TAXES ON INCOME. Our taxes on income were $10,000 for the year ended
December 31, 2005, compared to $266,000 for the year ended December 31, 2004.
Most of our taxes in 2004 were the result of our provision for the Israeli tax
authorities' demand for tax payment for the 1997-1999 period. We made a
provision in our financial statements for this tax demand for the amount deemed
probable.
EQUITY IN RESULTS OF AFFILIATE. We recognize income and loss from the
operations of our 50%-owned affiliate, Jusan S.A. For the year ended December
31, 2005 and 2004, we recognized income of $2,000 and $225,000, respectively.
QUARTERLY RESULTS OF OPERATIONS
The following tables set forth certain unaudited quarterly financial
information for each of the eight fiscal quarters ended December 31, 2006, in
dollars and as a percentage of revenues. In management's opinion, this data has
been prepared on a basis consistent with our audited consolidated financial
statements included elsewhere in this annual report and include all necessary
adjustments, consisting only of normal recurring adjustments, that we consider
necessary for a fair presentation of the unaudited information for the quarters
presented. The operating results for any quarter are not necessarily indicative
of results that we might achieve for any future periods.
For the Three Month Periods Ended
---------------------------------------------------------------------------------------------------------------------------
Mar. 31, Jun. 30, Sept. 30, Dec. 31, Mar. 31, Jun. 30, Sept. 30, Dec. 31,
2005 2005 2005 2005 2006 2006 2006 2006
----------- ----------- ----------- ----------- ----------- ----------- ----------- -----------
Revenues $ 2,726 $ 2,812 $ 3,013 $ 3,012 $ 2,814 $ 2,704 $ 2,652 $ 2,314
Cost of revenues 887 1,006 1,061 848 934 894 813 714
----------- ----------- ----------- ----------- ----------- ----------- ----------- -----------
Gross profit 1,839 1,806 1,952 2,164 1,880 1,810 1,839 1,600
----------- ----------- ----------- ----------- ----------- ----------- ----------- -----------
Selling and marketing 1,527 1,370 984 916 830 753 814 681
Research and development, net 1,294 1,030 1,118 953 1,060 898 915 760
General and administrative 1,045 677 588 520 578 630 746 697
Operating expenses 3,866 3,077 2,690 2,389 2,468 2,281 2,475 2,138
----------- ----------- ----------- ----------- ----------- ----------- ----------- -----------
Operating loss (2,027) (1,271) (738) (225) (588) (471) (636) (538)
Financial income (expense), net 21 83 (6) (45) 37 (26) (60) (5)
Other income (loss), net -- -- (2) 2 -- -- -- --
----------- ----------- ----------- ----------- ----------- ----------- ----------- -----------
Loss before taxes on income (2,006) (1,188) (746) (268) (551) (497) (696) (543)
Taxes on income -- -- -- 10 3 -- -- 115
----------- ----------- ----------- ----------- ----------- ----------- ----------- -----------
Net loss before equity in
results of affiliate (2,006) (1,188) (746) (278) (554) (497) (696) (658)
Equity in results of affiliate (28) 39 48 (57) 69 49 52 (11)
----------- ----------- ----------- ----------- ----------- ----------- ----------- -----------
Net loss $ (2,034) $ (1,149) $ (698) $ (335) $ (485) $ (448) $ (644) $ (669)
=========== =========== =========== =========== =========== =========== =========== ===========
Basic and diluted net loss per
share $ (0.44) $ (0.24) $ (0.13) $ (0.06) $ (0.08) $ (0.08) $ (0.11) $ (0.12)
Weighted average number of
ordinary shares used in
computing basic net loss per
share 4,638,004 4,712,561 5,306,565 5,724,504 5,744,864 5,763,845 5,765,289 5,773,845
Weighted average number of
ordinary shares used in
computing diluted net loss per
share 4,638,004 4,712,561 5,306,565 5,724,504 5,744,864 5,763,845 5,765,289 5,773,845
Revenues 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of revenues 32.5 35.8 35.2 28.2 33.2 33.1 30.7 30.9
----------- ----------- ----------- ----------- ----------- ----------- ----------- -----------
Gross profit 67.5 64.2 64.8 71.8 66.8 66.9 69.3 69.1
----------- ----------- ----------- ----------- ----------- ----------- ----------- -----------
Selling and marketing 56.0 48.7 32.7 30.4 29.5 27.8 30.7 29.4
Research and development, net 47.5 36.6 37.1 31.6 37.7 33.2 34.5 32.8
General and administrative 38.3 24.1 19.5 17.3 20.5 23.3 28.1 30.1
Operating expenses 141.8 109.4 89.3 79.3 87.7 84.3 93.3 92.3
----------- ----------- ----------- ----------- ----------- ----------- ----------- -----------
Operating loss (74.3) (45.2) (24.5) (7.5) (20.9) (17.4) (24.0) (23.2)
Financial income (expense), net 0.8 3.0 (0.2) (1.5) 1.3 (1.0) (2.3) (0.2)
Other income (loss), net - - (0.1) 0.1 - - - -
----------- ----------- ----------- ----------- ----------- ----------- ----------- -----------
Loss before taxes on income (73.5) (42.2) (24.8) (8.9) (19.6) (18.4) (26.3) (23.4)
Taxes on income - - - 0.3 0.1 - - 5.0
----------- ----------- ----------- ----------- ----------- ----------- ----------- -----------
Net loss before equity in
results of affiliate (73.5) (42.2) (24.8) (9.2) (19.7) (18.4) (26.3) (28.4)
Equity in results of affiliate (1.0) 1.4 1.6 (1.9) 2.5 1.8 2.0 (0.5)
----------- ----------- ----------- ----------- ----------- ----------- ----------- -----------
Net loss (74.6)% (40.8)% (23.2)% (11.1)% (17.2)% (16.6)% (24.3)% (28.9)
=========== =========== =========== =========== =========== =========== =========== ===========
31
SEASONALITY
Our operating results are generally not characterized by a seasonal pattern
except that our volume of sales in Europe is generally lower in the summer
months.
IMPACT OF INFLATION AND DEVALUATION ON RESULTS OF OPERATIONS, LIABILITIES AND ASSETS
The dollar cost of our operations in Israel is influenced by the extent to
which any increase in the rate of inflation in Israel is not offset, or is
offset on a lagging basis, by a devaluation of the NIS in relation to the
dollar. When the rate of inflation in Israel exceeds the rate of devaluation of
the NIS against the dollar, companies experience increases in the dollar cost of
their operations in Israel. Unless offset by a devaluation of the NIS, inflation
in Israel will have a negative effect on our profitability, as we receive
payments in dollars for most of our sales, while we incur a portion of our
expenses in NIS.
In addition, since part of our sales are quoted in NIS and a portion of our
expenses are incurred in NIS, our results have in the past been and would in the
future be adversely affected by a change in the rate of inflation in Israel when
the amount of our revenues in NIS is less than the amount of our expenses in NIS
or if such change in the rate of inflation is not offset, or is offset on a
lagging basis, by a corresponding devaluation of the NIS against the dollar and
other foreign currencies.
The following table presents information about the rate of inflation in
Israel, the rate of devaluation of the NIS against the dollar, and the rate of
inflation in Israel adjusted for the devaluation:
Israeli inflation
Year ended Israeli inflation NIS devaluation adjusted for
December 31, rate % rate % devaluation %
------------ ------ ------ -------------
2002 6.5 7.3 (0.7)
2003 (1.9) (7.6) 6.2
2004 1.2 (1.6) 2.8
2005 2.4 6.8 (4.1)
2006 (0.1) (8.2) 8.8
A devaluation of the NIS in relation to the dollar has the effect of
reducing the dollar amount of any of our expenses or liabilities which are
payable in NIS, unless those expenses or payables are linked to the dollar. This
devaluation also has the effect of decreasing the dollar value of any asset
which consists of NIS or receivables payable in NIS, unless the receivables are
linked to the dollar. Conversely, any increase in the value of the NIS in
relation to the dollar has the effect of increasing the dollar value of any
unlinked NIS assets and the dollar amounts of any unlinked NIS liabilities and
expenses.
Because exchange rates between the NIS and the dollar fluctuate
continuously, with a historically declining trend in the value of the NIS,
exchange rate fluctuations, particularly larger periodic devaluations, may have
an impact on our profitability and period-to-period comparisons of our results.
We cannot assure you that in the future our results of operations may not be
materially adversely affected by currency fluctuations.
32
CONDITIONS IN ISRAEL
We are incorporated under the laws of, and our principal executive offices
and manufacturing and research and development facilities are located in, the
State of Israel. Accordingly, our operations in Israel are directly influenced
by political, economic and military conditions affecting Israel. Specifically,
we could be adversely affected by any major hostilities involving Israel, a full
or partial mobilization of the reserve forces of the Israeli army, the
interruption or curtailment of trade between Israel and its present trading
partners, and a significant downturn in the economic or financial condition of
Israel.
POLITICAL 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. Although Israel has entered into
various agreements with Egypt, Jordan and the Palestinian Authority, there has
been an increase in unrest and terrorist activity in Israel, which began in
September 2000 and which has continued with varying levels of severity through
2006. In July 2006, an armed conflict began between Israel and Hezbollah forces
in Lebanon, which involved rocket attacks on populated areas in the northern
parts of Israel. On August 14, 2006, a cease-fire between Hezbollah and Israel
took effect. This situation has had an adverse effect on Israel's economy,
primarily in the geographical areas directly harmed by this conflict. Any future
armed conflict, political instability or violence in the region may have a
negative effect on our business condition, harm our results of operations and
adversely affect our share price. No predictions can be made as to whether or
when a final resolution of the area's problems will be achieved or the nature
thereof and to what extent the situation will impact Israel's economic
development or our operations.
Furthermore, there are a number of countries, primarily in the Middle East,
as well as Malaysia and Indonesia, that restrict business with Israel or Israeli
companies, and we are precluded from marketing our products to these countries.
Restrictive laws or policies directed towards Israel or Israeli businesses may
have an adverse impact on our operations, our financial results or the expansion
of our business.
In addition, some of our executive officers and employees in Israel are
obligated to perform annual reserve duty in the Israeli Defense Forces and may
be called for active duty under emergency circumstances at any time. If a
military conflict or war arises, these individuals could be required to serve in
the military for extended periods of time. Our operations could be disrupted by
the absence for a significant period of one or more of our executive officers or
key employees or a significant number of other employees due to military
service. Any disruption in our operations could adversely affect our business.
ECONOMIC CONDITIONS
In recent years Israel has been going through a period of recession in
economic activity, resulting in low growth rates and growing unemployment.
Although economic activity in Israel has improved recently, our operations could
be adversely affected if the economic conditions in Israel begin to deteriorate
again.
TRADE RELATIONS
Israel is a member of the United Nations, the International Monetary Fund,
the International Bank for Reconstruction and Development and the International
Finance Corporation. Israel is a member of the World Trade Organization and is a
signatory to the General Agreement on Tariffs and Trade, which provides for
reciprocal lowering of trade barriers among its members. In addition, Israel has
been granted preferences under the Generalized System of Preferences from the
United States, Australia, Canada and Japan. These preferences allow Israel to
export products covered by such programs either duty-free or at reduced tariffs.
33
Israel and the European Union Community concluded a Free Trade Agreement in
July 1975, which confers certain advantages with respect to Israeli exports to
most European countries and obligates Israel to lower its tariffs with respect
to imports from these countries over a number of years. In 1985, Israel and the
United States entered into an agreement to establish a Free Trade Area. The Free
Trade Area has eliminated all tariff and specified non-tariff barriers on most
trade between the two countries. On January 1, 1993, an agreement between Israel
and the European Free Trade Association, known as EFTA, established a free-trade
zone between Israel and the EFTA nations. In November 1995, Israel entered into
a new agreement with the European Union, which includes redefinement of rules of
origin and other improvements, including providing for Israel to become a member
of the research and technology programs of the European Union. In recent years,
Israel has established commercial and trade relations with a number of other
nations, including China, India, Russia, Turkey and other nations in Eastern
Europe and Asia.
EFFECTIVE CORPORATE TAX RATE
Israeli companies are generally subject to income tax on their taxable
income. The applicable rate for 2006 was 31%, which was reduced to 29% in 2007,
and will be further reduced to 27% in 2008, 26% in 2009 and 25% in 2010 and
thereafter.
However, certain of our manufacturing facilities have been granted
"Approved Enterprise" status under the Law for the Encouragement of Capital
Investments, 1959, as amended, commonly referred to as the Investment Law, and,
consequently, are eligible, subject to compliance with specified requirements,
for tax benefits beginning when such facilities first generate taxable income.
Subject to certain restrictions, we are entitled to a tax exemption in respect
of income derived from our approved facilities for a period of two years,
commencing in the first year in which such income is earned, and will be
entitled to a reduced tax rate of 10%-25% for an additional five to eight years
if we qualify as a foreign investors' company. If we do not qualify as a foreign
investors' company, we will instead be entitled to a reduced rate of 25% for an
additional five, rather than eight, years.
Our taxes outside Israel are dependent on our operations in each
jurisdiction as well as relevant laws and treaties. Under Israeli tax law, the
results of our foreign consolidated subsidiaries, which have generally been
unprofitable, cannot be consolidated for tax purposes with the results of
operations of the parent company.
ADOPTION OF NEW ACCOUNTING STANDARD
ACCOUNTING FOR EQUITY-BASED COMPENSATION
Effective January 1, 2006, we adopted Financial Accounting Standards Board,
or FASB, SFAS No. 123 (revised 2004), "Share-Based Payment," or SFAS No. 123(R).
SFAS 123(R) supersedes Accounting Principles Board Opinion No. 25, "Accounting
for Stock Issued to Employees," or APB No. 25, and related interpretations, and
amends FASB SFAS No. 95, "Statement of Cash Flows." Generally, the approach in
SFAS 123(R) is similar to the approach described in SFAS 123. However, SFAS
123(R) requires all equity-based payments to employees, including grants of
employee stock options, to be recognized in the statement of income based on
their fair values. Pro-forma disclosure is no longer an alternative. In 2006, we
recognized equity-based compensation expense under SFAS 123(R) in the amount of
$210,000.
As of December 31, 2006, we had $209,000 of unrecognized compensation
expense related to non-vested stock options. For options granted before January
1, 2006 and which had graded vesting, we recognized compensation expenses based
on the accelerated attribution method over the requisite service period of each
of the awards. Forfeitures were accounted for as they occurred, but have been
estimated with the adoption of SFAS 123(R) for those awards not yet vested. For
options granted after January 1, 2006, we recognize compensation costs using the
straight-line method over the requisite service period of each of the awards,
net of estimated forfeitures, and for stock options granted before adoption of
FAS 123(R) we use the accelerated method. SFAS 123(R) requires forfeitures to be
estimated at the time of grant and revised, if necessary, in subsequent periods
if actual forfeitures differ from those estimates. Estimated forfeitures are
based on actual historical pre-vesting forfeitures.
34
We adopted SFAS 123(R) using the modified prospective method. Under this
transition method, compensation costs recognized in 2006 include (a)
compensation costs for all stock-based payments granted prior to, but that had
not yet vested as of, January 1, 2006, based on the grant date fair value
estimated in accordance with the pro-forma provisions of SFAS 123, adjusted for
the effect of estimating forfeitures, and (b) compensation costs for the
equity-based payments granted subsequent to January 1, 2006, based on the grant
date fair value estimated in accordance with SFAS 123(R). Our consolidated
financial statements for prior periods have not been restated to reflect, and do
not include, the impact of SFAS 123(R). We selected the Black-Scholes option
pricing model as the most appropriate fair value method for our stock-options
awards and value restricted stock based on the market value of the underlying
shares at the date of grant.
As a result of adopting SFAS 123(R) on January 1, 2006, our income before
income taxes for 2006 is $144,000 lower than if we had continued to account for
equity-based compensation under APB No. 25. Basic and diluted earning per share
for 2006 is $0.03 lower than if we had continued to account for equity-based
compensation under APB No. 25.
The fair value for options granted in 2004, 2005 and 2006 is estimated at
the date of grant using a Black-Scholes options pricing model with the following
weighted average assumptions:
Year ended December 31,
-----------------------------------
Employee Stock Options 2004 2005 2006
---------------------- ---- ---- ----
Expected volatility 71.8% 56.9% 74.5%
Risk-free interest 2.0% 3.9% 4.6%
Dividend yield 0.0% 0.0% 0.0%
Expected life (years) 2.2 4 4
RECENTLY ISSUED ACCOUNTING STANDARDS
In July 2006, the FASB issued FASB Interpretation No. 48 "Accounting for
Uncertainty in Income Taxes an Interpretation of FASB Statement No. 109," or FIN
48. FIN 48 clarifies the accounting for income taxes by prescribing the minimum
recognition threshold a tax position is required to meet before being recognized
in the financial statements. FIN 48 utilizes a two-step approach for evaluating
tax positions. Recognition (step one) occurs when an enterprise concludes that a
tax position, based solely on its technical merits, is more-likely-than-not to
be sustained upon examination. Measurement (step two) is only addressed if step
one has been satisfied (when the position is more-likely-than-not to be
sustained). Under step two, the tax benefit is measured as the largest amount of
benefit, determined on a cumulative probability basis that is
more-likely-than-not to be realized upon ultimate settlement. FIN 48 applies to
all tax positions related to income taxes subject to the FASB SFAS No. 109,
"Accounting for income taxes". This includes tax positions considered to be
"routine" as well as those with a high degree of uncertainty. FIN 48 has
expanded disclosure requirements, which include a tabular roll forward of the
beginning and ending aggregate unrecognized tax benefits as well as specific
detail related to tax uncertainties for which it is reasonably possible the
amount of unrecognized tax benefit will significantly increase or decrease
within twelve months. These disclosures are required at each annual reporting
period unless a significant change occurs in an interim period. FIN 48 is
effective for fiscal years beginning after December 15, 2006. The cumulative
effect of applying FIN 48 will be reported as an adjustment to the opening
balance of retained earnings. We are currently evaluating the effect of the
adoption of FIN 48 on our financial statements.
In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements,"
or SFAS No. 157. SFAS No. 157 provides a single definition of fair value, a
framework for measuring fair value, and expanded disclosures concerning fair
value. Previously, different definitions of fair value were contained in various
accounting pronouncements creating inconsistencies in measurement and
disclosures. SFAS No. 157 applies under those previously issued pronouncements
that prescribe fair value as the relevant measure of value, except SFAS No.
123(R) and related interpretations. SFAS No. 157 does not apply to accounting
standards that require or permit measurement similar to fair value but are not
intended to measure fair value. SFAS No. 157 is effective for fiscal years
beginning after November 15, 2007. We are currently evaluating the impact of
adopting SFAS No. 157.
In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for
Financial Assets and Financial Liabilities," or SFAS No. 159. SFAS No. 159
provides companies with an option to report selected financial assets and
liabilities at fair value. Generally accepted accounting principles have
required different measurement attributes for different assets and liabilities
that can create artificial volatility in earnings. The Standard's objective is
to reduce both complexity in accounting for financial instruments and the
volatility in earnings caused by measuring related assets and liabilities
differently. SFAS No. 159 is effective as of the beginning of an entity's first
fiscal year beginning after November 15, 2007. We are currently evaluating the
impact of adopting SFAS No. 159.
35
B. LIQUIDITY AND CAPITAL RESOURCES
On December 31, 2006, we had $1.5 million in cash and cash equivalents,
$100,000 in short-term bank deposits, $159,000 in marketable securities and
working capital of $186,000 compared to $3.2 million in cash and cash
equivalents, $0 in short-term bank deposits, $132,000 in marketable securities
and working capital of $2.1 million on December 31, 2005. The decrease in cash
and cash equivalents and working capital at December 31, 2006 was primarily due
to our losses in 2006.
In order to finance the acquisition of TelSoft in July 2006, we obtained a
loan from Bank Hapoalim in the amount of approximately $1 million. The loan
principal will be repaid in 12 equal monthly installments commencing August 31,
2007. The loan bears annual interest at a rate of the monthly LIBOR + 2%,
payable on a monthly basis on the outstanding loan amount commencing August 31,
2006. Under the loan agreement, we are required to comply with the following
covenants: (i) the ratio between shareholders equity and total shareholders
equity and liabilities may not be less than 40% and in no event may our
shareholders equity decrease below $ 5,000 thousand; (ii) we must generate
operating income for each of the two subsequent quarters commencing the second
quarter of 2007 and onwards; and (iii) our cash and cash equivalents may not
decrease below $1 million at any given time. To secure the loan, we granted the
Bank a floating charge on all of our current and long term assets and a fixed
charge on our goodwill and on authorized but not outstanding shareholders
equity.
On August 10, 2005, we raised $2.8 million (before issuance costs) in a
private placement of 937,500 ordinary shares to institutional and private
investors. The private placement also involved the acquisition by the investors
of warrants to purchase an aggregate of 375,000 ordinary shares at an exercise
price of $4.00 per share (subject to anti-dilution adjustments), exercisable
from February 10, 2006 until August 10, 2009.
One of the principal factors affecting our working capital is the payment
cycle on our sales. Any material change in the current aging of our accounts
receivable could have an adverse effect on our working capital.
CASH FLOWS
The following table summarizes our cash flows for the periods presented:
Year ended December 31,
------------------
2005 2006
------ ------
($ in thousands)
Net cash used in operating activities (4,422) (1,609)
Net cash provided by (used in) investing activities 893 (1,206)
Net cash provided by financing activities 2,906 1,098
Net decrease (increase) in cash and cash equivalents (623) (1,717)
Cash and cash equivalents at beginning of period 3,814 3,191
Cash and cash equivalents at end of period 3,191 1,474
Net cash used in operating activities was approximately $1.6 million for
the year ended December 31, 2006. The use of our funds in 2006 was primarily
attributable to our continuing investment in product development. Net cash used
in operating activities was approximately $4.4 million for the year ended
December 31, 2005. The use of our funds in 2005 was primarily attributable to
our research and development expenses associated with the integration of the
Teleknowledge activity, as well as to our continuing investment in product
development.
36
Net cash used in investing activities was approximately $1.2 million for
the year ended December 31, 2006, primarily attributable to the acquisition of
certain assets and liabilities of TelSoft in July 2006. Net cash provided by
investing activities was approximately $893,000 for the year ended December 31,
2005, primarily attributable to the sales of available-for-sale marketable
securities.
Net cash provided by financing activities was approximately $1.1 million
for the year ended December 21, 2006 compared to approximately $2.9 million for
the year ended December 31, 2005. Of the cash provided by financing activities
in 2006, approximately $1 million was attributable to the loan we obtained form
Bank Hapoalim to finance the acquisition of TelSoft and $100,000 was
attributable to proceeds from exercise of stock options. Of the cash provided by
financing activities in 2005, approximately $2.6 million was attributable to
proceeds from a private offering of our securities in the United States in
August 2005 and approximately $300,000 was attributable to proceeds from
exercise of stock options.
In December 2000, we publicly announced our stock repurchase program, under
which our officers were authorized to repurchase up to 300,000 of our ordinary
shares. In May 2003, our Board of Directors increased the number of shares to be
repurchased to 600,000 ordinary shares. Through December 31, 2004, we
repurchased an aggregate 395,410 ordinary shares, at a total cost of $486,000.
We did not continue this program during 2005 and 2006 and based on our current
financial situation, we do not expect to repurchase any shares during 2007. We
cancelled 384,610 of the repurchased ordinary shares.
We currently do not have significant capital spending or purchase
commitments, but we expect to engage in capital spending consistent with the
level of our operations. We anticipate that our cash on hand and cash flow from
operations will be sufficient to meet our working capital and capital
expenditure requirements for at least 12 months. However, if we do not generate
sufficient cash from operations, we may be required to obtain additional
financing or to reduce level of expenditure. There can be no assurance that such
financing will be available in the future, or, if available, will be on terms
satisfactory to us.
C. RESEARCH AND DEVELOPMENT
Our product development plans are market-driven and address the major,
fast-moving trends that are influencing the telecommunications industry. We
intend to expand upon our existing family of TEM solutions by adding new
features and functions to address evolving market needs. We work closely with
our customers and prospective customers to determine their requirements and
design enhancements and new releases to meet their needs. Research and
development activities take place in our facilities in Israel. On December 31,
2006, we employed 37 persons in research and development.
Our quality management system has been ISO 9001:2000 certified since the
beginning of 2006, and prior thereto was ISO 9001:1994 certified.
We are evaluating approaches to solutions which will permit an information
technology manager to effectively measure the quality of the services received
from their service providers and to ensure that the users within the
organization received such services according to their needs and the overall
policy and priorities of the organization.
We have committed substantial financial resources to research and
development for our TEM and BSS activities. During 2004, 2005 and 2006, our net
research and development expenditures were $2.4 million, $4.4 million and $3.6
million, respectively. In the past, we received funding from the Israeli
Ministry of Industry, Trade and Labor's Office of the Chief Scientist for
selected research and development projects, but we stopped seeking funding for a
number of years. In late 2005 and early 2006 and 2007, we applied to the Office
of the Chief Scientist for new grants for our research and development projects.
We received an approval for the 2005 and 2006 applications and our two 2007
applications are currently pending.
Under the terms of research and development grants that we have received
from the Office of the Chief Scientist, we are required to pay royalties on the
revenues derived from products incorporating know-how developed with such grants
and ancillary services in connection therewith, up to 100% to 150% of the
dollar-linked value of the total grants, plus interest. We are required to pay
royalties at a rate of 3%-5%. 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. Since June 1997, we have paid the Office of the Chief
Scientist royalties on all call accounting product sales at the applicable rates
at the time of payment. See Item 10E. "Additional Information - Taxation -
Grants under the Law for the Encouragement of Industrial Research and
Development, 1984."
37
We have expensed royalties relating to the repayment of the Office of the
Chief Scientist grants in the amounts of $181,000, $198,000 and $187 for the
years ended December 31, 2004, 2005 and 2006, respectively.
As of December 31, 2006, we had a contingent obligation to pay royalties in
the amount of approximately $9.49 million (including a contingent obligation in
the amount of $1.64 million relating to royalties from revenues derived from
products that we acquired from Teleknowledge that were funded by the Office of
the Chief Scientist). The $5.5 million of grants received after January 1999 are
subject to interest at a rate equal to the 12 month LIBOR rate.
D. TREND INFORMATION
As a result of a less predictable business environment and the decline in
worldwide sales of PBX systems, we are unable to provide any guidance as to
current sales and profitability trends. We expect that our results will continue
to be impacted by a shift to a new line of products and increased marketing and
research and development expenditures.
E. OFF-BALANCE SHEET ARRANGEMENTS
We are not a party to any material off-balance sheet arrangements. In
addition, we have no unconsolidated special purpose financing or partnership
entities that are likely to create material contingent obligations.
F. TABULAR DISCLOSURE OF CONTRACTUAL OBLIGATIONS
The following table summarizes our minimum contractual obligations and
commercial commitments, including obligations of discontinued operations, as of
December 31, 2006 and the effect we expect them to have on our liquidity and
cash flow in future periods.
Contractual Obligations Payments Due By Period
----------------------- --------------------------------------------------
Less than More than
Total 1 Year 1-3 Years 3-5 Years 5 Years
----- ------ --------- --------- -------
(U.S. dollars in thousands)
Operating lease obligations $1,135 $ 357 $ 644 $ 134 $ --
Accrued severance pay* 946 -- -- -- 946
Total $2,081 $ 357 $ 644 $ 134 $ 946
----------
* See Item 6D. "Directors, Senior Management and Employees - Employees."
ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES
A. DIRECTORS AND SENIOR MANAGEMENT
Set forth below are the name, age, principal position and a biographical
description of each of our directors and executive officers:
38
NAME AGE POSITION WITH THE COMPANY
---- --- -------------------------
Chaim Mer 59 Chairman of the Board
Eytan Bar 41 President and Chief Executive Officer
Shlomi Hagai 36 Corporate Chief Operating Officer and Chief Financial Officer
Hanoch Magid 51 General Manager MTS Asia and Vice President Sales - Europe, Middle East and Africa
Alon Aginsky 44 Director
Isaac Ben-Bassat 53 Director
Dr. Orna Berry (1) 57 Outside Director
Dr. Yehoshua Gleitman (1) 57 Outside Director
Steven J. Glusband 60 Director
Yaacov Goldman (1) 52 Director
----------
(1) Member of our Audit Committee
Messrs. Mer, Aginsky, Ben-Bassat, Glusband and Goldman will serve as
directors until our 2007 Annual General Meeting of Shareholders. Dr. Gleitman
and Dr. Berry will serve as outside directors pursuant to the provisions of the
Israeli Companies Law for a three-year term until our 2007 annual general
meeting of shareholders and January 28, 2008, respectively, following which the
service of Dr. Gleitman as an outside director may not be extended and the
service of Dr. Berry as an outside director may be renewed for only one
additional three-year term.
CHAIM MER has served as Chairman of our Board of Directors and a director
since our inception in December 1995. Mr. Mer has been the Chairman of the Board
of Directors of C. Mer Industries Ltd., or C. Mer, a publicly traded company,
since 1988 and served as its President and Chief Executive Officer from 1988
until January 2005. Mr. Mer holds a B.Sc. degree in Computer Sciences and
Mathematics from the Technion - Israel Institute for Technology.
EYTAN BAR has served as our President and Chief Executive Officer since
December 2003. Prior to joining our company and from 2001, Mr. Bar served as
General Manager of the CEM product division of NICE Systems Ltd. From 2000
through 2001, Mr. Bar served as Vice President of Professional Services at NICE
Systems Inc. From 1993 through 1999, Mr. Bar served as General Manager of STS
Software Systems Ltd., a company that developed a unique VoIP technology for
recording solutions.
SHLOMI HAGAI has served as our Corporate Chief Operating Officer and Chief
Financial Officer since March 2005. Prior to that and from 2000, Mr. Hagai
served as our financial controller. Prior to joining our company and from 1998,
Mr. Hagai served as audit team manager in the Professional Department of Ernst &
Young Israel, supervising privately held and publicly traded companies engaged
in the hi-technology, industrial, services and infrastructure sectors. Mr. Hagai
is a certified public accountant since 1999 and holds a B.A. degree in Business
Administration (majoring in accounting) from the College of Management and LLM
degree from Bar-Ilan University.
HANOCH MAGID has served as our Vice President Sales- Europe, Middle East
and Africa since 2002 and as General Manager of MTS Asia since 2006. Prior to
joining our company and from 2001, Mr. Magid served as Vice President of
Operating and Professional Services of Xcitel Ltd., a start up company engaged
in the field of mobile communication. Prior to that and from 2000, Mr. Magid
served as Chief Operating Officer of Cellonet Interactive Mobile Commerce Ltd.
From 1992 to 2000, Mr. Magid served in various positions of sales, operating and
customer support at Scitex Corporation Ltd. Mr. Magid holds a B.Sc degree in
Mechanical Engineering from the Ben Gurion University, Be'er Sheva.
ALON AGINSKY has served as a director since June 1996. Since July 2000, Mr.
Aginsky has served as President and Chief Executive Officer of cVidya Inc.,
which is engaged in the development of a service assurance platform for next
generation broadband service providers. Mr. Aginsky served as our Vice President
Sales and Marketing from October 1996 until April 1999. From April 1999 to July
2000, Mr. Aginsky served as sales manager of C. Mer, when he was appointed
Manager of C. Mer. From 1990 until September 1996, Mr. Aginsky served as
President of MTS Inc., our U.S.-based marketing subsidiary. Mr. Aginsky holds a
B.A. degree in Business Administration from the New York Technology Institute.
39
ISAAC BEN-BASSAT has been a director since our inception in December 1995.
Mr. Ben-Bassat has been Executive Vice President and a director of C. Mer
Industries Ltd. since 1988. Mr. Ben-Bassat holds a B.Sc. degree in Civil
Engineering from the Technion - Israel Institute for Technology.
DR. ORNA BERRY has served as an outside director since January 2005 and is
a member of our audit committee. Dr. Berry is a Venture Partner in Gemini Israel
Funds Ltd. and since 2000 has served as Chairperson of Lambda Crossing, Ltd. and
Riverhead Networks, Inc., which was sold to Cisco in March 2004. Dr. Berry
served as the Chief Scientist of the Ministry of Industry and Trade of the
Government of Israel from 1997 to 2000 and Co-President of Ornet Data
Communications Technologies Ltd., a provider of high-speed switches, which was
acquired by Siemens AG, from 1993 to 1997. From 1992 to 1993, Dr. Berry served
as a consultant to Intel Communications Division and Elbit Systems, Ltd. Dr.
Berry holds a B.A. degree in statistics and mathematics from Haifa University,
an M.A. degree in statistics and mathematics from Tel Aviv University and a
Ph.D. in computer science from the University of Southern California.
DR. YEHOSHUA GLEITMAN has served as an outside director since July 2001 and
is a member of our audit committee. Since March 2000, Dr. Gleitman has been
Chief Executive Officer of SFKT, a company whose activities include venture
capital management, finance and investments in high-tech and telecommunications.
Mr. Gleitman was Chief Executive Officer of Ampal-American Israel Corporation,
or Ampal, from May 1997 and Managing Director of Ampal's Israeli wholly-owned
subsidiaries and head of Ampal's Israeli operations from April 1, 1997 until his
resignation in July 1999. From August 1996 until February 1997, Mr. Gleitman was
Director General of the Israeli Ministry of Industry and Trade and was Chief
Scientist at the Ministry of Industry and Trade of the Government of Israel from
January 1993 through February 1997. From 1991 through 1992, Mr. Gleitman was the
general manager of AIMS Ltd., and between 1990-1991, he was an advisor in charge
of marketing and business for Ashtrom Ltd. Dr. Gleitman holds a B.Sc., M.Sc. and
Ph.D. degrees in Physical Chemistry, all from the Hebrew University of
Jerusalem.
STEVEN J. GLUSBAND has served as a director since August 1, 1996. Mr.
Glusband has been a partner with Carter Ledyard & Milburn LLP, our U.S. counsel,
since March 1987. Mr. Glusband holds a B.B.A. degree from the City College of
the City University of New York, a J.D. degree from Fordham University School of
Law and an L.L.M. degree from the New York University School of Law.
YAACOV GOLDMAN has served as a director since May 2004 and is a member of
our audit committee. Mr. Goldman provides consulting services to companies in
strategic-financial areas, through his wholly owned company, Maanit-Goldman
Management & Investments (2002) Ltd. Mr. Goldman serves as a director of Bank
Leumi Le-Israel Ltd., Elron Electronic Industries Ltd, Golden House Ltd., Tagor
capital Ltd. and Renewable Resources Ltd. Mr. Goldman serves as the Professional
Secretary of the Peer Review Institute of the Certified Public accountants
Institute in Israel. From September 2000 until November 2001, Mr. Goldman served
as Managing Director of Argoquest Holdings, LLC, a U.S.-based investment company
focused on early stage high-technology companies. From November 1981 until
August 2000, Mr. Goldman was associated with Kessleman & Kessleman, the Israeli
member firm of PricewaterhouseCoopers, and was a Partner and Senior Partner at
such firm from January 1991 through August 2000. Mr. Goldman is a Certified
Public Accountant (Israel) since 1981 and holds a B.A. degree in Economics and
Accounting from Tel Aviv University.
B. COMPENSATION
The following table sets forth all compensation we paid with respect to all
of our directors and executive officers as a group for the year ended December
31, 2006.
40
Salaries, fees, Pension,
commissions retirement and
and bonuses similar benefits
----------- ----------------
All directors and executive officers
as a group (14 persons) $1,081,573 $ 162,803
All our executive officers work full time for us. Mr. Chaim Mer, the
Chairman of our Board of Directors, devotes approximately 20% of his time to the
management of our company in consideration of which we pay him a monthly salary
of $7,000 per month (as approved by our Audit Committee and Board of Directors
on November 8, 1999). We provide automobiles to our executive officers at our
expense.
During the year ended December 31, 2006, we paid to each of our directors
an annual fee of approximately $8,400 and a per meeting attendance fee of $300,
except for Mr. Yaacov Goldman, an independent director and our financial expert,
to whom we paid an annual fee of approximately $16,800 and a per meeting
attendance fee of $400.
As of December 31, 2006, our directors and executive officers as a group,
consisting of 14 persons, held options to purchase an aggregate 238,625 ordinary
shares, having exercise prices ranging from $1.844 to $3.87. The options vest
over a four-year period. Of such options, options to purchase 228,625 ordinary
shares were granted under our 2003 Israeli Share Option Plan (of which, options
to purchase 205,000 ordinary shares will expire in December 2008, options to
purchase 7,500 ordinary shares will expire in August 2009, options to purchase
2,500 ordinary shares will expire in May 2010, options to purchase 7,500
ordinary shares will expire in September 2010, options to purchase 2,500
ordinary shares will expire in November 2010 and options to purchase 3,625
ordinary shares will expire on March 2011) and options to purchase 10,000
ordinary shares were granted under our 1996 Stock Option Plan (all of which will
expire in December 2008). See Item 6.E., "Directors, Senior Management and
Employees - Share Ownership - Stock Option Plans."
C. BOARD PRACTICES
ELECTION OF DIRECTORS
Our Articles of Association provide for a Board of Directors consisting of
up to ten members or such other number as may be determined from time to time at
a general meeting of shareholders. Our Board of Directors is currently composed
of seven directors.
Pursuant to our articles of association, all of our directors (except the
outside directors) are elected at our annual general meeting of shareholders by
a vote of the holders of a majority of the voting power represented and voting
at such meeting and hold office until the next annual general meeting of
shareholders and until their successors have been elected. All the members of
our Board of Directors (except the outside directors) may be reelected upon
completion of their term of office. All of our current directors (except our
outside directors) were elected by our shareholders at our annual general
meeting of shareholders of July 2006.
We do not follow the requirements of the NASDAQ Marketplace Rules with
regard to the nomination process of directors, and instead, we follow Israeli
law and practice, in accordance with which our directors are recommended by our
board of directors for election by our shareholders. See below in this Item 6C.
"Directors, Senior Management and Employees - Board Practices - NASDAQ
Marketplace Rules and Home Country Practices."
OUTSIDE AND INDEPENDENT DIRECTORS
OUTSIDE DIRECTORS. Under the Israeli Companies Law, companies incorporated
under the laws of the State of Israel whose shares have been offered to the
public are required to appoint at least two outside directors. The Israeli
Companies Law provides that a person may not be appointed as an outside director
if the person, or the person's relative, partner, employer or an entity under
that person's control, has or had during the two years preceding the date of
appointment any affiliation with the company, or any entity controlling,
controlled by or under common control with the company. The term "relative"
means a spouse, sibling, parent, grandparent, child or child of spouse or spouse
of any of the above. The term affiliation includes:
41
o an employment relationship;
o a business or professional relationship maintained on a regular basis;
o control; and
o service as an officer holder, excluding service as an outside director
of a company that is offering its shares to the public for the first
time.
In addition, no person may serve as an outside director if the person's
position or other activities create, or may create, a conflict of interest with
the person's responsibilities as director or may otherwise interfere with the
person's ability to serve as director. If, at the time an outside director is
appointed all members of the board of directors are of the same gender, then
that outside director must be of the other gender. A director of one company may
not be appointed as an outside director of another company if a director of the
other company is acting as an outside director of the first company at such
time.
As of 2006, at least one of the outside directors elected must have
"accounting and financial expertise" and any other outside director must have
"accounting and financial expertise" or "professional qualification," as such
terms are defined by regulations promulgated under the Israeli Companies Law.
This requirement does not apply to outside directors appointed prior to 2006.
Outside directors are elected by shareholders. The shareholders voting in
favor of their election must include at least one-third of the shares of the
non-controlling shareholders of the company who voted on the matter. This
minority approval requirement need not be met if the total shareholdings of
those non-controlling shareholders who vote against their election represent 1%
or less of all of the voting rights in the company.
In general, outside directors serve for a three-year term, which may be
renewed for only one additional three-year term. Outside directors can be
removed from office only by the same special percentage of shareholders as can
elect them, or by a court, and then only if the outside directors cease to meet
the statutory qualifications with respect to their appointment or if they
violate their duty of loyalty to the company.
Any committee of the board of directors must include at least one outside
director and the audit committee must include all of the outside directors. An
outside director is entitled to compensation as provided in regulations adopted
under the Israeli Companies Law and is otherwise prohibited from receiving any
other compensation, directly or indirectly, in connection with such service.
INDEPENDENT DIRECTORS. In general, NASDAQ Marketplace Rules require that a
majority of our board of directors qualify as independent directors within the
meaning of the NASDAQ Marketplace Rules and our audit committee must have at
least three members and be comprised only of independent directors each of whom
satisfies the respective "independence" requirements of the Securities and
Exchange Commission and NASDAQ.
Our Board of Directors has determined that Dr. Yehoshua Gleitman and Dr.
Orna Berry both qualify as independent directors under the rules of the
Securities and Exchange Commission and NASDAQ and as outside directors under the
requirements of the Israeli Companies Law. Our Board of Directors has further
determined that Messrs. Alon Aginsky and Yaacov Goldman both qualify as
independent directors under the requirements of the Securities and Exchange
Commission and NASDAQ.
42
AUDIT COMMITTEE
Our audit committee, which was established in accordance with Section 114
of the Israeli Companies Law and Section 3(a)(58)(A) of the Securities Exchange
Act of 1934, assists our board of directors in overseeing the accounting and
financial reporting processes of our company and audits of our financial
statements, including the integrity of our financial statements, compliance with
legal and regulatory requirements, our independent public accountants'
qualifications and independence, the performance of our internal audit function
and independent public accountants, finding any defects in the business
management of our company for which purpose the audit committee may consult with
our independent auditors and internal auditor, proposing to the board of
directors ways to correct such defects, and such other duties as may be directed
by our board of directors.
The responsibilities of the audit committee also include approving
related-party transactions as required by law. Under Israeli law an audit
committee may not approve an action or a transaction with a controlling
shareholder, or with an office holder, unless at the time of approval two
outside directors are serving as members of the audit committee and at least one
of the outside directors was present at the meeting in which an approval was
granted.
Our audit committee consists of three members of our Board of Directors who
satisfy the respective "independence" requirements of the Securities and
Exchange Commission, NASDAQ and Israeli Law for audit committee members. Our
audit committee is currently composed of Dr. Yehoshua Gleitman, Dr. Orna Berry
and Mr.Yaacov Goldman. Our Board of Directors has determined that Mr. Goldman
qualifies as a financial expert. The audit committee meets at least once each
quarter.
INTERNAL AUDIT
Under the Israeli Companies Law, the board of directors of a public company
must appoint an internal auditor nominated by the audit committee. A person who
does not satisfy the Israeli Companies Law's independence requirements may not
be appointed as an internal auditor. The role of the internal auditor is to
examine, among other things, the compliance of the company's conduct with
applicable law and orderly business practice. Mr. Shaul Sofer, Certified Public
Accountant (Israel), serves as our internal auditor.
DIRECTORS' SERVICE CONTRACTS
We do not have any service contracts with our directors. There are no
arrangements or understandings between us and any of our subsidiaries, on the
one hand, and any of our directors, on the other hand, providing for benefits
upon termination of their employment or service as directors of our company or
any of our subsidiaries.
APPROVAL OF RELATED PARTY TRANSACTIONS UNDER ISRAELI LAW
The Israeli Companies Law codifies the fiduciary duties that "office
holders," including directors and executive officers, owe to a company. An
office holder's fiduciary duties consist of a duty of care and a duty of
loyalty. The duty of 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. The duty of loyalty includes avoiding any conflict of interest
between the office holder's position in the company and any other position or
his personal affairs, avoiding any competition with the company, avoiding
exploiting any business opportunity of the company in order to receive personal
gain for the office holder or others, and disclosing to the company any
information or documents relating to the company's affairs which the office
holder has received due to his position as an office holder. Each person listed
as a director or executive officer in the table under Item 6A. "Directors,
Senior Management and Employees -- Directors and Senior Management" is an office
holder.
Under the Israeli Companies Law, all arrangements as to compensation of
office holders who are not directors require approval of our board of directors,
and the compensation of office holders who are directors must be approved by our
audit committee, board of directors and shareholders, in that order.
43
The Israeli Companies Law requires that an office holder promptly disclose
any personal interest that he or she may have and all related material
information known to him or her, in connection with any existing or proposed
transaction by us. In addition, if the transaction is an extraordinary
transaction, that is, a transaction other than in the ordinary course of
business, other than on market terms, or likely to have a material impact on the
company's profitability, assets or liabilities, the office holder must also
disclose any personal interest held by the office holder's spouse, siblings,
parents, grandparents, descendants, spouse's descendants and the spouses of any
of the foregoing, or by any corporation in which the office holder or a relative
is a 5% or greater shareholder, director or general manager or in which he or
she has the right to appoint at least one director or the general manager. Some
transactions, actions and arrangements involving an office holder (or a third
party in which an office holder has an interest) must be approved by the board
of directors or as otherwise provided for in a company's articles of
association, as not being adverse to the company's interest. In some cases,
including in the case of an extraordinary transaction, such a transaction,
action and arrangement must be approved by the audit committee and by the board
of directors itself, and further shareholder approval is required to approve the
terms of compensation of an office holder who is a director. An office holder
who has a personal interest in a matter, which is considered at a meeting of the
board of directors or the audit committee, may not be present during the board
of directors or audit committee discussions and may not vote on this matter,
unless the majority of the members of the board or the audit committee have a
personal interest, as the case may be.
The Israeli Companies Law also provides that an extraordinary transaction
with a controlling shareholder or in which a controlling shareholder of the
company has a personal interest (including private offerings in which a
controlling shareholder has a personal interest) and a transaction with a
controlling shareholder or his relative regarding terms of service and
employment, must be approved by the audit committee, the board of directors and
shareholders. The shareholder approval for an extraordinary transaction must
include at least one-third of the shareholders who have no personal interest in
the transaction who voted on the matter. The transaction can be approved by
shareholders without this one-third approval, if the total shareholdings of
those shareholders who have no personal interest and voted against the
transaction do not represent more than one percent of the voting rights in the
company.
However, under the Companies Regulations (Relief from Related Party
Transactions), 5760-2000, promulgated under the Israeli Companies Law and
amended in January 2002, certain transactions between a company and its
controlling shareholder(s) and certain transaction with its director(s)
regarding terms of compensation do not require shareholder approval.
In addition, directors' compensation and employment arrangements do not
require the approval of the shareholders if both the audit committee and the
board of directors agree that such arrangements are for the benefit of the
company. If the director or the office holder is a controlling shareholder of
the company, then the employment and compensation arrangements of such director
or office holder do not require the approval of the shareholders provided that
certain criteria are met.
The above exemptions will not apply if one or more shareholders, holding at
least 1% of the issued and outstanding share capital of the company or of the
company's voting rights, objects to the grant of such relief, provided that such
objection is submitted to the company in writing not later than seven (7) days
from the date of the filing of a report regarding the adoption of such
resolution by the company pursuant to the requirements of the Israeli Securities
Law. If such objection is duly and timely submitted, then the compensation
arrangement of the directors will require shareholders' approval as detailed
above.
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 25% or greater shareholder of the
company. This rule does not apply if there is already another 25% or greater
shareholder of 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 hold greater than a
45% shareholder of the company, unless there is another shareholder holding more
than a 45% interest in the company. These requirements do not apply if, in
general, the acquisition (1) was made in a private placement that received
shareholder approval, (2) was from a 25% or greater shareholder of the company
which resulted in the acquiror becoming a 25% or greater shareholder of the
company, or (3) was from a shareholder holding more than a 45% interest in the
company which resulted in the acquiror becoming a holder of more than a 45%
interest in the company.
44
If, as a result of an acquisition of shares, the acquiror will hold more
than 90% of a company's outstanding shares, the acquisition must be made by
means of a tender offer for all of the outstanding shares. If less than 5% of
the outstanding shares are not tendered in the tender offer, all the shares that
the acquirer offered to purchase will be transferred to the acquirer. The
Israeli Companies Law provides for appraisal rights if any shareholder files a
request in court within three months following the consummation of a full tender
offer. If more than 5% of the outstanding shares are not tendered in the tender
offer, then the acquiror may not acquire shares in the tender offer that will
cause his shareholding to exceed 90% of the outstanding shares
Regulations under the Israeli Companies Law provide that the Israeli
Companies Law's tender offer rules do not apply to a company whose shares are
publicly traded outside of Israel, if pursuant to the applicable foreign
securities laws and stock exchange rules there is a restriction on the
acquisition of any level of control of the company, or if the acquisition of any
level of control of the company requires the purchaser to make a tender offer to
the public shareholders.
EXCULPATION, INDEMNIFICATION AND INSURANCE OF DIRECTORS AND OFFICERS
EXCULPATION OF OFFICE HOLDERS. The Israeli Companies Law provides that an
Israeli company cannot exculpate an office holder from liability with respect to
a breach of his or her duty of loyalty. If permitted by its articles of
association, a company may exculpate in advance an office holder from his or her
liability to the company, in whole or in part, with respect to a breach of his
or her duty of care. However, a company may not exculpate in advance a director
from his or her liability to the company with respect to a breach of his duty of
care in the event of distributions.
INSURANCE OF OFFICE HOLDERS. Israeli law provides that a company may, if
permitted by its articles of association, enter into a contract to insure its
office holders for liabilities incurred by the office holder with respect to an
act or omission performed in his or her capacity as an office holder, as a
result of: (i) a breach of the office holders duty of care to the company or
another person; (ii) a breach of office holders duty of loyalty to the company,
provided that the office holder acted in good faith and had reasonable cause to
assume that the act would not prejudice the company's interests; and (iii) a
financial liability imposed upon the office holder in favor of another person.
INDEMNIFICATION OF OFFICE HOLDERS. Under Israeli law a company may, if
permitted by its articles of association, indemnify an office holder for acts or
omissions performed by the office holder in such capacity for (a) monetary
liability imposed upon the office holder in favor of another person pursuant to
a court judgment, including a settlement or an arbitration award approved by a
court; (b) reasonable litigation expenses, including attorney's fees, actually
incurred by the office holder as a result of an investigation or proceeding
instituted against him or her by a competent authority, provided that such
investigation or proceeding concluded without the filing of an indictment
against the office holder or the imposition of any monetary liability in lieu of
criminal proceedings, or concluded without the filing of an indictment against
the office holder and a monetary liability was imposed on him or her in lieu of
criminal proceedings with respect to a criminal offense that does not require
proof of criminal intent; and (c) reasonable litigation expenses, including
attorneys' fees, actually incurred by the office holder or imposed upon the
office holder by a court: (i) in an action, suit or proceeding brought against
the office holder by or on behalf of the company or another person, (ii) in
connection with a criminal action in which the office holder was acquitted, or
(iii) in connection with a criminal action in which the office holder was
convicted of a crime that does not require proof of criminal intent.
Israeli law provides that a company's articles of association may permit
the company to (a) indemnify an office holder retroactively, following a
determination to this effect made by the company after the occurrence of the
event in respect of which the office holder will be indemnified; and (b)
undertake in advance to indemnify an office holder, except that with respect to
a moentary liability imposed on the office holder by any judgment, settlement or
court-approved arbitration award, the undertaking must be limited to types of
occurrences, which, in the opinion of the company's board of directors, are, at
the time of the undertaking, foreseeable due to the company's activities and to
an amount or standard that the board of directors has determined is reasonable
under the circumstances.
45
LIMITATIONS ON EXCULPATION, INSURANCE AND INDEMNIFICATION. These provisions
are specifically limited in their scope by Israeli law, which provides that a
company may not indemnify an office holder, nor exculpate an office holder, nor
enter into an insurance contract which would provide coverage for any monetary
liability, incurred as a result of certain improper actions.
The term "office holder" of a company includes a director, general manager,
chief business manager, deputy general manager, vice general manager, or any
person filling any of these positions in a company even if he or she holds a
different title, and also includes any other manager directly subordinate to the
general manager.
Pursuant to the Israeli Companies Law, exculpation of, procurement of
insurance coverage for, and an undertaking to indemnify or indemnification of,
our office holders must be approved by our audit committee and our board of
directors and, if the office holder is a director, also by our shareholders.
Our Articles of Association allow us to insure, indemnify and exempt our
office holders, to the fullest extent permitted by the provisions of the Israeli
Companies Law. We maintain a directors' and officers' liability insurance policy
with a per claim and aggregate coverage limit of $5 million, including legal
costs incurred in Israel. We have provided several of our directors and officers
a letter of indemnification for liabilities or expenses incurred as a result of
their acts in their capacity as directors and officers of our company, in an
aggregate amount not to exceed $3 million.
NASDAQ MARKETPLACE RULES AND HOME COUNTRY PRACTICES
Under NASDAQ Marketplace Rule 4350, or Rule 4350, foreign private issuers,
such as our company, are permitted to follow certain home country corporate
governance practices instead of certain provisions of Rule 4350. A foreign
private issuer that elects to follow a home country practice instead of any of
such provisions of Rule 4350, must submit to NASDAQ, in advance, a written
statement from an independent counsel in such issuer's home country certifying
that the issuer's practices are not prohibited by the home country's laws.
On June 21, 2005, we provided NASDAQ with a notice of non-compliance with
Rule 4350 with respect to the requirements regarding the directors' nominations
process. Instead, we follow Israeli law and practice in accordance with which
our directors are recommended by our board of directors for election by our
shareholders. See above in this Item 6C. "Directors, Senior Management and
Employees - Board Practices - Election of Directors."
D. EMPLOYEES
On December 31, 2006, we and our consolidated subsidiaries employed 104
persons, of which 37 persons were employed in research and development, 29 in
training and technical support, 20 in sales and marketing and 18 in operations
and administration. As of December 31, 2006, 60 of our employees were located in
Israel, 30 of our employees were located in the United States, 4 of our
employees were located in Hong Kong and 10 of our employees were located in
Brazil.
On December 31, 2005, we and our consolidated subsidiaries employed 124
persons, of which 58 persons were employed in research and development, 30 in
training and technical support, 18 in sales and marketing and 18 in operations
and administration. As of December 31, 2005, 85 of our employees were located in
Israel, 23 of our employees were located in the United States, 5 of our
employees were located in Hong Kong, 1 of our employees was located in Holland
and 10 of our employees were located in Brazil.
On December 31, 2004, we and our consolidated subsidiaries employed 153
persons, of which 47 persons were employed in research and development, 45 in
training and technical support, 35 in sales and marketing and 26 in operations
and administration. As of December 31, 2004, 86 of our employees were located in
Israel, 39 of our employees were located in the United States, 9 of our
employees were located in Hong Kong, 2 of our employees were located in Holland
and 17 of our employees were located in Brazil.
46
Certain provisions of the collective bargaining agreements between the
Histadrut (General Federation of Labor in Israel) and the Coordination Bureau of
Economic Organizations (including the Industrialists Association) are applicable
to our employees by order of the Israeli Ministry of Labor. These provisions
concern mainly the length of the workday, minimum daily wages for professional
workers, contributions to a pension fund, insurance for work-related accidents,
procedures for dismissing employees, determination of severance pay and other
conditions of employment. We generally provide our employees with benefits and
working conditions beyond the required minimums.
Cost of living adjustments of employees' wages are determined on a
nationwide basis and are legally binding. Under the current inflation rates,
these adjustments compensate employees for approximately 40% of the change in
the cost of living, with certain lag factors in implementation. Israeli
employers and employees are required to pay predetermined amounts to the
National Insurance Institute, which is similar to the United States Social
Security Administration. In 2006, payments to the National Insurance Institute
amounted to approximately 14.5% of wages, of which approximately two-thirds was
contributed by employees with the balance contributed by the employer.
Pursuant to Israeli law, we are legally required to pay severance benefits
upon certain circumstances, including the retirement or death of an employee or
the termination of employment of an employee without due cause. We partly
satisfy this obligation by contributing approximately 8.3% of between 80%-100%
of the employee's annual gross salary to a fund known as "Managers' Insurance"
or to pension fund. This fund provides a combination of savings plans, insurance
and severance pay benefits to the employee, giving the employee a lump sum
payment upon retirement and a severance payment, if legally entitled, upon
termination of employment. The remaining part of this obligation is presented in
our balance sheet as the difference between the "accrued severance pay" and
"severance pay fund."
E. SHARE OWNERSHIP
The following table sets forth certain information as of March 28, 2007
regarding the beneficial ownership of our ordinary shares by each of our
directors and executive officers.
Number of Percentage of
Ordinary Shares Outstanding
NAME Beneficially Owned(1) Ordinary Shares(2)
---- --------------------- ------------------
Chaim Mer 2,023,954 (3) 35.05%
Eytan Bar 227,725 (4) 3.80%
Shlomi Hagai 7,625 (4) *
Hanoch Magid 1,750 (4) *
Alon Aginsky 16,918 *
Isaac Ben-Bassat 689,214 (5) 11.94%
Dr. Orna Berry -- --
Dr. Yehoshua Gleitman -- --
Steven J. Glusband 11,000 (6) *
Yaacov Goldman -- --
----------
* Less than 1%.
(1) Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission and generally includes voting or
investment power with respect to securities. Ordinary shares relating
to options currently exercisable or exercisable within 60 days of the
date of this table are deemed outstanding for computing the percentage
of the person holding such securities but are not deemed outstanding
for computing the percentage of any other person. Except as indicated
by footnote, and subject to community property laws where applicable,
the persons named in the table above have sole voting and investment
power with respect to all shares shown as beneficially owned by them.
47
(2) The percentages shown are based on 5,773,845 ordinary shares
(excluding 10,800 ordinary shares held in treasury) issued and
outstanding as of March 28, 2007.
(3) Mr. Chaim Mer and his wife, Mrs. Dora Mer, are the holders of 267,821
ordinary shares, and are the beneficial owners of 1,744,453 ordinary
shares through their controlling interest in Mer Ofekim Ltd., 11,539
ordinary shares through their controlling interest in Mer Services
Ltd., 95 ordinary shares through their controlling interest in Mer &
Co. (1982) Ltd. and 46 ordinary shares through their controlling
interest in C. Mer Industries Ltd.
(4) Subject to currently exercisable stock options.
(5) Includes 630,045 ordinary shares held by Ron Dan Investments Ltd., a
corporation controlled by Mr. Ben-Bassat.
(6) Includes 10,000 ordinary shares subject to currently exercisable stock
options.
STOCK OPTION PLANS
1996 STOCK OPTION PLAN
Under our 1996 Stock Option Plan, as amended, or the 1996 Plan, options to
purchase up to 400,000 ordinary shares were issuable under options granted to
our employees, management, officers and directors or those of our subsidiaries.
Any options which are canceled or forfeited within the option period became
available for future grants. The 1996 Plan terminated on May 31, 2006.
The 1996 Plan provides that it is administered by the Board of Directors or
an Option Committee which may be appointed by the Board of Directors, which has
the authority, subject to applicable law, to determine the persons to whom
options will be granted, the number of ordinary shares to be covered by each
option the time or times at which options will be granted or exercised, and the
terms and conditions of the options. The exercise price of options granted under
the 1996 Plan may not be less than 100% of the fair market value of our ordinary
shares on the date of the grant of incentive stock options and 75% in the case
of options not designated as incentive stock options. Fair market value is the
mean between the highest and lowest quoted selling prices on the date of grant
of our shares traded on NASDAQ or a stock exchange on which such shares are
principally traded.
Options granted under the 1996 Plan are generally exercisable under such
circumstances as the Board or Option Committee determines. Such options are not
transferable by an optionee other than by will or by laws of descent and
distribution, and during an option holder's lifetime are exercisable only by
such option holder or by his or her legal representative. Options granted under
the 1996 Plan terminate at such time and under such circumstances as the Board
or Option Committee determines.
During 2006, options to purchase 15,000 ordinary shares were granted under
our 1996 Plan, with an average exercise price of $3.45, and no options were
exercised into ordinary shares. At December 31, 2006, options to purchase 62,400
ordinary shares were outstanding under the 1996 Plan, exercisable at an average
exercise price of $3.44 per share.
1996 SECTION 102 STOCK OPTION PLAN
In 1996, we adopted a Section 102 Stock Option Plan, as amended, or the
1996 102 Plan, providing for the grant of options to our Israeli employees,
management, officers and directors or those of our subsidiaries. The 1996 102
Plan was adopted pursuant to Section 102 of the Israeli Income Tax Ordinance
[New Version] - 1961, or Section 102, and provided recipients with tax
advantages under the Israeli Income Tax Ordinance. As of January 1, 2003,
Section 102 was amended, pursuant to which certain new tax advantages are
afforded with respect to option grants to employees and directors. In order to
enable employees and directors to benefit from such tax advantages with respect
to future grants of options and issuance of shares upon exercise thereof, such
grants have to be performed under a share option plan that is adjusted to the
amended Section 102, and therefore we adopted our 2003 Israeli Share Option
Plan. Upon the adoption of our 2003 Israeli Share Option Plan, we did not intend
to grant any more options under the 1996 102 Plan and the ordinary shares that
remained available for grant under the 1996 102 Plan were rolled-over into our
2003 Israeli Share Option Plan for issuance thereunder. The 1996 102 Plan
terminated on May 31, 2006.
48
Options granted under our 1996 102 Plan are exercisable under such
circumstances as the Board of Directors or Option Committee determined. Options
granted under the this plan are not transferable by an optionee other than by
will or by laws of descent and distribution, and during an option holder's
lifetime will be exercisable only by such option holder or by his or her legal
representative.
During 2006, no options were granted under the 1996 102 Plan and options to
purchase 30,000 ordinary shares were exercised. At December 31, 2006, no options
were outstanding under the 1996 102 Plan.
2003 ISRAELI SHARE OPTION PLAN
Under our 2003 Israeli Share Option Plan, or the 2003 Plan, options to
purchase up to 893,915 ordinary shares may be granted to directors, employees,
consultants, advisors, service providers, controlling shareholders and other
persons not employed by us or by our affiliates. Any options which are canceled
or forfeited within the option period will become available for future grants.
The 2003 Plan will terminate in 2013, unless earlier terminated by the Board of
Directors.
Options to Israeli employees, directors and officers, other than
controlling shareholders (as such term is defined in the Israeli Income Tax
Ordinance), under the 2003 Plan may only be granted under Section 102. Under
amended Section 102, options granted pursuant to Section 102 may be designated
as "Approved 102 Options" or "Unapproved 102 Options." An Approved 102 Option
may either be classified as a capital gains option or an ordinary income option.
We elected to initially grant our options pursuant to Section 102 as capitals
gain options. Such election is effective as of the first date of grant of such
capital gains options under the 2003 Plan and shall remain in effect at least
until the lapse of one year following the end of the tax year during which we
first granted capital gains options. All Approved 102 Options (or the ordinary
shares issued upon exercise thereof) must be held in trust by a trustee for the
requisite holding period under Section 102 in order to benefit from the certain
tax advantages. We may also grant Unapproved 102 Options, which do not have any
tax benefit and are not held by a trustee. Options granted under Section 102 are
taxed on the date of sale of the exercised ordinary shares and/or the date of
the release of the options or such exercised ordinary shares from the trust.
The 2003 Plan is administered by the Board of Directors or a committee of
the Board of Directors, if appointed, which has the authority, subject to
applicable law, to determine, the persons to whom options will be granted, the
terms and conditions of the respective options, including the time and the
extent to which the options may be exercised, may designate the type of options,
make an election as to the type of Approved 102 Option. The exercise price of
options granted under the 2003 Plan will be based on the fair market value of
our ordinary shares and are determined by the Board of Directors or the
committee at the time of the grant.
Options granted under the 2003 Plan are not assignable or transferable by
an optionee, other than by will or by laws of descent and distribution, and
during the lifetime of an optionee may be exercised only by the optionee or by
the optionee's legal representative. Such options may be exercised as long as
the optionee is employed by, or providing services to us or any of our
affiliates, to the extent the options have vested.
During 2006, options to purchase an aggregate of 45,000 ordinary shares
were granted under the 2003 Plan at an average exercise price of $3.33 per share
and options to purchase 10,341 ordinary shares were exercised. At December 31,
2006, options to purchase 608,000 ordinary shares were outstanding under the
2003 Plan, exercisable at an average exercise price of $2.66 per share.
49
2006 STOCK OPTION PLAN
In June 2006, we adopted our 2006 Stock Option Plan, or the 2006 Plan,
under which up to 400,000 ordinary shares may be issued (subject to standard
adjustments) to employees, officers and non-employee directors of ours and our
affiliates. Ordinary shares as to which an option granted under the 2006 Plan
has not been exercised at the time of its expiration, cancellation or forfeiture
may again be subject to new awards under the 2006 Plan. The total number of
ordinary shares with respect to which options may be granted to any eligible
employee during any period of 12 consecutive months may not exceed 100,000
ordinary shares (subject to adjustment as provided in the 2006 Plan).
The 2006 Plan will be administered by our Board of Directors or to the
extent permitted by Israeli law, a Compensation Committee of our Board of
directors, if established by our Board of Directors at its discretion. All
references below to the "Committee" refers to the Board of Directors or
compensation committee established by our Board of Directors, as applicable. The
Committee will have the authority, in its discretion, to establish from time to
time guidelines or regulations for the administration of the 2006 Plan, to
interpret the 2006 Plan, and to make all determinations it considers necessary
or advisable for the administration of the 2006 Plan, in addition to the other
responsibilities and powers assigned to the Committee in the 2006 Plan. All
decisions, actions or interpretations of the Committee under the 2006 Plan will
be final, conclusive and binding upon all parties.
Each option granted under the 2006 Plan will be either an option intended
to be treated as an "incentive stock option," within the meaning of Section 422
of the Internal Revenue Code of 1986, as amended, or the Code, or an option that
will be treated as a "non-qualified stock option." No incentive stock may be
granted to any individual who is not an eligible employee of our company or a
"subsidiary" within the meaning of the Code. No incentive stock option may be
granted to an employee if, as of the date of grant of such option, such employee
owns stock possessing more than ten percent of the total combined voting power
of all classes of stock of our company or any affiliated company, a "10%
Holder," unless (a) the exercise price per share under such option is at least
110% of the fair market value of an ordinary share determined as of the date of
grant of such option, and (b) such option is not exercisable after the
expiration of five years from the date of grant of such option. No incentive
stock option may be granted under the 2006 Plan after the ten year anniversary
of its adoption.
In no event may the term of any option exceed ten years from the date of
grant of the option. However, in no event may the term of any option granted to
a 10% Holder exceed five years from the date of grant of the option. No Option
may be exercised after its expiration.
Each option granted under the 2006 Plan will become exercisable, in whole
or in part, at such time or times during its term as the instrument evidencing
the grant of such option may specify.
The price at which ordinary shares may be purchased upon any exercise of an
option granted under the 2006 Plan will be the price per share determined by the
Committee, and specified in the instrument evidencing the grant of such option,
but in no event may the exercise price per share be less than (i) the fair
market value of an ordinary share determined as of the date of grant of the
option, or (ii), if greater, the par value of an ordinary share. However, with
respect to an option granted to a 10% Holder, in no event may the exercise price
per share be less than 110% of the fair market value of our ordinary shares
determined as of the date of grant of such option.
Options granted under the 2006 Plan will be nontransferable, other than by
will or the laws of descent and distribution, and may be exercised during the
grantee's lifetime only by the grantee. However, if the instrument evidencing
the grant of an option other than an incentive stock option so provides, the
grantee may transfer his or her rights with respect to such option or any
portion thereof, without consideration, to any "family member," as such term is
defined in the 2006 Plan.
The terms and conditions of an option grant may not be waived or amended
without the consent of the grantee if it would adversely affect, to any material
extent, any of the rights or obligations of the grantee with respect to such
grant, or in the case of any option that was intended to constitute an incentive
stock option, if such waiver or amendment would cause such option to fail to be
treated as an incentive stock option.
50
Our Board of Directors may, with prospective or retroactive effect, amend,
suspend or terminate the 2006 Plan or any portion of the 2006 Plan at any time.
However, no amendment, suspension or termination of the 2006 Plan may adversely
affect the rights of any grantee with respect to any options previously granted
to the grantee without his or her written consent. Also, no amendment which
constitutes a "material revision" of the 2006 Plan, as the term material
revision is defined in the applicable rules of the National Association of
Securities Dealers, may be effective unless approved by our shareholders in the
manner required by such rules and by applicable law.
During 2006, no options were granted under the 2006 Plan and no options
were outstanding under the 2006 Plan.
WARRANTS
On August 3, 2005, we issued a warrant to purchase 37,000 ordinary shares
to Mr. Avraham Ziv in connection with financial services that he provided to our
company. The warrant has an exercise price of $4.00 per share, subject to
anti-dilution adjustments, and is exercisable from February 3, 2006 until August
3, 2009. Mr. Ziv has provided financial services to us from to time during the
last five years.
In connection with our August 2005 private placement to institutional and
private investors, we issued to the investors warrants to purchase an aggregate
375,000 ordinary shares at an exercise price of $4.00 per share (subject to
anti-dilution adjustments), exercisable from February 10, 2006 until August 10,
2009.
On December 7, 2005, we issued a one-year warrant to purchase 100,000
ordinary shares to one of our consultants in connection with certain business
development services performed on our behalf. The warrant, which had an exercise
price of $3.12 per share (subject to anti-dilution adjustments), expired on
December 7, 2006.
ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS
A. MAJOR SHAREHOLDERS
The following table sets forth certain information as of March 28, 2007
regarding the beneficial ownership by all shareholders known to us to own
beneficially 5.0% or more of our ordinary shares:
Number of Percentage of
Ordinary Shares Outstanding
NAME Beneficially Owned(1) Ordinary Shares(2)
---- --------------------- ------------------
Chaim Mer and Dora Mer 2,023,954(3) 35.05%
Isaac Ben-Bassat 689,214(4) 11.94%
----------
(1) Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission and generally includes voting or
investment power with respect to securities. Ordinary shares relating to
options currently exercisable or exercisable within 60 days of the date of
this table are deemed outstanding for computing the percentage of the
person holding such securities but are not deemed outstanding for computing
the percentage of any other person. Except as indicated by footnote, and
subject to community property laws where applicable, the persons named in
the table above have sole voting and investment power with respect to all
shares shown as beneficially owned by them.
(2) The percentages shown are based on 5,773,845 ordinary shares (excluding
10,800 ordinary shares held in treasury) issued and outstanding as of March
28, 2007.
(3) Mr. Chaim Mer and his wife, Mrs. Dora Mer, are the holders of 267,821
ordinary shares, and are the beneficial owners of 1,744,453 ordinary shares
through their controlling interest in Mer Ofekim Ltd., 11,539 ordinary
shares through their controlling interest in Mer Services Ltd., 95 ordinary
shares through their controlling interest in Mer & Co. (1982) Ltd. and 46
ordinary shares through their controlling interest in C. Mer Industries
Ltd.
51
(4) Includes 630,045 ordinary shares held by Ron Dan Investments Ltd., a
corporation controlled by Mr. Ben-Bassat.
MAJOR SHAREHOLDERS VOTING RIGHTS
Our major shareholders do not have different voting rights
RECORD HOLDERS
Based on a review of the information provided to us by our transfer agent,
as of March 28, 2007, there were 42 holders of record of our ordinary shares, of
which six record holders holding approximately 58.35% of our ordinary shares had
registered addresses in the United States and 36 record holders holding
approximately 41.65% of our ordinary shares had registered addresses in Israel.
These numbers are not representative of the number of beneficial holders of our
shares nor are they representative of where such beneficial holders reside,
since many of these ordinary shares were held of record by brokers or other
nominees (including one U.S. nominee company, CEDE & Co., which held
approximately 41.63% of our otstanding ordinary shares as of such date).
B. RELATED PARTY TRANSACTIONS
Ms. Dora Mer, the wife of Chaim Mer, provides legal services to us and
receives a monthly retainer of $5,000. The conditions of retaining the services
of Ms. Mer were approved by our Board of Directors and Audit Committee.
Our subsidiaries, MTS Asia Ltd. and MTS IntegraTRAK, entered into an
agreement with C. Mer Industries Ltd., or C. Mer, pursuant to which they
distribute and support certain of C. Mer's products and provide certain services
on behalf of C. Mer. Generally, C. Mer compensates MTS Asia Ltd. for these
activities at cost plus 10% and compensates MTS IntegraTRAK at cost plus 5%. C.
Mer is a publicly traded company controlled by Mr. Chaim Mer, and Mr. Mer has
been the Chairman of its Board of Directors since 1988 and served as its
President and Chief Executive Officer from 1988 until January 2005.
Presently, the only service provided to us by C. Mer is our participation
in its umbrella liability insurance coverage. We believe that the terms under
which C. Mer provides such participation to us is on a basis no less favorable
than could be obtained from an unaffiliated third party.
On August 10, 2005, we entered into definitive agreements with
institutional and private investors, including our President, Mr. Eytan Bar, for
a private placement of ordinary shares and warrants to purchase ordinary shares
that raised $2.8 million. Pursuant to the agreements, the investors, other than
our President, Mr. Eytan Bar, paid $3.00 per share for the aggregate 937,500
ordinary shares issued in the private placement. Mr. Bar purchased 14,000 shares
at $3.88 per share, the closing price of our ordinary shares on the day prior to
the closing of the private placement. The private placement also involved the
acquisition by the investors of warrants to purchase an aggregate 375,000
additional ordinary shares at an exercise price of $4.00 per share (subject to
anti-dilution adjustments), exercisable from February 10, 2006 until August 10,
2009. Each investor, including Mr. Eytan Bar, received warrants to purchase two
ordinary shares for each five ordinary shares purchased.
Mr. Chaim Mer, the Chairman of our Board of Directors, devotes
approximately 20% of his time to the management of our company in consideration
of which we pay him a monthly salary of $7,000 per month (as approved by our
Audit Committee and Board of Directors on November 8, 1999). Mr. Isaac
Ben-Bassat, a director and one of our major shareholders, receives an annual fee
of approximately $8,400 and a per meeting attendance fee of $300 in connection
with his service as a director of our company. See Item. 6B. "Directors and
Senior Management - Compensation."
52
C. INTERESTS OF EXPERTS AND COUNSEL
Not applicable.
ITEM 8. FINANCIAL INFORMATION
A. CONSOLIDATED STATEMENTS AND OTHER FINANCIAL INFORMATION
FINANCIAL STATEMENTS
See the consolidated financial statements, including the notes thereto, and
the exhibits listed in Item 19 hereof and incorporated herein by this reference.
EXPORT SALES
See Note 17 of our Consolidated Financial Statements.
LEGAL PROCEEDINGS
On April 18, 2005, Amdocs (Israel) Ltd. and Amdocs Ltd. filed a complaint
in the Tel Aviv District Court naming our company, our chief executive officer
and others as defendants (Civil File No. 32419-05/05). The complaint alleges,
among other things, that professional and commercial information belonging to
the plaintiffs was transferred to the defendants for use in our company's
activity. The plaintiffs are seeking an injunction prohibiting the defendants
from making any use of the information and trade secrets that were allegedly
transferred, and mandatory injunctions requiring the return of any such
information and the payment of estimated damages of NIS 14,775,000
(approximately US$3.5 million). On June 27, 2005, we and the other defendants
filed a statement of defense, claiming that the factual and legal allegations
made by the plaintiffs have no basis and the causes of action and relief
requested are without merit. On March 22, 2007, the complaint was dismissed
without prejudice by mutual agreement and following a settlement between all
parties to the complaint and with no payment by any of the litigants.
In April 2000, the tax authorities in Israel issued to us a demand for a
tax payment in the amount of approximately NIS 6.0 million (approximately $1.4
million) for the 1997-1999 period. We have appealed to the Israeli district
court in respect of this tax demand. We believe that certain defenses can be
raised against the demand of the tax authorities. We have made a provision in
our financial statements for this tax demand for the amount deemed probable,
based on the current evidence, which we believe is adequate. We believe that the
outcome of this matter will not have a material adverse effect on our financial
position or results of operations.
On November 22, 2005, we received a letter from one of our customer's legal
counsel alleging, among other things, that we materially breached an agreement
relating to our billing solutions that we entered into with the customer on
March 9, 2005, as subsequently amended on June 6, 2005. The customer is seeking
full repayment of the amounts that were paid by him under the agreement in the
amount of approximately $100,000, plus interest and indemnification for damages
that he claims to have suffered as a result of our alleged breach. We and the
customer have since exchanged correspondence. We cannot currently assess the
outcome or possible adverse effect on our financial position or results of
operations.
On February 21, 2007, one of our suppliers filed a complaint in the
Kfar-Saba Magistrate Court against us, under which he seeks the payment of NIS
179,000 (approximately $42,000) for electronic components that were ordered by
us for a third party, which is the customer referred to in the foregoing
paragraph. On March 13, 2007, we filed a statement of defense. We have made a
provision in our financial statements for the claimed amount. Due to the
preliminary stage of this litigation, we and our legal advisors cannot currently
assess the outcome or possible adverse effect on our financial position or
results of operations.
53
On July 24, 2006, a claim was filed in the Tel-Aviv Superior Court against
our company and Tim Computers and Systems Ltd, or TIM, for an order of
inspection and monetary relief in the total amount of NIS 312,933 ($74,000), of
which NIS 112,933 ($27,000) is demanded from our company and NIS 200,000
($47,000) is demanded from TIM. The plaintiff is a former minority shareholder
of a company in which we were the major shareholder. The claim relates to the
rights to proceeds received under a software development project in which TIM
and our company participated and in which the plaintiff was involved. A
preliminary hearing was held on Jan. 15, 2007. Due to the preliminary stage of
this litigation, we and our legal advisors cannot currently assess the outcome
or possible adverse effect on our financial position or results of operations.
On March 15, 2007, we received a letter from one of our customer's legal
counsel alleging, among other things, that we materially breached an agreement
relating to our billing solutions that we entered into with the customer on
March 30, 2006. The customer is seeking full repayment of the amounts that were
paid by him under the agreement in the amount of approximately $141,000, plus
liquidated damages as provided in the agreement. We believe that the agreement
cancellation was unfounded and intend to vigorously pursue our rights under the
contract. Due to the preliminary stage of this matter, we and our legal advisors
cannot currently assess the outcome or possible adverse effect on our financial
position or results of operations.
Other than the above, we are not involved in any legal proceedings nor are
we subject to any threatened litigation that are material to our business or
financial condition.
DIVIDEND DISTRIBUTION POLICY
We have never paid cash dividends to our shareholders. We intend to retain
future earnings for use in our business and do not anticipate paying cash
dividends on our ordinary shares in the foreseeable future. Any future dividend
policy will be determined by our Board of Directors and will be based upon
conditions then existing, including our results of operations, financial
condition, current and anticipated cash needs, contractual restrictions and
other conditions as the Board of Directors may deem relevant.
According to the Israeli Companies Law, a company may distribute dividends
out of its profits (as such term is defined in the Israeli Companies Law),
provided that there is no reasonable concern that payment of the dividend will
prevent the company from satisfying all its current and foreseeable obligations,
as they become due. Notwithstanding the foregoing, dividends may be paid with
the approval of a court, at the company's request, provided that there is no
reasonable concern that payment of the dividend will prevent the company from
satisfying its current and foreseeable obligations, as they become due. In the
event cash dividends are declared, such dividends will be paid in NIS.
B. SIGNIFICANT CHANGES
Except as otherwise disclosed in this annual report, no significant change
has occurred since December 31, 2006.
ITEM 9. THE OFFER AND LISTING
A. OFFER AND LISTING DETAILS
ANNUAL STOCK INFORMATION
The following table sets forth, for each of the years indicated, the range
of high ask and low bid prices of our ordinary shares on the NASDAQ Capital
Market.
YEAR HIGH LOW
---- ---- ---
2006 $3.50 $1.50
2005 $4.23 $3.01
2004 $4.00 $1.90
2003 $3.56 $0.87
2002 $1.65 $0.75
QUARTERLY STOCK INFORMATION
The following table sets forth, for each of the full financial quarters in
the years indicated, the range of high ask and low bid prices of our ordinary
shares on the NASDAQ Capital Market.
54
HIGH LOW
---- ---
2005
First Quarter $4.00 $3.15
Second Quarter $3.83 $3.10
Third Quarter $4.23 $3.01
Fourth Quarter $3.98 $3.05
2006
First Quarter $3.50 $2.94
Second Quarter $3.34 $2.32
Third Quarter $2.85 $2.01
Fourth Quarter $2.49 $1.50
MONTHLY STOCK INFORMATION
The following table sets forth, for each of the most recent six months, the
range of high ask and low bid prices of our ordinary shares on the NASDAQ
Capital Market.
MONTH HIGH LOW
----- ---- ---
October 2006 $2.49 $2.01
November 2006 $2.26 $1.70
December 2006 $1.97 $1.50
January 2007 $1.92 $1.53
February 2007 $1.77 $1.60
March 2007 (until 28) $1.73 $1.60
B. PLAN OF DISTRIBUTION
Not applicable.
C. MARKETS
Our ordinary shares were listed on the NASDAQ National Market in connection
with our initial public offering on May 21, 1997. On December 23, 1998, the
listing of our ordinary shares was transferred to the NASDAQ Capital Market
(symbol: MTSL).
D. SELLING SHAREHOLDERS
Not applicable.
E. DILUTION
Not applicable.
F. EXPENSE OF THE ISSUE
Not applicable.
ITEM 10. ADDITIONAL INFORMATION
A. SHARE CAPITAL
Not applicable.
55
B. MEMORANDUM AND ARTICLES OF ASSOCIATION
SET OUT BELOW IS A DESCRIPTION OF CERTAIN PROVISIONS OF OUR ARTICLES OF
ASSOCIATION AND OF THE ISRAELI COMPANIES LAW RELATED TO SUCH PROVISIONS. THIS
DESCRIPTION IS ONLY A SUMMARY AND DOES NOT PURPORT TO BE COMPLETE AND IS
QUALIFIED BY REFERENCE TO THE FULL TEXT OF THE ARTICLES OF ASSOCIATION, WHICH
ARE INCORPORATED BY REFERENCE AS EXHIBITS TO THIS ANNUAL REPORT, AND TO ISRAELI
LAW.
PURPOSES AND OBJECTS OF THE COMPANY
We are a public company registered under the Israel Companies Law,
1999-5759, or the Israeli Companies Law, as MER Telemanagement Solutions Ltd.,
registration number 520042904. Our objects and purposes, as provided by our
Articles of Association, are to carry on any lawful activity.
On February 1, 2000, the Israeli Companies Law came into effect and
superseded most of the provisions of the Israeli Companies Ordinance (New
Version), 5743-1983, except for certain provisions which relate to bankruptcy,
dissolution and liquidation of companies. Under the Israeli Companies Law,
various provisions, some of which are detailed below, overrule the current
provisions of our Articles of Association.
THE POWERS OF THE DIRECTORS
Under the provisions of the Israeli Companies Law and our Articles of
Association, a director cannot participate in a meeting nor vote on a proposal,
arrangement or contract in which he or she is materially interested. In
addition, our directors cannot vote compensation to themselves or any members of
their body without the approval of our audit committee and our shareholders at a
general meeting. See Item 6C. "Directors, Senior Management and Employees -
Board Practices - Approval of Related Party Transactions Under Israeli Law."
The authority of our directors to enter into borrowing arrangements on our
behalf is not limited, except in the same manner as any other transaction by us.
Under our articles of association, retirement of directors from office is
not subject to any age limitation and our directors are not required to own
shares in our company in order to qualify to serve as directors.
RIGHTS ATTACHED TO SHARES
Our authorized share capital consists of 12,000,000 ordinary shares of a
nominal value of NIS 0.01 each. All outstanding ordinary shares are validly
issued, fully paid and non-assessable.
The rights attached to the ordinary shares are as follows:
DIVIDEND RIGHTS. Holders of our ordinary shares are entitled to the full
amount of any cash or share dividend subsequently declared. The board of
directors may declare interim dividends and propose the final dividend with
respect to any fiscal year only out of the retained earnings, in accordance with
the provisions of the Israeli Companies Law. Our Articles of Association provide
that the declaration of a dividend requires approval by an ordinary resolution
of the shareholders, which may decrease but not increase the amount proposed by
the board of directors. See Item 8A. "Financial Information - Consolidated and
Other Financial Information - Dividend Distribution Policy." If after one year a
dividend has been declared and it is still unclaimed, the board of directors is
entitled to invest or utilize the unclaimed amount of dividend in any manner to
our benefit until it is claimed. We are not obligated to pay interest or linkage
differentials on an unclaimed dividend.
VOTING RIGHTS. Holders of ordinary shares have one vote for each ordinary
share held on all matters submitted to a vote of shareholders. Such voting
rights may be affected by the grant of any special voting rights to the holders
of a class of shares with preferential rights that may be authorized in the
future.
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The quorum required for an ordinary meeting of shareholders consists of at
least two shareholders present in person or represented by proxy who hold or
represent, in the aggregate, at least one third of the voting rights of the
issued share capital. A meeting adjourned for lack of a quorum generally is
adjourned to the same day in the following week at the same time and place or
any time and place as the directors designate in a notice to the shareholders.
At the reconvened meeting, the required quorum consists of any two members
present in person or by proxy.
An ordinary resolution, such as a resolution for the declaration of
dividends, requires approval by the holders of a majority of the voting rights
represented at the meeting, in person, by proxy or by written ballot, and voting
thereon. Under our Articles of Association, a special resolution, such as
amending our memorandum of association or articles of association, approving any
change in capitalization, winding-up, authorization of a class of shares with
special rights, or other changes as specified in our Articles of Association,
requires approval of a special majority, representing the holders of no less
than 65% of the voting rights represented at the meeting in person, by proxy or
by written ballot, and voting thereon.
Pursuant to our articles of association, our directors (other than outside
directors) are elected at our annual general meeting of shareholders by a vote
of the holders of a majority of the voting power represented and voting at such
meeting and hold office until the next annual general meeting of shareholders
and until their successors have been elected. All the members of our Board of
Directors (except the outside directors) may be reelected upon completion of
their term of office. For information regarding the election of outside
directors, see Item 6C. "Directors, Senior Management and Employees - Board
Practices - Election of Directors."
RIGHTS TO SHARE IN OUR COMPANY'S PROFITS. Our shareholders have the right
to share in our profits distributed as a dividend and any other permitted
distribution. See this Item 10B. "Additional Information - Memorandum and
Articles of Association - Rights Attached to Shares - Dividend Rights."
RIGHTS TO SHARE IN SURPLUS IN THE EVENT OF LIQUIDATION. In the event of our
liquidation, after satisfaction of liabilities to creditors, our assets will be
distributed to the holders of ordinary shares in proportion to the nominal value
of their holdings. This right may be affected by the grant of preferential
dividend or distribution rights to the holders of a class of shares with
preferential rights that may be authorized in the future.
LIABILITY TO CAPITAL CALLS BY OUR COMPANY. Under our memorandum of
association and the Israeli Companies Law, the liability of our shareholders is
limited to the par value of the shares held by them.
LIMITATIONS ON ANY EXISTING OR PROSPECTIVE MAJOR SHAREHOLDER. See Item 6C.
"Directors and Senior Management -Board Practices - Approval of Related Party
Transactions Under Israeli Law."
CHANGING RIGHTS ATTACHED TO SHARES
According to our Articles of Association, in order to change the rights
attached to any class of shares, unless otherwise provided by the terms of the
class, such change must be adopted by a general meeting of the shareholders and
by a separate general meeting of the holders of the affected class with a
majority of 75% of the voting power participating in such meeting.
ANNUAL AND EXTRAORDINARY MEETINGS
Under the Israeli Companies Law a company must convene an annual meeting of
shareholders at least once every calendar year and within fifteen months of the
last annual meeting. Depending on the matter to be voted upon, notice of at
least 21 days or 35 days prior to the date of the meeting is required. Our board
of directors may, in its discretion, convene additional meetings as "special
general meetings." With respect to "special general meetings notice of at least
35 days prior to the date of the meeting is required. In addition, the board
must convene a special general meeting upon the demand of two of the directors,
25% of the nominated directors, one or more shareholders having at least 5% of
the outstanding share capital and at least 1% of the voting power in the
company, or one or more shareholders having at least 5% of the voting power in
the company. See Item 10B. "Additional Information - Memorandum and Articles of
Association - Rights Attached to Shares - Voting Rights."
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LIMITATIONS ON THE RIGHTS TO OWN SECURITIES IN OUR COMPANY
Neither our memorandum of association or our articles of association nor
the laws of the State of Israel restrict in any way the ownership or voting of
shares by non-residents, except with respect to subjects of countries, which are
in a state of war with Israel.
PROVISIONS RESTRICTING CHANGE IN CONTROL OF OUR COMPANY
The Israeli Companies Law requires that mergers between Israeli companies
be approved by the board of directors and general meeting of shareholders of
both parties to the transaction. The approval of the board of directors of both
companies is subject to such boards' confirmation that there is no reasonable
doubt that after the merger the surviving company will be able to fulfill its
obligations towards its creditors. Each company must notify its creditors about
the contemplated merger. Under our articles of association, such merger must be
approved by a resolution of the shareholders, as explained above. The approval
of the merger by the general meetings of shareholders of the companies is also
subject to additional approval requirements as specified in the Israeli
Companies Law and regulations promulgated thereunder. See also Item 6C.
"Directors, Senior Management and Employees - Board Practices - Approval of
Related Party Transactions Under Israeli Law."
DISCLOSURE OF SHAREHOLDERS OWNERSHIP
The Israeli Securities Law and regulations promulgated thereunder do not
require a company whose shares are publicly traded solely on a stock exchange
outside of Israel, as in the case of our company, to disclose its share
ownership.
CHANGES IN OUR CAPITAL
Changes in our capital are subject to the approval of the shareholders at a
general meeting by a special majority of 65% of the votes of shareholders
participating and voting in the general meeting.
C. MATERIAL CONTRACTS
On August 10, 2005, we entered into definitive agreements with
institutional and private investors, including our President, Mr. Eytan Bar, for
a private placement of ordinary shares and warrants to purchase ordinary shares
that raised $2.8 million. Pursuant to the agreements, the investors, other than
Mr. Bar, paid $3.00 per share for the aggregate 923,500 ordinary shares issued
in the private placement. Mr. Bar purchased 14,000 shares at $3.88 per share,
the closing price of our ordinary shares on the day prior to the closing of the
private placement. The private placement also involved the acquisition by the
investors of warrants to purchase an aggregate 375,000 additional ordinary
shares at an exercise price of $4.00 per share (subject to anti-dilution
adjustments), exercisable from February 10, 2006 until August 10, 2009. Each
investor, including Mr. Eytan Bar, received warrants to purchase two ordinary
shares for each five ordinary shares purchased. To date, no warrants have been
exercised.
On July 31, 2006, we completed the acquisition of certain assets and
liabilities of TelSoft, a California-based provider of call accounting and TEM
solutions. TelSoft products offer a complementary solution to our products. In
connection with the acquisition, we paid an initial consideration of $1.1
million and agreed to pay additional contingent consideration based on post
acquisition revenue performance during the 12 month period following the
acquisition.
D. EXCHANGE CONTROLS
Israeli law and regulations do not impose any material foreign exchange
restrictions on non-Israeli holders of our ordinary shares. In May 1998, a new
"general permit" was issued under the Israeli Currency Control Law, 1978, which
removed most of the restrictions that previously existed under such law, and
enabled Israeli citizens to freely invest outside of Israel and freely convert
Israeli currency into non-Israeli currencies.
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Non-residents of Israel who purchase our ordinary shares will be able to
convert dividends, if any, thereon, and any amounts payable upon our
dissolution, liquidation or winding up, as well as the proceeds of any sale in
Israel of our ordinary shares to an Israeli resident, into freely repatriable
dollars, at the exchange rate prevailing at the time of conversion, provided
that the Israeli income tax has been withheld (or paid) with respect to such
amounts or an exemption has been obtained.
E. TAXATION
The following is a discussion of Israeli and United States tax consequences
material to our shareholders. To the extent that the discussion is based on new
tax legislation which has not been subject to judicial or administrative
interpretation, the views expressed in the discussion might not be accepted by
the tax authorities in question. The discussion is not intended, and should not
be construed, as legal or professional tax advice and does not exhaust all
possible tax considerations.
HOLDERS OF OUR ORDINARY SHARES SHOULD CONSULT THEIR OWN TAX ADVISORS AS TO
THE UNITED STATES, ISRAELI OR OTHER TAX CONSEQUENCES OF THE PURCHASE, OWNERSHIP
AND DISPOSITION OF ORDINARY SHARES, INCLUDING, IN PARTICULAR, THE EFFECT OF ANY
FOREIGN, STATE OR LOCAL TAXES.
ISRAELI TAX CONSIDERATIONS
The following is a summary of the current tax structure applicable to
companies in Israel, with special reference to its effect on us. The following
also contains a discussion of the material Israeli tax consequences to
purchasers of our ordinary shares and Israeli government programs benefiting us.
This summary does not discuss all the aspects of Israeli tax law that may be
relevant to a particular investor in light of his or her personal investment
circumstances or to some types of investors subject to special treatment under
Israeli law.
GENERAL CORPORATE TAX STRUCTURE
Israeli companies are generally subject to income tax on their taxable
income. The applicable rate for 2006 was 31%, which was reduced to 29% in 2007,
and will be further reduced to 27% in 2008, 26% in 2009 and 25% in 2010 and
thereafter. However, the effective tax rate payable by a company, which derives
income from an approved enterprise (as further discussed below), may be
considerably less.
CONTROLLED FOREIGN COMPANIES
Under the controlled foreign companies rules an Israeli company may become
subject to Israeli taxes (as deemed dividends) on non-distributed profits 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)
and if the taxes imposed outside of Israel are no more than 20% of the profits.
TAX BENEFITS UNDER THE LAW FOR THE ENCOURAGEMENT OF CAPITAL INVESTMENTS, 1959
The Law for the Encouragement of Capital Investments, 1959, commonly
referred to as the Investment Law, provides that a proposed capital investment
in eligible facilities may, upon application to the Investment Center of the
Ministry of Industry, Trade and Labor 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. An approved
enterprise is entitled to benefits including Israeli Government cash grants and
tax benefits in specified development areas. 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 is approved, its effective tax rate is the
result of a weighted average of the applicable rates.
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Taxable income of a company derived from an approved enterprise is subject
to corporate tax at the maximum rate of 25% (rather than the regular corporate
tax rate) for the benefit period. This period is ordinarily seven years (or ten
years if the company qualifies as a foreign investors' company as described
below) commencing with the year in which the approved enterprise first generates
taxable income, and is limited to twelve years from commencement of production
or 14 years from the date of approval, whichever is earlier. Tax benefits under
the Investments Law also apply to income generated from the grant of a usage
right with respect to know-how developed by the approved enterprise, income
generated from royalties, and income derived from a service which is auxiliary
to such usage right or royalties, provided that such income is generated within
the approved enterprise's ordinary course of business. The Investment Law also
provides that a company that has an approved enterprise within Israel will be
eligible for a reduced tax rate and is entitled to claim accelerated
depreciation on buildings, machinery and equipment used by the approved
enterprise during the first five years of use.
A company owning an approved enterprise may elect to forego entitlement to
the grants otherwise available under the Investment Law and in lieu thereof
participate in an alternative track of benefits. Under the alternative track of
benefits, a company's undistributed income derived from an approved enterprise
will be exempt from company tax for a period of two years from the first year of
taxable income and such company will be eligible for a reduced tax rate for the
remainder, if any, of the otherwise applicable benefits period.
A company that has an approved enterprise program is eligible for further
tax benefits if it qualifies as a foreign investors' company. A foreign
investors' company is a company that more than 25% of its share capital and
combined share and loan capital is owned by non-Israeli residents. A company,
which qualifies as a foreign investors' company and has an approved enterprise
program is eligible for tax benefits for a ten-year benefit period. The company
tax rate applicable to income from the approved enterprise earned in the benefit
period (distributed or not) is as follows:
The company
For a company with foreign investment of tax rate is
---------------------------------------- -----------
over 25% but less than 49% 25%
49% or more but less than 74% 20%
74% or more but less than 90% 15%
90% or more 10%
In addition, the dividend recipient is taxed at the reduced rate applicable
to dividends from approved enterprises income (15%), if the dividend, deriving
from the approved enterprises, is distributed during the tax benefit period or
within 12 years thereafter, yet, no time limit is applicable to dividends from a
foreign investment company. The company must withhold this tax at source,
regardless of whether the dividend is converted into foreign currency. However,
if retained tax-exempt income is distributed in a manner other than upon the
complete liquidation of the company, the company would be taxed at the reduced
corporate tax rate applicable to such profits (between 10%-25%). Our company is
not obliged to distribute exempt retained profits under the alternative track of
benefits, and may generally decide from which source of income to declare
dividends. We intend to reinvest any income derived from our approved enterprise
programs and not to distribute such income as a dividend.
We have been granted approved enterprise status with respect to several
investment programs and chose the alternative track with respect to each of
these programs. See Item 5A. "Operating and Financial Review and Prospects -
Operating Results - Effective Corporate Tax Rate."
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, its tax
benefits could be canceled, in whole or in part, and it would be required to
refund the amount of tax benefits, with the addition of the Israeli consumer
price index linkage adjustment and interest.
AMENDMENT TO THE INVESTMENTS LAW
An amendment to the Investments Law, which came into effect on April 1,
2005, has changed certain provisions of such law, including the criteria for
investments qualified to receive tax benefits under such law. An eligible
investment program under the amendment will qualify for benefits as a
"Privileged Enterprise" (rather than the previous terminology of Approved
Enterprise). As a result of the amendment, a company is no longer obliged to
acquire approved enterprise status in order to receive the tax benefits
previously available under the alternative benefits track, and therefore there
is no need to apply to the Investment Center for this purpose (however, approved
enterprise status remains mandatory for companies seeking grants). Rather, a
company may claim the tax benefits offered by the Investment Law directly in its
tax returns, provided that its facilities meet the criteria for tax benefits set
out by the amendment. Companies may also approach the Israeli Tax Authority for
a pre-ruling regarding its eligibility for benefits under the amendment. The
amendment does not apply to investment programs approved prior to December 31,
2004. The new tax regime will apply only to new investment programs.
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Tax benefits are available under the April 2005 amendment to production
facilities (or other eligible facilities), which are generally required to
derive more than 25% of their business income from export. In order to receive
the tax benefits, a company must make an investment in the Privileged Enterprise
exceeding a minimum amount specified in the Investment Law. Such investment may
be made over a period of no more than three years ending at the end of the year
in which the company requested to have the tax benefits apply to the Privileged
Enterprise, referred to as the Year of Election. Where the company requests to
have the tax benefits apply to an expansion of existing facilities, only the
expansion will be considered a Privileged Enterprise and the company's effective
tax rate will be the result of a weighted combination of the applicable rates.
In such case, the minimum investment required in order to qualify as a
Privileged Enterprise is required to exceed a certain percentage of the
company's production assets before the expansion.
TAX BENEFITS FOR RESEARCH AND DEVELOPMENT
Israeli tax law allows, under specified conditions, a tax deduction for
expenditures, including capital expenditures, in the year incurred relating to
scientific research and development projects, if the expenditures are approved
by the relevant Israeli Government ministry, determined by the field of
research, and the research and development is for the promotion of the company
and is carried out by or on behalf of the company seeking such deduction.
However, the amount of such deductible expenses shall be reduced by the sum of
any funds received through government grants for the finance of such scientific
research and development projects. Expenditures not so approved are deductible
over a three-year period.
TAX BENEFITS UNDER THE LAW FOR THE ENCOURAGEMENT OF INDUSTRY (TAXES), 1969
Under the Law for the Encouragement of Industry (Taxes), 1969, or the
Industry Encouragement Law, Industrial Companies are entitled to certain
corporate tax benefits, including, among others:
o deduction, under certain conditions, of purchases of know-how and
patents over an eight-year period for tax purposes;
o right to elect, under specified conditions, to file a consolidated tax
return with additional related Israeli Industrial Companies;
o accelerated depreciation rates on equipment and buildings; and
o deductions over a three-year period of expenses involved with the
issuance and listing of shares on the Tel Aviv Stock Exchange or, on
or after January 1, 2003, on a recognized stock market outside of
Israel.
Eligibility for benefits under the Industry Encouragement Law is not
subject to receipt of prior approval from any governmental authority. Under the
Industry Encouragement Law, an "Industrial Company" is defined as a company
resident in Israel, at least 90% of the income of which, in any tax year,
determined in Israeli currency, exclusive of income from government loans,
capital gains, interest and dividends, is derived from an "Industrial
Enterprise" owned by it. An "Industrial Enterprise" is defined as an enterprise
owned by an Industrial Company, whose major activity in a given tax year is
industrial production activity.
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We believe that we currently qualify as an Industrial Company within the
definition of the Industry Encouragement Law. No assurance can be given that we
will continue to qualify as an Industrial Company or that the benefits described
above will be available in the future.
GRANTS UNDER THE LAW FOR THE ENCOURAGEMENT OF INDUSTRIAL RESEARCH AND
DEVELOPMENT, 1984
The Government of Israel encourages research and development projects
through the Office of Chief Scientist of the Israeli Ministry of Industry, Trade
and Labor, or the Office of the Chief Scientist, pursuant to the Law for the
Encouragement of Industrial Research and Development, 1984, and the regulations
promulgated thereunder, commonly referred to as the Research Law. Grants
received under such programs are repaid through a mandatory royalty based on
revenues from products incorporating know-how developed with the grants. This
government support is conditioned upon the ability of the participant to comply
with certain applicable requirements and conditions specified in the Office of
the Chief Scientist's programs and with the provisions of the Research Law.
Under the Research Law, research and development programs which meet
specified criteria and are approved by a research committee of the Office of the
Chief Scientist are eligible for grants of up to 50% of certain of the project's
approved expenditure, as determined by the research committee.
In exchange, the recipient of such grants is required to pay the Office of
the Chief Scientist royalties from the revenues derived from products
incorporating technology developed within the framework of the approved research
and development program or derived from such program (including ancillary
services in connection with such program), usually up to100% of the U.S.
dollar-linked value of the total grants received in respect of such program,
plus LIBOR interest.
The terms of the Israeli Government participation generally requires that
the products developed with such grants be manufactured in Israel. However,
under regulations promulgated under the Research Law, upon the approval of the
Chief Scientist, some of the manufacturing volume may be performed outside
Israel, provided that the grant recipient pays royalties at an increased rate.
The Research Law also allows for the approval of grants in cases in which the
applicant declares that part or all of the manufacturing will be performed
outside of Israel or by non-Israeli residents and the research committee is
convinced that this is essential for the execution of the program. The Research
Law also provides that know-how developed under an approved research and
development program may not be transferred to third parties in Israel without
the prior approval of the research committee. The Research Law further provides
that the know-how developed under an approved research and development program
may not be transferred to any third parties outside Israel. No approval is
required for the sale or export of any products resulting from such research and
development.
However, in June 2005, an amendment to the Research Law became effective,
which amendment was intended to make the Research Law more compatible with the
global business environment by, among other things, relaxing restrictions on the
transfer of manufacturing rights outside Israel and on the transfer of Office of
the Chief Scientist-funded know-how outside of Israel. The amendment permits the
Office of the Chief Scientist, among other things, to approve the transfer of
manufacturing rights outside Israel in exchange for an import of different
manufacturing into Israel as a substitute, in lieu of demanding the recipient to
pay increased royalties as described above. The amendment further permits, under
certain circumstances and subject to the Office of the Chief Scientist's prior
approval, the transfer outside Israel of know-how that has been funded by Office
of the Chief Scientist, generally in the following cases: (a) the grant
recipient pays to the Office of the Chief Scientist a portion of the
consideration paid for such funded know-how (according to certain formulas), (b)
the grant recipient receives know-how from a third party in exchange for its
funded know-how, or (c) such transfer of funded know-how arises in connection
with certain types of cooperation in research and development activities.
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The Research Law imposes reporting requirements with respect to certain
changes in the ownership of a grant recipient. The law requires the grant
recipient and its controlling shareholders and interested parties to notify the
Office of the Chief Scientist of any change in control of the recipient or a
change in the holdings of the means of control of the recipient that results in
a non-Israeli becoming an interested party directly in the recipient and
requires the new interested party to undertake to the Office of the Chief
Scientist to comply with the Research Law. In addition, the rules of the Office
of the Chief Scientist may require prior approval of the Office of the Chief
Scientist or additional information or representations in respect of certain of
such events. For this purpose, "control" is defined as the ability to direct the
activities of a company other than any ability arising solely from serving as an
officer or director of the company. A person is presumed to have control if such
person holds 50% or more of the means of control of a company. "Means of
control" refers to voting rights or the right to appoint directors or the chief
executive officer. An "interested party" of a company includes a holder of 5% or
more of its outstanding share capital or voting rights, its chief executive
officer and directors, someone who has the right to appoint its chief executive
officer or at least one director, and a company with respect to which any of the
foregoing interested parties owns 25% or more of the outstanding share capital
or voting rights or has the right to appoint 25% or more of the directors.
Accordingly, any non-Israeli who acquires 1% or more of our ordinary shares will
be required to notify the Office of the Chief Scientist that it has become an
interested party and to sign an undertaking to comply with the Research Law.
Additionally, procedures regulated under the Research Law require the grant
recipient to obtain the approval of the Office of the Chief Scientist prior to a
change in the holdings of the recipient or change in the holdings of the means
of control of the recipient if the recipient's shares are being issued to a
non-Israeli person or entity and require the new non-Israeli party to undertake
to the Office of the Chief Scientist to comply with the Research Law.
In the past, we received funding from the Office of the Chief Scientist for
selected research and development projects, but we stopped seeking funding for a
number of years. In 2005, we received the approval of the Office of the Chief
Scientist for a new research and development grant in the amount of $130,000. In
2006, we received the approval of the Office of the Chief Scientist for two new
research and development grants in an aggregate amount of $578,000, and in 2007,
we submitted two additional grant applications that are currently pending. See
Item 5C. "Operating and Financial Review and Prospects - Research and
Development, Patents and Licenses" for additional details on the grants that we
have received and our contingent liability to the Office of the Chief Scientist.
SPECIAL PROVISIONS RELATING TO TAXATION UNDER INFLATIONARY
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. Its features,
which are material to us, can be summarized as follows:
o There is a special tax adjustment for the preservation of equity
whereby some corporate assets are classified broadly into fixed assets
and non-fixed assets. Where a company's equity, as defined in such
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.
o Subject to specific limitations, depreciation deductions on fixed
assets and losses carried forward are adjusted for inflation based on
the increase in the consumer price index.
TAXATION OF NON-ISRAELI SHAREHOLDERS ON RECEIPT OF DIVIDENDS
Under Israeli tax law, a distribution of dividends from income attributable
to an Approved Enterprise and Privileged Enterprise will be subject to tax in
Israel at the rate of 15%, which is withheld and paid by the company paying the
dividend, if the dividend is distributed during the benefits period or within
the following 12 years (but the 12-year limitation does not apply to a Foreign
Investors Company). Any distribution of dividends from income that is not
attributable to an Approved Enterprise will be subject to tax in Israel at the
rate of 25%, except that dividends distributed on or after January 1, 2006 to an
individual and an entity who is deemed "a non-substantial shareholder" will be
subject to tax at the rate of 20%.
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Under the U.S.-Israel tax treaty, the maximum tax on dividends paid to a
holder of ordinary shares who is a U.S. resident is 25%. Dividends received by a
U.S. company that holds at least 10% of our voting rights will be subject to
withholding tax at the rate of 12.5%, provided certain other conditions in the
tax treaty are met (or at the tax rate of 15% in respect of dividends paid from
income attributable to our Approved Enterprises and Privileged Enterprises).
CAPITAL GAINS TAXES APPLICABLE TO NON-ISRAELI SHAREHOLDERS
Capital gains from the sale of our ordinary shares by non-Israeli
shareholders are exempt from Israeli taxation, provided that the capital gain is
not derived from a permanent establishment in Israel. However, non-Israeli
corporations will not be entitled to such exemption, if an Israeli resident (i)
has a controlling interest of 25% or more in such non-Israeli corporation, or
(ii) is the beneficiary or is entitled to 25% or more of the revenues or profits
of such non-Israeli corporation, whether directly or indirectly. In the event
that an exemption is not available, taxation of the non-Israeli resident may be
subject to the provisions of a tax treaty, if such treaty exists between Israel
and the applicable country. In some instances where our shareholders may be
subject to Israeli tax on the sale of their ordinary shares, the payment of the
consideration may be subject to the withholding of Israeli tax at the source.
In addition, the United States-Israel tax treaty exempts U.S. residents who
hold less than 10% of our voting rights, and who held less than 10% of our
voting rights during the 12 months prior to a sale of their shares, from Israeli
capital gains tax in connection with such sale.
FOREIGN EXCHANGE REGULATIONS
Dividends (if any) paid to the holders of our ordinary shares, and any
amounts payable with respect to our ordinary shares 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 reparable U.S. dollars
at the rate of exchange prevailing at the time of conversion, however, Israeli
income tax is required to have been paid or withheld on these amounts.
UNITED STATES FEDERAL INCOME TAX CONSEQUENCES
The following is a summary of certain material U.S. federal income tax
consequences that apply to U.S. Holders who hold ordinary shares as capital
assets. This summary is based on the United States Internal Revenue Code of
1986, as amended, or the Code, Treasury regulations promulgated thereunder,
judicial and administrative interpretations thereof, and the U.S.-Israel Tax
Treaty, all as in effect on the date hereof and all of which are subject to
change either prospectively or retroactively. This summary does not address all
tax considerations that may be relevant with respect to an investment in
ordinary shares. This summary does not account for the specific circumstances of
any particular investor, such as:
o broker-dealers,
o financial institutions,
o certain insurance companies,
o regulated investment companies,
o investors liable for alternative minimum tax,
o tax-exempt organizations,
o non-resident aliens of the U.S. or taxpayers whose functional
currency is not the U.S. dollar,
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o persons who hold the ordinary shares through partnerships or
other pass-through entities,
o persons who acquired their ordinary shares through the exercise
or cancellation of employee stock options or otherwise as
compensation for services,
o certain expatriates or former long-term residents of the United
States,
o investors that own or have owned, directly, indirectly or by
attribution, 10 percent or more of our voting shares, and
o investors holding ordinary shares as part of a straddle or
appreciated financial position or a hedging or conversion
transaction.
If a partnership or an entity treated as a partnership for U.S. federal
income tax purposes owns ordinary shares, the U.S. federal income tax treatment
of a partner in such a partnership will generally depend upon the status of the
partner and the activities of the partnership. A partnership that owns ordinary
shares and the partners in such partnership should consult their tax advisors
about the U.S. federal income tax consequences of holding and disposing of
ordinary shares.
This summary does not address the effect of any U.S. federal taxation other
than U.S. federal income taxation. In addition, this summary does not include
any discussion of state, local or foreign taxation.
You are urged to consult your tax advisors regarding the foreign and United
States federal, state and local tax considerations of an investment in ordinary
shares.
For purposes of this summary, a U.S. Holder is any beneficial owner of
ordinary shares that is:
o an individual who is a citizen or, for U.S. federal income tax
purposes, a resident of the United States;
o a corporation or other entity created or organized in or under
the laws of the United States or any political subdivision
thereof;
o an estate whose income is subject to U.S. federal income tax
regardless of its source; or
o a trust that (a) is subject to the primary supervision of a court
within the United States and the control of one or more U.S.
persons or (b) has a valid election in effect under applicable
U.S. Treasury regulations to be treated as a U.S. person.
TAXATION OF DIVIDENDS
SUBJECT TO THE DISCUSSION BELOW UNDER THE HEADING "PASSIVE FOREIGN
INVESTMENT COMPANIES," the gross amount of any distributions received with
respect to ordinary shares, including the amount of any Israeli taxes withheld
therefrom, will constitute dividends for U.S. federal income tax purposes, to
the extent of our current and accumulated earnings and profits as determined for
U.S. federal income tax purposes. You will be required to include this amount of
dividends in gross income as ordinary income. Distributions in excess of our
earnings and profits will be treated as a non-taxable return of capital to the
extent of your tax basis in the ordinary shares, and any amount in excess of
your tax basis will be treated as gain from the sale of ordinary shares. See
"--Disposition of Ordinary Shares" below for the discussion on the taxation of
capital gains. Dividends will not qualify for the dividends-received deduction
generally available to corporations under Section 243 of the Code.
65
Dividends that we pay in NIS, including the amount of any Israeli taxes
withheld therefrom, will be included in your income in a U.S. dollar amount
calculated by reference to the exchange rate in effect on the day such dividends
are received. A U.S. Holder who receives payment in NIS and converts NIS into
U.S. dollars at an exchange rate other than the rate in effect on the day of
receipt may have a foreign currency exchange gain or loss that would be treated
as ordinary income or loss. U.S. Holders should consult their own tax advisors
concerning the U.S. tax consequences of acquiring, holding and disposing of NIS.
Subject to complex limitations, any Israeli withholding tax imposed on such
dividends will be a foreign income tax eligible for credit against a U.S.
Holder's U.S. federal income tax liability, subject to certain limitations set
out in the Code (or, alternatively, for deduction against income in determining
such tax liability). The limitations set out in the Code include computational
rules under which foreign tax credits allowable with respect to specific classes
of income cannot exceed the U.S. federal income taxes otherwise payable with
respect to each such class of income. Dividends generally will be treated as
foreign-source passive category income or general category income for United
States foreign tax credit purposes. A U.S. Holder will be denied a foreign tax
credit with respect to Israeli income tax withheld from dividends received on
the ordinary shares to the extent such U.S. Holder has not held the ordinary
shares for at least 16 days of the 31-day period beginning on the date which is
15 days before the ex-dividend date or to the extent such U.S. Holder is under
an obligation to make related payments with respect to substantially similar or
related property. Any days during which a U.S. Holder has substantially
diminished its risk of loss on the ordinary shares are not counted toward
meeting the 16-day holding period required by the statute. Further, there are
special rules for computing the foreign tax credit limitation of a taxpayer who
receives dividends subject to a reduced tax rate. The rules relating to the
determination of the foreign tax credit are complex, and you should consult with
your personal tax advisors to determine whether and to what extent you would be
entitled to this credit.
Subject to certain limitations, "qualified dividend income" received by a
noncorporate U.S. Holder through 2010 will be subject to tax at a reduced
maximum tax rate of 15 percent. THE RATE REDUCTION DOES NOT APPLY TO DIVIDENDS
RECEIVED FROM PASSIVE FOREIGN INVESTMENT COMPANIES, SEE DISCUSSION BELOW.
Distributions taxable as dividends paid on the ordinary shares should qualify
for the 15 percent rate provided that either: (i) we are entitled to benefits
under the income tax treaty between the United States and Israel (the "Treaty")
or (ii) the ordinary shares are readily tradable on an established securities
market in the United States and certain other requirements are met. We believe
that we are entitled to benefits under the Treaty and that the ordinary shares
currently are readily tradable on an established securities market in the United
States. However, no assurance can be given that the ordinary shares will remain
readily tradable. The rate reduction does not apply unless certain holding
period requirements are satisfied. With respect to the ordinary shares, the U.S.
Holder must have held such shares for at least 61 days during the 121-day period
beginning 60 days before the ex-dividend date. The rate reduction also does not
apply in respect of certain hedged positions or in certain other situations. The
legislation enacting the reduced tax rate contains special rules for computing
the foreign tax credit limitation of a taxpayer who receives dividends subject
to the reduced tax rate. U.S. Holders of ordinary shares should consult their
own tax advisors regarding the effect of these rules in their particular
circumstances.
DISPOSITION OF ORDINARY SHARES
If you sell or otherwise dispose of ordinary shares, you will recognize
gain or loss for U.S. federal income tax purposes in an amount equal to the
difference between the amounts realized on the sale or other disposition and the
adjusted tax basis in ordinary shares. SUBJECT TO THE DISCUSSION BELOW UNDER THE
HEADING "PASSIVE FOREIGN INVESTMENT COMPANIES," such gain or loss generally will
be capital gain or loss and will be long-term capital gain or loss if you have
held the ordinary shares for more than one year at the time of the sale or other
disposition. In general, any gain that you recognize on the sale or other
disposition of ordinary shares will be U.S.-source for purposes of the foreign
tax credit limitation; losses will generally be allocated against U.S. source
income. Deduction of capital losses is subject to certain limitations under the
Code.
66
In the case of a cash basis U.S. Holder who receives NIS in connection with
the sale or disposition of ordinary shares, the amount realized will be based on
the U.S. dollar value of the NIS received with respect to the ordinary shares as
determined on the settlement date of such exchange. A U.S. Holder who receives
payment in NIS and converts NIS into United States dollars at a conversion rate
other than the rate in effect on the settlement date may have a foreign currency
exchange gain or loss that would be treated as ordinary income or loss.
An accrual basis U.S. Holder may elect the same treatment required of cash
basis taxpayers with respect to a sale or disposition of ordinary shares,
provided that the election is applied consistently from year to year. Such
election may not be changed without the consent of the Internal Revenue Service.
In the event that an accrual basis U.S. Holder does not elect to be treated as a
cash basis taxpayer (pursuant to the Treasury regulations applicable to foreign
currency transactions), such U.S. Holder may have a foreign currency gain or
loss for U.S. federal income tax purposes because of differences between the
U.S. dollar value of the currency received prevailing on the trade date and the
settlement date. Any such currency gain or loss would be treated as ordinary
income or loss and would be in addition to gain or loss, if any, recognized by
such U.S. Holder on the sale or disposition of such ordinary shares.
PASSIVE FOREIGN INVESTMENT COMPANIES
There is a substantial risk that we may become a passive foreign investment
company, or PFIC, for U.S. federal income tax purposes. Our treatment as a PFIC
could result in a reduction in the after-tax return to the U.S. Holders of our
ordinary shares and may cause a reduction in the value of such shares.
For U.S. federal income tax purposes, we will be classified as a PFIC for
any taxable year in which either (i) 75% or more of our gross income is passive
income, or (ii) at least 50% of the average value of all of our assets for the
taxable year produce or are held for the production of passive income. For this
purpose, cash is considered to be an asset which produces passive income.
Passive income generally includes dividends, interest, royalties, rents,
annuities and the excess of gains over losses from the disposition of assets
which produce passive income. As a result of our relatively substantial cash
position at the time, we believe that we were a PFIC in certain periods in the
past under a literal application of the asset test described above, which looks
solely to the market value of our assets. We do not believe that we were a PFIC
in 2006.
If we are a PFIC, dividends will not qualify for the reduced maximum tax
rate, applicable to qualified dividend income, discussed above, and, unless you
timely elect to "mark-to-market" your ordinary shares, as described below:
o you will be required to allocate income recognized upon receiving
certain dividends or gain recognized upon the disposition of ordinary
shares ratably over the holding period for such ordinary shares,
o the amount allocated to each year during which we are considered a
PFIC other than the year of the dividend payment or disposition would
be subject to tax at the highest individual or corporate tax rate, as
the case may be, in effect for that year and an interest charge would
be imposed with respect to the resulting tax liability allocated to
each such year,
o the amount allocated to the current taxable year and any taxable year
before we became a PFIC would be taxable as ordinary income in the
current year, and
o you will be required to make an annual return on IRS Form 8621
regarding distributions received with respect to ordinary shares and
any gain realized on your ordinary shares.
67
In addition, holders of stock in a PFIC may not receive a "step-up" in
basis on shares acquired from a decedent.
The PFIC provisions discussed above apply to U.S. persons who directly or
indirectly hold stock in a PFIC. Generally, a U.S. person is considered an
indirect shareholder of a PFIC if it is:
o A direct or indirect owner of a pass-through entity, including a
trust or estate, that is a direct or indirect shareholder of a
PFIC,
o A shareholder of a PFIC that is a shareholder of another PFIC, or
o A 50%-or-more shareholder of a foreign corporation that is not a
PFIC and that directly or indirectly owns stock of a PFIC.
An indirect shareholder may be taxed on a distribution paid to the direct
owner of the PFIC and on a disposition of the stock indirectly owned. Indirect
shareholders are strongly urged to consult their tax advisors regarding the
application of these rules.
If we cease to be a PFIC in a future year, a U.S. Holder may avoid the
continued application of the tax treatment described above by electing to be
treated as if it sold its ordinary shares on the last day of the last taxable
year in which we were a PFIC. Any gain would be recognized and subject to tax
under the rules described above. Loss would not be recognized. A U.S. Holder's
basis in its ordinary shares would be increased by the amount of gain, if any,
recognized on the sale. A U.S. Holder would be required to treat its holding
period for its ordinary shares as beginning on the day following the last day of
the last taxable year in which we were a PFIC.
If the ordinary shares are considered "marketable stock" and if you elect
to "mark-to-market" your ordinary shares, you would not be subject to the rules
described above. Instead, you will generally include in income any excess of the
fair market value of the ordinary shares at the close of each tax year over your
adjusted basis in the ordinary shares. If the fair market value of the ordinary
shares had depreciated below your adjusted basis at the close of the tax year,
you may generally deduct the excess of the adjusted basis of the ordinary shares
over its fair market value at that time. However, such deductions generally
would be limited to the net mark-to-market gains, if any, that you included in
income with respect to such ordinary shares in prior years. Income recognized
and deductions allowed under the mark-to-market provisions, as well as any gain
or loss (to the extent of net mark-to-market gains) on the disposition of
ordinary shares with respect to which the mark-to-market election is made, is
treated as ordinary income or loss. Loss on a disposition, to the extent in
excess of net mark-to-market gains, would be treated as capital loss. Gain or
loss from the disposition of ordinary shares (as to which a "mark-to-market"
election was made) in a year in which we are no longer a PFIC will be capital
gain or loss. Loss on a disposition, to the extent in excess of net
mark-to-market gains, would be treated as capital loss. Our ordinary shares
should be considered "marketable stock" if they traded at least 15 days during
each calendar quarter of the relevant calendar year in more than de minimis
quantities.
A U.S. Holder of ordinary shares will not be able to avoid the tax
consequences described above by electing to treat us as a qualified electing
fund, or QEF, because we do not intend to prepare the information that U.S.
Holders would need to make a QEF election.
BACKUP WITHHOLDING AND INFORMATION REPORTING
Payments in respect of ordinary shares may be subject to information
reporting to the U.S. Internal Revenue Service and to U.S. backup withholding
tax at a rate equal to the fourth lowest income tax rate applicable to
individuals which, under current law, is 28%. Backup withholding will not apply,
however, if you (i) are a corporation or come within certain exempt categories,
and demonstrate the fact when so required, or (ii) furnish a correct taxpayer
identification number and make any other required certification.
Backup withholding is not an additional tax. Amounts withheld under the
backup withholding rules may be credited against a U.S. Holder's U.S. tax
liability, and a U.S. Holder may obtain a refund of any excess amounts withheld
under the backup withholding rules by filing the appropriate claim for refund
with the IRS.
68
Any U.S. Holder who holds 10% or more in vote or value of our ordinary
shares will be subject to certain additional United States information reporting
requirements.
U.S. GIFT AND ESTATE TAX
An individual U.S. Holder of ordinary shares will be subject to U.S. gift
and estate taxes with respect to ordinary shares in the same manner and to the
same extent as with respect to other types of personal property.
F. DIVIDEND AND PAYING AGENTS
Not applicable.
G. STATEMENT BY EXPERTS
Not applicable.
H. DOCUMENTS ON DISPLAY
We are subject to the reporting requirements of the United States
Securities Exchange Act of 1934, as amended, as applicable to "foreign private
issuers" as defined in Rule 3b-4 under the Exchange Act, and in accordance
therewith, we file annual and interim reports and other information with the
Securities and Exchange Commission.
As a foreign private issuer, we are exempt from certain provisions of the
Exchange Act. Accordingly, our proxy solicitations are not subject to the
disclosure and procedural requirements of Regulation 14A under the Exchange Act,
transactions in our equity securities by our officers and directors are exempt
from reporting and the "short-swing" profit recovery provisions contained in
Section 16 of the Exchange Act. In addition, we are not required under the
Exchange Act to file periodic reports and financial statements as frequently or
as promptly as U.S. companies whose securities are registered under the Exchange
Act. However, we distribute annually to our shareholders an annual report
containing financial statements that have been examined and reported on, with an
opinion expressed by, an independent public accounting firm, and we file reports
with the Securities and Exchange Commission on Form 6-K containing unaudited
financial information for the first three quarters of each fiscal year.
This annual report and the exhibits thereto and any other document we file
pursuant to the Exchange Act may be inspected without charge and copied at
prescribed rates at the following Securities and Exchange Commission public
reference rooms: 100 F Street, N.E., Room 1580, Washington, D.C. 20549; and on
the Securities and Exchange Commission Internet site (http://www.sec.gov) and on
our website www.mtsint.com. You may obtain information on the operation of the
Securities and Exchange Commission's public reference room in Washington, D.C.
by calling the Securities and Exchange Commission at 1-800-SEC-0330 or by
visiting the Securities and Exchange Commission's website at http://www.sec.gov,
and may obtain copies of our filings from the public reference room by calling
1-800-SEC-0330. The Exchange Act file number for our Securities and Exchange
Commission filings is 0-28950.
The documents concerning our company referred to in this annual report may
also be inspected at our offices located at 22 Zarhin Street, Ra'anana
43662, Israel.
I. SUBSIDIARY INFORMATION
Not applicable.
69
ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
EXPOSURE TO MARKET RISKS
We are exposed to a variety of risks, including changes in interest rates
affecting primarily the interest received on short-term deposits, and foreign
currency fluctuations. We do not use derivative financial instruments to hedge
against such exposure.
INTEREST RATE RISK
Our exposure to market risk for changes in interest rates relates primarily
to our short term deposits. Our short term deposits are held in dollars and bear
annual interest of 3.5% to 4.5%, which is based upon the London Inter Bank
Offered Rate (LIBOR). We place our short term deposits with major financial
center U.S. banks. For purposes of specific risk analysis, we use sensitivity
analysis to determine the impact that market risk exposure may have on the
financial income derived from our short term deposits. The potential loss to us
over one year that would result from a hypothetical change of 10% in the LIBOR
rate would be approximately $20,000.
FOREIGN CURRENCY EXCHANGE RISK
We have operations in several countries in connection with the sale of our
products. A substantial portion of our sales and expenditures are denominated in
dollars. We have mitigated, and expect to continue to mitigate, a portion of our
foreign currency exposure through salaries, marketing and support operations in
which all costs are local currency based. As a result, our results of operations
and cash flows can be affected by fluctuations in foreign currency exchange
rates (primarily the Euro and NIS). A hypothetical 10% movement in foreign
currency rates (primarily the Euro and NIS) against the dollar, with all other
variables held constant on the expected sales, would result in a decrease or
increase in expected 2007 sales revenues of $200,000.
ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES
Not applicable.
PART II
ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES
None.
ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF
PROCEEDS
Not applicable.
ITEM 15. CONTROLS AND PROCEDURES
We maintain disclosure controls and procedures that are designed to ensure
that information required to be disclosed in its Exchange Act reports is
recorded, processed, summarized and reported within the time periods specified
in the Securities and Exchange Commission's rules and forms, and that such
information is accumulated and communicated to our chief executive officer and
chief financial officer to allow timely decisions regarding required disclosure.
Our management, including our chief executive officer and chief financial
officer, conducted an evaluation of our disclosure controls and procedures, as
defined under Exchange Act Rule 13a-15(e), as of the end of the period covered
by this Annual Report on Form 20-F. Based upon that evaluation, our chief
executive officer and chief financial officer have concluded that, as of such
date, our disclosure controls and procedures were effective.
70
ITEM 15T. CONTROLS AND PROCEDURES
Not applicable.
ITEM 16. [RESERVED]
ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT
Our board of directors has determined that Mr. Yaacov Goldman, an
independent director, meets the definition of an audit committee financial
expert, as defined by rules of the Securities and Exchange Commission.
ITEM 16B. CODE OF ETHICS
We have adopted a code of ethics that applies to our chief executive
officer and all senior financial officers of our company, including the chief
financial officer, chief accounting officer or controller, or persons performing
similar functions. Our code of ethics has been filed as an exhibit to this
annual report. Written copies are available upon request. If we make any
substantive amendment to the code of ethics or grant any waivers, including any
implicit waiver, from a provision of the codes of ethics, we will disclose the
nature of such amendment or waiver on our website.
ITEM 16C. PRINCIPAL ACCOUNTING FEES AND SERVICES
FEES PAID TO INDEPENDENT PUBLIC ACCOUNTANTS
The following table sets forth, for each of the years indicated, the fees
paid to our principal independent registered public accounting firm. All of such
fees were pre-approved in advance by our Audit Committee.
Year Ended December 31,
----------------------
Services Rendered 2006 2005
----------------- -------- --------
Audit (1) $ 83,173 $123,162
Audit-related(2) 8,601 7,500
Tax (3) 20,528 19,537
Other (4) -- 1,734
-------- --------
Total $112,302 $151,933
----------
(1) Audit fees consist of services that would normally be provided in
connection with statutory and regulatory filings or engagements,
including services that generally only the independent registered
public accounting firm can reasonably provide.
(2) Audit-related fees relate to services provided in connection with the
filing of a Report on Form 6-K for the six months period ended June
30, 2006.
(3) Tax fees relate to services performed by the tax division for tax
compliance, planning, and advice.
(4) Other fees relate to services provided by our principal independent
registered public accounting firm other than services covered by above
categories.
PRE-APPROVAL POLICIES AND PROCEDURES
Our audit committee has adopted a policy and procedures for the
pre-approval of audit and non-audit services rendered by our independent
registered public accountants, Kost Forer Gabbay & Kasierer, a member firm of
Ernst & Young Global. Pre-approval of an audit or non-audit service may be given
as a general pre-approval, as part of the audit committee's approval of the
scope of the engagement of our independent auditor, or on an individual basis.
Any proposed services exceeding general pre-approved levels also require
specific pre-approval by our audit committee. The policy prohibits retention of
the independent public accountants to perform the prohibited non-audit functions
defined in Section 201 of the Sarbanes-Oxley Act or the rules of the Securities
and Exchange Committee, and also requires the audit committee to consider
whether proposed services are compatible with the independence of the public
accountants.
71
ITEM 16D. EXEMPTIONS FROM THE LISTING REQUIREMENTS AND STANDARDS FOR AUDIT
COMMITTEE
Not applicable.
ITEM 16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS
ISSUER PURCHASE OF EQUITY SECURITIES
Neither we nor any affiliated purchaser has purchased any of our securities
during 2006.
PART III
ITEM 17. FINANCIAL STATEMENTS
We have elected to furnish financial statements and related information
specified in Item 18.
ITEM 18. FINANCIAL STATEMENTS
CONSOLIDATED FINANCIAL STATEMENTS OF MER TELEMANAGEMENT SOLUTIONS LTD.
Index to Consolidated Financial Statements .......................F-1
Report of Independent Registered Public Accounting Firm...........F-2
Consolidated Balance Sheets.......................................F-3 -F-4
Consolidated Statements of Operations.............................F-5
Consolidated Statements of Changes in Shareholders' Equity........F-6
Consolidated Statements of Cash Flows.............................F-7 - F-8
Notes to Consolidated Financial Statements........................F-9 - F-43
FINANCIAL STATEMENTS OF JUSAN, S.A. AS OF DECEMBER 31, 2005 AND 2006 AND FOR THE
THREE YEARS ENDED DECEMBER 31, 2006
Index to Financial Statements of Jusan, S.A.......................F-44
Report of Independent Registered Public Accounting Firm...........F-45
Balance Sheets....................................................F-46
Statements of Income..............................................F-47
Statements of Changes in Shareholders' Equity.....................F-48
Statements of Cash Flows..........................................F-49
Notes to Financial Statements.....................................F-50
72
ITEM 19. EXHIBITS
Index to Exhibits
EXHIBIT DESCRIPTION
1.1 Memorandum of Association of the Registrant (1)
1.2 Articles of Association of the Registrant (1)
2.1 Specimen of Ordinary Share Certificate (1)
4.1 1996 Employee Stock Option Plan (1)
4.2 Section 102 Stock Option Plan (1)
4.3 2003 Israeli Share Option Plan (2)
4.4 2006 Stock Option Plan (3)
4.5 Asset Purchase Agreement dated December 30, 2004 among the
Registrant and Teleknowledge Group Ltd. (4)
4.6 Securities Purchase Agreement dated August 10, 2005 among the
Registrant and the Investors therein (5)
4.7 Form of Warrant (6)
4.8 Registration Rights Agreement dated August 10, 2005 (7)
4.9 Form of Warrant issued to Mr. Avi Ziv (8)
5.0 Asset Purchase Agreement dated July 25, 2006 by and among MTS
Acquisition Corp. (now named MTS TelSoft Inc.), MTS IntegraTRAK
Inc., TelSoft Solutions, Inc. (now named Strategic Sciences
Inc.), Consulting Sciences, Inc., Donald Simons and Dale Zuehls
8.1 List of Subsidiaries of the Registrant
11.1 Code of Ethics (9)
12.1 Certification of Chief Executive Officer pursuant to Rule
13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as
amended.
12.2 Certification of Chief Financial Officer pursuant to Rule
13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as
amended.
13.1 Certification of Chief Executive Officer pursuant to 18 U.S.C.
Section1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
13.2 Certification of Chief Financial Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
15.1 Consent of Kost Forer Gabbay & Kasierer, a Member of Ernst &
Young Global
73
15.2 Consent of BDO Audiberia Auditores, S.L.
----------
(1) Filed as an exhibit to the Registrant's Registration Statement on Form F-1,
registration number 333-05814, filed with the Securities and Exchange
Commission, and incorporated herein by reference.
(2) Filed as Exhibit 10.3 to the Registrant's Annual Report on Form 20-F for
the year ended December 31, 2003, and incorporated herein by reference.
(3) Filed as Appendix B to Item 1 of the Registrant's Report on Form 6-K for
the month of June 2006 submitted on June 23, 2006, and incorporated herein
by reference.
(4) Filed as Exhibit 4.1 to the Registrant's Annual Report on Form 20-F for the
year ended December 31, 2004, and incorporated herein by reference.
(5) Filed as Item 1 to the Registrant's Report on Form 6-K for the month of
August 2005 submitted on August 19, 2005, and incorporated herein by
reference.
(6) Filed as Item 3 to the Registrant's Report on Form 6-K for the month of
August 2005 submitted on August 19, 2005, and incorporated herein by
reference.
(7) Filed as Item 2 to the Registrant's Report on Form 6-K for the month of
August 2005 submitted on August 19, 2005, and incorporated herein by
reference.
(8) Filed as Exhibit 4.6 to the Registrant's Registration Statement on Form
F-3, registration number 333-128225, and incorporated herein by reference.
(9) Filed as Exhibit 14.1 to the Registrant's Annual Report on Form 20-F for
the year ended December 31, 2003, and incorporated herein by reference.
74
MER TELEMANAGEMENT SOLUTIONS LTD. AND ITS SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
AS OF DECEMBER 31, 2006
U.S. DOLLARS IN THOUSANDS
INDEX
PAGE
--------------
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM F - 2
CONSOLIDATED BALANCE SHEETS F - 3 - F - 4
CONSOLIDATED STATEMENTS OF OPERATIONS F - 5
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY F - 6
CONSOLIDATED STATEMENTS OF CASH FLOWS F - 7 - F - 8
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS F - 9 - F - 43
F - 1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
TO THE BOARD OF DIRECTORS AND SHAREHOLDERS OF
MER TELEMANAGEMENT SOLUTIONS LTD.
We have audited the accompanying consolidated balance sheets of Mer
Telemanagement Solutions Ltd. ("the Company") and its subsidiaries as of
December 31, 2005 and 2006, 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, 2006. 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 Jusan SA, a 50% owned affiliate for the years ended
December 31, 2005 and 2006, in which the Company's investments totaled $ 1,615
thousand and $ 1,598 thousand as of December 31, 2005 and 2006, respectively and
the Company's equity in its income in 2004, 2005 and 2006 constitutes $ 225
thousand $ 2 thousand and $ 159 thousand, respectively. We also did not audit
the financial statements of MTS Asia Ltd., a wholly-owned subsidiary, which
statements reflect total assets of $ 302 thousand as of December 31, 2006, and
total revenues of $ 624 thousand for the year then ended. Those statements were
audited by other auditors whose reports have been furnished to us and our
opinion, insofar as it relates to amounts emanating from the financial
statements of Jusan SA and MTS Asia Ltd., is based solely on the reports of the
other auditors.
We conducted our audits in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. We were not engaged to
perform an audit of the Company's internal control over financial reporting. Our
audits included consideration of internal control over financial reporting as a
basis for designing audit procedures that are appropriate in the circumstances,
but not for the purpose of expressing an opinion on the effectiveness of the
Company's internal control over financial reporting. Accordingly, we express no
such opinion. An audit also includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits and the reports of other auditors provide a reasonable basis for our
opinion.
In our opinion, based on our audits 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, 2005 and 2006, and the consolidated results of
their operations and their cash flows for each of the three years in the period
ended December 31, 2006, in conformity with accounting principles generally
accepted in the United States.
As discussed in Note 2 to the consolidated financial statements, in 2006,
the Company adopted Financial Accounting Standard Board Statement No. 123(R),
"Share-Based Payment".
/s/ Kost Forer Gabbay & Kasierer
------------------------------------
Tel-Aviv, Israel KOST FORER GABBAY & KASIERER
March 30, 2007 A Member of Ernst & Young Global
F - 2
MER TELEMANAGEMENT SOLUTIONS LTD.
AND ITS SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
DECEMBER 31,
-----------------
2005 2006
------- -------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 3,191 $ 1,474
Short term bank deposits - 100
Marketable securities (Note 3) 132 159
Trade receivables (net of allowance for doubtful accounts of $ 402 and $ 505 at
December 31, 2005 and 2006, respectively) 1,895 2,484
Unbilled receivables 104 51
Other accounts receivable and prepaid expenses (Note 4) 491 763
Inventories (Note 5) 181 138
------- -------
TOTAL current assets 5,994 5,169
------- -------
LONG-TERM ASSETS:
Investments in an affiliate (Note 6) 1,615 1,598
Long-term loans, net of current maturities (Note 7) 3 -
Severance pay fund 478 673
Other investments (Note 8) 347 366
Deferred income taxes (Note 14) 115 112
------- -------
TOTAL long-term assets 2,558 2,749
------- -------
PROPERTY AND EQUIPMENT, NET (Note 9) 571 439
------- -------
OTHER ASSETS:
Goodwill (Note 10a) 3,700 4,058
Other intangible assets, net (Note 10b) 993 1,639
TOTAL other assets 4,693 5,697
------- -------
TOTAL assets $13,816 $14,054
======= =======
The accompanying notes are an integral part of the consolidated financial
statements.
F - 3
MER TELEMANAGEMENT SOLUTIONS LTD.
AND ITS SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE AND PER SHARE DATA)
DECEMBER 31,
--------------------
2005 2006
-------- --------
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Short term bank credit and current maturities on bank loan $ - $ 421
Trade payables 735 510
Accrued expenses and other liabilities (Note 11) 2,306 2,507
Deferred revenues 888 1,545
-------- --------
TOTAL current liabilities 3,929 4,983
-------- --------
LONG-TERM LIABILITIES:
Long term bank loan (Note 12) - 583
Accrued severance pay 713 946
-------- --------
TOTAL long-term liabilities 713 1,529
-------- --------
COMMITMENTS AND CONTINGENT LIABILITIES (Note 13)
SHAREHOLDERS' EQUITY (Note 16):
Share capital -
Ordinary shares of NIS 0.01 par value - Authorized: 12,000,000 shares at
December 31, 2005 and 2006; Issued: 5,744,304 and 5,784,645 shares at
December 31, 2005 and 2006, respectively; Outstanding: 5,733,504 and
5,773,845 shares at December 31, 2005 and 2006, respectively 17 17
Additional paid-in capital 15,966 16,109
Treasury shares (10,800 Ordinary shares at December 31, 2005 and 2006) (29) (29)
Deferred stock compensation (142) -
Accumulated other comprehensive income (loss) (75) 254
Accumulated deficit (6,563) (8,809)
-------- --------
TOTAL shareholders' equity 9,174 7,542
-------- --------
TOTAL liabilities and shareholders' equity $ 13,816 $ 14,054
======== ========
The accompanying notes are an integral part of the consolidated financial
statements.
F - 4
MER TELEMANAGEMENT SOLUTIONS LTD.
AND ITS SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE AND PER SHARE DATA)
YEAR ENDED DECEMBER 31,
-----------------------------------------
2004 2005 2006
----------- ----------- -----------
Revenues (Note 17):
Product sales $ 7,070 $ 7,628 $ 7,518
Services 2,343 3,935 2,966
----------- ----------- -----------
TOTAL revenues 9,413 11,563 10,484
----------- ----------- -----------
Cost of revenues:
Product sales 2,407 2,968 2,631
Services 407 834 724
----------- ----------- -----------
TOTAL cost of revenues 2,814 3,802 (*)3,355
----------- ----------- -----------
Gross profit 6,599 7,761 7,129
----------- ----------- -----------
Operating expenses:
Research and development, net of grants from the OCS in the amount
of $ 0, $ 130, $ 578 in 2004, 2005 and 2006, respectively 2,362 4,395 (*)3,633
Selling and marketing 6,300 4,797 (*)3,078
General and administrative 2,101 2,830 (*)2,651
----------- ----------- -----------
TOTAL operating expenses 10,763 12,022 9,362
----------- ----------- -----------
Operating loss (4,164) (4,261) (2,233)
Financial income (expenses), net 78 53 (54)
----------- ----------- -----------
Loss before taxes on income (4,086) (4,208) (2,287)
Taxes on income (Note 14) 266 10 118
----------- ----------- -----------
Loss before equity in earnings of affiliate (4,352) (4,218) (2,405)
Equity in earnings of affiliate 225 2 159
----------- ----------- -----------
Net loss $ (4,127) $ (4,216) $ (2,246)
=========== =========== ===========
Net loss per share:
Basic and diluted net loss per Ordinary share $ (0.89) $ (0.83) $ (0.39)
=========== =========== ===========
Weighted average number of Ordinary shares used in computing basic
and diluted net loss per share 4,634,413 5,092,117 5,762,311
=========== =========== ===========
(*) Including stock-based employee compensation in the amounts of $ 21, $ 101,
$ 17 and $ 71 in cost of revenues, research and development, selling and
marketing and general and administrative, respectively.
The accompanying notes are an integral part of the consolidated financial
statements.
F - 5
MER TELEMANAGEMENT SOLUTIONS LTD.
AND ITS SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
ACCUMULATED
SHARE CAPITAL ADDITIONAL DEFERRED OTHER ACCUMULATED TOTAL TOTAL
--------------------- PAID-IN TREASURY STOCK COMPREHENSIVE EARNINGS COMPREHENSIVE SHAREHOLDERS'
NUMBER AMOUNT CAPITAL SHARES COMPENSATION INCOME (LOSS) DEFICIT) INCOME (LOSS) EQUITY
--------- -------- -------- ---------- ----------- -------- ----------- ----------- --------
Balance as of January 1, 2004 4,624,471 $ 14 $ 12,613 $ (20) $ (10) $ 87 $ 1,780 $ 14,464
Exercise of options 17,333 *) - 2 - - - - 2
Employee stock based compensation - - 264 - (264) - - -
Amortization of deferred stock compensation - - - - 66 - - 66
Purchase of treasury shares (3,800) - - (9) - - - (9)
Other comprehensive loss:
Unrealized gains on available-for-sale
marketable securities, net - - - - - 83 - $ 83 83
Foreign currency translation adjustments - - - - - 171 - 171 171
Gain from cash flows hedging transaction - - - - - 7 - 7 7
-----------
Total other comprehensive income - 261
Net loss - - - - - - (4,127) (4,127) (4,127)
--------- -------- -------- ---------- ----------- -------- ----------- ----------- --------
Total comprehensive loss $ (3,866)
===========
Balance as of December 31, 2004 4,638,004 14 12,879 (29) (208) 348 (2,347) 10,657
Issuance of shares, net 937,500 2 2,623 - - - - 2,625
Exercise of options 158,000 1 308 - - - - 309
Stock based compensation related to warrants
issued to non employees - - 156 - - - - 156
Amortization of deferred stock compensation - - - - 66 - - 66
Other comprehensive loss:
Unrealized losses on available-for-sale
marketable securities, net - - - - - (76) - $ (76) (76)
Foreign currency translation adjustments - - - - - (347) - (347) (347)
-----------
Total other comprehensive loss (423)
Net loss - - - - - - (4,216) (4,216) (4,216)
--------- -------- -------- ---------- ----------- -------- ----------- ----------- --------
Total comprehensive loss $ (4,639)
===========
Balance as of December 31, 2005 5,733,504 17 15,966 (29) (142) (75) (6,563) 9,174
Exercise of options 40,341 *) - 65 - - - - 65
Stock based compensation related to warrants
issued to non employees - - 10 - - - - 10
Stock based compensation related to options issued
to employees - - 210 - - - - 210
Reclassification of deferred stock compensation
due to implementation of SFAS 123R - - (142) - 142 - - -
Other comprehensive loss:
Unrealized gains on available-for-sale
marketable securities, net - - - - - 1 - $ 1 1
Foreign currency translation adjustments - - - - - 328 - 328 328
-----------
Total other comprehensive income - - - - - - - 329
Net loss - - - - - - (2,246) (2,246) (2,246)
--------- -------- -------- ---------- ----------- -------- ----------- ----------- --------
Total comprehensive loss $ (1,917)
===========
Balance as of December 31, 2006 5,773,845 $ 17 $ 16,109 $ (29) $ - $ 254 $ (8,809) $ 7,542
========= ======== ======== ========== =========== ======== =========== ========
Accumulated unrealized gains from available-for-sale
marketable securities $ 11
Accumulated foreign currency translation adjustments 243
--------
$ 254
========
*) Represents an amount lower than $ 1.
The accompanying notes are an integral part of the consolidated financial
statements.
F - 6
MER TELEMANAGEMENT SOLUTIONS LTD.
AND ITS SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
YEAR ENDED DECEMBER 31,
------------------------------
2004 2005 2006
-------- -------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (4,127) $ (4,216) $ (2,246)
Adjustments required to reconcile net loss to net cash used in
operating activities:
Gains on sale of available-for-sale marketable securities - (77) (13)
Loss on sale of property and equipment 1 - -
Impairment of other investments - 27 -
Equity in earnings of affiliate (225) (2) (159)
Depreciation and amortization 399 655 675
Deferred income taxes, net 33 10 3
Employee stock-based compensation 66 66 210
Stock based compensation related to warrants issued to non
employees - 156 10
Accrued severance pay, net 2 119 38
Decrease (increase) in trade receivables and unbilled
receivables 144 (672) (549)
Decrease (increase) in other accounts receivable and prepaid
expenses 175 (99) (321)
Decrease (increase) in inventories 15 (3) 43
Increase (decrease) in trade payables 326 16 (218)
Increase (decrease) in accrued expenses and other liabilities 611 (46) 168
Increase (decrease) in deferred revenues (41) (366) 610
Increase in related parties, net 20 15 140
-------- -------- --------
Net cash used in operating activities (2,601) (4,417) (1,609)
-------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sale of property and equipment 22 7 1
Purchase of property and equipment (293) (251) (107)
Capitalization of research and development costs (386) - -
Investment in short term bank deposit - - (100)
Investment in lease deposits (5) (26) (6)
Investment in available-for-sale marketable securities (220) (163) (221)
Proceeds from sale of available-for-sale marketable securities 891 1,089 208
Additional investment in goodwill in consideration of
TeleKnowledge acquisition - (21) (204)
Acquisition of certain assets and liabilities of
Teleknowledge (a) (2,445) - -
Acquisition of certain assets and liabilities of Telsoft (a) - - (1,202)
Dividend from an affiliate 136 195 409
Others 50 63 16
-------- -------- --------
Net cash provided by (used in) investing activities (2,250) 893 (1,206)
-------- -------- --------
The accompanying notes are an integral part of the consolidated financial
statements.
F - 7
MER TELEMANAGEMENT SOLUTIONS LTD.
AND ITS SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
YEAR ENDED DECEMBER 31,
------------------------------
2004 2005 2006
-------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from long term loan $ - $ - $ 1,000
Proceeds from short term bank credit - - 4
Repayment of long-term loans (8) - -
Proceeds from issuance of shares and warrants, net - 2,625 -
Proceeds from exercise of options and warrants 2 281 94
Purchase of treasury shares (9) - -
-------- -------- --------
Net cash provided by (used in) financing activities (15) 2,906 1,098
-------- -------- --------
Effect of exchange rate changes on cash and cash equivalents (4) (5) -
-------- -------- --------
Decrease in cash and cash equivalents (4,870) (623) (1,717)
Cash and cash equivalents at the beginning of the year 8,684 3,814 3,191
-------- -------- --------
Cash and cash equivalents at the end of the year $ 3,814 $ 3,191 $ 1,474
======== ======== ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOWS ACTIVITIES:
Cash paid during the year for:
Interest $ 1 $ 3 $ 38
======== ======== ========
Income taxes $ 25 $ 17 $ 118
======== ======== ========
(a) IN CONJUNCTION WITH THE ACQUISITIONS, THE FAIR VALUES OF
ASSETS ACQUIRED AND LIABILITIES ASSUMED AT THE DATE OF
ACQUISITION WERE AS FOLLOWS (SEE NOTE 1C AND NOTE 1D):
Working capital (excluding cash and cash equivalents) $ 24 $ - $ (47)
Estimated fair value of assets acquired and liabilities
assumed at the acquisition date:
Property and equipment 40 - 5
Goodwill 1,391 - 166
Developed technology 690 - 433
Customer relationship 300 - 645
-------- -------- --------
$ 2,445 $ - $ 1,202
======== ======== ========
(b) SUPPLEMENTAL DISCLOSURE OF NON-CASH ACTIVITIES:
Earn out in respect of Teleknowledge acquisition $ - $ 264 $ 123
======== ======== ========
The accompanying notes are an integral part of the consolidated financial
statements.
F - 8
MER TELEMANAGEMENT SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE AND PER SHARE DATA)
NOTE 1: - GENERAL
a. Mer Telemanagement Solutions Ltd. ("the Company" or "MTS") was
incorporated on December 27, 1995. MTS and its subsidiaries
("the Group") design, develop, market and support a
comprehensive line of telecommunication management and
customer care & billing ("CC&B") solutions that enable
business organizations and other enterprises to improve the
efficiency and performance of all IP operations, and reduce
associated costs. The Group products include call accounting
and management products, fault management systems and web
based management solutions for converged voice, voice over
Internet Protocol, IP data and video and CC&B solutions. As
for MTS's subsidiaries, see Note 18.
b. MTS's products are designed to provide telecommunication and
information technology managers with tools to reduce
communication costs, recover charges payable by third parties,
and to detect and prevent abuse and misuse of telephone
networks including fault telecommunication usage.
The Group markets its products worldwide through distributors,
business telephone switching systems manufacturers and vendors
and its direct sales force. Several international private
automatic branch exchange ("PBX") manufacturers market the
Group's products as part of their PBX selling efforts or on an
Original Equipment Manufacturer ("OEM") basis. The Group is
highly dependent upon the active marketing and distribution of
its OEM's. If the Group is unable to effectively manage and
maintain a relationship with its OEM or any event negatively
affecting such dealer's financial condition, could cause a
material adverse effect on the Group's results of operations
and financial position. In 2004, 2005 and 2006, one major
customer generated 38%, 36% and 29% of the Group's revenues,
respectively.
Certain components and subassemblies included in the Group's
products are obtained from a single source or a limited group
of suppliers and subcontractors. If such supplier fails to
deliver the necessary components or subassemblies, the Company
may be required to seek alternative sources of supply. A
change in supplier could result in manufacturing delays, which
could cause a possible loss of sales and, consequently, could
adversely affect the Company's results of operations and
financial position.
MTS's shares are listed for trade on the Nasdaq Capital
Market.
c. On December 30, 2004, the Company and Teleknowledge Group Ltd.
("Teleknowledge") consummated an Assets Purchase Agreement
("the Agreement"). TeleKnowledge is a leading provider of
carrier-class billing and rating solutions. The integration of
Teleknowledge's billing solution enables MTS to offer an
end-to-end customer care and billing solution. Under the terms
of the Agreement, the Company acquired certain assets and
liabilities of Teleknowledge for the following consideration:
1. An initial consideration of $ 2,374 in cash.
F - 9
MER TELEMANAGEMENT SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE AND PER SHARE DATA)
NOTE 1: - GENERAL (CONT.)
2. Additional contingent consideration of up to an amount
of $ 3,650, based on post acquisition revenue
performance (calculated as 10% of renewal maintenance
fees and 20% of all other revenues from sales which
included Teleknowledge products), over a period of three
years. Such payments will be recorded as additional
goodwill, during the contingency period, when actual
revenue performance will be evaluated (see Note 10a). In
2005 and 2006 additional considerations of $285 and
$192, respectively, were recorded, in accordance with
the agreement.
3. In addition, the Company incurred transaction costs
totaling $ 71.
Prior to the acquisition, MTS and Teleknowledge had an OEM
relationship. The commercial arrangements and transactions
were settled before the date of the acquisition.
The acquisition was accounted for under the purchase method of
accounting in accordance with SFAS 141, "Business Combination"
("SFAS 141"). Accordingly, the purchase price has been
allocated to the assets acquired and the liabilities assumed
based on the estimated fair value at the date of acquisition.
The excess of the purchase price over the estimated fair value
of the net assets acquired has been recorded as goodwill.
Based upon a valuation of the tangible and intangible assets
acquired and the liabilities assumed, the Company has
allocated the total cost of the acquisition to Teleknowledge's
net assets at the date of acquisition, as follows:
Trade receivables $ 100
Property and equipment 40
Intangible assets:
Developed technology (four-year useful life) 690
Customer relationship (six-year useful life) 300
Goodwill 1,391
--------
Total assets acquired 2,521
Liabilities assumed - Deferred revenues (76)
--------
Net assets acquired $ 2,445
========
The valuation of the Company's developed technology was based
on the income approach, which reflects the future economic
benefits from Teleknowledge products. The value assigned to
customer relationship was based on the cost approach. Under
this approach, the customer relationship was valued by
calculating the savings realized by the Company through
obtaining a pre-existing customer relationship of
Teleknowledge.
Goodwill including accumulated earnout as of December 31, 2006
amounted to $ 1,868.
F - 10
MER TELEMANAGEMENT SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE AND PER SHARE DATA)
NOTE 1: - GENERAL (CONT.)
d. On July 25, 2006, the Company and Telsoft Solutions, Inc.
("Telsoft") consummated an Asset Purchase Agreement ("APA").
Telsoft is a provider of call accounting and TEM solutions to
organizations and the acquisition shall enable the Company to
increase its customer base. Under the terms of the APA, the
Company acquired certain assets and assumed certain enumerated
liabilities of Telsoft for the following consideration:
1. An initial consideration of $ 1,100 in cash.
2. Additional earn-out payments based on revenue milestones
for the 12 months period following the acquisition. Such
payments will be recorded as additional goodwill, during
the contingency period, when actual revenue performance
will be evaluated (see Note 10a).
The acquisition was completed on July 31, 2006.
In order to finance the acquisition, the Company signed a loan
agreement with Bank Hapoalim (the "Bank"), according to which
the Bank granted the Company a loan in the amount of
approximately $ 1,000 (see also Note 12).
The acquisition was accounted for under the purchase method of
accounting in accordance with SFAS 141, "Business Combination"
("SFAS 141"). Accordingly, the purchase price has been
allocated to the assets acquired and the liabilities assumed
based on the estimated fair value at the date of acquisition.
The excess of the purchase price over the estimated fair value
of the net assets acquired has been recorded as goodwill.
Based upon a valuation of the tangible and intangible assets
acquired and the liabilities assumed, the Company has
allocated the total cost of the acquisition to TelSoft's net
assets at the date of acquisition, as follows:
Property and equipment 5
Intangible assets:
Developed technology - ProductA
(six-year useful life) 270
Developed technology - Product B
(four-year useful life) 163
Customer relationship (six-year useful life) 645
Goodwill 166
--------
Total assets acquired 1,249
Liabilities assumed - Deferred maintenance (47)
--------
Net assets acquired $ 1,202
========
The valuation of the Company's developed technology was based
on the income approach, which reflects the future economic
benefits from TelSoft products. The value assigned to customer
relationship was based on the income approach. The fair value
of customer relationship was estimated by discounting to
present value, the cash flows that will be derived from
TelSoft's customers retained by MTS.
F - 11
MER TELEMANAGEMENT SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE AND PER SHARE DATA)
NOTE 1: - GENERAL (CONT.)
Pro forma results (Unaudited):
The following unaudited proforma information does not purport
to represent what the Company's results of operations would
have been had the acquisitions occurred on January 1, 2005 and
2006, nor does it purport to represent the results of
operations of the Company for any future period.
YEAR ENDED DECEMBER 31,
-----------------------
2005 2006
---------- ----------
Revenues $ 13,045 $ 12,032
========== ==========
Net loss from continuing operations $ (3,923) $ (1,888)
========== ==========
Basic and diluted net loss per share for continuing operations $ (0.77) $ (0.33)
========== ==========
Weighted average number of Ordinary shares in computation of basic
and diluted net loss per share 5,092,117 5,762,311
========== ==========
NOTE 2: - SIGNIFICANT ACCOUNTING POLICIES
The consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the
United States ("U.S. GAAP").
a. Use of estimates:
The preparation of financial statements in conformity with
generally accepted accounting principles requires management
to make estimates and assumptions that 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 majority of the revenues of the Company and certain of its
subsidiaries are generated in or linked to the U.S. dollar
("dollar"). In addition, a substantial portion of the
Company's and certain of its subsidiaries' costs is incurred
in dollars. Company's management believes that the dollar is
the currency of the primary economic environment in which the
Company and certain of its subsidiaries operate. Thus, the
functional and reporting currency of the Company and certain
of its subsidiaries is the dollar.
Accordingly, monetary accounts maintained in currencies other
than the dollar are remeasured into dollars in accordance with
SFAS No. 52, "Foreign Currency Translation". All transaction
gains and losses of the remeasurement of monetary balance
sheet items are reflected in the consolidated statements of
operations as financial income or expenses, as appropriate.
F - 12
MER TELEMANAGEMENT SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE AND PER SHARE DATA)
NOTE 2: - SIGNIFICANT ACCOUNTING POLICIES (CONT.)
For those foreign subsidiaries and affiliates, whose
functional currency has been determined to be their local
currency, assets and liabilities are translated at the year
end exchange rates and statements of operations items are
translated at the average exchange rate prevailing during the
period. The resulting translation adjustments are recorded as
a separate component of accumulated other comprehensive income
(loss) in shareholders' equity.
c. Principles of consolidation:
The consolidated financial statements include the accounts of
MTS and its wholly-owned subsidiaries. Intercompany
transactions and balances, including profits from intercompany
sales not yet realized outside the Group, have been eliminated
upon consolidation.
d. Cash equivalents:
The Company considers all short-term highly liquid investments
that are readily convertible to cash with original maturities
of three months or less to be cash equivalents.
e. Marketable securities:
The Company accounts for investments in debt and equity
securities (other than those accounted for under the equity
method of accounting) 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 classification of investments in
marketable debt and equity securities at the time of purchase
and reevaluates such determinations at each balance sheet
date.
The Company classifies all of its securities as available for
sale. Available for sale securitiesare carried at fair value,
with unrealized gains and losses reported in "accumulated
other comprehensive income (loss)" in shareholders' equity.
Realized gains and losses on sales of investments, are
included in earnings and are derived using the specific
identification method for determining the cost of securities.
Interest and dividends on securities are included in financial
income, net.
F - 13
MER TELEMANAGEMENT SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE AND PER SHARE DATA)
NOTE 2: - SIGNIFICANT ACCOUNTING POLICIES (CONT.)
f. Inventories:
Inventories are stated at the lower of cost or market value.
Inventory write-offs and write-down provisions are provided to
cover risks arising from slow moving items or technological
obsolescence.
The Company and its subsidiaries periodically evaluate the
quantities on hand relative to current and historical selling
prices and historical and projected sales volume. Based on
this evaluation, provisions are recorded when required to
write-off inventory according to its market value.
Cost is determined as follows:
Raw materials - using the "first in, first out" method.
Finished products are recorded on the basis of direct
manufacturing costs with the addition of allocable indirect
manufacturing costs.
g. Investments in an affiliate:
In these financial statements, the affiliated company is Jusan
S.A., a company held at a rate of 50% (which is not a
subsidiary), where the Company can exercise significant
influence over the operating and financial policy of the
affiliate.
The investment in the affiliate is accounted for by the equity
method, in accordance with Accounting Principle Board Opinion
No.18, "The Equity Method of Accounting for Investments in
Common Stock", ("APB No.18"). Profits on intercompany sales,
not realized through sales to third parties, were eliminated.
The excess of the purchase price over the fair value of net
tangible assets acquired has been attributed to goodwill.
Goodwill is reviewed annually (or more frequently if
circumstances indicate impairment has occurred) for impairment
in accordance with the provisions of Statement of Financial
Accounting Standard No. 142, "Goodwill and Other Intangible
Assets" ("SFAS No. 142").
Under APB 18, an impairment of value of an investment
accounted for under the equity method, which is other than a
temporary decline, should be recognized as a realized loss,
establishing a new carrying value for the investment. Factors
the Company considers in making this evaluation include: the
length of time and the extent to which the market value has
been lower than cost, the financial condition and near-term
prospects of the issuer, including cash flows of the investee
and any specific events which may influence the operations of
the issuer and the intent and ability of the Company to retain
its investments for a period of time sufficient to allow for
any anticipated recovery in market value. A current fair value
of an investment that is less than its carrying amount may
indicate an impairment of value of the investment. No
impairment losses were recorded during 2006.
F - 14
MER TELEMANAGEMENT SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE AND PER SHARE DATA)
NOTE 2: - SIGNIFICANT ACCOUNTING POLICIES (CONT.)
h. Investment in other companies:
The investment in these companies is stated at cost, since the
Group does not have the ability to exercise significant
influence over operating and financial policies of those
investments. The Company's investments in other companies are
reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount of an
investment may not be recoverable, in accordance with APB
No.18. As of December 31, 2006 and 2005, based on management's
most recent analyses, impairment losses in the amount of $ 0
and $ 27, respectively, have been identified and recorded.
i. Property and equipment:
Property and equipment are stated at cost, net of accumulated
depreciation. Depreciation is calculated using the
straight-line method, over the estimated useful lives of the
assets, at the following annual depreciation rates:
%
------------------------------------
Computers and peripheral equipment 33
Office furniture and equipment 6 - 20
Motor vehicles 15
Leasehold improvements Shorter of useful life or lease term
j. Impairment of long-lived assets:
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. As of December 31, 2006, no
impairment losses have been identified.
k. Goodwill:
Goodwill has been recorded as a result of acquisitions.
Goodwill is not amortized, but rather is subject to an annual
impairment test.
F - 15
MER TELEMANAGEMENT SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE AND PER SHARE DATA)
NOTE 2: - SIGNIFICANT ACCOUNTING POLICIES (CONT.)
SFAS No. 142 requires goodwill to be tested for impairment at
least annually or between annual tests if certain events or
indicators of impairment occur. The impairment test consists
of a comparison of the fair value of goodwill with its
carrying amount. If the carrying amount of goodwill exceeds
its fair value, an impairment loss is recognized in an amount
equal to that excess. Goodwill is tested for impairment at the
reporting unit level by a comparison of the fair value of a
reporting unit with its carrying amount. The Company has
elected to perform its analysis of goodwill at the end of the
third quarter of the year. During 2004, 2005 and 2006, no
impairment losses were identified (see also Note 10a).
l. Intangible assets:
Intangible assets are amortized over their useful lives using
a method of amortization that reflects the pattern in which
the economic benefits of the intangible assets are consumed or
otherwise used up, in accordance with SFAS 142. Developed
technology is amortized over a weighted average of four-six
years and customer relationship is amortized over a period of
six years. As for capitalized software costs, see n below.
m. Revenue recognition:
The Company generates revenues mainly from licensing the
rights to use its software products. Certain software licenses
require significant customization. The Company also generates
revenues from rendering maintenance, service bureau, support
and training. The Company sells its products directly to
end-users and indirectly through resellers and OEM's (who are
considered end users).
Revenues from software license agreements are recognized when
all criteria outlined in Statement of Position No. 97-2,
"Software Revenue Recognition" ("SOP No. 97-2") as amended are
met. 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 does not grant a right
of return to its customers.
Where software arrangements involve multiple elements, revenue
is allocated to each undelivered element based on vendor
specific objective evidence ("VSOE") of the fair values of
each undelivered element in the arrangement, in accordance
with the "residual method" prescribed by SOP No. 98-9,
"Modification of SOP No. 97-2, Software Revenue Recognition
With Respect to Certain Transactions". The VSOE used by the
Company to allocate the sales price to support services and
maintenance is based on the renewal rate charged when these
elements are sold separately. License revenues are recorded
based on the residual method. Under the residual method,
revenue is recognized for the delivered elements when (1)
there is VSOE of the fair values of all the undelivered
elements, and (2) all revenue recognition criteria of SOP No.
97-2, as amended, are satisfied. Under the residual method any
discount in the arrangement is allocated to the delivered
element.
Revenues from maintenance and support services are recognized
over the term of the maintenance and support agreement on a
straight line basis.
F - 16
MER TELEMANAGEMENT SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE AND PER SHARE DATA)
NOTE 2: - SIGNIFICANT ACCOUNTING POLICIES (CONT.)
Deferred revenues include unearned amounts received under
maintenance and support contracts, not yet recognized as
revenues.
Revenues from billing products which involve significant
customization of the Company's software to customer specific
specifications are recognized in accordance with Statement of
Position 81-1, "Accounting for Performance of
Construction-Type and Certain Production-Type Contracts",
using contract accounting on a percentage of completion
method, over the period from signing of the license through to
customer acceptance in accordance with the "Input Method". The
amount of revenue recognized is based on the total arrangement
and the percentage to completion achieved. The percentage to
completion is measured by monitoring progress using records of
actual costs incurred to date in the project compared with the
total estimated project requirement. Estimates of total
project requirements are based on prior experience of
customization, delivery and acceptance of the same or similar
technology and are reviewed and updated regularly by
management.
After delivery, if uncertainty exists about customer
acceptance of the software, license revenue is not recognized
until acceptance. Provisions for estimated losses on
uncompleted contracts are made in the period in which such
losses are first determined, in the amount of the estimated
loss on the entire contract. As of December 31, 2006, no such
estimated losses were identified.
Estimated gross profit or loss from long-term contracts may
change due to changes in estimates resulting from differences
between actual performance and original forecasts. Such
changes in estimated gross profit are recorded in results of
operations when they are reasonably determinable by
management, on a cumulative catch-up basis.
The Company believes that the use of the percentage of
completion method is appropriate as the Company has the
ability to make reasonably dependable estimates of the extent
of progress towards completion, contract revenues and contract
costs. In addition, contracts executed include provisions that
clearly specify the enforceable rights regarding services to
be provided and received by the parties to the contracts, the
consideration to be exchanged and the manner and terms of
settlement. In all cases the Company expects to perform its
contractual obligations and its licensees are expected to
satisfy their obligations under the contract.
Where arrangements recognized according to SOP 81-1 involve
maintenance and support services, revenues are recognized
according to Emerging Issues Task Force ("EITF"), Issue No.
00-21 "Revenue Arrangement with Multiple Deliverables" ("EITF
00-21").
According to EITF 00-21 a multiple-element arrangement (an
arrangement that involves the delivery or performance of
multiple products, services and/or rights to use assets) is
separated into more than one unit of accounting, if the
functionality of the delivered element is not dependent on the
undelivered element, there is vendor-specific objective
evidence (VSOE) of fair value of the undelivered element and
delivery of the delivered element(s) represents the
culmination of the earnings process for these elements. The
Company has established VSOE for maintenance and support
services based on the renewal rate charged when these elements
are sold separately and therefore, the arrangement
consideration is allocated to maintenance and support services
based on their relative VSOE.
F - 17
MER TELEMANAGEMENT SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE AND PER SHARE DATA)
NOTE 2: - SIGNIFICANT ACCOUNTING POLICIES (CONT.)
n. 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 and its subsidiaries' 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 grants received from
the Office of the Chief Scientist of Israel's Ministry of
Industry, Trade and Labor (see Note 13b).
Significant costs incurred by the Company and its subsidiaries
between completion of the working model and the point at which
the product is ready for general release, have been
capitalized.
Capitalized software costs are amortized by the greater of the
amount computed using the: 1) ratio that current gross
revenues from sales of the software to the total of current
and anticipated future gross revenues from sales of that
software, or 2) the straight-line method over the estimated
useful life of the product (three years). The Company assesses
the recoverability of this intangible asset on a regular basis
by determining whether the amortization of the asset over its
remaining life can be recovered through undiscounted future
operating cash flows from the specific software product sold.
Based on its most recent analyses, management believes that no
impairment of capitalized software development costs exists as
of December 31, 2006.
o. Government grants:
Royalty-bearing grants from the Government of Israel for
funding certain approved research and development projects are
recognized at the time the Company is entitled to such grants,
on the basis of the related costs incurred and recorded as a
deduction of research and development costs. Research and
development grants amounted $ 0, $ 130 and $ 578 in 2004, 2005
and 2006, respectively. Total royalties accrued or paid
amounted to $ 181, $ 198 and $ 187 in 2004, 2005 and 2006,
respectively and were recorded as part of the cost of goods
sold.
p. Income taxes:
The Company accounts for income taxes, in accordance with
Statement of Financial Accounting Standard No. 109,
"Accounting for Income Taxes" ("SFAS No. 109"). This statement
prescribes the use of the liability method whereby deferred
tax assets and liability account balances are determined based
on differences between financial reporting and tax bases of
assets and liabilities and are measured using the enacted tax
rates and laws that will be in effect when the differences are
expected to reverse. Valuation allowances are provided to
reduce deferred tax assets to their estimated realizable
value.
F - 18
MER TELEMANAGEMENT SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE AND PER SHARE DATA)
NOTE 2: - SIGNIFICANT ACCOUNTING POLICIES (CONT.)
q. Accounting for stock-based compensation:
On January 1, 2006, the Company adopted SFAS No. 123 (revised
2004), "Share-Based Payment" ("SFAS No. 123(R)") which
requires the measurement and recognition of compensation
expense based on estimated fair values for all share-based
payment awards made to employees and directors. SFAS No.
123(R) supersedes Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" ("APB No. 25"), for
periods beginning in fiscal year 2006. In March 2005, the
Securities and Exchange Commission issued Staff Accounting
Bulletin No. 107 ("SAB 107") relating to SFAS No. 123(R). The
Company has applied the provisions of SAB 107 in its adoption
of SFAS No. 123(R). SFAS No. 123(R) requires companies to
estimate the fair value of equity-based payment awards on the
date of grant using an option-pricing model. The value of the
portion of the award that is ultimately expected to vest is
recognized as an expense over the requisite service periods in
the Company's consolidated operations statements.
Prior to the adoption of SFAS No. 123(R), the Company
accounted for equity-based awards to employees and directors
using the intrinsic value method in accordance with APB No. 25
as allowed under SFAS No. 123, "Accounting for Stock-Based
Compensation" ("SFAS No. 123"). Pursuant to these accounting
standards, the Company recorded deferred compensation for
stock options granted to employees at the date of grant equal
to the excess of the market value of the underlying shares at
that date over the exercise price of the options.
The Company adopted SFAS No. 123(R) using the modified
prospective transition method, which requires the application
of the accounting standard starting from January 1, 2006, the
first day of the Company's fiscal year 2006. Under that
transition method, compensation cost recognized in the year
ended December 31, 2006, includes: (a) compensation cost for
all share-based payments granted prior to, but not yet vested
as of January 1, 2006, based on the grant date fair value
estimated in accordance with the original provisions of SFAS
No. 123, and (b) compensation cost for all share-based
payments granted subsequent to January 1, 2006, based on the
grant-date fair value estimated in accordance with the
provisions of SFAS No. 123(R). Results for prior periods have
not been restated.
The Company recognizes compensation expenses for the value of
its awards granted subsequent to January 1, 2006 based on the
straight line method over the requisite service period of each
of the awards, net of estimated forfeitures. SFAS No. 123(R)
requires forfeitures to be estimated at the time of grant and
revised, if necessary, in subsequent periods if actual
forfeitures differ from those estimates. Estimated forfeitures
are based on actual historical pre-vesting forfeitures.
Forfeitures were previously accounted for as they occurred,
but have been estimated with the adoption of SFAS No. 123(R)
for those awards not yet vested. For awards granted prior to
January 1, 2006, the Company recognizes compensation expenses
based on the accelerated attribution method over the requisite
service period of each of the awards. The net loss for the 12
months period ended December 31, 2006 was $ 22 lower than if
the Company had continued to account for share-based
compensation according to the accelerated attribution method.
F - 19
MER TELEMANAGEMENT SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE AND PER SHARE DATA)
NOTE 2: - SIGNIFICANT ACCOUNTING POLICIES (CONT.)
As a result of adopting SFAS No. 123(R) on January 1, 2006,
the Company's loss before taxes on income and operating loss
and net loss for the year ended December 31, 2006, were $ 144
lower, than if the Company had continued to account for
stock-based compensation under APB No. 25. Basic and diluted
net loss per share for the year ended December 31, 2006 were $
0.03 lower, than if the Company had continued to account for
stock-based compensation under APB No. 25.
The Company estimates the fair value of stock options granted
using the Black-Scholes-option pricing model. The
option-pricing model requires a number of assumptions, of
which the most significant are the expected stock price
volatility and the expected option term. Expected volatility
was calculated based upon actual historical stock price
movements. The expected term of options granted is based upon
historical experience and represents the period of time that
options granted are expected to be outstanding. The risk-free
interest rate is based on the yield from U.S. treasury bonds
with an equivalent term. The Company has historically not paid
dividends and has no foreseeable plans to pay dividends.
The fair value for options granted in 2004, 2005 and 2006 is
estimated at the date of grant using a Black-Scholes options
pricing model with the following weighted average assumptions:
YEAR ENDED DECEMBER 31,
------------------------
EMPLOYEE STOCK OPTIONS 2004 2005 2006
---------------------------------- ------ ------ ------
Expected volatility 71.8% 56.9% 74.5%
Risk-free interest 2.0% 3.9% 4.6%
Dividend yield 0.0% 0.0% 0.0%
Expected life (years) 2.2 4 4
The following table illustrates the effect on 2004 and 2005
net loss and earnings per share, assuming that the Company had
applied the fair value recognition provision of SFAS No. 123
on its stock-based employee compensation:
YEAR ENDED DECEMBER 31,
----------------------------
2004 2005
------------ ------------
Net loss available to Ordinary shares, as reported $ (4,127) $ (4,216)
Add: Stock-based employee compensation - intrinsic value 66 66
Deduct: Stock-based compensation expense determined under
fair value method for all awards, net of related tax effect (274) (264)
------------ ------------
Pro forma net loss $ (4,335) $ (4,414)
============ ============
Basic and diluted net loss per share, as reported $ (0.89) $ (0.83)
============ ============
Basic and diluted net loss per share, pro forma $ (0.94) $ (0.87)
============ ============
F - 20
MER TELEMANAGEMENT SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE AND PER SHARE DATA)
NOTE 2: - SIGNIFICANT ACCOUNTING POLICIES (CONT.)
r. Warranty costs:
The Company provides free warranty for up to 15 months for the
"OEM" distributors. A provision is recorded for probable costs
in connection with these services based on the Company's
experience.
The Company estimates the costs that may be incurred under its
basic limited 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 sold 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.
No changes to the provision have been recorded during 2006.
s. Fair value of financial instruments:
The following methods and assumptions were used by the Group
in estimating its fair value disclosures for financial
instruments:
The carrying amounts of cash and cash equivalents, short-term
bank deposits, trade receivables, other accounts receivable,
short-term bank credit and trade payables approximate their
fair value, due to the short-term maturity of such
instruments.
The fair value for marketable securities is based on quoted
market prices (see Note 3).
t. Severance pay:
The Company's liability for severance pay is calculated
pursuant to Israel's Severance Pay Law based on the most
recent salary of the employees multiplied by the number of
years of employment, as of the balance sheet date. Employees
are entitled to one month's salary for each year of employment
or a portion thereof. 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 may be withdrawn only upon the fulfillment
of the obligation pursuant to Israel's Severance Pay Law or
labor agreements. The value of the deposited funds is based on
the cash surrendered value of these policies, and includes
immaterial profits.
Severance expense for the years ended December 31, 2004, 2005
and 2006 amounted to approximately $ 344, $ 585 and $ 339,
respectively.
F - 21
MER TELEMANAGEMENT SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE AND PER SHARE DATA)
NOTE 2: - SIGNIFICANT ACCOUNTING POLICIES (CONT.)
u. Concentrations of credit risk:
Financial instruments that potentially subject the Company to
concentrations of credit risk consist principally of cash and
cash equivalents, short-term bank deposits, trade receivables,
marketable securities and long-term loans.
Cash and cash equivalents and short-term bank deposits are
deposited with major banks in Israel and major banks in United
States. Such deposits in the U.S. may be in excess of insured
limit 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 customers of the Company are located mainly in the U.S.
and Europe (see Note 17). The Company performs ongoing credit
evaluations of its customers. In certain circumstances, the
Company may require letters of credit, other collateral or
additional guarantees. The allowance for doubtful accounts is
determined with respect to specific debts that are doubtful of
collection according to management estimates.
The Company's marketable securities include investments in
equity securities and Israeli government securities.
Management believes that the portfolio is well diversified,
and accordingly, minimal credit risk exists with respect to
these marketable securities.
The Company has no off-balance-sheet concentration of credit
risk such as foreign exchange contracts, option contracts or
other foreign hedging arrangements.
v. Basic and diluted net earnings (loss) per share:
Basic net earnings (loss) per share is computed based on the
weighted average number of Ordinary shares outstanding during
each year. Diluted net earnings (loss) per share is computed
based on the weighted average number of Ordinary shares
outstanding during each year, plus potential Ordinary shares
considered outstanding during the year, in accordance with
Statement of Financial Accounting Standard No. 128, "Earnings
Per Share" ("SFAS No. 128").
The total number of shares related to the outstanding options
excluded from the calculation of diluted net loss per share
was 667,101, 1,011,584 and 685,410 for the years ended
December 31, 2004, 2005 and 2006, respectively.
w. Impact of recently issued accounting standards:
In July 2006, the FASB issued FASB Interpretation No. 48
"Accounting for Uncertainty in Income Taxes an Interpretation
of FASB Statement No. 109" ("FIN 48"). FIN 48 clarifies the
accounting for income taxes by prescribing the minimum
recognition threshold a tax position is required to meet
before being recognized in the financial statements. FIN 48
utilizes a two-step approach for evaluating tax positions.
Recognition (step one) occurs when an enterprise concludes
that a tax position, based solely on its technical merits, is
more-likely-than-not to be sustained upon examination.
F - 22
MER TELEMANAGEMENT SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE AND PER SHARE DATA)
NOTE 2: - SIGNIFICANT ACCOUNTING POLICIES (CONT.)
Measurement (step two) is only addressed if step one has been
satisfied (i.e., the position is more-likely-than-not to be
sustained). Under step two, the tax benefit is measured as the
largest amount of benefit, determined on a cumulative
probability basis that is more-likely-than-not to be realized
upon ultimate settlement.
FIN 48 applies to all tax positions related to income taxes
subject to the Financial Accounting Standard Board Statement
No. 109, "Accounting for income taxes" ("FAS 109"). This
includes tax positions considered to be "routine" as well as
those with a high degree of uncertainty.
FIN 48 has expanded disclosure requirements, which include a
tabular roll forward of the beginning and ending aggregate
unrecognized tax benefits as well as specific detail related
to tax uncertainties for which it is reasonably possible the
amount of unrecognized tax benefit will significantly increase
or decrease within twelve months. These disclosures are
required at each annual reporting period unless a significant
change occurs in an interim period.
FIN 48 is effective for fiscal years beginning after December
15, 2006. The cumulative effect of applying FIN 48 will be
reported as an adjustment to the opening balance of retained
earnings.
The Company is currently evaluating the effect of the adoption
of FIN 48 on its financial statements.
In September 2006, the FASB issued SFAS No. 157, "Fair Value
Measurements" ("SFAS No. 157"). This statement provides a
single definition of fair value, a framework for measuring
fair value, and expanded disclosures concerning fair value.
Previously, different definitions of fair value were contained
in various accounting pronouncements creating inconsistencies
in measurement and disclosures. SFAS No. 157 applies under
those previously issued pronouncements that prescribe fair
value as the relevant measure of value, except SFAS No. 123(R)
and related interpretations. The statements does not apply to
accounting standard that require or permit measurement similar
to fair value but are not intended to measure fair value. This
pronouncement is effective for fiscal years beginning after
November 15, 2007. The Company is currently evaluating the
impact of adopting SFAS 157.
In February 2007, the FASB issued SFAS No. 159, "The Fair
Value Option for Financial Assets and Financial Liabilities"
("SFAS No. 159"). This statement provides companies with an
option to report selected financial assets and liabilities at
fair value. Generally accepted accounting principles have
required different measurement attributes for different assets
and liabilities that can create artificial volatility in
earnings. The Standard's objective is to reduce both
complexity in accounting for financial instruments and the
volatility in earnings caused by measuring related assets and
liabilities differently. This Statement is effective as of the
beginning of an entity's first fiscal year beginning after
November 15, 2007. The Company is currently evaluating the
impact of adopting SFAS 159.
F - 23
MER TELEMANAGEMENT SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE AND PER SHARE DATA)
NOTE 3: - MARKETABLE SECURITIES
The following is a summary of the Company's investment in marketable
securities:
DECEMBER 31, 2005 DECEMBER 31, 2006
---------------------------------------------- ----------------------------------------------
GROSS GROSS FAIR GROSS GROSS FAIR
AMORTIZED UNREALIZED UNREALIZED MARKET AMORTIZED UNREALIZED UNREALIZED MARKET
COST GAINS LOSSES VALUE COST GAINS LOSSES VALUE
--------- ---------- ---------- -------- --------- ---------- ---------- --------
Available-for-sale:
Equity securities $ 35 $ 12 $ (5) $ 42 $ 40 $ 5 $ (2) $ 43
Corporate bonds - - - - 45 1 - 46
Israeli Government
debts 87 4 (1) 90 63 7 - 70
--------- ---------- ---------- -------- --------- ---------- ---------- --------
$ 122 $ 16 $ (6) $ 132 $ 148 $ 13 $ (2) $ 159
========= ========== ========== ======== ========= ========== ========== ========
The gross realized gains on sales of available-for-sale securities
totaled $ 0, $ 77 and $ 13 in 2004, 2005 and 2006, respectively,
recorded in financial income. The net adjustment to unrealized
holding gains (losses) on available-for-sale securities included as
a separate component of shareholders' equity, "Accumulated other
comprehensive gains (losses)" amounted to $ 83, $ (76) and $ 1 in
2004, 2005 and 2006, respectively.
None of the unrealized loss as of December 31, 2006, are outstanding
over than 12 months period.
The amortized cost and fair value of debt and marketable equity
securities as of December 31, 2006, by contractual maturity, are
shown below.
DECEMBER 31, 2006
------------------
FAIR
AMORTIZED MARKET
COST VALUE
------------------
Matures after one year through five years $ 63 $ 70
Matures after five years through ten years 29 30
Matures after ten years 16 16
Equity securities - No definite maturity date 40 43
--------- ------
Total $ 148 $ 159
========= ======
F - 24
MER TELEMANAGEMENT SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE AND PER SHARE DATA)
NOTE 4: - OTHER ACCOUNTS RECEIVABLE AND PREPAID EXPENSES
DECEMBER 31,
---------------------
2005 2006
--------- ---------
Grants receivable from the Office of the Chief Scientist $ 130 $ 454
Government authorities 75 77
Prepaid expenses 142 147
Deferred income taxes (1) 14 14
Others 130 71
--------- ---------
$ 491 $ 763
========= =========
(1) See Note 14d.
NOTE 5: - INVENTORIES
DECEMBER 31,
---------------------
2005 2006
--------- ---------
Raw materials $ 58 $ 57
Finished products 123 81
--------- ---------
$ 181 $ 138
========= =========
NOTE 6: - INVESTMENTS IN AFFILIATE
a. Composed as follows:
DECEMBER 31,
---------------------
2005 2006
--------- ---------
Investment in Jusan S.A. (50% owned)
Equity, net (1) $ 1,580 $ 1,563
Goodwill 35 35
--------- ---------
$ 1,615 $ 1,598
========= =========
(1) Investment as of purchase date $ 1,171 $ 1,171
Retained earnings (Net of dividends) 409 392
--------- ---------
$ 1,580 $ 1,563
========= =========
Dividend received from Jusan S.A. during the year $ 195 $ 409
========= =========
F - 25
MER TELEMANAGEMENT SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE AND PER SHARE DATA)
NOTE 6: - INVESTMENTS IN AFFILIATE (CONT.)
b. Summarized financial information of Jusan S.A. (50% owned):
DECEMBER 31,
------------------
2005 2006
-------- -------
Current assets $ 4,177 $ 3,743
Non-current assets $ 45 $ 88
Current liabilities $ (1,057) $ (694)
YEAR ENDED DECEMBER 31,
----------------------------
2004 2005 2006
------- -------- -------
Revenues $ 6,892 $ 5,682 $ 5,462
Gross profit $ 3,158 $ 2,530 $ 2,658
Net income $ 444 $ 4 $ 318
NOTE 7: - LONG-TERM LOAN, NET OF CURRENT MATURITIES
The Company's long term loans include a loan granted to the
purchaser of Silverbyte Ltd. shares which were sold by the Company
in July, 2000. The loan will be fully repaid in April 2007.
a. Composed as follows:
DECEMBER 31,
------------------
2005 2006
-------- -------
Loan to others in NIS - unlinked (1) $ 21 $ 4
Less - current maturities (2) 18 4
-------- -------
$ 3 $ -
======== =======
(1) The weighted average interest rate for the years ended
December 31, 2005 and 2006 is 7.65%.
(2) Included in other accounts receivable.
b. As of December 31, 2006, the aggregate annual maturities of
long-term loans are as follows:
2007 (current maturities) $ 4
========
F - 26
MER TELEMANAGEMENT SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE AND PER SHARE DATA)
NOTE 8: - OTHER INVESTMENTS
DECEMBER 31,
-----------------
2005 2006
------- -------
Long-term leasing deposits (1) $ 27 $ 46
Investment in other companies 320 320
------- -------
$ 347 $ 366
======= =======
(1) Linked to the Israeli CPI.
NOTE 9: - PROPERTY AND EQUIPMENT
DECEMBER 31,
-----------------
2005 2006
------- -------
Cost:
Computers and peripheral equipment $ 3,022 $ 3,118
Office furniture and equipment 566 572
Motor vehicles 48 48
Leasehold improvements 140 150
------- -------
3,776 3,888
Accumulated depreciation: 3,205 3,449
------- -------
Depreciated cost $ 571 $ 439
======= =======
The depreciation expense for the years ended December 31, 2004, 2005
and 2006 amounted to $ 211, $ 254 and $ 243, respectively.
NOTE 10: - GOODWILL AND OTHER INTANGIBLE ASSETS
a. Goodwill:
The changes in the carrying amount of goodwill for the year
ended December 31, 2005 are as follows:
Balance as of January 1, 2005 $ 3,415
Additional consideration in conjunction with TK
acquisition based on post-contract billing revenues,
see Note 1(c) 285
-------
Balance as of December 31, 2005 3,700
Additional consideration in conjunction with TK
acquisition based on post-contract billing revenues,
see Note 1(c) 192
Goodwill acquired during the year (see Note 1d) 166
-------
Balance as of December 31, 2006 $ 4,058
=======
F - 27
MER TELEMANAGEMENT SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE AND PER SHARE DATA)
NOTE 10: - GOODWILL AND OTHER INTANGIBLE ASSETS (CONT.)
b. Other intangibles consist of the following:
DECEMBER 31,
-----------------
2005 2006
------- -------
Cost:
Development technology $ 1,440 $ 1,873
Capitalized software development costs 386 386
Customer relationship 300 945
------- -------
2,126 3,204
------- -------
Accumulated amortization:
Development technology 923 1,131
Capitalized software development costs 160 289
Customer relationship 50 145
------- -------
1,133 1,565
------- -------
Amortized cost $ 993 $ 1,639
======= =======
Intangible assets resulted from acquisitions of IntegraTrak
and TelSoft (see Note 1d), the Company's U.S. subsidiaries and
TeleKnowledge (see Note 1c).
c. Amortization expenses amounted to $ 188, $ 401 and $ 432 for
each of the years ended December 31, 2004, 2005 and 2006,
respectively.
d. Estimated amortization expenses for:
YEAR ENDED DECEMBER 31,
-----------------------------------------
2007 $ 512
2008 416
2009 243
2010 227
2011 153
2012 88
-------
$ 1,639
=======
F - 28
MER TELEMANAGEMENT SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE AND PER SHARE DATA)
NOTE 11: - ACCRUED EXPENSES AND OTHER LIABILITIES
DECEMBER 31,
-----------------
2005 2006
------- -------
Employees and payroll accruals $ 991 $ 949
Income tax payable 291 498
Accrued expenses 760 638
Customer advances 187 205
Related parties 77 217
------- -------
$ 2,306 $ 2,507
======= =======
NOTE 12: - LONG-TERM BANK LOAN
a. Composed as follows:
2006
-------
Long-term loan $ 1,000
Less - current maturities 417
-------
$ 583
=======
The loan bears annual interest at a rate of the monthly LIBOR
+ 2%, payable on a monthly basis on the outstanding loan
amount commencing August 31, 2006. The loan principal shall be
repaid in twelve equal monthly installments commencing August
31, 2007.
b. As of December 31, 2006, the aggregate annual maturities of
long-term loans are as follows:
2007 (current maturities) $ 417
2008 583
-------
$ 1,000
=======
c. The loan agreement includes the following covenants:
(i) The ratio between shareholders equity and total
shareholders equity and liabilities shall not be less
than 40% and in no event shall the Company's
shareholders equity decrease below $ 5,000 thousand.
(ii) The Company will generate operating income for each of
the two subsequent quarters commencing the second
quarter of 2007 and onwards.
(iii) The Company's cash and cash equivalents shall not
decrease below $ 1,000 at any given time.
In the event that the Company violates one of the above
covenants the loan shall become immediately due.
d. To secure the loan, the Company provided the Bank a floating
charge on all its current and long term assets and a fixed
charge on its goodwill and on its authorized but not
outstanding shareholders equity.
F - 29
MER TELEMANAGEMENT SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE AND PER SHARE DATA)
NOTE 13: - COMMITMENTS AND CONTINGENT LIABILITIES
a. Lease commitments:
The facilities of the Company and its subsidiaries are rented
under operating leases for periods ending May 2007 through
June 2010.
Future minimum lease commitments under non-cancelable
operating leases as of December 31, 2006 are as follows:
2007 $ 357
2008 352
2009 292
2010 134
--------
$ 1,135
========
Lease expenses for the years ended December 31, 2004, 2005 and
2006 were approximately $ 334, $ 489 and $ 479, respectively.
b. Royalty commitments:
1. The Company is committed to pay royalties to the Office
of the Chief Scientist of the Ministry of Trade ("OCS")
of the Government of Israel on proceeds from sales of
products resulting from the research and development
projects in which the Government participated. In the
event that development of a specific product in which
the OCS participated is successful, the Company will be
obligated to repay the grants through royalty payments
at the rate of 3% to 5% based on the sales of the
Company, up to 100%-150% of the grants received linked
to the dollar. As of December 31, 2006, the Company has
a contingent liability to pay royalties in the amount of
$ 9,486. The obligation to pay these royalties is
contingent upon actual sales of the products and, in the
absence of such sales, no payment is required.
The Company has paid or accrued royalties in its cost of
revenues relating to the repayment of such grants in the
amount of $ 181, $ 198 and $ 186 for the years ended
December 31, 2004, 2005 and 2006, respectively.
2. The Israeli Government, through the Fund for
Encouragement of Marketing Activities, awarded the
Company grants for participation in foreign marketing
expenses. The Company is committed to pay royalties at
the rate of 3% of the increase in export sales, up to
the amount of the grants received linked to the U.S.
dollar. As of December 31, 2006, the Company has a
contingent obligation to pay royalties in the amount of
$ 259.
F - 30
MER TELEMANAGEMENT SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE AND PER SHARE DATA)
NOTE 13: - COMMITMENTS AND CONTINGENT LIABILITIES (CONT.)
c. Claims and demands:
1. In April 2000, the Tax Authorities in Israel issued to
the Company a demand for a tax payment, for the period
of 1997-1999, in the amount of approximately NIS 6,000
thousand ($ 1,420).
The Company has appealed to the Israeli Tel Aviv
district court in respect of the abovementioned tax
demand. The Company believes that certain defenses can
be raised against the demand of the tax authorities. The
Company believes that the outcome of this matter will
not have a material adverse effect on its financial
position or results of operations. The Company has
provided a provision for the amount considered probable.
2. On April 18, 2005, Amdocs (Israel) Ltd. and Amdocs Ltd.
("the plaintiffs") filed a complaint with the Tel-Aviv
District Court against the Company, its Chief Executive
Officer and others ("the Defendants") alleging, among
other things, that professional and commercial
information belonging to the plaintiffs was transferred
to the defendants for use in the Company's activity. The
plaintiffs are seeking an injunction prohibiting the
defendants from making any use of the information and
trade secrets that were allegedly transferred,
injunctions requiring the return of such information and
estimated damages of NIS 14,775 thousand (approximately
$ 3,500).
On June 27, 2005, the defendants filed a statement of
defense, in which the defendants claim that the factual
and legal allegations by the plaintiffs are baseless,
and the causes of action and relief requested are
without merit.
On March 22, 2007, the complaint had been dismissed
without prejudice by mutual agreement and following a
settlement between all parties to the complaint and with
no payment by any of the litigants.
3. On November 22, 2005, the Company received a letter from
one of its customer's legal counsel alleging, among
other things, that the Company materially breached the
agreement that was entered into with the customer who is
seeking full repayment of the amounts that were paid by
him under the agreement, including interest and
indemnification for damages. The Company cannot
currently assess the outcome of this claim or its
adverse effect on the Company's financial position or
results of operations.
4. On February 21, 2007, one of the Company's suppliers
("the plaintiffs") filed a complaint with the Kfar-Saba
Magistrate Court against the Company, in which he
demands payment of NIS 179 thousand (approximately $ 42)
with respect to electronic components that were ordered
by the Company. The Company made a provision in its
financial statements for this claimed amount. The
abovementioned claim is related to the claims raised in
Note 13c(3).
F - 31
MER TELEMANAGEMENT SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE AND PER SHARE DATA)
NOTE 13: - COMMITMENTS AND CONTINGENT LIABILITIES (CONT.)
5. On March 15, 2007, the Company received a letter from
one of its customer's legal counsel alleging, among
other things, that the Company materially breached an
agreement relating to its billing solutions which was
entered into on March 30, 2006. The customer is seeking
full repayment of the amounts that were paid by him
under the agreement in the amount of approximately $141
plus compensating damages as provided in the agreement.
The Company believes that the agreement cancellation was
unfounded and intends to vigorously pursue its rights
under the agreement. Due to the preliminary stage of
this matter, the Company and its legal advisors cannot
currently assess the outcome or possible adverse effect
on the Company's financial position or results of
operations.
d. Guarantees:
1. The Company provided a bank guarantee through April 2007
in the amount of $ 60 to secure its obligations under
one of its leasing agreements.
2. The Company provided a bank guarantee through February
2007 in the amount of $ 55 in favor of one of its
customers to secure its obligations under the agreement
that was signed by the parties.
3. The Company provided a bank guarantee through September
2010 in the amount of $ 190 to secure its obligations
under one of its leasing agreements.
NOTE 14: - TAXES ON INCOME
a. ISRAELI TAXATION:
1. CORPORATE TAX STRUCTURE:
Taxable income of Israeli companies is subject to tax at
the rate of 31% in 2006, 29% in 2007, 27% in 2008, 26%
in 2009 and 25% in 2010 and thereafter.
2. Tax benefits under the Law for the Encouragement of
Capital Investments, 1959 ("the Law"):
The Investment Law empowers the Israeli Investment
Center to grant Approved Enterprise status to capital
investments in production facilities that meet certain
relevant criteria ("Approved Enterprise"). In general,
such capital investments will receive Approved
Enterprise status if the enterprise is expected to
contribute to the development of the productive capacity
of the economy, absorption of immigrants, creation of
employment opportunities, or improvement in the balance
of payments.
F - 32
MER TELEMANAGEMENT SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE AND PER SHARE DATA)
NOTE 14: - TAXES ON INCOME (CONT.)
The tax benefits derived from any such Approved
Enterprise relate only to taxable income attributable to
the specific program of investment to which the status
was granted. Since MTS is operating more than one
"Approved Enterprise" program and since part of its
taxable income is not entitled to tax benefits under the
abovementioned law and is taxed at the regular corporate
tax rate, its effective tax rate is the result of a
weighted combination of the various applicable rate and
tax exemptions, and the computation is made for income
derived from each program on the basis of formulas
specified in the law and in the approvals.
MTS was granted the status of an "Approved Enterprise"
under the Law in respect of several different capital
expenditure programs. For all of such Approved
Enterprises, the Company elected to apply for
alternative tax benefits ("Alternative Package").
Accordingly, MTS Ltd.'s income attributed to the
Approved Enterprise under the alternative package is tax
exempt for a period of two years, commencing with the
year the Company earns taxable income, and subject to
corporate tax at the rate of 10% - 25% (depending on the
rate of foreign holdings in the Company), for additional
periods of five to eight years.
In the event of distribution of dividends from the said
tax-exempt income, the amount distributed will be
subject to corporate tax at the rate ordinarily
applicable to the Approved Enterprise's income.
The duration of tax benefits, for each of the Programs
is subject to limitations of the earlier of 12 years
from completion of the investment or commencement of
production, or 14 years from receipt of approval, as an
Approved Enterprise under the Law.
The entitlement to the above benefits is conditional
upon the Company's fulfilling the conditions stipulated
by the Law and regulations published thereunder.
Should MTS Ltd. fail to meet such requirements in the
future, income attributable to its Approved Enterprise
programs could be subject to the statutory Israeli
corporate tax rate and the Company could be required to
refund a portion of the tax benefits already received,
with respect to such programs.
On April 1, 2005, an amendment to the Investment Law
came into effect ("the Amendment") and has significantly
changed the provisions of the Investment Law. The
Amendment limits the scope of enterprises which may be
approved by the Investment Center by setting criteria
for the approval of a facility as a "Privileged
Enterprise" (rather than the previous terminology of
Approved Enterprise), such as a provision requiring that
at least 25% of the "Privileged Enterprise's" income
will be derived from export. Additionally, the Amendment
enacted major changes in the manner in which tax
benefits are awarded under the Investment Law so that
companies are no longer required for Investment Center
approval in order to qualify for tax benefits. The
period of tax benefits for a new "Privileged Enterprise"
commences in the "Year of Commencement". This year is
the later of: (1) the year in which taxable income is
first generated by the company, or (2) the Year of
Election.
F - 33
MER TELEMANAGEMENT SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE AND PER SHARE DATA)
NOTE 14: - TAXES ON INCOME (CONT.)
If a company requested the "Alternative Package" of
benefits for an Approved Enterprise under the old law
before the 2005 amendment, it is precluded from filing a
Year of Election notice for a "Privileged Enterprise"
for three years after the year in which the Approved
Enterprise was activated.
In addition, the Investment Law provides that terms and
benefits included in any certificate of approval already
granted will remain subject to the provisions of the law
as they were on the date of such approval. Therefore,
the existing Approved Enterprises will not be subject to
the provisions of the Amendment.
As a result of the amendment, tax-exempt income
generated under the provisions of the amended law, will
subject the Company to taxes upon dividend distribution
or complete liquidation.
Dividend distributed by an Approved Enterprise and
"Privileged Enterprise" will be subject to withholding
tax of 15%.
Out of the Company's retained earnings as of December
31, 2006 approximately $ 2,250 are tax exempt
attributable to its Approved Enterprise programs. . If
such tax exempt income is distributed in a manner other
than upon the complete liquidation of the Company, it
would be taxed at the reduced corporate tax rate
applicable to such profits (between 10%-25%) and an
income tax liability of up to approximately $ 562 would
be incurred as of December 31, 2006.
The Company's board of directors has determined that it
would not distribute any amounts of its undistributed
tax exempt income as dividend. The Company intends to
reinvest the amount of its tax exempt income.
Accordingly, no deferred income taxes have been provided
on income attributable to the Company's "Approved
Enterprise" as the undistributed tax exempt income is
essentially permanent in duration.
Income from sources other than the Approved Enterprise
is subject to tax at regular Israeli corporate tax rate.
3. Tax assessments:
Regarding the claim from the tax authorities in Israel,
see Note 13c(1). The Company has received final tax
assessments until the 1996 tax year.
4. Measurement of results for tax purposes 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 Consumer Price Index ("CPI"). As
explained in Note 2b, the financial statements are
presented in dollars. The difference between the annual
change in the CPI and in the NIS/dollar exchange rate
causes a further difference between taxable income and
the income before taxes presented in the financial
statements. In accordance with paragraph 9(f) of SFAS
109, MTS and its Israeli subsidiary have not provided
for deferred income taxes on the difference between the
functional currency and the tax bases of assets and
liabilities.
F - 34
MER TELEMANAGEMENT SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE AND PER SHARE DATA)
NOTE 14: - TAXES ON INCOME (CONT.)
5. Tax benefits under the Law for the Encouragement of
Industry (Taxation), 1969:
MTS is currently qualified as an "industrial company"
under the above law and, as such, is entitled to certain
tax benefits, mainly accelerated depreciation of
machinery and equipment, as prescribed by regulations
published under the Inflationary Adjustments Law, the
right to claim public issuance expenses and amortization
of intangible property rights as a deduction for tax
purposes.
b. Income taxes on non-Israeli subsidiaries:
Non Israeli subsidiaries are taxed according to the tax laws
in their respective country of residence.
c. Net operating losses carryforward:
As of December 31, 2006, the Company and its subsidiaries in
Israel, Asia and U.S. have an estimated total amount of
available carryforward tax losses of $ 10,705, $ 381 and $
437, respectively to offset against future taxable profits.
The operating tax loss carryforwards in Israel and in Hong
Kong (Asia) may be offset indefinitely against operating
income.
MTS IntegraTrak and MTS TelSoft are subject to U.S. income
taxes and have a net operating loss carryforward amounting to
approximately $ 437 as of December 31, 2006, which expires in
the years 2015 to 2021. Utilization of the U.S. net operating
losses may be subject to substantial annual limitation due to
the "change in ownership" provisions of the Internal Revenue
Code of 1986 and similar state provisions. The annual
limitation may result in the expiration of net operating
losses before utilization.
d. Deferred income taxes:
Deferred taxes reflect the net tax effects of temporary
differences between the carrying amounts of assets and
liabilities for financial reporting purposes and the amounts
used for income tax purposes. Significant components of the
Company's deferred tax liabilities and assets are as follows:
DECEMBER 31,
------------------
2005 2006
-------- -------
Tax loss carryforward of the Company $ 1,985 $ 2,416
Allowances for doubtful accounts and accruals for
employee benefits 57 69
In respect of marketable securities 47 47
Goodwill and other intangible assets-liability (208) (253)
Capitalized software and other intangible assets 76 304
Other 208 442
-------- -------
Net deferred tax asset before valuation allowance 2,176 3,025
Valuation allowance (2,036) (2,899)
-------- -------
Net deferred income taxes $ 129 $ 126
======== =======
Presented as follows:
Current assets - foreign $ 14 $ 14
======== =======
Other assets - foreign $ 115 $ 112
======== =======
F - 35
MER TELEMANAGEMENT SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE AND PER SHARE DATA)
NOTE 14: - TAXES ON INCOME (CONT.)
MTS and certain of its subsidiaries have provided valuation
allowances in respect of deferred tax assets resulting from
tax loss carryforward and other temporary differences, since
they have a history of losses over the past years. Management
currently believes that it is more likely than not that part
of the deferred tax regarding the loss carryforward in the
Company and other temporary differences will not be realized
in the foreseeable future.
e. A reconciliation between the theoretical tax expense, assuming
all income is taxed at the statutory tax rate applicable to
income of the Company and the actual tax expense as reported
in the statements of operations, is as follows:
YEAR ENDED DECEMBER 31,
------------------------------
2004 2005 2006
-------- -------- --------
Loss before taxes as reported in the
statements of operations $ (4,086) $ (4,208) $ (2,287)
======== ======== ========
Tax rates 35% 34% 31%
======== ======== ========
Theoretical tax benefit $ (1,430) $ (1,431) $ (709)
Increase in taxes resulting from:
Effect of different tax rates 2 38 (17)
Tax adjustment in respect of inflation in
Israel and others 12 (17) (9)
Utilization of carryforward tax losses for
which valuation allowance was provided (21) - (22)
Non-deductible expenses and tax exempt income - 10 13
Taxes and deferred taxes in respect of
previous years 256 (21) 112
Deferred taxes for which valuation allowance
was provided 1,447 1,431 750
-------- -------- --------
Taxes on income as reported in the statements
of operations $ 266 $ 10 $ 118
======== ======== ========
f. Loss before income taxes is comprised as follows:
Domestic $ (3,918) $ (4,042) $ (1,511)
Foreign (168) (166) (776)
-------- -------- --------
$ (4,086) $ (4,208) $ (2,287)
======== ======== ========
F - 36
MER TELEMANAGEMENT SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE AND PER SHARE DATA)
NOTE 14: - TAXES ON INCOME (CONT.)
g. Taxes on income are comprised as follows:
YEAR ENDED DECEMBER 31,
------------------------------
2004 2005 2006
-------- -------- --------
Current taxes $ 10 $ - $ 5
Deferred taxes 33 10 3
Taxes and deferred taxes in respect of
previous years 223 - 110
-------- -------- --------
$ 266 $ 10 $ 118
======== ======== ========
Domestic $ 256 $ - $ -
Foreign 10 10 118
-------- -------- --------
$ 266 $ 10 $ 118
======== ======== ========
NOTE 15: - RELATED PARTIES TRANSACTIONS AND BALANCES
a. On November 8, 1999, the Board of Directors and the audit
committee approved, subject to the shareholders' approval, an
increase in the monthly salary of the Chairman of the Board of
Directors from $ 5 to $ 7 per month and the grant of options
to purchase 98,824 Ordinary shares. The options were granted
to him at his request in lieu of salary for the 12 month
period ending December 31, 2000. The exercise price of the
options is $ 6 per share, expected dividend yield is 0%, and
the risk free interest rate is 6%. The options will vest
ratably over an eight-month period beginning January 1, 2000
and will terminate five years from the date of grant. The
options were forfeited by the end of the year 2004.
The wife of the Chairman of the Board of Directors provides
ongoing legal services to the Company and receives a monthly
retainer of $ 5. The conditions for retaining her services
were approved by the Company's Board of Directors and audit
committee.
MTS's subsidiaries, MTS Asia Ltd. and MTS IntegraTRAK, entered
into an agreement with C. Mer, pursuant to which they
distribute and support certain of C. Mer's (company under
common control) products and provide certain services on
behalf of C. Mer. Generally, C. Mer compensates MTS Asia Ltd.
for these activities at cost plus 10% and compensates MTS
IntegraTRAK at cost plus 5%.
b. In 2005 and 2006, the balance with C. Mer reflects short-term
debt and other receivables. Due to the short-term nature, no
interest was charged by or paid to C. Mer through December 31,
2005 and 2006.
F - 37
MER TELEMANAGEMENT SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE AND PER SHARE DATA)
NOTE 15: - RELATED PARTIES TRANSACTIONS AND BALANCES (CONT.)
c. Transactions with related parties were as follows:
YEAR ENDED DECEMBER 31,
------------------------------
2004 2005 2006
-------- -------- --------
Sales through related parties $ 15 $ - $ -
======== ======== ========
Amounts charged by related parties:
Cost of revenues $ 32 $ 8 $ 10
Operating expenses 7 42 60
-------- -------- --------
$ 39 $ 50 $ 70
======== ======== ========
Amounts charged by MTS Integra TRAK and MTS
Asia to related parties:
Selling and marketing $ 18 $ - $ 246
======== ======== ========
Payments from (repayments to) the related
parties, net $ 20 $ (80) $ (38)
======== ======== ========
d. Amounts due from an affiliate:
DECEMBER 31,
-------------------
2005 2006
-------- --------
Jusan S.A $ (18) $ (137)
======== ========
F - 38
MER TELEMANAGEMENT SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE AND PER SHARE DATA)
NOTE 16: - SHAREHOLDERS' EQUITY
a. Share capital:
The Ordinary shares entitle their holders the right to receive
notice to participate and vote in general meetings of MTS and
the right to receive cash dividends, if declared.
b. Private placement agreement:
On August 10, 2005, the Company has entered into definitive
agreements with institutional and private investors for a
private placement of Ordinary shares and warrants to purchase
Ordinary shares that has raised $ 2,625 (net of issuance costs
of approximately $ 200).
Pursuant to the agreements, MTS has issued an aggregate
937,500 Ordinary shares at $ 3.00 per share. In addition, the
Company provided the investors with warrants to purchase an
aggregate 375,000 additional Ordinary shares of MTS at an
exercise price of $ 4.00 per share. Each investor received
warrants to purchase two Ordinary shares for each five
Ordinary shares purchased. The warrants became exercisable six
months after their issuance and will expire within three and a
half years after they become exercisable.
c. Stock options:
MTS has authorized, through its 1996 Incentive Share Option
plan, the grant of options to officers, management, employees
and directors of MTS or any subsidiary of up to 1,900,000 of
MTS's Ordinary shares. Up to 1,500,000 options shall be
granted under the option plan pursuant to section 102 of the
Israel Income Tax Ordinance. Any option, which is canceled or
forfeited before expiration, will become available for future
grants.
Each option granted under the Plan is exercisable until the
earlier of five years from the date of the grant of the option
or the expiration dates of the option plan. 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 were
exercised. The options vest primarily gradually over three or
four years of employment.
In 2003, Section 102 of the Israeli Income Tax Ordinance was
amended effective as of January 1, 2003. Therefore MTS has
rolled-over the remaining options available at that time to be
granted under a new plan that conforms with the newly amended
provisions of Section 102 of the Israel Income Tax Ordinance.
The Incentive Share Option Plan will terminate in 2013, unless
cancelled earlier by MTS's board of directors.
In June 2006, MTS has authorized, through its 2006 Stock
Option plan ("2006 Plan"), the grant of options to officers,
management, employees and directors of MTS or any subsidiary
of up to 400,000 of MTS's Ordinary shares. Each option granted
under the 2006 Plan will be either an option intended to be
treated as an "incentive stock option," within the meaning of
Section 422 of the Internal Revenue Code of 1986, as amended,
or an option that will be treated as a "non-qualified stock
option."
F - 39
MER TELEMANAGEMENT SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE AND PER SHARE DATA)
NOTE 16: - SHAREHOLDERS' EQUITY (CONT.)
Each option granted under the Plan is exercisable until the
earlier of five years from the date of the grant of the option
or the expiration dates of the option plan. The exercise price
of the options granted under the plans may not be less than
the fair market value of an ordinary share determined as of
the date of grant of the option.
As of December 31, 2006, 665,574 options are available for
future grant.
d. A summary of option activity under the Company's Stock Option
as of December 31, 2006 and changes during the twelve months
ended December 31, 2006 are as follows:
WEIGHTED-
AVERAGE
WEIGHTED- REMAINING
AVERAGE CONTRACTUAL AGGREGATE
NUMBER OF EXERCISE TERM (IN INTRINSIC
OPTIONS PRICE YEARS) VALUE
----------- ----------- ----------- ---------
AUDITED
---------------------------------------------------
Outstanding at December 31, 2005 725,500 $ 2.66 2.68 $ -
Granted 60,000 $ 3.34 - -
Exercised (40,341) $ 1.61 - 55
Forfeited (144,759) $ 3.17 - -
-----------
Outstanding at December 31,2006 600,400 $ 2.67 2.79 $ -
=========== =========== =========== =========
Exercisable at December 31,2006 286,425 $ 2.24 2.31 $ -
=========== =========== =========== =========
Vested and expected to vest 545,383 $ 2.65 2.76 $ -
=========== =========== =========== =========
The weighted average grant-date fair value of options granted
during 2004, 2005 and 2006, was $ 0.781, $ 1.70 and $ 1.94 per
option, respectively.
The aggregate intrinsic value in the table above represents
the total intrinsic value (the difference between the
Company's closing stock price on the last trading day of the
fiscal year 2006 and the exercise price, multiplied by the
number of in-the-money options) that would have been received
by the option holders had all option holders exercised their
options on December 31, 2006. This amount changes based on the
fair market value of the Company's stock. The total intrinsic
value of options exercised during the years ended December 31,
2006, 2005, and 2004, was $ 55, $ 188, and $ 53, respectively.
As of December 31, 2006, there was $ 209 of total unrecognized
compensation cost related to non-vested share-based
compensation arrangements granted under the Company's stock
option plans. That cost is expected to be recognized over a
weighted-average period of 3 years.
F - 40
MER TELEMANAGEMENT SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE AND PER SHARE DATA)
NOTE 16: - SHAREHOLDERS' EQUITY (CONT.)
The options outstanding as of December 31, 2006 have been
separated into ranges of exercise prices, as follows:
RANGE OF REMAINING WEIGHTED REMAINING WEIGHTED
EXERCISE CONTRACTUAL AVERAGE CONTRACTUAL AVERAGE
PRICE OUTSTANDING LIFE (YEARS) EXERCISE PRICE EXERCISABLE LIFE (YEARS) EXERCISE PRICE
----------- ----------- ------------ -------------- ----------- ------------ --------------
$ 1.844 250,000 1.94 $ 1.844 187,500 1.94 $ 1.844
$ 2.2-2.35 83,500 2.70 $ 2.29 41,750 2.70 $ 2.29
$ 2.9-2.95 15,900 1.95 $ 2.91 11,925 1.95 $ 2.91
$ 3.27-3.4 70,000 3.60 $ 3.38 14,500 3.54 $ 3.37
$ 3.45-3.49 77,000 3.82 $ 3.47 7,750 3.34 $ 3.48
$ 3.87 104,000 3.74 $ 3.87 23,000 3.74 $ 3.87
----------- -----------
600,400 $ 2.67 286,425 $ 2.24
=========== ============== =========== ==============
e. Options and warrants to non-employees:
NUMBER OF OPTIONS EXERCISE
IN CONNECTION OPTIONS OPTIONS OPTIONS FORFEITED PRICE PER EXERCISABLE
ISSUANCE DATE WITH GRANTED EXERCISED EXERCISABLE OR EXPIRED SHARE THROUGH
-------------- ---------------- --------- --------- ----------- ---------- --------- --------------
January 2000 Advisory Board 98,824 - - 98,824 $ 6.000 December 2004
February 2001 Service provider 25,000 - - 25,000 $ 5.625 February 2006
January 2005 Service provider 70,000 - 70,000 - $ 3.250 January 2008
May 2005 Service provider 10,000 - 10,000 - $ 3.490 May 2015
August 2005 Service provider 37,000 - 37,000 - $ 4.000 August 2009
September 2005 Service provider 10,000 - - 10,000 $ 3.870 September 2015
December 2005 Service provider 100,000 - - 100,000 $ 3.120 December 2006
--------- --------- ----------- ----------
350,824 - 117,000 233,824
========= ========= =========== ==========
During 2006, no options to consultants were granted by the
Company. The Company had accounted for its outstanding options
to non-employees under the fair value method of SFAS No. 123
and EITF 96-18. The fair value for these options was estimated
at the measurement date using the Black-Scholes option-pricing
model with the following weighted-average assumptions for 2006
and 2005: risk-free interest rates of 5.23% and 4.06%,
respectively, dividend yields of 0%, volatility factors of the
expected market price of the Company's Ordinary shares of
34.22% and 52.37%, respectively, and a contractual life of
0.85 and 3.3 years, respectively.
Compensation expenses related to the granting of stock options
to consultants amounted to $ 0, $ 156 and $ 10 for the years
ended December 31, 2004, 2005 and 2006, respectively.
f. Treasury shares:
During 2004, 2005 and 2006, the Company purchased 3,800, 0 and
0 treasury shares in consideration of $ 9 $ 0 and $ 0,
respectively, according to the stock repurchase program, which
authorized the Company's officers to repurchase up to 600,000
Ordinary shares of MTS and was approved by the Company's Board
of Directors.
During 2003, MTS cancelled $457 of its treasury shares, which
represent 384,610 Ordinary shares.
F - 41
MER TELEMANAGEMENT SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE AND PER SHARE DATA)
NOTE 16: - SHAREHOLDERS' EQUITY (CONT.)
g. Dividends:
Dividends, if any, will be paid in NIS. Dividends paid to
shareholders outside Israel will be converted into dollars, on
the basis of the exchange rate prevailing at the date of
payment.
NOTE 17: - GEOGAPHIC INFORMATION AND MAJOR CUSTOMERS AND PRODUCTS
The Company adopted Statement of Financial Accounting Standard No.
131, "Disclosures About Segments of an Enterprise and Related
Information" ("SFAS No. 131"). The Company operates in one
reportable segment (see Note 1 for a brief description of the
Company's business). The total revenues are attributed to geographic
areas based on the location of the customer.
The following is a summary of revenues within geographic areas based
on end customer location and long-lived assets:
YEAR ENDED DECEMBER 31,
-----------------------------
2004 2005 2006
------- -------- --------
Revenues from sales:
United States $ 4,967 $ 6,043 $ 5,353
Germany 1,724 2,059 1,881
Asia 635 359 624
Holland 798 747 561
Others 1,289 2,355 2,065
------- -------- --------
$ 9,413 $ 11,563 $ 10,484
======= ======== ========
Total revenues from external customers divided on the basis of the
Company's product lines are as follows:
DECEMBER 31,
-------------------
2005 2006
-------- --------
TABS $ 7,454 $ 5,329
Application suits 2,603 4,044
Billing products 1,506 1,111
-------- --------
$ 11,563 $ 10,484
======== ========
Long-lived assets:
Israel $ 3,013 $ 3,177
United States 2,194 2,913
Others 57 46
-------- --------
$ 5,264 $ 6,136
======== ========
F - 42
MER TELEMANAGEMENT SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE AND PER SHARE DATA)
NOTE 18: - SUBSIDIARIES AND AFFILIATES
PERCENTAGE JURISDICTION OF
OF OWNERSHIP INCORPORATION
------------ ---------------
SUBSIDIARIES:
MTS IntegraTRAK Inc. 100% Delaware
MTS TelSoft Inc. (a subsidiary of MTS IntegraTRAK Inc.) 100% Delaware
MER Fifth Avenue Realty Inc. (a subsidiary of MTS
IntegraTRAK Inc.) *) 100% New York
MTS Asia Ltd. 100% Hong Kong
Telegent Ltd. *) 100% Israel
Jaraga B.V. 100% Netherlands
Verdura B.V. (a subsidiary of Jaraga B.V.) *) 100% Netherlands
Voltera Technologies V.O.F. (a partnership held 99% by
Jaraga B.V. and 1% by Verdura B.V.) *) 100% Netherlands
Bohera B.V. (a subsidiary of Jaraga B.V.) *) 100% Netherlands
Tabs Brazil Ltd. (a subsidiary of Bohera B.V.) 100% Brazil
AFFILIATE:
Jusan S.A. (an affiliate of Jaraga B.V.) 50% Spain
*) Inactive, or having immaterial activity.
NOTE 18: - SUBSEQUENT EVENTS
On February 6, 2006, the Board of Directors of the Company approved
the sale of the shares of TABS Brazil Ltda., to local Brazilian
individuals in consideration for $ 335 (the "Price"). The Price
shall be paid in 60 monthly installments, commencing January 1, 2008
with the first installment being in the amount of $ 67 and the
remaining installments in the amount of $ 6 each.
F - 43
JUSAN, S.A.
FINANCIAL STATEMENTS
AS OF DECEMBER 31, 2006 AND 2005
INDEX
PAGE
----------------
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM F-45
BALANCE SHEETS F-46
STATEMENTS OF INCOME F-47
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY F-48
STATEMENTS OF CASH FLOWS F-49
NOTES TO FINANCIAL STATEMENTS F-50 - F-61
F - 44
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders of JUSAN, S.A.
1. We have audited the accompanying balance sheets of JUSAN, S.A. ("the
Company") as of December 31, 2006 and 2005 and the related statements of
income, shareholders' equity and cash flows for each of the three years
in the period ended December 31, 2006. 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.
2. We conducted our audit 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. The
Company is not required to have, nor were we engaged to perform, an audit
of its internal control over financial reporting. Our audits 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, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable
basis for our opinion.
3. In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of JUSAN, S.A. as of
December 31, 2006 and 2005 and the results of its operations and its cash
flows for each of the three years in the period ended December 31, 2006 in
conformity with accounting principles generally accepted in the United
States of America.
BDO AUDIBERIA AUDITORES, S.L.
/s/ BDO Anderson
----------------
Madrid, Spain, January, 19, 2007
F - 45
FINANCIAL STATEMENTS AS OF DECEMBER 31, 2005 JUSAN, S.A.
JUSAN, S.A.
BALANCE SHEETS AS OF DECEMBER 31, 2006 AND 2005
EUROS IN THOUSANDS
DECEMBER 31,
2006 2005
----- -----
ASSETS
CURRENT ASSETS:
Cash and cash equivalents 236 737
Short-term bank deposits 867 400
Trade receivables (net of allowance for doubtful accounts of - thousand euros
as of December 31, 2006 and 57 thousand euros as of December 31, 2005 and net
of provision for returns of 4 thousand euros as of December 31, 2006 and 4
thousand euros as of December 31, 2005) (Note 5) 1,098 1,698
Other accounts receivable and prepaid expenses (Note 3) 138 186
Inventories (Note 4) 503 671
----- -----
Total current assets 2,842 3,692
----- -----
PROPERTY AND EQUIPMENT, NET (Note 6) 67 38
----- -----
Total assets 2,909 3,730
===== =====
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Short-term bank debt (Note 7) 17 8
Trade payables 324 482
Accrued expenses and other liabilities (Note 8) 176 365
Deferred revenues 10 49
----- -----
Total current liabilities 527 904
----- -----
COMMITMENTS (Note 9)
SHAREHOLDERS' EQUITY (Note 12):
Share capital -
15,052 Ordinary shares of (euro) 0.0042 par value - Authorized, issued and
outstanding as of December 31, 2006 and 2005 63 63
Retained earnings 2,319 2,763
----- -----
Total shareholders' equity 2,382 2,826
----- -----
Total liabilities and shareholders' equity 2,909 3,730
===== =====
The accompanying notes are an integral part of the financial statements
F - 46
FINANCIAL STATEMENTS AS OF DECEMBER 31, 2005 JUSAN, S.A.
JUSAN, S.A.
STATEMENTS OF INCOME AS OF DECEMBER 31, 2006, 2005 AND 2004
EUROS IN THOUSANDS (EXCEPT SHARE AND PER SHARE DATA)
YEAR ENDED DECEMBER 31,
2006 2005 2004
------ ------ ------
Revenues (Note 13):
Product sales 3,833 3,935 5,154
Services 520 632 640
------ ------ ------
Total revenues 4,353 4,567 5,794
------ ------ ------
Cost of revenues:
Product sales 1,812 2,098 2,658
Services 423 435 447
------ ------ ------
Total cost of revenues 2,235 2,533 3,105
------ ------ ------
Gross profit 2,118 2,034 2,689
------ ------ ------
Operating expenses:
Research and development 456 449 454
Selling and marketing 746 849 872
General and administrative 667 831 849
------ ------ ------
Total operating expenses 1,869 2,129 2,175
------ ------ ------
Operating income / (loss) 249 (95) 514
Financial income, net (Note 14) 6 20 2
------ ------ ------
Income before taxes on income 255 (75) 516
Income taxes (Note 10) 59 (55) 143
------ ------ ------
Net income / (loss) 196 (20) 373
====== ====== ======
Basic and diluted net earnings per share 13.02 (1.33) 24.78
Weighted average number of shares used in computing basic net
earnings per share 15,052 15,052 15,052
The accompanying notes are an integral part of the financial statements
F - 47
FINANCIAL STATEMENTS AS OF DECEMBER 31, 2005 JUSAN, S.A.
JUSAN, S.A.
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
AS OF DECEMBER 31, 2006, 2005 AND 2004
EUROS IN THOUSANDS
TOTAL
RETAINED SHAREHOLDERS'
SHARE CAPITAL EARNINGS EQUITY
------------- -------- ------
Balance as of December 31, 2003 63 2,710 2,773
Net income - 373 373
----- ----- -----
Balance as of December 31, 2004 63 3,083 3,146
----- ----- -----
Dividend paid - (300) (300)
Net income - (20) (20)
----- ----- -----
Balance as of December 31, 2005 63 2,763 2,826
Dividend paid - (640) (640)
Net income - 196 196
----- ----- -----
Balance as of December 31, 2006 63 2,319 2,382
===== ===== =====
The accompanying notes are an integral part of the financial statements
F - 48
FINANCIAL STATEMENTS AS OF DECEMBER 31, 2005 JUSAN, S.A.
JUSAN, S.A.
STATEMENTS OF CASH FLOWS AS OF DECEMBER 31, 2006, 2005 AND 2004
EUROS IN THOUSANDS
YEAR ENDED DECEMBER 31,
2006 2005 2004
---- ---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income 196 (20) 373
Adjustments to reconcile net income to net cash provided by (used in)
operating activities:
Depreciation 29 38 47
Deferred taxes 2 (30) 21
Decrease (increase) in trade receivables 600 367 (333)
Decrease (increase) in other accounts receivable and prepaid expenses 22 12 62
Decrease (increase) in inventories 168 241 (119)
Increase (decrease) in trade payables (158) (177) (136)
Increase (decrease) in accrued expenses and other liabilities (165) 14 32
Increase (decrease) in deferred revenues (39) (11) (172)
---- ---- ----
Net cash (provided by) operating activities 655 434 (225)
---- ---- ----
CASH FLOWS FROM INVESTING ACTIVITIES:
Investment in short-term bank deposits (467) 50 -
Purchase of property and equipment (58) (26) (19)
---- ---- ----
Net cash provided by (used in) investing activities (525) 24 (19)
---- ---- ----
CASH FLOWS FROM FINANCING ACTIVITIES:
Dividend paid (640) (300) (100)
Short-term bank debt 9 (10) (20)
---- ---- ----
Net cash used in financing activities (631) (310) (120)
---- ---- ----
Increase (decrease) in cash and cash equivalents (501) 148 (364)
Cash and cash equivalents at the beginning of the year 737 589 953
---- ---- ----
Cash and cash equivalents at the end of the year 236 737 589
==== ==== ====
NON-CASH FINANCING INFORMATION:
Accrued dividend - - -
SUPPLEMENTAL DISCLOSURE OF CASH FLOWS ACTIVITIES:
Cash paid during the year for:
Interest 6 20 2
---- ---- ----
Income taxes - - 120
---- ---- ----
The accompanying notes are an integral part of the financial statements
F - 49
FINANCIAL STATEMENTS AS OF DECEMBER 31, 2005 JUSAN, S.A.
JUSAN, S.A.
NOTES TO FINANCIAL STATEMENTS AS OF DECEMBER 31, 2006 AND 2005
NOTE 1: ORGANIZATION AND OPERATIONS
a. JUSAN, S.A. ("the Company") was incorporated in Spain on June 19, 1959. The
Company is engaged on development, manufacturing and assembly, sales and
distribution, and maintenance of vocal server and call billing
applications, as well as is in the television rental business.
b. The Company has five major customers (see also Note 13a).
c. In accordance with Spanish Companies' Law the directors present, for
comparative purposes, each of the balance sheet and profit and loss
account, the figures for the previous financial years, in addition to those
for the financial year 2006.
NOTE 2: SIGNIFICANT ACCOUNTING POLICIES
The financial statements have been prepared in accordance with generally
accepted accounting principles in the United States ("US 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 euros
Monetary accounts maintained in currencies other than the Euro are remeasured
into Euros in accordance with Statement of Financial Accounting Standard No. 52,
"Foreign Currency Translation" ("SFAS No. 52"). All effects of foreign currency
remeasurement of monetary balance sheet items are reflected in the statements of
operations as financial income or expenses, as appropriate.
c. Cash equivalents:
The Company considers all highly liquid investments originally purchased with
maturities of three months or less to be cash equivalents.
There are no restrictions for cash and cash equivalents.
F - 50
FINANCIAL STATEMENTS AS OF DECEMBER 31, 2005 JUSAN, S.A.
d. Short-term bank deposits:
Short-term bank deposits are deposits with maturities of more than three months
but less than one year. The deposits are in Euro and bear interest at an average
rate of 3%. The short-term deposits are presented at their cost, including
accrued interest.
e. Inventories:
Inventories are stated at the lower of cost or market value. Cost is determined
as follows: Raw materials, parts and supplies -using the weighted average cost
method. Work in progress and finished products are recorded on the basis of
direct manufacturing costs. Inventories write-offs are provided to cover risks
arising from slow moving items or technological obsolescence.
f. Property and equipment:
Property and equipment are stated at cost, net of accumulated depreciation.
Depreciation is calculated using the straight-line method, over the estimated
useful lives of the assets, at the following annual depreciation rates:
%
Computers and peripheral equipment 33
Office furniture and equipment 20
Motor vehicles 20
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.
g. Research and development costs:
Research and development costs are charged to the Statement of Operations as
incurred. Statement of Financial Accounting Standard 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.
F - 51
FINANCIAL STATEMENTS AS OF DECEMBER 31, 2005 JUSAN, S.A.
Based on the Company's product development process, technological feasibility is
established upon completion of a working model. Costs incurred by the Company
between completion of the working models and the point at which the products are
ready for general release have been insignificant. Therefore, all research and
development costs have been expensed.
h. Income taxes:
The Company accounts for income taxes in accordance with Statement of Financial
Accounting Standard No. 109, "Accounting for Income Taxes" ("SFAS No. 109").
This statement prescribes the use of the liability method whereby deferred tax
assets and liability account balances are determined based on differences
between financial reporting and tax bases of assets and liabilities and are
measured using the enacted tax rates and laws that will be in effect when the
differences are expected to reverse. Valuation allowances are provided to reduce
deferred tax assets to an amount whose realization is considered more likely
than not.
i. Revenue recognition:
The Company generates revenues from selling software-based products through
resellers and distributors who are considered end-users. The Company also
generates revenues from rendering maintenance and support services.
Revenues are recognized when all criteria outlined in Statement of Position No.
97-2 "Software Revenue Recognition" ("SOP No. 97-2") as amended are met. Revenue
from products 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.
Where the arrangements involve multiple elements, revenue is allocated to each
element based on vendor specific objective evidence ("VSOE") of the relative
fair values of each element in the arrangement, in accordance with the "residual
method" prescribed by SOP No. 98-9, "Modification of SOP No. 97-2, Software
Revenue Recognition With Respect to Certain Transactions". The VSOE used by the
Company to allocate the sales price to support services and maintenance is based
on the renewal rate charged when these elements are sold separately. Revenues
from products are recorded based on the residual method. Under the residual
method, revenue is recognized for the delivered elements when (1) there is VSOE
of the fair values of all the undelivered elements, and (2) all revenue
recognition criteria of SOP No. 97-2, as amended, are satisfied. Under the
residual method any discount in the arrangement is allocated to the delivered
element.
Provision for returns in the amount of thousand (euro) 3 is determined
principally on the basis of past experience.
Revenues from maintenance and support services are recognized over the life of
the maintenance agreement or at the time support services are rendered.
F - 52
FINANCIAL STATEMENTS AS OF DECEMBER 31, 2005 JUSAN, S.A.
Deferred revenues include unearned amounts received under maintenance and
support contracts, not yet recognized as revenues.
j. Warranty costs:
The Company provides free warranty for up to one year. A provision in the amount
of thousand (euro) 10 (thousand (euro) 20 in 2005) is recorded for probable
costs in connection with these services based on the Company's experience.
The Company estimates the costs that may be incurred under its basic limited
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.
k. Fair value of financial instruments:
The carrying amounts of cash and cash equivalents, short-term bank deposits,
trade receivables, other accounts receivable and trade payables approximate
their fair value, due to the short-term maturity of such instruments.
There are short term fixed-rate securities as an amount of thousand (euro) 867.
l. Concentrations of credit risk:
Financial instruments that potentially subject the Company to concentrations of
credit risk consist principally of cash and cash equivalents, short-term bank
deposits and trade receivables.
Cash and cash equivalents and short-term bank deposits are deposited with major
banks in Spain. Management believes that the financial institutions that hold
the Company's investments are financially sound, and accordingly, minimal credit
risk exists with respect to these investments.
The trade receivables of the Company are mainly derived from sales to customers
in Spain and Europe (see Note 13b). The Company performs ongoing credit
evaluations of its customers. The allowance for doubtful accounts is determined
with respect to specific debts that are doubtful of collection according to
management estimates (when the ageing of account receivable is more than 180
days). In certain circumstances, the Company may require letters of credit,
other collateral or additional guarantees.
The Company has no off-balance-sheet concentration of credit risk such as
foreign exchange contracts, option contracts or other foreign hedging
arrangements.
F - 53
FINANCIAL STATEMENTS AS OF DECEMBER 31, 2005 JUSAN, S.A.
m. Basic and diluted net earnings per share:
Basic net earnings per share is computed based on the weighted average number of
ordinary shares outstanding during each year. Diluted earnings per share is
computed based on the weighted average number of ordinary shares outstanding
during each year, plus potential ordinary shares considered outstanding during
the year, in accordance with Statement of Financial Accounting Standard No. 128,
"Earnings Per Share" ("SFAS No. 128").
NOTE 3: OTHER ACCOUNTS RECEIVABLE AND PREPAID EXPENSES
DECEMBER 31,
2006 2005
---- ----
Tax authorities 99 100
Deferred taxes 17 43
Employee advances 6 27
Deposits 16 16
---- ----
138 186
---- ----
NOTE 4: INVENTORIES
DECEMBER 31,
2006 2005
---- ----
Materials 479 735
Work in progress 31 29
Provision for obsolescence (7) (93)
---- ----
503 671
---- ----
F - 54
FINANCIAL STATEMENTS AS OF DECEMBER 31, 2005 JUSAN, S.A.
NOTE 5: TRADE RECEIVABLES
DECEMBER 31,
2006 2005
----- -----
Trade receivables 840 1,510
Bills receivable 258 245
Allowance for doubtful accounts - (57)
----- -----
1,098 1,698
----- -----
NOTE 6: PROPERTY AND EQUIPMENT
DECEMBER 31,
2005 ADDITIONS DISPOSALS 2006
---- --------- --------- ----
COST:
Computers and peripheral equipment 122 21 - 143
Office furniture and equipment 307 14 (3) 318
Motor vehicles 98 23 (21) 100
Leasehold improvements - -
----- ----- ----- -----
527 58 (24) 561
ACCUMULATED DEPRECIATION:
Computers and peripheral equipment (113) (10) - (123)
Office furniture and equipment (278) (8) 3 (283)
Motor vehicles (98) (11) 21 (88)
Leasehold improvements - - - -
----- ----- ----- -----
(489) (29) 24 (494)
----- ----- ----- -----
DEPRECIATED COST 38 29 - 67
===== ===== ===== =====
Depreciation expenses for the years ended December 31, 2006, 2005 and 2004 were
thousand (euro) 29, 38 and 47, respectively.
F - 55
FINANCIAL STATEMENTS AS OF DECEMBER 31, 2005 JUSAN, S.A.
NOTE 7: SHORT-TERM BANK DEBT
The Company has a short-term bank debt in the amount of thousand (euro) 17,
bearing interest of 5%.
NOTE 8: ACCRUED EXPENSES AND OTHER LIABILITIES
DECEMBER 31,
2006 2005
---- ----
Employees and payroll accruals 52 75
Income tax payable 59 -
Deferred tax - 24
Tax authorities 135 182
Current Accounts (80) 64
Warranty costs 10 20
---- ----
176 365
==== ====
NOTE 9: COMMITMENTS
The facilities of the Company are rented under operating leases for periods
ending in 2009.
Future minimum lease commitments under non-cancelable operating leases as of
December 31, are as follows:
2007 8
2008 8
2009 5
----
21
----
Rent expenses for years ended December 31, 2006, 2005 and 2004, were
approximately thousand (euro) 172, 157 and 152, respectively. Rent expenses will
be reviewed every year with the variation of the Consumer Price Index.
F - 56
FINANCIAL STATEMENTS AS OF DECEMBER 31, 2005 JUSAN, S.A.
NOTE 10: TAXES ON INCOME
Reconciliation between the theoretical tax expense, assuming all income is taxed
at the statutory tax rate applicable to income of the Company and the actual tax
expense as reported in the statements of operations, is as follows:
YEAR ENDED DECEMBER 31,
2006 2005 2004
---- ---- ----
Income before taxes as reported in the statements
of operations 255 (75) 516
Non-deductible bad debt allowance and others 2004 - (82) 82
Non-deductible bad debt allowance 2005 (20) 20 -
Tax depreciation 37 (37) -
Increase (decrease) in the taxable base - Forward
sales 33 29 (62)
Increase (decrease) in the taxable base -
Unrealized severance allowance (75) 75 -
---- ---- ----
Taxable income 230 (70) 536
---- ---- ----
Tax rates 35% 35% 35%
Tax expense (benefit) 80 (25) 188
Decrease in taxes resulting from:
Tax deduction for development (21) - (66)
Deferred tax liability (asset) - (30) 21
---- ---- ----
TAXES ON INCOME, TAX EXPENSE (BENEFIT), AS REPORTED
IN THE STATEMENTS OF OPERATIONS 59 (55) 143
==== ==== ====
Under the current tax legislation, 35% of development expense can be deducted
from the income tax with the limits of 35% of the theoretical tax charge. All
the income before income taxes is domestic.
F - 57
FINANCIAL STATEMENTS AS OF DECEMBER 31, 2005 JUSAN, S.A.
NOTE 11: RELATED PARTIES TRANSACTIONS
The balances with and the revenues derived from related parties (related parties
are shareholders, directors and family of both) were as follows:
a. Payments to related parties:
YEAR ENDED DECEMBER 31,
2006 2005 2004
---- ---- ----
Wages 332 299 255
---- ---- ----
In 2006 the payments of wages to related parties are based on the payments to
the directors (thousand (euro) 290), the social security paid to the directors
(thousand (euro) 18) and 20% from the leases (thousand (euro) 24).
b. Transactions with related parties were as follows:
YEAR ENDED DECEMBER 31,
2006 2005 2004
---- ---- ----
Sales to related parties 29 39 18
---- ---- ----
AMOUNTS CHARGED BY RELATED PARTIES:
Cost of revenues 41 18 100
---- ---- ----
F - 58
FINANCIAL STATEMENTS AS OF DECEMBER 31, 2005 JUSAN, S.A.
c. Amounts receivable from and payables to related parties:
DECEMBER 31,
2006 2005
---- ----
RECEIVABLES:
Mer Telemagement Solutions 5 36
MTS Asia - 4
MTS IntegraTRAK 1 -
Jaraga BV 100 -
PAYABLES:
Mer Telemagement Solutions - 18
NOTE 12: SHAREHOLDERS' EQUITY
a. Share capital:
The ordinary shares entitle their holders the right to receive notice, to
participate and vote in general meetings of the Company and the right to receive
dividends, if declared.
b. Legal reserve
As established by the Spanish Companies' Act, 10% of profits must be
allocated to the legal reserve, until such reserve is equal to 20% of share
capital. The legal reserve shall not be distributed and may only be used for
compensation of losses or to increase capital.
c. Shareholding
There are 15,052 ordinary shares of (euro) 0.0042 par value, authorized, issued
and outstanding as of December 31, 2006.
The shareholders at December 31, 2006 are:
%
Jaraga, B.V. 50%
Jose Lasry Nahon 25%
Mauricio Toledano Marques 25%
F - 59
FINANCIAL STATEMENTS AS OF DECEMBER 31, 2005 JUSAN, S.A.
d. Distribution of dividends.
The distribution of dividends amounting thousand (euro) 640 as a result of
reserves distribution, has been paid to the shareholders in direct proportion of
their shares.
Jaraga, B.V. 320
Jose Lasry Nahon 160
Mauricio Toledano Marques 160
NOTE 13: - SEGMENTS, CUSTOMERS AND GEOGRAPHIC INFORMATION
a. Major customers as a percentage of total revenues:
YEAR ENDED DECEMBER 31,
2006 2005 2004
---- ---- ----
%
Adictis 10% 13% 14%
Liberty Voz, S.L 6% - -
Cableuropa, S.A 6% 8% 8%
Siemens, S.A - - 8%
Telefonica de Espana 5% 5% 5%
Eurotelefonia del Sur, S.L 4% - 4%
Siemens Chile - 2% -
Accentic - 2% 4%
F - 60
FINANCIAL STATEMENTS AS OF DECEMBER 31, 2005 JUSAN, S.A.
b. The following is a summary of revenues within geographic areas based on end
customer location:
YEAR ENDED DECEMBER 31,
2006 2005 2004
----- ----- -----
Spain 2,586 2,275 2,287
European Community 1,280 1,437 2,796
Other 487 855 711
----- ----- -----
4,353 4,567 5,794
----- ----- -----
NOTE 14: SELECTED STATEMENTS OF OPERATIONS DATA
Financial income, net
YEAR ENDED DECEMBER 31,
2006 2005 2004
---- ---- ----
Financial expenses:
Interest expenses 6 3 3
Other expenses 27 6 11
---- ---- ----
33 9 14
---- ---- ----
Financial income:
Interest income 39 29 16
---- ---- ----
FINANCIAL INCOME, NET 6 20 2
==== ==== ====
F - 61
S I G N A T U R E S
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.
MER TELEMANAGEMENT SOLUTIONS LTD.
By: /s/ Eytan Bar
-----------------
Eytan Bar
Chief Executive Officer
By: /s/ Shlomi Hagai
--------------------
Shlomi Hagai
Chief Financial Officer
Dated: March 30, 2007
75