Modsys International Ltd 20-F 2009
Documents found in this filing:
F O R M 20 F/A
Date of event requiring this shell company report........................
For the transition period from ________ to ________
Commission file number: 005-52583
BLUEPHOENIX SOLUTIONS LTD.
8 Maskit Street, Herzliya 46733, Israel
Varda Sagiv, CFO, 8 Maskit Street, Herzliya 46733, Israel
Securities registered or to be registered pursuant to Section 12(b) of the Act:
Securities registered or to be registered pursuant to Section 12(g) of the Act:
Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:
Indicate the number of outstanding shares of each of the issuers classes of capital or common stock as of the close of the period covered by the annual report.
20,835,758 Ordinary shares, NIS 0.01 per share
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes o No x
If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
Yes o No x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer in Rule 12b-2 of the Exchange Act. (Check one):
Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing:
U.S. GAAP x
International Financial Reporting Standards as issued by the International Accounting Standards Board o
If Other has been checked in response to the previous question, indicate by check mark which financial statement item the registrant has elected to follow.
Item 17 o Item 18 o
If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o No x
TABLE OF CONTENTS
This Amendment No. 1 to Form 20-F (the Amended 20-F) contains information for the fiscal year ended December 31, 2008, which information was filed with the Securities and Exchange Commission on Form 20-F on March 31, 2009 (the Original 20-F) and the consolidated financial statements contained therein (the Original Financial Statements); the certifications (Exhibits 12.1, 12.2, 13.1 and 13.2) and consent of our independent auditors contained in the Amended 20-F speak as of the dates specified. The Amended 20-F is being filed to:
Except as specifically indicated, the Amended 20-F has not been updated to reflect events occurring subsequent to the filing of the Original 20-F. The filing of this Amended 20-F shall not be deemed an admission that the Original 20-F, when filed, included any untrue statement of a material fact or omitted to state a material fact necessary to make a statement not misleading.
Some of the statements in this annual report, including those in the Risk Factors, Operating and Financial Review and Prospects, and Business Overview sections, are forward-looking statements that involve risks and uncertainties. These forward-looking statements include statements about our plans, objectives, strategies, expectations, intentions, future financial performance, and other statements that are not historical facts. We use words like anticipates, believes, expects, future, intends, and similar expressions to mean that the statement is forward-looking. You should not unduly rely on these forward-looking statements, which apply only as of the date of this annual report. Our actual results could differ materially from those anticipated in the forward-looking statements for many reasons, including the risks described under Risk Factors.
As used in this annual report, references to we, our, ours, and us refer to BluePhoenix Solutions Ltd. and its subsidiaries, unless otherwise indicated. References to BluePhoenix refer to BluePhoenix Solutions Ltd.
The name BluePhoenix and the names BluePhoenix IT Discovery, BluePhoenix LogicMiner, BluePhoenix DBMSMigrator, BluePhoenix PlatformMigrator, BluePhoenix Rehosting, BluePhoenix LanguageMigrator, BluePhoenix DataMigrator, BluePhoenix SOA-Ready Enablement (Formerly known as WS4Legacy,) BluePhoenix FieldEnabler, BluePhoenix StandardsEnabler, BluePhoenix Refactoring Repository (Nebula- code name), BluePhoenix AppBuilder, BluePhoenix Redevelopment, ASNA Monarch , ASNA Visual RPG® (AVR) and ASNA DataGate® appearing in this annual report are trademarks of our company. Other trademarks in this annual report are owned by their respective holders.
The following tables present our consolidated statement of operations and balance sheet data for the periods and as of the dates indicated. We derived the statement of operations data for each of the years ended December 31, 2006, 2007 and 2008 and the balance sheet data as of December 31, 2007 and 2008 from our consolidated financial statements included in Item 18 of this annual report, which have been prepared in accordance with generally accepted accounting principles as applied in the United States, or U.S. GAAP. Our consolidated financial statements have been audited by Ziv Haft, independent registered public accounting firm, BDO member firm. The selected consolidated financial data as of December 31, 2004, 2005 and 2006 and for the years ended December 31, 2004 and 2005 is derived from our audited financial statements not included in this annual report, which have been prepared in accordance with U.S. GAAP. You should read the selected consolidated financial data set forth below together with our consolidated financial statements included elsewhere in this annual report. See Item 5. Operating and Financial Review and Prospects.
Our business, financial condition, and results of operations could be materially adversely affected by any of the following risks. Additional risks and uncertainties that we are not aware of or that we currently believe are immaterial may also adversely affect our business, financial condition, results of operations and our liquidity. The trading price of our ordinary shares could decline due to any of these risks, and you may lose all or part of your investment.
Risks Related to Our Business
The recent global economic and financial crisis has had and will continue to have a negative effect on our business, financial condition and results of operations.
The recent global economic and financial market crisis has caused, among other things, a general tightening in the credit markets, lower levels of liquidity, increases in the rates of default and bankruptcy, and reduced corporate profits and capital spending, all of which has had and will continue to have a negative effect on our business, results of operations and financial condition.
Demand for our tools and services depends in large part upon the level of information technology, or IT, capital spending and investment in IT projects by our customers. The current economic conditions have reduced the willingness or ability of our customers and prospective customers to commit funds to IT projects, and may reduce their ability to pay for our tools and services after purchase, whether as a result of possible customer insolvencies or otherwise. This has resulted in longer sales cycles and increased pressure on pricing. Similarly, our suppliers may not be able to supply us with needed components on a timely basis, may increase prices or go out of business, which could result in our inability to meet customer demand, fulfill our contractual obligations or affect our gross margins. We cannot predict the timing or duration of the global economic crisis or the timing or strength of any subsequent economic recovery. Accordingly, we cannot know how the economic conditions will affect our business. As a result, we cannot assure you that we will be able to increase our revenues or keep our revenues at the same level as in 2008.
If the economy or markets in which we operate experience continued weakness at current levels or deteriorate further, our business, financial condition and results of operations will be materially and adversely impacted.
The loss of, or significant reduction or delay in, purchases by our customers could reduce our revenues and profitability.
A small number of customers has accounted for a substantial portion of our current and historical net revenues. For example, in 2008, sales to The Capita Group Plc accounted for 10% of our revenues. In 2007, sales to SDC Udvikling A/S and EDS accounted for 12% and 11% of our revenues, respectively. In 2006, sales to EDS accounted for 11% of our revenues.
The loss of any of our major customers or a decrease or delay in orders or anticipated spending by such customers could materially reduce our revenues and profitability. Our customers could also engage in business combinations, which could increase their size, reduce their demand for our products and solutions as they recognize synergies or rationalize assets and increase or decrease the portion of our total sales concentration to any single customer.
Our acquisition of existing businesses and our failure to successfully integrate these businesses could disrupt our business, dilute your holdings in us, and harm our financial condition and operating results.
In recent years, we acquired and increased our investment in several businesses. We intend to make future strategic acquisitions of complementary companies, products, or technologies, depending on market conditions and available financing. Such acquisitions could disrupt our business. In addition, your holdings in our company would be diluted if we issue equity securities in connection with any acquisition, as we did in the acquisitions of BridgeQuest Inc. and CodeStream Software Ltd.. Acquisitions may result in losses as a result of our failure to successfully integrate the acquired businesses with our existing business. For example, in 2007, an impairment loss of $7 million related to goodwill in Mainsoft Corporation, or Mainsoft, was identified and charged to loss from discontinued operation. In 2008, we sold our entire holdings in Mainsoft, in which we held a 58% controlling interest. Mainsoft contributed a loss of approximately $8.5 million, charged to loss from discontinued operation in 2008. This decision to sell Mainsoft followed a strategic shift in Mainsofts product development and marketing strategy outside of BluePhoenixs core business focus.
Acquisitions involve numerous risks, including:
Further, products that we acquire from third parties often require significant expenditures of time and resources to upgrade and integrate with our existing product suite. We may not be able to successfully integrate any business, technologies, or personnel that we have acquired or that we might acquire in the future, and this could harm our financial condition and operating results.
If we fail to continue our growth and manage our growth effectively, our business could be disrupted, which could harm our operating results.
Our expansion during recent years placed a strain on our senior management team and other resources, such as our management information systems and operating, administrative, financial, and accounting systems. We have undergone rapid growth in the number of our employees, the size and locations of our physical facilities, and the scope of our operations, due, in part, to several acquisitions we have made. Any failure to manage our growth effectively could disrupt our business and harm operating results.
Many of our customers are financial institutions and a negative impact of the recent global economic and financial crisis on their business may cause a negative effect on our business, financial condition and results of operations.
Approximately 60% of our revenues in 2008 were derived from financial institutions. The recent global economic and financial market crisis had an adverse affect on various financial institutions and the banking sector. Lower levels of liquidity, increases in the rates of default and bankruptcy, and reduced corporate profits and capital spending, may have an adverse effect on our business, results of operations and financial condition.
If we are unable to effectively control our costs while maintaining our customer relationships, our business, results of operations and financial condition could be adversely affected.
It is critical for us to appropriately align our cost structure with prevailing market conditions, to minimize the effect of economic downturns on our operations, and in particular, to continue to maintain our customer relationships while protecting profitability and cash flow. If we are unable to align our cost structure in response to such downturns on a timely basis, or if such implementation has an adverse impact on our business or prospects, then our financial condition, results of operations and cash flows may be negatively affected.
Conversely, adjusting our cost structure to fit economic downturn conditions may have a negative effect on us during an economic upturn or periods of increasing demand for our IT solutions. If we have too aggressively reduced our costs, we may not have sufficient resources to capture new IT projects and meet customer demand. If, for example, during periods of escalating demand for our products, we were unable to add engineering and technical staff capacity quickly enough to meet the needs of our customers, they may turn to our competitors making it more difficult for us to retain their business. Similarly, if we are unable for any other reason to meet delivery schedules, particularly during a period of escalating demand, our relationships with our customers could be adversely affected. If we are unable to effectively manage our resources and capacity to capitalize on periods of economic upturn, there could be a material adverse effect on our business, financial condition, results of operations and cash flows.
If we are unable to accurately predict and respond to market developments or demands, our business will be adversely affected.
The IT modernization business is characterized by rapidly evolving technology and methodologies. This makes it difficult to predict demand and market acceptance for our modernization tools and services. In order to succeed, we need to adapt the tools and services we offer to keep up with technological developments and changes in customer needs. We cannot guarantee that we will succeed in enhancing our tools and services, or developing or acquiring new modernization tools and services that adequately address changing technologies and customer requirements. We also cannot assure you that the tools and services we offer will be accepted by customers. If our tools and services are not accepted by customers, our future revenues and profitability will be adversely affected. Changes in technologies, industry standards, the regulatory environment, customer requirements, and new product introductions by existing or future competitors could render our existing solutions obsolete and unmarketable, or require us to enhance our current tools or develop new tools. This may require us to expend significant amounts of money, time, and other resources to meet the demand. This could strain our personnel and financial resources.
We may experience significant fluctuations in our annual and quarterly results, which makes it difficult to make reliable period-to-period comparisons and may contribute to volatility in the market price of our ordinary shares.
Our quarterly and annual results of operations have fluctuated significantly in the past, and we expect them to continue to fluctuate significantly in the future. These fluctuations are the result of risks related to the introduction of new products and any of the following events:
In addition, unexpected events that do not occur on a regular basis and that are difficult to predict may cause fluctuations in our operating results. In 2008, we had a loss from continuing operation of $20.1 million. This loss is attributed to a number of factors including an impairment test performed by us, which resulted in an impairment loss of $13.3 million related to goodwill of our overall IT modernization reporting unit, and was charged to operations. Additional losses are attributed to costs incurred with regard to our cost saving plan, changes in foreign currencies that affected our financial expenses and to a decrease in our gross margin.
As a result of the foregoing, we believe that period-to-period comparisons of our historical results of operations are not necessarily meaningful and that you should not rely on them as an indication for future performance. Also, it is possible that our quarterly and annual results of operations may be below the expectations of public market analysts and investors.
A delay in collecting our fees could result in cash flow shortages, which in turn may significantly impact our financial results.
Typical modernization projects which deploy our solutions are long-term projects. Therefore, payment for these projects or a substantial portion of our fees may be delayed until the successful completion of specified milestones. In addition, the payment of our fees is dependent upon customer acceptance of the completed work and our ability to collect the fees. Further, although the timing of receipt of our fees varies, we incur the majority of our expenses on a current basis. As a result, a delay in the collection of our fees could result in cash flow shortages.
If we are unable to invest in new products and markets or to manage the effects of changes in our offering portfolio, our results will be adversely affected.
We specialize in the development and implementation of sophisticated software modernization and porting tools and products. We leverage our know-how, experience, and generic technologies to develop and introduce new software tools that enable the modernization of legacy systems. The need for our modernization solutions changes over time, and recent regulations or newly introduced technologies may create new needs for modernization solutions. As part of our growth strategy, as new needs evolve, we typically conduct a market analysis to qualify and quantify the market opportunity. If the results justify the investment required for the development of new products or tools, then we begin the development process of the new product. In order to maintain our position in the market, and our ability to address the constantly changing needs of the marketplace, we continually invest in the development of new products.
In order to properly introduce a new product to the marketplace or to introduce our current products into new markets, we continuously update our marketing materials, educate our sales force, and make changes to our operations. If these activities are not completed in a timely or satisfactory manner, or we limit our capital spending on these activities, our new product introduction may be delayed or harmed and our business, financial condition, and results of operations could be materially adversely affected.
Our future results could be adversely affected by an impairment of the value of certain intangible assets.
The assets listed in our consolidated balance sheet include, among other things, goodwill valued at approximately $52 million, capitalized research and development costs valued at approximately $17.6 million and intangible assets related to customers relations valued at approximately $3.0 million. The applicable accounting standards require that:
For example, in 2008 an impairment test was performed and a loss of $13.3 million related to goodwill of our overall IT modernization reporting unit was identified and charged to operations. Our ability to reconcile the gap between our market capitalization and our aggregate fair value depends on various factors, some of which are quantitative, such as an estimated control premium that an investor would be willing to pay for a controlling interest in us, and some of which are qualitative and involve management judgment, including stable relatively high backlog and growing pipe line. If our market capitalization stays below the value of our stockholders equity, or actual results of operations differ materially from our modeling estimates and related assumptions, or if any of our qualitative reconciliation factors changes in the future, we may be required to record additional impairment charges for our goodwill. In 2007, an impairment loss of $7 million related to goodwill in Mainsoft, was identified and charged to loss from discontinued operation. In 2008, we sold our entire holdings in Mainsoft, in which we held a 58% controlling interest. Mainsoft contributed a loss of approximately $8.5 million, charged to loss from discontinued operation in 2008. This decision to sell Mainsoft followed a strategic shift in Mainsofts product development and marketing strategy outside of BluePhoenixs core business focus. If our goodwill or capitalized research and development costs were deemed to be impaired in whole or in part due to our failure to achieve our goals, or if we fail to accurately predict the useful life of the capitalized research and development costs, we could be required to reduce or write off such assets, thus adversely affecting our operating results.
If we are unable to attract, train, and retain qualified personnel for our worldwide facilities at competitive prices, we may not be able to achieve our objectives and our business could be harmed.
In order to achieve our objectives, we hire from time to time additional software, administrative, operational, sales, and technical support personnel. The process of attracting, training, and successfully integrating qualified personnel can be lengthy and expensive. We may not be able to compete effectively for the personnel we need. As part of our growth strategy, we developed offshore centers in Cyprus, Romania and St. Petersburg (Russia). We hired professional consultants for these development centers, leveraging the lower employer costs that existed in these countries. In recent years, professional work in these countries became more expensive and professional fees may continue to increase in the future. The establishment of additional offshore facilities may result in significant capital expenses, which may affect our cash position. We cannot assure you that our offshore facilities will continue to be cost effective. Our future success depends on our ability to absorb and retain senior employees and to attract, motivate, and retain highly qualified professional employees worldwide at competitive prices.
If we fail to estimate accurately the costs of fixed-price contracts, we may incur losses.
We derive a portion of our revenues from engagements on a fixed-price basis. We price these commitments based upon estimates of future costs. We bear the risk of faulty estimates and cost overruns in connection with these commitments. Our failure to accurately estimate the resources required for a fixed-price project, to accurately anticipate potential wage increases, or to complete our contractual obligations in a manner consistent with the project plan could materially adversely affect our business, operating results, and financial condition. In addition, we may agree to a price before the design specifications are finalized, which could result in a fixed price that is too low, resulting in lower margins or losses to us.
If our tools or solutions do not function efficiently, we may incur additional expenses.
In the course of providing our modernization solutions, the project team conducts testing to detect the existence of failures, errors, and bugs. If our modernization solutions fail to function efficiently or if errors or bugs are detected in our tools, we may incur significant expenditures in an attempt to remedy the problem. The consequences of failures, errors, and bugs could have a material adverse effect on our business, operating results, and financial condition.
If we fail to satisfy our customers expectations regarding our solutions, our contracts may be cancelled and we may be the subject of damages claims.
In the event that we fail to satisfy our customers expectations from the results of the implementation of our solutions, or if we fail to timely deliver our solutions to our customers, these customers may suffer damages. When and if this occurs, customers may have the ability to cancel our contracts. Any cancellation of a contract could cause us to suffer damages, since we might not be paid for costs that we incurred in performing services prior to the date of cancellation. In addition, from time to time we may be subject to claims as a result of not delivering our products on time or in a satisfactory manner. Such disputes or others may lead to material damages.
We are exposed to significant claims for damage caused to our customers information systems.
Some of the products, tools, and services we provide involve key aspects of our customers information systems. These systems are frequently critical to our customers operations. As a result, our customers have a greater sensitivity to failures in these systems than do customers of other software products generally. If a customers system fails during or following the provision of modernization solutions or services by us, or if we fail to provide customers with proper support for our modernization solutions, we are exposed to the risk of a claim for substantial damages against us, regardless of our responsibility for the failure. We cannot guarantee that the limitations of liability under our product and service contracts, if any, would be sufficient to protect us against legal claims. We cannot assure you that our insurance coverage will be sufficient to cover one or more large claims, or that the insurer will not disclaim coverage as to any future claim. If we lose one or more large claims against us that exceed available insurance coverage, it may have a material adverse effect on our business, operating results, and financial condition. In addition, the filing of legal claims against us in connection with contract liability may cause us negative publicity and damage to our reputation.
If third parties assert claims of infringement against us, we may suffer substantial costs and diversion of managements attention.
Substantial litigation over intellectual property rights exists in the software industry. Software products may be increasingly subject to third-party infringement claims as the functionality of products in different industry segments overlaps. We cannot predict whether third parties will assert claims of infringement against us. In addition, our employees and contractors have access to software licensed by us from third parties. A breach of the nondisclosure undertakings by any of our employees or contractors may lead to a claim of infringement against us.
Any claim, with or without merit, could be expensive and time-consuming to defend, and would probably divert our managements attention and resources. In addition, such a claim if submitted may require us to enter into royalty or licensing agreements to obtain the right to use a necessary product or component. Such royalty or licensing agreements, if required, may not be available to us on acceptable terms, if at all.
A successful claim of product infringement against us and our failure or inability to license the infringed or similar technology could have a material adverse effect on our business, financial condition, and results of operations.
We may experience greater than expected competition that could have a negative effect on our business.
We operate in a highly competitive market. Competition in the modernization field is, to a large extent, based upon the functionality of the available automated tools and personnel expertise. Our competitors may be in a better position to devote significant funds and resources to the development, promotion and sale of their modernization tools and services, thus enabling them to respond more quickly to emerging opportunities and changes in technology or customer requirements. Current and potential competitors have established or may establish cooperative relationships among themselves or with third parties to increase such competitors ability to successfully market their tools and services. We also expect that competition will increase as a result of consolidation within the industry. As we develop new tools and services, we may begin to compete with companies with which we have not previously competed. Our competitors include small vendors who may provide a single solution for a particular area of modernization, large system integrators such as IBM, HP, SUN, Accenture, Cap Gemini and EDS, some of whom we also partner with, software houses such as Micro Focus and Metaware, and Indian system integrators such as Tata, WIPRO, Infosys and Patni.
We may be unable to differentiate our tools and services from those of our competitors or successfully develop and introduce new tools and services that are less costly than, or superior to, those of our competitors. This could have a material adverse effect on our ability to compete.
Many of our existing and potential competitors may have or acquire more extensive development, marketing, distribution, financial, technological and personnel resources than we do. This increased competition may result in our loss of market share and pricing pressure which may have a material adverse effect on our business, financial condition and results of operations. We cannot assure you that competition with both competitors within our industry and with the in-house IT departments of certain of our customers or prospective customers will not result in price reductions for our tools and services, fewer customer orders, deferred payment terms, reduced revenues or loss of market share, any of which could materially adversely affect our business, financial condition, and results of operations.
We may be unable to adequately protect our proprietary rights, which may limit our ability to compete effectively.
Our success and ability to compete are substantially dependent upon our internally developed technology. Our intellectual property consists of proprietary or confidential information that is not subject to patent or similar protection. Our employees and contractors have direct access to our technology. In general, we have relied on a combination of technical leadership, trade secret, copyright and trademark law, and nondisclosure agreements to protect our proprietary know-how. Unauthorized third parties may attempt to copy or obtain and use the technology protected by those rights. Any infringement of our intellectual property could have a material adverse effect on our business, financial condition, and results of operations. Policing unauthorized use of our products is difficult and costly, particularly in countries where the laws may not protect our proprietary rights as fully as in the United States.
Pursuant to agreements with certain of our customers, we have placed, and in the future may be required to place, in escrow, the source code of certain of our software. Pursuant to the escrow arrangements, the software may, under specified circumstances, be made available to our customers. From time to time, we also provide our software directly to customers. These factors may increase the likelihood of misappropriation or other misuse of our software.
We are exposed to litigation that could result in considerable financial liabilities.
In July 2003, a former Liraz shareholder filed an application with the Tel-Aviv-Jaffa District Court to approve a claim filed by him against us, as a class action. The claim relates to the acquisition of Liraz shares, which we completed in March 2003. The shareholder alleges that the share price we paid to Lirazs shareholders in the tender offer and in a subsequent mandatory purchase was lower than the fair price of Liraz shares. The maximum amount of the claim is approximately NIS 35 million ($8.7 million) in the aggregate. Under Israeli law, the courts approval is required for the plaintiff to represent all of the shareholders of Liraz who sold their shares to us pursuant to the tender offer and the mandatory acquisition. The plaintiff has applied for such approval in the lawsuit. If we are not successful in defending this claim, we could be exposed to considerable financial liabilities and, as a result, our financial condition could be materially adversely harmed.
In January 2008, we entered into an agreement for the purchase of the entire outstanding share capital of TIS Consultants Ltd., or TIS, a company incorporated in Cyprus, that wholly owns a subsidiary incorporated in India. We are in a dispute with TIS regarding the earn-out calculation and therefore, we notified TIS selling shareholders that we are not going to pay them the down payment for the year 2008, due in February 2009. Following such notice, the selling shareholders notified us of their intent to submit a claim against us for such payment. Our maximum unrecognized liability in that regard might be up to $5 million. If we are not successful in defending our calculation in a potential claim, we could be exposed to considerable financial liabilities and, as a result, our financial condition could be harmed.
Our existing credit facilities contain a number of restrictions and obligations that limit our operating and financial flexibility, and there is no assurance that credit facilities will be available in the future.
As of March27, 2009, we had an aggregate of $16 million of outstanding loans under our credit facilities. Our credit facilities contain a number of restrictive covenants that limit our operating and financial flexibility. These covenants restrict, among other things, our ability to pledge our assets, dispose of assets, make loans or give guarantees, make certain acquisitions, and engage in mergers or consolidations. Our credit facilities also contain covenants regarding maintaining certain financial ratios. Our ability to continue to comply with these and other obligations depends in part on the future performance of our business. There can be no assurance that such obligations will not materially adversely affect our ability to finance our future operations or the manner in which we operate our business. In particular, any noncompliance with performance-related covenants and other undertakings of our credit facilities could result in an acceleration of our outstanding debt under our credit facilities and restrict our ability to obtain additional funds, which could have a material adverse effect on our business, financial condition, and results of operations. In addition, there is no assurance that banks will continue to provide us with credit facilities in the future.
Risks Relating to International Operations
Marketing our tools and solutions in international markets may cause increased expenses and greater exposure to risks that we may not be able to successfully address.
We intend to continue to expand our international operations, which will require significant management attention and financial resources. In order to continue to expand worldwide sales, we need to establish additional marketing and sales operations, hire additional personnel, and recruit additional resellers internationally. To the extent that we are unable to do so effectively, our growth is likely to be limited and our business, operating results, and financial condition will be materially adversely affected.
Risks inherent in our worldwide business activities generally include:
We cannot assure you that these factors will not have a material adverse effect on our future international sales and, consequently, on our business, operating results, and financial condition.
Inflation, devaluation, and fluctuation of various currencies may adversely affect our results of operations, liabilities, and assets.
We run our operations in various countries. As a result, we enter into transactions with customers and suppliers in local currencies. The reporting currency of our consolidated financial statements and the functional currency of our business is the U.S. dollar. The fluctuations in foreign currency exchange rates in countries where we operate can adversely affect the reflection of these activities in our consolidated financial statements. Fluctuations in the value of our non-dollar revenues, costs, and expenses measured in dollars could materially affect our results of operations. In addition, our balance sheet reflects non-dollar denominated assets and liabilities, which can be adversely affected by fluctuations in the currency exchange rates.
We enter, from time to time, into forward currency exchange contracts or other arrangements in order to hedge this foreign currency exposure. Such arrangements may not always be effective or sufficient to offset the fluctuations in currency exchange rates. For additional information relating to the exchange rates between different relevant currencies, see Item 5.A. Operating ResultsOur Reporting Currency.
Fluctuations in foreign currency values affect the prices of our products and services, which in turn may affect our business and results of operations.
Most of our worldwide sales are currently denominated in U.S. dollars, British Pounds, Danish Krones and euros while our reporting currency is the dollar. A decrease in the value of the dollar relative to these foreign currencies would make our products more expensive and increase our operating costs and, therefore, could adversely affect our results and harm our competitive position in the markets in which we compete.
We are subject to multiple taxing jurisdictions. If we fail to estimate accurately the amount of income tax due in any of these jurisdictions, our net income might be affected.
We operate within multiple taxing jurisdictions and are subject to taxation by these jurisdictions at various tax rates. In addition, we may be subject to audits in these jurisdictions. These audits can involve complex issues, which may require an extended period of time to resolve. We cannot assure you that the final tax outcome of these issues will not be different from management estimates, which are reflected in our income tax provisions. Such differences could have a material effect on our income tax provision and net income in the period in which such outcome occurs.
Risks Relating to Operations in Israel
Political, economic, and military conditions in Israel could negatively impact our business.
Over the past several decades, a number of armed conflicts have occurred between Israel and its Arab neighbors. A state of hostility, varying in degree and intensity has led to security and economic problems for Israel. Since 2000, there have been ongoing hostilities between Israel and the Palestinians, which have adversely affected the peace process and at times have negatively influenced Israels economy as well as its relationship with several other countries. In 2006, Israel experienced a war with Hezbollah militants in Lebanon. Hamas, an Islamist movement responsible for many attacks, including missile strikes, against Israelis, won the majority of the seats in the Parliament of the Palestinian Authority in 2006 and took control of the entire Gaza Strip by force in 2007. In January 2009, Israel engaged in a military action against Hamas in Gaza to prevent continued rocket attacks against Israel. These developments have further strained relations between Israel and the Palestinians. The current political situation between Israel and its neighbors may not improve. These political, economic and military conditions in Israel could have a material adverse effect on our business, financial condition, results of operations and future growth. In addition, nonexempt male adult citizens of Israel, including some of our officers and employees, are obligated to perform military reserve duty until the age of 40 or 45 depending on their function in the army, and are subject to being called for active duty under emergency circumstances. We cannot predict the full impact of such conditions on us in the future, particularly if emergency circumstances occur. If many of our employees are called for active duty, our operations in Israel and our business may be adversely affected.
Political relations could limit our ability to sell or buy internationally.
We could be adversely affected by the interruption or reduction of trade between Israel and its trading partners. Some countries, companies and organizations continue to participate in a boycott of Israeli firms and others doing business with Israel or with Israeli companies. Also, over the past several years there have been calls in Europe and elsewhere to reduce trade with Israel. There can be no assurance that restrictive laws, policies or practices directed towards Israel or Israeli businesses will not have an adverse impact on our business.
It may be difficult to serve process and enforce judgments against our directors and executive officers in Israel.
We are organized under the laws of the State of Israel. Most of our executive officers and directors are nonresidents of the United States, and a substantial portion of our assets and the assets of these persons are located outside the United States. Therefore, it may be difficult to:
Risks Relating to Our Traded Securities
The market price of our ordinary shares may be extremely volatile and our investors may not be able to resell the shares at or above the price they paid, or at all.
During the past few years, the worldwide stock markets have experienced significant price and volume fluctuations. The market prices of securities of technology companies have been extremely volatile, and have experienced fluctuations that have often been unrelated or disproportionate to the operating performance of those companies. These broad market fluctuations could adversely affect market price of our ordinary shares. The high and low market prices of our ordinary shares traded on the NASDAQ Global Market and the Tel Aviv Stock Exchange, or TASE, during each of the last three years, are summarized in the table below:
Between January and December 2008, the market price of our ordinary shares dropped from $20.66 to $1.40. As of March 27, 2009, the market price of our ordinary shares was $1.98. We cannot assure you that the market price of our ordinary shares will rise to similar levels as it was in the past. The market price of our ordinary shares may continue to fluctuate substantially due to a variety of factors, including:
In addition, global and local economic, political and market conditions, and military conflicts and, in particular, those specifically related to the State of Israel, may affect the market price of our shares.
Our ordinary shares are traded on more than one market and this may result in price variations.
Our ordinary shares trade on the NASDAQ Global Market and the TASE. Trading in our ordinary shares on these markets will take place in different currencies (dollars on the NASDAQ Global Market and NIS on the TASE), and at different times (resulting from different time zones, different trading days, and different public holidays in the United States and Israel). The trading prices of our ordinary shares on these two markets may differ due to these and other factors. Any decrease in the trading price of our ordinary shares on one of these markets could cause a decrease in the trading price of our ordinary shares on the other market.
Future sales of our shares to be registered for resale in the public market could dilute the ownership interest of our existing shareholders and could cause the market price for our ordinary shares to fall.
As of March 27, 2009, we had 20,835,758 ordinary shares outstanding (excluding 2,326,246 ordinary shares held by BluePhoenix). In addition, we reserved 531,015 ordinary shares for issuance under our option plan and restricted share units award plan. We also have the following commitments to issue our ordinary shares:
We registered for resale the shares underlying the warrants issued to the institutional investors in March 2004, March 2006 and November 2007, pursuant to registration rights agreements entered into with such investors. For more information, see Item 4.B - Business Overview Investments and Acquisitions and Item 5.B - Liquidity and Capital Resources Contractual Commitments and Guarantees.
The exercise of options by our employees and the exercise of warrants by investors would dilute the ownership interests of our existing shareholders. Any sales in the public market of our ordinary shares issuable upon exercise of options or warrants could adversely affect the market price of our ordinary shares. If a large number of our ordinary shares are sold in a short period, the price of our ordinary shares would likely decrease.
Our U.S. investors could suffer adverse tax consequences if we are characterized as a passive foreign investment company.
Although we believe that we were not a passive foreign investment company, or PFIC, in 2008, we cannot assure you that the United States Internal Revenue Service will agree with our position. We would be a PFIC if (i) 75% or more of our gross income in a taxable year (including our pro rata share of the gross income of any company treated as a corporation for U.S. federal income tax purposes in which we are considered to own directly or indirectly 25% or more of the shares by value) is passive income, or (ii) the value of our assets averaged quarterly over our the taxable year (including our pro rata share of the assets of any company treated as a corporation for U.S. federal income tax purposes in which we are considered to own directly or indirectly 25% or more of the shares by value) that produce, or are held for the production of, passive income is at least 50%. Passive income includes interest, dividends, royalties, rents and annuities. If we are or become a PFIC, our U.S. investors could suffer adverse tax consequences, including being taxed at ordinary income tax rates and being subject to an interest charge on gain from the sale or other disposition of our ordinary shares and on certain excess distributions with respect to our ordinary shares. For additional information regarding our PFIC status, see the discussion under Item 10.E. Taxation United States Federal Income Tax Considerations Tax Consequences If We Are a Passive Foreign Investment Company.
As a foreign private issuer whose shares will be listed on The NASDAQ Global Market, we may follow certain home country corporate governance practices instead of certain listing requirements, which may not afford shareholders with the same protections that shareholders of domestic companies have.
As a foreign private issuer whose ordinary shares are listed on The NASDAQ Global Market, we are permitted to follow certain home country corporate governance practices instead of certain requirements of The NASDAQ Global Market. A foreign private issuer that elects to follow a home country practice instead of such requirements must submit to The NASDAQ Global Market in advance a written statement from an independent counsel in such issuers home country certifying that the issuers practices are not prohibited by the home countrys laws. In addition, a foreign private issuer must disclose in its annual reports filed with the SEC each such requirement that it does not follow and describe the home country practice followed by the issuer instead of any such requirement. We follow home country practice with regard to distribution of annual reports to shareholders, meetings of independent directors in which only independent directors participate, approval of share compensation plans and changes in such plans.
We were incorporated in Israel in 1987 under the name A. Crystal Solutions Ltd. In 1996, we changed our name to Crystal Systems Solutions Ltd. In 2003, following the acquisition of Liraz Systems Ltd., we changed our name to BluePhoenix Solutions Ltd. Our registered office is located at 8 Maskit Street, Herzliya, 46733 Israel and our telephone number is 972-9-9526110. Our agent in the United States is Blue Phoenix Solutions USA Inc., 8000 Regency Parkway, Cary, NC 27511 United States and its telephone number is (919) 380-5100.
We develop and market unique value driven enterprise legacy IT modernization solutions that enable companies to automate the process of modernizing and upgrading their mainframe and distributed IT infrastructure in order to more effectively compete in todays business environment. The combination of our comprehensive tools and services with our unique methodology provides an efficient and cost-effective process for extending the return on investment of existing enterprise IT assets. Our complete modernization solutions consist of a combination of automated technologies and services that minimize the risk through the whole life cycle of the modernization process. Our solutions are based on technologies that support the four phases of the process, which we call: Understanding, Migration, Remediation, and Redevelopment. The solutions allow companies to fully leverage their current systems and applications, speed up and reduce the cost of the renewal process, and effectively update their systems in order to be more agile when having to adapt to new business demands. In addition, by using our technologies our customers gain the added value of extending their systems to be ready for future demands, such as Service Oriented Architecture, or SOA. Our modernization solutions are offered to customers in all business market sectors, particularly financial services, automotive and governmental entities. In addition, we provide consulting services such as application development services and maintenance for core banking systems.
Our solution portfolio includes software products, software tools, and services that address the most pressing IT challenges which organizations and companies face today, including:
Our solutions enable companies to:
Our comprehensive enterprise technologies span mainframe, midrange, and client/server computing platforms. We have enhanced our expertise through the successful completion of projects for many large organizations over the past two decades, establishing our credibility and achieving international recognition and presence. Based on our technology and that of our affiliates, we develop and market software products, tools, and related methodologies. We deliver our tools and methodologies together with training and support in order to provide enterprises with comprehensive solutions, primarily for the modernization of existing IT systems.
Companies initiate IT modernization projects for a wide range of reasons, such as:
Alternatives to modernization include, among others, renewing legacy systems, buying packaged software, or rebuilding entire applications. Enterprise IT modernization has proven to be the most efficient and lowest risk path for companies looking to protect their existing investments. We provide a range of solutions designed to efficiently address the challenge of retaining the business knowledge built into the application code while updating the system to reflect new requirements.
The enterprise legacy IT modernization market is divided into the following categories:
Enterprise IT UnderstandingThese solutions enable companies to make informed strategic decisions regarding the future of their IT systems by automatically capturing multiple levels of operational and development information into a consolidated metadata warehouse. Our tools facilitate global assessments and impact analyses of application assets, thus helping reduce costs, streamline working processes, and increase efficiency.
Enterprise IT MigrationThese solutions enable companies to consolidate and eliminate a wide range of legacy hardware and software through automated migration of applications, databases, platforms, programming languages, and data. These tools help to reduce costs and resources, and minimize reliance on proprietary technology, sunset products, and dwindling skill sets. Our SOA-ready solution is provided as a post-migration service, allowing customers to extend their development environment by providing access to mainframe systems through Web services protocols, making legacy systems appear as modern systems.
Enterprise IT RemediationThese solutions enable companies to extend the life of their existing IT systems by quickly adapting to new regulatory changes and business requirements. These automated tools can be easily customized to fit any IT environment and corporate need, including data field adjustment, IT standardization, and system consolidation.
Enterprise IT RedevelopmentThese solutions enable companies to mine existing applications by extracting business rules, data flows, and data models, and then re-using the proven code base to create more flexible Java/Web-based applications. Our tools help to reduce maintenance costs and resources and application development time-to-market.
Enterprise IT Understanding
In the current lean budgetary environment, companies that want to extend the return on investment of their existing systems need to modernize their legacy systems. Since modernization projects are intricate and complex, the essential first step is a thorough review of existing IT assets.
Our understanding solutions provide automated, detailed mapping of system-wide IT activity and the interconnections between all software components. This detailed road map serves as the basis for optimizing the re-use of existing IT systems, tailoring the modernization plan for the companys unique IT environment and corporate requirements, and reducing future ongoing maintenance costs.
Modernization initiatives that need to be based on an in-depth examination of actual system elements include:
Our integrated set of enterprise IT understanding solutions are designed to assist companies in achieving these goals by accurately mapping raw IT operational and development data, down to the program code level, into a consolidated enterprise-wide warehouse. The gathered information enables companies to keep track of system inventories, resources, and inter-relationships and to intelligently mine systems and application metadata.
This enterprise-wide view can then be used for a variety of strategic purposes, including:
Our migration solutions provide numerous advantages, including:
BluePhoenix Rehosting Organizations implement mainframe rehosting in order to reduce the ongoing costs of existing legacy CICS and batch applications. Rehosting leverages the strength and investment of older COBOL applications while taking advantage of new, cost-efficient hardware and open operating system environments such as Linux, Unix, Windows, J2EE, and .NET.
Using our various automated migration tools, and through cooperation with our partners, we offer COBOL and RPG migrations, System i and mainframe rehosting solutions. We formed the following alliances for providing these solutions:
BluePhoenix LanguageMigrator An automated migration tool for converting COBOL and 4GLs (fourth generation languages) such as ADSO, Natural, CA Gen (formerly COOL: Gen), and PowerBuilder to COBOL and Java/J2EE. This reliable, time-efficient, and comprehensive solution enables site-wide installation, simultaneous testing, and implementation of batch programs. In addition, LanguageMigrator identifies the compatibility of the code, converts it to the new standards required by customers, and analyzes converted programs to identify potential problems. For more information about future developments of this tool, see Research and Development.
BluePhoenix DataMigratorA Windows-based tool for migrating data between various data system environments. Coupled with a step-by-step proven methodology, the tool provides a fully structured but still versatile automated data migration process. DataMigrator enables full control of source and target data definitions resulting in consistent, accurate, highest quality target data with no data loss, and efficient utilization of available resources. In addition, it provides support for partial or incremental migration and for multiple runtime environments.
BluePhoenix SOA-Ready Enablement This post-migration service extends the useful life of valuable legacy applications that run on historic mainframe platforms by allowing them to be easily reused in a modern Web-centric environment. This comprehensive solution provides Web services and Web customers for legacy applications. This unique set of tools enables the exposure of a legacy application to more modern applications written in Java or .NET by providing a Web service interface for the legacy system. Our tools also provide a Web-based display for legacy (3270) applications. These tools are noninvasive and allow the legacy application to remain untouched.
Enterprise IT Remediation
Our integrated set of enterprise IT remediation solutions enable companies to extend the life of their existing IT systems when facing ongoing regulatory changes and new business requirements. Our remediation solutions address a variety of corporate needs and include:
BluePhoenix FieldEnabler New business decisions or regulatory requirements often require companies to make changes that impact a wide range of system components. These include field adjustments that involve changes in the type, length, and structure of a database or program field, such as expanding a dealer code. FieldEnabler is a rule-based tool that enables a step-by-step, comprehensive process for making these kinds of modifications across an enterprise in a reliable and time-efficient manner.
BluePhoenix StandardsEnablerA highly automated solution for reliably facilitating system consolidation into a single set of naming standards. Since all resources being converted must be changed in parallel, the large task of manually standardizing the naming of system components is not practical. Our tool provides an automated solution addressing this problem.
Enterprise IT Redevelopment
Enterprise IT environments are complex, and can prevent companies from quickly and easily adapting to new business needs and requirements. The more companies can organize and understand their applications, the faster they can adapt to inevitable changes. While organizations are mostly satisfied with the existing business functionality of their applications, they usually want to improve their business processes and leverage technologies such as Web-enabled and service-oriented architectures. Additionally, they are eager to find a way to decrease their maintenance costs, which typically consume 70%80% of total IT spending.
Our enterprise IT redevelopment suite enables companies to efficiently mine, reuse, and rewrite their existing applications, thus incrementally redeveloping their legacy systems, extending them into new technologies, and saving on development and programmer costs, and includes:
BluePhoenix AppBuilderOur primary redevelopment legacy environment has been used for managing, maintaining, and reusing the complicated applications needed by large businesses. It provides the infrastructure for enterprises worldwide, across several industries, with applications running millions of transactions daily on legacy systems. Enterprises using AppBuilder can build, deploy, and maintain large-scale custom-built business applications for years without being dependent on any particular technology until they cease using their legacy infrastructure.
AppBuilder acts like a virtual application warehouse, keeping the underlying structure of the system in an organized framework such that developers can easily understand it. This allows companies to reuse critical business components, realizing a long-term return on investment for both new and existing applications.
BluePhoenix Redevelopment Based on AppBuilder and LogicMiner, Redevelopment transforms legacy COBOL programs into service oriented applications deployed on the latest platforms. The resulting application conforms to industry standards and is written in clean, maintainable source code. This conformance to standard architectures, such as full object-orientation and Web services, is a key differentiator in the Redevelopment approach when compared to more common migrations. Instead of using the common approach where each line of COBOL source code is translated to one or more statements in the target language (known as 1-1 approach), Redevelopment uses a model based approach. Redevelopment develops a platform independent model from platform specific models of legacy COBOL applications identified by BluePhoenix LogicMiner. This platform independent model may then be extended to meet new business requirements. Finally the application is generated in J2EE, .NET, or COBOL.
System i (previously known as AS/400 or iSeries) Family of Products
We develop and market a separate but complementary family of products that provides similar solutions for System i (previously known as AS/400) applications. The products described hereunder cover the areas of understanding, migration and redevelopment.
ASNA Monarch This product is used for understanding and migration of System i applications. It transforms applications originally written in RPG/400 into native and fully compliant Microsoft.NET®. It can also migrate the originating database to SQL Server, thus providing for a full re-platforming solution. ASNA Monarch reuses the original source code, which persists in a familiar syntax, allowing the existing development teams to maintain it.
ASNA Visual RPG® (AVR) is a modern implementation of RPG that enables RPG developers to easily build Web and Windows applications. AVR provides direct, secure and fast access to both files and program objects on IBMs System i server. Using a familiar, but modernized syntax, RPG programmers can quickly apply their long-standing RPG experience to create modern applications that connect seamlessly to the System i platform.
AVR for .NET provides similar functionalities under Microsofts .NET framework. It enables modernizing existing RPG applications, develop Web services, and extend System i applications to .NET and the inherent support in service oriented architecture while continuing to program with a familiar, RPG-like syntax. AVR for .NET is the only development solution available for Microsofts .NET that specifically supports high performance access to the System i database.
ASNA DataGate® ASNA DataGate provides fast and secure System i database access. Applications written to access the System i through DataGate can later be connected to SQL Server without modification. A single application may connect to both platforms concurrently, or an application may switch, automatically, from one platform to the other in the case of a failover situation.
ASNA Visual RPG® and ASNA DataGate® are used for migration and redevelopment solutions.
Investments and Acquisitions
In order to enhance our solutions and services portfolio, we have been pursuing a strategy of adding new technologies to our suite of automated modernization tools. We implement this strategy via internal development of new software tools and through acquisitions and investments. Accordingly, we devote significant resources to the development and marketing of new software modernization tools, and invest in businesses that develop software tools that are complementary to our existing portfolio. The broad portfolio that we established, among others, through these acquisitions, contributes to our ability to penetrate new markets and to offer a complete set of solutions addressing the broad array of changing demands of our customers. We integrate the acquired businesses into our business and assimilate many of their functions, including, marketing, sales, finance and administration into our existing infrastructure. For more information about our capital expenditures, see Item 5.B. Liquidity and Capital Resources- How We Have Financed Our Business-Capital expenditures.
Following is a description of our investments and acquisitions, which form a part of our business as described above:
TIS Consultants Ltd. In January 2008, we entered into an agreement for the purchase of the entire outstanding share capital of TIS Consultants Ltd., or TIS, a company incorporated in Cyprus, that wholly owns a subsidiary incorporated in India, TISA Software Consultants Private Limited. TIS provides consulting services, solutions and value added products to the banking industry, specializing in the market for Temenos GLOBUS/T24. TIS acquisition expands our product offerings and services.
Under the agreement, we paid to the selling shareholders an amount of $500,000 and an additional amount of $700,000 as a nonrefundable advance payment on account of contingent consideration described below. As part of the transaction, we undertook to pay the selling shareholders contingent consideration equal to 5.5 times of the average operating profit of TIS in 2008, 2009 and 2010 but not less than the maximum operating profit in a certain year during this period . We undertook to pay nonrefundable down payments in February 2009, February 2010 and February 2011, in each case based on the operating profit in previous years. Furthermore, we undertook to pay additional incremental consideration based on the growth in TIS revenues in each of 2008, 2009 and 2010 in an amount of up to 35% of the revenue growth in each of these years compared to the previous year. We are in a dispute with TIS regarding the earn-out calculation and therefore, we did not pay the down payment for 2008, due in February 2009. The selling shareholders notified us of their intent to submit a claim against us for such payment. Our maximum unrecognized liability in that regard approximates $5 million.
JLC Russia. In May 2008, in order to expand our off-shore center in Russia, we purchased the activity of an offshore professional outsourcing center in Nitzni (Russia), for total consideration of $1.18 million. Under the terms of the transaction, we agreed to pay to the selling shareholders of JLC Group Inc., or JLC, additional consideration if certain criteria are met, based on the revenue growth of JLCs activity in 2008 and 2009. Accordingly, during the period from May 1, 2008 to December 31, 2008, additional consideration of $406,000 was accrued and will be paid in April 2009.
ASNA. In August 2007, we entered into an agreement to purchase the entire outstanding share capital of Amalgamated Software North America Inc. (ASNA), a private company based in San Antonio, Texas, for total consideration of $7 million. Under the terms of the transaction, we agreed to pay to the selling shareholders additional consideration if certain criteria are met, based on ASNAs earnings before interest and taxes for 2007. Those criteria have not been met and no additional consideration was paid. In addition, we shall be required to pay to the selling shareholders an additional amount, calculated incrementally, based on a multiplier of between 6.5 times to 8 times of ASNAs average net profit in 2008 and 2009, if the average annual net profit exceeds a certain level.
ASNAs product, Monarch, is a fully integrated solution for transforming RPG applications to the Microsoft.NET® platform. ASNA is a Microsoft Gold Certified Partner, a Microsoft Visual Studio Industry Partner, an IBM Tools Network Partner, and an Advanced Tier Member of IBMs PartnerWorld.
BridgeQuest. Effective April 2007, we entered into an agreement to purchase the entire outstanding share capital of BridgeQuest Inc., a North Carolina corporation that manages and operates, through a wholly owned subsidiary, a professional outsourcing center in St. Petersburg, Through this alternative large off shore, center the Company will offer services at a low cost. The consideration amounted to $2 million. Under the terms of the transaction, as amended by the parties in January 2008, we granted to the selling shareholders warrants to purchase 200,000 BluePhoenix ordinary shares valued at $2.5 million based on B&S pricing model on the commitment date upon reaching the relevant milestone. These warrants were exercised in 2008 and paid the selling shareholders an additional consideration of $1.8 million, computed based on BridgeQuest revenues and earnings before interest and taxes, during the period from April 1, 2007 to December 31, 2007. On December 31, 2008, we signed an amendment to the agreement, pursuant to which we committed to pay the selling shareholders an amount of $1,620,000 as final consideration in connection with the transaction payable as follows: $750,000 on January 31, 2009 which has already been paid; $310,000 on October 1, 2009; and $560,000 on February 15, 2010.
CodeStream Software Ltd . In December 2006, we acquired from a company incorporated in the United Kingdom, CodeStream Software Ltd., certain business activities in the field of modernization of legacy databases, particularly IDMS and other mainframe platforms. Pursuant to the purchase agreement, we hired 18 persons previously employed by CodeStream and assumed all the obligations in respect of the purchased activities. In consideration thereof, we paid to CodeStream $10.2 million. Pursuant to the purchase agreement, as amended in December 2007, an amount of $2.1 million was paid in 2008. In addition, as a contingent consideration for the purchased activity, we issued to the selling shareholders 400,000 BluePhoenix ordinary shares in April 2008, and undertook to pay an additional amount of $2.5 million. This amount will be paid in April 2009.
BluePhoenix Technologies Ltd. (previously known as Intercomp Ltd.). In 1998, we initially invested in BluePhoenix Technologies, which developed a set of automated analysis and reengineering tools for legacy COBOL applications. Following a series of subsequent transactions, pursuant to which we issued to certain shareholders of BluePhoenix Technologies 100,719 of BluePhoenix ordinary shares in the first quarter of 2007, we now wholly own BluePhoenix Technologies. In the first quarter of 2006, First Israel Mezzanine Investors Ltd., FIMI, a creditor of Intercomp, completed the exercise of a put option to sell us convertible promissory notes issued by Intercomp, in an aggregate principal amount of $3.5 million. The put option was originally granted to FIMI in January 2001. As consideration therefor, we paid to FIMI, in 2006, an aggregate amount of $4.48 million including interest accrued, which equals the book value of the promissory notes, and issued to FIMI warrants to purchase 210,000 BluePhoenix ordinary shares at an exercise price of $4.00 per share. No gain or loss was recorded at the repayment date. In the first quarter of 2007, FIMI exercised the warrants for a total exercise price of $840,000.
I-Ter/Informatica & Territorio S.p.A. In the second quarter of 2005, we entered into an agreement to purchase the entire outstanding share capital of I-Ter/Informatica & Territorio S.p.A., referred to as I-Ter. Pursuant to the purchase agreement, we paid to the selling shareholders of I-Ter $1.4 million. In addition, under the terms of the agreement, we agreed to pay the selling shareholders additional contingent consideration based on I-Ters average earnings before interest and taxes, for the years 2005 through 2007. The total contingent consideration for these years amounted to $6.9 million and was recorded as goodwill. Our outstanding liability in this regard as of December 31, 2008 was $1.8 million due in two installments to be paid in the first half of 2009.
Outlook. Effective as of January 2004, we acquired from an Israeli company, Outlook Systems Ltd. its entire business activities in Israel in the field of research and development services. The purchase was made through our wholly owned subsidiary, Outlook & BluePhoenix Ltd. Under the purchase agreement, as amended in 2006, we paid to Outlook Systems an aggregate amount of approximately $1.3 million. In accordance with the amendment to the purchase agreement, Outlook Systems received, in 2006, 138,591 of BluePhoenix ordinary shares. Additional consideration in the amount of $174,000 was due and paid in 2007. In addition, under the terms of the agreement, we agreed to pay the selling shareholders an additional contingent consideration based on Outlook & BluePhoenix Ltd.s earnings before interest and taxes for the three years commencing on July 1, 2005. The accrued contingent consideration for these years amounted to $20,000.
Zulu Software Inc. In February 2005, we purchased 8% of the outstanding share capital of Zulu Software Inc., or Zulu, for an aggregate of $350,000. In January 2006, we purchased from the other shareholders of Zulu additional shares increasing our holdings to 72% of Zulus outstanding share capital. The aggregate consideration paid for this additional purchase was $2.4 million. The consideration for the acquisition was attributed to net assets on the basis of fair value of assets acquired and liabilities assumed. Based upon a purchase price allocation, the purchase price was allocated to the purchased technology in the amount of $3.5 million, and is amortized over a 5-year period. For more information about Zulus software solutions, see Enterprise IT MigrationBluePhoenix LanguageMigrator.
Cicero Inc. (formerly Level 8 Systems Inc.). Pursuant to an agreement signed in October 2007 with Cicero, we repaid $1.7 million on behalf of Cicero to cover a portion of Ciceros credit facility at Bank HaPoalim. In connection therewith, the bank released a $2.0 million bank guarantee previously provided by us to the bank to secure Ciceros bank loans. Accordingly, on the repayment date, an amount of $300,000 was charged to earnings. As consideration therefor, Cicero issued to us 2,546,149 ordinary shares of Cicero and a $1.0 million senior promissory note, bearing an annual interest rate of LIBOR + 1% (or in the event of any unpaid interest, LIBOR + 4%) payable in two installments, the first installment of $350,000 was paid in 2008, and the second installment of $671,000 was to be paid on December 31, 2011. As of December 31, 2008, we hold 2,801,997 ordinary shares of Cicero which are classified as available-for-sale marketable securities. Ciceros shares were registered for trading in March 2009. Due to the delay in registration, Cicero is obligated to issue to us an additional 120,000 ordinary shares of Cicero as compensation for the delay.
In January 2008, our board of directors announced our intent to sell our entire holdings in Mainsoft, in which we held a 58% controlling interest. This decision followed a strategic shift in Mainsofts product development and marketing strategy outside of BluePhoenixs core business focus. In October 2008 we sold our stake in Mainsoft for consideration of $1.7 million. Mainsoft met the definition of a component under SFAS 144. Accordingly the results of operation of Mainsoft as discontinued operation in the statement of operations and prior periods results have been reclassified accordingly. In addition, comparative data of the asset and liabilities attributed to the discontinued operation have been reclassified in the balance sheet.
We provide our modernization solutions directly or through our strategic partners, such as IBM, Electronic Data System Ltd. (EDS), NCS Pte Ltd., Mann India, and Sun Micro Systems. Additionally, from time to time, other IT services companies license our technologies for use in modernization projects in various markets. Our partners include system integrators, as well as other software vendors such as Oracle and Microsoft, who assist us in increasing our penetration and exposure in the market. We provide solutions to our partners customers in collaboration with the system integrators team. In most cases, the partners provide related services to the customers. Our arrangements with our partners vary. We may enter into distribution agreements under which we grant license rights to our partners or to the partners customers or provide related services, or a combination of both. Alternatively, we may enter into subcontractor relationships with our strategic partners.
Some of our agreements are fixed price contracts. These projects bear some risks and uncertainties as we price these contracts based on estimates of future costs, duration of the project, and the impact of potential changes in the scope of the work. We also enter into other types of contracts, including annual maintenance contracts, license agreements, and arrangements on a time and materials basis.
Our customer, the Capita Group Plc, accounted for 10% of our revenues in 2008. SDC Udvikling A/S accounted for 12% and 11% of our revenues in 2007 and 2006, respectively and EDS accounted for 11% in 2007.
The following table summarizes the revenues from our tools and services by geographic regions based on the location of the end customer for the periods indicated:
Research and Development
In order to maintain our position as a market leader in the IT modernization market, we are focusing our development efforts on further enhancements to current solutions, as well as addressing newly emerging aspects of the modernization market. We are planning additional research and development activities to extend our modernization solutions by leveraging our technological skills to create added value for our customers and to generate additional business opportunities.
Research and development expenses totaled $18.4 million, $12.7 million and $8.6 million for the years ended December 31, 2008, 2007, and 2006, respectively.
Enterprise IT Understanding
BluePhoenix IT Discovery By further refining our existing understanding technology and combining it with the additional technology licensed from Merrill Lynch, IT Discovery provides the basis for legacy understanding needed by the rest of our modernization solutions.
Enterprise IT Automated Migration
Fourth Generation Language MigrationIn the area of automated migration, we continue to build on our 4GL migration solutions. Our assets in the migration area cover COOL:Gen, ADSO/IDMS, Natural and PowerBuilder transformations. We continue to extend the support target platform of these transformations to include J2EE and .NET platforms.
Enterprise IT SOA Ready SolutionA comprehensive solution that provides Web services or clients for a legacy application. Our unique suite of tools enables a legacy application to be exposed to more modern applications written in Java or .NET by providing a web service interface for the legacy system. In addition, our tools are able to provide a web based appearance/connectivity/interface legacy applications. This solution is not intrusive and allows the legacy application to remain untouched.
BluePhoenix LogicMinerA comprehensive solution for recovery that mines COBOL and extracts business rules from the legacy code, thus providing IT departments with the ability to begin a modernization process based on techniques that preserve the functionality of a legacy code. This tool retains past investments in software assets by producing reusable code objects or descriptive data that can later be used for improving the quality of the legacy code, rewriting the legacy application, or building a full modernization plan. LogicMiner increases a systems manageability, while eliminating rules that no longer apply to current business procedures.
BluePhoenix Refactoring RepositoryA repository that supports the storage and management of the abstract models and code of applications that make use of multiple development architectures such as legacy information engineering and more modern object oriented and service oriented architectures.
BluePhoenix Redevelopment A solution that provides the ability to generate from the abstract platform independent model stored in the Refactoring Repository to platform specific models such as J2EE and .NET. To address this, we are extending robust generation technologies to generate platform specifics for object orientation and SOA. This model driven modernization environment can be used to gradually migrate applications rather than requiring an all at once approach. In order to address refactoring, which involves changing from one application model to another, we are adding the necessary tools to assist in the process of taking the information from legacy applications architectures via LogicMiner to more modern architectures such as object and SOA .
ASNA Monarch This product is used for understanding and migration of AS/400 applications. It transforms applications originally written in RPG/400 into native and fully compliant Microsoft.NET®. It can also migrate the originating database to SQL Server, thus providing for a full re-platforming solution. We intend to continue to provide full support for converting AS/400 applications to C# which is the premier development language under the Microsoft .NET environment. This will complete our offering and allow the AS/400 community a choice whether to use our ASNA Visual RPG® (AVR) or C#.
ASNA Visual RPG® (AVR) is a modern implementation of RPG that enables RPG developers to easily build Web and Windows applications. AVR provides direct, secure and fast access to both files and program objects on IBMs System i (formerly known as iSeries, AS/400) server. Using a familiar, but modernized syntax, RPG programmers can quickly apply their long-standing RPG experience to create modern applications that connect seamlessly to the System i (iSeries, AS/400) platform.
AVR for .NET provides similar functionalities under Microsofts .NET Framework. It enables modernizing existing RPG applications, develop Web services, and extend System i applications to .NET and the inherent support in Service Oriented Architecture while continuing to program with a familiar, RPG-like syntax. AVR for .NET is the only development solution available for Microsofts .NET that specifically supports high performance access to the System i database. We intend to continue to extend the functionality of AVR in order to make it a more attractive development environment that will be a preferred choice for AS/400 installations.
ASNA DataGate® ASNA DataGate provides fast and secure iSeries-400 database access. Applications written to access the iSeries through DataGate can later be connected to SQL Server without modification. A single application may connect to both platforms concurrently, or an application may switch, automatically, from one platform to the other in the case of a failover situation. We intend to continue to invest in research and development activities aimed to understand the feasibility of providing support for more modern RDBMSs such as ORACLE and UDB.
Chief Scientist Grants
PowerTextWe received through a subsidiary, an aggregate of approximately $261,000 in grants from the Office of the Chief Scientist, or the OCS, for the development of PowerText. PowerText is a software solution for automated electronic document mining, management and presentment. Royalties of 3% are payable to the OCS on all sales of PowerText up to 100% of the dollar-linked grant received.
BluePhoenix SOA - Ready EnablementWe received through our subsidiary, an aggregate of approximately $684,000 in grants from the OCS, for the development of BluePhoenix SOA - Ready Enablement. Royalties of 3% are payable to the OCS on sales of BluePhoenix SOA - Ready Enablement up to 100% of the dollar-linked grant received in respect of the funded product.
The balance of the contingent liability relating to the royalties payable by our subsidiaries to the OCS, at December 31, 2008, amounted to approximately $921,000.
In July 2007, our subsidiary, I-Ter, received final approval from the Ministry of Production in Italy for its Easy4Plan product. Easy4Plan is a workflow management tool designed for ISO9000 companies. The total funds amounted to approximately $650,000, of which 30% constitute a grant, and the balance is an 8-year loan to be repaid by I-Ter. The loan bears a minimal annual interest. 90% of the funds were received in December 2007. The remaining 10% is expected to be received during 2009 after a review of the Ministry of Production in Italy.
We rely on a combination of trade secret, copyright, and trademark laws and nondisclosure agreements, to protect our proprietary know-how. Our proprietary technology incorporates processes, methods, algorithms, and software that we believe are not easily copied. Despite these precautions, it may be possible for unauthorized third parties to copy aspects of our products or to obtain and use information that we regard as proprietary. However, we believe that with regard to most of our solutions, because of the rapid pace of technological change in the industry, patent and copyright protection are less significant to our competitive position than factors such as the knowledge, ability, and experience of our personnel, new product development, and ongoing product maintenance and support.
We face competition to our tools and services from various entities operating in the market. At the highest level, the legacy IT modernization market competes with two other approaches that can be employed to evolve the operating capabilities of a business: re-building business systems from scratch or buying a commercially available application package that can be configured to serve the specific needs of a particular business. The benefits of each approach have been widely documented by major research firms such as Gartner and Forrester. It is typically understood that legacy IT modernization provides several key advantages over the other two, including:
However, some enterprises still choose to abandon legacy technologies and invest in the redevelopment of new business systems.
The modernization market in which we operate is highly competitive. The principal competitive factors affecting the market for our modernization solutions include:
Competition in the legacy IT modernization field is, to a large extent, based upon the functionality of the available tools and personnel expertise. Vendors in this market address the modernization of legacy systems in different ways, and therefore do not always compete directly with the others. Many small vendors, those that possess just a few niche modernization technologies or a focused set of skills, are only capable of addressing a small portion of the overall modernization market. Selected few others are able to offer comprehensive suites of integrated tools and solutions and are able to address the broad set of needs encountered by businesses.
Our principal competitors consist of system integrators, offshore outsourcers, and tool vendors, including leading software developers, who enable the replacement or modernization of legacy systems.
Major system integrators in the market include IBM, HP, SUN, Accenture, Cap Gemini and EDS, some of whom we also partner with. IBM has established legacy modernization as a strategic aspect of its long-term application development strategy. Major system integrators have a specific and dominant advantage in the underlying application development infrastructure associated with many legacy environments (predominantly IBM mainframes) and a large service delivery capability. In some cases, we cooperate with some of these system integrators in providing specific solutions or portions of comprehensive projects. Major offshore outsourcers in the market include Tata, WIPRO, Infosys and Patni. Both systems integrators and offshore outsourcers have vertical market groups offering consulting and professional services. Although system integrators and offshore outsourcers often have the advantage of brand recognition and depth of resources, their ability to compete with purely automatic tool-based modernization techniques is still limited. Modernization approaches that use relatively inexpensive offshore manual labor to conduct migration projects are still more expensive than those conducted using automated tools and are more prone to project risks and delays.
We also face competition from niche tools and solutions companies operating in each of the four principal areas of the enterprise IT modernization continuum:
Examples of businesses that address specific sub-segments of the market include Cast, a vendor of an IT discovery product that reads application source code in order to analyze the relationships between software objects in order to deduce their business meaning. MetaWare provides services and products such as re-hosting, database and programming language conversions. Several software technologies address the needs of the ADABAS/Natural arena, and others are used to collect information about application portfolios in order to improve business process efficiencies. Other solution providers possess tools that allow them to engage as architecture modernization consultants.
In addition, enterprises themselves represent one of the largest categories of competition. For a variety of reasons, many businesses choose to execute legacy IT modernization projects using their own internal IT resources. The rationale for a company to attempt to conduct modernization activities using in-house resources varies. Reasons include wanting to justify the existence of available resources, the belief that using internal resources will be quicker or cheaper, and decision makers underestimating the complexity of modernization projects or failing to appreciate the benefits that can result by using experienced personnel and built-for-purpose tools.
We run our worldwide operations through several wholly owned and controlled subsidiaries, named below:
We, together with our subsidiaries and affiliates, currently occupy approximately 8,187 square meters of office space. The aggregate annual rent we paid for these facilities in 2008 was $2.6 million. The following table presents certain information about our facilities and the terms of lease of these facilities.
If, in the future, we determine that we need additional space to accommodate our growth, we believe that we will be able to obtain this additional space without difficulty and at commercially reasonable prices. We do not own any real property.
Following our board of directors decision to sell our holdings in our subsidiary, Mainsoft in January 2008, we included Mainsofts results in our financial statements as a discontinued operation. Accordingly, all figures in this annual report exclude Mainsofts results, which are presented as a discontinued operation. See Note 15 to our financial statements.
We concentrate our resources on a single line of business IT modernization solutions. We continue to pursue selective acquisitions that we believe will enrich our technological offering and will expose us to new geographies and markets. As a result of recent acquisitions and other factors described below under Operating Results, our revenues increased during recent years, from $61.4 million in 2006 to $81.2 million in 2007 and to $91.7 million in 2008.
We enhance our solutions and services via internal development of new software tools and devote significant resources to the development and marketing of new software modernization tools. We continue to reinvest in the Company through our investment in technology and process improvement. In 2008, our investment in research and development amounted to $18.4 million, as compared to $12.7 million in 2007. In addition, we invest in businesses that develop software tools that are complementary to our existing portfolio and we invest in a skilled and specialized workforce.
In January 2008, we acquired TIS, a company incorporated in Cyprus, that wholly owns a subsidiary incorporated in India, TISA Software Consultants Private Limited, or TIS. TIS provides consulting services, solutions and value added products to the banking industry, specializing in the market for Temenos GLOBUS/T24. In May 2008, we acquired the activity of JLC, an offshore professional outsourcing center in Nitzni, Russia.
We believe that several factors have significantly contributed to the increasing interest in our solutions and have helped to drive the growth in revenues from services. We continued to strengthen our sales team. Management has devoted significant attention to market awareness and to establishing a strong reputation as a leader in the modernization market. We have also increased our marketing efforts through targeted exhibitions, an expanded public relations program, web and email marketing, online web casts and other lead generation campaigns.
In evaluating our results, we focus on the following key financial and operating data: revenue growth, gross margin, recurring revenues, cash flow and adjusted EBITDA. We measure our revenue growth and recurring revenues as growing percentages year over year. Recurring revenues are also analyzed in terms of revenues from products, revenues from projects based on our tools, revenues based on geography and revenues from maintenance and long term service contracts. Projects and services are priced in an effort to generate a gross margin of not less than 50% on a non-GAAP basis as described below. In addition, cash flow from operating activities is targeted to be positive (see also Item 5.B. Liquidity and Capital resources).
The non-GAAP Measure of adjusted EBITDA serves as an additional indicator of our operating performance and not as a replacement for other measures such as cash flows from operating activities and operating income in accordance with GAAP. We believe that adjusted EBITDA is useful to investors as a measure of forward-looking cash flows as it excludes depreciation and amortization, stock based compensation and non recurring charges. Stock-based compensation is an incentive for certain individuals who are part of the executive management. Furthermore, such incentives include mainly RSUs which are measured based on the share price at the grant date. They are affected by historical stock prices which are irrelevant to forward-looking analyses and are not necessarily linked to the operational performance. We also believe that adjusted EBITDA is commonly used by analysts and investors in our industry and enables shareholders and potential investors to apply multiples on adjusted EBITDA in making investment decisions with respect to our company. Our management uses the Non-GAAP measure of adjusted EBITDA as the main indicator to evaluate operational performance and future cash flow of our business, and to assist management in allocating financial resources and workforce as well as to determine strategic targets and executive management remuneration.
Adjusted EBITDA does not take into account certain items and therefore it has inherent limitations. We obtain our adjusted EBITDA measurement by adding to net earnings (net loss), financial expenses, amortizations, income taxes and losses on exchange incurred during the fiscal year. We exclude from our adjusted EBITDA calculation the effects of non-monetary transactions recorded, such as stock-based compensation, one-time expenses related to cost saving plan and non-cash derivatives expenses. To compensate for these limitations, the Company analyzes adjusted EBITDA in conjunction with other GAAP measures and other operating performance measures. Adjusted EBITDA should not be considered in isolation or as a substitute for a GAAP measure. Investors should carefully consider the specific items included in adjusted EBITDA. While adjusted EBITDA has been disclosed to permit a more complete comparative analysis of our operating performance relative to other companies, investors should be cautioned that adjusted EBITDA as reported by us may not be comparable in all instances to adjusted EBITDA as reported by other companies.
The following table provides a reconciliation of net income (loss) to adjusted EBITDA for the periods indicated:
The following table provides a reconciliation of cash flow provided by operating activity to adjusted EBITDA for the periods indicated:
Pursuant to an impairment test performed in 2008, an impairment loss of $13.3 million related to goodwill of our overall IT modernization reporting unit, has been identified and was charged to income. This impairment loss is attributed mainly to the effect of the recent global economic and financial crisis on our business as described below.
The recent global economic and financial market crisis has caused, among other things, a general tightening in the credit markets, lower levels of liquidity, increases in the rates of default and bankruptcy, and reduced corporate profits and capital spending, all of which have had and continue to have a negative effect on our business, results of operations and financial condition. We cannot predict the timing or duration of the global economic crisis or the timing or strength of any subsequent economic recovery. We also cannot predict the effect of the economic conditions on our business. Accordingly, we cannot assure you that we will be able to increase our revenues or keep our revenues at the same level as in 2008. In response to these market conditions, we are focusing on providing customers with legacy modernization solutions that will have a cost effective impact on the customers information technology spending, which is particularly important during a difficult economic environment. We have also implemented initiatives to reduce costs and improve working capital to mitigate the effects of the different related economic conditions on our business.
Our quarterly and annual results of operations have fluctuated significantly in the past and we expect them to continue to fluctuate significantly in the future, as a result of numerous factors, including: global economic trends, like the recent global economic crisis; fluctuations in foreign currencies exchange rates in which we operate compared to the US dollar, our reporting currency; fluctuation in sale of software products; the impact of acquisitions and dispositions of companies, and the difficulties we have encountered in introducing our tools to the market. Therefore, we believe that period-to-period comparisons of our financial results are not necessarily meaningful and you should not rely on them as an indication of future performance.
Challenges and Opportunities.
Although the market for legacy IT modernization solutions is robust and one which we believe is growing, the challenges associated with driving constant revenue growth whilst continually improving profit margins are real. In a market that continues to innovate and evolve, new technologies and practices by definition render existing technology deployments out-of-date - or legacy. By the same measure, however, in order for us to capitalize on the constant source of legacy solutions, we must evolve our solutions portfolio to deal with the changing definition of what constitutes leading edge technologies and the growing set that is deemed to be legacy. Over time, as one legacy set of technologies is gradually replaced, we must be capable of addressing the modernization needs of the next set of aging technologies.
The fact that the modernization needs of the market are evolving on a constant basis, necessitates that we be capable of tracking and predicting changes in technologies. Anticipating the needs of the IT modernization market and delivering new tools and services that satisfy the emerging needs is a critical success factor.
However, even if we develop modernization solutions that address the evolving needs of the legacy IT modernization market, we cannot assure you that there will be a predictable demand for our offerings. Vagaries ranging from the macro-economic climate, to the competitive landscape, to the perceived need the enterprise market has for a specific modernization solution, will all have an impact such as a longer sales cycle and increased pressure on pricing.
In addition to our ability to foresee the needs of the market and develop appropriate modernization solutions, our growth is predicated, in part, on the acquisition of companies with services, tools, and technologies that extend or complement our existing business. We may face increased competition for choice acquisition targets or difficulties in identifying and locating new tools and technologies, which may inhibit our ability to complete suitable acquisitions on favorable terms. The successful integration of acquired businesses, technologies, and products into our existing portfolio of solutions will continue to be a significant challenge.
To keep up with the anticipated growing demand for our tools and services, we must retain our highly skilled personnel in the fields of project management, legacy systems, and leading modern technologies. Maintaining and growing the requisite skill base can be problematic; personnel with an understanding of legacy technologies is a finite resource and the market for recruiting and retaining such skills can be highly competitive.
Consolidation of the Results of Operations of Our Subsidiaries.
Following is information regarding the consolidation of the results of operations of certain of our subsidiaries, for the periods indicated. We began to consolidate the results of operations of each of these subsidiaries when we acquired control in them.
Following our board of directors decision to sell our holdings in our subsidiary, Mainsoft in January 2008, we included Mainsofts results in our financial statements as a discontinued operation, in accordance with SFAS 144. Accordingly, all figures in this annual report exclude Mainsofts results, which are presented as a discontinued operation. See Note 15 to our financial statements.
Critical Accounting Policies.
We prepare our consolidated financial statements in conformity with U.S. GAAP. Accordingly, we are required to make certain estimates, judgments, and assumptions that we believe are reasonable based upon the information available. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the periods presented. The significant accounting policies that we believe are the most critical to aid in fully understanding and evaluating our reported financial results include the following:
Revenue recognition. Our revenue recognition policy is significant because our revenue is a key component of our results of operations. We follow specific and detailed guidelines in measuring revenue; however, certain judgments affect the application of our revenue policy. Revenue results are difficult to predict and any shortfall in revenue or delay in recognizing revenue could cause our operating results to vary significantly from quarter to quarter and could result in future operating losses. Should changes in conditions cause management to determine that these guidelines are not met for certain future transactions, revenue recognized for any reporting period could be adversely affected.
Revenues derived from direct software license agreements are recognized in accordance with Statement of Position (SOP) 97-2 Software Revenue Recognition (as amended by SOP 98-4 and SOP 98-9), upon delivery of the software, when collection is probable, the license fee is otherwise fixed or determinable, and persuasive evidence of an arrangement exists. There are no rights to return products or similar contingencies in our contracts.
We typically sell our software products and services in stand-alone contracts for software product licenses, services, or maintenance and support. A relatively small portion of our arrangements includes multiple elements. These arrangements are usually arrangements in which we sell a software product license and PCS.
We follow paragraph 10 of SOP 97-2, Software Revenue Recognition, as amended, and allocate the total fee arrangement to the software and the PCS undelivered element based on vendor-specific objective evidence, referred to as VSOE. We allocate the total fee arrangement based on the guidance set forth in paragraph 57 of SOP 97-2, which states, The fair value of the PCS should be determined by reference to the price the customer will be required to pay when it is sold separately.
The fair value of the PCS is calculated by the consistent renewal rate of the PCS stated in the relevant contract. The portion of the fee arrangement allocated to the PCS is recognized as revenues ratably over the term of the PCS arrangement.
In some agreements with our customers, the customers have the right to receive unspecified upgrades on an if-and-when available basis (we do not provide specific upgrades). These upgrades are considered Post-Contract Support (PCS). Revenue allocated to the PCS is recognized ratably over the term of the PCS.
Long term contracts accounted for pursuant to SOP 81-1,Accounting for Performance of Construction-Type Contracts, are contracts in which we sell our software framework, on which material modifications, developments and customizations are performed, to provide the customer with a new and modern IT application with enhanced capabilities that were unavailable in its former legacy system. The aforementioned services are essential to the functionality of the software and to its compliance with customers needs and specifications. We account for these arrangements pursuant to paragraph 7 to SOP 97-2 and TPA 5100.48.
Under this method, estimated revenue is generally accrued based on costs incurred to date, as a percentage of total updated estimated costs. Changes in our estimates may effect the recognition of our long-term contract revenues.
We recognize contract losses, if any, in the period in which they first become evident. Some of our contracts include client acceptance clauses. In these contracts, we follow the guidance of TPA 5100.67 and SAB 104. In determining whether revenue can be recognized, when an acceptance clause exists, we consider our history with similar arrangements, the customers involvement in the negotiation process, and the existence of other service providers and the payment terms.
We present revenues from products and revenues from services in separate line items. The product revenues line item includes revenues generated from (i) stand-alone software products; and (ii) software products that were included in multiple-element arrangements and were separated pursuant to SOP 97-2 as aforementioned.
In the services revenue line item, we include (i) revenues generated from stand-alone consulting services; (ii) revenues generated from stand alone PCS; (iii) revenues accounted for pursuant to SOP 81-1; and (iv) revenues generated from PCS included in multiple-element arrangement and were separated pursuant to SOP 97-2 as aforementioned. We have included all SOP 81-1 arrangements in the service revenues line item since we can not establish VSOE of fair value to neither the service element nor the software element. Our software framework and these kinds of modifications and customizations are not sold separately. Therefore, we can not appropriately justify reflecting the product portion separately in our statement of operations.
We believe that our revenue recognition policies are in accordance with the Securities and Exchange Commission Staff Accounting Bulletin No. 101 and SAB 104, Revenue Recognition in Financial Statements.
Capitalized research and development costs. We capitalize research and development costs of software that are intended for sale that were incurred after the establishment of the technological feasibility of the relevant product based on a detailed program design.
Amortization of capitalized research and development costs begins when the product is available for general release to customers. Annual amortization is computed by the straight-line method, over the remaining useful life of the product, currently over a period of 5 years, or based on the ratio of current gross revenues to current and anticipated future gross revenues, whichever is higher. Our failure to accurately predict the useful life of capitalized research and development costs could cause a one-time amortization, which could adversely affect our operating results.
Impairment of goodwill and intangible assets. Our business acquisitions resulted in goodwill and other intangible assets. We periodically evaluate our goodwill, intangible assets, and investments in affiliates for potential impairment indicators. Our judgments regarding the existence of impairment indicators are based on legal factors, market conditions, and operational performance of our acquired businesses and investments.
In accordance with FASB Statement of Financial Accounting Standards No. 142 Goodwill and Other intangible Assets, or SFAS 142, indefinite life intangible assets and goodwill are not amortized but rather subject to periodic impairment testing.
Goodwill and intangible assets are tested for impairment by comparing the fair value of the reporting unit with its carrying value. Fair value is generally determined using discounted cash flows, market multiples, and market capitalization. Significant estimates used in the fair value methodologies include estimates of future cash flows, future short-term and long-term growth rates, weighted average cost of capital and estimates of market multiples of the reportable unit. If these estimates or their related assumptions change in the future, we may be required to record additional impairment charges for our goodwill and intangible assets. These write downs may have an adverse affect on our operating results. Future events could cause us to conclude that impairment indicators exist and that additional intangible assets associated with our acquired businesses are impaired. In addition, we evaluate a reporting unit for impairment if events or circumstances change between annual tests, indicating a possible impairment. Examples of such events or circumstances include: (i) a significant adverse change in legal factors or in the business climate; (ii) an adverse action or assessment by a regulator; (iii) a more likely than not expectation that portion of the reporting unit will be sold; (iv) continued or sustained losses at a reporting unit; (v) a significant decline in our market capitalization as compared to our book value or (vi) the testing for recoverability under SFAS 144 of a significant asset group within the reporting unit.
The process of evaluating the potential impairment of goodwill is subjective and requires significant judgment at many points during the analysis. In estimating the fair value of the reporting unit for the purpose of our periodic analysis, we make estimates and judgments about the future cash flows of the reporting unit. Although our cash flow forecasts are based on assumptions that are consistent with our plans and estimates we are using to manage the underlying businesses, there is significant exercise of judgment involved in determining the cash flows attributable to a reporting unit over its estimated remaining useful life. In addition, we make certain judgments about allocating shared assets to the estimated balance sheets of our reporting unit. Changes in judgment on these assumptions and estimates could result in a goodwill impairment charge. Any resulting impairment loss could have a material adverse impact on our financial condition and results of operations.
We are one operating segment and therefore one reporting unit of IT modernization. We utilize a two-step method to perform a goodwill impairment review in the fourth quarter of each fiscal year or when facts and circumstances indicate goodwill may be impaired. In the first step, we determine the fair value of the reporting unit using expected future discounted cash flows and estimated terminal values. If the net book value of the reporting unit exceeds the fair value, we would then perform the second step of the impairment test which requires allocation of the reporting units fair value of all of its assets and liabilities in a manner similar to a purchase price allocation, with any residual fair value being allocated to goodwill. The implied fair value of the goodwill is then compared to the carrying value to determine impairment, if any. In 2008 we performed an impairment test and an impairment loss of $13.3 million related to goodwill of our overall IT modernization reporting unit, was identified and charged to operations. We attribute this impairment to the recent global economic and financial market crisis, which had a negative effect on our business primarily as a result of the negative equity market conditions which caused a material decline in industry market multiples in the second half of 2008.
We determine the fair value of a reporting unit using the Income Approach, which utilizes a discounted cash flow model, as it believes that this approach best approximates its fair value at this time. We corroborated the fair values using the Market Approach. Judgments and assumptions related to revenue, gross profit, operating expenses, future short-term and long-term growth rates, weighted average cost of capital, interest, capital expenditures, cash flows, and market conditions are inherent in developing the discounted cash flow model. Additionally, we evaluated the reasonableness of the estimated fair value of the reporting unit by reconciling to its market capitalization. This reconciliation allowed us to consider market expectations in corroborating the reasonableness of the fair value of the reporting unit. Our ability to reconcile the gap between our market capitalization and our aggregate fair value depends on various factors, some of which are quantitative, such as an estimated control premium that an investor would be willing to pay for a controlling interest in us, and some of which are qualitative and involve management judgment, including stable relatively high backlog and growing pipe line. In that regard, the Company based its assumption on a 42% effective control premium rate which has been implied from various mergers and acquisitions in Israel and abroad involving similar companies, that took place during the six months ended in March 31, 2009. If our market capitalization stays below the value of our stockholders equity, or actual results of operations differ materially from our modeling estimates and related assumptions, or if any of our qualitative reconciliation factors changes in the future, we may be required to record additional impairment charges for our goodwill. We will continue to monitor market trends in our business, the related expected cash flows and our calculation of market capitalization for purposes of identifying possible indicators of impairment. Should our book value per share continue to exceed our market share price or we have other indicators of impairment, as previously discussed, we will be required to perform an interim step one impairment analysis, which may lead to a step two analysis resulting in a goodwill impairment. Additionally, we would then be required to review our remaining long-lived assets for impairment.
Valuation of financial instruments. Effective January 1, 2008, we adopted SFAS 157, Fair Value Measurements, and effective October 10, 2008, we adopted FSP No. SFAS 157-3, Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active, except as it applies to the nonfinancial assets and nonfinancial liabilities subject to FSP 157-2. SFAS 157 clarifies that fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or a liability. As a basis for considering such assumptions, SFAS 157 establishes a three-tier value hierarchy, as set forth below, which prioritizes the inputs used in the valuation methodologies in measuring fair value:
The fair value hierarchy also requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.
The actual value at which such securities could actually be sold or settled with a willing buyer or seller may differ from such estimated fair values depending on a number of factors, including, but not limited to, current and future economic conditions, the quantity sold or settled, the presence of an active market and the availability of a willing buyer or seller.
SFAS 123(R). On January 1, 2006, we adopted Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment, referred to as SFAS 123(R), which requires the measurement and recognition of compensation expense based on estimated fair values for all share-based payment awards made to employees and directors. SFAS 123(R) requires companies to estimate the fair value of equity-based payment awards on the date of grant using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as an expense over the requisite service periods in our consolidated income statement. Prior to the adoption of SFAS 123(R), we accounted for equity-based awards to employees and directors using the intrinsic value method in accordance with APB 25 as allowed under Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation, or SFAS 123. Our determination of fair value of share-based payment awards on the date of grant using an option-pricing model is affected by our share price as well as assumptions regarding a number of highly complex and subjective variables. These variables include, but are not limited to our expected share price volatility over the terms of the awards using historical volatility derived from our exchange traded shares, and actual and projected employee share option exercise behaviors. The dividend yield assumption is based on our historical experience and expectation of future dividends payouts and may be subject to change in the future. The risk-free interest assumption is the implied yield currently available on U.S. Treasury zero-coupon bonds, issued with a remaining term equal to the expected life term of our options. We use the simplified method to compute the expected option term for options granted in accordance with SAB110. Although the fair value of employee share options is determined in accordance with SFAS 123(R) using an option-pricing model, that value may not be indicative of the fair value observed in a willing buyer/willing seller market transaction.
Income taxes. In July 2006, the Financial Accounting Standards Board, or FASB, issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes - An Interpretation of FASB Statement No. 109, or FIN 48, which requires income tax positions to meet a more-likely-than-not recognition threshold to be recognized in the financial statements. Under FIN 48, tax positions that previously failed to meet the more-likely-than-not threshold should be recognized in the first subsequent financial reporting period in which that threshold is met. Previously recognized tax positions that no longer meet the more-likely-than-not threshold should be derecognized in the first subsequent financial reporting period in which that threshold is no longer met. Prior to 2007, we recorded estimated income tax liabilities to the extent they were probable and could be reasonably estimated. As a multinational corporation, we are subject to taxation in many jurisdictions, and the calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax laws and regulations in various taxing jurisdictions. If we ultimately determine that the payment of these liabilities will be unnecessary, we reverse the liability and recognize a tax benefit during the period in which we determine the liability no longer applies. Conversely, we record additional tax charges in a period in which we determine that a recorded tax liability is less than we expect the ultimate assessment to be. The application of tax laws and regulations is subject to legal and factual interpretation, judgment and uncertainty. Tax laws and regulations themselves are subject to change as a result of changes in fiscal policy, changes in legislation, the evolution of regulations and court rulings. Therefore, the actual liability for Israeli or foreign taxes may be materially different from our estimates, which could result in the need to record additional tax liabilities or potentially reverse previously recorded tax liabilities. The adoption of FIN 48 did not result in a change to our retained earning. As of December 31, 2008, there are no unrecognized tax benefits. Deferred taxes are determined utilizing the asset and liability method, whereby deferred tax asset and liability account balances are determined based on differences between financial reporting and the tax basis 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. We provide a valuation allowance, when its more likely than not that deferred tax assets will not be realized in the foreseeable future. In calculating our deferred taxes we are taking into account various estimations, which are examined and if necessary adjusted on a quarterly basis, regarding our future utilization of future carry forward losses.
Accounts receivable and Allowances for Doubtful Accounts. Our trade receivables include amounts due from customers. We perform ongoing credit evaluations of our customers financial condition and we require collateral as deemed necessary. We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make payments. In judging the adequacy of the allowance for doubtful accounts, we consider multiple factors including the aging of our receivables, historical bad debt experience and the general economic environment. Management applies considerable judgment in assessing the realization of receivables, including assessing the probability of collection and the current credit worthiness of each customer. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.
Derivative Instruments . We have adopted Statement of Financial Accounting Standards SFAS No. 133 Accounting for Derivative Instruments and Hedging Activities, referred to as SFAS 133. Under the provisions of SFAS 133, all derivatives are recognized on the balance sheet at their fair value. Changes in fair value are recognized periodically in earnings or accumulated other comprehensive income within shareholders equity, depending on the intended use of the derivative and whether the derivative has been designated by management as a hedging instrument. Changes in fair value of derivative instruments not designated as hedging instruments are recognized in earnings in the current period.
We use foreign currency options, forward exchange contracts and forward interest contracts to assist in managing financial risks. We do not use derivative financial instruments for speculative purposes. These instruments are recognized at fair value, with all changes in fair value recorded in current period earnings, as these transactions have not been designated as hedging instruments under SFAS 133.
Discontinued Operation. In January 2008, the board of directors announced its intent to sell the entire holdings in Mainsoft Corp., in which we held a 58% controlling interest. This decision followed a strategic shift in Mainsofts product development and marketing strategy outside of BluePhoenixs core business focus. In October 2008 we sold Mainsoft for consideration of $1.7 million. Mainsoft met the definition of a component under SFAS 144. Accordingly the results of operation of Mainsoft are discontinued operation in the statement of operations and prior periods results have been reclassified accordingly. In addition, comparative data of the asset and liabilities attributed to the discontinued operation have been reclassified in the balance sheet.
Recently Issued Accounting Pronouncements
FSP 142-3. In April 2008, the FASB issued FSP 142-3, Determination of the Useful Life of Intangible Assets, referred to as FSP 142-3. FSP 142-3 amends the factors that should be considered in developing renewal or extension assumptions on legal and contractual provisions used to determine the useful life of a recognized intangible asset under SFAS 142. FSP 142-3 is effective for fiscal years beginning after December 15, 2008. We are currently assessing the impact of FSP 142-3 on our consolidated financial position and results of operations.
SFAS 161. In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities, or SFAS 161, as an amendment to SFAS 133. SFAS 161 requires that objectives for using derivative instruments be disclosed in terms of underlying risk and accounting designation. The fair value of derivative instruments and their gains and losses will need to be presented in tabular format in order to present a more complete picture of the effects of using derivative instruments. SFAS 161 is effective for financial statements issued for fiscal years beginning after November 15, 2008. We are currently evaluating the impact of adopting this pronouncement.
SFAS 141R. In December 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations, or SFAS 141R. SFAS 141R provides revised guidance on how acquirers recognize and measure the consideration, identifiable assets acquired, liabilities assumed, contingencies, non-controlling interests and goodwill acquired in a business combination, and expands disclosure requirements surrounding the nature and financial effects of business combinations. Key changes include: acquired in-process research and development will no longer be expensed on acquisition, but capitalized and assessed for impairment where relevant and amortized over its useful life; acquisition costs will be expensed as incurred; restructuring costs will generally be expensed in periods after the acquisition date; the consideration in shares would be valued at closing date; and in the event that a deferred tax valuation allowance relating to a business acquisition, including from prior years, is subsequently reduced, the adjustment will be recognized in the statement of income. Early adoption is not permitted. As applicable to us, this statement will be effective, on a prospective basis, as of the year beginning January 1, 2009. We believe that the initial adoption of SFAS 141R will not have a material impact on our consolidated financial statements. However, if we consummate business combinations after the adoption of SFAS 141R, this could significantly impact our consolidated financial statements as compared to prior acquisitions which were accounted for under existing GAAP requirements, due to the changes described above.
SFAS 160. In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statementsan amendment of Accounting Research Bulletin 51, or SFAS 160, which establishes accounting and reporting standards for non-controlling interests in a subsidiary and deconsolidation of a subsidiary. Early adoption is not permitted. As applicable to us, this statement will be effective as of the year beginning January 1, 2009. The adoption of SFAS 160 will not have a material impact on our consolidated financial statements.
SFAS 157. On November 14, 2007, the FASB agreed to a one-year deferral for the implementation of SFAS 157 for non-financial assets and liabilities. We are currently assessing the impact of SFAS 157 for non-financial assets and liabilities on our consolidated financial statements.
EITF 07-05. In April 2008, the FASB issued EITF 07-05, Determining Whether an Instrument (or Embedded Feature) Is Indexed to an Entitys Own Stock, referred to as EITF 07- 05. EITF 07-05 provides guidance on determining what types of instruments or embedded features in an instrument held by a reporting entity can be considered indexed to its own stock for the purpose of evaluating the first criteria of the scope exception in paragraph 11(a) of SFAS No. 133. EITF 07-05 is effective for financial statements issued for fiscal years beginning after December 15, 2008 and early application is not permitted. The impact of this EITF on the beginning of 2009 equity is not expected to be material.
EITF 08-6. In November 2008, the Emerging Issues Task Force or EITF, issued Issue 08-6, Accounting for Equity Method Investments or FSP EITF 08-6, because of questions raised regarding the application of the equity method after FASB Statement 160 and FASB Statement 141(R) were issued. This EITF issue addresses other-than-temporary impairment, the accounting for gains or losses on issuance of shares by the investee and the loss of significant influence such that the accounting method must change. EITF 08-06 is effective on a prospective basis for transactions in an investees shares occurring or impairments recognized in fiscal years, beginning after December 15, 2008. We do not expect EITF 08-6 to have a significant impact on the accounting for our equity investments.
Our Reporting Currency
The currency of the primary economic environment in which the operations of BluePhoenix and most of its subsidiaries are conducted is the U.S. dollar. In addition, a substantial portion of our revenues and costs are incurred in dollars. Thus, the dollar is our functional and reporting currency.
We follow SFAS 52 Foreign Currency Translation and accordingly non monetary transactions denominated in currencies other than the dollar are measured and recorded in dollar at the exchange rates prevailing at transaction date. Monetary assets and liabilities denominated in currencies other than the dollar are translated at the exchange rate on the balance sheet date. Exchange gain or losses on foreign currency translation are recorded in income.
Following is a summary of the most relevant monetary indicators for the reported periods:
The following table presents the percentage relationships of certain items from our consolidated statement of operations, as a percentage of total revenues for the periods indicated:
Statement of Operations Data as a Percentage of Revenues:
Years Ended December 31, 2008 and 2007
Revenues. Revenues increased 13% from $81.2 million in 2007 to $91.7 million in 2008.
Revenues generated from our services increased by 38%, from $61.7 million in 2007 to $84.9 million in 2008. Our services revenues growth is attributable to our acquisitions of TIS and JLC which contributed approximately $6.3 million in 2008 revenues in the aggregate, while the remaining increase is attributed to revenue generated from certain sizable information technology modernization projects.
Revenues generated from recurring revenues such as long term services contracts and maintenance as a proportion of revenue increased from 54% in 2007 to 59% in 2008. Revenues generated from legacy modernization, namely turn-key projects and products, as a proportion of revenue decreased from 46% in 2007 to 41% in 2008. Revenues generated from our products (software license) were $19.6 million in 2007 when we signed several large-scale software agreements compared to $6.9 million in 2008. However, in 2008 we encountered a growing demand for turn-key projects, rather than products sales. Approximately 60% of our revenues in 2008 were derived from financial institutions. Following the economic crisis that accelerated in the second half of 2008, the crisis began to effect our business. There was a decrease in consulting services to existing customers and a number of new customers negotiated lower prices for our legacy modernization projects. The majority of our projects are specifically tailored and negotiated separately, and therefore, the lack of uniform rates and price lists makes us unable to quantify the decrease in pricing. Although a longer sales cycle in 2008 caused the closing of deals to be delayed into future periods, a strong backlog of deals from 2007 enabled us to maintain revenue growth in 2008.
The table below presents the breakdown of our revenues based on the location of our customers for the periods indicated:
Gross Margin. Gross margin was 50% in 2008 compared to 55% in 2007. The decrease is attributed mainly to the low revenues from product sales in 2008 compared to 2007, as revenues from products generates a higher margin than revenues from services and turn-key projects.
Cost of revenues. Cost of revenues consists of salaries, , amortization of intangible assets, fees paid to independent subcontractors and other direct costs. Cost of revenues increased by 26% from $36.5 million in 2007 to $46.0 million in 2008. This increase is attributed mainly to costs generated from TIS and JLC which were acquired in 2008, and as a direct result of our revenues growth. Cost of revenues as a percentage of revenues increased from 45% in 2007 to 50% in 2008, as a result of the change in the revenue mix in 2008 compared to 2007. Revenue mix in 2007 included 24% of our revenues generated from products (software license) and 76% from services, while in 2008, 8% of our revenues were generated from products (software license) and 92% from services. Cost of services is much higher than cost of products.
Research and development costs. Research and development costs consist of salaries and consulting fees that we pay to professionals engaged in the development of new software tools and related methodologies. Our development costs are attributed to the development of our modernization suite of tools and are charged to operations as incurred. Research and development costs increased 45% from $12.7 million in 2007 to $18.4 million in 2008. As a percentage of revenues, research and development costs, net increased from 16% in 2007 to 20% in 2008. The low level of costs in 2007 is attributed to a $3.9 million capitalization of research and development costs. The remaining increase is attributed to the consolidation of acquired companies.
Selling, general, and administrative expenses. Selling, general, and administrative expenses consist primarily of wages and related expenses, travel expenses, third party and sales commissions, selling expenses, marketing and advertising expenses, rent, insurance, utilities, professional fees, and depreciation. Selling, general, and administrative expenses increased by 14% from $28.4 million in 2007 to $32.4 million in 2008. As a percentage of revenues, selling, general and administrative expenses remained 35% in 2007 and 2008. The increase in selling, general, and administrative expenses is attributed to a provision of $2.3 million made in connection with an implementation of our global saving plan in the fourth quarter of 2008. This global saving plan cost consisted of: (a) severance pay and expenses related to the dismissal of employees; and (b) costs associated with closing offices in countries where we previously had two offices, such as in Italy and the United Kingdom. The remaining increase is attributed to the consolidation of acquired companies.
Goodwill impairment. Our intangible assets are tested for impairment on an annual basis or whenever events or circumstances indicate impairment may have occurred. For 2008 we performed an impairment test and an impairment loss of $13.3 million attributed to goodwill of over overall IT modernization reporting unit has been identified and was charged to operations. We attribute this impairment to the recent global economic and financial market crisis, which had a negative effect on our business primarily as a result of the negative equity market conditions which caused a material decline in industry market multiples in the second half of 2008.
Financial expenses, net. Financial expenses decreased from $4.3 million in 2007 to $2.2 million in 2008. The decrease in financial expenses is attributable to (a) a repayment of $32 million loans in November 2007; and (b) non-cash expenses related to the convertible debentures and embedded derivatives that were charged to 2007 financial expenses.
Other income, net. Other income, net, in 2008, consisted of a $350,000 payment from Cicero. Other income, net, in 2007, consisted of $758,000 payment from Cicero, of which $300,000 was paid in cash and $458,000 was in securities. For more information, see Item 4.B. Business OverviewInvestments and AcquisitionsCicero. Other income, net is also attributed to a dividend received from Steps Ventures, an Israeli venture capital investment group, in which we hold 375,000 shares representing 3.75% of its outstanding share capital. The dividend received in 2008 was $48,000 compared to $134,000 in 2007.
Income tax expense. In 2008, we had income tax benefits of $330,000 compared to an income tax expense of $68,000 in 2007. The tax expense is compounded from tax expense related to 2008 and prior years in the amount of $564,000 offset by a $894,000 deferred tax which represents our estimated tax benefits in the next three years. We have net operating losses carried forward for tax purposes in the amount of $56 million that resulted in relative low tax rate charges comparing to our income before tax results.
Minority interest. Minority interest in earnings in 2007 was $199,000 compared to $179,000 in 2008, and representing our minority share in the net profit of Liacom and Zulu. There were no changes in our minority interest.
Discontinued operation. Our discontinued operation related to Mainsoft was a loss of $8.5 million in 2008 compared to a loss of $7.5 million in 2007. In January 2008, we announced our decision to sell our holdings in our subsidiary Mainsoft, in which we held a 58% controlling interest. Our managements decision followed a strategic shift in Mainsofts product development and marketing strategy outside of BluePhoenixs core business focus. Based on an impairment test, an impairment loss of $7 million related to goodwill in Mainsoft was identified and charged to income in 2007 as a loss from discontinued operation. Mainsoft was sold in October 2008 for $1.7 million and as a result, additional amount of $3.8 million was charged to income in 2008 as discontinued operation. In order to reflect the consideration paid by the purchaser, the technology recorded in Mainsoft books was written down in the amount of $7.1 million. The sale of Mainsoft was completed in October 2008.
Years Ended December 31, 2007 and 2006
Revenues. Revenues increased 32% from $61.4 million in 2006 to $81.2 million in 2007. Revenues generated from products software license grew 102% from $9.7 million in 2006 to $19.6 million in 2007. The increase is attributed the expansion of our product offering through acquisitions and internal development efforts. Tools such as ICL/Migrator, ADABAS/Natural to RDBMS/Java, COBOL LE Enabler, PowerBuilder to Java, IMS migration and other were introduced during 2006 and 2007 and were integrated into our suite of solutions. In August 2007, we introduced the Monarch, for transforming RPG applications to Microsoft.Net platform.
Revenues from professional services grew 20% from $51.6 million in 2006 to $61.7 million in 2007. The increase in revenues from professional services is attributed to the increase in professional services related to our expanded product offerings which met the increasing demand for legacy software modernization.
The table below presents the breakdown of our revenues based on the location of our customers for the periods indicated:
Cost of revenues. Cost of revenues increased by 40% from $26.1 million in 2006 to $36.5 million in 2007. Cost of revenues in 2007 included $982,000 of integration expenses related to our recent acquisitions. Cost of revenues as a percentage of revenues increased from 42% in 2006 to 45% in 2007, as a result of an increase in amortization of intangible assets which increased from $5.6 million in 2006 to $9.0 million in 2007. This increase was mainly related to the amortization of capitalized research and development costs as a result of general release of developed modernization tools and the increase of the amortization of purchased technologies and intangible assets related to recent acquisitions.
Research and development costs. Research and development costs increased from $8.6 million in 2006 to $12.7 million in 2007. These costs are net of capitalization of research and development costs. In 2007 we capitalized research and development costs in an aggregate amount of $3.9 million compared to $6.4 million in 2006 and as a result, our research and development costs increased by $2.5 million. An additional increase of $500,000 is attributed to the research and development expenses in ASNA that was acquired during 2007. The remaining increase is attributed to our increase in effort to update our suite of solutions in order to support a larger variety of languages, databases, and platform conversions.
Selling, general, and administrative expenses. Selling, general, and administrative expenses increased by 47% from $19.3 million in 2006 to $28.4 million in 2007. As a percentage of revenues, selling, general and administrative expenses increased from 32% in 2006 to 35% in 2007. The increase is attributed to integration charges in the amount of $688,000 incurred as a result of the acquisitions of BridgeQuest and ASNA. A $1.8 million non-cash charge incurred by us as a result of the payment by Formula to our CEO of a bonus with respect to the sale by Formula of its shareholding in BluePhoenix, was also charged to selling, general, and administrative expenses. We also incurred a charge of stock-based non-cash compensation in the amount of $1.0 million compared to almost zero in 2006. The remaining increase is attributed to the increase of the increase in overall activity of our company.
Restructuring costs. In 2007, we went through a restructuring process, mainly due to recent acquisitions, which was followed by reorganization in our research and development and project delivery departments. Total restructuring expenses in 2007 amounted to $694,000 and consist of severance costs to terminated employees.
Financial expenses, net. Financial expenses increased from $3.6 million in 2006 to $4.3 million in 2007. The increase in financial expenses was mainly attributable to non-cash expenses related to the convertible debentures and embedded derivatives which increased from $1.2 million in 2006 to $2.1 million in 2007. This increase related to the conversion of the $3 million and $5 million debentures into equity and as such, all unamortized discount and the beneficial conversion features were charged to financial expenses. Additional financial expenses in 2007 were attributable to a $10.5 million increase in our overall borrowings from banks which were attributed to the acquisitions of BridgeQuest and ASNA. In November 2007, we consummated a $35 million private placement, the proceeds of which were mainly used to repay all of our bank loans, in the aggregate amount of $32 million. We expect financial expenses to be reduced significantly following such repayments and as a result of the conversion of all our debentures and notes as of December 31, 2007.
Other income, net. Other income consisted of a $758,000 payment from Cicero Inc., of which $300,000 was in cash and $458,000 was in securities. (For more information see Item 4.B. Business OverviewInvestments and AcquisitionsCicero.) Additional amount is attributed to a dividend received from Steps Ventures, an Israeli venture capital investment group, in which we hold 375,000 shares representing 3.75% of its outstanding share capital. The dividend received in 2007 was $134,000 compared to $282,000 in 2006.
Income tax expense. In 2007, we had tax expense of $68,000 compared to income tax benefits of $282,000 in 2006. The tax expenses are compound from taxes related to prior years in the amount of $208,000 and tax related to current year which include tax benefit related to exercise of share-options in the amount of $594,000 offset by $1.0 million deferred tax which represents our estimated tax benefits in the next three years. The income tax benefit in 2006 was related to the final settlement of tax assessments with the Israeli Income Tax Authorities, which was partially offset by our local taxes paid worldwide by our international subsidiaries. In 2007 we had net operating losses carried forward for tax purposes that resulted in relative low tax rate charges comparing to our income before tax results.
Minority interest. Minority interest in profit in 2007 was $199,000 representing our minority share in the net profit of Liacom and Zulu. Minority interest in earning in 2006 was $113,000, representing our minority share in the net losses of these companies. There were no changes in our minority interest.
Discontinued operation. In January 2008, we announced our decision to sell our holdings in our subsidiary Mainsoft, in which we held a 58% controlling interest. Our managements decision followed a strategic shift in Mainsofts product development and marketing strategy outside of BluePhoenixs core business focus. As a result, we generated a loss from discontinued operation of $7.5 million. Based on an impairment test, an impairment loss of $7 million related to goodwill in Mainsoft has been identified and was charged to income in 2007 as a loss from discontinued operation.
How We Have Financed Our Business
In 1997, we consummated two public offerings, and received net proceeds of $33.9 million after deducting underwriting discounts and commissions and offering expenses.
On March 30, 2004, we completed a private placement to institutional investors. Under the terms of this transaction as amended on February 18, 2005, we issued to the institutional investors, for an aggregate purchase price of $5 million, convertible debentures due in 2007, bearing interest at a rate of six months LIBOR paid quarterly. Pursuant to our agreement with the institutional investors, in March 2006, the institutional investors exercised their right to purchase from us, for an aggregate purchase price of $3 million, additional convertible debentures due in 2009. The institutional investors converted the entire principal amount of the debentures into 1,620,790 of our ordinary shares. For more information, see Contractual Commitments and Guarantees.
In February 2006, we completed an underwritten public offering in Israel of series A convertible notes in an aggregate principal amount NIS 54.0 million that were equal at the time of the transaction to approximately $11.5 million (the dollar amount was calculated based on the exchange rate at the date of the transaction). As of December 31, 2008, all of the notes have been converted into shares.
In order to improve our liquidity, we entered into sale of receivables agreements with regard to some of our customers, and control and risk of those trade receivables were fully transferred. This facility enables us to receive a short term financing from time to time, as the related costs of the financing are similar to the costs of credit lines from banks, and no covenants are required. In 2008, an amount of $24.2 million was sold. Out of this amount, $23.6 was collected by the financial institutions as of March 27, 2009.
In November 2007, we completed a $35 million private placement of ordinary shares and warrants issued to institutional investors. Under the Securities Purchase Agreement entered into with the institutional investors, we sold to the investors 2,000,000 ordinary shares at a purchase price of $17.50 per share. The investors were also granted warrants to purchase 800,000 ordinary exercisable during a 5-year term at an exercise price of $21.88. The net proceeds from the offering were mainly used for repayment of debt. As agreed with the investors, we registered the shares purchased by the investors and those underlying the warrants for resale under an effective registration statement.
We have entered into credit facilities with Bank Discount LeIsrael Ltd., Bank HaPoalim Ltd. and the First International Bank Ltd. The aggregate amount outstanding under these credit facilities as of December 31, 2008 and as of March 27, 2009, was $16 million. We use these credit facilities to finance certain acquisitions from to time, to make contingent consideration payments, to re-purchase our shares according to our policy, and for interim financing, in accordance with our cash requirements. In connection with these credit facilities, we are committed to the banks for certain covenants related to our operations, such as:
To date, we have met all such covenants.
As of December 31, 2008, we had cash and cash equivalents of $30.3 million and working capital of $32.4 million. As of December 31, 2007, we had cash and cash equivalents of $22.6 million and working capital of $32.0 million.
Net cash provided by operating activities was $902,000 in 2008 compared to $16.1 million in 2007. Cash provided by operating activities decreased primarily as a result of the decrease in revenues from software sales in 2008 compared to 2007 and increase in turn-key projects in which payments are received according to milestones and a s a result, payments might occur in the following year. Net cash provided by operating activities was $16.1 million in 2007 compared to $8.1 million in 2006. Cash provided by operating activities increased primarily as a result of increase in revenues from software sales in 2007 compared to 2006 which are paid close to delivery.
Although we incurred a loss from continued operation of $20.1 million in 2008, $27.6 million were non-cash charges, such as depreciation and amortization, goodwill impairment and stock-based compensation.
Our capital expenditures include the consideration paid for acquired activities and technologies. For more information about our investments and acquisitions, see Item 4.B. Business OverviewInvestments and Acquisitions.
In 2008, we invested $1.2 million in TIS, our newly consolidated subsidiary. Additional consideration paid in 2008 for previously acquired subsidiaries amounted to $7.9 million. The additional consideration was paid to shareholders of CodeStream, BridgeQuest and to the former shareholders of I-Ter.
In 2007, we invested $2.0 million in BridgeQuest Inc. and $7.0 million in ASNA. Additional consideration paid in 2007 for previously acquired subsidiaries amounted to $1.3 million. The additional consideration was paid with respect to CodeStream and Outlook transactions.
In 2006, we purchased the activities of CodeStream for consideration of $10.2 Million.
Investment in property and computer equipment required to support our research and development activities were $1.2 million in 2008, $1.1 million in 2007 and $650,000 in 2006.
In 2008, we repurchased 677,302 of our shares for an aggregate amount of $1.6 million under our buy-back programs in accordance with the resolution of our board of directors adopted in March 2008 authorizing the repurchase of our shares, subject to market conditions, under our existing buy-back programs. During 2007 and 2006, we did not repurchase any shares under our buy-back programs. As of December 31, 2008, we had repurchased, either by BluePhoenix or through our wholly owned subsidiaries, an aggregate of 2,326,246 of our ordinary shares under our buy-back programs, for an aggregate of approximately $15.1 million. Under our buy-back programs, we may purchase our shares from time to time, subject to market conditions and other relevant factors affecting us. Under the Israeli Companies Law, 1999, referred to as the Companies Law, the repurchased shares held by BluePhoenix do not confer upon their holder any rights. The first buy-back program adopted in May 1998 enables us to purchase our shares, utilizing up to $5 million. Under the second buy-back program adopted in September 1998, and amended in May 1999, we may purchase, up to an additional 2,000,000 ordinary shares. The closing price of our ordinary shares as quoted on the NASDAQ Global Market on March 27, 2009 was $1.98.
In January 2006, we sold an aggregate of 136,000 of the shares held by one of our subsidiaries to Israeli institutional investors in Israel, for aggregate consideration of approximately $534,000. In February 2006, we sold 86,971 shares held by one of our subsidiaries to Outlook Systems Ltd.
For more information about the shares purchased under our buy-back programs, see Item 16E. Purchases of Equity Securities by the Issuer and Affiliated Purchasers.
We believe that cash generated from operations together with existing sources of liquidity and existing credit facilities, will be sufficient to meet our anticipated cash needs for at least the next 18 months.
Contractual Commitments and Guarantees
Warrants Issued in a Private Placement to Institutional Investors
In connection with a private placement to institutional investors consummated in 2004, and further amended in 2005, we issued to the institutional investors, warrants, exercisable until September 2009, for 285,714 ordinary shares at a purchase price of $6.50 per share. Pursuant to our agreement with the institutional investors, in March 2006, the institutional investors exercised their right to purchase from us additional debentures (already fully converted into our shares) and received warrants, exercisable until September 2011, for 200,000 ordinary shares at a purchase price of $4.50 per share.
As of March 27, 2009, none of the warrants have been exercised. As agreed upon by the investors, we registered the shares underlying the warrants for resale under an effective registration statement.
Warrants Issued in November 2007
In November 2007, as part of a $35 million private placement, we issued to institutional investors warrants to purchase an aggregate of up to 800,000 BluePhoenix ordinary shares at an exercise price of $21.88 per share, subject to certain adjustments. These warrants may be exercised during a 5-year period, which commenced in November 2007. As agreed upon by the investors, we registered the shares underlying the warrants for resale under an effective registration statement.
Pursuant to the purchase agreement of CodeStream business activities, as amended in December 2007, we undertook to pay to the selling shareholders in April 2009 an amount of $2.5 million plus interest accrued since January 1, 2008. In addition, in connection with this transaction, we issued in April 2008, 400,000 ordinary shares to certain shareholders of CodeStream. See Item 4.B. Business OverviewInvestments and AcquisitionsCodeStream Software Ltd.
Two of our subsidiaries have entered into agreements with the Office of the Chief Scientist, or OCS. These subsidiaries are obliged to pay royalties to the OCS at a rate of 3% on sales of the funded products, up to 100% of the dollar-linked grant received in respect of these products from the OCS. As of December 31, 2008, the contingent liability amounted to $921,000 million.
Ministry of Production in Italy
In July 2007, our subsidiary, I-Ter, received final approval from the Ministry of Production in Italy for its Easy4Plan product. Easy4Plan is a workflow management tool designed for ISO9000 companies. The total funds amounted to approximately $650,000, of which 30% constitute a grant, and the balance is an 8-year loan to be repaid by I-Ter. The loan bears minimal annual interest. 90% of the funds were received in December 2007. The remaining 10% are expected to be received during 2009 after a review of the Ministry of Production.
Customers bank guarantees
Under agreements between us and certain of our customers, we undertook to provide these customers with bank guarantees for the assurance of performance of our obligations under our agreements with such customers. As of December 31, 2008, there were outstanding bank guarantees on our behalf for our customers in the aggregate amount of $286,350. As of March 31, 2009, we provided additional bank guarantees to our customers in an aggregate amount of $500,000.
We are committed under operating leases for rental of office facilities, vehicles, and other equipment for the years 2009 until 2014. Annual rental fees under current leases are approximately $2.3 million. In connection with the office leases, we issued bank guarantees of $71,000 in the aggregate.
Indemnification of Office Holders
We entered into an undertaking to indemnify our office holders in specified limited categories of events and in specified amounts, subject to certain limitations. For more information, see Item 7.B. Related Party Transactions Indemnification of Office Holders.
Effective Corporate Tax Rates
Following the tax reform enacted in 2003, an Israeli company is subject to tax on its worldwide income. An Israeli company that is subject to Israeli taxes on the income of its non-Israeli subsidiaries will receive a credit for income taxes paid by the subsidiary in its country of residence. Israeli tax payers are also subject to tax on income from a controlled foreign corporation, according to which an Israeli company may become subject to Israeli taxes on certain income of a non-Israeli subsidiary, if such subsidiarys primary source of income is a passive income (such as interest, dividends, royalties, rental income, or capital gains)
On January 1, 2006, an additional tax reform was passed relating primarily to profits from investments. The main goal of the reform was to unify the tax rates applicable to profits from investments, such as interest, capital gains, and dividends. In addition, under the new reform, the tax rates applicable to companies were reduced to 27% in 2008, 26% in 2009, and 25% from 2010 and on.
Our international operations are taxed at the local effective corporate tax rate in the countries of our subsidiaries residence. We believe that in the future we will derive an increasing percentage of our income from operations outside of Israel and that, accordingly, our effective tax rate may increase. However, we expect that this increase will be offset by carried forward accumulated losses of consolidated companies.
For a description of our research and development activities, see Item 4.B. Business Overview Research and Development.
The recent global economic and financial market crisis has caused, among other things, a general tightening in the credit markets, lower levels of liquidity, increases in the rates of default and bankruptcy, and reduced corporate profits and capital spending, all of which have had and continue to have a negative effect on our business, results of operations and financial condition.
Demand for our tools and services depends in large part upon the level of IT capital spending and investment in IT projects by our customers. The current economic conditions have reduced the willingness or ability of our customers and prospective customers to commit funds to IT projects, and may reduce their ability to pay for our tools and services after purchase, whether as a result of possible customer insolvencies or otherwise. This has already resulted in longer sales cycles and increased pressure on pricing. We cannot predict the timing or duration of the global economic crisis or the timing or strength of any subsequent economic recovery. We also cannot know how the economic conditions will affect our business. As we continue to market new products and penetrate international markets, we expect our selling, general and administrative expenses to continue to be relatively high.
The following table summarizes our contractual obligations and commitments as of December 31, 2008:
The above table does not include royalties that we may be required to pay to the OCS and that may reach, in the aggregate, as of December 31, 2008, $921,000. For more information about grants received from the OCS, see Item 4.B. Business Overview Research and Development. We are unable to reasonably estimate the amounts that we will eventually be required to pay to the OCS, if at all, and the timing of such payments, since these payments depend on our ability to sell products based on the OCS-funded technologies and the timing of such sales, if any.
The following table describes information about our executive officers and directors as of March 27, 2009.
Arie Kilman served as our chief executive officer and a director since May 2003 and until January 2009, when he was appointed an executive chairman of our board of directors. Mr. Kilman also served as president and chief executive officer of BluePhoenix Solutions B.V. since its inception in October 2001. Mr. Kilman previously served as the president of Liraz, which he founded in 1984, and managed since then. From 1998 to July 2000, Mr. Kilman served as chief executive officer of Level 8. Mr. Kilman holds a BA degree in economics and computer science from New York University.
Yaron Tchwella was appointed as our chief executive officer in January 2009. Mr. Tchwella first joined our company in August 2008 when he was appointed as our president and assumed responsibility for the overall activities of the company. Mr. Tchwella served during 2007 and 2008 as president of Comverse Inc. Prior to this position and as part of his 11 years at Comverse, Mr. Tchwella served as president of the Messaging Division and a member of the executive management team at Comverse. He has also held various executive managerial positions within the product, delivery and customer-facing organizations. Prior to joining Comverse, Mr. Tchwella held engineering and managerial positions over a 13 year period at Advanced Technology Ltd., known today as Ness Technology. Mr. Tchwella holds a BSc in electrical engineering from Tel Aviv University.
Michael Chill has served as one of our outside directors and a member of our audit committee since July 2003. From January 2008, Mr. Chill has served as a Managing Director at Rodman & Renshaw LLC, an investment bank. From July 2005 through December 2007, Mr. Chill served as Co-head of the Direct Investments at Paramount Biocapital Asset Management Inc., a venture capital hedge fund and broker dealer. Prior to that, Mr. Chill served as an analyst and independent advisor to various high technology companies and venture capital firms both in Israel and the United States. During 2000 and the first half of 2001, Mr. Chill served as the president and head of investment banking department at Jerusalem Global Ltd., a venture capital and investment banking firm. Prior to that, from 1999, Mr. Chill served as a managing director in the technology investment banking group at Gruntal and Co. Mr. Chill holds a B.S. in accounting from the Sy Syms School of Business at Yeshiva University and an MBA from the Columbia Business School.
Amira Berkovitz -Amir has served as one of our outside directors and as a member of our audit committee since December 2004. Since March 2007, Ms. Berkovitz-Amir has served as a director of finance of the Baruch Padeh Medical Center, Poriya. Until October 2005, Ms. Berkovitz-Amir served as vice president, finance of Of-Tov Products (2001) Ltd., a manufacturer in the food industry and a member of Osem Industries Group. Previously, Ms. Berkovitz-Amir served as vice president, finance and controller of Pri-Hagalil Industries, a manufacturer in the food industry. Ms. Berkovitz-Amir holds a BA degree in economics and accounting and an MA in business administration, both from the Hebrew University. Ms. Berkovitz-Amir is a certified public accountant in Israel.
Sam Somech has served as one of our outside directors since January 2009 and also serves as a member of our audit committee. Since 2007, Mr. Somech has served as a chairman of the boards of directors of Corelsense, Inc., Dapper, Inc., Action Base, Inc., and GigaSpaces, Inc. Mr. Somech has also served as a director of Super Derivatives, Inc. since 2004. In 2004, Mr. Somech co-founded Itemfield, Inc. (which was later sold to Informatica, Inc.) and served as its chief executive officer from its inception until 2006. Previously, Mr. Somech served as president and chief technology officer of Level 8, Inc., a public company traded on the NASDAQ, which he co-founded in 1995. Prior to that, Mr. Somech founded and served as chief executive officer of Data Voice Systems, Inc. Mr. Somech holds a B.S. in electrical engineering from the Technion, Israel Institute of Technology, an M.Sc. in computer science from Columbia University and an MBA from Baruch College.
Gur Shomron has served as one of our directors and as a member of our audit committee from July 2005 through December 2007, and was reappointed as a our director and as a member of our audit committee in May 2008, replacing a former director who resigned. Mr. Shomron has served as the chairman of the board of directors of Fidelis Diagnostics Inc. since 2004. Prior to that, Mr. Shomron served as a chairman of the board and chief executive officer of Mainsoft Corporation, a venture partner at StageOne VC fund, the president of Foraz R&D Fund and co-founder and R&D manager of Quality Computers 77 Ltd. Mr. Shomron is also a director of business development of Tangent Logic, Inc. and serves as a director of several privately-held high technology companies.
Varda Sagiv has served as our chief financial officer since June 2007. From 1998 until 2007, Ms. Sagiv served as the chief financial officer of Formula Ventures Ltd., a venture capital fund manager. Ms. Sagiv holds a BA in accounting from Tel Aviv University, and is a certified public accountant in Israel.
Eliezer Harkavi has served as our chief operations officer since January 2007. From January 2009 he is also serving as General Manager of the Legacy Modernization LOB (Line of Business). In his prior roll, since 1997, Mr. Harkavi served as our vice president of delivery and research and development. Prior to that, Mr. Harkavi served for 10 years as a director of software development Amdocs Ltd., a worldwide leader in customer care and billing systems. His responsibilities included management of several major development and implementation projects in the USA and Europe. Mr. Harkavi holds a BS in industrial engineering and management (cum laude) from the Technion, Israel Institute of Technology.
James Colby joined our management team in December 2008 as our chief marketing officer. Since 1997, Mr. Colby held a variety of director and vice president marketing positions in Unisys and Comverse. Mr. Colbys career with Comverse spanned some nine years, from 1999 until 2008 culminating in the position of general manager and chief marketing officer for the American division. In 2008, after leaving Comverse and the telecommunications industry, Mr. Colby took on the role of VP marketing at Insightix, a supplier of IT network visibility solutions. Mr. Colbys career in telecommunications started in 1988 in the United Kingdom where he held network engineering management positions at Orange and Vodafone. Mr. Colby holds a B.Sc. in physics and electronics from the University of Kent.
Len Erlikh joined our company in 2007 as our chief technology officer following the acquisition of BridgeQuest, where he was co-founder and chief technology officer. Prior to BridgeQuest, from 1997 until 2002, Mr. Erlikh served as chief technology officer of Relativity Technologies, a supplier of application modernization and application portfolio management software. Before co-founding Relativity Technologies, between 1990 and 1996, Mr. Erlikh also helped establish Seer Technologies, where he served as senior vice president of development and general manager of technology division. Mr. Erlikh holds a B.A.A in computer applications and business from Baruch College, CUNY, an M.S in advanced technology from SUNY in Binghamton, and a Ph.D from St. Petersburg State University, Russia.
Yael Peretz has served as our general counsel since 2000. Prior to joining BluePhoenix, Ms. Peretz worked as a lawyer with Shine, Hunter & Martin, a law firm. Ms. Peretz holds an LLB from the Hebrew University in Jerusalem and an MA in business administration from Tel Aviv University. Ms. Peretz is a member of the Israel Bar.
Greg Schottland has served as our vice president, sales, North America since December 2006, when we acquired certain business activities of CodeStream (formally Xitec Software) where he served as president. Prior to his work in the legacy modernization market, he founded and led Advanced Software Technologies. Mr. Schottland holds an M.S. in computer science from the University of Illinois and a B.S. in business from the University of Colorado.
Javier Jimenez has served as our vice president, sales, Americas since September 2008. Mr. Jimenez was the founder and chief executive officer of Scientia Network Solutions, a technology and consulting company. Prior to that, from 2003 to February 2008, Mr. Jimenez served as vice president and general manager of Comverse Latin America. From 1994 to 2000 he held a variety of management positions within Comverse including: sales, program management and channel management. From 2000 to 2002, Mr. Jimenez was vice president of sales Latin America for iWeb Technologies. From 1984 to 1994, Mr. Jimenez held a variety of engineering management positions for Lucas Aero Space, a Long Island New York defense contractor. Mr. Jimenez holds a B.Sc. in electrical engineering through the United States Air Force, an MBA from the Dowling Institute in New York and also completed the Global Leadership Program in Organizational Structure through the Technion Institute of Management in co-operation with MIT and Harvard Schools of Business.
Oren Gil-Or has served as our vice president, sales, EMEA & APAC since November 2008. From 2005 until 2008, Mr. Gil-Or was the senior director of marketing for BMC Software Asia Pacific. In 2001-2005, Mr. Gil-Or served as the marketing director for the application management business unit within BMC Software as well as a field marketing director within the worldwide marketing organization. From 1998 until 2000, Mr. Gil-Or served as the international sales director for New Dimension. Mr. Gil-Or holds an MBA from Tel-Aviv University and a BSc in computers science from Ben-Gurion University.
Steven Dmiszewicki was appointed our vice president and general manager, professional services in 2007, following the acquisition of BridgeQuest, where he was co-founder and chief executive officer. . Prior to 2003, Mr. Dmiszewicki held positions as managing director of a management consulting firm and president and chief executive officer at Level 8 Mr. Dmiszewicki came to Level 8 as part of the acquisition of Seer Technologies, where he held the post of co-president. Mr. Dmiszewicki originally joined Seer in 1990 and had a series of senior management positions in the company, including chief financial officer. Before 1990, Mr. Dmiszewicki held management positions with several UK-based investment banking firms. He is on the advisory board of several technology companies and is a graduate of Bucknell University.
In 2008, we paid to all of our directors and executive officers, as a group (15 persons), aggregate remuneration of approximately $2.2 million. This amount includes bonuses and amounts set aside or accrued to provide pension, social security or similar benefits but do not include amounts expended by us for automobiles made available to our officers and expenses (including business travel, professional and business association dues and expenses) reimbursed to officers.
Under Israeli law, we are not required to disclose, and have not otherwise disclosed, the compensation of our senior management and directors on an individual basis, except for Mr. Kilman, the active chairman of our board of directors whose compensation was recently approved by our shareholders.
We maintain written employment agreements with our officers. The employment agreements are not for a specific term and we may terminate them upon prior notice of between one and nine months. If we terminate the employment agreements, we will have to pay the usual severance pay required under Israeli law for all employees. Our directors, unless they also serve as officers, are not entitled to any benefits upon termination. The agreements with our officers provide for annual base salary and other benefits like vacation, sick leave, provision of an automobile, insurance contributions, and non-compete and confidentiality agreements.
Mr. Kilmans Employment Agreement
In December 2008, our shareholders approved, following the approval of our audit committee and our board of directors, the compensation of Mr. Arie Kilman, the executive chairman of our board of directors, as follows: (a) a base salary of $350,000 per annum, paid monthly, to be calculated based on the US$ representative exchange rate published by the Bank of Israel, but in any event such exchange rate shall be no less than NIS 3.35 per US$1; and (b) 90,000 restricted share units, referred to as RSUs, to be granted quarterly, at the end of each calendar quarter in 2009, and such other amount of RSUs in each quarter of the following years of service as to be determined by our board of directors. The RSUs will be granted under the terms and conditions set forth in our 2007 Award Plan. The RSUs shall vest in three equal installments over a 3-year period, on the date of grant and on the first day of each of two additional years of service. In addition, Mr. Kilman will be entitled to a bonus as described below, if the targets defined by our board of directors for each fiscal year of employment (beginning in 2009) are achieved and the terms defined by the board are fulfilled:
During the employment term, Mr. Kilman shall be entitled to a benefits package which includes, inter alia, contributions by our company to a Managers Insurance Policy in an amount equal to 8.33% of the base salary, Further Education Fund contributions by our company of 7.5% of the base salary, up to 26 vacation days per year, sick leave according to the law and recuperation pay as required by law. Mr. Kilman shall also be entitled to reimbursement for out-of-pocket expenses reasonably incurred by him in connection with his service, and to use a company car which all of its expenses shall be borne by us. The agreement is for a three-year period beginning on January 1, 2009. The agreement shall be renewed automatically for successive three-year periods (unless terminated by either of the parties in accordance with the terms of the agreement). Each of the parties shall be entitled to terminate the agreement upon 6-months prior notice, or a shorter period in certain circumstances defined in the agreement. The agreement with Mr. Kilman provides for compensation upon termination in such amounts and on such terms described in the agreement, such compensation to be paid in addition to earned amounts and vested benefits. The agreement with Mr. Kilman also includes non-competition and non-solicitation provisions. Mr. Kilman will focus on strategic customers and alliances, M&A activity and the Companys long term strategic direction.
Compensation of Our Non-Employee Directors
Our non-employee directors, which currently include Gur Shomron, receive cash compensation, as approved by our audit committee and the board of directors in accordance with the Companies Regulations (Reliefs in Transactions with Related Parties) 2000 in the same amounts and on such terms payable to our outside directors. See Compensation of our Outside Directors below. In addition, our shareholders approved in December 2008, following the approval of our audit committee and the board of directors, the grant of RSUs to each of our non-employee directors, as follows:
Furthermore, our shareholders approved, following the approval of our audit committee and the board of directors, the grant of 2,000 RSUs to Mr. Gur Shmoron, for his service as a director during 2008.
Non-employee directors referred to above include directors serving on our board of directors from time to time, including outside directors, and excluding directors that receive or may receive compensation or management fees from us.
The RSUs shall vest in three equal annual installments over a 3-year period, on the date of grant of the RSUs and on the first day of each of two additional years of service. The grant of the RSUs shall be under the terms set forth in our 2007 Award Plan and in accordance with our standard grant letter. In the event of termination of the service of a non-employee director (excluding outside directors), all outstanding RSUs previously granted shall be automatically vested, unless termination was made in accordance with sections 227A, 228(a)(2) (5) or 231-234 of the Companies Law.
Compensation of Our Outside Directors
In December 2008, our shareholders approved, following the approval of our audit committee and our board of directors, the compensation payable to our outside directors as follows:
The abovementioned amounts are linked to the Israeli consumer price index as provided in the Outside Directors Regulations.
The cash compensation shall be paid to the outside directors on the first day of each quarter for the preceding quarter.
In addition to the cash compensation, our shareholders approved, following the approval of our audit committee and the board of directors, the grant of RSUs to each of our outside directors in the same amounts and on such terms granted to our non-employee directors.
Pursuant to our articles of association, directors are elected at a general meeting of our shareholders by a vote of the holders of a majority of the voting power represented at the meeting. Additional directors may be elected between general meetings by a majority of our directors. Our board is comprised of 5 persons, of which 4 have been determined to be independent within the meaning of the applicable NASDAQ requirements. Three of these independent directors also serve as outside directors mandated under Israeli law and subject to additional criteria to help ensure their independence. See Outside Directors, below. Each director, except for the outside directors, holds office until the next annual general meeting of shareholders. Officers are appointed by our board of directors.
Under a recent amendment to the Companies Law, a person who lacks the necessary qualifications and the ability to devote an appropriate amount of time to the performance of his or her duties as a director shall not be appointed director of a publicly traded company and shall not serve as a director of such company. While determining a persons compliance with such provisions, the companys special requirements and its scope of business shall be taken into account. Where the agenda of a shareholders meeting of a publicly traded company includes the appointment of directors, each director nominee should submit a declaration to the company confirming that he or she has the necessary qualifications and he or she is able to devote an appropriate amount of time to performance of his duties as a director. In the declaration, the director nominee should specify his or her qualifications and confirm that the restrictions set out in the Companies Law, do not apply.
Under the Companies Law, if a director ceases to comply with any of the requirements provided in the Companies Law, such director must notify the company immediately about it, and his term of service shall terminate on the date of the notice.
Our board of directors has appointed an option committee, comprised of Messrs. Michael Chill, Amira Berkovitz-Amir and Arie Kilman. The option committee is responsible for granting options and restricted share units to employees and consultants. Options and restricted share units may also be granted by the majority of the independent directors.
The compensation of our executive officers, including options and other share-based compensation, is determined by the independent members of our board of directors. The compensation of officers that requires the approval of the audit committee or any other additional approval under applicable law, is also brought for such entities additional approval.
Outside Directors Under the Companies Law
Under the Companies Law, companies incorporated under the laws of Israel whose shares have been offered to the public in or outside of Israel, are required to appoint at least two outside directors. The Companies Law provides that a person may not be appointed as an outside director if the person or the persons relative, partner, employer, another person to whom he was directly or indirectly subject, or any entity under the persons control, has, as of the date of the persons appointment to serve as outside director, or had, during the two years preceding that date, any affiliation with the company or any entity controlling, controlled by or under common control with the company. The term affiliation includes:
No person may serve as an outside director if the persons position or other business activities create, or may create a conflict of interest with the persons responsibilities as an outside director or may otherwise interfere with the persons ability to serve as an outside director or if the person is an employee of the Israel Securities Authority or of an Israeli stock exchange. If, at the time of election of an outside director, all other directors are of the same gender, the outside director to be elected must be of the other gender. Outside directors are elected by a majority vote at a shareholders meeting, provided that either:
Pursuant to the Companies Law, all outside directors must have financial and accounting expertise or professional qualifications, and at least one outside director must have financial and accounting expertise. The terms financial and accounting expertise and professional qualifications have been defined in regulations promulgated under the Companies Law.
If an outside director ceases to comply with any of the requirements provided in the Companies Law with respect to the appointment of outside directors, such outside director must notify the company immediately about it, and his term of service shall terminate on the date of the notice.
The initial term of an outside director is three years and may be extended for an additional three years. At present, Michael Chill, Amira Berkovitz-Amir and Sam Somech serve as our outside directors, Mr. Chill to hold office until July 2012, Ms. Berkovitz-Amir until December 2010 and Mr. Somech until December 2011. In accordance with the Israeli Companies Regulations (Alleviation for Public Companies Whose Shares are Listed on a Stock Exchange Outside of Israel) 2000, dual listed companies, like us, may re-appoint an outside director for an additional three-year term, above the maximum six-year term permitted under the Companies Law, if the audit committee and the board of directors confirm that due to the expertise and special contribution of the outside director to the work of the board and its committees, his re-appointment is in the best interests of the company.
Each committee exercising the powers of the board of directors is required to include at least one outside director. However, the audit committee should include all the outside directors.
An outside director is entitled to compensation as provided in regulations promulgated under the Companies Law and is otherwise prohibited from receiving any compensation, directly or indirectly, in connection with services provided as an outside director. For more information about the compensation of our outside directors, see Item 6.B. Compensation-Compensation of Our Outside Directors.
Independent Directors Under the Companies Law
Under a recent amendment to the Companies Law, a publicly traded company may prescribe in its articles of association that its board of directors shall include independent directors in such number or such percentage as to be provided in the articles. An independent director is defined as a director who meets all of the following:
The Companies Law provides that if the company has no controlling shareholder or a shareholder that holds at least 25% of the voting rights in the company, most of the members of the board shall be independent directors. If the company has a controlling shareholder or a shareholder that holds at least 25% of the voting rights therein, at least one-third of the directors shall be independent directors.
As of the date of this annual report, our articles of association have not yet been amended to include the new provisions of the Companies Law relating to independent directors.
Qualifications of Other Directors Under the Companies Law
Under the Companies Law, the board of directors of a publicly traded company is required to make a determination as to the minimum number of directors who must have financial and accounting expertise according to criteria that is defined in regulations promulgated under the Companies Law. In accordance with the Companies Law, the determination of the board should be based on, among other things, the type of the company, its size, the volume and complexity of its activities and the number of directors. Based on the foregoing considerations, our board determined that the number of directors with financial and accounting expertise in our company shall not be less than two.
The Companies Law requires public companies to appoint an audit committee, comprised of at least three directors, which must include all of the companys outside directors. The chairman of the board of directors, any director which is employed or provides services to the company, and a controlling shareholder or any relative of a controlling shareholder, may not be a member of the audit committee.
In addition, under applicable NASDAQ rules, we are currently required to have at least three independent directors and to maintain an audit committee, whose members are independent of management. Our outside directors qualify as independent directors under the applicable NASDAQ rules and those of the Securities and Exchange Commission. We have established an audit committee, consisting of Mr. Gur Shomron and our three outside directors, Mr. Michael Chill, Ms. Amira Berkovitz-Amir and Mr. Somech. The board has determined that both Michael Chill and Amira Berkovitz-Amir are audit committee financial experts as defined by applicable SEC regulations.
Under the Companies Law, the audit committee is responsible for overseeing the business management practices of the company in consultation with the companys internal auditor and the independent auditor, making recommendations to the board to improve such practices and approving related party transactions as required by the Companies Law. In accordance with the Sarbanes-Oxley Act and NASDAQ requirements, our audit committee is directly responsible for the appointment, compensation and oversight of our independent auditors. In addition, the audit committee is responsible for assisting the board in monitoring our financial statements and the effectiveness of our internal controls. We have adopted a formal audit committee charter that we have implemented, embodying these responsibilities. The audit committee reviews and reassesses the adequacy of the audit committee charter on an annual basis.
Under the Companies Law, the board of directors appoints an internal auditor, nominated by the audit committee. The role of the internal auditor is to examine, among other matters, whether the companys actions comply with the law and orderly business procedure. Under the Companies Law, the internal auditor may be an employee of the company but not an office holder, or an interested party (defined as a holder of 5% or more of the voting rights in the company or of its issued share capital, the chief executive officer of the company or any of its directors, or a person who has the authority to appoint the companys chief executive officer or any of its directors), or a relative of an office holder or of an interested party. In addition, the companys external auditor or its representative may not serve as the companys internal auditor.
Approval of Certain Transactions under the Companies Law
The Companies Law codifies the fiduciary duties that office holders, including directors and executive officers, owe to a company. An office holders fiduciary duties consist of a duty of care and a duty of loyalty. The duty of loyalty includes (i) avoiding any conflict of interest between the office holders position in the company and his personal affairs; (ii) avoiding any competition with the company; (iii) avoiding exploiting any business opportunity of the company in order to receive personal advantage for himself or others; and (iv) revealing to the company any information or documents relating to the companys affairs that the office holder has received due to his position as an office holder. Each person listed in the table under Directors and Senior Management above is an office holder.
Under the Companies Law, arrangements regarding the compensation of directors require the approval of the audit committee, the board of directors and shareholder approval.
The Companies Law requires that an office holder of a company promptly disclose any personal interest that he or she may have and all related material information known to him or her, in connection with any existing or proposed transaction by the company. In addition, if the transaction is an extraordinary transaction as defined under the Companies Law, the office holder must also disclose any personal interest held by the office holders spouse, siblings, parents, grandparents, descendants, spouses descendants and the spouses of any of the foregoing.
In addition, the office holder must also disclose any interest held by any corporation in which the office holder owns 5% or more of the share capital, is a director or general manager or in which he or she has the right to appoint at least one director or the general manager. An extraordinary transaction is defined as a transaction other than in the ordinary course of business, otherwise than on market terms or that is likely to have a material impact on the companys profitability, assets or liabilities.
Under the Companies Law, after the office holder complies with the disclosure requirements described above, only board approval is required for any transaction that is not an extraordinary transaction, unless the articles of association of the company provide otherwise, and provided the transaction is not adverse to the companys interest. If the transaction is an extraordinary transaction, the company must receive any approval stipulated by its articles of association, the approval of the audit committee, the approval of the board of directors and shareholder approval. An office holder who has a personal interest in a matter that is considered at a meeting of the board of directors or the audit committee may not be present at this meeting or vote on this matter unless the majority of the board members or members of the audit committee, as applicable, have a personal interest in such matter and in such case, the matter should also be approved by the shareholders of the company.
The Companies Law applies the same disclosure requirements to a controlling shareholder of a public company, including a shareholder that holds 25% or more of the voting rights in the company if no other shareholder owns more than 50% of the voting rights in the company. Extraordinary transactions with a controlling shareholder or in which a controlling shareholder has a personal interest, and the terms of compensation of a controlling shareholder or its relative who is an office holder or an employee of the company, require the approval of the audit committee, the board of directors and the shareholders of the company. The shareholder approval must include at least one-third of the shareholders who have no personal interest in the transaction and are voting on the subject matter or, alternatively, the total shareholdings of those who have no personal interest in the transaction who vote against the transaction must not represent more than one percent of the voting rights in the company. In certain cases provided in regulations promulgated under the Companies Law, shareholder approval is not required.
The approvals of the board of directors and shareholders are required for a private placement of securities (or a series of related private placements during a 12-month period or that are part of one continuous transaction or transactions conditioned upon each other) in which:
Under the Companies Law, a shareholder has a duty to act in good faith towards the company and other shareholders and to refrain from abusing his power in the company including, among other things, voting in a general meeting of shareholders on the following matters:
In addition, any controlling shareholder, any shareholder who knowingly possesses power to determine the outcome of a shareholder vote and any shareholder who, pursuant to the provisions of a companys articles of association, has the power to appoint or prevent the appointment of an office holder in the company, is under a duty to act with fairness towards the company. The Companies Law does not describe the substance of this duty.
For information concerning personal interests of certain of our office holders and our principal shareholders in certain transactions with us, see Item 7.B. Related Party Transactions.
Exculpation, Insurance and Indemnification of Directors and Officers
Under the Companies Law, an Israeli company may not exempt an office holder from liability with respect to a breach of his duty of loyalty, but may exempt 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, provided, however, that such a breach is not related to a distribution of a dividend or any other distribution by the company.
Office Holders Insurance
Our articles of association provide that, subject to the provisions of the Companies Law, we may enter into a contract for insurance of all or a part of the liability of any of our office holders imposed on the office holder in respect of an act performed in his or her capacity as an office holder, in respect of each of the following:
Indemnification of Office Holders
Our articles of association provide that, subject to the provisions of the Companies Law, we may indemnify our office holders in respect of an obligation or expense specified below imposed on an office holder in respect of an act performed in his or her capacity as an office holder, as follows:
We may undertake to indemnify an office holder as aforesaid, (a) prospectively, provided that in respect of (i) above, the undertaking is limited to categories of events that in the opinion of our board of directors are foreseeable in light of the companys operations at the time that the undertaking to indemnify is given, and for an amount or criteria that our board has determined as reasonable under the circumstances, and further provided that that such events and amount or criteria are indicated in the indemnification undertaking; and (b) retroactively.
We have entered into an undertaking to indemnify our office holders in specified limited categories of events and in specified amounts, subject to the limitations set by the Companies Law and our articles of association, as described above. For more information, see Item 7.B. Related Party Transactions Indemnification of Office Holders.
Limitations on Exemption, Insurance and Indemnification
The Companies Law provides that a company may not indemnify an office holder, enter into an insurance contract that would provide coverage for any monetary liability, or exempt an office holder from liability, with respect to any of the following:
In addition, under the Companies Law, indemnification of, and procurement of insurance coverage for, our office holders must be approved by our audit committee and our board of directors and, in specified circumstances, by our shareholders.
We have procured directors and officers liability insurance and obtained all necessary approvals.
The table below presents certain information regarding the number of our employees, the sector in which they are employed and their geographical area of employment, in the periods indicated.
The numbers of employees indicated in the table above include expert consultants who we train for the implementation of our modernization tools and methodologies.
With respect to our employees in Israel, we are subject to various Israeli labor laws and labor practices, and to administrative orders extending certain provisions of collective bargaining agreements between the Histadrut (Israels General Federation of Labor) and the Coordinating Bureau of Economic Organizations (the Israeli federation of employers organizations) to all employees in Israel.
For example, mandatory cost of living adjustments, which compensate Israeli employees for a portion of the increase in the Israeli consumer price index, are determined on a nationwide basis. Israeli law also requires the payment of severance benefits upon the termination, retirement or death of an employee. We meet this requirement, inter alia, by contributing on an ongoing basis towards managers insurance and pension funds. In addition, Israeli employers and employees are required to pay specified percentages of wages to the National Insurance Institute, which is similar/compatible with the United States Social Security Administration. Other provisions of Israeli law and regulations govern matters such as the length of the workday, minimum wages, other terms of employment and restrictions on discrimination. We are also subject to the labor laws and regulations of other jurisdictions in the world where we have employees.
The following presents information regarding the ownership of our ordinary shares by the persons listed in the table under Directors and Senior Management, as of March 27, 2009. The percentage of outstanding ordinary shares is based on 20,835,758 ordinary shares outstanding as of March 27, 2009 (excluding 2,326,246 held by BluePhoenix).
Unless otherwise specifically indicated, the address of each of the persons set forth below is at c/o BluePhoenix, 8 Maskit Street, Herzliya 46733.
Arrangements Involving the Issuance of BluePhoenixs Shares or Grant of Options to Purchase Shares
In 1996, we adopted two option plans. One of these option plans was terminated after all options granted under it had been exercised. Pursuant to our other 1996 option plan, as amended, we reserved 3,700,000 ordinary shares for issuance to our and our subsidiaries directors, officers, consultants and employees. As of March 27, 2009, options to purchase 114,598 ordinary shares are available for future award under the plan. The exercise price of the options granted under the 1996 option plan ranges from $2.25 to $10.50.Our board of directors administers our 1996 option plan. Under the 1996 option plan, as amended, options to purchase our ordinary shares may be granted to our and our subsidiaries directors, officers, consultants and employees. Our board of directors is empowered, among other things, to designate the grantees, dates of grant, the exercise price of the options and the terms of exercise of the options. Unless determined otherwise by the board, the options generally vest over a three-year period. Unvested options are forfeited shortly following termination of employment, unless otherwise agreed. Under the 1996 option plan, the grantee is responsible for all personal tax consequences of the grant and the exercise of the options. Each option granted under the 1996 option plan is exercisable during a term of ten years from the date of grant of the option. The 1996 option plan will expire on August 6, 2013, except as to options outstanding on that date.
The following table presents information regarding the ownership of our ordinary shares at March 27, 2009 by each person known to us to be the beneficial owner of 5% or more of our ordinary shares. Options to purchase ordinary shares that are currently exercisable or exercisable within 60 days after the date of this report are deemed outstanding and beneficially owned by the person holding the options for the purpose of computing the percentage ownership of that person, but are not treated as outstanding for the purpose of computing the percentage ownership of any other person. Except where we indicated otherwise, we believe, based on information furnished by these owners, that the beneficial owners of our shares listed below have sole investment and voting power with respect to the shares.
All of our ordinary shares have equal voting rights. Under our two buy-back programs (as described in Item 5.B. Liquidity and Capital Resources above), two of our subsidiaries purchased ordinary shares, and as of March 27, BluePhoenix holds 2,326,246 of our ordinary shares. Under applicable Israeli law, so long as the shares are held by BluePhoenix, they do not confer upon their holder any rights.
As of March 23, 2009, there were 32 record holders of our ordinary shares. Of these record holders, 22 holders had mailing addresses in the United States owning an aggregate 97% of our outstanding ordinary shares.
Transactions Between Us and Our Subsidiaries
MultiConn Technologies, in which we held 40% of the outstanding share capital was consolidated in our financial statements commencing 2004. We agreed to make a certain loan to MultiConn Technologies as part of our agreement to acquire an interest in the company. The outstanding debt as of March 27, 2009 owed by MultiConn Technologies to us amounted to $1.1 million, the same as on December 31, 2008 and December 31, 2007. The loan is stated in NIS and is linked to the changes in the NIS to US dollar exchange rates. There is no set maturity date for this debt. During 2008, we purchased the remaining outstanding share capital of MultiConn Technologies not owned by us and we currently wholly own MultiConn Technologies, and the loan and related interest has been eliminated in consolidating our financial statements.
In 2000, we entered into a management agreement with Mainsoft (which was our subsidiary until June 2008), under which we provided Mainsoft with management and advisory consulting services until December 2007. The annual rate, as amended in January 2006, and was set at $60,000 and paid annually. In October 2008, Mainsoft paid to us an amount of $60,000 as a final payment for these services. Accordingly, $60,000 was the full amount paid during 2008 and no amounts have been paid in 2009.
Indemnification of Office Holders
Since July 2003, we grant to our office holders indemnification letters covering acts performed in their capacity as office holders or employees of our company. In December 2005, our shareholders approved an amendment to those indemnification letters, following an amendment to the Companies Law. Pursuant to the amended indemnification letters, we undertake to indemnify each office holder to the maximum extent permitted by law in respect of the following for any act or omission taken or made by the office holder in his or her capacity as an office holder of our company:
The indemnification also applies to any action taken by the office holder in respect of an act performed in his or her capacity as an office holder or an employee of one of our subsidiaries or as a director or observer at board of directors meetings of one of our affiliates. Our undertaking for indemnification is limited to up to 25% of our shareholders equity at the time of the claim for indemnification.
Our undertaking for indemnification does not apply to a liability incurred as a result of any of the following:
Our undertaking for indemnification is limited to such events specified in the indemnification letter and determined by our board of directors to be foreseeable in light of the companys operations.
Under the indemnification letters, we exempt our office holders to the fullest extent permitted by law, from liability for damages caused as a result of a breach by the office holder of his or her duty of care to the company.
Office Holders Insurance
We procured an insurance policy covering our directors and officers liability. Our subsidiaries participate in the premium payments of the insurance, on a proportional basis. The total premium we paid during 2008 was $305,000, including a run-off policy for 7 years for former directors and officers.
The financial statements required by this item are found at the end of this annual report, beginning on page F-1.
We are not involved in any proceedings in which any of our directors, members of our senior management or any of our affiliates is either a party adverse to us or to our subsidiaries or has a material interest adverse to us or to our subsidiaries. We are also not involved in any material legal proceedings, except as described below.
In July 2003, a former Liraz shareholder filed an application with the Tel Aviv, Jaffa District Court to approve a claim filed by him against us, as a class action. The claim relates to the acquisition of Liraz shares, which we completed in March 2003. The shareholder alleges that the share price we paid to Lirazs shareholders in the tender offer and in a subsequent mandatory purchase was lower than the fair price of Liraz shares. The maximum amount of the claim is approximately $8.7 million in the aggregate. Under Israeli law, the courts approval is required for the plaintiff to represent all of the shareholders of Liraz who sold their shareholdings to us pursuant to the tender offer and the mandatory acquisition. The plaintiff has applied for such approval in the lawsuit. Based on our analysis of the statement of claim, including an evaluation of the fair value of the Liraz shares, and the price paid for Liraz in a previous transaction immediately prior to the tender offer, we believe that the allegations against us in this proceeding are without merit and we intend to vigorously defend the claim and contest the allegations made therein.
In January 2008, we entered into an agreement for the purchase of the entire outstanding share capital of TIS. We are currently in a dispute with TIS regarding the earn-out calculation for 2008, and therefore, we notified TIS selling shareholders that we are not going to pay them the down payment for the year 2008, which was due in February 2009. Immediately following such notice, the selling shareholders notified us of their intent to submit a claim against us for such payment. As of the date of this annual report, a claim has not yet been filed with the court. Our exposure in that regard might be up to $5 million. We believe we can defend our position.
We have never declared or paid dividends to our shareholders and we do not intend to pay dividends in the future. We anticipate that we will retain all of our future earnings for use in the expansion and operation of our business. We are not subject to any contractual restrictions on paying dividends. Any future determination relating to our dividend policy will be made at the discretion of our board of directors and will depend on a number of factors, including our future earnings, capital requirements, financial condition, future prospects and other factors as the board of directors may deem relevant. Israeli law limits the distribution of cash dividends to the greater of retained earnings or earnings generated over the two most recent years, in either case provided that we reasonably believe that the dividend will not render us unable to meet our current or foreseeable obligations when due.
Except as otherwise disclosed in this annual report, there has been no material change in our financial position since December 31, 2008.
The following table shows the high and low closing price for our ordinary shares on the NASDAQ Global Market for the periods indicated.
The following table shows the high and low closing price for our ordinary shares on the TASE for the periods indicated.
Our ordinary shares have been traded in the United States on the NASDAQ Global Market since our initial public offering on January 30, 1997 and were not publicly traded prior to this date. The symbol on the NASDAQ Global Market for our ordinary shares is BPHX. On January 21, 2001, we listed our ordinary shares for trading on the TASE. Our series A convertible notes were traded on the TASE from February 12, 2006 and until February 19, 2008.
We are registered with the Israeli Companies Register under the number 52-004306-8. Our objects are specified in our memorandum of association. These objects include:
Description of Our Share Capital
Our company share capital consists of ordinary shares. Our articles of association do not restrict in any way the ownership of our ordinary shares by nonresidents, except that these restrictions may exist with respect to citizens of countries that are in a state of war with Israel.
Transfer of Shares
Fully paid ordinary shares are issued in registered form and may be freely transferred under our articles of association unless the transfer is restricted or prohibited by another instrument.
Modification of Class Rights
Under our articles of association, the rights attached to any class unless otherwise provided by the terms of the class, including voting, rights to dividends and the like, may be varied by adoption of the necessary amendment to the articles of association, provided that the affected shareholders approve the change by a class meeting in which a simple majority of the voting power of the class represented at the meeting and voting on the matter approves the change.
Dividend Rights and Liquidation Rights
Our board of directors is authorized to declare dividends, subject to the provisions of the Companies Law. Dividends, if declared, shall be paid to the holders of ordinary shares according to their rights and interests in our profits. Dividends on our ordinary shares may be paid only out of profits and other surplus, as defined in the Companies Law, as of the end date of the most recent financial statements or as accrued over a period of two years, whichever is higher. Alternatively, if we do not have sufficient profits or other surplus, then permission to effect a distribution can be granted by order of an Israeli court. In any event, our board of directors is authorized to declare dividends, provided there is no reasonable concern that the dividend will prevent us from satisfying our existing and foreseeable obligations as they become due. Under the Companies Law, the declaration of a dividend does not require the approval of the shareholders of the company, unless the companys articles of association require otherwise. Our articles of association provide that our board of directors may declare and pay dividends without any further action of our shareholders. Dividends may be paid in cash or in kind. We may pay the dividend as an allotment of shares or a distribution of assets. If we do decide to issue dividends by an allotment of shares at a price lower than the nominal value of those shares, we must convert a portion of our profits or any other source of equity to share capital in an amount equal to the difference between the nominal value of the shares and the price paid in the dividend. If dividends remain unclaimed for seven years from the date we declared the dividend, they lapse and revert back to us. In case of liquidation, after satisfying liabilities to creditors, our assets will be distributed to the holders of ordinary shares in proportion to their holdings. This right may be affected by the grant of a preferential dividend or distribution rights to the holders of a class of shares with preferential rights that may be authorized in the future.
In accordance with our articles of association, we may issue redeemable shares and accordingly redeem those shares. Our board may attach to redeemable shares the attributes of shares, including voting rights and the right to participate in profits.
Voting, Shareholder Meetings and Resolutions
Holders of our ordinary shares have one vote for each ordinary share held on all matters submitted to the vote of shareholders. These voting rights may be affected by the grant of any special voting rights to the holders of a class of shares with preferential rights that may be authorized in the future.
We must hold an annual general meeting once a year with a maximum period of fifteen months between the meetings. All other meetings of shareholders other than annual general meetings are considered special general meetings. Our board of directors may, whenever it decides it is appropriate, and shall, within 21 days after receiving a written demand from one director or from one or more shareholders representing at least 10% of the outstanding share capital and 1% of the voting power, call a special general meeting. The quorum required for a general meeting of shareholders consists of two or more holders present in person or by proxy who hold or represent at least 35% of the voting power. A meeting adjourned for a lack of a quorum generally is adjourned to the same day in the following week at the same time and place or to another later time if such time is specified in the original notice convening the general meeting or if we give notice to the shareholders of another time at least 72 hours before the date fixed for the adjourned meeting. At the reconvened meeting, if a quorum is not present within half an hour from the time appointed for holding the meeting, the required quorum will consist of two shareholders present in person or by proxy.
Under the Companies Law, unless otherwise provided in the articles of association or applicable law, all resolutions of the shareholders require a simple majority, except in certain circumstances provided for under the Companies Law, which require a majority of at least 75% of the shares present at the meeting. In accordance with the Companies Law, all shareholders meetings require prior notice of at least 21 days. In some instances specified in regulations promulgated under the Companies Law, a 35-day prior notice should be given of a shareholders meeting.
Under the Companies Law, a shareholder has a duty to act in good faith towards the company in which he holds shares and towards other shareholders and to refrain from abusing his power in the company including voting in the general meeting of shareholders on:
A shareholder has the general duty to refrain from depriving rights of other shareholders. Any controlling shareholder, any shareholder who knows that it possesses the power to determine the outcome of a shareholder vote and any shareholder that, under the provisions of the articles of association, has the power to appoint an office holder in the company, is under a duty to act in fairness towards the company. The Companies Law does not describe the substance of this duty.
Election of Directors
Our ordinary shares do not have cumulative voting rights in the election of directors. As a result, the holders of ordinary shares that represent more than 50% of the voting power represented at a shareholders meeting have the power to elect all of our directors, other than the outside directors that are appointed by a special majority of shareholders. For a summary of those provisions in our articles of association with respect to the directors, see Item 6. Directors, Senior Management, and Employees.
Anti-Takeover Provisions; Mergers and Acquisitions under Israeli Law
The Companies Law includes provisions that allow a merger transaction and requires that each company that is party to a merger approve the transaction by its board of directors and a vote of the majority of its shares voting on the proposed merger at a shareholders meeting called on at least 21 days prior notice. In determining whether a majority has approved the merger, shares held by the other party to the merger or any person holding at least 25% of the other party to the merger are excluded from the vote. The Companies Law does not require court approval of a merger other than in specified situations. Upon the request of a creditor of either party to the proposed merger, the court may delay or prevent the merger if it concludes that there exists a reasonable concern that as a result of the merger, the surviving company will be unable to satisfy the obligations of any of the parties to the merger. In addition, a merger may not be completed unless at least (i) 30 days have passed from the date of the merger approval by the shareholders of each of the merging companies; and (ii) 50 days have passed from the time that a proposal for approval of the merger has been filed with the Israeli registrar of companies.
The Companies Law also provides that an acquisition of shares of a public company on the open market 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. The 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, unless there is a shareholder holding at least 45% interest in the company. These rules do not apply if the acquisition is made by way of a merger as opposed to a tender offer. Regulations adopted under the Companies Law provide that these tender offer requirements do not apply to companies whose shares are listed for trading outside of Israel if, according to the law in the country in which the shares are traded, including the rules and regulations of the stock exchange on which the shares are traded, there is either a limitation on acquisition of any level of control of the company, or the acquisition of any level of control requires the purchaser to do so by means of a tender offer to the public. The Companies Law also provides that if following any acquisition of shares, the acquirer holds 90% or more of the companys shares or of a class of shares, the acquisition must be made by means of a tender offer for all the target companys shares or all the shares of the class, as applicable. An acquirer who wishes to eliminate all minority shareholders must do so by way of a tender offer and acquire 95% of all shares not held by or for the benefit of the acquirer before the acquisition. If, however, the tender offer to acquire 95% is not successful, the acquirer may not acquire shares tendered if by doing so the acquirer would own more than 90% of the shares of the target company.
We consider the agreements related to the $35 million private placement of shares and warrants completed in November 2007, the purchase agreement of BridgeQuest, the purchase agreement of ASNA and the purchase agreement with CodeStream, as material contracts. For a summary of the terms of these transactions, see Item 4.B. Business Overview Investments and Acquisitions and Item 5.B. Liquidity and Capital Resources.
In addition, on September 2008 we entered into loan agreements with three commercial banks in Israel, Bank Discount LeIsrael Ltd., Bank HaPoalim Ltd. and the First International Bank Ltd. The aggregate amount outstanding under the credit facilities with these banks was $16 million. The loans are in US dollars and bear an average interest rate of Libor (3 months) plus 2.7%. The loans were set for different maturity periods from one year to five years.
In connection with these credit facilities, we committed to the banks to comply with certain covenants related to our operations, such as:
To date, we have met all such covenants.
Under current Israeli regulations, we may pay dividends or other distributions in respect of our ordinary shares either in non-Israeli or Israeli currencies. If we make these payments in Israeli currency, they will be freely transferred in non-Israeli currencies at the rate of exchange prevailing at the time of conversion. Because exchange rates between the NIS and the dollar fluctuate continuously, a U.S. shareholder will be subject to the risk of currency fluctuations between the date when we declare NIS-denominated dividends and the date when we pay them in NIS. See Item 3.D. Risk Factors.
Nonresidents of Israel may freely hold and trade our securities pursuant to the general permit issued under the Israeli Currency Control Law, 1978. Neither our memorandum of association nor the laws of the State of Israel restrict in any way the ownership of our ordinary shares by nonresidents, except that these restrictions may exist with respect to citizens of countries that are in a state of war with Israel.
The following is a description of material tax consequences regarding the ownership and disposition of our ordinary shares under Israeli tax laws to which U.S. and other non-Israeli shareholders may be subject. The information below does not apply to specified persons or cover specified situations. Therefore, you are advised to consult your own tax advisor as to particular tax consequences unique to you related to an investment in our ordinary shares including the effects of applicable Israeli or foreign or other tax laws and possible changes in the tax laws.
To the extent that the discussion is based on legislation yet to be judicially or administratively interpreted, we cannot assure you that the views we express herein will accord with any such interpretation in the future.
Tax Consequences Regarding Disposition of Our Ordinary Shares
In general, Israel imposes capital gains tax on the sale of capital assets, including shares of Israeli companies by both Israeli residents and non-Israeli resident shareholders, unless a specific exemption is available or unless a tax treaty between Israel and the shareholders country of residence provide otherwise. Shareholders that are not Israeli residents are generally exempt from Israeli capital gains tax on any gain derived from the sale of our ordinary shares, provided that (i) such shareholders did not acquire the shares prior to our initial public offering; and (ii) such gains did not derive from a permanent establishment of such shareholders in Israel. However, non-Israeli corporations will not be entitled to the foregoing exemption if an Israeli resident (a) has a controlling interest of 25% or more in such non-Israeli corporation; or (b) is the beneficiary of or is entitled to 25% or more of the revenues or profits of such non-Israeli corporation, whether directly or indirectly.
In certain instances where our non-Israeli shareholders may be liable to Israeli tax on the sale of our ordinary shares, the payment of the consideration may be subject to Israeli withholding tax.
In addition, in the case when the sale, exchange or disposition of our ordinary shares by shareholders who are U.S. residents (within the meaning of the U.S.-Israel Tax Treaty) holding the ordinary shares as a capital asset will be also exempt from Israeli capital gains tax under the U.S.-Israel Tax Treaty, unless, either (i) the shareholders hold, directly or indirectly, shares representing 10% or more of our voting shares during any part of the 12-month period preceding such sale, exchange or disposition; or (ii) the capital gains arising from such sale, exchange or disposition are attributable to a permanent establishment of the shareholders located in Israel. In such case, the shareholders would be subject to Israeli capital gain tax, to the extent applicable, as mentioned above. However, under the U.S.-Israel Tax Treaty, the U.S. resident would be permitted to claim a credit for such taxes against the U.S. federal income tax imposed on the sale, exchange or disposition, subject to the limitation in the U.S. law applicable to foreign tax credits. The U.S.-Israel Tax Treaty does not relate to U.S. state or local taxes.
Taxes Applicable to Dividends
Nonresidents of Israel are generally subject to Israeli income tax on the receipt of dividends paid on our ordinary shares at the rate of 20% or 15% for dividends or income generated by an approved enterprise, which tax will be withheld at source, unless a different rate is provided in a treaty between Israel and the shareholders country of residence.
However, the tax rate on dividends paid to a substantial shareholder (which is someone who alone, or together with another person, holds, directly or indirectly, at least 10% in one or all of any of the means of control in the corporation) is 25%.
Under Israeli tax law, a distribution of dividends from income attributable to an Approved Enterprise will be subject to tax in Israel at the rate of 15%, which is withheld and paid by the company paying the dividend, if the dividend is distributed during the benefits period or within the following 12 years (but the 12-year limitation does not apply to a Foreign Investors Company). Any distribution of dividends from income that is not attributable to an Approved Enterprise after January 1, 2006, will be subject to tax in Israel at the rate of 20%.
Under the U.S.-Israel Tax Treaty, the maximum rate of tax withheld in Israel on dividends paid to a holder of our ordinary shares who is a U.S. resident (within the meaning of the U.S.-Israel Tax Treaty) is 25%. However, dividends paid from income derived from our Approved Enterprise are subject to withholding at the rate of 15%, although we cannot assure you that we will designate the profits that are being distributed in a way that will reduce shareholders tax liability according to the U.S.-Israel Tax Treaty. Furthermore, the maximum rate of withholding tax on dividends, not generated by our Approved Enterprise, that are paid to a U.S. corporation holding 10% or more of our outstanding voting capital during the part of the tax year that precedes the date of the payment of the dividend and during the whole of its prior tax year, is 12.5%. This reduced rate will not apply if more than 25% of our gross income consists of interest or dividends, other than dividends or interest received from a subsidiary corporation 50% or more of the outstanding shares of the voting shares of which are owned by the company.
A nonresident of Israel who receives dividends with respect of which tax was fully paid, is generally exempt from the duty to file returns in Israel in respect of such income, provided such income was not derived from a business conducted in Israel by the taxpayer, and the taxpayer has no other taxable sources of income in Israel.
United States Federal Income Tax Considerations
Subject to the limitations described herein, this discussion summarizes certain U.S. federal income tax consequences of the purchase, ownership and disposition of our ordinary shares to a U.S. holder. A U.S. holder is a holder of our ordinary shares that is:
If a partnership (or any other entity treated as a partnership for U.S. federal income tax purposes) holds our ordinary shares, the tax treatment of the partnership and a partner in such partnership will depend on the status of the partner and the activities of the partnership. Such a partner or partnership should consult its tax advisor as to its consequences.
Unless otherwise specifically indicated, this discussion does not consider the U.S. federal income tax consequences to a person that is not a U.S. holder of our ordinary shares (a Non-U.S. holder) and considers only U.S. holders that will own the ordinary shares as capital assets (generally, for investment).
This discussion is based on current provisions of the Internal Revenue Code of 1986, as amended (Code), current and proposed Treasury Regulations promulgated under the Code and administrative and judicial interpretations of the Code, all as currently in effect and all of which are subject to change, possibly with a retroactive effect. This discussion does not address all aspects of U.S. federal income taxation that may be relevant to any particular U.S. holder based on the U.S. holders individual circumstances. In particular, this discussion does not address the U.S. federal income tax consequences to U.S. holders who are broker-dealers or who own, directly, indirectly or constructively, 10% or more (by voting power) of our outstanding voting shares, U.S. holders holding the ordinary shares as part of a hedging, straddle or conversion transaction, U.S. holders whose functional currency is not the U.S. dollar, insurance companies, financial service companies, real estate investment trusts, regulated investment trusts, grantor trusts, certain former citizens and long-term residents of the United States, tax-exempt organizations, financial institutions, persons who acquired their ordinary shares upon the exercise of employee stock options or otherwise as compensation, and persons subject to the alternative minimum tax, who may be subject to special rules not discussed below. Additionally, the possible application of U.S. federal estate or gift taxes or any aspect of state, local or non-U.S. tax laws to a U.S. holder is not discussed below.
You are advised to consult your tax advisor with respect to the specific U.S. federal, state, local, and foreign income and other tax consequences to you of purchasing, owning, or disposing of our ordinary shares.
Taxation of Distributions on the Ordinary Shares
We have never paid dividends, and currently do not intend to pay dividends in the future. If we make distributions in the future, the amount of the distribution with respect to the ordinary shares will equal the amount of cash and the fair market value of any property distributed and will also include the amount of any non-U.S. tax withheld, including Israeli taxes withheld as described above under Taxation Israeli Taxation. Subject to the discussion below under Tax Consequences if We Are a Passive Foreign Investment Company, a distribution paid by us with respect to our ordinary shares to a U.S. holder will be treated as dividend income to the extent that the distribution does not exceed our current and accumulated earnings and profits, as determined for U.S. federal income tax purposes. The amount of any distribution that exceeds the amount treated as a dividend will be treated first as a nontaxable return of capital, reducing the U.S. holders tax basis in its ordinary shares to the extent thereof, and then as capital gain from the deemed disposition of the ordinary shares. Corporate holders will not be allowed a deduction for dividends received in respect of the ordinary shares. Dividends that are received by U.S. holders that are individuals, estates or trusts will be taxed at a reduced rate of tax (currently a maximum rate of 15% for taxable years beginning on or before December 31, 2010), provided that such dividends meet the requirements of qualified dividend income. Dividends that fail to meet such requirements, and dividends received by corporate U.S. holders, are taxed at ordinary income rates. No dividend received by a U.S. holder will be a qualified dividend (1) if the U.S. holder held the ordinary share with respect to which the dividend was paid for less than 61 days during the 121-day period beginning on the date that is 60 days before the ex-dividend date with respect to such dividend, excluding for this purpose, under the rules of Code Section 246(c), any period during which the U.S. holder has an option to sell, is under a contractual obligation to sell, has made and not closed a short sale of, is the grantor of a deep-in-the-money or otherwise nonqualified option to buy, or has otherwise diminished its risk of loss by holding other positions with respect to, such ordinary share (or substantially identical securities) or (2) to the extent that the U.S. holder is under an obligation (pursuant to a short sale or otherwise) to make related payments with respect to positions in property substantially similar or related to the ordinary share with respect to which the dividend is paid. If we were to be a passive foreign investment company (as such term is defined in the Code) for any taxable year, dividends paid on our ordinary shares in such year or in the following taxable year would not be qualified dividends. In addition, a non-corporate U.S. holder will be able to take a qualified dividend into account in determining its deductible investment interest (which is generally limited to its net investment income) only if it elects to do so; in such case the dividend will be taxed at ordinary income rates. U.S. holders are urged to consult their own tax advisors regarding the U.S. federal income tax rate that would be applicable to their receipt of any dividends paid with respect to any ordinary shares.
Dividends paid by us in NIS will be included in the income of U.S. holders at the dollar amount of the dividend (including any non-U.S. taxes withheld therefrom) based upon the spot rate of exchange in effect on the date the distribution is included in income. U.S. holders will have a tax basis in NIS for U.S. federal income tax purposes equal to that dollar value. Any subsequent gain or loss in respect of NIS arising from exchange rate fluctuations generally will be taxable as U.S. source ordinary income or loss.
Subject to the limitations set forth in the Code and the Treasury Regulations thereunder, U.S. holders may elect to claim as a foreign tax credit against their U.S. federal income tax liability the non-U.S. income taxes withheld from dividends received in respect of the ordinary shares. The limitations on claiming a foreign tax credit include, among others, computation rules under which foreign tax credits allowable with respect to specific classes of income cannot exceed the U.S. federal income taxes otherwise payable with respect to each such class of income. In this regard, dividends paid by us generally will be foreign source passive income for U.S. foreign tax credit purposes. U.S. holders that do not elect to claim a foreign tax credit may instead claim a deduction for the non-U.S. income tax withheld if they itemize deductions. The rules relating to foreign tax credits are complex, and you should consult your tax advisor to determine whether and to what extent you would be entitled to this credit. A U.S. holder will be denied a foreign tax credit for non-U.S. income taxes withheld from a dividend received on the ordinary shares (i) if the U.S. holder has not held the ordinary shares for at least 16 days of the 31-day period beginning on the date that is 15 days before the ex-dividend date with respect to such dividend or (ii) to the extent the U.S. holder is under an obligation to make related payments with respect to positions in 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 required 16-day holding period.
Taxation on Disposition of the Ordinary Shares
Subject to the discussion below under Tax Consequences if We are a Passive Foreign Investment Company, upon the sale, exchange or other disposition of our ordinary shares, a U.S. holder will recognize capital gain or loss in an amount equal to the difference between the amount realized on the disposition and the U.S. holders tax basis in the ordinary shares. The gain or loss recognized on the disposition will be long-term capital gain or loss if the U.S. holder held the ordinary shares for more than one year at the time of the disposition. Long-term capital gains of certain non-corporate taxpayers are subject to a maximum tax rate of 15% for taxable years beginning on or before December 31, 2010. Gain or loss recognized by a U.S. holder on a sale, exchange or other disposition of ordinary shares generally will be treated as U.S. source income or loss for U.S. foreign tax credit purposes.
A U.S. holder that uses the cash method of accounting calculates the dollar value of the proceeds received on the sale as of the date that the sale settles. However, a U.S. holder that uses the accrual method of accounting is required to calculate the value of the proceeds of the sale as of the trade date and may therefore realize foreign currency gain or loss. A U.S. holder may avoid realizing foreign currency gain or loss by electing to use the settlement date to determine the proceeds of sale for purposes of calculating the foreign currency gain or loss. In addition, a U.S. holder that receives foreign currency upon the disposition of ordinary shares and converts the foreign currency into dollars after the settlement date or trade date (whichever date the U.S. holder is required to use to calculate the value of the proceeds of sale) may have foreign exchange gain or loss based on any appreciation or depreciation in the value of the foreign currency against the dollar, which generally will be U.S. source ordinary income or loss.
Tax Consequences If We Are a Passive Foreign Investment Company
If we are a PFIC, a U.S. holder must determine under which of three alternative taxing regimes it wishes to be taxed:
The PFIC rules described above are complex. U.S. holders are urged to consult their tax advisors regarding the application of the PFIC rules, including eligibility for and the manner and advisability of making, the QEF election or the mark-to-market election.
Non-U.S. Holders of Ordinary Shares
Except as provided below, a Non-U.S. holder of ordinary shares will not be subject to U.S. federal income or withholding tax on the receipt of dividends on, and the proceeds from the disposition of, an ordinary share, unless, in the case of U.S. federal income taxes, that item is effectively connected with the conduct by the Non-U.S. holder of a trade or business in the United States and, in the case of a resident of a country that has an income tax treaty with the United States, that item is attributable to a permanent establishment in the United States or, in the case of an individual, a fixed place of business in the United States. In addition, gain recognized by an individual Non-U.S. holder on the disposition of the ordinary shares will be subject to tax in the United States if the Non-U.S. holder is present in the United States for 183 days or more in the taxable year of the sale and other conditions are met.
Information Reporting and Backup Withholding
A U.S. holder generally is subject to information reporting and may be subject to backup withholding at a rate of up to 28% with respect to dividend payments on, and the proceeds from the disposition of, the ordinary shares. Backup withholding will not apply with respect to payments made to exempt recipients, including corporations, or if a U.S. holder provides a correct taxpayer identification number certifies that such holder is not subject to backup withholding or otherwise establishes an exemption. Backup withholding is not an additional tax and may be claimed as a credit against the U.S. federal income tax liability of a U.S. holder, or alternatively, the U.S. holder may be eligible for a refund of any excess amounts withheld under the backup withholding rules, in either case, provided that the required information is furnished to the IRS.
Non-U.S. holders will generally not be subject to information reporting or backup withholding with respect to the payment of dividends on, and the proceeds from the disposition of, ordinary shares provided that the Non-U.S. holder provides its taxpayer identification number, certifies to its foreign status, or otherwise establishes an exemption.
BluePhoenix is subject to the reporting requirements of the Exchange Act of 1934, as amended, that are applicable to a foreign private issuer. In accordance with the Exchange Act, we file with the SEC reports, including annual reports on Form 20-F by June 30 each year. In addition, we file interim financial information on Form 6-K on a quarterly basis. We also furnish to the SEC under cover of Form 6-K certain other material information required to be made public in Israel, filed with and made public by any stock exchange or distributed by us to our shareholders. You may inspect without charge and copy at prescribed rates such material at the public reference facilities maintained by the SEC, 100 F Street, N.E., Washington, D.C. 20549. You may also obtain copies of such material from the SEC at prescribed rates by writing to the Public Reference Section of the SEC, 100 F Street, N.E., Washington, D.C. 20549. Please call the SEC at 1-800-SEC-0330 for further information on the public reference room.
The SEC maintains an Internet site at http://www.sec.gov that contains reports and other material that are filed through the SECs Electronic Data Gathering, Analysis and Retrieval (EDGAR) system. BluePhoenix began filing through the EDGAR system beginning on November 14, 2002.
BluePhoenix ordinary shares are quoted on the NASDAQ Global Market. You may inspect reports and other information concerning BluePhoenix at the offices of the National Association of Securities Dealers, Inc., 9513 Key West Avenue, Rockville, Maryland 20850. You may also find our reports filed with the ISA on the Magna site whose address is http://www.magna.isa.gov.il.
Our Internet address is http://www.bphx.com. A copy of each report submitted in accordance with applicable United States law is available for public review at our principal executive offices.
In light of our multi-currency activity and our exposure to fluctuation in foreign currencies exchange rates, we presently engage in hedging or other transactions intended to manage risks relating to foreign currency exchange rate or interest rate fluctuations. The Company uses foreign currency options, forward exchange contracts and forward interest contracts to assist in managing financial risks. The Company does not use derivative financial instruments for speculative purposes. These instruments are recognized at fair value, with all changes in fair value recorded in current period earnings, as these transactions have not been designated by management as hedging instruments under SFAS 133.
We invest our cash and cash equivalents in short-term deposits. As of December 31, 2008, we invested substantially all of the cash we held in US$ deposits. As of December 31, 2008, we had approximately $16 million outstanding loans to banks denominated in U.S. dollars.
Fluctuations in foreign currency exchange rates, such as euro or NIS versus the dollar may have a negative impact on our operating results and financial condition. Exposure relating to these exchange rates is recorded under the financial expenses line item of our consolidated statements of operations. Accordingly, financial expenses may fluctuate significantly from quarter to quarter.
The table below details the balance sheet main currency exposure for which the Company uses different foreign currency instruments in order to minimize its exposure (i.e., the gap between accounts receivables and accounts payables in a given currency). The details are provided by currency, as of December 31, 2008 (at fair value):
The table below details (US Dollar in thousands) the derivative instrument in order to limit the exposure to exchange rate fluctuations. The data are as of December 31, 2008 and are presented in U.S. Dollar equivalents. All instruments are matured in 2009:
In light of our multi-currency activity and our exposure to fluctuation in foreign currencies exchange rates, we presently engage in hedging or other transactions intended to manage risks relating to foreign currency exchange rate or interest rate fluctuations. The Company uses foreign currency options, forward exchange contracts and forward interest contracts to assist in managing financial risks. The Company does not use derivative financial instruments for speculative purposes. These instruments are recognized at fair value, with all changes in fair value recorded in current period earnings, as these transactions have not been designated by management as hedging instruments under SFAS 133.
We have market risk exposure to changes in interest rates on our long-term loans from banks. The majority of our loans are stated in US Dollars and have variable interest rates in order to reduce the risks associated with interest rate fluctuation. The book value of these liabilities approximates their fair value as of December 31, 2008. For each 1% upward shift in the LIBOR rate our yearly interest payments will increase by approximately $160 thousand in 2009, $150 in 2010 and $110 in 2011.
Our liabilities, the interest rate they bear and their repayment schedule by currency as of December 31, 2008, are set forth in the table below in US Dollars equivalent terms:
(a) Disclosure Controls and Procedures. Our management, with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act) as of December 31, 2008. Based on this evaluation, our chief executive officer and chief financial officer have concluded that, as of such date, our disclosure controls and procedures were (i) designed to ensure that material information relating to us, including our consolidated subsidiaries, is made known to our management, including our chief executive officer and chief financial officer, by others within those entities, as appropriate to allow timely decisions regarding required disclosure, particularly during the period in which this report was being prepared and (ii) effective, in that they provide reasonable assurance that information required to be disclosed by us in the reports that we file or