|
|
 | | | |
- close
- close
- close
- close
ECtel 20-F 2009 UNITED STATES
| |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Title of each class | Name of each exchange on which registered |
| Ordinary Shares, NIS 0.04 par value per share | Nasdaq Global Market |
Securities registered or to be registered pursuant to Section 12(g) of the Act:
None
Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:
None
(Title of Class)
Indicate the number of outstanding
shares of each of the issuer’s classes of capital or common stock as of December 31,
2008:
16,281,898 Ordinary
Shares, nominal value NIS 0.04 per share
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
o Yes x No
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.
o Yes x No
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.
x Yes o No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
| Large accelerated filer o | Accelerated filer o | Non-accelerated filer x |
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
Other 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).
o Yes x No
2
TABLE OF CONTENTS
| PART I | 4 |
| Item 1. | Identity of Directors, Senior Management and Advisers | 4 |
| Item 2. | Offer Statistics and Expected Timetable | 4 |
| Item 3. | Key Information | 4 |
| A. | Selected Financial Data | 4 | |
| B. | Capitalization and Indebtedness | 5 | |
| C. | Reasons for the Offer and Use of Proceeds | 5 | |
| D. | Risk Factors | 5 |
| Item 4. | Information on the Company | 14 |
| A. | History and Development of the Company | 14 | |
| B. | Business Overview | 15 | |
| C. | Organizational Structure | 22 | |
| D. | Property, Plants and Equipment | 22 |
| Item 4A. | Unresolved Staff Comments | 22 |
| Item 5. | Operating and Financial Review and Prospects | 22 |
| A. | Operating Results | 22 | |
| B. | Liquidity and Capital Resources | 32 | |
| C. | Research and Development, Patents and Licenses | 35 | |
| D. | Trend Information | 36 | |
| E. | Off-Balance Sheet Arrangements | 37 | |
| F. | Tabular Disclosure of Contractual Obligations | 37 |
| Item 6. | Directors, Senior Management and Employees | 37 |
| A. | Directors and Senior Management | 37 | |
| B. | Compensation | 39 | |
| C. | Board Practices | 39 | |
| D. | Employees | 42 | |
| E. | Share Ownership | 42 |
| Item 7. | Major Shareholders and Related Party Transactions | 43 |
| A. | Major Shareholders | 43 | |
| B. | Related Party Transactions | 44 | |
| C. | Interests of Expert and Counsel | 45 |
| Item 8. | Financial Information | 45 |
| A. | Consolidated Financial Statements and Other Financial Information | 45 | |
| B. | Significant Changes | 45 |
| Item 9. | The Offer and Listing | 46 |
| A. | Offer and Listing Details | 46 | |
| B. | Plan of Distribution | 46 | |
| C. | Markets | 46 | |
| D. | Selling Shareholders | 46 | |
| E. | Dilution | 46 | |
| F. | Expenses of the Issue | 47 |
| Item 10. | Additional Information | 47 |
| A. | Share Capital | 47 | |
| B. | Memorandum and Articles of Association | 47 | |
| C. | Material Contracts | 51 | |
| D. | Exchange Controls | 52 | |
| E. | Taxation | 52 | |
| F. | Dividends and Paying Agents | 60 | |
| G. | Statement by Experts | 60 | |
| H. | Documents on Display | 60 | |
| I. | Subsidiary Information | 61 |
| Item 11. | Quantitative and Qualitative Disclosures About Market Risk | 61 |
| Item 12. | Description of Securities Other than Equity Securities | 62 |
| PART II | 63 |
| PART III | 65 |
| Item 17. | Financial Statements | 65 |
| Item 18. | Financial Statements | 65 |
| Item 19. | Exhibits | 65 |
3
PART I
Unless the context otherwise requires, all references in this Annual Report on Form 20-F (the “Annual Report”) to “ECtel,” “us,” “we,” “our” and the “Company” refer to ECtel Ltd. and its subsidiaries. References to “dollars” or “$” are to United States dollars. References to “NIS” are to New Israeli Shekels.
Statements in this Annual Report concerning our business outlook or future economic performance; anticipated revenues, expenses or other financial items; introductions and advancements in development of products, and plans and objectives related thereto; and statements concerning assumptions made or expectations as to any future events, conditions, performance or other matters, are “forward-looking statements” as that term is defined under the United States federal securities laws. In some cases, you can identify forward-looking statements by our use of words such as “expect,” “anticipate,” “believe,” “intend,” “plan,” “seek,” and “estimate” and similar expressions. Forward-looking statements are subject to risks, uncertainties and other factors which could cause actual results to differ materially from those in such statements. Factors that could cause or contribute to these differences include, but are not limited to, those set forth under “Item 3D–Risk Factors” in this Annual Report and elsewhere in this Annual Report as well as our reports on Form 6-K submitted to the Securities and Exchange Commission (the “SEC”).
Item 1. Identity of Directors, Senior Management and Advisers
Not Applicable.
Item 2. Offer Statistics and Expected Timetable
Not Applicable.
Item 3. Key Information
| A. | Selected Financial Data |
The selected consolidated balance sheet data as of December 31, 2008 and 2007 and the selected consolidated statements of operations data for each of the years in the three-year period ended December 31, 2008, have been derived from our audited consolidated financial statements included elsewhere in this Annual Report, which have been prepared in accordance with accounting principles generally accepted in the United States, or U.S. GAAP, and audited by Somekh Chaikin, Independent Registered Public Accountants, a member firm of KPMG International. Its report appears elsewhere in this Annual Report. The selected consolidated balance sheet data as of December 31, 2006, 2005 and 2004 and the selected consolidated statements of operations data for the years ended December 31, 2005 and 2004 have been derived from our audited consolidated financial statements which are not included in this Annual Report. The following selected financial data should be read in conjunction with “Item 5–Operating and Financial Review and Prospects” and our consolidated balance sheets as of December 31, 2008 and 2007, our consolidated statements of operations for each of the years in the three-year period ended December 31, 2008, and the related notes thereto and the report of the independent registered public accounting firm, which refers to the Company’s adoption of the provisions of Statement of Financial Accounting Standards No.157, Fair Value Measurements, as of January 1, 2008, appearing elsewhere in this document.
In December 2005, we acquired all of the outstanding shares of Elron Telesoft Ltd. (the name of which was later changed to ECtel Telesoft Ltd.) and Elron Telesoft Export Ltd. (the name of which was later changed to ECtel Telesoft Export (98) Ltd.), two sister companies held by Elron Electronic Industries Ltd., which we refer to collectively as Telesoft. The effect of this acquisition is reflected in our consolidated balance sheet as at December 31, 2005.
In April 2008, we acquired substantially all of the assets of Compwise Ltd. (“Compwise”), an Israel-based company and a provider of business analytic solutions for telecommunication operators. The effect of this acquisition is reflected in our consolidated balance sheet as at December 31, 2008.
4
| Year ended December 31, |
|||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2008 |
2007 |
2006 |
2005 |
2004 | |||||||||||||
| (in thousands of U.S. dollars, except share and per share data) |
|||||||||||||||||
| Statements of Operations Data: | |||||||||||||||||
| Revenues | 24,984 | 20,898 | 28,802 | 23,151 | 12,605 | ||||||||||||
| Cost of revenues | 13,671 | 10,185 | 13,634 | 10,985 | 10,271 | ||||||||||||
| Gross profit | 11,313 | 10,713 | 15,168 | 12,166 | 2,334 | ||||||||||||
| Research and development costs, net | 4,548 | 4,789 | 4,277 | 3,622 | 5,390 | ||||||||||||
| Selling and marketing expenses | 8,653 | 8,546 | 9,502 | 6,917 | 9,071 | ||||||||||||
| General and administrative expenses | 6,964 | 5,757 | 3,812 | 4,099 | 8,500 | ||||||||||||
| Amortization of acquisition-related | |||||||||||||||||
| intangible assets | 164 | 94 | 466 | 49 | 49 | ||||||||||||
| Restructuring and related impairment costs | - | - | - | 360 | 3,358 | ||||||||||||
| Acquisition-related expenses | 118 | - | 640 | - | - | ||||||||||||
| Goodwill impairment | - | - | - | - | 2,186 | ||||||||||||
| Total operating expenses | 20,447 | 19,186 | 18,697 | 15,047 | 28,554 | ||||||||||||
| Operating loss | (9,134 | ) | (8,473 | ) | (3,529 | ) | (2,881 | ) | (26,220 | ) | |||||||
| Financial income, net | 653 | 1,159 | 1,233 | 1,494 | 438 | ||||||||||||
| Impairment of Auction Rate Securities, net | (235 | ) | (1,560 | ) | - | - | - | ||||||||||
| Other (expenses) income, net | 430 | - | - | - | (3 | ) | |||||||||||
| Loss from continuing operations before taxes | |||||||||||||||||
| on income | (8,286 | ) | (8,874 | ) | (2,296 | ) | (1,387 | ) | (25,785 | ) | |||||||
| Income tax benefit (expense) | (20 | ) | 73 | (4 | ) | 20 | 30 | ||||||||||
| Net loss from continuing operations | (8,306 | ) | (8,801 | ) | (2,300 | ) | (1,367 | ) | (25,755 | ) | |||||||
| Income from discontinued operations | - | - | - | - | 12,260 | ||||||||||||
| Net loss for the year | (8,306 | ) | (8,801 | ) | (2,300 | ) | (1,367 | ) | (13,495 | ) | |||||||
| Loss per ordinary share | |||||||||||||||||
| Basic and diluted loss per ordinary share: | |||||||||||||||||
| Continuing operations | (0.50 | ) | (0.53 | ) | (0.13 | ) | (0.08 | ) | (1.42 | ) | |||||||
| Discontinued operations | - | - | - | - | 0.68 | ||||||||||||
| (0.50 | ) | (0.53 | ) | (0.13 | ) | (0.08 | ) | (0.74 | ) | ||||||||
| Weighted average number of shares outstanding | 16,553,139 | 16,671,488 | 17,747,699 | 18,159,277 | 18,112,216 | ||||||||||||
| December 31, |
|||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2008 |
2007 |
2006 |
2005 |
2004 | |||||||||||||
| (in thousands of U.S. dollars) |
|||||||||||||||||
| Balance Sheet Data: | |||||||||||||||||
| Cash and cash equivalents | 8,452 | 5,668 | 6,101 | 11,810 | 17,683 | ||||||||||||
| Working capital | 12,053 | 12,333 | 25,603 | 35,937 | 41,986 | ||||||||||||
| Total assets | 49,764 | 56,951 | 65,524 | 78,023 | 81,751 | ||||||||||||
| Due to (from) related parties, net | (216 | ) | 1 | (335 | ) | 19 | (225 | ) | |||||||||
| Shareholders' equity | 35,286 | 43,082 | 49,957 | 61,368 | 62,689 | ||||||||||||
| B. | Capitalization and Indebtedness |
Not Applicable.
| C. | Reasons for the Offer and Use of Proceeds |
Not Applicable.
5
| D. | Risk Factors |
We believe that the occurrence of any one or some combination of the following factors could have a material adverse effect on our business, financial condition and results of operations.
Risks Related to Our Business and Our Industry
We have entered into a distribution agreement with ECI Telecom Ltd. (“ECI”) under which we appointed ECI as our exclusive distributor in significant portions of the former Soviet Union, which are important markets for us. Accordingly, we are presently dependent upon ECI for the achievement of sales in those markets.
In June 2005, we entered into a distribution agreement with ECI under which we appointed ECI as our exclusive distributor in the Russian Federation, Ukraine and Kazakhstan, territories from which we expect, in the aggregate, to derive a significant portion of our revenues. In 2008, we derived a significant portion of our revenues from sales achieved through ECI in these territories. The agreement is subject to termination by either party upon three months’ notice. In addition, either party may terminate the agreement at any time upon a material breach by the other party or in the event of liquidation or similar consequences of the other party. If ECI were to terminate this agreement or if it does not succeed in obtaining orders for our products and services, for whatever reason, our business and results of operations may be seriously harmed.
We depend on several relatively large customers and the loss of one or more of these customers, or a significant decrease in revenue from any of these customers, could have a disproportionate impact on our revenue and income.
A substantial portion of our revenue has come from relatively large purchases by a small number of customers. Sales to our top ten customers accounted for 69% of our revenues in 2008, with sales to four customers in Eastern Europe accounting for 43% of our revenues, the top two of which each accounted for more than 10% of our revenues. Sales to our top ten customers accounted for 51.5% of our revenues in 2007, with sales to three customers in the Americas accounting for 19.8% of such revenues, none of which individually accounted for more than 10% of our revenues . We expect to continue to depend on sales to a small number of customers but we do not have long-term commitments from any of our top customers to purchase any specific quantities of products. We expect that our largest customers will vary from period to period. If we lose one or more large customers and fail to add new customers, our results of operations could be seriously harmed.
We maintain significant cooperation with distribution channels for the sale of our products and services. If our relationship with these distribution channels is for any reason impaired, our business and results of operations may suffer.
We have agreements in place with distributors and system integrators to market and sell our products and services in addition to our direct sales force. We derive about one half of our revenues from these distribution and system integrators channels. When a sale is directed through a distribution channel and not directly by us, if the sales efforts of these channels are not successful, we may lose sales opportunities, customers and market share. In addition, there can be no assurance that in the future our channel partners will not develop or market products or services that compete with our products. Furthermore, our financial results may be affected if our contracts with distribution channels were terminated, if our relationship with channel partners was to deteriorate or if the financial condition of our channel partners was to weaken.
Volatility experienced by telecommunications service providers may adversely affect our sales and operating results. Current weakness in the U.S. and global markets can result in a decline of capital investment by telecommunications service providers, impact on our sales and may affect the pricing of our products. It may also affect our ability to keep our operating expenses in line with any reduction in revenues. This may harm our business, financial condition and results of operations.
We are subject to the effects of general global, economic and market conditions. The longer and deeper impact of the current global macroeconomic crisis is causing uncertainty in the telecommunications market. This has resulted and might further result in a decline in capital investment by telecommunications service providers. Such decline in capital expenditures has had and could further have a negative impact on our business by reducing the number and the value of new contracts we are able to sign and may harm our revenues and results of operation.
Furthermore, since a substantial portion of our operating expenses consist of salaries, we may not be able to reduce our operating expenses in line with any reduction in revenues or may elect not to do so for business reasons. We will need to continue to generate increased revenues and manage our costs to achieve profitability. Industry downturn may increase our inventories, decrease our revenues, result in additional pressure on the price of our products and prolong the time until we are paid, all of which would have a material adverse effect on the results of our operations and on our cash flow from operations.
Increased expense levels will harm our business if our revenues do not grow.
A significant portion of our expenses are comprised of fixed costs such as payrolls, rent for facilities and vehicles expense, which we cannot decrease in the short term even if our revenues were to decline. Accordingly, if our revenues do not grow, it will be difficult for us to decrease costs at a rate that is commensurate with the decrease in revenues. This will result in an increase in operating loss or decrease in operating income in the short term. In an effort to bring fixed costs more in line with our lower than anticipate revenues, our management adopted at the end of 2008 a series of proactive efficiency measures including a reduction in management and employee salaries, the downsizing of our workforce, cost efficiencies in the professional service functions and cost efficiencies with respect to our other operating expenses. Such measures are expected to reduce our expenses in 2009. If, however, revenues decrease or do not meet expectations for a particular period, and we are not able to reduce our expenses in the short term, or at all, our business, financial condition and results of operations will be adversely affected.
6
Because most of our revenues are generated in U.S. dollars but a significant portion of our expenses are incurred in New Israeli Shekels, our results of operations may be seriously harmed by currency fluctuations and inflation. Furthermore, as we consider the U.S. dollar to be our functional currency, but our revenues are sometimes generated in other currencies, fluctuations in exchange rates between the U.S. dollar and such other currencies may have an adverse effect on our results of operations and financial condition.
Although we have operations throughout the world, the majority of our revenue and approximately 50% of our operating costs in 2008 were denominated in, or linked to, the U.S. dollar. Accordingly, we consider the U.S. dollar to be our functional currency. However, a significant portion of our expenses is in NIS. Therefore, fluctuations in exchange rates between the NIS and the U.S. dollar may have an adverse effect on our results of operations and financial condition. For example, throughout the course of 2008, the average exchange rate between the U.S. dollar and the NIS reflected devaluation of the U.S. dollar by almost seven percent, thereby adversely affecting our dollar-measured results of operations.
Our operations could also be adversely affected if we are unable to hedge against currency fluctuations in the future. Accordingly, we may enter into currency hedging transactions to decrease the risk of financial exposure from fluctuations in the exchange rate of the U.S. dollar against the NIS.
An increasing portion of our revenues is now denominated in other non-U.S. currencies, and in the future additional revenues may be denominated in currencies other than U.S. dollars, thereby exposing us to gains and losses on non-U.S. currency transactions resulting from fluctuations in exchange rates between the U.S. dollar and such other currencies. Moreover, as currently our revenues are denominated primarily in U.S. dollars, devaluation in the local currencies of our customers relative to the U.S. dollar could cause customers to default on payment.
The payment cycle for our receivables may reduce the cash we have available to operate and expand our business.
Our contracts may provide for payments under a variety of payment schedules. For example, we may receive a deposit prior to shipment, a partial payment upon delivery and final payment after 180 or 360 days from delivery. Also, we may collect payments due to specific project milestones, upon specific customization and development progress. In the last few years, and recently due to impact of the current global macroeconomic crisis, we are receiving an increased amount of requests from our customers for even longer payment terms and alternative payment models such as revenue sharing based compensation proposals. Such payment cycles and alternative payment models may adversely affect the cash resources available to operate and expand our business.
The market for our products is highly competitive. Furthermore, because some of our competitors have much greater resources than we have or may have a lower cost structure than we have, it may be difficult for us to compete with them, as well as to achieve and maintain profitability. We may also face competition from our customers.
Competition in our industry is intense, and we expect it to continue. To compete effectively, we have, at times, been required to grant substantial discounts on our products, especially as some of our competitors utilize aggressive pricing strategies. Lower prices and the loss of sales to our competitors would reduce our ability to generate revenue, which would harm our business.
Some of the companies that compete with us have greater name recognition, longer operating histories, larger customer bases and significantly greater financial, marketing, public relations, sales, distribution and other resources. Some of our competitors and potential competitors are among the largest and most capitalized software and hardware companies in the world. Also, some of our competitors have located their research and development facilities in countries where labor costs for engineers and other experienced personnel are far lower than in Israel, where our research and development facilities are located. This has increased the pressure to reduce pricing on our products. In some situations, we may not be able to compete successfully because of these factors, and this may adversely affect our ability to achieve new sales.
We may also face competition from our customers. Some of our customers are developing their own solutions internally or through strategic alliances. As a result, solutions developed by our customers may replace and/or compete with products that we currently sell to them or that we may seek to sell to them in the future.
Consolidation of competitors may adversely affect our sales and operating results.
In recent years, our industry has experienced consolidation of solution providers, including consolidation of some of our direct competitors. This may result in the creation of one or more competitors possessing more significant market share than we possess. Consolidated competitors may be able to achieve significant advantages over us in terms of economies of scale, and therefore, may be able to compete against us more effectively. Consolidation can also adversely affect our business and operating results for other reasons, such as operators’ preferring to transact with consolidated solution providers for various reasons, such as their larger customer base, and larger sales, marketing and support organizations.
We have previously experienced, and may continue to experience, fluctuations in our annual and quarterly results of operations, which resulted, and may continue to result in the future, in our failing to meet expectations and could cause the trading price of our ordinary shares to decline.
In recent years we have experienced, and may continue to experience, significant fluctuations in our quarterly results of operations, and we may likewise experience significant fluctuations in our annual results of operations. Factors which have contributed and may in the future contribute to fluctuations in our results of operations include among others:
| — | changes in customer capital spending budgets and allocations throughout the year; |
| — | trends in customer purchasing; |
| — | the length of our sales process; |
| — | the size and timing of orders; |
| — | our relationships with, and sales through, our channel partners; |
| — | competitive market conditions, including the pricing actions of our customers; |
7
| — | timing and success of new products and new technologies introduced by us or our competitors; |
| — | our ability to integrate the technology and operations of acquired businesses with our own business; |
| — | regional or global economic and political conditions; |
| — | changes in our operating expenses and extraordinary expenses; |
| — | impairment of goodwill and intangibles; |
| — | the percentage of sales for which we pay sales commissions; and |
| — | fluctuations in foreign currency exchange rates. |
Unfavorable changes in the factors listed above, many of which are outside of our control, could materially adversely affect our business, operating results and financial condition. For example, our operating results for 2008 were lower than initially anticipated primarily due to three factors: (i) the longer and deeper impact of the global macroeconomic crisis on the Company’s activities, which was at least partially reflected in a lengthening of our sale cycles; (ii) the delay in our recognition of revenues from a major project; and (iii) the impact of substantial currency exchange rate fluctuations relative to the U.S. dollar. It is likely that in some future periods, our operating results may again be below our expectations, or the expectations of public market analysts or investors, which may cause our share price to drop.
We could be subject to warranty claims, which could be very expensive and harm our financial condition.
We typically provide one-year warranty programs with respect to our products. Our warranty generally provides for the repair or replacement of products with defects in materials or workmanship or that fail to meet agreed-upon specifications. Any significant product returns or warranty claims could adversely affect our results of operations. We offer sophisticated products that may contain software with undetected errors. In addition, new products may experience failures when first introduced, and both current and future products may experience failures as new versions are released. We rely to a large extent on our reputation among industry leaders in conducting our sales efforts. Such product returns or warranty claims and the associated negative publicity, could result in the loss of, or delay in, market acceptance of our products and hurt our business.
Our business could be materially adversely affected as a result of the risks associated with acquisitions and investments. In particular, we may not be effective in integrating our acquisitions or succeed in making additional acquisitions.
As part of our growth strategy, we may pursue mergers and acquisitions of businesses, products and technologies, or the establishment of joint venture arrangements, that could expand our business. For example, in April 2008 we acquired substantially all the assets of Compwise Ltd., an Israel-based company and a provider of business analytic solutions for telecommunication operators. In addition, in the fourth quarter of 2005 we acquired two sister companies engaged in the development and marketing of revenue assurance solutions. Also, during 2006 and 2008, we carried out due diligence processes for potential acquisition opportunities. Eventually, we decided not to complete these acquisitions.
The negotiation of potential acquisitions or joint ventures as well as the integration of an acquired or jointly developed business, technology or product may absorb significant management attention and involves large expenditure of funds that would otherwise be available for the ongoing development of our business. In addition, the process of integrating an acquired company’s business into our operations and/or of investing in new technologies may result in unforeseen operating difficulties and large expenditures. Other risks commonly encountered with acquisitions include the effect of the acquisition on our financial and strategic position and reputation, the failure of the acquired business to further our strategies, the inability to successfully integrate or commercialize acquired technologies or otherwise realize anticipated synergies or economies of scale on a timely basis and the potential impairment of acquired assets. Moreover, there can be no assurance that the anticipated benefits of any acquisition or investment will be realized. Future acquisitions or investments contemplated and/or consummated could result in potentially dilutive issuances of equity securities as part of the consideration for such acquisitions or investments, the incurrence of debt and contingent liabilities, and amortization expenses related to intangible assets, any of which could have a material adverse effect on our operating results and financial condition. In addition, we have limited experience with respect to operating acquired businesses. There can be no assurance that we will be successful in making additional acquisitions or effective in integrating such acquisitions into our existing business. If the operation of the business of any future acquisitions disrupts our operations, our business may suffer.
Developments affecting telecommunication service providers, such as mergers, can adversely affect us.
Developments in the telecommunications industry, such as the impact of general global economic conditions, continued industry consolidation, the formation of alliances among network operators and service providers, and changes in the regulatory environment have had, and could continue to have, a material adverse effect on our existing or potential customers. These conditions have reduced the high growth rates that the telecommunications industry had previously experienced, and have caused the market value, financial results and prospects, and capital spending levels of many telecommunications companies to decline or degrade. In recent years, the telecommunications industry has experienced significant financial pressures that have caused many in the industry to cut expenses and limit investment in capital-intensive projects and have led to numerous restructurings and bankruptcies. Recent telecommunications company mergers may have a material adverse effect on our results of operations, as existing or potential customers may be purchased or two customers may combine operations in a manner that results in a decline in repeat sales by us, reduces the number of licenses we can sell to the combined entity or cause us to have to repeat significant pre-sale efforts in respect of one or more of the merger parties.
8
Due in part to the deepening global macroeconomic crisis, many of our customers require a lengthy, detailed and comprehensive sale cycle, which may impact the timing of our revenues and result in us expending significant resources on sales efforts.
We derive substantially all of our revenues from the sale of products and related services for telecommunications service providers. The purchase of our products may represent a relatively significant capital expenditure for our customers. As a result, our products generally undergo a lengthy evaluation and purchase process before we can sell them. In recent years, reflecting in part the burgeoning global macroeconomic crisis, our customers have been conducting a more stringent and detailed evaluation of our products, and decisions are subject to additional levels of internal review. As a result, the evaluation process has significantly lengthened. This evaluation process generally takes between six and 18 months. Besides the global macroeconomic climate, which invariably impacts (whether directly or collaterally) the speed of our customers’ approval process, the following specific factors, among others, affect the length of such process:
| — | the time involved for our customers to determine and announce their specifications; |
| — | the time required for our customers to process approvals for purchasing decisions; |
| — | the complexity of the products involved; |
| — | the technological priorities and budgets of our customers; and |
| — | the need for our customers to obtain or comply with any required regulatory approvals. |
In 2008, partially due to the emergence of the current global macroeconomic crisis, our clients’ approval processes and our sales cycles lengthened further, and our revenues and overall economic results were adversely affected as a result. If customers continue to subject our products to lengthy evaluation processes, continue to delay project approval, delays lengthen further, or if such continued delays result in the eventual cancellation of any sale opportunities, it could harm our business and results of operations.
We depend upon our Bulgarian subsidiary for the performance of certain of our European professional services and operations. Failure to manage and expand our Bulgarian activities may have a material adverse effect on our business, results of operations and financial condition.
In recent years, we have outsourced a portion of our professional services and operations in Europe to a subcontractor in Bulgaria. On April 1, 2008, our contract with this subcontractor was terminated and the employees of this subcontractor are now directly employed by ECtel Bulgaria EOOD, our newly established subsidiary. We intend to strengthen our position in Eastern Europe, among other regions, through the operations of our Bulgarian subsidiary. Accordingly, our future success in this region will depend in part on our ability to manage and expand our Bulgarian subsidiary’s activities. In addition, as Bulgaria joined the European Market on January 1, 2007, the cost of our Bulgarian operations increased and it is likely that such cost will increase further over time, as was the case with companies in other countries joining the European Market.
We depend upon subcontracted outsourcers for the performance of certain of our European professional services and operations. The failure of these outsourcers to meet our quality or performance requirements may have a material adverse effect on our business, results of operations and financial condition.
Since November 2008, we have outsourced a portion of our professional services and operations in Europe to a subcontractor in the Ukraine. We believe that our future success will depend in part on our ability to continue, expand and manage the use of outsourced subcontracting resources for various services and operations, even beyond our current utilization. There are certain risks entailed in these practices, including but not limited to: the continued availability of these resources is not assured; the potential for migration of some expertise to a contractor outside of our organization; and our policies relating to protection of intellectual property rights may be harder or not possible to institute, manage or enforce vis-à-vis a subcontractor organization.
We depend on single suppliers for some of our product components, including key product components in our legacy probing devices. If any of these suppliers experiences delays, disruptions, quality control problems or a loss in capacity or is unwilling to continue providing these components, it could adversely affect our business and operating results.
We utilize single suppliers for some of our product components, including critical components needed for some of our products. We cannot control the delivery schedule for these components. In the event that any of these suppliers are unable or unwilling to meet our requirements, or fail to do so in a timely manner, we may experience an interruption in production until an alternative source of supply can be obtained. Any disruption, or any other interruption of a supplier’s ability to provide components to us, could result in delays in making product shipments, which could have a material adverse effect on our business, financial condition and results of operations. Furthermore, as suppliers discontinue their products, or modify them in manners incompatible with our current use, or use manufacturing processes and tools that cannot be easily migrated to other vendors, we could have significant delays in product availability, which would have a significant adverse impact on our results of operations and financial condition. We cannot assure you that our inventory and alternative sources of supply would be sufficient to avoid a material interruption or delay in production and in availability of spare parts.
ECI, our former major shareholder is the owner of certain intellectual property rights related to our legacy probing devices. While ECI currently permits our supplier to use its technology required for production of these components, we cannot assure that such permission will not be withheld by ECI in the future. To the extent ECI will withhold its permission, it has an obligation to supply these components to us under a components supply agreement executed between our Company and ECI in February 2004, which agreement has an initial period of seven years.
In addition, in connection with our sale to Verint Systems Limited of our government surveillance business, we agreed to supply some of these components for our legacy probing devices to Verint for a period of seven years. Any problems with the supply of such components, which may not be under our control, that cause us to breach our obligations to Verint, could expose us to claims by Verint. Such claims could harm our financial condition.
9
Implementation of new technologies by telecom carriers may result in a decline in demand for our products.
Technologies, such as Voice over Internet Protocol (“VoIP”), are facilitating the use of cheaper communications media and new and reduced pricing schemes which are not entirely based on usage level and records, such as flat rates, by some telecom operators. Such operators may be less inclined to invest in high-end solutions like ours, which by their nature monitor the usage records. Moreover, since these technologies enable service providers to offer relatively low calling rates to subscribers, this may reduce the incentive to commit telecom fraud. This, in turn, would reduce the need among service providers to constantly monitor revenue related processes and thereby reduce the demand for anti-fraud solution like ours. This trend may harm our revenues and results of operation.
Because the telecommunications market is characterized by rapid technological and other changes, our success depends on our ability to continually develop technologically advanced products and product enhancements that achieve market acceptance.
The telecommunications market is characterized by rapid technological advances and frequent product introductions and enhancements. We believe that our future success will largely depend upon our ability to continue to enhance our existing products and to successfully develop and market products on a cost-effective and timely basis. The technologies applicable to our products include applications capable of analyzing and processing data based on accepted telephony standards and protocols. If other technological standards and protocols gain broad market acceptance, we will be required to redesign our existing products or design new products that are able to view and analyze networks based on these new standards and protocols. For example, the types of fraudulent schemes to which service providers are subject change with the emergence of new technologies, networks and other developments. We cannot assure you that we will be successful in developing and marketing new applications or systems that will respond to technological change
Furthermore, the market in which we operate is highly competitive and unless we continue to enhance the functionality of our products and add additional features, our competitiveness may be harmed.
We do business with companies located in countries around the world, which subjects us to additional risks. If these risks materialize, our business will be materially adversely affected.
Because of the global nature of our business, we are exposed to the risk of economic or political instability in countries where our customers are located, particularly in developing countries such as countries in Africa and in Central and South America. In addition, there are often longer sales and payment cycles in developing countries, as well as greater difficulties in collecting accounts receivable.
We face additional risks from our international operations including:
| — | difficulties of obtaining licenses, the imposition of tariffs and the effects of other trade barriers; |
| — | difficulties in staffing and managing foreign operations; |
| — | potentially adverse tax consequences; |
| — | laws and business practices favoring local competitors; |
| — | costs and difficulties of customizing products for foreign countries; |
| — | compliance with a wide variety of complex foreign laws and treaties; |
| — | political instability; |
| — | variance and unexpected changes in local laws and regulations; and |
| — | imposition of exchange or price controls or other restrictions on the conversion of foreign currencies. |
Our proprietary technology is difficult to protect and unauthorized use of our proprietary technology by third parties may impair our ability to compete effectively.
Our success and ability to compete depend in large part upon our protection of our proprietary technology, including both software and hardware components of our products. We currently rely on a combination of patents, trade secret and copyright laws, nondisclosure and other contractual agreements and technical measures to protect our proprietary rights. We have several registered patents and trademarks as well as patent and trademark applications covering some of our technology and are in the process of preparing and filing additional patent and trademark applications. We cannot assure you that any of these applications will be granted. These agreements and measures may not be sufficient to protect our technology from third-party infringement, or to protect us from the claims of others. Additionally, our products may be sold in foreign countries that provide less protection to intellectual property than that provided under U.S. or Israeli laws. Moreover, competitors and potential competitors may attempt to copy or reverse engineer aspects of our product line or to obtain and use information that we regard as proprietary. If we are unable to maintain the security of our proprietary technology for these or any other reasons, our business may suffer.
Because our products may infringe on the intellectual property rights of third parties, our business will suffer if we are sued for infringement or cannot obtain licenses to these rights on commercially acceptable terms.
We are subject to the risk of adverse claims and litigation alleging infringement by us of the intellectual property rights of others. Many participants in the telecommunications industry have an increasing number of patents and patent applications and have frequently demonstrated a readiness to pursue litigation based on allegations of patent and other intellectual property infringement. All of our products rely on technology that could be the subject of existing patents or patent applications of third parties. We have agreed to indemnify our customers with respect to infringement by our products of the proprietary rights of third parties. Third parties may assert infringement claims in the future with respect to our current or future products. These claims may require us to enter into license arrangements or result in protracted and costly litigation, regardless of the merits of these claims. Any necessary licenses may not be available or, if available, may not be obtainable on commercially reasonable terms. If we cannot obtain all necessary licenses on commercially reasonable terms, we may be forced to stop selling our products in some or all countries, and our business would be seriously harmed.
10
Our products contain certain hardware components. We must maintain sufficient inventory levels of these components to meet anticipated demand. If we cannot predict orders accurately, our inventory may become obsolete and our financial performance may be harmed.
Our solutions consist of both software and hardware components. The timing and volume of our customers’ orders are generally difficult to forecast for each quarter, as a substantial majority of our sales of hardware components are booked and shipped in the same quarter pursuant to purchase orders. We purchase the hardware components of our solutions from a small number of manufacturers, some of which may not always timely fill our orders. We must therefore maintain or have available sufficient inventory levels to satisfy anticipated demand on a timely basis. Maintaining sufficient inventory levels to assure prompt delivery of our products increases the risk of inventory obsolescence and associated write-offs. A shift in demand could also result in inventory write-offs, which could harm our financial performance.
We may be subject to European regulations that will require us to use components consisting of environmentally friendly materials. Compliance with these regulations may increase our costs and adversely affect our results of operations.
We may be subject to telecommunications industry regulations published in territories in which we are selling our hardware products, requiring the use of environmentally-friendly materials in telecommunications equipment. For example, European telecommunications industry regulations require telecom equipment suppliers to eliminate the lead solders from their products by 2010. Compliance with European Community directives may require us to undertake significant expenses with respect to the re-design of certain of our hardware products or find other complying alternatives. In addition, we may be required to pay higher prices for third-party components that comply with this directive. Our inability or failure to comply with these regulations could harm our ability to sell our products within the European Community and in any other countries that may adopt this directive, and may have an adverse effect on our results of operations.
We depend on a limited number of key personnel who would be difficult to replace. If we lose the services of these individuals or cannot hire additional qualified personnel, our business may be harmed.
Our business and future growth and success largely depend on the managerial and technical skills of members of our management. If one or more of the members of the senior management team are unable or unwilling to continue in our employ, our results of operations could be materially and adversely affected.
Our success also depends to a substantial degree upon our ability to attract, motivate, and retain other highly-qualified personnel. There is competition in Israel for the services of highly-qualified technical and engineering personnel. There is also considerable competition for the services of experienced sales and marketing personnel. We may not be able either to retain our current personnel or hire additional qualified personnel if and when needed.
We are dependent upon Verint to perform our remaining obligations under certain contracts with government customers on which we remain the named party.
In connection with the sale to Verint of our government surveillance business, we remain the named party on a number of contracts which required additional performance, including for warranty and other remaining services. With respect to these contracts, the customers consented to the performance by Verint of all the remaining obligations of ECtel under the contracts. The customers also agreed to communicate directly with Verint in connection with the performance of the contracts by Verint. However, we still may be liable to the customer in the event that Verint does not perform as required under these agreements, and our financial condition and results of operations may suffer if these customers pursue claims against us. In the event that we suffer damages as a result of Verint’s non-performance, we may pursue our indemnification rights against Verint. However, Verint may not have the ability to satisfy our claims.
Risks Related to Operations in Israel
Potential political, economic and military instability in Israel may adversely affect our results of operations.
Our principal offices and manufacturing facilities and many of our suppliers are located in Israel. Accordingly, political, economic and military conditions in and surrounding Israel may directly affect our business. Since the establishment of the State of Israel in 1948, a number of armed conflicts have taken place between Israel and its Arab neighbors, as well as incidents of civil unrest. In addition, Israel and companies doing business with Israel have, in the past, been the subject of an economic boycott. Although Israel has entered into various agreements with Egypt, Jordan and the Palestinian Authority, Israel has been and is subject to civil unrest and terrorist activity, with varying levels of severity, since September 2000. Recently, there was an escalation in violence among Israel and Hamas, and significant hostilities along Israel’s border with the Gaza Strip. Any future armed conflicts or political instability in the region may negatively affect business conditions and adversely affect our results of operations. In addition, the political and security situation in Israel may result in parties with whom we have agreements involving performance in Israel claiming that they are not obligated to perform their commitments under those agreements pursuant to force majeure provisions in the agreements.
We can give no assurance that security and political conditions will have no impact on our business in the future. Hostilities involving Israel or the interruption or curtailment of trade between Israel and its present trading partners could adversely affect our operations and could make it more difficult for us to raise capital.
In addition, our business insurance does not cover losses that may occur as a result of events associated with the security situation in the Middle East. Although the Israeli government currently covers the reinstatement value of direct damages that are caused by terrorist attacks or acts of war, we cannot assure you that this government coverage will be maintained. Any losses or damages incurred by us could have a material adverse effect on our business.
11
Our results of operations may be negatively affected by the obligation of key personnel to perform military service.
Some of our executive officers and employees in Israel are obligated to perform military reserve duty annually. They may also be further subject to being called to active duty at any time under emergency circumstances. Our operations could be disrupted by the absence for a significant period of one or more of our executive officers or key employees due to military service, and any disruption in our operations would harm our business. The full impact on our workforce or business if some of our executive officers and employees will be called upon to perform military service, especially in times of national emergency, is difficult to predict.
It may be difficult to enforce a U.S. judgment against us, our officers or directors or to assert U.S. securities law claims in Israel.
Service of process upon us, since we are incorporated and headquartered in Israel and upon our directors and officers, substantially all of whom reside outside the United States, may be difficult to obtain within the United States. Furthermore, because substantially all of our assets, and substantially all of our directors and officers are located outside the United States, any judgment obtained in the United States against us or any of them may not be collectible within the United States.
There is doubt as to the enforceability of civil liabilities under the Securities Act of 1933, as amended (the “Securities Act”) and the Securities Exchange Act of 1934, as amended (the “Exchange Act”) in original actions instituted in Israel. However, subject to specified time limitations, Israeli courts may enforce a U.S. final executory judgment in a civil matter, provided that:
| — | adequate service of process has been effected and the defendant has had a reasonable opportunity to be heard; |
| — | the judgment and its enforcement are not contrary to the law, public policy, security or sovereignty of the State of Israel; |
| — | the judgment was obtained after due process before a court of competent jurisdiction according to the rules of private international law prevailing in Israel; |
| — | the judgment was not obtained by fraudulent means and does not conflict with any other valid judgment in the same matter between the same parties; |
| — | an action between the same parties in the same matter is not pending in any Israeli court at the time the lawsuit is instituted in the U.S. court; and |
| — | the U.S. court is not prohibited from enforcing judgments of Israeli courts. |
If a foreign judgment is enforced by an Israeli court, it generally will be payable in NIS, which can then be converted into non-Israeli currency and transferred out of Israel. The usual practice in an action to recover an amount in non-Israeli currency is for the Israeli court to render judgment for the equivalent amount in NIS at the rate of exchange on the date of payment, but the judgment debtor also may make payment in non-Israeli currency. Pending collection, the amount of the judgment of an Israeli court stated in NIS ordinarily will be linked to the Israel Consumer Price Index plus interest at the annual rate (set by Israeli law) prevailing at that time. Judgment creditors bear the risk of unfavorable exchange rates.
Provisions of Israeli law may delay, prevent or make more difficult a merger or other business combination, and therefore depress the price of our stock.
The Israeli Companies Law – 1999 includes restrictions on mergers, such as special voting requirements, the ability of creditors to seek court intervention to delay or prevent a merger and mandatory waiting periods. In addition, under certain circumstances, the Companies Law requires that acquisitions be performed via tender offer. For more information, see “Item 10B–Memorandum and Articles of Association–Mergers and Acquisitions Under Israeli Law.”
The tax benefits to which we are currently entitled from the Investment Center of the Israeli Ministry of Industry, Trade and Labor require us to meet several conditions and may be terminated or reduced in the future, which would increase our taxes.
We are entitled to tax benefits under Israeli law for capital investments that are designated as approved enterprises. To maintain our eligibility for these tax benefits, we must continue to meet conditions stipulated in applicable law and in our specific approvals, including making specified investments in fixed assets. If we fail to comply with these conditions, in whole or in part, with respect to any approved enterprise program we establish, we may be required to pay additional taxes for the period in which we benefited from the tax exemption or reduced tax rates and we would likely be denied these benefits in the future. From time to time, we submit requests for expansion of our approved enterprise programs or for new programs to be designated as approved enterprises. These requests might not be approved, particularly in light of difficult economic conditions in Israel. In addition, in March 2005, the law governing these tax benefits was amended to revise the criteria for investments that qualify for tax benefits as an approved enterprise. We cannot assure you that we will, in the future, be eligible to receive additional tax benefits under this law. In addition, if we fail for any reason to meet the conditions of an approved investment program, our future tax benefits under the Israeli law for capital investments will be materially reduced. In light of our carry forward losses, we are currently not in a taxable position in Israel.
We received an approval in principle from the Investment Center with respect to the sale of our government surveillance business to Verint in March 2004. If the Investment Center declines, for any reason, to grant us the final approval, our tax benefits under Israeli law will be materially reduced, see “Item 10E–Taxation–Israeli Taxation.” The termination or reduction of these tax benefits could seriously harm our financial condition and results of operations.
12
Because we received grants from the Office of the Chief Scientist, we are subject to ongoing restrictions, and certain of our large shareholders are required to undertake to observe such restrictions.
We received royalty-bearing grants from the Office of the Chief Scientist of the Israeli Ministry of Industry Trade and Labor, or the Office of the Chief Scientist (OCS), for research and development programs that meet specified criteria. According to Israeli law, any products developed with grants from the OCS are required to be manufactured in Israel, unless we obtain prior approval of a governmental committee. As a condition to obtaining this approval, we may be required to pay the OCS up to 300% of the grants we received and to repay such grants at a quicker rate. Furthermore, the transfer to a non-Israeli entity of technology developed with OCS funding, including pursuant to a merger or similar transaction, and the transfer of rights related to the manufacture of more than 10% of a product developed with OCS funding are subject to approval by an OCS committee and to various conditions, including payment by us to the OCS of a percentage of the consideration paid to us or our shareholders in the transaction in which the technology is transferred. In connection with a merger or similar transaction, the amount payable would be a fraction of the consideration equal to the relative amount invested by the OCS in the development of the relevant technology compared to the total investment in our company, net of financial assets that we have at the time of the transaction, but in no event less than the amount of the grant. In addition, in the event that the committee believes that the consideration to be paid in a transaction requiring payment to the OCS pursuant to the provisions of the law described above does not reflect the true value of the technology or the company being acquired, it may determine an alternate value to be used as the basis for calculating the requisite payments. These restrictions may impair our ability to enter into agreements for those products or technologies, without OCS approval.
Risks Related to the Market for Our Ordinary Shares
Our ordinary shares may be delisted from the Nasdaq Global Market, and as a result the liquidity and price of our ordinary shares would likely decline.
Our ordinary shares are currently listed on the Nasdaq Global Market. One of Nasdaq’s continued listing requirements is that the minimum bid price of a listed security must be at least $1.00. Nasdaq has temporarily suspended this requirement through July 19, 2009. Our ordinary shares have traded below $1.00 per share since November 2008. If Nasdaq reinstates the minimum bid price rule and we fail to meet the minimum bid price requirement at that time, Nasdaq could delist our ordinary shares from the Nasdaq Global Market. Such delisting would likely have an adverse impact on the liquidity of our ordinary shares and, as a result, the market price for our ordinary shares would likely become more volatile and decline significantly.
Class action litigation due to stock price volatility or other factors could cause us to incur substantial costs and divert our management’s attention and resources.
Companies such as ours, which operate in technology industries, are particularly vulnerable to class action litigation as a result of the volatility of their stock prices. Any litigation of this sort could result in substantial costs and a diversion of management’s attention and resources.
On October 19, 2004, a class action complaint (the “Class Action Complaint”), Leumi Gemel Ltd. v. ECtel Ltd., et al., Case No. 8:04-CV-03380-RWT, was filed in the United States District Court for the District of Maryland. Named as defendants are ECtel Ltd., ECI Telecom Ltd., and certain of ECtel’s directors and officers. The Class Action Complaint alleges that the defendants violated Sections 10(b) and 20(a) of the Exchange Act, and Rule 10b-5 promulgated thereunder, by making false and misleading statements in the Company’s SEC filings and press releases during a period beginning April 24, 2001, and lasting through April 2, 2003. The claims are purportedly brought on behalf of all persons who purchased our stock during that period. The plaintiffs seek unspecified compensatory damages against the defendants, as well as attorneys’ fees and costs.
The Company filed a motion to dismiss the class action complaint. At a hearing on this motion held on July 17, 2006, the court granted our motion to dismiss the class action complaint. Following the dismissal, the plaintiff filed a motion to further amend the class action complaint. We responded by requesting that the court deny the motion to amend. On March 6, 2007, the court denied the plaintiff’s motion to further amend the class action. Plaintiff filed an appeal of the district court’s orders with the United States Court of Appeals for the Fourth Circuit. After briefing in the Fourth Circuit but before oral argument or any decision thereon, the parties reached an agreement in principle to resolve the litigation. The parties have executed a stipulation of settlement documenting their agreement. The District Court of Maryland held its hearing on preliminary approval of stipulation of settlement and granted preliminary approval. The hearing on the final approval of stipulation of settlement has been scheduled for July 27, 2009.
13
Our share price has decreased significantly during 2008 and could continue to fluctuate significantly in the future.
The market price for our ordinary shares, as well as the prices of shares of other technology companies, has been volatile. Our share price has decreased significantly during 2008. Numerous factors, some of which are beyond our control, have caused and may continue to cause the market price of our ordinary shares to fluctuate significantly, such as:
| — | shortfalls in our operating results from levels forecasted by securities analysts and by us; |
| — | fluctuations in our quarterly revenues and earnings and those of our publicly held competitors; |
| — | announcements concerning us, our affiliates, or our competitors; |
| — | the introduction of new telecommunications services; |
| — | changes in pricing policies by us or our competitors; |
| — | failure to successfully execute our growth strategy through the acquisition of other businesses; |
| — | market conditions in our industry and the global economy in general; and |
| — | the general state of the securities market (particularly the technology sector). |
In addition, trading in shares of companies listed on the Nasdaq Global Market in general and trading in shares of technology companies in particular have experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to operating performance. These broad market and industry factors may depress our share price, regardless of our actual operating results.
U.S. holders of our ordinary shares may suffer adverse tax consequences if we are classified as a passive foreign investment company for U.S. federal income tax purposes.
There is a substantial risk that we are a passive foreign investment company, or PFIC, for U.S. federal income tax purposes. Our treatment as a PFIC could result in a reduction in the after-tax return to our U.S. holders of our ordinary shares and could cause a reduction in the value of our ordinary shares. We will be classified as a PFIC for any taxable year if (after taking into account certain look-through rules with respect to the income and assets of our corporate subsidiaries) either (i) 75% or more of our gross income is passive income, or (ii) at least 50% of the average value of all of our assets for a taxable year (determined on a quarterly basis) produce or are held for the production of passive income. For this purpose, cash is considered to be a passive asset, which produces passive income. The market capitalization approach has generally been used to determine the fair market value of the assets of a publicly traded corporation, though other valuations methods may available for these purposes. If we are a PFIC for U.S. federal income tax purposes, highly complex rules will apply to U.S. holders of our ordinary shares. Accordingly, U.S. holders are urged to consult their tax advisors regarding the application of the PFIC rules. U.S. holders should carefully read “Item 10E–Taxation–Certain U.S. Federal Income Tax Considerations” for a more complete discussion of the U.S. federal income tax risks (including the PFIC rules) related to owning and disposing of our ordinary shares.
Item 4. Information on the Company
| A. | History and Development of the Company |
ECtel Ltd. is our legal and commercial name. Until April 1998, we operated under the name ECI Telesystems Ltd. We were incorporated as a wholly-owned subsidiary of ECI Telecom Ltd. on April 4, 1990, under the laws of the State of Israel. Our principal executive offices are located at 10 Amal Street, Rosh Ha’ayin, Israel and our telephone number is (972-3) 900-2115. Our agent in the United States, ECtel Inc., is located at 8211 W. Broward Blvd., Suite 460, Fort Lauderdale, Florida.
On December, 29 2005, we acquired all of the outstanding shares of Telesoft. Telesoft is engaged in the development and marketing of software solutions for the management of large communications and internet networks, including its revenue assurance solution for telecommunication services providers, which effectively complements our Integrated Revenue Management solution. We believe that the acquisition of Telesoft has allowed us to provide telecommunications service providers with a flexible solution that addresses many of their revenue assurance needs.
On April 30, 2008, we acquired substantially all the assets of Compwise Ltd. (“Compwise”), an Israel-based company and a provider of business analytic solutions for telecommunication operators. This acquisition is expected to expand and strengthen our Integrated Revenue Management solutions, as well as expand our customer base.
Principal Capital Expenditures
Our principal capital expenditures in the past three years (aside from the acquisitions of Telesoft and Compwise) have been the purchase of equipment and other fixed assets used in our business (mainly in Israel). On April 30, 2008, we acquired substantially all of the assets of Compwise for approximately $1.5 million in cash.
Capital equipment purchases totaled approximately $0.7 million in 2008, $0.4 million in 2007 and $0.6 million in 2006. Our capital expenditures in 2008 were primarily for the procurement of test and production equipment computers and for the implementation of a new ERP system. We have used our working capital to finance these capital expenditures.
14
| B. | Business Overview |
General
We develop and market our Integrated Revenue Management™, or IRM™, solutions. IRM enables communications service providers to deploy, execute, and oversee multiple revenue management programs, such as our fraud prevention and revenue assurance products, on the same platform. As a result, communications service providers moving towards integrating all existing and future revenue management programs can, initially, implement any part of the IRM, while gradually migrating to a comprehensive IRM solution. Our solutions equip telecommunications service providers with comprehensive data gathering, monitoring, control and analysis capabilities to improve their operational efficiency and profitability by:
| — | detecting and preventing fraud; |
| — | monitoring and controlling revenue related processes; |
| — | detecting revenue leakage, (i.e., failure of a telecommunications service provider to correctly and fully bill and collect revenues for services provided by it), as part of a revenue assurance process, including leakage of billing events; and |
| — | monitoring customers' credit and risk (i.e., assigning risk level to each customer, based on predefined parameters, at each stage of its life cycle). |
Industry Overview
Changes in the Telecommunications Industry
The telecommunications industry is characterized by, among others, the following factors:
Convergence of Circuit-Switched and Packet-Switched Networks. Telecommunications networks of the early 1990s were not designed to handle the dramatic increases in data traffic which have been fueled by the growing use of the Internet. This led to the development of a new generation of data-oriented communications networks, often based on Internet Protocol, that use packet-networking technology, as an alternative to traditional, circuit-switched telephone networks. These packet-based, or next-generation, networks, however, are not expected to immediately replace circuit-switched networks. As a result, packet-switched and circuit-switched networks are expected to coexist and interconnect with each other for the foreseeable future, creating what is known as converged networks.
Development of Value-Added Services. Greater competition and advances in technology have led service providers to seek to differentiate themselves by offering advanced, value-added services. The increased connectivity to the Internet is making Internet-based communications, such as multimedia content, including video and audio, and e-commerce services, an integral part of these value-added services. Service providers are also expanding the range of wireless services to include data services such as e-mail, Short Message Service (SMS) and limited Internet access. Furthermore, the emerging third generation wireless (3G) technology enables the wireless provisioning of an even broader range of services, including full Internet access, downloading music and video, video conferencing and mobile banking, trading and online games.
Increased Focus on Operational Improvements and Revenue Assurance. Due to competitive industry conditions, service providers have often been forced to lower the prices they charge for value added services. In turn, lower prices have resulted in lower profit margins for the service providers with respect to these value-added services. Operators seeking greater profitability per subscriber are looking internally to improve business efficiency to ensure that they capture as much of the revenues associated with these value added services as possible. In addition, the recent increase in regulatory scrutiny by U.S. security laws and other countries’ regulators serve as an incentive for our potential customers to implement advanced revenue assurance systems, thereby improving the quality of their internal controls.
On the other hand, new technologies, such as VoIP, are facilitating the use of cheaper communications media and new and reduced pricing schemes which are not entirely based on usage level and records, such as flat rates, by some telecom operators. Such operators may be less inclined to invest in high-end solutions like ours, which by their nature monitor the usage records. Moreover, since these technologies enable service providers to offer relatively low calling rates to subscribers, this may reduce the incentive to commit telecom fraud. This, in turn, may reduce the need among service providers to constantly monitor revenue related processes and thereby reduce the demand for anti-fraud and revenue assurance solutions like ours.
Service Provider Challenges
As service providers focus on fraud prevention and revenue assurance, they face challenges in the following areas:
Fraud and Revenue Leakage Prevention. Fraud and revenue leakage typically represent a significant loss of revenues for service providers. We believe that there are several significant reasons telecommunications service providers invest in fraud and revenue leakage prevention:
| — | The complexities of telecommunications networks, and the large number of interconnected billing systems, operations support systems (OSS) and business support systems, present an environment in which failures and errors of such networks and systems, their interconnectivity or the lack of such interconnectivity, as well as human errors, are likely to occur. Such failures might affect the revenues and the profitability of the service providers. Operators are seeking solutions such as ours to monitor and supervise their revenue-affecting processes in order to minimize the effect of such failures and errors; |
15
| — | Product improvements, increased maturity of the revenue assurance market, and market education by independent software vendors and consultants, is increasing the willingness of operators to shift some of their investments in outsourced revenue assurance services towards internally-deployed revenue assurance software products; |
| — | The current competitive business environment in the communications markets drives operators to increase their focus on profitability per customer in addition to number of customers and average revenue per customer. Operators must therefore look internally to improve execution and internal operations, such as with respect to fraud and revenue leakage prevention; |
| — | Immature systems, products, and processes that result from adoption of emerging technologies, such as Next Generation, VoIP, and 3G, and innovative services, including high value transactions such as on-line banking, mobile commerce, and content, as well as from the integration of operators’ systems after mergers and consolidations among operators and internal changes in operators’ organizational structure, increase vulnerability to errors, faults, leakage and fraud; and |
| — | In some countries, “pirate” services providers have begun providing international voice service on data lines which they lease from the network operator. These leased data lines are generally not permitted by various laws governing data and voice traffic in these countries to carry voice traffic. By using these data lines, the pirate providers bypass the high international toll tariffs that traditional service providers are required to pay when providing international voice service. As a result, the pirate providers can charge less to customers than traditional service providers can, which in turns results in the loss of customers by traditional service providers. |
Service providers require increasingly sophisticated fraud prevention and revenue assurance solutions in order to overcome these challenges and effectively detect and prevent fraud in modern telecommunications networks.
Interconnect/Intranetwork Billing. The number of usage transactions, both among service providers and within the network is continually increasing, making it more important to verify the accuracy of both intranetwork and interconnection arrangements. In addition, the current flat rate billing solutions do not enable service providers to bill their subscribers and other providers based on usage of new value-added services, such as SMS or cellular roaming, over their networks. In order to maximize potential revenues, service providers require usage-based billing solutions.
In order for service providers to effectively address these challenges and remain competitive, they require comprehensive revenue assurance solutions to prevent fraud and accurately bill for their intranetwork and interconnect transmissions. These solutions must be capable of processing hundreds of millions of sessions per day from objective and/or comparable sources, operating with hardware and software provided by multiple vendors and supporting the multiple technologies that exist in converged networks. In addition, solutions must be flexible in order to adapt easily to rapidly changing technologies. Finally, service providers seek revenue assurance solutions that meet all of these objectives and provide a demonstrable and rapid return on investment.
The ECtel Solution
We develop and market our Integrated Revenue Management™, (or IRM™), framework. IRM enables communications service providers of both wireline, wireless, Internet Protocol (“IP”) and converged networks to deploy, execute, and oversee multiple revenue management products such as our fraud prevention, credit and risk management, and revenue assurance products, on the same platform. As a result, communications service providers moving towards integrating all existing and future revenue management programs can, initially, implement any part of the IRM, while gradually migrating to comprehensive IRM solutions. Our products consist of proprietary software and hardware components, as well as off-the-shelf hardware and software components.
We believe that our solutions provide our customers with the following benefits:
| — | Comprehensive View of the Network. Modern international communications networks function on a variety of transmission protocols. For example, transmission protocols for circuit-switched networks are different from those used in packet-switched networks. Our solutions have the capability to view and analyze many of the transmission protocols used in converged networks. In addition, our solutions are capable of viewing and analyzing not only the signaling information, but also the embedded session information. Signaling information consists of basic information, such as time and place of origin and destination of the message. Embedded session information includes the classification of message type (e.g., voice, fax or data) and information regarding the message content, such as touch tones initiated during a call. Most alternative solutions provided by our competitors only analyze the signaling information. Moreover, our solutions perform the crucial mediation function, which is necessary in order to analyze and correlate data from a wide variety of information sources in a packet-switched network. These information sources include specialized probes that provide value-added services and other applications. As a result, our solutions are generally able to provide a more comprehensive view of modern, interconnected networks than those of our competitors. |
| — | Real-Time Functionality. Our system platform is designed to collect, process and present data about the network in real-time. This allows our customers to react to network conditions and events generally as they occur. For example, using our fraud prevention product, a service provider can detect and interrupt fraudulent activity as it occurs or even before it begins, thereby reducing losses. This real-time functionality is of increasing importance with respect to data services that support high value transactions, such as on-line banking or securities trading, in which both the network provider and the subscriber bear the risk of substantial losses as a result of acts of fraud. Based on this information, the provider can reroute traffic and initiate maintenance on its network within minutes. |
16
| — | Flexible, Scalable, Multi-Application Platform. Our system platform has been designed to meet the continually evolving requirements of service providers. Our platform is based on a modular architecture, which enables our customers to easily and cost-effectively add capacity and network coverage. In addition, because all of our applications run on the same platform, our customers can easily add new functionalities to their installed solution. Our solutions can also be easily upgraded to keep up with the rapid introduction of new technologies and services. |
| — | Vendor Independent Solutions. Our probing solutions analyze raw signaling information and embedded session information, each captured directly from the network. These solutions do not rely on information provided in vendor-specific format such as data that is processed and formatted for billing systems. By analyzing raw information, our fraud prevention system enables our customers to detect types of fraud that would not be detected by analyzing only processed data. For example, our solutions capture and analyze information about unsuccessful call attempts, which is not usually registered with billing systems, and which is important in detecting some types of fraud and implementing a proactive approach for fraud prevention. |
| — | Sophisticated Algorithms. We have developed sophisticated proprietary algorithms to enable our products to perform comprehensive session analyses. Using these algorithms and supporting hardware, our solutions can analyze signaling information and embedded session information on multiple channels simultaneously. For example, our powerful data-mining algorithm uses neural networks and decision tree techniques that enable our fraud prevention solutions to detect types of fraud that the rule-based solutions of many of our competitors are unable to detect. We have also developed proprietary digital signal processing algorithms to enable our products to perform comprehensive session signal analysis. |
| — | Personalized Dashboards. Our system platform and applications provide service providers with the flexibility to have their personnel define the scope of the data they require and the preferred method of viewing this data. For example, a service provider’s revenue assurance professional may use our revenue assurance products to view a bar graph showing revenue leakages for various products offered by the service provider. At the same time, its marketing professional may use the same product to view usage information. Using a standard personal computer, each user can generate customized reports and easily select, organize and analyze the data relevant to the user. |
Business Strategy
Our objective is to be a leading provider of integrated revenue management solutions worldwide. Currently our IRM™ suite of integrated revenue management solutions includes fraud prevention solutions, credit and risk management, and revenue assurance solutions. The following are key elements of our strategy:
| — | Offer Comprehensive Fraud Prevention and Revenue Assurance Solutions within our IRM suite. We offer our service provider customers comprehensive fraud prevention, credit and risk management, and revenue assurance solutions to meet their fraud prevention and revenue assurance needs. We also seek to regularly add new functionality and applications to our products to enable our customers to meet the full range of fraud prevention, credit and risk management, and revenue assurance challenges that exist in converged networks. We continually seek to adapt our existing fraud prevention, credit and risk management, and revenue assurance solutions to be compatible with emerging technologies and services. |
| — | Pursue Organic and Non-Organic Growth. We plan to grow our business by increasing our installed base of customers and by offering additional solutions to telecom operators in fields related to our current business mainly in the areas of customers’profitability and customers’ retention. By doing so, we will be able to leverage our sales channels and customers base for the sale of additional solutions. In order to execute such growth plan we pursue mergers and acquisition transactions with other suppliers. We consider acquisition of companies that provide us with additional products, with complementary sales channels and customers, and that contribute to the overall shareholder value. |
| — | Maintain and Enhance Our Technological Leadership. We believe that our technology platform provides us with a competitive advantage in developing revenue assurance solutions to meet the rapidly changing needs of service providers. We have invested significant resources over the years in both internal development and selective acquisitions. We intend to continue to invest in our technology, through internal development and selective acquisitions, to maintain our position as a technological leader in revenue assurance solutions. |
| — | Focus on Leading Worldwide Service Providers. We focus our marketing efforts on leading worldwide service providers of wireline, wireless and next-generation communication services, many of whom have global affiliations. We have sold our solutions to many of the world’s largest telecommunications service providers, including Hutchison H3G, TO2, Tele2 group, MTS group, Digicel group, Portugal Telecom, Verizon (MCI), Telenor (Vodafone Sweden), Kyivstar, Qwest Communications International, Swisscom, the Telefonica Group, Serbia Telecom and Rostelecom. We believe that sales to market leaders will assist our marketing efforts to establish our brand name and industry position. |
| — | Maintain Direct and Interactive Relationships With Our Customers. We work closely with our existing customers, both to support the solutions already sold to them, and to provide additional products through cross sales and professional services to help them refine and upgrade their solutions. This enables us to market complementary products to our customers to meet their changing needs and to stay abreast of the evolving needs of the marketplace. |
17
Products
Fraud Prevention Solutions
Our fraud prevention solutions enable communication service providers (CSPs) to detect, prevent and manage the treatment of suspected fraudulent activities. The system gathers information about calls both in real-time and offline and compares it to fraudulent scenarios established within user-specified filter parameters, subscriber profiles and thresholds. When defined thresholds are reached, an alert is automatically generated and appropriate intervention can take place according to the user’s chosen parameters. Our FraudView® system provides comprehensive fraud detection and prevention solution for wireline, wireless and next generation networks.
Our latest version of FraudView features an array of fraud detection and prevention technologies, enabling large amount of anti-fraud checks and controls for the protection of operators’ business. In addition, it enables and facilitates a subscriber-centric fraud management process, in which a fraud analyst can evaluate the behavior of its subscribers by reviewing information obtained from various sources, which was consolidated and analyzed by the FraudView® system.
Revenue Assurance Solutions
Our revenue assurance solutions enable wireline, wireless, and next-generation CSPs to implement automated revenue assurance processes which facilitate auditing the accuracy of billing processes, including revenue leakage detection, help settling of interconnect disputes between operators, monitor network usage and provide traffic trend reports. Our solution gathers information such as call and customer details as well as trends and balances from several sources, and compares the information in order to discover discrepancies and generate Key Performance Indicators (KPIs), which are metrics that help the user quantify the level of leakage and level of performance of a certain revenue-related process. Each user can build, revise and add KPIs according to its organizational needs. Through its top-down viewing approach, it empowers users to locate risk points, validate revenue assurance processes, prioritize repair actions and fix leakages. Our RAP™ product is an automated revenue assurance product that facilitates cost-effective assurance of revenues and processes.
Credit and Risk Management Solution
Our credit and risk management solution is an innovative tool that enables CSPs to pursue aggressive sales goals while safeguarding themselves against undue financial risk. It applies a four-stage screening and evaluation process to evaluate subscribers’ risk and avoid bad debtors. Based on our IRM™ platform, RiskView™ combines fraud prevention, subscription risk and credit management over wireline, 2.0/2.5/3G wireless, VoIP/IP and converged networks, and provides end-to-end financial risk management across the entire telecom network spectrum.
Billing Verification
Our billing verification solution, BillView, is targeted at the financial aspect of the complex telecom operation. It provides operators and service providers with tools to increase control and reduce financial exposure. An off-the-shelf automated solution, BillView offers comprehensive rating and billing audit of all revenue-bearing events, reducing revenue leakage and financial exposure. BillView facilitates independent charging and billing verification of large usage samples of all existing and future service types: voice, data, content, 3G, 3.5G, and more. Addressing both invoice-level and call-level charges, the application can protect revenues amounting to millions of dollars annually, demonstrating clear benefits and rapid ROI.
Business Intelligence
Our Business Intelligence solution helps telecom operators to fight churn while managing price plans’ costs and revenues and the customers’ lifecycle. BusinessView enables telecom operators to structure themselves towards focusing on building and successfully implementing pricing plans. This approach reduces churn by better managing customer retention and accurately targeting marketing campaigns, which leads to higher revenues and profitability. BusinessView meets the challenges of today’s highly competitive markets by focusing on three integrated areas: business and marketing analysis, cost management, and customer retention.
18
Integrated Revenue Management (IRM) Platform for all Solutions
Our IRM platform can be leveraged for our fraud prevention, credit and risk management, and revenue assurance solutions. The platform includes the following components:
| — | Probes; |
| — | Data Management Layer or data loaders; and |
| — | Dashboard. |
Probes. Our application-specific probes are attached to the CSP’s network. Our probes for circuit-switched networks are a combination of our proprietary software and hardware components. Our probes for next generation networks are a combination of our proprietary software and off-the-shelf probe hardware. The probes capture, filter, aggregate, correlate and merge data collected from network links, such as E-1/T-1 links, and Internet, fast Internet and gigabit Internet links. Our probes gather information from all layers of the network, from the physical layer to the application layer, without disrupting the operation of the network service.
Data Management Layer or data loaders software component. Our software solutions perform the crucial data loading and data preparation functions. This consists of extracting, collecting, re-formatting, filtering and enriching raw data from various network elements and management systems, including switches, soft switches, billing systems, mediation systems, CRM systems, routers, authentication servers, VoIP gateways and other information systems. This information can be combined with information obtained from probes to create complete data records relating to sessions passing through the network.
DashBoard. Our solutions include installed software with a central display that provides an overview of key information and KPIs. It is fully configurable and provides enterprise-wide visibility across all monitored revenue and cost streams. It enables users to drill down to the raw data level of each KPI. It also provides users and managers with a wide range of analytical and statistical reports, including multi-level reports with drill-down capabilities.
Our platform’s flexible, scalable architecture is designed to evolve and grow with emerging technologies and the changing needs of our customers. It enables our customers to:
| — | scale the capacity and processing power of our products; |
| — | add new applications to an installed system; and |
| — | assimilate new and emerging network standards, devices and applications. |
Sales and Marketing
As of March 31, 2009 our direct sales force and marketing staff consisted of 25 employees worldwide. We market our IRM framework to service providers worldwide, through a direct sales force, as well as indirect sales channels. Our sales staff operates out of our offices in Israel, UK, Singapore and the United States. In addition, we engage local sales representatives, distributors and sales consultants worldwide. In some territories, we engage full time sales consultants for management of sales activities in those territories.
Sales of our solutions are made predominantly to large service providers and involve lengthy evaluation processes before the customers issue purchase orders. Because the purchase of our products is a relatively significant capital expenditure, prospective customers generally commit substantial resources to an evaluation of our solutions and require us to expend significant time, effort and money educating them about the value of our solutions. This sales cycle for our solutions is an average of between six and 18 months. Our primary marketing activities include raising awareness among existing and potential customers of the benefits provided by the features of our products. We utilize our sales force as well as the sales and marketing services of local sales representatives for such activities. We also participate in exhibitions and industry trade shows in an effort to promote our products.
The recent events in the financial market may have an impact on our business. In particular, many enterprises, telecommunications carriers and service providers may reduce their capital investments. Such decline in capital expenditures could have a negative impact on our business by reducing the number and the value of new contracts we are able to sign and may harm our revenues and results of operation. Furthermore, recently we have received an increased amount of requests from our customers for longer payment terms and alternative payment models such as revenue sharing based compensation proposals.
Customers
Our customers are communications service providers, of both fixed and wireless services. We have recently sold our solutions to leading CSPs worldwide, including the following: Digicel, Telecom Sprska, China Mobile, Cellcom Israel and Zon.
In 2008, our top ten customers accounted for 69% of our revenues, with sales to four customers in Eastern Europe accounting for 43% of our revenues, two of which each accounted for more than 10% of our revenues. In 2007, our top ten customers accounted for 51.5% of our revenues, with sales to three customers in the Americas accounting for 19.8% of our revenues, none of which accounted for more than 10% of our revenues individually.
19
The following table shows a breakdown of our revenues by geographical region during 2008, 2007 and 2006 (in thousands of U.S. dollars):
| 2008 |
2007 |
2006 | |||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| Europe | 14,683 | 11,132 | 16,341 | ||||||||
| Americas | 8,299 | 7,429 | 6,303 | ||||||||
| Middle East and Africa | 942 | 1,591 | 4,152 | ||||||||
| Asia Pacific and others | 1,060 | 746 | 2,006 | ||||||||
| 24,984 | 20,898 | 28,802 | |||||||||
PSO (Professional Services Organization)
Our professional services organization (PSO) consists of technical personnel possessing an in-depth understanding of customers’ business environments. The PSO provides to our customers comprehensive technical services, including consulting services, project management, training and on-going support, thereby maximizing the value of our Integrated Revenue Management solution to our customers.
In recent years, we outsourced a portion of our technical services and activities in Europe to a subcontractor in Bulgaria. Due to the low cost of operations in Bulgaria, we gradually expanded our outsourced activities there and in December 2006, we established a wholly-owned subsidiary in Bulgaria named ECtel Bulgaria EOOD. As of April 1, 2008, as per our agreement with our Bulgarian subcontractor, substantially all of the employees of our former Bulgarian subcontractor were engaged directly by ECtel Bulgaria. In addition, since November 2008, we have outsourced a portion of our technical services and activities in Europe to a subcontractor in Ukraine.
We have focused on building a strong customer care organization for our systems which provides services and support to our customers. We maintain at our headquarters in Israel a staff of highly skilled customer service engineers that offer support to our customers and sales channels. These service engineers, as well as additional service engineers located in our offices in the United States and Europe, provide first class field services and support. We maintain training and expert guidance services for our customers, as well.
Our products are generally sold with a warranty for repairs of hardware and software defects and malfunctions, the term of which is usually one year after acceptance of the system. Post-warranty support and maintenance services are made available to customers on a contractual basis for an additional charge. The maintenance agreements generally provide for remote support and maintenance as well as updates to correct bugs or errors in the software. Upgrades and enhancements to the software may be purchased as part of the support and maintenance services for additional consideration and subject to additional specific terms.
Manufacturing
We purchase some hardware, such as servers and storage devices, from third-party vendors such as IBM and Hewlett Packard. Our manufacturing operations consist primarily of integration, final assembly and testing, involving the application of extensive testing and quality control procedures to materials, modules, subassemblies and systems. ECI, our former major shareholder is the owner of certain intellectual property rights related to our legacy probing devices. ECI currently permits our supplier to use its technology required for production of these components. To the extent ECI will withhold its permission, it will have to supply these components to us under a components supply agreement executed between our Company and ECI in February 2004. The supply has an initial period of seven years.
We maintain an organization-wide quality assurance system, based upon ISO9000:2000. This system helps us to coordinate and continuously improve our business processes in our R&D, manufacturing, delivery, sales and services departments. Our primary manufacturing and research and development facilities are certified for Quality Standard ISO 9001:2000. ISO 9001:2000 is an international standard of quality assurance for companies that perform design, development, manufacturing, service and installation of products and systems. This standard was established by the International Organization for Standardization (ISO), an international federation of national standards bodies. To be certified for ISO 9001:2000, a company must be audited by an ISO-accredited auditing body, in our case the SII (Standard Israel Institute), and must meet or surpass the standards requirements. We believe that our customers value the process, control and traceability, for which we have been awarded ISO 9001:2000 certification.
Research and Development
In order to accommodate the rapidly changing needs of our markets, we place considerable emphasis on research and development projects designed to improve our existing product lines, develop new product lines and customize our products to meet our customers’ needs. As of March 31, 2009, 27 of our employees were engaged primarily in product development activities. We expect that we will continue to commit substantial resources to product development in the future.
As a recipient of grants from the Office of the Chief Scientist (OCS), we are obligated to perform, in Israel, all development activities related to products under these grants, unless we receive an exemption. Know-how from the research and development used to produce these products may not be transferred to third parties without the approval of the OCS. Approval is not required for the export of any products resulting from the research and development based on these grants. Also, during the fourth quarter of 2006, we committed to repay in full all the grants related to programs connected to our FraudView® solution. These grants were fully repaid during 2007. For further information regarding the OCS of the Israeli Ministry of Industry, Trade and Labor, see “Item 5C–Research and Development, Patents and Licenses–Grants from the Office of the Chief Scientist.”
20
Competition
The telecommunications industry is characterized by intense competition. Some of the companies that compete with us have greater name recognition, longer operating histories, lower cost structure, extensive presence in a specific territory, larger customer bases or significantly greater financial, marketing, public relations, sales, distribution and other resources. Some of our competitors and potential competitors are among the largest and most well capitalized software and hardware companies in the world.
Our main competitors in the fraud prevention and revenue assurance markets are Subex Limited, Hewlett-Packard, WeDo Technologies, FairIsaac Corp., Martin Dawes Systems, cVidya Networks and Neural Technologies Limited.
We also face competition from our customers, and we expect this trend to continue in the future. Some of our customers are developing their own solutions internally or through strategic alliances.
In recent years, our industry has experienced consolidation of solution providers, including consolidation of some of our direct competitors. This may result in the creation of one or more competitors possessing more significant market share than we possess. We believe that the principal competitive factors in the markets in which we compete are product functionality, the ability to provide effective and comprehensive solutions, recommendations and references of other customers, pricing, timely introduction of new products, especially products of next generation networks, and responsive customer support.
Seasonality
Our business depends on purchases by large telecom companies. Since some of these telecom providers operate according to annual budgets, their tendency is to approve their budgets toward the beginning of their fiscal year and utilize their budgets toward the end of their fiscal year. This mode of operation may affect our results of operations throughout the year and may cause certain seasonality in our financial results.
Intellectual Property and Proprietary Rights
The telecommunications industry is characterized to a great extent by its reliance on proprietary technology. We believe that we own or have the license to use the technologies used in our products. We depend on a combination of technical innovations, patents, trade secrets, and non-disclosure agreements for the protection of this technology. Also, we are filing patent applications to protect our technology and trademark applications to register our trademarks. We have nine–issued patents, of which three were issued in 2008, and five pending patent applications. Various trademarks of ours have already been registered in certain countries. Our registered trademarks include among others QUALIVIEW, NGN FRAUDVIEW, I-PROBE, SIGVIEW, X-ELLENCE, QUALIVOIP, QUALIMOBILE, PRE-VIEW, VALUEROUTE, BILLGUARD, FLOWGUARD, SERVGUARD and IRM.
Although we intend to protect our rights in technology vigorously, we cannot be sure that these measures will be successful. It may be possible for unauthorized third parties to misappropriate or reverse engineer aspects of our products or technology, independently develop technology of substantially similar functionality or performance, or obtain information that we regard as proprietary. Moreover, the laws of some foreign countries in which we sell or may sell our products may not fully protect, or may not protect at all, our proprietary rights in products.
Third parties may, from time to time, claim that our current or future products infringe their intellectual property rights. Intellectual property litigation is complex and we cannot assure you of the outcome of any such litigation. Any future intellectual property litigation, regardless of outcome, could result in substantial expense and significant diversion of the efforts of our technical and management personnel and disrupt or otherwise severely impact our relationships with current and potential customers. An adverse determination in any such proceeding could subject us to significant liabilities to third parties, require disputed rights to be licensed from those parties, assuming licenses to the rights could be obtained, or require us to cease using the technology and expend significant resources to develop non-infringing technology. We may not be able to obtain a license at an acceptable price.
Government Regulations
We receive grants from the OCS for research and development programs. We are also entitled to tax benefits under Israeli law for capital investments that are designated as approved enterprises. Our participation in these programs is subject to our compliance with certain conditions and imposes certain restrictions upon us.
Demand for products by service providers is affected by various types of laws and regulations in Israel and other countries in which we operate, in the areas of use of communications customer records, network service standards, billing for use of interconnected networks, certification of and charges paid by VoIP service providers and opening markets to competition. For more information regarding the OCS and tax benefits for approved enterprises, see “Item 5C–Research and Development, Patents and Licenses–Grants from the Office of the Chief Scientist” and “Item 10E–Taxation–Israeli Taxation–Tax Benefits under the Law for the Encouragement of Capital Investments, 1959,” respectively.
21
| C. | Organizational Structure |
As of March 31, 2009, IDB Holding Corporation Ltd. and its affiliates Koor Industries Ltd., Clal Electronics Industries Ltd. and others (“IDB”) beneficially held 38.6% of our outstanding shares.
We have outsourced a portion of our technical services and activities in Europe to a subcontractor in Bulgaria. Due to the low cost of operations in Bulgaria we have gradually expanded our outsourced activities In Bulgaria and in December 2006, we established a wholly-owned subsidiary in Bulgaria named ECtel Bulgaria EOOD. As of April 1, 2008 as per our agreement with our Bulgarian subcontractor, substantially all of the employees of our Bulgarian subcontractor have been engaged directly by ECtel Bulgaria.
We own all the outstanding shares of
| — | ECtel Inc., a Maryland corporation |
| — | ECtel (2000) U.K. Ltd., a U.K. company; |
| — | ECtel Telesoft Ltd, an Israeli company; |
| — | ECtel Telesoft Export (98) Ltd, an Israeli company; |
| — | ECtel Bulgaria EOOD, a Bulgarian company; |
| — | ECtel BV, a Dutch company which, in turn, holds all of the shares of ECtel GmbH (in the process of voluntary liquidation), a German company; and |
| — | Telrad Hawk Net - I Ltd. (in the process of voluntary liquidation), an Israeli company. |
| D. | Property, Plants and Equipment |
We lease our headquarters and main facilities located in Rosh Ha’ayin, Israel for our executive offices, sales, marketing, administrative, development, professional services and support activities. The facilities occupy approximately 37,232 square feet. We lease these facilities pursuant to an agreement. The lease period commenced on July 10, 2005 and runs through June 30, 2015. We are entitled to shorten the term of the lease at any time following its fifth or sixth anniversary, subject to certain penalty payments. We are further entitled to discontinue the lease on the seventh, eight, or ninth anniversaries, upon providing six months written notice, without any penalty payments.
ECtel Inc., our U.S. subsidiary, leases approximately 1,500 square feet of office space in Florida which is used mainly for sales and marketing activities. The term of the Florida lease is through September 24, 2010.
ECtel Bulgaria EOOD, our Bulgarian subsidiary, leases approximately 4,000 square feet of office space in Sofia, which is used mainly for professional services and support activities. The term of the Sofia lease is through March 31, 2010.
ECtel (2000) U.K. Ltd, our UK subsidiary, leases approximately 100 square feet of office space in London which is used mainly for sales and marketing activities. The term of the London lease is through October 12, 2009.
We believe that our existing facilities are adequate to meet our current and foreseeable needs.
Item 4A. Unresolved Staff Comments
Not Applicable.
Item 5. Operating and Financial Review and Prospects
| A. | Operating Results |
We make forward-looking statements in this Annual Report and in other filings with the SEC. You can identify these forward-looking statements by use of words such as “strategy”, “expects”, “continues”, “plans”, “anticipates”, “believes”, “may”, “estimates”, “intends”, “projects”, “goals”, “targets”, and other words of similar meaning. You can also identify them by the fact that they do not relate strictly to historical or current facts.
We cannot assure you that any forward-looking statement will be realized, although we believe we have been prudent in our plans and assumptions. Achievement of future results is subject to risks, uncertainties and inaccurate assumptions. Should known or unknown risks or uncertainties materialize, or should underlying assumptions prove inaccurate, actual results could vary materially from those anticipated, estimated or projected. Investors should bear this in mind as they consider forward-looking statements and whether to invest or remain invested in ECtel securities. The forward-looking statements relate to, among other things: revenues, operating results; anticipated cash flows; gross margins; and the market’s acceptance of our technologies, products and solutions.
22
In connection with the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995, we are identifying important factors that, individually or in the aggregate, could cause actual results and outcomes to differ materially from those contained in any forward-looking statements made by us; any such statement is qualified by reference to the following cautionary statements. Please read the section above entitled “Risk Factors” to review conditions that we believe could cause actual results to differ materially from those contemplated by the forward-looking statements. You should understand that it is not possible to predict or identify all risk-factors. Consequently, you should not consider the factors discussed in “Risk Factors” to be a complete discussion of all potential risks or uncertainties. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect our view only as of the date of this Annual Report. Except as required by law, we undertake no obligation to update these forward-looking statements to reflect future events or circumstances or the occurrence of unanticipated events.
You should read this discussion in conjunction with the consolidated financial statements and the other financial information appearing elsewhere in this Annual Report.
Overview
We develop and market Integrated Revenue Management™ (IRM™) solutions for wireline, wireless, converged and next-generation operators. Our solutions equip telecommunications service providers with comprehensive data gathering, monitoring, control and analysis capabilities to improve their operational efficiency and profitability by:
| — | detecting and preventing fraud; |
| — | monitoring and controlling revenue related processes; |
| — | detecting revenue leakage, (i.e., failure of a telecommunications service provider to correctly and fully bill and collect revenues for services provided by it), as part of a revenue assurance process, including leakage of billing events; and |
| — | monitoring customers' credit and risk (i.e., assigning risk level to each customer, based on redefined parameters, at each stage of its life cycle). |
In April 2008, we acquired substantially all of the assets of Compwise Ltd., an Israel-based company, a provider of business analytic solutions for telecommunication operators, for $1.5 million, pursuant to an asset purchase agreement, which is described below under “Item 10C–Material Contracts.” The goal of this acquisition was to expand and strengthen our Integrated Revenue Management solution, as well as expand our customer base. The results of operations described in this annual report were not significantly affected by the acquisition of Compwise’s assets.
In December 2005, we acquired Telesoft, comprised of two sister companies engaged in the development and marketing of software solutions for the management of large communications and internet networks, for $2.5 million. This acquisition enhanced our ability to provide communications services providers with a comprehensive Integrated Revenue Management solution.
Our revenues increased in 2008 compared to 2007 by 20% reaching $25.0 million, compared to $20.9 million in 2007. We increased our revenues, both by winning new accounts, including orders for our FraudView and RAP solutions from major telecommunication carriers in various geographic regions, and by making sales to existing customers, including sales of a new version of our FraudView and RAP solutions. We increased our maintenance and support revenues largely through renewals and extensions from our installed customer base. We also believe that the additions to our installed customer base resulting from the acquisition of Compwise may further increase our revenues from maintenance and support and allow for cross-sales opportunities.
Our operating loss for 2008 increased compared to 2007. The increase was mainly due to the following factors: (a) in 2008, we recorded a provision for bad debt in the amount of $0.4 million, compared to a recovery of bad debt provision in the amount of $0.1 million in 2007, (b) acquisition-related expenses in connection with a potential acquisition that was not completed in the amount of $0.1 million, (c) the contribution of two lower-margin, yet strategic projects with major telecom groups, and (d) the ongoing weakening of the US dollar contributed to an increase in our NIS-denominated expenses.
Our net loss for 2008 decreased compared to 2007. This was mainly due to recovery of certain Auction Rate Securities (ARS), as described below under “Item 5A–Operating Results–Comparison of 2008, 2007 and 2006–Impairment of ARS”.
The recession in the U.S. and global markets is affecting the global economy, causing uncertainty in the telecommunications market, and may result in further decreases in capital investments by telecommunication service providers. The decline in capital expenditures has had, and may in the future have, a negative impact on our sales and may adversely affect the pricing of our products. Furthermore, we may need to adjust our business and financial models to the possible lower levels of capital expenditures of our customers, which may have negative affect on our revenues. Nevertheless, despite market expectations for a decrease in capital investments by telecommunication service providers, in the first quarter of 2009 we experienced growing demand for our products, which we believe is a result of our customers’ urgent need to preserve revenues.
23
Recently we have received an increased amount of requests from our customers for longer payment terms than those which we currently offer and for alternative payment models, such as revenue sharing based compensation proposals. These payment cycles and alternative payment models may adversely affect the cash resources available to operate and expand our business. Furthermore, the global recession has impacted a number of our customers resulting in payment collection issues with respect to some customers in the first quarter of 2009. While we believe that payment will be received from these customers during this year, and are working closely with our customers to help them navigate their liquidity issues, we cannot provide assurance that these payments will be made.
Our revenues for the first quarter of 2009 were lower than we expected, at $3.4 million, as they were impacted by the longer product implementation cycles with our customers.
As the global markets continue to be in turmoil, we adopted, in the fourth quarter of 2008, a series of proactive efficiency measures including a reduction in management and employee salaries, downsizing our workforce and cost efficiencies in the professional service (PSO) functions as well as in our other operating expenses. Our planned operating expenses for the year 2009, including their scope and structure, were planned based upon our estimation as to the level of our revenues in 2009 in an aim to reduce our losses. It is our goal for 2009 to preserve cash, without compromising either our development or growth prospects.
Acquisitions and Dispositions
Our business and financial position during the three years ended December 31, 2008 were influenced by acquisitions. The acquisitions were accounted for under the purchase method of accounting, and, accordingly, the purchase price for the acquisitions were allocated to the assets acquired and liabilities assumed based on their respective fair values. The results of operations related to acquisitions are included in our consolidated statements of operations from the date of acquisitions. The following are details for each of these acquisitions and disposition:
| — | In April 2008, we acquired substantially all the assets of Compwise Ltd., an Israel-based company, a provider of business analytic solutions for telecommunication operators, for $1.5 million dollars, pursuant to an asset purchase agreement, which is described below under “Item 10C–Material Contracts.” This acquisition is expected to expand and strengthen our Integrated Revenue Management solution, as well as expand our customer base. |
| — | On December 29, 2005, we acquired Telesoft, from Elron Electronic Industries Ltd. The aggregate purchase price was $2.5 million consisting of $2.1 million in cash paid to Elron Electronic Industries Ltd., at the closing and $0.4 million in direct transaction costs consisting primarily of professional fees. In addition to the purchase price, we were obligated to pay to Elron Electronic Industries an amount of up to $0.4 million in connection with an earn outif certain milestones were met, in accordance with purchase agreement. The earn-outwas over the period of 12 months following the closing date. No such earn-out was paid, as the milestones were not met. |
Share Repurchase Plans
In July 2008 we announced a plan to repurchase our ordinary shares on the open market in an amount in cash of up to $4 million. Since we adopted the plan, we repurchased an amount of 404,503 of our ordinary shares for total consideration of $0.5 million. In April 2006 we announced a plan to repurchase our ordinary shares on the open market in an amount in cash of up to $15 million. Under this plan, we repurchased an amount of 2,304,794 of our ordinary shares for total consideration of $11.5 million. That plan expired in April 2007. As of December 31, 2008, our total cash and investments were approximately $17.6 million. See also “Liquidity and Capital Resources” in connection with our cash position.
Results of Operations
The following table sets forth the percentage relationships of certain items from our consolidated statements of operations, as a percentage of revenues for the periods indicated:
| Year ended December 31, |
|||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| 2008 |
2007 |
2006 | |||||||||
| Revenues | 100.0 | % | 100.0 | % | 100.0 | % | |||||
| Cost of revenues | 54.7 | 48.7 | 47.3 | ||||||||
| Gross profit | 45.3 | 51.3 | 52.7 | ||||||||
| Research and development costs, net | 18.2 | 22.9 | 14.8 | ||||||||
| Selling and marketing expenses | 34.6 | 40.9 | 33.0 | ||||||||
| General and administrative expenses | 27.9 | 27.5 | 13.2 | ||||||||
| Acquisition-related expenses | 0.5 | - | 2.2 | ||||||||
| Amortization of acquisition-related intangible assets | 0.7 | 0.4 | 1.6 | ||||||||
| Total operating expenses | 81.9 | 91.7 | 64.8 | ||||||||
| Operating loss | (36.6 | ) | (40.4 | ) | (12.1 | ) | |||||
| Financial income, net | 2.6 | 5.5 | 4.3 | ||||||||
| Other income (expenses), net | 0.8 | (7.5 | ) | - | |||||||
| Loss before taxes on income | (33.2 | ) | (42.4 | ) | (7.8 | ) | |||||
| Income tax (expense) benefit | (0.1 | ) | 0.3 | (*) | |||||||
| Net loss | (33.3 | )% | (42.1 | )% | (7.8 | )% | |||||
| (*) | Represent a percentage less than 0.1% |
24
Comparison of 2008, 2007 and 2006
Revenues
Our revenues consist of fees from the sale of our solutions, which include license of our software, as well as the software and hardware of third parties, to telecommunications services providers, and from fees for our professional and maintenance services.
2008 vs. 2007
Total revenues increased by 20% from $20.9 million in 2007 to $25.0 million in 2008 for the reasons discussed above in the “Overview” of this section.
2007 vs. 2006
Total revenues decreased by 27% from $28.8 million in 2006 to $20.9 million in 2007. Our revenues decreased in 2007 mainly due to the following two reasons: (i) a slower than anticipated purchasing cycle of a few of our customers, causing our revenues for the first quarter of 2007 to be below expected levels, and as a result of the fact that these orders continued to occupy some of our sales personnel during the second quarter, causing lower than expected revenues during the balance of 2007; and (ii) a delay in obtaining acceptance by certain customers of certain projects which were part of our backlog at the end of 2006 which caused delayed recognition of the revenues from those projects and occupied our operational resources involved in those projects for longer than anticipated periods, thus delaying generation of revenues from other customer projects.
Cost of Revenues
Cost of revenues consists primarily of the direct cost of materials, employee compensation expenses, payments to subcontractors and outsourcers, payments to consultants, depreciation related to manufacturing facilities, allocated overhead, maintenance and support of our products, changes in inventory and royalties to the OCS.
2008 vs. 2007
Cost of revenues increased from $10.2 million in 2007 to $13.7 million in 2008 primarily due to the increase in our revenues. Our gross profit increased primarily because our revenues increased. Our gross profit margin decreased from 51% in 2007 to 45% in 2008 mainly due to the contribution of two lower-margin, yet strategic projects with major telecom groups, the ongoing weakening of the US dollar against the Israeli shekel and the foreign exchange fluctuation between the US dollar and other currencies, which weakening and fluctuations had the effect of increasing our non-dollar expenses.
2007 vs. 2006
Cost of revenues decreased from $13.6 million in 2006 to $10.2 million in 2007 primarily due to the non-recurrence of a provision of $2.3 million for royalties to the OCS, recorded in the fourth quarter of 2006, which represented substantially full repayment of prior funding to the OCS arising from its participation plan. Our gross profit margin was 51%, compared to a gross profit margin of 53% in 2006. Our gross profit decreased primarily because our revenues decreased, however, our level of fixed expenses, such as payrolls, rent of facilities and vehicles expense remained the same. In addition, the appreciation of the NIS compared to the U.S. dollar resulted in an increase of the U.S. dollar cost of our operations in Israel compared to our cost of operations in 2006, measured based upon the 2006 average exchange rate between the NIS and the U.S. dollar.
25
Operating Expenses
| (in millions of U.S. dollars, except for percentages) |
Year ended December 31, |
% Change 2008 vs. 2007 |
% Change 2007 vs. 2006 | ||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2008 |
2007 |
2006 |
|||||||||||||||
| Research and development costs, net | 4.5 | 4.8 | 4.3 | (6.3 | ) | 12.0 | |||||||||||
| Selling and marketing expenses | 8.7 | 8.5 | 9.5 | 2.4 | (10.1 | ) | |||||||||||
| General and administrative expenses | 7.0 | 5.8 | 3.8 | 20.7 | 51.0 | ||||||||||||
| Amortization of acquisition-related intangible assets | 0.2 | 0.1 | 0.5 | 100 | (79.8 | ) | |||||||||||
| Acquisition-related expenses | 0.1 | - | 0.6 | N/A | N/A | ||||||||||||
| Total operating expenses | 20.5 | 19.2 | 18.7 | 6.8 | 2.6 | ||||||||||||
Research and Development Costs, Net
Research and development costs consist primarily of employee compensation expenses, payments to subcontractors and consultants and allocated overhead, costs of materials and software and amortization of purchased technologies associated with our research and development activities. Grants received in previous years from the OCS are deducted from gross research and development expenses to determine net research and development expenses.
2008 vs. 2007
Research and development costs, net decreased by 6.3% from $4.8 million in 2007 to $4.5 million in 2008. This decrease resulted mainly from the decrease in direct research and development expenses, partially offset by the ongoing weakening of the US dollar against the Israeli shekel.
2007 vs. 2006
Research and development costs, net increased by 12.0% from $4.3 million in 2006 to $4.8 million in 2007. This increase was due to the following factors: (i) grants from the OCS that we recorded in our books decreased by 100.0% from approximately $0.2 million in 2006 to $0 in 2007, as we did not request OCS grants or participation in any new programs; and (ii) the appreciation of the NIS compared to the U.S. dollar resulted in an increase of the U.S. dollar cost of our operations in Israel compared to our cost of operations in 2006.
Selling and Marketing Expenses
Selling and marketing expenses consist primarily of employee compensation expenses, payments to consultants, agents’ commissions and costs associated with advertising, exhibitions, market research, participation in industry trade shows, travel and allocated overheads.
2008 vs. 2007
Selling and marketing expenses increased by 2.4% from $8.5 million in 2007 to $8.7 million in 2008. The increase was mainly due to higher expense for agents’ commissions resulting from the increase in our revenues, and the ongoing weakening of the US dollar against the Israeli shekel.
2007 vs. 2006
Selling and marketing expenses decreased by 10.1% from $9.5 million in 2006 to $8.5 million in 2007. The decrease was mainly due to lower expense for agents’ commissions resulting both from the decrease in our revenues and from increased cooperation with distributors and system integrators in an effort to broaden our penetration in various markets. Sales through distributors and system integrators generally do not involve payment by us of agent commissions. The decrease in selling and marketing expenses was partially offset by the appreciation of the NIS compared to the U.S. dollar which resulted in an increase of the U.S. dollar cost of our operations in Israel compared to our cost of operations in 2006.
General and Administrative Expenses
General and administrative expenses consist primarily of employee compensation expenses, professional fees, including legal and accounting fees, recruiting costs, allocated overheads and changes in the balance of provision for doubtful accounts.
2008 vs. 2007
General and administrative expenses increased by 21.0% from $5.8 million in 2007 to $7.0 million in 2008. The increase was primarily due to (i) increases in senior management headcount and compensation levels in transition periods (i.e. turnover of employees), (ii) an increase in our doubtful debts expense totaled $0.4 million as compared to a recovery in 2007 totaling $0.1 million, and (iii) an increase in legal expenses resulting from the class action filed against the Company.
2007 vs. 2006
General and administrative expenses increased by 51.0% from $3.8 million in 2006 to $5.8 million in 2007. The increase was primarily due to expenses related to changes in our senior management resulting from: (i) payment of extended separation compensation to one of our executives who resigned from his position with the Company, (ii) increases in senior management headcount and compensation levels in transition periods (i.e. turnover of employees), (iii) the appreciation of the NIS compared to the U.S. dollar which resulted in an increase of our U.S. dollar cost of our operations in Israel compared to our cost of operations in 2006, and (iv) a decrease in our doubtful debts recovery as compared to 2006.
26
Amortization of Acquisition-Related Intangible Assets
2008 vs. 2007
In 2008 we recorded amortization of acquisition-related intangible assets in the amount of $0.2 million, related to our acquisitions of Telesoft and Compwise. Such amounts consist of amortization expense related to intangible assets recorded in connection with acquisitions accounted for by the purchase method of accounting.
2007 vs. 2006
In 2007 and 2006 we recorded amortization of acquisition-related intangible assets in the amount of $0.1 million and $0.5 million, respectively, related to our acquisition of Telesoft,.
Acquisition-Related Expenses
2008 vs. 2007
During 2008, we incurred expenses in the amount of $0.1 million in connection with a due diligence process and legal work for a potential acquisition. During the second quarter of 2008 we decided, after evaluating all the relevant parameters, not to conclude the negotiations, and therefore, we released all incurred expenses to our statements of operations. These expenses primarily consisted of third-party legal, accounting and other professional services fees.
2007 vs. 2006
No material expenses were recorded in our results of operations in 2007 in respect of acquisition-related expenses. During 2006, we incurred expenses in the amount of $0.6 million in connection with a due diligence process and legal work for a potential acquisition. During the third quarter of 2006 we decided, after evaluating all the relevant parameters, not to conclude the negotiations, and therefore, we released all incurred expenses to our statements of operations. These expenses primarily consisted of third-party legal, accounting and other professional services fees.
Operating Loss
2008 vs. 2007
Operating loss increased from $8.5 million in 2007 to $9.1 million in 2008. The increase was mainly due to the following factors: (a) we recorded a provision for bad debt in the amount of $0.4 million, compared to a recovery of bad debt provision in the amount of $0.1 million in 2007 (b) acquisition-related expenses in connection with a potential acquisition that was not completed in the amount of $0.1 million, (c) the contribution of two lower-margin, yet strategic projects with major telecom groups, and (d) the ongoing weakening of the US dollar further increased our operating loss. The effect of these factors was partially offset by the increase in revenues.
2007 vs. 2006
Operating loss increased from $3.5 million in 2006 to $8.5 million in 2007. The increase in our operating loss in 2007 was mostly due to (i) a reduction in our revenues during 2007 while our level of fixed expenses, such as payrolls, rent of facilities and vehicles expense remained the same; (ii) payment of extended separation compensation to one of our executives who resigned from his position with the Company, (iii) increases in senior management headcount and compensation levels in transition periods (i.e. turnover of employees), (iv) the appreciation of the NIS compared to the U.S. dollar which resulted in an increase of our U.S. dollar cost of our operations in Israel compared to our cost of operations in 2006, and (v) a decrease in our doubtful debts recovery as compared to 2006. This increase in operating loss in 2007 was partially offset, compared to 2006, by the following factors: (i) lower expense for agents’ commissions, resulting both from the decrease in our revenues and from increased cooperation with distributors and system integrators; and (ii) the following two non-recurring expenses which were recorded in 2006: (a) repayment of royalties to the OCS and (b) expenses for a due diligence process in connection with a potential acquisition.
27
Financial Income, Net
2008 vs. 2007
Financial income, net decreased by 43.7% from $1.16 million in 2007 to $0.65 million in 2008. This decrease was primarily due to the following three factors: (i) decrease in the average cash available for investment during 2008 compared to 2007, due to a share repurchase plan and use of funds during 2008; (ii) appreciation of the NIS compared to the U.S. dollar; and (iii) depreciation of the GBP compared to the U.S. dollar.
2007 vs. 2006
Financial income, net decreased by 6.0% from $1.23 million in 2006 to $1.16 million in 2007. This decrease was primarily due to the following two factors: (i) decrease in the average cash available for investment during 2007 compared to 2006, due to a share repurchase plan and repayment of grants to the OCS; and (ii) appreciation of the NIS compared to the U.S. dollar.
Impairment of Auction Rate Securities (ARS)
As of December 31, 2008, we had $2.7 million of principal invested in ARS. We have a long history of investing excess cash under a conservative corporate policy that only allows investments in highly rated investment-grade securities, with preservation of capital and liquidity as primary objectives. Our ARS were ranked as AAA and AA at the time of purchase, and there had been no change in their rating since that time, until the end of the first quarter of 2008 in which they experienced a rating downgrade. All securities continue to pay interest in accordance with their stated terms. However, since these ARS have experienced multiple failed auctions due to a lack of liquidity in the market for these securities, we recognized an impairment charge with respect to our ARS portfolio. As a result, in the year ended 2007, we recorded an impairment charge of $1.6 million, which is considered “other than temporary”, and an unrealized loss of $178 thousand recorded in other comprehensive loss as a reduction of shareholders’ equity, which was considered a “temporary” impairment.
In October 2008, several of the ARS held by us that were previously impaired were redeemed at par-value at the amount of $1.7 million, resulting in a gain of $1.6 million. As of December 31, 2008, we had $ 2.7 million of principal invested in ARS. As a result of market conditions and the continuing lack of liquidity, we recorded an impairment charge of $1.8 million, which is considered “other than temporary”.
Net Loss
2008 vs. 2007
Net loss decreased from $8.8 million in 2007 to $8.3 million in 2008. The decrease in our net loss in 2008 was mostly due to the increase in our gross profit in 2008 compared to 2007 which was partially offset by the increase in our operating expenses and decrease in our financial income in 2008 compared to 2007, as described above.
2007 vs. 2006
Net loss increased from $2.3 million in 2006 to $8.8 million in 2007. The increase in our net loss in 2007 was mostly due to (i) a reduction in our revenues during 2007 while our level of fixed expenses, such as payrolls, rent of facilities and vehicles expense remained the same; (ii) payment of extended separation compensation to one of our executives who resigned from his position with the Company, (iii) increases in senior management headcount and compensation levels in transition periods (i.e. turnover of employees), (iv) the appreciation of the NIS compared to the U.S. dollar which resulted in an increase of our U.S. dollar cost of our operations in Israel compared to our cost of operations in 2006, (v) a decrease in our doubtful debts recovery as compared to 2006, and (vi) an other than temporary impairment charge related to certain ARS. This increase in the net loss in 2007 was partially offset, compared with 2006 by the following factors: (i) lower expense for agents’ commissions resulting both from the decrease in our revenues and from increased cooperation with distributors and system integrators; and (ii) the following two non-recurring expenses which were recorded in 2006: (a) repayment of royalties to the OCS, and (b) expenses for a due diligence process of a potential acquisition.
Critical Accounting Policies
The preparation of our financial statements in conformity with generally accepted accounting principles in the United States requires our management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period, which could potentially result in materially different results under different assumptions and conditions. These are our management’s best estimates based on experience and historical data; however, actual results could differ materially from these estimates. Our significant accounting principles are presented within Note 2 to our consolidated financial statements appearing elsewhere in this Annual Report. While all the accounting policies impact the financial statements, certain policies may be viewed to be critical. Management believes that the following policies are those that are most important to the portrayal of our financial condition and results of operations and are the most critical to aid in fully understanding and evaluating our reported results:
| — | revenue recognition; |
| — | warranty provision |
| — | trade accounts receivables and allowance for doubtful accounts; |
| — | business acquisitions; goodwill and other intangible assets; |
| — | estimations and assumptions; |
28
| — | impairment of long-lived assets; |
| — | accounting for income taxes; |
| — | contingencies; |
| — | share-based compensation; and |
| — | classification of investments. |
Revenue Recognition
Our revenue recognition policy is significant because our revenue is a key component of our results of operations. We follow very specific and detailed guidelines in measuring revenues, as discussed below. However, such guidelines may require the exercise of certain judgments, estimates and assumptions.
We have adopted the requirements of American Institute of Certified Public Accountants (AICPA) Statement of Position (“SOP”) 97-2, “Software Revenue Recognition.” Therefore we recognize revenue from product sales (which include software) when the following criteria are met: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred; (3) the fee is fixed or determinable and (4) collectability is probable.
We include post-contract customer support (“PCS”), within the price of the product sale. This PCS is for a one-year period and includes a standard product warranty and updates and enhancements to correct minor bugs or errors in the software. The cost of providing the PCS is insignificant, and the warranty and bug fixes have been infrequent. Therefore, the PCS revenue is recognized upon delivery of the product, in accordance with SOP 97-2.
We use the residual method to recognize revenue when an arrangement includes one or more elements to be delivered at a future date and vendor-specific objective evidence of the fair value (“VSOE”) of all undelivered elements exists. Such VSOE is based on the normal pricing practices for those products and services when sold separately. Under the residual method, the fair value of the undelivered elements is deferred and the remaining portion of the arrangement fee is recognized as revenue. If evidence of the fair value of one or more undelivered elements does not exist, the revenue is deferred and recognized when delivery of those elements occurs or when fair value can be established.
When a software product is sold together with implementation or consulting services, product fees are recognized upon delivery, provided that the above criteria are met, payment of the license fees is not dependent upon the performance of the services, and the services do not provide significant customization or modification of the software products and are not essential to the functionality of the software that was delivered. When implementation and consulting services are sold, revenues are recognized based on the proportional performance method subject to the guidance of SAB 104 “Revenue Recognition in Financial Statements”.
If, at the outset of an arrangement, the arrangement fee is determined as not fixed or determinable, revenue is deferred until the arrangement fee becomes due. If, at the outset of the arrangement, collectability is determined to be not probable, revenue is deferred until the earlier of when collectability becomes probable or the receipt of payment. If an arrangement provides for customer acceptance, revenue is not recognized until the earlier of receipt of customer acceptance or expiration of the acceptance period.
Revenues from product maintenance and support contracts are recognized on a straight-line basis over the term of the support period. The majority of our maintenance agreements provide technical support as well as unspecified software product upgrades and releases when and if made available by us during the term of the support period.
Revenues from contracts that require significant design, development, modification and customization are recognized using the percentage of completion method, which is in accordance with SOP 81-1, “Accounting for performance of construction type and certain production type contracts.” The percentage of completion is determined as a ratio of the extent of the progress toward completion of the contract, using an input measure method of labor hours performed. In the event that management anticipates a loss on a particular contract, such anticipated loss is provided for in full in the period when the loss is first anticipated. If collectability is determined as not being probable, we recognize revenues from contracts with significant design, development, modification and customization, using the completed-contract method.
Warranty provision
We provide warranty on our products sold. Accrued warranty costs are calculated in respect of such products and work performed (for periods subsequent to delivery of the products or performance of the work), based on management’s estimation and in accordance with our prior experience.
Trade accounts receivable and allowance for Doubtful Accounts
Trade accounts receivable are recorded at the invoiced amount and do not bear interest. Amounts collected on trade accounts receivable are included in net cash provided by operating activities in the consolidated statements of cash flows. We do not have any off-balance-sheet credit exposure related to its customers.
Our financial statements include an allowance, which we believe reflects adequately the loss inherent in our accounts receivable portfolio. In establishing the required allowance, our management bases its determination, among other factors, on information available about the debtor’s financial situation, the volume of their operations and evaluation of the security received from them. We use our best estimate to assess the recoverability of open accounts. If there is a major deterioration in a major customer’s credit worthiness or actual defaults are higher than our historical experience, our estimates of the recoverability of amounts due to us could be adversely affected. This would result in an increase in our general and administrative expenses by increasing the allowance for bad and doubtful debts and would decrease the amount of our trade receivables.
29
Business Acquisitions; Goodwill and Other Intangible Assets
Our business acquisitions may result in the recognition of goodwill and other intangible assets, and in certain cases non-recurring charges associated with the write-off of in-process research and development (“IPR&D”), which may affect the amount of current and future period charges and amortization expense. Goodwill represents the excess of the purchase price over the fair value of net assets acquired, including identified intangible assets, in connection with our business combinations accounted for by the purchase method of accounting. We amortize our acquisition-related intangible assets using the straight-line method and based on forecasted cash flows associated with the assets over the estimated useful lives. We adopted SFAS 142 requirements regarding goodwill and other intangible assets with indefinite useful lives. Such goodwill is not amortized, but rather is periodically assessed for impairment.
The determination of the value of these components of a business combination, as well as associated asset useful lives, requires management to make various estimates and assumptions. Critical estimates in valuing certain of the intangible assets include but are not limited to: future expected cash flows from product sales, maintenance agreements, customer contracts, and acquired developed technologies; expected costs to develop the IPR&D into commercially viable products and estimating cash flows from the projects when completed; assumptions about the period of time the acquired products and will continue to be used in our product portfolio; and discount rates. Management’s estimates of fair value and useful lives are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable. Unanticipated events and circumstances may occur and assumptions may change. Estimates using different assumptions could also produce significantly different results.
We continually review the events and circumstances related to our financial performance and economic environment for factors that would provide evidence of the impairment of our intangible assets. When impairment indicators are identified with respect to our previously recorded intangible assets, then we test for impairment using undiscounted cash flows. If such tests indicate impairment, then we measure the impairment as the difference between the carrying value of the asset and the fair value of the asset, which is measured using discounted cash flows. Significant management judgment is required in forecasting of future operating results, which are used in the preparation of the projected discounted cash flows and should different conditions prevail, material write downs of net intangible assets and other long-lived assets could occur. We periodically review the estimated remaining useful lives of our acquired intangible assets. A reduction in our estimate of remaining useful lives, if any, could result in increased amortization expense in future periods.
We conduct our annual goodwill impairment test as of June 30 every year. We performed annual impairment tests during 2008, 2007 and 2006 and did not identify any impairment. At December 31, 2008, given the adverse change in the general business climate and the recent decrease in the Company’s market capitalization, the Company has performed an additional goodwill impairment assessment and has determined that no impairment has occurred as of December 31, 2008.
We will continue to perform an impairment test at least annually and on an interim basis should circumstances indicate that an impairment loss may exist. The outcome of such testing may lead to the recognition of an impairment loss.
Intangible assets that have finite useful lives are amortized over their expected useful lives and are evaluated for recoverability whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. Intangible assets consist mainly of acquired technology and customer relations and are amortized over three to ten years.
Estimations and assumptions
The preparation of financial statements in conformity with United States generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The estimates and assumptions used are management’s best estimates based on experience and historical data, however actual results could differ from those estimates.
Significant items subject to such estimates and assumptions include the useful lives of fixed assets, allowances for doubtful accounts goodwill and intangible assets, fixed assets, inventory, investments and share-based compensation income tax uncertainties and other contingencies. The current economic environment has increased the degree of uncertainty inherent in those estimates and assumptions.
Impairment of Long-Lived Assets
We have investments in tangible and intangible long-lived assets. Changes in technology or changes in our intended use of these assets may cause the value of these assets to change.
We account for long-lived assets under the provisions of SFAS 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”. SFAS 144 addresses financial accounting and reporting for the impairment or disposal of long-lived assets. SFAS 144 requires that long-lived assets be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized by the amount by which the carrying amount of the asset exceeds the fair value of the asset. SFAS 144 requires companies to separately report discontinued operations and extends that reporting to a component of an entity that either has been disposed of (by sale, abandonment, or in a distribution to owners) or is classified as held for sale.
30
Accounting for Income Taxes
We account for income taxes under SFAS 109, “Accounting for Income Taxes”. Under SFAS 109, deferred tax assets or liabilities are recognized in respect of temporary differences between the tax bases of assets and liabilities and their financial reporting amounts as well as in respect of tax losses and other deductions which may be deductible for tax purposes in future years, based on tax rates applicable to the periods in which such deferred taxes will be realized. Deferred tax assets for future tax benefits from realization, are included in the balance sheets, when, in our estimation, their realization is more likely than not.
Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. A valuation allowance has been made for almost all of our deferred tax assets and those of our subsidiary companies, since we believe that it is more likely than not that the deferred tax assets will not be realized, as we are uncertain as to whether loss carry forwards will be utilizable in the foreseeable future.
In June 2006, the Financial Accounting Standards Board (the “FASB”) issued FASB Interpretation (“FIN”) No. 48, “Accounting for Uncertainty in Income Taxes–an interpretation of FASB Statement No. 109" (the “Interpretation”). The Interpretation clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS 109. The Interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The Interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. The Interpretation is effective for fiscal years beginning after December 15, 2006. The Company applied the provisions of the Interpretation effective January 1, 2007; however, the adoption of the Interpretation did not have an effect on the Company’s financial condition, results of operations or cash flows.
Contingencies
From time to time, we are a defendant or plaintiff in various legal actions, which arise in the normal course of business. We are required to assess the likelihood of any adverse judgments or outcomes to these matters as well as potential ranges of probable losses. When we believe that it is probable that we will not prevail in a particular matter, we then estimate the amount of the liability based in part on advice of legal counsel. See Note 9F to our consolidated financial statements appearing elsewhere in this Annual Report and “Item 8A–Consolidated Financial Statements and Other Financial Information–Legal Proceedings” in relation to the class action filed against us in October 2004.
Share-Based Compensation
Prior to January 1, 2006, we applied the intrinsic value-based method of accounting prescribed by Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees”, and related interpretations, in accounting for our fixed plan stock options. As such, compensation expense was determined on the date of grant only if the current market price of the underlying stock exceeded the exercise price and was amortized over the vesting period.
We also adopted the disclosure provisions of SFAS 123 “Accounting for Stock-Based Compensation” that were in force until December 31, 2005, but opted to remain under the expense recognition provisions of APB 25.
In December 2004, FASB issued SFAS No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123R”), which requires entities to measure the cost of employee services received in exchange for an award of equity instruments based on the grant date fair value of the award and recognize the cost over the period during which an employee is required to provide service in exchange for the award. SFAS 123R does not change the accounting guidance for share-based payment transactions with parties other than employees provided in SFAS 123 as originally issued. In March 2005, the SEC issued Staff Accounting Bulletin (“SAB”) No. 107, which expressed views of the SEC staff regarding the application of SFAS 123R. Among other things, SAB 107 provides interpretive guidance related to the interaction between SFAS 123R and certain SEC rules and regulations, as well as providing the SEC staff’s views regarding the valuation of share-based payment arrangements for public companies. In December 2007, the SEC published Staff Accounting Bulletin (“SAB”) No. 110, which amends SAB No. 107 by extending the usage of the Simplified Method, as discussed in SAB No. 107, in developing an estimate of expected term of “plain vanilla” share options in accordance with SFAS 123R. SAB No. 110 was declared effective on January 1, 2008, and allows companies, which do not have sufficient historical experience, to provide a reasonable estimate to continue use of the Simplified Method for estimating the expected term of “plain vanilla” share option grants after December 31, 2007. Accordingly, we will continue to use the Simplified Method until there is sufficient historical experience to provide a reasonable estimate of expected term.
We implemented SFAS 123R using the modified prospective method starting January 1, 2006. We have selected the Black-Scholes option-pricing model to determine the fair value of our awards on the date of grant and recognizing compensation cost on a straight-line basis over our awards’ vesting period for all unvested and new granted awards as of January 1, 2006, based on the grant date fair value of these awards.
31
The implementation of SFAS 123R resulted in an increase in our operating expenses during 2008, 2007 and 2006 in the amount of approximately $0.8 million, $1.1 million and $1 million, respectively. We expect to grant additional stock-based awards in future years which will result in additional share-based compensation expense.
Classification of Investments
Long-term marketable securities consist of corporate bonds, ARS and U.S. government agencies’ debt securities. At the end of 2008, we classify our corporate bonds, ARS and U.S. government agencies’ debt securities as available-for-sale. Marketable securities available-for-sale are carried at fair value, held for an indefinite period of time and intended for use in meeting the ongoing liquidity needs. Fair value is determined based on observable market value quotes or, if market values are not available, using valuation models including assessments of counterparty credit worthiness, credit default risk, underlying security, type of collaterals, risk premium and overall capital market liquidity conditions. Declines in fair value that are considered other-than-temporary are charged to earnings and those that are considered temporary are reported, net of tax, as a component of accumulated other comprehensive income in stockholders’ equity. The cost of securities sold is based on the specific identification method.
At the end of 2007, the Company classified its Corporate Bonds and U.S. Government Agencies debt securities as held-to-maturity and its Auction Rate Securities as available-for-sale. Held-to-maturity securities are those securities in which the we have the ability, and intent, to hold the security until maturity. Held-to-maturity securities are recorded at amortized cost, adjusted for the amortization or accretion of premiums or discounts. During 2008, due to market conditions at the time, we sold some held-to-maturity securities prior to maturity and must now classify our securities as available-for-sale.
Any decline in the market value of any held-to-maturity or available-for-sale security below cost, that is deemed to be other than temporary, results in a reduction in the carrying amount to fair value. The impairment is charged to earnings and a new cost basis for the security is established. Premiums and discounts are amortized or accreted over the life of the related held-to-maturity security as an adjustment to yield using the straight-line method. Interest income is recognized when earned.
Short-term deposits and marketable securities with maturity dates between 91 to 365 days are considered to be short-term investments.
| B. | Liquidity and Capital Resources |
As of December 31, 2008, we had $8.5 million in cash and cash equivalents, compared to $5.7 million in cash and cash equivalents as of December 31, 2007. As of December 31, 2008, we had $1 million in short-term investments and $8.2 million in long-term marketable securities, compared to $5.7 million in short-term investments and $17.8 million in long-term marketable securities, as of December 31, 2007.
Generally, we invest our excess cash in instruments that are liquid and generate yields, with conservative and low risk. As of December 31, 2008, we had $2.7 million of principal invested in ARS. We have a long history of investing excess cash under a conservative corporate policy that only allows investments in highly rated investment-grade securities, with preservation of capital and liquidity as primary objectives. Our ARS were ranked as AAA and AA at the time of purchase, and there had been no change in their rating since that time, until the end of the first quarter of 2008 in which they experienced a rating downgrade. All securities continue to pay interest in accordance with their stated terms. However, since these ARS have experienced multiple failed auctions due to a lack of liquidity in the market for these securities, based on third-party indications, we recognized an impairment charge with respect to our ARS portfolio. As a result, in the year ended 2007, we recorded, an impairment charge of $1.6 million, which is considered “other than temporary”, and an unrealized loss of $178 thousand recorded in other comprehensive loss as a reduction of shareholders’ equity, which was considered a “temporary” impairment.
In October 2008, several of the ARS held by us were redeemed at par-value at the amount of $1.7 million, resulting in a gain of $1.6 million. As of December 31, 2008, as a result of the market condition and the lack of liquidity continuation, we recorded an impairment charge of $1.8 million, which is considered “other than temporary”.
We believe that our current cash and cash equivalents, together with our short-term investments and long-term marketable securities, including interest to be earned thereon, will be sufficient to fund our working and other capital requirements over the course of the next twelve months. In the normal course of business, we evaluate the merits of acquiring technology or businesses. We may elect to use available cash and cash equivalents and marketable security investments to fund such activities in the future. In the event additional needs for cash arise, we may raise additional funds from a combination of sources, including the potential issuance of debt or equity securities. Additional financing might not be available on terms favorable to us, or at all. If adequate funds were not available or were not available on acceptable terms, our ability to take advantage of unanticipated opportunities or respond to competitive pressures could be limited.
Net Cash Provided by/Used in Operating Activities. Net cash used in our operating activities was approximately $8.7 million in 2008. Cash use in operations for 2008 was primarily attributable to (a) longer than expected sale cycles resulting in slower collection and increase in customer balances; (b) recovery gains in 2008 related to partial redemption of our ARS portfolio which was impaired in 2007, as described above, and (c) our net loss as described above under ” Item 5A–Operating Results–Comparison of 2008, 2007 and 2006–Net loss”. Net cash used in our operations for 2007 was approximately $6.7 million. Cash use in operations for 2007 was primarily attributable to (a) the repayments made during 2007 in respect to the OCS prior years funding in the amount of approximately $3 million; and (b) an increase in our net loss as described above under ” Item 5A–Operating Results–Comparison of 2008, 2007 and 2006–Net loss”. Net cash used in our operating activities was approximately $2.1 million in 2006. Cash use in operations for 2006 was primarily attributable to a longer collection cycle in the fourth quarter of 2006, which was reflected by a decrease in operating cash flow during the fourth quarter and which resulted in cash flow used in operating activities for 2006.
32
From time to time, we enter into accounts receivable factoring agreements with unaffiliated financial institutions. During 2008, 2007 and 2006, we sold no trade account receivables. Our ability to sell such receivables, if any, to these financial institutions on current terms and conditions is uncertain and is dependent on the creditworthiness of the customers involved, the credit risks in the specific countries concerned and the applicable institutions’ policies from time to time.
Capital Expenditures. Our capital expenditures were $0.7 million in 2008, $0.4 million in 2007 and $0.6 million in 2006. Our capital expenditures in each of these periods related primarily to the purchase of testing and computer equipment and investment in back-office equipment. In addition, in 2008 we invested $1.5 million in the acquisition of Compwise’s assets. We expect our capital expenditures to decrease in 2009 due to the completion of implementation of new enterprise resource software platform during 2008. In addition, we invest in capital expenditures pursuant to the requirements applicable to us under our approved enterprise programs. As of December 31, 2008, no amounts remain to be invested in order to comply with our current approved program. This program was concluded and filed with the Investment Center during 2007. This program will provide us with tax benefits in the future; however, if we do not comply with applicable requirements of our approved programs, all current and future benefits from this program may be cancelled.
Net Cash Used in/Provided by Financing Activities. Net cash used in our financing activities in 2008 was approximately $0.5 million. This was due to the repurchase of shares. Net cash provided by our financing activities in 2007 was approximately $1 million due to the issuance of our ordinary shares to employees upon the exercise of share options. Net cash used in our financing activities in 2006 was approximately $10.1 million. This was due to the repurchase of our shares partially offset by issuance of our ordinary shares to employees upon the exercise of share options.
Bank Credit. In September 2002, we entered into an arrangement with an Israeli bank which supplies us with various credit facilities and/or banking services, such as bank guarantees to our customers to guarantee our contractual obligations to such customers. As of December 31, 2008, outstanding bank guarantees totaled approximately $1 million. In connection with this arrangement, we executed a negative pledge in favor of the bank, in which we undertook not to perform the following without the bank’s prior written consent:
| — | mortgage, or undertake to mortgage, in any manner or form, any of our assets; or |
| — | sell assets (other than in the ordinary course of business) the value of which exceed $1 million in the aggregate. |
In addition, from time to time other banks make credit available to us in the form of bonds to secure our obligations to our customers or in connection with hedging transactions.
Impact of Related Party Transactions
Prior to June 28, 2006, we accounted for transactions with ECI as “related party transactions” based on ECI’s holdings in our shares. On June 28, 2006, ECI distributed its remaining shares of ECtel as a dividend to its shareholders. As a result, ECI is no longer a shareholder of ECtel; however, ECI and ECtel may have been deemed related parties between December 31, 2006 and September 30, 2007, during which period IDB beneficially held between 31% and 38% of our outstanding shares, as well as approximately 40% of ECI’s outstanding shares. On September 30, 2007 all the shares of ECI were acquired by a group of investors and ECI became a private company. Therefore ECI and ECtel are no longer deemed to be related parties. In our ordinary course of business, we have entered into a few agreements with ECI which are material to our operations:
Distribution Agreement. In June 2005, we entered into a distribution agreement with ECI under which we appointed ECI as our exclusive distributor in the Russian Federation, Ukraine and Kazakhstan, territories. Under this agreement, ECI, among other things, maintains a business and sales organization in these territories to promote and/or affect the sale of those of our products and services covered by the agreement. The agreement is subject to termination by either party upon three months’ notice. In addition, either party may terminate the agreement at any time upon a material breach by the other party or in the event of liquidation or similar consequences of the other party.
Supply Agreement. In February 2004, we executed a supply agreement with ECI, which replaced an earlier supply agreement entered into in October 1999. Under the terms of the supply agreement, ECI supplies us with the components (so-called “modules”) for use in our products. We agreed on the prices for these modules after negotiations with ECI. In accordance with its right under the Supply Agreement, ECI stopped manufacturing some of these components as of August 2006. Accordingly, we contracted with an alternate supplier for the manufacture of these components. While ECI currently permits our supplier to use its technology required for production of these components, we cannot assure that such permission will not be withheld by ECI in the future. To the extent ECI will withhold its permission, it has an obligation to supply these components to us under a components supply agreement executed between our Company and ECI in February 2004, which agreement has an initial period of seven years.
Corporate Tax Rate
Generally, Israeli companies are subject to corporate tax on taxable income. The corporate tax rate was reduced in July 2005, from 34% to 31% for the 2006 tax year, 29% for the 2007 tax year, 27% for the 2008 tax year, 26% for the 2009 tax year and 25% for the 2010 tax year and thereafter. However, the effective tax rate payable by a company that derives income from an approved enterprise (as defined and discussed below) may be considerably less. Israeli companies are also subject to capital gains tax at a rate of 25% on capital gains (other than gains derived from the sale of listed securities that are taxed at the prevailing corporate tax rates) derived after January 1, 2003. Also, regarding assets acquired prior to January 1, 2003, the reduced tax rate will apply to a proportionate part of the gain, in accordance with the holding periods of the asset, before or after January 1, 2003, on a linear basis.
33
Our manufacturing facilities in Rosh Ha’ayin have been granted approved enterprise status under the Law for the Encouragement of Capital Investments, 1959. Consequently, these facilities are eligible for tax benefits. We have derived, and expect to continue to derive, a substantial portion of our income from our approved enterprise facilities. Subject to compliance with applicable requirements, the income derived from our approved enterprise facilities will be subject through 2018 to a reduced tax rate of a maximum of 25%. The actual tax rate will depend upon the percentage of non-Israeli holders of our share capital. Based on our information as to share ownership as at December 31, 2008, our effective tax rate for 2008 applicable to our taxable income derived from approved enterprises would be between 0% to 25%. In light of our carry forward losses, we are currently not in a taxable position. However, according to the Law for the Encouragement of Capital Investments, prior to its amendment in 2005 (see “Item 10E–Taxation–Israeli Taxation–Tax Benefits Under the Law for the Encouragement of Capital Investments, 1959”), the tax benefits of the law require us to invest in qualifying assets. To the extent that we invest in non-qualifying assets, we would not be entitled to the tax benefits under the law for a portion of our taxable income reflecting the ratio of our qualifying to non-qualifying assets, for those programs which are subject to the old provisions of the law.
The above benefits are conditioned upon our fulfillment of conditions stipulated by the Law for the Encouragement of Capital Investments, the regulations promulgated thereunder and the instruments of approval for the specific investments in approved enterprises. If we fail to comply with these conditions, our benefits may be canceled and we may be subject to higher corporate tax rate.
Impact of Inflation, Devaluation, Appreciation and Fluctuation of Currencies on Results of Operations, Liabilities and Assets
The dollar cost of our operations is influenced by the extent to which any increase in the rate of inflation in Israel is offset by the devaluation of the NIS in relation to the U.S. dollar. Inflation in Israel will cause contracts under which we are to receive payment in dollars or dollar-linked NIS, while incurring expenses in NIS linked to the Israeli consumer price index, to be less profitable, unless such inflation is offset by a devaluation of the NIS.
Most of our sales are denominated in dollars or are dollar linked. However, a significant portion of our expenses, primarily expenses associated with employee compensation, is denominated in NIS unlinked to the dollar. A devaluation of the NIS in relation to the dollar has the effect of decreasing the dollar value of any asset of ours which consists of NIS or receivables payable in NIS, unless such receivables are linked to the dollar. Such devaluation also has the effect of reducing the dollar amount of any of our expenses or liabilities which are payable in NIS, unless such expenses or payables are linked to the dollar. Conversely, any increase in the value of the NIS in relation to the dollar has the effect of increasing the dollar value of any of our unlinked NIS assets and the dollar amounts of any of our unlinked NIS liabilities and expenses. For example, during 2007, the NIS appreciated against the U.S. dollar, which resulted in a significant increase in the U.S. dollar cost of our operations in Israel. Similarly, throughout the course of 2008, the average exchange rate between the U.S. dollar and the NIS reflected, relative to the start of 2008, a further devaluation of the U.S. dollar by almost seven percent relative to the NIS. As a result of this differential, we have experienced increases in the costs of our operations.
The following table presents information about the rate of inflation in Israel, the rate of devaluation of the NIS against the U.S. dollar, and the rate of inflation of Israel adjusted for the devaluation:
| Year Ended December 31, |
Israeli Inflation Rate |
Israeli Devaluation (appreciation) Rate |
Israel Inflation Adjusted for Devaluation | ||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| 2004 | 1.2 | (1.6 | ) | 2.8 | |||||||
| 2005 | 2.4 | 6.8 | (4.4 | ) | |||||||
| 2006 | (0.1 | ) | (8.2 | ) | 8.1 | ||||||
| 2007 | 3.4 | (9.0 | ) | 12.4 | |||||||
| 2008 | 3.8 | (1.1 | ) | 4.9 | |||||||
Because exchange rates between NIS and the U.S. dollar fluctuate continuously, exchange rate fluctuations will have an impact on our profitability and period-to-period comparisons of our results. The effects of foreign currency re-measurements are reported in our consolidated financial statements. Due to the fact that most of our revenues are in dollars while approximately 50% of our expenses are linked to NIS, inflation in Israel has not had a material effect on our results of operations, however, exchange rate fluctuations between NIS and the U.S. dollar had a material effect on our results of operation.
Market Risk
For information on our market risk, see “Item 11–Quantitative and Qualitative Disclosures About Market Risk.”
34
| C. | Research and Development, Patents and Licenses |
In order to accommodate the rapidly changing needs of our markets, we place considerable emphasis on research and development projects designed to improve our existing product lines and to develop new product lines to meet the changing needs of our market. Our research and development expenses, net were $4.5 million in 2008, $4.8 million in 2007 and $4.3 million in 2006. As of March 31, 2009, 27 of our employees were engaged primarily in research and development activities. We expect that we will continue to commit substantial resources to research and development in the future.
Grants from the Office of the Chief Scientist
We received grants under several programs from the OCS, until the end of 2006. From time to time we may decide to apply for new programs.
We recorded grant participations from the OCS totaling $0.2 million in 2006. Pursuant to the terms of these grants we are obligated to pay royalties of 3%-3.5% of revenues derived from sales of products funded with these grants. As of December 31, 2008, our contingent liability to the OCS for remaining programs, after repayment of some of the programs as mentioned above, in respect of grants received was approximately $0.4 million.
In April 2006, we repaid to the OCS an amount of $0.4 million, which represents the entire obligation of Telesoft, in connection with grants received by Telesoft in prior years.
During the fourth quarter of 2006, we committed to repay in full all the grants related to programs connected to our FraudView® solution. Pursuant to an agreement entered into with the OCS, the OCS agreed to conclude its participation in the OCS sponsored research and development programs relating to FraudView. As part of this agreement, we have fully repaid during 2007 to the OCS approximately $3 million, which includes interest accrued on the outstanding balance of the royalties. Such royalties are presented in our cost of revenues, see also Note 9B of our consolidated financial statements.
Support received from the OCS is conditioned upon our ability to comply with certain applicable requirements and conditions specified in the Chief Scientist’s program and with the provisions of the Law for the Encouragement of Research and Development in the Industry, 1984, and the regulations promulgated thereunder, or the Research and Development Law.
Under the Research and Development Law, research and development programs that meet specified criteria and are approved by the research committee of the OCS are eligible for grants of up to 50% of certain approved expenditures of such programs, as determined by said committee.
In exchange, the recipient of such grants is required to pay the OCS royalties from the revenues derived from products incorporating know-how developed within the framework of each such program or derived therefrom (including ancillary services in connection therewith), up to an aggregate of 100% of the dollar-linked value of the total grants received in respect of such program, plus interest, or up to 150% thereof in the case of some of our earliest programs.
The State of Israel does not own proprietary rights in technology developed with OCS funding and there is no restriction on the export of products manufactured using technology developed with OCS funding. The technology is, however, subject to transfer restrictions, as described below. These restrictions may impair our ability to sell our technology assets or to outsource manufacturing and the restrictions continue to apply even after we have paid the full amount of royalties payable for the grants. In addition, the restrictions may impair our ability to consummate a merger or similar transaction in which the surviving entity is not an Israeli company.
The transfer to a non-Israeli entity of technology developed with OCS funding, including pursuant to a merger or similar transaction, and the transfer of rights related to the manufacture of more than ten percent of a product developed with OCS funding are subject to approval by an OCS committee and to the following conditions:
| — | Transfer of Technology. If the committee approves the transfer of OCS-backed technology, such a transfer would be subject to the payment to the OCS of a portion of the consideration we receive for such technology. The amount payable would be a fraction of the consideration equal to the relative amount invested by the OCS in the development of such technology compared to our total investment in the technology, but in no event less than the amount of the grant. However, in the event that in consideration for our transfer of technology out of Israel we receive technology from a non-Israeli entity for use in Israel, we would not be required to make payments to the OCS if the approval committee finds that such transfer of non-Israeli technology would significantly increase the future return to the OCS. |
| — | Transfer of Manufacturing Rights. The committee is authorized to approve transfers of manufacturing rights only if the transfer is conditioned upon either (1) payment of increased aggregate royalties, ranging from 120% to 300% of the amount of the grant plus interest, depending on the percentage of foreign manufacture or (2) a transfer of manufacturing rights into Israel of another product of similar or more advanced technology. |
| — | Merger or Acquisition. If the committee approves a merger or similar transaction in which the surviving entity is not an Israeli company, such a transaction would be subject to the payment to the OCS of a portion of the consideration paid. The amount payable would be a fraction of the consideration equal to the relative amount invested by the OCS in the development of such technology compared to the total investment in the company, net of financial assets that the company has at the time of the transaction, but in no event less than the amount of the grant. |
35
In the event that the committee believes that the consideration to be paid in a transaction requiring payment to the OCS pursuant to the provisions of the law described above does not reflect the true value of the technology or the company being acquired, it may determine an alternate value to be used as the basis for calculating the requisite payments.
The Research and Development Law imposes reporting requirements with respect to certain changes in the ownership of a grant recipient. The law requires the grant recipient and its controlling shareholders and interested parties to notify the OCS of any change in control of the recipient or a change in the holdings of the means of control of the recipient that results in a non-Israeli becoming an interested party directly in the recipient and requires the new interested party to undertake to OCS to comply with the Research and Development Law. In addition, the rules of OCS may require prior approval of the OCS or additional information or representations in respect of certain of such events. For this purpose, “control” is defined as the ability to direct the activities of a company other than any ability arising solely from serving as an officer or director of the company. A person is presumed to have control if such person holds 50% or more of the means of control of a company. “Means of control” refers to voting rights or the right to appoint directors or the chief executive officer. An “interested party” of a company includes a holder of 5% or more of its outstanding share capital or voting rights, its chief executive officer and directors, someone who has the right to appoint its chief executive officer or at least one director, and a company with respect to which any of the foregoing interested parties owns 25% or more of the outstanding share capital or voting rights or has the right to appoint 25% or more of the directors. Accordingly, any non-Israeli who acquires 5% or more of our ordinary shares will be required to notify the OCS that it has become an interested party and to sign an undertaking to comply with the Research and Development Law.
The funds available for OCS grants out of the annual budget of the State of Israel were reduced in the past, and the Israeli authorities have indicated that the government may further reduce or abolish OCS grants in the future. Even if these grants are maintained, we cannot predict what would be the amounts of future grants, if any, which we might receive if we decide to apply for new grants participation programs.
| D. | Trend Information |
The recession in the U.S. and global markets is affecting the global economy, causing uncertainty in the telecommunications market, and may result in further decreases in capital investments by telecommunication service providers. The decline in capital expenditures has had, and may in the future have, a negative impact on our sales and may adversely affect the pricing of our products. Furthermore, we may need to adjust our business and financial models to the possible lower levels of capital expenditures of our customers, which may have negative affect on our revenues.
New technologies, such as VoIP, are facilitating the use of cheaper communication media by some telecom service providers. Such service providers may be less inclined to invest in high-end solutions such as those offered by the Company. Moreover, since these technologies enable service providers to offer relatively low calling rates to subscribers, this may reduce the incentive to commit telecom fraud and thereby reduce the demand for anti-fraud solutions. This trend may negatively impact our revenues and results of operations.
Our business depends on the purchases by large telecom companies. Since some of these telecom providers operate according to annual budgets, their tendency is to approve budgets toward the beginning of the fiscal year and utilize the budgets toward the end of the fiscal year. This mode of operation may affect our results of operations throughout the year and may cause certain seasonality in our financial results.
Currently, the demand for revenue assurance and fraud prevention technologies looks stable, especially in large telecom providers. We expect the demand for revenue assurance and fraud prevention technologies to remain stable in the near future. In addition, despite market expectations for a decrease in capital investments by telecommunication service providers, in the first quarter of 2009 we experienced growing demand for our products, which we believe is a result of our customers’ need to preserve revenues. However, internal processes at our prospective customers and resellers as well as competition, may affect our ability to close deals and maintain profitability at current levels. In addition, the above factors may cause fluctuations in our quarterly and annual results of operations. For example, in the fourth quarter of 2008, we announced that revenues for the fourth quarter, and subsequently the full year, were lower than initially anticipated primarily due to three factors, one of which was the longer and deeper impact of the global macroeconomic crisis on the Company’s activities reflected in a lengthening in sale cycles.
Recently we have received an increased amount of requests from our customers for longer payment terms than those which we currently offer and for alternative payment models, such as revenue sharing based compensation proposals. These payment cycles and alternative payment models may adversely affect the cash resources available to operate and expand our business. Furthermore, the global recession has impacted a number of our customers resulting in payment collection issues with respect to some customers in the first quarter of 2009. While we believe that payment will be received from these customers during this year, and are working closely with our customers to help them navigate their liquidity issues, we cannot provide assurance that these payments will be made.
The exchange rate between the U.S. dollar and the NIS fluctuated significantly in 2008, resulting in a significant increase in the U.S. dollar cost of our operating expenses. The fluctuation of the exchange rate between the U.S. dollar and the NIS has continued in 2009, with a slightly stronger dollar in the beginning of 2009, compared to 2008. Although we have operations throughout the world, the majority of our revenue and operating expenses are denominated in, or linked to, the U.S. dollar. Accordingly, we consider the U.S. dollar to be our functional currency. However, a significant portion of our expenses is in NIS. Therefore, fluctuations in exchange rates between the NIS and the U.S. dollar may have a negative effect on our results of operations and financial condition. For further information regarding the effect of fluctuations in exchange rates between NIS and the U.S. dollar on our results of operations and financial condition, see “Item 5–Operating and Financial Review and Prospects.”
36
| E. | Off-Balance Sheet Arrangements |
In the ordinary course of business, we have various commercial commitments that amounted, at December 31, 2008, in the aggregate to approximately $1 million. These consist of primarily performance bonds and other bonds and guarantees, such as tender guarantees.
We do not believe that these commitments have or are reasonably likely to have a current or future effect on our financial condition.
| F. | Tabular Disclosure of Contractual Obligations |
The following table sets forth, as of December 31, 2008, our known contractual obligations by type of obligation and for the periods indicated:
| Payments due by period (in thousands of U.S. dollars) | |||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Contractual Obligations |
Total |
Less than 1 year |
1-3 years |
3-5 years |
More than 5 years | ||||||||||||
| Operating lease obligations | |||||||||||||||||
| (vehicles and facilities) | 3,767 | 1,347 | 2,420 | - | |||||||||||||
| Liability for employee severance | |||||||||||||||||
| benefits | 2,823 | 805 | 2,018 | ||||||||||||||
| Total | 6,590 | 2,152 | 2,420 | - | 2,018 | ||||||||||||
Item 6. Directors, Senior Management and Employees
| A. | Directors and Senior Management |
The following table sets forth information with respect to our directors and senior managers:
| Name | Age | Position |
|---|---|---|
| Itzik Weinstein | 50 | President and Chief Executive Officer |
| Michael Neumann | 45 | Senior Vice President and Chief Financial Officer |
| Benny Yehezkel | 42 | Executive Vice President, Worldwide Marketing and Sales |
| Gonen Roditti | 50 | Vice President, Professional Services and Operations |
| Michael Bar Joseph | 51 | Vice President, Research and Development |
| Liat Inbar-Arad | 43 | Vice President, Human Resources |
| Yair Cohen (1) | 54 | Chairman of the Board |
| Ra'anan Cohen | 41 | Director |
| Sami Totah (1) (2) (3) | 51 | Director |
| Rami Entin (2) (3) | 57 | Director |
| Mali Baron (1) (2) (3) | 61 | Director |
(1) Member of the compensation committee
(2) Member of the audit committee
(3) Member of the investment committee
Itzik Weinstein has served as our President and Chief Executive Officer since May 1, 2007. Previously, he served as our Executive Vice President for Professional Services and Operations since July 2004. Prior to this position, he was Vice President Customer Services and Product Management at VocalTec Ltd., a VoIP company, since the year 2000. Prior to that, Mr. Weinstein served as Engineering Site Manager at NetManage Ltd., a major ISP in Israel, since 1999, and Software Engineering Manager of KLA-Tencor Corporation’s optical metrology division since the year 1995. Mr. Weinstein holds an MBA from the Kellogg-Recanati Executive MBA Program of Tel Aviv University and a B.Sc. in Computer Engineering from the Technion – Israeli Institute of Technology.
Michael Neumann has served as our Senior Vice President and Chief Financial Officer since July 2007. Previously, Mr. Neumann worked for 12 years at Cellcom Israel Ltd., a major telecommunications company in Israel, where he served as Vice President Economics and Control and interim Chief Financial Officer, among other managerial positions. Prior to that, Mr. Neumann was Finance Manager at Fibronics Ltd., a manufacturer of fiber optic communication networks, where he was responsible for the company’s worldwide financial activities. Mr. Neumann holds a B.Sc. in Economics and Management from the Technion – Israeli Institute of Technology.
37
Benny Yehezkel has served as our Executive Vice President of Worldwide Sales since September 2006. In late 2007 he also assumed the role of Executive Vice President of Worldwide Marketing. He joined us as the Senior Vice President of Telesoft following our December 2005 acquisition of Telesoft, where he had served as CEO since November 2002. Prior to Telesoft, Mr. Yehezkel served in various executive positions in the Elron Electronic Industries Group, including Vice President of Business Development of Elbit Ltd., and Chief Executive Officer of Dealigence Inc. Previously, Mr. Yehezkel was the Chief Executive Officer of Sintec Call Centers (SCC). Mr. Yehezkel holds an MBA from Tel Aviv University and a B.Sc. in Computer Science from the Technion – Israeli Institute of Technology.
Gonen Roditti was appointed as our Vice President Global Professional Services in March 2009. Prior to joining ECtel, Mr. Roditti worked at Migdal Capital Markets where he served as CIO. Prior to that Mr. Roditti worked for 15 years at Amdocs where he served in various executive positions, including Vice President Delivery, responsible for delivery aspects of customer care and billing software systems to global telecommunications accounts in Europe. Mr. Roditti has a B.A in Political Science from the University of Tel Aviv.
Michael Bar-Joseph joined us in January 2008 as Vice President of Research and Development. Prior to that, Mr. Bar-Joseph served as General Manager of Skyrider’s center in Israel, where he led and managed many innovative developments in the P2P arena. Prior to Skyrider, he was Executive Vice President of Research and Development at Red Bend Software, a leading provider of over-the-air software updates for mobile devices, successfully installed in Nokia, Sony Ericsson and other major enterprises. Previously, Mr. Bar-Joseph was the General Manager of Tundo Communication and Telephony Ltd., where he managed the R&D and engineering efforts for the company’s IP telephony system. Prior to that, Mr. Bar-Joseph led an engineering team at RAD Data Communications, where he was responsible for designing and delivering the company’s key products. He also was senior software engineer at Advanced Technology Ltd., and software engineer at Israel Aircraft Industries. Mr. Bar-Joseph received his B.Sc. in Aeronautical Engineering from the Technion –Israeli Institute of Technology, with honors.
Liat Inbar-Arad has served as our Vice President of Human Resources and a member of our executive management team since October 2007. Previously, Ms. Inbar-Arad served as Vice President Human Resources in Finjan Software. Prior to that, Ms. Inbar-Arad was the organizational development and training manager of Orbotech Ltd., an optical inspection systems manufacturer. She also served as training development manager at ECI Telecom. Prior to that, Ms. Inbar-Arad held various lecture and research positions at the Open University and Tel Aviv University. Ms. Inbar-Arad holds an M.A. in Labor Studies and a B.A. in Humanities from Tel Aviv University, with honors.
Yair Cohen has served as the Chairman of our Board since August 2006. Mr. Cohen has served as a Vice President of Elron Electronic Industries Ltd. (“Elron”) since July 2005. From 2000 until joining Elron, Mr. Cohen served as a Brigadier General in Unit 8200, the central military intelligence unit of the Israeli Defense Force, engaged in the development of advanced technology. Mr. Cohen serves on the boards of several Elron group companies. Mr. Cohen holds a B.A. degree in History and Arabic (summa cum laude) from Bar-Ilan University, Israel, and an M.A. degree in Management of National Resources (summa cum laude) from Industrial College (NDU), United States.
Ra’anan Cohen has served as one of our directors since July 2007. Mr. Cohen was appointed Chief Executive Officer of Koor in July 2006. Mr. Cohen served as President and Chief Executive Officer of Scailex Corporation Ltd. (formerly Scitex) from 2004 to July 2006. He also serves as Vice President of Discount Investment Corporation Ltd. (“DIC”), Koor’s controlling shareholder, since August 2001 and previously served as Executive Assistant to the Chief Executive Officer of DIC from 1999. Prior to joining DIC, Mr. Cohen was an associate with McKinsey & Company, Inc. in London, beginning in 1997. Mr. Cohen is a lawyer, admitted to the Israel Bar. Mr. Cohen is a member of the board of directors of a number of companies in the IDB group, including Makhteshim Agan Industries Ltd. and Cellcom Israel Ltd. Mr. Cohen holds a B.A. degree in Law and in Economics from Tel Aviv University and an M.A. in management from J.L. Kellogg Graduate School of Management at Northwestern University, United States.
Sami Totah has served as one of our external directors since September 2006. Mr. Totah has served as chairman of the board of directors of several Israeli start-up companies since 2003, including Red Bend and Flash Networks. From 1984 until 2002, Mr. Totah served in various positions at Amdocs, including the position of Chief Operations Officer. Mr. Totah is a practical software engineer and participated in professional courses over the years, including courses of the Executive MBA program of the Hebrew University Business School.
Rami Entin has served as one of our directors since June 2004. From 2001 until 2003, Mr. Entin was the chairman of the Hashavim Group, a data center for direct taxation and employment laws and a processor of wages and personnel data. From 1999 until 2001, Mr. Entin was Co-Chief Executive Officer and a director of Hilan-Tech Ltd., where he was in charge of financial, personnel, sales and marketing and Lotus Notes operations. From 1985 until 1999, he was financial manager and a director of Hilan Ltd., where he was in charge of financial and personnel operations. From 1981 until 1985, Mr. Entin worked for Kesselman & Kesselman, an accounting firm, where he served various publicly traded companies engaged in the services and industry fields. Mr. Entin is an external director of Solomon Holdings Ltd., Cimatron Ltd and of BSP Ltd., and is director of Hilan Tech Ltd. and of Gilon BI Limited. Mr. Entin holds a B.A. degree in Accounting and Economics and an MBA degree from the Tel Aviv University, and he is a certified accountant in Israel. He is also a graduate of the Advanced Management Program at Harvard University, United States.
Mali Baron has served as our external director since July 2007. From 1997 until 2006, Ms. Baron served as Senior Assistant General Manager, Head of Branches and Mortgages Division of Mercantile Discount Bank. From 1990 until 1996, she held various positions with United Mizrahi Bank, including the Director of the Business Credit Division, General Manager of Bank Mizrahi for Industry, Director of B.N.S. Leasing Company of Bank Mizrahi and Director of the Economic Division of the bank. From 1988 to 1989, Ms. Baron served as the Head Economist and Director of Human Resources for the General Bank. From 1986 to 1987, she served as an economic consultant for the First International Bank. From 1975 to 1985, Ms. Baron worked in the Budget Department of the Ministry of Finance and served as its Deputy Director from 1982-1985. Ms. Baron serves as an External Director of Bank Hapoalim Ltd. and as member of the Investment Committee of the Phoenix Insurance Company Ltd. She holds a B.A. in Economics and Developing Countries from Tel Aviv University and an MBA in Business Administration from Hebrew University. Ms. Baron has also completed course work toward a Masters in Economics.
There are no family relationships between any directors or senior managers.
38
| B. | Compensation |
The aggregate direct remuneration paid during 2008 to executive officers and directors as a group (15 persons), as well as remuneration paid to former executives in connection with their services during 2008 and payments made in connection with their termination, was approximately $2.5 million (including bonuses and deposits to pension funds). This does not include amounts expended by us for automobiles made available to our officers, expenses (including business travel, professional and business association dues and expenses) reimbursed to officers and other fringe benefits commonly reimbursed or paid by companies in Israel. In addition, we recorded an amount of $0.6 million of share-based compensation expenses, in accordance with SFAS 123R, which relate to our executive officers and directors.
Our board of directors granted options to executive officers and directors to purchase an aggregate of 410,000 ordinary shares, at an exercise price of $2.59 per share, during 2008. The exercise price was equal to the fair market value of our ordinary shares on the date of grant. The vesting of these options is spread over various periods commencing on various dates from April 2008 and ending February 2012, unless terminated sooner, in accordance with their terms. All of the options that were granted expire after the lapse of six or ten years from the date of grant, unless terminated sooner in accordance with their terms.
| C. | Board Practices |
Appointment of Directors and Terms of Office
According to the Companies Law and our articles of association, the management of our business is vested in our board of directors. The board of directors may exercise all powers and may take all actions that are not specifically granted to our shareholders. As part of its powers, our board of directors may cause us to borrow or secure payment of any sum or sums of money for our purposes, at times and upon terms and conditions as it thinks fit, including the grant of security interests in all or any part of our property.
Our directors are elected at annual meetings of our shareholders. Except for outside directors appointed according to the Companies Law, our directors hold office until the next annual meeting of shareholders following the annual meeting at which they were appointed, which is required to be held at least once during every calendar year and not more than fifteen months after the last preceding meeting. Directors may be removed earlier from office by resolution passed at a general meeting of our shareholders. Our board of directors may temporarily fill vacancies in the board until the next annual meeting of shareholders.
There are no arrangements or understandings between us and any of our directors for benefits upon termination of service, except that the vesting date of the options held by directors may accelerate upon termination in certain circumstances.
The terms of office of our directors, Yair Cohen, Rami Entin and Ra’anan Cohen, expire at our 2009 annual general meeting. The terms of office of our outside directors, Mr. Totah and Ms. Baron, expire in September 2009 and July 2010, respectively.
Audit Committee
Nasdaq Requirements
Our ordinary shares are listed for quotation on the Nasdaq Global Market, and we are subject to the rules of Nasdaq applicable to listed companies. Pursuant to the current listing requirements of the Nasdaq Global Market, we are required to have at least three independent directors on our audit committee. We have appointed such directors to our audit committee. Pursuant to the Sarbanes-Oxley Act of 2002, the Nasdaq Global Market has introduced listing standards requiring all members of an audit committee to comply with tightened independence requirements. All members of our audit committee currently comply with those requirements.
We have adopted an audit committee charter, which sets forth the powers and responsibilities of our audit committee. Our audit committee assists the board in fulfilling its responsibility for oversight of the quality and integrity of our accounting, auditing and financial reporting practices and financial statements and the independence qualifications and performance of our independent auditors. Our audit committee also has the authority and responsibility to oversee our independent auditors, to recommend for shareholder approval the appointment and, where appropriate, replacement of our independent auditors and to pre-approve audit engagement fees and all permitted non-audit services and fees.
Our board of directors has resolved to authorize our audit committee to serve as our qualified legal compliance committee. As such, our audit committee will be responsible for investigating reports made by attorneys appearing and practicing before the SEC in representing us with respect to perceived material violations of U.S. federal or state securities laws, breaches of fiduciary duty or similar violations by us or any of our agents.
The members of our audit committee are Messrs. Totah and Entin, and Ms. Baron, each of whom is an independent director under the requirements of the SEC and Nasdaq. Our board of directors has determined that Mr. Entin qualifies as a financial expert for purposes of SEC and Nasdaq rules. As stated above, Mr. Totah and Ms. Baron qualify as external directors under the Israeli Companies Law.
39
Companies Law Requirements
Under the Companies Law, the board of directors of a public company is required to appoint an audit committee, which must be comprised of at least three directors and include all of the outside directors, but may not include:
| — | the chairman of the board of directors; |
| — | any controlling shareholder or any relative of a controlling shareholder; and |
| — | any director employed by the company or providing services to the company on a regular basis. |
The duty of the audit committee is to identify flaws in the management of the company’s business, including in consultation with the internal auditor and the company’s independent accountants, and to recommend remedial action. In addition, the approval of the audit committee is required under the Companies Law to effect certain related-party transactions.
Independent Directors
Nasdaq Marketplace Rules require that the board of directors of a Nasdaq-listed company have a majority of independent directors, each of whom satisfies the “independence” requirements of Nasdaq, and its audit committee must have at least three members and be comprised only of independent directors, each of whom satisfies the respective “independence” requirements of Nasdaq and the SEC. Our board of directors has determined that each of Rami Entin, Mali Baron and Sami Totah qualifies as an independent director under the requirements of the SEC and Nasdaq, thereby constituting both a majority of our entire board and the entire composition of our audit committee.
Outside Directors
Under the Companies Law, public companies are required to have at least two outside directors. Our outside directors are Mr. Sami Totah and Ms. Mali Baron.
The Companies Law provides that a person may not be appointed as an outside director of a company if the person or the person’s relative, partner, employer or any entity under the person’s control has, as of the date of the person’s appointment to serve as an outside director, or had, during the two years preceding that date any affiliation with:
| — | the company; |
| — | any entity controlling the company; or |
| — | any entity controlled by the company or by its controlling entity. |
The term affiliation includes:
| — | an employment relationship; |
| — | a business or professional relationship maintained on a regular basis; |
| — | control; and |
| — | service as an office holder. |
The Companies Law defines the term “office holder” of a company to include a director, the chief executive officer, the chief business manager, a vice president and any officer that reports directly to the chief executive officer.
No person can serve as an outside director if the person’s position or other business creates, or may create conflict of interests with the person’s responsibilities as an outside director or may otherwise interfere with the person’s ability to serve as an outside director. Until the lapse of two years from termination of office, a company may not engage an outside director to serve as an office holder and cannot employ or receive services from that person, either directly or indirectly, including through a corporation controlled by that person.
40
Outside directors are to be elected by a majority vote at a shareholders’ meeting, provided that either:
| — | at least one third of the shares of non-controlling shareholders voted at the meeting vote in favor of the election; or |
| — | the total number of shares voted against the election of the outside director does not exceed one percent of the aggregate voting rights in the company. |
The initial term of an outside director is three years and may be extended for an additional three years. Outside directors may be removed from office only by the same percentage of shareholders as is required for their election, or by a court, and then only if the outside directors cease to meet the statutory qualifications for their appointment or if they violate their duty of loyalty to the company. If all directors are of the same gender, the next new outside director elected must be of the other gender.
Each committee of a company’s board of directors is required to include at least one outside director, except for the audit committee, which is required to include all outside directors. Pursuant to regulations promulgated under the Companies Law, each public company must have one outside director who has financial and accounting expertise and any other external directors must either have such financial and accounting expertise or meet certain professional qualifications. A director with financial and accounting expertise is a director who, due to his/her education, experience, and skills, possesses capabilities relating to, and an understanding of, business and accounting matters and financial statements, which enable him/her to understand in depth the company’s financial statements and to initiate a debate regarding the manner in which the company’s financial information is presented. A director who meets certain professional qualifications is a director who satisfies one of the following requirements: (i) the director holds an academic degree in either economics, business administration, accounting, law or public administration, (ii) the director either holds another academic degree or has obtained other high education in the company’s primary field of business or in an area that is relevant to his position, or (iii) the director has at least five (5) years of experience serving in one of the following capacities or an aggregate of at least five (5) years of experience in two or more of the following capacities: (a) a senior business management position of a company with a substantial scope of business, (b) a senior position in the primary field of business of the company or (c) a senior public administration position.
The determination as to whether a director possesses accounting and financial expertise or meets one of the required professional qualifications is made by the board of directors. In making the determination as to a director’s accounting and financial expertise, the board of directors is required to consider, among other things, the education, experience and knowledge of such person with respect to (i) accounting and internal controls matters that are typical to the industry in which the company engages and to companies of similar size and complexity to those of the company, (ii) the responsibilities of the company’s auditor and (iii) the preparation and approval of financial statements under the Companies Law and the Israeli Securities Law.
These regulations further provide that the declaration submitted by a proposed external director to the company pursuant to the Companies Law (in which such person declares that he meets all of the requirements for his appointment as an external director) will include a declaration as to such person’s education and experience, to the extent relevant to examining whether such person meets the requirements set forth in the new regulations. Such declaration shall be accompanied by documents and certifications supporting the declaration.
Other Board Committees
Subject to the provisions of the Companies Law, our board of directors may delegate its powers to committees consisting of board members. In addition to our audit committee, which is described above, our board of directors has also appointed a compensation committee, which reviews and handles certain compensation matters and investment committee, which reviews and approves our investment policy.
The members of our compensation committee are Messrs. Yair Cohen and Sami Totah, and Ms. Mali Baron. Our board of directors has determined that each of Mr. Totah and Ms. Baron is “independent”, as defined under the Nasdaq Marketplace Rules. While Mr. Cohen is not " independent ” under the Nasdaq Marketplace Rules, we have elected to follow home country practice in lieu of compliance with the NASDAQ requirement for an entirely independent compensation committee, and Mr. Cohen can therefore serve on our compensation committee notwithstanding this NASDAQ requirement.
The members of our investment committee are Messrs. Rami Entin and Sami Totah, and Ms. Mali Baron.
Internal Auditor
Under the Companies Law, our board of directors is also required to appoint an internal auditor proposed by the audit committee. The role of the internal auditor is to examine, among other things, whether our activities comply with the law and orderly business procedure. The internal auditor may not be an interested party or office holder, or a relative of any interested party or office holder, nor a member or representative of our independent accounting firm. The Companies Law defines the term “interested party” to include a person who holds 5% or more of the company’s outstanding share capital or voting rights, a person who has the right to appoint one or more directors or the general manager, or any person who serves as a director or as the general manager. Our internal auditor is Mr. Moshe Cohen, of Chaikin, Cohen, Rubin & Gilboa, an Israeli auditing firm.
41
| D. | Employees |
The following table describes the number of our employees and subcontractors as of March 31, 2009 and December 31 of each of the indicated years:
| March 31, 2009 |
December 31, 2008 |
December 31, 2007 |
December 31, 2006 | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Approximate numbers of employees by geographic location: | ||||||||||||||
| Israel | 102 | 131 | 130 | 135 | ||||||||||
| United States | 12 | 11 | 12 | 10 | ||||||||||
| Europe and elsewhere | 47 | 56 | 27 | 25 | ||||||||||
| Total workforce | 161 | 198 | 169 | 170 | ||||||||||
| Approximate numbers of employees by category of activity: | ||||||||||||||
| Management and administration | 26 | 30 | 27 | 23 | ||||||||||
| Research and development | 27 | 37 | 36 | 36 | ||||||||||
| Professional services and operations | 83 | 101 | 78 | 83 | ||||||||||
| Sales and marketing | 25 | 30 | 28 | 28 | ||||||||||
| Total workforce | 161 | 198 | 169 | 170 | ||||||||||
Relationship with Employees. Competition for highly-qualified technical and engineering personnel in the telecommunications industry is intense. We believe we have been able to attract talented engineering and other technical personnel. None of our employees are represented by a labor union, and we have not experienced any work stoppage. We believe our relations with our employees to be good and that our future success will depend in part on a continuing ability to hire, assimilate and retain qualified personnel.
Labor Laws, Pension Funds. Israeli labor laws and regulations apply to all of our employees in Israel. The laws principally concern matters such as paid vacation, paid sick days, length of the workday, payment for overtime and severance payments upon the retirement or death of an employee or termination of employment under specified circumstances. The severance payments may be funded, in whole or in part, through Managers’ Insurance or a Pension Fund, as described below. The payments to the Managers’ Insurance fund or Pension Fund toward severance amount to 8.3% of wages. Furthermore, Israeli employees and employers are required to pay predetermined sums to the National Insurance Institute, which is similar to the U.S. Social Security Administration. Since January 1, 1995, these amounts also include payments for health insurance. The payments to the National Insurance Institute amount to approximately 14.5% of wages, of which the employee contributes 66% and the employer contributes 34%.
Our general practice is to contribute funds on behalf of all of our employees to Managers’ Insurance or a Pension Fund. Each employee who agrees to participate in the Managers’ Insurance plan contributes 5% of his or her base salary and we contribute 13.3%. Each employee who agrees to participate in the Pension Fund contributes 5.5% of his or her base salary and we contribute 14.3%. Another savings plan we offer some of our employees, although not legally required, is known as the Advanced Studies Fund. Each employee who agrees to participate in the Advanced Studies fund contributes 2.5% of his or her base salary and we contribute 7.5%.
Labor Unions. We are a member of the Industrialists Association in Israel, an employers’ union. As a result of this membership, a number of collective bargaining agreements apply to us. These agreements principally concern cost-of-living wage increases, paid vacation and holidays, length of the workday, wage tariffs, termination, severance payments and other conditions of employment. We provide our employees with benefits and working conditions that are at least as favorable as the conditions specified in the collective bargaining agreements.
| E. | Share Ownership |
Security Ownership of Our Directors and Executive Officers
Other than Ra’anan Cohen, as of March 31, 2009, none of our directors or executive officers beneficially owned shares, including options to acquire our ordinary shares that are vested or vest within 60 days, which represent more than 1% of our outstanding ordinary shares. Mr. Ra’anan Cohen, in the capacity of his position as Chief Executive Officer of Koor Industries Ltd., may be deemed to beneficially own the 3,498,836 shares of our company owned by Koor. All our officers and directors listed in Item 6A above, but excluding Ra’anan Cohen, have been granted options to acquire our ordinary shares. As of March 31, 2009, they held, as a group, 36,387 of our ordinary shares and options to purchase an additional 1,670,434 ordinary shares. The following table sets forth detailed information about the options granted to our executive officers and directors, for the periods indicated:
| Grant
date |
Exercise price |
Granted amount |
Cancelled amount |
Vested options |
Non-vested options |
Options which were exercised | ||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2003 | $ | 4.67 | 40,000 | - | 40,000 | - | - | |||||||||||||
| 2004 | $ | 2.63-3.14 | 917,308 | 66,872 | 856,058 | - | 662,502 | |||||||||||||
| 2005 | $ | 3.64-4.97 | 295,000 | 175,000 | 195,000 | - | - | |||||||||||||
| 2006 | $ | 4.47-4.86 | 810,000 | 427,500 | 260,207 | 122,293 | - | |||||||||||||
| 2007 | $ | 3.28-3.49 | 620,000 | 100,000 | 239,578 | 330,422 | - | |||||||||||||
| 2008 | $ | 2.59 | 410,000 | - | 225,000 | 185,000 | ||||||||||||||
| Total | 3,092,308 | 769,372 | 1,815,843 | 637,715 | 662,502 | |||||||||||||||
All of the above listed options expire after the lapse of periods of six or ten years from the date of grant, unless terminated sooner in accordance with their terms.
42
Options to Purchase Our Ordinary Shares
In 1998, our board of directors adopted a share option plan for our employees. In 1999, our board of directors adopted a share option plan for our non-employee directors. Terms of the options granted under the plans, such as length of term, exercise price, vesting and exercisability, were determined by our board of directors.
In 2003, our board of directors adopted the “ECtel Ltd. 2003 Share Option Plan” for our officers, directors and consultants who are Israeli residents. Pursuant to the Israeli tax reform (described below under “Item 10E–Taxation–Israeli Taxation”), our board of directors resolved to elect the “capital gains route.” Accordingly, subject to the fulfillment of certain conditions, gains realized by Israeli residents from the sale of shares issued upon exercise of options will be taxed at a rate of only 25% and not at the marginal income tax rate applicable to the grantee (up to 50%). Also in 2003, our board of directors adopted the “ECtel Ltd. U.S. Employee Stock Option Plan” for residents of the United States to enable eligible grantees to benefit from favorable U.S. federal income tax treatment of options that qualify as incentive stock options. These plans were approved by our shareholders and currently have pools of 1,700,000 shares and 50,000 ordinary shares, respectively. Terms of the options granted under the plans, such as length of term, exercise price, vesting and exercisability, are determined by our board of directors.
In September 2004, our shareholders resolved to increase the number of ordinary shares underlying our 2003 Share Option Plan from 200,000 ordinary shares to 1,700,000 ordinary shares and to decrease the number of ordinary shares underlying our other share option plans (other than the 2003 U.S. Stock Option Plan) by an aggregate of (i) 490,266 ordinary shares as of the date of said resolution and (ii) 437,933 ordinary shares underlying the then outstanding options, which were scheduled to expire within 30 days following the date of said resolution.
In April 2006, our shareholders resolved to approve an amendment to our 2003 Share Option Plan (the “2003 Plan” and as amended by such amendment, the “Amended Plan”) intended to, among other things, increase the number of shares reserved for issuance under the Amended Plan by 2,000,000 shares, from 1,700,000 shares to 3,700,000 shares, add Restricted Stock Units and Stock Appreciation Rights to the types of awards available for issuance under the Amended Plan, terminate our ECtel Ltd. 2003 U.S. Employee Stock Option Plan and consolidate its terms into the Amended Plan so that we would have only one equity incentive plan under which we make awards.
As of March 31, 2009, options to purchase a total of 2,150,605 of our ordinary shares were outstanding. During 2008, no options to purchase ordinary shares granted under the plans had been exercised and 410,000 options had been granted at an exercise price of $2.59 per share.
Item 7. Major Shareholders and Related Party Transactions
| A. | Major Shareholders |
The following table shows the number of our ordinary shares beneficially owned by the only shareholders known to us as of March 31, 2009 to beneficially own 5% or more of our outstanding ordinary shares. As of that date, 16,281,898 of our ordinary shares were issued and outstanding. In accordance with the rules of the SEC, the number of ordinary shares used in calculating the percentage for each person listed below includes the shares underlying options or warrants held by such person that are exercisable within 60 days, but excludes both (i) the shares underlying any other options or warrants held by such person and (ii) shares underlying any options or warrants held by any other person (even if exercisable by such other persons within 60 days). None of our shareholders, including our major shareholders have special voting rights.
| Shares Beneficially Owned |
||||||||
|---|---|---|---|---|---|---|---|---|
| Name |
Number |
Percentage | ||||||
| IDB Holding Corporation Ltd. and its subsidiaries (1) | 6,284,955 | 38.6 | % | |||||
| Diker GP, LLC (2) | 2,920,731 | 17.94 | % | |||||
| Skiritai Capital LLC (3) | 883,599 | 5.43 | % | |||||
(1) Based upon notifications from IDB Holding Corporation Ltd. (“IDBH”), Koor Industries Ltd (“Koor”) and Clal Industries and Investments Ltd. (“Clal”) sent to us on April 7, 2009 and March 3, 2009, respectively. This number of shares includes: (a) 3,498,836 of our ordinary shares held by Koor which is an Israeli corporation. Koor’s ordinary shares are traded on the Tel Aviv Stock Exchange (the “TASE”); (b) 2,767,153 of our ordinary shares held directly by Clal Electronics Industries Ltd. (“CEI”), which is a wholly-owned subsidiary of Clal. CEI and Clal are Israeli corporations. Clal’s shares are traded on TASE; (c) 9,483 of our ordinary shares held directly by IDB Development Corporation Ltd. (“IDBD”); and (d) 9,483 of our ordinary shares held by Badal Securities Ltd. (“Badal”), a wholly-owned subsidiary of IDBH. Badal and IDBH are Israeli corporations. IDBH’s shares are traded on TASE.
43
Approximately 62.66% of Koor’s ordinary shares are held by Discount Investment Corporation Ltd. (“DIC”), and approximately 13.35% of Koor’s ordinary shares are held directly by IDBD. DIC is an Israeli corporation whose shares are traded on TASE. Clal and DIC are controlled by IDBD. IDBD is controlled by IDBH.
IDBH is controlled as follows: (a) Ganden Holdings Ltd. (“Ganden”), a private Israeli company controlled by Nochi Dankner and his sister Shelly Bergman, holds, directly and through a wholly-owned subsidiary, approximately 55.26% of the outstanding shares of IDBH; (b) Shelly Bergman, through a wholly-owned company, holds approximately 4.23% of the outstanding shares of IDBH; (c) Avraham Livnat Ltd (“Livnat”), a private Israeli company controlled by Avraham Livnat, holds directly and through a wholly-owned subsidiary, approximately 13.43% of the outstanding shares of IDBH; and (d) Manor Holdings BA Ltd. (“Manor”), a private company controlled by Ruth Manor holds, directly and through a majority-owned subsidiary, approximately 13.42% of the outstanding shares of IDBH.
Subsidiaries of Ganden, Livnat and Manor have entered into a shareholders agreement with respect to shares of IDBH constituting 31.02%, 10.34% and 10.34%, respectively, of the outstanding shares of IDBH for the purpose of maintaining and exercising control of IDBH as a group. Their additional holdings in IDBH are not subject to the shareholders agreement. The term of the shareholders agreement expires in May 2023.
Based on the foregoing, IDBH (by reason of its control of Badal and IDBD, and by reason of IDBD’s control of Clal, CEI, Clal Insurance, DIC, Koor, Ganden, Manor and Livnat (by reason of their control of IDBH) and Nochi Dankner, Shelly Bergman, Ruth Manor and Avraham Livnat (by reason of their control of Ganden, Manor and Livnat, respectively) may be deemed to share with Badal, IDBD, Clal, CEI, Clal Insurance, DIC and Koor the power to vote and dispose of our ordinary shares held by these entities.
(2) Based upon a Form 4 filed with the SEC on March 6, 2009. As the sole general partner of the Diker Funds (Diker Value Tech Fund, LP, Diker Value Tech QP Fund, LP, Diker Micro-Value Fund, LP, the Diker Micro-Value QP Fund, LP, Diker Micro & Small Cap Fund LP and Diker M&S Cap Master Ltd.), Diker GP, LLC, a Delaware limited liability company (“Diker GP”), has the power to vote and dispose of the ordinary shares owned by the Diker Funds and, accordingly, may be deemed the beneficial owner of such shares. Pursuant to investment advisory agreements, Diker Management, LLC, a Delaware limited liability company (“Diker Management”), serves as the investment manager of the Diker Funds. Accordingly, Diker Management may be deemed the beneficial owner of shares held by the Diker Funds. Charles M. Diker and Mark N. Diker are the managing members of each of Diker GP and Diker Management and in that capacity direct their operations. Therefore, Charles M. Diker and Mark N. Diker may be deemed the beneficial owners of shares beneficially owned by Diker GP and Diker Management.
(3) Based upon a Schedule 13G filed with the SEC on January 13, 2009. Following are the entities on behalf of which the aforementioned Schedule 13G was filed: The Leonidas Opportunity Fund L.P. and Leonidas Opportunity Offshore Fund Ltd., both formed to engage in the business of acquiring, holding and disposing of investments in various companies. The present principal business of SKIRITAI Capital LLC is serving as the General Partner of the Leonidas Opportunity Fund L.P. and the Investment Manager of the Leonidas Opportunity Offshore Fund Ltd. Russell R. Silvestri and Lyron L. Bentovim are Managing Directors of SKIRITAI Capital LLC.
Pursuant to a Schedule 13G filed with the SEC on March 2, 2009 by Potomac Capital Management LLC (“Potomac”), the number of shares beneficially owned by Potomac as of March 2, 2009 is 310,032. As a result, Potomac is no longer considered a major shareholder of ECtel.
Record Holders
As of March 31, 2009, there were 305 holders of record of our ordinary shares. 227 record holders, holding 6,688,161 shares, or approximately 24.91%, of our outstanding ordinary shares, were located in the United States. These numbers are not representative of the number of beneficial holders of our shares nor is it representative of where such beneficial holders reside since many of these ordinary shares were held of record by brokers or other nominees.
There is currently no trading market for our ordinary shares outside of the United States.
We are unaware of any arrangements, the operation of which may at a subsequent date result in a change of control of the Company.
| B. | Related Party Transactions |
Registration Rights Agreement with members of the IDB Group
In April 2008, we entered into a Registration Rights Agreement with our two largest shareholders: (a) Koor Industries Ltd. and (b) Clal Electronics Industries Ltd., a wholly-owned subsidiary of Clal Industries and Investments Ltd., both of which are members of the IDB Group, and their affiliates IDB Development Corporation Ltd. and Badal Securities Ltd. Koor Industries Ltd., Clal Electronics Industries Ltd., IDB Development Corporation Ltd. and Badal Securities Ltd are referred to as “Holders” in this section. For additional information regarding our major shareholders, please refer to “Item 7A–Major Shareholders.” Pursuant to this Registration Rights Agreement, we granted to the Holders registration rights in connection with sales, from time to time, of our ordinary shares held by such Holders. As required by the Israeli Companies Law, this agreement was approved by our audit committee, board of directors and a special majority of our shareholders. Under this agreement, the Holders are entitled to demand and piggyback registration rights. The first of such demand registrations must be for an offering to be made on a delayed or continuous basis pursuant to Rule 415 of the United States Securities Act registering the resale from time to time by the Holders (commonly known as a “shelf” registration), and the second demand registration may only be effected not less than 2 years after the effective date of the shelf registration. In addition, if we propose to register for public sale any of our ordinary shares under the Securities Act, the Holders would be entitled to request that we include some of their ordinary shares in such registration (commonly known as “piggyback” registration rights). The Registration Rights Agreement has a term of five years unless terminated earlier upon the percentage holdings of the Holders falling below a specified threshold.
For additional information regarding the Registration Rights Agreement, please refer to “Item 10C–Material Contracts.”
44
| C. | Interests of Expert and Counsel |
Not Applicable.
Item 8. Financial Information
| A. | Consolidated Financial Statements and Other Financial Information |
Financial Statements
See Item 18.
Legal Proceedings
On October 19, 2004, a class action complaint (the “Class Action Complaint”), Leumi Gemel Ltd. v. ECtel Ltd., et al., Case No. 8:04-CV-03380-RWT, was filed in the United States District Court for the District of Maryland. Named as defendants are ECtel Ltd., ECI Telecom Ltd., and certain of ECtel’s directors and officers. The Class Action Complaint alleges that the defendants violated Sections 10(b) and 20(a) of the Exchange Act, and Rule 10b-5 promulgated thereunder, by making false and misleading statements in the Company’s SEC filings and press releases during a period beginning April 24, 2001, and lasting through April 2, 2003. The claims are purportedly brought on behalf of all persons who purchased our stock during that period. The plaintiffs seek unspecified compensatory damages against the defendants, as well as attorneys’ fees and costs.
The Company filed a motion to dismiss the class action complaint. At a hearing on this motion held on July 17, 2006, the court granted our motion to dismiss the class action complaint. Following the dismissal, the plaintiff filed a motion to further amend the class action complaint. We responded by requesting that the court deny the motion to amend. On March 6, 2007, the court denied the plaintiff’s motion to further amend the class action. Plaintiff filed an appeal of the district court’s orders with the United States Court of Appeals for the Fourth Circuit. After briefing in the Fourth Circuit but before oral argument or any decision thereon, the parties reached an agreement in principle to resolve the litigation. The parties have executed a stipulation of settlement documenting their agreement. The District Court of Maryland held its hearing on preliminary approval of stipulation of settlement and granted preliminary approval. The hearing on the final approval of stipulation of settlement has been scheduled for July 27, 2009.
Dividend Policy
We did not pay any cash dividends during 2008, and we do not expect paying any in the foreseeable future.
We participate in the “alternative benefits program” under the Israeli Law for the Encouragement of Capital Investments, 1959, under which we realize certain tax exemptions. If we distribute a cash dividend from tax-exempt income, we would have to pay corporate tax at a rate of up to 25% on the amount distributed and to withhold an additional 15% of the amount distributed on behalf of the recipient. For more information about the “alternative benefits program,” see ““Item 10E–Taxation–Israeli Taxation–Tax Benefits Under the Law for the Encouragement of Capital Investments, 1959.”
Dividends on our ordinary shares may be paid only out of profits and other surplus, as defined in the Israeli Companies Law, as of the end of the most recent fiscal period or as accrued over a period of two years, whichever is higher. Our board of directors is authorized to declare dividends, provided that there is no reasonable concern that the dividend will prevent us from satisfying our existing and foreseeable obligations as they become due. Notwithstanding the foregoing, dividends may be paid with the approval of a court, provided that there is no reasonable concern that the dividend will prevent us from satisfying our existing and foreseeable obligations as they become due.
| B. | Significant Changes |
Revenue for the first quarter of 2009 totaled $3.4 million, compared to $6.5 million in the first quarter of 2008. Operating loss for the first quarter of 2009 totaled $1.8 million, compared to operating losses of $2 million in the first quarter of 2008 and $3.2 million in the fourth quarter of 2008.
Net loss for the first quarter of 2009 totaled $1.6 million or 10 cents per share compared to $1.3 million dollar or 8 cents per share in the first quarter of 2008. Net loss for the fourth quarter of 2008 totaled $3.4 million or 21 cents per share.
Cash, cash equivalents and marketable bonds and securities as of March 31, 2009 were $14.8 million compared to $17.6 million as of December 31, 2008.
For additional information regarding significant change in our financial position since December 31, 2008 see “Item 5A–Operating Results–Overview.”
Since the date of our consolidated financial statements included in this annual report, there has not been a significant change in our Company other than as described in this Item 8B.
45
Item 9. The Offer and Listing
| A. | Offer and Listing Details |
Our ordinary shares have been quoted on the Nasdaq Global Market under the symbol “ECTX” since October 26, 1999. The following table sets forth, for the periods indicated, the high and low closing prices of our ordinary shares, as reported on the Nasdaq Global Market (in U.S. dollars):
| High |
Low | |||||||
|---|---|---|---|---|---|---|---|---|
| Calendar Year: | ||||||||
| 2004 | 5.49 | 2.11 | ||||||
| 2005 | 5.35 | 3.34 | ||||||
| 2006 | 5.75 | 4.00 | ||||||
| 2007 | 5.30 | 2.81 | ||||||
| 2008 | 2.84 | 0.58 | ||||||
| Calendar Quarter: | ||||||||
| 2007: | ||||||||
| First Quarter | 5.30 | 4.40 | ||||||
| Second Quarter | 4.65 | 3.04 | ||||||
| Third Quarter | 3.66 | 2.93 | ||||||
| Fourth Quarter | 3.42 | 2.81 | ||||||
| 2008: | ||||||||
| First Quarter | 2.84 | 2.14 | ||||||
| Second Quarter | 2.52 | 1.90 | ||||||
| Third Quarter | 1.99 | 1.19 | ||||||
| Fourth Quarter | 1.36 | 0.58 | ||||||
| 2009: | ||||||||
| First Quarter | 0.63 | 0.25 | ||||||
| Calendar Month | ||||||||
| November 2008 | 1.09 | 0.62 | ||||||
| December 2008 | 0.84 | 0.58 | ||||||
| January 2009 | 0.63 | 0.45 | ||||||
| February 2009 | 0.56 | 0.32 | ||||||
| March 2009 | 0.58 | 0.25 | ||||||
| April 2009 | 0.53 | 0.35 | ||||||
| B. | Plan of Distribution |
Not Applicable.
| C. | Markets |
Our ordinary shares are quoted on the Nasdaq Global Market under the symbol ECTX.
| D. | Selling Shareholders |
Not Applicable.
| E. | Dilution |
Not Applicable.
46
| F. | Expenses of the Issue |
Not Applicable.
Item 10. Additional Information
| A. | Share Capital |
Not Applicable.
| B. | Memorandum and Articles of Association |
We were first registered under Israeli law on April 4, 1990 as a private company, and on October 29, 1999 became a public company. Our registration number with the Israeli registrar of companies is 52-004446-2.
Objects and Purposes
Our object is to engage, directly or indirectly, in any lawful undertaking or business whatsoever, including, without limitation, as stipulated in our memorandum of association. See Article 1 of our articles of association, which sets forth our purposes.
The following sections, to the extent they refer to our articles of association are qualified in their entirety by the articles themselves, filed as an exhibit to our annual report submitted for 2005.
Transfer and Ownership of Shares; Notices
The ownership or voting of our ordinary shares by non-residents of Israel, except for citizens of countries that are in a state of war with Israel, is not restricted in any way by our memorandum or articles of association or by the laws of the State of Israel.
Fully paid ordinary shares may be freely transferred pursuant to our articles of association unless the transfer is restricted or prohibited by another instrument. Unless otherwise prescribed by law, each shareholder of record will be provided at least 21 calendar days’ prior notice of any general shareholders meeting.
Dividend and Liquidation Rights
Dividends on our ordinary shares may be paid only out of profits and other surplus, as defined in the Israeli Companies Law, as of the end of the most recent financial statements or as accrued over a period of two years, whichever is higher. Our board of directors is authorized to declare dividends, provided that there is no reasonable concern that payment of the dividend will prevent us from satisfying our existing and foreseeable obligations as they become due. Notwithstanding the foregoing, dividends may be paid with the approval of a court, provided that there is no reasonable concern that payment of the dividend will prevent us from satisfying our existing and foreseeable obligations as they become due. Dividends that remain unclaimed after seven years will generally be forfeited and returned to the company. In the event of our liquidation, after satisfaction of liabilities to creditors, our assets will be distributed to the holders of ordinary shares in proportion to their respective holdings. These dividend and liquidation rights may be affected by the grant of preferential dividends or liquidation rights to the holders of a class of shares with preferential rights that may be authorized in the future.
Voting, Shareholders’ Meetings and Resolutions
Holders of ordinary shares have one vote for each ordinary share held on all matters submitted to a vote of shareholders. Under the Companies Law and our articles of association, all resolutions of our shareholders, except for a resolution to liquidate the company, require approval by a simple majority of the ordinary shares voting thereon. 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. No cumulative voting is permitted.
We have two types of general shareholders meetings: the annual general meetings and extraordinary general meetings. These meetings may be held either in Israel or in any other place the board of directors determines. An annual general meeting must be held in each calendar year, but not more than 15 months after the last annual general meeting. Our board of directors may convene an extraordinary meeting, from time to time, at its discretion and is required to do so upon the request of shareholders holding at least 5% of our ordinary shares or at least two directors or one quarter of our directors then serving.
The quorum required for a meeting of shareholders consists of at least two shareholders present in person or by proxy who hold or represent in the aggregate at least 25% of the outstanding voting shares. A meeting adjourned for lack of a quorum generally is adjourned to the same day in the following week at the same time and place or any time and place as the chairman may designate with the consent of the holders of a majority of the voting power represented at the meeting and voting on the matter adjourned.
47
Mergers and Acquisitions under Israeli Law
The Israeli Companies Law includes provisions that allow a merger transaction and requires that each company that is a party to a merger have the transaction approved by its board of directors and a vote of the majority of its shares, at a shareholders’ meeting called on at least 21 days’ prior notice. For purposes of the shareholder vote, unless a court rules otherwise, the merger will not be deemed approved if a majority of the shares held by parties other than the other party to the merger, or by any person who holds 25% or more of the shares or the right to appoint 25% or more of the directors of the other party, vote against the merger. 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 50 days have passed from the date that a proposal of the merger was filed with the Israeli Registrar of Companies by each merging company and 30 days from the date that shareholder approval of both merging companies was obtained. The request for the approval of a merger may be filed once a shareholder meeting has been called to approve the merger.
The Companies Law also provides that an acquisition of shares of a public company must be made by means of a tender offer if as a result of the acquisition the purchaser would become a 25% shareholder of the company and there is not any other existing shareholder who holds 25% or more of the company. In addition, an acquisition of shares of a public company must be made by means of a tender offer if as a result of the acquisition the purchaser would become a 45% shareholder of the company unless there already is another 45% shareholder in the company. If following any acquisition of shares, the acquiror will hold 90% or more of the company’s shares, the acquisition may not be made other than through a tender offer to acquire all of the shares of such class. If more than 95% of the outstanding shares are tendered in the tender offer, all the shares that the acquirer offered to purchase will be transferred to it. However, the remaining minority shareholders may seek to alter the tender offer consideration by court order.
Lastly, Israeli tax law treats some acquisitions, such as stock-for-stock exchanges between an Israeli company and a foreign company less favorably than U.S. tax laws. For example, Israeli tax law may, under certain circumstances, subject a shareholder who exchanges his ordinary shares for shares in another corporation, to taxation prior to the sale of the shares received in such stock-for-stock swap.
Modification of Class Rights
Our articles of association provide that the rights attached to any class (unless otherwise provided by the terms of that class), such as voting, rights to dividends and the like, may be varied by a shareholders resolution, subject to the sanction of a resolution passed by the holders of a majority of the shares of that class at a separate class meeting.
Fiduciary Duties of Office Holders
The Israeli Companies Law imposes a duty of care and a duty of loyalty on all office holders of a company.
The duty of care requires an office holder to act with the level of care with which a reasonable office holder in the same position would have acted under the same circumstances. The duty of care includes a duty to use reasonable means to obtain:
| — | information on the advisability of a given action brought for his approval or performed by him by virtue of his position; and |
| — | all other important information pertaining to these actions. |
The duty of loyalty of an office holder includes a duty to:
| — | refrain from any conflict of interest between the performance of his duties in the company and the performance of his other duties or his personal affairs; |
| — | refrain from any activity that is competitive with the company; |
| — | refrain from exploiting any business opportunity of the company to receive a personal gain for himself or others; and |
| — | disclose to the company any information or documents relating to the company’s affairs which the office holder has received due to his position as an office holder. |
Approval of Related-Party Transactions Under Israeli Law
The Israeli Companies Law requires that an office holder of a company disclose to the company any personal interest that he may have and all related material information known to him, in connection with any existing or proposed transaction by the company. The disclosure is required to be made promptly and in any event no later than the board of directors meeting in which the transaction is first discussed. If the transaction is an extraordinary transaction, the office holder must also disclose any personal interest held by:
| — | the office holder's spouse, siblings, parents, grandparents, descendants, spouse's descendants and the spouses of any of these people; or |
48
| — | any corporation in which the office holder is a 5% or greater shareholder, director or general manager or in which he has the right to appoint at least one director or the general manager. |
Under the Companies Law, an extraordinary transaction is a transaction:
| — | other than in the ordinary course of business; |
| — | otherwise than on market terms; or |
| — | that is likely to have a material impact of the company's profitability, assets or liabilities. |
Once an office holder complies with the above disclosure requirement, the board of directors may approve a transaction between the company and an office holder, or a third party in which an office holder has a personal interest. A transaction that is adverse to the company’s interest may not be approved.
If the transaction is an extraordinary transaction, approval of both the audit committee and the board of directors is required. Under specific circumstances, shareholder approval may also be required. A director who has a personal interest in an extraordinary transaction which is considered at a meeting of the board of directors or the audit committee may not be present at this meeting or vote on this matter, unless a majority of the members of the board of directors or the audit committee, as the case may be, has a personal interest in the matter. If a majority of members of the board of directors have a personal interest therein, shareholder approval is also required.
Under the Companies Law, all arrangements as to compensation of directors in public companies generally require the approvals of the audit committee, board of directors and shareholders, in that order.
Duties of Shareholders
Disclosure of Personal Interests of a Controlling Shareholder
Under the Israeli Companies Law, the disclosure requirements that apply to an office holder also apply to a controlling shareholder of a public company. A controlling shareholder is a shareholder who has the ability to direct the activities of a company, including a shareholder that owns 25% or more of the voting rights if no other shareholder owns more than 50% of the voting rights, but excluding a shareholder whose power derives solely from his or her position on the board of directors or any other position with the company. Extraordinary transactions with a controlling shareholder or in which a controlling shareholder has a personal interest, and the engagement of a controlling shareholder as an office holder or employee, require the approvals of the audit committee, the board of directors and the shareholders of the company, in that order. The shareholder approval must be by a majority of the shares voted on the matter, provided that either:
| — | at least one-third of the shares of shareholders who have no personal interest in the transaction and who vote on the matter vote in favor thereof; or |
| — | the shareholders who have no personal interest in the transaction who vote against the transaction do not represent more than one percent of the voting rights in the company. |
Shareholders generally have the right to examine document in the company’s possession pertaining to any matter that requires shareholder approval.
Duties of Good Faith and Fairness
In addition, under the Companies Law, each shareholder has a duty to act in good faith toward the company and other shareholders and to refrain from abusing his or her power in the company, such as in shareholder votes. In addition, specified shareholders have a duty of fairness toward the company. These shareholders include any controlling shareholder, any shareholder who knows that it possesses the power to determine the outcome of a shareholder vote and any shareholder who, pursuant to the provisions of the articles of association, has the power to appoint an office holder or any other power with respect to the company. However, the Companies Law does not define the substance of this duty of fairness except to state that the remedies generally available upon a breach of contract will apply also in the event of a breach of the duty to act with fairness.
Indemnification of Directors and Officers
Exculpation of Office Holders
Under the Companies Law, an Israeli company may not exempt an office holder from liability for breach of his duty of loyalty, but may exempt in advance an office holder from liability to the company, in whole or in part, for a breach of his duty of care provided that the articles of association of the company allow it to do so. Our articles of association allow us to exempt our office holders to the fullest extent permitted by law.
49
Insurance Relating to Office Holders
Our articles of association provide that, subject to the provisions of the Companies Law, we may enter into an insurance contract which would provide coverage for any monetary liability incurred by any of our office holders, with respect to an act performed in the capacity of an office holder for:
| — | a breach of his duty of care to us or to another person; |
| — | a breach of his duty of loyalty to us, provided that the office holder acted in good faith and had reasonable cause to assume that his act would not prejudice our interests; or |
| — | a financial liability imposed upon him in favor of another person. |
We have obtained liability insurance covering our officers and directors.
Indemnification of Office Holders
An Israeli company may indemnify an office holder in respect of certain liabilities following an event or in advance of an event, provided that a provision authorizing such indemnification is inserted in its articles of association and that the company’s undertaking to indemnify an office holder is limited to such events which the board of directors shall deem to be likely to occur in light of the operations of the company at the time that the undertaking is made and for such amounts or criteria which the board of directors may, at the time, deem to be reasonable under the circumstances. Our articles of association were amended on September 2005 to contain such an authorization. An undertaking by an Israeli company to indemnify an office holder with respect to a financial liability for acts performed as an office holder imposed on him or her in favor of another person pursuant to a judgment, settlement or arbitrator’s award approved by court must be limited to foreseeable liabilities and reasonable amounts determined by the board of directors. In addition, a company may indemnify an office holder against the following liabilities incurred for acts performed as an office holder:
Our articles of association provide that we may indemnify an office holder against the following obligations and expenses imposed on the office holder with respect to an act performed in the capacity of an office holder:
| — | a financial obligation imposed on him or her in favor of another person by a court judgment, including a compromise judgment or an arbitrator's award approved by court; and |
| — | reasonable litigation expenses, including attorneys’ fees, expended by the office holder or charged to him by a court in connection with: |
| — | proceedings we institute against him or that are instituted on our behalf or by another person; |
| — | a criminal charge from which he is acquitted; or |
| — | a criminal proceeding in which he is convicted of an offense that does not require proof of criminal intent. |
Our articles of association also include provisions:
| — | authorizing us to undertake to indemnify an office holder as described above, and |
| — | setting forth such events which our board of directors deems to be anticipated when the undertaking is given and such; |
| — | amounts and/or criteria determined by our board of directors to be reasonable under the circumstances; and |
| — | authorizing us to retroactively indemnify an officer or director. |
Limitations on Exculpation, Insurance and Indemnification
The Companies Law provides that a company may not exculpate or indemnify an office holder, or enter into an insurance contract which would provide coverage for any monetary liability incurred as a result of any of the following:
| — | a breach by the office holder of his duty of loyalty unless, with respect to insurance coverage, the office holder acted in good faith and had a reasonable basis to believe that the act would not prejudice the company; |
| — | a prohibited dividend or distribution to shareholders; |
50
| — | a breach by the office holder of his duty of care if the breach was committed intentionally or recklessly (excluding a breach arising out of negligent conduct of the office holder); |
| — | any act or omission committed with the intent to derive an illegal personal benefit; or |
| — | any fine imposed on the office holder. |
In addition, under the Companies Law, exculpation and indemnification of, and procurement of insurance coverage for our office holders must be approved by our audit committee and our board of directors and, if the beneficiary is a director, by our shareholders.
Our articles of associations also provide that, subject to the provisions of applicable law, we may procure insurance for, or indemnify, any person who is not an office holder, including without limitation, any of our employees, agents, consultants or contractors.
| C. | Material Contracts |
Transaction with Compwise Ltd.
On March 24, 2008, we agreed to purchase substantially all the assets of Compwise Ltd. (“Compwise”), an Israeli based company, a provider of business analytic solutions for telecommunication operators. The transaction was consummated on April 30, 2008. The material terms of our asset purchase agreement and ancillary agreements with Compwise are summarized below. This summary is qualified in its entirety by reference to the full agreements filed as exhibits to this Annual Report. See “Item 19–Exhibits.”
Pursuant to the asset purchase agreement, we acquired substantially all the assets of Compwise for approximately $1.5 million in cash. The transferred assets included mainly intellectual property and goodwill associated therewith, contracts with customers, accounts receivable, backlog contracts and third-party software licenses. The assumed liabilities included support and maintenance obligations arising under Compwise’s contracts with its customers. In addition, upon consummation of the transaction, we hired five employees of Compwise.
Following consummation of the transaction, Compwise is to take all required actions in order to effect voluntary liquidation.
Compwise and certain of its employees and shareholders undertook certain non-compete, non-solicitation and confidentiality commitments towards ECtel.
Registration Rights Agreement
Our former shareholder, ECI Telecom Ltd. (“ECI”), had registration rights pursuant to an agreement entered into in 2002 for our ordinary shares owned by it, pursuant to which ECI was entitled to five demand registrations and unlimited piggyback registrations. Prior to May 10, 2004, ECI held of record 10,490,325, or approximately 57.9%, of our outstanding shares at that time. Over the course of 2004 and 2006 ECI distributed all those shares to its shareholders, including the “Holders”, as defined below. While pursuant to its registration rights agreement with us ECI had the right to assign its registration rights thereunder to its transferees, it did not do so.
Therefore, in April 2008, we entered into a Registration Rights Agreement with our two largest shareholders, Koor Industries Ltd. and Clal Electronics Industries Ltd., a wholly-owned subsidiary of Clal Industries and Investments Ltd., both members of the IDB Group, and their affiliates IDB Development Corporation Ltd. and Badal Securities Ltd. Jointly referred to herein as “Holders” will be Koor Industries Ltd.; Clal Electronics Industries Ltd.; IDB Development Corporation Ltd. and Badal Securities Ltd. For additional information regarding our major shareholders, please refer to “Item 7A–Major Shareholders.” Pursuant to this Registration Rights Agreement we granted to the Holders rights in connection with sales, from time to time, of our ordinary shares held by such Holders. As required by the Israeli Companies Law, the agreement was approved by our audit committee, board of directors and a special majority of our shareholders. Under this agreement, the Holders are entitled to demand and piggyback registration rights. The first of such demand registrations must be for an offering to be made on a delayed or continuous basis pursuant to Rule 415 of the United States Securities Act registering the resale from time to time by the Holders (commonly known as a “shelf” registration) and the second demand registration may only be effected not less than 2 years after the effective date of the shelf registration. In addition, if we propose to register for public sale any of our ordinary shares under the Securities Act, the Holders would be entitled to request that we include some of their ordinary shares in such registration (commonly known as “piggyback” registration rights). The Registration Rights Agreement has a term of five years unless terminated earlier upon the percentage holdings of the Holders falling below a specified threshold.
The demand and piggyback registrations are subject to customary covenants and conditions, such as possible limitations on the number of shares that may be underwritten (commonly known as “underwriter cut-backs”) and cross-indemnification for liabilities and expenses that may be incurred in connection with the registration. In the event that our company, from time to time, effects an underwritten public offering of its shares held by the Holders, either at their request or upon our initiative, the Agreement requires us to enter into an underwriting agreement in a form usual and customary for such offerings. Underwriting agreements typically include, among other things, an undertaking of the issuer to indemnify the underwriters and selling shareholders for liabilities and expenses that may be incurred in connection with the public offering.
Demand registrations are also subject to certain customary limitations, such as a requirement that any demand registration involve registration of not less than 30% of shares held by the Holders as of the date of the agreement, and the right of the Company, exercisable once in any 12-month period, to postpone a demand registration for up to 90 days if it believes that effecting a registration then would be detrimental to the Company and its shareholders. Upon certain conditions, the Holders are entitled to assign their registration rights under the Agreement to transferees of the shares.
All expenses incurred in connection with any piggyback registration and in connection with a demand registration in which the Company includes securities to be sold for its own account will be borne by the Company and the participating Holders, which expenses will be allocated among them pro rata to the number of securities registered by each of them, except that any expenses incurred by advisors to a Holder will be borne by that Holder. All expenses incurred in connection with any demand registration in which the Company does not sell shares for its own account will be borne by the Holders.
51
The Agreement includes a covenant of the Holders not to sell any of their shares covered by the Agreement for 90 days following the effective date of any underwritten public offering (commonly known as a “lock-up” agreement). This covenant, which is a customary condition of underwritten public offerings, applies whether or not the Holders are selling shares in the public offering.
| D. | Exchange Controls |
Exchange Controls and Other Limitations Affecting Security Holders
There are currently no Israeli currency control restrictions on payments of dividends or other distributions with respect to our ordinary shares or the proceeds from the sale of the shares, except for the obligation of Israeli residents to file reports with the Bank of Israel regarding certain transactions. However, legislation remains in effect under which currency controls may be imposed by administrative action at any time.
The ownership or voting of our ordinary shares by non-residents of Israel, except with respect to citizens of countries which are in a state of war with Israel, is not restricted in any way by our memorandum of association or articles of association or by the laws of the State of Israel.
| E. | Taxation |
The following is a general summary only and should not be considered as income tax advice or relied upon for tax planning purposes. Holders of our ordinary shares should consult their own tax advisors as to the United States, Israeli or other tax consequences of the purchase, ownership and disposition of ordinary shares, including, in particular, the effect of any foreign, state or local taxes.
CERTAIN U.S. FEDERAL INCOME TAX CONSIDERATIONS
Subject to the limitations described below, the following discussion summarizes certain U.S. federal income tax consequences of the purchase, ownership and disposition of our ordinary shares to a U.S. holder that owns our ordinary shares as a capital asset, generally, for investment. A U.S. holder is a holder of our ordinary shares who is, for U.S. federal income tax purposes:
| — | an individual citizen or resident of the United States, |
| — | a corporation (or other entity taxable as a corporation for U.S. federal income tax purposes) created or organized in the United States or under the laws of the United States, or any political subdivision thereof, or the District of Columbia, |
| — | an estate, the income of which is subject to U.S. federal income tax regardless of its source, or |
| — | a trust if, in general, (i) a court within the United States is able to exercise primary supervision over its administration and one or more U.S. persons have the authority to control all of its substantial decisions, or (ii) that has in effect a valid election under applicable U.S. Treasury Regulations to be treated as a U.S. person. |
This discussion does not purport to be a comprehensive description of all of the tax considerations that may be relevant to each person’s decision to purchase our ordinary shares.
If a partnership (or any other entity treated as a partnership for U.S. Federal income tax purposes) holds our ordinary shares, the treatment of the partnership and a partner in such partnership will generally 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 tax consequences.
Certain aspects of U.S. federal income tax is relevant to a holder of our ordinary shares that is not a U.S. holder (a "non-U.S. holder") are also discussed below.
This discussion is based on current provisions of the Internal Revenue Code of 1986 as amended (the “Code”), current and proposed Treasury Regulations promulgated thereunder, and administrative and judicial decisions as of the date of this Annual Report, all of which are subject to change, possibly on a retroactive basis. This discussion does not address all aspects of U.S. federal income taxation that may be relevant to any particular U.S. holder in light of the holder’s individual circumstances. In particular, this discussion does not address the potential application of the alternative minimum tax or the U.S. federal income tax consequences to U.S. holders that are subject to special treatment, including U.S. holders that:
| — | are broker-dealers or insurance companies, |
| — | have elected mark-to-market accounting, |
| — | are tax-exempt organizations or retirement plans, |
52
| — | are grantor trusts, |
| — | are certain former citizens or long-term residents of the United States, |
| — | are financial institutions or financial services entities, |
| — | hold ordinary shares as part of a straddle, hedge or conversion transaction with other investments, |
| — | acquired their ordinary shares upon the exercise of employee stock options or otherwise as compensation, |
| — | are real estate investment trusts or regulated investment companies, |
| — | own directly, indirectly or by attribution at least 10% of our voting power, or |
| — | have a functional currency that is not the U.S. dollar. |
In addition, this discussion does not address any aspect of state, local or non-U.S. tax laws or the possible application of United States federal gift or estate taxes.
U.S. holders of our ordinary shares are urged to consult their own tax advisors with respect to the specific tax consequences of purchasing, holding or disposing of our ordinary shares, including the applicability and effect of federal, state, local and foreign income and other tax laws to their particular circumstances.
Taxation of Dividends Paid on Ordinary Shares if we are not a Passive Foreign Investment Company
If we are not classified as a passive foreign investment company, or PFIC, (see discussion below regarding our PFIC status) under “Tax Consequences if We are a Passive Foreign Investment Company,” a U.S. holder will be required to include in gross income as dividend income the amount of any distribution paid on our ordinary shares, including any non-U.S. taxes withheld from the amount paid, on the date the distribution is received to the extent the distribution is paid out of our current or accumulated earnings and profits, as determined for U.S. federal income tax purposes. Distributions in excess of earnings and profits will be applied against and will reduce the U.S. holder’s tax basis in our ordinary shares and, to the extent in excess of that basis, will be treated as gain from the sale or exchange of our ordinary shares. The dividend portion of such distribution generally will not qualify for the dividends received deduction otherwise available to corporations.
Dividends that are received by U.S. holders that are individuals, estates or trusts will be taxed at the rate applicable to long-term capital gains 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 year, dividends paid on our ordinary shares in such year or in the following 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.
Distributions of current or accumulated earnings and profits paid in foreign currency to a U.S. holder (including any non-U.S. taxes withheld from the distributions) will be includible in the income of a U.S. holder in a U.S. dollar amount calculated by reference to the exchange rate on the date of the distribution. A U.S. holder that receives a foreign currency distribution and converts the foreign currency into dollars after the date of distribution may have foreign exchange gain or loss based on any appreciation or depreciation in the value of the foreign currency against the U.S. dollar, which will generally be U.S. source ordinary income or loss.
U.S. holders will have the option of claiming the amount of any non-U.S. income taxes withheld on dividend distribution either as a deduction from gross income or as a dollar-for-dollar credit against their U.S. federal income tax liability. Individuals who do not claim itemized deductions, but instead utilize the standard deduction, may not claim a deduction for the amount of the non-U.S. income taxes withheld, but such amount may be claimed as a credit against the individual’s U.S. federal income tax liability. The amount of non-U.S. income taxes that may be claimed as a credit in any year is subject to complex limitations and restrictions, which must be determined on an individual basis by each shareholder. These limitations include, amongst others, rules which limit foreign tax credits allowable with respect to specific classes of income to the U.S. federal income taxes otherwise payable on each such class of income. The total amount of allowable foreign tax credits in any year cannot exceed the pre-credit U.S. tax liability for the year attributable to foreign source taxable income. Distributions of our current or accumulated earnings and profits will generally be foreign source passive income for U.S. foreign tax credit purposes.
53
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:
| — | 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 which is 15 days before the ex-dividend date with respect to such dividend; or |
| — | 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.
If we are classified as a PFIC, the rules described above would generally only apply to distributions that were not “excess distributions” received by a U.S. holder who does not make a QEF or mark-to market election (both described below).
Taxation of the Disposition of Ordinary Shares if we are not a Passive Foreign Investment Company
If we are not classified as a PFIC, (see discussion below regarding our PFIC status 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 U.S. holder’s basis in such ordinary shares, which is usually the cost to the U.S. holder of such ordinary shares, and the amount realized on the disposition. Capital gain from the sale, exchange or other disposition of ordinary shares held more than one year is long-term capital gain and may be subject to a reduced rate of taxation for individuals (long-term capital gains are currently taxable at a maximum rate of 15% for taxable year beginning in or before December 31, 2010). Gain or loss recognized by a U.S. holder on a sale, exchange or other disposition of ordinary shares will generally be treated as U.S. source income for U.S. foreign tax credit purposes. The deductibility of a capital loss recognized on the sale, exchange or other disposition of ordinary shares is subject to limitations.
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 if he or she has elected to use the settlement date to determine its proceeds of sale for purposes of calculating the foreign currency gain or loss. In addition, a U.S. holder that receives foreign currency upon 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 may generally be U.S. source ordinary income or loss.
Tax Consequences if we are a Passive Foreign Investment Company
There is a substantial risk that we are a PFIC for U.S. federal income tax purposes. Our treatment as a PFIC could result in a reduction in the after-tax return to the U.S. holders of our ordinary shares and could cause a reduction in the value of our ordinary shares.
For U.S. federal income tax purposes, we will be classified as a PFIC for any taxable year if (after taking into account certain look-through rules with respect to the income and assets of our corporate subsidiaries) either (i) 75% or more of our gross income in a taxable year is passive income, or (ii) at least 50% of the average value of all of our assets for a taxable year (determined on a quarterly basis) produce or are held for the production of passive income. For this purpose, cash is considered to be an asset which produces passive income. Passive income includes dividends, interest, royalties, rents, annuities and the excess of gains over losses from the disposition of assets which produce passive income. The Code does not specify how a corporation must determine the fair market value of its assets for this purpose and the issue has not been definitively determined by the United States Internal Revenue Service (“IRS”) or the courts. The market capitalization approach has generally been used to determine the fair market value of the assets of a publicly traded corporation, though other valuations methods may be available for these purposes.
If we are a PFIC, each U.S. holder will (unless it made one of the elections discussed below on a timely basis) be taxable on gain recognized from the disposition of our ordinary shares (including gain deemed recognized if the ordinary shares are used as security for a loan) and upon receipt of certain “excess distributions” with respect to our ordinary shares as if such income had been recognized ratably over the U.S. holder’s holding period for the ordinary shares. The U.S. holder’s income for the current taxable year would include (as ordinary income) amounts allocated to the current taxable year and to any taxable period prior to the first day of the first taxable year for which we were a PFIC. Tax would also be computed at the highest ordinary income tax rate in effect for each other taxable period to which income is allocated, and an interest charge on the tax as so computed would also apply. Additionally, if we were a PFIC, U.S. holders who acquire our ordinary shares from a decedent (other than certain nonresident aliens) would be denied the normally-available step-up in basis for such shares to fair market value on the date of death and, instead, would generally have a tax basis in such ordinary shares equal to the lower of the decedent’s basis or the fair market value of such shares on the date of the decedent’s death. We will generally be treated as a PFIC with respect to any U.S. holder if we are a classified as a PFIC for any taxable year during the U.S. holder’s holding period for our ordinary shares. However, if we cease to satisfy the requirements for PFIC classification in any taxable year, a U.S. holder may avoid the consequences of our PFIC classification for subsequent taxable years by making a “purging” election to recognize gain based on the U.S. holder’s unrealized appreciation in our ordinary shares through the close of the last taxable year in which we are a PFIC. Any gain recognized would be subject to the excess distribution rules described immediately above.
54
As an alternative to the tax treatment described above, a U.S. holder could elect to treat us as a “qualified electing fund” (“QEF”); provided that we supply certain information to the U.S. holder. If a U.S. holder makes a QEF election, the U.S. holder would be required to include in income, for each taxable year that we are a PFIC, its pro rata share of our ordinary earning as ordinary income and its pro rata share of our net capital gain as long-term capital gain, subject to a separate election to defer payment of taxes, which deferral is subject to an interest charge. Any income inclusion will be required whether or not such U.S. holder owns our ordinary shares for an entire taxable year or at the end of our taxable year. The amount so includable will be determined without regard to our prior year losses or the amount of cash distributions, if any, received from us. Special rules and elections (e.g., “purging” election) may apply if a U.S. holder makes a QEF election after the first taxable year in its holding period in which we are a PFIC. A U.S. holder may not make a QEF election with respect to warrants. A U.S. holder’s basis in its ordinary shares will increase by any amount included in income and decrease by any amounts not included in income when distributed because such amounts were previously taxed under the QEF rules. So long as a U.S. holder’s QEF election is in effect beginning with the first taxable year in which we are a PFIC during the U.S. holder’s holding period for its ordinary shares, any gain or loss realized by such holder on the disposition of its ordinary shares held as a capital asset ordinarily would be a capital gain or loss. Such capital gain or loss ordinarily would be long-term if such U.S. holder had held such ordinary shares for more than one year at the time of the disposition. The QEF election must be made on or before the due date of the U.S holder’s federal tax return for the taxable year for which the election is made. The QEF election is made on a shareholder-by-shareholder basis, applies to all ordinary shares held or subsequently acquired by an electing U.S. holder and can be revoked only with the consent of the IRS.
Although a U.S. holder normally is not permitted to make a retroactive QEF election for a foreign corporation, a retroactive election may generally be made for a taxable year of the U.S. holder (the “retroactive election year”) if the U.S. holder (i) reasonably believed that, as of the date the QEF election was due, the foreign corporation was not a PFIC for its taxable year that ended during the retroactive election year and (ii) filed a protective statement with respect to the foreign corporation with its tax return for the retroactive election year, in which the U.S. holder described the basis for its reasonable belief and extended the period of limitation on the assessment of taxes determined under Sections 1291 through 1298 of the Code with respect to the foreign corporation (PFIC related taxes) for all taxable years of the U.S. holder to which the protective statement applies. Certain “qualified shareholders” may be exempt from satisfying the reasonable belief requirement or filing a protective statement in certain circumstances.
As an alternative to making a QEF election, a U.S. holder of PFIC stock which is “marketable stock” (e.g., “regularly traded” on the NASDAQ Global Market) may in certain circumstances avoid certain of the tax consequences generally applicable to holders of stock in a PFIC by electing to mark the stock to market as of the beginning of such U.S. holder’s holding period for the ordinary shares. Special rules will apply if a U.S. holder makes the mark-to-market election after the first taxable year in a U.S. holder’s holding period in which we are a PFIC. In addition, under current law, a mark-to-market election cannot be made for warrants. As a result of such election, in any taxable year that we are a PFIC, a U.S. holder would generally be required to report gain or loss to the extent of the difference between the fair market value of the ordinary shares at the end of the taxable year and such U.S. holder’s tax basis in its ordinary shares at that time. Any gain under this computation, and any gain on an actual disposition of the ordinary shares, in a taxable year in which we are a PFIC, would be treated as ordinary income. Any loss under this computation, and any loss on an actual disposition of the ordinary shares, in a taxable year in which we are a PFIC, generally would be treated as ordinary loss to the extent of the cumulative net-mark-to-market gain previously included. Any remaining loss from marking ordinary shares to market will not be allowed, and any remaining loss from an actual disposition of ordinary shares generally would be capital loss. A U.S. holder’s tax basis in its ordinary shares is adjusted annually for any gain or loss recognized under the mark-to-market election. There can be no assurances that there will be sufficient trading volume with respect to the ordinary shares for the ordinary shares to be considered “regularly traded” or that our ordinary shares will continue to trade on the NASDAQ Global Market. Accordingly, there are no assurances that the ordinary shares will be marketable stock for these purposes. As with a QEF election, a mark-to-market election is made on a shareholder-by-shareholder basis, applies to all ordinary shares held or subsequently acquired by an electing U.S. Holder and can only be revoked with consent of the IRS (except to the extent the ordinary shares no longer constitute “marketable stock”).
The tests for determining PFIC status are applied annually and it is difficult to make accurate predictions of future income and assets, and the future price of our ordinary shares, which are all relevant to the determination of whether we are classified as a PFIC for a taxable year. Accordingly, there can be no assurances that we will not be classified as a PFIC in 2009 or in subsequent taxable years.
An entity in which we own or acquire an interest (directly or indirectly) that is classified as a corporation for U.S. federal income tax purposes may be a treated as a PFIC. A U.S. holder may be able to make separate QEF elections for such entities, provided that such entities provide certain information to the U.S. holder. If a QEF election is not made with respect to such entities that are PFICs, then the general PFIC rules described above will apply to direct and indirect dispositions of (including a U.S. holder’s disposition of our ordinary shares), and excess distributions by, such entities. In addition, a mark-to-market election made with respect to us would generally not be applicable to subsidiaries or other entities which we own or acquire (directly or indirectly) that are PFICs.
All U.S. Holders are urged to consult their own tax advisers about the PFIC rules and specifically about the advisability, procedures and timing of making any of the available tax elections, including the QEF or mark-to-market elections.
Tax Consequences for Non-U.S. Holders of Ordinary Shares
Except as described in “Information Reporting and Back-up Withholding” below, a non-U.S. holder of ordinary shares will not be subject to U.S. federal income or withholding tax on the payment of dividends on, and the proceeds from the disposition of, our ordinary shares, unless, in the case of U.S. federal income taxes:
| — | such 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 which has a treaty with the United States, the item is attributable to a permanent establishment; or in the case of an individual, the item is attributable to a fixed place of business in the United States; or |
55
| — | in the case of a disposition of our ordinary shares, the non-U.S. holder is an individual who holds the ordinary shares as a capital asset and is present in the United States for 183 days or more in the taxable year of the disposition and certain other conditions are met. |
Information Reporting and Back-up Withholding
U.S. holders (other than exempt recipients such as corporations) generally are subject to information reporting requirements with respect to dividends paid in the United States on or proceeds from the disposition of our ordinary shares. In addition, a U.S. holder may be subject, under certain circumstances, to backup withholding at a rate of up to 28% with respect to dividends paid on or proceeds from the disposition of our ordinary shares unless the U.S. holder provides proof of an applicable exemption or correct taxpayer identification number and otherwise complies with applicable requirements of the backup withholding rules. A U.S. holder of our ordinary shares who does not provide a correct taxpayer identification number may be subject to penalties imposed by the IRS. Amounts withheld under the backup withholding rules are not an additional tax and may be refunded or credited against the holder’s federal income tax liability, provided the required information is furnished to the IRS.
Non-U.S. holders generally are not subject to information reporting or back up withholding with respect to dividends paid on, or proceeds from the disposition of, our ordinary shares, provided that the non-U.S. holder provides taxpayer identification number, certifies to its foreign status, or establishes another exemption to the information reporting or back-up withholding requirements.
ISRAELI TAXATION
The following summary describes the current tax structure applicable to companies incorporated in Israel, with special reference to its effect on us. It also discusses Israeli tax consequences material to persons purchasing our ordinary shares. To the extent that the summary is based on new tax legislation yet to be judicially or administratively interpreted, we cannot be sure that the views expressed will accord with any future interpretation by the Israeli tax authorities or courts. The summary is not intended, and should not be construed, as legal or professional advice and does not exhaust all possible tax considerations. Accordingly, you should consult your tax advisor as to the particular tax consequences of an investment in our ordinary shares.
Transfer Pricing
In accordance with Section 85A of the Israeli Tax Ordinance, if, in an international transaction, (whereby at least one party is a foreigner or all or part of the income from such transaction is to be taxed abroad as well as in Israel) there is a special relationship (including, but not limited to family relationship or a relationships of control between companies) between the parties, and due to this relationship the price set for an asset, right, service or credit was determined or other conditions for the transaction were set such that a smaller profit was realized then what would have been expected to be realized from a transaction of this nature, then such transaction shall be reported in accordance with customary market conditions and tax shall be charged accordingly. This Section shall apply solely to transactions which transpire after November 29, 2006 at which time regulations with respect to this section were legislated. The assessment of whether a transaction falls under the aforementioned definition shall be implemented in accordance with one of the procedures mentioned in the regulations and is based, among others, on comparisons of characteristics which portray similar transactions in ordinary market conditions, such as profit, the area of activity, nature of the asset, the contractual conditions of the transaction and according to additional terms and conditions specified in the regulations.
General Corporate Tax Structure
Generally, Israeli companies are subject to corporate tax on taxable income. The corporate tax rate was reduced to 31% for the 2006 tax year, 29% for the 2007 tax year, 27% for the 2008 tax year, 26% for the 2009 tax year and 25% for the 2010 tax year and thereafter. However, the effective tax rate payable by a company that derives income from an approved enterprise (as discussed below) may be considerably less. Israeli companies are also subject to capital gains tax at a rate of 25% on capital gains (other than gains derived from the sale of listed securities that are taxed at the prevailing corporate tax rates) derived after January 1, 2003. Also, regarding assets acquired prior to January 1, 2003, the reduced tax rate will apply to a proportionate part of the gain, in accordance with the holding periods of the asset, before or after January 1, 2003, on a linear basis.
Tax Benefits Under the Law for the Encouragement of Capital Investments, 1959
The Law for the Encouragement of Capital Investments, 1959 (“the Investments Law”) provides that upon application to the Investment Center of the Ministry of Industry, Trade and Labor of the State of Israel, a proposed capital investment in eligible facilities may be designated as an approved enterprise. Each certificate of approval for an approved enterprise relates to a specific investment program delineated both by its financial scope, including its capital sources, and by its physical characteristics, such as the equipment to be purchased and utilized pursuant to the program. The tax benefits derived from any such certificate of approval relate only to taxable income derived from the specific approved enterprise. If a company has more than one approval or only a portion of its capital investments are approved, its effective tax rate is the result of a weighted combination of the applicable rates. The tax benefits under the Investments Law are not generally available with respect to income derived from products manufactured outside of Israel.
56
The Investments Law was amended in 2005 as further described below. The Amendment will apply to approved enterprise programs in which the year of election under the Investments Law is 2004 or later, unless such programs received approval from the Investment Center on or prior to December 31, 2004, in which case the Amendment provides that terms and benefits included in any certificate of approval already granted will remain subject to the provisions of the law as they were on the date of such approval.
Prior to the amendment, taxable income of a company derived from an approved enterprise (including income generated by a company from the grant of a usage right with respect to know-how developed by the approved enterprise, income generated from royalties and income derived from a service which is auxiliary to such usage right or royalties, provided that such income is generated within the approved enterprise’s ordinary course of business) is subject to company tax at the maximum rate of 25%, rather than the usual rate for the “Benefit Period”. The Benefit Period is seven years (and under certain circumstances, as further detailed below, ten years), commencing with the year in which the approved enterprise first generates taxable income, and is limited to 12 years from commencement of production or 14 years from the date of approval, whichever is earlier.
A company that has an approved enterprise program is eligible for further tax benefits if it qualifies as a “foreign investors’ company”. A “foreign investors’ company” is a company more than 25% of whose shares of capital stock and combined share capital and loan, without interest charge, is owned by non-Israeli residents. A company that qualifies as a foreign investors’ company and has an approved enterprise program is eligible for tax benefits for a ten-year benefit period and to a reduced tax rate of 10% to 25% depending on the level of foreign investment in each year.
A company owning an approved enterprise may elect (as we have done) to forego certain government grants extended to approved enterprises in return for an alternative package of benefits. Under the alternative package, the company’s undistributed income derived from an approved enterprise will be exempt from tax for a period of between two and ten years from the first year of taxable income, depending on the geographic location of the approved enterprise within Israel, and the company will be eligible for the reduced tax benefits under the law for the remainder of the benefit period.
The Investment Center bases its decision of whether to approve or reject a company’s application for designation as an approved enterprise, among other things, on criteria set forth in the law and related regulations, the then prevailing policy of the Investment Center and the specific objectives and financial criteria of the applicant. Accordingly, a company cannot be certain in advance whether its application will be approved. In addition, the benefits available to an approved enterprise are conditional upon compliance with the conditions stipulated in the law and related regulations and the criteria set forth in the specific certificate of approval. In the event that a company violates these conditions, in whole or in part, it may be required to refund the amount of tax benefits plus an amount linked to the Israeli consumer price index and interest.
A major portion of our production facilities have been granted the status of approved enterprises. Income arising from our approved enterprises facilities is tax-free under the alternative package of benefits described above for the period in which such alternative package is in effect and thereafter, entitled to reduced tax rates based on the level of foreign ownership for specified periods. We have derived, and expect to continue to derive, a substantial portion of our income from our approved enterprises facilities. Subject to compliance with applicable requirements, the benefits for most of our production facilities in Israel will continue throughout the duration as stipulated in the Investment Law. Our current investments in development facilities are made under new approvals. If we fail for any reason to meet the conditions of the approved revised investment program, our future tax benefits under the Law for the Encouragement of Capital Investments may be materially reduced. In light of our carry forward losses, we are currently not in a taxable position.
We received an approval in principle from the Investment Center with respect to the sale of our government surveillance business to Verint in March 2004. If the Investment Center declines, for any reason, to grant us the final approval, our future tax benefits under the Investments Law will be materially reduced.
All dividends are considered to be attributable to the entire enterprise and their effective tax rate is the result of a weighted combination of the applicable tax rates. We currently intend to reinvest the amount of our income and not to distribute such income as a dividend. In the event that we do pay a dividend from income that is derived from our approved enterprises pursuant to the alternative package of benefits, which income would normally be tax-exempt, we would be required to pay tax on the amount intended to be distributed as dividends at the rate which would have been applicable had we not elected the alternative package of benefits, which rate is ordinarily up to 25%, and to withhold at source on behalf of the dividend recipient an additional 15% of the amount distributed as dividends.
The Investments Law also provides that an approved enterprise is entitled to accelerated depreciation on its property and equipment that are included in an approved investment program.
In March 2005, the government of Israel passed an amendment to the Investments Law in which it revised the criteria for investments qualified to receive tax benefits as a benefited enterprise. Among other things, companies that meet the criteria of the alternate package of tax benefits will receive those benefits without prior approval. However, no assurance can be given that we will in the future be eligible to receive additional tax benefits under this law.
57
The reform primarily included the following provisions:
| n | Companies that meet the criteria of the “Alternate Path” will receive its benefits without need for prior approval. In addition, such companies will not be required to file reports with the Investment Center. Such companies will be able to request to obtain pre-rulings. |
| n | Tax benefits of the Alternate Path include lower tax rates or exemptions, depending upon the field in which a company engages and the “path” chosen, as well as lower tax rates on dividends and accelerated depreciation. |
| n | In order to receive benefits within the framework of the Grant Path, under which a company may elect to receive certain grants instead of being eligible for tax reductions or exemptions, or the Alternate Path, the Industrial Enterprise must be deemed to contribute to the “economic independence” of the State of Israel’s economy in one of the following manners: |
| (i) | its primary activity involves the biotechnology or nanotechnology fields and pre-approval is received from the head of research and development at the OCS; |
| (ii) | its revenue derived from activity within a certain market does not exceed 75% of its total revenues in such year; |
| (iii) | 25% or more of its revenues are derived from a certain market of at least 12 million residents. |
| n | Upon the establishment of an approved enterprise, an investment, within three years, of at least NIS 300,000 in production machinery and equipment within is required. |
| n | In order to be eligible for increased tax benefits under an expansion of the Industrial Enterprise, a company is required to invest, within three years of the expansion of a benefited enterprise, the greater of NIS 300,000 in production machinery and equipment or a certain percentage of its existing production machinery and equipment as follows: |
| Production assets | % of required investment | Required investment |
|---|---|---|
| Up to NIS 140 million | 12% | Up to NIS 16.8 million |
| From NIS 140 - 500 million | 7% | From NIS 16.8 - 42 million |
| Over NIS 500 million | 5% | From NIS 42 million |
Tax Benefits for Research and Development
Israeli tax ordinance allows, under specified circumstances, a tax deduction for expenditures in the year incurred, including capital expenditures, in scientific research and development projects, if the expenditures are approved by the relevant Israeli government ministry and the research and development is for the promotion of the company and carried out by or on behalf of the company seeking such deduction. However, the amount of such deductible expenses must be reduced by the sum of any funds received through government grants for the finance of such scientific research and development projects. Expenditures not so approved are deductible over a three-year period.
Tax Benefits Under the Law for the Encouragement of Industry (Taxes), 1969
According to the Law for the Encouragement of Industry (Taxes), 1969 (“the Industry Encouragement Law”), an “Industrial Company” is a company located in Israel, at least 90% of the income of which, in any tax year, exclusive of income from defense loans, capital gains, interest and dividends, is derived from an “Industrial Enterprise” owned by it. An “Industrial Enterprise” is defined as an enterprise whose major activity in a given tax year is industrial production activity. We believe that we currently qualify as an Industrial Company within the definition of the Industry Encouragement Law.
Under the Industry Encouragement Law, Industrial Companies are entitled to preferred corporate tax benefits, among others, such as:
| — | deduction of purchases of know-how and patents over an eight-year period for tax purposes; |
| — | deduction over a three-year period of expenses involved with the issuance and listing of shares on a stock exchange; |
| — | the right to elect, under certain conditions, to file a consolidated tax return with related Israeli Industrial Companies that satisfy conditions set forth in the Industry Encouragement Law; |
| — | accelerated depreciation rates on equipment and buildings. |
Eligibility for the benefits under the law is not subject to receipt of prior approval from any governmental authority. However, the Israeli tax authorities may determine that we do not qualify as an Industrial Company. In addition, we might not continue to qualify as an Industrial Company in the future. As a result of either of the foregoing, the benefits described above might not be available in the future.
58
Special Provisions Relating to Taxation Under Inflationary Conditions
The Income Tax Law (Inflationary Adjustments), 1985 represents an attempt to overcome the problems presented to a traditional tax system by an economy undergoing inflation. The law is highly complex. Its features that are material to us can be described as follows:
| — | A special tax adjustment for the preservation of equity whereby certain corporate assets are classified broadly into fixed (inflation immune) assets and non-fixed (soft) assets. Where a company’s equity, as defined in the law, exceeds the depreciated cost of its fixed assets, as defined in the law, the company may take a deduction from taxable income that reflects the effect of multiplication of the annual rate of inflation on such excess, up to a ceiling of 70% of taxable income in any single tax year, with the unused portion carried forward, linked to the increase in the consumer price index. If the depreciated cost of fixed assets exceeds a company’s equity, then the excess multiplied by the annual rate of inflation is added to taxable income. |
| — | Subject to certain limitations set forth in the law, depreciation deductions on fixed assets and losses carried forward are adjusted for inflation based on the increase of the Israeli consumer price index. |
| — | Taxable gains on certain traded securities, which are taxed at a reduced tax rate with respect to individuals following the Tax Reform (and which were previously exempt from tax), are taxable at the company’s tax rate in certain circumstances. |
On February 26, 2008, the Israeli Income Tax Law (Inflationary Adjustments) (Amendment No. 20) (Restriction of Period of Application) – 2008 (“the Amendment”) was passed by the Knesset. According to the Amendment, the Inflationary Adjustments Law will no longer be applicable subsequent to the 2007 tax year, except for certain transitional provisions.
Further, according to the Amendment, commencing with the 2008 tax year, the adjustment of income for the effects of inflation for tax purposes will no longer be calculated. Additionally, depreciation on fixed assets and tax loss carry forwards will no longer be linked to future changes in the CPI, such that these amounts will continue to be linked only to the CPI as of the end of the 2007 tax year and will not be linked to CPI changes after this date. Finally, due to the Company’s adoption of US dollar regulations in 2008 , the Inflationary Adjustments Law will no longer be applicable.
Measurement of results for tax purposes under the Israeli Income Tax Regulations (Rules for Maintaining Accounting Records of Foreign Invested Companies and Certain Partnerships and Determining Their Taxable Income) – 1986
Commencing in taxable year 2007, the Company has elected to measure its taxable income and file its tax return under the Israeli Income Tax Regulations (Principles Regarding the Management of Books of Account of Foreign Invested Companies and Certain Partnerships and the Determination of Their Taxable Income), 1986. Such an elective obligates the Company for three years. Accordingly, commencing taxable year 2007, results for tax purposes are measured in terms of earnings in U.S. dollars.
Capital Gains Tax
Israeli law generally imposes a capital gains tax on the sale of any capital assets by residents of Israel, as defined for Israeli tax purposes, and on the sale of assets located in Israel, including shares in Israeli companies, by both residents and non-residents of Israel, unless a specific exemption is available or unless a tax treaty between Israel and the shareholder’s country of residence provides otherwise. The law distinguishes between real gain and inflationary surplus. The inflationary surplus is a portion of the total capital gain which is equivalent to the increase of the relevant asset’s purchase price which is attributable to the increase in the Israeli consumer price index or, in certain circumstances, a foreign currency exchange rate, between the date of purchase and the date of sale. The real gain is the excess of the total capital gain over the inflationary surplus.
Generally, until the 2006 tax year, capital gains tax was imposed on Israeli resident individuals at a rate of 15% on real gains derived on or after January 1, 2003, from the sale of shares in, among others, Israeli companies publicly traded on NASDAQ or on a recognized stock exchange or regulated market in a country that has a treaty for the prevention of double taxation with Israel. This tax rate was contingent upon the shareholder not claiming a deduction for financing expenses in connection with such shares (in which case the gain was generally be taxed at a rate of 25%), and did not apply to: (i) the sale of shares to a relative (as defined in the Israeli Income Tax Ordinance); (ii) the sale of shares by dealers in securities; (iii) the sale of shares by shareholders that report in accordance with the Inflationary Adjustments Law (that were taxed at corporate tax rates for corporations and at marginal tax rates for individuals); or (iv)the sale of shares by shareholders who acquired their shares prior to an initial public offering (that may be subject to a different tax arrangement).
As of January 1, 2006, the tax rate applicable to capital gains derived from the sale of shares, whether or not listed on a stock market, is 20% for Israeli individuals, unless such shareholder claims a deduction for financing expenses in connection with such shares, in which case the gain will generally be taxed at a rate of 25%. Additionally, if such shareholder is considered a “material shareholder” at any time during the twelve-month period preceding such sale, that is, such shareholder holds directly or indirectly, including with others, at least 10% of any means of control in the company, the tax rate shall be 25%. Israeli companies are subject to the corporate tax rate on capital gains derived from the sale of shares, unless such companies were not subject to the Inflationary Adjustments Law (or certain regulations) at the time of publication of the aforementioned amendment to the Tax Ordinance that came into effect on January 1, 2006, in which case the applicable tax rate is 25%. However, the foregoing tax rates do not apply to: (i) dealers in securities; and (ii) shareholders who acquired their shares prior to an initial public offering (that may be subject to a different tax arrangement).
59
The tax basis of shares acquired prior to January 1, 2003 will be determined in accordance with the average closing share price in the three trading days preceding January 1, 2003. However, a request may be made to the tax authorities to consider the actual adjusted cost of the shares as the tax basis if it is higher than such average price.
Non-Israeli residents are exempt from Israeli capital gains tax on any gains derived from the sale of shares of Israeli companies publicly traded on a recognized stock exchange or regulated market outside of Israel, provided, however, that such capital gains are not derived from a permanent establishment in Israel, such shareholders are not subject to the Inflationary Adjustments Law, and such shareholders did not acquire their shares prior to an initial public offering. However, non-Israeli corporations will not be entitled to such exemption if an Israeli resident (i) has a controlling interest of 25% or more in such non-Israeli corporation, or (ii) is the beneficiary or is entitled to 25% or more of the revenues or profits of such non-Israeli corporation, whether directly or indirectly.
In some instances where our shareholders may be liable to Israeli tax on the sale of their ordinary shares, the payment of the consideration may be subject to the withholding of Israeli tax at the source.
Pursuant to the Convention Between the government of the United States of America and the government of Israel with Respect to Taxes on Income, as amended, generally referred to as the U.S.-Israel Tax Treaty, the sale, exchange or disposition of ordinary shares by a person who (i) holds the ordinary shares as a capital asset, (ii) qualifies as a resident of the United States within the meaning of the U.S.-Israel Tax Treaty and (iii) is entitled to claim the benefits afforded to such person by the U.S.-Israel Tax Treaty, generally, will not be subject to the Israeli capital gains tax. Such exemption will not apply if (a) such Treaty U.S. Resident holds, directly or indirectly, shares representing 10% or more of our voting power during any part of the twelve-month period preceding such sale, exchange or disposition, subject to certain conditions, or (b) the capital gains from such sale, exchange or disposition can be allocated to a permanent establishment in Israel. In such case, the sale, exchange or disposition of ordinary shares would be subject to Israeli tax, to the extent applicable; however, under the U.S.-Israel Tax Treaty, such Treaty U.S. Resident would be permitted to claim a credit for such taxes against the U.S. federal income tax imposed with respect to such sale, exchange or disposition, subject to the limitations in U.S. laws applicable to foreign tax credits. The U.S.-Israel Tax Treaty does not relate to U.S. state or local taxes.
Taxation of Dividends
Non-residents of Israel are subject to income tax on income accrued or derived from sources in Israel. These sources of income include passive income such as dividends, royalties and interest, as well as non-passive income from services rendered in Israel. On distributions of dividends (other than bonus shares or stock dividends) to Israeli individuals and foreign resident individuals and corporations we would be required to withhold income tax at the rate of 20% (25% if the shareholder holds 10% or more of the “means of control” of the company, as such term is defined by the law). If the income out of which the dividend is being paid is attributable to an Approved Enterprise or Benefited Enterprise under the Investment Law, the rate is 15%. A different rate may be provided for in a treaty between Israel and the shareholder’s country of residence. Under the U.S.-Israel tax treaty, if the income out of which the dividend is being paid is not attributable to an Approved Enterprise or Benefited Enterprise, then we are required to withhold income tax at a rate of 12.5% with respect to shareholders that are U.S. corporations and held at least 10% of our voting power in the 12 month period preceding the distribution of such dividends.
Residents of the United States will generally have taxes in Israel withheld at source. Such persons generally would be entitled to a credit or deduction for United States Federal income tax purposes for the amount of such taxes withheld, subject to limitations applicable to foreign tax credits.
| F. | Dividends and Paying Agents |
Not Applicable.
| G. | Statement by Experts |
Not Applicable.
| H. | Documents on Display |
We are subject to the informational requirements of the Exchange Act, as amended, applicable to foreign private issuers and fulfill the obligations with respect to such requirements by filing reports with the SEC. You may read and copy any document we file, including any exhibits, with the SEC without charge at the SEC’s public reference room at 100 F Street, N.E., Washington, D.C. 20549. Copies of such material may be obtained by mail from the Public Reference Branch of the SEC at such address, at prescribed rates. Please call the SEC at 1-800-SEC-0330 for further information on the public reference room. Certain of our SEC filings are also available to the public at the SEC’s website at http://www.sec.gov.
As a foreign private issuer, we are exempt from the rules under the Exchange Act prescribing the furnishing and content of proxy statements, and our officers, directors and principal shareholders are exempt from the reporting and “short-swing” profit recovery provisions contained in Section 16 of the Exchange Act. In addition, we are not required under the Exchange Act to file periodic reports and financial statements with the SEC as frequently or as promptly as United States companies whose securities are registered under the Exchange Act.
60
| I. | Subsidiary Information |
Not Applicable.
Item 11. Quantitative and Qualitative Disclosures about Market Risk
Through our normal operations, we are exposed to market risks including movements in currency exchange rates and interest rates. We are exposed to currency risks mainly because we generate most of our revenues in dollars but incur a majority of our salaries and related expenses and part of our other expenses in New Israeli Shekels. We do not actively hedge interest rate exposure or engage in other transactions intended to manage risks relating to interest rate fluctuations. We do hedge assets or liabilities denominated in currencies other than the dollar.
Generally, we invest our excess cash in instruments that are liquid and generate yields, with conservative and low risk. As of December 31, 2008, we had $2.7 million of principal invested in ARS. We have a long history of investing excess cash under a conservative corporate policy that only allows investments in highly rated investment-grade securities, with preservation of capital and liquidity as primary objectives. Our ARS were ranked as AAA and AA at the time of purchase, and there had been no change in their rating since that time, until the end of the first quarter of 2008 in which they experienced a rating downgrade. All securities continue to pay interest in accordance with their stated terms. However, since these ARS have experienced multiple failed auctions due to a lack of liquidity in the market for these securities, based on third-party indications, we recognized an impairment charge with respect to our ARS portfolio. As a result, in the year ended 2007, we recorded, an impairment charge of $1.6 million, which is considered “other than temporary”, and an unrealized loss of $178 thousand and recorded in other comprehensive loss as a reduction of shareholders’ equity, which was considered a “temporary” impairment. In October 2008, several of the ARS held by us, and previously impaired, were redeemed at par-value at the amount of $1.7 million, resulting in a gain of $1.6 million. As of December 31, 2008, as a result of the market condition and the lack of liquidity continuation, we recorded an impairment charge of $1.8 million, which is considered “other than temporary”.
Presentation of interest rate risk (position as of December 31, 2008)
We do not use any derivative instruments to protect us from fluctuations in interest rates. Details regarding our interest rate exposure are set forth in the table below. Interest rate exposure is monitored by tracking actual and projected commitments and through the use of a sensitivity analysis.
| Total as of |
Settlement Date |
Fair value as of |
|||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| December 31, 2008 |
2009 |
2010 |
2011 |
2012 |
After 2013 |
December 31, 2008 |
|||||||||||||||||
| (in thousands of U.S. dollars, except percentages) |
|||||||||||||||||||||||
| Assets that incur interest | |||||||||||||||||||||||
| A. Cash and cash equivalents | |||||||||||||||||||||||
| U.S. dollars | 6,619 | 6,619 | - | - | - | - | 6,619 | ||||||||||||||||
| Weighted-average interest rate | 0.44 | % | 0.44 | % | - | - | - | - | - | ||||||||||||||
| NIS | 1,417 | 1,417 | - | - | - | - | 1,417 | ||||||||||||||||
| Weighted-average interest rate | 0.90 | % | 0.90 | % | - | - | - | - | - | ||||||||||||||
| B. Short-term investments | |||||||||||||||||||||||
| U.S. dollars | 1,011 | 1,011 | - | - | - | - | 1,011 | ||||||||||||||||
| Weighted-average interest rate | 4.63 | % | 4.63 | % | - | - | - | - | - | ||||||||||||||
| C. Long-term marketable | |||||||||||||||||||||||
| securities | |||||||||||||||||||||||
| U.S. dollars | 8,172 | - | - | 7,267 | - | 905 | 8,172 | ||||||||||||||||
| Weighted-average interest rate | 3.41 | % | - | - | 3.21 | % | - | 5.08 | % | - | |||||||||||||
Exchange Rate Risk Management
Our functional currency and that of our subsidiaries is the dollar. From time to time, we enter into forward exchange contracts to reduce the impact of fluctuations of foreign currencies against the dollar resulting from existing trade receivables and trade payables. We do not believe that our activities in entering into these contracts subject us to exchange rate risk because gains and losses on these contracts offset losses and gains on the trade receivables or trade payables that are hedged.
As at December 31, 2008, the Company had nine open currency forward contracts. The gain related thereto in the amount of $55 thousand is included in the statements of operations as of December 31, 2008.
61
Presentation of foreign currency-denominated assets and liabilities (position as of December 31, 2008)
Details regarding our foreign exchange exposure are set forth in the table below. Foreign exchange exposure is monitored by tracking actual and projected commitments and through the use of a sensitivity analysis.
| Total as of |
Settlement Date |
Fair value as of |
|||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| December 31, 2008 |
2009 |
2010 |
2011 |
2012 |
After 2013 |
December 31, 2008 |
|||||||||||||||||
| (in thousands of U.S. dollars) |
|||||||||||||||||||||||
| Current Assets | |||||||||||||||||||||||
| NIS | 2,031 | 2,031 | - | - | - | - | 2,031 | ||||||||||||||||
| Euro | 3,033 | 3,033 | - | - | - | - | 3,033 | ||||||||||||||||
| Other | 842 | 842 | - | - | - | - | 842 | ||||||||||||||||
| Total | 5,906 | 5,906 | - | - | - | - | 5,906 | ||||||||||||||||
| Long-term assets | |||||||||||||||||||||||
| NIS | 1,193 | 3 | 2 | 75 | - | 1,113 | 1,193 | ||||||||||||||||
| Current liabilities | |||||||||||||||||||||||
| NIS | 4,073 | 4,073 | - | - | - | - | 4,073 | ||||||||||||||||
| Euro | 624 | 624 | - | - | - | - | 624 | ||||||||||||||||
| Other | 63 | 63 | - | - | - | - | 63 | ||||||||||||||||
| Total | 4,760 | 4,760 | - | - | - | - | 4,760 | ||||||||||||||||
| Long-term liabilities | |||||||||||||||||||||||
| NIS | 2,018 | 2,018 | 2,018 | ||||||||||||||||||||
Item 12. Description of Securities Other than Equity Securities
Not Applicable.
62
PART II
Item 13. Defaults, Dividend Arrearages and Delinquencies
Not Applicable.
Item 14. Material Modifications to the Rights of Security Holders and Use of Proceeds
There are no material modifications to, or qualifications of, the rights of security holders that are required to be disclosed.
Item 15T. Controls and Procedures
(a) Disclosure Controls and Procedures
Our Chief Executive Officer and Chief Financial Officer are responsible for establishing and maintaining our disclosure controls and procedures, as defined in Rule 13a-15(e) and Rule 15d-15(e) of the Exchange Act. These controls and procedures were designed to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC. Our management evaluated these disclosure controls and procedures under the supervision of our Chief Executive Officer and Chief Financial Officer as of December 31, 2008. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were (i) effective as of December 31, 2008, in that they provide reasonable assurance that the information required to be disclosed in filings and submissions under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified by the SEC’s rules and forms and (ii) designed to ensure that material information related to us and our consolidated subsidiaries is accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions about required disclosure.
(b) Management's Annual Report on Internal Control Over Financial Reporting
Our management, under the supervision of our Chief Executive Officer and Chief Financial Officer, is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) and Rule 15d-15(f) of the Exchange Act. Our internal control system is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation and fair presentation of our consolidated financial statements for external purposes in accordance with generally accepted accounting principles. Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, assessed the effectiveness of our internal control over financial reporting as of December 31, 2008. In making this assessment, they used the criteria established in Internal Control–Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on this assessment, our Chief Executive Officer and Chief Financial Officer have concluded that, as of December 31, 2008, our internal control over financial reporting is effective based on those criteria. Notwithstanding the foregoing, all internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective may not prevent or detect misstatements and can provide only reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
This Annual Report does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s registered public accounting firm pursuant to temporary rules of the SEC that permit the Company to provide only management’s report in this Annual Report.
(c) Changes in Internal Control Over Financial Reporting
During the period covered by this Annual Report, there were no changes in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Item 16A. Audit Committee Financial Expert
Our board of directors has determined that Mr. Rami Entin qualified as our audit committee financial expert. Our board has determined that Mr. Entin is “independent” as defined by Nasdaq Marketplace Rule 4200(a)(15).
Item 16B. Code of Ethics
Our board of directors has adopted our Code of Ethics and Business Conduct, a code that applies to all of our directors and employees (including our principal executive officer, principal financial officer and principal accounting officer). A copy of our Code of Ethics and Business Conduct may be obtained, free of charge, by writing to ECtel Ltd., Attention: Corporate Secretary, 10 Amal Street, Rosh Ha’ayin, Israel.
63
Item 16C. Principal Accountant Fees and Services
At our annual meeting held on September 25, 2008, our shareholders re-appointed Somekh Chaikin, a member firm of KPMG International, to serve as our independent auditors for fiscal year 2009.
The following table presents fees for professional services rendered by Somekh Chaikin for the audit of the Company’s annual financial statements for 2008 and 2007 and for certain taxation and other matters (in thousands of U.S. dollars):
| Year Ended December 31, | ||||||||
|---|---|---|---|---|---|---|---|---|
| 2008 |
2007 | |||||||
| Audit Fees | 133 | 160 | ||||||
| Tax Fees | 5 | 5 | ||||||
| All Other Fees | - | 22 | ||||||
| Total | 138 | 187 | ||||||
“Audit Fees” are the aggregate fees billed and billable for the audit of our annual financial statements. This category also includes services that generally the independent accountant provides, such as statutory audits (including audits required by the OCS and other Israeli government institutes), and consents and assistance with and review of documents filed with the SEC.
“Tax Fees” are the aggregate fees billed for professional services rendered for tax compliance, other than in connection with the audit.
“All Other Fees” are the aggregate fees billed for non-audit fees with regards to a transfer pricing study.
Our audit committee’s policy is to pre-approve each audit and non-audit service to be performed by our independent accountant before the accountant is engaged.
Item 16D. Exemptions from Listing Standards for Audit Committees
Not Applicable.
Item 16E. Purchases of Equity Securities by the Issuer and Affiliated Purchasers
In July 2008 we announced a plan to repurchase our ordinary shares on the open market in an amount in cash of up to $4 million. Under the plan, share purchases may be made from time to time depending on market conditions, share price, trading volume and other factors. The plan is for one year and may be suspended from time to time or discontinued. Since we adopted the plan, we have repurchased an amount of 404,503 of our ordinary shares for total consideration of $0.57 million. The plan is currently suspended. In April 2006, we announced a plan to repurchase our ordinary shares on the open market in an amount in cash of up to $15 million. From the time that we adopted the plan until its expiration in April 2007, we repurchased an amount of 2,304,794 of our ordinary shares for total consideration of $11.5 million.
ISSUER PURCHASES OF EQUITY SECURITIES
| Period |
Total Number of Shares Purchased (All Purchased as Part of Publicly Announced Plans) |
Average Price Paid per Share |
Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plan | ||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| September 2006 | 55,400 | $ | 4.31 | $ | 14,760,747 | ||||||
| October 2006 | 1,974,396 | $ | 4.79 | $ | 4,974,923 | ||||||
| November 2006 | 274,998 | $ | 5.05 | $ | 3,585,909 | ||||||
| September 2008 | 128,545 | $ | 1.45 | $ | 3,813,833 | ||||||
| October 2008 | 275,958 | $ | 1.16 | $ | 3,492,723 | ||||||
| Total | 2,709,297 | ||||||||||
64
Item 16G. Corporate Governance.
Pursuant to the Israel Companies Law, the quorum requirement for general meetings of our shareholders is 25% of the voting power in our company, rather than 33%, as is otherwise required by the Nasdaq Marketplace Rules for domestic U.S. listed companies.
The members of our compensation committee are Messrs. Yair Cohen and Sami Totah and Ms. Mali Baron. Our board of directors has determined that each of Mr. Totah and Ms. Baron is “independent”, as defined under the Nasdaq Marketplace Rules. While Mr. Cohen is not “independent” under the Nasdaq Marketplace Rules, we have elected to follow home country practice in lieu of compliance with the NASDAQ requirement for an entirely independent compensation committee and we have provided notice to that effect, and Mr. Cohen can therefore serve on our compensation committee notwithstanding this NASDAQ requirement.
PART III
Item 17. Financial Statements
We have responded to Item 18 in lieu of this item.
Item 18. Financial Statements
See pages F-1 through F- 41, incorporated herein by reference.
Item 19. Exhibits
| Exhibit No. | Description |
| 1.1 | Memorandum of Association (previously filed as Exhibit to our Registration Statement on Form F-1, and incorporated herein by reference). |
| 1.2 | Amended and Restated Articles of Association (as amended on September 26, 2005) (previously filed as Exhibit to our Annual Report on Form 20-F for the fiscal year ended December 31, 2005, filed June 15, 2006, and incorporated herein by reference). |
| 4.(b)1 | Registration Rights Agreement, of 2008, by and among certain investors and the Registrant (previously filed as Exhibit to our Annual Report on Form 20-F for the fiscal year ended December 31, 2007, filed June 18, 2008 and incorporated herein by reference). |
| 4.(b)2* | Asset Purchase Agreement, dated March 24, 2008, by and between Compwise Ltd. and the Registrant. |
| 4.(c)1 | ECtel Managers and Employees Option Allotment Plan, as amended (previously filed as Exhibit to our Annual Report on Form 20-F for the fiscal year ended December 31, 1999, filed June 30, 2000, and incorporated herein by reference) (1). |
| 4.(c)2 | ECtel International Employee Stock Option Plan, as amended (previously filed as Exhibit to our Annual Report on Form 20-F for the fiscal year ended December 31, 1999, filed June 30, 2000, and incorporated herein by reference). |
| 4.(c)3 | ECtel Director Share Option Plan 1999 (previously filed as Exhibit to our Registration Statement on Form F-1, and incorporated herein by reference). |
| 4.(c)4 | ECtel 2003 Share Option Plan (previously filed as Exhibit to our Annual Report on Form 20-F for the fiscal year ended December 31, 2003, filed June 28, 2004, and incorporated herein by reference). |
| 4.(c)5 | ECtel 2003 U.S. Employee Stock Option Plan (previously filed as Exhibit to our Annual Report on Form 20-F for the fiscal year ended December 31, 2003, filed June 28, 2004, and incorporated herein by reference). |
| 4.(c)6 | 2003 Equity Incentive Plan (previously filed as Exhibit to our Annual Report on Form 20-F for the fiscal year ended December 31, 2005, filed June 15, 2006, and incorporated herein by reference). |
| 4.(c)7* | Form of Indemnification Letter |
| 8.1* | List of Subsidiaries |
65
| 12.1* | Certification of Principal Executive Officer pursuant to 17 CFR 240.13a-14(a), as adopted pursuant toss.302 of the Sarbanes-Oxley Act |
| 12.2* | Certification of Principal Financial Officer pursuant to 17 CFR 240.13a-14(a), as adopted pursuant toss.302 of the Sarbanes-Oxley Act |
| 13.1* | Certification of Principal Executive Officer pursuant to 17 CFR 240.13a-14(b) and 18 U.S.C.ss. 1350, as adopted pursuant toss.906 of the Sarbanes-Oxley Act |
| 13.2* | Certification of Principal Financial Officer pursuant to 17 CFR 240.13a-14(b) and 18 U.S.C.ss. 1350, as adopted pursuant toss.906 of the Sarbanes-Oxley Act |
| 15.1* | Consent of Independent Registered Public Accounting Firm |
| (1) | English translation from Hebrew original. |
* Filed herewith.
SIGNATURES
The Registrant hereby certifies that it meets all of the requirements for filing on Form 20-F and that it has duly caused and authorized the undersigned to sign this Annual Report on its behalf.
| ECTEL LTD. (Registrant) By: /s/ Itzik Weinstein —————————————— Itzik Weinstein President and Chief Executive Officer Date: May 12, 2009 |
66
ECtel Ltd. and Subsidiaries
Consolidated Financial
Statements
as
at and for the year ended
December 31, 2008
| ECtel Ltd. and Subsidiaries |
| Consolidated Financial Statements as at and for the year ended December 31, 2008 |
Contents
| Somekh Chaikin | Telephone | 972 3 684 8000 | |
| KPMG Millennium Tower | Fax | 972 3 684 8444 | |
| 17 Ha'arba'a Street, PO Box 609 | Internet | www.kpmg.co.il | |
| Tel Aviv 61006 Israel |
Report of Independent
Registered Public Accounting Firm
To the Board of Directors and Shareholders
ECtel
Ltd.:
We have audited the accompanying consolidated balance sheets of ECtel Ltd. and its subsidiaries (“the Company”), as at December 31, 2008 and 2007 and the related consolidated statements of operations, shareholders’ equity and comprehensive loss and cash flows for each of the years in the three-year period ended December 31, 2008. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by the Company’s management, as well as evaluating the overall financial statements presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company at December 31, 2008 and 2007, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2008 in conformity with U.S. generally accepted accounting principles.
As discussed in Note 2V to the consolidated financial statements, the Company adopted the provisions of Statement of Financial Accounting Standards No.157, Fair Value Measurements, as of January 1, 2008, for fair value measurements of all financial assets and financial liabilities and for fair value measurements of nonfinancial items that are recognized or disclosed at fair value in the consolidated financial statements on a recurring basis.
Somekh Chaikin
Certified Public
Accountants (Israel)
Member Firm of KPMG International
Tel Aviv, Israel
March
22, 2009
F - 2
ECtel Ltd. and Subsidiaries
| Consolidated Balance Sheets as at December 31 |
| 2008 |
2007 | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| Note |
$ in thousands |
||||||||||
| Assets | |||||||||||
| Current assets | |||||||||||
| Cash and cash equivalents | 8,452 | 5,668 | |||||||||
| Short-term investments | 4 | 1,011 | 5,652 | ||||||||
| Receivables: | |||||||||||
| Trade, net of allowance for doubtful accounts | 13A | 10,904 | 8,612 | ||||||||
| Other | 13B | 1,177 | 1,372 | ||||||||
| Related parties | 12B | 247 | 17 | ||||||||
| Deferred expenses | 475 | 282 | |||||||||
| Inventories | 3 | 2,247 | 2,247 | ||||||||
| Total current assets | 24,513 | 23,850 | |||||||||
| Long-term marketable securities | 4 | 8,172 | 17,760 | ||||||||
| Long-term other assets | 5 | 1,193 | 1,612 | ||||||||
| Property, plant and equipment, net | 6 | 2,282 | 2,115 | ||||||||
| Goodwill | 7 | 12,792 | 11,322 | ||||||||
| Other intangible assets, net | 8 | 812 | 292 | ||||||||
| Total assets | 49,764 | 56,951 | |||||||||
The accompanying notes are an integral part of the consolidated financial statements.
F - 3
ECtel Ltd. and Subsidiaries
| 2008 |
2007 |
||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| Note |
$ in thousands |
||||||||||
| Liabilities and Shareholders' equity | |||||||||||
| Current liabilities | |||||||||||
| Payables: | |||||||||||
| Trade | 5,126 | 4,737 | |||||||||
| Related parties | 12B | 31 | 18 | ||||||||
| Advances from customers | 596 | 966 | |||||||||
| Other payables and accrued liabilities | 13C | 6,707 | 5,796 | ||||||||
| Total current liabilities | 12,460 | 11,517 | |||||||||
| Long-term liabilities | |||||||||||
| Liability for employee severance benefits | 2,018 | 2,352 | |||||||||
| Total liabilities | 14,478 | 13,869 | |||||||||
| Commitments and contingencies | 9 | ||||||||||
| Shareholders' equity | 10 | ||||||||||
| Share capital | |||||||||||
| Ordinary shares NIS 0.04 par value per share, authorized | |||||||||||
| 125,000,000 shares; issued and outstanding 16,281,898 | |||||||||||
| shares as at December 31, 2008 and 16,686,401 shares | |||||||||||
| as at December 31, 2007 | 221 | 221 | |||||||||
| Treasury shares at cost - 2,709,297 ordinary shares as at | |||||||||||
| December 31, 2008 and 2,304,794 ordinary shares as at | |||||||||||
| December 31, 2007 | (11,979 | ) | (11,472 | ) | |||||||
| Additional paid-in capital | 77,879 | 77,122 | |||||||||
| Accumulated other comprehensive gain (loss) | 82 | (178 | ) | ||||||||
| Accumulated loss | (30,917 | ) | (22,611 | ) | |||||||
| Total shareholders' equity | 35,286 | 43,082 | |||||||||
| Total liabilities and shareholders' equity | 49,764 | 56,951 | |||||||||
The accompanying notes are an integral part of the consolidated financial statements.
F - 4
ECtel Ltd. and Subsidiaries
| Consolidated Statements of Operations for the years ended December 31 |
| 2008 |
2007 |
2006 |
||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Note |
$ in thousands, except per share data |
|||||||||||||
| Revenues | 13D | 24,984 | 20,898 | 28,802 | ||||||||||
| Cost of revenues | 9B, 12 | 13,671 | 10,185 | 13,634 | ||||||||||
| Gross profit | 11,313 | 10,713 | 15,168 | |||||||||||
| Research and development costs, net | 4,548 | 4,789 | 4,277 | |||||||||||
| Selling and marketing expenses | 12 | 8,653 | 8,546 | 9,502 | ||||||||||
| General and administrative expenses | 12 | 6,964 | 5,757 | 3,812 | ||||||||||
| Acquisition-related expenses | 13G | 118 | - | 640 | ||||||||||
| Amortization of acquisition-related | ||||||||||||||
| intangible assets | 8 | 164 | 94 | 466 | ||||||||||
| Operating loss | (9,134 | ) | (8,473 | ) | (3,529 | ) | ||||||||
| Financial expenses | 13E | (737 | ) | (533 | ) | (797 | ) | |||||||
| Financial income | 12, 13E | 1,390 | 1,692 | 2,030 | ||||||||||
| Other income (loss),net | 4, 13H | 195 | (1,560 | ) | - | |||||||||
| Loss before taxes on income | (8,286 | ) | (8,874 | ) | (2,296 | ) | ||||||||
| Income tax benefit (expense) | 11 | (20 | ) | 73 | (4 | ) | ||||||||
| Net loss | (8,306 | ) | (8,801 | ) | (2,300 | ) | ||||||||
| Loss per ordinary share | ||||||||||||||
| Net basic and diluted loss per ordinary | ||||||||||||||
| share: | (0.50 | ) | (0.53 | ) | (0.13 | ) | ||||||||
| Weighted average number of ordinary | ||||||||||||||
| shares outstanding | 16,553,139 | 16,671,488 | 17,747,699 | |||||||||||
The accompanying notes are an integral part of the consolidated financial statements.
F - 5
ECtel Ltd. and Subsidiaries
| Consolidated Statements of Shareholders' Equity and Comprehensive Loss for the years ended December 31, 2008, 2007 and 2006 |
| Ordinary shares |
Share capital |
Treasury shares |
Capital surplus |
Accumulated loss |
Accumulated other comprehensive gain (loss) |
Comprehensive loss |
Total shareholders' equity | |||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Number |
$ in thousands |
|||||||||||||||||||||||||
| Balance at December 31, 2005 | 18,169,089 | 214 | - | 72,664 | (11,510 | ) | - | - | 61,368 | |||||||||||||||||
| Exercise of stock options | 500,373 | 4 | - | 1,362 | - | - | - | 1,366 | ||||||||||||||||||
| Share-based compensation | - | - | - | 995 | - | - | - | 995 | ||||||||||||||||||
| Repurchase of shares | (2,304,794 | ) | - | (11,472 | ) | - | - | - | - | (11,472 | ) | |||||||||||||||
| Net loss | - | - | - | - | (2,300 | ) | - | (2,300 | ) | (2,300 | ) | |||||||||||||||
| Comprehensive loss | (2,300 | ) | ||||||||||||||||||||||||
| Balance at December 31, 2006 | 16,364,668 | 218 | (11,472 | ) | 75,021 | (13,810 | ) | - | - | 49,957 | ||||||||||||||||
| Exercise of stock options | 321,733 | 3 | - | 971 | - | - | - | 974 | ||||||||||||||||||
| Share-based compensation | - | - | - | 1,130 | - | - | - | 1,130 | ||||||||||||||||||
| Comprehensive loss: | ||||||||||||||||||||||||||
| Net loss | - | - | - | - | (8,801 | ) | - | (8,801 | ) | (8,801 | ) | |||||||||||||||
| Unrealized loss on marketable securities | - | - | - | - | - | (178 | ) | (178 | ) | (178 | ) | |||||||||||||||
| Comprehensive loss | (8,979 | ) | ||||||||||||||||||||||||
| Balance at December 31, 2007 | 16,686,401 | 221 | (11,472 | ) | 77,122 | (22,611 | ) | (178 | ) | 43,082 | ||||||||||||||||
| Share-based compensation | - | - | - | 757 | - | - | - | 757 | ||||||||||||||||||
| Repurchase of shares | (404,503 | ) | - | (507 | ) | - | - | - | - | (507 | ) | |||||||||||||||
| Comprehensive loss: | ||||||||||||||||||||||||||
| Net loss | - | - | - | - | (8,306 | ) | - | (8,306 | ) | (8,306 | ) | |||||||||||||||
| Reclassified adjustment for other than temporary | ||||||||||||||||||||||||||
| impairment reported in net loss | - | - | - | - | - | 178 | 178 | 178 | ||||||||||||||||||
| Unrealized gain on marketable securities | - | - | - | - | - | 82 | 82 | 82 | ||||||||||||||||||
| Comprehensive loss | (8,046 | ) | ||||||||||||||||||||||||
| Balance at December 31, 2008 | 16,281,898 | 221 | (11,979 | ) | 77,879 | (30,917 | ) | 82 | 35,286 | |||||||||||||||||
The accompanying notes are an integral part of the consolidated financial statements.
F - 6
ECtel Ltd. and Subsidiaries
| Consolidated Statements of Cash Flows for the years ended December 31 |
| 2008 |
2007 |
2006 | |||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| $ in thousands |
|||||||||||
| Cash flows from operating activities | |||||||||||
| Net loss | (8,306 | ) | (8,801 | ) | (2,300 | ) | |||||
| Adjustments to reconcile net loss to | |||||||||||
| cash used in operating activities: | |||||||||||
| Depreciation and amortization | 673 | 600 | 1,077 | ||||||||
| Impairment of Auction Rate Securities | 1,795 | 1,560 | - | ||||||||
| Gain from the sale of Auction Rate Securities | (1,560 | ) | - | - | |||||||
| Loss on sale of long-term marketable securities | 94 | ||||||||||