UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 20-F
[_] REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE
SECURITIES EXCHANGE ACT OF 1934
OR
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2007
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
OR
[_] SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Date of event requiring this shell company report _____________
For the transition period from ________ to ________
Commission file number: 2-0-27648
VOCALTEC COMMUNICATIONS LTD.
(Exact name of registrant as specified in its charter and
translation into English)
STATE OF ISRAEL
(Jurisdiction of incorporation or organization)
60 MEDINAT HAYEHUDIM STREET
HERZLIYA 46140
ISRAEL
(Address of principal executive offices)
ELI GENDLER, PHONE: 972-9-9703888, FACSIMILE: 972-9-9558175
ADDRESS: 60 MEDINAT HAYEHUDIM STREET, HERZLIYA 46140, ISRAEL
(Name, Telephone, Facsimile number and Address of Company Contact Person)
Securities registered or to be registered pursuant to Section 12(b) of the Act:
NONE.
Securities registered or to be registered pursuant to Section 12(g) of the Act:
ORDINARY SHARES, PAR VALUE OF NIS 0.13
Title of each class
Securities for which there are a reporting obligation pursuant to Section 15(d)
of the Act:
NONE.
The number of outstanding shares of each of the issuer's classes of capital or
common stock as of December 31, 2007
7,376,364 ORDINARY SHARES, PAR VALUE NIS 0.13 PER SHARE
Indicate by check mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act.
[_] Yes [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.
[_] 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 ninety (90) days.
[X] Yes [_] No
2
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer.
[_] Large accelerate filer [_] Accelerate filer [X] Non-accelerated filer
Indicate by check mark which basis of accounting the registrant has used to
prepare the financial statements included in this filing:
[X] U.S. GAAP
[_] International Financial Reporting Standards as issued by the International
Accounting Standards Board
[_] Other
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 [_] Item 18
If this is an annual report, indicate by check mark whether the registrant is a
shell company (as defined in rule 12b-2 of the Exchange Act)
[_] Yes [X] No
(APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PAST
FIVE YEARS)
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Sections 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court.
[_] Yes [_] No
3
PRELIMINARY NOTE
THIS ANNUAL REPORT CONTAINS HISTORICAL INFORMATION AND FORWARD-LOOKING
STATEMENTS WITHIN THE MEANING OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF
1995 WITH RESPECT TO THE BUSINESS, FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OF VOCALTEC. THE WORDS "ANTICIPATE," "BELIEVE," "ESTIMATE," "EXPECT," "INTEND,"
"MAY," "PLAN," "PROJECT" AND "SHOULD" AND SIMILAR EXPRESSIONS, AS THEY RELATE TO
VOCALTEC OR ITS MANAGEMENT, ARE INTENDED TO IDENTIFY FORWARD-LOOKING STATEMENTS.
SUCH STATEMENTS REFLECT THE CURRENT VIEWS AND ASSUMPTIONS OF VOCALTEC WITH
RESPECT TO FUTURE EVENTS AND ARE SUBJECT TO RISKS AND UNCERTAINTIES. MANY
FACTORS COULD CAUSE THE ACTUAL RESULTS, PERFORMANCE OR ACHIEVEMENTS OF VOCALTEC
TO BE MATERIALLY DIFFERENT FROM ANY FUTURE RESULTS, PERFORMANCE OR ACHIEVEMENTS
THAT MAY BE EXPRESSED OR IMPLIED BY SUCH FORWARD-LOOKING STATEMENTS, INCLUDING,
AMONG OTHERS, CHANGES IN THE TELECOMMUNICATIONS AND VOIP MARKETS AND IN GENERAL
ECONOMIC AND BUSINESS CONDITIONS, LOSS OF KEY CUSTOMERS AND UNPREDICTABLE SALES
CYCLES, COMPETITIVE PRESSURES, MARKET ACCEPTANCE OF NEW PRODUCTS, INABILITY TO
MEET EFFICIENCY AND COST REDUCTION OBJECTIVES, CHANGES IN BUSINESS STRATEGY AND
VARIOUS OTHER FACTORS, BOTH REFERENCED AND NOT REFERENCED IN THIS ANNUAL REPORT.
THESE RISKS ARE MORE FULLY DESCRIBED UNDER ITEM 3 - KEY INFORMATION - RISK
FACTORS OF THIS ANNUAL REPORT. SHOULD ONE OR MORE OF THESE RISKS OR
UNCERTAINTIES MATERIALIZE, OR SHOULD UNDERLYING ASSUMPTIONS PROVE INCORRECT,
ACTUAL RESULTS MAY VARY MATERIALLY FROM THOSE DESCRIBED HEREIN AS ANTICIPATED,
BELIEVED, ESTIMATED, EXPECTED, INTENDED, PLANNED OR PROJECTED. VOCALTEC DOES NOT
INTEND OR ASSUME ANY OBLIGATION TO UPDATE THESE FORWARD-LOOKING STATEMENTS.
In this annual report, all references to "VocalTec," "we," "us" or "our" are to
VocalTec Communications Ltd., a company organized under the laws of the State of
Israel, and its wholly-owned subsidiaries.
VocalTec, Essentra, Internet Phone, the logo Internet I Phone, Surf&Call
(together with a third party), are registered trademarks of VocalTec
Communications Ltd. and its wholly-owned subsidiaries. Other trademarks are the
property of their respective holders.
In this annual report, unless otherwise specified or unless the context
otherwise requires, all references to "$" or "dollars" are to U.S. dollars and
all references to "NIS" are to New Israeli Shekels. Except as otherwise
indicated, financial statements of, and information regarding, VocalTec are
presented in U.S. dollars.
4
INDEX
PART ONE 6
ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS 6
ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE 6
ITEM 3. KEY INFORMATION 6
ITEM 4. INFORMATION ON THE COMPANY 24
ITEM 4A. UNRESOLVED STAFF COMMENTS 34
ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS 34
ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES 51
ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS 57
ITEM 8. FINANCIAL INFORMATION 59
ITEM 9. THE OFFER AND LISTING 59
ITEM 10. ADDITIONAL INFORMATION 62
ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 89
ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES 90
PART TWO 91
ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES 91
ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY
HOLDERS AND USE OF PROCEEDS 91
ITEM 15T. CONTROLS AND PROCEDURES 91
ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT 93
ITEM 16B. CODE OF ETHICS 93
ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES 93
PART THREE 95
ITEM 17. FINANCIAL STATEMENTS 95
ITEM 18. FINANCIAL STATEMENTS 95
ITEM 19. EXHIBITS 96
EXHIBITS INDEX
SIGNATURES
5
PART ONE.
ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS
Not applicable.
ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE
Not applicable.
ITEM 3. KEY INFORMATION
3.A. SELECTED FINANCIAL DATA
In November 2005, VocalTec Communications Ltd., or the Company or VocalTec,
acquired all of the issued and outstanding ordinary shares of Tdsoft Ltd., a
privately-held company organized in Israel ("Tdsoft"), and as consideration
issued to the Tdsoft shareholders ordinary shares of VocalTec constituting,
immediately following such issuance, 75% of the issued and outstanding share
capital of VocalTec (the "business combination"). The business combination was
accounted under U.S. generally accepted accounting principles ("GAAP") as a
reverse acquisition and therefore we are presenting in this report the
consolidated financial statements of Tdsoft for the years ended December 31,
2003 and 2004 and for the eleven months ended November 30, 2005, and the
consolidated financial statements of the combined company for the period of
December 1, 2005 and the years ended December 31, 2006 and 2007.
Our historical consolidated financial statements are prepared in accordance with
U.S. GAAP and are presented in U.S. dollars. Historical information as of and
for the three years ended December 31, 2007 is derived from our consolidated
financial statements, which have been audited by Kost Forer Gabbay & Kasierer, a
Member of Ernst & Young Global.
The information presented below is qualified by the more detailed historical
consolidated financial statements set forth elsewhere in this report, and should
be read in conjunction with those consolidated financial statements, the notes
thereto and the discussion under "Operating and Financial Review and Prospects"
included elsewhere in this report.
6
STATEMENT OF OPERATIONS DATA - YEAR ENDED DECEMBER 31ST
(IN THOUSANDS OF U.S. DOLLARS, EXCEPT PER SHARE DATA)
2003 2004 2005 2006 2007
------- ------- ------- ------- -------
Sales
Products 3,685 3,719 3,668 4,738 3,006
Services 248 433 925 2,542 2,748
------- ------- ------- ------- -------
3,933 4,152 4,593 7,280 5,754
------- ------- ------- ------- -------
Cost of sales
Products 1,174 1,587 1,450 2,171 2,027
Services 21 22 315 563 523
------- ------- ------- ------- -------
1,195 1,609 1,765 2,734 2,550
Inventory write off - - 639 - 459
Amortization of intangibles assets 188 206 172 392 385
------- ------- ------- ------- -------
1,383 1,815 2,576 3,126 3,394
------- ------- ------- ------- -------
Gross profit 2,550 2,337 2,017 4,154 2,360
------- ------- ------- ------- -------
Operating expenses:
Research and development, net 3,243 5,474 4,363 4,619 4,567
Selling and marketing 2,314 1,909 2,763 4,147 4,736
General and administrative 919 805 1,748 2,474 1,992
Impairment of goodwill - - 5,437
------- ------- ------- ------- -------
Total operating expenses 6,476 8,188 8,874 11,240 16,732
------- ------- ------- ------- -------
Operating loss (3,926) (5,851) (6,857) (7,086) (14,372)
Other income, net - - 24 42 -
Financial income, net 150 165 184 32 230
------- ------- ------- ------- -------
Loss before income taxes (3,776) (5,686) (6,649) (7,012) (14,142)
Tax benefit (income taxes) - - 19 - (37)
------- ------- ------- ------- -------
Net Loss (3,776) (5,686) (6,630) (7,012) (14,179)
------- ------- ------- ------- -------
Accretion of redeemable convertible
Preferred shares (3,256) (3,256) (348) - -
Induced conversion of convertible
Preferred shares - - (17,406) - -
------- ------- ------- ------- -------
Cumulative dividend on convertible
Preferred shares (2,585)
------- ------- ------- ------- -------
Dividend in respect of reduction in
exercise price of certain warrants - (37) -
------- ------- ------- ------- -------
Net loss attributable to common
shareholders (7,032) (8,942) (26,969) (7,049) (14,179)
======= ======= ======= ======= =======
Basic and diluted net loss per
Ordinary share (19.00) (24.16) (34.05) (1.3) (1.92)
------- ------- ------- ------- -------
Weighted average number of Ordinary
shares used in computing net loss
per share-basic and diluted 370 370 792 5,436 7,376
7
BALANCE SHEET DATA - YEAR ENDED DECEMBER 31
(IN THOUSANDS OF U.S. DOLLARS, EXCEPT SHARE DATA)
2003 2004 2005 2006 2007
---------- ---------- ---------- ---------- ----------
Cash and cash
equivalents and
short term
deposits 13,934 9,260 5,138 8,954 4,496
Working capital 14,400 9,595 925 8,196 657
Total assets 18,572 13,538 22,442 24,587 14,328
Total liabilities 2,640 2,878 9,579 6,049 8,621
Redeemable
convertible 51,301 54,557 - - -
Preferred shares
Capital stock 108 116 132 213 213
Accumulated
deficit (34,017) (42,568) (66,854) (73,903) (88,116)
Total
shareholders'
equity (deficiency) (35,369) (43,897) 12,863 18,538 5,707
Number of Ordinary
shares outstanding 370,059 370,059 4,661,627 7,376,364 7,376,364
3.B. CAPITALIZATION AND INDEBTEDNESS
Not applicable.
3.C. REASONS FOR THE OFFER AND USE OF PROCEEDS
Not applicable.
3.D. RISK FACTORS
Many factors could have an effect on our financial condition, cash flow and
results of operations. We are subject to various risks resulting from changing
economic, political, industry, business and financial conditions. The principal
risk factors affecting our operations are described below.
8
VOCALTEC INCURRED SIGNIFICANT HISTORICAL OPERATING LOSSES AND THERE IS NO
ASSURANCE THAT THE COMPANY WILL NOT CONTINUE TO INCUR OPERATING LOSSES IN THE
FUTURE.
Since its incorporation in 1989, VocalTec (prior to the business combination)
has had limited sales and has incurred significant operating losses. The
combined company had operating losses of $7.1 million and $14.4 million in 2006
and 2007, respectively, and may continue to incur operating losses in the future
due to, among other reasons, the fact that the Company operates in new target
markets and sells to new customers and has not yet obtained substantial
credibility and market share of its VoIP equipment in some of these markets. To
achieve profitability and increased sales levels, the Company must, among other
things, establish and increase market demand and acceptance of its products,
respond effectively to competitive pressures, offer high quality customer
service and support, introduce advanced versions and enhancements of its
products as well as new products that meet market needs on a timely basis, and
constantly increase operational efficiency.
The Company may continue to incur operating losses in 2008 and thereafter, if
revenues are insufficient to cover sales and marketing, research and
development, administrative and other expenses. If revenue levels do not
increase sufficiently, operating results will be adversely affected because any
reduction in expenses may not sufficiently cover a reduction in revenues. There
is no assurance that the Company will achieve or sustain significant sales or
profitability in the future.
WE HAVE EXPERIENCED AND MAY CONTINUE TO EXPERIENCE SIGNIFICANT FLUCTUATIONS IN
OUR QUARTERLY RESULTS, WHICH MIGHT MAKE IT DIFFICULT FOR INVESTORS TO MAKE
RELIABLE PERIOD-TO-PERIOD COMPARISONS AND MAY CONTRIBUTE TO VOLATILITY IN THE
MARKET PRICE OF OUR ORDINARY SHARES.
Our operating results have fluctuated and may continue to fluctuate from period
to period for a number of reasons. Due to the past volatility of the market for
telecommunication equipment, we cannot predict the impact on our revenues or
results of operations that any deterioration in such market may have.
There are several market conditions that could continue to cause our customers
and potential customers to be conservative in their spending:
o Networks that are based on old Time Division Multiplexing, or TDM,
equipment which have been used by telecommunications carriers for
several decades, are still operating and generating revenues.
o Large and mid-size carriers are showing an increased interest in
migrating their TDM-based, Public Switch Telephone Networks, or PSTNs,
to VoIP softswitch-based networks, in order to enable advanced,
IP-based services and save costs, but there is still uncertainty with
respect to the extent and timing of shifting PSTNs to VoIP softswitch
networks.
o As a result of our long sales cycle (described below under "OUR
ESSENTRA PRODUCTS GENERALLY HAVE A LONG SALES CYCLE, WHICH INCREASES
OUR COSTS IN OBTAINING ORDERS, REDUCES THE PREDICTABILITY OF OUR
EARNINGS AND REQUIRES HIGH WORKING CAPITAL"), we may need extended
time to build up an order backlog.
9
o Increased competition, from new service providers, and companies like
Skype who offer cheap, or even free telephony, causing financial
pressure on our customers.
o Macro economic conditions causing our potential customers to be more
conservative with their capital expenditures.
o Evolving new technologies which may cause our customers to delay their
deployment plans and wait for these new technologies to mature.
These and other factors make the forecasting of sales inherently uncertain.
Significant annual and quarterly fluctuations in our results of operations may
also be caused by, among other factors, the timing and composition of orders
from our customers, reduced prices for our products, the economic viability and
credit-worthiness of our customers, the collectability of our receivables, the
timing of new product announcements and releases of new products by us and by
our competitors.
In addition to our significant operating losses, general economic conditions
have adversely affected our share price and trading volumes in recent years.
Factors that could cause the market price of our ordinary shares to further
decrease significantly include the loss of any of our major customers or key
personnel, new product developments or enhancements by our competitors, sales of
our securities by our shareholders, quarterly fluctuations in actual or
anticipated operating results (as described above), continued significant
operating losses, market conditions in the industry, law suits against the
Company, its officers or directors, negative analysts' reports, announcements by
competitors, regulatory actions or other events or factors, including the risk
factors described herein and general economic conditions. In the past, following
decreases or volatility in the market price of a company's securities,
securities class action litigation has often been instituted. Such litigation
could result in substantial costs and a diversion of management's attention and
resources, which would have a material adverse effect on our business, operating
results and financial condition.
Our future results may also be affected by our ability to continue to develop,
introduce and deliver enhanced and new products in a timely manner, to offer new
products at competitive prices, to offer existing products at lower prices, to
compete with competitors that are larger than us and to anticipate and meet
customer demands. There can be no assurance that sales in any particular quarter
will not be lower than those of the preceding quarters, including comparable
quarters.
As a result, we believe that period-to-period comparisons of our results of
operations are not necessarily meaningful and should not be relied upon as
indications of future performance. The volatility in our operating results may
also result in significant volatility in our share price. Furthermore, as
described above, our share price is also subject to the price volatility
experienced by many companies in the telecommunications sector, VoIP industry
and related sectors. It is also possible that our quarterly results of
operations may be below the expectations of public market analysts and
investors. If this happens, the price of our ordinary shares is likely to
decrease.
10
THERE IS NO ASSURANCE THAT WE WILL BE SUCCESSFUL IN OBTAINING AND MAINTAINING A
SUFFICIENT MARKET SHARE FOR OUR PRODUCTS. IN ADDITION, WE HAVE BEEN ENCOUNTERING
VARIOUS CHALLENGES AFFECTING THE SALE OF OUR PRODUCTS.
Since the consummation of the business combination, we have encountered various
challenges inherent to entering into a new business, including learning and
understanding new target markets, positioning our products in an already
competitive market, creating and maintaining relationships with new suppliers,
customers and other third parties and subjecting the products to testing and
training of sales and marketing employees to enable them to successfully promote
the sale of the Essentra products. This requires the allocation of substantial
resources.
In addition, since the consummation of the business combination the Company has
been focusing its development efforts on the Essentra line of products. The
Essentra product solutions were already deployed by several customers and are
carrying live traffic; however, certain elements of the products are still
subject to additional development, testing and modifications and have not yet
been used extensively by customers, which prevents us from demonstrating a
proven track record and wide deployment references, which are crucial for our
growth and expansion to larger carriers. Furthermore, unlike the companies first
generation of products, which were unique and the first of their kind to be
introduced to the telecommunications market, the Essentra products compete with
existing, comparable products of various companies, some of which have certain
advantages over us, including larger financial resources, access to prospective
customers and an established market for their products.
Our products must comply with various international and domestic regulations and
standards defined by regulatory agencies. If we do not comply with existing or
evolving industry standards and other regulatory requirements or if we fail to
obtain in a timely manner any required domestic or foreign regulatory approvals
or certificates, we will not be able to sell our products where these standards
or regulations apply, which may harm our business.
Maintaining and increasing our revenues are dependent, among other things, upon
the ability of our products to meet market and customer requirements. To this
end, we are involved in a continuous process to evaluate changing market demands
and customer requirements, and to develop and introduce new products, features
and applications to meet such changing demands and requirements. In addition,
prospective customers may require product features and capabilities that are not
included in our current product offerings. The introduction of new or enhanced
products also requires that we carefully manage the transition from our older
products as we ensure the continued provision of maintenance and other services
for our older products.
A number of risks are inherent in this process, including the fact that we may
not successfully anticipate market requirements or complete the development or
introduction of these products and that the development of new technologies and
products is increasingly complex and uncertain. This can result in delays in the
introduction of new technologies and products, and requires close collaboration
and continued technological advancement involving multiple software design teams
and outside suppliers of key components. The failure of any one of these
elements could cause new products to fail to meet specifications, market
requirements or customer demands, or to miss delivery schedules. If we fail to
develop products and offer services that satisfy customer requirements, or if we
fail to effectively manage the transition from our older products to our new or
enhanced products, our ability to create or increase demand for our products
would be seriously harmed and we may lose current and prospective customers,
thereby harming our business.
11
Deployment, sale and marketing of products in certain states and countries may
subject us to environmental and other regulations including, in some instances,
the requirement to provide to customers the ability to return products at the
end of their useful life.
Further, our results could be adversely affected by factors such as lack of
market acceptance of our products, delays in product development, and delays in
customer purchases of products in anticipation of the introduction of new
products and the rapidly changing landscape of emerging standards.
In addition, telecommunications carriers increasingly require that VoIP products
be designed to meet local homologation and regulatory requirements, such as
lawful interception and other requirements to demonstrate interoperability with
existing networks of incumbent telecommunications carriers, each of which may
have different specifications. Failure to obtain such homologation
certifications or other industry standard certifications for our products may
result in decreased revenues and significant warranty, support and repair costs,
which may divert the attention of our engineering personnel and may cause
significant customer relations problems.
Due to the fact that we have been developing and offering new products, some of
which are targeted at new customers in new markets, we have encountered and
expect to continue to encounter various challenges. In addition, while seeking
midsize carriers, we offer solutions to alternative small carriers as well,
raising the need for flexibility and competitiveness within a wide range of
solutions. Also, our solutions have to be inter-operable with offerings of
various third parties, which results in a more complex and expensive development
and upgrading of the products. Furthermore, in recent years we have witnessed an
increasing competition in the VoIP market, resulting in declining prices, as
VoIP has become more of a mainstream technology. One of the main challenges in
penetrating the market with the products offered by VocalTec relates to the
ability to provide a broad, and to a certain extent complete, solution, which
includes third party elements.
Therefore, there is no assurance that we will be successful in obtaining and
maintaining a sufficient market share for the existing Essentra products and our
future products.
OUR BUSINESS DEPENDS TO A CERTAIN EXTENT ON THE ABILITY OF OUR CHANNELS AND
BUSINESS PARTNERS WHO PURCHASE OUR PRODUCTS TO ACHIEVE BROAD MARKET ACCEPTANCE
FOR THEIR PRODUCTS. IF THESE CHANNELS AND BUSINESS PARTNERS DO NOT SUCCEED IN
SELLING THEIR PRODUCTS, THIS WILL REDUCE DEMAND FOR OUR PRODUCTS AND OUR
REVENUES WILL BE ADVERSELY AFFECTED.
In many cases our products are sold through channels, i.e., vendors, systems
integrators and business partners, who repackage or resell our products, under
varying types of OEM or reseller arrangements, to communications service
providers (rather than us selling our products directly to these service
providers).
12
To continue this method of sales, we will have to allocate resources to train
vendors, systems integrators and business partners as to the use of our
products, resulting in additional costs and additional time until sales by such
vendors, systems integrators and business partners are made feasible. Our
business depends to a certain extent upon the success of such channels and the
broad market acceptance of their products. To the extent that our channels are
unsuccessful in selling our products, our revenues and operating results will be
adversely affected.
Many factors out of our control could interfere with our ability to market,
license, implement or support our products with any of our channels, which in
turn could harm our business. These factors include, but are not limited to, a
change in the business strategy of our channels, the introduction of competitive
product offerings by other companies that are sold through one or more of our
channels, potential contract defaults by one or more of our channels or changes
in ownership or management of one or more of our channels. Some of our
competitors may have stronger relationships with our channels than we do, and we
have limited control, if any, as to whether those channels implement our
products rather than our competitors' products or whether they devote resources
to market and support our competitors' products rather than our offerings. Also,
the loss of or reduction in sales by these channels could reduce our revenues.
If we fail to maintain relationships with these channels, fail to develop new
channels, fail to effectively manage, train, or provide incentives to existing
channels or if these channels are not successful in their sales efforts, sales
of our products may decrease and our operating results would suffer.
OUR ESSENTRA PRODUCTS GENERALLY HAVE A LONG SALES CYCLE, WHICH INCREASES OUR
COSTS IN OBTAINING ORDERS, REDUCES THE PREDICTABILITY OF OUR EARNINGS AND
REQUIRES SIGNIFICANT WORKING CAPITAL.
Our Essentra products are technologically complex and are typically intended for
use in solutions that may be critical to the business of our customers.
Prospective customers for such products generally must make a significant
commitment of resources to test and evaluate products and to integrate them into
their solutions. As a result, the sales process for such products is long and
often subject to delays associated with lengthy approval processes that
typically accompany the design and testing of our solutions. The sales cycles of
our products to new customers currently average 6 to 12 months from the time we
make a proposal to a customer until the time the customer begins using the
relevant product in production mode. This requires us to invest significant
resources to make sales, which increases our costs in obtaining orders and
reduces the predictability of our sales. In addition, in some cases we need to
finance the equipment that we install in our customers' premises during the
period of installment, testing and approval of the equipment, which requires us
to allocate working capital for the period of such financing. Furthermore, in
many cases the sale of our products is conditioned upon a trial period during
which the products are installed at the customers' premises, which installation
requires an investment by us of capital and manpower, without assurance that the
customers will in fact purchase the products.
Long sales cycles also subject us to risks not usually encountered by companies
whose products have short sales cycles, complicating our planning processes and
reducing the predictability of our earnings. These risks include:
o a pre-sale process that includes traveling, demonstrations, technical
and commercial sessions, and trial procedure intended for defining
customers' needs, all of which involve additional costs;
13
o the potential cancellation of orders based on our customers` changing
budgetary constraints;
o the shift in orders expected between quarters because of the timing of
our customers` procurement decisions; and
o Changes in organizational structure and decision makers within our
customers necessitating that we establish new relationships and
effectively restart the sales process.
BECAUSE MANY OF OUR CURRENT AND PLANNED PRODUCTS ARE HIGHLY COMPLEX, THEY MAY
CONTAIN DEFECTS OR ERRORS THAT ARE DETECTED ONLY AFTER DEPLOYMENT IN COMMERCIAL
APPLICATIONS. MOREOVER, OUR CUSTOMERS MAY BUNDLE OUR PRODUCTS WITH THE PRODUCTS
OF OTHER PROVIDERS THAT CONTAIN DEFECTS THAT ARE WHOLLY UNRELATED TO OUR
PRODUCTS. IN EITHER INSTANCE, IF THIS OCCURS, IT COULD HARM OUR REPUTATION AND
RESULT IN REDUCED REVENUES OR INCREASED EXPENSES.
Our products are highly complex and may contain undetected defects, errors or
failures. These products are deployed in complex and versatile networks, which
include complex equipment of other vendors. Although we invest heavily in
testing our products, we cannot simulate and test all potential events and cases
relating to the operation of our products, and as a result, in some cases our
customers may discover errors after the products have been deployed. The
occurrence of any defects, errors or failures could result in:
o product returns, repairs or replacements;
o cancellation of and reduction in orders;
o uncollectible accounts receivable and delays in collecting accounts
receivable;
o diversion of our resources;
o legal actions by our customers or our customers' end users;
o adverse effect to our reputation;
o increased insurance costs; and
o other losses to us, our customers or the end users of our products.
Any of these occurrences could also result in the loss of or delay in market
acceptance of our products and loss of sales, which would harm our business and
adversely affect our results of operations. There can be no assurance that,
despite testing by us or by our customers, errors will not be found in our
products after commencement of commercial deployment. We have from time to time
experienced defects in our products and expect to experience defects in the
future. We may in the future incur costs associated with warranty claims.
Moreover, as our solutions grow in complexity this risk may intensify over time
and may result in increased expenses.
In addition, our customers may bundle, incorporate or connect our products into
or to complex systems that contain errors or defects that may be unrelated to
our products. Such occurrences may result in undue delays or cancellations of
the implementation of our customers' bundled products and services. In such
cases, our reputation could be harmed and our results of operations could be
adversely affected, which could result in reduced revenues or increased
expenses.
14
IF OUR RELATIONSHIP WITH ANY OF OUR KEY CUSTOMERS IS TERMINATED, OUR REVENUES
WILL DECLINE AND OUR BUSINESS WILL BE ADVERSELY AFFECTED.
During 2007, Mobifon-2000 and Deutsche Telekom accounted for 12% and 22%,
respectively, of our revenues.
If our relationship with these customers is terminated, or if either of these
key customers reduces purchases of our products or maintenance or replaces an
existing equipment in its networks with competing products, then our business,
financial condition and results of operations would be materially adversely
affected. In the past we were adversely affected by the termination of a
relationship with a key customer, as well as reductions in orders from key
customers. The impact of the termination or reduction of our key customer
relationships would be intensified if we were unable to establish and increase
sales to other customers in order to offset this termination or reduction.
WE DEPEND TO A CERTAIN DEGREE ON THIRD PARTIES FOR THE SUPPLY AND QUALITY OF
HARDWARE AND SOFTWARE ELEMENTS REQUIRED FOR THE MARKETING OF OUR PRODUCTS, AND
ANY DELAY OR DISRUPTION IN THE SUPPLY OF THESE PRODUCTS WILL ADVERSELY AFFECT
OUR RESULTS. IN ADDITION, INACCURATE ESTIMATES OF OUR INVENTORY / PURCHASING
REQUIREMENTS COULD ADVERSELY AFFECT OUR RESULTS OF OPERATIONS.
As many times our customers require from us a "complete solution", that
comprises, in addition to our Essentra Software, various third party elements,
we depend on such third-party partners for the successful marketing of our
products, (including IBM, Dialogic, AudioCodes, and various other suppliers for
Operating System software, SIP and SS7 software, as well as additional software
and other elements). If we overestimate our purchasing requirements, we could
have excess inventory, which would increase our costs and result in write-downs
harming our operating results. If we underestimate our requirements, we may not
have an adequate supply, which could result in delays in shipments and revenues.
We currently do not have long-term supply contracts with our third-party
suppliers and they are not required to supply us with products for any specified
periods, in any specified quantities or at any set price, except as may be
specified in a particular purchase order. Because the key components of our
products are complex and often require integration into our solutions, in the
event of a disruption or delay in supply or an inability to obtain products, we
may not be able to develop an alternate source in a timely manner, at favorable
prices, or at all.
Following the sale and installation of our products, we rely on our hardware and
software suppliers (to varying extents) for maintenance and support services
that we provide to our customers. To that end, our agreements with our suppliers
include obligations of our suppliers to provide us with certain levels of
service and maintenance, as well as restrictions on the right of the supplier to
discontinue the product or the support services we purchase from them.
15
In addition, manufacturing problems may occur with these third parties. A
supplier may supply us with products and components that do not meet our
quality, quantity or cost requirement, or may cease to provide support with
respect to the hardware and software purchased by the Company; therefore, we
face the risk of inadequate supply, price increases, late deliveries, poor
quality and failure in the availability and level of support and maintenance, as
any supplier may terminate its relationship with us. If we were to lose our
relationship with any of such suppliers, the lead time required to qualify new
suppliers could be several months. Also, if we lose our relationship with any of
such suppliers or these suppliers are otherwise unable to satisfy our volume and
delivery schedule requirements, it may be difficult to locate alternative
suppliers that are able to develop, manufacture, deliver and provide products,
service and maintenance with respect to the specialized components we need for
our products in the desired lead times and quality.
Furthermore, if we experience quality problems from any of our component
suppliers, it could take us a significant amount of time to identify the problem
as associated with a particular component, ascertain whether this is as a result
of a design or a manufacturing flaw and either correct the problem, if possible,
replace the components or find an alternate source of supply. Any such quality
problem or delay could, in addition to causing us lost sales, detrimentally
affect our reputation in the market and cause us to incur additional costs as a
result of the recall and replacement of affected products.
Finally, our dependence on third party suppliers of hardware significantly
limits our ability to compete successfully with some of our competitors, which
supply themselves the hardware components that are used in their solutions and
therefore have the flexibility of making more competitive offers to potential
customers.
WE MAY BE UNABLE TO ADEQUATELY PROTECT OUR PROPRIETARY RIGHTS, WHICH MAY LIMIT
OUR ABILITY TO COMPETE EFFECTIVELY.
Our success is dependent, to a significant extent, upon our proprietary
technology. We currently rely on a combination of trade secret, patent,
copyright and trademark law, together with non-disclosure, contractual licensing
restrictions, and invention assignment agreements, to establish and protect the
proprietary rights and technology used in our products. There can be no
assurance, however, that such measures will provide commercially significant
protection for our proprietary technology, that competitors will not develop
products with features based upon, or otherwise similar to, our products or that
we will be able to prevent competitors from selling similar products.
Specifically, our ability to adequately protect our proprietary rights in
Ukraine (where a portion of our research and development operations is
outsourced to subcontractors) is unclear due to the political instability in
such country and the fact that the protection of intellectual properties in
eastern European countries has traditionally been difficult to achieve.
In addition, the software market has traditionally experienced widespread
unauthorized reproduction of products in violation of manufacturers'
intellectual property rights. Such activity is difficult to detect and legal
proceedings to enforce the manufacturers' intellectual property rights are often
burdensome and involve a high degree of uncertainty and costs. Unauthorized use
and reproduction of the registration codes contained in our various software
products has occurred from time to time and may continue to occur in the future.
There can be no assurance that our software products will not experience
unauthorized use or reproduction on a massive scale, which may result in an
adverse affect on our business, financial condition and results of operations.
OUR MANAGEMENT HAS IDENTIFIED A MATERIAL WEAKNESS IN OUR INTERNAL CONTROL OVER
FINANCIAL REPORTING. UNTIL WE REMEDY SUCH MATERIAL WEAKNESS, THERE IS A
REASONABLE POSSIBILITY THAT OUR FINANCIAL STATEMENTS MAY BE MATERIALLY MISTATED.
As disclosed in detail in Item 15T of this annual report, our management
performed an assessment of our disclosure controls and procedures and our
internal controls over financial reporting as of the end of the period covered
by this annual report and determined that we had a material weakness with
respect to the financial statement close process.
Until we are able to remedy such material weakness or if we are not successful
in remedying such material weakness, there is a reasonable possibility that our
quarterly or annual financial statements could be materially misstated, which
could require a restatement and cause investors to lose confidence in our
reported financial information. This could lead to a decrease in the price of
our shares. In addition, if we fail to implement the improvements of our system
of internal controls, we may not be able to accurately report our future
financial results and our management may not be able to conclude that we have
effective disclosure controls and procedures and effective internal controls
over financial reporting as required by the Sarbanes-Oxley Act.
16
WE MAY NOT BE ABLE TO ENFORCE AGAINST OUR EMPLOYEES AND SUBCONTRACTORS COVENANTS
NOT TO COMPETE AND THEREFORE MAY BE UNABLE TO PREVENT OUR COMPETITORS FROM
BENEFITING FROM THE EXPERTISE OF SOME OF OUR FORMER EMPLOYEES AND
SUBCONTRACTORS.
We currently have non-competition clauses in the employment agreements of nearly
all of our employees, including all of our key employees. The provisions of such
clauses prohibit our employees, if they cease working for us, from directly
competing with us or working for our competitors. Recently, Israeli courts have
required employers, seeking to enforce non-compete undertakings against former
employees, to demonstrate that the competitive activities of the former
employees will cause harm to one of a limited number of material interests of
the employer recognized by the courts (for example, the confidentiality of
certain commercial information or a company's trade secrets). In the event that
any of our employees chooses to work for one of our competitors, we may be
unable to prevent our competitors from benefiting from the expertise our former
employees obtained from us, if we cannot demonstrate to the court that we would
be harmed.
Additionally, our ability to enforce non-compete covenants against our
sub-contractors in Ukraine, where we conduct a portion of our research and
development operations, is unclear.
LITIGATION AND OTHER DISPUTES REGARDING OUR INTELLECTUAL PROPERTY OR THE
INTELLECTUAL PROPERTY OF OUR SUPPLIERS COULD PROVE COSTLY AND THEREBY ADVERSELY
IMPACT OUR FINANCIAL POSITION AND COULD ALSO RESULT IN AN INJUNCTION OR JUDGMENT
AGAINST US, WHICH COULD ADVERSELY AFFECT OUR BUSINESS.
Third parties have asserted patent infringement and other claims against us from
time to time. A number of these claims were directed at certain basic and
fundamental components of our products. There can be no assurance that third
parties will not assert such claims against us in the future or that such
present and future claims will not be successful. In addition, third parties may
in the future assert patent infringement and other claims against us in
connection with components used in our products that are manufactured by our
suppliers. Patents relating to basic technologies in the communications and
multimedia areas have been recently allowed and patents may be filed in the
future which relate to basic technologies incorporated in our products. Also,
from time to time there have been claims challenging the ownership of open
source software against companies that incorporate open source software into
their products. We use certain open source software in our products and may use
more open source software in the future. As a result, we could be subject to
suits by parties claiming ownership of what we believe to be open source
software. We would incur substantial costs and would experience diversion of
management resources with respect to the defense of any claims relating to
proprietary rights, and this could have a material adverse effect on our
business, financial condition and results of operations. Furthermore, parties
making such claims could secure a judgment awarding substantial damages, as well
as injunctive or other equitable relief which could effectively block our
ability to make, use, sell, distribute or otherwise license our products in the
United States or any other jurisdiction. Such a judgment could have a material
adverse effect on our business, financial condition and results of operations.
Litigation, which is generally costly and time consuming, may be necessary to
determine the scope and validity of others' proprietary rights or to enforce any
patents issued to us, in judicial or administrative proceedings. In the event a
claim relating to proprietary technology or information is asserted against us,
we may seek licenses for such intellectual property. There can be no assurance,
however, that licenses could be obtained on commercially reasonable terms, if at
all, or that the terms of any offered licenses will be acceptable to us. The
failure to obtain the necessary licenses or other rights could preclude the
sale, manufacture or distribution of our products and, therefore, could have a
material adverse effect on our business, financial condition or results of
operations. The cost of responding to any such claim may be material, whether or
not the assertion of such claim is valid.
17
IF THE SALE OF 11 OF OUR PATENTS IS NOT CONSUMMATED, WE MAY REQUIRE SIGNIFICANT
CAPITAL TO PURSUE OUR GROWTH STRATEGY, BUT WE MAY NOT BE ABLE TO OBTAIN
ADDITIONAL FINANCING ON FAVORABLE TERMS OR AT ALL. ANY FINANCING OBTAINED BY US
MAY CAUSE DILUTION TO OUR SHAREHOLDERS OR IMPOSE ON US CERTAIN RESTRICTIVE
COVENANTS
On May 27, 2008, we announced that we entered into an agreement for the sale of
11 of our patents for an aggregate consideration (before the payment of
expenses) of US$12.5 million. Consummation of this transaction is subject to
certain conditions. If this transaction is not consummated, we will need to
obtain additional financing to pursue our business strategy, to develop new
products, to respond to competition and market opportunities and to acquire
complementary businesses or technologies. There is no assurance that we will be
able to obtain such financing on favorable terms or at all. If we raise
additional capital through further sales of our equity securities, our
shareholders would suffer dilution of their equity ownership in the Company. If
we raise additional capital through the issuance of debt, we may not be able to
comply with covenants assumed by us pursuant to such debt issuance, which may
cause an acceleration of the repayment of the debt amount.
ANY FUTURE MERGERS WITH OR ACQUISITIONS OF COMPANIES OR TECHNOLOGIES AND THE
RESULTING INTEGRATION PROCESS MAY DISTRACT THE ATTENTION OF OUR MANAGEMENT AND
DISRUPT OUR BUSINESS.
In recent years, the telecommunications market has experienced consolidation.
One of our business strategies is to pursue strategic partnerships, alliances,
mergers and/or acquisitions of complementary businesses, products and
technologies. Pursuit of such strategies requires significant investments in
management time and attention, and we have limited experience in the
consummation of strategic partnerships, alliances, mergers and acquisitions and
in the post-transaction integration.
Mergers with or acquisitions of companies involve a number of risks including
the difficulty of assimilating the operations and personnel of the merged or
acquired companies and of maintaining uniform standards, controls and policies.
There can be no assurance that technology or rights acquired by us will be
incorporated successfully into products we introduce or market, that such
products will achieve market acceptance or that we will not encounter other
problems in connection with such acquisitions.
Such acquisitions may expose us to additional risks, including the following:
- we may find that the acquired company, asset or technology does not
further our business strategy, that we overpaid for the company, asset
or technology or that the economic conditions underlying our
acquisition decision have changed;
- we may have difficulty retaining the key personnel of the acquired
company;
18
- our ongoing business and management's attention may be disrupted or
diverted by transition or integration issues and the complexity of
managing geographically or culturally diverse enterprises; and
- we may experience significant problems or liabilities associated with
product quality, technology and legal contingencies relating to the
acquired business or technology, such as intellectual property or
employment matters.
In addition, if we proceed with one or more significant acquisitions or
investments in which the consideration includes cash, we are likely to be
required to use a substantial portion of our available cash. To the extent we
issue securities as consideration in such acquisitions, existing shareholders
might be diluted and earnings per share might decrease. In addition,
acquisitions and investments may result in the incurrence of debt, large
one-time write-offs, such as acquired in-process research and development costs,
and restructuring charges.
WE MAY BE ADVERSELY AFFECTED IF THE EXCHANGE RATE FLUCTUATIONS DECREASE OUR
EARNINGS AND IF WE ARE NOT ABLE TO HEDGE OUR CURRENCY EXCHANGE RISKS
EFFECTIVELY.
A significant portion of our sales are made outside of Israel in Unites States
Dollars (USD) and we incur a significant portion of our expenses in New Israeli
Shekels (NIS). The cost of our operations in Israel, as expressed in USD, is
influenced by the extent to which any increase in the rate of inflation is not
offset by the devaluation of the NIS in relation to the USD. Inflation in Israel
may have the effect of increasing the USD cost of our operations in Israel. If
the USD declines in value in relation to the NIS, it will become more expensive
for us to fund our operations in Israel. During 2005 the exchange rate of the
U.S. dollar to the NIS increased; this trend reversed in 2006, and continued to
further decrease in 2007 and subsequently in 2008.
WE ARE SUBJECT TO STRONG COMPETITION. ACCEPTANCE OF OUR COMPETITORS' PRODUCTS
AND TECHNOLOGIES COULD RESULT IN REDUCED REVENUES OR GROSS MARGINS.
The competition in the VoIP equipment for the communications market is very
strong. Our competitors include several VoIP equipment vendors. Many of our
competitors are larger than we are, and can offer more comprehensive solutions
either on their own or by partnering with others. In addition, many of our
competitors have greater name recognition, larger installed customer bases,
broader product offerings, and significantly greater financial, technical and
marketing resources than we do. Finally, some of these competitors are not
dependent, as we are, on third parties for the supply and quality of components
required for the operation of their products. Such competition may result in a
reduction in prices. Even if we reduce the prices of our products, there can be
no assurance that we will be able to compete successfully and effectively for
deals against our competitors' product offerings. Furthermore, if we reduce our
prices below current levels due to competition, our operating losses may
increase.
In the future, additional competitors may include companies that currently
provide computer software products and services, such as telephone, media and
cable television. The ability of some of our competitors to bundle other
enhanced services and other products with VoIP products could give these
competitors an advantage over us.
19
WE ARE DEPENDENT UPON THE CONTINUED EMPLOYMENT OF KEY PERSONNEL.
Our future success depends to a significant extent upon the continued active
participation of our directors, senior executive officers, management members
and other key employees. The loss of the services of any such person could have
a material adverse effect on our business. These persons are not bound by
employment agreements for any specific term. The loss of the services of any of
these persons may adversely affect the development and sales of our products,
and the management of our company. Our success is also dependent upon our
continuing ability to attract and retain highly qualified personnel and key
engineers and sales and marketing personnel, to perform research and
development, commercialize products, and perform the sales and marketing
functions required to bring these products to the market. There can be no
assurance that we will continue to attract and retain such personnel. Even if we
are successful in hiring additional qualified sales and engineering personnel,
we will incur additional costs and our operating results, including our gross
margin, may be adversely affected.
OUR INTERNATIONAL OPERATIONS EXPOSE US TO THE RISKS INHERENT IN CONDUCTING
BUSINESS IN INTERNATIONAL MARKETS.
The majority of our sales is in international markets. In addition, a small, but
growing portion of our research and development operations is outsourced to
subcontractors in Ukraine. There are certain risks inherent in conducting
business in international markets, including unexpected changes in regulatory
requirements, export restrictions, homologation certifications, tariffs and
other trade barriers, difficulties in staffing and managing foreign operations,
longer payment cycles, credit-worthiness of potential customers, and political
instability, all of which can adversely impact the success of our international
operations. There can be no assurance that one or more of such factors will not
have a material adverse effect on our international operations and,
consequently, on our business, financial condition and results of operations.
OUR PRINCIPAL SHAREHOLDERS, INCLUDING OUR EXECUTIVE OFFICERS AND DIRECTORS, ARE
ABLE TO INFLUENCE MATTERS REQUIRING SHAREHOLDER APPROVAL.
As of July 10, 2008 our principal shareholders (i.e., holders of more than 10%
of our issued and outstanding share capital), together with our directors and
executive officers, beneficially owned approximately 54.7% of our outstanding
ordinary shares (including options that are exercisable on such date or within
60 days thereafter). As a result, such shareholders together have the ability to
significantly influence the election of our directors and most corporate
actions, including the ability to vote against merger and acquisitions, which
other shareholders of the Company may believe to be beneficial to the
shareholders.
CERTAIN PROVISIONS OF OUR ARTICLES OF ASSOCIATION AND ISRAELI LAW COULD DELAY,
HINDER OR PREVENT A CHANGE IN OUR CONTROL.
Our articles of association contain provisions, which could make it more
difficult for a third party to acquire control of us, even if that change would
be beneficial to our shareholders. Specifically, our articles of association
provide that our board of directors is divided into three classes, each serving
a three-year term. In addition, certain provisions of the Israeli Companies Law
of 1999, or the Companies Law, could also delay or otherwise make more difficult
a change in our control. The provisions of the Companies Law relating to mergers
and acquisitions are discussed in greater detail in "ITEM 10 - Additional
Information".
20
IT MAY BE DIFFICULT TO PURSUE AN ACTION IN THE U.S. OR TO ENFORCE A U.S.
JUDGMENT, INCLUDING ACTIONS OR JUDGMENTS BASED UPON THE CIVIL LIABILITY
PROVISIONS OF THE U.S. FEDERAL SECURITIES LAWS, AGAINST US AND OUR EXECUTIVE
OFFICERS AND DIRECTORS, OR TO ASSERT U.S. SECURITIES LAWS CLAIMS IN ISRAEL.
Most of our directors and officers are not residents of the United States and
most of their assets and our assets are located outside the United States.
Without consent to service of process, additional procedures may be necessary to
serve individuals who are not U.S. residents. Therefore, it may be difficult to
serve process on those directors, officers who are not U.S. residents, in order
to commence any lawsuit against them before a U.S. court, including an action
based on the civil liability provisions of U.S. federal securities laws.
An investor also may find it difficult to enforce a U.S. court judgment in an
Israeli court, including a judgment based on federal securities laws. In
accordance with the Israeli Law on Enforcement of Foreign Judgments, 5718-1958,
and subject to certain time limitations, an Israeli court may declare a foreign
civil judgment enforceable only if it finds that:
o the judgment was rendered by a court which was, according to the laws
of the state of the court, competent to render the judgment;
o the judgment may no longer be appealed;
o the obligation imposed by the judgment is enforceable according to the
rules relating to the enforceability of judgments in Israel and the
substance of the judgment is not contrary to public policy; and
o the judgment is executory in the state in which it was given.
Even if these conditions are satisfied, an Israeli court will not enforce a
foreign judgment if it was given in a state whose laws do not provide for the
enforcement of judgments of Israeli courts (subject to exceptional cases) or if
its enforcement is likely to prejudice the sovereignty or security of the State
of Israel. An Israeli court will also not declare a foreign judgment enforceable
if:
o the judgment was obtained by fraud;
o there is a finding of lack of due process;
o the judgment was rendered by a court not competent to render it
according to the laws of private international law in Israel;
o the judgment is in conflict with another judgment that was given in
the same matter between the same parties and that is still valid; or
o at the time the action was instituted in the foreign court, a suit in
the same matter and between the same parties was pending before a
court or tribunal in Israel.
An investor may also find it difficult to bring an original action in an Israeli
court to enforce liabilities based upon the U.S. federal securities laws against
us, or against our directors and officers. Israeli courts may refuse to hear a
claim based on a violation of U.S. securities laws and rule that Israel is not
the most appropriate forum in which to bring such a claim. In addition, even if
an Israeli court agrees to hear such a claim, it may determine that Israeli law
and not U.S. law is applicable to the claim. If U.S. law is found to be
applicable, the content of applicable U.S. law must be proved as a fact, which
can be a time-consuming and costly process.
21
OUR UNITED STATES INVESTORS COULD SUFFER ADVERSE TAX CONSEQUENCES IF WE ARE
CHARACTERIZED AS A PASSIVE FOREIGN INVESTMENT COMPANY.
As more fully described in "ITEM 10 - Additional Information - Taxation and
Government Programs", we could be characterized, for United States federal
income tax purposes, as a passive foreign investment company ("PFIC"). Such
characterization could result in adverse United States tax consequences to U.S.
Holders (as defined in "ITEM 10 - Additional Information - Taxation and
Government Programs"). Our status as a PFIC could cause, among other things, any
gain recognized on the sale or disposition of our ordinary shares to be treated
as ordinary income for U.S. Holders and to potential adverse tax treatment of
certain distributions. Although we do not believe that we should have been
characterized as a PFIC for any tax year through and including 2007, there can
be no assurance that the United States Internal Revenue Service will agree with
this conclusion. Furthermore, there can be no assurance that we will not be a
PFIC in the future. We are not yet able to determine whether we will be a PFIC
in 2008 and we can give no assurance that we will not be a PFIC in 2008. Because
the determination of whether our ordinary shares constitute shares of a PFIC is
determined annually based upon the composition of the Company's income and
assets, including the income and assets of certain entities in which we hold at
least a 25% interest, we cannot determine whether we will become a PFIC in the
future and it is possible that we may be a PFIC in 2008 or may will become a
PFIC in the future. While we will attempt to manage our business so as to avoid
PFIC status, to the extent consistent with its other business goals, we cannot
predict whether our business plans will allow us to avoid PFIC status or whether
our business plans will change in a manner that affects our PFIC determination.
In addition, because the market price of our ordinary shares may affect the
determination of whether we will be considered a PFIC, fluctuations in market
price may themselves impact our PFIC status. U.S. Holders should consult their
own advisers concerning the U.S. federal income tax consequences that would
apply if the Company is a PFIC and certain U.S. federal income tax elections
that may help to minimize adverse U.S. federal income tax consequences. For a
further discussion of the consequences of our possible PFIC status, please refer
to "ITEM 10 - Additional Information - Taxation and Government Programs"
CERTAIN BENEFITS AVAILABLE TO US FROM ISRAELI GOVERNMENT PROGRAMS MAY BE
DISCONTINUED OR REDUCED AT ANY TIME, WHICH WOULD LIKELY INCREASE OUR NET
RESEARCH AND DEVELOPMENT EXPENSES.
We benefit from participation by the Office of the Chief Scientist of the State
of Israel (the "Chief Scientist" or "OCS") in certain of our research and
development projects. To be eligible for these participations, we must continue
to meet certain conditions. There can be no assurance that such participations
will be continued at their current levels or otherwise. The termination or
reduction of the participation of the Chief Scientist in research and
development projects is likely to increase our net research and development
expenses or limit or terminate certain research and development projects. In
addition, our royalty payment obligation towards the OCS will continue even if
we receive no additional, or reduced, grants from the Chief Scientist.
THE GRANTS WE HAVE RECEIVED FROM THE ISRAELI GOVERNMENT FOR CERTAIN RESEARCH AND
DEVELOPMENT EXPENDITURES RESTRICT OUR ABILITY TO MANUFACTURE PRODUCTS AND
TRANSFER TECHNOLOGIES OUTSIDE OF ISRAEL AND REQUIRE US TO SATISFY SPECIFIED
CONDITIONS. IF WE FAIL TO SATISFY THESE CONDITIONS, WE MAY BE REQUIRED TO REFUND
GRANTS PREVIOUSLY RECEIVED TOGETHER WITH INTEREST AND PENALTIES.
Our research and development efforts have been financed, in part, through grants
that we have received from the Chief Scientist. We, therefore, must comply with
the requirements of the Israeli Law for the Encouragement of Industrial Research
and Development, 1984 and related regulations, or the Research Law.
Under the Research Law, the discretionary approval of an OCS committee is
required for any transfer of technology or manufacturing of products developed
with OCS funding. OCS approval is not required for the export of any products
resulting from the research or development. There is no assurance that we would
receive the required approvals for any proposed transfer. Such approvals, if
granted, may be subject to the following additional restrictions:
22
o we could be required to pay the OCS a portion of the consideration we
receive upon any transfer of such technology to an entity that is not
Israeli. Among the factors that may be taken into account by the OCS
in calculating the payment amount are the scope of the support
received, the royalties that were paid by us, the amount of time that
elapsed between the date on which the know-how was transferred and the
date on which the grants were received, as well as the sale price; and
o the transfer of manufacturing rights could be conditioned upon an
increase in the royalty rate and payment of increased aggregate
royalties and payment of interest on the grant amount.
These restrictions may impair our ability to sell our company, technology assets
or to outsource manufacturing outside of Israel. The restrictions will continue
to apply even after we have repaid the full amount of royalties payable for the
grants.
POLITICAL, ECONOMIC AND MILITARY CONDITIONS IN DOMESTIC OR FOREIGN LOCATIONS,
INCLUDING ISRAEL, COULD NEGATIVELY IMPACT OUR BUSINESS.
Most of our operations are conducted in the State of Israel. Although virtually
all of our sales currently are made to customers outside Israel, we are
nonetheless directly influenced by the political, economic, military and other
conditions in and around Israel and in other countries in which our business is
located or in which our products are sold. In addition, any major hostilities
involving Israel or the interruption or curtailment of trade between Israel and
its present trading partners could have a material adverse effect on our
business, financial conditions or results of operations.
Accordingly, political, economic and military conditions in Israel may directly
affect our business. Since the establishment of the State of Israel in 1948, a
number of armed conflicts have occurred between Israel and its Arab neighbors.
During the summer of 2006, Israel was engaged in an armed conflict with
Hezbollah, a Lebanese Islamist Shiite militia group and political party. This
conflict involved missile strikes against civilian targets in northern Israel,
and negatively affected business conditions in Israel. Although Israel has
entered into various agreements with Egypt, Jordan and the Palestinian
Authority, there has been an increase in unrest and terrorist activity, which
began in September 2000 and has continued with varying levels of severity into
2008. The election in 2006 of representatives of the Hamas movement to a
majority of seats in the Palestinian Legislative Council and the tension between
the different Palestinian fractions may create additional unrest and
uncertainty. Furthermore, several countries, principally in the Middle East,
still restrict doing business with Israel and Israeli companies, and additional
countries may impose restrictions on doing business with Israel and Israeli
companies if hostilities in Israel increase. Any hostilities involving Israel or
the interruption or curtailment of trade between Israel and its present trading
partners, or a significant downturn in the economic or financial condition of
Israel, could adversely affect our operations and product development, cause our
revenues to decrease and adversely affect the share price of publicly traded
companies having operations in Israel, such as us.
23
SOME OF OUR MANAGEMENT AND EMPLOYEES ARE OBLIGATED TO PERFORM MILITARY RESERVE
DUTY.
Generally, all non-exempt male adult citizens and permanent residents of Israel
under the age of 40 (or older, for citizens with certain occupations), and many
of our Israeli male employees are obligated to perform annual military reserve
duty, usually up to a period of one month. Additionally, all such persons are
subject to being called to active duty at any time under emergency
circumstances. In the event of severe unrest or other conflict, individuals
could be required to serve in the military for extended periods of time. In
response to increases in terrorist activity, including armed conflicts, there
have been periods of significant call-ups of military reservists. Although we
have operated effectively under these circumstances since we began operations,
no assessment can be made as to the full impact of these requirements on our
workforce or business if conditions should change, and we cannot predict the
effect on us of any expansion of these obligations.
WE MAY NOT BE DEEMED IN COMPLIANCE WITH NASDAQ LISTING REQUIREMENTS IN ORDER TO
MAINTAIN THE LISTING OF OUR SHARES ON NASDAQ CAPITAL MARKET
On February 5, 2008, the Nasdaq Capital Market sent us a Staff Deficiency
Letter, indicating that we have failed to comply with the minimum bid price
requirement for continued listing set forth in Nasdaq's Marketplace Rule
4320(e)(2)(E)(ii). The letter provided that we have until August 4, 2008 to
regain compliance, i.e., that the bid price of our shares will close at $1.00
per share or more for a minimum of 10 consecutive business days during the
period ending on August 4, 2008. If we are not in compliance with such rule by
August 4, 2008, then we may be afforded a second 180 calendar day grace period
provided that we satisfy the Nasdaq Capital Market's Initial listing criteria
(except for the bid price requirement), as set forth in Marketplace Rule
4320(e)(2)(E)(ii). We cannot assure you that we will timely, or at all, comply
with the Nasdaq listing requirements. If we fail to be in compliance with the
Nasdaq listing requirements, our shares will be de-listed from the Nasdaq
Capital Market, resulting in the loss of liquidity to our shareholders and
potentially an adverse effect to the price of our shares.
ITEM 4. INFORMATION ON THE COMPANY
4.A. HISTORY AND DEVELOPMENT OF THE COMPANY.
Our corporate name is VocalTec Communications Ltd. for both legal and commercial
purposes. VocalTec was organized under the laws of the State of Israel in 1989
and is subject to the Companies Law. In November 2005, we consummated the
business combination with Tdsoft and the shareholders of Tdsoft, pursuant to
which the Company acquired all of the issued and outstanding share capital of
Tdsoft and as consideration issued to the Tdsoft shareholders ordinary shares
that constituted, immediately following such issuance, 75% of the issued and
outstanding share capital of the Company. Following consummation of the
transaction, Tdsoft became a wholly owned subsidiary of the Company. Tdsoft was
organized under the laws of the State of Israel in April 1994. Our principal
executive offices are located at 60 Medinat HaYehudim Street, Herzliya Pituach,
46140, Israel, and the telephone number at that location is +972-9-970-3888. Our
website is http://www.vocaltec.com.
We are a provider of carrier-class voice-over-IP solutions for communication
service providers. We provide trunking, peering and and residential/enterprise
VoIP application solutions that enable flexible deployment of next-generation
networks (NGNs). We develop, market and support advanced telecom solutions that
enable the deployment and smooth migration of telephony networks from legacy
networks to next generation, packet based networks and the implementation of
Greenfield next generation telecom networks. Designed for carriers, our
standards based solutions handle call control, media relaysignaling and security
within state-of-the-art NGN networks. Our SIP-based solutions support a variety
of other protocols, including Megaco/H.248, MGCP, H.323, SIGTRAN and SS7 and
incorporate key elements of the IMS/TISPAN (IP Multimedia Subsystem)
architecture.
24
Our Essentra product line was designed to replace legacy products and simplify
the deployment of NGN networks and the migration of networks to new, SIP-based
networks. During 2005 and 2006, there were initial deployments and field trials
of the Essentra products, including Essentra CX, EX and BAX, to new and existing
customers. Tdsoft's sales of products in 2005 included the TdGATE, TdMAX and
legacy products that are a range of broadband and narrowband access gateways.
The TdGATE, first deployed in 2000 to support Voice over ATM, later evolved to
support voice over IP, supporting Megaco/H.248, MGCP, NCS, V5.2 and GR303
protocols. These products were discontinued in 2007 as described further below.
Following completion of the business combination with Tdsoft in November 2005,
the combined company focused on completing the integration of the companies'
operations, including product development, marketing, sales, customer support,
finance and administration. After careful analysis of the companies' core
strengths, management decided to focus on providing VoIP solutions for carriers,
by leveraging the VocalTec brand and the combined capabilities of both VocalTec
and Tdsoft under the Essentra brand and product line. In addition, management
identified carriers in several geographic areas, including Russia, the
Commonwealth of Independent States ("CIS"), Eastern Europe, South East Asia,
Latin America and Africa as the Company's targeted growth markets. As part of
the post business combination integration process, management allocated
substantial resources to complete the integration, enhance our brand and market
recognition, further develop our Essentra products, increase our market share in
the target segments and improve our operational efficiencies. In addition,
substantial resources were allocated to the development of an integrated
product, an Intelligent Border Gateway, which leverages the capabilities and
strengths of both VocalTec and Tdsoft, and the functionality of several Essentra
elements into one integrated platform.
During 2006, the Company completed two financing rounds, raising an aggregate
net amount of $11.6 million.
Towards the end of 2007 we discontinued the development of a hardware-based
media platform, which we had intended to complement our solution. The underlying
reason was our decision to focus our development on software solutions and rely
on off-the-shelf third-party media platforms as needed. This decision further
decreased our dependency on suppliers of hardware components and served to
improve our cost structure.
On May 28, 2008, the Company entered into a Patent purchase Agreement, pursuant
to which the Company agreed to sell 11 patents and certain patent-related
rights, out of the Company's portfolio of 22 patents, for an aggregate
consideration of $12.5 million. The patents to be sold consist of nine US
patents, one Israeli patent and one Australian patent. On July 13, 2008, the OCS
approved the consummation of the foregoing sale, subject to the payment to the
OCS of approximately $2.08 million. The Company expects to consummate the
foregoing sale shortly following the filing of this annual report. Upon
consummation of the transaction, VocalTec will be granted a geographically
unlimited, non-exclusive license to use the sold patents and other
patent-related rights in connection with the development and marketing of its
products.
25
In 2007, the Company's sales decreased by approximately 21%, with gross margins,
excluding amortization of intangible assets and inventory write off, decreasing
to 56%, while keeping a stable level of operating expenses along the year. The
decrease in revenues is due to the fact that the Company has determined that no
VSOE (Vendor Specific Objective Evidence) of the fair market value existed for
various elements of the Company's bundled software solutions and associated
post-contract support services during the fiscal year ended December 31, 2007.
As a result, revenues for the year ended December 31, 2007 decreased by
approximately $2.7 million. The change is expected to impact only the timing of
recognition of revenue by the Company (deferral of revenues from 2007 to 2008),
and not the validity of the underlying transactions or cash flows.
CAPITAL EXPENDITURES: The Company's capital expenditures for fiscal year 2007
were $178,000 compared to $335,000 in 2006. Tdsoft's capital expenditures for
fiscal year 2005 amounted to $308,000. VocalTec's capital expenditures for
fiscal year 2005 amounted to $138,000. These expenditures were primarily for
hardware and software.
CAPITAL EXPENDITURES CURRENTLY IN PROGRESS: During the first quarter of 2008,
the Company had capital expenditures in an aggregate amount of approximately
$134,000, primarily for hardware and software. The capital expenditures
currently in progress are being financed by the Company through the use of
internal sources. Currently, the Company has no capital divestitures in
progress.
4.B. BUSINESS OVERVIEW
Over a decade after first being introduced by VocalTec, Voice over IP (VoIP)
technology has become part of the telecom mainstream. The demand for legacy, TDM
based equipment is declining and all aspects of telephony, including networking,
transport, control and services, are being gradually migrated to IP and to Voice
over IP (VoIP). While most incumbent carriers are planning their migration
strategy from the existing circuit switched network (which is the technology
used during the last three decades), to VoIP next generation networks, new
(Greenfield) carriers, without legacy networks and migration considerations, are
deploying new networks based solely on VoIP.
As the "first name in VoIP", we gained our experience in deploying carrier-based
VoIP solutions based on H.323 and SIP protocols; this for the past 11 years. For
additional information, see "4.A - History and Development of the Company."
Following consummation of the business combination with Tdsoft in November 2005,
we continue to develop and sell products and provide support and maintenance
services to carriers and service providers that are migrating their network to
NGNs, or building new VoIP networks. Our solutions provide carriers with call
control, interfaces to legacy telephone systems, and interconnect solutions
(peering) with other VoIP NGNs and residential/enterprise telephony services.
Our solutions enable carriers and service providers to reduce both capital and
operating expenses and provide a platform for them to increase their revenues
through the delivery of IP-based residential and enterprise voice and data
services, such as long distance and peering services, Voice over Broadband,
Voice over WYMAX and hosted Enterprise (IP Centrex) solutions , thereby helping
them to retain and expand their customer base.
26
REQUIREMENTS FOR THE NEW VOICE INFRASTRUCTURE SOLUTIONS
For voice traffic to run over packet networks, voice infrastructure solutions
must satisfy a number of requirements that differ among carriers, including:
o Carrier class equipment that complies with telecommunications carriers'
quality standards.
o Assured voice quality at a similar level to traditional TDM based voice.
o Scalable solutions that support incremental growth from entry level
deployments to massive global networks.
o Interoperability with PSTNs, supporting the full range of traditional
telephone signaling variants.
o Mediation and peering capabilities between the various networks, to allow
for seamless delivery of voice/multimedia services.
o Simple and rapid installation, deployment and support.
THE VOCALTEC SOLUTION
We develop, market and sell a variety of carrier-grade VoIP solutions for
telecommunications service providers.
We believe that our particular advantages are:
o A wide product offering and solutions that enable fast deployment of VoIP
networks;
o Mediation between the core VoIP network and various other networks,
supporting a variety of connections including:
o Peering with other VoIP networks;
o Connecting to Legacy Public Switched Telephony Networks (PSTNs); and
o Connecting with a variety of Access equipment;
o Strong telecom signaling and signaling conversion technology and know-how;
o Significant SIP, H248, MGCP, SS7 and H.323 experience, resulting from
deployments in a large number of carrier networks worldwide;
o Flexible deployment options enabling cost-effective entry points as well as
the ability to efficiently grow the network;
o Multi-tiered service provisioning and management for hosted services,
enabling carriers to offer services to non-facility based carriers;
o Simple installation processes and ease of use and operation;
o More than twelve years of experience in developing and deploying VoIP
products and networks.
27
THE ESSENTRA PRODUCT SUITE
Designed for easy integration in multi-vendor environments, VocalTec's
best-of-breed solutions handle call control, media relay, signaling and security
within state-of-the-art next generation networks. VocalTec's SIP-based solutions
support a variety of protocols, including SIP, Megaco/H.248, MGCP, H.323,
SIGTRAN and SS7 and incorporate key elements of the IMS/TISPAN (IP Multimedia
Subsystem) architecture.
The Essentra product suite is a modular set of open and highly focused VoIP
products for next generation network operators. Essentra products can be
deployed individually or in any combination of groupings in order to provide
tailored and cost-effective solutions for each carrier's specific service
application needs. It enables carriers to seamlessly integrate state-of-the-art
network components from VocalTec and third party vendors to create best-of-breed
network solutions, and allows service providers to offer VoIP interconnection
services, as well as services to residential and SOHO/SME customers over any
broadband access infrastructure.
Essentra is a scalable, carrier-grade SIP-based solution for carriers looking to
deploy a reliable next generation network (NGN) solution. Leveraging our
extensive global experience in implementing large packet tandem networks,
Essentra offers high quality voice services, carrier grade reliability and
maximum service flexibility. Essentra enables quick and simple deployment of
VoIP networks as well as the smooth migration of legacy networks to NGN, while
maintaining seamless connectivity to PSTN/SS7 and VoIP networks.
VOCALTEC PRODUCT OFFERINGS
The Essentra product family includes three major elements required when
implementing a VoIP network: (i) trunking; (ii) peering, and (iii) applications.
ESSENTRA CX MEDIA GATEWAY CONTROLLER: Essentra CX enables providers of National
and International Long Distance services as well as VoIP wholesale providers to
build and/or migrate their infrastructure to packet-based VoIP networks, with
seamless connectivity to PSTN/SS7 services. This is a scalable, carrier-grade
SIP-based media gateway controller.
ESSENTRA EX PEERING MANAGER: Essentra EX facilitates peering between SIP and/or
H.323 networks. It addresses carriers' requirements in the areas of protocol
interworking, security and intelligent voice routing.
ESSENTRA BAX APPLICATION SERVER: Essentra BAX enables the delivery of
residential and hosted enterprise VoIP services over a wide variety of broadband
access infrastructures. With a cost effective entry point and the capability of
scaling up to large numbers of subscribers over time, it allows service
providers to take advantage of evolving IP opportunities.
Using Essentra products, a variety of NGN network solutions may be offered, to
OEMs, resellers, existing carriers and emerging operators.
28
The following are some examples of such solutions:
VOICE OVER BROADBAND / CLASS 5 REPLACEMENT
Essentra(R) BAX application server can be quickly and easily deployed and
integrated in the service provider's network. End users connect to the service
through SIP-based Integrated Access Devices (IAD), SIP Phones, soft-phones,
SIP-enabled PDAs as well as Megaco endpoints such as Multi Service Access Nodes
providing legacy subscriber services. The VoIP telephone service includes
traditional subscriber calling features (e.g., call waiting, call forward), new
IP-enabled features (e.g., conferencing, "do not disturb") as well as web-based
self-provisioning tools. Essentra BAX functions as a comprehensive Class 5
softswitch for both residential and enterprise users.
SOHO, SME AND CORPORATE HOSTED SERVICES
Essentra BAX application server supports a powerful IP Centrex service, which
allows the service provider to offer its enterprise customers a wide array of
enterprise telephony features from a single central location. In this manner,
multiple enterprise customers, whether small or large and whether local or
global in nature with distributed locations, can enjoy the benefits of VoIP
telephony. One numbering plan across the entire corporation and short dialing
within all corporate offices create the look and feel of one single office PBX.
The rich feature set and supported executive desk telephone stations offer a
solution that can compete with advanced PBX services.
VOIP BASED WHOLESALE CARRIERS AND INTERNATIONAL LONG DISTANCE CARRIERS
The Essentra suite may be used to build/migrate a wholesale carrier network to
an NGN based solution. Using the Essentra EX Peering Manager and the Essentra CX
Media Gateway Controller, plus additional optional Essentra elements, a carrier
grade VoIP network may be built providing the needs of such carriers. Essentra
EX allows for un-matched connectivity to other peer IP networks, providing the
required protocol mediation, security and routing schemes to allow for the
appropriate network termination at any given time. Essentra CX enables such
carriers to carry traffic to the PSTN using the SS7 PSTN protocol, which is
commonly used for Network to Network connectivity.
NATIONAL LONG DISTANCE
Building a National Class 4 packet-based network entails the replacement of
existing tandem switches. Replacing the core TDM network results in traffic and
bandwidth optimization as well as reduced OpEx.
With Essentra, service providers can easily build their next-generation network
or migrate their existing tandem network to a packet-based infrastructure.
Essentra CX is the core of VocalTec's solution for national Class 4 networks.
Essentra CX is a feature-rich Media Gateway Controller offering seamless
connectivity to PSTN services.
29
Essentra CX can be deployed in various configuration suited for both centralized
and distributed networks. Offered in conjunction with a wide range of Media
Gateway density options, the solution allows service providers to optimize their
deployment and their upfront CapEx investment.
The solution's flexibility and proven interoperability makes it ideal for
service providers building a packet-based core network
Other Essentra elements, such as the Essentra EX, enable Peering and session
control towards peer VoIP network.
VOICE OVER WYMAX
As the adoption of VoIP technology and services continues to grow we now see a
large number of service providers looking to deliver VoIP services over wireless
infrastructures, WYMAX primary among them. WYMAX technology is quickly gaining
ground with service providers looking to take advantage of evolving IP
opportunities.
The ability to efficiently provide widespread broadband internet together with
quality VoIP services is paramount to the successful implementation of these
network solutions.
VocalTec, a pioneer in VoIP technologies, brings to market a robust and
comprehensive Voice over WYMAX offering designed to assist this new generation
of service providers meet their business objectives.
A clear advantage of the VocalTec solution is that it offers the service
provider a complete end-to-end VoIP solution containing all elements required
for the successful implementation of a Voice over WYMAX service. VocalTec's
packaged solution enables WYMAX providers to deploy a voice solution in record
time while benefiting from a cost-effective offering conducive to significant
cost savings and quick ROI.
The solution includes all main components of the Essentra solution suite. The
Essentra BAX being the Class 5 feature server and the Essentra CX and Essentra
EX, each enabling connectivity to other networks; the PSTN and other VoIP
networks respectively.
Specifically designed with WYMAX deployments in mind, the solution is both
compact and cost-effective allowing service providers to launch a service while
controlling their capital expenditures. The solution is easily scalable in
accordance with the service provider's business objectives and capabilities
LEGACY PRODUCTS
In the past, VocalTec and Tdsoft developed and marketed products that used TDM,
ATM and H.323 technologies. These products were sold in the past to a number of
carriers, who are still requiring support and maintenance services for these
products.
30
The Company's primary legacy products include:
o ATM Gateways, including two platforms: the TdGATE(tm) 3X00 and the
HUNT 8110. The TdGATE 3X00 is a Voice over Broadband Gateway that
allows service providers to provide ISDN and telephony services over
Broadband access infrastructure based on ATM AAL2 standards. The HUNT
8110 is a Broadband Access Concentrator that can aggregate several
types of traffic coming from the Enterprise network, including TDM and
IP, towards the ATM network.
o H323 Products, including VoIP Gateways, Gatekeapers and network
management solutions. VoIP Gateways include the VocalTec GW2000 and
GW480 carrier grade Gateways, providing TDM to VoIP interconnection.
The VocalTec VA Gatekeeper used to manage a network of Gateways and
enable routing management of such networks and the VNM network
management software, used to manage the network and provide element
management and OSS functions to such networks.
THIRD PARTY ELEMENTS INCLUDED IN OUR SOLUTIONS
In many cases our customers are expecting us to provide a wide solution that is
comprised of third party Software and Hardware elements. We are dependent on the
following suppliers of hardware and software elements that are integrated into
or complement our solutions: AudioCodes Ltd. for the supply of media gateways;
Dialogic for the supply of SS7 signaling software and boards, IBM for X series
servers and BladeCenter technology, and various other suppliers for Operating
System Software, SIP software, SS7 Software and other software and hardware
components. If our relationship with any of these suppliers is terminated, then
we will need to invest time and resources to integrate our products with the
hardware and software components of alternative suppliers. See "Item 3 - Key
Information - Risk Factors - We depend on third parties for the supply and
quality of components required for the manufacture of our products, and any
delay or disruption in the supply of these products will adversely affect our
results".
Notwithstanding the foregoing, our dependency on the foregoing suppliers is less
than the dependency we had on suppliers of hardware components for our
hardware-based products, since our Essentra products are based on Linux and
general-purpose IBM servers.
In addition, our dependency on Dialogic for signaling software has been reduced
due to the support of the standard protocol Sigtran that is used in both our
Essentra CX and on Dialoic components (Sigtran is a standard-based protocol,
which is also available from other signaling gateway vendors). In developing our
past H.323 products, we were required to support a proprietary protocol provided
by Dialogic, which was significantly harder to replace.
We are also dependent on contracts with certain customers. See "Item 3 - Key
Information - risk factors - if our relationships with our key customers are
terminated, our revenues will decline and our business will be adversely
affected".
31
MARKETING, SALES AND DISTRIBUTION
We market and distribute our products both directly and via multiple
distribution channels, and our main target customers include fixed line national
and international long distance carriers, competitive local exchange carriers
(CLEC), incumbent local exchange carriers (ILEC), alternative VoIP telephony
carriers (such as Vonage) and Internet Telephony Service Providers (ITSPs). We
target both carriers with an existing infrastructure as well as those greenfield
carriers building new VoIP networks.
Since the business combination with Tdsoft, we have substantially increased our
sales and marketing efforts, in order to enhance and leverage the VocalTec
brand, and in order to penetrate specific geographic areas in which we believe
our products can be successfully sold. Such areas include primarily Russia, CIS,
Latin America, South East Asia and Africa. As part of these efforts we reached
agreements with a large number of local agents and distributors / Systems
Integrators. These efforts resulted in new customers acquisitions and serve as a
platform for further sales into each such target market.
In addition, we are continuously making efforts to establish relationships with
channel partners, including resellers and other vendors, in order to leverage
their market presence and increase our market reach and sales. Audiocodes is an
example of one such reseller partner with which we saw sales increasing during
2007.
The sales cycles for our solutions are typically long as is common to the
telecommunications market and the nature of our products and solutions. Once
purchased by our end user customers, our solutions require installation in the
network. After installation the system usually enters into a warranty period of
twelve to eighteen months. We offer two maintenance and service agreements,
which are renewed on an annual basis. The standard service is a 9X5 support
service (i.e. during regular business hours), including fixing of errors and
faulty hardware replacement. The premium service includes a 24X7 support service
and versions updates.
INDUSTRY STANDARDS
We recognize that standards are important for interoperability and for providing
the means for market growth. Over the years, we have taken an active role in
international standards bodies and we continuously strive to keep abreast of
evolving standards and specifications.
We actively support important communications standards in our products,
including IETF SIP, ITU-T H.323, SS7, ISDN, MEGACO, MGCP, SIGTRAN, Radius and
others, and work closely with our carrier customers and equipment manufacturers
in ensuring standards are correctly and uniformly implemented. The Essentra
product suite was designed to meet the IMS specifications, which are being
adopted by both wireless and fixed line operators. Our prime focus is on the
TISPAN IMS family of standards, as most of our customers are fixed line
carriers.
32
COMPETITION
Our market is highly competitive and rapidly evolving, and is characterized by
evolving standards, new alliances and consolidation. Since the Essentra solution
combines trunking, peering, and application elements, our competitive landscape
includes providers of softswitches ("trunking"), application servers
("application") and session border controllers ("peering"). Our principal
competitors include Huawei, Veraz, Cirpack (part of Thomson Technology), Verso
(who recently filed Chapter 11), Cisco Systems and Sonus Networks Inc. as
softswitch vendors; Broadsoft, NetCentrex (part of Comverse Technologies), and
Sylantro as application server vendors; and AcmePacket and Nextpoint as session
border controller vendors.
Many of our competitors are difficult to compete with, as they are larger than
we are, have stronger brand recognition, have greater long-term resources and
can sustain larger price reductions for their products.
We believe that in such a rapidly changing market, key competitive factors
include time to market, technology and experience, reputation, a broad base of
users, strategic alliances, key reference customers, interoperability, product
performance, product features and ease of use, price, customer support,
distribution channels and the ability to respond quickly to emerging
opportunities.
EFFECTS OF GOVERNMENTAL REGULATIONS
See "Item 10 - Additional Information - Taxation and Government Programs".
4.C. ORGANIZATIONAL STRUCTURE
We are organized under the laws of the State of Israel. Our principal
operational direct and indirect wholly-owned subsidiaries and their countries of
incorporation are:
o Tdsoft Ltd. (Israel)
o Tdsoft Communications Inc. (United States)
o Tdsoft BV (Netherlands)
o VocalTec Communications, Inc. (United States)
o VocalTec Communications Deutschland GmbH (Germany)
o VocalTec Communications Hong-Kong Limited (Hong-Kong)
o VocalTec Communications Singapore PTE Ltd. (Singapore)
As of December 31, 2007, the only significant subsidiary is Tdsoft Ltd.
4.D. PROPERTY, PLANTS AND EQUIPMENT
Our headquarters are located in Herzliya Pituach, Israel, and occupy 21,500
square feet pursuant to a lease expiring during April 2010. We currently pay a
total yearly rental amount of approximately $468,000. These facilities are used
for management, administration, operations, marketing, sales, research and
development, and testing.
We maintain car leases, and our total liability for early termination of the
leases is approximately $41,000.
33
ITEM 4A. UNRESOLVED STAFF COMMENTS
Not applicable.
ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS
THE FOLLOWING DISCUSSION OF OUR FINANCIAL CONDITION AND RESULTS OF OPERATIONS
SHOULD BE READ IN CONJUNCTION WITH OUR CONSOLIDATED FINANCIAL STATEMENTS AND
RELATED NOTES INCLUDED ELSEWHERE IN THIS ANNUAL REPORT. THIS DISCUSSION CONTAINS
FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. OUR ACTUAL
RESULTS MAY DIFFER SIGNIFICANTLY FROM THOSE PROJECTED IN THE FORWARD-LOOKING
STATEMENTS. FACTORS THAT MIGHT CAUSE FUTURE RESULTS TO DIFFER SIGNIFICANTLY FROM
THOSE PROJECTED IN THE FORWARD-LOOKING STATEMENTS INCLUDE, BUT ARE NOT LIMITED
TO, THOSE DISCUSSED BELOW AND ELSEWHERE IN THIS ANNUAL REPORT, PARTICULARLY
THOSE DESCRIBED ABOVE UNDER "ITEM 3 - KEY INFORMATION - RISK FACTORS".
You should read the following discussion and analysis in conjunction with our
audited consolidated financial statements for the year ended December 31, 2007
and notes thereto. This "Operating and Financial Review and Prospects" section
contains forward-looking statements that involve risks and uncertainties. Our
actual results could differ materially from those anticipated in these
forward-looking statements.
OVERVIEW
We are a provider of carrier-class multimedia and voice-over-IP (VoIP) solutions
for communication service providers. We provide trunking, peering and
residential/enterprise VoIP application solutions that enable flexible
deployment of next-generation networks (NGNs). Partnering with prominent system
integrators, resellers and equipment manufacturers, we serve an installed base
of leading service providers. Designed for easy integration in multi-vendor
environments, our solutions handle call control, media processing, signaling and
security within state-of-the-art NGN networks. Our SIP-based solutions support a
variety of protocols, including Megaco/H.248, MGCP, H.323, Sigtran, ISUP, and
incorporate various elements of the IMS/TISPAN (IP Multimedia Subsystem)
architecture.
Growth in the VoIP market is being driven largely by new entrants and service
providers looking to reduce operational costs and easily add new, advanced
services to their offering. While there are favorable industry trends that we
believe create an opportunity for us, the ultimate demand for our products will
depend upon the magnitude and timing of capital spending on VoIP infrastructure
by telecommunications service providers and our ability to penetrate the market
with new products and gain market share.
REVENUES. In 2007, we had sales of $5.8 million, compared to $7.3 million in
2006. Through 2007, we generated our revenues from sales of our products
(primarily the Essentra family products) and related services. Sales of products
accounted for 52% of our revenues in 2007.
In late 2006, we began marketing and selling our products also through resellers
/ systems integrators and partners. We sell our products to such resellers /
systems integrators / partners for a consideration that is more competitive than
the prices to end customers. As a result of the sale to resellers / system
integrators, we gain access to a broader range of customers, resulting in a
larger amount of transactions. Due to the manner in which we recognize our
revenues in 2007, such greater number of transactions did not result in an
increase in our revenues in 2007, compared to 2006. We expect to continue
selling our products through such channels.
Sales to our customers are generally made under short-term non-cancelable
purchase orders. Although our customers may provide us with forecasts, our
ability to predict revenues in any future period is limited and subject to
change based on demand for our customers' equipment.
We market and sell our products worldwide. The percentages of our revenues by
geographic area for the periods indicated were as follows:
YEAR ENDED DECEMBER 31,
----------------------------------
2005 2006 2007
-------- -------- --------
% % %
North and South America 22 11 6
Europe and Israel 72 66 83
Asia Pacific ("APAC"), Africa
and Middle East 6 23 11
-------- -------- --------
100% 100% 100%
-------- -------- --------
34
We attribute revenues to the geographic area where the customer, or its business
unit that makes the purchase, is based.
COST OF SALES. Our cost of sales in 2007 was $3.4 million (including an
amortization of acquired intangibles in the amount of $0.4 million and inventory
write off in the amount of $0.5 million), or 59% of sales, compared with $3.1
million (including an amortization of acquired intangibles in the amount of $0.4
million), or 43 % of sales in 2006. Our cost of sales in 2007, excluding the
amortization of acquired intangibles and inventory write off was $2.6 million,
or 44% of sales. The cost of our sales consists primarily of (i) the cost of
hardware components, (ii) salaries and other related expenses of our employees
who are engaged in the production and support of our products, and (iii)
royalties paid by us to 3rd party software licenses and the Chief Scientist.
Our consolidated financial statements are prepared in accordance with U.S. GAAP,
and are the basis for the discussion and analysis of our results of operations,
liquidity and capital resources. Our functional and reporting currency is the
U.S. Dollar, which is the currency of the primary economic environment in which
our consolidated operations are conducted. Transactions and balances originally
denominated in dollars are presented at their original amounts. Transactions and
balances in currencies other than dollars (including NIS) are re-measured in
dollars in accordance with the principles set forth in FASB Statement No. 52 -
"Foreign Currency Translation". Our reported amounts of assets, liabilities,
revenues and expenses and the related disclosure of contingent assets and
liabilities are based on certain estimates and judgments made in the preparation
of our financial statements, which estimates and judgments are revised
periodically as required. Our estimates and assumptions are based on factors
such as analysis of prior years' experience, trends within the Company and the
telecommunications industry, and general economic conditions. However, actual
results may differ from our estimates and assumptions as a result of varying
market and economic conditions, and may result in lower revenues and bigger
operating losses.
CRITICAL ACCOUNTING POLICIES
Our discussion and analysis of our financial condition and the results of
operations is based on our consolidated financial statements that have been
prepared in accordance with US GAAP. The preparation of these consolidated
financial statements requires us to make estimates and judgments that affect the
reported amounts of assets, liabilities, revenues and expenses. On an ongoing
basis, we evaluate our estimates, including those related to revenue
recognition, inventories and accounting for stock based compensation. We base
our estimates on historical experience and on various other assumptions that we
believe to be reasonable under the circumstances, the results of which form the
basis for making judgments about the carrying values of assets and liabilities
that are not readily apparent from other sources.
We have identified below our critical accounting policies. These policies are
both the most important to the portrayal of our financial condition and results
of operations and require our management's most difficult, subjective and
complex judgments and estimates. Actual results may differ from these estimates
under different assumptions or conditions.
IMPAIRMENT AND DISPOSAL OF LONG-LIVED ASSETS:
The Company's amortizable long-lived assets are reviewed for impairment in
accordance with Statement of Financial Accounting Standards No. 144, "Accounting
for the Impairment or Disposal of Long-Lived Assets" whenever events or changes
in circumstances indicate that the carrying amount of an asset may not be
recoverable. Recoverability of assets to be held and used is measured by a
comparison of the carrying amount of an asset to the future undiscounted cash
flows expected to be generated by the asset. If an asset is considered to be
impaired, the impairment is measured by the difference between the carrying
amount of the asset and its fair value. During the periods presented no
impairment changes were recorded.
INTANGIBLE ASSETS:
Intangible assets include mainly goodwill technology, customer relations,
customer contracts and other identifiable intangible assets acquired in
connection with the purchase of businesses. Technology and other identifiable
intangible definite lived assets are amortized over their estimated useful
lives.
The Company evaluates the amortization periods of all identifiable intangible
assets to determine whether events or circumstances warrant revised estimates of
useful lives.
Under Statement of Financial Accounting Standard No. 142 "Goodwill and other
Intangible Assets" ("SFAS 142") goodwill is no longer amortized but instead is
tested for impairment at least annually (or more frequently if impairment
indicators arise). SFAS 142 prescribes a two-phase process for impairment
testing of goodwill. The first phase screens for impairment, while the second
phase (if necessary) measures impairment.
In the first phase of impairment testing, goodwill attributable to a reporting
unit is tested for impairment by comparing the fair value of the reporting unit
to its carrying amount. We determined that the company has only one reporting
unit. In 2007, the fair value of a single reporting unit of the Company was
found to be lower than its carrying value. The second phase was then performed.
The second phase of the goodwill impairment test compares the implied fair value
of the reporting unit's goodwill with the carrying amount of that goodwill. If
the carrying amount of the reporting unit's goodwill exceeds the implied fair
value of that goodwill, an impairment loss is recognized in an amount equal to
that excess. The implied fair value of goodwill is determined in the same manner
as the amount of goodwill recognized in a business combination. That is, the
fair value of the reporting unit is allocated to all of the assets and
liabilities of that unit (including all unrecognized intangible assets) as if
the reporting unit had been acquired in a business combination and the fair
value of the reporting unit was the purchase price paid to acquire the reporting
unit.
35
Fair value is determined using discounted cash flows and market capitalization.
Significant estimates used in the discounted cash flow methodology include
estimates of future cash flows, future short-term and long-term growth rates and
discount rates. The Company performs its annual impairment test during the
fourth fiscal quarter of each year.
REVENUE RECOGNITION:
The Company generates revenues from licensing the rights to use its software
products, from the sale of its systems and from providing maintenance,
engineering and support services. The Company's products are sold to resellers,
who are considered end-users for the purpose of revenue recognition (except as
indicated below).
Revenue from software products is recognized when all criteria outlined in the
American Institute of Certified Public Accountants Statement of Position ("SOP")
97-2, "Software Revenue Recognition", as amended by SOP 98-9, "Modification of
SOP 97-2, Software Reveneue Recognition, with Respect to Certain Transactions",
are met: persuasive evidence of an arrangement exists, the product has been
delivered, no significant obligation to the customer remains, the sales price is
fixed or determinable and collectibility is reasonably assured. The Company does
not grant a right of return to its customers.
Where software arrangements involve multiple elements, revenue is allocated to
each undelivered element based on vendor specific objective evidence ("VSOE") of
the fair value of the undelivered element. The VSOE used by the Company to
allocate the arrangement fees to support services and maintenance is based on
the price charged when these elements are sold separately (upon renewal).
Revenues for the delivered product are recorded based on the "residual method"
presented by SOP 98-9, "Modification of SOP 97-2, Software Revenue Recognition
With Respect to Certain Transactions", whereby the reminder of the arrangement
fee, after allocating revenue to undelivered elements as described above is
allocated to the delivered product. Under the residual method revenue is
recognized for the delivered elements when (1) there is VSOE of fair value on
all the undelivered elements and (2) all revenue recognition criteria of SOP
97-2 are satisfied. Under the residual method any discount in the arrangement is
allocated to the delivered element.
Prior to January 1, 2007, revenues from the sale of software was recognized upon
delivery, assuming all other revenue recognition criteria are met while the
amounts allocated to the support services and maintenance were recognized
ratably over the service period. Effective January 1, 2007, due to a limited
number of separate support services and maintenance contracts consummated during
2007 and since the Company began providing its services through distributors and
integrators, VSOE is no longer attainable to the support services and
maintenance subsequent to that date. Accordingly, revenues from bundled software
arrangements in 2007 are recognized ratably over the period of the last
delivered element in the arrangement, which is typically the customer support
and maintenance service period, assuming all other revenue recognition criteria
are met.
When an arrangement provides for acceptance of the product by the customer,
revenue is not recognized until such acceptance is received.
In certain cases, when the company sells its products through resellers in new
and emerging market channels for which no comparable history has been
established, the Company recognizes revenues only when all obligations to the
end user have been completed, provided all other revenue recognition criteria
have been met.
Arrangements including training and installation services are recognized only
after the services are performed.
Revenue from software maintenance and technical support contracts is recognized
on a straight line basis over the term of the maintenance and support
arrangement.
Engineering services are recognized as services are performed.
In 2006 deferred revenue includes unearned amounts received under the
maintenance and support contracts and amounts received from customers but not
recognized as revenues. In 2007, deferred revenue includes amounts received
under bundled software arrangements and amounts received from customers, but not
recognized as revenue.
Revenue from sale of systems is recognized upon delivery to the end-user or the
reseller. Provisions for warranty are made at the time of the sale. Such
revenues are recognized in accordance with Staff Accounting Bulletin No. 104,
"Revenue Recognition in Financial Statements" ("SAB No. 104").
INCOME TAXES:
The Company and its subsidiaries account for income taxes in accordance with
SFAS No. 109, "Accounting for Income Taxes" ("Fas 109"). This Statement
prescribes the use of the liability method whereby deferred tax assets and
liability account balances are determined for loss carryforwards and other
temporary differences between financial reporting and tax bases of assets and
liabilities, using the enacted tax rates and laws that will be in effect when
the differences are expected to reverse. The Company and its subsidiaries
provide a valuation allowance, if necessary, to reduce deferred tax assets to
the amount that is more likely than not to be realized. In July 2006, the FASB
issued FASB Interpretation No. 48, "Accounting for Uncertainty in Income Taxes,
an Interpretation of FASB Statement No. 109" ("FIN 48").
FIN 48 clarifies the accounting for income taxes by prescribing the minimum
recognition threshold a tax position is required to meet before being recognized
in the financial statements. FIN 48 utilizes a two-step approach for evaluating
tax positions. Recognition (step one) occurs when an enterprise concludes that a
tax position, based solely on its technical merits, is more-likely-than-not to
be sustained upon examination. Measurement (step two) is only addressed if step
one has been satisfied (i.e., the position is more-likely-than-not to be
sustained) otherwise a full liability in respect of a tax position not meeting
the more-than-likely-than-not criteria is recognized. Under step two, the tax
benefit is measured as the largest amount of benefit, determined on a cumulative
probability basis, that is more-likely-than-not to be realized upon ultimate
settlement.
FIN 48 applies to all tax positions related to income taxes subject to "FAS
109". This includes tax positions considered to be "routine" as well as those
with a high degree of uncertainty.
FIN 48 has expanded disclosure requirements, which include a tabular roll
forward of the beginning and ending aggregate unrecognized tax benefits as well
as specific detail related to tax uncertainties for which it is reasonably
possible the amount of unrecognized tax benefit will significantly increase or
decrease within twelve months. (See also note 15).
FIN 48 is effective for fiscal years beginning after December 15, 2006. The
cumulative effect of applying FIN 48 is reported as an adjustment to the opening
balance of retained earnings. The adoption of FIN 48, as of January 1, 2007,
affected the Company's accumulated deficit, as described in note 15.
36
SHARE-BASED COMPENSATION:
Until January 1, 2006, the Company has elected to follow Accounting Principles
Board Statement No. 25, "Accounting for Stock Options Issued to Employees" ("APB
No. 25") and Financial Accounting standard Board (FASB) Interpretation No. 44,
"Accounting for Certain Transactions Involving Stock Compensation" ("FIN No.
44") in accounting for its employee stock option plans. According to APB No. 25,
compensation expense is measured under the intrinsic value method, whereby
compensation expense is equal to the excess, if any, of the quoted market price
of the stock over the exercise price at the grant date of the award. Forfeitures
are accounted for as occurred.
Effective January 1, 2006, the Company adopted FASB Statement No. 123 (revised
2004), "Share-Based Payment" ("SFAS 123(R)") , and related Securities and
Exchange Commission rules included in Staff Accounting Bulletin No. 107, on a
modified prospective basis. Under this method, compensation cost recognized in
2006 includes costs related to 1) all share-based payments granted prior to but
not yet vested as of January 1, 2006, based on the grant-date fair value
estimated in accordance with the original provisions of SFAS 123 and 2) all
share-based payments granted subsequent to January 1, 2006 based on the
grant-date fair value estimated in accordance with the provisions of SFAS
123(R). Results for prior periods have not been restated. Compensation cost for
stock options is recognized ratably over the vesting period using the straight
line method.
SFAS No. 123(R) requires companies to estimate the fair value of equity based
payment awards on the date of grant using an option-pricing model. The value of
the portion of the award that is ultimately expected to vest is recognized as an
expense over the requisite service periods, on a straight-line basis, in the
Company's consolidated income statements.
5A. OPERATING RESULTS
YEAR ENDED DECEMBER 31, 2007 COMPARED TO YEAR ENDED DECEMBER 31, 2006
SALES
In 2007, we had sales of $5.8 million, compared to $7.3 million in 2006, a
decrease of $1.5 million, or 21%. Through 2007, we generated our revenues from
sales of our products (primarily the Essentra family of products) and from the
sale of maintenance, support and other services. Sales of products accounted for
52% of our revenues in 2007, whereas sales of services accounted for 48% of our
revenues in 2007. Prior to January 1, 2007, revenues from the sale of software
were recognized upon delivery, assuming all other revenue recognition criteria
are met while the amounts allocated to the support services and maintenance were
recognized ratably over the service period. Effective January 1, 2007, due to a
limited number of separate support services and maintenance contracts
consummated during 2007 and since the Company began providing its services
through distributors and integrators, VSOE is no longer attainable to the
support services and maintenance subsequent to that date. Accordingly, revenues
from bundled software arrangements in 2007 are recognized ratably over the
period of the last delivered element in the arrangement, which is typically the
customer support and maintenance service period, assuming all other revenue
recognition criteria are met. The decrease in our revenues from the sale of
products resulted from the manner in which the Company accounted for such sales,
resulting in the deferral of approximately $2.7 million of revenues from 2007 to
2008. For additional information on our revenue recognition policies, see Note
2(k) to the financial statements attached to this annual report. Revenues from
the sale of services did not change significantly in 2007, compared to 2006.
In late 2006, we began selling our products also to resellers / systems
integrators and partners. We sell our products to such resellers/systems
integrators/partners for a consideration that is more competitive than the
prices to end customers. As a result of the sale to resellers/systems
integrators, we gain access to a broader range of customers, resulting in a
larger amount of transactions. Due to the manner in which we recognize our
revenues, such greater number of transactions did not result in an increase in
our revenues in 2007, compared to 2006. We expect to continue selling our
products to such channels.
In late 2006 we started selling our Essentra family of products as part of
solutions consisting also of certain hardware that we purchase from third
parties, resulting in an increase in sales (some of which were deferred to 2008,
as described above).
To date, we have derived a substantial portion of our revenues from a relatively
small number of customers (including resellers / systems integrators and
partners). Each of the following customers accounted for more than 10% of our
revenues for the periods indicated:
YEAR ENDED DECEMBER 31,
--------------------------------
2005 2006 2007
-------- -------- --------
Lucent 18% 13% *
OG Vodafone 16% * *
Deutche telecom * 18% 22%
Mobifon 2000 * * 12%
Integrated Networks * * 10%
* less than 10%
Total sales to the foregoing major customers accounted for 34%, 31% and 44% of
our total revenues for the years ended December 31, 2005, 2006 and 2007,
respectively.
37
To date, most of our global sales have been in U.S. dollars and have not been
adversely affected by foreign currency fluctuations. If global business
conditions require us to sell our solutions in other local currencies, our sales
may be adversely affected by devaluation of local currencies against the U.S.
dollar. If, on the other hand, such local currencies' value increases against
the U.S. dollar, our sales (in U.S. dollar terms) will be positively affected.
For additional information regarding the potential effect of foreign currency
fluctuations on our sales, see Item 3.D "Risk Factors".
We plan to increase our market share in the growing VoIP market. In 2006, we
started selling our products in new regions, including Russia, Africa and
Vietnam. In late 2006, we started selling our products also to resellers /
systems integrators, resulting in an increase in the number of transactions. In
2007, while continuing to sell our solutions to the markets discussed above, we
also began selling our solutions to Latin America both directly and through
Resellers / systems integrators.
COST OF SALES
Cost of sales in 2007 was $3.4 million, or 59% of sales (including an
amortization of acquired intangibles in the amount of $0.4 million and an
inventory write-off in the amount of $0.5 million), compared with $3.1 million,
or 43% of sales (including an amortization of acquired intangibles in the amount
of $0.4 million), in 2006. Cost of products was $2.0 million in 2007 compared
with $2.2 million in 2006. Cost of services was $0.5 million in 2007 compared
with $0.6 million in 2006.
The increase in the cost of sales in 2007 compared to 2006, resulted from the
inventory write-off, and the increase in the cost of sales as a percentage of
sales in 2007 compared to 2006 resulted primarily from the sale of solutions
that include, in addition to our Essentra family of products, third party
products (which carry a lower gross margin).
Cost of our sales consists primarily of the cost of hardware components,
salaries and other related expenses of our employees who are engaged in the
production and support of our products and royalties paid by us to licensors of
software and to the Chief Scientist.
In 2007, gross margins were 41%, including amortization of acquired intangibles
and an inventory write-off, or 56%, excluding amortization of acquired
intangibles and an inventory write-off. In 2006, gross margins were 57%,
including amortization of acquired intangibles, or 62%, excluding amortization
of acquired intangibles.
OPERATING EXPENSES
RESEARCH AND DEVELOPMENT, NET
Research and development costs, net were $4.6 million in 2006 and 2007,
representing 63% and 79% of sales in 2006 and 2007, respectively. Research and
development costs, net consist principally of salaries and benefits for software
and hardware engineers and sub-contractors, related facilities costs and
activities and expenses associated with computer, software and other equipment
used in software and hardware development and testing. Research and development
costs, net in 2007 and 2006 included stock-based compensation amount of $353,000
and $248,000, respectively, due to the implementation of FASB 123(R) in 2006.
None of our software or hardware development costs have been capitalized during
any of the reported periods, as the amount of software and hardware development
costs eligible for capitalization at this stage has historically been
insignificant.
We believe that continued investment in research and development is essential to
remain competitive in the marketplace and is directly related to the timely
development of new and enhanced products. Specifically, in order to bring our
future products to maturity and thereafter increase sales, we are allocating
significant resources to research and development activities, including
outsourcing certain research and development assignments.
Our research and development efforts in 2007 have been financed from internal
resources and through programs sponsored by the Chief Scientist. Pursuant to the
terms of the Chief Scientist royalty-bearing program, we are required to pay
royalties of between 3% and 4.5% of sales of products and related services
developed in any project partially funded by the Chief Scientist, up to an
amount of 100% of the grant obtained. For grants received under programs
approved subsequent to January 1, 1999, royalties are payable up to 100% of the
grant obtained plus interest at the annual rate of Libor applicable to U.S.
dollar deposits. We expect to participate only in royalty bearing programs but
we cannot make any assurances that we will be awarded any future grants.
38
Our research and development expenses in 2007 and 2006 were net of participation
from the Chief Scientist. In each of 2006 and 2007, participation received or
accrued from the Chief Scientist was $0.8 million. In 2007, we paid or accrued
royalties to the Chief Scientist in an aggregate amount of approximately
$175,000 compared with $201,000 in 2006. Our contingent liability to the Chief
Scientist amounts to approximately $21 millions. On May 27, 2008, the Company
signed an agreement to sell part of its patents for the aggregate selling price
of $12.5 million. On July 13, 2008, the OCS approved the consummation of the
foregoing sale, subject to the payment to the OCS of approximately $2.08
million.
SELLING AND MARKETING
In 2007, selling and marketing expenses were $4.7 million, or 82% of sales,
compared with $4.1 million or 57% of sales in 2006. Selling and marketing
expenses include salaries and benefits, sales commissions, travel expenses and
related costs for our sales, marketing, and distribution personnel, reserves for
potential damages to, loss of, or obsoleteness of trial systems. Selling and
marketing expenses in 2006 and 2007 included stock-based compensation amounting
to $138,000 and $224,000, respectively, due to the implementation of FASB 123(R)
in 2006. Selling and marketing expenses also include the costs of programs aimed
at increasing revenue, such as advertising, trade shows and other market
development programs. The increase in selling and marketing expenses in absolute
numbers in 2007 compared to 2006 resulted primarily from selling and marketing
activities in Russia.
GENERAL AND ADMINISTRATIVE
General and administrative expenses consist principally of salaries and
benefits, outside legal, accounting and consultant fees, travel expenses and
related costs for management, directors' fees, directors and officers insurance,
finance, logistics, human resources, communication, legal, information systems
and administrative personnel. General and administrative expenses in 2006 and
2007 included stock-based compensation amounting to $554,000 and $552,000,
respectively, due to the implementation of FASB 123(R) in 2006. General and
administrative expenses also include expenses associated with computing
equipment and software used in the administration operations. General and
administrative expenses were $2.0 million, or 35% of sales, in 2007, compared
with $2.5 million, or 34% of sales, in 2006. The decrease in general and
administrative expenses in absolute numbers resulted primarily from the fact
that in 2006 the Company paid its former Chief Executive Officer certain
severance payments.
OTHER INCOME (EXPENSE), NET
In 2007, we recorded $5,437 expenses, regarding impairment of goodwill. Under
Statement of Financial Accounting Standard No. 142 "Goodwill and other
Intangible Assets" ("SFAS 142") goodwill is no longer amortized but instead is
tested for impairment at least annually (or more frequently if impairment
indicators arise).
The Company decided to perform an impairment test mainly due to the fact that in
addition to its losses, as of December 31, 2007, the Company's market
capitalization was lower than the Company's shareholders' equity as of such
date. That indication did not exist in 2006. We had no material other income
(expenses) in 2007 and 2006.
FINANCE INCOME, NET
Finance income, net in 2007 consisted principally of interest income received in
connection with our bank deposits, bank charges and currency differences between
the NIS and US dollar. In 2007, finance income, net was $230,000, or 4% of
sales, compared to $32,000, or less than 1% of sales, in 2006.
39
TAXES ON INCOME, TAX REFUNDS AND TAX BENEFITS
In 2007, VocalTec and Tdsoft had two and four, respectively, Approved Enterprise
programs under the Law for the Encouragement of Capital Investments, 1959,
respectively. Such programs are eligible for certain tax benefits for the first
several years in which they generate taxable income. Income derived from an
Approved Enterprise is subject to a zero tax rate for two years and up to an
additional eight years of reduced corporate tax rate of 25% until the earlier of
(i) seven to ten consecutive years, commencing in the year in which the specific
Approved Enterprise first generates taxable income (which income is not offset
by deductions attributable to the other sources), (ii) twelve years from
commencement of production or (iii) fourteen years from the date of approval of
the Approved Enterprise status. Some of our production and development
facilities have been granted Approved Enterprise status. To date, neither of our
Approved Enterprise programs has generated any taxable income.
As of December 31, 2007, we had net operating loss carry forwards in Israel of
approximately $187 million ($140 million allocated to VocalTec and $47 million
allocated to Tdsoft). This net-operating loss may be carried forward and offset
against future taxable income under applicable tax laws. We also had an
aggregate net operating loss carry forwards in the U.S. of approximately $9
million, which may not be carried forward and offset against future taxable
income due to change of control in the Company regarding the merger between
Vocaltec and Tdsoft in November 2005. Tax benefits, which apply to us under
Israeli law, do not apply to any income generated by any of our other
subsidiaries.
NET INCOME (LOSS)
Net loss in 2007 was $14.2 million, representing 246% of sales, compared with a
net loss of $7.0 million, representing 96% of sales in 2006.
Our financial statements are reported in dollars and the vast majority of our
sales are made in U.S. dollars. Most of our expenses are in New Israeli Shekels
(NIS) and dollars. The cost of our operations in Israel, as expressed in
dollars, is influenced by the extent to which any increase/decrease in the rate
of inflation in Israel is not offset by the appreciation/depreciation of the NIS
in relation to the dollar. In 2007, the rate of inflation in Israel was 3.4% and
the rate of appreciation of the NIS in relation to the dollar was 8.9%.
YEAR ENDED DECEMBER 31, 2006 COMPARED TO YEAR ENDED DECEMBER 31, 2005
SALES
We recorded sales of $7.3 million in 2006 compared to $4.6 million in 2005
(which comprised primarily of the Tdsoft operations), an increase of 59%. The
increase in sales in 2006 compared with 2005 was attributable to the inclusion
of the results of operations of VocalTec, which were not included in 2005.
Product sales in 2006 were $4.7 million, an increase of 29% compared to $3.7
million in 2005 (which comprised primarily of the Tdsoft products), mainly
attributable to the inclusion of VocalTec products (which were not included in
2005), offset by a decrease in sales of Tdsoft's products.
40
Revenues from engineering, maintenance, support and other services in 2006 were
$2.5 million, an increase of 275% compared to 2005 support services revenues of
$0.9 million. Services revenues increased in 2006 compared with 2005 due to the
inclusion of maintenance services provided to VocalTec's customers and
engineering services which were not included in the 2005 results.
COST OF SALES
Cost of sales in 2006 was $3.1 million, or 43% of sales (including an
amortization of acquired intangibles in the amount of $0.4 million), compared
with $2.6 million, or 56 % of sales (including an inventory write-off in the
amount of $0.6 million and amortization of acquired intangibles in the amount of
$0.2 million), in 2005. The decrease in the cost of sales in percentage in 2006
compared to 2005 resulted from a write-off of $0.6 million of obsolete
inventories in 2005 and of a provision for warranty of $0.2 million in 2005,
reversed in 2006 due to a decrease in sales of related products, offset by an
increase in amortization of acquired intangibles from $0.2 million in 2005 to
$0.4 million in 2006
Cost of products was $2.2 million in 2006 compared with $1.5 million in 2005.
Cost of services was $0.6 million in 2006 compared with $0.3 million in 2005.
The increase in cost of products in 2006 compared to 2005 was mainly due to the
increase in sales.
Cost of our sales consists primarily of the cost of hardware components,
salaries and other related expenses of our employees who are engaged in the
production and support of our products and royalties paid by us to licensors of
software and to the Chief Scientist.
In 2006, gross margins were 57%, including amortization of acquired intangibles,
or 62%, excluding amortization of acquired intangibles. In 2005, gross margins
were 44%, including inventory write-off and amortization of acquired
intangibles, or 62%, excluding inventory write-off and amortization of acquired
intangibles.
OPERATING EXPENSES
RESEARCH AND DEVELOPMENT, NET
Research and development costs, net were $4.6 million in 2006, or 63% of sales,
compared with $4.4 million, or 95% of sales, in 2005. Research and development
costs, net consist principally of salaries and benefits for software and
hardware engineers and sub contractors, related facilities costs and activities
and expenses associated with computer, software and other equipment used in
software and hardware development and testing. Research and development costs,
net in 2006 included stock-based compensation amount of $248,000 due to the
implementation of FASB 123(R) in 2006. Research and development costs, net in
2005 included a non recurring stock-based compensation amount of $522,000 which
resulted from the amount of VocalTec shares issued to founders and employees of
Tdsoft pursuant to the business combination being in excess of the pro rata
holding percentage of such founders and employees of Tdsoft prior to the
business combination. None of our software or hardware development costs have
been capitalized during any of the reported periods, as the amount of software
and hardware development costs eligible for capitalization at this stage has
historically been insignificant. The increase in research and development costs,
net, in absolute numbers in 2006 compared to 2005, resulted mainly from a
decrease in the participation of the BIRD (Bi-national Industrial Research and
Development) foundation in our research and development expenses.
41
Our research and development efforts were financed in 2005 from internal
resources and through programs sponsored by the Chief Scientist and the BIRD
foundation. As a result of the acquisition of the assets owned by Cisco Systems
and the assets of Be-Connected in 2001 and 2004, respectively, Tdsoft assumed
the liability to pay royalties to the Chief Scientist in connection with grants
received prior to the purchase of such products. Such royalties were paid during
2005 and 2006.
Our research and development expenses in 2006 and 2005 were net of participation
from the Chief Scientist and the BIRD foundation. In 2006, participation
received or accrued from the Chief Scientist and the BIRD foundation was $0.8
million compared with $1.3 million in 2005. In 2006, we paid or accrued
royalties to the Chief Scientist in an aggregate amount of approximately
$201,000 compared with $63,000 in 2005.
SELLING AND MARKETING
In 2006, selling and marketing expenses were $4.1 million, or 57% of sales,
compared with $2.8 million or 60% of sales in 2005. Selling and marketing
expenses included salaries and benefits, sales commissions, travel expenses and
related costs for our sales, marketing, and distribution personnel, reserves for
potential damages to, loss of, or obsoleteness of trial systems. Selling and
marketing expenses in 2006 included stock-based compensation amount of $138,000
due to the implementation of FASB 123 in 2006. Selling and marketing expenses in
2005 included a non recurring stock-based compensation amount of $13,000 which
resulted from the amount of VocalTec shares issued to founders and employees of
Tdsoft pursuant to the business combination being in excess of the pro rata
holding percentage of such founders and employees of Tdsoft prior to the
business combination. Selling and marketing expenses also included the costs of
programs aimed at increasing revenue, such as advertising, trade shows and other
market development programs. The increase in selling and marketing expenses in
absolute numbers in 2006 compared to 2005 resulted primarily from an increase in
salaries and benefits related to increase in personnel engaged in selling and
marketing activities and due to amortization of the intangibles acquired in the
business combination between Tdsoft and VocalTec, offset by a decrease in
material use for selling and marketing activities.
42
GENERAL AND ADMINISTRATIVE
General and administrative expenses consisted principally of salaries and
benefits, outside legal, accounting and consultant fees, travel expenses and
related costs for management, finance, logistics, human resources,
communication, legal, information systems and administrative personnel. General
and administrative expenses in 2006 included stock-based compensation amount of
$554,000 due to the implementation of FASB 123 in 2006. General and
administrative expenses in 2005 included a non recurring stock-based
compensation amount of $268,000 which resulted from the amount of VocalTec
shares issued to founders and employees of Tdsoft pursuant to the business
combination being in excess of the pro rata holding percentage of such founders
and employees of Tdsoft prior to the business combination. General and
administrative expenses also included expenses associated with computing
equipment and software used in the administration operations General and
administrative expenses were $2.5 million, or 34% of sales, in 2006, compared
with $1.7 million, or 38% of sales, in 2005. The increase in general and
administrative expenses in absolute numbers resulted primarily from an increase
in salaries and benefits related to personnel engaged in general and
administrative activities and to an increase in stock based compensation
expenses.
OTHER INCOME (EXPENSE), NET
We had immaterial other income in 2006 and 2005.
FINANCE INCOME, NET
Finance income, net in 2006 consisted principally of interest income received in
connection with our bank deposits, bank charges and currency differences between
the NIS and US dollar. In 2006, financial income, net was $32,000 - less than 1%
of sales, compared to $0.2 million, or 4% of sales, in 2005.
TAXES ON INCOME, TAX REFUNDS AND TAX BENEFITS
In 2006, Vocaltec and Tdsoft had two and four, respectively, Approved Enterprise
programs under the Law for the Encouragement of Capital Investments, 1959,
respectively. Such programs are eligible for certain tax benefits for the first
several years in which they generate taxable income. Income derived from an
Approved Enterprise is subject to a zero tax rate for two years and up to an
additional eight years of reduced corporate tax rate of 25% until the earlier of
(i) seven to ten consecutive years, commencing in the year in which the specific
Approved Enterprise first generates taxable income (which income is not offset
by deductions attributable to the other sources), (ii) twelve years from
commencement of production or (iii) fourteen years from the date of approval of
the Approved Enterprise status. Some of our production and development
facilities have been granted Approved Enterprise status. To date, neither of our
Approved Enterprise programs has generated any taxable income.
As of December 31, 2006, we had net operating loss carry forwards in Israel of
approximately $160 million ($117 million allocated to VocalTec and $43 million
allocated to Tdsoft), and an aggregate net operating loss carry forwards in the
U.S. of approximately $8.5 million. These net-operating losses may be carried
forward and offset against future taxable income under applicable tax laws. Tax
benefits, which apply to us under Israeli law, do not apply to any income
generated by any of our other subsidiaries.
43
NET INCOME (LOSS)
Net loss in 2006 was $7.0 million, representing 96% of sales, compared with a
net loss of $6.6 million, representing 144% of sales in 2005.
Our financial statements are reported in dollars and the vast majority of our
sales are made in U.S. dollars. Most of our expenses are in New Israeli Shekels
(NIS) and dollars. The cost of our operations in Israel, as expressed in
dollars, is influenced by the extent to which any increase/decrease in the rate
of inflation in Israel is not offset by the appreciation/depreciation of the NIS
in relation to the dollar. In 2006, the rate of inflation in Israel was -0.1%
and the rate of depreciation of the NIS in relation to the dollar was -8.2%.
5B. LIQUIDITY AND CAPITAL RESOURCES
During the past three years, we covered our cash flow requirements from cash
proceeds from the issuance of shares and warrants to investors, operating
revenues and grants from the BIRD foundation (only in 2005) and the Chief
Scientist.
As of December 31, 2007, we had approximately $4.5 million in cash and cash
equivalents. As of December 31, 2006, we had approximately $9.0 million in cash,
cash equivalents and bank deposits, comprised of $6.0 million in cash and cash
equivalents and $3.0 million in bank deposits.
As of December 31, 2007, we had working capital of approximately $0.7 million,
compared with $8.2 million as of December 31, 2006. The net decrease in working
capital during 2007 resulted primarily from a decrease in cash and an increase
in deferred revenues. Excluding deferred revenues, the working capital was $3.4
million as of December 31, 2007, compared with $8.4 million as of December 31,
2006. The net decrease is mainly due to the decrease in cash.
Net cash used in operating activities was $3.9 million, $7.4 million and $4.8
million for the years ended December 31, 2007, 2006 and 2005, respectively. The
principal use of cash in each of these years was to fund our operations.
Net cash provided by (used in) investing activities was $2.5 million, $(2.5)
million and $0.5 million for the years ended December 31, 2007, 2006 and 2005,
respectively. Cash used for purchase of equipment was $0.2 million, $0.3 million
and $0.3 million for 2007, 2006 and 2005, respectively. Proceeds from the sale
of equipment were $4,000, $26,000 and $109,000 for 2007, 2006 and 2005,
respectively.
The Company had no net cash generated by financing activities in 2007.
We anticipate that operating expenses may exceed revenues, net of cost of sales
in 2008 and possibly beyond if we do not sufficiently increase sales and reduce
our costs. We expect to receive net proceeds of approximately $9.2 million from
the sale of a portion of our patents, as described in "Item 4.A - History and
Development of the Company". We believe that such net proceeds, current cash and
cash equivalents balances, cash flows from operations and grants from the Chief
Scientist are sufficient to meet our anticipated cash needs for working capital
and capital expenditures for at least the next 12 months.
44
Capital expenditures in 2007 were approximately $178,000, compared with $335,000
in 2006 and $308,000 in 2005.
We maintained annual car leases in the amount of approximately $407,000 in 2007,
and our total liability for early termination of the leases is in the amount of
up to approximately $41,000.
INVENTORY AND RECEIVABLES
Inventories as of December 31, 2007 were $1.5 million, compared to $1.1 million
as of December 31, 2006.
Trade receivables are from purchases of our products, primarily by
telecommunications Systems Integrators, Resellers and service providers. Trade
receivables are presented at gross value less reserve for doubtful accounts of
$160,000 and $120,000 as of December 31, 2007 and 2006, respectively. Trade
receivables, net, as of December 31, 2007 were $0.6 million, compared to trade
receivable, net of $1.4 million as of December 31, 2006. The decrease in trade
receivable, net, resulted from improved collection and from the manner in which
the Company accounted for such trade receivable. For additional information on
our revenue recognition policies, see Note 2(k) to the financial statements
attached to this annual report.
Prepaid expenses and other receivables were $0.3 million as of December 31,
2007, compared with $0.8 million as of December 31, 2006. The decrease in 2007
was mainly due to the payment by the Chief Scientist of the receivable
outstanding as of December 31, 2006.
5C. RESEARCH AND DEVELOPMENT, PATENTS AND LICENSES
INTELLECTUAL PROPERTY
We believe that the improvement of existing products, our technologies and the
development of new products are important in establishing and maintaining a
competitive advantage. We believe that the value of our products is dependent,
to a certain extent, upon the maintenance of patent, trade secret or copyright
protection of our proprietary software and technologies. We rely on a
combination of trade secrets, copyright, trademark and patent law, together with
non-disclosure and invention assignment agreements, to establish and protect the
technology used in our products.
45
We have filed numerous patent applications in the United States and other
countries with respect to certain technologies employed in our products. Some of
those applications have already registered and we own those registered patents.
In addition, we have filed trademark applications in the United States and other
countries with respect to trademarks associated with us, and our products. Some
of those applications have already been registered and we own those registered
trademarks.
Generally, we enter into non-disclosure and invention assignment agreements with
our employees, and into non-disclosure agreements with our consultants,
subcontractors and distributors and channel partners. However, there can be no
assurance that such measures will protect our proprietary technology, that
competitors will not develop products with features based upon, or otherwise
similar to, our products or that we will be able to enjoin competitors from
selling similar products.
Although we do not believe that our products infringe on any valid claim of a
patent owned by any third party, third parties have asserted infringement and
other claims against us from time to time. These claims have been directed at
certain basic and fundamental components of our products, those of which were
not abandoned were resolved by successfully implementing a licensing agreement.
There can be no assurance that third parties will not assert such claims against
us in the future or that such claims will not be successful.
We could incur substantial costs and diversion of management resources with
respect to the defense of any claims relating to proprietary rights that could
have a material adverse effect on our business, financial condition or results
of operations. If any such claims or actions are asserted or prosecuted against
us, we may seek to obtain a license under a third party's intellectual property
rights. There can be no assurance, however, that under such circumstances a
license would be available on reasonable terms or at all. In the event a party
that is successful in asserting a claim against us does not grant a license,
such party could secure a judgment resulting in the award of damages, as well as
injunctive or other equitable relief which could effectively block us from
manufacturing, using, selling, or otherwise distributing its products.
VocalTec, Essentra, Internet Phone Surf&Call, TdSOFT, TdGATE and TdVIEW are
trademarks or registered trademarks of VocalTec and its fully owned
subsidiaries. All other trademarks or registered trademarks used in this Annual
Report are the property of their respective owners.
RESEARCH AND DEVELOPMENT
We believe that our ability to enhance our current products, develop and
introduce new products on a timely basis, maintain technological competitiveness
and meet customer requirements is essential to our future success. Accordingly,
we devote and intend to continue to devote a significant portion of our
personnel and financial resources to research and development. We also intend to
continue seeking and maintaining close relationships with our customers in order
to remain responsive to their needs. We have an educated and experienced
research and development team that specializes in telecommunications and
networking, computer and networking software, communications protocols and VoIP
application software development. We seek to employ highly qualified technical
personnel in order to maintain and expand our technological expertise.
46
The Company may engage in the future in joint research and development projects
with third parties. The ownership of any intellectual or other proprietary
property developed in such projects shall be negotiated between the Company and
the relevant third party.
See "Item 5 - Operating and Financial Review and Prospects - Operating Results -
Research and development costs, net".
5D. TREND INFORMATION
We believe that our business is subject to the following trends:
TRENDS IN THE COMMUNICATIONS INDUSTRY
REGULATION AND COMPETITION: Service providers worldwide are facing an increasing
array of challenges given the ongoing regulatory changes and technological
advances in the communications industry. Global deregulation is promoting
competition to incumbent service providers from both new entrants and operators
in adjacent industries, such as wireless, satellite, Internet and cable
television service providers. At the same time, end user demands are rapidly
evolving. While in the past, communications traffic consisted primarily of
traditional voice communications and basic data traffic, such as email and
facsimiles, in recent years, with the wide acceptance of the Internet and
broadband infrastructure, end users are increasingly seeking fast, personalized,
content-rich, easy-to-use communications and are relying on these applications
in both their professional and personal lives. Accordingly, this trend is
increasing demand for high-speed access services, including IP-based voice,
video, data and wireless services.
The combination of competitive pressures and end user demands is placing
pressure on service providers to add new services to their existing offerings
quickly, with the flexibility to continue to add functionality and to scale as
needed. Many new and incumbent service providers presently offer a bundle of
voice, video and data services to end users, often referred to as "triple-play,
or "multi-play". For example, these services may include both traditional and
enhanced voice services, broadcast television and on-demand video, and
high-speed Internet access delivered over a converged broadband connection to
the home or office. Operators also are increasingly adding wireless to the
triple-play bundle, referred to as "quad-play", which has contributed to
consolidation in the service provider market. The bundling of services enables
service providers to generate new sources of revenue and enhance customer
relationships.
The initial capital costs and ongoing operating expense associated with the
deployment of new services are considerable. Many service providers have
significant investments in their existing network infrastructures, which may
consist of disparate media, such as copper, coax and fiber, as well as numerous
protocol families based on Internet Protocol, or IP, Asynchronous Transfer Mode,
or ATM, and Time Division Multiplexing, or TDM. Service providers generally seek
to maximize their return on investment by leveraging existing infrastructure to
offer new services. This has increased the demand both for upgrades to existing
equipment and for cost-effective new equipment that supports disparate media and
numerous protocol families.
47
INVESTMENT MADE IP INFRASTRUCTURES: As voice, video and data traffic travels
over communications network infrastructure, it typically passes through the core
and access networks before arriving at the customer premise, or destination. The
growing demand for Internet bandwidth over the last decade prompted service
providers to make significant capacity investments in the core network, which is
the part of the network that is responsible for transporting large volumes of
traffic between and within cities. Service providers have also made significant
investments in upgrading the core network to a mostly IP-based infrastructure to
more efficiently manage the increased data traffic. This is an ongoing
transformation that is expected to continue in the coming years.
The access network is located between the core network and the customer premise
and is integral to the aggregation and distribution of network services and to
the creation of new services. Service providers have begun looking at ways to
efficiently enable the deployment of new services with ever-increasing bandwidth
requirements, such as video or bundled services. To complement the investments
made in the core network and to combine voice, video and data over a common
network, service providers are increasingly seeking to upgrade access
infrastructures based on IP technologies. Increasingly, the use of IP as a
transport technology to combine voice, video and data over a common network is
emerging as the principal network architecture for service providers. The demand
for broadband connectivity to the Internet led incumbent local exchange carriers
to offer broadband over copper to the residential market. This was offered using
ADSL technology. The fast deployment of ADSL opened up an opportunity for
alternative carriers to offer voice over this broadband connection, bypassing
the need for any permission from the provider of the ADSL service. In addition,
new wireless technologies today provide an alternative low cost method of
offering broadband access services. The initial adoption of wireless broadband
technologies, such as WYMAX is a good example of this. WYMAX technology is said
to facilitate the deployment of a broadband access infrastructure by omitting
the need to drive cables underground; this is conducive to both a quicker and
more cost-effective deployment. Alternative and Greenfield carriers are looking
to WYMAX technology for the delivery of both a data and video/voice service.
The availability of broadband services is a very significant factor in the
ability to offer Essentra BAX as a service delivery platform, for providing
Class 5 Voice over Broadband (VoBB) services. Various market research firms
estimate that in 2010 approximately 15% of all wire-line telephone lines will
implement Voice over Broadband (VoBB) technology.
CONVERGENCE OF VOICE AND DATA: The maturing of VoIP technology and the
advantages of an IP network is leading to the convergence of data and voice
networks and the offering of a mix of data and voice services over a single
packet based IP network. This trend is expected to change telephony network
deployment and operation by removing all territorial/localized networks and the
localization aspect of the telephone number and possibly even replacing
traditional telephone numbers with an alternative personal ID. Converged
networks will reduce the cost of deployment of telephony switching equipment.
Converged networks will also reduce the cost of operation as the same
packet-based network will serve voice and data. Softswitch technology is at the
heart of this evolution. The softswitch will not only replace the legacy TDM
switch, but it will no longer be an integral part of each and every
neighborhood. Fewer high capacity softswitches will serve larger populations.
The physical location of the softswitch will not be related to the subscribers
that it will serve. Massive efforts and large projects are planned by most
telephony service providers, which are expected to result in around 200 million
telephony lines connected to softswitches by 2010 (according to a 2007 report by
Infonetics Research). Essentra product family aims at this market, which is
expected to grow (according to the same report) by an annual average of 30-40%
in the coming years.
48
WIRELINE AND MOBILE CONVERGENCE AND IMS: A new network architecture known as IMS
(Internet Multimedia Subsystem) has been designed by the 3GPP (3rd Generation
Partnership Project) to deliver IP-based service to end-users. This will be the
network architecture for the mobile third generation migration to packetized
voice. The unique abilities of IMS to offer fast implementations of new services
and the comfortable handling of access networks led the industry to consider the
adoption of IMS also for the wireline business, especially for VoIP technology.
In few years, we expect to start experiencing IMS offering Fixed-Mobile
Convergence (FMC), where the same handset will be used in both fixed and mobile
networks and offer identical services to the consumer. This will be the final
step in convergence of all multimedia fixed and mobile networks, offering a
single service platform to all terminals, whether a computer, a PDA, a wireline
phone or a mobile phone. Essentra architecture has followed the guidelines of
IMS/TISPAN, and more adjustments will be needed as implementation of IMS
continues.
INCREASING NEED FOR VOIP INTERCONNECTION: With the dramatic rise in Broadband
infrastructures throughout the world, service provider and end-user demand for
VoIP is growing rapidly. Established global telecommunications service providers
such as British Telecom, AT&T and KDDI have joined new entrants such as Skype
and Vonage, as well as cable operators such as Comcast and Cablevision in
offering IP telephony services. Currently, there are hundreds of VoIP providers
operating throughout the world. Some offer stand-alone telephony service, while
others bundle VoIP with Internet access and video service for a full triple play
suite. With this tremendous growth come a variety of challenges for carriers and
service providers as they either build out their networks or migrate from legacy
TDM technology to an IP-based infrastructure.
Traditional fixed-line service providers are not the only ones migrating to IP,
several leading mobile operators have announced plans to convert to an IP-based
infrastructure in the coming years. The growing implementation of IP
communications, coupled with the emerging fixed-mobile convergence over IP, is
driving the need for more sophisticated infrastructure solutions that can
facilitate smooth deployments and transitions.
Unlike traditional telephony service, there is no single global standard for
VoIP. As such, VoIP implementations are based on a variety of different
standards, making VoIP networks essentially a growing number of islands. In
order to ensure a successful VoIP roll out and generate steady revenues for
providers, these islands need to be connected to one another in a manner that is
secure, reliable and seamless. While traditional architecture was once an
effective way in which to connect multiple islands, it is becoming increasingly
necessary for carriers to rely on IP-based solutions for VoIP interconnection.
The ability for VoIP networks to interconnect directly one to the other is of
paramount importance in the further adoption of VoIP technology. VoIP
interconnect traffic is expect to grow significantly in coming years.
49
HOSTED SERVICES FOR ENTERPRISES: Carriers have usually not succeeded to offer
more than basic services to enterprises. The basic services included E1/T1
trunking with PRI, or Primary Rate Interface (an ISDN link between customer
premises, usually a PBX, and the Class 5 switch) and DID, or Direct Inward
Dialing (which allows to call a person's office telephone extension from an
outside telephone service). Centrex services have been offered by carriers,
mainly in the US, since the early 1980's, but never became a significant
business. Softswitch technology combined with application servers offering a
rich PBX-type set of features and the trends of outsourcing such services, lead
to the re-evaluation of the potential of the new IP-based Centrex services. The
availability of web based self-care services encourages carriers to offer
IP-Centrex as a competing service to IP-PBX solutions. IP technology adds the
ability to combine IP-Centrex with VPN to effectively interconnect multiple
corporate offices from one central location. Considering this, Essentra offers
rich Centrex features combined with VPN capability and corporate level
provisioning tools. The expected size of the IP-Centrex market is currently
unclear, but the feature set is becoming a must in most softswitch deployments.
CONSOLIDATION: In recent years, we have witnessed a consolidation in our
industry. Large service providers are acquiring other service providers, and
large equipment vendors are acquiring smaller vendors, in order to leverage the
benefits of synergies and size and to provide their customers with a more
complete solution. We expect this trend to continue in the future.
OTHER TRENDS: In addition to the foregoing, we have identified the following
trends:
(i) VoIP networks have emerged in many business segments, in both the
carrier and the enterprise market. Due to reasons such as security, protocol
variance and other reasons, these networks are still not linked to each other
using native IP. This has created an opportunity, which the Company is planning
to leverage using the Essentra EX Peering Manager and derivatives of that
product, to provide products that meet the need of VoIP interconnect. This
transition is due in part to the fact that being connected using IP is more
cost-effective than being connected through the PSTN; Essentra EX facilitates
routing between disparate networks and enables optimizing use of network
resources and costs;
(ii) Adoption of a standard IMS (IP Multimedia Subsystem) architecture by
carriers and vendors, including mobile and fixed carriers and networks,
resulting in a new definition of telecom infrastructure, focusing on IP
multimedia service implementation. The Company is continuously looking at the
evolution of IMS and is investigating the further alignment of its solutions
with the functional description described in the standard;
(iii) Convergence between fixed and mobile networks, both on the
infrastructure and the service and business aspects, with respect to which the
Company offers a solution providing some of the elements in an FMC-type (fixed
mobile conveyance) implementation. This trend is characterized by the
unification of infrastructures (including unification at the infrastructure and
service layers); The Company recently began looking at how it can address the
needs specific to mobile operators.
50
5E. OFF-BALANCE SHEET ARRANGEMENTS
There are no off-balance sheet arrangements that have or are reasonably likely
to have a current or future material effect on the company's financial
condition, changes in financial condition, revenues or expenses, results of
operations, liquidity, capital expenditures or capital resources.
5F. TABULAR DISCLOSURE OF CONTRACTUAL OBLIGATIONS
Contractual Obligations Payment Due by Period (in thousands of dollars)
----------------------- -----------------------------------------------------------------
Less than
Total 1 Year 1-3 Years 3-5 years More than 5 Years
----- ------ --------- --------- -----------------
CONTRACTUAL OBLIGATIONS
Short term Debt obligations - tax provision
according to FIN 48 1,275 1,275 - - -
Operating Lease Obligations 1,053 468 585 - -
Other Long Term Liabilities Reflected on
the Registrant's Balance Sheet under U.S.
GAAP 1,945* 552 - - 1,393
Total 4,273 2,295 585 0 1,393
* As of December 31, 2007 we had 1,431 in severance pay funds to cover such
liabilities.
ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES
6.A. DIRECTORS AND SENIOR MANAGEMENT
The following sets forth certain information regarding our directors and
executive officers:
NAME POSITION
---- --------
Joseph Albagli (1) Director, President and Chief Executive Officer
Ilan Rosen (1) Chairman of the Board of Directors
Robert Wadsworth Director
Joseph Atsmon (1)(2) Director
Yoseph Dauber (1)(2) External Director
Eli Gendler Chief Financial Officer
----------
(1) Member of the Compensation Committee
(2) Member of the Audit Committee
51
Set forth below is a biographical summary of the business experience of each of
the Directors and executive officers named above:
JOSEPH ALBAGLI was appointed as a director and as the Company's President and
Chief Executive Officer in November 2005 (following and pursuant to the business
combination). Mr. Albagli is a co-founder of Tdsoft and has served as its
President, Chief Executive Officer and as a director since Tdsoft was founded in
1994. Mr. Albagli has over two decades of technical and management experience
gained prior to founding Tdsoft at Tadiran Telecommunications, the Israeli
Aircraft Industries and the Israel Defense Forces. He received a diploma in
Practical Electronics Engineering from Bosmat, Haifa in 1972, a B.Sc. (cum
laude) in Civil Engineering from the Technion - Israel Institute of Technology
in 1980, and a diploma in Computer Science from the Tel Aviv University in 1989.
ILAN ROSEN was appointed as Chairman of the Board of Directors in November 2005
(following and pursuant to the business combination). He has been a member of
the board of directors of Tdsoft since 1997, and has served as Chairman of
Tdsoft's board of directors since 1997. Mr. Rosen has served as a special
advisor to HarbourVest Partners LLC since March 2003 and is an observer on the
board of directors of Telrad Networks Ltd. and PacketLight Networks Ltd. Between
1989 and 1993, Mr. Rosen served on various boards of directors as a Business
Manager at Polar Investments Ltd., an investment company of Bank Hapoalim Ltd.
From 1993 to 1996, he served as President of Adsha Development & Investments
Ltd., an Israeli investment company that was listed on the Tel Aviv Stock
Exchange, and in that capacity served on various boards of directors. From
November 1996 through January 2004, Mr. Rosen served as Vice President of
Teledata Networks (formerly ADC Telecommunications, Israel and prior thereto
Teledata Communications Ltd.) and in that capacity, in addition to serving as a
board member of Tdsoft, Mr. Rosen served on the board of directors of each of
G-Connect Ltd., VManage Ltd., Mind CTI Ltd. and various other companies. In
early 2000, ADC Telecommunications Inc. launched a project in the name of ADC
Ventures, and Mr. Rosen served as the Managing Director of this project in
Israel. Mr. Rosen received a B.Sc. (cum laude) in mechanical engineering from
Tel Aviv University in 1979, and an M.B.A. from Tel Aviv University in 1986.
ROBERT M. WADSWORTH was appointed as a director in November 2005 (following and
pursuant to the business combination). He is Managing Director of HarbourVest
Partners, LLC. Mr. Wadsworth oversees many of HarbourVest's investment
activities in both the industrial and information technology sectors. He is
currently a director of Network Engines, Inc. and Trintech Group PLC, which are
both public companies. He is also a director of Akibia, AWS Convergence
(Weatherbug), Kinaxis, Loxam and several other U.S. and non-U.S. private
companies. His prior experience includes management consulting with Booz, Allen
& Hamilton, where he specialized in the areas of operations strategy and
manufacturing productivity. Mr. Wadsworth received a B.S. (magna cum laude) in
Systems Engineering and Computer Science from the University of Virginia in 1982
and an MBA (with distinction) from Harvard Business School in 1986.
52
JOSEPH ATSMON was appointed as a director in November 2005 (following and
pursuant to the business combination). He currently serves as Vice-Chairman of
the board of directors of NICE Systems Ltd. and as a director of Ceragon
Networks and Radvision Ltd. From 1995 until 2000, Mr. Atsmon served as Chief
Executive Officer of Teledata Communications Ltd., a public company acquired by
ADC Telecommunications Inc. in 1998. Prior thereto, Mr. Atsmon had a twenty-year
career with Tadiran Ltd. In his last role at Tadiran Ltd., Mr. Atsmon served as
Corporate VP - Business Development. Prior thereto, he served as president of
various military communications divisions. Mr. Atsmon received a B.Sc. in
Electrical Engineering, suma cum laude, from the Technion, Israel Institute of
Technology in 1975.
YOSEPH DAUBER has served as a director of NICE Systems Ltd. since April 2002.
Mr. Dauber has served in various senior positions at Bank Hapoalim since 1973.
Until June 2002, he was Deputy Chairman of the Board of Management and joint
Managing Director of Bank Hapoalim and was responsible for the commercial
division of the bank. Between 1994 and 1996 and until June 2002, Mr. Dauber
served as Chairman of Poalim American Express and of the Isracard Group. From
2002 to 2003, he served as Chairman of the Israel Maritime Bank Ltd. He
currently serves as a director of Bank Hapoalim. He also serves as a director of
Clal Insurance Holding Ltd., Lodzia Rotex Ltd., and Afcon Industries Ltd. Mr.
Dauber holds a Bachelor's degree in Economics and Statistics from the Hebrew
University in Jerusalem and a Masters degree in Law from Bar Ilan University.
Mr. Dauber qualifies as an External Director under the Companies Law.
ELI GENDLER joined VocalTec in June 2006. Prior to joining VocalTec, Mr. Gendler
held a number of key positions, including Chief Financial Officer at each of (i)
Zone IP Ltd. (formerly Ki-Bi Mobile Technologies Ltd.), currently engaged in the
development of Video Over IP products listed on the AIM in London, (ii) Cimatron
Ltd., a developer of software tools listed on NASDAQ, and (iii) IFN, Israel File
Net, listed on the Tel-Aviv Stock Exchange. Mr. Gendler holds a B.A. in
Accounting and Economics from the Tel-Aviv University and a Masters degree in
Law from Bar-Ilan University.
MICHAL EVEN CHEN, who served as an external director of the Company, notified
the Company on July 3, 2008, of her resignation from the Company's board of
directors, effective as of such date.
6.B. COMPENSATION OF DIRECTORS AND EXECUTIVE OFFICERS
The aggregate compensation paid to VocalTec's directors and executive officers
as a group during the fiscal year ended December 31, 2007 was approximately $0.5
million in salaries, directors' fees and bonuses. No additional amounts were set
aside or accrued by the Company or its subsidiaries in 2007 to provide pension
retirement or similar benefits to the directors and executive officers.
53
During the fiscal year ended December 31, 2007, 8,615 options were granted to
each of Joseph Atsmon, Lior Bregman, Yoseph Dauber, Michal Even Chen and Robert
Wadsworth, 19,570 options were granted to Ilan Rosen, and 225,365 options were
granted to Mr. Joseph Albagli, at an exercise price per share of $3.308.
6.C. BOARD PRACTICES
The period during which our directors and senior management have each
served in their respective offices is set forth in "Item 6 - Directors, Senior
Management and Employees - Directors and Senior Management". There is no date of
expiration of the current term of office of any of the senior management
members. The expiration date of the terms of office of our directors are as
follows: (a) Ilan Rosen and Joseph Atsmon - at the annual shareholders meeting
in 2008 (at which time each of them may be re-appointed as a director); (b)
Michal Even-Chen, who was elected as an external director in November 2004, and
was re-appointed for an additional three-year term as an external director at
the annual shareholders meeting in 2007 (resigned from her office as a director
on July 3, 2008); (c) Joseph Albagli and Robert Wadsworth - at the annual
shareholders meeting to be held in 2009 (at which time each of them may be
re-appointed as a director); and (d) Yoseph Dauber, who was elected as an
external director in August 2006, will serve in such position for three years
and may then be appointed for an additional three-year term as an external
director.
There are no service contracts between us or any of our subsidiaries and our
directors in their capacity as directors providing for benefits upon termination
of employment, except for the termination provisions included in the employment
agreement of Joseph Albagli, our President and Chief Executive Officer, which
provide for: (i) the vesting acceleration with respect to a portion of the
options granted to him and (ii) his entitlement, in addition to payment received
during the 90-day notice period, to severance pay and to an amount equal to his
then Basic Salary (as such term is defined in his employment agreement) and the
benefits payable to him under the employment agreement, multiplied by six. In
addition, Mr. Albagli may exercise his options to purchase shares of the Company
during the eighteen-month period following termination of his employment.
In November 2005, we entered into new indemnification agreements with our
directors at such time, in which the Company undertook to indemnify the
directors for the matters and in the circumstances described in such
indemnification agreements, in an aggregate amount of up to $4 million, provided
that if such amount is insufficient to cover all amounts to which such persons
are entitled pursuant to such undertaking of the Company, such amount shall be
allocated among the indemnified persons pro rata to the amounts to which they
are so entitled. During 2007, we entered into similar indemnification agreements
with Messrs. Yoseph Dauber and Lior Bregman, who were elected as directors in
August 2006 (Mr. Bregman was not re-elected as a director of the Company at the
meeting of the Company's shareholders held on November 29, 2007). All the
indemnification agreements provide protection against personal liability due to
an act performed or failure to act in the capacity as a director or officer. In
November 2007, our Board determined that in light of the expansion of the
Company's business, it is appropriate to increase the indemnification coverage
under the directors and officers insurance policy from US$5,000,000 per event
and in the aggregate to US$10,000,000 per event and in the aggregate. Such
increase was approved by our shareholders at the annual shareholders meeting
held on November 29, 2007.
54
Under the Companies Law, the board of directors of any publicly traded company
must also appoint an audit committee, comprised of at least three directors,
including all of the external directors, but excluding:
o the chairman of the board of directors;
o any controlling shareholder or a relative of a controlling
shareholder; and
o any director employed by the Company or who provides services to the
Company on a regular basis.
Our audit committee is comprised of Joseph Atsmon and Yoseph Dauber. We believe
that Mr. Atsmon and Mr. Dauber qualify as audit committee financial experts (as
such term is defined under the US Securities Exchange Act of 1934 (the "Exchange
Act")), and that they qualify as independent directors (as such term is defined
under the Nasdaq rules). The Company will convene an extraordinary general
meeting of shareholders for the approval of the appointment of an external
director further to Michal Even Chen's resignation. The purpose of the audit
committee is to provide assistance to the Board of Directors in fulfilling its
legal and fiduciary obligations with respect to matters involving the
accounting, auditing, financial reporting and internal control functions of
VocalTec and its subsidiaries as well as complying with the legal requirements
under Israeli law and the Sarbanes-Oxley Act of 2002. The following are examples
of functions within the authority of the audit committee:
o To detect irregularities in the management of our business and our
internal controls procedures through, among other things, consultation
with our internal and external auditors and to suggest to the Board of
Directors methods to correct those irregularities.
o To decide whether to approve acts or transactions involving directors,
executive officers, controlling shareholders and third parties in
which directors, executive officers or controlling shareholders have
an interest.
o To assist our Board of Directors in performing its duties to oversee
our accounting and financial policies, internal controls, and
financial reporting practices and to communicate on a regular basis
with the company's outside auditors and review their operation and
remuneration.
o To maintain and facilitate communication between our Board of
Directors and our financial management and auditors.
In addition, the approval of the audit committee is required to effect specified
actions and transactions with office holders, controlling shareholders and third
parties in which an office holder or controlling shareholder has a personal
interest (as such term is interpreted under Israeli law).
55
An audit committee may not approve an action or a transaction with an office
holder or a controlling shareholder or an entity in which either of them has a
personal interest unless at the time of approval the two external directors are
serving as members of the audit committee and at least one of the external
directors is present at the meeting in which an approval is granted.
Our audit committee usually convenes at least once per quarter to review the
Company's quarterly financial results, and as necessary to resolve issues that
are in the scope of responsibility of the committee.
Our compensation committee is comprised of Joseph Albagli, Yoseph Dauber, Joseph
Atsmon and Ilan Rosen, and meets several times per year regarding option grants
and general compensation issues relating to our employees.
6.D. EMPLOYEES
As of December 31, 2007, we employed 60 full time employees and 4 part-time
employees, of which 33 were employed in research and development, 20 were
employed in sales and marketing, 9 were employed in general and administrative,
and 2 were employed in operations. All of these employees were based in our
facilities in Israel.
We believe that our relations with our employees are good. Neither our employees
nor we are parties to any collective bargaining agreements, except for
provisions of such agreements that are applicable to the industry in which the
Company is engaged by virtue of expansion orders of the Israeli Ministry of
Labor and Welfare issued under applicable Israeli laws.
6.E. SHARE OWNERSHIP
As of July 10, 2008, each of the individuals listed in "Item 6 - Directors,
Senior Management and Employees - Directors and Senior Management" (other than
Mr. Joseph Albagli) beneficially owned less than 1% of our ordinary shares, and
each such person's individual share ownership has not been previously disclosed
to shareholders or otherwise made public.
In the past, each of VocalTec and Tdsoft had adopted various plans for the grant
of options to their employees, directors and consultants. In August 2005, the
board of directors of VocalTec resolved to transfer to the 2003 Master Stock
Option Plan all of the shares then available for grants of options under the
other VocalTec option plans. Pursuant to the business combination, the number of
shares underlying the 2003 Master Stock Option Plan was increased by 576,923
shares and the Company adopted each of Tdsoft's option plans, such that all
outstanding options granted under the various Tdsoft option plans to purchase
ordinary shares of Tdsoft were assumed by VocalTec, except that the Tdsoft
ordinary shares underlying such options were replaced by VocalTec's ordinary
shares in amounts and for exercise prices in accordance with a conversion ratio
set forth in the agreement for the business combination (and which options
continued to be subject, except as set forth herein, to the terms of the Tdsoft
option plans under which they were granted).
56
Following consummation of the business combination, the Company's board of
directors resolved (i) to effect certain amendments to the 2003 Master Stock
Option Plan and (ii) that options granted under older stock option plans shall
revert to the amended 2003 Master Stock Option Plan upon the expiration or
cancellation of such option.
On February 15, 2006, we filed with the U.S. Securities and Exchange Commission
a registration statement on Form S-8, pursuant to which we registered for resale
all of the shares underlying our amended 2003 Master Stock Option Plan that had
not been registered previously. As of the date hereof, the Company has
registered for resale an aggregate of 1,038,461 (reflecting the 1-for-13 reverse
split effected on November 25, 2005) ordinary shares that have been or may in
the future be granted under the Company's option plans. Options generally have a
term of seven (7) years. However, options granted prior to December 13, 2005
have a term of ten (10) years. Earlier termination may occur if the employee's
employment with us is terminated or if certain corporate changes or transactions
occur. Our Board of Directors determines the grant and the exercise price at the
time the options are granted upon recommendation of the Compensation Committee.
The Company's shareholders approved at the extraordinary general meeting of
shareholders held on April 11, 2007, an annual increase of the number of
ordinary shares underlying the Company's 2003 Amended Master Stock Option Plan
by such number of ordinary shares that shall equal 3% of the issued and
outstanding share capital of the Company, on a fully diluted basis, at the time
of the relevant increase, starting in 2008 (each such increase to be effected
immediately following the annual general meeting of the Company's shareholders
in the relevant year). Such 3% increase, will replace, commencing in 2008, the
annual increase of 180,000 shares that was approved by the Company's
shareholders at the annual general meeting held on August 21, 2006 (which is in
effect for 2007).
The exercise price per share is determined by the Board, or the Compensation
Committee, and is usually granted at the approximate fair market value of the
shares on the date of grant, as determined by the closing price of our ordinary
shares as reported by Nasdaq on the business day prior to the date of grant.
Each stock option agreement specifies the date and period over which the option
becomes exercisable. Options granted by us to employees generally vest over a
period of four years, either in equal quarterly installments of 6.25% of the
option shares, starting three months after the date of grant, or 25% of the
option shares are vested one year following option grant, and the remaining 75%
vest in equal quarterly installments of 6.25% over the remaining three years.
Vesting of options granted to employees is conditional upon the grantee
remaining continuously employed by VocalTec or its subsidiaries.
ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS
7.A. MAJOR SHAREHOLDERS
The following table sets forth, as of July 10, 2008, the number of our ordinary
shares, which constitute our only voting securities, beneficially owned by (i)
all shareholders known to us to own more than five percent (5%) of our
outstanding ordinary shares, and (ii) all of our directors and executive
officers as a group.
57
ORDINARY SHARES BENEFICIALLY OWNED
--------------------------
NAME AND ADDRESS NUMBER PERCENT
---------------- --------- ---------
Cisco Systems International BV (1) 1,673,549 22.69%
HarbourVest International Private Equity
Partners III - Direct Fund L.P. (1) (2) 1,218,444 16.32%
Various entities affiliated with Apex (3) 604,231 8.15%
The Israeli Aircraft Industries Workers'
Provident Fund (4) 420,000 5.56%
Officers and directors as a group
(6 persons) (5) 280,272 3.68%
(1) These shareholders are parties to a shareholders agreement dated December
7, 2005, to which certain other shareholders of the Company are parties,
and pursuant to which the parties to such agreement have agreed to vote
their Company shares for the voting of certain persons as directors of the
Company. As a result, the shareholders that are parties to such agreement
may be deemed to constitute a "group" pursuant to Rule 13d-5 of the
Exchange Act. Each of these shareholders disclaims any beneficial ownership
of the Company shares held by the other shareholder party to such
agreement.
(2) Includes 88,000 ordinary shares underlying outstanding warrants that are
currently exercisable.
(3) Includes 360,000 ordinary shares underlying outstanding warrants that are
currently exercisable.
(4) Includes 180,000 ordinary shares underlying outstanding warrants that are
currently exercisable.
(5) Includes 237,934 ordinary shares for which options or warrants granted to
officers and directors of the Company are exercisable within 60 days of the
date hereof.
Our major shareholders do not have different voting rights from each other or
from other shareholders.
To our knowledge, (A) we are not directly or indirectly owned or controlled (i)
by another corporation or (ii) by any foreign government or (iii) by any other
natural or legal persons and (B) there are no arrangements, the operation of
which may at a subsequent date result in a change in control of VocalTec.
For information as to the portion of each class of securities held in the United
States and the number of record holders see "Item 9 - The Offer and Listing".
58
7.B. RELATED PARTY TRANSACTIONS
None.
7.C. INTERESTS OF EXPERTS AND COUNSEL
Not applicable.
ITEM 8. FINANCIAL INFORMATION
8.A. CONSOLIDATED STATEMENTS AND OTHER FINANCIAL INFORMATION
Our consolidated financial statements are set forth in Item 18 of this document.
EXPORT SALES
Export sales of VocalTec in 2007 were $5.6 million or 98% of sales compared with
export sales in 2006 which were $6.7 million or 93% of sales, and with $4.0
million or 87% of sales in 2005.
LEGAL PROCEEDINGS
From time to time, we are involved in various routine legal proceedings
incidental to the ordinary course of our business. We do not believe that the
outcome of these pending legal proceedings will have a material adverse effect
on our business or consolidated financial condition.
DIVIDENDS
We have never declared or paid cash dividends on the ordinary shares. We intend
to retain our earnings for future growth and therefore do not anticipate paying
any cash dividends in the foreseeable future.
8.B. SIGNIFICANT CHANGES
Except as disclosed elsewhere in this annual report, there have been no other
significant changes since December 31, 2007.
ITEM 9. THE OFFER AND LISTING
9.A. OFFER AND LISTING DETAILS
Through July 10, 2008, for the periods indicated, the high and low reported
trading prices on the close of trading of our ordinary shares as reported by
Nasdaq were as follows:
59
HIGH LOW
---------- ----------
2003 7.60 0.47
2004 6.90 1.06
2005 24.7 3.45
2006 10.95 3.07
2007 4.09 0.82
2006
First Quarter 10.95 7.03
Second Quarter 8.72 4.05
Third Quarter 4.51 3.07
Fourth Quarter 5.23 3.2
2007
First Quarter 4.09 3.10
Second Quarter 3.61 2.63
Third Quarter 3.19 1.99
Fourth Quarter 2.15 0.82
MOST RECENT SIX MONTHS
January 2008 0.79 0.37
February 2008 0.75 0.61
March 2008 0.67 0.46
April 2008 0.65 0.45
May 2008 0.60 0.45
June 2008 0.64 0.48
Closing price on the first trading day of:
December 2007 - $1.25
January 2008 - $0.69
February 2008 - $0.75
March 2008 - $0.64
April 2008 - $0.63
May 2008 - $0.50
June 2008 - $0.53
As of July 10, 2008, 7,376,364 of our ordinary shares were issued and
outstanding. At such date, the last reported sale price of the ordinary shares
was $0.45 per share, and the ordinary shares were held by 256 record holders. Of
those 256 record holders, 29 are shown on our records as having United States
addresses. We believe that as of July 10, 2008 approximately 38% of our
outstanding ordinary shares were held in the United States.
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9.B. PLAN OF DISTRIBUTION
Not applicable.
9.C. MARKETS
Our ordinary shares were initially quoted on the Nasdaq National Stock Market on
February 7, 1996 under the symbol "VOCLF," which was changed to "VOCL" on April
20, 1999. Our ordinary shares were quoted on the Nasdaq Stock Market from
October 17, 2000 until December 2002, under the symbol "VOCL". In December 2002,
we transferred to the Nasdaq Capital Market (formerly: Nasdaq SmallCap), in July
2003 we transferred back to the Nasdaq National Market and in April 2005, due to
the fact that we no longer satisfied the minimum stockholders' equity continued
listing requirement of the Nasdaq National Market, we transferred back to the
Nasdaq Capital Market, where our shares continue to be listed under the trading
symbol VOCL. In August 2005, we were notified by Nasdaq Capital Market that we
were not in compliance with its minimum stockholders' equity standard listing
requirements. On November 25, 2005, following the consummation of the
transaction with Tdsoft, and in order for our shares to continue to be listed on
the Nasdaq Capital Market, we effected a 1-for-13 reverse split of our issued
and outstanding share capital, resulting in the par value of our ordinary shares
being increased to NIS 0.13 per share. On November 28, 2005, the Nasdaq Capital
Market informed us that we complied with all initial listing requirements of the
Nasdaq Capital Market. Our shares traded on the Nasdaq Capital Market under the
symbol "VOCLD" from November 28, 2005 through December 27, 2005 and under the
symbol "VOCL" since December 28, 2005. On February 5, 2008, the Nasdaq Capital
Market sent us a Staff Deficiency Letter, indicating that we have failed to
comply with the minimum bid price requirement for continued listing set forth in
Nasdaq's Marketplace Rule 4320(e)(2)(E)(ii). The letter provided that we have
until August 4, 2008 to regain compliance, i.e., that the bid price of our
shares will close at $1.00 per share or more for a minimum of 10 consecutive
business days during the period ending on August 4, 2008. If we are not in
compliance with such rule by August 4, 2008, then we may be afforded a second
180 calendar day grace period provided that we satisfy the Nasdaq Capital
Market's Initial listing criteria (except for the bid price requirement), as set
forth in Marketplace Rule 4320(e)(2)(E)(ii). We are examining several potential
courses of action aimed at regaining compliance with the requirements for
continued listing the Nasdaq Capital Market.
9.D. SELLING SHAREHOLDERS
Not applicable.
9.E. DILUTION
Not applicable.
61
9.F. EXPENSES OF THE ISSUE
Not applicable.
ITEM 10. ADDITIONAL INFORMATION
10.A. SHARE CAPITAL
Not applicable
10.B. MEMORANDUM AND ARTICLES OF ASSOCIATION
VocalTec is a public company organized in the State of Israel under the
Companies Law. We are registered with the Registrar of Companies of the State of
Israel and have been assigned company number 52-004262-3.
OBJECTS AND PURPOSES
The objects and purposes of our company are to engage in any legal occupation
and/or business.
RIGHTS, PREFERENCES AND RESTRICTIONS UPON SHARES
Our articles of association authorize one class of shares, which are our
ordinary shares. We may declare a dividend to be paid to the holders of our
ordinary shares according to their rights and interests in our profits. Our
board may declare interim dividends and a final dividend for any fiscal year
only out of retained earnings, or earnings derived over the two most recent
fiscal years, whichever is higher. The Companies Law and our articles provide
that our board may declare and pay dividends (subject to certain limitations)
without any further action by our shareholders. All unclaimed dividends may be
invested or otherwise used by the board for our benefit until those dividends
are claimed. In the event an unclaimed dividend is claimed, only the principal
amount of the dividend will be paid to the person entitled to the dividend.
Subject to the creation of any special rights regarding the distribution of
dividends, any dividends we declare will be distributed to shareholders in
proportion to their holdings.
If we liquidate, after satisfying liabilities to creditors, our assets will be
distributed to the holders of ordinary shares in proportion to their holdings.
Holders of ordinary shares have one vote for each paid-up ordinary share on all
matters submitted to a vote of our shareholders. These voting rights may be
affected by the grant of any special voting rights to the holders of a class of
shares with preferential rights that may be authorized in the future.
Our articles provide that directors are elected by an ordinary resolution of a
general meeting of our shareholders. Our ordinary shares do not have cumulative
voting rights in the election of directors. Accordingly, the holders of ordinary
shares representing more than 50% of the voting power in our company have the
power to elect all directors. However, our board of directors (other than the
external directors) is divided into three classes, the members of each of which
are elected for a three-year term.
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We may, subject to the applicable provisions of the Companies Law, issue
redeemable shares and subsequently redeem them. In addition, our board may make
calls upon shareholders in respect of any sum, which has not been paid up in
respect of any shares held by those shareholders.
Under the Companies Law, the disclosure requirements that apply to an office
holder and are described below under "Approval of Related Party Transactions
Under Israeli Law" also apply to a controlling shareholder of a public company.
A shareholder that holds more than 50% of the voting rights in a public company
is deemed to be a controlling shareholder. A shareholder that holds more than
25% of the voting rights in a public company may also be deemed to be a
controlling shareholder, for purposes of approval of certain related party
transactions, if there is no other shareholder holding more than 25% of the
voting rights at such time. Extraordinary transactions with a controlling
shareholder or in which a controlling shareholder has a personal interest, and
the terms of compensation of a controlling shareholder who is an office holder,
require the approval of the audit committee, the board of directors and the
shareholders of the company, in such order, provided that either (i) the
shareholder approval includes the approval of the holders of at least one third
of the shares of shareholders having no personal interest in the transaction who
vote at the meeting, or (ii) the total number of shares of shareholders having
no personal interest in the transaction who vote against the transaction does
not exceed one percent of the aggregate voting rights in the company.
The Companies Law also requires a shareholder to act in good faith towards a
company in which he holds shares and towards other shareholders and to refrain
from abusing his power in the company, including in connection with the voting
at a shareholders' meeting on:
o Any amendment to the articles of association;
o An increase in the company's authorized capital;
o A merger; or
o Approval of certain transactions with control person and other related
parties, which require shareholder approval.
A shareholder has the general duty to refrain from depriving other shareholders
of their rights. Any controlling shareholder, any shareholder that knows that it
possesses the power to determine the outcome of a shareholder vote and any
shareholder that, under the provisions of the articles of associations, has the
power to appoint an office holder in the company, is under a duty to act in
fairness towards the company. The Companies Law does not describe the substance
of this duty (except by providing that the remedies generally available upon a
breach of contract will be available also in the event of a breach of the duty
to act with fairness) and such substance has not yet been adjudicated by Israeli
courts.
63
MODIFICATIONS OF SHARE RIGHTS
Under our articles of association, the rights attached to any class may be
varied by adoption of the necessary amendment of the articles, provided that the
holders of shares of the affected class approve the change by a class meeting in
which the holders of at least 75% of the voting power represented at the meeting
and voting on the issue approve the change. Our articles differ from the
Companies Law in this respect as under the law, changes in the rights of
shareholders require the consent of more than 50% of the voting power of the
affected class represented at the meeting and voting on the change.
SHAREHOLDERS MEETINGS AND RESOLUTIONS
We are required to hold an annual general meeting of our shareholders once every
calendar year, but no later than 15 months after the date of the previous annual
general meeting. All meetings other than the annual general meeting of
shareholders are referred to as extraordinary general meetings. Extraordinary
general meetings may be called by our board whenever it sees fit, at such time
and place, within or without the State of Israel, as the board may determine. In
addition, the Companies Law provides that the board of a public company is
required to convene an extraordinary meeting upon the request of (a) any two
directors of the company or one quarter of the company's board of directors or
(b) one or more shareholders holding, in the aggregate, (i) five percent of the
outstanding shares of the company and one percent of the voting power in the
company or (ii) five percent of the voting power in the company.
The quorum required for a meeting of shareholders consists of at least two
shareholders present in person or by proxy who hold or represent between them at
least 33.3% of our issued share capital. A meeting adjourned for lack of a
quorum is adjourned to the same day in the following week at the same time and
place or any time and place as the chairman of the meeting determines. At such
reconvened meeting, the required quorum consists of any two shareholders present
in person or by proxy.
Notwithstanding the foregoing, our articles provide that a resolution in writing
signed by all our shareholders then entitled to attend and vote at general
meetings or to which all such shareholders have given their written consent (by
letter, telegram, facsimile or otherwise) shall be deemed to have been
unanimously adopted by a duly convened general meeting.
Our articles enable our board to fix a record date to allow us to determine the
shareholders entitled to notice of, or to vote at, any general meeting of our
shareholders. The record date may not be more than 40 days and not less than
four days before the date of the meeting. Each shareholder of record as of the
record date determined by the board may vote the shares then held by that
shareholder unless all calls and other sums then payable by the shareholder in
respect of its shares have not been paid.
LIMITATION ON OWNERSHIP OF SECURITIES
The ownership and voting of our ordinary shares by non-residents of Israel are
not restricted in any way by our articles or by the laws of the State of Israel,
except for shareholders who are subjects of countries that are enemies of the
State of Israel.
64
MERGERS AND ACQUISITIONS; TENDER OFFERS; ANTI-TAKEOVER PROVISION
The Companies Law includes provisions allowing corporate mergers. These
provisions require that the board of directors of each company that is party to
the merger approve the transaction. In addition, the shareholders of each
company must approve the merger by a vote of the majority of the company's
shares, present and voting on the proposed merger at a shareholders' meeting,
called on at least 35 days' prior notice. In determining whether the requisite
majority has approved the merger, shares held by the other party to the merger
or any person holding at least 25% of such other party, are excluded from the
vote. If the merger would have been approved but for the exclusion of the votes
of certain shareholders as provided above, a court may still approve the merger
upon the request of holders of at least 25% of the voting rights of a company,
if the court holds that the merger is fair and reasonable, taking into account
the value of the parties to the merger and the consideration offered to the
shareholders. 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, and the court may also provide instructions to assure the rights of
creditors. In addition, a merger may not be completed unless at least 50 days
have elapsed from the date that a proposal for approval of the merger was filed
with the Israel Registrar of Companies and at least 30 days have elapsed from
the date that shareholder approval of both merging companies was obtained.
Notwithstanding the foregoing, a merger is not subject to shareholders approval
if (i) the target company is a wholly-owned subsidiary of the acquiring company
and (ii) the acquiring company is issuing to the shareholders of the target
company up to 20% of its share capital and no person will become, as a result of
the merger, a control person, subject to certain limitation relating to the
counting of the votes, at a meeting of the shareholders of a company that is a
party to the merger, of any entity or person that is either the other party to
the merger or a control person thereof.
The Companies Law also provides that, except in certain circumstances set forth
in the Companies Law, the acquisition of shares in a public company must be made
by means of a special tender offer if, as a result of the acquisition, the
purchaser would become a 25% shareholder of the company. The rule does not apply
if there already is another 25% shareholder of the company. Similarly, the law
provides that an acquisition of shares in a public company must be made by means
of a special tender offer if, as a result of the acquisition, the purchaser
would become a 45% shareholder of the company, unless there already is a 45%
shareholder of the company. These requirements do not apply if, in general, the
acquisition (1) was made in a private placement that received the approval of
the company's shareholders; (2) was from a 25% or greater shareholder of the
company which resulted in the acquirer becoming a 25% or greater shareholder of
the company, or (3) was from a 45% or greater shareholder of the company which
resulted in the acquirer becoming a 45% or greater shareholder of the company.
The tender offer must be extended to all shareholders, but the offeror is not
required to purchase more than 5% of the company's outstanding shares,
regardless of how many shares are tendered by shareholders (if more shares are
tendered than proposed by the purchaser to be purchased, the purchaser will
purchase shares from all tendering shareholders the amount of shares proposed by
the purchase to be purchased, on a pro rata basis). The tender offer may be
consummated only if (i) at least 5% of the company's outstanding shares will be
acquired by the offeror, and (ii) the number of shares tendered in the offer
exceeds the number of shares, the holders of which objected to the offer.
65
If, following any acquisition of shares, the purchaser would hold 90% or more of
the shares of the company, such acquisition must be made by means of a tender
offer for all of the target company's shares. An acquirer who wishes to
eliminate all minority shareholders must do so by means of a tender offer and
acquire such amount of shares that will cause him to hold at least 95% of the
outstanding shares of the target company. If less than 5% of the outstanding
shares are not tendered, all of the shares that the acquirer offered to purchase
will be transferred to the acquirer by operation of law. The Companies Law
provides for appraisal rights if any shareholder files a request in court within
three months following the consummation of a full tender offer. If more than 5%
of the outstanding shares are not tendered in the tender offer, the acquirer may
not acquire tendered shares if by doing so the acquirer would own more than 90%
of the outstanding shares of the target company.
Our articles contain provisions that could delay, defer or prevent a change in
our control. These provisions include advance notice requirements and a
staggered board. Under the advance notice requirements, shareholders seeking to
propose items for inclusion on the agenda for a general meeting of shareholders,
must submit those items in writing to our corporate secretary not less than 60
days (or not less than 90 days for the nomination of candidates for election of
directors) and not more than 120 days prior to the particular meeting. The
staggered board provisions of our articles are described above under "Item 6 -
Directors, Senior Management and Employees - Board Practices"
BOARD PRACTICES
Under our articles of association, our board can, at its discretion, cause the
Company to borrow money or secure the payment of any sum upon terms and
conditions it deems fit. The board can utilize this power through various
methods, including the issuance of bonds or debentures, or mortgages, charges or
other securities on the whole of the Company or any part of it.
Our directors are not subject to any age limit requirement, nor are they
disqualified from serving on the board because of a failure to own VocalTec
shares.
Directors (other than external directors) are classified into three classes.
Each class has a nearly equal number of directors, as determined by the Board of
Directors. The terms for these classes of directors will expire at the annual
shareholder meetings in 2008, 2009 and 2010. At each shareholders' meeting, the
successors of each class of directors whose terms expire are elected to hold
office for a term expiring at the annual shareholders meeting held in the third
year following the year of their election. The staggered board structure may not
be amended without the approval of the greater of (i) holders of not less than
75% of the voting power represented at a shareholders' meeting in person or by
proxy and voting thereon, or (ii) holders of a majority of the outstanding
voting power of all shares of the Company.
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EXTERNAL DIRECTORS
We are subject to the provisions of the Companies Law. Under the Companies Law,
companies incorporated under the laws of the State of Israel whose shares have
been offered to the public in or outside of Israel are required to appoint at
least two external directors. Certain regulations promulgated under the
Companies Law set out the conditions and criteria for a director qualifying as
having a "financial and accounting expertise" or a "professional qualification".
A director with financial and accounting expertise is a director who, due to his
education, experience and skills, possesses capabilities relating to and an
understanding of business and accounting matters and financial statements, which
enable him 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 a professional qualification 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, (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. A
proposed external director must submit to the company a declaration as to his or
her compliance with the requirements for his or her election as an external
director (including with respect to such person's financial and according
expertise or professional qualification). At least one of the external directors
should have a "financial and accounting expertise" and the other external
directors should have a "professional qualification". The board of directors
should determine the minimum number of directors who should have financial and
accounting expertise in addition to at least one external director. In
determining such number, the board of directors shall consider, among other
things, the type and size of the company and the scope and complexity of its
operations. The Companies Law provides that a person may not be appointed as an
external director 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 external director, or had, at any time 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 the
controlling entity of the company. The term "affiliation" includes:
o an employment relationship;
o a business or professional relationship maintained on a regular basis;
o control; and
o service as an office holder (other than as a director that has been
appointed as an external director of a company that is intending to
consummate its initial public offering).
"Office holder" is defined as a director, general manager, chief business
manager, deputy general manager, vice general manager, executive vice president,
vice president, other manager directly subordinate to the general manager or any
other person assuming the responsibilities of any of the foregoing positions,
without regard to such person's title.
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In addition, no person can serve as an external director if the person's
position or other business activities create, or may create, a conflict of
interest with the person's responsibilities as an external director or may
otherwise interfere with the person's ability to serve as an external director.
Until the lapse of two years from termination of office, a company may not
engage a former external 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.
External directors are to be elected by a majority vote at a shareholders'
meeting, provided that either (i) the shareholder approval includes the approval
of the holders of at least one third of the shares of non-controlling
shareholders who vote at the meeting or (b) the total number of shares of
non-controlling shareholders who vote against the transaction does not exceed
one percent of the aggregate voting rights in the company.
The initial term of an external director is three years, and he or she may be
reelected to one additional term of three years. External directors may be
removed only by the same percentage of shareholders as is required for their
election, or by a court, and then only if the external directors cease to meet
the statutory qualifications for their appointment or if they violate their duty
of loyalty to the company. If an external directorship becomes vacant, our board
of directors is required under the Companies Law to call a shareholders' meeting
immediately to appoint a new external director. Each committee of a company's
board of directors that has the power to exercise discretion of the board is
required to include at least one external director, and all external directors
have to be members of the company's audit committee. If at the time of
appointment of an external director all of the members of the board of directors
are of one gender, the appointed external director must be of the other gender.
External directors are entitled to compensation as provided in regulations
promulgated under the Companies Law and are otherwise prohibited from receiving
any other compensation, directly or indirectly, from the company.
INDEPENDENT DIRECTORS
We are subject to the rules of Nasdaq applicable to listed companies. Under the
Nasdaq rules, a majority of our board of directors must be comprised of
independent directors and we are required to appoint a minimum of three
independent directors. The independence standard under the Nasdaq rules excludes
current employees, former employees of a company or of any of its affiliates for
a period of three years after cessation of employment, as well as any immediate
family member of an executive officer of a company or of any of its affiliates.
Four of our current directors meet the independence standards of the Nasdaq
rules and we currently comply with the foregoing requirements.
AUDIT COMMITTEE
See "Item 6 - Directors, Senior Management and Employees - Board Practices".
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INTERNAL AUDITOR
The Companies Law also requires us to appoint an internal auditor nominated by
the audit committee. The role of the internal auditor is to examine, among other
matters, whether the company's actions comply with the law and orderly business
procedure. Under the Companies Law, the internal auditor may not be an
interested party, an office holder or an affiliate, or a relative of an
interested party, an office holder or an affiliate, nor may the internal auditor
be the company's independent accountant or its representative. In October 2000,
VocalTec (prior to the business combination) appointed the firm of Brukner
Ingber as the company's internal auditor in accordance with the requirements of
the Companies Law.
APPROVAL OF RELATED PARTY TRANSACTIONS UNDER ISRAELI LAW
The Companies Law imposes a duty of care and a duty of loyalty on all of a
company's office holders (as defined under "External Directors" above),
including directors and executive officers. The duty of care requires an office
holder to act with the level of care that a reasonable office holder in the same
position would have acted under the same circumstances. The duty of loyalty
generally requires an office holder to act in good faith and for the benefit of
the company.
The Companies Law requires that an office holder of a company promptly disclose
any personal interest that he may have and all related material information
known to him, in connection with any existing or proposed transaction
contemplated by the company. Once an office holder complies with these
disclosure requirements, the board of directors may approve a transaction
between the company and the office holder, or a third party in which an office
holder has a personal interest, unless the articles of association provide
otherwise.
A transaction that is adverse to the company's interest cannot be approved. If
the transaction is an extraordinary transaction under the Companies Law, then,
in addition to any approval stipulated by the articles of association, it also
requires audit committee approval before board approval and, in certain
specified circumstances, subsequent shareholder approval.
Under the Companies Law, the disclosure requirements that apply to an office
holder also apply to a controlling shareholder of a public company. A
controlling shareholder includes a shareholder that holds 25% or more of the
voting rights in a public company if no other shareholder owns more than 50% of
the voting rights in the company. A shareholder that holds more than 25% of the
voting rights in a public company may also be deemed to be a controlling
shareholder, for purposes of approval of certain related party transactions, if
there is no other shareholder holding more than 25% of the voting rights at such
time. Extraordinary transactions with a controlling shareholder or in which a
controlling shareholder has a personal interest, and the terms of compensation
of a controlling shareholder who is an office holder, require the approval of
the audit committee, the board of directors and the shareholders of the company,
provided that either (i) the shareholder approval includes the approval of the
holders of at least one third of the shares of shareholders having no personal
interest in the transaction who vote at the meeting or (ii) the total number of
shares of shareholders having no personal interest in the transaction who vote
against the transaction does not exceed one percent of the aggregate voting
rights in the company.
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Under the Companies Law, the entering by a company into a contract with a non
controlling director as to the terms of his office, requires the approval of the
board of directors followed by the approval of the shareholders of the company,
and in a public company, the transaction requires the approval of the audit
committee followed by the approval of the board of directors and the
shareholders of the company.
A director who has a personal interest in the approval of a transaction that is
submitted to approval of the audit committee or the board of directors shall not
be present during the deliberations and shall not take part in the voting of the
audit committee or of the board of directors on such transaction.
Notwithstanding the above, a director may be present at a deliberation of the
audit committee and the board of directors and may take part in the voting, if
the majority of the members of the audit committee or the board of directors, as
the case may be, have a personal interest in the approval of the transaction, in
which case the transaction shall also require the approval of the shareholders
of the company.
EXEMPTION, INSURANCE AND INDEMNIFICATION OF DIRECTORS AND OFFICERS
EXEMPTION
Under the Companies Law, an Israeli company may not exempt an office holder from
liability with respect to a breach of his duty of loyalty, but may exempt in
advance an office holder from his liability to the company, in whole or in part,
with respect to a breach of his duty of care (other than with respect to a
breach of duty of care with respect to the distribution of a dividend or
redemption of the company's securities). Under the Companies Law, a company may
not indemnify an office holder, nor enter into an insurance contract that would
provide coverage for any monetary liability incurred as a result of any of the
following:
o a breach by the office holder of his duty of loyalty, unless the
office holder acted in good faith and had a reasonable basis to
believe that the act would not prejudice the company;
o a breach by the office holder of his duty of care, if such breach was
done intentionally or in disregard of the circumstances of the breach
or its consequences, other than a breach committed solely by
negligence;
o any act or omission done with the intent to derive an illegal personal
benefit; or
o any fine levied against the office holder as a result of a criminal
offense.
OFFICE HOLDER INSURANCE
Our Articles of Association provide that, subject to the provisions of the
Companies Law, we may enter into a contract for the insurance of the liability
of any of our office holders with respect to:
o a breach of his duty of care to us or to another person;
70
o 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
o a financial liability imposed upon him in favor of another person
concerning an act performed by him in his capacity as an office
holder.
INDEMNIFICATION OF OFFICE HOLDERS
Our Articles of Association provide that we may indemnify an office holder
against:
o a financial liability imposed on him in favor of another person by any
judgment, including a settlement or an arbitrator's award approved by
a court concerning an act performed in his capacity as an office
holder;
o reasonable litigation expenses, including attorneys' fees, expended by
the office holder or charged to him by a court, in proceedings we
institute against him or instituted on our behalf or by another
person, or in a criminal charge from which he was acquitted, or in
which he was convicted of an offence that does not require proof of
criminal intent; or
o reasonable litigation expenses, including attorneys' fees, expended by
the office holder as a result of an investigation or proceeding
instituted against him by an authority authorized to conduct such
investigation or proceeding, provided that (i) no indictment (as
defined in the Companies Law) was filed against such office holder as
a result of such investigation or proceeding, and (ii) no financial
liability as a substitute for the criminal proceeding (as defined in
the Companies Law) was imposed upon him as a result of such
investigation or proceeding or if such financial liability was
imposed, it was imposed with respect to an offence that does not
require proof of criminal intent.
Under the Companies Law, our Articles of Association may also include a
provision authorizing us to grant in advance an undertaking to indemnify an
office holder, provided that the undertaking 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 to indemnify is made and for
such amounts or criteria which the board of directors may, at the time of the
giving of such undertaking to indemnify, deem to be reasonable under the
circumstances. Such undertaking shall set forth 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 to indemnify is made, and the amounts
and/or criteria which the board of directors may, at the time of the giving of
such undertaking to indemnify, deem to be reasonable under the circumstances;
and a provision authorizing us to retroactively indemnify an office holder.
REQUIRED APPROVALS
In addition, under the Companies Law, indemnification of, and procurement of
insurance coverage for, our office holders, must be approved by our audit
committee and our board of directors and, with respect to directors, by our
shareholders.
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THRESHOLD FOR DISCLOSURE OF SHARE OWNERSHIP
We are subject to the rules of the US Securities and Exchange Commission, and
our shareholders are subject to the requirements under Section 13 of the
Exchange Act with respect to disclosure of their holding percentage in the
Company. Under such Section and the rules promulgated thereunder, each of our
shareholders that owns 5% or more of our outstanding share capital must file
with the US Securities and Exchange Commission a form disclosing such
shareholder's holding percentage and certain other information (and provide us
with a copy of such form).
CERTAIN LISTING REQUIREMENTS OF NASDAQ
We are not in compliance with Nasdaq Marketplace Rules 4350(c)(4)(B) (requiring
companies to adopt a formal written charter or board resolution addressing the
company's nominations process), 4350(c)(2) (Regularly scheduled meetings of the
company's independent directors) and 4350(i)(1)(A) (Regarding the establishment
of or a material amendment to a stock option or purchase plan or other equity
compensation arrangement). Under Israeli law, the nominations process is
conducted by the full board of directors. Similarly, under Israeli law all
matters that are subject to the approval of a company's board of directors are
discussed by the full board of directors. Finally, under Israeli law the board
of directors has the authority to establish stock option or purchase plans or
other equity compensation arrangements, and to adopt material amendments to such
plans.
10.C. MATERIAL CONTRACTS NOT IN THE ORDINARY COURSE OF BUSINESS
o On May 28, 2008, the Company entered into a patent purchase agreement,
pursuant to which the Company agreed to sell 11 patents and certain
patent-related rights, out of the Company's portfolio of 22 patents,
for an aggregate consideration of $12.5 million. The patents to be
sold consist of nine US patents, one Israeli patent and one Australian
patent. On July 13, 2008, the OCS approved the consummation of the
foregoing sale, subject to the payment to the OCS of approximately
$2.08 million. The Company expects to consummate the foregoing sale
shortly following the filing of this annual report. Upon consummation
of the transaction, VocalTec will be granted a geographically
unlimited, non-exclusive license to use the sold patents and other
patent-related rights in connection with the development and marketing
of its products.
o On November 27, 2006, we received and accepted orders from Israeli
institutional investors for a private placement of 1,750,000 ordinary
shares at a price of $4.3 per share. As part of the offering, the
Company issued to the investors warrants exercisable during a period
ending on June 30, 2011 into 1,312,500 additional ordinary shares at
an exercise price per share of $5.5.
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10.D. EXCHANGE CONTROLS
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 shares, except for the obligation of Israeli residents
to file reports with the Bank of Israel regarding certain transactions. However,
legislation remains in effect, pursuant to which currency controls can be
imposed by administrative action at any time.
Non-residents of Israel who purchase our securities with non-Israeli currency
will be able to repatriate dividends (if any), liquidation distributions and the
proceeds of any sale of such securities, into non-Israeli currencies at the rate
of exchange prevailing at the time of repatriation, provided that any applicable
Israeli taxes have been paid (or withheld) on such amounts.
Neither our Articles of Association nor the laws of the State of Israel restrict
in any way the ownership or voting of ordinary shares by non-residents of
Israel, except with respect to citizens of countries that are in a state of war
with Israel.
10.E. TAXATION AND GOVERNMENT PROGRAMS
The following is a summary of the current tax structure, which is applicable to
companies in Israel, with special reference to its effect on us and our group
companies. The following also contains a discussion of material Israeli and U.S.
tax consequences to our shareholders and government programs from which we, and
some of our group companies, benefit. The following also contains a discussion
of certain Israeli and U.S. tax consequences to persons purchasing our ordinary
shares. To the extent that the discussion is based on new tax legislation, which
has yet to be subject to judicial or administrative interpretation, there can be
no assurance that the views expressed in the discussion will accord with any
such interpretation in the future. The discussion is not intended and should not
be construed as legal or professional tax advice and is not exhaustive of all
possible tax considerations.
In July 2002, the Israeli Parliament approved a law enacting extensive changes
to Israel's tax law (the "Tax Reform Legislation") generally effective January
1, 2003. Among the key provisions of the Tax Reform Legislation were (i) changes
which may result in the imposition of taxes on dividends received by an Israeli
company from its foreign subsidiaries; and (ii) the introduction of the
"controlled foreign corporation" concept according to which an Israeli company
may become subject to Israeli taxes on certain income of a non-Israeli
subsidiary if the subsidiary's primary source of income or profit is passive
income (such as interest, dividends, royalties, rental income or capital gains).
An Israeli company that is subject to Israeli taxes on the income of its
non-Israeli subsidiaries may receive a credit for certain income taxes
paid/withheld or that will be paid/withheld by the subsidiary in its country of
residence, according to the terms and conditions determined in the Israeli Tax
Ordinance.
The following summary is included herein as general information only and is not
intended as a substitute for careful tax planning. Accordingly, each investor
should consult his or her own tax advisor as to the particular tax consequences
to such investor of the purchase, ownership or sale of an ordinary share,
including the effect of applicable state, local, foreign or other tax laws and
possible changes in tax laws.
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ISRAEL CORPORATE TAX CONSIDERATIONS
GENERAL CORPORATE TAX STRUCTURE
The regular rate of corporate tax, which Israeli companies were subject to in
2007 was 29% (such tax rate has been reduced to 27% in 2008 and will be reduced
further to 26% in 2009 and 25% in 2010). However, the effective rate of tax
payable by a company (such as ours) which derives income from an "Approved
Enterprise" (as further discussed below) may be considerably lower.
LAW FOR THE ENCOURAGEMENT OF CAPITAL INVESTMENTS, 1959
GENERAL. Certain of our production and development facilities have been granted
approved enterprise status pursuant to the Law for the Encouragement of Capital
Investments, 1959 (the "Investment Law"). The Investment Law provides that a
capital investment in eligible facilities may, upon application to the
Investment Center of the Ministry of Industry and Trade of the State of Israel,
or the Investment Center, be designated as an Approved Enterprise. Each
certificate of approval for an Approved Enterprise relates to a specific
investment program delineated both by its financial scope, including its capital
sources, and by its physical characteristics, e.g., the equipment to be
purchased and utilized pursuant to the program. The tax benefits derived from
any such certificate of approval relate only to taxable income attributable to
the specific Approved Enterprise.
Subject to certain provisions concerning income and subject to the Alternative
Benefits (see below), any distributed dividends are deemed attributable to the
entire enterprise, and the effective tax rate and the effective withholding tax
rates represent the weighted combination of the various applicable tax rates.
TAX BENEFITS. Taxable income of a company derived from an Approved Enterprise is
subject to corporate income tax at the rate of up to 25% (rather than the tax
rates referred to under "General Corporate Tax Structure" above) for a certain
period of time. The benefit period is a period of seven years commencing in the
year in which the Approved Enterprise first generates taxable income. The
benefits may be shorter as it is limited to 12 years from the commencement of
production of the Approved Enterprise or 14 years from the date of approval,
whichever is earlier. Under certain circumstances (as further detailed below),
the benefit period may extend to a maximum of ten years from the commencement of
the benefit period. A company which operates under more than one approval or
that has capital investments which are only partly approved (such a company
being designated as a Mixed Enterprise), may have an effective company tax rate
that is the result of a weighted combination of the various applicable rates.
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A company owning an Approved Enterprise which was approved after April 1, 1986,
may elect to forego the entitlement to grants or state guarantees and apply for
an alternative package of tax benefits. These benefits provide that
undistributed income from the Approved Enterprise is fully tax exempt from
corporate tax for a defined period, which ranges between two and ten years from
the first year of taxable income, subject to the limitations described above,
depending principally upon the geographic location within Israel and the type of
the approved enterprise. Upon expiration of such period, the Approved Enterprise
is eligible for a beneficial tax rate (25% or lower in the case of an FIC, as
described below), for the remainder of the otherwise applicable period of
benefits, as described above.
Should the percentage of share capital of the companies having Approved
Enterprises held by non - Israeli shareholders exceed 25%, future Approved
Enterprises of such companies would qualify for reduced tax rates for an
additional three years period, after the seven years mentioned above.
The company tax rate applicable to income earned from Approved Enterprise
programs (currently, for programs on which an application for an approved
enterprise status was submitted before December 31, 2004) in the benefit period
by a company meeting these qualifications is as follows:
PERCENTAGE OF NON - ISRAELI OWNERSHIP TAX RATE
------------------------------------- --------
Over 25% but less than 49% 25%
49% or more but less than 74% 20%
74% or more but less than 90% 15%
90% or more 10%
Entitlement to these benefits is subject to the final ratification of the
Investment Center, and is conditioned upon fulfillment of all terms of the
approved program. However, there can be no assurance that our group companies
which enjoy Approved Enterprise benefits will obtain approval for additional
Approved Enterprises, or that the provisions of the Investment Law will not
change with respect to future approvals, or that the above-mentioned
shareholding portion will be reached for each subsequent year. In the event of
our failure to comply with these conditions, the tax and other benefits could be
canceled, in whole or in part, and we might be required to refund the amount of
the canceled benefits, together with the addition of CPI linkage difference and
interest. We believe that our Approved Enterprise substantially complies with
all such conditions at present, but there can be no assurance that it will
continue to do so.
The undistributed income derived from each of our approved enterprise programs
is tax-exempt for a two year period beginning with the first year in which it
generates otherwise taxable income and is subject to a reduced tax rate for the
remainder of the benefit period.
A company that pays a dividend out of income derived from the Approved
Enterprise(s) during the tax exemption period will be required to recapture the
deferred corporate income tax applicable to the amount distributed (grossed up
to reflect such tax) at the rate which would have been applicable had such
company not elected the Alternative Package. This rate is generally 10% to 25%,
depending on the extent to which non-Israeli shareholders hold such company's
shares.
The dividend recipient is taxed at the reduced rate applicable to dividends from
Approved Enterprises (generally 15% as compared to 25% for individuals or an
exemption for companies), if the dividend is distributed during the tax benefit
period or within 12 years after this period. However, the limitation does not
apply if the company qualifies as a foreign investors' company. This tax must be
withheld by such company at source, regardless of whether the dividend is
converted into foreign currency.
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Subject to certain provisions concerning income subject to Mixed Enterprises,
all dividends are considered to be attributable to the entire enterprise and the
effective tax rate on the dividend is the result of a weighted combination of
the various applicable tax rates. However, such company is not obliged to
distribute exempt retained profits under the Alternative Package, and such
company may generally decide from which year's profits to declare dividends.
Each application to the Investment Center is reviewed separately, and a decision
as to whether or not to approve such application is based, among other things,
on the then prevailing criteria set forth in the Investment Law, on the specific
objectives of the applicant company set forth in such application and on certain
financial criteria of the applicant company. Accordingly, there can be no
assurance that any such application by any of our group companies will be
approved. In addition, the benefits available to an Approved Enterprise are
conditional upon the fulfillment of certain conditions stipulated in the
Investment Law and its regulations and the criteria set forth in the certificate
of approval, as described above. In the event that these conditions are
violated, in whole or in part, a company with an Approved Enterprise would be
required to refund the amount of tax benefits, with the addition of the Israeli
consumer price index linkage differences and interest.
A company which qualifies as a foreign investment company (FIC) is a company,
like us, in which more than 25% of the share capital (in terms of shares, rights
to profit, voting and appointment of directors) and of the combined share and
loan capital is owned, directly or indirectly, by non-residents of Israel and is
therefore entitled to further tax benefits relating to its approved enterprises.
Such a company will be eligible for an extension of the period of tax benefits
for its approved enterprises (up to ten years) and further tax benefits, should
the level of non - Israeli ownership in it increase above 49%.
Notwithstanding the foregoing, proceeds received from the sale of our products
may be deemed to be royalties under the domestic law of the country of residence
of the purchaser/licensee or under an applicable tax treaty and as such subject
to withholding tax in such country. For instance, proceeds received by our
company from the sale of our software in the United States might be treated as
royalties and as such subjected to U.S. withholding tax of either 10% or 15%,
pursuant to the U.S.-Israel Tax Treaty.
Where withholding tax is paid by our company to the country of residence of the
purchaser/licensee, such tax would generally be creditable by our company for
Israeli income tax purposes, pursuant to any relevant income tax treaty and
under Israeli law against income derived from the same source. However, where we
do not have taxable income for Israeli tax purposes because of the application
of a tax exemption available to an Approved Enterprise or because of losses for
tax purposes, we would have no Israeli tax liability against which to credit the
foreign tax withheld and paid by us. Furthermore, under Israeli law, we cannot
carry forward such unused credit to future tax years in the case of exempt
income or have limited ability to carry forward such credit in the case of
taxable income.
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From time to time, the Government of Israel has discussed reducing the benefits
available to companies under the Investment Law. The termination or substantial
reduction of any of the benefits available under the Investment Law could have a
material adverse effect on future investments by our company in Israel.
Notwithstanding the foregoing, on March 29, 2005, the Israeli Parliament passed
an amendment to the Investment Law, which revamps the Israeli tax incentives for
future industrial and hotel investments (the "2005 amendment"). A tax "holiday"
package can now be elected for up to 15 years for a "Privileged Enterprise" as
defined in the 2005 amendment, if certain conditions are met, without needing to
obtain approval. The extent of the tax benefits available depends upon the level
of foreign investment.
The 2005 amendment became effective on April 1, 2005. Taxpayers may, under
certain conditions, claim Privileged Enterprise status for new and expanded
enterprises with respect to 2004 or subsequent years, unless the Investment
Center granted such taxpayer Approved Enterprise status prior to December 31,
2004.
Subject to certain conditions, various alternative tax-only benefit packages can
now be elected with respect to investments in a "Privileged Enterprise", without
prior approval. Companies in industry or tourism in Israel may elect between:
o Tax "holiday" package - for a "Privileged Enterprise": a tax exemption
applies to undistributed profits for 2 to 15 years depending on
geographical location of the "Privileged Enterprise" and the level of
foreign ownership. Company tax rates of between 10% and 25% apply to
distributed exempt profits or profits derived subsequent to the exempt
period. The total period of tax benefits is 7 to 15 years, or
o Grant / Reduced tax package - for an "Approved Enterprise": Fixed
asset grants of between 20% and 32% for enterprises in a development
area and reduced company tax rates between 0% and 25% for 7 to 15
years.
Dividend withholding tax also applies at a rate of 4% or 15% depending on the
package selected.
GRANTS UNDER THE LAW FOR THE ENCOURAGEMENT OF INDUSTRIAL RESEARCH AND
DEVELOPMENT, 1984
Israeli tax laws have allowed, under certain conditions, a tax deduction for
expenditures (including capital expenditures) in scientific research and
development projects, if the expenditures are approved or funded by the Israeli
Government and the research and development is for the promotion of the
enterprise and is carried out by or on behalf of the company seeking such
deduction. Expenditures not approved as above or funded are deductible in equal
portions over a three-year period.
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Under the law for the Encouragement of Industrial Research and Development, 1984
(the "Research Law"), research and development programs that meet specified
criteria and are approved by a committee of the Chief Scientist, are eligible
for grants of up to 50% of the program's expenses. Under the provisions of
Israeli law in effect until 1996, royalties of 2%-3% of the revenues derived in
connection with products developed according to, or as a result of, a research
and development program funded by the Chief Scientist had to be paid to the
State of Israel. Pursuant to an amendment effected in 1996 effective with
respect to Chief Scientist programs funded in or after 1994, royalties at the
rate of 3% during the first three years, 4% over the following three years and
5% in or after the seventh year of the revenues derived in connection with
products developed according to such programs are payable to the State of
Israel. The maximum aggregate royalties will not exceed 100% (or, for funding
prior to 1994, 100%-150%) of the dollar-linked value of the total grants
received. Pursuant to an amendment effected in 2000, effective with respect to
Chief Scientist programs funded in or after 2000, the royalty rates described
above were updated to 3% during the first three years and 3.5% in or after the
fourth year, of the revenues derived in connection with products developed under
such programs. Pursuant to an amendment effected on January 1, 1999, effective
with respect to Chief Scientist programs approved in or after 1999, funds
received from the Chief Scientist shall bear annual interest at a rate equal to
LIBOR for twelve months.
Generally, the Research Law requires that the manufacturing of any product
developed through research and development funded by the Israeli Government
shall be in Israel. It also provides that know-how from the research and
development that is used to produce the product may not be transferred to third
parties without the approval of a research committee of the Chief Scientist.
Such approval is not required for the export of any products resulting from such
research and development.
However, under the Regulations, in the event that any portion of the
manufacturing is not performed in Israel, if approved by the Chief Scientist, we
would be required to pay an increased royalty at the rates of 120%, 150% or 300%
of the grant if the manufacturing portion that is performed outside of Israel is
less than 50%, between 50% and 90% and more than 90%, respectively.
In 2002, the Research Law was amended to, among other things, enable companies
applying for grants from the Chief Scientist to seek prior approval for
conducting manufacturing activities outside of Israel without being subject to
increased royalties. However, this amendment will not apply to any of our
existing grants. In addition, the amendment provides that one of the factors to
be taken into consideration by the Chief Scientist in deciding whether to
approve a grant application is the percentage of the manufacturing of the
relevant product that will be conducted outside of Israel. Accordingly, should
we seek additional grants from the Chief Scientist in connection with which we
also seek prior approval for manufacturing products outside of Israel, we may
not receive such grant or may receive a grant in an amount that is less than the
amount we sought.
In March 2005, an amendment to the Research Law was enacted. One of the main
modifications included in the amendment was an authorization to the research
committee to allow transfer outside of Israel of know-how derived from an
approved program and the related manufacturing rights. Essentially the research
committee may approve transfer of know-how in limited circumstances as follows:
o in the event of a sale of the know-how itself to a non affiliated
third party, provided that upon such sale the owner of the know-how
pays to the Chief Scientist a certain amount of cash payment set forth
in the Research Law. In addition, the amendment provides that if the
purchaser of the know-how gives the selling Israeli company the right
to exploit the know-how by way of an exclusive, irrevocable and
unlimited license, the research committee may approve such transfer in
special cases without requiring the payment of payment of such amount.
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o in the event of a sale of the company which is the owner of the
know-how, pursuant to which the company ceases to be a an Israeli
company, provided that upon such sale the owner of the know-how pays
to the Chief Scientist a certain cash payment set forth in the
Research Law.
o in the event of an exchange of know-how such that in exchange for the
transfer of know-how outside of Israel, the recipient of such know-how
transfers know-how to the company in Israel such that the Chief
Scientist is convinced that the benefit to the Israeli economy as a
result of such exchange is greater then the benefit without such
exchange.
Another provision in the amendment concerns the transfer of manufacture rights.
The research committee may, in special cases, approve the transfer of
manufacture or of manufacturing rights of a product developed within the
framework of the approved program or which results therefrom, outside of Israel.
If the research committee does approve a transfer of manufacturing rights out of
Israel, the aggregate total of royalties' payments under the royalties
regulations increases to an amount of 120%-300% of the grants, depending on the
portion of manufacture transferred. The rates of royalties may also increase
upon "export of manufacturing rights".
LAW FOR THE ENCOURAGEMENT OF INDUSTRY (TAXES), 1969
Pursuant to the Law for the Encouragement of Industry (Taxes), 1969, a company
qualifies as an "Industrial Company" if it is a resident of Israel and at least
90% of its gross income in any tax year (exclusive of income from certain
defense loans, capital gains, interest and dividends) is derived from an
"industrial enterprise" it owns. An "industrial enterprise" is defined as an
enterprise whose major activity, in a given tax year, is industrial
manufacturing.
We believe that we currently qualify as an Industrial Company. Accordingly, we
are entitled to certain tax benefits, including a deduction of 12.5% per annum
on the purchase of patents or certain other intangible property rights (other
than goodwill) used for the development or promotion of the industrial
enterprise over a period of eight years beginning with the year in which such
rights were first used.
The tax laws and regulations dealing with the adjustment of taxable income for
local inflation provide that an industrial enterprise, like us, is eligible for
special rates of depreciation deductions. These rates vary in the case of plant
and machinery according to the number of shifts in which the equipment is being
operated and range from 20% to 40% on a straight-line basis, or 30% to 50% on a
declining balance basis (instead of the regular rates which are applied on a
straight-line basis).
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Moreover, industrial enterprises which are approved enterprises (see below) can
choose between (a) the special rates referred to above and (b) accelerated
regular rates of depreciation applied on a straight-line basis with respect to
property and equipment, generally ranging from 200% (with respect to equipment)
to 400% (with respect to buildings) of the ordinary depreciation rates during
the first five years of service of these assets, provided that the depreciation
on a building may not exceed 20% per annum. In no event may the total
depreciation exceed 100% of the cost of the asset.
In addition, Industrial Companies may (i) amortize the cost of purchased
know-how and patents over an eight-year period for tax purposes, (ii) elect to
file consolidated tax returns with additional related Israeli Industrial
Companies and (iii) deduct expenses related to public offerings in equal amounts
over three-years.
Eligibility for benefits under the Encouragement of Industry Law is not
contingent upon the approval of any governmental authority. No assurance can be
given that we will continue to qualify as an Industrial Company, or will avail
ourselves of any benefits under this law in the future or that Industrial
Companies will continue to enjoy such tax benefits in the future.
EMPLOYEE STOCK OPTIONS
Effective from January 1, 2003, the Tax Reform Legislation enables a company to
grant options through one of three tax tracks:
(a) the income tax track through a trustee pursuant to which the optionee pays
income tax rate (according to the marginal tax rate of the optionee - up to
48% tax) plus payments to the National Insurance Institute and health tax
on the profit gained upon the earlier to occur of the transfer of the
options or the underlying shares from the trustee to the optionee or the
sale of the options or the underlying shares by the trustee, and the
company may recognize expenses pertaining to the options for tax purposes.
The options (or upon their exercise, the underlying shares) must be held by
a trustee for a period of 12 months commencing from the end of the year in
which the options were granted. Options that were granted following January
1, 2006 must be held by a trustee for a period of 24 months commencing on
the date on which the options were granted; or
(b) the capital gains tax track through a trustee pursuant to which the
optionee pays capital gains tax at a rate of 25% on the profit upon, the
earlier to occur of the transfer of the options or the underlying shares
from the trustee to the optionee or the sale of the options or the
underlying shares by the trustee (in this track the optionee is not
required to make payments to the National Insurance Institute and health
tax) and the Company may not recognize expenses pertaining to the options
for tax purposes. Options (or upon their exercise, the underlying shares)
granted Prior to January 1, 2006, must be held by a trustee for either (i)
a period of 24 months commencing from the end of the year in which the
options were granted or (ii) for a period of 30 months commencing on the
date on which the options were granted, at the optionee's discretion and
deposited with the trustee. Options that were granted following January 1,
2006 must be held by a trustee for a period of 24 months commencing on the
date on which the options were granted and deposited with the trustee; or
(c) the income tax track without a trustee pursuant to which the optionee pays
income tax rate (according to the marginal tax rate of the optionee up to
48% tax) plus payments to the National Insurance Institute and health tax
on the profit upon the sale of the underlying shares, and the company may
not recognize expenses pertaining to the options for tax purposes.
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In accordance with the provisions of the Tax Reform Legislation, if a company
has selected the capital gains track, the company must continue granting options
under the selected capital gains track until the end of the year following the
year in which the first grant of options under that trustee track will be made.
Notwithstanding the above, the company may at any time also grant options under
the provisions of the income tax track without a trustee.
The above rules apply only to employees, including officer holders but excluding
controlling shareholders.
TAXATION OF OUR SHAREHOLDERS
CAPITAL GAINS AND INCOME TAXES; ESTATE AND GIFT TAX
Israeli law imposes a capital gains tax on the sale of capital assets. The law
distinguishes between real gain and inflationary surplus. The inflationary
surplus is the portion of the total capital gain that is equivalent to the
increase of the relevant asset's purchase price, which is attributable to the
increase in the Israeli consumer price index between the date of purchase and
the date of sale. Foreign residents who purchased an asset in foreign currency
may request that the inflationary surplus be computed on the basis of the
devaluation of the NIS against such foreign currency. The real gain is the
excess of the total capital gain over the inflationary surplus. The inflationary
surplus accumulated from and after December 31, 1993, is exempt from any capital
gains tax in Israel while the real gain is taxed at the applicable rate
discussed below. Dealers in securities in Israel are taxed at regular tax rates
applicable to business income. Under the convention between the United States
and Israel concerning taxes on income, Israeli capital gains tax will not apply
to the sale, exchange or disposition of ordinary shares by a person:
o who qualifies as a resident of the United States within the meaning of
the U.S.-Israel tax treaty; and
o who is entitled to claim the benefits available to the person by the
U.S.-Israel tax treaty.
However, this exemption does not apply, among other cases, if the gain is
attributable to a permanent establishment of such person in Israel, or if the
holder is a resident of the United States within the meaning of the U.S.-Israeli
tax treaty who holds, directly or indirectly, shares representing 10% or more of
our voting power during any part of the 12-month period preceding the sale,
exchange or disposition, subject to specified conditions. Under these
circumstances, the sale, exchange or disposition would be subject to Israeli
tax, to the extent applicable. However, under the U.S.-Israel tax treaty, a U.S.
resident generally would be permitted to claim a credit for the Israeli taxes
paid against the U.S. federal income tax imposed on the sale, exchange or
disposition, subject to the limitations under U.S. law applicable to foreign tax
credits. The U.S.-Israel tax treaty does not relate to U.S. state or local
taxes. For non-U.S. residents, the purchaser of securities may be required to
withhold a maximum of 20% capital gains tax on all amounts received for the sale
of our securities, for so long as the capital gain from such a sale is not
exempt from Israeli capital gains tax, and unless a different rate is provided
in a treaty between Israel and the seller's country of residence.
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On January 1, 2003, the Law for Amendment of the Income Tax Ordinance
(Amendment No. 132), 5762-2002 (the "Tax Reform"), came into effect thus
imposing capital gains tax at a rate not to exceed 20% on gains derived on or
after 1 January 2003 from the sale of securities in Israeli companies publicly
traded on the Tel-Aviv Stock Exchange ("TASE") or from the sale of shares of an
Israeli company traded on a recognized stock exchange outside of Israel. The
aforesaid does not apply to the sale of securities by an individual who is
classified as a "significant shareholder" in the Company (one who holds,
directly or indirectly, alone or together with another, at least 10% in one or
more of the means of control in the Company - either at the time of sale of the
securities or at any time during the 12 months that preceded the above stated
sale), in which case the rate of tax in respect of the capital gains will not
exceed 25%. Furthermore, this tax rate does not apply to: (1) dealers in
securities; (2) shareholders that report in accordance with the Income Tax Law
(Inflationary Adjustment)-1985; or (3) shareholders who acquired their shares
prior to an initial public offering. 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. Non-Israeli residents
will be exempt from Israeli capital gains tax on any gains derived from the sale
of shares publicly traded on the TASE or on a recognized stock exchange outside
of Israel provided such shareholders did not acquire their shares prior to an
initial public offering and provided that the profits were not derived from a
permanent establishment in Israel. However, non-Israeli corporations selling
such securities, including US resident corporations, will not be entitled to
such an exemption if an Israeli resident (i) has a controlling interest of 25%
or more in the non-Israeli corporation, or (ii) if the beneficiary is directly
or indirectly entitled to 25% or more of the revenues or profits of the
non-Israeli corporation. Notwithstanding the foregoing, dealers in securities in
Israel are taxed at regular tax rates applicable to business income. In any
event, the provisions of the Tax Reform do not affect the exemption from capital
gains tax for gains accrued before 1 January 2003.
In addition, there is an exemption under certain Israeli domestic
regulations, according to which U.S. resident purchasers who are unable to
benefit from the U.S.-Israel tax treaty may wish to utilize a recently
introduced special exemption on capital gains arising from the sale of
securities in an Israeli company (including companies which are deemed an
Israeli resident corporation for tax purposes) between July 1, 2005, and
December 31, 2008. In order for this exemption to apply, the following
conditions need to be met:
o an application is to be submitted to the Israeli Tax Authority at the
same time as the reporting of the sale and capital gain;
o the capital gain does not derive from a permanent establishment of the
seller in Israel;
o the seller is an individual and has been a resident of a country with
which Israel has a tax treaty (e.g., the U.S) during the ten
continuous years prior to the acquisition or is an entity where at
least 75% of the means of control of the entity are ultimately held,
directly or indirectly, by individual shareholders who are resident of
a country with which Israel has a tax treaty (e.g., the U.S) during
the ten continuous years prior to the acquisition. Where the entity is
listed on a non-Israel stock exchange, this condition is deemed met
automatically in respect of "non-material" shareholders and unless it
can be proved otherwise. "Material" is defined as a 10% or more
holding, directly or indirectly, of any means of control, together
with related parties;
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o the shares were not purchased from a related party and the provision
of the part of the Israeli Income Tax Ordinance which addresses
capital gains or a certain tax exemption granted in connection with
the issuance of shares in exchange for the transfer of ownership in a
real estate property to the issuer, did not apply to such purchase of
shares;
o the sale was reported to the tax authority in the country of the
seller's residence; and
o within 30 days of the acquisition, the transaction was disclosed in
full to the Israeli Tax Authority.
Israel presently has no estate or gift tax.
U.S.-ISRAEL TAX TREATY
Pursuant to the Convention Between the Government of the United States of
America and the Government of Israel with respect to Taxes on Income (referred
to as the U.S.-Israel Tax Treaty), the sale, exchange or disposition of ordinary
shares by a person who qualifies as a resident of the United States within the
meaning of the U.S.-Israel Tax Treaty and who is entitled to claim the benefits
afforded to such resident by the U.S.-Israel Tax Treaty (called a Treaty U.S.
Resident) will not be subject to Israeli capital gains tax unless (a) such
Treaty U.S. Resident is an individual and was present in Israel for more than
183 days during the relevant taxable year or (b) such Treaty U.S. Resident
holds, directly or indirectly, shares representing 10% or more of the voting
power of a company during any part of the 12-month period preceding such sale,
exchange or disposition. A sale, exchange or disposition of shares by a Treaty
U.S. Resident who is an individual and was present in Israel for more than 183
days during the relevant taxable year or who holds, directly or indirectly,
shares representing 10% or more of the voting power of a company at any time
during such preceding 12-month period would be subject to such Israeli tax, to
the extent applicable, unless the aforementioned exemption from capital gain tax
for shares listed on the Tel-Aviv Stock Exchange applies; however, in case under
the U.S.-Israel Tax Treaty and the Israeli tax law a Treaty U.S. Resident will
be subject to capital gain tax in Israel, such Treaty U.S. Resident would be
permitted to claim a credit for such taxes against U.S. income tax , subject to
the limitations in U.S. laws applicable to foreign tax credits.
UNITED STATES FEDERAL INCOME TAX CONSIDERATIONS
The following discussion of United States federal income tax considerations is
based on the United States Internal Revenue Code of 1986, as amended (the
"Code"), Treasury regulations, judicial decisions and published positions of the
United States Internal Revenue Service (the "IRS"), all as in effect on the date
hereof. This discussion does not address all aspects of United States federal
income taxation (including potential application of the alternative minimum tax)
that may be relevant to a particular shareholder based on such shareholder's
particular circumstances. In particular, the following discussion does not
address the United States federal income tax consequences of purchasing, holding
or disposing of our ordinary shares to shareholders who own (directly,
indirectly constructively or through attribution) 10% or more of our outstanding
voting stock, who hold our stock as part of a straddle or hedging or conversion
transaction, or who are broker-dealers, traders in securities who elect to
market - to - market, insurance companies, tax-exempt organizations, banks,
financial institutions, non-resident aliens of the United States, partnerships
or entities classified as partnerships of U.S. federal income tax purposes or
U.S. Holders (as defined below) whose functional currency is not the U.S.
dollar. The following discussion also does not address any aspect of state,
local or non-United States tax laws. Further, this summary generally considers
only a U.S. Holder that will own our ordinary shares as capital assets
(generally, assets held for investment). Each prospective investor should
consult its tax advisor with respect to the specific United States federal,
state and local tax consequences of purchasing, holding or disposing of our
ordinary shares.
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IRS CIRCULAR 230 DISCLOSURE
To ensure compliance with requirements imposed by the IRS, we inform you that:
(i) any United States federal tax advice contained in this document (including
any attachment) is not intended or written by us to be used, and cannot be used,
by any taxpayer for the purpose of avoiding tax penalties under the Code; (ii)
such advice was written in connection with the promotion or marketing of the
transactions or matters addressed herein; and (iii) taxpayers should seek advice
based on their particular circumstances from an independent tax advisor.
TAXATION OF U.S. HOLDERS
For purposes of this discussion, a "U.S. Holder" means any beneficial owner of
our ordinary shares who, for United States federal income tax purposes, is: (i)
a citizen or resident of the United States; (ii) a corporation or entity treated
as a corporation organized in or under the laws of the United States or any
state thereof or the District of Columbia; (iii) an estate the income of which
is subject to United States federal income taxation regardless of source; or
(iv) a trust, if a United States court is able to exercise primary supervision
over its administration and one or more United States persons have the authority
to control all of its substantial decisions or a trust that was in existence on
August 20, 1996 and validly elected to continue to be treated as a domestic
trust. A "Non-U.S. Holder" is any beneficial owner other than a U.S. Holder. If
a partnership or any other entity or arrangement treated as a partnership holds
our ordinary shares, the United States federal income tax treatment of a partner
generally will depend upon the status of the partner and the activities of the
partnership. If you are a partner in a partnership holding our ordinary shares,
you should consult your tax advisor.
DISTRIBUTIONS. We do not anticipate that we will make distributions to
shareholders in the foreseeable future. If we do make any such distributions,
the gross amount of such distributions (before reduction for any Israeli
withholding tax) will be included in the gross income of U.S. Holders to the
extent of our earnings and profits, as calculated under United States federal
income tax principles. Such dividends will not qualify for the dividends
received deduction available in certain circumstances to corporate holders.
Subject to the PFIC discussion below, to the extent that any such distribution
exceeds our earnings and profits, such distribution will be treated as a
non-taxable return of capital to the extent of the U.S. Holder's adjusted basis
in our ordinary shares and thereafter as taxable capital gain. For United States
federal income tax purposes, the amount of any dividend that we pay in NIS to a
U.S. Holder will equal the U.S. dollar value of such NIS at the exchange rate in
effect on the date the dividend is considered to be received by the U.S. Holder,
regardless of whether the NIS are actually converted into U.S. dollars at that
time. A U.S. Holder who receives a foreign currency distribution and converts
the foreign currency into U.S. dollars subsequent to receipt will 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 United
States source ordinary income or loss.
REDUCED TAX RATES FOR CERTAIN DIVIDENDS
REDUCED TAX RATES FOR CERTAIN DIVIDENDS. Subject to the discussion below under
"Passive Foreign Investment Company treatment", for taxable years before January
1, 2011, a dividend paid by us to certain shareholders will be taxed at the
preferential tax rates applicable to long-term capital gains if (a) we are a
"qualified foreign corporation" (as defined below), (b) the U.S. Holder
receiving such dividend is an individual, estate, or trust and (c) such dividend
is paid on our ordinary shares that have been held by such U.S. Holder for more
than 60 days during the 120-day period beginning 60 days before the "ex-dividend
date" (i.e., the first date that a purchaser of such Share will not be entitled
to receive such dividend).
Generally, we may be considered a "qualified foreign corporation" (a "QFC") if
we are eligible for the benefits of a comprehensive income tax treaty with the
United States which includes an information exchange program that the IRS
determines is satisfactory. However, even if we are so eligible, we will not be
treated as a QFC if we were a PFIC for the taxable year during which we paid a
dividend or for the preceding taxable year. As discussed below, we do not
believe that we should be considered a PFIC for any tax year through and
including the tax year ended December 31, 2007 and thus for those years we
expect to be a QFC. However, we cannot assure shareholders that we will continue
to be considered a QFC for any taxable year.
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CREDIT FOR ISRAELI TAXES WITHHELD. Any dividends that we pay to a U.S. Holder
with respect to our ordinary shares generally will be treated for United States
federal income tax purposes as foreign-source income. Subject to certain
conditions and limitations, any Israeli taxes withheld or paid with respect to
dividends on our ordinary shares generally will be eligible for credit against
the U.S. Holder's United States federal income tax liability. Such limitations
include extensive separate computation rules under which foreign tax credits
allowable with respect to specific classes of foreign-source income cannot
exceed the United States federal income taxes otherwise payable with respect to
such classes of income. Subject to the particular circumstances of a U.S.
Holder, any dividends with respect to our ordinary shares generally will be
classified as "passive income" for foreign tax credit purposes.
Alternatively, a U.S. Holder may elect to claim a United States tax deduction
for any such Israeli tax, but only for a tax year in which the U.S. Holder
elects to do so with respect to all foreign income taxes paid. In addition, a
non-corporate U.S. Holder cannot elect to deduct Israeli taxes if such U.S.
Holder does not itemize deductions.
DISPOSITIONS. In general, any gain or loss recognized by a U.S. Holder on the
sale or other disposition of our ordinary shares will be United States-source
income or loss for purposes of the United States foreign tax credit limitation,
except in certain limited situations (typically only applicable to sales through
a permanent establishment in Israel) where the gain may be re-sourced. U.S.
Holders should consult their tax advisors regarding the application of the
United States foreign tax credit limitation to gain or loss recognized on the
disposition of our ordinary shares and the treatment of any foreign currency
gain or loss on any NIS received in respect of the sale or other disposition of
our ordinary shares.
PASSIVE FOREIGN INVESTMENT COMPANY STATUS
Generally a non-United States corporation is treated as a passive foreign
investment company ("PFIC") for United States federal income tax purposes if
either (i) 75% or more of its gross income (including the pro rata gross income
of any company (United States or non-United States) in which such corporation is
considered to own 25% or more of the stock by value) for the taxable year is
passive income, generally referred to as the "income test," or (ii) 50% or more
of the average value of its assets (including the pro rata value of the assets
of any company in which such corporation is considered to own 25% or more of the
stock by value) during the taxable year, measured at the end of each quarter,
produce or are held for the production of passive income in the taxable year,
generally referred to as the "asset test".
We do not believe that we should be treated as a PFIC for any tax year through
and including the tax year ended December 31, 2007. However, the statutory
provisions, legislative history and administrative pronouncements with respect
to the principles under which the asset test is to be implemented leave
unanswered a number of questions pertaining to the application of the asset test
to us. In addition, there are circumstances both in our control and out of our
control that may affect our status as a PFIC. Sale of non-passive assets in
exchange for passive assets (such as cash) may increase the chance of the assets
test applying to us. Fluctuation in the market price in our shares may also
impact this test. While we will attempt to manage our business so as to avoid
PFIC status, to the extent consistent with its other business goals, we cannot
predict whether our business plans will allow us to avoid PFIC status or whether
our business plans will change in a manner that affects our PFIC determination.
We have not determined the possibility of PFIC status in 2008 but it is
possible, depending on various factors such as our cash position, that we will
be PFIC in 2008. In view of this uncertainty, U.S. holders are urged to consult
their tax advisors for guidance.
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If we were deemed to be a PFIC for any taxable year during which a U.S. Holder
held ordinary shares and such holder failed to make either a "QEF election" or a
"mark-to-market election" (each as described below):
o gain recognized by the U.S. Holder upon the disposition of, as well as
income recognized upon receiving certain dividends on, our ordinary
shares would be taxable as ordinary income;
o the U.S. Holder would be required to allocate such dividend income
and/or disposition gain ratably over such holder's entire holding
period for such ordinary shares;
o the amount allocated to each year other than the year of the dividend
payment or disposition would be subject to tax at the highest
individual or corporate tax rate, as applicable, and an interest
charge would be imposed with respect to the resulting tax liability;
o the U.S. Holder would be required to file an annual return on IRS Form
8621 regarding distributions received on, and gain recognized on
dispositions of, our ordinary shares; and
o any U.S. Holder who acquired our ordinary shares upon the death of a
U.S. Holder would not receive a step-up of the income tax basis to
fair market value of such shares. Instead, such U.S. Holder
beneficiary would have a tax basis equal to the decedent's basis, if
lower.
Although a determination as to a corporation's PFIC status is made annually, an
initial determination that a corporation is a PFIC for any taxable year
generally will cause the above described consequences to apply for all future
years to U.S. Holders who held shares in the corporation at any time during a
year when the corporation was a PFIC and who did not timely make a QEF election
or mark-to-market election (each as described below) with respect to such shares
with their United States federal income tax return for the first tax year in
which such U.S. Holder owned the shares and the corporation was a PFIC. This
will be true even if the corporation ceases to be a PFIC in later years.
However, with respect to a PFIC that does not make any distributions or deemed
distributions, the above tax treatment would apply only to U.S. Holders who
realize gain on their disposition of shares in the PFIC.
QEF election
A U.S. Holder that owns ordinary shares may elect, provided that the Company
provides such person with certain information, to have the Company treated, with
respect to that person, as a "Qualified Electing Fund" or QEF. (A U.S. Holder
who makes a QEF election with respect to the Company is referred to herein as an
"Electing Shareholder"). The QEF election is made on a
shareholder-by-shareholder basis, applies to all ordinary shares held or
subsequently acquired by the Electing Shareholder and can only be revoked with
consent of the United States Internal Revenue Service. The QEF Election must be
made by a shareholder on or before the due date (with regard to extensions) for
such person's tax return for the taxable year for which the election is made
and, once made, will be effective for all subsequent taxable years of such
person unless revoked.
An Electing Shareholder generally will be required to include currently in gross
income its pro rata share of the Company's annual ordinary earnings and net
capital gains, if any, in any taxable year that the Company is a PFIC. Any
income inclusion will be required whether or not such shareholder owns ordinary
shares for an entire taxable year or at the end of the Company's taxable year.
The amount that the Electing Shareholder will have to include in income will be
determined without regard to the Company's prior year losses or the amount of
cash distributions, if any, received from the Company. Electing Shareholders
will be required to pay tax currently on such income, unless an election is made
to defer such payment and the shareholder pays an interest charge.
An Electing Shareholder is required to make an annual information statement
which would include information as to its pro rata share of ordinary earnings
and net capital gains, calculated under U.S. tax principles, and as to
distributions on such ordinary shares. If, in the future, we determine that we
are or were a PFIC, we may attempt to assist such shareholder with the gathering
of the information required to make such information statement, but we are not
required to do so. Electing Shareholders should be aware that the information
required may not be freely available.
So long as an Electing Shareholder's QEF election is in effect with respect to
the entire holding period for its ordinary shares, any gain or loss realized by
such shareholder on the sale or exchange of such ordinary shares held as capital
assets ordinarily would be a capital gain or loss and taxable to such
shareholder in the same manner as if the shares were not shares in a PFIC.
86
U.S. Holders will be permitted to make retroactive elections in particular
circumstances, including if the U.S. Holder had a reasonable belief that the
Company was not a PFIC and filed a protective election. U.S. Holders should
consult their tax advisors as to the consequences of making a protective QEF
election or other consequences of making the QEF election.
In the event that we were deemed to be a PFIC for any taxable year and a U.S.
Holder failed to make a QEF election for the first taxable year that we were a
PFIC and such U.S. Holder owned our ordinary shares, the U.S. Holder could
obtain treatment similar to that afforded a shareholder who has made a timely
QEF election by making a QEF election and a deemed sale election or "purging
election" for the same taxable year. If a purging election is made, the U.S.
Holder will be treated if it had sold our ordinary shares for their fair market
value on the last day of the taxable year and will recognize gain, but not loss,
on such deemed sale in accordance with the general PFIC rules, including the
interest charge provisions described above. Thereafter, the U.S. Holder's
interest will be treated as an interest in a qualified electing fund.
Mark-to-market election
A U.S. Holder generally may make a mark-to-market election with respect to
shares of "marketable stock" of a PFIC. The term "marketable stock" generally
includes stock of a PFIC that is "regularly traded" on a "qualified exchange or
other market". Generally, a "qualified exchange or other market" means (i) a
national securities exchange which is registered with the United States
Securities and Exchange Commission or the national market system established
pursuant to Section 11A of the United States Securities Exchange Act of 1934 or
(ii) a foreign securities exchange that is regulated or supervised by a
governmental authority of the country in which the market is located and that
has the following characteristics: (a) the exchange has trading volume, listing,
financial disclosure, surveillance and other requirements designed to prevent
fraudulent and manipulative acts and practices, to remove impediments to and
perfect the mechanism of a free and open, fair and orderly, market, and to
protect investors, and the laws of the country in which the exchange is located
and the rules of the exchange ensure that such requirements are actually
enforced and (b) the rules of the exchange effectively promote active trading of
listed stocks. A class of stock is "regularly traded" on a qualified exchange or
other market for any calendar year during which such class of stock is traded
(other than in de minimis quantities) on at least 15 days during each calendar
quarter, subject to special rules for an initial public offering. In the event
that our shares do not qualify as "marketable stock" for these purposes, a U.S.
Holder will not be eligible to make a mark-to-market election.
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 a U.S. Holder and can only be revoked with consent of
the United States Internal Revenue Service (except to the extent the ordinary
shares no longer constitute "marketable stock"). As a result of a mark-to-mark
election, in any taxable year that the Company is a PFIC, a U.S. Holder would
generally be required to report gain or loss annually 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 adjusted tax basis of the ordinary
shares at that time. Any gain under this computation, and any gain on an actual
disposition of the ordinary shares, would be treated as ordinary income. Any
loss under this computation, and any loss on an actual disposition of ordinary
shares, 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.
The U.S. Holder's tax basis in the ordinary shares is adjusted annually for any
gain or loss recognized under the mark-to-market election.
Unless either (i) the mark-to-market election is made with respect to the
taxable year in which the U.S. Holder's holding period for the ordinary shares
commences or (ii) a QEF election has been in effect for such person's entire
holding period, any mark-to-market gain for the election year generally will be
subject to the general rules applicable to the disposition of shares of a PFIC,
discussed above.
U.S. HOLDERS OF OUR ORDINARY SHARES SHOULD CONSULT THEIR TAX ADVISORS ABOUT THE
PFIC RULES, INCLUDING THE POSSIBILITY, AND ADVISABILITY OF, AND THE PROCEDURE
AND TIMING FOR MAKING A QEF OR MARK-TO-MARKET ELECTION IN CONNECTION WITH THEIR
HOLDING OF ORDINARY SHARES, INCLUDING OPTIONS TO ACQUIRE OUR ORDINARY SHARES.
87
CONTROLLED FOREIGN CORPORATION STATUS
We have not determined whether we meet the definition of a controlled foreign
corporation ("CFC") for United States federal income tax purposes. We would be a
CFC if U.S. persons each owning (directly, indirectly or by attribution) 10% or
more of the voting power of our shares ("10% Shareholders") own in the aggregate
more than 50% of the voting power or value of our shares. If we were a CFC, 10%
Shareholders could have adverse consequences, including being required to
include a portion of our undistributed income as constructive dividends in
taxable income each year.
U.S. HOLDERS OF OUR ORDINARY SHARES WHO MAY BE 10% SHAREHOLDERS SHOULD CONSULT
THEIR INDEPENDENT TAX ADVISORS ABOUT THE CFC RULES.
TAXATION OF NON-U.S. HOLDERS
Subject to the discussion below with respect to the United States backup
withholding tax, a Non-U.S. Holder generally will not be subject to United
States federal income tax on dividends from us, if any, or gain from the sale or
other disposition of ordinary shares, unless (i) such income is effectively
connected with the conduct by the Non-U.S. Holder of a United States trade or
business, and in the case of a resident of a country which has an income tax
treaty with the United States, such income is attributable to a permanent
establishment (or in the case of an individual, a fixed place of business) in
the United States; or (ii) with respect to any gain on the sale or other
disposition of ordinary shares realized by an individual Non-U.S. Holder, such
individual Non-U.S. Holder is present in the United States for 183 days or more
in the taxable year of the sale or other disposition and meets certain other
conditions.
BACKUP WITHHOLDING AND INFORMATION REPORTING
Under the Code, under certain circumstances, United States tax information
reporting and "backup withholding" of United States federal income tax on
dividends on, and the proceeds of dispositions of, our ordinary shares may apply
to both U.S. Holders and Non-U.S. Holders. Backup withholding will not apply,
however, to a holder who furnishes a correct taxpayer identification number or
certificate of foreign status and makes any other required certification or who
is otherwise exempt from backup withholding. Generally, a U.S. Holder will
provide such certification on IRS Form W-9, and a non-U.S. Holder will provide
such certification on IRS Form W-8. Any amounts withheld under the United States
backup withholding rules will be allowed as a refund or credit against the U.S.
Holder's or the non-U.S. Holder's United States federal income tax liability,
provided the required information is furnished to the IRS.
10.F. DIVIDENDS AND PAYING AGENTS
Not applicable.
10.G. STATEMENT BY EXPERTS
Not applicable.
88
10.H. DOCUMENTS ON DISPLAY
We are subject to certain of the information reporting requirements of the
Exchange Act. As a "foreign private issuer" we are exempt from the rules and
regulations 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, with respect to their purchase and sale of
our shares. In addition, we are not required to file reports and financial
statements with the Securities and Exchange Commission as frequently or as
promptly as U.S. companies whose securities are registered under the Exchange
Act. However, we file with the Securities and Exchange Commission an annual
report on Form 20-F containing financial statements audited by an independent
accounting firm, within 180 days after the end of each fiscal year.
You may read and copy any document we file with the SEC at its public reference
facilities at, 100 F Street, N.E., Room 1580, Washington, D.C. 20549 and at the
SEC's regional offices at 233 Broadway, New York, NY 10279 and Citicorp Center,
500 West Madison Street, Suite 1400, Chicago, IL 60661. You may also obtain
copies of the documents at prescribed rates by writing to the Public Reference
Section of the SEC at 100 F Street, N.E., Room 1580, Washington, D.C. 20549. The
SEC also maintains a web site that contains reports, proxy and information
statements and other information regarding registrants that file electronically
with the SEC. The address of this web site is http://www.sec.gov. Please call
the SEC at 1-800-SEC-0330 for further information on the operation of the public
reference facilities.
10.I. SUBSIDIARY INFORMATION
Not applicable.
ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We sometimes use derivative financial instruments in our investment portfolio to
hedge foreign currency or other types of market risks. We place our investments
in instruments that meet high credit quality standards. We generally invest cash
in time deposit. We do not expect any material loss with respect to our
investment portfolio.
The table below provides information about our investment portfolio. For
investment securities, the table presents principal cash flows and related
weighted average interest rates by expected maturity dates. Our investment
policy requires that all investments mature in two years or less.
89
Principal (Notional) Amounts by Expected Maturity in U.S. Dollars:
FAIR MARKET VALUE ON DECEMBER 31
(IN THOUSANDS, EXCEPT INTEREST RATES AND DURATION)
2005 2006 2007
-------- -------- --------
Total Portfolio 5,291 9,116 5,035
Average Interest Rate 4.2% 4.9% 4.7%
Average Duration (Month) 0.25 0.25 0.25
Cash Equivalents (up to three
months maturity) 5,291 6,116 5,035
Average Interest Rate 4.2% 4.8% 4.7%
Short Term Investments
(three-twelve months maturity) - 3,000 -
Average Interest Rate - 5.2% -
ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES
Not applicable.
90
PART TWO.
ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES
The Company is not in default of any payment of principal, interest, sinking or
purchase fund installment, or indebtedness of the Company or any of its
subsidiaries exceeding 5% of total assets on a consolidated basis-. There has
been no payment of dividends that is in arrears, and there has been no material
delinquency relating to any class of preferred stock in the Company or its
subsidiaries.
ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF
PROCEEDS
There have been no material changes to or limitations on the rights of the
holders of any class of registered shares caused by the changes in the terms of
the securities or the issuance or modification of a different class of
securities. There has been no material withdrawal or substitution of assets.
ITEM 15T. CONTROLS AND PROCEDURES
15.A. EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
The Company's management, with the participation of the Company's Chief
Executive Officer and Chief Financial Officer, has evaluated the effectiveness
of the Company's disclosure controls and procedures (as such term is defined in
Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the
period covered by this annual report. Our management recognizes that any
controls and procedures, no matter how well designed and operated, can provide
only reasonable assurance of achieving their objectives and our management
applies its judgment in evaluating the cost-benefit relationship of possible
controls and procedures.
Our management has concluded that, as of December 31, 2007, the Company's
controls and procedures were not effective and did not provide reasonable
assurance that information required to be disclosed by us in the reports we file
or submit under the Exchange Act and the rules thereunder is recorded,
processed, summarized and reported, on a timely basis, and that such 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. The
reason for such conclusion was the identification by management of material
weaknesses in our internal control over financial reporting (described below),
which we view as an integral part of our disclosure controls and procedures. To
address the material weaknesses in internal control over financial reporting,
the Company performed additional analyses and other post closing procedures in
an effort to reasonably assure that the consolidated financial statements
included in this annual report have been prepared in accordance with generally
accepted accounting principles in the United States.
15.B. MANAGEMENT'S ANNUAL REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Our management is responsible for establishing and maintaining adequate internal
control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f)
under the Exchange Act. Our internal control over financial reporting is a
process to provide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external purposes in
accordance with generally accepted accounting principles. Our internal control
over financial reporting includes those policies and procedures that:
o pertain to the maintenance of records that, in reasonable detail,
accurately and fairly reflect the transactions and dispositions of our
assets;
o provide reasonable assurance that transactions are recorded as
necessary to permit preparation of financial statements in accordance
with generally accepted accounting principles, and that our receipts
and expenditures are being made only in accordance with authorizations
of our management and directors; and
o provide reasonable assurance regarding prevention or timely detection
of unauthorized acquisition, use or disposition of our assets that
could have a material effect on the financial statements.
91
Our management recognizes that there are inherent limitations in the
effectiveness of any system of internal control over financial reporting,
including the possibility of human error and the circumvention or override of
internal control. Accordingly, even effective internal control over financial
reporting can provide only reasonable assurance with respect to financial
statement preparation, and may not prevent or detect all misstatements. Further,
because of changes in conditions, the effectiveness of internal control over
financial reporting may vary over time.
Our management assessed the effectiveness of our internal control over financial
reporting as of December 31, 2007. The objective of this assessment was to
determine whether the Company's internal control over financial reporting was
effective as of December 31, 2007. That assessment identified the following
material weaknesses in internal control over financial reporting as of December
31, 2007. A material weakness is a deficiency, or a combination of deficiencies,
in internal control over financial reporting, which result(s) in more than a
remote likelihood that a material misstatement of financial statements will not
be prevented or detected on a timely basis.
Financial Statement Close and Reporting: The Company has recently
determined that no Vendor Specific Objective Evidence ("VSOE") of fair market
value existed for various elements of the Company's bundled software solutions
and associated post-contract support services provided during the year ended
December 31, 2007. The changes to the Company's revenue recognition
implementation have resulted in (i) the deferral of a substantial amount of
revenue from 2007 to 2008 and (ii) revenues for the year ended December 31, 2007
being lower than what was previously indicated by the Company. The Company's
inability to support the existence of VSOE in the 2007 annual financial
statements, [contrary to the quarterly unaudited results of operations for the
first, second and third quarter of 2007, which were prepared under the
assumption of the existence of VSOE on an annual basis], resulted from a low
level of actual renewals, the lack of material deal flow through the sign off of
the financial statements, and the fact that the Company began working with
resellers/integrators providing second level support, which created new and
additional support services for which fair market value could not be
established.
As a result, management has concluded that as of December 31, 2007 a
material weakness existed with respect to procedures applied by the Company in
connection with the financial statements close process, which material weakness
results in a more than a remote likelihood possibility that a material
misstatement of the financial statements will not be prevented or detected. Such
weakness was reflected mainly in (1) a lack of adequate review and approval
procedures to ensure that financial statements are prepared in accordance with
GAAP, particularly the Company refraining from using US GAAP checklists when
preparing its financial statements, (2) a lack of effective controls designed to
provide reasonable assurance that material errors in revenues with respect to
establishment of VSOE would be prevented or detected in a timely manner and (3)
a lack of adequate information flow between the Company's sales and financial
departments, resulting in the information processed by the financial department
being incomplete.
Management intends to take the following remediation steps in connection
with the foregoing material weaknesses:
(1) The Company intends to compose a policy for Financial Closing &
Reporting (FCR) process.
(2) The Company intends to allocate responsibilities in a clear manner
among the employees who are involved in the FCR process, including the
management.
(3) The Company intends to start using US GAAP checklists,
(4) The Company intends to adopt a clear policy of financial department
approval for each sale and sales department input for each sale
recognized in the reports.
(5) The Company intends to take steps to ensure that its accounting and
financing personnel is more proficient and up-to-date with respect to
accounting matters and other areas relevant to the preparation of
financial reporting
We intend to continue to monitor our internal controls and our progress on the
remediation steps identified above. We believe that the measures described
above, once designed and operating effectively, will remediate the material
weaknesses we have identified and strengthen our internal control over financial
reporting. However, if further improvements and/or enhancements are necessary,
we will take steps to implement such improvements and/or enhancements.
Our financial statements have been audited by Kost, Forer, Gabbay & Kasierer (a
Member of Ernst & Young Global), an independent registered public accounting
firm.
THIS ANNUAL REPORT DOES NOT INCLUDE AN ATTESTATION REPORT OF OUR REGISTERED
PUBLIC ACCOUNTING FIRM REGARDING INTERNAL CONTROL OVER FINANCIAL REPORTING.
MANAGEMENT'S REPORT WAS NOT SUBJECT TO ATTESTATION BY OUR REGISTERED PUBLIC
ACCOUNTING FIRM PURSUANT TO TEMPORARY RULES OF THE SECURITIES AND EXCHANGE
COMMISSION THAT PERMIT US TO PROVIDE ONLY MANAGEMENT'S REPORT IN THIS ANNUAL
REPORT.
15.C. ATTESTATION REPORT OF REGISTERED PUBLIC ACCOUNTING FIRM
Not applicable.
15.D. CHANGES IN INTERNAL CONTROLS OVER FINANCIAL REPORTING
There have not been any changes in the Company's internal control over financial
reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the
Exchange Act) or in other factors during the period covered by this annual
report that have materially affected, or are reasonably likely to materially
affect, the Company's internal control over financial reporting.
92
ITEM 16.A. AUDIT COMMITTEE FINANCIAL EXPERT.
The Company's audit committee is comprised of Joseph Atsmon and Yoseph Dauber.
We believe that Mr. Atsmon and Mr. Dauber qualify as audit committee financial
experts as such term is defined in the Form 20-F. The Company was informed by
Michal Even Chen, who served as an external director in the Company, on July 3,
2008, of her resignation from the office as a director of the Company, effective
as of such date. The Company will convene an extraordinary shareholders meeting
for the approval of the appointment of an external director who will join the
Company's audit committee in substitution of Michal Even Chen.
ITEM 16.B. CODE OF ETHICS.
We have adopted a written code of ethics that applies to our principal executive
officer, principal financial officer, executive vice president global sales,
principal controller, treasurer and to persons performing similar functions. A
copy of our code of ethics was filed with our annual report on Form 20-F for the
year ended December 31, 2003 as Exhibit 11.
We have also adopted written standards of business conduct that apply to all
directors, officers and employees. During 2006, our board of directors adopted
certain amendments to the insider trading policy included in such standards of
business conduct. A copy of the amended insider trading policy was filed as an
exhibit to our annual report on Form 20-F for the year ended December 31, 2006.
ITEM 16.C. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
Our audit committee is responsible for the oversight of our independent
auditors' work. The audit committee's policy is to pre-approve all audit and
non-audit services provided by our auditors. These services may include audit
services, audit-related services, tax services and other services, as further
described below. The audit committee sets forth the basis for its pre-approval
in detail, listing the particular services or categories of services which are
pre-approved, and setting forth a specific budget for such services. Additional
services may be pre-approved by the audit committee on an individual basis. Our
audit committee pre-approval policies and procedures for audit and non-audit
services are referred to in Exhibit 4.1(f) to this annual report.
The auditors of VocalTec billed for the following fees for audit and
audit-related services in 2006 and 2007 (in thousands of U.S. dollars):
Year Ended December 31,
---------------------------------------------------
2006 2007
---------------------- ----------------------
Services rendered Fees Percentages Fees Percentages
----------------- -------- -------- -------- --------
Audit (1) 71 70% 85 77%
Audit-related (2) 16 16% - -
Tax (3) 15 14% 25 23%
Other (4) - % - -
Total 102 100% 110 100%
(1) Audit fees consist of services that would normally be provided in connection
with statutory and regulatory filings or engagements, including services that
generally only the independent accountant can reasonably provide.
93
(2) Audit-related fees relate to assurance and associated services that
traditionally are performed by the independent auditor, including: accounting
consultation and consultation concerning financial accounting and reporting
standards.
(3) Tax fees relate to tax compliance, planning and advice.
(4) Other fees relate to consulting services.
All of the services referred to in clauses (2), (3) and (4) above were approved
by the audit committee of VocalTec.
ITEM 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES - NONE.
ITEM 16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS
- NONE.
94
PART THREE.
ITEM 17. FINANCIAL STATEMENTS
Not applicable.
ITEM 18. FINANCIAL STATEMENTS
CONSOLIDATED FINANCIAL STATEMENTS
AS OF DECEMBER 31, 2007
CONTENTS
PAGE
------
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM F - 2
CONSOLIDATED BALANCE SHEETS F - 3 - F - 4
CONSOLIDATED STATEMENTS OF OPERATIONS F - 5
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (DEFICIENCY) F - 6
CONSOLIDATED STATEMENTS OF CASH FLOWS F - 7 - F - 8
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS F - 9 - F - 39
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
TO THE BOARD OF DIRECTORS AND SHAREHOLDERS OF
VOCALTEC COMMUNICATIONS LTD.
We have audited the accompanying consolidated balance sheets of VocalTec
Communications Ltd. ("the Company") and its subsidiaries as of December 31, 2007
and 2006, and the related consolidated statements of operations, changes in
shareholders' equity and cash flows for the three years then ended. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audit in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. We were not engaged to
perform an audit of the Company's and its subsidiaries' internal control over
financial reporting. Our audits included consideration of internal control over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company's and its subsidiaries' internal
control over financial reporting. Accordingly, we express no such opinion. An
audit also includes examining, on a test basis, evidence supporting the amounts
and disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
the Company and its subsidiaries as of December 31, 2007 and 2006, and the
consolidated results of their operations and their cash flows for the three
years then ended, in conformity with U.S. generally accepted accounting
principles.
As discussed in Note 2(o) to the consolidated financial statements,
effective January 1, 2006, the Company adopted Statement of Financial Accounting
Standards Board No. 123 (revised 2004), "Share-Based Payment". As discussed in
Note 2(n) to the consolidated financial statements, effective January 1, 2007,
the Company adopted FIN 48, "Accounting for Uncertainty in Income Taxes - an
Interpretation of FASB Statement No. 109".
Tel-Aviv, Israel KOST FORER GABBAY & KASIERER
July 15, 2008 A Member of Ernst & Young Global
F-2
VOCALTEC COMMUNICATIONS LTD.
AND ITS SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
DECEMBER 31,
-----------------------------
NOTE 2007 2006
------ ------------ ------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 4,496 $ 5,954
Short term deposit - 3,000
Restricted cash 539 162
Trade receivables (net of allowance for doubtful accounts of $160
and $120 as of December 31, 2007 and 2006, respectively 625 1,443
Prepaid expenses and other accounts receivable 4 1,543 1,328
Severance pay funds 421 91
Inventories 5 261 538
------------ ------------
TOTAL current assets 7,885 12,516
------------ ------------
SEVERANCE PAY FUNDS 1,010 1,186
------------ ------------
PROPERTY AND EQUIPMENT, NET 6 655 888
------------ ------------
INTANGIBLE ASSETS: 3,7
Goodwill 2,297 6,950
Other intangible assets 2,481 3,047
------------ ------------
TOTAL intangible assets 4,778 9,997
------------ ------------
Total assets $ 14,328 $ 24,587
============ ============
The accompanying notes are an integral part of the consolidated financial
statements.
F-3
VOCALTEC COMMUNICATIONS LTD.
AND ITS SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE DATA
DECEMBER 31,
-----------------------------
NOTE 2007 2006
------ ------------ ------------
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Trade payables $ 813 $ 930
Accrued expenses and other accounts payable 8 3,166 2,996
Accrued severance pay 552 217
Deferred revenues 2,697 177
------------ ------------
TOTAL current liabilities 7,228 4,320
------------ ------------
LONG-TERM LIABILITIES:
Other liabilities - 8
Accrued severance pay 1,393 1,721
------------ ------------
TOTAL long-term liabilities 1,393 1,729
------------ ------------
TOTAL liabilities 8,621 6,049
------------ ------------
COMMITMENTS AND CONTINGENCIES 9
SHAREHOLDERS' EQUITY: 10
Share capital
Ordinary shares of NIS 0.13 par value: Authorized - 150,000,000
shares at December 31, 2007 and 2006; Issued and outstanding -
7,376,364 shares at December 31, 2007 and 2006 213 213
Other comprehensive income 18 -
Additional paid-in capital 93,592 92,228
Accumulated deficit (88,116) (73,903)
------------ ------------
TOTAL shareholders' equity 5,707 18,538
------------ ------------
$ 14,328 $ 24,587
============ ============
The accompanying notes are an integral part of the consolidated financial
statements.
F-4
VOCALTEC COMMUNICATIONS LTD.
AND ITS SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA
YEAR ENDED DECEMBER 31,
------------------------------------------------------
NOTE 2007 2006 2005
-------- --------------- --------------- --------------
Sales: 12
Products $ 3,006 $ 4,738 $ 3,668
Services 2,748 2,542 925
--------------- --------------- --------------
5,754 7,280 4,593
--------------- --------------- --------------
Cost of sales *):
Products 2,027 2,171 1,450
Services 523 563 315
--------------- --------------- --------------
2,550 2,734 1,765
Inventory write-off 459 - 639
Amortization of intangible assets 385 392 172
--------------- --------------- --------------
3,394 3,126 2,576
--------------- --------------- --------------
Gross profit 2,360 4,154 2,017
--------------- --------------- --------------
Operating expenses:
Research and development, net *) 13 4,567 4,619 4,363
Selling and marketing *) 4,736 4,147 2,763
General and administrative *) 1,992 2,474 1,748
Impairment of goodwill 5,437 - -
--------------- --------------- --------------
TOTAL operating expenses 16,732 11,240 8,874
--------------- --------------- --------------
Operating loss (14,372) (7,086) (6,857)
Other income, net - 42 24
Financial income, net 14 230 32 184
--------------- --------------- --------------
Loss before taxes on income (14,142) (7,012) (6,649)
Taxes on income (tax benefit) 15 37 - (19)
--------------- --------------- --------------
Net loss $ (14,179) $ (7,012) $ (6,630)
=============== =============== ==============
Accretion of redeemable convertible Preferred shares 10 $ - $ - $ (348)
Induced conversion of convertible Preferred shares 10 - - (17,406)
Cumulative dividend on convertible Preferred shares - - (2,585)
Dividend in respect of reduction in exercise price of
certain warrants - (37) -
--------------- --------------- --------------
Net loss attributable to common shareholders $ (14,179) $ (7,049) $ (26,969)
=============== =============== ==============
Basic and diluted net loss per Ordinary share 11 $ (1.92) $ (1.30) $ (34.05)
=============== =============== ==============
Weighted average number of Ordinary shares used in
computing net loss per Ordinary share - basic and
diluted 7,376 5,436 792
=============== =============== ==============
*) Expenses include stock based compensation related
to employees as follows:
Cost of sales $ 18 $ 8 $ -
Research and development, net 353 248 522
Selling and marketing 224 138 13
General and administrative 552 554 268
--------------- --------------- --------------
$ 1,147 $ 948 $ 803
=============== =============== ==============
The accompanying notes are an integral part of the consolidated financial
statements.
F-5
VOCALTEC COMMUNICATIONS LTD.
AND ITS SUBSIDIARIES
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (DEFICIENCY)
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE DATA
NUMBER OF SHARES (*) AMOUNT
------------------------------------- ---------------------------------
ORDINARY ORDINARY A PREFERRED ORDINARY ORDINARY A PREFERRED
----------- ----------- ---------- -------- ---------- ---------
Balance as of January 1, 2005 370,059 45,590 83,479 $ 14 $ 1 $ 3
Accretion of redeemable
convertible Preferred
shares - - - - - -
Conversion of redeemable
convertible Preferred B and
C shares into Preferred
shares - - 70,752 - - 2
Stock based compensation
related to shares and
options issued to employees 122,343 - - 3 - -
Conversion of convertible
Preferred shares into
Ordinary shares 199,821 (45,590) (154,231) 6 (1) (5)
Issuance of shares and
options pursuant to the
merger with VocalTec 1,162,142 - - 32 - -
Exercise of employees stock
options 17,979 - - - - -
Induced conversion of
convertible Preferred
shares 2,789,283 - - 77 - -
Net loss - - - - - -
----------- ---------- ---------- -------- ---------- ---------
Balance as of December 31,
2005 4,661,627 - - 132 - -
Reclassification of deferred
stock compensation due to
the adoption of SFAS 123(R) - - - - - -
Stock based compensation
related to options issued
to employees
Exercise of employees stock
options 29,737 - - 1 - -
Issuance of ordinary shares
and warrants in private
placements 2,685,000 - - 80 - -
Dividend in respect of
reduction in exercise
price of certain warrants - - - - - -
Net loss - - - - -
----------- ---------- ---------- -------- ---------- ---------
Balance as of December 31,
2006 7,376,364 - - 213 - -
Stock based compensation
related to options issued
to employees - - - - - -
Other comprehensive income
related to unrealized gain
on derivative instrument - - - - - -
Cumulative effect of FIN 48
adoption - - - - - -
Reversal of a provision for
issuance expenses - - - - - -
Net loss - - - - - -
----------- ---------- ---------- -------- ---------- ---------
Balance as of December 31,
2007 7,376,364 - - $ 213 $ - $ -
=========== =========== ========== ======== ========== =========
TOTAL
ADDITIONAL TREASURY DEFERRED OTHER SHAREHOLDERS'
PAID-IN STOCK STOCK BASED ACCUMULATED COMPREHENSIVE EQUITY
CAPITAL AT COST COMPENSATION DEFICIT INCOME (DEFICIENCY)
----------- ---------- ------------ ----------- ------------- -------------
Balance as of January 1, 2005 $ - $ (1,445) $ - $ (42,470) $ - $ (43,897)
Accretion of redeemable
convertible Preferred
shares - - - (348) - (348)
Conversion of redeemable
convertible Preferred B and
C shares into Preferred
shares 54,903 - - - - 54,905
Stock based compensation
related to shares and
options issued to employees 867 - (67) - - 803
Conversion of convertible
Preferred shares into
Ordinary shares - - - - - -
Issuance of shares and
options pursuant to the
merger with VocalTec 6,401 1,445 - - - **) 7,878
Exercise of employees stock
options 152 - - - - 152
Induced conversion of
convertible Preferred
shares 17,329 - - (17,406) - -
Net loss - - - (6,630) - (6,630)
----------- ---------- ------------ ----------- ------------- -------------
Balance as of December 31,
2005 79,652 - (67) (66,854) - 12,863
Reclassification of deferred
stock compensation due to
the adoption of SFAS 123(R) (67) - 67 - -
Stock based compensation
related to options issued
to employees 948 - - 948
Exercise of employees stock
options 149 - - - - 150
Issuance of ordinary shares
and warrants in private
placements **) 11,509 - - - - 11,589
Dividend in respect of
reduction in exercise
price of certain warrants 37 - - (37) - -
Net loss - - - (7,012) - (7,012)
----------- ---------- ------------ ----------- ------------- -------------
Balance as of December 31,
2006 92,228 - - (73,903) - 18,538
Stock based compensation
related to options issued
to employees 1,147 - - - - 1,147
Other comprehensive income
related to unrealized gain
on derivative instrument - - - - 18 18
Cumulative effect of FIN 48
adoption - - - (34) - (34)
Reversal of a provision for
issuance expenses 217 - - - - 217
Net loss - - - (14,179) - (14,179)
----------- ---------- ------------ ----------- ------------- -------------
Balance as of December 31,
2007 $ 93,592 $ - $ - $ (88,116) $ 18 $ 5,707
=========== ========== ============ =========== ============= =============
*) For the periods until the date of the business combination (November 2005)
- restated to reflect the number of the Company's shares issued in
exchange for each type of Tdsoft shares in the business combination - see
Notes 3a and 11a.
**) Net of issuance expenses of $ 1,075.
The accompanying notes are an integral part of the consolidated financial
statements.
F-6
VOCALTEC COMMUNICATIONS LTD.
AND ITS SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
YEAR ENDED DECEMBER 31,
--------------------------------------
2007 2006 2005
---------- ---------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (14,179) $ (7,012) $ (6,630)
Adjustments required to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization 977 1,428 811
Impairment of Goodwill 5,437 - -
Changes in the accrued liability for severance pay 7 (697) 77
Compensation expense related to shares and options issued to
employees, net 1,147 948 803
Gain on sale of equipment (4) (19) (8)
Loss (gain) on amounts funded in respect of severance pay (187) (158) 14
Decrease (increase) in trade receivables, net 818 (868) 379
Decrease (increase) in prepaid expenses and other receivables (197) 50 (624)
Decrease in inventories 277 517 500
Decrease in trade payables (117) (483) (423)
Increase (decrease) in accrued expenses and other liabilities (439) (1,142) 295
Increase in deferred revenues 2,520 6 37
---------- ---------- ----------
Net cash used in operating activities (3,940) (7,430) (4,769)
---------- ---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (178) (335) (308)
Cash and cash equivalents resulting from the merger between
VocalTec and Tdsoft (schedule A) - - 727
Proceeds from sale of property and equipment 4 26 109
Investment in short term deposit - (3,000) -
Investment in restricted cash (377) - -
Proceeds from short term deposit and restricted cash 3,000 - -
Amounts withdrawn (funded) in respect of severance pay funds, net 33 847 (33)
---------- ---------- ----------
Net cash provided by (used in) investing activities 2,482 (2,462) 495
---------- ---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of loan from shareholder - (1,031) -
Proceeds from issuance of shares upon exercise of stock options by
employees - 150 152
Issuance of shares, net - 11,589 -
---------- ---------- ----------
Net cash provided by financing activities - 10,708 152
---------- ---------- ----------
Increase (decrease) in cash and cash equivalents (1,458) 816 (4,122)
Cash and cash equivalents at the beginning of the year 5,954 5,138 9,260
---------- ---------- ----------
Cash and cash equivalents at the end of the year $ 4,496 $ 5,954 $ 5,138
========== ========== ==========
SUPPLEMENTAL CASH FLOWS INFORMATION:
Cash paid during the year for income taxes $ 22 $ 27 $ 10
========== ========== ==========
The accompanying notes are an integral part of the consolidated financial
statements.
F-7
VOCALTEC COMMUNICATIONS LTD.
AND ITS SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
SCHDULE A:
CASH AND CASH EQUIVALENTS RESULTING FROM THE MERGER BETWEEN VOCALTEC AND TDSOFT
YEAR ENDED DECEMBER 31,
-----------------------------------------
2007 2006 2005
----------- ----------- -----------
Working capital deficiency, excluding cash $ - $ - $ 3,708
Loan granted to VocalTec prior to the acquisition - - 341
Accrued severance pay, net - - 261
Property and equipment - - (328)
Intangible assets other than goodwill - - (3,896)
Goodwill - - (7,237)
Issuance of shares - - 7,878
----------- ----------- -----------
$ - $ - $ 727
=========== =========== ===========
The accompanying notes are an integral part of the consolidated financial
statements.
F-8
VOCALTEC COMMUNICATIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 1:- GENERAL
a. VocalTec Communications Ltd. ("VocalTec") and its subsidiaries ("the
Company"), is a global provider of carrier-class multimedia and
voice-over-IP solutions for communication service providers. The
Company provides trunking, peering, access gateway and service
delivery solutions (the Essentra product line) that enable flexible
deployment of next-generation networks (NGNs).
b. On November 24, 2005, VocalTec acquired all of the issued and
outstanding Ordinary shares of Tdsoft Ltd. ("Tdsoft"), a
privately-held company organized in Israel, and as consideration
issued to Tdsoft shareholders Ordinary shares of VocalTec
constituting, immediately following such issuance, 75% of the issued
and outstanding share capital of VocalTec. For accounting purposes,
the transaction was accounted for as a reverse acquisition, with
Tdsoft treated as the accounting acquirer. Accordingly, the
acquisition was accounted for as a purchase business combination
using Tdsoft's historical financial information and recording
VocalTec acquired assets and assumed liabilities at fair value as of
November 24, 2005 (see Note 3a). Tdsoft was engaged in the
development and marketing of systems that enable service providers
to deliver voice services over different types of access networks.
Tdsoft derived revenues from the sale of its systems, including
software it develops and maintenance services relating to the
systems and software sold. Towards the end of 2007, Tdsoft
discontinued the marketing of most of its products.
c. During 2007, 2006 and 2005, 44%, 31% and 34% of the Company's
revenues, respectively, were derived from major customers (see Note
2).
d. As reflected in the consolidated financial statements, in 2006 and
2007, the Company's results of operations were negatively impacted
by the impairment of its Goodwill, The changes to the Company's
revenue recognition implementation, competitive pricing pressures,
and increased competition in the marketplace. All these factors
resulted in net losses of $ 14,179 and $ 7,012 for 2007 and 2006,
respectively.
The Company is addressing its liquidity issues by implementing
initiatives to improve revenues and cash collections and reducing
expenses. During the end of 2007 the Company performed a cost
reduction process, in order to reduce its operational expenses and
to improve its cash position. In addition, during May 2008, the
Company signed a Patent Purchase Agreement to sell selected patents
for the aggregated selling price of $12.5 million. On July 13, 2008,
the OCS approved the consummation of the foregoing sale, subject to
the payment to the OCS of approximately $2.08 million. The Company
expects to consummate the foregoing sale shortly following the
filing of this annual report and to receive net proceeds of
approximately $9.2 million from the foregoing sale (see also Note
16).
Accordingly, the Company's management believes that the cost
reduction plan implemented in 2007 and the expected proceed from the
sale of the patents will enable the Company to continue its
peration at least through the end of 2008.
F-9
VOCALTEC COMMUNICATIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES
The consolidated financial statements have been prepared in conformity
with accounting principles generally accepted in the United States ("U.S.
GAAP"). The significant accounting policies followed in the preparation of
the financial statements, applied on a consistent basis, are:
a. Use of estimates:
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and
liabilities and disclosures of contingent assets and liabilities at
the date of the financial statements, and the reported amounts of
income and expenses during the reported period. Actual results could
differ from those estimates.
b. Financial statements in U.S. dollars:
The financial statements have been prepared in U.S. dollars
("dollar"), since the currency of the primary economic environment
in which the operations of the Company are conducted is the dollar.
Most of the Company's revenues are generated in dollar. In addition,
a considerable portion of the Company's costs is incurred in dollars
and the Company's financing is obtained in dollar. The Company's
management believes that the dollar is the currency of the primary
economic environment in which the Company operates. Thus, the
functional and reporting currency of the Company is the dollar.
Accordingly, the Company's and its subsidiaries' transactions and
balances denominated in dollars are presented at their original
amounts. Transactions and balances in other currencies have been
remeasured into dollars in accordance with the guidance in
Statements of the Financial Accounting Standard No. 52, "Foreign
Currency Translation" ("SFAS No. 52").
Amounts in currencies other than the dollar have been translated as
follows:
Monetary balances - at the exchange rate in effect on the balance
sheet date.
Revenues and costs - at the exchange rates in effect as of the date
of recognition of the transactions.
All exchange gains and losses from the remeasurement mentioned above
are reflected in the statement of operations under financial income,
net.
The representative exchange rate for the new Israeli shekel ("NIS")
and the U.S. dollar at December 31, 2007 was $ 1.00 = NIS 3.846
(December 31, 2006 - NIS 4.225 and December 31, 2005 - NIS 4.603).
c. Principles of consolidation:
The consolidated financial statements include the accounts of the
Company and its directly and indirectly wholly-owned subsidiaries.
As of the balance sheet date the only significant subsidiary is
Tdsoft Ltd.
F-10
VOCALTEC COMMUNICATIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)
d. Business combination:
Business combinations have been accounted for using the purchase
method of accounting. Under the purchase method of accounting the
results of operations of the acquired business are included from the
effective date of acquisition. The costs to acquire companies,
including transactions costs, have been allocated to the underlying
net assets of the acquired company in proportion to their respective
fair values. Any excess of the purchase price over estimated fair
values of the identifiable net assets acquired has been recorded as
goodwill.
e. Cash equivalents, restricted cash and short term bank deposits:
Cash equivalents are short-term, highly liquid investments that are
readily convertible to cash with original maturities of three months
or less.
Restricted cash is invested in highly liquid deposits, which are
used as security for bank guarantees provided primarily to lessors
of office premises and motor vehicles.
Short term bank deposits with original maturities of more than three
months but less than one year are presented as part of short-term
investments. Such deposits are presented at cost including accrued
interest. Interest on the deposits is recorded as financial income.
f. Inventories:
Inventories are stated at the lower of cost or market value.
Inventory write-offs are provided to cover risks arising from
slow-moving items, technological obsolescence and discontinued
products. Costs are determined as follows:
Components cost is determined by the average-cost method.
Finished goods are determined on the basis of direct costs, with
costs measured on an average basis.
Write-off of inventories for the years ended December 31, 2007, 2006
and 2005 amounted to $459, $0 and $639, respectively, due to
discontinued products.
g. Fair value of financial instruments:
SFAS No. 107 "Disclosure about Fair Value of Financial Instruments",
requires disclosure of an estimate of the fair value of certain
financial instruments. The Company's financial instruments consist
of cash and cash equivalents, short-term deposit, trade receivables,
other accounts receivable, trade payables, other accounts payable
and other liabilities. The estimated fair value of these financial
instruments approximates their carrying value as of December 31,
2007 and 2006 due to the short term maturities of those instruments.
F-11
VOCALTEC COMMUNICATIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)
h. Property and equipment, net:
Equipment is stated at cost less accumulated depreciation.
Depreciation is calculated by the straight-line method over the
estimated useful lives of the assets at the following annual rates:
%
-------------------------------
Computers and related equipment 33
Office furniture and equipment 6 - 25
Motor vehicles 15
Leasehold improvements Over the shorter of the term of
the lease or the life of the
asset *)
*) See also Note 9d.
i. Impairment and disposal of long-lived assets:
The Company's amortizable long-lived assets are reviewed for
impairment in accordance with Statement of Financial Accounting
Standards No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets" whenever events or changes in circumstances
indicate that the carrying amount of an asset may not be
recoverable. Recoverability of assets to be held and used is
measured by a comparison of the carrying amount of an asset to the
future undiscounted cash flows expected to be generated by the
asset. If an asset is considered to be impaired, the impairment is
measured by the adifference between the carrying amount of the asset
and its fair value. During the periods presented no impairment
losses were identified.
j. Intangible assets:
Intangible assets include mainly goodwill technology, customers
relations, customer contracts and other identifiable intangible
assets acquired in connection with the purchase of businesses.
Technology and other identifiable intangible definite lived assets
are amortized over their estimated useful lives.
The Company evaluates the amortization periods of all identifiable
intangible assets to determine whether events or circumstances
warrant revised estimates of useful lives.
Under Statement of Financial Accounting Standard No. 142 "Goodwill
and other Intangible Assets" ("SFAS 142") goodwill is no longer
amortized but instead is tested for impairment at least annually (or
more frequently if impairment indicators arise). SFAS 142 prescribes
a two-phase process for impairment testing of goodwill. The first
phase screens for impairment, while the second phase (if necessary)
measures impairment.
F-12
VOCALTEC COMMUNICATIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)
In the first phase of impairment testing, goodwill attributable to a
reporting unit is tested for impairment by comparing the fair value
of the reporting unit to its carrying amount. We determined that the
company has only one reporting unit. In 2007, the fair value of a
single reporting unit of the Company was found to be lower than its
carrying value. The second phase was then performed. The second
phase of the goodwill impairment test compares the implied fair
value of the reporting unit's goodwill with the carrying amount of
that goodwill. If the carrying amount of the reporting unit's
goodwill exceeds the implied fair value of that goodwill, an
impairment loss is recognized in an amount equal to that excess. The
implied fair value of goodwill is determined in the same manner as
the amount of goodwill recognized in a business combination. That
is, the fair value of the reporting unit is allocated to all of the
assets and liabilities of that unit (including all unrecognized
intangible assets) as if the reporting unit had been acquired in a
business combination and the fair value of the reporting unit was
the purchase price paid to acquire the reporting unit. In 2007, the
Company recorded an impairment of goodwill in the amount of $5,437
(see also Note 7).
Fair value is determined using discounted cash flows and market
capitalization. Significant estimates used in the discounted cash
flow methodology include estimates of future cash flows, future
short-term and long-term growth rates and discount rates. The
Company performs its annual impairment test during the fourth fiscal
quarter of each year.
k. Revenue recognition:
The Company generates revenues from licensing the rights to use its
software products, from the sale of its systems and from providing
maintenance, engineering and support services. The Company's
products are sold to resellers, who are considered end-users for the
purpose of revenue recognition (except as indicated below).
Revenue from software products is recognized when all criteria
outlined in the American Institute of Certified Public Accountants
Statement of Position ("SOP") 97-2, "Software Revenue Recognition",
as amended by SOP 98-9, "Modification of SOP 97-2, Software Reveneue
Recognition, with Respect to Certain Transactions", are met:
persuasive evidence of an arrangement exists, the product has been
delivered, no significant obligation to the customer remains, the
sales price is fixed or determinable and collectibility is
reasonably assured. The Company does not grant a right of return to
its customers.
Where software arrangements involve multiple elements, revenue is
allocated to each undelivered element based on vendor specific
objective evidence ("VSOE") of the fair value of the undelivered
element. The VSOE used by the Company to allocate the arrangement
fees to support services and maintenance is based on the price
charged when these elements are sold separately (upon renewal).
Revenues for the delivered product are recorded based on the
"residual method" presented by SOP 98-9, "Modification of SOP 97-2,
Software Revenue Recognition With Respect to Certain Transactions",
whereby the reminder of the arrangement fee, after allocating
revenue to undelivered elements as described above is allocated to
the delivered product. Under the residual method revenue is
recognized for the delivered elements when (1) there is VSOE of fair
value on all the undelivered elements and (2) all revenue
recognition criteria of SOP 97-2 are satisfied. Under the residual
method any discount in the arrangement is allocated to the delivered
element.
F-13
VOCALTEC COMMUNICATIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)
Prior to January 1, 2007, revenue from the sale of software was
recognized upon delivery, assuming all other revenue recognition
criteria are met while the amounts allocated to the support services
and maintenance were recognized ratably over the service period.
Effective January 1, 2007, due to a limited number of separate
support services and maintenance contracts consummated during 2007
and since the Company began providing its services through
distributors and integrators, VSOE is no longer attainable to the
support services and maintenance subsequent to that date.
Accordingly, revenues from bundled software arrangements in 2007 are
recognized ratably over the period of the last delivered element in
the arrangement, which is typically the customer support and
maintenance service period, assuming all other revenue recognition
criteria are met.
When an arrangement provides for acceptance of the product by the
customer, revenue is not recognized until such acceptance is
received.
In certain cases, when the company sells its products through
resellers in new and emerging market channels for which no
comparable history has been established, the Company recognizes
revenues only when all obligations to the end user have been
completed, provided all other revenue recognition criteria have been
met.
Arrangements including training and installation services are
recognized only after the services are performed.
Revenue from software maintenance and technical support contracts is
recognized on a straight line basis over the term of the maintenance
and support arrangement.
Engineering services are recognized as services are performed.
In 2006 deferred revenue includes unearned amounts received under
the maintenance and support contracts and amounts received from
customers but not recognized as revenues. In 2007, deferred revenue
includes amounts received under bundled software arrangements and
amounts received from customers, but not recognized as revenue.
For the sale of systems the Company records at the time of sale a
provision to cover the expected costs in order to honor its warranty
obligation. As of December 31, 2007 and 2006 the warranty provision
amounted to $ 0 and $ 20, respectively.
Revenue from sale of systems is recognized upon delivery to the
end-user or the reseller. Provisions for warranty are made at the
time of the sale. Such revenues are recognized in accordance with
Staff Accounting Bulletin No. 104, "Revenue Recognition in Financial
Statements" ("SAB No. 104").
F-14
VOCALTEC COMMUNICATIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)
l. Research and development costs, net:
Research and development costs, net of grants received, are charged
to the statement of operations as incurred. Statement of Financial
Accounting Standard No. 86, "Accounting for the Costs of Computer
Software to be Sold, Leased or Otherwise Marketed", ("SFAS No. 86"),
requires capitalization of certain software development costs
subsequent to the establishment of technological feasibility.
Therefore, all research and development costs have been expensed.
Research and development grants were deducted from research and
development costs (See m below).
m. Royalties-bearing grants
Royalty-bearing grants from the Government of Israel and other
governmental institutions for funding approved research and
development projects are recognized at the time the Company is
entitled to such grants, on the basis of the research and
development costs incurred. Such grants are included as a deduction
of research and development costs since at the time received it is
not probable the Company will generate sales from these projects and
pay the royalties resulting from such sales. For the grants received
and deducted from the research and development costs - see Note 13.
n. Income taxes:
The Company and its subsidiaries account for income taxes in
accordance with SFAS No. 109, "Accounting for Income Taxes" ("Fas
109"). This Statement prescribes the use of the liability method
whereby deferred tax assets and liability account balances are
determined for loss carryforwards and other temporary differences
between financial reporting and tax bases of assets and liabilities,
using the enacted tax rates and laws that will be in effect when the
differences are expected to reverse. The Company and its
subsidiaries provide a valuation allowance, if necessary, to reduce
deferred tax assets to the amount that is more likely than not to be
realized. In July 2006, the FASB issued FASB Interpretation No. 48,
"Accounting for Uncertainty in Income Taxes, an Interpretation of
FASB Statement No. 109" ("FIN 48").
FIN 48 clarifies the accounting for income taxes by prescribing the
minimum recognition threshold a tax position is required to meet
before being recognized in the financial statements. FIN 48 utilizes
a two-step approach for evaluating tax positions. Recognition (step
one) occurs when an enterprise concludes that a tax position, based
solely on its technical merits, is more-likely-than-not to be
sustained upon examination. Measurement (step two) is only addressed
if step one has been satisfied (i.e., the position is
more-likely-than-not to be sustained) otherwise a full liability in
respect of a tax position not meeting the more-than-likely-than-not
criteria is recognized. Under step two, the tax benefit is measured
as the largest amount of benefit, determined on a cumulative
probability basis, that is more-likely-than-not to be realized upon
ultimate settlement.
F-15
VOCALTEC COMMUNICATIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)
FIN 48 applies to all tax positions related to income taxes subject
to "FAS 109". This includes tax positions considered to be "routine"
as well as those with a high degree of uncertainty.
FIN 48 has expanded disclosure requirements, which include a tabular
roll forward of the beginning and ending aggregate unrecognized tax
benefits as well as specific detail related to tax uncertainties for
which it is reasonably possible the amount of unrecognized tax
benefit will significantly increase or decrease within twelve
months. (See also note 15).
FIN 48 is effective for fiscal years beginning after December 15,
2006. The cumulative effect of applying FIN 48 is reported as an
adjustment to the opening balance of retained earnings. The adoption
of FIN 48, as of January 1, 2007, affected the Company's accumulated
deficit, as described in note 15.
o. Share-based compensation:
Until January 1, 2006, the Company has elected to follow Accounting
Principles Board Statement No. 25, "Accounting for Stock Options
Issued to Employees" ("APB No. 25") and Financial Accounting
standard Board (FASB) Interpretation No. 44, "Accounting for Certain
Transactions Involving Stock Compensation" ("FIN No. 44") in
accounting for its employee stock option plans. According to APB No.
25, compensation expense is measured under the intrinsic value
method, whereby compensation expense is equal to the excess, if any,
of the quoted market price of the stock over the exercise price at
the grant date of the award. Forfeitures are accounted for as
occurred.
Effective January 1, 2006, the Company adopted FASB Statement No.
123 (revised 2004), "Share-Based Payment" ("SFAS 123(R)"), and
related Securities and Exchange Commission rules included in Staff
Accounting Bulletin No. 107, on a modified prospective basis. Under
this method, compensation cost recognized in 2006 includes costs
related to 1) all share-based payments granted prior to but not yet
vested as of January 1, 2006, based on the grant-date fair value
estimated in accordance with the original provisions of SFAS 123 and
2) all share-based payments granted subsequent to January 1, 2006
based on the grant-date fair value estimated in accordance with the
provisions of SFAS 123(R). Results for prior periods have not been
restated. Compensation cost for stock options is recognized ratably
over the vesting period using the straight line method.
SFAS No. 123(R) requires companies to estimate the fair value of
equity based payment awards on the date of grant using an
option-pricing model. The value of the portion of the award that is
ultimately expected to vest is recognized as an expense over the
requisite service periods, on a straight-line basis, in the
Company's consolidated income statements.
F-16
VOCALTEC COMMUNICATIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)
The Company estimates the fair value of stock options on the grant
date using the Black-Scholes option-pricing model with the following
weighted average assumptions:
2007 2006 2005
--------- --------- ----------
Dividend yield 0% 0% 0%
Expected volatility 120% 105% 102%
Risk-free interest rate 4.7% 4.9% 4.4%
Weighted average expected life 5.0 years 4.6 years 4.17 years
Forfeiture rate 12.0% 7.5% -
The Company is required to assume a dividend yield as an input in
the Black-Scholes model. The dividend yield assumption is based on
Company's historical and expectation of future dividend. The
dividend yield used was 0%, as the Company does not expect to pay
dividend over the option terms.
The weighted average volatility used is based on the historical
volatility of the Company's stock over a period equal to the
expected life of the option.
The risk-free interest rate assumption is based on the U.S. Treasury
yield curve.
The Company determined the expected life of the options according to
the "simplified method" allowed under SAB107, which is the midpoint
between the vesting and the contractual term of the Company's stock
options.
The computation of the forfeiture rate is based on the historical
observation of employees pre-vesting termination behavior.
The Company's aggregate compensation cost for the twelve months
ended December 31, 2007 and 2006 totaled $1,147 and $ 948,
respectively.
The following table illustrates the effect on net and net earnings
loss per share, assuming that the Company had applied the fair value
recognition provisions of SFAS 123 to options granted under the
Company's stock options plans in all periods presented prior to the
adoption of SFAS 123(R). For purposes of this pro forma disclosure,
the value of the options is estimated using a Black-Scholes-Merton
option-pricing model and amortized to expense over the options'
vesting periods using the accelerated attribution method.
F-17
VOCALTEC COMMUNICATIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)
YEAR ENDED
DECEMBER 31,
2005
-------------
Net loss as reported $ (6,630)
Add: stock based employee compensation expense
included in reported net loss for the year 803
Deduct: stock based employee compensation expense
determined under fair value method for all options granted (1,129)
-------------
Pro forma net loss $ (6,956)
=============
Accretion of redeemable convertible Preferred shares $ (348)
Induced conversion of convertible Preferred shares (17,406)
Cumulative dividend on convertible preferred shares (2,585)
-------------
Pro forma net loss attributable to common shareholders $ (20,335)
=============
Basic and diluted net loss per Ordinary share:
Net loss per Ordinary share as reported $ (34.05)
Pro forma net loss per Ordinary share $ (34.46)
The Company's additional disclosures required by SFAS 123(R) are
provided in Note 10.
As of December 31, 2007, the total unrecognized estimated
compensation cost related to non-vested stock options granted prior
to that date was $3,125, which is expected to be recognized over a
weighted average period of 2.8 years. No stock options were
exercised during 2007.
p. Severance pay:
The Company's liability for severance pay for its Israeli employees
is calculated pursuant to Israel's Severance Pay Law and employment
agreements based on the most recent salary of the employees. The
Company's liability for all of its employees, is fully covered by
monthly deposits with managers' insurance policies and by an
accrual. The value of these managers' insurance policies is recorded
as an asset in the Company's balance sheet.
The deposited funds include profits accumulated up to the balance
sheet date. The deposited funds may be withdrawn only upon the
fulfillment of the obligation pursuant to Israel's Severance Pay Law
or labor agreements. The value of the deposited funds is based on
the cash surrendered value of these funds and includes immaterial
profits.
Severance expense for the years ended December 31, 2007, 2006 and
2005 amounted to approximately $ 787, $ 170 and $ 77, respectively.
F-18
VOCALTEC COMMUNICATIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)
q. Concentration of credit risks:
Financial instruments that potentially subject the Company to
concentrations of credit risk consist principally of cash and cash
equivalents, restricted cash, marketable securities and trade
receivables.
Cash and cash equivalents and the short term deposit are invested in
U.S. dollars with major banks in the United States and in Israel.
Management believes that the financial institutions that hold the
Company investments are financially sound and, accordingly, minimal
credit risk exists with respect to these investments.
The Company's trade receivables are generally derived from sales of
products and services rendered to large and solid organizations
located primarily in Europe, North America, and the Far East. The
Company performs ongoing credit evaluations of its customers. To
date the Company has not experienced any material losses in respect
of its trade receivable. For new customers, the Company may require
a letter of credit or upfront cash payments. An allowance for
doubtful accounts is determined based on Management's estimation and
historical experience.
Expense resulting from the net increase in the allowance for
doubtful accounts was $ 40, $ 70 and $ 0 for the years ended
December 31, 2007, 2006 and 2005, respectively.
The Company sometimes uses derivative financial instruments to
manage its exposure to fluctuations in foreign exchange rates. The
Company accounts for derivative financial instruments in accordance
with SFAS 133, "Accounting for Derivative Instruments and Hedging
Activities" ("SFAS No. 133"). Under SFAS No. 133, all derivatives
are recorded as either assets or liabilities in the consolidated
balance sheet, and periodically adjusted to fair value. The
classification of gains and losses resulting from changes in the
fair values of derivatives is dependent on the intended use of the
derivative and its resulting designation. Adjustments to reflect
changes in fair values of derivatives not designated as hedging
instruments are reflected in earnings. For derivative instruments
that are designated and qualify as a cash flow hedge, the effective
portion of the gain or loss on the derivative instrument is reported
as a component of other comprehensive income and reclassified into
earnings in the same line item associated with the forecasted
transaction in the same period during which the hedge transaction
affects earnings.
r. Net loss per share:
Basic net loss per share is computed using the weighted average
number of Common shares outstanding during the period, and excludes
any dilutive effects of options. Diluted net loss per share is
computed using the weighted average number of Common shares plus
dilutive potential shares of Ordinary stock considered outstanding
during the period. In accordance with Emerging Issues Task Force
Issue 03-6 "Participating Securities and the Two-Class Method under
FASB Statement No. 128" ("EITF 03-6"), participating convertible
securities are excluded from the computation since there is no
contractual obligation for these securities to share in the Company
net loss.
F-19
VOCALTEC COMMUNICATIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)
In the years ended December 31, 2007, 2006 and 2005, all outstanding
stock options and in the year ended December 31, 2005 also all the
series of Preferred shares have been excluded from the calculation
of the diluted net loss per Ordinary share since such securities
were anti-dilutive.
s. Recently issued Accounting Standards:
In December 2007, the FASB issued SFAS 141(R), Business Combinations
("SFAS No. 141(R)"). This Statement replaces SFAS 141, Business
Combinations ("SFAS No. 141"), and requires an acquirer to recognize
the assets acquired, the liabilities assumed, including those
arising from contractual contingencies, any contingent
consideration, and any noncontrolling interest in the acquiree at
the acquisition date, measured at their fair values as of that date,
with limited exceptions specified in the statement. SFAS 141(R) also
requires the acquirer in a business combination achieved in stages
(sometimes referred to as a step acquisition) to recognize the
identifiable assets and liabilities, as well as the noncontrolling
interest in the acquiree, at the full amounts of their fair values
(or other amounts determined in accordance with SFAS 141(R)). In
addition, SFAS 141(R)'s requirement to measure the noncontrolling
interest in the acquiree at fair value will result in recognizing
the goodwill attributable to the noncontrolling interest in addition
to that attributable to the acquirer. SFAS 141(R) amends SFAS No.
109, Accounting for Income Taxes ("SFAS No. 109"), to require the
acquirer to recognize changes in the amount of its deferred tax
benefits that are recognizable because of a business combination
either in income from continuing operations in the period of the
combination or directly in contributed capital, depending on the
circumstances.
It also amends SFAS 142, Goodwill and Other Intangible Assets ("SFAS
No. 142"), to, among other things, provide guidance on the
impairment testing of acquired research and development intangible
assets and assets that the acquirer intends not to use. SFAS 141(R)
applies prospectively to business combinations for which the
acquisition date is on or after the beginning of the first annual
reporting period beginning on or after December 15, 2008. The
Company is currently evaluating the impact that SFAS 141(R) will
have on its consolidated financial statements.
In December 2007, the FASB issued SFAS 160 ("SFAS No. 160"),
Noncontrolling Interests in Consolidated Financial Statements. SFAS
160 amends Accounting Research Bulletin 51, Consolidated Financial
Statements, to establish accounting and reporting standards for the
noncontrolling interest in a subsidiary and for the deconsolidation
of a subsidiary. It also clarifies that a noncontrolling interest in
a subsidiary is an ownership interest in the consolidated entity
that should be reported as equity in the consolidated financial
statements. SFAS 160 also changes the way the consolidated income
statement is presented by requiring consolidated net income to be
reported at amounts that include the amounts attributable to both
the parent and the noncontrolling interest. It also requires
disclosure, on the face of the consolidated statement of income, of
the amounts of consolidated net income attributable to the parent
and to the noncontrolling interest. SFAS 160 requires that a parent
recognize a gain or loss in net income when a subsidiary is
deconsolidated and requires expanded disclosures in the consolidated
financial statements that clearly identify and distinguish between
the interests of the parent owners and the interests of the
noncontrolling owners of a subsidiary. SFAS 160 is effective for
fiscal periods, and interim periods within those fiscal years,
beginning on or after December 15, 2008. The Company is currently
evaluating the impact that SFAS 160 will have on its consolidated
financial statements.
F-20
VOCALTEC COMMUNICATIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)
In September 2006, the FASB issued Statement No. 157, "Fair value
Measurements" ("SFAS 157"). SFAS 157 defines fair value, establishes
a framework for measuring fair value in generally accepted
accounting principles, and expands disclosures about fair value
measurements. SFAS 157 applies under other accounting pronouncements
that require or permit fair value measurements. The provisions of
SFAS 157 are effective for the Company beginning January 1, 2008.
The FASB issued a FASB Staff position to defer the effective date of
SFAS 157 for one year for all nonfinancial assets and nonfinancial
liabilities, except for those items that are recognized or disclosed
at fair value in the financial statements on a recurring basis. The
Company does not except the adoption will have material impact on
its consolidated financial statements.
In February 2008, the FASB issued FASB Staff Position FSP 157-2,
"Effective Date of FASB Statement No. 157" ("FSP 157-2"). FSP 157-2
delays the effective date of SFAS No. 157 for all non-financial
assets and non-financial liabilities, except for items that are
recognized or disclosed at fair value in the financial statements on
a recurring basis (at least annually), until the beginning of the
first quarter of fiscal 2009. The Company is currently evaluating
the impact that SFAS No. 157 will have on its consolidated financial
statements when it is applied to non-financial assets and
non-financial liabilities beginning in the first quarter of 2009.
In February 2007, the FASB issued Statement No. 159, "The Fair Value
Option for Financial Assets and Financial Liabilities" ("SFAS 159").
SFAS 159 permits companies to choose to measure certain financial
instruments and certain other items at fair value. The standard
requires that unrealized gains and losses on items for which the
fair value option has been elected be reported in earnings. The
provisions of SFAS 159 are effective for the Company beginning
January 1, 2008. The Company does not expect the adoption of SFAS
159 will have an impact on its consolidated financial statements.
In December 2007, the SEC staff issued Staff Accounting Bulletin No.
110 ("SAB 110"), which, effective January 1, 2008. SAB 110 amends
and replaces Staff Accounting Bulletin No. 107 ("SAB 107"),
Share-Based Payment. SAB 110 expresses the views of the SEC staff
regarding the use of a "simplified" method in developing an estimate
of expected term of "plain vanilla" share options in accordance with
FASB Statement No. 123(R), Share-Based Payment. Under the
"simplified" method, the expected term is calculated as the midpoint
between the vesting date and the end of the contractual term of the
option. The use of the "simplified" method, which was first
described in SAB 107, was scheduled to expire on December 31, 2007.
SAB 110 extends the use of the "simplified" method for "plain
vanilla" awards in certain situations. The SEC staff does not expect
the "simplified" method to be used when sufficient information
regarding exercise behavior, such as historical exercise data or
exercise information from external sources, becomes available. The
adoption of SAB 110 would not have any effect on the Company's
financial statements.
F-21
VOCALTEC COMMUNICATIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)
In March 2008, the FASB issued SFAS No. 161, "Disclosures about
Derivative Instruments and Hedging Activities - an amendment to FASB
Statement No. 133". SFAS No. 161 is intended to improve financial
standards for derivative instruments and hedging activities by
requiring enhanced disclosures to enable investors to better
understand their effects on an entity's financial position,
financial performance, and cash flows. Entities are required to
provide enhanced disclosures about: (a) how and why an entity uses
derivative instruments; (b) how derivative instruments and related
hedged items are accounted for under Statement 133 and its related
interpretations; and (c) how derivative instruments and related
hedged items affect an entity's financial position, financial
performance, and cash flows. It is effective for financial
statements issued for fiscal years beginning after November 15,
2008, with early adoption encouraged. The Company is currently
evaluating the impact of SFAS No. 161 on its financial statements.
In May 2008, the FASB issued SFAS No. 162, "The Hierarchy of
Generally Accepted Accounting Principles". SFAS 162 identifies the
sources of accounting principles and the framework for selecting the
principles to be used in the preparation of financial statements of
nongovernmental entities that are presented in conformity with
generally accepted accounting principles in the United States. It is
effective 60 days following the SEC's approval of the Public Company
Accounting Oversight Board amendments to AU Section 411, "The
Meaning of Present Fairly in Conformity With Generally Accepted
Accounting Principles". The Company is currently evaluating the
impact of SFAS No. 162 on its financial statements, and the adoption
of this statement is not expected to have a material effect on the
Company's financial statements.
t. Reclassification:
Certain figures from prior years have been reclassified in order to
conform to the 2007 presentation.
NOTE 3:- BUSINESS COMBINATION
a. TdSoft:
On November 24, 2005 VocalTec acquired all the issued and
outstanding Ordinary shares of Tdsoft Ltd. ("Tdsoft"), a provider of
Voice over IP gateways for carriers, in consideration for issuance
of shares to Tdsoft shareholders representing as of the closing date
of the transaction 75% of the issued and outstanding share capital
of VocalTec. As a result, Tdsoft became a wholly-owned subsidiary of
VocalTec. Although the merger with Tdsoft was formed as a merger of
Tdsoft into VocalTec, immediately after the merger the shareholders
of Tdsoft held the majority of VocalTec outstanding Ordinary shares.
Accordingly, for accounting and financial reporting purposes, the
merger was treated as a reverse acquisition of VocalTec by Tdsoft
under the purchase method of accounting pursuant to Statement of
Financial Accounting Standard No. 141 "Business Combination" ("SFAS
141"). The financial statements of the combined company reflect the
financial statements of Tdsoft on a historical basis and include the
results of operations and cash flows of VocalTec from November 24,
2005.
F-22
VOCALTEC COMMUNICATIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 3:- BUSINESS COMBINATION (CONT.)
However, Tdsoft's shareholders' equity was restated retroactively to
reflect the transaction as a reverse recapitalization. As such, all
share capital (number and amounts) reflect Vocaltec shares exchanged
for the Tdsoft shares existing at each relevant date.
The fair value of the Ordinary shares of VocalTec was determined
based on the average market price of the shares during the period of
two days before and ending two days after the date VocalTec and
Tdsoft announced the merger agreement on October 28, 2005. The
purchase price also included the fair value of the VocalTec stock
options and other costs of the transaction. Accordingly, the total
purchase price was as follows:
Number of shares of VocalTec outstanding as of November 24, 2005 $ 1,162,142
===========
VocalTec's average share price for the two trading days before through
the two trading days after October 28, 2005, the date VocalTec and
Tdsoft announced their merger 6.77
===========
Fair value of VocalTec's Ordinary shares $ 7,869
Fair value of 186,597 VocalTec share options *) 226
Transaction costs of Tdsoft 138
-----------
Purchase price $ 8,233
===========
*) The fair value of the options was determined based on the Black & Scholes
options pricing model.
The purchase price was allocated based on an estimate of the fair
value of the assets acquired and the liabilities assumed as of
November 24, 2005, as follows:
Current assets $ 2,009
Severance pay funds 1,123
Equipment 328
------------
TOTAL tangible assets 3,460
------------
Identifiable intangible assets:
Current Essentra technology (7 years useful life) 1,963
Current VEA technology (2 years useful life) 123
Customer contract (1 year useful life) 372
Customer relations (7 years useful life) 887
Trade name (10 years useful life) 301
Patents (10 years useful life) 250
Goodwill *) 7,734
------------
TOTAL intangible assets acquired 11,630
------------
TOTAL tangible and intangible assets acquired 15,090
------------
TOTAL liabilities assumed *) (6,857)
------------
Net assets acquired $ 8,233
============
F-23
VOCALTEC COMMUNICATIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 3:- BUSINESS COMBINATION (CONT.)
*) After reduction of $287 due to adjustments to the estimated
fair value of the inventory acquired and certain liabilities
assumed, mainly the accrued expenses with respect to office
lease, and increasing the tax provision in the amount of $784
due to the implementation of FIN 48.
The implementation of FIN 48 resulted in an increase in the
tax provision related to tax exposures existed at the
acquisition date. Accordingly, additional tax provision was
recorded as an increase of goodwill.
The resulting goodwill is attributed but is not limited to the
synergistic value and potential benefits that could be realized by
the Company from the acquisition, as well as VocalTec's skilled and
specialized workforce. The goodwill is not deductible for tax
purposes. In accordance with Statement of Financial Accounting
Standards No. 142 ("SFAS 142") "Goodwill and Other Intangible
Assets", goodwill arising from acquisition will not be amortized.
Values assigned to intangible assets were determined using the
income approach by discounting the future cash flows an asset will
generate over its remaining useful life. Current assets and
liabilities were recorded at their carrying value since such
carrying amounts were proxies for their market values due to their
short-term maturities.
See Note 7(c) for impairment loss recorded on goodwill.
b. Supplemental pro forma information (unaudited):
The unaudited pro forma information regarding 2005 presents the
results of operations of Tdsoft after giving effect to the merger
with Vocaltec in 2005, and includes the effect of amortization of
intangible assets from these dates. The pro forma information is
based upon the historical financial statements of VocalTec and
TdSoft. The pro forma data does not incorporate, nor does it assume,
any benefits from cost savings or synergies of the combined
companies. The pro forma data is presented for comparative purposes
only and is not necessary indicative of the operating results that
would have occurred had the merger been consummated at the dates
indicated, nor are they necessarily indicative of future operating
results or financial conditions.
YEAR ENDED
DECEMBER 31,
2005
------------
Sales $ 8,427
============
Operating loss $ (16,833)
============
Net loss $ (15,137)
============
Basic and diluted net loss per Ordinary share $ (19.28)
============
Weighted average number of Ordinary shares
used in computation of basic and diluted
net loss per share 1,840
============
F-24
VOCALTEC COMMUNICATIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 4:- PREPAID EXPENSES AND OTHER ACCOUNTS RECEIVABLE
DECEMBER 31,
-----------------------
2007 2006
---------- ----------
Prepaid expenses *) $ 1,394 $ 672
Research and development participation
and grants receivable 14 460
Government authorities 80 162
Other 55 34
---------- ----------
$ 1,543 $ 1,328
========== ==========
*) As of December 31, 2007 and 2006, including $1,283 and 560,
respectively, finished goods delivered to customers' sites and not
recognized as cost of sales since revenue recognition criteria for
the related sales have not been met.
NOTE 5:- INVENTORIES
DECEMBER 31,
-----------------------
2007 2006
---------- ----------
Components and work in progress $ 61 $ 538
Finished goods 200 -
---------- ----------
$ 261 538
========== ==========
*) Write-off of inventories for the years ended December 31, 2007, 2006
and 2005 amounted to $ 459, $ 0 and $ 757, respectively.
NOTE 6:- PROPERTY AND EQUIPMENT, NET
DECEMBER 31,
-----------------------
2007 2006
---------- ----------
Cost:
Computers and related equipment $ 4,579 $ 4,409
Office furniture, equipment and leasehold
improvements 1,314 1,304
Motor vehicle 10 29
---------- ----------
5,903 5,742
Less - accumulated depreciation 5,248 4,854
---------- ----------
Property and equipment, net $ 655 $ 888
========== ==========
Depreciation expense was $ 411, $ 522 and $ 581 for the years ended
December 31, 2007, 2006 and 2005, respectively.
Nearly all of the property and equipment is located in Israel.
F-25
VOCALTEC COMMUNICATIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 7:- GOODWILL AND OTHER INTANGIBLE ASSETS
DECEMBER 31,
---------------------
2007 2006
-------- ---------
Cost:
Technology $ 3,049 $ 3,049
Customer relations and other intangible assets 1,810 1,810
-------- ---------
4,859 4,859
Less - accumulated amortization 2,378 1,812
-------- ---------
2,481 3,047
-------- ---------
Goodwill 2,297 6,950
-------- ---------
Total amortized cost $ 4,778 $ 9,997
======== =========
a. The future annual estimated amortization expense of the intangible
assets in the next 5 years relating to VocalTec's amortizable
intangible assets existing as of December 31, 2007, is approximately
as follows:
TOTAL
AMORTIZATION
------------
2008 $ 510
2009 462
2010 462
2011 462
2012 421
b. Amortization expenses amounted to approximately $ 566, $ 906 and $
230 for the years ended December 31, 2007, 2006 and 2005,
respectively.
c. The changes in the carrying amount of goodwill for the years ended
December 31, 2007 are as follows:
Balance as of January 1, 2005 $ -
Newly consolidated company 7,237
--------
Balance as of December 31, 2005 7,237
Adjustments to the estimated fair value of
certain assets and liabilities (287)
--------
Balance as of December 31, 2006 6,950
Adjustment of goodwill due to increase in tax provision
resulted from the implementation of FIN 48 784
Impairment loss (5,437)
Balance as of December 31, 2007 $ 2,297
========
F-26
VOCALTEC COMMUNICATIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 7:- GOODWILL AND OTHER INTANGIBLE ASSETS (Cont.)
d. As a result of the annual impairment test, performed in the fourth
quarter of each year and due to the Company's loss in 2007 and the
fact that as of December 31, 2007, the Company's market
capitalization was lower than the Company's shareholders' equity as
of such date, the Company recorded impairment loss of approximately
$5,437 related to goodwill during 2007. This impairment loss is
included in separate line item in the statement of operations. The
fair value of the reporting unit was estimated using the discount
cash flow approach.
NOTE 8:- ACCRUED EXPENSES AND OTHER ACCOUNTS PAYABLE
DECEMBER 31
---------------------
2007 2006
--------- ---------
Employees and payroll accruals $ 706 $ 948
Accrued expenses 370 303
Accrued vacation pay 536 620
Accrued income tax 1,275 420
Government Institutions 195 542
Office lease 8 97
Other 76 66
--------- ---------
$ 3,166 $ 2,996
========= =========
NOTE 9:- COMMITMENTS AND CONTINGENCIES
a. In connection with its research and development activities through
December 31, 2007, the Company received and accrued participation
payments from the Office of the Chief Scientist of the Ministry of
Industry and Trade in Israel ("OCS"). In return for the Government
of Israel's participation, the Company is committed to pay royalties
at a rate of 3.5% - 4.5% of sales of the developed product, up to
100% of the amount of grants received linked to the U.S. dollar
(grants received under programs approved subsequent to January 1,
1999, are subject to interest at the annual rate of LIBOR applicable
to U.S. dollar deposits).
The Company's total contingent liability for royalties payable to
the OCS with respect to future sales, based on Government of Israel
participations received or accrued, net of royalties paid or
accrued, totaled approximately $ 21 million as of December 31, 2007.
The obligation to pay these royalties is contingent on actual sales
of the products, and in the absence of such sales, no payment is
required.
Cost of sales includes royalties paid and accrued to the Government
of Israel in the amount of $ 175, $ 201 and $ 63 for the years ended
December 31, 2007, 2006, and 2005, respectively. With respect to the
sale of patents and negotiation conducted with the OCS, see Note 16.
F - 27
VOCALTEC COMMUNICATIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 9:- COMMITMENTS AND CONTINGENCIES (CONT.)
b. In April 2005, Tdsoft entered into a co-operation and project
funding agreement effective as of December 1, 2004, with Nuera
Communications, Inc. ("Nuera") and the Israel-United States
Bi-national Industrial Research and Development Fund ("BIRD"), for
the development of "Next Generation VoIP Gateway" with certain
funding assistance from BIRD.
Under the agreement, Tdsoft shall be reimbursed by BIRD for 50% of
its research and development expenses, up to an aggregate amount of
$ 770. In accordance with the agreement with BIRD, Tdsoft is
obligated to pay royalties at the rate of 5% of the sales of the
developed products up to a maximum of 150% of the amount received
depending of the year following the termination of the agreement in
which the participation is fully paid. During 2006 and 2005, grants
received and accrued from BIRD amounted to $ 21 and 749,
respectively. Tdsoft's contingent liability to BIRD amounts to
approximately $ 770. The obligation to pay these royalties is
contingent on actual sales of the products, and in the absence of
such sales, no payment is required.
The Company has no future commitments for royalties in respect of
other participations received.
c. Certain claims, mainly for patent infringement and breach of
contract have been made against VocalTec Ltd., Tdsoft Ltd. or its
U.S. subsidiary. These allegations have not resulted in any action
brought against the Company. The Company's management does not
believe that it is probable that the above mentioned allegations
will result in a loss to the Company. Accordingly, no provision was
recorded with respect to these allegations.
d. The Company's facilities in Israel are rented under operating leases
with different periods ending through April 2010 (with renewal
option). Rent expense amounted to $ 415, $ 256 and $ 308 for the
years ended December 31, 2007, 2006 and 2005, respectively. Annual
minimum rental commitments under non-cancelable leases at balance
sheet date are approximately as follows:
2008 $ 468
2009 468
2010 117
-------
Total $ 1,053
-------
The Company also maintains motor vehicle leases. The total liability
for early termination of such leases is approximately $ 41. Motor
vehicle lease expense amounted to $ 407, $ 470 and $ 390 for the
years ended December 31, 2007, 2006 and 2005, respectively.
e. Under the purchase agreement with Be-Connected from 2004, the bank
provided the shareholders of Be-Connected on behalf of Tdsoft a
bank guarantee of $ 500, in respect of certain guarantees that a
shareholder of Be-Connected gave to its customers. $ 140 out of the
$ 500 expired in November 2006, the other $ 360 will expire in May
2009.
f. The bank provided, with respect to offices lessors, bank guarantee
on behalf of Tdsoft, in the amount of NIS 600.
F - 28
VOCALTEC COMMUNICATIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 10:- SHARE CAPITAL
a. Share capital
1. All Ordinary shares of the Company have the same rights.
Dividends declared by the company will be distributed to
shareholders in proportion to their holdings. If the Company
is liquidated, after satisfying liabilities to creditors, the
Company's assets will be distributed to the holders of
Ordinary shares in proportion to their holdings.
Holders of Ordinary shares have one vote for each paid-up
Ordinary share on all matters submitted to a vote of our
shareholders. These voting rights may be affected by the grant
of any special voting rights to the holders of a class of
shares with preferential rights that may be authorized in the
future.
2. Pursuant to an amendment to the articles of association of
Tdsoft, which amendment was adopted immediately prior to the
consummation of the business combination between VocalTec and
TdSoft in November 2005, all series of convertible Preferred
shares were converted into Ordinary shares of TdSoft.
Immediately after, all the Ordinary shares of TdSoft were
exchanged for VocalTec Ordinary shares. The conversion ratio
was established for each class of shares. The group of the
founders and the employees of the Company received a preferred
conversion ratio, according to which the founders and the
employees received approximately twice the amount received by
the other Ordinary shareholders. Accordingly, the Company
recorded stock-based compensation in the amount of $ 870, of
which $ 803 was recorded in the statement of operations in
2005.
In addition, the Preferred shareholders also received a
preferred conversion ratio over the Ordinary Shares, although
the original terms of the convertible Preferred shares
provided for a conversion at the ratio of 1:1. Consequently,
as required by EITF D-42, "The Effect on the Calculation of
Earnings per Share to the Redemption or Induced Conversion of
Preferred Stock" and EITF D-53, "Computation of Earnings per
Share for a Period that Includes a Redemption or an Induced
Conversion of a Portion of a Class of Preferred Stock", the
financial statements for the year ended December 31, 2005
include an amount of $ 17,406 attributed to the value of the
incremental number of Ordinary shares received by the holders
of the preferred stock upon the conversion of the preferred
stock as part of the business combination with VocalTec.
All the share stock amounts have been restated to reflect the
Ordinary shares received as part of the business combination,
as described in Note 3a.
3. Prior to the conversion and exchange of all the shares of
TdSoft, the holders of series B and C Preferred shares of
Tdsoft had certain redemption rights. In February 2005, all
redemption rights were waived and the redeemable convertible
Preferred shares were converted into convertible Preferred
shares.
F - 29
VOCALTEC COMMUNICATIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 10:- SHARE CAPITAL (Cont.)
The Preferred shares also held certain liquidation preferences
over Ordinary shares (Preferred C prior to Preferred A and
Preferred B, Preferred A and B prior to all Ordinary shares
and Ordinary A shares prior to Ordinary shares), and were
convertible into Ordinary shares as follows: each series A
Preferred share, series B and B-2 Preferred share and series C
Preferred share was convertible at any time into an Ordinary
share at the option of the holder.
In addition, holders of series A, series B, series B-2 and
series C convertible Preferred shares were entitled to receive
cumulative dividends in preference to the holders of Ordinary
and Ordinary A shares at the rate of 8% per annum. Such
dividends would accrue quarterly for the benefit of the
holders of the Preferred shares.
4. On November 25, 2005, the Company effected a reverse split of
its issued and outstanding share capital of 1:13. All the
stock share amounts were adjusted to reflect the reverse
split.
b. In May 2006 the Company issued in a private placement in
consideration for $ 4,591, net of issuance expenses of $ 548,935,000
Ordinary Shares and warrants to purchase up to 424,050 Ordinary
Shares at an exercise price of $ 7.9 per share. The warrants became
exercisable 6 months after issuance and will remain exercisable
until the fifth anniversary of the date of issuance. According to
the agreements, the investors have the right to receive payment for
liquidated damages if a registration statement on Form F-3 is not
declared effective within 60 days from the date of the closing
and/or the failure to maintain the registration Statement effective.
The liquidated damages will be in the amount of 0.0333% of the
purchase price paid by the investors for each day of delay up to 10%
of the proceeds received. The shares and shares to be derived from
the warrants were registered for trading on NASDAQ on May 22, 2006.
As of December 31, 2007, no liability was recorded in respect of the
liquidated damages as the Company does not deem it probable that
such liquidated damages will be made.
In December 2006 the Company decided to reduce the exercise price
of the warrants issued by the Company to the investors from $7.9
per share to $6.87 per share - the closing price of the Company's
ordinary shares on the Nasdaq Capital Market at the close of
business immediately prior to execution of the agreement relating
to the May 2006 issuance. The benefit of $37 to the warrant
holders from the aforementioned reduction in the exercise price
was recorded as a preferred dividend to the warrant holders.
As of December 31, 2007, none of these warrants were exercised into
the Company's Ordinary shares.
c. In November 2006, the Company issued in a private placement in
consideration for $ 6,998, net of issuance expenses of $ 527,
1,750,000 Ordinary Shares and warrants to purchase up to
1,400,000 Ordinary Shares at an exercise price of $ 5.5 per
share. The warrants are exercisable during a period ending
June 30, 2011. The shares were registered for trading on
NASDAQ on December 4, 2006. As of December 31, 2007, none of
these warrants were exercised into the Company's ordinary
shares.
F-30
VOCALTEC COMMUNICATIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 10:- SHARE CAPITAL (CONT.)
d. Share option plans:
Tdsoft had seven Share Option Plans, which provided for the grant by
Tdsoft of option awards to purchase Ordinary shares of Tdsoft to
officers, employees and directors of Tdsoft and its subsidiaries.
Immediately upon allotment, the Ordinary shares purchased in
exercise of the options would have the same rights as other Tdsoft
Ordinary shares. The options vest ratably over vesting periods
ranging from three to five years (mainly 5 years). The options
expire 84 months from the date of issuance which was extended by the
board of directors by additional 36 months. The exercise price of
options under the plans is to be determined by the compensation
committee. The exercise price for options granted in 2005, 2004 and
2003 was determined at fair market value at the date of each grant.
In August 2005, the board of directors of VocalTec resolved to
transfer to the VocalTec 2003 Master Stock Option Plan all of the
shares then available for grants of options under the other VocalTec
option plans. Pursuant to the business combination, the number of
shares underlying the 2003 Master Stock Option Plan was increased by
576,923 to a total of 1,038,462 shares, and VocalTec adopted each of
Tdsoft's option plans, such that all outstanding options granted
under the various Tdsoft option plans to purchase Ordinary shares of
Tdsoft were assumed by VocalTec, except that the Tdsoft Ordinary
shares underlying such options were replaced by VocalTec's Ordinary
shares in amounts and for exercise prices in accordance with the
conversion ratio set forth in the agreement for the business
combination (and which options continued to be subject, except as
set forth herein, to the terms of the Tdsoft option plans under
which they were granted).
Following consummation of the business combination, the Company's
board of directors resolved (i) to effect certain amendments to the
2003 Master Stock Option Plan and (ii) that options granted under
older stock option plans shall revert to the amended 2003 Master
Stock Option Plan upon the expiration or cancellation of such
option.
Options granted under the VocalTec amended 2003 Master Stock Option
Plan generally have a term of seven (7) years. However, options
granted prior to December 13, 2005 have a term of ten (10) years.
Earlier termination may occur if the employee's employment with the
Company is terminated or if certain corporate changes or
transactions occur. The Company's board of directors determines the
grant and the exercise price at the time the options are granted
upon recommendation of the compensation committee.
Each stock option agreement specifies the date and period over which
the option becomes exercisable. Options granted generally vest over
a period of four years, either in equal quarterly installments of
6.25% of the option shares, starting three months after the date of
grant, or 25% of the option shares are vested one year following
option grant, and the remaining 75% vest in equal quarterly
installments of 6.25% over the remaining three years. Vesting of
options granted to employees is conditional upon the grantee
remaining continuously employed by VocalTec or its subsidiaries.
As of December 31, 2007, 621,569 share options are still available
for future grants under the Company's existing plans, including a
one time increase of 700,718 share options and an annual increase of
180,000 share options approved by the 2007 annual general meeting of
the shareholders. Options which are cancelled or forfeited before
expiration become available for future grants.
F-31
VOCALTEC COMMUNICATIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 10:- SHARE CAPITAL (CONT.)
A summary of the Company's share option activity under the plans is
as follows:
YEAR ENDED DECEMBER 31, 2005
-----------------------------
WEIGHTED
NUMBER OF AVERAGE
OPTIONS EXERCISE PRICE
---------- --------------
Outstanding - beginning of year 52,315 $ 8.05
Granted 860,416 $ 11.92
Exercised (17,979) $ 8.44
Forfeited (25,852) $ 44.51
---------
Outstanding - end of year 868,900 $ 10.79
========= ==============
Options exercisable - end of year 214,817 $ 26.68
========= ==============
*) The number and the exercise price of the options were restated to reflect
such amounts and exercise prices as adjusted in business combination.
YEAR ENDED DECEMBER 31, 2006
------------------------------------------------
WEIGHTED
AVERAGE
WEIGHTED REMAINING
AVERAGE CONTRACTUAL AGGREGATE
NUMBER OF EXERCISE TERM (IN INTRINSIC
OPTIONS PRICE YEARS) VALUE
-------- -------- -------- --------
Outstanding - beginning of year 868,900 $ 10.79
Granted 148,870 $ 5.62
Exercised (29,776) $ 5.04
Forfeited (278,141) $ 14.24
-------- --------
Outstanding - end of year 709,853 $ 8.60 6.14 $ 27
======== ======== ======== ========
Vested and expected to vest - end of year 608,713 $ 6.14 6.11 $ 26
======== ======== ======== ========
Options exercisable - end of year 227,986 $ 7.13 5.77 $ 17
======== ======== ======== ========
F-32
VOCALTEC COMMUNICATIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 10:- SHARE CAPITAL (CONT.)
YEAR ENDED DECEMBER 31, 2007
------------------------------------------------
WEIGHTED
AVERAGE
WEIGHTED REMAINING
AVERAGE CONTRACTUAL AGGREGATE
NUMBER OF EXERCISE TERM (IN INTRINSIC
OPTIONS PRICE YEARS) VALUE
--------- --------- ----------- ----------
Outstanding - beginning of year 709,853 $ 8.60
Granted 1,017,158 $ 3.32
Exercised - $ -
Forfeited (400,315) $ 8.23
--------- ---------
Outstanding - end of year 1,326,696 $ 4.67 5.85 $ -
========= ========= =========== ==========
Vested and expected to vest - end of year 1,020,578 $ 2.63 5.78 $ -
========= ========= =========== ==========
Options exercisable - end of year 343,840 $ 6.86 5.34 $ -
--------- --------- ----------- ----------
The weighted average fair values of the options granted during
2007, 2006 and 2005, were $ 3.32, $ 3.22 and $ 3.42,
respectively.
The following table summarizes information about options
outstanding and exercisable at December 31, 2007:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
---------------------------------------- -------------------------
AMOUNT WEIGHTED-
OUTSTANDING AVERAGE WEIGHTED AMOUNT WEIGHTED
AT REMAINING AVERAGE OUTSTANDING AT AVERAGE
RANGE OF DECEMBER 31, CONTRACTUAL EXERCISE DECEMBER 31, EXERCISE
EXERCISE PRICES 2007 LIFE PRICES 2007 PRICES
---------------- ------------ ----------- --------------
(YEARS)
-----------
$ 0.00-3.00 45,600 6.61 $ 2.88 - $ 0.00
$ 3.00-7.50 1,257,478 5.85 $ 4.28 321,308 $ 5.22
$ 7.50-18.75 11,458 4.12 $ 11.83 10,410 $ 11.27
$ 18.75-46.88 7,043 4.45 $ 31.28 7,043 $ 31.28
$ 46.88-117.20 4,559 3.07 $ 58.96 4,521 $ 58.96
$ 117.20-224.25 558 1.71 $ 157.56 558 $ 157.56
----------- -------------- --------
1,326,696 5.85 $ 4.67 343,840 $ 1.78
=========== ============== ========
F-33
VOCALTEC COMMUNICATIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 11:- NET LOSS PER SHARE
The following table sets forth the computation of basic and diluted net
loss per Ordinary share:
YEAR ENDED DECEMBER 31,
----------------------------------
2007 2006 2005
--------- --------- --------
Numerator:
Net loss $ (14,179) $ (7,012) $ (6,630)
Accretion of redeemable convertible Preferred shares - - (348)
Induced conversion of convertible Preferred shares - - (17,406)
Cumulative dividend on convertible preferred shares - - (2,585)
Dividend in respect to reduction in exercise price
of certain warrants - (37) -
--------- --------- --------
Net loss attributable to common shareholders after
allocation of undistributed earnings to convertible
Preferred shares $ (14,179) $ (7,049) $(26,969)
========= ========= ========
Denominator:
Weighted average number of Ordinary shares
outstanding during the year used to compute basic
and diluted net loss per Ordinary share 7,376 5,436 792
========= ========= ========
Basic and diluted net loss per Ordinary share $ (1.92) $ (1.30) $ (34.05)
========= ========= ========
The Company manages its business on a basis of one reportable segment. The
Company follows the guidance in Statement of Financial Accounting
Standards No. 131, "Disclosure about Segment of an Enterprise and Related
Information".
YEAR ENDED DECEMBER 31,
------------------------------------------------
2007 2006 2005
-------------- -------------- --------------
Sales classified by geographic areas based on end-
customer location:
Russia $ 1,635 $ 399 $ -
Germany 1,314 947 273
Italy 884 1,666 731
Iceland 155 272 701
Europe - other 643 1,015 1,013
Americas (principally United States) 351 770 992
Asia 124 882 275
Israel 145 540 608
Africa and Middle East 503 789 -
-------------- -------------- --------------
$ 5,754 $ 7,280 $ 4,593
============== ============== ==============
F-34
VOCALTEC COMMUNICATIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 12:- GEOGRAPHIC, MAJOR CUSTOMERS AND PRODUCT LINE INFORMATION
YEAR ENDED DECEMBER 31,
------------------------------------------------
2007 2006 2005
-------------- -------------- --------------
%
------------------------------------------------
Sales to a single customer exceeding 10%:*)
Customer A *) 13 18
Customer B *) *) 16
Customer C 22 18 *)
Customer D 12 *) *)
Customer E 10 *) *)
*) Less than 10%
Total revenues from external customers on the basis of the Company's
product lines are as follows:
YEAR ENDED DECEMBER 31,
------------------------------------------------
2007 2006 2005
-------------- -------------- --------------
The Essentra family 4,482 4,550 79
Tdgate 769 1,542 1,837
Hunt 192 360 612
Proxi 100 73 375
Tas 179 388 946
Core (software) 32 367 744
-------------- -------------- --------------
$ 5,754 $ 7,280 $ 4,593
============== ============== ==============
NOTE 13:- RESEARCH AND DEVELOPMENT, NET
YEAR ENDED DECEMBER 31,
------------------------------------------------
2007 2006 2005
-------------- -------------- --------------
Research and development expenses $ 5,340 $ 5,439 $ 5,669
Less- participations from:
OCS 773 799 557
BIRD - 21 749
-------------- -------------- --------------
$ 4,567 $ 4,619 $ 4,363
============== ============== ==============
NOTE 14:- FINANCIAL INCOME, NET
YEAR ENDED DECEMBER 31,
------------------------------------------------
2007 2006 2005
-------------- -------------- --------------
Financial income:
Interest on cash and cash equivalents, net of
bank fees $ 321 $ 112 $ 173
Foreign currency translation adjustments, net (91) (80) 11
-------------- -------------- --------------
$ 230 $ 32 $ 184
============== ============== ==============
F-35
VOCALTEC COMMUNICATIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 15:- TAXES ON INCOME
a. Measurement of taxable income under the Income Tax Law (Inflationary
Adjustments), 1985:
Results for tax purposes are measured and reflected in real terms in
accordance with the change in the Israeli Consumer Price Index
("CPI"). As explained in Note 2b, the consolidated financial
statements are presented in U.S. dollars. The differences between
the change in Israel's CPI and in the NIS/U.S. dollar exchange rate
causes a difference between taxable income or loss and the income or
loss before taxes reflected in the consolidated financial
statements. In accordance with paragraph 9(f) of SFAS No. 109,
VocalTec Ltd. and Tdsoft Ltd. have not provided deferred income
taxes on the differences resulting from changes in exchange rates
and indexing for tax purposes.
b. Tax benefits under Israel's Law for the Encouragement of Industry
(Taxation), 1969:
VocalTec Ltd. and Tdsoft Ltd. are considered each an "industrial
company", as defined by the Law for the Encouragement of Industry
(Taxes), 1969, and as such, are entitled to certain tax benefits,
mainly the right to claim public issuance expenses and accelerated
depreciation.
c. Tax benefits under the Law for the Encouragement of Capital
Investments, 1959:
Certain investments of VocalTec Ltd. and Tdsoft Ltd. received
"Approved Enterprise" status through the "Alternative Benefits"
track, and, as such, are eligible for various benefits. VocalTec
Ltd. and Tdsoft Ltd. currently have two and four "Approved
Enterprise" programs, respectively. These benefits include
accelerated depreciation of equipment used in the investment
program, as well as a full tax exemption on undistributed income for
a period of two years and reduced tax rates of 25% or less for an
additional period of up to eight years (depending on the percentage
of foreign ownership), commencing with the date on which taxable
income is first earned. Since VocalTec Ltd. and Tdsoft Ltd. have had
no taxable income since inception, the benefits period has not yet
commenced.
The period of tax benefits detailed above, except the full tax
exemption period, is subject to a limit of 12 years from the
commencement of production, or 14 years from the approval date,
whichever is earlier. The entitlement to the above benefits is
conditional upon VocalTec Ltd. and Tdsoft Ltd. fulfilling the
conditions stipulated by the above law, regulations published
there-under and the letters of approval for the specific investments
in "Approved Enterprises". In the event of failure to comply with
these conditions, the benefits may be cancelled and VocalTec Ltd.
and Tdsoft Ltd. may be required to refund the amount of the
benefits, in whole or in part, including interest. As of December
31, 2007, management believes that VocalTec Ltd. and Tdsoft Ltd. are
meeting all of the aforementioned conditions.
F-36
VOCALTEC COMMUNICATIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 15:- TAXES ON INCOME (CONT.)
The tax-exempt income attributable to the "Approved Enterprise" can
be distributed to shareholders without subjecting the distributing
company to taxes only upon the complete liquidation of the company.
If these retained tax-exempt profits are distributed in a manner
other than in the complete liquidation of the company, they would be
taxed at the corporate tax rate applicable to such profits as if the
company had not elected the alternative track of benefits, currently
25% for an "Approved Enterprise". As of December 31, 2007, the
accumulated deficit of each company does not include tax-exempt
profits earned by their "Approved Enterprise".
Income from sources other than the "Approved Enterprise" during the
benefit period will be subject to tax at the regular corporate tax
rate of 29%. The regular corporate tax rate is to be gradually
reduced to 25% by 2010 (27% in 2008, 26% in 2009 and 25% in 2010).
d. VocalTec Ltd. received final tax assessment for the tax years up to
2000. Tdsoft Ltd. received final tax assessment for the tax years up
to 2001.
e. VocalTec Ltd. and Tdsoft Ltd. have net operating loss carryforwards
for tax purposes of approximately $ 140,000 and $ 47,000 as of
December 31, 2007, respectively, which may be carried forward
indefinitely. VocalTec Communications Inc. and Tdsoft
Communications, Inc., which are subject to U.S. income taxes, have a
loss for tax purposes of approximately $ 9,000 as of December 31,
2007. These losses can be carried forward until 2025. A valuation
allowance was recorded for the entire deferred tax asset in respect
of the carryforward losses, due to the uncertainty regarding future
realization. Management currently believes that since the Company
has a history of losses it is more likely than not that the deferred
tax regarding the loss carryforward will not be realized in the
foreseeable future.
Utilization of U.S. net operating losses may be subject to
substantial annual limitations due to the "change in ownership"
provisions of the Internal Revenue code of 1986 and similar state
provisions. The annual limitation may result in the expiration of
net operating losses before utilization.
F-37
VOCALTEC COMMUNICATIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 15:- TAXES ON INCOME (CONT.)
f. Taxes on income are comprised as follows:
YEAR ENDED DECEMBER 31,
------------------------------------------------
2007 2006 2005
-------------- -------------- --------------
Current taxes $ (37) $ - $ 19
============== ============== ==============
g. Deferred taxes on income:
Deferred income taxes reflect the net tax effect of temporary
differences between the carrying amounts of assets and liabilities
for financial reporting purposes and the amounts used for income tax
purposes and the tax effect for carryforward losses. Significant
components of the Company's deferred tax assets are as follows:
DECEMBER 31
-------------------------------
2007 2006
-------------- --------------
Deferred tax asset:
Reserves and allowances $ 329 $ 468
Net operating losses carryforward 46,802 42,250
-------------- --------------
Net deferred tax asset before valuation allowance 47,131 42,718
Valuation allowance (47,131) (42,718)
-------------- --------------
Net deferred tax asset $ - $ -
============== ==============
Management currently believes that since the Company has a history
of losses, it is more likely than not that the deferred tax asset
will not be utilized.
h. Loss before income taxes is comprised as follows:
YEAR ENDED DECEMBER 31,
------------------------------------------------
2007 2006 2005
-------------- -------------- --------------
Israel $ (13,531) $ (6,396) $ (6,429)
Foreign (611) (616) (220)
-------------- -------------- --------------
$ (14,142) $ (7,012) $ (6,649)
============== ============== ==============
i. The difference between the theoretical tax computed and the actual
tax expense resulted mainly from valuation allowance recorded with
respect to carryforward losses and other temporary differences,
primarily related to severance and vacation reserves.
j. In June 2006, the FASB issued Interpretation No. 48, "Accounting for
Uncertainty in Income Taxes" ("FIN 48"). FIN 48 clarifies the
accounting for uncertainty in income taxes recognized in an
enterprise's financial statements in accordance with FAS 109. This
interpretation prescribes a minimum recognition threshold a tax
position is required to meet before being recognized in the
financial statements. FIN 48 also provides guidance on derecognition
of tax positions, classification on the balance sheet, interest and
penalties, accounting in interim periods, disclosure and transition.
FIN 48 requires significant judgment in determining what constitutes
an individual tax position as well as assessing the outcome of each
tax position. Changes in judgment as to recognition or measurement
of tax positions can materially affect the estimate of the effective
tax rate and consequently, affect the operating results of the
Company.
F-38
VOCALTEC COMMUNICATIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 15:- TAXES ON INCOME (CONT.)
The Company adopted the provisions of FIN 48 as of January 1, 2007.
The accumulated effects of applying FIN 48 have been recorded as an
increase of $784 of the goodwill and an increase of $34 of the
accumulated deficit and $818 of the income tax payable as of January
1, 2007, of which $93 related to interest and penalties.
A reconciliation of the beginning and ending balances of the total
amounts of gross tax benefits is as follows:
Gross unrecognized tax benefits of January 1, 2007 $ 420
Increase in income tax position related to prior years 818
Increase in income tax position related to current year 37
----------
Gross unrecognized tax benefits at December 31, 2007 $ 1,275
==========
NOTE 16:- SUBSEQUENT EVENT
On May 28, 2008, the Company signed a Patent Purchase Agreement (PPA) to
sell selected patents to Karo Millennium J.P., L.L.C. Pursuant to the PPA,
The Company will sell 11 patents and certain patent-related rights, out of
the Company's current portfolio of 22 patents, for the aggregate selling
price of $12.5 million. On July 13, 2008, the OCS approved the
consummation of the foregoing sale, subject to the payment to the OCS of
approximately $2.08 million. The transaction-related expenses will also
include brokerage fees in the amount of approximately $1.1 million. The
Company expects to receive net proceeds of approximately $9.2 million from
the foregoing sale. Upon consummation of the transaction, The Company will
be granted a geographically unlimited, non-exclusive license to use the
sold patents and other patent-related rights in connection with the
development and marketing of its products.
F-39
ITEM 19. EXHIBITS
1. Amended and Restated Articles of Association, previously filed with
the SEC on June 20, 2007 as Exhibit 1 to the Company's Annual Report
on Form 20-F for the year ended December 31, 2006 and incorporated
herein by reference.
2.1 Form of Share Certificate of VocalTec Communications Ltd., previously
filed with the SEC on April 21, 2006 as Exhibit 2.1 to the Company's
Annual Report on Form 20-F for the year ended December 31, 2005 (as
amended on May 16, 2006) and incorporated herein by reference.
4.1 (a) 2003 Amended Master Stock Option Plan previously filed with
the SEC on February 15, 2006 as Exhibit 99.2 to the Company's
registration statement on Form S-8 (File Number 333-131870) and
incorporated herein by reference.
(b) Summary of the lease agreement between Tdsoft and Limor Hugi
and others dated April 26, 2004, previously filed with the SEC on
April 21, 2006 as Exhibit 4.1(b) to the Company's Annual Report on
Form 20-F for the year ended December 31, 2005 (as amended on May 16,
2006) and incorporated herein by reference.
(c) Share Sale and Purchase Agreement dated as of October 27,
2005 by and among the Company, Tdsoft and the shareholders of Tdsoft,
previously filed with the SEC on November 7, 2005 as Exhibit 99 to the
Company's Report on Form 6-K, as amended on November 8, 2005, and
incorporated herein by reference.
(d) Form of security purchase agreement dated May 18, 2006,
pursuant to which the Company issued to institutional investors
ordinary shares at a price per share of $5.5 and warrants to purchase
Company shares, at an exercise price per share of $7.9 (which exercise
price was amended in December 2006 to $6.87 per share), previously
filed with the SEC on May 25, 2006 as an exhibit to the Company's
Report on Form 6-K and incorporated herein by reference.
(e) Form of Order to Purchase Securities dated November 27, 2006,
pursuant to which the Company issued to institutional investors
ordinary shares at a price per share of $4.3 and warrants to purchase
Company shares at a price per share of $5.5, previously filed with the
SEC on June 20, 2007 as Exhibit 4.1(e) to the Company's Annual Report
on Form 20-F for the year ended December 31, 2006 and incorporated
herein by reference.
(f) Audit committee pre-approval policies and procedures for
audit and non-audit services, previously filed with the SEC on April
2, 2004 as Exhibit 4.1(k) to the Company's Annual Report on Form 20-F
for the year ended December 31, 2003, and incorporated herein by
reference.
96
(g) Form of indemnification undertaking dated as of November 24,
2005 between the Company and each of Joseph Albagli, Ilan Rosen,
Robert Wadsworth and Joseph Atsmon, previously filed with the SEC on
April 21, 2006 as Exhibit 4.1(g) to the Company's Annual Report on
Form 20-F for the year ended December 31, 2005 (as amended on May 16,
2006) and incorporated herein by reference.
(h) Form of indemnification undertaking dated as of November 24,
2005 between the Company and each of Dr. Elon Ganor, Yoav Chelouche
and Michal Even Chen, previously filed with the SEC on April 21, 2006
as Exhibit 4.1(h) to the Company's Annual Report on Form 20-F for the
year ended December 31, 2005 (as amended on May 16, 2006) and
incorporated herein by reference.
(j) Patent Purchase Agreement dated May 28, 2008 by and between
the Company and Karo Millennium J.P., L.L.C.
8. List of Subsidiaries previously filed with the SEC on June 20, 2007 as
Exhibit 8 to the Company's Annual Report on Form 20-F for the year
ended December 31, 2006 and incorporated herein by reference.
11. (a) Code of ethics for our principal executive officer, principal
financial officer, executive vice presidents, principal controller,
treasurer and persons performing similar functions, previously filed
with the SEC on April 2, 2004 as Exhibit 11 to the Company's Annual
Report on Form 20-F for the year ended December 31, 2003 and
incorporated herein by reference.
(b) Amended insider trading policy, previously filed with the SEC
on June 20, 2007 as Exhibit 11 to the Company's Annual Report on Form
20-F for the year ended December 31, 2006 and incorporated herein by
reference.
12. Certifications of CEO and CFO of VocalTec Communications Ltd. required
by Rule 13a-14(a) (17 CFR 240.13a - 14(a)) or Rule 15d-14(a) (17 CFR
240.15d - 14(a)).
13. Certifications of CEO and CFO of VocalTec Communications Ltd. required
by Rule 13a-14(b) (17 CFR 240.13a - 14(b)) or Rule 15d-14(b) (17 CFR
240.15d - 14(b)).
14. Consent of Kost Forer Gabbay & Kasierer, an affiliate of Ernst & Young
Global, Independent Auditors.
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SIGNATURES
The registrant hereby certifies that it meets all of the requirements for filing
on Form 20-F and it has duly caused and authorized the undersigned to sign this
annual report on its behalf.
By: /s/ Joseph Albagli
----------------------
Joseph Albagli
Chief Executive Officer
Date: July 15, 2008