRUCTURE
The Company's wholly owned subsidiaries include:
IN ISRAEL - (1) BOScom Ltd. (formerly Lynk, a Division of B.O.S. Ltd.). (2)
Quasar Telecom (2004) Ltd. ("Quasar Telecom"), which obtained the assets we
acquired from Quasar Communication Systems Ltd., an Israeli company engaged in
the business of developing, manufacturing and selling cellular communication
gateways, on September 29, 2004 (see item 4A).
28
We also hold 63.8% of the issued and outstanding shares of Odem Electronic
Technologies 1992 Ltd. ("Odem"), which we purchased on November 18, 2004 from
Odem's existing shareholders. Odem, an Israeli company, is a major solution
provider and distributor of electronics components and advance technologies in
the Israeli market (see item 4A).
IN EUROPE - BOScom has a UK subsidiary, Better On-Line Solutions Ltd., and its
subsidiary, Better On-Line Solutions S.A.S in France, which, until mid-2003,
distributed and serviced BOScom's products abroad. In mid-2003 we decided, due
to cost-efficiency considerations, to cease operations in Europe through the
subsidiaries and to market through distributors and resellers.
IN THE U.S. - Lynk USA Inc., and its subsidiary PacInfo (both Delaware
corporations) and PacInfo's subsidiary, Dean Tech Technologies Associates, LLC.
("Dean Tech"), a Texan corporation, none of which are operational. Until the
fourth quarter of 2002, the marketing and distribution of the BOScom products
was carried out through the "BOS US" division of PacInfo.
In October 2002, BOScom established a new wholly-owned subsidiary, BOSDelaware,
a Delaware corporation, and in the future may market and distribute its products
in the US through this subsidiary. Currently, the US marketing is carried out
through a master distributor, and BOSDelaware is not operational.
The voting power we (or our subsidiaries) have in all subsidiaries, equates to
our shareholdings.
The Company also has an interest in Surf Communication Solutions Ltd. ("Surf").
We have been investing in Surf since 1997 (see Item 4A).
4D. PROPERTY, PLANTS AND EQUIPMENT
Our executive offices and engineering, development, testing, shipping and
service operations are located in three Israeli facilities (in Teradyon, Rehovot
and Rishon Lezion), and occupy a total of approximately 4,880 square meters. BOS
and BOScom occupy 3,300 square meters in Teradyon pursuant to a lease which will
expire in December 2005. Odem occupies 707 square meters in Rishon Lezion, of
which 302 square meters are owned by Odem and the remaining space is rented
pursuant to a monthly lease agreement. Quasar Telecom occupies 873 square meters
in Rehovot pursuant to a lease which will expire in June 2005. Quasar Telecom is
currently negotiating a new lease agreement with the same lessor, with the
purpose of reducing the rented area to 450 square meters from April 2005 and to
extend the lease agreement until June 2007. The monthly rental fees of the
Company and its subsidiaries currently amount to $18,000.
The facility in Teradyon is located in a part of Israel which has been
designated by the government as a "Development A" area. This designation relates
to the benefits available to us as an "Approved Enterprise" under Israeli law,
that entitles us and our shareholders to reduced income tax rates on our income
and on dividend distributions.
We believe that our facilities are sufficient to accommodate our anticipated
needs in the foreseeable future.
ITEM 5: OPERATING AND FINANCIAL REVIEW AND PROSPECTS
The following management's discussion and analysis of financial condition and
results of operations should be read in conjunction with our financial
statements and notes thereto. Certain matters discussed below and throughout
this annual report are forward-looking statements that are based on our beliefs
and assumptions as well as information currently available to us. Such
forward-looking statements may be identified by the use of the words
"anticipate", "believe", "estimate", "expect", "plan" and similar expressions.
Such statements reflect our current views with respect to future events and are
subject to certain risks and uncertainties. While we believe such
forward-looking statements are based on reasonable assumptions, should one or
more of the underlying assumptions prove incorrect, or these risks or
uncertainties materialize, our actual results may differ materially from those
described herein. Please read the section below entitled "Factors That May
Affect Future Results" to review conditions that we believe could cause actual
results to differ materially from those contemplated by the forward-looking
statements.
29
The Company's discussion and analysis of its financial condition and result of
operations is based upon the Company's consolidated financial statements which
have been prepared in accordance with generally accepted accounting principles
("GAAP ") in the United States of America.
CRITICAL ACCOUNTING POLICIES
USE OF ESTIMATES
The preparation of these financial statements required the Company to make
estimations and judgments, in accordance with U.S. GAAP, that affect the
reporting amounts of assets, liabilities, revenues and expenses and related
disclosure of contingent assets and liabilities. On an ongoing basis, the
Company evaluates its estimates, including those related to revenue recognition,
bad debts, inventories, and legal contingencies. The Company based its estimates
on historical experience and on various other assumptions that are believed to
be reasonable under the circumstances, the results of which form the basis of
making judgments about the values of assets and liabilities that are not readily
apparent from other sources. Actual results may differ from these estimates
under different assumptions or conditions.
For a review of the accounting policies that form the basis of the
above-referenced estimates and judgments that the Company made in preparing its
consolidated financial statements, please see Note 2 (Significant Accounting
Policies) to the Consolidated Financial Statements. The following accounting
policies had the most significant impact on the Financial Statements for the
year ended December 31, 2004.
INVENTORY
Inventories are valued at the lower of cost or market value. Cost is determined
as follows: Raw and packaging materials - moving average cost method. Products
in progress and finished products - on the production costs basis (see also Note
4 to the Consolidated Financial Statements). If actual market conditions prove
less favorable than those projected by management, additional inventory
write-downs may be required. Inventories are written down for estimated
obsolescence based upon assumptions about future demand and market conditions.
Likewise, favorable future demand and market conditions could positively impact
future operating results if inventory that has been written down is sold.
INVESTMENT IN AN AFFILIATED COMPANY
An affiliated company is a company in which the Company is able to exercise
significant influence, but that is not a consolidated subsidiary and is
accounted for by the equity method, net of write-down for decrease in fair value
which is not of a temporary nature.
If there is a sudden and significant decrease in the fair values of our
investments in affiliate companies, we may be required to write off part of our
investments due to impairment. The Company's investment in an affiliated company
is reviewed for impairment whenever events or changes in circumstances indicate
that the carrying amount of the investment may not be recoverable, in accordance
with Accounting Principle Board Opinion No. 18 "The Equity Method of Accounting
for Investments in Common Stock" ("APB No. 18"). During 2004, 2003 and 2002,
based on management's analyses, no impairment losses have been identified.
30
GOODWILL, INTANGIBLE ASSETS AND OTHER LONG-LIVED ASSETS
Under current accounting standards, we make judgments about the remaining useful
lives of goodwill, other intangible assets and other long-lived assets,
including assumptions about estimated future cash flows and other factors to
determine the fair value of the respective assets.
We have adopted SFAS No. 142 "Goodwill and Intangible Assets" issued in July
2001. Pursuant to SFAS No. 142 goodwill and intangible assets that have
indefinite useful lives will not be subject to amortization, but instead will be
tested at least annually for impairment. Intangible assets that have finite
useful lives will continue to be amortized over their useful lives, but without
the constraint of an arbitrary.
Goodwill represents excess of the costs over the net assets of businesses
acquired. SFAS No. 142 requires goodwill to be tested for impairment at least
annually or between annual tests in certain circumstances, and written down when
impaired. 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. Fair value is determined using income and market approaches. Significant
estimates used in the methodologies include estimates of future cash flows,
future short-term and long-term growth rates, weighted average cost of capital
and estimates of market multiples for each of the reportable units. During 2004,
2003 and 2002 no impairment losses have been identified.
We adopted SFAS No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets" as of January 1, 2002. SFAS No. 144 requires that long-lived
assets be reviewed for impairment 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 future cash flows expected to be generated by the
asset or used in its disposal. If the carrying amount of an asset exceeds its
estimated future cash flows, an impairment charge is recognized. Long lived
assets held for sale are reported at the lower of the carrying amount or fair
value less costs to sell, and are not depreciated from the day they are
classified as held for sale.
REVENUE RECOGNITION
The Company derives its revenues from the sale of products, license fees for its
products, commissions, maintenance, support and services.
Revenues from product sales are recognized in accordance with Staff Accounting
Bulletin No. 104 "Revenue Recognition in Financial Statements" ("SAB 104") when
delivery has occurred, persuasive evidence of an arrangement exists, the
vendor's fee is fixed or determinable, no further obligation exists, and
collectability is reasonably assured.
Revenues from license fees are recognized in accordance with Statement of
Position ("SOP") 97-2 "Software Revenue Recognition", when persuasive evidence
of an agreement exists, delivery of the product has occurred, no significant
obligations with regard to implementation remain, the fee is fixed or
determinable, and collection is probable. The Company generally does not grant a
right of return to its customers. When a right of return exists, the Company
defers revenue until the right of return expires, at which time revenue is
recognized provided that all other revenue recognition criteria have been met.
Revenues from maintenance and support are recognized ratably over the period of
the maintenance contract. The fair value of the maintenance is determined based
on the price charged when it sold separately or renewed.
Revenues derived from the Company's master distributor in the U.S. are
recognized based on consignment method.
31
Revenues from commissions are recognized upon their actual receipt, since under
agreements with suppliers consideration is received on the basis of collection
from customers.
LEGAL CONTINGENCIES
The Company has been a party to various legal proceedings in the normal course
of its business (see Item 8A for more details). The results of legal proceedings
are difficult to predict and an unfavorable resolution of a lawsuit or
proceeding may occur. Management believes that the prospects of these
proceedings to prevail and recover a significant amount, seem remote, and
accordingly no provision was recorded. As additional information becomes
available, management will reassess the potential liability related to these
legal proceedings and may revise its estimate of the probable cost of this
proceedings. Such revisions in the estimates of the probable cost could have a
material adverse effect on the Company's future results of operations and
financial position.
5A. RESULTS OF OPERATIONS
COMPARISON OF 2004 AND 2003
Year 2004 results of operation reflected the following strategic actions:
o Reorganization in sales and marketing organization in Europe:
Up until the second quarter of 2003, we marketed our BOScom products
through subsidiaries in the U.K. and France. Since the third quarter
of 2003, we market our products through local distributors that
provide pre and post sales support. Products sold in the rest of the
world are serviced from our headquarters in Israel. As a result, the
sales and marketing expenses were reduced in year 2004 in comparison
to year 2003.
o Dividing the Company operations into three segments:
Commencing in 2004 and subsequent to the acquisition of a controlling
stake of Odem and of most of the assets of Quasar Communication
Systems Ltd. (which were transferred to our subsidiary, Quasar
Telecom), the Company manages its business in three reportable
segments, which consist of Connectivity Solutions, Communication
Solutions and supply of Electronic Components (see also Note 18 to the
Consolidated Financial Statements). This action was accompanied by an
increase in senior officers which mainly affected the general and
administrative expenses which increased in comparison to year 2003.
o Business Combination:
The abovementioned acquisitions partially affected the Company's
results of operation, since the results of operations of Quasar
Telecom and Odem were consolidated commencing September 28, 2004 and
November 18, 2004, respectively. As a result, the revenues, cost of
goods and general and administrative expenses were increased in year
2004 in comparison to year 2003 (see also Note 1b to the Consolidated
Financial Statements).
Consolidated revenues for year 2004 were $8,282,000 compared with $5,728,000 in
2003, a 44.6% increase, which is mainly due to the consolidation of Quasar
Telecom and Odem operations.
Gross profit in 2004 totaled $3,674,000, representing 44.4% of revenues,
compared with $4,273,000, constituting 74.5% of revenues in 2003. Cost of
revenues of year 2003 includes income of $339,000 due to a reversal of a
non-recurring royalty for the Office of the Chief Scientist (see also Note 17a
to the Consolidated Financial Statements). Excluding such income, the gross
profit for year 2003 represented 68.6% of revenues compared to 44.4% in year
2004. The major reason for the decrease in the gross margin was the acquisition
of Odem in November 2005. Odem's gross profit represents 17% of revenues. The
gross profit will continue to decline as a result of the full inclusion of Odem
activity in 2005 and thereafter.
32
Net research and development costs in 2004 amounted to $1,804,000 compared to
$1,846,000 in 2003. Grants and participation from the Office of the Chief
Scientist amounted to $492,000 in year 2004 compared to $283,000 in year 2003.
Sales and marketing expenses decreased by 21.7% to $1,706,000 in year 2004
compared to $2,178,000 in 2003, mainly due to the reorganization in sales and
marketing which is described above.
General and administrative expenses increased by 29.4% to $1,705,000 in year
2004 compared to $1,317,000 in 2003, mainly due to an increase in the number of
senior officers. Restructuring costs in year 2003 amounted to $678,000 which
resulted from ceasing the operation of the Company's subsidiaries in Europe.
As a result of the foregoing, our operating loss in year 2004 was $1,541,000
compared to an operating loss of $1,746,000 in year 2003.
Financial expenses amounted to $158,000 in year 2004 compared with net financial
income of $109,000 in year 2003. The major reason for year 2004 financial
expenses was related to the convertible note (see also Note 17b to the
Consolidated Financial Statements).
Equity in losses of an affiliated company refers to investment in Surf which
amounted to $308,000 in 2004 compared to $465,000 in 2003. The investment in a
company is stated at equity method, since the Company's holding in Surf exceeded
20% (see also Note 6 to the Consolidated Financial Statements).
Minority interest in earning of subsidiary refers to investment in Odem. The
minority rights in Odem amounted to 36.2% of its earnings (see also Note 1b to
the Consolidated Financial Statements).
As a result, net loss from the continuing operations for 2004 amounted to
$2,044,000 compared with loss of $2,057,000 in 2003. On a per share basis, the
net loss from the continuing operations in 2004 was $0.44 per share compared
with a $0.56 net loss per share in 2003. (For details regarding computation of
net loss per share, see Note 17c to the Consolidated Financial Statements.)
The loss related to the discontinuing operations for 2004 was $9,000 compared
with an income of $2,036,000 in 2003. The income of 2003 resulted from debt
settlement with more than 95% of PacInfo's external creditors for an amount
which was significantly lower than the face value of the debt.
The total net loss for 2004 was $2,053,000, compared with loss of $21,000 in
2003. On a per share basis, the net loss in 2004 was $0.44 per share compared
with a $0.01 net loss per share in 2003.
COMPARISON OF 2003 AND 2002
Year 2003 results of operation reflected the reorganization made in the sales
and marketing organization. In the United States, up until the fourth quarter of
2002, we marketed our BOScom products through a US subsidiary (the BOS US
division of PacInfo). Since 2003, we market our products through one Master
Distributor.
In Europe, up until the end of the second quarter of 2003, we marketed our
BOScom products through subsidiaries in the U.K. and France. Currently, we
market our products through local distributors that provide pre and post sales
support. Products sold in the rest of the world are serviced from our
headquarters in Israel.
33
As a result of the above reorganization, the Company experienced a significant
decrease in revenues in 2003, due to the distributors' margin, which was only
partially compensated for by the decrease in sales and marketing expenses.
Furthermore, as a result of the reorganization, in 2003 the Company recorded a
restructuring cost of $678,000.
Consolidated revenues for 2003 were $5,728,000 compared with $9,441,000 in 2002,
a 39% decrease.
The major reasons for the decrease were: (a) sales through master distributors
in year 2003 compared to sales through subsidiaries in year 2002, as the margins
of the master distributors decreased revenues; and (b) slowdown in sales due to
global slowdown in the telecommunications industry.
Gross profit in 2003 totaled $4,273,000, representing 75% of revenues, compared
with $7,141,000, constituting 76% of revenues in 2002. Cost of revenues of year
2003 includes income of $339,000 due to a reversal of a non-recurring royalty
for the Office of the Chief Scientist (see also Note 17a to the Consolidated
Financial Statements). Excluding such income, the gross profit for year 2003
represented 69% of revenues compared to 76% in year 2002, the major reasons for
the decrease being (a) sales through master distributors in year 2003 compared
to sales through subsidiaries in year 2002 which caused a decrease in the sale
price while the cost of revenue remained virtually the same; and (b) revenues of
BOSaNOVA PrintBoss in year 2003 decreased to $448,000 compared to $1,387,000 in
year 2002. Since the BOSaNOVA PrintBoss is a software product with a relatively
low cost of production, its decrease in revenues in year 2003 compared to year
2002 significantly affected the gross profit.
Net research and development costs in 2003 decreased by 15% to $1,846,000
compared to $2,182,000 in 2002. The expenses in 2003 included $283,000 funding
that the Company received from the Office of the Chief Scientist. In 2002 the
Company did not receive such funding. Excluding the effect of the funds received
from the Office of the Chief Scientist in 2003, the research and development
costs in 2003 remained virtually the same as in year 2002.
Selling and marketing expenses in year 2003 decreased by 41% to $2,178,000,
compared to $3,705,000 in 2002. The major reason for such decrease was sales
through subsidiaries in 2002, as opposed to sales through distributors in year
2003 after the operation of the subsidiaries was ceased.
General and administrative expenses in year 2003 decreased by 22% to $1,317,000
compared to $1,697,000 in 2002. The major reason was the reduction in payroll of
employees and directors, by 17%, effected July 2003.
Restructuring costs in year 2003 amounted to $678,000 which resulted from
ceasing the operation of the Company's subsidiaries in Europe.
As a result of the foregoing, our operating loss in 2003 was $1,746,000 compared
to an operating loss of $443,000 in 2002.
The Company had net financial income of $109,000 in 2003 compared with net
financial income of $295,000 in 2002. The decrease in the financial income is
related to the decrease in cash and investment balances during 2003 and to
decrease of financial income from translation of foreign currency into dollar.
Equity in losses of an affiliated company refers to the Company's investment in
Surf which amounted to $465,000 in 2003 compared to $570,000 in 2002. The
investment in Surf is accounted for using the equity method, since the Company's
holding in Surf exceeds 20% (see also Note 6 to the Consolidated Financial
Statements).
34
As a result, net loss from the continuing operations for 2003 amounted to
$2,057,000 compared with $813,000 in 2002. On a per share basis, the net loss
from the continuing operations in 2003 was $0.56 per share compared with a $0.26
net loss per share in 2002. (For details regarding computation of net loss per
share, see Note 17c to the Consolidated Financial Statements.)
The net earnings related to the discontinuing operations for 2003 was $2,036,000
compared with a loss of $7,674,000 in 2002. The earnings of 2003 resulted from
debt settlement with more than 95% of PacInfo's external creditors for an amount
which was significantly lower than the face value of the debt.
The total net loss for 2003 was $21,000, compared with $8,487,000 in 2002. On a
per share basis, the net loss in 2003 was $0.01 per share compared with a $2.72
net loss per share in 2002.
VARIABILITY OF QUARTERLY OPERATING RESULTS
Our revenues and profitability may vary in any given year, and from quarter to
quarter, depending on the number of products sold. In addition, due to potential
competition, uncertain market acceptance and other factors, we may be required
to reduce prices for our products in the future.
Our future results will be affected by a number of factors including our ability
to:
o increase the number of products sold,
o acquire effective distribution channels and manage them,
o develop, introduce and deliver new products on a timely basis,
o anticipate accurately customer demand patterns and
o manage future inventory levels in line with anticipated demand.
These results may also be affected by currency exchange rate fluctuations and
economic conditions in the geographical areas in which we operate. There can be
no assurance that our historical trends will continue, or that revenues, gross
profit and net income in any particular quarter will not be lower than those of
the preceding quarters, including comparable quarters.
IMPACT OF INFLATION AND CURRENCY FLUCTUATIONS
The US Dollar cost of our operations in Israel is influenced by the differential
between the rate of inflation in Israel and any change in the value of the NIS
relative to the Dollar.
A devaluation of the NIS in relation to the US Dollar will have the effect of
decreasing the costs in NIS and a converse effect in case of devaluation of the
US Dollar in relation to the NIS.
A devaluation of the NIS in relation to the US Dollar will have the effect of
decreasing the Dollar value of any of our assets which consist of NIS (unless
such asset is linked to the Dollar). Such a devaluation would also have the
effect of reducing the Dollar amount of any of our liabilities which are payable
in NIS (unless such 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 our assets which consist of NIS (unless such
asset is linked to the Dollar). Such an increase would also have the effect of
increasing the Dollar amount of any of our liabilities which are payable in NIS
(unless such payables are linked to the Dollar).
In the years ended December 31 2004, 2003, 2002, 2001, and 2000, the annual
inflation rate in Israel as adjusted for the devaluation of the Israeli currency
in relation to the Dollar was 2.8%, 5.7%, (0.8)%, (7.8)%, and 2.7%,
respectively. The closing representative exchange rate of the Dollar at the end
of each such period, as reported by the Bank of Israel, was NIS 4.308, NIS
4.379, NIS 4.737, NIS 4.416, and NIS 4.041, respectively. As a result, the
Company experienced increases in the Dollar costs of operations in Israel in,
2000, 2003 and 2004, and decreases in 2001 and 2002.
35
EFFECTIVE CORPORATE TAX RATE
On June 2004, the Israeli Parliament approved an amendment to the Income Tax
Ordinance (No. 140 and Temporary Provision) (the "Amendment"), which
progressively reduces the regular corporate tax rate from 36% to 35% in 2004,
34% in 2005, 32% in 2006 and to a rate of 30% in 2007 and thereafter. The
amendment was signed and published in July 2004 and is, therefore, considered
enacted in July 2004.
The effective tax rate payable by a company such as ours which derives part of
its income from an "Approved Enterprise," may be considerably less. See Note 16b
to the Consolidated Financial Statements and Item 10E ahead. Subject to relevant
tax treaties, dividends or interest received by an Israeli corporation from
subsidiaries are generally subject to tax (unless the subsidiary's income is
subject to Israeli corporate tax) regardless of its status as an Approved
Enterprise. We anticipate that most of our taxable income over the next several
years will be tax exempt in Israel. Odem and Quasar Telecom operations are
subject to regular income tax rates.
On January 1, 2003, a comprehensive tax reform took effect in Israel. Pursuant
to the reform, resident companies are subject to Israeli tax on income accrued
or derived in Israel or abroad. In addition, the concept of "controlled foreign
corporations" was introduced, according to which an Israeli company may become
subject to Israeli taxes on certain income of a non-Israeli subsidiary if the
subsidiary's primary source of income is passive income (such as interest,
dividends, royalties, rental income or capital gains). The tax reform also
substantially changed the system of taxation of capital gains.
STAMP TAX LAW
The Israeli Stamp Tax on Documents Law, 1961, or the "Stamp Tax Law", provides
that certain documents signed by Israeli companies are subject to a stamp tax,
generally at a rate of between 0.4% and 1% of the value of the subject matter of
the applicable document. As a result of an amendment to the Stamp Tax Law that
came into effect in June 2003, the Israeli tax authorities have commenced
enforcement of the provisions of the Stamp Tax Law.
Consequently, we may be liable to pay stamp taxes on some or all of the
documents we have signed since June 2003, which could have a material adverse
effect on our results of operations.
Currently, the Israeli High Court of Justice is considering a petition
concerning the abovementioned amendment to the Stamp Tax Law and the enforcement
actions taken by the Israeli tax authorities. In addition, recently promulgated
regulations provide for a gradual phase-out of the stamp tax by 2008.
GRANTS AND PARTICIPATION
Under the Law for the Encouragement of Industrial Research and Development, 1984
(the "Research Law"), research and development programs approved by a research
committee appointed by the Israeli Government are eligible for grants in
exchange for payment to the Government of royalties from the sale of products
developed in accordance with the Program. Regulations issued under the Research
Law generally provide for the payment of royalties to the Office of the Chief
Scientist ("OCS") of 3.5% on sales of products developed as a result of a
research project so funded until 100% of the dollar-linked grant is repaid.
Royalties payable with respect to grants received under programs approved by the
OCS after January 1, 1999, are subject to interest on the U.S. dollar-linked
value of the total grants received at the annual rate of LIBOR applicable to
U.S. dollar deposits at the date the grants received.
36
The Research Law requires that the manufacture of any product developed as a
result of research and development funded by the Israeli Government take place
in Israel. It also provides that know-how from the research may not be
transferred to third parties without the approval of the Israeli Office of the
Chief Scientist in the Ministry of Industry and Trade. As of December 31, 2004,
the Company has an outstanding contingent obligation to pay royalties in the
amount of approximately $6,114,000 in respect of these grants, compared to
5,621,000 as of December 31, 2003.
We are committed to paying royalties to the Fund for the Encouragement of
Exports for its participation, by way of grants, in our marketing expenses
outside of Israel. Royalties payable are 3% of the growth in exports, from the
year we received the grant, up to 100% of the dollar-linked amount of the grant
received at the date the grants received. As of December 31, 2004, the Company
has an outstanding contingent obligation to pay royalties of $64,000 with
respect to these grants, compared with $144,000 on December 31, 2003.
CONDITIONS IN ISRAEL
We are incorporated under the laws of Israel. Our offices and product
development and manufacturing facilities are located in Israel. As a
consequence, we are directly affected by political, economic and military
conditions in Israel. Our operations would be substantially impaired if major
hostilities involving Israel should occur or if trade between Israel and its
present trading partners should be curtailed. See also Item 3D - Risk Factors.
POLITICAL AND ECONOMIC CONDITIONS
Since the establishment of the State of Israel in 1948, a number of armed
conflicts have taken place between Israel and its Arab neighbors and a state of
hostility, varying from time to time in intensity and degree, has led to
security and economic problems for Israel. A peace agreement between Israel and
Egypt was signed in 1979. However, economic relations have been limited. 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 written 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.
Despite the limited progress towards peace between Israel, its Arab neighbors
and the Palestinians, 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 the expansion of our business.
Some of our employees are obligated to perform annual reserve duty in the Israel
Defense Forces and may, at any time, be called for active military duty. While
we have operated effectively under those and similar requirements in the past,
no assessment can be made of the full impact of such requirements on us in the
future, particularly if emergency circumstances occur.
37
In recent years Israel has been going through a period of recession in economic
activity, resulting in low growth rates and growing unemployment. Our operations
could be adversely affected if the economic conditions in Israel continue to
deteriorate. In addition, due to significant economic measures proposed by the
Israeli Government, there have been several general strikes and work stoppages
in 2003 and 2004, affecting all banks, airports and ports. These strikes have
had an adverse effect on the Israeli economy and on business, including our
ability to deliver products to our customers. Following the passage by the
Israeli Parliament of laws to implement the economic measures, the Israeli trade
unions have threatened further strikes or work-stoppages, and these may have an
adverse effect on the Israeli economy and our business.
In 1998, the Israeli currency control regulations were liberalized dramatically.
As a result, Israeli citizens can generally freely purchase and sell Israeli
currency and assets. The Government of Israel has periodically changed its
policies in these areas. There are currently no Israeli currency control
restrictions on remittances of dividends on ordinary shares or proceeds from the
sale of ordinary shares; however, legislation remains in effect pursuant to
which currency controls can be imposed by administrative action at any time.
The costs of our operations in Israel are generally incurred in New Israeli
Shekels ("NIS"). If the inflation rate in Israel exceeds the rate of devaluation
of the NIS against the US Dollar in any period, the costs of our Israeli
operations, as measured in US Dollars, could increase. Israel's economy has, at
various times in the past, experienced high rates of inflation.
Like many Israeli companies, we receive grants and tax benefits from the Israeli
Government. We also participate in programs sponsored by the Israeli Government.
The reduction or termination of any such grants, programs or tax benefits,
especially those benefits available as a result of the "Approved Enterprise"
status of certain facilities in Israel, could have a materially adverse effect
on future investments by us in Israel.
5B. LIQUIDITY AND CAPITAL RESOURCES
We finance our activities by different means, including proceeds of equity
financing, long-term loans, grants from the Office of the Chief Scientist in
Israel and income from operating activities.
On June 10, 2004 the Company entered into a Securities Purchase Agreement (the
"Purchase Agreement"), with Laurus Master Fund Ltd. (the "Investor"), under
which the Company issued and sold to the Investor in a private placement (i) a
Secured Convertible Term Note of a $2 million principal amount, due June 10,
2007 (the "Note") and (ii) a warrant to purchase 130,000 Ordinary Shares at an
exercise price of $4.04 per share (the "Warrant"). The Warrant is exercisable,
in whole or in part, until June 10, 2011. The Note bears interest at a
fluctuating interest rate equal at all times to the WSJ prime rate plus 3%,
subject to reduction in any particular month, if the average closing price of
our Ordinary Shares for any five consecutive trading days, exceeds the
conversion price by at least 25%. The proceeds from the private placement will
be used for general working capital purposes and/or mergers and acquisitions.
The Note is convertible into Ordinary Shares at a price of $3.08 per share. The
note conversion price is subject to proportional adjustment in the event of
stock splits, combinations, subdivisions of the ordinary shares or if dividend
is paid on the ordinary shares in ordinary shares. In addition, if the Company
issues stock in certain types of transactions at a price lower than the initial
conversion price, then the conversion price will be adjusted to a lower price
based on a weighted average formula. As a result of the price per share in the
private placement offering described below (the closing of which is scheduled
for June 30, 2005), the conversion price of the convertible note will be reduced
to $2.9042.
38
The principal amount of the Note is repayable in monthly installments,
commencing as of October 1, 2004, in the initial amount of $20,000 eventually
increasing to $73,600, and may be paid in cash or, subject to certain
conditions, in Ordinary Shares. Interest on the Note is payable monthly and may
be paid in cash or, subject to certain conditions, in Ordinary Shares. Each
month, the Investor may elect to convert all or a portion of the convertible
note monthly payments (comprised of principal amortization and interest) into
ordinary shares. If the market price of the ordinary shares at the time of
payment is at least 10% greater than the conversion price per ordinary share,
the monthly payment shall be made in the form of ordinary shares. The conversion
of the note and exercise of the warrants are limited by certain restrictions. In
any event, the number of ordinary shares issuable under the note and/or the
warrants shall not exceed an aggregate of 833,085 ordinary shares (subject to
certain adjustments). On March 23, 2005, after the Investor elected to convert
$308,000 of the principal sum of the convertible note, the Investor was issued
100,000 ordinary shares of the Company.
The note is secured by a first priority floating charge on all of the Company's
assets and by a first priority fixed charge on all of the Company's right, title
and interest in its wholly-owned subsidiary, BOScom Ltd.
Pursuant to its undertaking in the Registration Rights agreement with the
Investor the Company filed with the Securities and Exchange Commission a
registration statement on Form F-3 covering the resale of Ordinary Shares that
is issuable upon conversion of the Note and/or exercise of the Warrants, and/or
issuable in payment of principal and interest on the Note. The Registration
Rights agreement provided that any delay in registration and/or effectiveness of
the underlying shares of the transaction, or failure to maintain their
effectiveness, will result in penalties to be paid in cash, as liquidated
damages. The registration statement became effective on March 11, 2005. Due to
the delay in the effectiveness of the registration of the shares, we paid the
Investor liquidated damages until March 11, 2005, in the amount of $92,000.
On May 24, 2005 the Company entered into a Share Purchase Agreement, under which
the Company shall issue and sell to certain Israeli and European investors, in a
private placement offering, 953,698 Ordinary Shares at a price of $2.30 per
share (reflecting an aggregate investment of $2,193,510), and 572,219 warrants
to purchase Ordinary Shares reflecting a 60% warrant coverage, exercisable for
three years from their date of issuance. The exercise price under the warrants
is $2.50 per Ordinary Share during for the first year from the issuance, and
increasing to $2.75 per Ordinary Share and $3.03 per Ordinary Share, on the
first and second anniversaries of the issuance, respectively. The principal
investor is the Catalyst Fund L.P., the Company's largest shareholder, that will
invest $793,500 and will hold 22.31% of the Company's outstanding share capital
post-transaction. The Company also entered into a Registration Rights Agreement
pursuant to which it agreed to prepare and file with the Securities and Exchange
Commission a registration statement covering the resale of the Ordinary Shares
issued to the investors. The closing of the transaction is scheduled for June
30, 2005, and is subject to certain closing conditions, including the approval
of the shareholders at the upcoming Annual General Meeting scheduled for June
29, 2005.
As of December 31, 2004, we had $2,578,000 in cash and cash equivalents,
$3,081,000 in marketable securities, $3,202,000 short and long-term loans and
positive working capital of $5,256,000. Net cash used in operating activities of
continuing operations in 2004 was $1,023,000 compared to $1,937,000 in 2003.
During year 2004 we used $1,866,000 in investing activities, mainly for
investment in Odem. In year 2003 we provided $519,000 from investing activities
mainly due to proceeds from redemption of marketable securities.
The Company's long and short term loans as of December 31, 2004, amounted to
$3,202,000, of which $1,456,000 is loans from Israeli banks and the convertible
note issued to Laurus Master Fund Ltd. accounts for the remainder.
39
Working capital and working capital requirements will vary from time-to-time and
will depend on numerous factors, including but not limited to operating results,
the level of resources devoted to research and development, new product
introductions, grants from the Office of the Chief Scientist in Israel,
marketing and acquisition activities.
We have in-balance sheet financial instruments and off-balance sheet contingent
commitments. Our in-balance sheet financial instruments consist of our assets
and liabilities. Our cash is invested in short-term (less than 3 months) U.S.
dollars and NIS interest bearing deposits with banks. Our receivables' aging is
between 40 to 70 days and our current liabilities' aging is approximately 60
days. The fair value of our financial instruments is similar to their book
value. Our off-balance sheet contingent commitments consist of: (a) royalty
commitments that are directly related to our future revenues, (b) lease
commitments of our premises and vehicles, (c) directors and officers'
indemnities, in excess of the proceeds received from liability insurance which
we obtain and (d) legal proceeding.
We believe that cash resources are sufficient to meet our needs for at least 12
months following the date of this submission. However, it is our intention to
engage in equity and loan financing to further feature-rich products of the
Company, establish distribution channels in new markets and search for new
merger and acquisition opportunities. There is, however, no assurance that we
shall be able to obtain such financing.
5C. RESEARCH AND DEVELOPMENT
We believe that our future growth will depend upon our ability to enhance our
existing products and introduce new products on a timely basis. Since we
commenced operations, we have conducted extensive research and development
activities. In 2004, gross research and development costs totaled $2,296,000,
compared to $2,129,000 in 2003 and $2,182,000 in 2002.
Our research and development efforts have been focused on Communication and
Connectivity Solutions. We intend to finance our research and development
activities with our own resources and grants from the Office of the Chief
Scientist. Grants from the Chief Scientist totaled $492,000 in 2004 and $283,000
in 2003 (no grants were received for the year 2002).
5D. TREND INFORMATION
Commencing the second half of year 2003 we completed the transfer of sales and
marketing activities of Connectivity and VoIP products from our subsidiaries
abroad to master distributors and resellers. This trend is continuing by
increasing the number of distributors and resellers in order to deepen our
penetration in existing markets such as in West Europe and expanding into new
geographical markets such as East Europe.
In the Connectivity Solutions segment, the trend of customer immigration from
IBM iSeries to different systems and the decrease in the number of competitors
has continued. In response we have increased our sales and marketing activities
as abovementioned and continue to develop new products and solutions in order to
maintain our market share and maintain revenues from the Connectivity segment.
We are continuously seeking additional distributors and resellers.
In the Communication Solutions segment we have experienced a trend of decrease
in sales prices, as a result of increase in competition. In order to maintain
the gross profit margin, we initiated at the end of year 2004 a cost reduction
plan and its implementation will continue through year 2005. Currently the
Company continues to invest in R&D to maintain technological advantages mainly
in the Communication Solutions segment, that will successfully compete with
Legacy telephony quality and reliability, and will allow special CTI (Computer
Telephony Integration) features that are not available in Legacy telephony
today.
40
Odem increased its revenues in 2004 and so far has continued to increase
revenues in 2005 as well. The continuous increase in Odem sales is due to the
global expansion and Odem's penetration into additional markets.
Since the end of year 2003 we increased our financial resources through three
private placements of debt and equity, and our intention is to engage in equity
and loan financing to further feature-rich products of the Company, establish
distribution channels in new markets and search for new merger and acquisition
opportunities. There is, however, no assurance that we shall be able to obtain
such financing.
5E. OFF-BALANCE SHEET ARRANGEMENTS
In 1998, as part of the PacInfo Share Purchase Agreement between the Company the
Sellers of PacInfo who became shareholders of the Company, certain actions
involving PacInfo, if occurring before the end of 2003, may trigger a tax event
for the Sellers. In such event, we may be obligated, under the purchase
agreement, to grant the Sellers a loan on a full recourse basis for certain tax
payments the Sellers may be liable for, currently estimated at approximately $2
million (see Item 3D).
In respect of the Company's outstanding contingent obligation to pay royalties
to the Office of the Chief Scientist and to the Fund for the Encouragement of
Exports, see Item 5A (under caption "Grants and Participation").
5F. TABULAR DISCLOSURE OF CONTRACTUAL OBLIGATIONS
The following table summarizes our contractual obligations as of December 31,
2004:
Payment due by period
---------------------------------------------------------------
Less than 1 More than
Total year 1-3 years 3-5 years 5 years
----------- ----------- ----------- --------- ---------
Operating lease - cars $ 746,000 $ 310,000 $ 436,000 - -
Purchase obligation for service
and inventory $ 4,745,000 $ 4,745,000 - - -
Facilities lease $ 153,000 $ 153,000 - - -
Total $ 5,644,000 $ 5,208,000 $ 436,000 - -
The above table does not include contingent obligations to pay royalties to the
Office of the Chief Scientist and to the Overseas Marketing Fund since the total
amount to be paid under the terms of those agreements are a function of future
sales, and does not include contingent legal claims (see note 14 of the
Consolidated Financial Statements).
41
ITEM 6: DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES
6A. DIRECTORS AND SENIOR MANAGEMENT
The following is a listing of our directors, senior officers and key employees:
Name Age Position
---- --- --------
Mr. Edouard Cukierman 40 Chairman of the Board of Directors
Mr. Adiv Baruch 42 Director, President and Chief Executive Officer
Mr. Avishai Gluck (2) 33 Director
Mr. Andrea Mandel-Mantello 46 Director
Mr. Ronen Zavlik (1) 44 Director
Dr. Yael Ilan (1) 56 External Director
Prof. Adi Raveh (1)(2) 57 External Director
Mr. Nehemia Kaufman 56 Chief Financial Officer
Mr. Offer David 46 Chief of Operations
Mr. Amir Gil 40 Senior VP, Business Development
Mr. Shai Sadeh 50 Senior VP, Connectivity Division
Mr. Itai Becher 48 Senior VP, Communication Division
(1) Member of the Audit Committee.
(2) Member of the Remuneration Committee.
MR. EDOUARD CUKIERMAN, 40, has been a director since May 2003, and Chairman of
the Company since June 2003. He is the Chairman of Cukierman & Co. Investment
House and CEO of Catalyst Investments L.P. Former President and Managing
Director of the Astra Fund, Mr. Cukierman provides a key role in determining and
implementing Catalyst's investment selection and exit strategies for its
investments. Mr. Cukierman holds several Board positions in portfolio companies
including VCON, BOS and Omrix. He is also the Vice Chairman of Citec Environment
and Services in Paris and a Board member of Lamina Technologies in Switzerland.
In addition, Mr. Cukierman is on the Board of Sar-El, an Israeli Defense Forces
volunteer organization and serves in the IDF Spokesman Unit (Reserves). In 1997,
Mr. Cukierman was awarded the Prize of Honor from the Israel-France Chamber of
Commerce as CEO of Astra. He was listed among the most influential businessmen
in the Israeli high-tech industry by Israel's most widely read newspaper. Mr.
Cukierman holds an M.B.A. from INSEAD, Fontainebleau, France, and a B.Sc. from
the Technion - Israel Institute of Technology.
MR. ADIV BARUCH, 42, has been a director since February 2004 and the Company's
President and CEO service provider since January 1, 2004. From June 2004 he also
serves as the CEO service provider of the Company's subsidiary, BOScom Ltd. From
1999 to 2003 he served as Executive VP Business Development of Ness
Technologies, and has expertise in the Telecom and High-tech industries. Mr.
Baruch is also a former partner and active director of IPEX, acquired by Ness.
He has served as founder and an executive or director for several IT companies
and Internet start-ups, and was significantly involved in the M&A process and in
assisting these companies in their global expansion. Mr. Baruch is actively
involved as the chairman of the Israeli Export Institute Hi-Tech and Telecom
Division, and serves as a director for MLL Software Industries Ltd., an Israeli
public company traded on the TASE. He has a B.Sc. in Information Systems and
Industrial Engineering from the Technion - Israel Institute of Technology.
MR. AVISHAI GLUCK, 33, has been a director since February 2004. He serves as the
Executive Vice President of Catalyst Investments. Mr. Gluck has financial
management, accounting and tax consultation experience, as well as extensive
knowledge of the Israeli high tech market, having screened hundreds of companies
for Catalyst and as a senior corporate consultant at E&Y Israel. Mr. Gluck
currently serves as a director in MTI Wireless-Edge Ltd. and Onset Technology
Ltd. Prior to joining Catalyst, he held the position of Corporate Finance
Consultant and accountant with Ernst & Young's Israeli affiliate Kost Forer &
Gabbay, a leading Israeli CPA firm with a dominant position among Israeli
technology companies. Mr. Gluck has a BA from Tel-Aviv University in Accounting
and Economics and is a licensed CPA.
42
MR. ANDREA MANDEL-MANTELLO, 46, has been a director since November 2003. Mr.
Mandel-Mantello is Founder and Partner of Advicorp PLC, a UK Investment Bank
regulated by the UK Financial Services Authority. He was an advisor on the first
high yield corporate bond issue in Italy. From 2000 to 2001 he was an advisor to
a US based private equity group on business development in Israel. Prior to his
work at Advicorp, Mr. Mandel Mantello spent 9 years at SBC Warburg (now known as
UBS) in London in various senior management positions including Executive
Director of SBC Warburg, member of the Board of SBC Warburg Italia SIM S.p.A,
and Country Head for Israel. Prior to working at SBCW Mr. Mandel-Mantello spent
2 years at Chemical Bank International Ltd. in London and 3 years at Banca
Nazionale dell'Agricoltura in Rome. He is currently on the boards of Telit Plc
(telecom equipment) listed on AIM; Coraline S.p.A., a company set up to acquire
the business of Frette S.p.A. (luxury homeware products); and Moto S.p.A., a
joint venture between Cremonini S.p.A. and Compass Group Plc (motorway
restaurants). He holds a Bachelors degree in Economics and Political Science
from Yale University.
MR. RONEN ZAVLIK, 44, has been a director since May 2003. He is a partner in the
CPA firm of Grinberg-Zavlik, which he founded in 1987. His firm provides a wide
range of audit, tax consultancy and CFO services to a wide variety of companies.
Mr. Zavlik provides internal auditing services to a number of large companies
whose shares are traded on the Tel Aviv Stock Exchange, including Ma'ariv
Holdings Ltd, Extra Plastic Ltd., Israel Land Development Malls and Shopping
Centers Ltd., Rapid Vision Ltd., and Optima Management and Investments 66 Ltd.
Mr. Zavlik holds a B.A. in Accountancy and Business Management from the College
of Management in Tel-Aviv. Mr. Zavlik is a licensed CPA in Israel and a member
of the Institute of Certified Public Accountants in Israel.
DR. YAEL ILAN, 56, has been an external director since November 2002. Dr. Ilan
is the president of Yedatel Ltd., an economic consulting company, and serves as
a director of CI Systems in the technology sector. Until 1998 she served on the
board of Bezeq - Israel's Telecommunication Company in which she headed the
committee of technological policy and infrastructure and was a member of the
audit committee and the committee for strategic planning and investment. From
1998 through 2000 she served as an external director of Elron Industries. In
2000-01 she founded and managed Optichrom, an optical component start-up. From
1995 through 2000 Dr. Ilan served as the head of program of the Broad Band
Communication, a consortium of MAGNET - the Israeli Government hi-tech
cooperation initiative. Dr. Ilan holds a Ph.D. in industrial engineering from
Stanford University, a Ph.D. in physical chemistry from the Hebrew University
and a Masters degree in business administration from the Hebrew University.
PROF. ADI RAVEH, 57, has been an external director since February 2003. Prof.
Raveh is a professor and head of the B.A. Program at the School of Business
Administration, Hebrew University, Jerusalem. Since 1998 he serves as an
external director at Clal Insurance Company Ltd. Since 2002 he serves as the
Chairman of the Board of Jerusalem Capital Markets Underwriting limited. He also
serves as a director of Meitav - a Mutual Funds Management company (since 1995),
and as a director of Peilim - a Portfolio Management company - part of Bank
Hapoalim Group (since 1996). Since 1992 he is a director who represents the
Hebrew University at Hi-Tech - a Technology Entrepreneurship located at
Har-Hahotzvim, Jerusalem. Prof. Raveh also serves as a director of two start-up
companies: A.D.M (Advanced Dialysis Methods Ltd.) and Virtouch Ltd. Between
1994-1999 he served as a director and a member of the executive committee of the
Bank of Jerusalem, Ltd. Between 1996-1998 he served as a member of an ad-hoc
committee of the Council of Higher Education. In 1999 he served as a member of
the Budget Committee for Research at the Israel Science Foundation. Prof. Raveh
holds a Ph.D. from the Hebrew University. He is the author of about 50
professional publications, was a visiting professor at Stanford University,
Columbia University and Baruch College, N.Y., and has received a number of
grants and honors.
43
MR. NEHEMIA KAUFMAN, 56, has been a CFO and financial service provider to the
Company through Mocha Global Managerial Services Ltd. ("Mocha Global"), of which
he is the Managing Director, since September 2002. Before then, from May 2002,
he served as CFO and financial services provider through Mocha Global, of the
Company's subsidiary, BOScom Ltd. From 1999 to 2002 he co-founded and served as
CFO of Trellis Photonics Ltd., from 1997 to 1999 Mr. Kaufman was self-employed
as a CFO service provider, from 1995 to 1997 he served as CFO of Computer Direct
Ltd. (TASE: CMDR), and from 1993 through 1995 he served as CFO of Rogosin
Enterprises Ltd. (TASE: ROGO). Mr. Kaufman holds an MBA degree from the Hebrew
University in Jerusalem (graduated with distinction) and a BA degree in
Economics and Business Administration from Haifa University.
MR. OFFER DAVID, 46, has been Chief of Operations since August 2004. From 2003
to 2004, Mr. David was Projects Dept. Manager at Arkal Filtration and Water
Treatment Systems, and from 1977 to 2003 he was with the Israel Navy, where he
held select command assignments, retiring as a Captain (Navy). Mr. David has an
MBA in Business Management from Haifa University Graduate School of Business
Administration, a B.Sc. in Chemical Engineering from the Technion - Israel
Institute of Technology, and graduated a 1-year course at the Naval Command
College (NCC - Millennium class) in Newport, Rhode Island in the USA.
MR. AMIR GIL, 40, has been Senior VP, Business Development, since June 2004.
Previously, he was with Tescom Software Systems Testing Ltd. from 2000 to 2004,
where he served as Director of Marketing and Business Development, and Product
Marketing Manager. From 1998 to 2000 Mr. Gil served as Product Manager at
Applicatek High Performance Applications. From 1996 to 1998 he served as the
representative of Terra Computers Ltd. to the Board of Directors of the DAAT
Drug Design $50 million consortium and Joint Ventures Manager. From 1994 to 1996
he worked as an Applications Engineer. Mr. Gil has a Masters of Entrepreneurship
and Innovation from Swinburne University and a B.Sc. in Chemical Engineering and
Biotechnology from Ben-Gurion University.
MR. SHAI SADEH, 50, has been Senior VP, Connectivity Division since April 2004.
Previously, from 1994 to 2004 he served in several executive capacities at
Sintec/Formula Group; he was the founder and CEO of Tochna Veod, a Formula Group
company; Manager of IBM iSeries (AS/400) Technical Support team; and founder of
the Sintec Group Professional Services Division. Mr. Sadeh has a BA in Social
Sciences from Tel Aviv University and has studied towards an MBA at the
University of Tel Aviv.
MR. ITAI BECHER, 48, has been Senior VP, Communication Division, since April
2005. Previously, he was with Telrad Connegy Ltd. from 2001 to 2005, where he
served as VP of Sales and Marketing. In 2001 he served as VP of Marketing in
Start-up company. From 1997 to 2000 Mr. Becher served as Sales Director at Nexus
Telocation Systems Ltd (NASDAQ: NXUS). From 1984 to 1997 he served as Elisra
Electronic System's representative and as team leader. From 1982 to 1984 he
worked as a Hardware Engineer at Tadiran Systems. Mr. Becher has a M.Sc degree
in Electronic Engineering from Tel-Aviv University and an MBA degree from
Heriot-Watt University from Edinburgh.
In addition, MR. ZVI GREENGOLD, 53, is an observer at Board of Director
meetings. Mr. Greengold served as a director from June 2002 to August 2004, and
served as Chairman from September 2002 to June 2003. He also provides
consultancy services to BOScom Ltd. Mr. Greengold is currently self-employed in
the field of industrial management, promotion and consulting, and serves as
Chairman of Polysac Ltd. and Polyraz of kibbutz Maoz-Haim.
44
6B. BOARD COMPENSATION
The directors who are not executive officers are paid a fee for their services
as directors to the extent that such fees are approved by a general meeting of
our shareholders. Until February 18, 2003, only the Company's external directors
were paid for their service on the Company's Board of Directors and its
committees. As resolved by the shareholders, the external directors are
compensated according to the maximum rate permitted (now and in the future) by
Israeli law and regulation. The current rates for companies the size of ours,
are an annual fee of approximately $6,000, and a participation fee in meetings
of approximately $310. On February 18, 2003 the shareholders approved
compensation for all directors who are not employees or consultants(1),
including directors appointed in the future, at the same rate the external
directors of the Company are paid. On June 26, 2003, the Board of Directors
resolved to reduce the annual fee for all directors by 18%, effective July 1,
2003, as part of a cost reduction plan, and recently the audit committee and
Board of Directors resolved, subject to shareholder approval at the upcoming
annual general meeting, to reinstate the directors' annual fee as before the 18%
reduction, from January 1, 2005. Additionally, the Company's directors are
granted options (see "Share Ownership" ahead). The Company does not have any
contracts with any of its non employee/consultant directors, that would provide
for benefits upon termination of service.
The following table presents the total compensation paid to or accrued on behalf
of all of our directors and officers as a group for the year ended December 31,
2004:
Salaries, Directors' Fees,
Service Fees(2), Pension, Retirement and
Commissions and Bonuses Similar Benefits
-------------------------- -----------------------
All directors and officers as a
group (then 17 persons) $ 1,041,000 $ 38,000
Such remuneration does not include amounts expended by the Company for expenses,
including business association dues and expenses reimbursed to said officers,
and other fringe benefits commonly reimbursed or paid by companies in the
location in which the particular executive officer of the Company is located, as
the case may be.
6C. BOARD PRACTICES
Our Board of Directors is currently comprised of seven directors, including two
external directors. The directors are elected at the annual shareholders
meeting, by a simple majority, to serve until the next annual meeting of our
shareholders and until their respective successors are elected and qualified,
with the exception of the external directors who, by rule of the Companies Law
1999, serve for three years. Our Articles of Association provide that the number
of directors in the Company (including external directors) shall be determined
from time to time by the annual general meeting of shareholders, provided that
it shall not be less than four nor more than eleven. Our Articles of Association
provide that the directors may appoint additional directors (whether to fill a
vacancy or to expand the Board) so long as the number of directors so appointed
does not exceed the number of directors authorized by shareholders at the annual
general meeting, and such appointees shall serve until the next annual general
meeting.
----------
(1) However, on August 5, 2004 the shareholders approved an exception - that
Edouard Cukierman, Chairman of the Board, will receive remuneration
(retroactively from the date of his nomination in May 2003) as a Board member,
under the same terms as all other directors, despite his being (indirectly) a
controlling shareholder and senior executive of Cukierman & Co. Investment House
Ltd. (a service provider to the Company). Additionally, in August 2004 the
shareholders ratified the audit committee and Board of Directors' resolutions
that the consulting fee paid to Mr. Zvi Greengold (see Item 7B), be in addition
to the remuneration and options Mr. Greengold received as a director of the
Company until August 2004.
(2) We receive CFO services from Mocha Global Managerial Services Ltd., and
the services are provided by Mr. Nehemia Kaufman. From January 1, 2004 we
receive managerial/CEO services from Signum Ltd., and the services are provided
by Mr. Adiv Baruch. Figure also includes consulting and other fees paid to
Cukierman & Co. Investment House Ltd., of which Mr. Edouard Cukierman, the
Company's Chairman, is (indirectly) a controlling shareholder.
45
The Company has determined that Messrs. Gluck, Mandel-Mantello, Zavlik and Raveh
and Ms. Ilan, who constitute a majority of the Board of Directors, are
independent directors under the applicable Nasdaq Stock Market requirements.
Under the Companies Law and the regulations promulgated pursuant thereto,
Israeli companies whose shares have been offered to the public in, or that are
publicly traded outside of, Israel are required to appoint at least two natural
persons as "external directors". No person may be appointed as an external
director if the person, or a relative, partner or employer of the person, or any
entity under the person's control, has or had, on or within the two years
preceding the date of the person's appointment to serve as an external director,
any affiliation with the company to whose board the external director is
proposed to be appointed or with any entity controlling or controlled by such
company or by the entity controlling such company. The term affiliation includes
an employment relationship, a business or professional relationship maintained
on a regular basis, control and service as an office holder (which term includes
a director).
In addition, no person may serve as an external director if the person's
position or other business activities create, or may create, a conflict of
interest with the person's responsibilities as an external director or interfere
with the person's ability to serve as an external director or if the person is
an employee of the Israel Securities Authority or of an Israeli stock exchange.
If, at the time of election of an external director, all other directors are of
the same gender, the external director to be elected must be of the other
gender. At least one of the external directors must be a financial expert.
External directors are elected for a term of three years and may be re-elected
for one additional three-year term. Each committee of a company's Board of
Directors that has the authority to exercise powers of the Board of Directors is
required to include at least one external director and its audit committee must
include all external directors.
External directors are elected at the general meeting of shareholders by a
simple majority, provided that the majority includes at least one-third of the
shareholders who are not controlling shareholders, who are present and voting,
or that the non-controlling shareholders who vote against the election hold one
percent or less of the voting power of the company.
Under the Companies Law an external director cannot be dismissed from office
unless: (i) the Board of Directors determines that the external director no
longer meets the statutory requirements for holding the office, or that the
external director is in breach of the external director's fiduciary duties and
the shareholders vote, by the same majority required for the appointment, to
remove the external director after the external director has been given the
opportunity to present his or her position; (ii) a court determines, upon a
request of a director or a shareholder, that the external director no longer
meets the statutory requirements of an external director or that the external
director is in breach of his or her fiduciary duties to the company; or (iii) a
court determines, upon a request of the company or a director, shareholder or
creditor of the company, that the external director is unable to fulfill his or
her duty or has been convicted of specified crimes.
Our Articles of Association provide that a director may appoint, by written
notice to us, any individual to serve as an alternate director, up to a maximum
period of one month, if the alternate is not then a member of the Board. Any
alternate director shall have all of the rights and obligations of the director
appointing him or her and shall be subject to all of the provisions of the
Articles of Association and the Companies Law. Unless the time period or scope
of any such appointment is limited by the appointing director, such appointment
is effective for all purposes for a period of one month, but in any event will
expire upon the expiration of the appointing director's term, removal of the
alternate at an annual general meeting, the bankruptcy of the alternate, the
conviction of the alternate for an offense under Section 232 of the Companies
Law, the legal incapacitation of the alternate, the removal of the alternate by
court order or the resignation of the alternate. Currently, no alternate
directors have been appointed.
46
Officers serve at the discretion of the Board or until their successors are
appointed.
According to the provisions of our Articles of Association and the Companies
Law, the Board of Directors convenes in accordance with the Company's
requirements, and at least once every three months. In practice, the Board of
Directors convenes more often.
In accordance with the requirements of the Nasdaq Stock Market, commencing on
July 31, 2005, nominees for directors will be selected by a majority of the
independent directors.
AUDIT COMMITTEE:
The Companies Law requires public companies to appoint an audit committee
comprised of at least three directors, including all of the external directors,
and further stipulates that the chairman of the Board of Directors, any director
employed by or providing other services to a company and a controlling
shareholder or any relative of a controlling shareholder may not be members of
the audit committee. The responsibilities of the audit committee include
identifying flaws in the management of a company's business, making
recommendations to the Board of Directors as to how to correct them and deciding
whether to approve actions or transactions which by law require audit committee
approval. An audit committee may not approve an action or transaction with a
controlling shareholder or with an office holder unless at the time of approval
two external directors are serving as members of the audit committee and at
least one participated in the meeting at which the action or transaction was
approved.
In order to comply with the Sarbanes-Oxley Act of 2002, the Board of Directors
has expanded the role of the Company's Audit Committee to provide assistance to
the Board of Directors in fulfilling its legal and fiduciary obligations with
respect to matters involving the accounting, auditing, financial reporting and
internal control functions of the Company. In carrying out these duties, the
Audit Committee must meet at least once in each fiscal quarter with management
at which time, among other things, it reviews, and either approves or
disapproves, the financial statements of the Company for the immediately
preceding fiscal quarter and conveys its conclusions in this regard to the Board
of Directors. The Audit Committee also monitors generally the services provided
by the Company's external auditors to ensure their independence, and reviews,
and either approves or disapproves, all audit and non-audit services provided by
them. The Company's external and internal auditors must also report regularly to
the Audit Committee at its meetings, and the Audit Committee discusses with the
Company's external auditors the quality, not just the acceptability, of the
accounting principles, the reasonableness of significant judgments and the
clarity of disclosures in the Company's financial statements, as and when it
deems it appropriate to do so.
Under the Sarbanes-Oxley Act of 2002, the Audit Committee is also responsible
for the appointment, compensation, retention and oversight of the work of the
Company's external auditors. However, under Israeli law, the appointment of
external auditors requires the approval of the shareholders of the Company.
Accordingly, the appointment of the external auditors is approved and
recommended to the shareholders by the Audit Committee and ratified by the
shareholders. Furthermore, pursuant to the Company's Articles of Association,
the Board of Directors is the organ that has the authority to determine the
compensation of the external auditors, however, the Board of Directors recently
delegated its authority to the audit committee, so that a second discussion by
the Board of Directors shall not be necessary.
47
The Company has determined that the members of the audit committee meet the
applicable Nasdaq Stock Market and SEC independence standards.
In 2003 the Company adopted an Audit Committee Charter which sets forth the
responsibilities of the committee. A copy of this charter is available on the
Company's website.
REMUNERATION COMMITTEE
The role of the Remuneration Committee is to provide assistance and make
recommendations to the Board of Directors regarding matters related to the
compensation of directors and certain employees of the Company. The Remuneration
Committee of the Company meets on an ad hoc basis, and in the past has not
always been active. Under the Israeli Companies Law, generally the Remuneration
Committee may only make recommendations to the Board of Directors concerning the
grant of options (and in some cases, such grants may need approval of the audit
committee, the Board of Directors and the shareholders as well).
Commencing July 31, 2005, the compensation of the Company's chief executive
officer and other executive officers shall be determined by a majority of the
independent directors on the Company's Board of Directors.
6D. EMPLOYEES
As of December 31, 2004, we employed 93 employees (including employees of our
subsidiaries as well). All are employed in Israel. Of the 93 employees, 20
employees are in administration and finance, 26 employees in marketing and
sales, 29 employees in engineering, research and development, 7 employees in
technical support, and 11 employees in manufacturing and related activities. As
of December 31, 2003 we employed 57 employees worldwide (the increase in the
number of employees in 2004 compared to 2003, is mainly due to the acquisition
of Odem). As of December 31, 2002, we employed 104 employees worldwide. We
believe that our relations with our employees are satisfactory. We have not
experienced a collective labor dispute or strike.
Israeli labor laws are applicable to all of our employees in Israel. The laws
principally concern the length of the work day, minimum daily wages for
professional workers, contributions to a pension fund, insurance for
work-related accidents, allotment of vacation and sickness days, procedures for
dismissing employees, determination of severance pay and other conditions of
employment.
All Israeli employers, including us, are required to provide a certain
escalation of wages in relation to the increase in the Israeli Consumer Price
Index. The specific formula of such escalation varies according to agreements
reached between the Government of Israel, the Manufacturers' Association and the
Histadrut, the general labor union in Israel. The majority of our employees are
covered by comprehensive life and pension insurance policies. The remainder are
covered by retirement accounts. Israeli employees and employers are required to
pay predetermined sums to the Israel National Insurance Institute which amounts
also include, since January 1, 1995, payments for national health insurance.
6E. SHARE OWNERSHIP
As of May 10, 2005, none of our directors and officers, now consisting of 12
persons, hold any ordinary shares. We have granted our officers and directors
options to purchase 406,282 ordinary shares under our Stock Option Plans(3). The
average exercise price of these options is $3.06 per option. Of these options,
none have been exercised until now and 191,126 had vested as of May 10, 2005.
----------
(3) Includes options granted to Mocha Global Manageri al Services Ltd. and to
Signum Ltd.. Does not include 7,500 options granted to Mr. Yair Shamir (who was
a director of the Company until March 31, 2005), which expired on May 31, 2005.
Does not include 12,805 options granted to Mr. Israel Gal, who was a director of
the Company until May 10, 2005, with respect to which the acceleration of
vesting and extension of exercise terms are pending shareholder approval. Does
not include additional grant to Signum Ltd. currently pending shareholder
approval.
48
On February 18, 2003 the Company's shareholders approved the grant of 7,500
options to any future first-time director, who is not an employee or paid
consultant of the Company. The terms and conditions of the grant, as approved by
the shareholders, are as follows: the exercise price shall be $1.84; the options
will vest over a three year period from the date of grant (one-third vesting
every year) and be exercisable within five years from the date of grant. As the
share price has fluctuated over the past year, at the recommendation of the
Board of Directors the shareholders resolved on August 5, 2004, that future
issuances to new directors will have an exercise price equal to the average
closing price of the shares on the Nasdaq National Market on the 20 trading days
preceding their appointment.
The shareholders approved on August 5, 2004, that Edouard Cukierman, Chairman of
the Board, will be granted 7,500 options under the same terms as all other
directors (with a grant date of August 31, 2003), despite his being (indirectly)
a controlling shareholder and senior executive of Cukierman & Co. Investment
House Ltd. (a service provider to the Company), and therefore not eligible for
options according to the current shareholder resolution.
The audit committee and the Board of Directors have also approved, subject to
shareholder approval at the upcoming annual meeting of shareholders, to grant
all directors of the Company (including external directors), who are not
employees or consultants of the Company (or who have been granted options
similar to all directors despite their employment and/or services), an
additional 7,500 options to purchase Ordinary Shares of the Company on the third
anniversary of their service as directors, under the same terms approved by the
shareholders on February 18, 2003 and as amended on August 5, 2004.
SHARE OPTION PLANS
The purpose of the Share Option Plans is to enable us to attract and retain
qualified persons as employees, officers, directors, consultants and advisors
and to motivate such persons by providing them with an equity participation in
the company. In addition, the Incentive Stock Options (ISO)/ Restricted Stock
Option (RSO) Plan is designed to afford qualified optionees certain tax benefits
available under the U.S. Internal Revenue Code of 1986, as amended (the "Code").
The Section 102 Plan is designed to afford qualified optionees certain tax
benefits under the Israel Income Tax Ordinance. The Share Option Plans will
expire 10 years after their adoption, unless terminated earlier by the Board of
Directors.
The Share Option Plans are administered by the Board of Directors which has
broad discretion, subject to certain limitations, to determine the persons
entitled to receive options or rights to purchase (in the case of the Section
102 Plan).
Under the Share Option Plans, the terms and conditions under which options or
rights to purchase (in the case of the Section 102 Plan) are granted and the
number of shares subject thereto shall be determined by the Board of Directors.
The Board of Directors also has discretion to determine the nature of the
consideration to be paid upon the exercise of an option and/or right to purchase
granted under the Share Option Plans. Such consideration generally may consist
of cash, or, at the discretion of the Board of Directors, cash and a recourse
promissory note.
Stock options issued as incentive stock options pursuant to the ISO/RSO Plan
will only be granted to our employees, including those of all subsidiaries. The
exercise price of incentive stock options issued pursuant to the ISO/RSO Plan
must be at least equal to the fair market value of the ordinary shares as of the
date of grant. The price per share under options awarded pursuant to the Section
102 Plan may be any price determined by the Board.
49
The ordinary shares acquired upon exercise of an option are subject to certain
restrictions on transfer, sale or hypothecation. Options are exercisable and
restrictions on disposition of shares lapse pursuant to the terms of the
individual agreements under which such options were granted or shares issued.
Due to a tax reform in Israel, after January 1, 2003 the Company may not grant
options pursuant to an "old" Section 102 Plan. Therefore, the Company may not
grant any more options pursuant to the 2000 and 1995 Plans described below.
Previous grants under these Plans remain unaffected.
2003 PLAN
In May 2003 the Company's shareholders approved the adoption of the 2003 Israeli
Stock Option Plan, pursuant to which 625,000 ordinary shares were reserved for
purchase by the employees, directors, consultants and service providers of the
Company and its subsidiaries. The Board of Directors has approved the increase
of ordinary shares reserved for issuance under the 2003 Plan, subject to
shareholder approval at the upcoming annual general meeting, to 1 million
ordinary shares. The Board of Directors has resolved that no further grants
shall be made from the previous plans (1994, 1995, 1999, 2000 and 2001), which,
as of December 31, 2004, had in the aggregate 397,499 options left for issuance
from the existing option pools previously approved by the shareholders). The
Company has elected the benefits available under the "capital gains"
alternative. There are various conditions that must be met in order to qualify
for these benefits, including registration of the options in the name of a
trustee (the "Trustee") for each of the employees who is granted options. Each
option, and any ordinary shares acquired upon the exercise of the option, must
be held by the Trustee for a period commencing on the date of grant and ending
no earlier than 24 months after the end of the tax year in which the option was
granted and deposited in trust with the Trustee. Pursuant to an election made by
the Company, capital gains derived by optionees arising from the sale of shares
derived from the exercise of options granted to them under Section 102, will be
subject to a flat capital gains tax rate of 25% (instead of the gains being
taxed as salary income at the employee's marginal tax rate). However, as a
result of this election, the Company will no longer be allowed to claim as an
expense for tax purposes the amounts credited to such employees as a benefit
when the related capital gains tax is payable by them, as the Company was
previously entitled to do. The Company may change its election in the year 2005.
As of December 31, 2004, we had 483,279 options outstanding under the 2003 plan,
228,282 at an exercise price of $3.00 per share, 121,997 at an exercise price of
$2.00 per share, 60,000 at an exercise price of $1.84 per share, and 73,000 at
an exercise price of less than $0.01 per share. 158,055 options were vested as
of December 31, 2004.
2001 PLAN
In March 2002, the Company's shareholders approved the adoption of the 2001
Stock Option Plan, pursuant to which 250,000 ordinary shares were reserved for
purchase by the Company's employees, directors, consultants or service
providers, as determined by the Board of Directors or its authorized
sub-committee. As of December 31, 2004, we had 101,641 options outstanding under
this plan, 75,000 at an exercise price of $4.00 per share and 26,641 at an
exercise price of $6.80 per share. All of the outstanding options had vested as
of December 31, 2004.
50
2000 PLAN
In April 2001, the Company's shareholders approved our 2000 Employees Incentive
Share Option Plan, pursuant to which 112,500 ordinary shares were reserved for
purchase. The plan is subject to Section 102 of the Israeli Income Tax
Ordinance. As of December 31, 2004, we had 50,825 options outstanding under this
plan, 41,075 at an exercise price of $28.00 per share and 9,750 at an exercise
price of $6.80 per share. Of these options, 50,075 were vested as of December
31, 2004.
1999 PLAN
In November 1999, the Company's shareholders approved the adoption of the 1999
Stock Option Plan (incentive and restricted stock options). The 1999 plan has
193,750 ordinary shares reserved in its favor. As of December 31, 2004, 44,257
of the options granted under this plan had been exercised, and no options were
outstanding.
1995 PLANS
In December 1995, we adopted the following plans: (i) the Stock Option Plan
(Incentive and Restricted Share Options) (the "ISO/RSO Plan"), which provides
for the grant of incentive and restricted stock options and (ii) the Section 102
Stock Option/Stock Purchase Plan (the "Section 102 Plan" and together with the
ISO/RSO Plan, the "Share Option Plans").
The Share Option Plans provide for the grant of options to purchase up to an
aggregate of 50,000 ordinary shares. As of December 31, 2004, 22,300 of the
options granted under this plan had been exercised, and there were 11,113 more
options outstanding, 7,963 at an exercise price of $17.00 per share, and 3,150
at an exercise price of $18.00 per share. All of the outstanding options had
vested as of December 31, 2004.
1994 PLAN
In 1994, we adopted a plan for the grant of options to purchase 50,000 ordinary
shares to our employees. As of December 31, 2004, 28,615 of the options granted
under this plan had been exercised, and no options were outstanding.
ITEM 7: MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS
7A. MAJOR SHAREHOLDERS
We are not directly or indirectly owned or controlled by another corporation or
by any foreign government.
The following table presents, to the best of our knowledge, certain information
as of May 10, 2005 with respect to each shareholder known to the Company to be
the beneficial owner of more than 5% of our outstanding ordinary shares. Except
where indicated, we believe, based on information provided by the owners, that
the beneficial owners of the ordinary shares listed below have sole investment
and voting power with respect to those shares (subject to community property
laws, where applicable). Applicable percentage ownership in the following table
is based on 4,838,651 shares outstanding as of May 10, 2005.
51
Shares Beneficially Owned
-------------------------
NAME AND ADDRESS NUMBER PERCENT
---------------- ------- -------
Catalyst Fund, LP (1)
3 Daniel Frisch Street,
Tel-Aviv 64731, Israel 947,275 19.58%
Hillswood Holdings Limited (2)
C/o Credit Suise Trust Limited
Guernsey Office
P.O. Box 122, Helvetia Court
South Esplanade, St. Peter Port
Guernsey, GY1 4EE Channel Islands 297,719 6.15%
Quasar Communication Systems Ltd.
2 Pekris Street, Science Park
Rehovot 76702, Israel 285,000 5.89%
M. Wertheim Holdings, Ltd.
7 Zabotinski Street
Ramat-Gan 52520, Israel 279,958 5.79%
Ms. Yael Gal (3)
Moshav Yaad
Misgav 20155, Israel 244,336 5.05%
Officers and directors as a group (4) 0 0%
(1) Does not include 345,000 ordinary shares that Catalyst has agreed to
purchase from the Company pursuant to a share purchase agreement dated May 24,
2005 (see Item 5B).
(2) Does not include 12,400 Ordinary Shares held by the son of the controlling
shareholder of Hillswood Holdings Limited.
(3) Does not include indirect ownership of 16,649 Ordinary Shares (and 12,805
options) owned by Mr. Israel Gal, Ms. Yael Gal's spouse, as to which Ms. Gal
disclaims beneficial ownership.
(4) Does not include 406,282 options to purchase Ordinary Shares of the Company
granted and currently held by Officers and/or Directors of the Company.
Of the major shareholders, to the best of our knowledge, only the holdings of
Ms. Yael Gal changed over the last three years: as of December 31, 2002 and 2003
- 244,467 ordinary shares, and as of December 31, 2004 - 244,336 ordinary
shares(4).
The shareholders' holdings reflect their voting rights. The Company's major
shareholders do not have different voting rights than other shareholders, with
respect to their shares.
As of May 10, 2005, there were 19 record holders of ordinary shares, of which 7
were registered with addresses in the United States, representing approximately
64% of the outstanding ordinary shares. However, the number of record holders in
the United States is not representative of the number of beneficial holders nor
is it representative of where such beneficial holders are resident since many of
the ordinary shares are held of record by brokers and other nominees.
7B. RELATED PARTY TRANSACTIONS
M&A ADDENDUM TO THE SERVICES AGREEMENT OF CUKIERMAN & CO.
In 2003, the Company's audit committee and Board of Directors approved the
engagement of Cukierman & Co. Investment House Ltd., to provide non-exclusive
investment-banking services and business development services to the Company,
effective as of April 15, 2003. Cukierman & Co. is a company indirectly
controlled by Mr. Edouard Cukierman, who, since June 26, 2003, serves as
Chairman of our Board of Directors, and is a co-manager of the Catalyst Fund,
the Company's largest shareholder. For its services, Cukierman & Co. is paid a
monthly sum of $10,000 plus VAT, in addition to a success fee of 4-6% for a
consummated private placement. According to its terms, the Company may terminate
the agreement at any time, by giving one month prior written notice. The
agreement provided that the success fees for securing M&A transactions shall be
discussed by the parties and drafted as a future addendum to the agreement. Such
an addendum was approved on August 22, 2004, and it provides Cukierman & Co.
with a success fee of 3.5% of the proceeds exchanged in an M&A transaction.
----------
(4) Her spouse, Mr. Israel Gal, was also a major shareholder until recently.
His holdings over the last three years: as of December 31, 2002 and 2003 -
321,332 ordinary shares, as of December 31, 2004 - 244,635 ordinary shares, and
as of May 10, 2005 - 16,649 ordinary shares.
52
CONSULTING AGREEMENT BETWEEN BOSCOM AND ZVI GREENGOLD
On August 5, 2004, at the recommendation of the audit committee and Board of
Directors, the shareholders approved a consulting agreement between the
Company's subsidiary, BOScom Ltd. and Mr. Zvi Greengold (who until August 5,
2004 was a director of the Company and Chairman of the Board of Directors of
BOScom, and is currently an observer on the Company's Board of Directors and a
director of BOScom), effective September 1, 2003, and that the consulting fee of
4,500 NIS per month (approximately $1,000) plus applicable VAT and reimbursement
of expenses, shall be in addition to the remuneration and options Mr. Greengold
receives as a director of the Company (as do all directors who are non
employees/consultants of the Company). The consulting services include
accompanying management in formalization of managerial processes and providing
consulting services to the CEO. The agreement may be terminated by either party
for any reason by 30 day advance written notice.
On September 26, 2004 the Board of Directors resolved that Mr. Greengold, who
since August 2004 serves as an observer on the Board, shall not be compensated
for his participation in Board meetings, but will continue to hold the options
granted to him in August 2003 while he was a director, just like the Company
directors.
CONSULTING AGREEMENT BETWEEN BOSCOM AND ISRAEL GAL
The audit committee and the Board of Directors have approved, subject to
shareholder approval at the upcoming annual meeting of shareholders, a
consultancy agreement between BOScom and Xorcom Ltd., a company controlled by
Israel Gal, who was a director of the Company until May 10, 2005 and who was
employed by the Company and Boscom in various positions, the most recent as CTO
of VOIP products in BOScom. On December 31, 2004 the employment was terminated
and Mr. Gal began providing consultancy services (as well as aid in the
preparation of the Chief Scientist proposal and outsourcing of hardware) to
BOScom, through his company, Xorcom Ltd. The term of the consultancy agreement
is January 1, 2005 through June 30, 2005. The amount paid for Mr. Gal's
consulting services is equal to the amount borne by the employer with respect to
his salary as of December 31, 2004. The Company may, by the decision of its CEO
and the approval of the Board, terminate the agreement at any time, by giving
one month prior written notice.
ASSIGNMENT OF VOTING RIGHTS TO MR. YAIR SHAMIR
On February 5, 2004 the audit committee and Board of Directors approved an
Assignment and Assumption Agreement, between the Company, Catalyst Investments
L.P, and Mr. Yair Shamir (who was a director of the Company until March 31, 2005
and is the Chairman of Catalyst Investments), according to which the voting
rights in all but one of the Surf shares that the Company has an option to
purchase from Catalyst (see Item 4A), have been assigned to Yair Shamir.
Pursuant to the agreement, Yair Shamir irrevocably undertook to assign the
voting rights to the Company immediately upon the earlier to occur of the
following, and subject to the receipt of a written request from the Company to
effect such assignment: a) at the time Surf's shares are offered to the public
in a public offering pursuant to a registration statement filed by Surf under
the Securities Act of 1933 or a similar act of another jurisdiction, or b) the
Company exercises its option to purchase the additional shares from Catalyst.
INDEMNITY UNDERTAKINGS BY THE COMPANY TO ITS DIRECTORS AND OFFICERS
On February 18, 2003, the Company's shareholders approved indemnity undertakings
to its directors and officers (including future directors and officers as may be
appointed from time to time), in excess of any insurance proceeds, not to
exceed, in the aggregate over the years, a total amount of $2,500,000 (two and a
half million dollars).
53
SETTLEMENT AGREEMENT BETWEEN THE COMPANY, CATALYST INVESTMENTS L.P, AND CERTAIN
SHAREHOLDERS
In January 2003, the Company's Board of Directors approved the transaction with
Catalyst Investments, L.P. ("Catalyst" and the "Transaction"), pursuant to which
Catalyst was issued Company shares, in exchange for the sale of most of its Surf
shares to the Company (see also Item 4A). Shortly thereafter, certain
shareholders filed suit against the Company demanding that a shareholders
meeting be convened and requesting a declaratory judgment that the transaction
is subject to shareholder approval. The court issued a temporary restraining
order, EX PARTE, prohibiting the Company from signing the transaction agreements
and closing the deal, and scheduled a hearing in the presence of all parties.
The Company's position was that the shareholders lack voting authority with
regard to the Transaction.
In February 2003, a settlement agreement reached between the parties provided
for the dismissal of the lawsuit, so that the Transaction will be executed
without the need for shareholder approval. Under the settlement agreement,
Catalyst was prohibited, until February 1, 2005, from entering into a voting
agreement of any kind, with other shareholders of the Company, unless some of
the plaintiff shareholders enter into voting agreements of their own. Catalyst
also represented that it purchased the Company shares for investment purposes
and undertook to not sell its shares until February 1, 2006, subject to certain
agreed-upon exceptions. The settlement agreement also provided Catalyst with the
same registration rights with regard to the purchased shares, as some of the
plaintiff shareholders received when they invested in the Company in May 2000.
Furthermore, all parties waived claims against each other and against the
directors of the Company, with regard to the Transaction, as well as any claims
against Orwer Ltd. and/or Mr. Aviram Wertheim, with relation to the private
placement between the Company and Orwer Ltd., which did not take place despite
the authorization given by the shareholders in March 2002.
PRIVATE PLACEMENT WITH CERTAIN INVESTORS, INCLUDING CATALYST
On May 24, 2005 the Company entered into a Share Purchase Agreement with certain
investors, including the Catalyst Fund L.P., which is the Company's largest
shareholder. The transaction is subject to certain closing conditions, including
shareholder approval at the upcoming Annual General Meeting (scheduled for June
29, 2005). See Item 5B.
7C. INTERESTS OF EXPERTS AND COUNSEL
Not applicable.
54
ITEM 8: FINANCIAL INFORMATION.
8A. CONSOLIDATED STATEMENTS AND OTHER FINANCIAL INFORMATION
CONSOLIDATED FINANCIAL STATEMENTS
See Item 18.
SALES OUTSIDE ISRAEL
The total amount of export sales of the Company has been as follows:
2004 - $4,318,000 (totaling 52% of all revenues); 2003 - $4,172,000 (totaling
73% of all revenues); 2002 - $7,137,000 (totaling 76% of all revenues).
LEGAL PROCEEDINGS
In July 2002, the Company received a claim letter from a car leasing vendor,
under which it claims that the Company's termination notice of the leasing
agreement in March 2002 constituted a breach of the agreement and the car vendor
is demanding compensation of which the nominal sum is approximately $292,000. No
legal proceeding has yet been filed. At this stage, according to the Company's
counsel assessment, the prospects of vendor to prevail and recover a significant
amount, seem remote. The financial statements do not include any provision for
this claim.
In September 2003, a supplier filed a legal claim in the amount of $107,000
against the Company's subsidiary (Odem). The claim alleges the breach of an
agreement for the purchase of products. The Company's legal counsel is unable to
reasonably estimate the outcome of this claim. In addition, the Company's
management believes that the chances of the claim are remote. Accordingly, no
provision has been included in the financial statements in respect of this
claim.
DIVIDEND POLICY
The Company does not currently have a dividend policy. The declaration and
payment of any cash dividends in the future will be determined by the Board of
Directors in light of the conditions existing at the time. This will include our
earnings and financial condition. We may only pay cash dividends in any fiscal
year out of "profits," as determined under Israeli statutory standards. Any
dividends paid out of Approved Enterprise earnings (i.e. tax exempt income) will
be liable to tax. As we cannot currently distribute dividends, no provision has
been made for this additional tax in our Financial Statements.
8B. SIGNIFICANT CHANGES
Not applicable.
ITEM 9: THE OFFER AND LISTING.
9A. OFFER AND LISTING DETAILS
Our ordinary shares were traded, and our warrants, until they expired on April
2, 2000, were traded in the over-the-counter market in the United States, as
quoted on the NASDAQ Small Capitalization Market under the symbol "BOSC" and
"BOSCW," respectively. In September 2000, our shares started to be traded on the
NASDAQ National Market. In January 2002, our shares began trading, as well, on
the Tel-Aviv Stock Exchange, under the symbol "BOSC", pursuant to the
dual-listing regulations of the Israeli Securities Authority.
Prices set forth below are high and low reported closing prices for our ordinary
shares and warrants of the Company, as reported by NASDAQ for the period
indicated. All share prices have been retroactively adjusted to reflect the 1:4
reverse stock split effected May 29, 2003.
55
ORDINARY SHARES WARRANTS
--------------- --------------
Period High Low High Low
2000 Annual 71.24 10.36 40.00* 4.56*
2001 Annual 16.68 3.64
2002 Annual 7.92 2.40
2003 Annual 3.97 1.67
First Quarter 1.96 1.92
Second Quarter 2.40 1.99
Third Quarter 1.90 1.67
Fourth Quarter 3.97 2.60
2004 Annual 4.00 1.62
First Quarter 4.00 2.31
Second Quarter 3.25 1.77
Third Quarter 2.10 1.62
Fourth Quarter 3.96 1.82
2004 December 3.96 2.17
2005 January 3.50 2.35
February 3.49 2.43
March 3.18 2.59
April 2.79 2.27
May 2.52 2.24
June (until June 21) 2.34 2.15
(*) The warrants expired and ceased to be traded on April 2, 2000.
9B. PLAN OF DISTRIBUTION
Not applicable.
9C. MARKETS
Our securities are traded on the NASDAQ Stock Exchange (symbol "BOSC") and the
Tel-Aviv Stock Exchange (symbol "BOSC").
9D. SELLING SHAREHOLDERS
Not applicable.
9E. DILUTION
Not applicable.
9F. EXPENSES OF ISSUE
Not applicable.
56
ITEM 10: ADDITIONAL INFORMATION.
10A. SHARE CAPITAL
Not applicable.
10B. MEMORANDUM AND ARTICLES OF ASSOCIATION
In March 2002 the Company adopted new Articles of Association, in view of the
Israeli Companies Law, 1999.
Set forth below is a summary of certain provisions governing our share capital.
This summary is not complete and should be read together with our Memorandum and
Articles of Association, copies of which have been filed as exhibits to the
Annual Report.
1. OBJECTS OF THE COMPANY:
The company's objects and purposes are outlined in the Memorandum of
Association. These objects include: the development of sophisticated interfaces
for IBM mainframe computers; the export of hi-tech products to Europe and the
USA; and research, development and manufacture of products in the sphere of
communication networks. The Company's Articles of Association (Article 2) allow
it to engage in any legal business.
2. PROVISIONS RELATED TO THE DIRECTORS OF THE COMPANY:
(a) Approval of Certain Transactions under the Companies Law:
We are subject to the provisions of the Israeli Companies Law 1999, which became
effective on February 1, 2000.
The Companies Law codifies the fiduciary duties that an Office Holder has to the
Company. An "Office Holder" is defined in the Companies Law as any Director,
General Manager or any other Manager directly subordinate to the General Manager
and any other person with similar responsibilities.
An Office Holder's fiduciary duties consist of a Duty of Loyalty and a Duty of
Care.
The Duty of Loyalty includes: the avoidance of any conflict of interest between
the Office Holder's position in the company and his personal affairs; the
avoidance of any competition with the company; the avoidance of any exploitation
of any business opportunity of the Company in order to receive personal
advantage for himself or others; and a duty to reveal to the Company any
documents or information relating to the Company's affairs that the Office
Holder has received due to his position.
The Duty of Care requires an Office Holder to act at a level of care that a
reasonable Office Holder in the same position would employ under the same
circumstances. This includes the duty to utilize reasonable means to obtain (1)
information regarding the appropriateness of a given action brought for his
approval or performed by him by virtue of his position and (2) all other
information of importance pertaining to the foregoing actions.
Under the Companies Law, all arrangements with regard to the compensation of
Office Holders who are not Directors require the approval of the Board of
Directors. Arrangements regarding the compensation of Directors require Audit
Committee, Board and Shareholder approval.
The Companies Law requires that an Office Holder of a company promptly disclose
to the company's Board of Directors any personal interest that he or she may
have, and all related material information known to him in connection with any
existing or proposed transaction by the company. This disclosure must be made by
the Office Holder, whether orally or in writing, no later than the first meeting
of the Company's Board of Directors which discusses the particular transaction.
An Office Holder is deemed to have a "personal interest" if he, certain members
of his family, or a corporation in which he or any one of those family members
is a 5% or greater shareholder or exercises or has the right to exercise
control, has an interest in a transaction with the company. An "Extraordinary
Transaction" is defined as a transaction - other than in the ordinary course of
business, not on market terms, or that is likely to have a material impact on
the company's profitability, assets or liabilities.
57
In the case of a transaction that is not an Extraordinary Transaction, after the
office holder complies with the above disclosure requirements, only board
approval is required. The transaction must not be adverse to the company's
interests. In the case of an Extraordinary Transaction, the company's Audit
Committee and the Board of Directors, and, under certain circumstances, the
shareholders of the company must approve the transaction, in addition to any
approval stipulated by the Articles of Association. An Office Holder who has a
personal interest in a matter that is considered at a meeting of the Board of
Directors or the Audit Committee may not be present at this meeting or vote on
this matter, unless a majority of the members of the Board of Directors or Audit
Committee, respectively, have a personal interest in the matter, in which case
they may all be present and vote, after which the matter must be approved by the
shareholders of the Company.
(b) Borrowing powers exercisable by the Directors are not specifically outlined
in the Company's Articles of Association, however, according to Article 15: "Any
power of the Company which has not been vested in another organ pursuant to the
Companies Law or the articles may be exercised by the Board of Directors".
(c) The Company's Articles of Association do not contain provisions regarding
the retirement of directors under an age limit requirement, nor do they contain
a provision requiring a Director to hold any Company shares in order to qualify
as a Director.
For further reference to the Articles of Association regarding the Company's
directors, see Item 6.
3. WITH REGARD TO THE RIGHTS, PREFERENCES AND RESTRICTIONS ATTACHING TO THE
SHARES, THE COMPANY'S ARTICLES OF ASSOCIATION PROVIDE THE FOLLOWING:
(a),(c),(d): Dividends, Rights to Share in the Company's Profits and Rights to
Share in any Surplus upon Liquidation
All holders of paid-up ordinary shares of the Company have an equal right to
participate in the distribution of (i) dividends, whether by cash or by bonus
shares; (ii) Company assets; and (iii) the Company's surplus assets upon winding
up, all pro rata to the nominal value of the shares held by them (Articles
4.2.2, 4.2.3 and 7.3).
The Board of Directors is the organ authorized to decide upon the distribution
of dividends and bonus shares (Article 26). The shareholders who are entitled to
a dividend are the shareholders on the date of the resolution for the dividend
or on a later date if another date is specified in the resolution on the
dividend's distribution. If the Board of Directors does not otherwise determine,
any dividend may be paid by way of a cheque or payment order that shall be sent
by mail in accordance with the registered address of the shareholder or person
entitled thereto, or in the case of registered joint shareholders to the
shareholder whose name appears first in the shareholders' register in relation
to the joint shareholding. Every such cheque shall be drawn up to the order of
the person to whom it is being sent. The receipt of a person who on the date of
the dividend's declaration is listed in the shareholders' register as the holder
of any share or, in the case of joint shareholders, of one of the joint
shareholders shall serve as confirmation of all the payments made in connection
with such share. For the purpose of implementing any resolution pursuant to the
provisions of this paragraph, the Board of Directors may settle, as it deems
fit, any difficulty arising in relation to the distribution of the dividend
and/or bonus shares, including determine the value for the purpose of the said
distribution of certain assets and resolve that payments in cash shall be made
to members in reliance upon the value thus determined, determine regulations in
relation to fractions of shares or in relation to non-payment of amounts less
than NIS 200.
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(b) Voting Rights
All holders of paid-up ordinary shares of the Company have an equal right to
participate in and vote at the Company's general meetings, whether ordinary or
special, and each of the shares in the Company shall entitle its holder, present
at the meeting and participating in the vote, himself, by proxy or through a
voting instrument, to one vote (Article 4.2.1). Shareholders may vote either in
person or through a proxy or voting instrument, unless the Board of Directors
prohibited voting through a voting instrument on a certain matter and stated so
in the notice of the meeting (Articles 14.1 and 14.6). A resolution at the
general meeting shall be passed by an ordinary majority unless another majority
is specified in the Companies Law or the Company's Articles of Association
(Article 14.3).
Directors of the Company stand for reelection at every annual meeting (Article
16.2) and not at staggered intervals, with the exception of the External
directors who are appointed for a period of 3 years under the Israeli Companies
Law, 1999. The Articles do not provide for cumulative voting.
(e) Redemption
The Company may, subject to any applicable law, issue redeemable securities on
such terms as determined by the Board of Directors, provided that the general
meeting of shareholders approves the Board of Director's recommendation and the
terms determined (Article 27).
(g) Capital Calls by the Company
The Board of Directors may only make calls for payment upon shareholders in
respect of monies not yet paid for shares held by them (Article 7.2).
(h) Discrimination
No provision in the Company's Articles of Association discriminates against an
existing or prospective holder of securities, as a result of such shareholder
owning a substantial amount of shares.
4. MODIFICATION OF RIGHTS OF HOLDERS OF STOCK
The general meeting of shareholders may resolve to create new shares of an
existing class or of a new class with special rights and/or restrictions
(Article 9.1).
So long as not otherwise provided in the shares' issue terms and subject to the
provisions of any law, the rights attached to a particular class of shares may
be altered, after a resolution is passed by the Company and with the approval of
a resolution passed at a general meeting of the holders of the shares of such
class or the written agreement of all the class holders. The provisions of the
Company's Articles of Association regarding general meetings shall apply,
mutatis mutandis, to a general meeting of the holders of a particular class of
shares (Article 10.1). The rights vested in the holders of shares of a
particular class that were issued with special rights shall not be deemed to
have been altered by the creation or issue of further shares ranking equally
with them, unless otherwise provided in such shares' issue terms (Article 10.2).
The above mentioned conditions are not more onerous than is required by law.
5. ANNUAL GENERAL MEETINGS AND EXTRAORDINARY GENERAL MEETINGS
General meetings shall be convened at least once a year at such place and time
as determined by the Board of Directors but no later than 15 months from the
last general meeting. Such general meetings shall be called "annual meetings".
The Company's other meetings shall be called "special meetings" (Article 12.1).
The annual meeting's agenda shall include a discussion of the Board of
Directors' reports and the financial statements as required at law. The annual
meeting shall appoint an auditor, appoint the directors pursuant to these
articles and discuss all the other matters which must be discussed at the
Company's annual general meeting, pursuant to these articles or the Law, as well
as any other matter determined by the Board of Directors (Article 12.2).
59
The Board of Directors may convene a special meeting pursuant to its resolution
and it must convene a general meeting if it receives a written requisition from
any one of the following (hereinafter referred to as "requisition") (i) two
directors or one quarter of the directors holding office; and/or (ii) one or
more shareholders holding at least 5% of the issued capital and at least 1% of
the voting rights in the Company; and/or (iii) one or more shareholders holding
at least 5% of the voting rights in the Company (Article 12.3). A requisition
must detail the objects for which the meeting must be convened and shall be
signed by the persons requisitioning it and sent to the Company's registered
office. The requisition may be made up of a number of documents in an identical
form of wording, each of which shall be signed by one or more of the persons
requisitioning the meeting (Article 12.4). Where the Board of Directors is
required to convene a special meeting, it shall do so within 21 days of the
requisition being submitted to it, for a date that shall be specified in the
invitation and subject to the law (Article 12.5).
Notice to the Company's members regarding the convening of a general meeting
shall be sent to all the shareholders listed in the Company's shareholders'
register at least 21 days prior to the meeting and shall be published in other
ways insofar as required by the law. The notice shall include the agenda,
proposed resolutions and arrangements with regard to a written vote. The
accidental omission to give notice of a meeting to any member, or the
non-receipt of notice sent to such member, shall not invalidate the proceedings
at such meeting (Article 12.6).
The shareholders entitled to participate in and vote at the general meeting are
the shareholders on the date specified by the Board of Directors in the
resolution to convene the meeting, and subject to the law (Article 14.1).
No discussions may be commenced at the general meeting unless a quorum is
present at the time of the discussion's commencement. A quorum is the presence
of at least two shareholders holding at least 33?% of the voting rights
(including presence through a proxy or a voting instrument), within half an hour
of the time fixed for the meeting's commencement (Article 13.1). If no quorum is
present at a general meeting within half an hour of the time fixed for the
commencement thereof, the meeting shall be adjourned for one week, to the same
day, time and place, or to a later time if stated in the invitation to the
meeting or in the notice of the meeting (hereinafter referred to as "the
adjourned meeting") (Article 13.2). The quorum for the commencement of the
adjourned meeting shall be any number of participants.
The Articles of Association provide that all shareholder resolutions shall be
passed by an ordinary (simple) majority of the votes cast, unless another
majority is specified in the Companies Law or in the Articles (Article 14.3).
6. LIMITATIONS ON THE RIGHTS TO OWN SECURITIES
There are no limitations on the rights to own the Company's securities,
including the rights of non-residents or foreign shareholders to do so.
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7. CHANGE OF CONTROL
Under the Companies Law, a merger is generally required to be approved by the
shareholders and Board of Directors of each of the merging companies.
Shareholder approval isn't required if the company that will not survive is
controlled by the surviving company. Additionally, the law provides some
exceptions to the shareholder approval requirement in the surviving company. If
the share capital of the company that will not be the surviving company is
divided into different classes of shares, the approval of each class is also
required, unless determined otherwise by the court. A majority of votes
approving the merger shall suffice, unless the company (like ours) was
incorporated in Israel prior to the Companies Law of 1999, in which case a
majority of 75% of the voting power is needed in order to approve the merger.
Additionally, unless the court determines differently, a merger will not be
approved if it is objected to by a majority of the shareholders present at the
meeting, after excluding the shares held by the other party to the merger, by
any person who holds 25% or more of the other party to the merger and by the
relatives of and corporations controlled by these persons. Upon the request of a
creditor of either party to the proposed merger, the court may delay or prevent
the merger if it concludes that there exists a reasonable concern that, as a
result of the merger, the surviving company will be unable to satisfy the
obligations of any of the parties of the merger. Also, a merger can be completed
only after all approvals have been submitted to the Israeli Registrar of
Companies and provided that 30 days have elapsed since shareholder approval was
received and 50 days have elapsed from the time that a proposal for approval of
the merger was filed with the Registrar.
The Companies Law also provides that an acquisition of shares in a public
company must be made by means of a tender offer if, as a result of the
acquisition, the purchaser would become a holder of 25% or more of the voting
power at general meetings. This rule does not apply if there is already another
holder of 25% or more of the voting power at general meetings. Similarly, the
Companies Law provides that an acquisition of shares in a public company must be
made by means of a tender offer if, as a result of the acquisition, the
purchaser would become a holder of more than 45% of the voting power of the
company. This rule does not apply if someone else already holds 45% of the
voting power of the company. An acquisition from a 25% or 45% holder, which
turns the purchaser into a 25% or 45% holder respectively, does not require a
tender offer. An exception to the tender offer requirement may also apply when
the additional voting power is obtained by means of a private placement approved
by the general meeting of shareholders. These tender offer requirements do not
apply to companies whose shares are listed for trading outside of Israel if,
under local law or the rules of the stock exchange on which their shares are
traded, there is a limitation on the percentage of control which may be acquired
or the purchaser is required to make a tender offer to the public.
Under the Companies Law, a person may not acquire shares in a public company if,
after the acquisition, he will hold more than 90% of the shares or more than 90%
of any class of shares of that company, unless a tender offer is made to
purchase all of the shares or all of the shares of the particular class. The
Companies Law also provides that as long as a shareholder in a public company
holds more than 90% of the company's shares or of a class of shares, that
shareholder shall be precluded from purchasing any additional shares. If a
tender offer is accepted and less than 5% of the shares of the company are not
tendered, all of the shares will transfer to the ownership of the purchaser. If
5% or more of the shares of the company are not tendered, the purchaser may not
purchase shares in a manner which will grant him more than 90% of the shares of
the company.
8. DISCLOSING SHARE OWNERSHIP
The Company has no bylaw provisions governing the ownership threshold, above
which shareholder ownership must be disclosed.
10C. MATERIAL CONTRACTS
All material contracts have been described in detail throughout this form,
wherever applicable.
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10D. EXCHANGE CONTROLS
All exchange control restrictions imposed by the State of Israel have been
removed, although there are still reporting requirements for foreign currency
transactions. Legislation remains in effect, however, pursuant to which currency
controls can be imposed by administrative action at any time.
Pursuant to the General Permit issued by the Israeli Controller of Foreign
Currency, at the Bank of Israel (under the Currency Control Law, 1978),
non-residents of Israel who purchase our ordinary shares will be able to convert
any proceeds from the sale of these ordinary shares, as well as dividend and
liquidation distributions, if any, into non-Israeli currency, provided that
Israeli Income Tax has been paid (or withheld) on such amounts (to the extent
applicable).
There are no limitations on the Company's ability to import and export capital.
10E. TAXATION
The following is a summary of the material Israeli tax consequences, Israeli
foreign exchange regulations and certain Israeli government programs affecting
the Company.
To the extent that the discussion is based on new tax or other legislation that
has not been subject to judicial or administrative interpretation, there can be
no assurance that the views expressed in the discussion will be accepted by the
tax or other authorities in question. The discussion is not intended, and should
not be construed, as legal or professional tax advice and is not exhaustive of
all possible tax considerations.
ISRAELI TAX CONSIDERATIONS
On January 1, 2003 a comprehensive tax reform took effect in Israel. Pursuant to
the reform, resident companies are subject to Israeli tax on income accrued or
derived in Israel or abroad. In addition, the concept of "controlled foreign
corporation" was introduced according to which an Israeli company may become
subject to Israeli taxes on certain income of a non-Israeli subsidiary if the
subsidiary's primary source of income is passive income. The tax reform also
substantially changes the taxation of capital gains.
GENERAL CORPORATE TAX STRUCTURE
Israeli companies are generally subject to income tax on their taxable income at
the rate of 35% for the 2004 tax year, 34% for the 2005 tax year, 32% for the
2006 tax year and 30%for the 2007 tax year and thereafter, and are subject to
capital gains tax at a rate of 25% for capital gains (other than gains deriving
from the sale of listed securities) derived after January 1, 2003.
TAX BENEFITS UNDER THE LAW FOR THE ENCOURAGEMENT OF CAPITAL INVESTMENTS, 1959.
The Company's facilities have been granted Approved Enterprise status pursuant
to the Law for the Encouragement of Capital Investments, 1959 (the "Investment
Law"), which provides certain tax and financial benefits to investment programs
that have been granted such status.
The Investment Law provides that a proposed capital investment in eligible
facilities may, upon application to the Investment Center of the Ministry of
Industry and Trade of the State of Israel, 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. If a company has more than one approval or
only a portion of its capital investments are approved, its effective tax rate
is the result of a weighted combination of the applicable rates. Income derived
from activity that is not integral to the activity of the enterprise should not
be divided between the different enterprises and should not enjoy tax benefits.
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Taxable income of a company derived from an approved enterprise is subject to
company tax at the rate of 10-25% (subject to the percentage of the foreign
shareholders holding in the company), rather than at the regular rate, for the
benefit period. This period is ordinarily seven years commencing with the year
in which the approved enterprise first generates taxable income, and is limited
to 12 years from completion of the investment under the approved plan
(commencement of production) or 14 years from the date of approval, whichever is
earlier. The Investment Law also provides that a company that has an approved
enterprise is entitled to accelerated depreciation on its property and equipment
that are included in an approved investment program. A Foreign Investors Company
("FIC"), as defined in the Investment Law, may enjoy benefits for a period of up
to 10 years, or 12 years if it complies with certain export criteria stipulated
in the Investment Law.
A company owning an approved enterprise may elect to receive an alternative
package of benefits. Under the alternative package, a company's undistributed
income derived from an approved enterprise will be exempt from company tax for a
period of between two and ten years from the first year of taxable income,
depending on the geographic location of the approved enterprise within Israel,
and such company will be eligible for a reduced tax rate for the remainder of
the benefits period.
The Company has four approved enterprise programs under the Capital Investments
Law, which entitle the Company to some tax benefits. In our first program, we
elected to participate in a government guaranteed loans and grants approved
enterprise program and have received grants from the investment center. Income
derived from the first program which began in 1991 and completed in 1992, was
subject to a reduced tax rate of 25% for the period of seven years ended 1999.
In our second and third programs we have elected to participate in government
guaranteed loans programs. Income derived from these programs, which began in
1992 and 1994, respectively, are tax exempt for a period of ten years commencing
on the first year of taxable income.
In our fourth program, we have elected to participate in the "alternative
benefit program". Income derived from "alternative benefit program" which began
in 1997 is exempt from tax for a period of ten years, starting in the first year
in which we generate taxable income from the approved enterprise. The tax
benefit period for this program will expire through 2010. The fourth plan was
extended until 2001.
During 2002, as part of the transfer of operations from the Company to BOScom,
all tax benefits that were related to the Approved Enterprise of the Company,
were transferred to BOScom.
Since 2002, we elected not to participate in any approved enterprise program.
Accordingly, taxable income generated in that period will be split by the assets
ratio into a taxable income that is entitled to the benefits of the approved
enterprise and into an income that will be taxed at regular corporate tax rate.
Our subsidiary, BOScom, also has a production facility, which was granted an
"Approved Enterprise" status and had a separate investment program. BOScom
elected to receive the "alternative benefits". Income derived from BOScom's
investment program, which commenced operations in 1997 and 2002, is exempt from
income tax for a period of ten years commencing with the first year in which
taxable income is generated.
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The tax-exempt income attributable to the "Approved Enterprise" can be
distributed to shareholders without imposing tax liability on the Company only
upon the complete liquidation of the Company. In the event of a distribution of
such tax-exempt income as a cash dividend in a manner other than in the complete
liquidation of the Company and BOScom, the Company (or BOScom) will be required
to pay corporate tax at the reduced corporate tax rate applicable to such
profits between 10% and 25%. In addition, dividends from approved enterprises
are generally taxable at the reduced rate of 15% if distributed during the tax
exemption period or within 12 years thereafter (this time limit does not apply
to an FIC). Tax must be withheld at source, regardless of whether the dividend
is converted into foreign currency. The Company currently intends to reinvest
the amounts of tax-exempt income and not to distribute such income as dividends.
The Investment Center of the Ministry of Industry and Trade bases its decision
as to whether or not to approve an application, on the criteria set forth in the
Investment Law and regulations, the then prevailing policy of the Investment
Center, and the specific objectives and financial criteria of the applicant.
Accordingly, there can be no assurance that any such application will be
approved. In addition, the benefits available to an approved enterprise are
conditional upon the fulfillment of conditions stipulated in the Investment Law
and its regulations and the criteria set forth in the specific certificate of
approval, as described above. In the event that a company does not meet these
conditions, it would be required to refund the amount of tax benefits, with the
addition of the consumer price index linkage adjustment and interest.
TAX BENEFITS AND GRANTS FOR RESEARCH AND DEVELOPMENT
Israeli tax law allows, under certain conditions, a tax deduction in the year
incurred for expenditures (including capital expenditures) in scientific
research and development projects, if the expenditures are approved by the
relevant Israeli government ministry, determined by the field of research, the
research and development is for the promotion of the enterprise and is carried
out by or on behalf of the company seeking such deduction.
In case the tax deduction, in the year research and development expenditures are
incurred, is not approved by the relevant Israeli government ministry, the
Company will be entitled for the tax deduction over a period of three years.
TAX BENEFITS UNDER THE LAW FOR THE ENCOURAGEMENT OF INDUSTRY (TAXATION), 1969
According to the Law for the Encouragement of Industry (Taxation), 1969, or the
Industry Encouragement Law, an "Industrial Company" is a company resident in
Israel and at least 90% of the income of which, in any tax year, determined in
Israeli currency, exclusive of income from certain government 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. Until December
31, 2001 the Company qualified as an "Industrial Company" within the definition
of the Industry Encouragement Law. Under the Industry Encouragement Law,
Industrial Companies are entitled to certain preferred corporate tax benefits.
Eligibility for the benefits under the Industry Encouragement Law is not subject
to receipt of prior approval from any governmental authority. In January 2002,
subsequent to the Company's restructure transforming it into a holding company
by transferring its industrial operations to its wholly-owned subsidiary,
BOScom, the Company disqualified from being an "Industrial Company" and
therefore the benefits described above are not available since then.
SPECIAL PROVISIONS RELATING TO TAXATION UNDER INFLATIONARY CONDITIONS
The Income Tax Law (Inflationary Adjustments), 1985, generally referred to as
the "Inflationary Adjustments Law," represents an attempt to overcome the
problems presented to a traditional tax system by an economy undergoing rapid
inflation. The Inflationary Adjustments Law is highly complex. The material
aspects to the Company can be described as follows:
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There is a special tax adjustment for the preservation of equity whereby certain
corporate assets are classified broadly into fixed, inflation resistant, assets
and non-fixed (soft) assets. Where a company's equity, as defined in law,
exceeds the depreciated cost of fixed assets, a deduction from taxable income
that takes into account the effect of the applicable annual rate of inflation on
such excess is allowed, up to a ceiling of 70% of taxable income in any single
tax year, with the unused portion permitted to be carried forward on a linked
basis. If the depreciated cost of fixed assets exceeds a company's equity, then
such excess multiplied by the applicable annual rate of inflation is added to
taxable income.
Subject to certain limitations, depreciation deductions on fixed assets and
losses carried forward are adjusted for inflation based on the increase in the
Israeli consumer price index (CPI). Under Law, results for tax purposes are
measured in real terms, in accordance with the changes in the Israeli CPI, or in
the exchange rate of the dollar for a "foreign investors' company". The Company
elected to measure its results for tax purposes on the basis of the changes in
the Israeli CPI.
CAPITAL GAINS TAX ON SALES OF ORDINARY SHARES
Israeli law generally imposes a capital gains tax on the sale of securities and
other capital assets, by both residents and non-residents of Israel, unless a
specific exemption is available or unless a treaty between Israel and the
country of a non-resident provides otherwise. Until the Israeli tax reform that
became effective on January 1, 2003, sales by both residents and non-residents
of Israel (other than certain Israeli corporations) of securities of Israeli
companies that qualified as "Industrial Companies" or Industrial Holding
Companies" on recognized stock exchanges outside of Israel were exempt from the
capital gains tax. This exemption did not apply to dealers in securities in
Israel and persons subject to Inflationary Adjustments Law who were taxed at
regular tax rates applicable to business income. Subsequent to the
disqualification of the Company as an "Industrial Company" since January 2002, a
sale of shares on the Nasdaq National Market by the Company's Israeli
shareholders was not tax exempt under paragraph 4a of the Regulation for
"Exemption of Capital Gain Incurred in a Sale of Shares" (1981) (the
"Regulation"). However, since January 2002, the Company registered its shares
for trade in the Tel Aviv Stock Exchange (TASE). Accordingly, sales (other than
by certain Israeli corporations) of securities of Israeli companies were subject
to tax exemption throughout the year 2002, if sold on the TASE. However, the tax
reform of January 2003 repealed these exemptions and now imposes a 15% capital
gains tax on Israeli resident individuals, in respect of gains derived after
January 1, 2003 from the sale of shares of an Israel company on the TASE or a
recognized stock exchange outside Israel, and the status of an Industrial
Company is no longer relevant. The 15% tax rate does not apply to dealers in
securities, persons subject to Inflationary Adjustments Law, and shareholders
who acquired their shares prior to an initial public offering. This tax does not
affect non-residents who are exempt from Israeli capital gains tax on any gains
derived from the sale of shares publicly traded on a recognized stock exchange,
provided such shareholders did not acquire their shares prior to an initial
public offering.
THE US-ISRAEL TAX TREATY
Pursuant to the Convention Between the Government of the United States of
America and the Government of Israel with Respect to Taxes on Income, as amended
(the "United States- Israel Tax Treaty"), the sale, exchange or disposition of
ordinary shares by a person who qualifies as a resident of the United States
within the meaning of the United States-Israel Tax Treaty and who is entitled to
claim the benefits afforded to such person by the United States- Israel Tax
Treaty (a "Treaty United States Resident") generally will not be subject to the
Israeli capital gains tax unless such Treaty United States Resident holds,
directly or indirectly, shares representing 10% or more of the Company's voting
power during any part of the 12- month period preceding such sale, exchange or
disposition, subject to certain conditions. A sale, exchange or disposition of
ordinary shares by a Treaty United States Resident who holds, directly or
indirectly, shares representing 10% or more of the Company's voting power at any
time during such preceding 12-month period would be subject to such Israeli tax,
to the extent applicable; however, under the United States-Israel Tax Treaty,
such Treaty United States Resident would be permitted to claim a credit for such
taxes against the United States federal income tax imposed with respect to such
sale, exchange or disposition, subject to the limitations specified in the
treaty. The United States-Israel Tax Treaty does not relate to United States
state or local taxes.
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TAXATION OF NON-RESIDENT HOLDERS OF ORDINARY SHARES
Non-residents of Israel are subject to Israeli income tax on income accrued or
derived from sources in Israel, including passive income such as dividends,
royalties and interest. On distributions of dividends, other than bonus shares
and stock dividends, income tax at the rate of 25%, (or 15% for dividends
generated by an approved enterprise) is withheld at the source, unless a
different rate is provided in a treaty between Israel and the shareholder's
country of residence. Under the United States- Israel Tax Treaty, the maximum
tax on dividends paid to a holder of ordinary shares who is a Treaty United
States Resident will be 25%, however, under the Investment Law, dividends
generated by an approved enterprise are taxed at the rate of 15%. The Treaty
further provides that a 12.5% Israeli dividend withholding tax will apply to
dividends paid to a United States corporation owning 10% or more of an Israeli
company's voting shares during, in general, the current and preceding tax years
of the Israeli company. The lower 12.5% rate applies only on dividends
distributed from income not derived from an Approved Enterprise in the
applicable period and does not apply if the company has certain amounts of
passive income.
Under an amendment to the Inflationary Adjustments Law 1985, effective January
1, 1999, non-Israeli corporations might be subject to Israeli taxes on the sale
of traded securities in an Israeli company, subject to the provisions of any
applicable double taxation treaty.
FOREIGN EXCHANGE REGULATIONS
Dividends, if any, paid to the holders of the ordinary shares, and any amounts
payable upon dissolution, liquidation or winding up, as well as the proceeds of
any sale in Israel of the ordinary shares to an Israeli resident, may be paid in
non-Israeli currency or, if paid in Israeli currency, may be converted into
freely repatriable dollars at the rate of exchange prevailing at the time of
conversion.
UNITED STATES FEDERAL INCOME TAXES
The following general discussion sets forth the material United States federal
income tax consequences applicable to the following persons who purchase, hold
or dispose of the ordinary shares as capital assets ("U.S. Shareholders"): (i)
citizens or residents (as defined for U.S. federal income tax purposes) of the
United States; (ii) corporations or other entities taxable as corporations
created or organized in or under the laws of the United States or any state
thereof; (iii) estates, the income of which is subject to United States federal
income taxation regardless of its source; and (iv) a trust if (a) a U.S. court
is able to exercise primary supervision over its administration and (b) one or
more U.S. persons have the authority to control all of its substantial
decisions. This discussion is based on the provisions of the Internal Revenue
Code of 1986, as amended (the "Code"), United States Treasury Regulations
promulgated thereunder and administrative and judicial interpretations thereof,
all as in effect as of the date of this Annual Report on Form 20-F. This
discussion generally considers only U.S. Shareholders that will hold the
ordinary shares as capital assets and does not consider (a) all aspects of U.S.
federal income taxation that may be relevant to particular U.S. Shareholders by
reason of their particular circumstances (including potential application of the
alternative minimum tax), (b) U.S. shareholders subject to special treatment
under the U.S. federal income tax laws, such as financial institutions,
insurance companies, broker-dealers, tax-exempt organizations, financial
institutions or foreign individuals or entities, (c) U.S. Shareholders owning
directly or by attribution 10% or more of the Company's outstanding voting
shares, (d) U.S. Shareholders who hold the ordinary shares as part of a hedging,
straddle or conversion transaction, (e) U.S. Shareholders who acquire their
ordinary shares in a compensatory transaction, (f) U.S. Shareholders whose
functional currency is not the dollar, or (g) any aspect of state, local or
non-United States tax law.
66
THE FOLLOWING SUMMARY DOES NOT ADDRESS THE IMPACT OF AN INVESTOR'S INDIVIDUAL
TAX CIRCUMSTANCES. ACCORDINGLY, EACH INVESTOR SHOULD CONSULT HIS OR HER OWN TAX
ADVISOR AS TO THE PARTICULAR TAX CONSEQUENCES TO HIM OR HER OF AN INVESTMENT IN
THE ORDINARY SHARES, INCLUDING THE EFFECTS OF APPLICABLE STATE, LOCAL OR FOREIGN
TAX LAWS AND POSSIBLE CHANGES IN THE TAX LAWS.
DIVIDENDS PAID ON THE ORDINARY SHARES
Distributions paid on ordinary shares (including any Israeli taxes withheld) to
a U.S. Shareholder will be treated as ordinary dividend income for United States
federal income tax purposes to the extent of the Company's current and
accumulated earnings and profits (as computed for U.S. federal income tax
purposes). Such dividends, which will be treated as foreign source income for
U.S. foreign tax credit purposes, generally will not qualify for the
dividends-received deduction available to corporations. Distributions in excess
of such earnings and profits will be applied against and will reduce the
shareholder's tax basis in the ordinary shares and, to the extent in excess of
such tax basis, will be treated as gain from a sale or exchange of such ordinary
shares. The amount of the distribution will equal the US Dollar value of the
distribution, calculated by reference to the exchange rate in effect on the date
the distribution is received (or otherwise made available to the U.S.
Shareholders), regardless of whether a payment in Israeli currency is actually
converted to US Dollars at that time. U.S. Shareholders should consult their own
tax advisors concerning the treatment of foreign currency gain or loss, if any,
on any Israeli currency received which is converted into US Dollars subsequent
to receipt.
Qualified dividend income received by an individual (as well as certain trusts
and estates) U.S. Shareholder for taxable years beginning before January 1, 2009
are taxed at reduced rates of either 5 or 15 percent, depending upon the amount
of such shareholder's taxable income. If a non-corporate U.S. Shareholder does
not hold ordinary shares for more than 60 days during the 120 day period
beginning 60 days before an ex-dividend date, dividends received on ordinary
shares are not eligible for reduced rates. Dividends received from a foreign
corporation that was a passive foreign investment company (as further discussed
below) in either the taxable year of the distribution or the preceding taxable
year are not qualified dividend income. Qualified dividend income includes
dividends received from a "qualified foreign corporation." A "qualified foreign
corporation" includes a foreign corporation whose shares are readily tradable on
an established securities market in the United States as well as a foreign
corporation that is entitled to the benefits of a comprehensive income tax
treaty with the United States which includes an exchange of information program.
Israel and the United States are parties to a comprehensive income tax treaty
which includes an exchange of information program. The United States Treasury
Department will periodically issue guidance regarding which income tax treaties
will be satisfactory for treating a corporation as a "qualified foreign
corporation". In the event ordinary shares should not be readily tradable on an
established securities market in the United States, non-corporate U.S.
Shareholders should consult their own tax advisors as to whether any
distributions paid on ordinary shares will be taxed for United States federal
income tax purposes at reduced tax rates.
67
CREDIT FOR ISRAELI TAXES WITHHELD
Subject to certain conditions and limitations, any Israeli tax withheld or paid
with respect to dividends on the ordinary shares generally will be eligible for
credit against a U.S. Shareholder's United States federal income tax liability
at such U.S. Shareholder's election. The Code provides limitations on the amount
of foreign tax credits that a U.S. Shareholder may claim, including extensive
separate computation rules under which foreign tax credits allowable with
respect to specific categories of income cannot exceed the United States federal
income taxes otherwise payable with respect to each such category of income.
Dividends with respect to the ordinary shares generally will be classified as
foreign source "passive income" for the purpose of computing a U.S.
Shareholder's foreign tax credit limitations for U.S. foreign tax credit
purposes. The availability of the Israeli withholding tax as a foreign tax
credit will also be subject to certain restrictions on the use of such credits,
including a prohibition on the use of the credit to reduce liability for the
United States individual and corporate minimum taxes by more than 90%.
Alternatively, U.S. Shareholders that do not elect to claim a foreign tax credit
may instead claim a deduction for Israeli income tax withheld or paid, but only
for a year in which these U.S. Shareholders elect to do so for all foreign
income taxes. The rules relating to foreign tax credits are complex, and you
should consult your tax advisor to determine whether and if you would be
entitled to this credit.
DISPOSITION OF THE ORDINARY SHARES
Subject to the discussion under the heading "Passive Foreign Investment Company
Status" the sale or exchange of ordinary shares generally will result in the
recognition of capital gain or loss in an amount equal to the difference between
the amount realized on the sale or exchange and the U.S. Shareholder's tax basis
in the ordinary shares. Such gain or loss generally will be long-term capital
gain or loss if the U.S. Shareholder's holding period of the ordinary shares
exceeds one year at the time of the disposition. Certain limitations apply to
the deductibility of capital losses by both corporate and non-corporate
taxpayers. Under the Code, gain or loss recognized by a U.S. Shareholder on a
sale or exchange of ordinary shares generally will be treated as U.S. source
income or loss for U.S. foreign tax credit purposes. Under the tax treaty
between the United States and Israel, however, gain derived from the sale,
exchange or other disposition of ordinary shares by a holder who is a resident
of the United States for purposes of the treaty and who sells the ordinary
shares within Israel may be treated as foreign source income for U.S. foreign
tax credit purposes. U.S. Shareholders should consult their own tax advisors
regarding the treatment of any foreign currency gain or loss on any Israeli
currency received in respect of the sale, exchange or other disposition of
ordinary shares.
PASSIVE FOREIGN INVESTMENT COMPANY STATUS
A foreign corporation generally will be treated as a "passive foreign investment
company" ("PFIC") if, after applying certain "look-through" rules, either (i)
75% or more of its gross income is passive income or (ii) 50% or more of the
average value of its assets is attributable to assets that produce or are held
to produce passive income. Passive income for this purpose generally includes
dividends, interest, rents, royalties and gains from securities and commodities
transactions. The look-through rules require a foreign corporation that owns at
least 25% by value, of the stock of another corporation to treat a proportionate
amount of assets and income as held or received directly by the foreign
corporation.
68
The Company has not made the analysis necessary to determine whether or not it
is currently a PFIC or whether it has ever been a PFIC. However, the Company
does not believe that it was a PFIC in 2004. However, there can be no assurance
that the Company is not, has never been or will not in the future be a PFIC. If
the Company were to be treated as a PFIC, any gain recognized by a U.S.
Shareholder upon the sale (or certain other dispositions) of ordinary shares (or
the receipt of certain distributions) generally would be treated as ordinary
income, and a U.S. Shareholder may be required, in certain circumstances, to pay
an interest charge together with tax calculated at maximum rates on certain
"excess distributions," including any gain on the sale or certain dispositions
of ordinary shares. In order to avoid this tax consequence, a U.S. Shareholder
(i) may be permitted to make a "qualified electing fund" election, in which
case, in lieu of such treatment, such holder would be required to include in its
taxable income certain undistributed amounts of the Company's income or (ii) may
elect to mark-to-market the ordinary shares and recognize ordinary income (or
possible ordinary loss) each year with respect to such investment and on the
sale or other disposition of the ordinary shares. Additionally, if the Company
is deemed to be a PFIC, a U.S. Shareholder who acquires ordinary shares in the
Company from a decedent will be denied the normally available step-up in tax
basis to fair market value for the ordinary shares at the date of the death and
instead will have a tax basis equal to the decedent's tax basis if lower than
fair market value. Neither the Company nor its advisors have the duty to or will
undertake to inform U.S. Shareholders of changes in circumstances that would
cause the Company to become a PFIC. U.S. Shareholders should consult their own
tax advisors concerning the status of the Company as a PFIC at any point in time
after the date of this Annual Report on Form 20-F. The Company does not
currently intend to take the action necessary for a U.S. Shareholder to make a
"qualified electing fund" election in the event the Company is determined to be
a PFIC.
TAX CONSEQUENCES FOR NON-U.S. HOLDERS OF ORDINARY SHARES
Except as described in "Information Reporting and Back-up Withholding" below, a
non-U.S. holder of ordinary shares will not be subject to U.S. federal income or
withholding tax on the payment of dividends on, and the proceeds from the
disposition of, ordinary shares, unless:
o the item is effectively connected with the conduct by the non-U.S.
holder of a trade or business in the United States and:
(i) in the case of a resident of a country which has a treaty with
the United States, the item is attributable to a permanent
establishment; or
(ii) in the case of an individual, the item is attributable to a fixed
place of business in the United States;
o the non-U.S. holder is an individual who holds the ordinary shares as
a capital asset and is present in the United States for 183 days or
more in the taxable year of the disposition and does not qualify for
an exemption; or
o the non-U.S .holder is subject to tax under the provisions of U.S. tax
law applicable to U.S. expatriates.
INFORMATION REPORTING AND BACK UP WITHHOLDING.
A non-corporate U.S. Shareholder may, under certain circumstances, be subject to
information reporting requirements and "backup withholding" at a 30% rate on
cash payments in the United States of dividends on, and the proceeds of
disposition of, ordinary shares. Backup withholding will apply only if a U.S.
Shareholder: (a) fails to furnish its social security or other taxpayer
identification number ("TIN") within a reasonable time after the request
therefore; (b) furnishes an incorrect TIN; (c) is notified by the IRS that it
has failed properly to report payments of interest and dividends; or (d) under
certain circumstances, fails to certify, under penalty of perjury, that it has
furnished a correct TIN and has not been notified by the IRS that it is subject
to backup withholding for failure to report interest and dividend payments. U.S.
Shareholders should consult their tax advisors regarding their qualification for
exemption, if applicable. The amount of backup withholding from a payment to a
U.S. Shareholder generally will be allowed as a credit against such U.S.
Shareholder's federal income tax liability and may entitle such U.S. Shareholder
to a refund, provided that the required information is furnished to the IRS.
69
10F. DIVIDENDS AND PAYING AGENTS
Not applicable.
10G. STATEMENT BY EXPERTS
Not applicable.
10H. DOCUMENTS ON DISPLAY
The documents concerning the Company that are referred to in the form may be
inspected at the Company's office in Israel.
10I. SUBSIDIARY INFORMATION
For information relating to the Company's subsidiaries, see Item 4 -
"Organizational Structure" as well as the Company's Consolidated Financial
Statements (Items 8 and 18 of this form).
70
ITEM 11: QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK.
CURRENCY EXCHANGE RATE RISK MANAGEMENT
The Company's functional currency is the US Dollar. Since the Company operates
in Israel and Europe it manages assets and liabilities in currencies other than
US Dollar such as Israeli Shekel and Euro.
The excess balance of monetary assets on liabilities in non-dollar currencies in
the Balance Sheet as of 31.12.04 and 31.12.03 ("Balance Sheet Exposure") is
presented in the table below. The data is presented in US Dollars (in
thousands):
DECEMBER 31, 2004 DECEMBER 31, 2003
------------------- -------------------
ISRAELI NON-DOLLAR ISRAELI NON-DOLLAR
CURRENCY CURRENCIES CURRENCY CURRENCIES
(1) (2) (1) (2)
------ ------ ------ ------
U.S.$ U.S.$ U.S.$ U.S.$
------ ------ ------ ------
CURRENT ASSETS:
Cash and cash equivalents $ 873 $ 244 $ 629 $ 41
Trade receivables 3,794 121 388 2
Other accounts receivable 390 - 87 68
------ ------ ------ ------
$5,057 $ 365 $1,104 $ 111
====== ====== ====== ======
CURRENT LIABILITIES:
Short term loans from banks $1,354 $ - $ - $ -
Current maturities of long-term bank 48 - - -
loans and convertible note
Trade payables 1,514 21 41 16
Other accounts payable 988 - 406 110
------ ------ ------ ------
$3,904 $ 21 $ 447 $ 126
====== ====== ====== ======
Bank loans (net of current maturities) $ 54 $ - $ - $ -
====== ====== ====== ======
TOTAL LIABILITIES $3,958 $ 21 $ 447 $ 126
====== ====== ====== ======
NET $1,099 $ 344 $ 657 $ (15)
====== ====== ====== ======
(1) The above does not include balances in Israeli currency linked to the US
dollar.
(2) Primarily Euro.
The Company does not use financial instruments and derivatives, but manages the
risk of Balance Sheet Exposure by attempting to maintain a similar balance of
assets and liabilities in any given currency.
The selling prices of our products in Israel and Europe are quoted and collected
in the local currency. The purchases and salary expenses in Israel are paid in
the local currency.
A material change in currency exchange rate of the NIS or Euro compared to the
US Dollar may have an effect on the Company's financial results and cash flow.
CREDIT RISK MANAGEMENT
The company sells its products and purchases products from vendors on credit
terms.
71
The trade receivables of the Company are derived from sales to customers located
primarily in the United States, Europe and Israel. The Company generally does
not require collateral; however, in certain circumstances, the Company may
require letters of credit, other collateral, additional guarantees or advanced
payments.
Provisions are made for doubtful debts on a specific basis and, in management's
opinion, appropriately reflect the loss inherent in collection of the debts.
Management bases this provision on its assessment of the risk of the debt.
The table below presents the accounts receivables balance by geographical market
as of 31.12.04 and 31.12.03:
DECEMBER 31,
--------------------
2004 2003
------ ------
United States $ 734 $ 392
Europe $ 345 $ 117
Israel and others $3,478 $ 566
------ ------
$4,557 $1,075
====== ======
INTEREST RATE RISK
The Company's exposure to market risk for changes in interest rates, is due to
its investment of its surplus funds, loans and Convertible Note that carried
variable interest.
The Company has a conservative investment policy. According to this policy the
Company invests in bank deposits and in high level marketable securities.
A material change in yields of the securities which the company invests in and
the need of cash before the securities' maturation, may have an effect on the
Company's financial results and cash flow.
A material change in interest we receive on our bank deposits or pay on our
loans and Convertible Note may have an effect on the Company's financial results
and cash flow.
BANK RISK
The Company invests and manages the majority of its funds in two banks which are
among the five largest in Israel.
ITEM 12: DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES.
Not applicable.
72
PART II
ITEM 13: DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES.
Not applicable.
ITEM 14: MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF
PROCEEDS.
Not applicable.
ITEM 15: CONTROLS AND PROCEDURES
The Company performed an evaluation of the effectiveness of its disclosure
controls and procedures that are designed to ensure that the material financial
and non-financial information required to be disclosed on Form 20-F and filed
with the Securities and Exchange Commission is recorded, processed, summarized
and reported timely. Based on the Company's evaluation, the Company's
management, including the CEO and CFO, has concluded that the Company's
disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e)
of the Securities Exchange Act of 1934, as amended) as of the end of the period
covered by this report are effective. Notwithstanding the foregoing, there can
be no assurance that the Company's disclosure controls and procedures will
detect or uncover all failures of persons within the Company to disclose
material information otherwise required to be set forth in the Company's
reports.
Subsequent to the date of the evaluation thereof, there have been no significant
changes in the Company's internal controls or in other factors that could have
materially affected or are reasonably likely to materially affect these
controls. Therefore, no corrective actions with regard to significant
deficiencies and material weaknesses were taken.
ITEM 16: [RESERVED]
ITEM 16A: AUDIT COMMITTEE FINANCIAL EXPERT
The Company's Board of Directors has determined that Prof. Adi Raveh and Mr.
Ronen Zavlik, both members of the audit committee, are "audit committee
financial experts", as defined by the applicable SEC regulations. The experience
of each is listed under Item 6A. Both are "independent" under the applicable SEC
and Nasdaq regulations.
ITEM 16B: CODE OF ETHICS
The Company has adopted a Code of Ethics applicable to its executive officers,
directors and all other employees. A copy of the code may be obtained, without
charge, upon a written request addressed to the Company's investor relations
department.
ITEM 16C: PRINCIPAL ACCOUNTANT FEES AND SERVICES
The Company's principal accountants for the years 2003 and 2004 were Kost Forer
Gabbay & Kasierer, a member of Ernst & Young Global.
The table below summarizes the audit and other fees paid and accrued by the
Company and its consolidated subsidiaries to Kost Forer Gabbay & Kasierer,
during each of 2003 and 2004:
73
YEAR ENDED DECEMBER 31, 2004 YEAR ENDED DECEMBER 31, 2003
---------------------------- ----------------------------
AMOUNT PERCENTAGE AMOUNT PERCENTAGE
------ ---------- ------ ----------
Audit Fees 81,000 75% $40,000 61%
Audit-Related Fees (1) 19,000 18% $ 7,650 12%
Tax Fees (2) 3,000 3% $ 8,000 12%
All Other Fees (3) 4,000 4% $ 9,500 15%
Total 107,000 100% $65,150 100%
(1) "Audit-related fees" are fees related to assurance and associated services
that traditionally are performed by the independent auditor, including
consultation concerning reporting standards.
(2) "Tax fees" are fees for professional services rendered by the Company's
auditors with respect to tax advice related to acquisitions and tax
compliance with the Israeli law for encouragement of investment.
(3) "All Other Fees" are fees for consulting services rendered by the Company's
auditors with respect to government incentives.
The Audit Committee pre-approves on an annual basis the audit and certain
non-audit services provided to the Company by its auditors. Such annual
pre-approval is given with respect to particular services and sets forth a
specific budget for such services. Additional services not covered by the annual
pre-approval may be approved by the Audit Committee on a case-by-case basis as
the need for such services arises. Furthermore, the Audit Committee has
authorized the Committee Chairman to pre-approve engagements of the Company's
auditors so long as the fee for each such engagement does not exceed $5,000 and
so long as the engagement is notified to the Committee at its next subsequent
meeting. Any services pre-approved by the Audit Committee (or by the Chairman)
must be permitted by applicable law.
ITEM 16D: EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES
Not applicable to Registrant
ITEM 16E: PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS
Neither the Company nor any Affiliated Purchasers (or anyone acting on their
behalf) purchased any of the Company's securities in 2004.
74
PART III
ITEM 17: FINANCIAL STATEMENTS
Not applicable.
ITEM 18: FINANCIAL STATEMENTS
The following financial statements are filed as part of this Annual Report:
PAGE
----
Report of Independent Auditors F-2
Consolidated Balance Sheets F-3 - F-4
Consolidated Statements of Operations F-5
Statement of Changes in Shareholders' Equity F-6
Statements of Cash Flows F-7 - F-8
Notes to Consolidated Financial Statements F-9 - F-39
The consolidated financial statements of Surf Communications Solutions Ltd., are
also filed as part of this Annual Report.
ITEM 19: EXHIBITS
The following exhibits are filed as part of this Annual Report:
1.1 Memorandum of Association, as amended (incorporated by reference to the
Company's Annual Report on Form 20-F filed on June 27, 2003).
1.2 Articles of Association, as amended (incorporated by reference to the
Company's Annual Report on Form 20-F filed on June 27, 2003).
4.1 Form of Indemnification Agreement between the Company and its officers and
directors (incorporated by reference to the Company's Current Report on
Form 6-K filed on January 17, 2003).
4.2 Share Purchase Agreement, dated as of February 23, 2003, and Option
Agreement and Registration Rights Agreement, dated as of March 30, 2003, by
and between Catalyst Investments L.P. and the Registrant (incorporated by
reference to the Company's Annual Report on Form 20-F filed on June 17,
2004).
4.3 Share Purchase Agreement and Registration Rights Agreement, dated as of
December 14, 2003, by and between Hillswood Holdings Limited and Vamos Inc.
and the Registrant (incorporated by reference to the Company's Annual
Report on Form 20-F filed on June 17, 2004).
4.4 Services Agreement, dated as of April 15, 2003, between Cukierman & Co.
Investment House Ltd., BOScom Ltd. and the Registrant (incorporated by
reference to the Company's Annual Report on Form 20-F filed on June 17,
2004).
4.5 M&A Addendum to the Service Agreement, as of August 22, 2004, between
Cukierman & Co. Investment House Ltd., BOScom Ltd. and the Registrant.
4.6 Management Agreement between Signum Ltd., Adiv Baruch and the Registrant,
dated as of January 1, 2004 (incorporated by reference to the Company's
Annual Report on Form 20-F filed on June 17, 2004)
4.7 Securities Purchase Agreement, Master Security Agreement and Registration
Rights Agreement, dated as of June 10, 2004, by and between Laurus Master
Fund Ltd. and the Registrant (incorporated by reference to the Company's
Annual Report on Form 20-F filed on June 17, 2004), and Amendment no. 1 to
the Securities Purchase Agreement dated as of November 16, 2004
(incorporated by reference to the Company's Registration Statement on Form
F-3 no. 333-117529).
75
4.8 Distribution Agreement, dated as of January 15, 2003, by and between Boscom
Ltd. and Bosanova Inc. (incorporated by reference to the Company's Annual
Report on Form 20-F/A filed on January 6, 2005).
4.9 Asset Purchase Agreement, dated as of September 29, 2004, by and between
Quasar Communication Systems Ltd. and the Registrant (incorporated by
reference to the Company's Registration Statement on Form F-3 no.
333-117529).
4.10 Share Purchase Agreement, dated as of November 2, 2004, by and between
Jacob and Sara Neuhof, Odem Electronic Technologies 1992 Ltd. and the
Registrant (incorporated by reference to the Company's Registration
Statement on Form F-3 no. 333-117529).
4.11 Share Purchase Agreement, dated as of November 2, 2004, by and between
Telsys Ltd., Odem Electronic Technologies 1992 Ltd. and the Registrant
(incorporated by reference to the Company's Registration Statement on Form
F-3 no. 333-117529).
4.12 Share Purchase Agreement, dated as of May 24, 2005, by and between certain
investors and the Registrant.
4.13 The Registrant's Israeli 2003 Share Option Plan (incorporated by reference
to the Company's Registration Statement on Form S-8 No. 333-11650).
8.1 List of subsidiaries (incorporated by reference to Item 4C of this Annual
Report on Form 20-F).
10.1 Consent of Kost Forer Gabbay & Kasierer, a member of Ernst &Young Global.
10.2 Consent of Kesselman & Kesselman, a member of PriceWaterhouseCoopers
International Limited.
10.3 Consent of Walter Fey, CPA.
10.4 Consent of Mazars Paardekooper Hoffman.
12.1 Certification by Chief Executive Officer pursuant to Rule 13a-14(a) or Rule
15d-14(a) of the Securities Exchange Act of 1934.
12.2 Certification by Chief Financial Officer pursuant to Rule 13a-14(a) or Rule
15d-14(a) of the Securities Exchange Act of 1934.
13.1 Certification by Chief Executive Officer and Chief Financial Officer
pursuant to Rule 13a-14(b) or Rule 15d-14(b) of the Securities Exchange Act
of 1934.
76
SIGNATURES
The Registrant 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.
B.O.S. Better Online Solutions Ltd.
/s/ Adiv Baruch /s/ Nehemia Kaufman
--------------- -------------------
Adiv Baruch Nehemia Kaufman
President and Chief Executive Officer Chief Financial Officer
Date: June 27, 2005
77
B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
AS OF DECEMBER 31, 2004
U.S. DOLLARS IN THOUSANDS
INDEX
PAGE
----
REPORT OF INDEPENDENT AUDITORS REGISTERED PUBLIC ACCOUNTING FIRM F - 2
CONSOLIDATED BALANCE SHEETS F - 3 - F - 4
CONSOLIDATED STATEMENTS OF OPERATIONS F - 5
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY F - 6
CONSOLIDATED STATEMENTS OF CASH FLOWS F - 7 - F - 8
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS F - 9 - F - 39
[ERNST & YOUNG LOGO] o KOST FORER GABBAY & KASIERER o Phone: 972-3-6232525
3 Aminadav St. Fax: 972-3-5622555
Tel-Aviv 67067, Israel
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
TO THE SHAREHOLDERS OF
B.O.S. BETTER ONLINE SOLUTIONS LTD.
We have audited the accompanying consolidated balance sheets of B.O.S
Better Online Solutions Ltd. ("the Company") and subsidiaries as of December 31,
2004 and 2003, and the related consolidated statements of operations, changes in
shareholders' equity and cash flows for each of the three years in the period
ended December 31, 2004. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits. We did not audit the financial
statements of Odem electronic technologies 1992 Ltd ("Odem") a subsidiary, which
statements reflect total assets constituting 30.6% as of December 31, 2004, and
total revenues for the period from November 18, 2004 (date of acquisition of
Odem) to December 31, 2004 constituting 23.5% of the related consolidated
totals. 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
Odem, is based solely on the reports of the other auditors. Those auditors
expressed an unqualified opinion on those statements in their report dated
March 25, 2005.
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 report of the other auditors provide a reasonable basis for our
opinion.
In our opinion, based on our audits and the report 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 at December 31, 2004 and 2003, and the consolidated results of
their operations and their cash flows for each of the three years in the period
ended December 31, 2004, in conformity with U.S. generally accepted accounting
principles.
Tel-Aviv, Israel KOST FORER GABBAY & KASIERER
March 30, 2005 A Member of Ernst & Young Global
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Shareholders of
ODEM ELECTRONIC TECHNOLOGIES 1992 LTD.
We have audited the consolidated balance sheets of Odem Electronic Technologies
1992 Ltd. (the "Company") and its subsidiaries as of December 31, 2003 and 2004
and the related consolidated statements of operations, changes in shareholders'
equity and cash flows for each of the years ended on those dates. These
financial statements are the responsibility of the Company's Board of Directors
and management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in Israel and the standards of the Public Company Accounting Oversight Board
(United States), including those prescribed by the Israeli Auditors (Mode of
Performance) Regulations, 1973. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by the Company's Board of Directors and management, as well as
evaluating the overall financial statement presentation. We believe that our
audit provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above, present
fairly, in all material respects, the consolidated financial position of the
Company and its subsidiaries as of December 31, 2003 and 2004 and the
consolidated results of operations, changes in shareholders' equity and cash
flows for each of the years ended on those dates, in conformity with accounting
principles generally accepted in the United States of America.
Jerusalem, Israel Kesselman & Kesselman
March 25, 2005 Certified Public Accountants (Israel)
A member of PricewaterhouseCoopers International Limited
F - 2
B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
-------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
DECEMBER 31,
------------------------
2004 2003
------- -------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 2,578 $ 3,872
Marketable securities (Note 5) 2,324 1,014
Trade receivables (net of allowance for doubtful accounts of $ 38 and $ 171 as
of December 31, 2004 and 2003, respectively) 4,557 1,075
Other accounts receivable and prepaid expenses (Note 3) 722 317
Inventories (Note 4) 3,086 961
------- -------
Total current assets 13,267 7,239
------- -------
LONG-TERM ASSETS:
LONG TERM MARKETABLE SECURITIES (Note 5) 757 1,862
------- -------
SEVERANCE PAY FUND 1,143 684
------- -------
INVESTMET IN AN AFFILIATED COMPANY (Note 6) 2,472 2,780
------- -------
OTHER ASSETS 395 -
------- -------
PROPERTY, PLANT AND EQUIPMENT, NET (Note 7) 1,019 598
------- -------
GOODWILL (Note 9) 1,569 741
------- -------
CUSTOMER LIST, NET (Note 8) 1,389 -
------- -------
OTHER INTANGIBLE ASSETS, NET (Note 8) 471 -
------- -------
ASSETS RELATED TO DISCONTINUED OPERATIONS (Note 1c) 3 119
------- -------
$22,485 $14,023
======= =======
The accompanying notes are an integral part of the consolidated financial
statements.
F - 3
B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
-------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
DECEMBER 31,
---------------------------
2004 2003
-------- --------
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Short term loans from banks (Note 10) $ 1,354 $ -
Current maturities of long-term bank loans and convertible note 643 -
Trade payables 3,845 464
Employees and payroll accruals 664 404
Deferred revenues 364 378
Accrued expenses and other liabilities (Note 11) 1,141 911
-------- --------
Total current liabilities 8,011 2,157
-------- --------
LONG-TERM LIABILITIES:
Bank loans (net of current maturities) (Note 12) 54 -
Convertible note (net of current maturities) (Note 13) 1,151 -
Put option issued to minority shareholders in a subsidiary 359 -
Deferred taxes 348 -
Accrued severance pay 1,468 951
-------- --------
TOTAL long-term liabilities 3,380 951
MINORITY INTEREST IN A SUBSIDIARY 809 -
======== ========
LIABILITIES RELATED TO DISCONTINUED OPERATIONS (Note 1c) 237 374
======== ========
COMMITMENTS AND CONTINGENT LIABILITIES (Note 14)
SHAREHOLDERS' EQUITY (Note 15):
Share capital
Ordinary shares of NIS 4.00 par value: Authorized: 8,750,000 shares at
December 31, 2004 and 2003; Issued: 4,737,658 and 4,167,509 shares at
December 2004 and 2003, respectively; Outstanding: 4,737,658 and 4,162,126
shares at December 2004 and 2003, respectively 4,823 4,309
Additional paid-in capital 44,426 43,247
Deferred stock-based compensation (174) -
Accumulated other comprehensive income 31 -
Treasury shares: 0 Ordinary shares at December 31, 2004 and 5,383 Ordinary
shares at December 31, 2003 - (150)
Accumulated deficit (39,058) (36,865)
-------- --------
TOTAL SHAREHOLDERS' EQUITY 10,048 10,541
-------- --------
TOTAL liabilities and shareholder's equity $ 22,485 $ 14,023
======== ========
The accompanying notes are an integral part of the consolidated financial
statements.
F - 4
B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA
YEAR ENDED DECEMBER 31,
-----------------------------------------
2004 2003 2002
------- ------- -------
Revenues $ 8,282 $ 5,728 $ 9,441
Cost of revenues 4,608 1,794 2,300
Non recurring royalty reversal (Note 17a) - 339 -
------- ------- -------
Gross profit 3,674 4,273 7,141
------- ------- -------
Operating costs and expenses:
Research and development 2,296 2,129 2,182
Less - grants and participation (492) (283) -
Sales and marketing 1,706 2,178 3,705
General and administrative 1,705 1,317 1,697
Restructuring and related costs - 678 -
------- ------- -------
Total operating costs and expenses 5,215 6,019 7,584
------- ------- -------
Operating loss (1,541) (1,746) (443)
Financial income (expenses), net (Note 17b) (158) 109 295
Other income (expenses) - 45 (95)
------- ------- -------
Loss before taxes on income (1,699) (1,592) (243)
Taxes on income (Note 16) (20) - -
Equity in losses of an affiliated company (308) (465) (570)
Minority interest in earnings of a subsidiary (17) - -
------- ------- -------
Loss from continuing operations (2,044) (2,057) (813)
income (loss) related to discontinued operations (Note 1c) (9) 2,036 (7,674)
------- ------- -------
Net loss $(2,053) $ (21) $(8,487)
======= ======= =======
Basic and diluted net loss per share from continuing operations
(Note 17c) $ (0.44) $ (0.56) $ (0.26)
======= ======= =======
Basic and diluted net income (loss) per share from discontinued
operations (Note 17c) $ 0.00 $ 0.55 $ (2.46)
======= ======= =======
Basic and diluted net loss of NIS 4.00 par value per share (Note 17c) $ (0.44) $ (0.01) $ (2.72)
======= ======= =======
The accompanying notes are an integral part of the consolidated financial
statements.
F - 5
B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE DATA
ACCUMULATED
ADDITIONAL DEFERRED OTHER
ORDINARY SHARE PAID IN SHARE BASED COMPREHENSIVE
SHARES CAPITAL CAPITAL COMPENSATION INCOME
--------- --------- --------- ------------- -------------
Balance at January1, 2002 3,102,264 $ 3,628 $ 41,220 $ - $ -
Issuance of shares 3,750 3 27 - -
Issuance of shares related to the
private placement in 2000 71,250 59 (1) - -
Reversal of accrued issuance expenses - - 66 - -
Stock based compensation related to
warrants issued to service providers - - 7 - -
Net loss - - - - -
Total other comprehensive loss - - - - -
--------- --------- --------- ------------- -------------
Total comprehensive loss
Balance at December 31, 2002 3,177,264 3,690 41,319 - -
Issuance of shares related to share swap
transaction 633,102 537 1,059 - -
Issuance of shares related to the
private placement 357,143 82 846 - -
Stock based compensation related to
warrants issued to service providers - - 23 - -
Net loss - - - - -
Total other comprehensive loss - - - - -
--------- --------- --------- ------------- -------------
Total comprehensive loss
Balance at December 31, 2003 4,167,509 4,309 43,247 - -
Deferred employee share-based
compensation - - 179 (179) -
Amortization of deferred employee
share-based compensation - - 5 -
Issuance of shares related to the
acquisitions of Quasar and Odem 570,149 514 784 -
Stock based compensation related to
warrants issued to service providers - - 117 -
Beneficial conversion feature related to
convertible note - - 99 - -
Other comprehensive loss
Net loss - - - - -
Gain on available for sales marketable
securities - - - 5
Foreign currency translation adjustments - - - 26
--------- --------- --------- ------------- -------------
Total comprehensive loss
Balance at December 31, 2004 4,737,658 $ 4,823 $ 44,426 $ (174) $ 31
========= ========= ========= ============= =============
TOTAL TOTAL
TREASURY ACCUMULATED COMPREHENSIVE SHAREHOLDERS'
SHARES DEFICIT LOSS EQUITY
------------- ------------- ------------- ---------
Balance at January1, 2002 $ (150) $ (28,357) $ 16,341
Issuance of shares - - 30
Issuance of shares related to the
private placement in 2000 - - 58
Reversal of accrued issuance expenses - - 66
Stock based compensation related to
warrants issued to service providers - - 7
Net loss - (8,487) $ (8,487) (8,487)
Total other comprehensive loss - - - -
------------- ------------- ------------- ---------
Total comprehensive loss $ (8,487)
=============
Balance at December 31, 2002 (150) (36,844) 8,015
Issuance of shares related to share swap
transaction - - 1,596
Issuance of shares related to the
private placement - - 928
Stock based compensation related to
warrants issued to service providers - - 23
Net loss - (21) $ (21) (21)
Total other comprehensive loss - - - -
------------- ------------- ------------- ---------
Total comprehensive loss $ (21)
=============
Balance at December 31, 2003 (150) (36,865) 10,541
Deferred employee share-based
compensation - - -
Amortization of deferred employee
share-based compensation - - 5
Issuance of shares related to the
acquisitions of Quasar and Odem 150 (140) 1,308
Stock based compensation related to
warrants issued to service providers - - 117
Beneficial conversion feature related to
convertible note - - 99
Other comprehensive loss
Net loss - (2,053) $ (2,053) (2,053)
Gain on available for sales marketable
securities - - 5 5
Foreign currency translation adjustments - - 26 26
------------- ------------- ------------- ---------
Total comprehensive loss $ (2,022)
=============
Balance at December 31, 2004 $ - $ (39,058) $ 10,048
============= ============= =========
F - 6
B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
YEAR ENDED DECEMBER 31,
-------------------------------------
2004 2003 2002
------- ------- -------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(2,053) $ (21) $(8,487)
Adjustments to reconcile net loss to net cash provided by (used in)
operating activities:
Loss (income) from discontinued operations 9 (2,036) 7,674
Depreciation and amortization of intangible assets 351 307 390
Amortization of marketable securities premium 47 101 89
Impairment of property and equipment - 110 95
Accrued severance pay, net 8 36 (49)
Equity in losses of an affiliated company 308 465 570
Minority interest in earnings in a subsidiary 17 - -
Capital loss from sale of property and equipment 5 6 -
Gain on sale of marketable securities - (13) -
Stock based compensation related to warrants issued to service
providers 126 23 7
Amortization of financial expenses related to issuance of
convertible note 78 - -
Decrease (increase) in trade receivables (342) 448 (28)
Decrease in deferred taxes (47) - -
Decrease in other accounts receivable and prepaid expenses 33 131 186
Increase in inventories (461) (106) (548)
Increase (decrease) in trade payables 961 (580) 596
Decrease in employees and payroll accruals, deferred revenues,
accrued expenses and other liabilities (63) (808) (368)
------- ------- -------
Net cash provided by (used in) operating activities from continuing
operations (1,023) (1,937) 127
Net cash provided by (used in) operating activities from
discontinued operations (96) (1,032) 728
------- ------- -------
Net cash provided by (used in) operating activities (1,119) (2,969) 855
------- ------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (214) (64) (163)
Proceeds from sale of property and equipment 38 8 9
Investment in long-term marketable securities (1,247) (971) (196)
Investment in an affiliated company - (155) -
Acquisitions, net of cash acquired (a,b) (1,443) - -
Realization of (investment in) restricted cash - 700 (700)
Proceeds from redemption of marketable securities 1,000 1,001 -
------- ------- -------
Net cash provided by (used in) investing activities from continuing
operations (1,866) 519 (1,050)
Net cash used in investing activities from discontinued operations - - (160)
------- ------- -------
Net cash provided by (used in) investing activities (1,866) 519 (1,210)
------- ------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of short term and long term bank loans (93) - (286)
Proceeds from long term convertible note and warrants, net of
issuance expenses 1,787 - -
Payment of long term convertible note (80) - -
Proceeds from issuance of shares, net - 928 58
Issuance expenses related to investment in a affiliated company - (159) -
------- ------- -------
Net cash provided by (used in) financing activities from continuing
operations 1,614 769 (228)
Net cash used in financing activities from discontinued operations - (47) (3,216)
------- ------- -------
Net cash provided by (used in) financing activities 1,614 722 (3,444)
------- ------- -------
Decrease in cash and cash equivalents (1,371) (1,728) (3,799)
Increase in cash and cash equivalents from discontinued operations 66 354 720
Effect of exchange rate changes on cash and cash equivalents 11 - -
Cash and cash equivalents at the beginning of the year 3,872 5,246 8,325
------- ------- -------
Cash and cash equivalents at the end of the year $ 2,578 $ 3,872 $ 5,246
======= ======= =======
The accompanying notes are an integral part of the consolidated financial
statements.
F - 7
B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
YEAR ENDED DECEMBER 31,
----------------------------------------
2004 2003 2002
------- ----------- -------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW ACTIVITIES:
(i) Net cash paid during the year for:
Interest $ 129 $ 1 $ 82
======= =========== =======
(ii) Non-cash activities:
Investment in an affiliated company against issuance of shares $ - $ 1,755 $ 30
======= =========== =======
A. ACQUISITION OF QUASAR:
Fair value of net assets acquired (excluding cash and cash
equivalents) and liabilities assumed at acquisition date: $ 597 $ - $ -
Less - amount acquired by issuance of shares (539) - -
------- ----------- -------
$ 58 $ - $ -
======= =========== =======
B. ACQUISITION OF ODEM:
Fair value of net assets acquired (excluding cash and cash
equivalents) and liabilities assumed at acquisition date: $ 2,293 $ - $ -
Less :
Amount acquired by issuance of shares (769) - -
Unpaid acquisition expenses (139)
------- ----------- -------
$ 1,385 $ - $ -
======= =========== =======
The accompanying notes are an integral part of the consolidated financial
statements.
F - 8
B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
-------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT FOR SHARE AND SHARE DATA)
NOTE 1:- GENERAL
a. B.O.S. Better Online Solutions Ltd. is an Israeli corporation
(together with its subsidiaries "the Company").
The Company's wholly-owned subsidiary BOScom Ltd. ("BOScom") develops
high technology connectivity solutions that provide PC emulation
products for the IBM iSeries (AS/400) and cross-platform printing
solutions answering a demand for central printing and output
management solutions in organizations. BOScom also engages in the
business of communication solutions which provide multi-path,
intelligent routing voice over IP gateways.
In September 2004, the Company acquired the assets of Quasar
Communication Systems Ltd. Through the acquisition the Company will
expand its communication solutions which will include GSM gateways and
other cellular gateways (see note 1b).
In November 2004, the Company Purchased 63.6% of Odem Electronic
Technologies 1992 Ltd. ("Odem"). Odem is a solutions supplier of
electronic components and systems to the technologies sector (see note
1b).
The Company's products are sold and supported through a network of
distributors and value-added resellers.
B.O.S holds 22.6% interest in Surf Communication Solutions Ltd.
("Surf") which is a developer and supplier of access and network
convergence software solutions to the wire line and wireless
telecommunications and data communications industries.
b. Business combinations:
In September 2004, the Company entered into an agreement with Quasar
Communication Systems Ltd, to purchase the assets and liabilities of
Quasar Communication Systems Ltd, for an aggregate consideration of $
539 by the issuance of 285,000 of the Company's ordinary shares. The
assets and liabilities of Quasar Communication Systems were
transferred into Quasar Telecom (2004) Ltd., a wholly owned subsidiary
("Quasar"). The results of Quasar's operations have been included in
the consolidated financial statements since September 28, 2004 ("the
closing date").
The acquisition will enable the Company to continue developing the
communication division, while offering to the Company's clients an
extended product line that will enable savings in telecommunication
expenses for enterprise.
On November 18, 2004 the Company purchased 63.6% of the outstanding
shares of Odem, from Odem's existing shareholders. In consideration
for Odem's shares the Company (i) issued 290,532 of the Company's
ordinary shares subject to "lock-up" periods of 2 to 4 years and (ii)
paid an amount of $ 1,971 in cash. In addition, Odem's selling
shareholders and the Company have certain put and call options, based
on performance, with respect to all of the remaining Odem shares held
by such sellers, exercisable for a consideration comprised of
additional cash and issuance of additional ordinary shares of the
Company. The Company recorded assets and liability with respect to
these options at fair value. The put option liability will be measured
periodically until it expires or exercised and changes in the fair
value will be charged to finance expenses.
F - 9
B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
NOTE 1:- GENERAL (CONT.)
The Company's consolidated financial statements reflect the purchase price
determined as follows:
QUASAR ODEM
------ ------
Issuance of shares (1) $ 539 $ 769
Cash consideration - 1,971
Transaction costs 58 139
------ ------
Total purchase price $ 597 $2,879
====== ======
(1) The value of the Ordinary shares issued was determined based on the
average market price of the Company's Ordinary shares over the period
including two days before and after the terms of the transaction were
agreed to and announced.
The acquisitions have been treated using the purchase method of
accounting in accordance with SFAS141 "Business Combinations". The
purchase price has been allocated to the assets and liabilities
assumed acquired based on their estimated fair value at the date of
acquisition. The excess of the purchase price over the estimated fair
value of the tangible and intangible assets acquired has been recorded
as goodwill.
Based upon on valuation of tangible and intangible assets acquired, the
Company has allocated the total cost of the acquisitions as follows:
ESTIMATED
ALLOCATION OF PURCHASE CONSIDERATION QUASAR ODEM USEFUL LIFE
--------------------------------------------- --------------- ----------------- ---------------
Cash $ - $ 586
Tangible assets 77 780
Put option to minority shareholders (6) - (359)
Call option to minority shareholders (6) - 230
Inventory purchase commitment (1) (147) -
Customer list (5) - 1,406 10 years
Deferred tax liability - (430) 10 years
Trade name (2) 180 - 7 years
Core technology (3) 125 - 5 years
Distribution networks (4) 200 - 5 years
Goodwill 162 666
------- --------
Total purchase price $ 597 $ 2,879
======= ========
(1) The Company is committed to purchase Quasar Communication Systems Ltd.
inventory in the ordinary course of business for a cash consideration
of $ 517. The fair value of Quasar's inventory at the purchase date
amounted to $ 370. A provision in the amount of $ 147 has been
recorded at the date of the acquisition.
(2) The Company's allocation of purchase price valuated the acquired trade
name using the relief from royalty approach.
F - 10
B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
NOTE 1:- GENERAL (CONT.)
(3) The Company's allocation of purchase price valuated the acquired core
technology using the discounted cash flows to be derived from the
sales of these products to present value.
(4) The Company's allocation of purchase price valuated the acquired
distribution networks by calculating the savings realized by the
Company through obtaining a pre-existing distribution network.
(5) The Company's allocation of purchase price valuated the acquired
customer list by calculating the benefit from the protection against
the loss in revenues and related cash flow as a direct result of the
customer relationship.
(6) The put and call options were valuated by using the Black & Scholes
option pricing model.
The following unaudited pro forma financial information presents the
Company's results of operations as if the acquisitions had occurred as
of the beginning of the fiscal years 2003 and 2004, after giving
effect to certain adjustments, including amortization of intangible
assets. The unaudited pro forma financial information does not
necessarily reflect the results of operations that would have
occurred, and is not necessarily indicative of results which may be
obtained in the future.
YEAR ENDED
----------------------------
DECEMBER 31,
----------------------------
2004 2003
--------- --------
Pro forma revenues $ 24,154 $ 17,960
========= ========
Pro forma net loss from continuing operations $ (2,631) $ (3,642)
========= ========
Pro forma basic and diluted net loss per share from continuing
operations $ (0.56) $ (0.86)
========= ========
c. Discontinued operations:
On June 1, 1998, the Company acquired 100% of the share capital of
Pacific Information Systems Inc. ("Pacinfo"), a U.S. corporation.
Pacinfo was a reseller of computer networking products.
During the fourth quarter of 2002, the Company initiated a plan to
cease operations of Pacinfo.
The results of operations including revenues, operating expenses and
other income and expenses of Pacinfo for 2004, 2003 and 2002 have been
reclassified in the accompanying statements of operations as
discontinued operations. The Company's balance sheets at December 31,
2004 and 2003 reflect the net liabilities of Pacinfo as liabilities
and assets related to discontinued operations.
F - 11
B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
NOTE 1:- GENERAL (CONT.)
The carrying amounts of the major classes of assets and liabilities
included as part of the discontinued operations are:
DECEMBER 31,
------------------------
2004 2003
---------- ----------
Cash $ 3 $ 69
Trade receivables, other receivables and prepaid expenses - 18
Property and equipment, net - 32
---------- ----------
Assets of discontinued operations $ 3 $ 119
========== ==========
Trade payables $ 194 $ 299
Accrued expenses and other liabilities 43 75
---------- ----------
Liabilities of discontinued operations $ 237 $ 374
========== ==========
The results of operations, including revenues, cost of revenues and
operating expenses of Pacinfo's operations for 2004, 2003 and 2002
have been reclassified in the statements of operations. Taxes were not
attributed to the discontinued operations due to utilization of losses
from previous years, for which a valuation allowance was provided.
Summarized selected financial information of the discontinued
operations is as follows:
YEAR ENDED DECEMBER 31,
---------------------------------------------
2004 2003 2002
---------- -------- --------
Revenues $ - $ 25 $ 32,912
========== ======== ========
Net income (loss) $ (9) $ 2,036 $ (7,674)
========== ======== ========
d. The Company had one major customer in 2004 and 2003, which constituted
39% and 52% of the revenues, respectively. This major customer is the
Company's master distributor in the U.S. In the event that the Company
encounters problems working with the master distributor, the Company
may experience an interruption in sales until an alternative source of
distribution can be found, which may have a material adverse effect on
the financial statements.
F - 12
B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES
The consolidated financial statements are prepared according to United
States generally accepted accounting principles ("U.S. GAAP").
a. Use of estimates:
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates
and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Actual results could differ from
those estimates.
b. Financial statements in U.S. dollars ("dollar"):
A substantial portion of the Company's revenues is generated in U.S.
dollar ("dollars"). In addition, most of the Company's costs are
incurred in dollars. Company's management believes that the dollar is
the primary currency of the economic environment in which the Company
operates. Thus, the functional and reporting currency of the Company
is the dollar.
Accordingly, monetary accounts maintained in currencies other than the
dollar are remeasured into U.S. dollars in accordance with Statement
No. 52 of the Financial Accounting 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.
The financial statements of certain subsidiary, whose functional
currency is other than dollar, have been translated into U.S. dollars.
All balance sheet accounts have been translated using the exchange
rates in effect at the balance sheet date. Statement of operations
amounts have been translated using the average exchange rate for the
period. The resulting translation adjustments are reported as a
component of shareholders' equity in accumulated other comprehensive
income (loss).
c. Principles of consolidation:
The consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiaries and those of Odem (see Note
1b). Inter-company transactions and balances including profits from
inter-company sales not yet realized outside the Company have been
eliminated upon consolidation.
d. Cash equivalents:
Cash equivalents are short-term highly liquid investments that are
readily convertible to cash originally purchased with maturities of
less than three months.
F - 13
B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)
e. Marketable securities:
The Company accounts for investments in debt securities in accordance
with Statement of Financial Accounting Standard No.115, "Accounting
for Certain Investments in Debt and Equity Securities" ("SFAS
No.115"). Management determines the appropriate classification of its
investments in debt and equity securities at the time of purchase and
reevaluates such determinations at each balance sheet date. Debt
securities are classified as held-to-maturity since the Company has
the positive intent and ability to hold the securities to maturity and
are stated at amortized cost. The amortized cost of held-to-maturity
securities is adjusted for amortization of premiums and accretion of
discounts to maturity. Such amortization and decline in value judged
to be other than temporary and interest are included in financial
income, net.
Other marketable securities consist mutual funds securities classified
as "available-for-sale" securities. Available-for-sale securities are
carried at fair value with unrealized gains, and are reported as a
separate item under "other comprehensive loss".
f. Inventories:
Inventory write-offs are provided to cover risks arising from
slow-moving items or technological obsolescence. As of December 31,
2004, inventory is presented net of $ 300 general provision for
technological obsolescence and slow moving items (see also Note 4).
Inventories are valued at the lower of cost or market value. Cost is
determined as follows: Raw and packaging materials - moving average
cost method.
Products in progress and finished products - on the production costs
basis
g. Grants and royalty-bearing grants:
Grants and royalty-bearing grants from the Chief Scientist of the
Ministry of Industry and Trade in Israel for funding certain approved
research projects are recognized at the time the Company is entitled
to such grants, on the basis of the related costs incurred, and are
presented as a deduction of research and development costs.
h. Investment in an affiliated company:
An affiliated company is a company in which the Company is able to
exercise significant influence, but that is not a consolidated
subsidiary and is accounted for by the equity method, net of
write-down for decrease in fair value which is not of a temporary
nature.
The investment in an affiliated company represents investments in
Ordinary shares and Preferred shares of that Company. The Company
applies EITF 99-10, "Percentage Used to Determine the Amount of Equity
Method Losses". Accordingly, losses of the affiliated company are
recognized based on the ownership level of the particular security of
the affiliated company held by the Company.
F - 14
B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)
The Company's investment in this company is reviewed for impairment
whenever events or changes in circumstances indicate that the carrying
amount of the investment may not be recoverable, in accordance with
Accounting Principle Board Opinion No. 18 "The Equity Method of
Accounting for Investments in Common Stock" ("APB No. 18"). During
2004, 2003 and 2002, based on management's analyses, no impairment
losses have been identified.
i. Property plant and equipment:
Property, plant and equipment are stated at cost, net of accumulated
depreciation. Depreciation is calculated by using the straight-line
method over the estimated useful lives of the assets, at the following
annual rates:
%
------------------
Computers and software 20 - 33
Office furniture and equipment 6 - 15
Leasehold improvements 10
Vehicles 15
Plant 4
j. Impairment of long-lived assets:
The Company's long-lived assets are reviewed for impairment in
accordance with Statement of Financial Accounting Standard No. 144
"Accounting for the Impairment or Disposal of Long-Lived Assets"
("SFAS No. 144") whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable.
Recoverability of assets to be held and used is measured by a
comparison of the carrying amount of an asset to the future
undiscounted cash flows expected to be generated by the assets. If
such assets are considered to be impaired, the impairment to be
recognized is measured by the amount by which the carrying amount of
the assets exceeds the fair value of the assets. Impairment losses
recorded amounted to $ 110 and $ 95 for the years ended December 31,
2003 and 2002, respectively and none in 2004.
k. Goodwill:
Goodwill represents excess of the costs over the net assets of
businesses acquired. SFAS No. 142 requires goodwill to be tested for
impairment at least annually or between annual tests in certain
circumstances, and written down when impaired. 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. Fair
value is determined using income and market approaches. Significant
estimates used in the methodologies include estimates of future cash
flows, future short-term and long-term growth rates, weighted average
cost of capital and estimates of market multiples for each of the
reportable units. During 2004, 2003 and 2002 no impairment losses have
been identified.
F - 15
B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)
l. Research and development costs:
Statement of Financial Accounting Standards No. 86 "Accounting for the
Costs of Computer Software to be Sold, Leased or Otherwise Marketed,"
("SFAS No. 86") requires capitalization of certain software
development costs subsequent to the establishment of technological
feasibility. Based on the Company's product development process,
technological feasibility is established upon completion of a working
model. Research and development costs incurred in the process of
developing product improvements or new products, are generally charged
to expenses as incurred, net of participation of the Office of the
Chief Scientist of the Israeli Ministry of Industry and Trade. Costs
incurred by the Company between completion of the working model and
the point at which the product is ready for general releases are
insignificant.
m. Severance pay:
The Company's liability for severance pay for Israeli resident
employees is calculated pursuant to the Israeli severance pay law
based on the most recent salary of the employees multiplied by the
number of years of employment as of the balance sheet date. Employees
are entitled to one month's salary for each year of employment or a
portion thereof. The Company's liability for its Israeli resident
employees is covered by insurance policies designed solely for
distributing severance pay. The value of these policies is recorded as
an asset in the Company's balance sheet.
The insurance policies include profits accumulated up to the balance
sheet date. The insurance policies may be withdrawn only upon
complying with the Israeli severance pay law or labor agreements. The
value of the deposited funds is based on the cash surrendered value of
these policies and includes profits. Severance expenses for 2004, 2003
and 2002 amounted to $ 214, $ 178 and $ 114, respectively.
n. Revenue recognition:
The Company sells its products primarily through distributors and
resellers.
The Company derives its revenues from the sale of products, license
fees for its products, commissions, maintenance, support and services.
Revenues from product sales are recognized in accordance with Staff
Accounting Bulletin No. 104 "Revenue Recognition in Financial
Statements" ("SAB 104") when delivery has occurred, persuasive
evidence of an arrangement exists, the vendor's fee is fixed or
determinable, no further obligation exists, and collectability is
reasonably assured.
F - 16
B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)
Revenue from license fees is recognized in accordance with Statement
of Position ("SOP") 97-2 "Software Revenue Recognition", when
persuasive evidence of an agreement exists, delivery of the product
has occurred, no significant obligations with regard to implementation
remain, the fee is fixed or determinable, and collectability is
probable. The Company generally does not grant a right of return to
its customers. When a right of return exists, the Company defers
revenue until the right of return expires, at which time revenue is
recognized provided that all other revenue recognition criteria have
been met.
Revenues from maintenance and support are recognized ratably over the
period of the maintenance contract. The fair value of the maintenance
is determined based on the price charged when it sold separately or
renewed.
Revenues derived from the Company's master distributor in the U.S. are
recognized based on consignment method.
Revenues from commissions are recognized upon their actual receipt,
since under agreements with suppliers consideration is received on the
basis of collection from customers.
o. Warranty:
The Company provides a warranty between 3 to 36 months at no extra
charge, whereby defective hardware covered by the warranty should be
sent back to the Company. The Company estimates the costs that may be
incurred under its warranty and records a liability in the amount of
such costs at the time product revenue is recognized. Factors that
affect the Company's warranty liability include the number of
installed units, historical and anticipated rates of warranty claims,
and cost per claim. The Company periodically assesses the adequacy of
its recorded warranty liabilities and adjusts the amounts as
necessary. As of December 31, 2004 and 2003, the Company's product
warranty amounted to $132.
p. Income taxes:
The Company accounts 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 differences between financial reporting and tax bases of
assets and liabilities and are measured using the enacted tax rates
and laws that will be in effect when the differences are expected to
reverse. The Company provides a valuation allowance, if necessary, to
reduce deferred tax assets to their estimated realizable value.
q. Concentrations of credit risk:
Financial instruments that potentially subject the Company to
concentrations of credit risk consist principally of cash and cash
equivalents, trade receivables, other accounts receivable and
marketable securities.
F - 17
B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)
Cash and cash equivalents are invested mainly in U.S. dollars in
deposits with major banks in Israel. Management believes that the
financial institutions that hold the investments of the Company are
financially sound and, accordingly, minimal credit risk exists with
respect to these investments.
The trade receivables of the Company are derived from sales to
customers located primarily in the United States, Europe and Israel.
The Company generally does not require collateral; however, in certain
circumstances, the Company may require letters of credit, other
collateral, additional guarantees or advanced payments.. An allowance
for doubtful accounts is determined with respect to specific debts
that are doubtful of collection.
Investments in marketable securities are conducted through a bank in
Israel, and include investments in corporate and governmental
debentures. Management believes that the financial institutions that
hold the Company's investments are financially sound, the portfolio is
well diversified and accordingly, minimal credit risk exists with
respect to these investments.
The Company has no off-balance-sheet concentrations of credit risk
such as foreign exchange contracts, option contracts or other foreign
hedging arrangements.
r. Basic and diluted net loss per share:
Basic net loss per share is calculated based on the weighted average
number of Ordinary shares outstanding during each year. Diluted net
loss per share is calculated based on the weighted average number of
Ordinary shares outstanding during each year, plus dilutive potential
Ordinary shares considered outstanding during the year, in accordance
with SFAS No. 128, "Earnings Per Share".
The total weighted average number of shares related to the outstanding
options and warrants excluded from the calculations of diluted net
loss per share, since they would have an anti-dilutive effect, were
855,783, 505,178 and 288,804 for the years ended December 31, 2004,
2003 and 2002, respectively.
s. Accounting for stock-based compensation:
The Company has elected to follow Accounting Principles Board Opinion
No. 25, "Accounting for Stock Issued to Employees" ("APB-25"), and
Interpretation No. 44, "Accounting for Certain Transactions Involving
Stock Compensation" ("FIN 44"), in accounting for its employee stock
option plan. Under APB-25, when the exercise price of the Company's
employee stock options equals or is above than the market price of the
underlying shares on the date of grant, no compensation expense is
recognized.
F - 18
B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)
Pro-forma disclosure is required by SFAS No. 123, had the compensation
expense for stock options granted under the Company's plans been
determined based on the fair value at the date of grant. The Company's
net loss and loss per Ordinary share in 2004, 2003 and 2002 would have
changed to the pro forma amounts shown below:
YEAR ENDED DECEMBER 31,
-----------------------------------------------
2004 2003 2002
------- --------- ---------
Net loss from continuing operations as reported $(2,044) $ (2,057) $ (813)
------- --------- ---------
Add: stock-based compensation expense determined
under intrinsic value method 5 - -
Deduct: stock-based compensation expense
determined under fair value method for all
awards (96) (124) (341)
------- --------- ---------
Pro forma net loss from continuing operations $(2,135) $ (2,181) $ (1,154)
Net income (loss) from discontinuing operations
as reported $ (9) $ 2,036 $ (7,674)
Add: stock-based compensation expense determined
under intrinsic value method - - -
Deduct: stock-based compensation expense
determined under fair value method for all
awards - - -
------- --------- ---------
Pro forma net income (loss) from discontinuing
operations $ (9) $ 2,036 $ (7,674)
------- --------- ---------
Pro forma net loss $(2,144) $ (145) $ (8,828)
======= ========= =========
Basic and diluted earning (loss) per share as
reported:
Continuing operations $ (0.44) $ (0.56) $ (0.26)
Discontinuing operations $ 0.00 $ 0.55 $ (2.46)
------- --------- ---------
Net loss $ (0.44) $ (0.01) $ (2.72)
Pro forma earning (loss) per share:
Continuing operations $ (0.46) $ (0.59) $ (0.37)
Discontinuing operations $ 0.00 $ 0.55 $ (2.46)
------- --------- ---------
Net loss $ (0.46) $ (0.04) $ (2.83)
The fair value of each option granted is estimated on the date of
grant, using the Black & Scholes option pricing model with expected
volatility of approximately 68%, 64% and 71% in 2004, 2003 and 2002,
respectively and using the following weighted average assumptions:
(1) Dividend yield of zero percent for each year.
(2) Risk-free interest rate of 2.5%, 1.8% and 1.5% in 2004, 2003 and
2002, respectively.
(3) Expected average lives of the options of three years from the
date of grant as of 2004, 2003 and 2002.
F - 19
B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)
The Company applies SFAS No. 123 "Accounting for stock Based
Compensation" ("SFAS No. 123") and EITF 96-18, "Accounting for Equity
Instruments that are Issued to Other than Employees for Acquiring, or
in Conjunction With, Selling, Goods or Services", with respect to
warrants issued to non-employees. SFAS No. 123 requires the use of
option valuation models to measure the fair value of the warrants at
the date of grant.
t. Fair value of financial instruments:
The following methods and assumptions were used by the Company in
estimating their fair value disclosures for financial instruments:
The carrying amounts of cash and cash equivalents, trade receivables,
other accounts receivable and trade payables approximate their fair
value due to the short-term maturities of such instruments. The fair
value for marketable securities is based on quoted market prices.
u. Impact of recently issued accounting standards:
In November 2004, the FASB issued Statement of Financial Accounting
Standard No. 151, "Inventory Costs, an amendment of ARB No. 43,
Chapter 4." ("SAFS 151"). SFAS 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 151 requires that allocation of fixed production
overheads to the costs of conversion be based on normal capacity of
the production facilities. SAFS 151 is effective for inventory costs
incurred during fiscal years beginning after June 15, 2005. The
Company does not expect that the adoption of SFAS 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 123R"), 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, Statements 123 permitted, but not required,
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 123R
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. The
new standard will be effective for the Company in the first interim
period beginning after June 15, 2005 (change if applicable otherwise).
The adoption of Statement 123R will have a significant effect on the
Company's results of operations
r. Reclassification:
Certain amounts from prior years have been reclassified to conform to
the current year presentation. As a result of the decision of the
Board of Directors to cease the operations of Pacinfo, the financial
statements of the Company classify the assets, liabilities and
operations of Pacinfo as discontinued operations.
F - 20
B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
NOTE 3:- OTHER ACCOUNTS RECEIVABLE AND PREPAID EXPENSES
DECEMBER 31,
------------------------
2004 2003
---------- ----------
Government authorities - Income tax advances and V.A.T $ 287 $ 62
Grants receivables 103 75
Accrued interest 96 58
Prepaid expenses 231 107
Other 5 15
---------- ----------
$ 722 $ 317
========== ==========
NOTE 4:- INVENTORIES
DECEMBER 31,
--------------------------
2004 2003
---------- ----------
Raw materials (including packaging materials) $ 809 $ 299
Products in progress 367 277
Finished products 1,910 385
---------- ----------
$ 3,086 $ 961
========== ==========
The inventories are presented net of provision for technological
obsolescence and slow-moving items of $ 300 as of December 31, 2004
and 2003.
NOTE 5:- MARKETABLE SECURITIES
The following is a summary of securities:
DECEMBER 31,
---------------------------------------------------------------------------------------------------
2004 2003
---------------------------------------------- ----------------------------------------------
ESTIMATED ESTIMATED
GROSS GROSS FAIR GROSS GROSS FAIR
AMORTIZED UNREALIZED UNREALIZED MARKET AMORTIZED UNREALIZED UNREALIZED MARKET
COST GAINS LOSSES VALUE COST GAINS LOSSES VALUE
------ ------- ------- ------ ------ ------ ------ ------
HELD-TO-MATURITY:
Government debts $ 612 $ 9 $ - $ 621
Corporate
debentures $2,279 $ 14 $ - $2,293 2,264 50 - 2,314
------ ------- ------- ------ ------ ------ ------ ------
$2,279 $ 14 $ - $2,293 $2,876 $ 59 $ - $2,935
====== ======= ======= ====== ====== ====== ====== ======
The fair value of the Company's available for sale securities as of
December 31, 2004 amounted to $ 802. Gain of $ 5 was recorded at
shareholders' equity.
F - 21
B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
NOTE 5:- MARKETABLE SECURITIES (CONT.)
Aggregate maturities of held-to-maturity securities for years subsequent to
December 31, 2004 are:
ESTIMATED FAIR
AMORTIZED COST MARKET VALUE
------ ------
HELD-TO-MATURITY:
2005 (short-term marketable securities) $1,522 $1,529
2006 290 292
2007 206 206
2008 261 266
------ ------
$2,279 $2,293
====== ======
NOTE 6:- INVESTMENT IN AN AFFILIATED COMPANY
Investment in Surf:
In November 2001, the Company invested $ 1,000 as part of a private
placement in Surf Communication System Ltd. ("Surf"). At the same time, the
Company converted its convertible loan in the amount of $ 1,042 (principal
and accrued interest) into Preferred shares in Surf at an exercise price
equal to Surf's fair value as determined in the investment agreement. As a
result of this private placement, the Company's holding in Surf was diluted
to 17%. Accordingly, the investment was accounted based on the cost
accounting method.
In March 2003, the Company engaged with Catalyst Investors L.P.
("Catalyst"), in order to purchase additional 191,548 series C Preferred
shares of Surf. In consideration, the Company issued to Catalyst 633,102
Ordinary shares, at a purchase price of $ 2.77, aggregating to $ 1,755 and
incurred transaction cost of $ 155. The value of the Ordinary shares issued
was determined based on the average market price of the Company's ordinary
shares over the period including two days before and after the terms of the
transaction were agreed to and announced. Catalyst also granted the
Company, at no additional consideration, an option to purchase on or prior
to January 31, 2006, any shares of Surf then held by Catalyst at an
exercise price of $ 9.1632 plus interest of 4.75% and until such purchase
shall be granted voting rights in Surf shares. In the event that Catalyst
will sell its remaining shares in Surf prior to January 1, 2006, the
Company will be entitled to the gain that will be realized in such sale.
As a result of this investment, the Company has the ability to exercise
significant influence over Surf and has become qualified for the use of the
equity method since the Company's holding in Surf exceeded 20%. According
to APB 18 when an investment qualifies for use of the equity method, the
investor should adopt the equity method of accounting by adjusting
retroactively the investment, results of operations (current and prior
periods presented), and retained earnings, in a manner consistent with the
accounting for a step-by-step acquisition of a subsidiary.
F - 22
B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
NOTE 6:- INVESTMENT IN AN AFFILIATED COMPANY (CONT.)
Summarized combined financial information is as follows:
DECEMBER 31,
-------------------
2004 2003
------ ------
Balance sheet items:
Current assets $3,764 $5,339
====== ======
Non-current assets $ 879 $ 893
====== ======
Current liabilities $1,431 $1,175
====== ======
Non-current liabilities $ 525 $ 472
====== ======
Shareholders' equity $2,687 $4,585
====== ======
YEAR ENDED DECEMBER 31,
---------------------------------
2004 2003 2002
------ ------ ------
Statement of operations items:
Revenues $2,762 $1,403 $1,108
====== ====== ======
Cost of sales $ 700 $ 563 $ 758
====== ====== ======
Operating expenses from continuing operation $4,037 $4,332 $7,174
====== ====== ======
Net loss $1,971 $3,427 $6,773
====== ====== ======
F - 23
B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
NOTE 7:- PROPERTY, PLANT AND EQUIPMENT
DECEMBER 31,
-------------------
2004 2003
------ ------
Cost:
Computers and software $2,108 $1,798
Office furniture and equipment 560 532
Leasehold improvements and plant 1,137 778
Vehicles 112 6
------ ------
3,917 3,114
------ ------
Accumulated depreciation:
Computers and software 1,812 1,561
Office furniture and equipment 291 351
Leasehold improvements and plant 749 598
Vehicles 46 6
------ ------
2,898 2,516
------ ------
Depreciated cost $1,019 $ 598
====== ======
Depreciation expenses amounted to $ 300, $ 307 and $ 390 for the years
ended December 31, 2004, 2003 and 2002, respectively.
NOTE 8:- INTANGIBLE ASSETS
DECEMBER 31,
------
2004
------
Cost:
Trade name $ 179
Core technology 125
Distribution network 200
Customer list 1,406
------
1,910
------
Accumulated amortization:
Trade name 6
Core technology 6
Distribution network 21
Customer list 17
------
50
------
Amortized cost $1,860
======
Amortization expenses amounted to $ 50 for the year ended December 31,
2004.
F - 24
B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
NOTE 8:- INTANGIBLE ASSETS (CONT.)
Estimated amortization expenses for the years ended:
DECEMBER 31,
-----------
2005 $ 231
2006 231
2007 231
2008 231
2009 205
NOTE 9:- GOODWILL
Goodwill attributed to operating segments for the years ended December 31,
2004 and 2003 is as follows:
ELECTRONIC
COMMUNICATION COMPONENT TOTAL
------ ------ ------
Balance as of January 1, 2004 $ 741 $ - $ 741
Acquisition of Odem - 666 666
Acquisition of Quasar 162 - 162
------ ------ ------
Balance as of December 31, 2004 $ 903 $ 666 $1,569
====== ====== ======
NOTE 10:- SHORT TERM BANK LOANS
WEIGHTED
INTEREST
RATE DECEMBER 31,
------------- -------------------
% 2004 2003
---- ---- ----
NIS 5.56 $1,354 $ -
Regarding collateral given to insure short-term credit and loans see note
12c.
F - 25
B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
NOTE 11:- ACCRUED EXPENSES AND OTHER LIABILITIES
DECEMBER 31,
-------------------
2004 2003
------ ------
Government of Israel - royalties and V.A.T $ 349 $ 635
Provision for warranty 132 132
Issuance cost related to accrued convertible note 160 -
Inventory purchase commitment liability 147 -
Other 353 144
------ ------
$1,141 $ 911
====== ======
NOTE 12:- LONG-TERM BANK LOANS
a. Classified by linkage terms and interest rates, the total amount of
the loans is as follows:
WEIGHTED
INTEREST
RATE DECEMBER 31,
-------- ------------------------
% 2004 2003
-------- -------- ----------
NIS linked to the Israeli CPI 7.95 $ 51 $ -
NIS 6.38 51 -
----- ----------
102 -
Less - current maturities (48) -
----- ----------
$ 54 $ -
===== ==========
b. The loans mature in the following years after the balance sheet dates:
DECEMBER 31,
-------------------
2004 2003
-------- --------
First year (current maturities) $ 48 $ -
Second year 36 -
Third year 17 -
Fourth year 1 -
-------- --------
$ 102 $ -
======== ========
c. The Company's subsidiary (Odem) has registered fixed pledged on its
real estate, plant and equipment and vehicles.
F - 26
B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
NOTE 13:- LONG-TERM CONVERTIBLE NOTE
On June 10, 2004, the Company entered into a Securities Purchase Agreement
("the Purchase Agreement"), with Laurus Master Fund Ltd. ("the Investor"),
under which the Company issued to the Investor in a private placement (i) a
Secured Convertible Term Note of a $ 2,000 principal amount, due June 10,
2007 ("the Note"). According to the agreement, several fees in the amount
of $ 115 were paid to the Investor. These fees are presented as discount of
the principal convertible loan. The Note is convertible into Ordinary
shares at a price of $ 3.08 per share. The principal amount of the Note is
repayable in monthly installments, commencing as of September, 2004, in the
initial amount of $ 20 eventually increasing to $ 74. The Note bears prime
interest rate plus 3% which subject to reduction in certain conditions(ii)
a warrant to purchase 130,000 Ordinary shares at an exercise price of $
4.04 per share ("the Warrant"). The Warrant is exercisable, in whole or in
part, until June 10, 2011. Any delay in registration and/or effectiveness
of the underlying shares of the transaction, or failure to maintain their
effectiveness, will result in penalties to be paid in cash, as liquidated
damages, equal to 2.0% for each thirty (30) day period of the original
principal amount of the note.
The Note conversion price is subject to proportional adjustment in the
event of stock splits, combinations, subdivisions of the Ordinary shares or
if dividend is paid on the Ordinary shares in ordinary shares. In addition,
if the Company issues stock in certain types of transactions at a price
lower than the initial conversion price, then the conversion price will be
adjusted to a lower price based on a weighted average formula.
The fair value of the warrants was calculated using the Black and Scholes
Option Pricing Model with the following assumptions: a risk-free interest
rate of 3.34%, a dividend yield of 0%, a volatility of the expected market
price of the Company's Ordinary shares of 100% and a weighted-average
contractual life of 7 year. The fair value of the warrants in the amount of
$ 99 is presented as a component in shareholders' equity. Since the
effective conversion price was grater than the share price at the
commitment date, no beneficial conversion feature exists.
Aggregate portion:
DECEMBER 31,
2004
------
First year (current maturities) $ 595
Second year 883
Third year 442
------
1,920
Less - discount 174
------
$1,746
======
F - 27
B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
NOTE 14:- COMMITMENTS AND CONTINGENT LIABILITIES
a. Commitments:
1. Royalty commitments:
i) Under the Company's research and development agreements with
the Office of the Chief Scientist ("OCS") and pursuant to
applicable laws, the Company is required to pay royalties at
the rate of 3.5% of sales of products developed with funds
provided by the OCS, up to an amount equal to 100% of the
research and development grants (dollar-linked) received
from the OCS. The obligation to pay these royalties is
contingent upon actual sales of the products. Royalties
payable with respect to grants received under programs
approved by the OCS after January 1, 1999, are subject to
interest on the U.S. dollar-linked value of the total grants
received at the annual rate of LIBOR applicable to U.S.
dollar deposits at the time the grants are received.
As of December 31, 2004, the Company has an outstanding
contingent obligation to pay royalties in the amount of
approximately $ 6,114 in respect of these grants.
ii) The Israeli Government, through the Overseas Marketing Fund,
awarded the Company grants for participation in expenses for
overseas marketing. The Company is committed to pay
royalties to the Fund for Encouragement of Marketing
Activities at the rate of 3% of the increase in export
sales, up to the amount of the grants received by the
Company linked to the dollar and bearing interest of LIBOR
(for a period of six months).
As of December 31, 2004, the Company has an outstanding
contingent obligation to pay royalties of $ 64 with respect
to these grants.
2. Other commitments:
The facilities of the Company are rented under operating lease
agreements that expire on various dates ending in 2005. Minimum
future rental payments for 2005 are $ 153.
The Company's motor vehicles are rented under various operating
lease agreements. The lease agreements for the motor vehicles
expire on various dates ending in 2007. The breach of contract
fees amounted to $61.
Lease payments for the facilities occupied by the Company and the
Company's motor vehicles in 2004, 2003 and 2002 amounted to $
385, $ 426 and $ 383, respectively.
F - 28
B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 14:- COMMITMENTS AND CONTINGENT LIABILITIES (CONT.)
b. (1) In July 2002, the Company received a claim letter from car
leasing vendor, under which it claims that the Company's
termination notice of the leasing agreement in March 2002
constitutes a breach of the agreement and the vendor is demanding
compensation in which the nominal claim amount is of $ 292. No
legal proceeding has yet been filed. At this stage, according to
the Company's counsel assessment, the prospects of vendor to
prevail and recover a significant amount, seem remote. The
financial statements do not include any provision in that regard.
(2) In September 2003, a supplier filed a legal claim in the amount
of $107 against the Company. The claim alleges the breach of an
agreement for the purchase of products. The Company's legal
counsel is unable to reasonably estimate the outcome of this
claim. In addition, the Company's management believes that the
chances of the claim are remote. Accordingly, no provision has
been included in the financial statements in respect of this
claim.
(3) In 1998, as part of Pacinfo Share Purchase Agreement between the
Company and Mr. Lee and Ms. Lee ("the Sellers"), certain actions
involving PacInfo, if occurring before the end of 2003, may
trigger a tax event for the Sellers. The Company may be
obligated under the purchase agreement to grant the Sellers a
loan on a full recourse basis for certain tax payments the
Sellers may be liable for, currently estimated at approximately $
2 million. The Company will receive a security interest in shares
of the Company that the Sellers holds at the time of the loan
with a fair market value as of the date of the loan of at least
125% of the amount of the loan as security for the repayment of
the loan. In addition, in the event the Company is required to
lend such sum to the Sellers, the Company may also be required to
reimburse the Sellers for certain interest on taxes that he may
owe. It is possible that the windup of PacInfo during 2002 and
2003 may have triggered such a tax event for the Sellers, which
would result in an obligation by the Company to lend the Sellers
such amount and to reimburse him for interest expenses incidental
to the tax event. Based on the Company's legal consul opinion and
management estimation, no provision was recoded.
NOTE 15:- SHAREHOLDERS' EQUITY
a. On May 29, 2003, the Company effected a one-to-four reverse split. All
shares, options and earnings per share amounts have been retroactively
adjusted for all periods presented to reflect the stock splits.
b. In December 2003, the Company completed a private placement for the
Company's Ordinary shares with two European private investors. The
Company issued to the investors 357,143 shares at a purchase price of
$ 2.80, for consideration of $ 928 (net of $ 72 issuance expenses).
F - 29
B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 15:- SHAREHOLDERS' EQUITY (CONT.)
c. Stock option plans:
During 1994, 1995, 1999, 2000, 2001, the Board of Directors of the
Company adopted stock option plans ("the Plans") pursuant to which
656,250 options for the purchase of the Company's Ordinary shares may
be granted to officers, directors, consultants and employees of the
Company. The Board of Directors has resolved that no further grants
shall be made from the above mentioned plans. In May 2003, the
Company's shareholders approved the adoption of the 2003 Stock Option
Plan, pursuant to which 625,000 Ordinary shares are reserved for
purchase by employees, directors, consultants and service providers of
the Company. As of December 31, 2004, an aggregate 141,721 of these
options are still available for future grant. Each option granted
under the Plans expires between 5-10 years from the date of the grant.
The options vest gradually over a period ranging between two to three
years. Options, that are cancelled or forfeited, become available for
future grants.
On November 18, 2004, upon acquisition of Odem, the Company granted
73,000 options to one of Odem's key employee. Each option can be
exercised to purchase one ordinary share of the purchaser
without consideration. The options vest over a period of three years
from the grant date and expire 10 years from the date of the grant.
The market price of the Company's shares on the date of grant was $
2.5. Accordingly, The Company recorded a compensation expense of $ 5.
This expense was included as part of general and administrative
expenses.
Except for these options, all other options are granted to employees
in 2004, 2003 and 2002, have an exercise price equal to the fair
market value of Ordinary shares at the date of grant. The weighted
average fair values of the options granted during 2004, 2003 and 2002
were $ 2.58, $ 3.91 and $ 3.2, respectively.
The following is a summary of the Company's stock options granted to
officers, directors, and employees among the various plans:
YEAR ENDED DECEMBER 31,
------------------------------------------------------------------------------
2004 2003 2002
--------------------- --------------------- --------------------
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 426,252 $11.93 211,929 $16.00 243,380 $16.48
Changes during the
year:
Granted 92,500 $ 0.54 278,076 $ 8.97 55,000 $ 6.76
Forfeited or
cancelled (88,176) $11.97 (63,753) $12.53 (86,451) $11.40
-------- -------- --------
Options outstanding
at end of year 430,576 $ 9.47 426,252 $11.93 211,929 $16.00
======== ====== ======== ====== ======== ======
Options exercisable
at the end of the
year 248,790 $ 5.49 194,926 $20.36 169,054 $16.24
======== ====== ======== ====== ======== ======
F - 30
B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 15:- SHAREHOLDERS' EQUITY (CONT.)
The options outstanding as of December 31, 2004, have been separated
into ranges of exercise price as follows:
WEIGHTED
OPTIONS WEIGHTED OPTIONS 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 2004 PRICE LIFE (YEARS) 2004 EXERCISABLE
----- ---- ----- ------------ ---- -----------
$ 0 73,000 $ 0.00 9.88 - $ 0.00
$ 1.84-2.00 181,997 $ 1.95 7.01 85,961 $ 1.96
$ 3 12,000 $ 3.00 9.00 - $ 3.00
$ 6.8 36,391 $ 6.80 6.78 35,641 $ 6.80
$ 17.00-18.00 11,113 $17.28 2.73 11,113 $17.28
$ 28.00 116,075 $28.00 2.74 116,075 $28.00
------- -------
430,576 $ 9.47 6.27 248,790 $15.49
======= ====== ======= ======
d. Options issued to service providers:
The Company accounts for these options in accordance with the
provisions of SFAS 123 and EITF 96-18. The fair value for these
options was estimated at the date of grant using an option pricing
model with the following assumptions: risk-free interest rate of 1.5%,
dividend yields of 0% volatility of 70%, and an expected life of 2.5
years.
The compensation expenses that have been recorded in the consolidated
financial statements regarding these warrants for the years 2004, 2003
and 2002 were $ 117, $ 23 and $ 7, respectively.
The Company's outstanding warrants to service providers as of December
31, 2004 are as follows:
WARRANTS FOR EXERCISE
ORDINARY PRICE PER WARRANTS EXERCISABLE
ISSUANCE DATE SHARES SHARE EXERCISABLE THROUGH
-------------- ------------- ---------------- ----------------- ----------------
October 2002 75,000 $ 4.00 75,000 June 2011
December 2002 938 $ 8.00 938 December 2005
December 2002 937 $ 4.00 937 December 2005
March 2003 1,025 $ 8.00 1,025 December 2005
March 2003 1,026 $ 4.00 1,026 December 2005
January 2004 216,282 $ 3.00 72,094 December 2013
June 2004 130,000 $ 4.04 130,000 October 2011
------------- -------------
425,208 281,020
============= =============
F - 31
B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 16:- TAXES ON INCOME
a. Reduction in corporate tax rate:
On June 2004, the Israeli Parliament approved an amendment to the
Income Tax Ordinance (No. 140 and Temporary Provision) (the
"Amendment"), which progressively reduces the regular corporate tax
rate from 36% to 35% in 2004, 34% in 2005, 32% in 2006 and to a rate
of 30% in 2007 and thereafter. The amendment was signed and published
in July 2004 and is, therefore, considered enacted in July 2004.
b. Tax benefits under the Law for the Encouragement of Capital
Investments, 1959:
The Company's production facilities have been granted an "Approved
Enterprise" status under the above Law under four separate investment
programs. According to the Capital Investments Law, the Company has
elected to receive for the first program state-guaranteed loans and
grants, for the second and third programs, the Company has elected to
receive only state-guaranteed loans. As for the fourth program, the
Company has elected the "alternative benefits" and has waived
Government grants in return for a tax exemption.
The Company is also a "Foreign Investors' Company", as defined by the
abovementioned law, and as such, is entitled to a 10-year period of
benefits and to an additional reduction in tax rates, up to 10% or 25%
(based on the percentage of foreign ownership in each taxable year).
Income from the second, third, fourth programs, which commenced
operations in 1992, 1994, 1997, respectively, are exempt from income
tax for a period of ten years commencing with the first year in which
they generate taxable income. During 2002, as part of the transfer of
operations from the Company to BOScom, all tax benefits that were
related to the Approved Enterprise of the Company were transferred to
BOScom. In addition, since 2002, the Company's investments are not
subject to the Approved Enterprise program. Accordingly, taxable
income generated in that period will be split by the assets ratio into
a taxable income that is entitled to the benefits of the approved
enterprise and into an income that will be taxed at the corporate tax
rate as described in article a above.
BOScom also has a production facility, which was granted an "Approved
Enterprise" status and had a separate investment program. BOScom
elected to receive the "alternative benefits". Income derived from
BOScom's investment program, which commenced operations in 1997 and
2002, is exempt from income tax for a period of ten years commencing
with the first year in which taxable income is generated.
The period of tax benefits detailed above is subject to limits of the
earlier of 12 years from commencement of production, or 14 years from
receiving the approval. Accordingly, the period of benefits relating
to all investment programs expire in the years 2001 through 2014.
F - 32
B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 16:- TAXES ON INCOME (CONT.)
The entitlement to the above benefits is conditional upon the
Company's and BOScom's fulfilling the conditions stipulated by the
above law, regulations published thereunder and the instruments of
approval for the specific investments in "Approved Enterprises". In
the event of failure to comply with these conditions, the benefits may
be canceled and the Company and BOScom may be required to refund the
amount of the benefits, in whole or in part, including interest.
The tax-exempt income attributable to the "Approved Enterprise" can be
distributed to shareholders without imposing tax liability on the
Company only upon the complete liquidation of the Company. In the
event of a distribution of such tax-exempt income as a cash dividend
in a manner other than in the complete liquidation of the Company and
BOScom, the Company and BOScom will be required to pay tax at the rate
of 10% to 25% on the amount distributed. In addition, these dividends
will be subject to 15% withholding tax.
The Company's Board of Directors has determined that such tax-exempt
income will not be distributed as dividends. Accordingly, no deferred
taxes have been provided on income attributable to the Company
"Approved Enterprise".
If the Company and BOScom derive income from sources other than an
"Approved Enterprise", such income will be taxable at the regular
corporate tax rate as described in article a above.
Odem operation is subject to regular income tax rate.
c. Loss carryforward:
Domestic (Israel):
The Company and its Israeli subsidiary have accumulated losses for
Israel income tax purposes as of December 31, 2004, in the amount of
approximately $ 24,000. These losses may be carryforward (linked to
the Israeli Consumer Price Index ("CPI")) and offset against taxable
income in the future for an indefinite period.
Foreign:
As of December 31, 2004, the U.S. subsidiaries which were classified
as discontinued operations had U.S. Federal and State net operating
loss carryforward of approximately $ 11,300, that can be carried
forward and offset against taxable income and expire through 2021.
Utilization of U.S. net operating losses may be subject to substantial
annual limitations due to the "change in ownership" provisions of the
Internal Revenue Code of 1986 and similar state law provisions. The
annual limitations may result in the expiration of net operating
losses before utilization.
As of December 31, 2004, B.O.S. U.K. had net operating loss
carryforward of approximately $ 3,900, which can be carried forward
indefinitely and offset against taxable income.
F - 33
B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 16:- TAXES ON INCOME (CONT.)
d. Taxable income under the Inflationary Income Tax (Inflationary
Adjustments) Law, 1985:
Results of the Company and its Israeli subsidiary for tax purposes are
measured and reflected in real terms in accordance with the changes in
the Israeli CPI. As explained in Note 2b, the financial statements are
presented in U.S. dollars. The difference between the change in the
Israeli CPI and in the NIS/U.S. dollar exchange rate causes a
difference between taxable income or loss and the income or loss
before taxes reflected in the financial statements. In accordance with
SFAS 109, the Company has not provided deferred income taxes on this
difference between the reporting currency and the tax bases of assets
and liabilities.
e. Deferred income 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 2003
-------- --------
Assets in respect of:
Property, plant and equipment $ 21 $ -
Allowances and provisions 239 273
Net operating loss carry forward 13,851 12,991
-------- --------
14,111 13,264
Liabilities in respect of intangible assets (424) -
-------- --------
Net deferred tax assets before valuation allowance 13,687 13,264
Valuation allowance (1) (14,039) (13,264)
-------- --------
Net deferred tax liability $ (352) $ -
======== ========
Presented in balance sheet:
Current liabilities (4) -
Long-term liabilities (348) -
-------- --------
Net deferred tax liability $ (352) $ -
======== ========
Domestic $ (352) -
Foreign - -
-------- --------
Net deferred tax $ (352) -
======== ========
(1) The Company has provided valuation allowances in respect of
deferred tax assets resulting from tax loss carryforward and
other reserves and allowances due to its history of operating
losses and current uncertainty concerning its ability to realize
these deferred tax assets in the future.
F - 34
B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 16:- TAXES ON INCOME (CONT.)
f. Income (Loss) before taxes on income:
YEAR ENDED DECEMBER 31,
-------------------------------------
2004 2003 2002
------- ------- -------
Domestic $(1,883) $ 320 $ 48
Foreign 184 (1,912) (291)
------- ------- -------
Total $(1,699) $(1,592) $ (243)
======= ======= =======
g. Effective tax
YEAR ENDED DECEMBER 31,
---------------------------------------
2004 2003 2002
------- ------- -------
Loss before taxes on income, as reported in the
consolidated statements of operation $(1,699) $(1,592) $ (243)
======= ======= =======
Statutory tax rate 35% 36% 36%
======= ======= =======
Provision at Israel, tax rate 595 573 87
Non deductible expenses (16) (13) (37)
Valuation allowance (599) (560) (50)
------- ------- -------
TOTAL TAX EXPENSES $ (20) $ - $ -
======= ======= =======
h. Tax assessments:
The Company and BOScom received final assessments through 1998 and
Odem through 2000 tax year.
NOTE 17:- SUPPLEMENTARY INFORMATION TO STATEMENTS OF OPERATIONS
a. Non recurring royalty reversal:
Certain research and development activities of the Company are
supported by the OCS. In return for the OCS's participation, the
Company was committed to pay royalties as described in Note 14 a.1.
During the third quarter of 2003, the OCS completed its examination of
the Company's technology and use of grant funding for the years 1991
through 1999, which reduced the royalties' expenses provision.
Accordingly, the Company reversed $ 339 of accrued royalties as a
reduction in cost of sales during the third quarter of 2003.
F - 35
B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 17:- SUPPLEMENTARY INFORMATION TO STATEMENTS OF OPERATIONS (CONT.)
YEAR ENDED DECEMBER 31,
--------------------------------------
2004 2003 2002
------- ------- -------
b. Financial income (expenses), net
Financial income:
Interest on bank deposits and marketable
securities $ 98 $ 158 $ 243
Other (mainly foreign currency translation
income) 100 48 140
------- ------- -------
198 206 383
------- ------- -------
Financial expenses:
In respect of long-term bank loans and
convertible note (324) - (14)
Other (mainly foreign currency translation
losses) (32) (97) (74)
------- ------- -------
(356) (97) (88)
------- ------- -------
$ (158) $ 109 $ 295
======= ======= =======
c. Loss per share:
1. Numerator:
Numerator for basic and diluted net loss
per share -
Net loss from continuing operations $(2,044) $(2,057) $ (813)
======= ======= =======
Net income (loss) from discontinued operation $ (9) $ 2,036 $(7,674)
======= ======= =======
Net loss available to Ordinary shareholders $(2,053) $ (21) $(8,487)
======= ======= =======
2. Denominator (in thousands):
Denominator for basic and diluted net loss
per share -
Weighted average number of shares 4,631 3,683 3,117
======= ======= =======
F - 36
B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 18:- SEGMENTS AND GEOGRAPHICAL INFORMATION
Commencing in 2004 and subsequent to the acquisition of Odem and Quasar,
the Company manages its business on three reportable segments, which
consists of connectivity solutions, communication solution and supply of
electronic components.
The Company's management makes financial decisions and allocates resources,
based on the information it receives from its internal management system.
The Company allocates resources and assesses performance for each operating
segment using information about revenues, gross profit and operating income
(loss) before interest and taxes.
Segment information for prior years was not presented on the new basis of
segmentation since it is impracticable to do so.
a. Revenues, gross profit and operating profit (loss) for operating
segments for the year ended 2004 were as follow:
YEAR ENDED DECEMBER 31, 2004
-----------------------------------------------------------------------------
ELECTRONICS
CONNECTIVITY COMMUNICATION COMPONENTS NOT ALLOCATED CONSOLIDATED
------- ------- ------- ------- -------
Revenues $ 5,011 $ 1,363 $ 1,908 $ - $ 8,282
======= ======= ======= ======= =======
Gross profit $ 2,933 $ 414 $ 327 $ - $ 3,674
======= ======= ======= ======= =======
Operating profit (loss) $ 1,009 $(1,846) $ 66 $ (770) $(1,541)
======= ======= ======= ======= =======
b. The following presents total revenues and long-lived assets for the
years ended December 31, 2004, 2003 and 2002 based on the customers'
location:
YEAR ENDED DECEMBER 31,
---------------------------------------------------------------------------------------
2004 2003 2002
---------------------- ---------------------- -----------------------
TOTAL LONG-LIVED TOTAL LONG-LIVED TOTAL LONG-LIVED
REVENUES ASSETS *) REVENUES ASSETS *) REVENUES ASSETS *)
------ ------ ------ ------ ------ ------
United States $3,252 $ - $2,974 $ 5 $4,989 $ 10
Europe 1,066 - 1,198 - 2,148 154
Israel and others 3,964 4,448 1,556 1,334 2,304 1,542
------ ------ ------ ------ ------ ------
$8,282 $4,448 $5,728 $1,339 $9,441 $1,706
====== ====== ====== ====== ====== ======
Total revenues are attributed to geographic areas based on the
location of customers in accordance with Statement of Financial
Accounting No. 131, "Disclosures about Segments of an Enterprise and
Related Information" ("SFAS 131").
*) Long-lived assets comprise goodwill intangible assets, property
and equipment.
F - 37
B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 18:- SEGMENTS AND GEOGRAPHICAL INFORMATION (CONT.)
c. Major customer's data as a percentage of total revenues:
YEAR ENDED DECEMBER 31,
---------------------------------
2004 2003 2002
------- ------- -------
Customer A 39% 52% -
======= ======= =======
Customer B 3% 2% 13%
======= ======= =======
Major customer's balances as of December 31, 2004 and 2003 are $ 603
and $ 476, respectively.
NOTE 19:- RELATED PARTIES
a. M&A Addendum to the Services Agreement of Cukierman & Co.
In 2003, the Company's audit committee and Board of Directors approved
the engagement of Cukierman & Co. Investment House Ltd., to provide
non-exclusive investment-banking services and business development
services to the Company, effective April 15, 2003. Cukierman & Co. is
a company indirectly controlled by Mr. Edouard Cukierman, who, since
June 26, 2003, serves as Chairman of the Company's Board of Directors,
and is a co-manager of the Catalyst Fund, the Company's largest
shareholder. For its services, Cukierman & Co. is paid a monthly sum
of $10,000 plus VAT, in addition to a success fee of 4-6% for a
consummated private placement. According to its terms the Company may
terminate the agreement at any time, by giving one month prior written
notice. The agreement provided that the success fees for securing M&A
transactions shall be discussed and drafted as an Addendum to the
Services Agreement. Such an Addendum was approved on August 22, 2004,
and provides a success fee of 3.5% of the proceeds exchanged in such a
transaction.
The payments the Company paid according to the service agreement are:
DECEMBER 31,
----------------------
2004 2003
-------- --------
Business development $ 120 $ 80
Success fee in respect of issuance of convertible loan 15 -
Success fee in respect of private placement - 60
-------- --------
$ 135 $ 140
======== ========
Current liabilities in respect with related parties as of December 31,
2004 and 2003 were $234 and $18.
F - 38
B.O.S. BETTER ONLINE SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 19:- RELATED PARTIES (CONT.)
b. Assignment of Voting Rights to Mr. Yair Shamir
On February 5, 2004 the audit committee and Board of Directors
approved an Assignment and Assumption Agreement, between the Company,
Catalyst Investments L.P, and Mr. Yair Shamir (who is a director of
the Company and the Chairman of Catalyst Investments), according to
which the voting rights in all but one of the Surf shares that the
Company has an option to purchase from Catalyst (see Note 6), have
been assigned to Yair Shamir. Pursuant to the agreement, Yair Shamir
irrevocably undertook to assign the voting rights to the Company
immediately upon the earlier to occur of the following, and subject to
the receipt of a written request from the Company to effect such
assignment: a) at the time Surf's shares are offered to the public in
a public offering pursuant to a registration statement filed by Surf
under the Securities Act of 1933 or a similar act of another
jurisdiction, or b) the Company exercises its option to purchase the
additional shares from Catalyst.
NOTE 20: SUBSEQUENT EVENT
On March 23, 2005 the Company received a notice from Laurus Master Fund to
convert $308 of the Convertible note according to the condition of the
Securities Purchase Agreement (see Note 13).
F - 39
================================================================================
SURF-COMMUNICATION SOLUTIONS LTD. AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
AS OF DECEMBER 31, 2004
IN U.S. DOLLARS
INDEX
PAGE
----------
REPORT OF INDEPENDENT AUDITORS 2
CONSOLIDATED BALANCE SHEETS 3 - 4
CONSOLIDATED STATEMENTS OF OPERATIONS 5
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY 6
CONSOLIDATED STATEMENTS OF CASH FLOWS 7
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 8 - 21
================================================================================
[ERNST & YOUNG LOGO] o KOST FORER GABBAY & KASIERER o Phone: 972-3-6232525
3 Aminadav St. Fax: 972-3-5622555
Tel-Aviv 67067, Israel
REPORT OF INDEPENDENT AUDITORS
TO THE SHAREHOLDERS OF
SURF-COMMUNICATION SOLUTIONS LTD.
We have audited the accompanying consolidated balance sheets of
Surf-Communication Solutions Ltd. (the "Company") and its subsidiaries as of
December 31, 2003 and 2004, and the related consolidated statements of
operations, changes in shareholders' equity and cash flows for each of the two
years in the period ended December 31, 2004. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits. We did not audit the
financial statements of certain subsidiaries, which statements reflect total
assets constituting 12% and 18% as of December 31, 2003 and 2004, respectively,
and total revenues constituting 36% and 20% of the related consolidated totals
for the years ended December 31, 2003 and 2004, respectively. Those statements
were audited by other auditors whose reports have been furnished to us, and our
opinion, insofar as it relates to data included for those subsidiaries is based
solely on the reports of the other auditors.
We conducted our audits in accordance with the Standards of 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, assessing the accounting principles used and significant estimates
made by management and evaluating the overall financial statements presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, based on our audit and the reports of the other auditors,
the consolidated financial statements referred to above, present fairly, in all
material respects, the consolidated financial position of the Company and its
subsidiaries as of December 31, 2003 and 2004, and the consolidated results of
their operations and cash flows for each of the two years in the period ended
December 31, 2004, in conformity with U.S. generally accepted accounting
principles.
Tel-Aviv, Israel KOST FORER GABBAY & KASIERER
March 14, 2005 A Member of Ernst & Young Global
WALTER FEY, CPA
223 Mass Ave
Arlington, MA 02474
TEL (781) 641-9889
To the Board of Directors and shareholders
Surf Communication Solutions, Inc.
495 Old Connecticut Path, Suite 320
Framingham, MA 01701
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
I have audited the accompanying balance sheets of Surf Communication Solutions,
Inc. as of December 31, 2004 and 2003 and the related statements of operations
and accumulated deficit and cash flows for the years then ended. These financial
statements are the responsibility of the Company's management. My responsibility
is to express an opinion on these financial statements based on my audit.
I conducted my audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that, I 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. I believe that my audits provide a reasonable
basis for my opinion.
As explained in Note D to the financial statements, certain related party
transactions with the Company's parent have not been recorded in the financial
statements. U.S. generally accepted accounting principles require such related
party transactions to be recorded at their fair value at the date they were
incurred. It was not practical to determine the effects of the unrecorded
related party transactions on the financial statements.
In my opinion, except for the effects of not recording certain related party
transactions, as discussed in the preceding paragraph, the financial statements
referred to above present fairly, in all material respects, the financial
position of Surf Communication Solutions, Inc. as of December 31, 2004 and 2003
and the results of its operations and changes in cash flows for the years then
ended in conformity with accounting principles generally accepted in the United
States.
/S/ Walter Fey
January 18, 2005
AUDITOR'S REPORT
INTRODUCTION
We have audited the accompanying balance sheets of Surf Communication Solutions
BV. (the "Company") as of December 31, 2002 and 2003, and the related statements
of operations, changes in shareholders' equity (deficiency) and cash flows for
each of the two years in the period ended December 31, 2003. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
SCOPE
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.
OPINION
In our opinion, based on our audit, the financial statements referred to above,
present fairly, in all material respects, the financial position of the Company
as of December 31, 2002 and 2003, and the results of their operations and cash
flows for each of the two years in the period ended December 31, 2003, in
conformity with accounting principles generally accepted in the United States.
Amsterdam, April 2, 2004
/S/ MAZARS PAARDEKOOPER HOFFMAN
MAZARS PAARDEKOOPER HOFFMAN
F.D.N. Walta RA
2
SURF-COMMUNICATION SOLUTIONS LTD. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
DECEMBER 31,
---------------
2003 2004
------ ------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $3,552 $2,534
Short-term deposits 1,124 91
Trade receivables (Note 3) 434 882
Other accounts receivable (Note 4) 229 257
------ ------
TOTAL current assets 5,339 3,764
------ ------
LONG-TERM INVESTMENTS:
Long-term deposits 34 78
Severance pay fund 388 435
------ ------
TOTAL long-term investments 422 513
------ ------
PROPERTY AND EQUIPMENT, NET (Note 5) 471 366
------ ------
$6,232 $4,643
====== ======
The accompanying notes are an integral part of the consolidated financial
statements.
3
SURF-COMMUNICATION SOLUTIONS LTD. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT FOR SHARE DATA)
DECEMBER 31,
--------------------
2003 2004
-------- --------
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Trade payables $ 133 $ 294
Accrued expenses and other liabilities (Note 6) 1,042 1,137
-------- --------
TOTAL current liabilities 1,175 1,431
-------- --------
LONG-TERM LIABILITIES:
Accrued severance pay 472 525
-------- --------
COMMITMENTS AND CONTINGENT LIABILITIES (Note 7)
SHAREHOLDERS' EQUITY (Note 8):
Ordinary shares of NIS 0.01 par value:
Authorized: 15,631,286 shares as of December 31, 2003 and 2004; Issued and
outstanding: 1,077,126 and 1,225,232 shares as of December 31, 2003 and
2004, respectively 3 3
Preferred shares of NIS 0.01 par value:
Authorized: 4,368,714 shares as of December 31, 2003 and 2004; Issued and
outstanding: 3,300,034 shares as of December 31, 2003 and 2004;
Aggregate liquidation preference of $ 43,062 as of December 2003 and 2004 7 7
Additional paid-in capital 30,881 30,877
Deferred stock compensation (181) (104)
Accumulated deficit (26,125) (28,096)
-------- --------
TOTAL shareholders' equity 4,585 2,687
-------- --------
$ 6,232 $ 4,643
======== ========
The accompanying notes are an integral part of the consolidated financial
statements.
4
SURF-COMMUNICATION SOLUTIONS LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
YEAR ENDED
DECEMBER 31,
------------------
2003 2004
------- -------
Revenues:
Software licenses $ 1,242 $ 2,346
Royalties 161 416
------- -------
TOTAL revenues 1,403 2,762
------- -------
Cost of revenues:
Software license 522 653
Royalties 41 47
------- -------
TOTAL cost of revenues 563 700
------- -------
Gross profit 840 2,062
------- -------
Operating expenses:
Research and development, net (Note 10a) 2,035 1,466
Selling and marketing (Note 10b) 1,486 1,898
General and administrative 577 673
Non-recurring costs 234 -
------- -------
TOTAL operating expenses 4,332 4,037
------- -------
Operating loss 3,492 1,975
Financial income, net (Note 10c) (72) (15)
Other expenses - 11
------- -------
Loss before income taxes 3,420 1,971
Income taxes 7 -
------- -------
Net loss $ 3,427 $ 1,971
======= =======
The accompanying notes are an integral part of the consolidated financial
statements.
5
SURF-COMMUNICATION SOLUTIONS LTD. AND SUBSIDIARIES
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT FOR SHARE AMOUNTS)
ORDINARY SHARES PREFERRED SHARES ADDITIONAL DEFERRED TOTAL
------------------- ----------------- PAID-IN STOCK ACCUMULATED SHAREHOLDERS'
SHARES AMOUNT SHARES AMOUNT CAPITAL COMPENSATION DEFICIT EQUITY
--------- ------- --------- ------ ---------- ------------ ----------- -------------
Balance as of January 1, 2002 965,000 $ 3 3,300,034 $ 7 $ 30,773 $ (207) $ (22,698) $ 7,878
Deferred compensation related to
options issued to employees - - - - 108 (78) - 30
Amortization of deferred stock
compensation - - - - - 104 - 104
Exercise of stock options 112,126 *)- - - - - - *)-
Net loss - - - - - - (3,427) (3,427)
--------- ------- --------- ------ --------- --------- --------- ---------
Balance as of December 31, 2003 1,077,126 3 3,300,034 7 30,881 (181) (26,125) 4,585
Amortization of deferred stock
compensation - - - - (4) 77 - 73
Exercise of stock options 148,106 *)- - - - - - *)-
Net loss - - - - - - (1,971) (1,971)
--------- ------- --------- ------ --------- --------- --------- ---------
Balance as of December 31, 2004 1,225,232 $ 3 3,300,034 $ 7 $ 30,877 $ (104) $ (28,096) $ 2,687
========= ======= ========= ====== ========= ========= ========= =========
*) Represents an amount lower than $ 1.
The accompanying notes are an integral part of the consolidated financial
statements.
6
SURF-COMMUNICATION SOLUTIONS LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
YEAR ENDED DECEMBER 31,
-----------------------
2003 2004
------- -------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(3,427) $(1,971)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation 382 190
Loss on sale of property and equipment - 11
Amortization of deferred stock compensation 134 73
Interest rate income on short-term deposits (3) (7)
Decrease (increase) in trade receivables 41 (448)
Increase in other accounts receivable (21) (28)
Increase (decrease) in trade payables (44) 161
Increase in accrued expenses and other liabilities 433 95
Increase in accrued severance pay, net 5 6
------- -------
Net cash used in operating activities (2,500) (1,918)
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sale of property and equipment - 11
Purchase of property and equipment (35) (107)
Long-term deposits 39 (44)
Short-term bank deposit (1,000) 1,040
------- -------
Net cash provided by (used in) investing activities (996) 900
------- -------
Decrease in cash and cash equivalents (3,496) (1,018)
Cash and cash equivalents at the beginning of the year 7,048 3,552
------- -------
Cash and cash equivalents at the end of the year $ 3,552 $ 2,534
======= =======
The accompanying notes are an integral part of the consolidated financial
statements.
7
SURF-COMMUNICATION SOLUTIONS LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
NOTE 1:- GENERAL
Surf-Communication Solutions Ltd. ("the Company") was incorporated and
commenced its activities under the laws of Israel in 1996. The Company
is a developer and global supplier of universal access and network
convergence software solutions to the wireline and wireless
telecommunications and data communications industries.
The Company owns and controls 100% of its subsidiaries "Surf
Communication Solutions Inc.". registered in the USA and " Surf
Communication Solutions B.V." registered in Holland.
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES
The consolidated financial statements have been prepared in accordance
with accounting principles generally accepted in the United States.
a. Use of estimates:
The preparation of financial statements in conformity with
generally accepted accounting principles requires management to
make estimates and assumptions that affect the amounts reported
in the financial statements and accompanying notes. Actual
results could differ from those estimates.
b. Financial statements in U.S. dollars:
The functional currency of the Company and its subsidiaries is
the U.S dollar, as the U.S. dollar is the primary currency of the
economic environment in which the Company and its subsidiaries
have operated and expect to continue to operate in the
foreseeable future. The majority of the Company's operations is
currently conducted in Israel and most of the Israeli expenses
are currently paid in new Israeli shekels ("NIS"). A majority of
the revenues of the Company and its subsidiaries is generated in
U.S. dollars ("dollar"). Financing activities including loans,
equity transactions and cash investments, are made in U.S.
dollars.
The Company's transactions and balances denominated in U.S.
dollars are presented at their original amounts. Non-dollar
transactions and balances have been remeasured to U.S. dollars in
accordance with Statement No. 52 of the Financial Accounting
Standards Board ("SFAS"). All transaction gains and losses from
remeasurement of monetary balance sheet items denominated in
non-dollar currencies are reflected in the statements of
operations as financial income or expenses, as appropriate. For
the years ended December 31, 2003 and 2004, these expenses were
immaterial (see Note 10c).
c. Principles of consolidation:
The consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiaries. Intercompany
transactions and balances have been eliminated upon
consolidation.
8
SURF-COMMUNICATION SOLUTIONS LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)
d. Cash equivalents:
Cash equivalents are short-term highly liquid investments that
are readily convertible to cash with original maturities of three
months or less.
e. Short-term deposits:
Bank deposits with maturities of more than three months but less
than one year are included in short-term deposits. The short-term
deposits are presented at their cost, including accrued interest.
f. Property and equipment:
Property and equipment are stated at cost, net of accumulated
depreciation. Depreciation is calculated by the straight-line
method over the estimated useful lives of the assets at the
following annual rates:
%
----------------------------
Computers and peripheral equipment 33
Office furniture and equipment 6 - 15
Motor vehicles 15
Leasehold improvements over the term of the lease
g. Impairment of long-lived assets and long-lived assets to be
disposed of:
The Company's long-lived assets and certain identifiable
intangibles are reviewed for impairment in accordance with
Statement of Financial Accounting Standard No. 144, "Accounting
for the Impairment or Disposal of Long-Lived Assets" ("SFAS No.
144"), whenever events or changes in circumstances indicate that
the carrying amount of an asset may not be recoverable.
Recoverability of assets to be held and used is measured by a
comparison of the carrying amount of an asset to the future
undiscounted cash flows expected to be generated by the assets.
If such assets are considered to be impaired, the impairment to
be recognized is measured by the amount by which the carrying
amount of the assets exceeds the fair value of the assets. Assets
to be disposed of are reported at the lower of the carrying
amount or fair value less costs to sell. As of December 31, 2004,
no impairment losses have been identified.
h. Research and development costs:
FASB No. 86, "Accounting for the Costs of Computer Software to be
Leased or Otherwise Marketed", requires capitalization of certain
software development costs subsequent to the establishment of
technological feasibility.
9
SURF-COMMUNICATION SOLUTIONS LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)
Based on the Company's product development process, technological
feasibility is established upon completion of a working model.
The Company does not incur material costs between the completion
of the working model and the point at which the products are
ready for general release. Therefore, research and development
costs are charged to the statement of operations as incurred.
i. Income taxes:
The Company accounts for income taxes in accordance with FASB 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 differences
between financial reporting and tax bases of assets and
liabilities and are measured using the enacted tax rates and laws
that will be in effect when the differences are expected to
reverse. The Company provides a valuation allowance, if
necessary, to reduce deferred tax assets to their estimated
realizable value.
j. Revenue recognition:
The Company accounts for software sales in accordance with
Statement of Position No. 97-2, "Software Revenue Recognition" as
amended by Statement of Position 98-9, "Modifications of SOP
97-2, Software Revenue Recognition with Respect to Certain
Transactions" ("SOP No. 97-2"). SOP No. 97-2 generally requires
revenues earned from software arrangements involving multiple
elements to be allocated to each element based on the relative
fair values of the elements determined by the vendor's specific
objective evidence (VSOE) of fair value. Revenues are recognized
under the "residual method" VSOE of fair value exists for all
undelivered elements and VSOE of fair value does not exist for
all of the delivered elements, and when all SOP No. 97-2 criteria
for revenue recognition are met.
To date, the Company has derived its revenue from licensing fees
and royalties on its products, maintenance and support, and
rendering of consulting services, including implementation,
training and installation. The Company sells its products
primarily through its direct sales force.
Revenue from license fees is recognized when persuasive evidence
of an agreement exists, delivery of the product has occurred, no
significant obligations with regard to implementation remain, the
fee is fixed or determinable, and collectibility is probable. The
Company generally does not grant a right of return to its
customers. When a right of return exists, the Company defers
revenue until the right of return expires, at which time revenue
is recognized provided that all other revenue recognition
criteria have been met. The Company considers all arrangements
with payment terms extending beyond 180 days not to be fixed or
determinable.
If the fee is not fixed or determinable, revenue is recognized as
payments become due from the customer provided that all other
revenue recognition criteria have been met.
10
SURF-COMMUNICATION SOLUTIONS LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)
Maintenance and support revenue included in multiple element
arrangements is deferred and recognized on a straight-line basis
over the term of the maintenance and support agreement. The VSOE
of fair value of the undelivered elements (maintenance, support
and services) is determined based on the price charged for the
undelivered element when sold separately.
The Company is entitled to royalties from revenue sharing upon
the sublicensing of the Company's products to end-users.
Royalties out of revenue sharing arrangements are recognized when
such royalties are reported to the Company.
Arrangements that include consulting services are evaluated to
determine whether those services are essential to the
functionality of other elements of the arrangement. When services
are considered essential, revenue under the arrangement is
recognized using contract accounting. When services are not
considered essential, the revenue allocable to the software
services is recognized as the services are performed. To date,
the Company had determined that the services are not considered
essential to the functionality of other elements of the
arrangement. Revenues from software license that require
significant customization, integration and installation are
recognized using contract accounting on a percentage of
completion method based on the relationship of actual costs
incurred to total costs estimated to be incurred over the
duration of the contract.
k. Concentrations of credit risk:
Financial instruments that potentially subject the Company and
its subsidiaries to concentrations of credit risk consist
principally of cash, cash equivalents, short-term deposits and
trade receivables.
Cash and cash equivalents and short-term deposits are invested in
major banks in Israel and the United States. Such deposits in the
United States may be in excess of insured limits and are not
insured in other jurisdictions. Management believes that the
financial institutions that hold the Company's investments are
financially sound and, accordingly, minimal credit risk exists
with respect to these investments.
The trade receivables of the Company and its subsidiaries are
mainly derived from sales to customers located primarily in the
U.S., Europe and Asia. The Company performs ongoing credit
evaluations of its customers and to date has not experienced any
material losses. An allowance for doubtful accounts is determined
with respect to those amounts that the Company has determined to
be doubtful of collection.
The Company has no significant off-balance-sheet concentration of
credit risk such as foreign exchange contracts, option contracts
or other foreign hedging arrangements.
11
SURF-COMMUNICATION SOLUTIONS LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)
l. Accounting for stock-based compensation:
The Company has elected to follow Accounting Principles Board
Opinion No. 25 ("APB 25") "Accounting for Stock Issued to
Employees" and Interpretation No. 44 "Accounting for Certain
Transactions Involving Stock Compensation" ("FIN 44") in
accounting for its employee stock option plans. Under APB 25,
when the exercise price of the Company's share options is less
than the market price of the underlying shares on the date of
grant, compensation expense is recognized.
Pro forma information regarding the Company's net income (loss)
and net earnings (loss) per share is required by SFAS No. 123,
"Accounting for Stock-Based Compensation", as amended by SFAS No.
148, "Accounting for Stock-Based Compensation - Transition and
Disclosure" ("SFAS No. 123") was not included in the financial
statements due to immateriality.
The Company applies FASB 123 and EITF 96-18, "Accounting for
Equity Instruments that are Issued to Other than Employees for
Acquiring, or in Conjunction with Selling Goods or Services" with
respect to options issued to non-employees. FASB 123 requires use
of an option valuation model to measure the fair value of the
options at the grant date.
m. Government grant:
Royalty-bearing grants from the Government of Israel for funding
approved research and development projects are recognized at the
time the Company is entitled to such grants, on the basis of the
costs incurred and included as a reduction of research and
development costs. Research and development grants amounted to $
257 and $ 298 in 2003 and 2004, respectively. Total royalties,
accrued or paid, amounted to $ 0 and $ 19 in 2003 and 2004,
respectively, and were recorded as part of the cost of goods
sold.
Royalty-bearing grants from the Bi-National Industrial Research
and Development Foundation ("BIRD-F"), for funding certain
approved research projects and for funding marketing activity are
recognized at the time when the Company is entitled to such
grants, on the basis of the related costs incurred. In 2004, the
Company received BIRD-F grants amounting to $ 175.
n. Severance pay, net:
The Company's liability for severance pay is calculated pursuant
to Israeli severance pay law based on the most recent salary of
the employees multiplied by the number of years of employment, as
of the balance sheet date. Employees are entitled to one month's
salary for each year of employment or a portion thereof. The
Company's liability for all of its employees, is fully provided
by monthly deposits with insurance policies and by an accrual.
The value of these policies is recorded as an asset in the
Company's balance sheet.
The deposited funds include profits accumulated up to the balance
sheet date. The deposited funds may be withdrawn only upon the
fulfillment of the obligation pursuant to Israeli severance pay
law or labor agreements. The value of the deposited funds is
based on the cash surrendered value of these policies, and
includes immaterial profits.
Severance pay expenses for the years ended December 31, 2003 and
2004, amounted to approximately, $ 92 and $ 20, respectively.
12
SURF-COMMUNICATION SOLUTIONS LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)
o. Fair value of financial instruments:
The following methods and assumptions were used by the Company
and its subsidiaries in estimating their fair value disclosures
for financial instruments:
The carrying amounts of cash and cash equivalents, short-term
deposits, trade receivables, other accounts receivable and trade
payables approximate their fair value due to the short-term
maturity of such instruments.
p. New Accounting Pronouncements:
In December 2004, the FASB issued SFAS 123(R), "Share-Based
Payment". SFAS No. 123(R) revises FAS 123, Accounting for
Stock-Based Compensation, and supersedes APB Opinion No. 25,
Accounting for Stock Issued to Employees, and its related
implementation guidance. SFAS 123(r) will require compensation
costs related to share-base payment transaction to be recognized
in the financial statements (with limited exceptions). The amount
of compensation cost will be measured based on the grant-date
fair value of the equity or liability instruments issued.
Compensation cost will be recognized over the period that an
employee provides service in exchange for the award. This
statement will be effective in the fiscal year 2006. The Company
is currently evaluating the impact from this standard on its
results of operations and financial position.
NOTE 3:- TRADE RECEIVABLES
DECEMBER 31,
-------------------
2003 2004
-------- --------
Accounts receivable $ 486 $ 925
Less: allowance for doubtful accounts 52 43
-------- --------
$ 434 $ 882
======== ========
NOTE 4:- OTHER ACCOUNTS RECEIVABLE
Government authorities $ 186 $ 235
Prepaid expenses and others 43 22
-------- --------
$ 229 $ 257
======== ========
13
SURF-COMMUNICATION SOLUTIONS LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
NOTE 5:- PROPERTY AND EQUIPMENT
DECEMBER 31,
-------------------
2003 2004
-------- --------
Cost:
Computers and peripheral equipment $ 1,780 $ 1,612
Office furniture and equipment 256 229
Leasehold improvements 188 190
Motor vehicles 22 -
-------- --------
2,246 2,031
-------- --------
Accumulated depreciation:
Computers and peripheral equipment 1,577 1,473
Office furniture and equipment 93 87
Leasehold improvements 91 105
Motor vehicles 14 -
-------- --------
1,775 1,665
-------- --------
Depreciated cost $ 471 $ 366
======== ========
NOTE 6:- ACCRUED EXPENSES AND OTHER LIABILITIES
Accrued expenses and other liabilities $ 336 $ 441
Employees and payroll accruals 421 466
Deferred revenue 207 147
Provision for warranty costs 78 83
-------- --------
$ 1,042 $ 1,137
======== ========
NOTE 7:- COMMITMENTS AND CONTINGENT LIABILITIES
a. Lease commitments:
The facilities of the Company and its subsidiaries are rented
under operating leases, for periods ending in June 2005. Future
minimum lease commitments under non-cancelable leases for the
years ended December 31, are as follows:
2005 $ 90
=====
Rent expenses for the years ended December 31, 2003 and 2004,
amounted to $ 234 and $ 167, respectively.
b. Guarantees:
The Company purchased bank guarantees in the amount of $ 100 as
security for the rental of its facilities.
14
SURF-COMMUNICATION SOLUTIONS LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT FOR SHARE DATA)
NOTE 7:- COMMITMENTS AND CONTINGENT LIABILITIES (CONT.)
c. Royalties:
The Company participated in a program sponsored by the Israeli
Government for the support of research and development
activities. Through December 31, 2004, the Company had obtained a
grant from the Office of the Chief Scientist of the Israeli
ministry of Industry and Trade ("the OCS") aggregating to $ 555
for certain of the Company's research and development projects.
The Company is obligated to pay royalties to the OCS, amounting
to 3-5% of the sales of the products and other related revenues
generated from such projects, up to 100%-150% of the grants
received, linked to the U.S. dollars and bearing interest at the
rate of LIBOR.
The obligation to pay these royalties is contingent on actual
sales of the products and in the absence of such sales no payment
is required.
Under the Company's research and development agreements with
BIRD-F, the Company is required to pay royalties at the rate of
3%-5% of sales of the consolidated products developed with funds
provided by BIRD-F, up to an amount equal to 150% of BIRD-F
research and development grants linked to the U.S. dollar that
have been received by the Company.
Through December 31, 2004, the Company has not paid or accrued
royalties to BIRD-F.
NOTE 8:- SHAREHOLDERS' EQUITY
a. Share capital:
DECEMBER 31, DECEMBER 31
-------------------------------------------------- ------------------------
2003 2004 2003 2004
------------------------ ------------------------ ------------------------
ISSUED AND ISSUED AND
AUTHORIZED OUTSTANDING AUTHORIZED OUTSTANDING LIQUIDATION PREFERENCE
---------- ----------- ---------- ----------- ------------------------
NUMBER OF SHARES U.S.DOLLARS IN THOUSANDS
-------------------------------------------------- ------------------------
Shares of NIS 0.01 par value:
Ordinary shares (1) 15,631,286 1,077,126 15,631,286 1,225,232 $ - $ -
Preferred "A" shares (2) 340,000 336,704 340,000 336,704 3,030 3,030
Preferred "A1" shares (2) 130,000 128,300 130,000 128,300 1,155 1,155
Preferred "B" shares (2) 169,500 169,500 169,500 169,500 250 250
Preferred "B1" shares (2) 18,834 18,834 18,834 18,834 2,250 2,250
Preferred "C" shares (2) 3,710,380 2,646,696 3,710,380 2,646,696 36,377 36,377
---------- ---------- ---------- ---------- ---------- ----------
20,000,000 4,377,160 20,000,000 4,525,266 $ 43,062 $ 43,062
========== ========== ========== ========== ========== ==========
The Company granted to the Preferred C investors and previous
bridge loan lender a total of 866,297 warrants to purchase
Preferred C shares at exercise prices between $ 7.33 and $ 9.16
per share, exercisable until four years from the grant date.
15
SURF-COMMUNICATION SOLUTIONS LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT FOR SHARE DATA)
NOTE 8:- SHAREHOLDERS' EQUITY (CONT.)
(1) The Ordinary shares confer upon the holders the right to
receive notice to participate and vote in shareholders
meetings of the Company and to receive dividend, if
declared.
(2) The Preferred shares ("A", "A1", "B", "B1" and "C") have the
same rights as the Ordinary shares (except for the Preferred
"A1" and "B1" shares, which do not confer voting rights). In
addition, the shares are convertible into Ordinary shares,
have an aggregate preference in liquidation of $ 43,062 as
of December 31, 2004 and 2003 and have veto rights in
certain matters. The Preferred shares are convertible, at
the holders' option, upon an IPO of the Company, into
Ordinary shares.
b. Stock Option Plans:
Under the Company's 1999 and 2003 Stock Option Plans, options may
be granted to officers, directors, employees and consultants of
the Company or its subsidiaries.
The 2003 Employee Stock Option Plan is designed to benefit from,
and is made pursuant to the provisions of Section 102 of the
Israeli Income Tax Ordinance.
As of December 31, 2004, an aggregate of 652,105 options are
still available for future grant.
Each option granted under the Plans is exercisable until ten
years from the grant date. The exercise price of the options
granted under the Plans may not be less than the nominal value of
the shares, into which such options are exercised. Each option
granted can be exercised to one Ordinary share of the Company.
The options vest over one to four years. Any options, which are
forfeited or not exercised before expiration, become available
for future grants.
In February 2002, 211,521 previously granted options with
exercise prices ranging from $ 6 to $ 14 were repriced to par
value of NIS 0.01, which resulted in a total compensation expense
of $ 133, of which an amount of $ 87 was recognized in 2002 for
the portion already vested, and the remaining amount of $ 46 was
deferred to be recognized over the remaining vesting period
ending in 2006. Amounts of $ 17 and $ 48 were recognized during
2003 and 2004, respectively.
In July 2003, 175,155 previously granted options with an exercise
price of $ 6 were repriced to par value of NIS 0.01 resulting in
a total compensation expense of $ 108, of which $ 30 was
recognized in 2003 for the portion already vested and $ 78 was
deferred to be recognized over the remaining vesting period
ending in 2006.
During the year 2004, an amount of $ 25 was recognized.
16
SURF-COMMUNICATION SOLUTIONS LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT FOR SHARE DATA)
NOTE 8:- SHAREHOLDERS' EQUITY (CONT.)
A summary of the Company's stock option activity and related
information is as follows:
YEAR ENDED DECEMBER 31,
--------------------------------------------------
2003 2004
----------------------- ------------------------
WEIGHTED WEIGHTED
NUMBER AVERAGE NUMBER AVERAGE
OF EXERCISE OF EXERCISE
OPTIONS PRICE OPTIONS PRICE
--------- ---------- --------- ----------
Outstanding at the beginning of the
year 837,369 $ 1.93 1,358,402 $ 0.15
Granted 779,046 $ - 97,000 $ -
Exercised (112,126) $ - (148,106) $ -
Forfeited (145,887) $ 2.23 (136,425) $ -
--------- ---------
Outstanding at the end of the year 1,358,402 $ 0.15 1,170,871 $ 0.18
========= ========== ========= ==========
Exercisable options 502,838 $ 0.41 639,755 $ 0.33
========= ========== ========= ==========
c. Options issued to consultants:
1. The Company's outstanding options to consultants as of
December 31, 2004, are as follows:
OPTIONS FOR EXERCISE
ORDINARY PRICE PER OPTIONS
ISSUANCE DATE SHARES SHARE EXERCISABLE
--------------------- ----------- --------- -----------
April 1998 22,012 $ 1.36 22,012
=========== ========= ===========
2. The fair value for these options was estimated using a
Black-Scholes option-pricing model with the following
weighted-average assumptions for 2003 and 2004: risk-free
interest rates of 6%, dividend yields of 0%, volatility
factors of the expected market price of the Company's
Ordinary shares of 0 for each year, and a weighted-average
expected life of the options of approximately 4 years.
d. Dividends:
In the event that cash dividends are declared in the future, such
dividends will be paid in NIS. The Company does not intend to pay
cash dividends in the foreseeable future.
17
SURF-COMMUNICATION SOLUTIONS LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT FOR SHARE DATA)
NOTE 9:- TAXES ON INCOME
a. Measurement of taxable income under the Income Tax (Inflationary
Adjustments) Law, 1985:
Results for tax purposes are measured in terms of earnings in NIS
after certain adjustments for increases in the Israeli CPI. As
explained in Note 2b, the financial statements are measured in
U.S. dollars. The difference between the annual change in the
Israeli CPI and in the NIS/dollar exchange rate causes a further
difference between taxable income and the income before taxes
shown in the financial statements. In accordance with paragraph
9(f) of SFAS No. 109, the Company has not provided deferred
income taxes on the difference between the reporting currency and
the tax bases of assets and liabilities.
b. Tax benefits under the Law for the Encouragement of Capital
Investments, 1959 ("the Law"):
The Company's production facilities were granted the status of
"Approved Enterprise", under the law. According to the provisions
of said law, the Company elected the "alternative benefits" and
waived Government grants, in return for a tax exemption. Income
derived from the "Approved Enterprise" will be tax exempt for a
period of ten years, commencing with the year in which the
Company first earns taxable income. The period of benefits has
not yet commenced.
Two expansion projects have been granted "Approved Enterprises"
status under the Law.
The two expansion programs are as follows:
1. In December 1997, the Company received approval for the
first program, which entitles the Company to a ten-year tax
exemption period. The period of benefits for this expansion
has not yet commenced.
2. In July 2001, the Company received approval for the second
program of its "Approved Enterprises". This program entitles
the Company to a ten-year tax exemption period. The period
of benefits for this expansion has not yet commenced.
The entitlement to the above benefits is conditional upon the
Company fulfilling the conditions stipulated by the above law,
regulations published thereunder and the instruments of approval
for the specific investments in "Approved Enterprises". In the
event of failure to comply with these conditions, the benefits
may be canceled and the Company may be required to refund the
amount of the benefits, in whole or in part, including interest.
As of December 31, 2004, management believes that the Company is
meeting all of the aforementioned conditions.
In the event of a distribution of such tax-exempt income as cash
dividend in a manner other than in the complete liquidation of
the Company, the Company will be taxed at the rate of 10% to 25%
on the amount distributed (based on the percentage of foreign
ownership in each taxable year).
18
SURF-COMMUNICATION SOLUTIONS LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT FOR SHARE DATA)
NOTE 9:- TAXES ON INCOME (CONT.)
The period of tax benefits described above is limited to 12 years
from the commencement of production, or 14 years from date of
approval, whichever is earlier.
Income from sources other than the "Approved Enterprise" will be
taxable at the regular tax rate of 35%.
The Law also allows the Company to claim accelerated depreciation
on machinery and equipment used by the "Approved Enterprise",
during five tax years.
c. Tax benefits under the Law for the Encouragement of Industry
(Taxation), 1969:
The Company is qualified as an "industrial company" under the
above law and as such is entitled to certain tax benefits,
including accelerated depreciation and the deduction of public
offering expenses in three equal annual installments.
d. Tax rates:
Until December 31, 2003, the regular tax rate applicable to
income of companies in Israel (which are not entitled to benefits
due to an "Approved Enterprise", as described above) was 36%. In
June 2004, an amendment to the Income Tax Ordinance (No. 140 and
Temporary Provision), 2004 was passed by the "Knesset" (Israeli
parliament), which determines, among other things, that the
corporate tax rate is to be gradually reduced to the following
tax rates: 2004 - 35%, 2005 - 34%, 2006 - 32% and 2007 and
thereafter - 30%.
e. Net operating losses carryforward:
As of December 31, 2004, the Company's operating loss
carryforward amounted to approximately $ 22,761, which can be
carried forward and offset against taxable income in the future
for an indefinite period.
As of December 31, 2004, the U.S. subsidiary's operating loss
carryforward amounted to approximately $ 4,228, which can be
carried forward and offset against taxable income for 20 years no
later than 2022.
19
SURF-COMMUNICATION SOLUTIONS LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT FOR SHARE DATA)
NOTE 10:- SELECTED STATEMENTS OF OPERATIONS DATA
YEAR ENDED
DECEMBER 31,
------------------------
2003 2004
---------- ----------
a. Research and development:
Research and development costs $ 2,292 $ 1,939
Less - participation from government authorities and other funds 257 473
---------- ----------
$ 2,035 $ 1,466
========== ==========
b. Selling and marketing expenses, net:
Salaries $ 856 $ 908
Advertising 47 256
Other 583 734
---------- ----------
$ 1,486 $ 1,898
========== ==========
c. Financial income, net:
Financial expenses:
Interest $ 12 $ 7
Foreign currency remeasurement differences 107 26
---------- ----------
119 33
---------- ----------
Financial income:
Interest 74 44
Foreign currency remeasurement differences 117 4
---------- ----------
191 48
---------- ----------
$ (72) $ (15)
========== ==========
NOTE 11:- RELATED PARTIES TRANSACTIONS AND BALANCES
The balances with and the revenues derived from related parties. The
commitment was carried out under ordinary market conditions.
Revenues from related parties:
YEAR ENDED
DECEMBER 31,
--------------------
2003 2004
------ ------
Texas Instruments $ - $ 12
Motorola Inc. 51 327
------ ------
$ 51 $ 339
====== ======
20
SURF-COMMUNICATION SOLUTIONS LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT FOR SHARE DATA)
NOTE 12:- MAJOR CUSTOMER DATA
Major customer data as percentage of total revenue:
YEAR ENDED
DECEMBER 31,
------------------
2003 2004
---- ----
Customer A 7% 14%
Customer B 4% 12%
Customer C 12% 9%
Customer D 26% 1%
Customer E 19% 6%
21