SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
FORM 20-F
[ ] REGISTRATION STATEMENT PURSUANT TO SECTION 12(b)
OR (g) OF THE SECURITIES EXCHANGE ACT OF 1934
OR
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _________ to _________
Commission file number: 0-28950
MER TELEMANAGEMENT SOLUTIONS LTD.
(Exact name of Registrant as specified in its charter
and translation of Registrant's name into English)
Israel
(Jurisdiction of incorporation or organization)
22 Zarhin Street, Ra'anana 43662, Israel
(Address of principal executive offices)
Securities registered or to be registered pursuant to Section 12(b) of the Act:
None
Securities registered or to be registered pursuant to Section 12(g) of the Act:
Ordinary Shares, NIS 0.01 Par Value
(Title of Class)
Securities for which there is a reporting obligation pursuant to Section 15(d)
of the Act: None
Indicate the number of outstanding shares of each of the issuer's classes of
capital or common stock as of the close of the period covered by the annual
report:
Ordinary Shares, par value NIS 0.01 per share ............ 4,624,471
(as of December 31, 2003)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No _____
Indicate by check mark which financial statement item the registrant has elected
to follow:
Item 17 Item 18_X_
This Report on Form 20-F is incorporated by reference into our Form F-3
Registration Statement File No. 333-11644 and into our Form S-8 Registration
Statement File No. 333-12014.
INTRODUCTION
Mer Telemanagement Solutions Ltd. designs, develops, markets and
supports a comprehensive line of telecommunication management solutions that
enable business organizations and other enterprises to improve the efficiency
and performance of their IP operations and to significantly reduce associated
costs. Our products include call accounting and management products, facility
management solutions, fault management systems and Web-based management
solutions for converged voice, voice over Internet Protocol, or IP, data and
video. These products are designed to provide telecommunication and information
technology managers with tools to reduce communication costs, recover charges
payable by third parties, detect and report the abuse and misuse of telephone
networks, monitor and detect hardware and software faults in telecommunications
networks and generate telecommunications usage information for use in the
management of an enterprise. We were among the first to offer PC-based call
accounting systems when we introduced our TABS product in 1985. To date, over
60,000 TABS call accounting systems have been sold to end-users in more than 60
countries.
Since our public offering in May 1997, our ordinary shares have been
listed on the Nasdaq Stock Market (symbol: MTSL). As used in this annual report,
the terms "we," "us" and "our" mean Mer Telemanagement Solutions Ltd. and its
subsidiaries, unless otherwise indicated.
Except for the historical information contained in this annual report,
the statements contained in this annual report are "forward-looking statements"
within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended, and the Private
Securities Litigation Reform Act of 1995, as amended, with respect to our
business, financial condition and results of operations. Such forward-looking
statements reflect our current view with respect to future events and financial
results. We urge you to consider that statements which use the terms
"anticipate," "believe," "do not believe," "expect," "plan," "intend,"
"estimate," "anticipate" and similar expressions are intended to identify
forward-looking statements. We remind readers that forward-looking statements
are merely predictions and therefore inherently subject to uncertainties and
other factors and involve known and unknown risks that could cause the actual
results, performance, levels of activity, or our achievements, or industry
results, to be materially different from any future results, performance, levels
of activity, or our achievements expressed or implied by such forward-looking
statements. Readers are cautioned not to place undue reliance on these
forward-looking statements, which speak only as of the date hereof. Except as
required by applicable law, including the securities laws of the United States,
we undertake no obligation to publicly release any update or revision to any
forward-looking statements to reflect new information, future events or
circumstances, or otherwise after the date hereof. We have attempted to identify
significant uncertainties and other factors affecting forward-looking statements
in the Risk Factors section that appears in Item 3D. "Key Information - Risk
Factors"
TABS by MER (R), TABS.IT(TM), eTABS(TM), VoIPTABS(TM), wTABS(TM),
FaciliTRAK(TM), TABSbill(TM), TOPS(TM) and PMSi(TM) are our trademarks. All
other trademarks and trade names appearing in this annual report are owned by
their respective holders.
Our consolidated financial statements appearing in this annual report
are prepared in U.S. dollars and in accordance with generally accepted
accounting principles in the United States, or U.S.
i
GAAP. All references in this annual report to "dollars" or "$" are to U.S.
dollars and all references in this annual report to "NIS" are to New Israeli
Shekels.
Statements made in this annual report concerning the contents of any
contract, agreement or other document are summaries of such contracts,
agreements or documents and are not complete descriptions of all of their terms.
If we filed any of these documents as an exhibit to this annual report or to any
registration statement or annual report that we previously filed, you may read
the document itself for a complete description of its terms.
ii
TABLE OF CONTENTS
Page
----
PART I........................................................................5
ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS.............5
ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE............................5
ITEM 3. KEY INFORMATION....................................................5
A. Selected Financial Data........................................5
B. Capitalization and Indebtedness................................6
C. Reasons for the Offer and Use of Proceeds......................6
D. Risk Factors...................................................6
ITEM 4. INFORMATION ON THE COMPANY........................................17
A. History and Development of the Company........................17
B. Business Overview.............................................19
C. Organizational Structure......................................27
D. Property, Plants and Equipment................................28
ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS......................28
B. Liquidity and Capital Resources...............................39
C. Research and Development......................................40
D. Trend Information.............................................41
E. Off-Balance Sheet Arrangements................................41
F. Tabular Disclosure of Contractual Obligations.................41
ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES........................41
A. Directors and Senior Management...............................41
B. Compensation..................................................43
C. Board Practices...............................................44
D. Employees.....................................................49
E. Share Ownership...............................................50
ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS.................53
A. Major Shareholders............................................53
B. Related Party Transactions....................................54
C. Interests of Experts and Counsel..............................55
ITEM 8. FINANCIAL INFORMATION.............................................55
A. Consolidated Statements and Other Financial Information.......55
B. Significant Changes...........................................56
ITEM 9. THE OFFER AND LISTING.............................................56
A. Offer and Listing Details.....................................56
B. Plan of Distribution..........................................57
C. Markets.......................................................57
D. Selling Shareholders..........................................57
E. Dilution......................................................57
F. Expense of the Issue..........................................57
ITEM 10. ADDITIONAL INFORMATION............................................57
A. Share Capital.................................................57
B. Memorandum and Articles of Association........................57
iii
C. Material Contracts............................................60
D. Exchange Controls.............................................60
E. Taxation......................................................61
F. Dividend and Paying Agents....................................72
G. Statement by Experts..........................................72
H. Documents on Display..........................................72
I. Subsidiary Information........................................72
ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISKS............................................................73
ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES............73
PART II......................................................................73
ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES...................73
ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS
AND USE OF PROCEEDS...............................................73
ITEM 15. CONTROLS AND PROCEDURES...........................................74
ITEM 16. [RESERVED]........................................................74
ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT..................................74
ITEM 16B. CODE OF ETHICS....................................................74
ITEM 16C. PRINCIPAL ACCOUNTING FEES AND SERVICES............................74
ITEM 16D. EXEMPTIONS FROM THE LISTING REQUIREMENTS AND
STANDARDS FOR AUDIT COMMITTEE...................................75
ITEM 16E. PURCHASE OF EQUITY SECURITIES BY THE ISSUER AND
AFFILIATES AND PURCHASERS.......................................75
PART III.....................................................................77
ITEM 17. FINANCIAL STATEMENTS..............................................77
ITEM 18. FINANCIAL STATEMENTS..............................................77
ITEM 19. EXHIBITS..........................................................77
S I G N A T U R E S..........................................................79
iv
PART I
ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS
-----------------------------------------------------
Not applicable.
ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE
---------------------------------------
Not applicable.
ITEM 3. KEY INFORMATION
---------------
A. SELECTED FINANCIAL DATA
The following selected consolidated financial data for and as of the
five years ended December 31, 2003 are derived from our audited consolidated
financial statements, which have been prepared in accordance with U.S. GAAP. Our
consolidated financial statements were audited by Kost Forer Gabbay & Kasierer,
a Member of Ernst & Young Global. Our audited consolidated financial statements
with respect to the three years ended December 31, 2003 and as of December 31,
2002 and 2003 appear elsewhere in this Report. The selected consolidated
financial data set forth below should be read in conjunction with Item 5.
"Operating and Financial Review and Prospects," and our consolidated financial
statements and notes thereto included elsewhere in this annual report.
Statement of Operations Data:
Year Ended December 31,
------------------------------------------------------
1999 2000 2001 2002 2003
---- ---- ---- ---- ----
(in thousands, except per share data)
Revenues............................. $12,780 $11,067 $10,725 $9,787 $9,230
Cost of revenues..................... 3,137 2,842 2,552 1,896 1,849
----- ----- ----- ----- -----
Gross profit......................... 9,643 8,225 8,173 7,891 7,381
Selling and marketing, net........... 4,186 4,853 4,911 3,954 3,916
Research and development, net........ 3,491 4,039 3,562 2,127 1,825
General and administrative........... 1,593 1,845 1,943 1,858 1,830
In process research and development
write-off ......................... -- 945 -- -- --
----- ----- ----- ----- -----
Operating income (loss).............. 373 (3,457) (2,243) (48) (190)
Financial income, net................ 35 374 138 134 124
Other income (expenses).............. 5,150 1,591 (654) (140) 6
----- ----- ----- ----- -----
Income (loss) before taxes........... 5,558 (1,492) (2,759) (54) (60)
Taxes on income (tax benefit)........ 1,277 (155) 16 52 198
----- ----- ----- ----- -----
Net income (loss) before equity in
earnings of affiliates and minority
interest........................... 4,281 (1,337) (2,775) (106) (258)
Equity in earnings of affiliates... 211 66 221 236 345
Minority interest in a subsidiary.... -- -- -- -- --
----- ----- ----- ----- -----
Net income (loss).................... $4,492 $(1,271) $(2,554) $ 130 $ 87
====== ======= ======= ===== =====
Basic net earnings (loss) per share.. $0.96 $(0.26) $(0.53) $0.03 $0.02
====== ======= ======= ===== =====
Diluted net earnings (loss) per share $0.94 $(0.26) $(0.53) $0.03 $0.02
====== ======= ======= ===== =====
5
Balance Sheet Data:
As of December 31,
------------------------------------------------------
1999 2000 2001 2002 2003
---- ---- ---- ---- ----
Working capital...................... $ 13,701 $ 10,342 $ 9,060 $ 9,244 $ 9,437
Total assets......................... 21,615 21,812 18,095 17,707 18,182
Long-term loans...................... 8 84 13 8 --
Shareholders' equity................. 17,557 16,497 13,856 14,013 14,464
B. CAPITALIZATION AND INDEBTEDNESS
Not applicable.
C. REASONS FOR THE OFFER AND USE OF PROCEEDS
Not applicable.
D. RISK FACTORS
Investing in our ordinary shares involves a high degree of risk and
uncertainty. You should carefully consider the risks and uncertainties described
below before investing in our ordinary shares. If any of the following risks
actually occurs, our business, prospects, financial condition and results of
operations could be harmed. In that case, the value of our ordinary shares could
decline, and you could lose all or part of your investment.
Risks Relating to Our Business and Market
We have had a recent history of operating losses and may not achieve or sustain
profitability in the future.
We have incurred operating losses in each of the four last fiscal years
and we cannot assure you that we will be able to achieve or sustain profitable
operations in the future.
Our operating results fluctuate significantly.
Our quarterly results have fluctuated significantly in the past and are
likely to fluctuate significantly in the future. Our future operating results
will depend on many factors, including, but not limited to the following:
o demand for our products;
o changes in our pricing policies or those of our competitors;
o the number, timing and significance of product enhancements;
o new product announcements by us and our competitors;
o our ability to develop, introduce and market new and enhanced products
on a timely basis;
o changes in the level of our operating expenses;
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o budgeting cycles of our customers;
o customer order deferrals in anticipation of enhancements or new
products that we or our competitors offer;
o product life cycles;
o changes in our strategy;
o seasonal trends and general domestic and international economic and
political conditions, among others; and
o currency exchange rate fluctuations and economic conditions in the
geographic areas where we operate.
Due to the foregoing factors, quarterly revenues and operating results
are difficult to forecast, and it is likely that our future operating results
will be adversely affected by these or other factors.
Revenues are also difficult to forecast because the market for
telecommunication management solutions is rapidly evolving and our sales cycle,
from initial evaluation to purchase, is lengthy and varies substantially from
customer to customer. We typically ship product orders shortly after receipt of
a purchase order and, consequently, order backlog at the beginning of any
quarter has in the past represented only a small portion of that quarter's
revenues. As a result, license revenues in any quarter depend substantially on
orders booked and shipped in that quarter.
Due to all of the foregoing, we cannot predict revenues for any future
quarter with any significant degree of accuracy. Accordingly, we believe that
period-to-period comparisons of our operating results are not necessarily
meaningful and you should not rely upon them as indications of future
performance. Although we have experienced revenue growth in the past, we may not
be able to sustain this growth rate, and you should not consider such past
growth indicative of future revenue growth, or of future operating results.
Our operating results vary quarterly and seasonally.
We have often recognized a substantial portion of our revenues in the
last quarter of the year and in the last month, or even weeks or days, of a
quarter. Our expense levels are substantially based on our expectations for
future revenues and are therefore relatively fixed in the short term. If revenue
levels fall below expectations, our quarterly results are likely to be
disproportionately adversely affected because a proportionately smaller amount
of our expenses varies with our revenues.
Our operating results reflect seasonal trends and we expect to continue
to be affected by such trends in the future. We expect to continue to experience
relatively higher sales in the fourth quarter ending December 31, and relatively
lower sales in the third quarter ending September 30, as a result of reduced
sales activity in Europe during the summer months. Due to the foregoing factors,
in some future quarter, our operating results may be below the expectations
7
of public market analysts and investors. In such event, it is likely that the
price of our ordinary shares would be materially and adversely affected.
We depend on the market for telemanagement products, which market has declined
in recent years.
We have derived substantially all of our revenues and expect to continue
to derive the vast majority of our revenues in the foreseeable future from sales
of our TABS.IT call accounting and billing products. Our future financial
performance will depend, in significant part, on the successful development,
introduction, marketing and customer acceptance of the new versions of TABS.IT
and related telemanagement products. Our revenues have declined each year since
1999 and there can be no assurance that the market for these products will grow
in the future. If the market for TABS.IT and related telemanagement products
fails to return to previous levels, or grows more slowly than we currently
anticipate, our business, operating results and financial condition would be
materially and adversely affected.
We depend on business telephone system manufacturers, vendors and distributors
for our sales.
One of the primary distribution channels for our call accounting
management products are PBX original equipment manufacturers, or OEMs, and
vendors who market our products to end-users in conjunction with their own
products. Sales by PBX manufacturers and vendors have declined markedly in the
recent past, and no assurance can be given that sales through this channel will
recover. Our success will be dependent to a substantial degree on the marketing
and sales efforts of such third parties in marketing products integrating our
products. There can be no assurance that these customers will give priority to
the sale of our products as an enhancement to their products. Although most of
the major business telephone switching systems manufacturers and vendors
currently rely on third-party suppliers to provide call accounting and other
telemanagement products, no assurance can be given that these manufacturers and
vendors, including our current customers, will not develop their own competing
products or purchase competing products from others.
We are highly dependent upon the active marketing and distribution
efforts of our PBX OEM's. In 2001, 2002 and 2003, our three major OEMs, Siemens
Gmbh, Philips Communications Systems B.V. and Ericsson, generated 44.0%, 46.0%
and 51.0% of our consolidated revenues respectively. The percentage of sales
attributable to each of these OEMs in each of the three years ended December 31,
2003 follows:
2001 2002 2003
---- ---- ----
Siemens.................... 32.0% 36.0% 40.0%
Philips.................... 8.0% 6.0% 7.0%
Ericsson................... 4.0% 4.0% 4.0%
Because we sell our products through local master distributors in
countries where we do not have a marketing subsidiary, we are highly dependent
upon the active marketing and distribution efforts of our distributors. We also
depend in large part upon our distributors for product maintenance and support.
There can be no assurance that our distributors will continue to provide
adequate maintenance and support to end-users or will provide maintenance and
support for new products, which might cause us to seek new or additional
distributors or incur
8
additional service and support costs. The distributors to whom we sell our
products are generally not contractually required to make future purchases of
our products and could, therefore, discontinue carrying our products at any
time. None of our distributors or resellers are subject to any minimum purchase
requirements under their agreements with us. There can be no assurance that we
will continue our relationships with our OEM customers or, if such relationships
are not maintained, that we would be able to attract and retain comparable PBX
original equipment manufacturers. Although we have distribution agreements with
a number of our resellers, we do not have any agreements with the PBX
manufacturers who market our products. The loss of any of our major resellers,
either to competitive products offered by other companies or products developed
by such resellers, would have a material adverse effect on our business,
financial condition and results of operations. Our future performance will
depend, in part, on our ability to attract additional PBX manufacturers and
vendors that will be able to market and support our products effectively,
especially in markets in which we have not previously distributed our products.
We may decide to acquire other businesses in the future, which could result in
potentially dilutive issuances, the incurrence of debt and the incurrence of
other expenses which could negatively impact our operating results and financial
condition.
In April 2000 we acquired IntegraTRAK Inc., a privately held developer
and marketer of high-end telemanagement software, and in April 2002 we acquired
software technology that we are presently marketing under the name FaciliTRAK.
FaciliTRAK is a comprehensive software system that greatly simplifies the
day-to-day task of maintaining and managing the physical layer details for any
network. If we continue to acquire businesses or products in the future, such
acquisitions could result in dilutive issuances of equity securities, the
incurrence of debt and contingent liabilities and amortization expenses related
to goodwill and other intangible assets, any of which could negatively impact
our operating results and financial position. Acquisitions may also involve
other risks, including entering markets in which we have limited or no direct
prior experience and the potential loss of key employees.
We face risks associated with expanding and maintaining our distribution
network.
We sell our products through distributors, business telephone switching
systems manufacturers and vendors, post, telephone and telegraph authorities, or
PTTs and our direct sales force. Our ability to achieve revenue growth in the
future will depend in large part on our success in establishing and maintaining
relationships with business telephone switching systems manufacturers and
vendors and PTTs, establishing and maintaining relationships with distributors,
and recruiting and training additional direct sales personnel. We plan to invest
significant resources to expand our direct sales force and to develop new
distribution relationships. Historically, we have at times experienced
difficulty in recruiting qualified sales personnel and in establishing effective
distribution relationships. There can be no assurance that we will be able to
successfully expand our direct sales force or other distribution channels or
that any such expansion will result in an increase in revenues. The failure to
expand or maintain our direct sales force or other distribution channels could
have a material adverse effect on our business, operating results and financial
condition.
9
We are subject to risks associated with international operations.
We are based in Israel and generate a large percentage of our sales
outside the United States. Our sales in the United States accounted for 61.0%,
66.0% and 53.0% of our total revenues for the years ended December 31, 2001,
2002 and 2003, respectively. Although we continue to expand our international
operations and commit significant management time and financial resources to
developing direct and indirect international sales and support channels, we
cannot be certain that we will be able to maintain or increase international
market demand for our products. To the extent that we cannot do so in a timely
manner, our business, operating results and financial condition will be
materially and adversely affected.
International operations are subject to inherent risks, including the
following:
o the impact of possible recessionary environments in multiple foreign
markets;
o costs of localizing products for foreign markets;
o longer receivables collection periods and greater difficulty in
accounts receivable collection;
o unexpected changes in regulatory requirements;
o difficulties and costs of staffing and managing foreign operations;
o reduced protection for intellectual property rights in some countries;
o potentially adverse tax consequences; and
o political and economic instability.
We cannot be certain that we, our distributors or resellers will be able
to sustain or increase revenues from international operations or that the
foregoing factors will not have a material adverse effect on our future revenues
and, as a result, on our business, operating results and financial condition.
We may be adversely affected by fluctuations in currency exchange rates.
While our revenues are generally denominated in U.S. dollars and Euros, a
significant portion of our expenses are incurred in NIS. We do not currently
engage in any currency hedging transactions intended to reduce the effect of
fluctuations in foreign currency exchange rates on our results of operations. If
we were to determine that it was in our best interests to enter into any hedging
transactions in the future, there can be no assurance that we will be able to do
so or that such transactions, if entered into, will materially reduce the effect
of fluctuations in foreign currency exchange rates on our results of operations.
In addition, if, for any reason, exchange or price controls or other
restrictions on the conversion of foreign currencies into NIS were imposed, our
business could be adversely affected. Although exposure to currency fluctuations
to date has not had a material adverse effect on our business, there can be no
assurance such fluctuations in the future will not have a material adverse
effect on revenues from international sales and, consequently, on our business,
operating results and financial condition.
10
We are subject to risks relating to proprietary rights and risks of
infringement.
We are dependent upon our proprietary software technology and we rely
primarily on a combination of copyright and trademark laws, trade secrets,
confidentiality procedures and contractual provisions to protect our proprietary
rights. We try to protect our software, documentation and other written
materials under trade secret and copyright laws, which afford only limited
protection. It is possible that others will develop technologies that are
similar or superior to our technology. Despite our efforts to protect our
proprietary rights, unauthorized parties may attempt to copy aspects of our
products or to obtain and use information that we regard as proprietary. It is
difficult to police the unauthorized use of our products, and we expect software
piracy to be a persistent problem, although we are unable to determine the
extent to which piracy of our software products exists. In addition, the laws of
some foreign countries do not protect our proprietary rights as fully as do the
laws of the United States. We cannot be certain that our means of protecting our
proprietary rights in the United States or abroad will be adequate or that our
competition will not independently develop similar technology.
We are not aware that we are infringing upon any proprietary rights of
third parties. It is possible, however, that third parties will claim
infringement by us of their intellectual property rights. We believe that
software product developers will increasingly be subject to infringement claims
as the number of products and competitors in our industry segment grows and the
functionality of products in different industry segments overlaps. It would be
time consuming for us to defend any such claims, with or without merit, and any
such claims could:
o result in costly litigation;
o divert management's attention and resources;
o cause product shipment delays; or
o require us to enter into royalty or licensing agreements. Such royalty
or licensing agreements, if required, may not be available on terms
acceptable to us, if at all.
If there is a successful claim of product infringement against us and we
are not able to license the infringed or similar technology, our business,
operating results and financial condition would be materially and adversely
affected.
We rely upon certain software that we license from third parties,
including software that we integrate with our internally developed software. We
cannot be certain that these third-party software licenses will continue to be
available to us on commercially reasonable terms. If we lose or are unable to
maintain any such software licenses, we could suffer shipment delays or
reductions until equivalent software could be developed, identified, licensed
and integrated, which would materially and adversely affect our business,
operating results and financial condition.
Our results may be adversely affected by competition.
The market for telemanagement products is fragmented and is intensely
competitive. Competition in the industry is generally based on product
performance, depth of product line, technical support and price. We compete both
with international and local competitors
11
(including providers of telecommunications services), many of whom have
significantly greater financial, technical and marketing resources than us. We
anticipate continuing competition in the telemanagement products market and the
entrance of new competitors into the market. Our existing and potential
customers, including business telephone switching system manufacturers and
vendors, may be able to develop telemanagement products and services that are as
effective as, or more effective or easier to use than, those offered by us. Such
existing and potential competitors may also enjoy substantial advantages over us
in terms of research and development expertise, manufacturing efficiency, name
recognition, sales and marketing expertise and distribution channels. There can
be no assurance that we will be able to compete successfully against current or
future competitors or that competition will not have a material adverse effect
on our future revenues and, consequently, on our business, operating results and
financial condition.
We are subject to risks associated with rapid technological change and risks
associated with new versions and new products.
The telecommunications management market in which we compete is
characterized by rapid technological change, introductions of new products,
changes in customer demands and evolving industry standards. Our future success
will depend upon our ability to keep pace with the technological developments
and to timely address the increasingly sophisticated needs of our customers by
supporting existing and new telecommunication technologies and services and by
developing and introducing enhancements to our current and new products. There
can be no assurance that we will be successful in developing and marketing
enhancements to our products that will respond to technological change, evolving
industry standards or customer requirements, that we will not experience
difficulties that could delay or prevent the successful development,
introduction and sale of such enhancements or that such enhancements will
adequately meet the requirements of the marketplace and achieve any significant
degrees of market acceptance. If release dates of any new products or
enhancements are delayed or, if when released, they fail to achieve market
acceptance, our business, operating results and financial condition would be
materially and adversely affected. In addition, the introduction or announcement
of new product offerings or enhancements by us or our competitors may cause
customers to defer or forgo purchases of current versions of our product, which
could have a material adverse effect on our business, operating results and
financial condition.
We may not be able to retain or attract key managerial, technical and research
and development personnel we need to succeed.
Our success has largely depended and will depend in the future on our
skilled professional and technical employees, substantially all of whom have
written employment agreements. The competition for these employees is intense.
We may not be able to retain our present employees, or recruit additional
qualified employees as we require them.
Three of our shareholders are in a position to control matters requiring a
shareholder vote.
Mr. Chaim Mer, our Chairman, and his wife, Dora Mer, currently control
the vote of approximately 44.3% of our outstanding ordinary shares, and Isaac
Ben-Bassat, one of our directors, is the owner of 14.8% of our outstanding
ordinary shares. As a result, such persons control and will continue to control
the election of our entire Board of Directors other than our two outside
directors and generally have the ability to direct our business and affairs.
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We are subject to risks arising from product defects and potential product
liability.
We provide free warranty and support for up to one year for end-users
and up to eighteen months for our OEM distributors. Our sales agreements
typically contain provisions designed to limit our exposure to potential product
liability or related claims. The limitation of liability provisions contained in
our agreements may not be effective. Our products are used by businesses to
reduce communication costs, recover charges payable by third parties and prevent
abuse and misuse of telephone networks and, as a result, the sale of products by
us may entail the risk of product liability and related claims. A product
liability claim brought against us could have a material adverse effect upon our
business, operating results and financial condition. Products such as those
offered by us may contain undetected errors or failures when first introduced or
when new versions are released. Despite our testing and testing by current and
potential customers, there can be no assurance that errors will not be found in
new products or releases after commencement of commercial shipments. The
occurrence of these errors could result in adverse publicity, loss of or delay
in market acceptance or claims by customers against us, any of which could have
a material adverse effect upon our business, operating results and financial
condition.
Risk Factors Related to Our Ordinary Shares
Holders of our ordinary shares who are United States residents face income tax
risks.
There is a substantial risk that we will be classified as a passive
foreign investment company, or PFIC. Our treatment as a PFIC could result in a
reduction in the after-tax return to the holders of our ordinary shares and
would likely 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, passive
income includes dividends, interest, royalties, rents, annuities and the excess
of gains over losses from the disposition of assets which produce passive
income. If we were determined to be a PFIC for U.S. federal income tax purposes,
highly complex rules would apply to U.S. holders owning our ordinary shares.
Accordingly, you are urged to consult your tax advisors regarding the
application of such rules.
As a result of our substantial cash position and the decline in the
value of our stock, there is a substantial risk that we will be classified as a
PFIC under the asset test described in the preceding paragraph. However, because
the determination of whether we are a PFIC is based upon the composition of our
income and assets from time to time, this determination can not be made with
certainty until the end of the calendar year.
Based on studies performed by an independent consultant, we believe that
we were not a PFIC in the years 2001, 2002, or 2003.
U.S. residents should carefully read "Item 10E. Additional Information -
Taxation - United States Federal Income Tax Consequences" for a more complete
discussion of the U.S. federal income tax risks related to owning and disposing
of our ordinary shares.
13
Our share price has been volatile in the past and may decline in the future.
Our ordinary shares have experienced significant market price and volume
fluctuations in the past and may experience significant market price and volume
fluctuations in the future in response to factors such as the following, some of
which are beyond our control:
o quarterly variations in our operating results;
o operating results that vary from the expectations of securities
analysts and investors;
o changes in expectations as to our future financial performance,
including financial estimates by securities analysts and investors;
o announcements of technological innovations or new products by us or
our competitors;
o announcements by us or our competitors of significant contracts,
acquisitions, strategic partnerships, joint ventures or capital
commitments;
o changes in the status of our intellectual property rights;
o announcements by third parties of significant claims or proceedings
against us;
o additions or departures of key personnel;
o future sales of our ordinary shares; and
o stock market price and volume fluctuations.
Domestic and international stock markets often experience extreme price
and volume fluctuations. Market fluctuations, as well as general political and
economic conditions, such as a recession or interest rate or currency rate
fluctuations or political events or hostilities in or surrounding Israel, could
adversely affect the market price of our ordinary shares.
In the past, securities class action litigation has often been brought
against a company following periods of volatility in the market price of its
securities. We may in the future be the target of similar litigation. Securities
litigation could result in substantial costs and divert management's attention
and resources.
We do not expect to distribute cash dividends.
We do not anticipate paying cash dividends in the foreseeable future.
Our Board of Directors will decide whether to declare any cash dividends in the
future based on the conditions then existing, including our earnings and
financial condition. According to the Israeli Companies Law, a company may
distribute dividends out of its profits, so long as the company reasonably
believes that such dividend distribution will not prevent the company from
paying all its current and future debts. Profits, for purposes of the Companies
Law, means the greater of retained earnings or earnings accumulated during the
preceding two years.
14
Risks Relating to Operations in Israel
Conducting business in Israel entails special risks.
We are incorporated under the laws of, and our executive offices and
research and development facilities are located in, the State of Israel.
Although most of our sales are made to customers outside Israel, we are directly
influenced by the 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, or a significant downturn in the economic or financial
condition of Israel.
Since the establishment of the State of Israel in 1948, a number of
armed conflicts have taken place between Israel and its Arab neighbors, and a
state of hostility, varying from time to time in intensity and degree, has led
to security and economic problems for Israel. Since September 2000, there has
been a marked increase in violence, civil unrest and hostility, including armed
clashes, between the State of Israel and the Palestinians, and acts of terror
have been committed inside Israel and against Israeli targets in the West Bank
and Gaza. There is no indication as to how long the current hostilities will
last or whether there will be any further escalation. Any further escalation in
these hostilities or 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.
Furthermore, there are a number of countries that restrict business with Israel
or Israeli companies. Restrictive laws or policies of those countries directed
towards Israel or Israeli businesses may have an adverse impact on our
operations, our financial results or the expansion of our business.
Our results of operations may be negatively affected by the obligation of our
personnel to perform military service.
Many of our directors, officers and employees are obligated to perform
up to 36 days, depending on rank and position, of military reserve duty annually
and are subject to being called for active duty under emergency circumstances.
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 Israel.
In recent years Israel has been going through a period of recession in
economic activity, resulting in low growth rates and growing unemployment. Our
operations could be adversely affected if the economic conditions in Israel
continue to deteriorate. In addition, due to significant economic measures
proposed by the Israeli Government, there have been several general strikes and
work stoppages in 2003 and 2004, affecting banks, airports and ports. These
strikes have had an adverse effect on the Israeli economy and on business,
including our ability to deliver products to our customers. Following the
passage by the Israeli Parliament of laws to implement the economic measures,
the Israeli trade unions have threatened further strikes or work-stoppages, and
these may have a material adverse effect on the Israeli economy and on us.
15
Our financial results may be adversely affected by inflation and currency
fluctuations.
Since we report our financial results in dollars, fluctuations in rates
of exchange between the dollar and non-dollar currencies may affect our results
of operations. The majority of our expenses are paid in NIS (primarily salaries)
and are influenced by the timing of, and the extent to which, any increase in
the rate of inflation in Israel over the rate of inflation in the United States
is not offset by the devaluation of the NIS in relation to the dollar. We
believe that the rate of inflation in Israel has not had a material adverse
effect on our business to date. However, our dollar costs in Israel will
increase if inflation in Israel exceeds the devaluation of the NIS against the
dollar or if the timing of such devaluation lags behind inflation in Israel.
Over time, the NIS has been devalued against the dollar, generally reflecting
inflation rate differentials. In 1999 and 2000, while the rate of inflation was
low and in 2003 when there was a negative rate of inflation, there was a
devaluation of the dollar against the NIS. In the years 2001 and 2002, and in
2003 when there was a negative rate of inflation, the rate of devaluation of the
NIS against the dollar exceeded the rate of inflation. We cannot predict any
future trends in the rate of inflation in Israel or the rate of devaluation of
the NIS against the dollar. If the dollar cost of our operations in Israel
increases, our dollar measured results of operations will be adversely affected.
Likewise, our operations could be adversely affected if we are unable to guard
against currency fluctuations in the future.
The government programs and tax benefits we currently participate in or receive
require us to meet several conditions and may be terminated or reduced in the
future.
We have benefited from certain Israeli Government grants, programs and
tax benefits. To remain eligible for these grants, programs and tax benefits, we
must comply with certain conditions, including making specified investments in
fixed assets from our own equity and paying royalties with respect to grants
received. In addition, some of these programs restrict our ability to
manufacture particular products and to transfer particular technology outside of
Israel. If we do not meet these conditions in the future, the benefits we
received could be canceled and we may have to refund payments previously
received under these programs or pay increased taxes. The Government of Israel
has reduced the benefits available under these programs in recent years and
these programs and tax benefits may be discontinued or curtailed in the future.
We do not expect to receive any grants during 2004 or 2005.
Service and enforcement of legal process on us and our directors and officers
may be difficult to obtain.
Service of process upon our directors and officers and the Israeli
experts named herein, most of whom reside outside the United States, may be
difficult to obtain within the United States. Furthermore, since substantially
all of our assets, most of our directors and officers and the Israeli experts
named in this annual report are located outside the United States, any judgment
obtained in the United States against us or these individuals or entities may
not be collectible within the United States.
There is doubt as to the enforceability of civil liabilities under the
Securities Act and the Securities Exchange Act in original actions instituted in
Israel. However, subject to certain time limitations and other conditions,
Israeli courts may enforce final judgments of United States courts for
liquidated amounts in civil matters, including judgments based upon the civil
liability provisions of those Acts.
16
Provisions of Israeli law may delay, prevent or make difficult an acquisition of
us, which could prevent a change of control and therefore depress the price of
our shares.
Provisions of Israeli corporate and tax law may have the effect of
delaying, preventing or making more difficult a merger with, or other
acquisition of, us. This could cause our ordinary shares to trade at prices
below the price for which third parties might be willing to pay to gain control
of us. Third parties who are otherwise willing to pay a premium over prevailing
market prices to gain control of us may be unable or unwilling to do so because
of these provisions of Israeli law.
Your rights and responsibilities as a shareholder will be governed by Israeli
law and differ in some respects from the rights and responsibilities of
shareholders under U.S. law.
We are incorporated under Israeli law. The rights and responsibilities
of holders of our ordinary shares are governed by our memorandum of association,
our articles of association and by Israeli law. These rights and
responsibilities differ in some respects from the rights and responsibilities of
shareholders in typical U.S. corporations. In particular, a shareholder of an
Israeli company has a duty to act in good faith toward the company and other
shareholders and to refrain from abusing his power in the company, including,
among other things, in voting at the general meeting of shareholders on certain
matters.
ITEM 4. INFORMATION ON THE COMPANY
--------------------------
A. HISTORY AND DEVELOPMENT OF THE COMPANY
MER Telemanagement Solutions Ltd. was incorporated under the laws of the
State of Israel in December 1995. We are a public limited liability company
under the Israeli Companies Law 5739-1999 and operate under such law and
associated legislation. Our registered offices and principal place of business
are located at 22 Zarhin Street, Ra'anana 43662, Israel, and our telephone
number is 972-9-762-1777. Our address on the Internet is www.mtsint.com. The
information on our website is not incorporated by reference into this annual
report.
We design, develop, market and support a comprehensive line of
telecommunication management solutions that enable business organizations and
other enterprises to more effectively manage and optimize the use of their
communication resources. Our products include call accounting and management
products, fault management systems and Web-based management solutions for
converged voice, voice over Internet Protocol, or IP, data and video. These
products are designed to provide telecommunication and information technology
managers with tools to reduce communication costs, recover charges payable by
third parties, detect and report the abuse and misuse of telephone networks,
monitor and detect hardware and software faults in telecommunications networks
and generate telecommunications usage information for use in the management of
an enterprise. We were among the first to offer PC-based call accounting systems
when we introduced our TABS product in 1985. To date, over 60,000 TABS call
accounting systems have been sold to end-users in more than 60 countries.
Call accounting systems afford businesses easy access to complete
information on telephone usage, including the dialed number, calling extension,
call duration, time of day, destination, trunk line usage, cost of each call and
multi-carrier analysis. We started developing the TABS line of call accounting
products for the DOS operating system and have upgraded and
17
re-written our call accounting and management systems as the industry and
technology advanced providing full compatibility to support the Windows
operating systems (3.1, 95, 98, 2000) and most versions of Windows NT. As our
sales of TABS were worldwide, we needed to have a flexible and easily updated
set of pricing tables to accommodate the different pricing schemes and modes
used worldwide and with different carriers. As enterprises expanded and required
information from their remote sites, so TABS has expanded to accommodate their
needs by providing multi-site solutions and supporting most business telephone
switching systems currently available for sale. The solutions are capable of
monitoring up to 100,000 extensions. Various modules were developed to service
the needs of different vertical markets such as our PMSi module for the hotel
industry and a solution for performing tie-line reconciliation for organizations
and utilities having multiple PBXs. TRAK-View, our fault management system,
provides an enterprise with early warning problem detection and prevention for
multi-site and multi-vendor networks including PBXs. In 1998, we introduced
IP.TRAK, a Web-based call accounting and management system that was built on the
original model and principles of TABSweb(TM). IP.TRAK was designed to harness
the power of the Internet for the needs of Information Technology managers
through its ability to access reports using a standard Internet browser. We then
added additional modules that could collect the information from routers,
firewalls and gateways. These additional modules provided tools for a
comprehensive communications management system. We were able to collect
additional data from files, FTP servers, voice over IP (VoIP) and external
buffers. We then merged the functionality of PBX systems and IP networks to
provide a unified management solution for multiple communication platforms from
different vendors supporting voice, VoIP, video and data communications.
On April 24, 2000, we acquired all of the assets and assumed certain
liabilities of IntegraTRAK Inc., a privately held Seattle-based company, engaged
in the development and sale of packaged computer software for tracking telephone
calls and costs.
In line with our strategic planning, we determined in late 2001 not to
promote TRAK-View and IP.TRAK as stand-alone products, but to offer them as part
of larger solutions.
In 2001, we developed our Web Access module that provides access and
control to the communications usage database, under strict control and privacy,
from anywhere on the web. During the second quarter of 2002, we added
FaciliTRAK, which is a comprehensive software system that greatly simplifies the
day-to-day task of maintaining and managing the physical layer details for any
network. FaciliTRAK allows the user to record the equipment, cables, and
pathways for the cable plant and define the connectivity and circuit routes. A
user can utilize FaciliTRAK to plan and manage the moves and changes within his
or her organization with the aid of the self-documenting service desk functions.
The FaciliTRAK system is an essential tool for any enterprise that is thinking
of implementing a disaster recovery program. We operate in five geographical
areas. Our operations in Israel include research and development, sales,
marketing and support. Our operations in the United States, Brazil, Europe and
Asia include sales, marketing and customer service.
Our strategy is to maintain and enhance our position as a leading
supplier in the enterprise communication management market of call accounting,
facility management solutions and other management solutions while expanding our
product line to address the telemanagement needs of the rapidly converging
voice, video and data communication markets.
18
In July 2000, we sold a 31% interest in Silverbyte, a 50% owned
privately held affiliate. We received $150,000 in consideration from the sale
payable in 24 equal monthly payments. In December 2000, we reached an agreement
to reschedule the remaining balance of the payments due. According to this
agreement, the balance of $110,000 will be repaid in 19 monthly payments
starting April 2002. In April 2002, we reached a new agreement rescheduling the
remaining $85,000 balance to be repaid in 48 monthly payments starting April
2002. We recorded a $73,000 gain from the sale. Although we continue to hold a
19% interest in Silverbyte, we do not have any representation on its board of
directors. Accordingly, our investment in Silverbyte is accounted for according
to the cost method.
B. BUSINESS OVERVIEW
Industry Background
Technological advances and worldwide deregulation and privatization in
the telecommunications industry have resulted in the growth of alternative
telecommunication services providers, such as cellular companies, competitive
access providers, cable companies and data transmission companies. This growth,
in conjunction with dramatic improvements in computing and communications
technology, including the convergence of telephony systems and computers, or
computer telephony integration, has fostered the rapid expansion of
communication services and an increase in the volume of voice and data traffic
by business organizations. The diversification of services and providers using
varied pricing algorithms and the proliferation of domestic and international
networks using varied equipment and technologies for different services and
modes of transmission has placed new demands on telecommunication and
information technology managers and has created the need for sophisticated and
flexible telecommunication management solutions. This has created a demand for
telemanagement solutions that are capable of supporting multiple sites,
switching platforms, languages and currencies, as well as the generation of
telecommunications usage information vital to an enterprise's operations.
Telemanagement solutions have evolved from the stand-alone PC-based
telephone call accounting and billing systems of the mid-1980's to local area
network or LAN-based systems operating in Windows 98/2000/XP and Windows NT
environments offering call accounting, fraud detection and fault management
solutions for users with complex voice and data networks. Today, the trend is
moving more and more to Web-based solutions.
Call accounting products, a fundamental management tool, record,
retrieve and process data received from a PBX or other telephone switching
system, providing a telecommunications manager with information on telephone
usage. This information enables managers to optimize an enterprise's
telecommunications resources and reduce communication expenses, typically the
second or third highest administrative expense of a business, through
cost-tracking and management awareness.
As the trend continues toward enterprises utilizing one infrastructure
for both voice and data services, more and more emphasis will be placed on
finding efficient solutions to cope with the increasing demand on network
resources and for reducing congestion. Enterprises have been required to buy
additional communications resources to meet this demand immediately rather than
optimizing their existing networks due to the time consuming nature of such
projects. IT
19
managers are constantly trying to justify the ever increasing expenses created
by managing the enormous amount of data that is being transmitted through the
Internet.
The abuse and misuse of telephone and data networks, either by employees
making unauthorized telephone calls or by outside "hackers" who tap into an
organization's long distance service has become a major problem for
organizations resulting in great losses. Likewise, employees surfing the web for
private use during working hours overloads the network, preventing critical
tasks from getting through as well as reducing the overall productivity of the
enterprise. These losses have led to the development of intelligent toll fraud
detection systems that immediately alert or initiate preventive measures upon
detecting a suspicious occurrence in network usage traffic.
Organizations with multiple PBXs and providers of maintenance services
require systems that are capable of alerting telecommunications managers of
impending or actual problems in a communications network. Financial and
operational benefits of a fault management system can be immediate and
significant, as down time of the system is reduced due to early problem
detection and real information on remote site events. Maintenance costs are
significantly lowered through better use of human resources and more efficient
inventory management.
In addition, other executives and operational managers are now seeking
telemanagement solutions which permit them to assess how efficiently employees
are using their time, monitor customer service calls, analyze the effectiveness
of marketing expenditures, utilize toll-free responses to determine demographics
of callers through the use of Caller ID information, know who is using the
network and when they are using it, and obtain additional data that aid them in
management of the business.
IP telephony and video conferencing are reaching technological maturity
and are being adopted by an increasing number of organizations. Enterprises have
begun to use the IP platform as a single common telecommunication infrastructure
for all services. The convergence of voice, data and video has become
commonplace, and there is a trend of data equipment manufacturers and PBX system
manufacturers offering platforms that support all services. These developments
as well as customer demands will require future management systems to be
upgraded to support the convergence of voice, data and video and provide a
unified management system that will provide information technology managers with
knowledge about the usage of their resources, the ability to ensure the optimal
use of these resources and centralized control over their networks.
With today's greater mobility, the need to keep track of moves and
changes in an organization requires the use of tools to control, manage and
document these changes more effectively. The useful life of a standard cabling
structure should be fifteen years. This means that existing cables should be
able to support an average of three upgrades of communication equipment during
its lifetime, plus an average of five changes to all outlets. It is virtually
impossible to achieve this performance level without maintaining accurate
records reflecting all details of cabling installations.
The continuing increase in use of cellular phones for business, during
and outside working hours, has created the need to develop products that will
enable an enterprise to generate a true and full record of all the calls made by
its employees, including cellular calls and calls made by calling cards and
other charge plans.
20
Products and Services
We offer a range of call accounting and converged voice/data management
solutions, based on our standard platform which can be adjusted to specific
customers' needs and requests, as well as fault management systems for networks
and PBXs, and facilities management for cabling and equipment. Additionally,
some of our products are geared for communications resellers and as such enable
them to issue regular bills for the communications services rendered. Today
these products and services, starting with the original TABS line, constitute
the basic building blocks for adding modules to cater to the new advanced
communications infrastructures and services.
Background History
We were the first to offer a PC-based non-dedicated call accounting
system when we introduced the first version of TABS in 1985. To date, over
60,000 TABS accounting systems have been sold to end-users located in over 60
countries. TABS supports worldwide charging methods (pulse and duration), call
pricing tables and currencies and is available in different languages. Our PBX
interface database includes default formats for the major PBX manufacturers and
business phone systems, including those manufactured by Ericsson, Philips,
Siemens, Lucent, Nortel, Alcatel, ECI/Tadiran, Harris, NEC, Avaya, Mitel,
Damovo, LG and Panasonic, making TABS compatible with substantially all
currently available PBX and business phone systems. Our flexible format allows
some of the newer equipment such as VoIP PBXs and routers/gateways to be
inputted to and reported on TABS. This includes the RADVision and Cisco gateways
and gatekeepers.
Call Accounting and Management Solutions for Enterprises
TABS.IT
TABS.IT is a solution for small offices, medium sized businesses, and
Fortune 500 enterprises that want to take full control over their communications
network. Specific applications enable hotels, shared tenant environments,
hospitals, universities and service bureaus to resell communications services to
users employing simple, yet efficient mark-up formulas.
TABS.IT tracks the details of all voice communications usage (dialed
numbers, call duration, destination, cost of each call, trunk line usage, etc.)
and produces accurately priced individual customer bills. In addition, TABS.IT
tracks the details of all data communications (IP address, name, number of
bytes, bandwidth usage, nodes, etc.) and can produce a relative cost figure.
TABS.IT products are able to:
o Register and track incoming and outgoing, trunk-to-trunk and internal
calls, including response time, ring time and Caller ID.
o Add billing details and cost of calls according to applicable pricing
tables, including mark-up calculations by extension and other
user-defined categories and rate updates.
o Perform multi-carrier analysis, providing carrier comparison "what if"
reports.
21
o Support authorization and account codes.
o Identify inactive and defective trunks and extensions.
o Operate in a LAN environment, permitting multi-user and multi-tasking
functionality.
o Generate and electronically distribute billing documents, management
and verification reports and 3-D color graphs for easy data analysis.
With additional modules, the following optional features are available:
o Reporting on e-mails (eTABS).
o Reporting on VoIP (VoIPTABS).
o Reporting on web browsing (wTABS).
o Accessing the information over the Internet (Web Access).
These additional modules were developed especially for Internet usage
and provide enterprises with the scalability necessary to permit growing
enterprise organizations to further extend their ability to monitor and optimize
their local networks. With the introduction of Web Access, multiple users now
have the ability to access the TABS database and easily generate reports and
graphs from any PC that has access to the Internet. With this new module, each
authorized user anywhere in the world can browse and review reports containing
restricted data, according to his authorization. These reports are created from
the TABS database by using a web browser at a remote station. In addition,
powerful graphs give the manager an immediate overview of the situation. Both
the graphs and reports can be exported to other applications, such as PowerPoint
for the graphs or Excel for the reports.
The powerful TABS.IT report generator provides a wide variety of usage
reports that are easy to read and understand, yet provide all the information
necessary to identify how communications network resources are being utilized.
These reports can be generated either as a summary of the call data or complete
with all the details necessary to make informed management decisions. Their
structural flexibility allows the user to quickly zero in on the specific data
of greatest interest. Historical reports may be maintained for an unlimited
period of time and can become useful tools for assessing budget needs for the
coming months or years. Specific report categories include ring time reports,
call breakdown reports, hit parade reports, directory reports, exception reports
and trunk reports. In addition, a robust custom reporting feature offers the
user an effective means of generating reports that can go far beyond the
standard categories. With this feature, the user is able to create reports that
can be tailored to meet even the most specific of reporting requirements, and
they can be scheduled to run automatically at a prescribed time.
Version 7 of TABS.IT is fully web-based allowing users to see their own
call usage on-line from anywhere, and incorporates most of the features that
were offered as separate modules in previous versions. This version is easily
adapted to companies that have multiple sites, and would want to view the
activity from a central site. The administrative functions can also be
22
performed remotely using Internet Explorer. Full security and privacy is assured
by use of various levels of password protection.
The WinTRAK family of products is MTS IntegraTrak's telemanagement
solution that has been sold in the U.S. market since 1985. After incorporating
all the functionality of WinTRAK, we migrated TABS.IT for use in the United
States in 2002. Although we are no longer marketing WinTRAK, we continue to
support this product.
Facilities Management System
With today's greater mobility, the need to keep track of moves and
changes in an organization requires the use of tools to control, manage and
document these changes more effectively. In March 2002, we acquired a software
product from Total Wire Software Company, Inc., a privately held Florida-based
company. The purchase of this software, now marketed as FaciliTRAK, enables us
to offer a product that provides tracking of inventory such as telephones,
computers and ancillary equipment associated with a user and develop a complete
composite report of an enterprise's resources. Additionally, it gives us the
ability to provide a full "total information" system to enterprises for
controlling and managing the entire physical layer of an organization's voice
and data system. The "top of the line" FaciliTRAK product is a full featured,
graphic-oriented cable and asset management system, that comes complete with
Visio Technical, a CAD interface, and is available in both a single workstation
and a multi-user network version. Its unique flexibility allows users to
"mirror" complex networks commonly found in large companies, while its enhanced
ability allows it to document and design cable plant projects of all sizes.
FaciliTRAK documents and controls the management of the physical layer,
device configuration and circuit connectivity for a wide range of network
topologies including ethernet, token ring, voice, fiber distributed data
interface, etc. that range in size, from just a few hundred nodes to many
thousand, and with its universal functionality can be extended to interface with
logical network management systems, cable testing and labeling systems, help
desk, call accounting, and other facility management tools. Using a flexible and
multipurpose database, FaciliTRAK documents the physical characteristics for any
network, recording the network, asset, user, device configuration, and exact
connections between equipment and cabling. The results are then presented in
either a database view, dynamic schematic, or Visio Technical drawing. The
schematics generated by those modules are used to show the physical connectivity
and logical path of the equipment and cabling connections in the database.
As a multi site system, FaciliTRAK can store information for multiple
buildings or campuses and show views by floor, closet and zones. Specific
information such as port or pair assignment, network addresses, and circuit
connections are easily entered to match the level of detail required.
The FaciliTRAK help desk feature provides both an administrative process
and audit trail for recording, scheduling and maintenance changes that need to
be made to items and connections in a site. There are three options within
service desk: (i) service requests, (ii) trouble tickets, and (iii) work orders.
Each provides its own choices and reference numbering for easy tracking and
assignment. Both service requests and trouble tickets provide the option of
being used globally for the entire organization, regardless of whether the item
in service has been
23
recorded in the site database, or used for items within the current site. We
intend to migrate to a new facilities management product in late summer 2004.
Billing Solutions
In 2002 we introduced the TABSBill module for vertical enterprises, such
as hospitals, universities, medical clinics and tenant sharing facilities,
enabling the enterprises to rapidly generate bills based on usage. TABSBill,
which is geared to resellers of billing services, provides for the scheduled
reporting and automatic distribution of customer communications bills based on
tracking phone calls, e-mail, network usage as well as for one time or recurring
charges. The bills can be generated directly from the data collected by TABS,
from CDs from the service provider, or from downloaded files of call data. All
kinds of communications usage data may be billed. The user can view his bills
on-line as TABSBill is web based. The bills can be displayed, printed out or
sent by e-mail. There is even provision for the secure payment of the bill
on-line.
Other Modules
An add-on module, Tie Line Reconciliation, or TLR, provides for the
accurate costing of calls in a private PBX network by calculating the actual
cost of calls routed over private tie lines and assigning charges to the
originating extension. The call is resolved into an accurate
origination-destination configuration even though the call may pass many "nodes"
along the way, with each potentially discharging an independent call record.
Another add-on module, Property Management System interface, or PMSi,
provides an interface protocol and format for telecommunication management
systems with hotel billing solutions (Front Office or PMS systems). Through the
use of this interface, which can also connect to PBXs, the hotel system is able
to control the opening and closing of guest extensions on check in or out.
New Trends
We have implemented a new strategy for our company that has led to the
introduction of an application suite. The suite is built on the Microsoft.Net
platform and establishes a framework for us to provide customized solutions that
include customer care and billing, in addition to the traditional telemanagement
solutions. We are currently investing heavily in research and development to
support these new operations.
Customer Service and Installation
We provide customer support to end-user customers in the United States,
Israel, Hong Kong, the Netherlands and Brazil on both a service contract and a
per-incident basis. Our technical support engineers answer support calls
directly and generally seek to provide same-day responses. We provide updated
telephone rate tables to customers on a periodic basis under annual service
contracts. The rate tables are obtained from third-party vendors who provide
this data for all major long-distance service providers. Our distributors
provide a full range of service and technical support functions for our
products, including rate tables, to their respective end-user customers.
24
Our support staff installs products at end-user locations from offices
in Israel, the United States, Hong Kong, the Netherlands and Brazil. Customers
who maintain their own technical staffs are often able to install our products
themselves with minimal telephone support from us. We charge our customers a fee
for each installation performed by our employees. Our distributors are
responsible for the installation and support of our products with respect to
their end-user customers.
Sales and Marketing
We market our products in over 60 countries worldwide through OEM
distribution channels and our own direct sales force in the United States,
Europe, Israel, Hong Kong and Brazil, and through a network of local
distributors in these and various other countries in Europe, Asia and Latin
America. We employed 15 persons in our sales and marketing force and 31 persons
in support as of December 31, 2003. With the acquisition of IntegraTRAK in April
2000, our marketing efforts in North America were significantly increased. This
also enabled us to acquire additional Fortune 500 companies as our customers. We
also sell our products to business telephone switching systems manufacturers and
vendors, distributors and PTTs. Since 1985, over 60,000 TABS call accounting
products have been sold, many of which have been sold to large organizations. In
addition, as customers move to consolidate the management of their multi-site
telecommunications activities, we intend to capitalize on our initial successes
with our customers and expand the use of our products by offering these
organizations the added capabilities of expanding and monitoring on the Web. By
acquiring the FaciliTRAK software in March 2002, we gained access to a whole new
realm of opportunities and we now are able to offer a complete solution to the
high-end market sector.
Managed Services
Our managed services solution is an outsourcing solution geared to
multi-national companies that centrally manage their telecommunications usage
and is being offered as an added value service. This solution has been offered
in the U.S. where our Seattle office acts as a service bureau.
Switching Systems Manufacturers and Vendors. We believe that the most
efficient means of selling our telemanagement products is to enter into
relationships with major business telephone system manufacturers and vendors who
market our products on either an original equipment manufacturer, or OEM, basis,
or supplemental sales basis at the time they sell their switching systems. We
also utilize our distributors to market our products to local business telephone
switching systems manufacturers and distributors. We intend to establish
additional strategic relationships with business telephone switching systems
manufacturers and vendors and PTTs. These manufacturers have begun to consider
telemanagement capability as a competitive tool when selling their products and
have begun to offer end-users a complete, integrated solution. Among the
companies that have been selling our products are Siemens, Philips, Ericsson,
Nortel, Alcatel, ECI/Tadiran, NEC, Cisco, Damovo and Panasonic. The percentages
of sales attributable to our three largest OEM customers, Siemens, Philips and
Ericsson, in each of the three years ended December 31, 2003 are as follows:
25
2001 2002 2003
---- ---- ----
Siemens.................... 32.0% 36.0% 40.0%
Philips.................... 8.0% 6.0% 7.0%
Ericsson................... 4.0% 4.0% 4.0%
Distributors. In general, in those countries where we do not have a
marketing subsidiary, we distribute our products through a local distributor.
Marketing, sales, training, product and client support are provided by our local
distributors. A local distributor is typically a telecommunication products
marketing organization with the capability to add value with installation,
training, and support. Distributors are generally responsible for the
localization of our products into their native language. The distributor also
translates our standardized product marketing literature and technical
documentation. Prior to becoming an authorized distributor, the distributor's
employees must undergo sales and technical training. We are available for
second-tier support for the distributor and for end-users. In coordination with
the distributors, we also provide technical support for large and multinational
accounts. We have distributors worldwide and intend to expand our network of
distributors and resellers and to expand our direct sales force and field
organization in selected markets.
PTTs. We also market our products to PTTs who integrate our solutions
with the telephone systems they sell or lease to their customers. Among the PTTs
who sell our products are Telecom Italy, Cable and Wireless, Trinidad PTT and
Hong Kong Telecom.
Strategic Relationships. As part of our marketing strategy, we attempt
to develop and establish new strategic relationships with manufacturers of voice
and data communication systems and IP based equipment as means of entering new
markets and channels. We are also continuing our relationship with RADVision, a
recognized IP technology leader. Together with RADVision, we offer solutions
consisting of RADVision's Gatekeeper and our advanced Web-based call management
solution. We also signed an agreement with Cisco, pursuant to which Cisco may
use our VoIP solution in their CallManager call processing software, a key
component of Cisco's AVVID (Architecture for Voice, Video and Integrated Data).
Our software provides validated reports on call records, start time, duration,
and origin and final destination. Additional features include the ability to
allocate usage-sensitive call costing and, using an integrated fraud module,
detect unauthorized or inappropriate system access.
We recently entered into an OEM agreement with TeleKnowledge Group Ltd.,
a leading provider of carrier-class billing & rating solutions, pursuant to
which we will market TeleKnowledge's Total-e billing, rating and customer care
solutions on an OEM basis as a comprehensive end-to-end solution.
Other Marketing Activities. We are conducting a wide range of marketing
activities aimed at generating awareness and leads, including public relations,
attendance at trade shows and exhibitions, user conferences, direct mail,
response mail and seminars. We have joined alliances with strategic partners
such as Alcatel and Cisco. We regularly advertise our products in prominent
trade publications, and we also participate in major regional and international
technology and communications trade shows, forums, and fairs worldwide. These
activities are intended both to generate leads and maintain the general public
awareness of our products. We maintain our web site on-line, allowing for
correspondence and queries from new potential customers as well as promoting
support for our existing customer base.
26
Competition
The market for telemanagement products is fragmented and is intensely
competitive. Competition in the industry is generally based on product
performance, depth of product line, technical support and price. We compete both
with international and local competitors (including providers of
telecommunications services), many of whom have significantly greater financial,
technical and marketing resources than we do. Our existing and potential
customers, including business telephone switching system manufacturers and
vendors, may be able to develop telemanagement products and services that are as
effective as, or more effective or easier to use than, those offered by us. Such
existing and potential competitors may also enjoy substantial advantages over us
in terms of research and development expertise, manufacturing efficiency, name
recognition, sales and marketing expertise and distribution channels. Although
we believe that the quality of our products is equal to or better than the
product quality of our competitors with regard to performance and reliability,
we have no quantitative data other than the evaluations of our present customers
from which to assess our current ability to compete. There can be no assurance
that we will be able to compete successfully against current or future
competitors or that competition will not have a material adverse effect on our
future revenues and, consequently, on our business, operating results and
financial condition.
Intellectual Property Rights
We do not hold any patents and rely upon a combination of security
devices, copyrights, trademarks, trade secret laws, confidentiality procedures
and contractual restrictions to protect our rights in our products. Our policy
has been to pursue copyright protection for our software and related
documentation and trademark registration of our product names. Some of our
products have the added protection afforded by a hardware component which has
embedded software that it is difficult to misappropriate. In addition, our key
employees and independent contractors are required to sign non-disclosure and
secrecy agreements. All of the intellectual property rights with respect to our
products are held by Mer Telemanagement Solutions Ltd.
Our trademark rights include rights associated with the use of our
trademarks, and rights obtained by registration of our trademarks. We have
obtained trademark registrations in Israel and the United States. The use and
registration rights of our trademarks does not ensure that we have superior
rights over other third parties that may have registered or used identical
related marks on related goods or services.
We believe that, because of the rapid pace of technological change in
the communication industry, the legal protections for our products are less
significant factors in our success than the knowledge, ability and experience of
our employees, the frequency of product enhancements and the timeliness and
quality of support services provided by us.
C. ORGANIZATIONAL STRUCTURE
Our wholly owned subsidiaries in the United States, Hong Kong, the
Netherlands and Brazil, MTS IntegraTRAK Inc., MTS Asia Ltd., JARAGA B.V. and
TABS Brazil Ltd., respectively, act as marketing and customer service
organizations in those countries. Our 50% owned affiliate in Spain, Jusan S.A.,
is engaged in the development and distribution of telemanagement products.
27
D. PROPERTY, PLANTS AND EQUIPMENT
Our executive offices and research and development facilities are
located at 22 Zarhin Street, Ra'anana, Israel, where we occupy approximately
7,310 feet. The lease, which expires on December 31, 2005, has an annual rental
charge of approximately $107,335.
Our U.S. operations are headquartered in an 8,408 square foot space in
Bellevue, Washington at annual rental of approximately $208,000. The lease will
expire in September 2004. We have subleased 2,040 square feet of this space
until September 2004 and are receiving annual rental income of approximately
$46,305. The lease for space we previously utilized in Secaucus, New Jersey
expired in April 2003. The annual rental for the Secaucus space was $103,780.
The annual rental cost for our Hong Kong and Sao Paulo offices is approximately
$34,000.
ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS
--------------------------------------------
The following discussion of our results of operations should be read
together with our consolidated financial statements and the related notes, which
appear elsewhere in this annual report. The following discussion contains
forward-looking statements that reflect our current plans, estimates and beliefs
and involve risks and uncertainties. Our actual results may differ materially
from those discussed in the forward-looking statements. Factors that could cause
or contribute to such differences include those discussed below and elsewhere in
this annual report.
General
Overview
We design, develop, market and support a comprehensive line of
telecommunication management solutions that enable business organizations and
other enterprises to improve the efficiency and performance of all IP
operations, and to significantly reduce associated costs. Our products include
call accounting and management products, fault management systems and Web-based
management solutions for converged voice, voice over Internet Protocol, or IP,
data and video. These products are designed to provide telecommunication and
information technology managers with tools to reduce communication costs,
recover charges payable by third parties, detect and report the abuse and misuse
of telephone networks, monitor and detect hardware and software faults in
telecommunications networks and generate telecommunications usage information
for use in the management of an enterprise. We were among the first to offer
PC-based call accounting systems when we introduced our TABS product in 1985. To
date, over 60,000 TABS call accounting systems have been sold to end-users in
more than 60 countries.
General
Our consolidated financial statements are stated in dollars and prepared
in accordance with generally accepted accounting principles in the United
States. Transactions and balances originally denominated in dollars are
presented at their original amounts. Transactions and balances in other
currencies are remeasured into dollars in accordance with the principles set
forth in Financial Accounting Standards Board Statement No. 52. The majority of
our sales are made outside Israel in dollars. In addition, substantial portions
of our costs are incurred in dollars. Since the dollar is the primary currency
of the economic environment in which we and
28
certain of our subsidiaries operate, the dollar is our functional and reporting
currency and, accordingly, monetary accounts maintained in currencies other than
the dollar are remeasured using the foreign exchange rate at the balance sheet
date. Operational accounts and non-monetary balance sheet accounts are measured
and recorded at the exchange rate in effect at the date of the transaction. The
financial statements of certain subsidiaries and an affiliate whose functional
currency is not the dollar, have been translated into dollars. All balance sheet
accounts have been translated using the exchange rates in effect at the balance
sheet date. Statement of operations amounts have been translated using the
average exchange rate for the period. The resulting translation adjustments are
reported as a component of shareholders' equity in accumulated other
comprehensive income (loss).
Discussion of Critical Accounting Policies
The preparation of financial statements in conformity with generally
accepted accounting principles requires us to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates and the use of different
assumptions would likely result in materially different results of operations.
Critical accounting policies are those that are both most important to
the portrayal of a company's financial position and results of operations, and
require management's most difficult, subjective or complex judgments. Although
not all of our significant accounting policies require management to make
difficult, subjective or complex judgments or estimates, the following policies
and estimates are those that we deem most critical.
Impairment of long-lived assets
Our 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," or 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, 2003, no impairment was required. The use of different assumptions
with respect to the expected cash flows from our assets and other economic
variables, primarily the discount rate, may lead to different conclusions
regarding the recoverability of our assets' carrying values and to the potential
need to record an impairment loss for our long-lived assets.
Goodwill
Goodwill represents excess of the costs over the net assets of business
acquired. Goodwill from acquisitions made prior to July 1, 2001 was amortized
until December 31, 2001 by the straight-line method over 10 years. Under SFAS
No. 142, goodwill acquired in a business contraction on or after July 1, 2001
will not be amortized.
29
Effective January 1, 2002, we adopted SFAS No. 142. SFAS No. 142
requires goodwill to be tested for impairment on adoption and at least annually
thereafter, and written down when impaired, rather than being amortized as
previous accounting standards required. Goodwill attributable to each of our
reporting units is tested for impairment by comparing the fair value of each
reporting unit with its carrying value. Fair value is determined using
discounted cash flows. Significant estimates used in the methodologies include
estimates of future cash flows, future short-term and long-term growth rates,
and weighted average cost of capital for each of the reportable units. We have
selected December 31, as the date we will perform our annual goodwill impairment
tests. The annual goodwill impairment test for 2003 was prepared for us by an
independent consulting firm. As of December 31, 2003, no impairment was
required. Any changes in our key assumptions could result in an impairment
charge and such a change could have a material adverse affect on our financial
position and results of operations.
Investments in affiliates and other companies
Investments in privately held companies, in which we hold 20% to 50%
ownership of voting rights and can exercise significant influence over operating
and financial policy of the affiliate, are presented using the equity method of
accounting. In accordance with SFAS No. 142, goodwill related to investments in
affiliates is no longer amortized. The goodwill is reviewed annually (or more
frequently if circumstances indicate impairment has occurred) for impairment in
accordance with Accounting Principles Board Opinion No. 18. "The Equity Method
of Accounting for Investments in Common Stock," or "APB No. 18." Before the
adoption of SFAS No. 142 on January 1, 2002, goodwill was amortized on a
straight-line basis over 10 years, in accordance with APB Opinion No. 17,
"Intangible Assets."
Investments in privately held companies in which the we hold less than
20% and do not have the ability to exercise significant influence over their
operating and financial policy, are presented at cost. We periodically review
the carrying value, in accordance with APB No. 18. If this review indicates that
the carrying value is not recoverable, the carrying value is reduced to its
estimated fair value. As of December 31, 2003, no impairment losses have been
identified. Any changes in our key assumptions concerning their carrying value
could have a material adverse affect on our financial position and results of
operations.
Research and development costs
Research and development costs, net of grants received, are charged to
expenses as incurred. Statement of Financial Accounting Standard No. 86,
"Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise
Marketed," requires capitalization of certain software development costs
subsequent to the establishment of technological feasibility. Based on our
product development process, technological feasibility is established upon
completion of a working model. Costs incurred by us between completion of the
working model and the point at which the product is ready for general release
should be capitalized. During 2003 such costs were immaterial.
Capitalized software costs are amortized by the greater of: (i) ratio of
current gross revenues from sales of the software to the total of current and
anticipated future gross revenues from sales of that software or (ii) the
straight-line method over the remaining estimated useful life of the product
(not greater than three years). We assess the recoverability of this intangible
asset on a regular basis by determining whether the amortization of the asset
over our remaining
30
life can be recovered through undiscounted future operating cash flows from the
specific software product sold. Based on the most recent analyses, our
management believes that no impairment of capitalized software development costs
exists as at December 31, 2003. Under different assumptions with respect to the
recoverability of this intangible asset, our determination may be different,
which may negatively affect our financial position and results of operations.
Concentrations of credit risk
Financial instruments that potentially subject us and our subsidiaries
to concentrations of credit risk consist principally of cash and cash
equivalents, short and long-term bank deposits, trade receivables and long-term
trade receivables. Our cash and cash equivalents and short-term and long-term
bank deposits are invested in major Israeli and U.S. banks. Such deposits in
U.S. banks may be in excess of insured limits and are not insured in other
jurisdictions. We believe that the financial institutions that hold our
investments are financially sound and, accordingly, minimal credit risk exists
with respect to these investments.
We perform ongoing credit evaluations of our customers and have not
experienced any material losses in recent years. An allowance for a doubtful
account is determined with respect to those amounts that we have determined to
be doubtful of collection. Any changes in our assumptions relating to the
collectability of our accounts receivable may affect our financial position and
results of operations.
Recently Issued Accounting Standards
In January 2003, the FASB issued FASB Interpretation No. 46, or FIN 46,
"Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51,"
which addresses consolidation by business enterprises of variable interest
entities, or VIEs, either: (1) that do not have sufficient equity investment at
risk to permit the entity to finance its activities without additional
subordinated financial support, or (2) in which the equity investors lack an
essential characteristic of a controlling financial interest. In December 2003,
the FASB completed deliberations of proposed modifications to FIN 46, or the
Revised Interpretation, resulting in multiple effective dates based on the
nature as well as the creation date of the VIE. VIEs created after January 31,
2003, but prior to January 1, 2004, may be accounted for either based on the
original interpretation or the Revised Interpretation. However, the Revised
Interpretation must be applied no later than our first quarter of fiscal 2004.
VIEs created after January 1, 2004 must be accounted for under the Revised
Interpretation. Special Purpose Entities, or SPEs, created prior to February 1,
2003 may be accounted for under the original or Revised Interpretation's
provision no later than our fourth quarter of fiscal 2003. Non-SPEs created
prior to February 1, 2003, should be accounted for under the Revised
Interpretation's provisions no later than our first quarter of fiscal 2004.
We have not entered into any material arrangements with VIEs created
prior to or after January 31, 2003.
31
Operating Results
The following table presents certain financial data expressed as a
percentage of total revenues for the periods indicated:
Year Ended December 31,
-----------------------------------
2001 2002 2003
---- ---- ----
Revenues
Product sales....................................... 73.1% 75.6% 75.2%
Services............................................ 26.9 24.4 24.8
Total revenues...................................... 100.0% 100.0% 100.0%
Cost of revenues
Product sales....................................... 17.8 16.9 16.5
Services............................................ 6.0 2.5 3.5
------ ------ ------
Total cost of revenues.............................. 23.8 19.4 20.0
Gross profit........................................ 76.2 80.6 80.0
Selling and marketing............................... 45.8 40.4 42.5
Research and development............................ 33.2 21.7 19.8
General and administrative.......................... 18.1 19.0 19.8
Operating loss...................................... (20.9) (0.5) (2.1)
Financial income, net............................... 1.3 1.4 1.3
Other income (expenses)............................. (6.1) (1.5) 0.1
------ ------ ------
Loss before taxes................................... (25.7) (0.6) (0.7)
Taxes on income..................................... 0.2 0.5 2.1
------ ------ ------
Net loss before equity in earnings of affiliate..... (25.9) (1.1) (2.8)
Equity in earnings of affiliate..................... 2.1 2.4 3.7
------ ------ ------
Net income (loss)................................... (23.8)% 1.3% 0.9%
====== ====== ======
Years Ended December 31, 2003 and 2002
Revenues. Revenues consist primarily of products sales and revenues from
services, including service center income, custom made projects, maintenance and
support. Revenues decreased 5.8% to $9.23 million in 2003 from $9.8 million in
2002 as a result of the continued global decline in the demand for
telecommunication products, such as PBX systems, which effected our revenue
stream. In 2003, the revenues from our wholly owned U.S. subsidiary, MTS
IntegraTRAK, declined 23% from 2002 and accounted for 53.0% of our total
revenues. In 2004, we took measures to reverse the sales decline in the United
States, but no assurance can be given that we will be successful in our efforts.
Cost of Revenues. Cost of revenues consists primarily of (i) production
costs (including hardware, media, packaging, freight and documentation); (ii)
certain royalties and licenses payable to third parties (including the Office of
the Chief Scientist of the Ministry of Industry and Trade of the State of
Israel, or OCS) and (iii) warranty and support costs for up to one year for
end-users. Cost of revenues decreased 2.6% to $1.85 million in 2003 from $1.9
million in 2002, principally as a result of the overall decrease in revenues.
Gross margin. Gross profit as a percentage of revenues was 80% in 2003
compared to 80.6% in 2002. We expect that our gross margin will fluctuate on a
quarterly basis due to the changing nature of our sales and the timing of
product introductions.
32
Selling and Marketing, Net. Selling and marketing expenses consist
primarily of costs relating to promotion, advertising, trade shows and
exhibitions, sales compensation, presales support, and travel expenses. Selling
and marketing expenses were $3.92 million in 2003, a decrease of 1% from $3.95
million in 2002. In 2003, we succeeded in increasing our sales to existing OEM
customers, which increased by 45% to $2.3 million compared to $1.59 million in
2002. During 2004, we began to increase our selling efforts, particularly in the
U.S. and Europe, and we expect to increase our selling and marketing investment
during the year.
Research and Development, Net. Research and development expenses consist
primarily of salaries of employees engaged in on-going research and development
activities, outsourcing subcontractor development and other related costs. Net
research and development costs decreased 14% to $1.83 million in 2003 from $2.13
million in 2002. The total research and development expenses decreased due to
the downsizing process that we continued to implement until the end of the third
quarter of 2003. Beginning in the fourth quarter of 2003, we began to increase
our research and development expenses. We did not receive any royalty-bearing
grants from the OCS in 2002 or 2003 and we do not expect to receive any grants
during 2004. We did not capitalize any software development costs in either
year.
General and Administrative. General and administrative expenses consist
primarily of compensation costs for administration, finance and general
management personnel, professional fees and office maintenance and
administrative costs. General and administrative expenses decreased 1.6% to
$1.83 million in 2003 from $1.86 million in 2002 as we attempted to contain such
expenses in light of our decreased sales.
Financial Income, Net. Financial income consists primarily of interest
income on bank deposits and foreign currency translation adjustments. As a
result of interest income earned on the remaining proceeds from our initial
public offering, the sale of our wholly owned subsidiary, STS Software Systems
Ltd., to NICE Systems Ltd. and the sale of our office condominium space on Fifth
Avenue in New York, we recorded financial income of $124,000 in 2003 as compared
to financial income of $134,000 in 2002. During the last three years our
interest income was negatively affected by the prevailing low interest rates in
both the United States and in Israel.
Other Income. During 2003 we recorded income of $6,000 from the exercise
of marketable securities compared to a loss of $140,000 in 2002. During 2002 the
loss was the result of the decline in the value of our marketable securities
whose value had decreased as a result of the global recession.
Taxes on Income. In 2003 our taxes on income were $198,000 as compared
to $52,000 in 2002. Most of the taxes in 2003 were the result of our realization
of the deferred tax assets according to our conservative accounting policy.
During 2003 we realized a tax benefit of $80,000 from a tax return received from
the Spanish tax authorities.
Equity Interest in Results of Affiliates. We recognize income and loss
from the operations of our 50%-owned affiliate, Jusan S.A. In 2003 and in 2002,
we recognized income of $345,000 and $236,000, respectively.
33
Years Ended December 31, 2002 and 2001
Revenues. Revenues decreased 8.4% to $9.8 million in 2002 from $10.7
million in 2001 as a result of the depressed global economic environment and the
decline in worldwide sales of telecommunication products. In 2002, revenues from
software products increased while revenues from products with hardware
components decreased. In 2002, our wholly owned U.S. subsidiary, MTS
IntegraTRAK, accounted for 66.0% of our total revenues.
Cost of Revenues. Cost of revenues decreased 25.5% to $1.9 million in
2002 from $2.55 million in 2001, principally as a result of the significant
efforts that we initiated beginning in the fourth quarter of 2001 to reduce
costs and the decrease in our revenues.
Gross Margin. Gross profit as a percentage of revenues, increased to
80.6% in 2002 from 76.2% in 2001, principally as a result of our cost cutting
measures.
Selling and Marketing, Net. Selling and marketing expenses decreased
significantly by 19.4% to $3.95 million in 2002 from $4.9 million in 2001.
Although we reduced our selling and marketing expenses in 2002 by participating
in fewer trade shows and focusing on development of new channels and direct
sales, we enhanced our marketing efforts, particularly in the United States, and
were able to maintain our sales to existing OEM customers.
Research and Development, Net. Net research and development costs
decreased 40.2% to $2.13 million in 2002 from $3.56 million in 2001, as a result
of a downsizing process that we implemented during 2002. We did not receive any
royalty-bearing grants from the OCS in 2002 as compared to $990,000 received in
2001 and we do not expect to receive any grants during 2003. We did not
capitalize any software development costs in either 2002 or 2001.
General and Administrative. General and administrative expenses
decreased 4.1% to $1.86 million in 2002 from $1.94 million in 2001, principally
as a result of downsizing that we implemented during year 2002.
Financial Income, Net. As a result of interest income earned on the
remaining proceeds from our initial public offering, the sale of our wholly
owned subsidiary, STS Software Systems Ltd. to NICE Systems Ltd. and the sale of
our office condominium space on Fifth Avenue in New York, we recorded financial
income of $134,000 in 2002 as compared to financial income of $138,000 in 2001.
During both 2002 and 2001 our interest income was negatively affected by the
prevailing low interest rates in both the U.S. and in Israel.
Other Income (Expenses). During 2001 we recorded a one-time capital loss
of $741,000 ($606,000 after tax) from a permanent value depreciation of the NICE
Systems Ltd. securities we acquired as part of the consideration received from
the sale of STS Software Ltd. to NICE Systems Ltd. During 2002 we recorded a
loss of $140,000 from an exercise of marketable securities, whose value had
decreased as a result of the global recession.
Taxes on Income. In 2002 our taxes on income was $52,000 as compared to
$16,000 in 2001.
Equity Interest in Results of Affiliate. In 2002 and in 2001, we
recognized income of $236,000 and $221,000 respectively from the operations of
our 50%-owned affiliate, Jusan S.A.
34
Quarterly Results of Operations
The following tables set forth certain unaudited quarterly financial
information for the two years ended December 31, 2003. The 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. The operating results for any quarter are not
necessarily indicative of results for any future periods.
Three months ended
----------------------------------------------------------------------------
2002 2003
------------------------------------- --------------------------------------
Mar. 31, Jun. 30, Sept.30, Dec. 31, Mar. 31, Jun. 30, Sept. 30, Dec. 31,
-------- -------- -------- -------- -------- -------- --------- --------
Revenues........................ $2,581 $2,494 $2,196 $2,516 $2,240 $2,193 $2,286 $2,511
------ ------ ------ ------ ------ ------ ------ ------
Cost of revenues................ 569 407 475 445 540 411 457 441
------ ------ ------ ------ ------ ------ ------ ------
Gross profit.................... 2,012 2,087 1,721 2,071 1,700 1,782 1,829 2,070
------ ------ ------ ------ ------ ------ ------ ------
Selling and marketing, net...... 1,014 1,071 970 899 918 1,061 938 999
Research and development, net... 605 539 497 486 441 386 434 564
General and administrative...... 460 473 459 466 483 422 462 463
Operating expenses.............. 2,079 2,083 1,926 1,851 1,842 1,869 1,834 2,026
------ ------ ------ ------ ------ ------ ------ ------
Operating income (loss)......... (67) 4 (205) 220 (142) (87) (5) 44
Financial income (expense), net. 3 101 42 (12) 16 22 (11) 97
Other income (loss)............. 17 (5) (71) (81) -- 6 -- --
------ ------ ------ ------ ------ ------ ------ ------
Income (loss) before taxes...... (47) 100 (234) 127 (126) (59) (16) 141
Taxes on income (tax benefit)... -- 65 (51) 38 -- (2) 98 102
------ ------ ------ ------ ------ ------ ------ ------
Net income (loss) before equity in
earnings (loss) of affiliate.. (47) 35 (183) 89 (126) (57) (114) 39
Equity interest in results of
affiliate....................... 38 84 84 30 139 48 117 41
------ ------ ------ ------ ------ ------ ------ ------
Net income (loss)............... $(9) $119 $ (99) $ 119 $ 13 $ (9) $ 3 $80
====== ====== ====== ====== ====== ====== ====== ======
Revenues........................ 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of revenues................ 22.0 16.3 21.6 17.7 24.1 18.7 20.0 17.6
------ ------ ------ ------ ------ ------ ------ ------
Gross profit.................... 78.0 83.7 78.4 82.3 75.9 81.3 80.0 82.4
------ ------ ------ ------ ------ ------ ------ ------
Selling and marketing, net...... 39.3 42.9 44.2 35.7 41.0 48.4 41.0 39.8
Research and development,
net ......................... 23.4 21.6 22.6 19.3 19.7 17.6 19.0 22.5
General and administrative...... 17.8 19.0 20.9 18.5 21.6 19.2 20.2 18.4
Operating expenses.............. 80.5 83.5 87.7 73.5 82.3 85.2 80.2 80.7
------ ------ ------ ------ ------ ------ ------ ------
Operating income (loss)......... (2.5) 0.2 (9.3) 8.8 (6.4) (3.9) (0.2) 1.7
Financial income (expense), net. 0.1 4.1 1.9 (0.5) 0.7 1.0 (0.5) 3.9
Other income (loss)............. 0.7 (0.2) (3.2) (3.2) -- 0.3 -- --
------ ------ ------ ------ ------ ------ ------ ------
Income (loss) before taxes...... (1.7) 4.1 (10.6) 5.1 (5.7) (2.6) (0.7) 5.6
Taxes on income (tax benefit)... -- (2.6) 2.3 (1.5) -- (0.1) 4.3 4.1
------ ------ ------ ------ ------ ------ ------ ------
Net income (loss) before equity in
results of affiliate.......... (1.7) 1.5 (8.3) 3.6 (5.7) (2.5) (5.0) 1.5
Equity interest in results of
affiliate..................... 1.5 3.4 3.8 1.2 6.2 2.2 5.1 1.6
------ ------ ------ ------ ------ ------ ------ ------
Net income (loss)............... (0.2%) 4.9% (4.5%) 4.8% 0.5% (0.3)% 0.1% 3.1%
====== ====== ====== ====== ====== ====== ====== ======
Seasonality
Our operating results are generally not characterized by a seasonal
pattern except that our volume of sales in Europe are generally lower in the
summer months.
35
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 or dollar-linked NIS 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 may be adversely affected by a
change in the rate of inflation in Israel if the amount of our revenues in NIS
decreases and is less than the amount of our expenses in NIS (or if such
decrease is offset on a lagging basis) 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 %
------------ ----------------- - ---------------- ------------------
1999 1.3 (0.2) 1.5
2000 0 (2.7) --
2001 1.4 9.3 (7.2)
2002 6.5 7.3 (0.7)
2003 (1.9) (7.6) 6.2
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.
Conditions in Israel
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
36
affected by political, economic and military conditions in 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, has led to security
and economic problems for Israel. Since September 2000, there has been a marked
increase in violence, civil unrest and hostility, including armed clashes,
between the State of Israel and the Palestinians, and acts of terror have been
committed inside Israel and against Israeli targets in the West Bank and Gaza.
There is no indication as to how long the current hostilities will last or
whether there will be any further escalation. Any further escalation in these
hostilities or 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. Furthermore, there
are a number of countries that restrict business with Israel and with Israeli
companies. Restrictive laws or policies of those countries 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 up to 36 days, depending on rank and position, of military
reserve duty annually and are subject to being called for active duty under
emergency circumstances. 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.
To date, no executive officer or key employee has been recruited for
military service for any significant time period. Any further deterioration of
the hostilities between Israel and the Palestinian Authority into a full-scale
conflict might require more significant military reserve service by some of our
employees, which may have a material adverse effect on our business.
Economic Conditions
Israel's economy has been subject to numerous destabilizing factors,
including a period of rampant inflation in the early to mid-1980s, low foreign
exchange reserves, fluctuations in world commodity prices, military conflicts
and civil unrest. Due to the continuing budget deficit of the Israeli Government
and the slow down of the Israeli economy in recent years, the Israeli Parliament
approved, during 2003, several economic measures which entail, among other
things, budget cuts in various sources of government spending, the increase of
various tax liabilities and cuts in various social benefits. It is not known at
this stage what impact the implementation of the approved economic plan will
have on the Israeli economy.
As a result of political instability, the increased level of hostilities
with the Palestinian Authority and the world-wide economic crisis in the hi-tech
and communication industries, the Israeli rate of economic growth deteriorated
in 2001 and 2002, the NIS was devalued and the rate
37
of inflation increased. The Israeli Government has proposed certain budgetary
cuts and other changes, which were recently adopted by the Israeli Parliament.
Although with the assistance of the U.S. Government economic stability was
reached in 2003 and the rate of inflation was negative for the first since the
establishment of the State, we cannot assure you that the Israeli Government
will be successful in its attempts to stabilize the Israeli economy or to
maintain Israel's current credit rating. Should Israel's credit rating decline,
the ability of the Israeli Government to generate foreign financial and economic
assistance may be adversely affected. Economic decline as well as price and
exchange rate instability may have a material adverse effect on us.
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.
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 tax at the rate of 36% of
taxable income. 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. The tax benefits under the Investment Law are not available with
respect to income derived from products manufactured outside of Israel. 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 to four years,
commencing in the first year in which such income is earned, and will be
entitled to a reduced tax rate of 15% for an additional 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.
38
Our effective tax rates in Israel were 25% during the years 2001, 2002
and 2003. Our effective corporate tax rate may substantially exceed the Israeli
tax rate.
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, which historically have been profitable.
B. LIQUIDITY AND CAPITAL RESOURCES
On December 31, 2003, we had $8.7 million in cash and cash equivalents,
$1.6 million in marketable securities and working capital of $9.4 million as
compared to $9.1 million in cash and cash equivalents, $1.2 million in
marketable securities and $9.2 million in working capital on December 31, 2002.
The increase in working capital in 2003 is mainly due to an increase in both
accounts receivables and other accounts receivable and prepaid expenses. During
2003 we continued our stock buy back program, purchasing 130,510 ordinary shares
through December 31, 2003 at a cost of $147,000, an average of $1.13 per share.
During 2003 we retired 384,610 ordinary shares, which we purchased pursuant to
our stock buy-back program. Depending upon market conditions, we may decide to
continue this program during 2004. We may use the repurchased shares for
issuance upon exercise of employee stock options or other corporate purposes.
One of the principal factors affecting our working capital is the
payment cycle on our sales. Payment for goods shipped is generally received from
60 to 70 days after shipment. Any material change in the aging of our accounts
receivable could have an adverse effect on our working capital.
The decrease in inventory for the year ended December 31, 2003 was
primarily due to our efforts to reduce inventories in light of the difficult
economic conditions prevailing worldwide. Our net accounts receivable at
year-end 2003 were $1.39 million compared to $1.26 million as of December 31,
2002. The change is attributed to outstanding accounts receivable belong to
recent projects that were performed at the end of 2003. The allowance for
doubtful accounts was $356,000 and $350,000 as of December 31, 2002 and 2003,
respectively.
Our operations provided $163,000 for the year ended December 31, 2003,
compared to $489,000 for the year ended December 31, 2002. The decrease in cash
provided from operations was primarily due the reduced equity in the earnings of
our affiliates and an increase in trade payables, accounts receivable and
prepaid expenses.
As of December 31, 2003, our principal commitments consisted of
obligations outstanding under operating leases. We currently do not have
significant capital spending or purchase commitments, but we expect to continue
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 to 18 months. Thereafter, if we do not generate sufficient cash from
operations, we may be required to obtain additional financing. There can be no
assurance that such financing will be available in the future, or, if available,
will be on terms satisfactory to us.
39
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 telemanagement 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. We are ISO
9001:1994 certified and we are currently in the process of upgrading the quality
system according to ISO 9001:2000.
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.
On December 31, 2003, we employed 23 persons in research and
development. As part of our product development team, we employ technical
writers who prepare user documentation for our products.
We have committed substantial financial resources to research and
development for our telemanagement business. We enjoyed the aid of the Israeli
Ministry of Industry and Trade's Office of the Chief Scientist for selected
research and development projects. During 2001, 2002 and 2003, our research and
development expenditures were $4.6 million, $2.1 million and $1.8 million,
respectively, for which the Office of the Chief Scientist reimbursed us
approximately $0.99 million in 2001. We did not receive any grants in 2002 or
2003.
Under research and development agreements with the Office of the Chief
Scientist, we are required to pay royalties on the revenues derived from
products incorporating know-how developed with grants received from the Office
of the Chief Scientist (including ancillary services in connection therewith),
up to a dollar-linked amount equal to 100% to 150% of such grants and bearing
LIBOR interest. Commencing in 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. Under these agreements and existing laws and
regulations, we are required to pay royalties at a rate of 3%-5% of our software
sales. See Item 10E. "Additional Information - Taxation - Grants under the Law
for the Encouragement of Industrial Research and Development, 1984."
We have expensed royalties relating to the repayment of such grants in
the amounts of $176,000, $132,000 and $146,000 for the years ended December 31,
2001, 2002 and 2003, respectively.
As of December 31, 2003, we had a contingent obligation to pay royalties
in the amount of approximately $7.52 million. The $3.45 million of grants
received after January 1999 are subject to interest at a rate equal to the 12
month LIBOR rate. We do not expect to receive additional grants from the
Government of Israel during 2004.
40
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, 2003 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
-------- --------- --------- --------- ---------
Long-term debt obligations....... -- -- -- -- --
Capital (finance) lease obligations -- -- -- -- --
Operating lease obligations...... $540,000 $276,000 $264,000 -- --
Purchase obligations............. -- -- -- -- --
Other long-term liabilities reflected
on our balance sheet under U.S.
GAAP ........................ -- -- -- -- --
Total............................ $540,000 $276,000 $264,000 -- --
======= ======= ======= == ==
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:
Name Age Position with the Company
---- --- ---------------------------------
Chaim Mer............... 56 Chairman of the Board
Eytan Bar............... 38 President and Chief Executive Officer
Yossi Brikman........... 46 Corporate Chief Operating Officer and Chief
Financial Officer-Israel
Richard Bruyere......... 40 Chief Operating Officer-MTS IntegraTRAK Inc.
Alon Aginsky............ 41 Director
Isaac Ben-Bassat........ 50 Director
41
Name Age Position with the Company
---- --- ---------------------------------
Dr. Yehoshua Gleitman... 54 Director
Steven J. Glusband...... 57 Director
Yaacov Goldman.......... 49 Director
Prof. Nava Pliskin...... 56 Director
Messrs. Mer, Aginsky, Ben-Bassat, Glusband and Goldman will serve as
directors until our 2004 Annual General Meeting of Shareholders. Dr. Gleitman
and Prof. Pliskin serve as outside directors pursuant to the provisions of the
Israeli Companies Law for a three-year term from the date of their appointment
until our 2004 annual general meeting of shareholders. At that time, they may be
re-elected 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 President,
Chief Executive Officer and Chairman of the Board of C. Mer Industries Ltd.
since 1988. 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 us, and between 2001 and 2003, Mr. Bar served as
General Manager of the CEM product division of NICE Systems Ltd. From 2000
through 2001 Mr. Bar served as a Vice President of Professional Services at NICE
Systems Inc. From 1993 through 1999, Mr. Bar served as a General Manager of STS
Software Systems Ltd., a company that developed a unique VoIP technology for
recording solutions.
Yossi Brikman has been our Vice President and Chief Financial Officer
since January 1998. Since March 2000, Mr. Brikman has also served as our
Secretary. He was appointed as General Manager of our operations in Israel in
August 2000. Before joining us, he served as co-founder and co-manager of STS
Software Systems Ltd. from its inception in 1988 until January 1998. Mr. Brikman
holds a B.Sc. degree from Fairleigh Dickenson University and an M.B.A. degree
from Haifa University.
Richard Bruyere has been the Chief Operating Officer of our subsidiary,
MTS IntegraTRAK Inc., since January 2002. After having served as Director of
Telecommunications for Memorial Hospital from 1987 to 1995, Mr. Bruyere joined
IntegraTRAK Inc. in January 1995. In October 1998, he was elected Vice President
of Operations of IntegraTRAK Inc. Mr. Bruyere joined MTS as part of our
acquisition of IntegraTRAK Inc. in April 2000.
Alon Aginsky has been 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
Marketing and Sales from October 1996 until April 1999, when he was appointed
Manager of C. Mer Industries Ltd. He served as President of MTS Inc., our U.S.
based marketing subsidiary from 1990 until September 1996. Mr. Aginsky holds a
B.A. degree in Business Administration from the New York Technology Institute.
Isaac Ben-Bassat has been a director since our inception in December
1995. He has been Executive Vice President and a director of C. Mer Industries
Ltd. since 1988.
42
Mr. Ben-Bassat holds a B.Sc. degree in Civil Engineering from the Technion
Israel Institute for Technology.
Dr. Yehoshua Gleitman has served as an outside director since July 2001.
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, he was Director General of the
Israeli Ministry of Industry and Trade and was Chief Scientist at the Ministry
of Industry and Trade from January 1993 through February 1997. From 1991 through
1992, he was the general manager of AIMS Ltd., and between 1990-1991, was an
advisor in charge of marketing and business for Ashtrom Ltd. Dr. Gleitman holds
a Ph.D. and an M.Sc. in Physical Chemistry and a B.Sc. 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 was elected as a director by our Board of Directors in
May 2004 and will be a nominee for election at our 2004 Annual General Meeting
of Shareholders. 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. and Elron Electronic Industries Ltd. From March 2002 until
October 2002, he served as consultant for Poalim Capital Markets and Investments
Ltd. From September 2000 until November 2001, he served as Managing Director of
Argoquest Holdings, LLC, a U.S. based investment company focused on early stage
high-tech companies. From November 1981 until August 2000, he 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.
Prof. Nava Pliskin has served as an outside director since July 2001.
Prof. Pliskin has been a Full Professor since 2002 in the areas of Information
Systems (IS) and Information Technology (IT) at the Department of Industrial
Engineering and Management of Ben-Gurion University in Israel. She has been a
faculty member at Ben-Gurion University since 1985, receiving tenure in 1992.
Prof. Pliskin was a Thomas Henry Carroll Ford Foundation Visiting Associate
Professor at the Harvard Business School in 1996-1997. Prof. Pliskin holds Ph.D.
and S.M. degrees in Engineering and Applied Physics from Harvard University and
a B.Sc. in Mathematics and Statistics 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, 2003.
43
Salaries, fees, Pension,
commissions and retirement and
bonuses similar benefits
---------------- ----------------
All directors and executive officers
as a group, consisting of twelve (12)
persons $625,694 $179,327
All our executive officers work full time for us, except for Mr. Mer,
who is employed on a part-time basis. We provide automobiles to our executive
officers at our expense. During the year ended December 31, 2003, we paid each
of our independent directors an annual fee of approximately $8,400 and a per
meeting attendance fee of $300.
As of December 31, 2003, our directors and executive officers as a
group, consisting of 12 persons, held options to purchase an aggregate 262,990
ordinary shares.
C. BOARD PRACTICES
Our Articles of Association provide for a Board of Directors consisting
of up to 10 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. All directors (except the outside directors) hold
office until the next annual general meeting of shareholders and until their
successors have been elected.
Election of Directors
Pursuant to our articles of association, all of our 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. 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 2003.
Independent and Outside Directors
The Israeli Companies Law requires Israeli companies with shares that
have been offered to the public in or outside of Israel to appoint at least two
outside directors. No person may be appointed as an outside director if the
person or the person's relative, partner, employer or any entity under the
person's control has or had, on or within the two years preceding the date of
the person's appointment to serve as outside director, any affiliation with the
company or any entity controlling, controlled by or under common control with
the company. The term affiliation includes:
o an employment relationship;
o a business or professional relationship maintained on a regular basis;
o control; and
o service as an officer holder.
44
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 an outside director or may otherwise interfere with the
person's ability to serve as an outside director. If, at the time an outside
director is to be appointed, all current members of the board of directors are
of the same gender, then the outside director must be of the other gender.
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 are present at the meeting and
voting 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.
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.
In addition, the Nasdaq Stock Market requires us to have at least two
independent directors on our Board of Directors and to establish an audit
committee. Under Nasdaq rules promulgated pursuant to the Sarbanes-Oxley Act of
2002, we will be required in the future to have three independent directors on
our audit committee. Dr. Yehoshua Gleitman and Prof. Nava Pliskin qualify both
as independent directors under the Nasdaq Stock Market requirements and as
outside directors under the Israeli Companies Law requirements. Messrs. Alon
Aginsky and Yaacov Goldman qualify as independent directors under the Nasdaq
Stock Market requirements.
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 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.
45
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, such
a transaction must be approved by the audit committee and by the board of
directors itself (with further shareholder approval required in the case of
extraordinary transactions). 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 some transactions between a
public company and a controlling shareholder, or transactions in which a
controlling shareholder of the company has a personal interest but which are
between a public company and another entity, require the approval of the board
of directors and of the shareholders. Moreover, an extraordinary transaction
with a controlling shareholder or the terms of compensation of a controlling
shareholder 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 and are present at the meeting. 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) do not require shareholder approval.
In addition, pursuant to the recent amendment to these regulations,
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
46
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% shareholder of the company. This
rule does not apply if there is already another 25% shareholder of the company.
Similarly, the Companies Law provides that an acquisition of shares in a public
company must be made by means of a tender offer if as a result of the
acquisition the purchaser would become a 45% shareholder of the company, unless
there is a 50% shareholder of the company. Regulations under the Companies Law
provide that the 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
The Israeli Companies Law provides that an Israeli company cannot
exculpate an office holder from liability with respect to a breach of his duty
of loyalty, but may, if permitted by its articles of association, exculpate in
advance an office holder from his liability to the company, in whole or in part,
with respect to a breach of his duty of care. Our Articles of Association permit
us to exempt an officer for his liability, in whole or in part, for damage
caused due to the breach of the duty of care, subject to the provisions of the
Israeli Companies Law.
Our Articles of Association provide that, subject to the provisions of
the Israeli Companies Law, we may enter into an insurance contract for the
liability of an officer with respect to an act performed by him in his capacity
as an officer, for:
o a breach of his duty of care to us or to another person;
o breach of his duty of loyalty to us, provided that the office holder
acted in good faith and had reasonable cause to assume that his act
would not prejudice our interests; or
o a financial liability imposed upon him in favor of another person.
In addition, our Articles of Association provide that we may, with
respect to an act performed by an officer in such capacity, (i) undertake in
advance to indemnify an officer, provided that the undertaking shall be
restricted to types of events that the board of directors shall deem to have
been foreseeable at the time the undertaking to indemnify is made, and to a sum
which shall not exceed an amount in NIS equal to $3 million; and (ii) indemnify
an officer retroactively; against:
o a financial liability imposed on him in favor of another person by any
judgment, including a settlement or an arbitration award approved by a
court; and
47
o reasonable litigation expenses, including attorneys' fees, expended by
such office holder or charged to him by a court, in a proceeding we
instituted against him or instituted on our behalf or by another
person, or in a criminal charge from which he was acquitted or in
which he was convicted of an offense that does not require proof of
criminal intent.
These provisions are specifically limited in their scope by the Israeli
Companies 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.
Pursuant to the 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 such office holder is a director, also by our shareholders.
Our audit committee, board of directors and shareholders resolved to
indemnify our office holders, pursuant to a standard indemnification agreement
that provides for indemnification of an office holder in an amount up to $3
million. We currently maintain a directors' and officers' liability insurance
policy with a per claim and aggregate coverage limit of $2.5 million including
legal costs incurred in Israel. We intend to increase our coverage to $5
million, subject to shareholder ratification at our Annual General Meeting that
is scheduled to take place in July 2004.
Directors' Service Contracts
We do not have any service contracts with our directors. Our directors
are not entitled to any benefits upon termination of their service as our
directors.
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, approving related-party
transactions as required by Israeli law, and such other duties as may be
directed by our board of directors.
Our audit committee consists of four board members 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, Prof. Nava Pliskin and
Messrs. Alon Aginsky and 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.
48
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.
Internal Audit
The Israeli Companies Law also requires the board of directors of a
public company to 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 serves as our internal auditor.
D. EMPLOYEES
On December 31, 2003, we and our consolidated subsidiaries employed 86
persons, of which 23 persons were employed in research and development, 31 in
training and technical support, 15 in marketing and sales and 17 in operations
and administration. As of December 31, 2003, 40 of our employees were located in
Israel, 31 of our employees were located in the United States, 8 of our
employees were located in Hong Kong, 2 of our employees were located in Holland
and 5 of our employees were located in Brazil.
On December 31, 2002, we and our consolidated subsidiaries employed 90
persons, of which 27 persons were employed in research and development, 31 in
training and technical support, 15 in marketing and sales and 17 in operations
and administration.
On December 31, 2001, we and our consolidated subsidiaries employed 106
persons, of which 33 persons were employed in research and development, 37 in
training and technical support, 20 in marketing and sales and 16 in operations
and administration.
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 2003, 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.
49
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
satisfy approximately 8.3% of this obligation by contributing funds to a fund
known as "Managers' Insurance." 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 "provision of severance pay."
E. SHARE OWNERSHIP
The following table sets forth certain information as of June 1, 2004
regarding the beneficial ownership of our ordinary shares by each of our
directors and executive officers.
Number of Percentage of
Ordinary Shares Outstanding
Beneficially Ordinary
Name Owned(1) Shares(2)
---- ---------------- -------------
Chaim Mer........................... 2,099,778 (3)(4) 44.3%
Eytan Bar .......................... 31,250 *
Yossi Brikman....................... 150,000 (5) 3.2
Richard Bruyere..................... 20,000 (5) *
Alon Aginsky........................ -- (5) --
Isaac Ben-Bassat.................... 689,214 (6) 14.8
Dr. Yehoshua Gleitman............... -- --
Steven J. Glusband.................. 5,722 (5)(7) *
Yaacov Goldman...................... -- --
Prof. Nava Pliskin.................. -- --
----------
* 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.
(2) The percentages shown are based on 4,641,804 ordinary shares (excluding
7,000 shares held in treasury) issued and outstanding as of June 1,
2004.
(3) Mr. Chaim Mer and his wife, Mrs. Dora Mer, are the holders of 244,821
ordinary shares, and are the beneficial owners of 1,744,453 ordinary
shares through their
50
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) Includes 98,824 ordinary shares issuable upon exercise of stock options.
(5) Subject to currently exercisable stock options.
(6) Includes 630,045 ordinary shares held by Ron Dan Investments Ltd., a
corporation controlled by Mr. Ben-Bassat.
(7) Includes 4,722 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 may be granted to our employees,
management, officers and directors or those of our subsidiaries. Any options
which are canceled or forfeited within the option period will become available
for future grants. The 1996 Plan will terminate in 2006, unless earlier
terminated by the Board of Directors.
The 1996 Plan 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. According to the 1996 Plan, we may provide loans to employees to assist
them in purchasing the shares upon exercise of an option on terms and conditions
approved by the Board of Directors and subject to applicable law. Such loans
have never been granted.
Options granted under the 1996 Plan will generally be exercisable under
such circumstances as the Board or Option Committee determines. Such options
will not be 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. Options
granted under the 1996 Plan will terminate at such time and under such
circumstances as the Board or Option Committee determines.
During 2003, options to purchase 35,000 ordinary shares were granted
under our 1996 Plan, with an average exercise price of $2.94 and no options were
exercised into ordinary shares. At December 31, 2003, options to purchase
103,350 ordinary shares were outstanding under the 1996 Plan, exercisable at an
average exercise price of $2.85 per share.
51
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. We do 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 new 2003 Israeli Share Option Plan for issuance thereunder.
Options granted under our 1996 102 Plan are exercisable under such
circumstances as the Board of Directors or Option Committee determined.
According to the 1996 102 Plan, we may provide loans to employees to assist them
in purchasing the shares upon exercise of an option on terms and conditions
approved by the Board of Directors and subject to applicable law. Such loans
have never been granted. 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 2003, options to purchase 67,000 ordinary shares were granted
under the 1996 102 Plan at an exercise price below the fair market value of the
stock on the date of grant and options to purchase 133,333 ordinary shares were
exercised into ordinary shares. At December 31, 2003, options to purchase
362,791 ordinary shares were outstanding, exercisable at an average exercise
price of $2.85 per share.
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
52
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. However, such committee,
if appointed, is not entitled to grant options. 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 2003, options to purchase an aggregate of 332,500 ordinary shares
were granted under the 2003 Plan at an average exercise price of $2.11 per
share, including 250,000 options having exercise prices below the fair market
value of our ordinary shares on the date of grant. No options were exercised
into ordinary shares in 2003. At December 31, 2003, there were 332,500 options
outstanding under the 2003 Plan having an exercise price of $2.11 per share.
Warrants
On February 7, 2001, we issued five-year warrants to purchase 25,000 of
our ordinary shares to Investec Bank (Mauritius) Ltd. in connection with certain
financial services performed on our behalf. The warrants had an exercise price
of $4.95 per ordinary share until February 2004, and from thereafter until
February 2006, the exercise price is $5.625 per ordinary share.
ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS
-------------------------------------------------
A. MAJOR SHAREHOLDERS
The following table sets forth certain information as of June 1, 2004
regarding the beneficial ownership by all shareholders known to us to own
beneficially 5.0% or more of our ordinary shares:
53
Number of Percentage of
Ordinary Shares Outstanding
Name Beneficially Owned(1) Ordinary Shares(2)
---- --------------------- ------------------
Chaim Mer and Dora Mer............ 2,099,778 (3)(4) 44.3%
Isaac Ben-Bassat.................. 689,214 14.8%
----
Total............................. 2,788,992 59.1%
========= ====
-----------
(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.
(2) The percentages shown are based on 4,641,803 ordinary shares (excluding
384,610 shares held in treasury) issued and outstanding as of June 1,
2004.
(3) Mr. Chaim Mer and his wife, Mrs. Dora Mer, are the holders of 234,821
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) Includes 98,824 ordinary shares issuable upon exercise of stock options.
As of June 1, 2004 there were 26 holders of record of our ordinary
shares, of which 8 record holders holding approximately 32% of our ordinary
shares had registered addresses in the United States. We believe that there were
over 52 beneficial holders of our ordinary shares on June 1, 2004.
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 the Board of Directors and by the 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 its President, Chief Executive Officer and Chairman of its Board of
Directors since 1988.
54
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.
C. INTERESTS OF EXPERTS AND COUNSEL
Not applicable.
ITEM 8. FINANCIAL INFORMATION
---------------------
A. CONSOLIDATED STATEMENTS AND OTHER FINANCIAL INFORMATION
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(b) of our Consolidated Financial Statements.
Legal Proceedings
In March 2004, our U.S.-based subsidiary was named as a defendant in
a complaint filed in the United States District Court for the Northern District
of Georgia, Atlanta Division, captioned Telemate.net Software, Inc. v. James A.
Myers, Total Wire Software Company, Inc. and MTS Integratrak, Inc., Civ. No.
1:04-CV 0570. The plaintiff alleges among other things federal copyright
infringement, federal unfair competition, common law unfair competition and
misappropriation of trade secrets in connection with our license of software
from James A. Myers. In a related action in the State Court of Fulton County,
State of Georgia, captioned James A. Myers v. Telemate.net Software, Inc. v. MTS
Integratrak, Inc. and Total Wire Software Company, Inc., Case No. OIVS021284-Y,
Telemate filed a third-party complaint against MTS Integratrak based on the same
license, claiming misappropriation of trade secrets. The plaintiff is seeking an
injunction against our future sales of the product, damages, an accounting of
any sales of such product, and attorneys' fees. We have moved to dismiss the
federal complaint and have not responded to the state complaint as yet, but
believe that we have good and valid defenses that we will assert.
Tax assessment
In April 2000, the tax authorities in Israel issued to us a demand for a
tax payment in the amount of approximately NIS 6,000,000 (approximately
$1,350,000) for the period of 1997 to 1999.
We have appealed to the Israeli district court in respect of the
abovementioned tax demand. Based on the opinion of our tax counsel, we believe
that certain defenses can be raised against the demand of the tax authorities.
We believe that the outcome of this matter will not have a material adverse
effect on our financial position or results of operations. We made a provision
for such assessment based on the current evidence and the opinion of our tax
consultants, which we believe is adequate.
55
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 the 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, so long as the company reasonably believes that
such dividend distribution will not prevent the company from paying all its
current and future debts. Profits, for purposes of the Israeli Companies Law,
means the greater of retained earnings or earnings accumulated during the
preceding two years. In the event cash dividends are declared, such dividends
will be paid in NIS.
B. SIGNIFICANT CHANGES
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
SmallCap Market.
Year High Low
---- ---- ---
2003................... $3. 56 $0. 87
2002................... 1. 65 0. 75
2001................... 4. 63 0. 90
2000................... 17. 75 2. 50
1999................... 7. 13 1. 25
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 SmallCap Market.
High Low
---- ---
2002
----
First Quarter........... $1. 65 $0. 98
Second Quarter.......... 1. 05 0. 91
Third Quarter........... 1. 00 0. 80
Fourth Quarter.......... 1. 23 0. 75
2003
----
First Quarter........... $1. 05 $0. 87
Second Quarter.......... 1. 90 0. 97
Third Quarter........... 2. 65 1. 65
Fourth Quarter.......... 3. 56 2. 01
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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
SmallCap Market.
Month High Low
----- ---- ---
December 2003............ $3. 56 $2. 82
January 2004............. 4. 00 3. 20
February 2004............ 3. 90 3. 15
March 2004............... 3. 90 3. 18
April 2004............... 3. 62 3. 29
May 2004................. 3. 45 3. 00
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 SmallCap
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.
B. MEMORANDUM AND ARTICLES OF ASSOCIATION
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.
58
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." 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.
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
58
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 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. 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
The Board of Directors must convene an annual meeting of shareholders at
least once every calendar year, within fifteen months of the last annual
meeting. Notice of at least twenty-
59
one days prior to the date of the meeting is required. An extraordinary meeting
may be convened by the board of directors, as it decides or upon a demand of any
two directors or 25% of the directors, whichever is less, or of one or more
shareholders holding in the aggregate at least 5% of our issued capital. An
extraordinary meeting must be held not more than thirty-five days from the
publication date of the announcement of the meeting. See Item 10B. "Additional
Information -- Memorandum and Articles of Association -- Rights Attached to
Shares--Voting Rights."
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' confirmations 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 the Israeli Companies Law, our
Articles of Association are deemed to include a requirement that such merger be
approved by an extraordinary 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
None.
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
60
previously existed under such law, and enabled Israeli citizens to freely invest
outside of Israel and freely convert Israeli currency into non-Israeli
currencies.
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
On January 1, 2003, a comprehensive tax reform took effect in Israel.
Pursuant to the reform, resident companies are subject to Israeli tax on income
accrued or derived in Israel or abroad. In addition, the concept of "controlled
foreign corporation" was introduced according to which an Israeli company may
become subject to Israeli taxes on certain income of a non-Israeli subsidiary if
the subsidiary's primary source of income is passive income (such as interest,
dividends, royalties, rental income or capital gains). The tax reform also
substantially changed the system of taxation of capital gains.
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.
General Corporate Tax Structure
Israeli companies are subject to "Company Tax" at the rate of 36% of
taxable income. However, the effective tax rate payable by a company, which
derives income from an approved enterprise (as further discussed below), may be
considerably less.
Tax Benefits Under the Law for the Encouragement of Capital Investments, 1959
The Law for the Encouragement of Capital Investments, 1959, as amended,
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 and Trade of the State of Israel, be designated as
an approved enterprise. Each certificate of approval for an approved enterprise
relates to a specific investment program delineated both by its financial scope,
including its capital sources, and by its physical characteristics, e.g., the
equipment to be purchased and utilized pursuant to the program. 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
61
a portion of its capital investments is approved, its effective tax rate is the
result of a weighted average of the applicable rates.
Taxable income of a company derived from an approved enterprise is
subject to company tax at the maximum rate of 25% (rather than 36%) 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. 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 between two and ten years from
the first year of taxable income, depending on the geographic and social
economical location of the approved enterprise within Israel, 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 more than 25% of whose 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
---------------------------------------- -----------
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.
Subject to applicable provisions concerning income under the alternative
track , all dividends are considered to be attributable to the entire enterprise
and their effective tax rate is the result of a weighted average of the various
applicable tax rates. We currently intend to reinvest any income derived from
our approved enterprise programs and not to distribute such income as a
dividend.
62
The Investment Center bases its decision as to whether or not to approve
an application on the criteria set forth in the Investment Law and regulations,
the prevailing policy of the Investment Center and the specific objectives and
financial criteria of the applicant. Accordingly, we cannot assure you that any
of our applications, if made, will be approved in the future.
C. Mer Industries Ltd. was granted approved enterprise status with
respect to five investment projects and chose the alternative track with respect
to each of these projects. Subsequent to our incorporation, C. Mer Industries
Ltd. transferred four continuing approved programs to us were also granted
approval. A fifth and sixth program were also granted approval. 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,
it would be required to refund the amount of tax benefits, with the addition of
the Israeli consumer price index linkage adjustment and interest. In our
opinion, we have been in full compliance with the conditions of the above
programs through December 31, 2003.
Grants under the Law for the Encouragement of Industrial Research and
Development, 1984
Under the Law for the Encouragement of Industrial Research and
Development, 1984, or 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 of the Israeli Ministry of Industry and Trade are
eligible for grants of up to 50% of certain of the project's expenditure, as
determined by the research committee, in exchange for the payment of royalties
from revenues derived from products (and ancillary services) incorporating
technology developed within the framework of the approved research and
development program. Regulations promulgated under the Research Law generally
provide for the payment of royalties to the Office of the Chief Scientist of
3%-5% of such revenues, until 100% to 150% of the U.S. dollar-linked grant is
repaid. Effective for grants received from the Office of the Chief Scientist
under programs approved after January 1, 1999, the outstanding balance of such
grants will be subject to interest equal to the 12 month LIBOR rate applicable
to U.S. dollar deposits that is published on the first business day of each
calendar year. Following the full repayment of the grant, there is no further
liability for repayment.
The terms of the Israeli Government participation generally requires
that the manufacture of products developed with such grants be performed 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 and the aggregate repayment amount is increased, depending on the
portion of the total manufacturing volume that is performed outside Israel (120%
of the grant if the manufacturing volume performed outside of Israel is less
than 50%; 150% of the grant if the manufacturing volume performed outside of
Israel is between 50% and 90%, and 300% of the grant if the manufacturing volume
performed outside of Israel is more than 90%). As of April 1, 2003, the Research
Law also allows for the approval of grants in cases in which the applicant
declares that part of the manufacturing will be performed outside of Israel or
by non-Israeli residents and the research committee is convinced that the same
is essential for the execution of
63
the program. This declaration will be a significant factor in the determination
of the Office of Chief Scientist whether to approve a research and development
program and the amount and other terms of benefits to be granted. In such cases,
the increased royalty and repayment amount will be required.
The technology developed pursuant to the Chief Scientist grants may not
be transferred to third parties in Israel without the prior approval of the
research committee. Approval of the transfer of technology may be granted in
specific circumstances, only if the recipient agrees to abide by the provisions
of the Research Law and regulations promulgated thereunder, including the
restrictions on the transfer of technology and the obligation to pay royalties
in an amount that may be increased. We cannot assure you that such consent, if
requested, will be granted. The Research Law provides that the technology
developed under an approved research and development program may not be
transferred to any third parties outside Israel. No approval is required for the
export of any products developed under the funded plan.
The funds generally available for grants from the Office of the Chief
Scientist were reduced in 1998, and the Israeli authorities have indicated in
the past that the government may further reduce or abolish grants from the
Office of the Chief Scientist in the future. We did not receive any grants from
the Office of the Chief Scientist during 2003, and we do not expect to receive
any grants during 2004. In the event that development of a specific product in
which the Chief Scientist participates is successful, we will become obligated
to repay the grants received relating to the specific product through royalty
payments at the rate of 3% to 5%, based on our sales revenues, up to an amount
equal to 100% to 150% of the grant received, linked to the exchange rate of the
U.S. dollar. As of December 31, 2003, we had a contingent obligation to pay
royalties in the amount of approximately $7,520,000. The outstanding balance of
grants received after January 1999 is subject to interest equal to the 12-month
LIBOR rate.
Tax Benefits and Grants for Research and Development
Israeli tax law allows, under specific conditions, a tax deduction in
the year incurred for expenditures, including capital expenditures, 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.
Expenditures not so approved are deductible over a three-year period.
Tax Benefits Under the Law for the Encouragement of Industry (Taxes), 1969
According to the Law for the Encouragement of Industry (Taxes), 1969, or
the Industry Encouragement Law, an Industrial Company is a company resident in
Israel, at least 90% of the income of which, in a given tax year, determined in
Israeli currency (exclusive of income from some government loans, capital gains,
interest and dividends), is derived from an Industrial Enterprise owned by it.
An "Industrial Enterprise" is defined as an enterprise whose major activity in a
given tax year is industrial production activity.
Under the Industry Encouragement Law, Industrial Companies are entitled
to the following preferred corporate tax benefits:
64
o amortization 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.
Eligibility for benefits under the Industry Encouragement Law is not
subject to receipt of prior approval from any governmental authority. We cannot
assure you that we will continue to qualify as an Industrial Company or that the
benefits described above will be available to us in the future.
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:
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.
o Capital gains on specific marketable securities are exempt from tax
for individuals until December 31, 2002 and from January 1, 2003,
individuals are subject to a 15% tax rate on the real capital gains,
companies are subject to a 36% tax rate on the real capital gains and
dealers in securities are subject to the regular tax rules applicable
to business income in Israel.
Capital Gains Tax on Sales of Our Ordinary Shares
Israeli law imposes a capital gains tax on the sale of capital assets.
The law distinguishes between real gain and inflationary surplus. The
inflationary surplus is a portion of the total capital gain that is equivalent
to the increase of the relevant asset's purchase price which is attributable to
the increase in the Israeli consumer price index between the date of purchase
and the date of sale. The real gain is the excess of the total capital gain over
the inflationary surplus. The inflationary surplus accumulated from and after
December 31, 1993 is exempt from any capital gains tax in Israel while the real
gain is added to ordinary income, which is taxed at ordinary rates of 30% to 50%
for individuals and 36% for corporations. For purchases subject to capital gains
treatment made since January 1, 2003, the tax has been reduced to 25%. Purchases
made prior to January 1, 2003 will be subject to taxes ranging up to 36%.
65
Under current law, sales of our ordinary shares until December 31, 2002,
are exempt from Israeli capital gains for individuals so long as they are quoted
on Nasdaq or listed on a stock exchange in another country and we qualify as an
Industrial Company. We cannot assure you that we qualify or will maintain such
qualification or our status as an Industrial Company. Notwithstanding the
foregoing, dealers in securities in Israel are taxed at regular tax rates
applicable to business income. From January 1, 2003, individuals are subject to
a 15% tax rate on the real capital gain.
Pursuant to the Convention Between the government of the United States
of America and the government of Israel with respect to Taxes on Income, as
amended (the "Treaty"), the sale, exchange or disposition of ordinary shares by
a person who qualifies as a resident of the United States within the meaning of
the Treaty and who is entitled to claim the benefits afforded to such person by
the Treaty generally will not be subject to the Israeli capital gains tax unless
such Treaty U.S. Resident holds, directly or indirectly, shares representing 10%
or more of our voting power during any part of the 12-month period preceding
such sale, exchange or disposition, subject to particular conditions. A sale,
exchange or disposition of ordinary shares by a Treaty U.S. Resident who holds,
directly or indirectly, shares representing 10% or more of our voting power at
any time during such preceding 12-month period would be subject to such Israeli
tax, to the extent applicable; however, under the Treaty, such Treaty U.S.
Resident would be permitted to claim a credit for such taxes against the U.S.
federal income tax imposed with respect to such sale, exchange or disposition,
subject to the limitations in U.S. laws applicable to foreign tax credits. The
Treaty does not relate to U.S. state or local taxes.
Taxation of Non-Resident Holders of Shares
Non-residents of Israel are subject to income tax on income accrued or
derived from sources in Israel. Such sources of income include passive income
such as dividends, royalties and interest, as well as non-passive income from
services rendered in Israel. On distributions of dividends other than bonus
shares or stock dividends, income tax at the rate of 25% (12.5% for dividends
not generated by an approved enterprise if the non-resident is a U.S.
corporation that holds 10% of our voting power, and 15% for dividends generated
by an approved enterprise) is withheld at source, unless a different rate is
provided by a treaty between Israel and the shareholder's country of residence.
Under the Treaty, the maximum tax on dividends paid to a holder of ordinary
shares who is a Treaty U.S. Resident will be 25%. However, under the Investment
Law, dividends generated by an approved enterprise are taxed at the rate of 15%.
Under an amendment to the Inflationary Adjustments Law, non-Israeli
entities might be subject to Israeli taxes on the sale of traded securities in
an Israeli company, subject to the provisions of any applicable double taxation
treaty.
Foreign Exchange Regulations
Dividends (if any) paid to the holders of 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.
66
Recent Tax Reform Legislation
On July 24, 2002, Amendment 132 to the Israeli Tax Ordinance was
approved by the Israeli parliament and came into effect on January 1, 2003. The
principal objectives of the amendment were to broaden the categories of taxable
income and to reduce the tax rates imposed on employees' income.
The material consequences of the amendment applicable to our company
include, among other things, imposing a tax upon all income of Israeli
residents, individuals and corporations, regardless of the territorial source of
the income and certain modifications in the qualified taxation tracks of
employee stock options.
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 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 investors liable for alternative minimum tax,
o tax-exempt organizations,
o regulated investment companies,
o non-resident aliens of the U.S. or taxpayers whose functional currency
is not the U.S. dollar,
o persons who acquired their ordinary shares through the exercise or
cancellation of employee stock options or otherwise as compensation
for services,
o persons who hold the ordinary shares through partnerships or other
pass-through entities,
o investors that own, or have owned, actually or constructively own 10%
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.
67
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 partnership, 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
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 principles. You will be required to include this amount of dividends
in gross income as ordinary income (see "-New Tax Law Applicable to Dividends
and Long-Term Capital Gain," below). 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.
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 such day 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.
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.
68
federal income taxes otherwise payable with respect to each such class of income
(see "-New Tax Law Applicable to Dividends and Long-Term Capital Gain," below).
Dividends generally will be treated as foreign-source passive income or
financial services income for United States foreign tax credit purposes. Foreign
income taxes exceeding the credit limitation for the year of payment or accrual
may be carried back for two taxable years and forward for five taxable years in
order to reduce U.S. federal income taxes, subject to the credit limitation
applicable in each of such years. Other restrictions on the foreign tax credit
include a prohibition on the use of the credit to reduce liability for the U.S.
individual and corporation alternative minimum taxes by more than 90%. 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 30-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. 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.
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 U.S. dollar value of the amount realized, as discussed
below, 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.
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,
or the IRS. 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
69
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.
New Tax Law Applicable to Dividends and Long-Term Capital Gain
Under recently enacted amendments to the Code, dividends received by
individual U.S. Holders from certain foreign corporations, and long-term capital
gain realized by individual U.S. Holders, generally are subject to a reduced
maximum tax rate of 15 percent through December 31, 2008. Dividends received
with respect to ordinary shares should qualify for the 15 percent rate. The rate
reduction does not apply to dividends received from "foreign investment
companies," "foreign personal holding company" or "passive foreign investment
companies" (see below), or in respect of certain short-term or hedged positions
in the common stock or in certain other situations. The legislation contains
special rules for computing the foreign tax credit limitation of a taxpayer who
receives dividends subject to the rate reduction. U.S. Holders should consult
their own tax advisors regarding the implications of these rules in light of
their particular circumstances.
Passive Foreign Investment Companies
For U.S. federal income tax purposes, we will be considered a passive
foreign investment company, or 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, passive income includes
dividends, interest, royalties, rents, annuities and the excess of gains over
losses from the disposition of assets which produce passive income. If we were
determined to be a PFIC for U.S. federal income tax purposes, highly complex
rules would apply to U.S. Holders owning ordinary shares. Accordingly, you are
urged to consult your tax advisors regarding the application of such rules.
As a result of our substantial cash position and the declining value of
our stock, there is a substantial risk that we will be classified as a PFIC
under the asset test described in the preceding paragraph. However, because the
determination of whether we are a PFIC is based upon the composition of our
income and assets from time to time, this determination can not be made with
certainty until the end of each calendar year. Based on studies preformed by an
independent consultant, we believe that we were not a PFIC in 2001, 2002 or
2003.
If we are treated as a PFIC for any taxable year, then, unless you elect
either to treat your investment in ordinary shares as an investment in a
"qualified electing fund," or a QEF election, or to "mark-to-market" your
ordinary shares, as described below, dividends would not qualify for the reduced
maximum tax rate, discussed above, and
o you would 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, and an interest
70
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 would 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.
If you make either a timely QEF election or a timely mark-to-market
election in respect of your ordinary shares, you would not be subject to the
rules described above. If you make a timely QEF election, you would be required
to include in your income for each taxable year your pro rata share of our
ordinary earnings as ordinary income and your pro rata share of our net capital
gain as long-term capital gain, whether or not such amounts are actually
distributed to you. You would not be eligible to make a QEF election unless we
comply with certain applicable information reporting requirements. We will
provide U.S. Holders with the information needed to report income and gain under
a QEF election if we are classified as a PFIC.
Alternatively, if you elect to "mark-to-market" your ordinary shares,
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 on the
disposition of ordinary shares with respect to which the mark-to-market election
is made, is treated as ordinary income or loss.
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.
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.
71
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: 450 Fifth Street, N.W., Judiciary Plaza, Room 1024, 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. The Exchange Act file number for our Securities
and Exchange Commission filings is 0-28950.
The documents concerning our company, which, 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.
72
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 1.0% to 1.5%, 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). A hypothetical 10% movement in foreign
currency rates (primarily the Euro) against the dollar, with all other variables
held constant on the expected sales, would result in a decrease or increase in
expected 2004 sales of $500,000. In 2003 we entered into a commitment to
purchase dollars and sell euros having a value of euro 700,000, of which euro
300,000 was purchased in January 2001.
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.
73
ITEM 15. CONTROLS AND PROCEDURES
-----------------------
During 2003, we carried out an evaluation, under the supervision and
with the participation of our senior management, including our chief executive
officer and chief financial officer, of the effectiveness of the design and
operation of our disclosure controls and procedures pursuant to Rule 13(a)-14 of
the Securities Exchange Act of 1934. Based upon that evaluation, our management,
including our chief executive officer and chief financial officer, concluded
that our company's disclosure controls and procedures are effective in timely
alerting them to material information relating to us required to be included in
the our periodic SEC filings.
There have been no significant changes in our internal controls or other
factors which could significantly affect internal controls subsequent to the
date of the evaluation.
It should be noted that any system of controls, however well designed
and operated, can provide only reasonable, and not absolute, assurance that the
objectives of the system are met. In addition, the design of any control system
is based in part upon certain assumptions about the likelihood of future events.
Because of these and other inherent limitations of control systems, there can be
no assurance that any design will succeed in achieving its stated goals under
all potential future conditions.
ITEM 16. [RESERVED]
--------
ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT
--------------------------------
Our board of directors has determined that Mr. Yaacov Goldman meets the
definition of an audit committee financial expert, as defined in Item 401 of
Regulation S-K.
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 independent public accountants and the percentage of each of
the fees out of the total amount paid to the accountants.
74
Year Ended December 31,
------------------------------------------------------
2002 2003
------------------------- -------------------------
Services Rendered Fees Percentages Fees Percentages
--------------------- -------- ----------- ------- -----------
Audit (1)............ $53,269 51.0% $45,500 61.0%
Audit-related (2).... 2,047 2.0% 484 1.0%
Tax (3).............. 48,485 47.0% 28,700 38.0%
Other (4)............ -- -- -- --
Total ............... $103,801 100.0% $74,684 100.0%
--------------
(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 accountant can
reasonably provide.
(2) Audit-related fees relate to attestation services that are required by
statute or regulation.
(3) Tax fees relate to services performed by the tax division for tax
compliance, planning, and advice.
(4) Other fees relate to products and services provided by the independent
accountant, other than the services reported under the categories above.
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 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 SEC, and
also requires the audit committee to consider whether proposed services are
compatible with the independence of the public accountants all the services
provided by our independent accountants in 2003 were approved in advance by our
Audit committees.
ITEM 16D. EXEMPTIONS FROM THE LISTING REQUIREMENTS AND STANDARDS FOR AUDIT
COMMITTEE
---------------------------------------------------------------------
Not applicable.
ITEM 16E. PURCHASE OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATES AND
PURCHASERS
---------------------------------------------------------------------
Issuer Purchase of Equity Securities
The following table sets forth, for each of the months indicated, the
total number of shares purchased by us or on our behalf or any affiliated
purchaser, the average price paid per share, the number of shares purchased as
part of a publicly announced repurchase plan or
75
program, the maximum number of shares or approximate dollar value that may yet
be purchase under the plans or programs.
Maximum Number
Total Number of (or Approximate
Shares Purchased Dollar Value) of
as Part of Shares that May
Publicly Yet Be Purchased
Total Number of Average Price Announced Plans Under the Plans
Period in 2003 Shares Purchased Paid per Share or Programs or Programs
-------------- ---------------- -------------- ----------- -----------
January.......... 4,450 $0.963 265,550 34,450
February......... 7,360 $0.99 272,910 27,090
March............ 2,900 $1.035 275,810 24,190
April............ 108,800 $1.0489 384,610 215,390
May.............. --- --- 384,610 215,390
June............. --- --- 384,610 215,390
July............. --- --- 384,610 215,390
August........... 2,000 $2.095 386,610 213,390
September........ 1,100 $2.06 387,710 212,290
October.......... --- --- 387,710 212,290
November......... --- --- 387,710 212,290
December......... 3,900 $3.077 391,610 208,390
1. Under our stock repurchase program, which was publicly announced in
December 2000, 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 under our stock repurchase program to 600,000 ordinary
shares. Through June 1, 2004 we have repurchased 391,610 ordinary shares, at a
total cost of $477,000.
76
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.
Index to Consolidated Financial Statements. ................................F-1
Report of Independent Auditors .....................................F-2
Consolidated Balance Sheets.........................................F-3
Consolidated Statements of Operations...............................F-5
Statements of Changes in Shareholders' Equity.......................F-6
Consolidated Statements of Cash Flows...............................F-7
Notes to Consolidated Financial Statements..........................F-9
Appendix to Consolidated Financial Statements.......................F-37
ITEM 19. EXHIBITS
--------
Index to Exhibits
Exhibit Description
------- -----------
*3.1 Memorandum of Association of the Registrant
*3.2 Articles of Association of the Registrant
*4.1 Specimen of Ordinary Share Certificate
8.1 List of Subsidiaries of the Registrant
*10.1 1996 Employee Stock Option Plan
*10.2 Section 102 Stock Option Plan
10.3 2003 Israeli Share Option Plan
**10.4 Form of Consultant's Warrant
14.1 Code of Ethics
77
23.1 Consent of Kost Forer Gabbay & Kasierer, a Member of Ernst &
Young Global
31.1 Certification of Chief Executive Officer pursuant to Rule
13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act,
as amended.
31.2 Certification of Chief Financial Officer pursuant to Rule
13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act,
as amended.
32.1 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.
32.2 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.
-----------------
* Filed as an exhibit to our registration statement on Form F-1,
registration number 333-05814, filed with the Securities and
Exchange Commission, and incorporated herein by reference.
** Filed as exhibit 10.5 to our Annual Report on Form 20-F for the
year ended December 31, 2002, and incorporated herein by
reference.
78
MER TELEMANAGEMENT SOLUTIONS LTD. AND ITS SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
AS OF DECEMBER 31, 2003
U.S. DOLLARS IN THOUSANDS
INDEX
Page
------------
Report of Independent Auditors F-2
Consolidated Balance Sheets F-3 - F-4
Consolidated Statements of Operations F-5
Statements of Changes in Shareholders' Equity F-6
Consolidated Statements of Cash Flows F-7 - F-8
Notes to Consolidated Financial Statements F-9 - F-36
Appendix to Consolidated Financial Statements F-37
- - - - - - - - - -
F-1
ERNST & YOUNG
o Kost Forer Gabbay & Kasierer
3 Aminadav St. o Phone: 972-3-6232525
Tel-Aviv 67067, Israel Fax: 972-3-5622555
REPORT OF INDEPENDENT AUDITORS
To the 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, 2002 and 2003, and the related consolidated statements of
operations, changes in shareholders' equity and cash flows for each of the three
years in the period ended December 31, 2003. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of the Company and
its subsidiaries as of December 31, 2002 and 2003, and the consolidated results
of their operations and their cash flows for each of the three years in the
period ended December 31, 2003, in conformity with accounting principles
generally accepted in the United States.
As discussed in Note 10a to the financial statements, the Company adopted
Statement of Financial Accounting Standards No. 142 in 2002.
/s/ Kost Forer Gabbay and Kasierer
Tel-Aviv, Israel KOST FORER GABBAY & KASIERER
February 2, 2004 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,
---------------------
2002 2003
---------- ---------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 9,062 $ 8,684
Marketable securities (Note 3) 1,153 1,644
Trade receivables (net of allowance for doubtful accounts of
$ 356 and $ 350 as of December 31, 2002 and 2003, respectively) 1,259 1,391
Other accounts receivable and prepaid expenses (Note 4) 511 566
Inventories (Note 5) 240 193
------- -------
Total current assets 12,225 12,478
----- ------- -------
LONG-TERM INVESTMENTS:
Investments in an affiliate (Note 6) 1,335 1,859
Long-term loans, net of current maturities (Note 7) 86 95
Severance pay fund 545 564
Other investments (Note 8) 368 368
------- -------
Total long-term investments 2,334 2,886
---- ------- -------
PROPERTY AND EQUIPMENT, NET (Note 9) 602 482
------- -------
OTHER ASSETS:
Goodwill (Note 10a) 2,025 2,025
Other intangible assets, net (Note 10b) 360 206
Deferred income taxes (Note 14) 161 105
------- -------
Total other assets 2,546 2,336
----- ------- -------
Total assets $17,707 $18,182
----- ======= =======
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 data)
December 31,
---------------------
2002 2003
---------- ---------
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Current maturities of long-term loans (Note 12) $ 8 $ 8
Trade payables 350 393
Accrued expenses and other liabilities (Note 11) 1,439 1,421
Deferred revenues 1,184 1,219
--------- --------
Total current liabilities 2,981 3,041
----- --------- --------
LONG-TERM LIABILITIES:
Long-term loans, net of current maturities (Note 12) 8 -
Accrued severance pay 705 677
--------- --------
Total long-term liabilities 713 677
----- --------- --------
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 as of December 31, 2002 and 2003; Issued: 4,882,748
and 4,631,471 shares as of December 31, 2002 and 2003,
respectively; Outstanding: 4,621,648 and 4,624,471 shares as
of December 31, 2002 and 2003, respectively 15 14
Additional paid-in capital 12,846 12,603
Treasury shares (261,100 and 7,000 shares as of December 31,
2002 and 2003, respectively) (330) (20)
Accumulated other comprehensive income (loss) (211) 87
Retained earnings 1,693 1,780
--------- --------
Total shareholders' equity 14,013 14,464
----- --------- --------
Total liabilities and shareholders' equity $ 17,707 $ 18,182
---- ========= ========
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,
--------------------------------------------
2001 2002 2003
------------- ------------ ------------
Revenues (Note 17):
Products sales $ 7,843 $ 7,397 $ 6,944
Services 2,882 2,390 2,286
----------- ----------- -----------
Total revenues 10,725 9,787 9,230
----------- ----------- -----------
Cost of revenues:
Products sales 1,909 1,655 1,523
Services 643 241 326
----------- ----------- -----------
Total cost of revenues 2,552 1,896 1,849
----------- ----------- -----------
Gross profit 8,173 7,891 7,381
----------- ----------- -----------
Operating expenses:
Research and development, net (Note17c) 3,562 2,127 1,825
Selling and marketing 4,911 3,954 3,916
General and administrative 1,943 1,858 1,830
----------- ----------- -----------
Total operating expenses 10,416 7,939 7,571
----------- ----------- -----------
Operating loss (2,243) (48) (190)
Financial income, net (Note 17d) 138 134 124
Other income (expenses), net (Note 17e) (654) (140) 6
----------- ----------- -----------
Loss before taxes on income (2,759) (54) (60)
Taxes on income (Note 14) 16 52 198
----------- ----------- -----------
(2,775) (106) (258)
Equity in earnings of affiliate 221 236 345
----------- ----------- -----------
Net income (loss) $ (2,554) $ 130 $ 87
=========== =========== ===========
Net earnings (loss) per share:
Basic net earnings (loss) per ordinary share $ (0.53) $ 0.03 $ 0.02
=========== =========== ===========
Diluted net earnings (loss) per ordinary share $ (0.53) $ 0.03 $ 0.02
=========== =========== ===========
Weighted average number of ordinary shares used in
computing basic net earning (loss) per share 4,826,126 4,709,796 4,617,099
=========== =========== ===========
Weighted average number of ordinary shares used in
computing diluted net earning (loss) per share 4,826,126 4,709,796 4,628,249
=========== =========== ===========
The accompanying notes are an integral part of the consolidated financial
statements.
F-5
MER TELEMANAGEMENT SOLUTIONS LTD.
AND ITS SUBSIDIARIES
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
--------------------------------------------------------------------------------
U.S. dollars in thousands
Accumulated
other Total
Additional comprehensive comprehensive Total
Share paid-in Treasury Income Retained income shareholders'
capital capital shares (loss) earnings (loss) equity
------- ---------- -------- ------------- -------- ------------- -------------
Balance as of January 1, 2001 $ 15 $ 12,836 $ (40) $ (431) $ 4,117 $ 16,497
Exercise of options *) - 10 - - - 10
Purchases of treasury shares - - (118) - - (118)
Other comprehensive income (loss):
Unrealized gains on available for sale
marketable securities - - - 72 - $ 72 72
Foreign currency translation adjustments - - - (51) - (51) (51)
-------------
Total other comprehensive income 21
Net loss - - - - (2,554) (2,554) (2,554)
------ -------- ---------- -------------- ------- ------------- ------------
$ (2,533)
Total comprehensive loss =============
Balance as of December 31, 2001 15 12,846 (158) (410) 1,563 13,856
Purchase of treasury shares - - (172) - - (172)
Other comprehensive income:
Unrealized losses on available for sale
marketable securities - - - (3) - $ (3) (3)
Foreign currency translation adjustments - - - 202 - 202 202
-------------
Total other comprehensive income 199
Net income - - - - 130 130 130
------ -------- ---------- -------------- ------- ------------- ------------
$ 329
Total comprehensive income =============
Balance as of December 31, 2002 15 12,846 (330) (211) 1,693 14,013
Exercise of options *) - - - - - *) -
Employee stock based compensation - 213 - - - 213
Retirement of treasury shares (1) (456) 457 - - -
Purchase of treasury shares - - (147) - - (147)
Other comprehensive income:
Unrealized gains on available for sale
marketable securities, net - - - 109 - $ 109 109
Foreign currency translation adjustments - - - 196 - 196 196
Loss from cash flows hedges transaction - - - (7) - (7) (7)
-------------
Total other comprehensive income 298
Net income - - - - 87 87 87
------ -------- ---------- -------------- ------- ------------- ------------
$ 385
Total comprehensive income =============
Balance as of December 31, 2003 $ 14 $ 12,603 $ (20) $ 87 $ 1,780 $ 14,464
====== ======== ========== ============= ======= ============
Accumulated unrealized gains from
available-for-sale
marketable securities 3
Accumulated foreign currency translation
adjustments 91
Accumulated losses from cash flow hedges (7)
-------------
$ 87
=============
*) 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,
-----------------------------
2001 2002 2003
------- ------- -------
Cash flows from operating activities:
-------------------------------------
Net income (loss) $(2,554) $ 130 $ 87
Adjustments required to reconcile net income (loss)
to net cash provided by (used in) operating
activities:
Loss (gain) on sale of available-for-sale and
trading marketable securities, net 279 140 (6)
Loss on sale of property and equipment 51 6 39
Loss from impairment of investment in warrants 375 - -
Equity in earnings of affiliates (221) (236) (345)
Proceeds from trading securities, net - 81 -
Depreciation and amortization 1,110 501 401
Deferred income taxes, net (20) 29 23
Employee stock-based compensation - - 213
Accrued severance pay, net 57 (2) (47)
Decrease (increase) in trade receivables 269 (87) (132)
Decrease (increase) in other accounts receivable
and prepaid expenses 673 215 (89)
Decrease in inventories 220 82 47
Increase (decrease) in trade payables (169) (149) 43
Decrease in accrued expenses and other liabilities (623) (419) (99)
Increase (decrease) in deferred revenues (173) 187 35
Others - 11 (7)
------- ------- -----
Net cash provided by (used in) operating activities (726) 489 163
------- ------- -----
Cash flows from investing activities:
-------------------------------------
Changes in related parties account, net 50 108 -
Proceeds from sale of property and equipment 45 26 5
Purchase of property and equipment (226) (166) (171)
Investment in short-term bank deposit (7,528) - -
Proceeds from realization of short-term bank deposits 7,448 1,942 -
Investment in available for sale marketable
securities (401) (1,512) (969)
Investment in held-to-maturity marketable securities - (476) -
Proceeds from sale of available-for-sale marketable
securities 1,631 2,508 318
Proceeds from redemption of held-to-maturity
marketable securities - 201 275
Dividend from an affiliate 56 190 100
Others - (12) 16
------- ------- -----
Net cash provided by (used in) investing activities 1,075 2,809 (426)
------- ------- -----
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,
-----------------------
2001 2002 2003
---- ---- ----
Cash flows from financing activities:
-------------------------------------
Changes in related parties, net - 4 51
Repayment of long-term loans (91) (55) (8)
Proceeds from exercise of options and warrants, net 10 - *) -
Purchase of treasury shares (118) (172) (147)
------- ------- -------
Net cash used in financing activities (199) (223) (104)
------- ------- -------
Effect of exchange rate changes on cash and cash
equivalents - - (11)
------- ------- -------
Increase (decrease) in cash and cash equivalents 150 3,075 (378)
Cash and cash equivalents at the beginning
of the year 5,837 5,987 9,062
------- ------- -------
Cash and cash equivalents at the end of the year $ 5,987 $ 9,062 $ 8,684
======= ======= =======
Supplemental disclosure of cash flows activities:
-------------------------------------------------
Cash paid during the year for:
Interest $ 45 $ 10 $ 1
======= ======= =======
Income taxes $ 8 $ 58 $ 49
======= ======= =======
*) Represents an amount lower than $ 1.
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 data)
NOTE 1:- GENERAL
MER Telemanagement Solutions Ltd. ("MTS") was incorporated on December
27, 1995. MTS and its subsidiaries ("the Company") designs, develops,
markets and supports a comprehensive line of telecommunication
management solutions that enable business organizations and other
enterprises to improve the efficiency and performance of all IP
operations, and reduce associated costs. The Company's products
include call accounting and management products, fault management
systems and web based management solutions for converged voice, voice
over Internet Protocol or IP data and video. As for MTS's
subsidiaries, see Note 18.
These 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 Company markets its products worldwide through distributors,
business telephone switching systems manufacturers and vendors and its
direct sales force. Several international PBX manufacturers market the
Company's products as part of their PBX selling efforts or on an
Original Equipment Manufacturer ("OEM") basis. The Company is highly
dependent upon the active marketing and distribution of its OEM's. In
2001, 2002 and 2003, two major customers generated 40%, 42% and 47% of
the Company's revenues, respectively (see Note 17a).
Certain components and subassemblies included in the Company'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 source 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 cash position.
MTS's shares are listed for trade on the Nasdaq SmallCap Market.
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES
The consolidated 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.
F-9
MER TELEMANAGEMENT SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share data)
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)
b. Financial statements in U.S. dollars:
The majority of the Company's sales is made outside Israel in
U.S. dollars ("dollars"). In addition, a substantial portion of
MTS and certain portion of its subsidiaries costs is incurred in
dollars. Since the Company's management believes that the dollar
is the primary currency of the economic environment in which MTS
and certain of its subsidiaries operate, the dollar is their
functional and reporting currency.
Accordingly, monetary accounts maintained in currencies other
than the dollar are remeasured into U.S. dollars 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.
The subsidiairies and affiliate whose functional currency has
been determined to be other than U.S. dollars, assets and
liabilities are translated at year-end exchange rates and
statement of operations items are translated at average exchange
rates prevailing during the year. Such 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 subsidiaries. Intercompany balances and transactions have
been eliminated upon consolidation.
d. Cash equivalents:
The Company considers all highly liquid investments originally
purchased with 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").
F-10
MER TELEMANAGEMENT SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share data)
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)
Management determines the appropriate classification of its
investments in marketable debt and equity securities at the time
of purchase and reevaluates such determinations at each balance
sheet date. Debt securities are classified as held to maturity
when the Company has a positive intent and ability to hold the
securities to maturity, and are stated at amortized cost. The
amortized cost of debt securities is adjusted for amortization of
premiums and accretion of discounts to maturity. Such
amortization and interest are included in the statement of
operations as other expenses or income. Debt securities for which
the Company does not have the intent or ability to hold to
maturity are classified as available-for-sale, along with any
investments in equity securities that have not been classified as
"trading securities". Securities available for sale are carried
at fair value, with the unrealized gains and losses, net of
income taxes, reported as a separate component of shareholders'
equity, under accumulated other comprehensive income (loss).
Realized gains and losses on sales of investments, as determined
on a specific identification basis, are included in the
consolidated statements of operations in other income (expenses).
The Company's trading securities are carried at their fair value
based upon the quoted market price of those investments at each
balance sheet date. Net realized and unrealized gains and losses
on these securities are included in the statements of operations
in other income (expenses).
At December 31, 2003, all marketable securities covered by SFAS
No. 115 were designated as available-for-sale. Accordingly, these
securities are stated at fair value, with unrealized gains and
losses reported in accumulated other comprehensive income (loss),
a separate component of shareholders' equity, net of taxes.
Realized gains and losses on sales of investments, as determined
on a specific identification basis, are included in the
consolidated Statement of Operations.
f. Inventories:
Inventories are stated at the lower of cost or market value. Cost
is determined as follows: Raw materials, parts and supplies
-using the "first in, first out" method with the addition of
allocable indirect manufacturing costs. Finished products are
recorded on the basis of direct manufacturing costs with the
addition of allocable indirect manufacturing costs. Inventories
write-offs are provided to cover risks arising from slow moving
items or technological obsolescence.
g. Investments in affiliate and other companies:
Investment in privately held company in which the Company holds
20% to 50% ownership of voting rights and can exercise
significant influence over operating and financial policy of the
affiliate is presented using the equity method of accounting.
Profits on intercompany sales, not realized outside the Company,
were eliminated. The excess of the purchase price over the fair
value of net tangible assets acquired has been attributed to
goodwill. In accordance with Statement of Financial Accounting
Standard No. 142, "Goodwill and Other Intangible Assets" ("SFAS
No. 142") goodwill related to investments in affiliates is no
longer amortized. The goodwill is reviewed for impairment in
accordance with Accounting Principles Board Opinion No. 18, "The
Equity Method of Accounting for Investments in Common Stock"
("APB No. 18"). Before the adoption of SFAS No. 142 on January 1,
2002, goodwill was amortized on a straight-line basis over 10
years, in accordance with APB Opinion No. 17, "Intangible
Assets".
F-11
MER TELEMANAGEMENT SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share data)
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)
Investments in privately held companies in which the Company
holds less than 20% and does not have the ability to exercise
significant influence over operating and financial policy of the
Company, are presented at cost. The carrying value is
periodically reviewed by management, in accordance with APB 18.
If this review indicates that the carrying value is not
recoverable, the carrying value is reduced to its estimated fair
value. As of December 31, 2003, no impairment losses have been
identified.
h. 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 Over the term of the
lease agreement
i. Impairment of long-lived assets:
Long-lived assets of the Company 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, 2003 no impairment was required.
j. Goodwill:
Goodwill represents excess of the costs over the net assets of
business acquired. Goodwill from acquisitions prior to July 1,
2001 was amortized until December 31, 2001, by the straight-line
method, over 10 years. Under SFAS No. 142, goodwill acquired in a
business combination on or after July 1, 2001, will not be
amortized.
SFAS No. 142 requires goodwill to be tested for impairment on
adoption and at least annually thereafter of between annual tests
in certain circumstances, and written down when impaired, rather
than being amortized as previous accounting standards required.
Goodwill is tested for impairment by comparing the fair value of
the reporting unit with its carrying value. Fair value is
determined using discounted cash flows. Significant estimates
used in the methodologies include estimates of future cash flows,
future short-term and long-term growth rates, and weighted
average cost of capital. The Company has selected December 31 as
the date it will perform its annual goodwill impairment tests. As
of December 31, 2003 no impairment was required. As for
application of SFAS No. 142, see Note 10a.
F-12
MER TELEMANAGEMENT SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share data)
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)
k. Other intangible assets:
Intangible assets acquired in a business combination are being
amortized on a straight-line basis, over their useful life.
Acquired developed technology is amortized using the
straight-line method over 5 years.
Distributor relationship and Assembled workforce were amortized
over 10 and 4 years, respectively, until December 31, 2001.
According to SFAS No. 142, the net carrying amount of Distributor
relationship and Assembled workforce was subsumed into goodwill
at January 1, 2002 (see Note 10a).
l. Research and development costs:
Research and development costs, net of grants received, 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.
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.
m. Royalty-bearing 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.
n. 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.
o. Revenue recognition:
The Company generates revenues from licensing the rights to use
their software products directly to end-users and indirectly
through resellers and OEM's (who are considered end users). The
Company also generates revenues from rendering maintenance,
service bureau and support.
F-13
MER TELEMANAGEMENT SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share data)
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)
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, the fee
is fixed or determinable and collectibility is probable. The
Company generally does not grant a right of return to its
customers. When a right of return exists, the Company defers
revenue until the right of return expires, at which time revenue
is recognized provided that all other revenue recognition
criteria are met.
Where software arrangements involve multiple elements, revenue is
allocated to each undelivered element based on vendor specific
objective evidence ("VSOE") of the relative 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. Arrangements that include services are
evaluated to determine whether those services are essential to
the functionality of other elements of the arrangement.
When services are considered essential, revenue under the
arrangement is recognized using contract accounting. When
services are not considered essential, the revenue allocable to
the software services is recognized as the services are
performed. To date, the Company had determined that the services
are not considered essential to the functionality of other
elements of the arrangement.
Revenues from maintenance and support services are recognized
over the life of the maintenance agreement or at the time that
support services are rendered.
Deferred revenues include unearned amounts received under
maintenance and support contracts, not yet recognized as
revenues.
p. Warranty costs:
The Company provides free warranty for up to one year for
end-users and 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 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. The provision for the year ending December
31, 2003 amounted to of $ 22.
F-14
MER TELEMANAGEMENT SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share data)
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)
q. Accounting for stock-based compensation:
The Company has elected to follow Accounting Principles Board
Opinion No. 25 "Accounting for Stock Issued to Employees" ("APB
No. 25") and FASB Interpretation No. 44 "Accounting for Certain
Transactions Involving Stock Compensation" ("FIN No. 44") in
accounting for its employee stock option plans. Under APB No. 25,
when the exercise price of the Company's stock options is less
than the market price of the underlying shares on the date of
grant, compensation expense is recognized.
The following table illustrates the effect on net income (loss)
and earnings (loss) per share as if the fair value method had
been applied to all outstanding and unvested awards in each
period:
Year ended December 31,
--------------------------------------------
2001 2002 2003
------------- ------------ ------------
Net income (loss), as reported $(2,554) $ 130 $ 87
Add: Stock-based employee
compensation - intrinsic value - - 213
Deduct: Total stock-based
compensation expense determined
under fair value method for all
awards, net of related tax effect (769) (177) (286)
------------- ------------ ------------
Pro forma net income (loss) $(3,323) $ (47) $ 14
============= ============ ============
Basic and diluted net earnings
(loss) per share, as reported $ (0.53) $ 0.03 $ 0.02
============= ============ ============
Basic and diluted net loss per $ (0.68) $ (0.01) $ -
share, pro forma ============= ============ ============
The fair value for each option granted was estimated at the date
of grant using a Black-Scholes option-pricing model, assuming no
expected dividends and the following weighted average
assumptions:
Year ended December 31,
------------------------------------
2001 2002 2003
---- ---- ----
Dividend 0% 0% 0%
Average risk-free interest rates 3.5% 2% 2%
Average expected life (in years) 4 4 2.5
Volatility 87.2% 66.8% 71.8%
The Company applies Statement of Financial Accounting Standard
No. 123 "Accounting for Stock-Based Compensation" ("SFAS No.
123") and Emerging Issues Task Force No. 96-18 ("EITF No. 96-18")
"Accounting for Equity Instruments that are Issued to Other than
Employees for Acquiring, or in Conjunction with Selling, Goods or
Services" with respect to options issued to non-employees. SFAS
No. 123 requires use of an option valuation model to measure the
fair value of the options at the grant date.
F-15
MER TELEMANAGEMENT SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share data)
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)
r. Severance pay:
The Company's liability for severance pay is calculated pursuant
to Israeli severance pay law based on the most recent salary of
the employees multiplied by the number of years of employment, as
of the balance sheet date. Employees are entitled to one month's
salary for each year of employment or a portion thereof. The
Company's liability for all of its employees is fully provided by
monthly deposits with insurance policies and by an accrual. The
value of these policies is recorded as an asset in the Company's
balance sheet.
The deposited funds may be withdrawn only upon the fulfillment of
the obligation pursuant to Israeli severance pay law or labor
agreements. The value of the deposited funds is based on the cash
surrendered value of these policies, and includes immaterial
profits.
Severance expenses for the years ended December 31, 2001, 2002
and 2003 amounted to approximately $ 189, $ 104 and $ 13,
respectively.
s. Fair value of financial instruments:
The following methods and assumptions were used by the Company in
estimating its fair value disclosures for financial instruments:
The carrying amounts of cash and cash equivalents, trade
receivables, other accounts receivable 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).
Long-term loans - The carrying amounts of the Company's
borrowings under its long-term agreements, both as a lender and
as a borrower, approximate their fair value. The fair value was
estimated using discounted cash flow analyses, based on the
Company's incremental borrowing rates for similar type of
borrowing arrangements.
t. Concentrations of credit risk:
Financial instruments that potentially subject the Company to
concentrations of credit risk consist principally of cash and
cash equivalents, trade receivables, marketable securities and
long-term loans.
Cash and cash equivalents 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.
F-16
MER TELEMANAGEMENT SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share data)
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)
The trade receivables of the Company are mainly derived from
sales to customers in the U.S. and Europe (see Note 17b). 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. In certain circumstances, the Company may
require letters of credit, other collateral or additional
guarantees.
The Company's marketable securities include mainly investments in
corporate debts and mutual funds. 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.
u. 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 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").
The total number of shares related to the outstanding options
excluded from the calculation of diluted net earnings (loss) per
share was 1,227,141, 757,580 and 766,141 for the years ended
December 31, 2001, 2002 and 2003, respectively.
v. Derivatives and hedging:
The Company in 2003 hedged the exposure of revenues denominated
in foreign currencies with forward. To protect against the risk
of overall changes in cash flows resulting from export sales over
the year.
The Company accounts for derivatives and hedging based on
Statement of Financial Accounting Standard No. 133, "Accounting
for Derivative Instruments and Hedging Activities" ("SFAS No.
133"). SFAS No. 133 requires the Company to recognize all
derivatives on the balance sheet at fair value. If the derivative
meets the definition of a hedge and is so designated, depending
on the nature of the hedge, changes in the fair value of
derivatives will either be offset against the change in fair
value of the hedged assets, liabilities, or firm commitments
through earnings or recognized in other comprehensive income
until the hedged item is recognized in earnings. The derivative's
change in fair value is recognized in earnings. During 2003 there
were no significant gains or losses recognized in earning for
hedge ineffectiveness.
F-17
MER TELEMANAGEMENT SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share data)
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)
w. Impact of recently issued accounting standards:
In April 2003, the FASB issued SFAS No. 149 ("SFAS 149"),
"Amendment of Statement 133 on Derivative Instruments and Hedging
Activities." SFAS 149 amends and clarifies (1) the accounting
guidance on derivative instruments (including certain derivative
instruments embedded in other contracts) and (2) hedging
activities that fall within the scope of FASB Statement No. 133
("SFAS 133"), "Accounting for Derivative Instruments and Hedging
Activities." SFAS 149 amends SFAS 133 to reflect decisions made
(1) as part of the Derivatives Implementation Group ("DIG")
process that effectively required amendments to SFAS 133, (2) in
connection with other projects dealing with financial
instruments, and (3) regarding implementation issues related to
the application of the definition of a derivative. SFAS 149 is
effective (1) for contracts entered into or modified after June
30, 2003, with certain exceptions, and (2) for hedging
relationships designated after June 30, 2003. The guidance is to
be applied prospectively. Generally, SFAS 149 improves financial
reporting by (1) requiring that contracts with comparable
characteristics be accounted for similarly and (2) clarifying
when a derivative contains a financing component that warrants
special reporting in the statement of cash flows. SFAS 149 is not
expected to have a material impact on the Company's financial
statements.
In January 2003, the Financial Accounting Standards Board issued
Interpretation No. 46, Consolidation of Variable Interest
Entities, an interpretation of Accounting Research Bulletin No.
51 ("the interpretation"). In general, a variable interest entity
(VIE) is an entity that has (1) insufficient amount of equity for
the entity to carry on its principal operations, without
additional subordinated financial support from other parties, (2)
equity investors that as a group do not have the ability through
voting or similar rights to make decisions about the entity's
activities, or (3) investors that as a group do not have the
obligation to absorb the entity's losses or have the right to
receive the benefits of the entity. The interpretation requires
the consolidation of a VIE by the primary beneficiary. The
primary beneficiary is the entity that absorbs a majority of the
entity's expected losses, receives a majority of the entity's
expected residual returns, or both, as a result of ownership,
contractual or other financial interests in the entity.
Presently, entities are generally consolidated by an enterprise
that has a controlling financial interest through ownership of a
majority voting interest in the entity.
The Interpretation requires a public entity with a variable
interest in a VIE that is a special-purpose entity created before
February 1, 2003 to apply the provisions of the revised
Interpretation, or the Interpretation as originally issued, to
that entity no later than the end of the first reporting period
ending after December 15, 2003, and the provisions of the revised
Interpretation to all variable interests no later than the end of
the first reporting period ending after March 15, 2004.
The Company is currently evaluating the effects of this
interpretation in respect of its investments. It is possible that
some of its unconsolidated investees may be considered a VIE in
accordance with the interpretation, but it is the management
opinion that the Company would not be considered the primary
beneficiary of the above VIE.
F-18
MER TELEMANAGEMENT SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share data)
NOTE 3:- MARKETABLE SECURITIES
The following is a summary of the Company's investment in marketable
securities:
December 31, 2002
------------------------------------------------------
Gross Gross Estimated
Amortized unrealized unrealized fair market
cost gains losses value
------------ ---------- ---------- -----------
Held-to-maturity corporate debt $ 275 $ 26 $ - $ 301
Available-for-sale:
Mutual funds 566 - (49) 517
Equity securities 418 - (57) 361
------------ ---------- ---------- -----------
$ 1,259 $ 26 $ (106) $ 1,179
============ ========== ========== ===========
December 31, 2003
------------------------------------------------------
Gross Gross Estimated
Amortized unrealized unrealized fair market
cost gains losses value
------------ ---------- ---------- -----------
Available-for-sale:
Mutual funds $ 623 $ 5 $ - $ 628
Equity securities 51 12 - 63
Corporate bonds 702 - (8) 694
Israeli governmental debts 265 - (6) 259
------------ ---------- ---------- -----------
$ 1,641 $ 17 $ (14) $ 1,644
============ ========== ========== ===========
The gross realized gains (losses) on sales of available-for-sale
securities totaled $ 31, $ (128) and $ 6 in 2001, 2002 and 2003,
respectively. The net increase (decrease) to unrealized holding losses
on available-for-sale securities included as a separate component of
shareholders' equity, under other comprehensive income (loss), totaled
$ (3) and $ 109 in 2002 and 2003, respectively.
During 2001, the Company recorded a loss in the gross amount of $ 282
due to other than temporary decline in the value of available for sale
marketable securities.
The amortized cost and estimated fair value of debt and marketable
equity securities as of December 31, 2003, by contractual maturity,
are shown below.
December 31, 2003
-----------------
Amortized Market
cost value
---- -----
Matures in one year $ 295 $ 291
Matures after one year through nine years 672 662
Equity securities and mutual funds 674 691
-------- -------
Total $ 1,641 $ 1,644
======== =======
F-19
MER TELEMANAGEMENT SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share data)
NOTE 4:- OTHER ACCOUNTS RECEIVABLE AND PREPAID EXPENSES
December 31,
------------------------------
2002 2003
------------- -------------
Government authorities $ 288 $ 232
Prepaid expenses 91 103
Deferred income taxes 33 66
Others 99 165
------------- -------------
$ 511 $ 566
============= =============
NOTE 5:- INVENTORIES
Raw materials $ 118 $ 73
Finished products 122 120
------------- -------------
$ 240 $ 193
============= =============
The Company periodically assesses its inventory valuation in
accordance with its revenues forecasts, technological obsolescence,
and the market conditions. Marked down inventory that is expected to
be sold at a price lower than the carrying value is not material.
NOTE 6:- INVESTMENTS IN AFFILIATE
a. Composed as follows:
December 31,
--------------------------
2002 2003
----------- -----------
Investment in Jusan S.A.: (50% owned)
Equity, net (1) $ 1,300 $ 1,824
Goodwill 35 35
----------- -----------
$ 1,335 $ 1,859
=========== ===========
(1)Investment as of purchase date $ 1,171 $ 1,171
Foreign currency translation adjustments (136) 143
Accumulated net earnings 265 510
----------- -----------
$ 1,300 $ 1,824
=========== ===========
Dividend received from Jusan S.A. during the year: $ 190 $ 100
=========== ===========
F-20
MER TELEMANAGEMENT SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share data)
NOTE 6:- INVESTMENTS IN AFFILIATE (Cont.)
b. Summarized financial information of Jusan S.A. (50% owned):
December 31,
------------------------------
2002 2003
------------- -------------
Current assets $ 4,397 $ 5,266
Non-current assets $ 149 $ 99
Current liabilities $ (1,454) $ (1,861)
Year ended
December 31,
----------------------------------------
2001 2002 2003
----------- ----------- ----------
Revenues $ 5,906 $ 6,848 $ 6,049
Gross profit $ 2,944 $ 3,260 $ 3,079
Net income $ 704 $ 708 $ 594
NOTE 7:- LONG-TERM LOANS
a. Composed as follows:
December 31,
------------------------------
2002 2003
------------- -------------
Loans to others in NIS (New Israeli
Shekels) - unlinked (1) $ 140 $ 131
Less - current maturities (2) 54 36
-------------- --------------
$ 86 $ 95
============== ==============
(1) The weighted average interest rate for the year ended December
31, 2003 and 2002 is 6.375%.
(2) Included in other accounts receivable.
b. As of December 31, 2003, the aggregate annual maturities of
long-term loans are as follows:
December 31,
2003
----------------
First year (current maturities) $ 36
Second year 39
Third year 36
Fourth year 20
----------------
$ 131
================
F-21
MER TELEMANAGEMENT SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share data)
NOTE 8:- OTHER INVESTMENTS
December 31,
------------------------------
2002 2003
------------- -------------
Long-term deposits (1) $ 21 $ 21
Investment in other companies (2) 347 347
------------- -------------
$ 368 $ 368
============= =============
(1) Linked to the Israeli CPI.
(2) These investments are stated at cost and represent
investments in which the Company holds less than 20% of the
voting rights and does not have the right to have
representation on the board of directors. Based on
assessment performed by the Company no impairment is
required.
NOTE 9:- PROPERTY AND EQUIPMENT, NET
December 31,
-------------------
2002 2003
-------- -------
Cost:
Computers and peripheral equipment $2,387 $2,528
Office furniture and equipment 492 536
Motor vehicles 107 96
Leasehold improvements 191 100
------ ------
3,177 3,260
------ ------
Accumulated depreciation:
Computers and peripheral equipment 2,116 2,300
Office furniture and equipment 310 358
Motor vehicles 66 64
Leasehold improvements 83 56
------ ------
2,575 2,778
------ ------
Depreciated cost $ 602 $ 482
====== ======
Depreciation expenses for the years ended December 31, 2001, 2002
and 2003 were $ 488, $ 348 and $ 247, respectively.
F-22
MER TELEMANAGEMENT SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share data)
NOTE 10:- GOODWILL AND OTHER ASSETS
a. Goodwill:
Effective January 1, 2002, the Company adopted SFAS No. 142.
The Company evaluated its goodwill and intangibles acquired prior
to June 30, 2001 using the criteria of SFAS No. 142, which
resulted in the net carrying amount of $ 1,872 related to other
intangibles to be subsumed into goodwill. Such intangibles
comprise assembled workforce, with an original cost of $ 848
(amortized cost of $ 495), and distributors' relationship with an
original cost of $ 1,653 (amortized cost of $ 1,377) being
subsumed into goodwill at January 1, 2002. As of December 31,
2003, $ 2,025 of the goodwill balance is attributed to the
Company's operation since the Company has one reporting unit.
The results of operations presented below for the year ended
December 31, 2001, reflect the operations had the Company adopted
the non-amortization provisions of SFAS No. 142 effective January
1, 2001:
Year ended
December 31,
2001
-------------
Reported net loss $ (2,554)
Goodwill amortization 431
-------------
Adjusted net loss $ (2,123)
=============
Basic and diluted net loss per share:
Reported net loss per share $ (0.53)
Goodwill amortization 0.09
-------------
Adjusted basic and diluted net loss per share $ (0.44)
=============
b. Other intangibles consist of the following:
December 31, 2002 December 31, 2003
---------------------------------- -----------------------------------
Gross Other Gross Other
carrying Accumulated intangibles,carrying Accumulated intangibles,
amount amortization net amount amortization Net
---------- ----------- ---------- ----------- ------------ ----------
Developed
technology $ 750 $ (390) $ 360 $ 750 $ (544) $ 206
========== =========== ========== =========== ============ ==========
Developed technology amortization expenses for the years ended
December 31, 2001, 2002 and 2003, were $ 142, $ 154 and $ 154,
respectively. The expected amortization expenses for 2004 and
2005 are $ 154 and $ 52, respectively.
F-23
MER TELEMANAGEMENT SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share data)
NOTE 11:- ACCRUED EXPENSES AND OTHER LIABILITIES
December 31,
----------------------------
2002 2003
------------ ------------
Employees and payroll accruals $ 550 $ 473
Income tax payable 26 242
Accrued expenses 422 456
Customer advances 437 203
Related parties 4 47
------------ ------------
$ 1,439 $ 1,421
============ ============
NOTE 12:- LONG-TERM LOANS
December 31,
----------------------------
2002 2003
------------ ------------
Loan from others (1) $ 16 $ 8
Less - current maturities 8 8
------------ ------------
$ 8 $ -
============ ============
(1) In U.S. dollars, bearing an average interest rate of 18.14%.
NOTE 13:- COMMITMENTS AND CONTINGENT LIABILITIES
a. Lease commitments:
1. The facilities of the Company are rented under operating
leases for periods ending in 2005.
Future minimum lease commitments under non-cancelable
operating leases as of December 31, are as follows:
2004 $ 276
2005 264
-----------
$ 540
===========
Rent expenses for the years ended December 31, 2001, 2002
and 2003, were approximately $ 576, $ 446 and $ 372,
respectively.
F-24
MER TELEMANAGEMENT SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share data)
NOTE 13:- COMMITMENTS AND CONTINGENT LIABILITIES (Cont.)
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 up to the amount received
by the Company. 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, 2003, the Company
has a contingent obligation to pay royalties in the amount
of $ 7,520. 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 outstanding balance of obligations in respect of grants
received after January 1999 amounts to $ 3,447 and also
bears LIBOR interest.
The Company has paid or accrued royalties relating to the
repayment of such grants in the amount of $ 176, $ 132 and $
146 for the years ended December 31, 2001, 2002 and 2003,
respectively.
2. The Israeli Government, through the Fund for Encouragement
of Marketing Activities, awarded the Company grants for
participation in marketing expenses overseas. 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, 2003, the
Company has a contingent obligation to pay royalties in the
amount of $ 259. The Company did not pay or accrue any
royalties during the three years ending on December 31,
2003.
c. Claim and demand:
In April 2000, the tax authorities in Israel issued to MTS a
demand for a tax payment, for the period of 1997 - 1999, in the
amount of approximately NIS 6,000 thousand (approximately $
1,350).
MTS has appealed to the Israeli district court in respect of the
abovementioned tax demand. Based on the opinion of its tax
counsel, MTS believes that certain defenses can be raised against
the demand of the tax authorities. MTS believes that the outcome
of this matter will not have a material adverse effect on its
financial position or results of operations and, MTS provided a
provision, based on the current evidence and on the basis of the
said opinion of its tax consultants, which in the opinion of MTS
is an adequate provision.
F-25
MER TELEMANAGEMENT SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share data)
NOTE 14:- TAXES ON INCOME
a. Tax benefits under the Law for the Encouragement of Capital
Investments, 1959 ("the Law"):
MTS was granted the status of an "Approved Enterprise" under the
Law in respect of expansion projects. According to the provisions
of the Law, MTS elected to enjoy "alternative benefits" - waiver
of grants in return for tax exemption and, accordingly, income
derived from the "Approved Enterprise" is tax-exempt for a period
of two to four years, commencing with the year it first earns
taxable income, and subject to corporate tax at the rate of 25%,
for additional periods of three to five years.
The expansion programs which are assigned to MTS are as follows:
1. One program entitled MTS to tax-exemption for a two-year
period ended December 31, 1999, and is subject to a reduced
tax rate of 25% for a five-year period ending December 31,
2004.
2. The current program entitles MTS to tax exemption for a two
year period and were subject to tax rate of 25% for five
year period. The benefits in respect of this program have
not yet commenced.
The period of tax benefits detailed above is subject to limit of
the earlier of 12 years from the commencement of production or 14
years from receiving the approval.
The entitlement to the above benefits is conditional upon MTS's
fulfilling the conditions stipulated by the above Law,
regulations published hereunder and the instruments of approval
for the specific investment in "Approved Enterprises". In the
event of failure to comply with these conditions, the benefits
may be canceled and MTS may be required to refund the amount of
the benefits, in whole or in part, including interest. As of
December 31, 2003, management believes that MTS is meeting all of
the aforementioned conditions.
The tax-exempt income attributable to the "Approved Enterprise"
amounting to $ 2,250 as of December 31, 2003 can be distributed
to shareholders without subjecting MTS to taxes only upon the
complete liquidation of MTS. MTS has determined that such
tax-exempt income will not be distributed as dividends and
permanently re-invested these profits. Accordingly, no deferred
taxes have been nor will be provided on income attributable to
MTS's "Approved Enterprise".
Should the retained tax-exempt income be distributed in a manner
other than in the complete liquidation of MTS, it would be taxed
at the corporate tax rate applicable to such profits as if MTS
had not elected the alternative tax benefits (currently - 25% for
an "Approved Enterprise").
Should MTS and its Israeli subsidiary derive income from sources
other than an "Approved Enterprise", they will be subject to tax
at regular rates of 36%.
Since MTS is operating under more than one "Approved Enterprise"
and since part of its taxable income is not entitled to tax
benefits under the abovementioned law and is taxed at the regular
tax rate of 36%, 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.
F-26
MER TELEMANAGEMENT SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share data)
NOTE 14:- TAXES ON INCOME (Cont.)
b. Measurement of results for tax purposes under the Income Tax Law
(Inflationary Adjustments), 1985:
Results for tax purposes are measured in terms of earnings in NIS
after certain adjustments for 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.
c. Tax benefits under the Law for the Encouragement of Industry
(Taxation), 1969:
MTS is an "industrial company" as defined by this law and, as
such, is entitled to certain tax benefits, mainly accelerated
depreciation of machinery and equipment, 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.
d. Tax loss carryforward:
The Company's subsidiaries in Asia, U.S., Holland and Israel have
estimated a total amount of available carryforward tax losses of
$ 177, $486, $ 212 and $ 71, respectively to offset against
future taxable profits.
Tax loss carryforward in Israel may be used indefinitely to
offset against operating income. The operating loss carryforwards
of MTS and its Israeli subsidiary, which can be used
indefinitely, amounted to approximately $ 2,662.
e. Tax assessment:
Regarding the claim from the tax authorities in Israel, see Note
13c.
F-27
MER TELEMANAGEMENT SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share data)
NOTE 14:- TAXES ON INCOME (Cont.)
f. 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,
------------------
2002 2003
-------- -------
Tax loss carryforwards of the Company $ 364 $ 845
Allowances for doubtful accounts and provisions
for employee benefits 92 121
In respect of marketable securities 29 84
Capitalized software and other intangible assets 93 134
Other (140) 5
----- -------
Net deferred tax asset before valuation allowance 438 1,189
Valuation allowance (244) (1,018)
----- -------
Net deferred income taxes $ 194 $ 171
===== =======
Presented as follows:
Current assets - foreign $ 21 $ 66
===== =======
Other assets - foreign $ - $ 73
===== =======
Current assets - domestic $ 12 $ -
===== =======
Other assets - domestic $ 161 $ 32
===== =======
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.
F-28
MER TELEMANAGEMENT SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share data)
NOTE 14:- TAXES ON INCOME (Cont.)
g. 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,
---------------------------------------
2001 2002 2003
------------ ----------- ------------
Loss before taxes as reported in the
statements
of operations $ (2,759) $ (54) $ (60)
============ =========== ============
Tax rates 36% 36% 36%
============ =========== ============
Theoretical tax benefit $ (993) $ (19) $ (22)
Increase in taxes resulting from:
Effect of different tax rates and "Approved
Enterprise" benefit 396 200 -
Tax adjustment in respect of inflation in
Israel and others 193 (61) (22)
Utilization of carryforward tax losses for
which valuation allowance was provided - (246) (86)
Non-deductible expenses and tax exempt income (43) (24) 9
Taxes and deferred taxes in respect of
previous years - - 175
Deferred taxes for which valuation allowance
was provided 463 202 144
------------ ----------- ------------
Taxes on income as reported in the
statements of operations $ 16 $ 52 $ 198
============ =========== ============
h. Loss before income taxes is comprised as follows:
Domestic $ (1,772) $ (841) $ (312)
Foreign (987) 787 252
------------ ----------- ------------
$ (2,759) $ (54) $ (60)
============ =========== ============
i. Taxes on income are comprised as follows:
Current taxes $ 36 $ 23 $ -
Deferred taxes (20) 29 23
Taxes and deferred taxes in respect
of previous years - - 175
------------ ----------- ------------
$ 16 $ 52 $ 198
============ =========== ============
Domestic $ (42) $ 29 $ 322
Foreign 58 23 (124)
------------ ----------- ------------
$ 16 $ 52 $ 198
============ =========== ============
F-29
MER TELEMANAGEMENT SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share data)
NOTE 14:- TAXES ON INCOME (Cont.)
j. On January 1, 2003, a comprehensive tax reform took effect in
Israel. Pursuant to the reform, resident companies are subject to
Israeli tax on income accrued or derived in Israel or abroad. In
addition, the concept of "controlled foreign corporation" was
introduced according to which an Israeli company may become
subject to Israeli taxes on certain income of a non-Israeli
subsidiary if the subsidiary's primary source of income is
passive income (such as interest, dividends, royalties, rental
income or capital gains). The tax reform also substantially
changed the system of taxation of capital gains. The Company does
not expect the tax reform to have a material impact on its
results of operations or financial position.
NOTE 15:- RELATED PARTIES TRANSACTIONS
a. On November 8, 1999, the board of directors and the audit
committee approved, subject to 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 twelve 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 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 of retaining the services of her
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 2002 and 2003, the balance with C. Mer reflects short-term
debt and other receivable. Due to the short-term nature no
interest was charged by or paid to C. Mer through December 31,
2002 and 2003.
F-30
MER TELEMANAGEMENT SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share data)
NOTE 15:- RELATED PARTIES TRANSACTIONS (Cont.)
c. Transactions with related parties were as follows:
Year ended December 31,
--------------------------------------
2001 2002 2003
----------- ----------- -----------
Sales through related parties $ 58 $ 65 $ 28
=========== =========== ===========
Amounts charged by related parties:
Cost of revenues 62 $ 239 $ 34
Research and development 58 8 -
Selling and marketing - 2 -
General and administrative - 4 5
----------- ----------- -----------
$ 120 $ 253 $ 39
=========== =========== ===========
Amounts charged by MTS Integra TRAK and
MTS Asia to related parties:
Selling and marketing $ 44 $ 2 $ -
=========== =========== ===========
Repayments to the related parties, net $ (10) $ (172) $ (48)
=========== =========== ===========
d. Amounts due from an affiliate:
December 31,
------------------------------
2002 2003
------------- -------------
Jusan S.A $ 10 $ (2)
============= =============
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. Share Option Plan:
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. 1,500,000 options were granted 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.
F-31
MER TELEMANAGEMENT SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share data)
NOTE 16:- SHAREHOLDERS' EQUITY (Cont.)
Each option granted under the Plan is exercisable until the
earlier of four 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 2002, 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 for grant into 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.
As of December 31, 2003, 826,776 options are available for future
grant.
Summary of MTS's stock options activity and related information
for the three years ended December 31, is as follows:
Weighted
Options Number average
available of options Options exercise
for grant outstanding exercisable price
------------ ----------- ----------- -------------
Options exercisable at January 778,325 $ 3.02
1, 2001 ===========
Balance on January 1, 2001 447,598 1,315,152 $ 3.88
Options granted (436,405) 436,405 $ 2.05
Options forfeited 520,416 (520,416) $ 2.74
Options exercised - (4,000) $ 2.5
------------ ----------- -------------
Options exercisable at December 800,887 $ 4.48
31, 2001 ===========
Balance on December 31, 2001 531,609 1,227,141 $ 3.74
Options granted (35,000) 35,000 $ 1.2
Options forfeited 504,561 (504,561) $ 4.19
------------ ----------- -------------
Options exercisable at December 502,644 $ 3.76
31, 2002 ===========
Balance on December 31, 2002 1,001,170 757,580 $ 3.32
Options granted (434,500) 434,500 $ 1.85
Options exercised - (133,333) $ -
Options forfeited 260,106 (260,106) $ 2.91
------------ ----------- -------------
Options exercisable at December 355,413 $ 3.68
31, 2003 =========== =============
Balance on December 31, 2003 826,776 798,641 $ 2.85
============ =========== =============
F-32
MER TELEMANAGEMENT SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share data)
NOTE 16:- SHAREHOLDERS' EQUITY (Cont.)
The options outstanding as of December 31, 2003 have been
separated into ranges of exercise prices, as follows:
Options Weighted Weighted
outstanding average Weighted average
as of remaining average exercise price
Exercise December 31, contractual exercise Options of exercisable
price 2003 life (in years) price exercisable options
--------------- ------------- ------------ ------------ ------------- -------------
$ 0.93 - $ 1.3 32,500 2.08 $1.19 10,830 $1.19
$ 1.844 250,000 4.92 $1.844 - $ -
$ 1.9 - $ 2.05 239,967 1.38 $1.96 192,213 $1.95
$ 2.9 - $ 2.95 117,500 4.93 $2.91 - $ -
$ 4.5 2,000 1.08 $4.5 1,333 $4.5
$ 5.5 19,000 0.58 $5.5 19,000 $5.5
$ 5.9375 - $ 6 116,724 1.00 $5.99 115,749 $5.99
$ 7.0625 20,950 0.33 $7.0625 16,288 $7.0625
------------- -------------
798,641 $2.85 355,413 $3.68
============= ======== ============= ==========
c. The weighted average fair value of options granted during 2001
and 2002, whose exercise price equals the fair value of the stock
on the date of grant, was $ 2.05 and $ 1.20 per option,
respectively.
During 2003, the Company granted 434,500 options, of such
options, 117,500 options were granted at a weighted average
exercise price of $ 2.91 per share (the fair market value of the
shares on the date of grant) and 317,000 options with a weighted
average exercise price of $ 1.45 were granted at exercise prices
below the fair value of the shares on the date of grant.
The Company has recorded deferred stock compensation expense for
options issued with an exercise price below the fair market value
of the shares; the deferred stock compensation expense has been
amortized and recorded as compensation expense ratably over the
vesting period of the options. Compensation expense of
approximately $ 60 was recognized during 2003.
During 2003, the Company reduced the exercise price of 83,000
options to zero resulting in a compensation expense of
approximately $ 153.
d. In January 2000, MTS granted 98,824 options to Mr. Chaim Mer,
chairman of the Company, having an exercise price of $ 6.00 per
share. These options were granted in lieu of Mr. Mer's salary ($
7 per month) in 2000. The options are exercisable for five years
commencing January 1, 2000 (see Note 15).
e. On February 7, 2001, MTS issued five-year warrants to purchase
25,000 ordinary shares of MTS to Investec Bank (Mauritius) Ltd.
in connection with certain financial services performed on MTS's
behalf. The warrants have an exercise price of $ 4.95 per share
for warrants exercised until February 2004 and $ 5.625 per share
for warrants exercised until February 2006. The fair value of the
warrants, at the date of the grant, using a Black-Scholes option
pricing model was immaterial and therefore no compensation
expenses were recorded.
F-33
MER TELEMANAGEMENT SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share data)
NOTE 16:- SHAREHOLDERS' EQUITY (Cont.)
f. Treasury shares:
During the years 2001, 2002 and 2003, the Company purchased
54,665, 195,183 and 130,510 treasury shares in consideration of $
118, $ 172 and $ 147 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 the year, MTS cancelled $458 of its treasury shares, which
represent 384,610 Ordinary shares.
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:- SELECTED STATEMENTS OF OPERATIONS DATA
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.
a. Major customers as a percentage of total revenues:
Year ended December 31,
---------------------------------------
2001 2002 2003
----------- ------------ ----------
%
---------------------------------------
Philips 8 6 7
Siemens 32 36 40
b. The following is a summary of revenues within geographic areas
based on end customer location and long-lived assets:
Year ended December 31,
-----------------------------------------
2001 2002 2003
------------ ------------ -----------
Revenues from sales:
--------------------
Israel $ 358 $ 217 $ 186
United States 6,496 6,449 4,917
Germany 1,355 1,130 1,826
Holland 1,009 756 924
Europe (excluding Austria,
Germany and Holland) 448 296 516
Asia 500 469 364
South America 419 328 368
Austria 24 - -
Others 116 142 129
------------ ------------ -----------
$ 10,725 $ 9,787 $ 9,230
============ ============ ===========
F-34
MER TELEMANAGEMENT SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share data)
NOTE 17:- SELECTED STATEMENTS OF OPERATIONS DATA (Cont.)
Year ended December 31,
----------------------------------------
2001 2002 2003
----------- ------------ -----------
Long-lived assets:
------------------
Israel $ 809 $ 624 $ 394
United States 2,437 2,302 2,268
Holland 10 10 8
Asia 35 29 16
South America 23 22 27
----------- ------------ -----------
$ 3,314 $ 2,987 $ 2,713
=========== ============ ===========
c. Research and development, net:
Total costs $ 4,552 $ 2,128 $ 1,825
Less - grants and
participations (990) (1) -
----------- ------------ ----------
$ 3,562 $ 2,127 $ 1,825
=========== ============ ==========
d. Financial income, net
Financial expenses:
Interest expenses $ (232) $ (205) $ (64)
Other expenses (9) (7) -
Foreign currency translation
differences (81) - (11)
------------ ------------ -----------
(322) (212) (75)
------------ ------------ -----------
Financial income:
Interest income 403 310 186
Other income 57 1 13
Foreign currency translation
differences - 35 -
------------ ------------ -----------
460 346 199
------------ ------------ -----------
Financial income, net $ 138 $ 134 $ 124
============ ============ ===========
e. Other income (expenses):
Loss from impairment of
investments in warrants $ (375) $ - $ -
Gain (loss) on marketable
securities, net (279) (140) 6
------------ ------------ -----------
$ (654) $ (140) $ 6
============ ============ ===========
F-35
MER TELEMANAGEMENT SOLUTIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share data)
NOTE 18:- SUBSIDIARIES AND AFFILIATES
Percentage of Jurisdiction of
ownership incorporation
---------------- ----------------
Subsidiaries:
-------------
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% The Netherlands
Verdura B.V. (a subsidiary of Jaraga B.V.) 100% The Netherlands
Voltera Technologies V.O.F. (a partnership held
99% by Jaraga B.V. and 1% by Verdura B.V.) 100% The Netherlands
Bohera B.V. (a subsidiary of Jaraga B.V.) 100% The Netherlands
Tabs Brazil Ltd. (a subsidiary of Bohera B.V.) 100% Brazil
Affiliate:
----------
Jusan S.A. (a subsidiary of Jaraga B.V.) 50% Spain
NOTE 19:- SUBSEQUENT EVENTS (UNAUDITED)
In March 2004, MTS IntegraTRAK was named as a defendant in a complaint
filed in the United States District Court for the Northern District of
Georgia, Atlanta Division, captioned Telemate.net Software, Inc. v. James
A. Myers, Total Wire Software Company, Inc. and MTS IntegraTRAK, Inc. The
plaintiff alleges among other things federal copyright infringement,
federal unfair competition, common law unfair competition and
misappropriation of trade secrets in connection with MTS IntegraTRAK
license of software from James A. Myers. In a related action in the State
Court of Fulton County, State of Georgia, captioned James A. Myers v.
Telemate.net Software, Inc. v. MTS IntegraTRAK, Inc. and Total Wire
Software Company, Inc., Telemate filed a third-party complaint against MTS
IntegraTRAK based on the same license, claiming misappropriation of trade
secrets. The plaintiff is seeking an injunction against MTS IntegraTRAK
future sales of the product, damages, an accounting of any sales of such
product, and attorneys' fees. MTS IntegraTRAK has not responded to the
complaints as yet, but believes that it has good and valid defenses that it
will assert.
- - - - - - - - - - -
F-36
JUSAN, S.A.
FINANCIAL STATEMENTS
AS OF DECEMBER 31, 2003
EUROS IN THOUSANDS
INDEX
Page
------------
Report of Independent Auditors F-38
Balance Sheets F-39
Statements of Income F-40
Statements of Changes in Shareholders' Equity F-41
Statements of Cash Flows F-42
Notes to Financial Statements F-43-F-51
- - - - - - - - - -
F-37
ERNST & YOUNG
o Kost Forer Gabbay & Kasierer
3 Aminadav St. o Phone: 972-3-6232525
Tel-Aviv 67067, Israel Fax: 972-3-5622555
REPORT OF INDEPENDENT AUDITORS
To the Shareholders of
JUSAN, S.A.
We have audited the accompanying balance sheets of JUSAN, S.A. ("the
Company") as of December 31, 2003 and 2002, and the related statements of
income, changes in shareholders' equity and cash flows for each of the two years
in the period ended December 31, 2003. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audit.
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. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of the Company as of December
31, 2003 and 2002, and the results of its operations and its cash flows for each
of the two years in the period ended December 31, 2003, in conformity with
accounting principles generally accepted in the United States.
/s/ Kost Forer Gabbay and Kasierer
Tel-Aviv, Israel KOST FORER GABBAY & KASIERER
January 14, 2004 A Member of Ernst & Young Global
F-38
JUSAN, S.A.
BALANCE SHEETS
--------------------------------------------------------------------------------
Euros in thousands
December 31,
------------------------------
2002 2003
------------- -------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents (euro) 338 (euro) 953
Short-term bank deposits 402 450
Trade receivables (net of allowance
for doubtful accounts of 6
euros as of December 31, 2002 and
2003 and provision for
returns of 7 euros as of December 31, 2003) 1,578 1,732
Other accounts receivable and prepaid expenses (Note 3) 262 240
Inventories (Note 4) 900 793
------------- -------------
Total current assets 3,480 4,168
----- ------------- -------------
PROPERTY AND EQUIPMENT, NET (Note 5) 118 78
------------- -------------
Total assets (euro) 3,598 (euro)4,246
----- ============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Short-term bank debt (Note 6) (euro) 16 (euro) 38
Trade payables 623 795
Accrued expenses and other liabilities (Note 7) 386 408
Deferred revenues 126 232
------------- -------------
Total current liabilities 1,151 1,473
----- ------------- -------------
COMMITMENTS (NOTE 8)
SHAREHOLDERS' EQUITY (Note 11):
Share capital -
15,052 Ordinary shares of (euro) 0.0042
par value (Authorized,
issued and outstanding) as of
December 31, 2002 and 2003 63 63
Retained earnings 2,384 2,710
------------- -------------
Total shareholders' equity 2,447 2,773
----- ------------- -------------
Total liabilities and shareholders' equity (euro) 3,598 (euro)4,246
----- ============= =============
The accompanying notes are an integral part of the financial statements.
F-39
JUSAN, S.A.
STATEMENTS OF INCOME
--------------------------------------------------------------------------------
Euros in thousands (except share and per share data)
Year ended December 31,
--------------------------------------------
2001 2002 2003
------------- ------------- ------------
Unaudited
-------------
Revenues (Note 12):
Product sales (euro)5,227 (euro)6,060 (euro)5,353
Services 986 819 707
------------- ------------- ------------
Total revenues 6,213 6,879 6,060
------------- ------------- ------------
Cost of revenues:
Product sales 2,871 3,336 2,797
Services 737 658 538
------------- ------------- ------------
Total cost of revenues 3,608 3,994 3,335
------------- ------------- ------------
Gross profit 2,605 2,885 2,725
------------- ------------- ------------
Operating expenses:
Research and development 325 470 425
Selling and marketing 628 718 770
General and administrative 852 892 882
------------- ------------- ------------
Total operating expenses 1,805 2,080 2,077
------------- ------------- ------------
Operating income 800 805 648
Financial income, net (Note 13) 6 7 9
------------- ------------- ------------
Income before taxes on income 806 812 657
Income taxes (Note 9) 183 185 131
------------- ------------- ------------
Net income (euro) 623 (euro)627 (euro)526
============= ============= ============
Basic and diluted net earnings per share (euro) 41.4 (euro)41.7 (euro)34.95
============= ============= ============
Weighted average number of shares used in
computing basic and diluted net earnings per share 15,052 15,052 15,052
============= ============= ============
The accompanying notes are an integral part of the financial statements.
F-40
JUSAN, S.A.
--------------------------------------------------------------------------------
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
Euros in thousands
Total
Share Retained shareholders'
Capital earnings equity
------------- -------------- ---------------
Balance as of January 1, 2001 (unaudited) (euro)63 (euro)1,934 (euro)1,997
Dividends - (120) (120)
Net income - 623 623
------------- -------------- ---------------
Balance as of December 31, 2001 (unaudited) 63 2,437 2,500
Dividends - (680) (680)
Net income - 627 627
------------- -------------- ---------------
Balance as of December 31, 2002 63 2,384 2,447
Dividend paid - (100) (100)
Accrued dividend - (100) (100)
Net income - 526 526
------------- -------------- ---------------
Balance as of December 31, 2003 (euro)63 (euro)2,710 (euro)2,773
============= ============== ===============
The accompanying notes are an integral part of the financial statements.
F-41
JUSAN, S.A.
STATEMENTS OF CASH FLOWS
--------------------------------------------------------------------------------
Euros in thousands
Year ended December 31,
--------------------------------------------
2001 2002 2003
------------- ------------- ------------
Unaudited
-------------
Cash flows from operating activities:
-------------------------------------
Net income (euro) 623 (euro) 627 (euro) 526
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation 48 63 64
Decrease (increase) in trade receivables 71 (236) (154)
Decrease (increase) in other accounts receivable
and prepaid expenses 31 (51) 22
Decrease (increase) in inventories 270 (252) 107
Increase (decrease) in trade payables 422 (264) 172
Increase (decrease) in accrued expenses and other
liabilities 176 (218) (78)
Increase in deferred revenues - 126 106
------------- ------------- -----------
Net cash provided by (used in) operating activities 1,641 (205) 765
------------- ------------- -----------
Cash flows from investing activities:
-------------------------------------
Investment in short-term bank deposits (1,103) 702 (48)
Purchase of property and equipment (62) (94) (24)
------------- ------------- ------------
Net cash provided by (used in) investing activities (1,165) 608 (72)
------------- ------------- ------------
Cash flows from financing activities:
-------------------------------------
Dividend paid (120) (680) (100)
Short-term bank debt (129) (61) 22
------------- ------------- ------------
Net cash used in financing activities (249) (741) (78)
------------- ------------- ------------
Increase (decrease) in cash and cash equivalents 227 (338) 615
Cash and cash equivalents at the beginning
of the year 449 676 338
------------- ------------- ------------
Cash and cash equivalents at the end of the year (euro) 676 (euro) 338 (euro) 953
============= ============= ============
Non-cash financing information:
-------------------------------
Accrued dividend - - (euro) 100
============= ============= ============
Supplemental disclosure of cash flows activities:
-------------------------------------------------
Cash paid during the year for:
Interest (euro) 7 (euro) 9 (euro) 8
============= ============= ============
Income taxes (euro) 82 (euro) 183 (euro) 184
============= ============= ============
The accompanying notes are an integral part of the financial statements.
F-42
JUSAN, S.A.
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
Euros in thousands
NOTE 1:- ORGANIZATION AND OPERATIONS
a. JUSAN, S.A. ("the Company") was incorporated in Spain on June 19,
1959. The Company is engaged in 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 two major customers (see also Note 12a).
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.
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 2%. 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-43
JUSAN, S.A.
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
Euros in thousands
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)
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.
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 their estimated realizable value.
F-44
JUSAN, S.A.
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
Euros in thousands
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)
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 as of December 31, 2003 in the amount of (euro)
7 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.
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 as
of December 31, 2003 in the amount of (euro) 18 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.
F-45
JUSAN, S.A.
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
Euros in thousands
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)
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.
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 12a). 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. 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.
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").
n. Reclassification:
Certain amounts from prior years have been reclassified to conform the
current year's presentation. The reclassification had no effect on
previously reported net loss, shareholders' equity or cash flows.
F-46
JUSAN, S.A.
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
Euros in thousands
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)
o. Impact of recently issued accounting standards:
In January 2003, the Financial Accounting Standards Board issued
Interpretation No. 46, Consolidation of Variable Interest Entities, an
interpretation of Accounting Research Bulletin No. 51 ("the
interpretation"). In general, a variable interest entity (VIE) is an
entity that has (1) insufficient amount of equity for the entity to
carry on its principal operations, without additional subordinated
financial support from other parties, (2) equity investors that as a
group do not have the ability through voting or similar rights to make
decisions about the entity's activities, or (3) investors that as a
group do not have the obligation to absorb the entity's losses or have
the right to receive the benefits of the entity. The interpretation
requires the consolidation of a VIE by the primary beneficiary. The
primary beneficiary is the entity that absorbs a majority of the
entity's expected losses, receives a majority of the entity's expected
residual returns, or both, as a result of ownership, contractual or
other financial interests in the entity. Presently, entities are
generally consolidated by an enterprise that has a controlling
financial interest through ownership of a majority voting interest in
the entity.
The Company's management believes that this standard will have no
effect on the Company.
NOTE 3:- OTHER ACCOUNTS RECEIVABLE AND PREPAID EXPENSES
December 31,
------------------------------
2002 2003
------------- -------------
Government authorities (euro)201 (euro)191
Employee advances 34 33
Deposits 16 16
Other 11 -
------------- -------------
(euro)262 (euro)240
============= =============
NOTE 4:- INVENTORIES
Raw materials (euro)551 (euro)489
Work in progress 38 23
Finished products 311 281
------------- -------------
(euro)900 (euro)793
============= =============
F-47
JUSAN, S.A.
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
Euros in thousands
NOTE 5:- PROPERTY AND EQUIPMENT, NET
December 31,
-----------------------------
2002 2003
------------- ------------
Cost:
Computers and peripheral equipment (euro) 140 (euro) 152
Office furniture and equipment 285 294
Motor vehicles 100 103
Leasehold improvements 140 140
------------- -------------
665 689
------------- -------------
Accumulated depreciation:
Computers and peripheral equipment 97 127
Office furniture and equipment 243 265
Motor vehicles 67 79
Leasehold improvements 140 140
------------- -------------
547 611
------------- -------------
Depreciated cost (euro) 118 (euro) 78
============= =============
Depreciation expenses for the years ended December 31, 2001, 2002 and 2003
were (euro) 48, (euro) 63 and (euro) 64, respectively.
NOTE 6:- SHORT-TERM BANK DEBT
The Company has a short-term bank debt in the amount of (euro)38, bearing
interest of 3.5%.
NOTE 7:- ACCRUED EXPENSES AND OTHER LIABILITIES
December 31,
-------------------------------
2002 2003
-------------- --------------
Employees and payroll accruals (euro) 53 (euro) 55
Income tax payable 184 131
Government authorities 131 104
Accrued dividends - 100
Warranty costs 18 18
-------------- --------------
(euro) 386 (euro) 408
============== ==============
F-48
JUSAN, S.A.
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
Euros in thousands
NOTE 8:- CONTINGENT LIABILITIES AND COMMITMENTS
The facilities of the Company are rented under operating leases for periods
ending in 2006.
Future minimum lease commitments under non-cancelable operating leases as
of December 31, are as follows:
2004 (euro) 140
2005 92
2006 35
---------------
(euro) 267
===============
Rent expenses for years ended December 31, 2001, 2002, and 2003, were
approximately (euro) 141, (euro) 142 and (euro) 152, respectively.
NOTE 9:- 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,
---------------------------------------
2001 2002 2003
------------ ----------- ------------
Unaudited
------------
Income before taxes as reported
in the statements of operations (euro)806 (euro)812 (euro)657
============ =========== ============
Tax rates 35% 35% 35%
============ =========== ============
Theoretical tax benefit (euro)282 (euro)284 (euro)230
Decrease in taxes resulting from:
Tax deduction for development (99) (99) (99)
------------ ----------- ------------
Taxes on income (tax benefit) as reported
in the statements of operations (euro)183 (euro)185 (euro)131
============ =========== ============
Under the current tax legislation, 35% of development expense can be
deducted from the income tax with the limits of 45% of the theoretical tax
benefits. In 2001 and 2002 this limit was 35%.
All the income before income taxes is domestic. Income taxes include only
current tax expenses.
F-49
JUSAN, S.A.
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
Euros in thousands (except per share data)
NOTE 10:- RELATED PARTIES TRANSACTIONS
The balances with and the revenues derived from related parties were as
follows:
a. Payments to related parties:
Year ended December 31,
--------------------------------------
2001 2002 2003
----------- ----------- -----------
Unaudited
-----------
Wages (euro)295 (euro)274 (euro)308
=========== =========== ===========
In 2002 and 2003, the balance with personnel reflects short-term debt.
b. Transactions with related parties were as follows:
Year ended December 31,
----------------------------------------
2001 2002 2003
------------ ------------- -----------
Unaudited
------------
Sales through related parties (euro) - (euro) - (euro) 15
============ ============= ===========
Amounts charged by related parties:
Cost of revenues (euro)117 (euro)80 (euro)205
============ ============= ===========
c. Amounts receivable from and payables to related parties:
December 31,
------------------------------
2002 2003
------------- -------------
Receivables:
Mer Telemagement Solutions (euro)1 (euro) 9
============= =============
Payables:
Beheer (euro)- (euro)128
============= =============
NOTE 11:- 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. Dividends:
On October 31, 2003 the General Meeting of Shareholders approved to
pay dividend of (euro) 200 ((euro) 13.29 per share) of which (euro)
100 has been paid during the year. The remaining amount of (euro) 100
is included in accrued expenses and other liabilities include accrued
dividend to one of the shareholders as of December 31, 2003.
F-50
JUSAN, S.A.
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
Euros in thousands
NOTE 11:- SHAREHOLDERS' EQUITY (Cont.)
c. 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 can only be used to compensate for
losses or to increase capital.
NOTE 12:- SEGMENTS, CUSTOMERS AND GEOGRAPHIC INFORMATION
a. Major customers as a percentage of total revenues:
Year ended December 31,
------------------------------------------
2001 2002 2003
------------ ----------- ------------
Unaudited
------------
%
------------------------------------------
Adictis - 3% 13%
Telefonica de Espana 7% 3% 10%
b. The following is a summary of revenues within geographic areas based
on end customer location:
Year ended December 31,
------------------------------------------
2001 2002 2003
------------ ----------- ------------
Unaudited
------------
Spain (euro)4,016 (euro)4,335 (euro)3,360
European Community 1,902 2,067 2,179
Other 295 477 521
------------ ----------- ------------
(euro)6,213 (euro)6,879 (euro)6,060
============ =========== ============
NOTE 13:- SELECTED STATEMENTS OF OPERATIONS DATA
Financial income, net
Year ended December 31,
------------------------------------------
2001 2002 2003
------------ ----------- ------------
Unaudited
------------
Financial expenses:
Interest expenses (euro) 7 (euro) 9 (euro) 5
Other expenses 12 13 8
------------ ----------- ------------
19 22 13
------------ ----------- ------------
Financial income:
Interest income 25 29 22
------------ ----------- ------------
Financial income, net (euro) 6 (euro) 7 (euro) 9
============ =========== ============
-------------------------
F-51
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/Yossi Brikman
----------------
Yossi Brikman
Chief Financial Officer
Dated: June 24, 2004
79