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, 2005
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________ to ________
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 _____________
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)
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, 2005
4,661,627 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
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
Page 2
Indicate by check mark which financial statement item the registrant has elected
to follow.
[_] Item 17 [X] 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
Page 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 AND TDSOFT LTD. 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 and Surf&Call TdSOFT, TdGATE and TdVIEW 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.
Page 4
Index
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
Item 4. Information on the Company
Item 4A. Unresolved Staff Comments - Not applicable
Item 5. Operating and Financial Review and Prospects
Item 6. Directors, Senior Management and Employees
Item 7. Major Shareholders and Related Party Transactions
Item 8. Financial Information
Item 9. The Offer and Listing
Item 10. Additional Information
Item 11. Quantitative and Qualitative Disclosure about Market Risk
Item 12. Description of Securities Other than Equity Securities -
Not applicable
PART TWO
Item 13. Defaults, Dividend Arrearages and Delinquencies
Item 14. Material Modifications to the Rights of Security Holders
and Use of Proceeds
Item 15. Controls and Procedures
Item 16A. Audit Committee Financial Expert
Item 16B. Code of Ethics; Standards of Business Conduct
Item 16C. Principal Accountant Fees and Services
Item 16D. Exemptions from the Listing Standards for Audit Committees
Item 16E. Purchases of Equity Securities by the Issuer and Affiliated
Purchasers
PART THREE
Item 17. Financial Statements - Not applicable
Item 18. Financial Statements
Item 19. Exhibits
EXHIBITS INDEX
SIGNATURES
Page 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
3A. SELECTED FINANCIAL DATA
In November 2005, 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. GAAP as a reverse acquisition and
therefore, we are presenting in this report the consolidated financial
statements of Tdsoft for the two years ended December 31, 2004 and for the
eleven months ended November 30, 2005 and the consolidated financial statements
of the combined company for the period of December 1-31, 2005.
Our historical Consolidated Financial Statements are prepared in accordance with
generally accepted accounting principles in the United States ("GAAP") and are
presented in U.S. dollars. The selected historical consolidated financial
information set forth below has been derived from the historical Consolidated
Financial Statements of VocalTec Communications Ltd., or the Company, for the
years presented. Historical information as of and for the three years ended
December 31, 2005 is derived from our Consolidated Financial Statements, which
have been audited by Kesselman & Kesselman, a Member of PriceWaterhouseCoopers
(for the years ended December 31, 2003 and 2004) and by Kost Forer Gabbay &
Kasierer, a Member of Ernst & Young Global, for the year ended December 31,
2005.
The information presented below is qualified by the more detailed historical
Consolidated Financial Statements set forth elsewhere in this document, 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.
Page 6
STATEMENT OF OPERATIONS DATA - YEAR ENDED DECEMBER 31ST
(IN THOUSANDS OF U.S. DOLLARS, EXCEPT PER SHARE DATA)
2001 2002 2003 2004 2005
------- ------ ------ ------ -------
Sales
Products 11,479 5,346 3,685 3,719 3,668
Services 269 104 248 433 925
------- ------ ------ ------ -------
11,748 5,450 3,933 4,152 4,593
------- ------ ------ ------ -------
Cost of sales
Products 3,988 1,819 1,174 1,587 1,450
Services 22 22 21 22 315
------- ------ ------ ------ -------
4,010 1,841 1,195 1,609 1,765
Inventory write off - - - - 639
Amortization of intangibles assets - 188 188 206 172
------- ------ ------ ------ -------
4,010 2,029 1,383 1,815 2,576
------- ------ ------ ------ -------
Gross profit 7,738 3,421 2,550 2,337 2,017
------- ------ ------ ------ -------
Operating expenses:
Research and development, net 9,148 5,235 3,243 5,474 4,363
Selling and marketing 6,301 3,599 2,314 1,909 2,763
General and administrative 1,834 1,075 919 805 1,748
------- ------ ------ ------ -------
Total operating expenses 17,283 9,909 6,476 8,188 8,874
------- ------ ------ ------ -------
Operating loss (9,545) (6,488) (3,926) (5,851) (6,857)
Other income, net - - - - 24
Financial income, net 300 275 150 165 184
------- ------ ------ ------ -------
Loss before income taxes (9,245) (6,213) (3,776) (5,686) (6,649)
Tax benefit (income taxes) - (506) - - 19
Net Loss (9,245) (6,719) (3,776) (5,686) (6,630)
Accretion of redeemable convertible Preferred
shares (3,123) (3,256) (3,256) (3,256) (348)
Induced conversion of convertible Preferred shares - - - - (17,406)
------- ------ ------ ------ -------
Net loss attributable to common shareholders (12,368) (9,975) (7,032) (8,942) (24,384)
------- ------ ------ ------ -------
Basic and diluted net loss per Ordinary share (33.42) (26.96) (19.00) (24.16) (34.05)
------- ------ ------ ------ -------
Weighted average number of Ordinary shares used
in computing net loss per share-basic and diluted 370 370 370 370 792
Page 7
BALANCE SHEET DATA - YEAR ENDED DECEMBER 31
(IN THOUSANDS OF U.S. DOLLARS, EXCEPT SHARE DATA)
2001 2002 2003 2004 2005
------- ------- ------- ------- ---------
Cash and cash equivalents 20,719 16,914 13,934 9,260 5,138
Working capital 22,607 17,315 14,400 9,595 925
Total assets 30,775 22,960 18,572 13,538 22,442
Total liabilities 3,972 3,035 2,640 2,878 9,579
Redeemable convertible 44,922 48,045 51,301 54,557 -
Preferred shares
Capital stock 108 108 108 116 155
Accumulated deficit (16,540) (26,697) (34,017) (42,568) (49,546)
Total shareholders'
equity (deficiency) (18,119) (28,120) (35,369) (43,897) 12,863
Number of Ordinary
shares outstanding 370,059 370,059 370,059 370,059 4,661,627
3B. CAPITALIZATION AND INDEBTEDNESS
Not applicable.
3C. REASONS FOR THE OFFER AND USE OF PROCEEDS
Not applicable.
3D. RISK FACTORS
Many factors could have an effect on our financial condition, cash flows and
results of operations. We are subject to various risks resulting from changing
economic, political, industry, business and financial conditions. The principal
factors are described below.
Page 8
THE OUTCOME OF THE BUSINESS COMBINATION WITH TDSOFT IS NOT YET KNOWN AND THERE
IS NO ASSURANCE THAT THE BUSINESS COMBINATION WILL RESULT IN THE BENEFITS THE
COMPANY CURRENTLY ANTICIPATES.
The main purpose for the business combination was the companies' belief that the
combined company would be better positioned to offer competitive VoIP products
to existing and prospective customers. Achieving the expected benefits of the
business combination depends on the timely, efficient and successful integration
of the operations and personnel of both companies. The challenges presented by
the business combination include the successful development and promotion of
unified strategy, procedures and policies, the ability to realize the synergies
between the companies' products and to succeed in offering to current and
prospective customers the combined company's products and the successful
retention of talented employees who may suffer from uncertainties regarding
their position in the combined company and changes in corporate culture. In
addition, the integration is expected to require substantial attention from the
combined company's management, which may result in the diversion of management
resources from regular business concerns to integration considerations. The
integration process may also result in the need to invest unanticipated
additional cash resources, which may divert funds that the Company expects to
use for working capital, including the pursuit of new business opportunities,
and may force the Company to raise additional funds. If the businesses of the
Company and Tdsoft are not successfully integrated, the benefits of the business
combination will not be realized and, as a result, the combined company's
operating results may be adversely affected. In addition, the success of the
combined company depends to a great extent on its ability to successfully build
customer confidence in the products of the Company and Tdsoft and offer a
comprehensive solution and support to existing and potential customers. There is
no assurance that the combined company will be successful in achieving and
maintaining the foregoing.
THE COMPANY MAY LOSE CUSTOMERS AND BUSINESS PARTNERS DUE TO UNCERTAINTIES
ASSOCIATED WITH THE BUSINESS COMBINATION.
Current and prospective customers and business partners of the Company and
Tdsoft may experience uncertainty about their future relationships with the
combined company. In particular, some of Tdsoft's business partners may be
concerned about competition from the combined company and the companies'
respective customers may be concerned about the combined company's continued
supply of products and services and continued provision of customer service
during the period of integration of the businesses of the Company and Tdsoft and
in the future. There is currently no assurance that the combined company will
continue supplying and servicing the companies' current products. If the
combined company discontinues supplying or servicing any such current product,
current customers of the Company and Tdsoft may terminate their relationship
with us. The loss of any customer or business partner could adversely affect the
Company's results of operations.
IF THE COMPANY FAILS TO MANAGE ITS POST-BUSINESS COMBINATION GROWTH EFFECTIVELY,
ITS EXPENSES COULD INCREASE AND ITS MANAGEMENT'S TIME AND ATTENTION COULD BE
DIVERTED.
As part of the business combination, the Company intends to broaden the scope of
its operations. As a result, its business, results of operations and financial
condition will be substantially harmed if it is unable to manage its expanding
operations efficiently. The Company plans to continue to expand its sales and
marketing, customer support and research and development organizations. Any
future growth may place a significant strain on its management systems and
resources. The Company's failure to manage its growth efficiently could increase
its expenses and divert management's time and attention. In addition, the
Company is likely to incur higher expenses during the initial period of
integration of the operations and personnel of the Company and Tdsoft. These
costs may be significant and may include expenses and other liabilities for or
relating to:
o employee redeployment or relocation;
Page 9
o maintaining or subletting the leases of the Company's and Tdsoft's
respective corporate headquarters (or any portions thereof);
o liquidating subsidiaries outside of Israel;
o relocation or disposition of excess equipment; and
o establishing combined research and development facilities and
information technology, or IT, infrastructure.
The integration costs that the Company incurs may negatively impact the
financial condition of the Company and the market price of the Company's shares.
THE EXERCISE OF THE REGISTRATION RIGHTS GRANTED TO THE TDSOFT SHAREHOLDERS MAY
RESULT IN A DECREASE OF THE TRADING PRICE OF THE COMPANY'S ORDINARY SHARES. IN
ADDITION, THE REVERSE SPLIT OF THE COMPANY'S SHARES HAS RESULTED IN A
SIGNIFICANT DECREASE IN THE NUMBER OF THE COMPANY'S SHARES OUTSTANDING, WHICH
MAY ADVERSELY EFFECT THE LIQUIDITY AVAILABLE TO THE COMPANY'S SHAREHOLDERS.
None of the shareholders of the combined company are subject to any "lock up"
arrangement with respect to their shares, and therefore all of them are free to
sell their shares, subject to limitations imposed by applicable securities laws.
For example, the Tdsoft shareholders may sell the Company shares they received
pursuant to the business combination beginning on the first anniversary of the
closing of the business combination, subject to volume limitations under US
federal securities laws. In addition, at the closing of the business combination
the Company granted certain registration rights to the Tdsoft shareholders,
including without limitation the right to demand that the Company register their
shares during a seven-year period commencing nine months following the closing
of the business combination. The exercise of such registration rights may result
in an offer of a large number of shares which may adversely affect the trading
price of the Company's ordinary shares.
Immediately following the closing of the business combination, the Company
effected a reverse split of the Company's shares in the range of 1-for-13, which
has significantly decreased the number of the Company's shares outstanding and
is likely to have an adverse effect on the liquidity available to the Company's
shareholders.
Page 10
THE COMPANY HAS TO RAISE ADDITIONAL FUNDS TO SUSTAIN ITS OPERATIONS, RESEARCH
AND DEVELOPMENT AND SALES INFRASTRUCTURE, AS WELL AS THE INTEGRATION OF THE
BUSINESSES OF THE COMPANY AND TDSOFT. THERE IS NO ASSURANCE THAT SUCH FUNDS CAN
BE RAISED ON TERMS ACCEPTABLE TO THE COMPANY OR AT ALL. IF SUCH FUNDS ARE
RAISED, THEN THE EXISTING SHAREHOLDERS OF THE COMPANY MAY SUFFER SUBSTANTIAL
DILUTION.
As of December 31, 2005, the Company had $5.3 million in cash, cash equivalents
and restricted cash. Such amount is sufficient only for a short period, and the
Company needs to raise additional funds in order to finalize the integration of
the companies' businesses and sustain and thereafter expand the Company's
operations, research and development and sales infrastructure. There is no
assurance that the Company's revenues will increase, and even if the revenues of
the Company increase significantly, it will nevertheless have to raise
additional funds in order to cover the cost of the integration of the Company's
and Tdsoft's businesses and the cost of the Company's operations, research and
development, sales and infrastructure. Prior to the business combination, the
Company sought unsuccessfully financing; hence, additional financing, whether
obtained through public or private debt or equity financing, may not be
available to the Company or may not be available on terms acceptable to the
Company. Although the Company is currently considering various ways to raise
funds, there is no assurance that such funds will be raised on terms acceptable
to the Company or at all. On April 18, 2006, our audit committee and board of
directors approved a contingency plan that will be used by the Company if we
fail to raise, by the end of the second quarter of 2006, the additional capital
necessary for us to meet our anticipated cash needs for working capital and
capital expenditures. The contingency plan provides for certain cost cut
measures, which will enable us to finance our operations and to meet our capital
obligations at least through December 31, 2006. The implementation of such cost
cut measures (which include the postponement of certain research and development
activities relating to the development of an integrated product and reductions
in marketing and other activities) may have an adverse effect on our ability to
pursue our business and effectively implement our business strategy and on our
results of operations. If additional funds are raised through the issuance of
equity securities, the ownership percentage of the Company's existing
shareholders may be substantially diluted. Moreover, new investors in the
Company may receive registration rights with respect to their shares, and upon
registration of their shares there will be an increased number of our ordinary
shares available for trading, which may adversely affect the trading price of
our ordinary shares.
If additional funding is raised through debt instruments, the Company may become
subject to various covenants, restrictions, pledges and other security interests
that typically accompany debt funding, and there can be no assurance that the
Company will be able to comply with such covenants and restrictions.
Page 11
IN 2002 WE BEGAN DEVELOPING, AND IN 2004 WE BEGAN MARKETING, THE ESSENTRA
PRODUCTS TO NEW CUSTOMERS IN NEW MARKETS. IN 2005 TDSOFT BEGAN MARKETING ITS
TDGATE IP-V5 AND IP-303 AND TDMAX PRODUCTS. SINCE THE BUSINESS COMBINATION, THE
COMPANY IS DEVELOPING PRODUCTS AND TECHNOLOGY LEVERAGING THE KNOW-HOW OF BOTH
TDSOFT AND VOCALTEC. THERE IS NO ASSURANCE THAT WE WILL BE SUCCESSFUL IN
OBTAINING AND MAINTAINING A SUFFICIENT MARKET SHARE FOR OUR PRODUCTS.
During 2002, VocalTec began developing the Essentra products, which are
replacing the H.323 traditional products that were designed for the use of
international long distance networks and carriers in emerging markets. The first
version of the Essentra products during 2003 and a modular product approach of
the Essentra product line was released during July 2004. The initial versions of
the Essentra products were designed based on the then new softswitch
architecture and standards, to approach the same markets and solutions as in our
prior H.323 products. The Essentra products were designed to provide migration
from H.323 networks to new, higher scale softswitch based networks. After
commencing the development of the Essentra products, VocalTec identified a
decrease in the demand for the traditional H.323 products, resulting, among
other reasons, from a decrease in the prices of international long distance
calls, which caused a sharp decrease in demand for solutions of the type that we
offered. This raised concerns about whether there would be a demand for the new
Essentra products, which, while using modern softswitch architecture, were
nevertheless targeted to the declining market. After analyzing alternatives and
witnessing the fast deployment of broadband Internet access to end users and the
increased competition that wireline residential and enterprise services face
from mobile telephony as well as from telephony services offered by cable
operators, VocalTec anticipated that changes in the residential and enterprise
wireline telephony services would be occurring in coming years. VocalTec
expected this change to be in the form of replacement of legacy VoIP equipment,
broadband carriers (also known as Class 5 switches) with modern softswitches and
the offer of telephony services over broadband Internet available at an
increasing number of homes. VocalTec therefore refocused its product development
effort on the redesign of the Essentra products to cope with the much wider set
of requirements of a Class 5 replacement softswitch, supporting legacy
telephony, voice over broadband and hosted enterprise services. Targeted
geographic markets were also changed. While the H.323 products were offered
mainly in developing countries, the Class 5 replacement products were targeted
initially at developed countries.
Through the acquisition of the assets of B-Connected in 2004, Tdsoft acquired
the TAS product, which is a new generation DLC (Digital Loop Carrier - a product
enabling the connection of a subscriber's phone to the carrier access network).
Tdsoft developed the DLC to be a single sided VoIP device for the class 5
replacement market. The TdMAX product (which is the the successor of the TAS) is
a line gateway device that connects POTS (Plain Old Telephone System) and ADSL
modems to the network backbone over IP and VoIP technology.
During 2003, Tdsoft began developing the TdGATE products, a group of devices
connected to a variety of infrastructure domains such as ATM, TDM and IP.
Initially, such products were ATM-based interface that enabled voice over DSL
extension to a Class5 switch, and during 2004 such products were enhanced with
VoIP capabilities, to enable Class5 replacement using VoIP. The majority of the
installations are with existing class 5 switches connected to deliver voice
traffic to DSL based networks. The Hunt 8110 is an ATM edge device that is
installed within the demarcation point between the ATM network and the IP
network to deliver Ethernet services (which is a protocol commonly used in
today's data networks). The TdGATE family design allows us to install the system
in versatile environment to bring solutions to TDM to IP/ATM or ATM/IP to TDM
networks.
We have encountered various challenges inherent to entering into a new business,
including learning and understanding the 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, as well as the
TdGATE IP and TdMAX products. This required the allocation of substantial
resources.
Page 12
Although we have conducted initial trials with respect to, and have received
several small orders for, our Essentra, TdGATE IP and TdMAX products, some of
these products (for example, our Essentra BAX product) are still subject to
additional testing and modifications and have not yet been used extensively by
customers, which prevents us from developing a track record that is crucial for
the expansion and the development of additional sales channels for our new
products. Essentially, our new products have not yet been fully field-tested by
the market, and therefore the products' advantages have not yet been recognized
and acknowledged by our target markets. Furthermore, unlike our traditional
H.323 and the TdGATE IP products, which were unique and the first of their kind
to be introduced to the telecommunications market, our Essentra and TdMAX
products compete with existing, comparable products of various companies, some
of which have certain advantages over us, including the ability to manufacture
the hardware components used in their solutions, access to prospective customers
and an established market share.
In light of the foregoing, there is no assurance that we will be successful in
obtaining and maintaining a sufficient market share for our Essentra, TdGATE IP
and TdMAX new products.
WE HAVE ENCOUNTERED AND EXPECT TO CONTINUE TO ENCOUNTER VARIOUS CHALLENGES
INHERENT TO ENTERING INTO A NEW BUSINESS AND THERE IS NO ASSURANCE THAT WE WILL
BE SUCCESSFUL IN OVERCOMING SUCH CHALLENGES.
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. For example, customers of
VOBB (Voice over Broad Band) service providers require various features
products, which features are more complex than those offered through our
traditional products. In addition, while seeking midsize carriers, being new to
this market, we had to consider offering 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 a mainstream technology. One of the main challenges
in penetrating the market with the products offered by VocalTec and Tdsoft
relates to the ability to fulfill the full set of class features, when deployed
either in conjunction with a Class5 softswitch from a partner vendor, or when
offered as a stand-alone solution. In addition, price pressure and strong
competition cause difficulties to the market penetration of such products. The
TdMAX product faces stiff competition from Chinese vendors and we may not be
able to compete in markets where the Chinese vendors sell at low prices. If
unsuccessful at generating volume sales of this product, the cost structure will
not enable us to be competitive in this market and we may consider divesting the
TdMAX.
Page 13
The TdGATE IP-V5 and TdGATE IP-303 gateways are targeted at the market for
replacement of TDM class 5 softswitches while using legacy access connected via
the V5 and GR303 protocols. Currently, the market has not yet adopted this
concept and there is a possibility that carriers may choose not to replace the
TDM switches prior to upgrading the legacy access to VoIP access therefore
eliminating the need for these gateways.
Furthermore, in order to materially increase our revenues, we have to enter into
a larger number of contracts with more customers and create more partnerships
with more vendors, which requires the allocation of more resources by us. Unless
we do so, or are able to successfully re-allocate our resources and reduce our
operational expenses, reaching profitability could be delayed. Moreover, due to
the fact that we are currently in the early stages of penetrating the VOBB
market, the loss of a contractual relationship with any of the customers with
which we have established, or are in the process of establishing, a
relationship, could materially adversely affect our results of operations.
Finally, the Class 5 replacement market is new and is in its early stages, which
is reflected by carrier hesitation and long decision-making process as well as
expectations for evaluation and trial phases prior to the purchase of the
product. In addition, the ability to sell and promote the traditional Tdsoft
products, which are highly dependent on the Class 5 replacement opportunity and
are positioned to allow migrations of such networks from legacy to new networks,
is effected by the early stage of the Class 5 replacement market. Some carriers
prefer to take the overlay network approach, deploying a whole new network
infrastructure side by side with the older network, instead of doing a
replacement of the core or the access equipment. In such cases, the Tdsoft
products are not required; however, the Essentra products can come into play in
such cases with the offering of an NGN Class5 type solution, which can be
installed as the overlay network.
There is no assurance that we will be successful in encountering the foregoing
as well as other challenges in our attempt to offer our Essentra (which now
include the Tdsoft TdGATE products and TdMAX products which are offered as
additional products under the Essentra product line) to new customers in
developed countries and to the channel partners of the combined company. A
failure to successfully encounter such challenges may prevent us from obtaining
and maintaining a sufficient market share, which may materially adversely affect
our results of operations.
OUR ESSENTRA, TDGATE AND TDMAX PRODUCTS GENERALLY HAVE A LONG SALES CYCLE, WHICH
INCREASES OUR COSTS IN OBTAINING ORDERS, REDUCES THE PREDICTABILITY OF OUR
EARNINGS AND REQUIRES HIGHER WORKING CAPITAL
Our Essentra, TdGATE and TdMAX 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 customers'
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 purchase the products.
Page 14
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 trial procedure intended for defining customers' needs,
which involves additional costs;
o the potential cancellation of orders based on our customers` changing
budgetary constraints; and
o the shift in orders expected in one quarter to another quarter because
of the timing of our customers` procurement decisions.
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 can only be fully tested when deployed in commercial
applications and other equipment. Consequently, 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 increased insurance costs; and
o other losses to us or to our customers or end users.
Page 15
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.
Because the trend in our industry is moving toward even more complex solutions
and products in the future, this risk will 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 are wholly 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.
WE DEPEND 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.
Tdsoft's products are normally sold through other vendors, system integrators
and business partners, who repackage or resell the Tdsoft products under their
own private label to consumers or incorporate the Tdsoft products into their own
products, which are then sold to end customers (rather than selling our products
directly to carriers). We plan to use these channels to promote the sale of
Essentra and future products. To achieve this, we will have to allocate
resources to train such channels as to the use of our Essentra products,
resulting in additional costs increased by us and additional time until sales by
our channels of our Essentra products will be feasible. We are dependent upon
the success of our customers and business partners and the broad market
acceptance of their products. To the extent that our channels and business
partners are unsuccessful in selling our products, our revenues and operating
results will be adversely affected.
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.
The operating results of each of VocalTec (prior to the business combination)
and Tdsoft have fluctuated and may continue to fluctuate from period to period
for a number of reasons. Although during the years 2003 through 2005 we
witnessed a general improvement in the market for telecommunication equipment,
due to the past volatility of this market we cannot predict the duration or
extent of any recovery in this market or the impact it may have on our revenues
or results of operations.
Page 16
There are several market conditions that could continue to cause our customers
and potential customers to be conservative in their spending:
o The VoIP market for telecommunications carriers is experiencing a
shift from H.323 technology to softswitch technology, from current
Time Division Multiplexing, or TDM, networks to the innovative
services delivered by Next Generation VoIP Networks, or NGNs,
resulting in a transitional period for many VoIP vendors, including
our company.
o Large carriers are showing an increased interest in migrating their
Public Switch Telephone Networks, or PSTNs, to VoIP softswitch based
networks, and 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 above), we may need
extended time to build up an order backlog.
These 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 (some of which are recognized on a cash basis), the timing of
new product announcements and releases by both our company and our
competitors.
Our future results may also be affected by factors that include 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 we are, 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, 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.
Page 17
EACH OF VOCALTEC (PRIOR TO THE BUSINESS COMBINATION) AND TDSOFT HAS INCURRED
SIGNIFICANT HISTORICAL OPERATING LOSSES AND THERE IS NO ASSURANCE THAT THE
COMPANY WILL NOT CONTINUE TO INCUR OPERATING LOSSES.
Since its incorporation in 1989, VocalTec (prior to the business combination)
has had limited sales and has incurred significant operating losses. VocalTec
(excluding the results of operations of Tdsoft) had operating losses in 2005,
2004 and 2003 of $9.5 million, $13.2 million and $8.1 million, respectively. In
2005, 2004 and 2003, Tdsoft had operating losses of approximately $6.4 million,
$5.9 million and $3.9 million, respectively. The Company may continue to incur
operating losses in the future due to, among other reasons, (i) the fact that
the new Essentra products and the TdGATE IP-VS and IP-303 and the TdMAX products
have only recently been offered in new target markets to new customers and has
not yet obtained a substantial market share of the VoIP broadband business and
(ii) the integration of the businesses of VocalTec and Tdsoft, which will
require the allocation of substantial resources. 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, and
introduce advanced versions, enhancements and new products that meet market
needs on a timely basis.
The Company may continue to incur operating losses in 2006 and thereafter if
revenues are insufficient to cover sales and marketing, research and
development, administrative and other expenses. If revenue levels do not
sufficiently increase, operating results will be adversely affected because any
reduction in expenses may not sufficiently cover reduction in revenues. There is
no assurance that the Company will achieve or sustain significant sales or
profitability in the future.
IF NGN VOIP BASED CARRIER MARKETS FOR OUR PRODUCTS AND TECHNOLOGY FAIL TO GROW,
OR OUR PRODUCTS FAIL TO ACHIEVE MARKET ACCEPTANCE, OUR BUSINESS WILL BE
ADVERSELY AFFECTED.
The markets for our Essentra, TdMAX and TdGATE products are relatively new and
are rapidly evolving technologically. Our products compete with similar products
and services developed by our competitors, some of which have greater market
share and acceptance as well as greater resources to develop and promote such
products. Sales of VoIP products have fluctuated and have been generally
unpredictable, as fluctuation in demand for voice infrastructure products is
dependent on the customers establishing and/or expanding their networks. As is
typical in the case of an evolving industry, demand and market acceptance for
recently introduced technology products and services are subject to a high level
of uncertainty. Furthermore, there is uncertainty as to whether, when and the
pace at which the VoIP market will further increase. Broad market demand and
acceptance of our technology, products and solutions, including our Essentra,
TdMAX and TdGATE products, and interoperability of such products with other VoIP
products are very important to our success and to our ability to generate
revenues.
Market demand and acceptance of our technology, products and solutions will be
highly dependent on functionality, interoperability, reliability, stability and
performance, as well as on external factors beyond our control such as the
development of the VoIP market, including the Voice over Broadband and Class 5
replacement, the introduction of competing products or technologies into the
market and the stability and bandwidth of those networks. There can be no
assurance that packet based voice networks will become widespread, that
connections between Internet Protocol, or IP, networks and PSTNs will become
widespread or that our products and solutions, including our Essentra, TdMAX and
TdGATE products, will generate sales or gain market acceptance. The adaptation
process of connecting IP networks and PSTNs can be time consuming and costly to
both us and our customers and the acceptance of the product or system may
depend, to a substantial extent, on the success of the adaptation. There can be
no assurance that the market for our products and services will grow above
current levels, that our products and solutions will achieve market acceptance
or that other, competitive products will not achieve better acceptance in the
market. If the market does not grow above current levels, or if our products and
solutions do not achieve market acceptance, our business, financial condition
and results of operations will be materially adversely affected.
Page 18
IF OUR RELATIONSHIPS WITH OUR KEY CUSTOMERS ARE TERMINATED, OUR REVENUES WILL
DECLINE AND OUR BUSINESS WILL BE ADVERSELY AFFECTED.
During 2003, the two main customers of VocalTec (prior to the business
combination), Deutsche Telekom and its T-Systems subsidiary and DataAccess
(India) Limited, or DataAccess, accounted for 52% and 22% of the sales of
VocalTec (prior to the business combination), respectively. In 2004, DataAccess,
which accounted for 6% of the sales of VocalTec (prior to the business
combination) in that year, experienced financial difficulties. Deutsche Telekom
and its T-Systems subsidiary accounted for 31% of the sales of VocalTec (prior
to the business combination) in 2004. In addition, in 2004, Intelecom San Marino
accounted for 12% of the sales of VocalTec (prior to the business combination).
The loss of DataAccess, one of the two largest customers in 2003 and in 2002, as
well as the decrease in revenues from Deutsche Telekom and its T-Systems
subsidiary had an adverse effect on the results of operations of VocalTec (prior
to the business combination). During 2003, the three main customers of Tdsoft
(prior to the business combination), TNN Networks, Graybar and Lucent, accounted
for 20%, 18% and 12% of the sales of Tdsoft (prior to the business combination),
respectively. During 2004, the four main customers of Tdsoft (prior to the
business combination), OG Vodafone, Graybar, ECI and VoIP Pty Ltd., accounted
for 13%, 12%, 11% and 10% of the sales of Tdsoft (prior to the business
combination), respectively. During 2005, the two main customers of Tdsoft (prior
to the business combination), Lucent and OG Vodafone, accounted for 18% and 16%
of the sales of Tdsoft (prior to the business combination), respectively. If for
any reason, our relationship with Deutsche Telekom, Intelecom San Marino, Lucent
or OG Vodafone 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. The impact of the
termination or reduction of our key customer relationships would be intensified
if we are unable to establish and increase sales to other customers in order to
offset this termination or reduction.
Page 19
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.
We depend on third parties for the manufacture, supply and support of certain
hardware and software components that are integrated into our Essentra, TdMAX
and TdGATE products (including IBM BladeCenterT platform and blades, Intel
signaling gateways, AudioCodes media gateways, TTI Telecom software and various
other suppliers for gateway platforms, voice processing chips, DSP software, SIP
software and SS7 Software). Following the sale and installation of our products,
we rely on our hardware and software suppliers (to varying extents) for
maintenance and service 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 manufacture of the hardware components
we purchase from them. We depend on third party suppliers for certain key
components, however, we do not have a long-term supply contract with our
suppliers, and, to date, we did not yet establish a relationship with alternate
suppliers of such components. In addition, manufacturing problems may occur with
these third parties. A supplier may fail to develop and supply products and
components to us on a timely basis, or 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 component supply, price
increases, late deliveries, poor component quality and failure in the
availability and level of support and maintenance, as any supplier may terminate
its relationships with us or pursue other relationships with our competitors. If
we were to lose our relationship with these suppliers, the lead time required to
qualify new suppliers could be as long as four months. Also, if we lose our
single 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 service and
maintenance with respect to the specialized components we need for our products
in the desired lead times and quality. In addition, if the processes that our
suppliers use to manufacture products and components are proprietary, we may be
unable to obtain comparable components from alternative suppliers.
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 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.
Page 20
IF OUR NEW PRODUCTS DO NOT MEET MARKET AND CUSTOMER REQUIREMENTS OR IF OUR
PRODUCTS DO NOT ACHIEVE INDUSTRY STANDARD CERTIFICATIONS IN OUR TARGET MARKETS,
WE WILL NOT ATTRACT AND RETAIN CUSTOMERS.
Maintaining and increasing our sales revenues are dependent 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. A number of risks
are inherent in this process. We may not successfully anticipate market
requirements or complete the development or introduction of these products. In
addition, 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 hardware and 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. As the variety
and complexity of our product lines increase, the process of planning production
and inventory levels also becomes increasingly complex.
Our results could be adversely affected by factors such as lack of market
acceptance of our products, development or manufacturing delays, and delays in
customer purchases of products in anticipation of the introduction of new
products and the rapidly changing landscape of emerging standards.
Further, telecommunications carriers outside the U.S. increasingly require that
VoIP products be designed to meet local homologation 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, significant warranty, support and
repair costs may divert the attention of our engineering personnel, and may
cause significant customer relations problems.
THE MARKET PRICE OF OUR ORDINARY SHARES MAY BE VOLATILE AND INVESTORS MAY NOT BE
ABLE TO RESELL THEIR SHARES AT OR ABOVE THE PRICE PAID, OR AT ALL. IN ADDITION,
IF WE ARE UNABLE TO MAINTAIN THE LISTING OF OUR ORDINARY SHARES ON THE NASDAQ
CAPITAL MARKET, IT WILL BE MORE DIFFICULT FOR OUR SHAREHOLDERS TO SELL THEIR
SHARES.
In addition to our significant operating losses, generally depressed economic
conditions have adversely affected our share price and trading volumes in recent
years. Our ordinary shares were initially quoted on the Nasdaq National Market
in 1996. In December 2002 we transferred to the Nasdaq Capital Market, in July
2003 we transferred back to the Nasdaq National Market, and in April 2005 we
transferred back to the Nasdaq Capital Market, where our shares continue to be
listed under the trading symbol VOCL. We transferred back to the Nasdaq Capital
Market in April 2005 because we no longer satisfied the minimum stockholders'
equity continued listing requirement of the Nasdaq National Market. In August
2005, we received a notice from Nasdaq Capital Market that we were not in
compliance with the Nasdaq Capital Market shareholders equity continuing listing
requirement, and in November 2005 (simultaneously and in conjunction with the
consummation of the business combination) we re-listed our ordinary shares on
the Nasdaq Capital Market. Certain of the initial listing requirements of Nasdaq
Capital Market were met due to consummation of the business combination. If we
are unable to maintain the listing of our ordinary shares on the Nasdaq Capital
Market, due to our non-compliance with certain continued listing requirements of
the Nasdaq Capital Market, it will be more difficult for our shareholders to
sell their shares.
Page 21
Additional 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, continued significant operating losses, market
conditions in the industry, law suits against the Company, its officers or
directors, 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.
WE ARE SUBJECT TO STRONG COMPETITION. ACCEPTANCE OF OUR COMPETITORS' PRODUCTS
AND TECHNOLOGY COULD RESULT IN REDUCED REVENUES OR GROSS MARGINS.
The competition in the VoIP communications market is very strong. Our
competitors include telecommunications companies, data communication companies
and pure VoIP companies. Almost all 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 manufacture 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
successfully launch our new products, or compete successfully and effectively
for deals against other companies' product offerings. Furthermore, if we reduce
our prices below current levels due to the competition, our operating losses may
increase and we may be unable to increase our revenues and gross margins.
We expect that additional companies will compete in the IP-based voice networks
market. In the future, we may also develop and introduce other products with new
or additional telecommunications capabilities or services. As a result of any
such development or introductions, we may compete directly with traditional
telecommunications infrastructure and service providers. 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.
Page 22
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 State of Israel was established in 1948, a number
of armed conflicts have occurred between Israel and its Arab neighbors. 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. 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 2006. The recent election of representatives of the Hamas movement
to a majority of seats in the Palestinian Legislative Council 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. These
restrictions may limit materially our ability to sell our solutions to companies
in these countries.
WE EXTEND CREDIT TO CUSTOMERS FOR PURCHASES OF OUR PRODUCTS AND MAY NOT BE ABLE
TO COLLECT ACCOUNTS RECEIVABLE.
A portion of our receivables results from credit extended to customers for
purchases of our products. There can be no assurance that any of our accounts
receivable will be collected in whole or in part. Any failure in the collection
of accounts receivable will adversely affect our cash flow position and will
result in decreased revenues.
SOME OF OUR DIRECTORS, OFFICERS AND EMPLOYEES ARE OBLIGATED TO PERFORM MILITARY
RESERVE DUTY.
Some of our Israeli directors, and many of our Israeli male officers and
employees are currently obligated to perform up to 36 days of annual reserve
duty. Additionally, all such persons are subject to being called to active duty
at any time under emergency circumstances. We have operated effectively under
these requirements since we began operations. No assessment can be made,
however, 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 or reduction of these obligations.
Page 23
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.
OUR INTERNATIONAL OPERATIONS EXPOSE US TO THE RISKS INHERENT IN CONDUCTING
BUSINESS IN INTERNATIONAL MARKETS.
A substantial portion of our sales is in international markets. In addition, a
portion of our research and development operations is outsourced to
subcontractors in Ukraine and Bulgaria. 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. Specifically with respect to Ukraine and Bulgaria,
each of them is still economically and politically unstable, suffers from
exchange rate and inflation fluctuations, political and criminal corruption, and
lack of commercial experience and unpredictability of the civil justice system.
There can be no assurances 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 or results of operations.
WE MAY BE UNABLE TO ADEQUATELY PROTECT OUR PROPRIETARY RIGHTS, WHICH MAY LIMIT
OUR ABILITY TO COMPETE EFFECTIVELY. IN ADDITION, WE MAY ENGAGE IN RESEARCH AND
DEVELOPMENT PROJECTS IN WHICH WE DEVELOP CERTAIN INTELLECTUAL OR OTHER
PROPRIETARY PROPERTY WITH THIRD PARTIES, AND THERE IS NO ASSURANCE THAT WE WILL
OWN ANY SUCH INTELLECTUAL OR OTHER PROPRIETARY PROPERTY.
Our success is dependent, to a certain 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. In addition, our ability to
adequately protect our proprietary rights in Ukraine and Bulgaria (where a
portion of our research and development operations to is outsourced
subcontractors) is further unclear due to their political instability and the
fact that the protection of intellectual properties in eastern European
countries has traditionally been difficult to achieve.
Page 24
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 will adversely affect
our business, financial condition and results of operations.
Furthermore, we 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 with such
third parties. There is no assurance that we will own any such intellectual or
other proprietary property. For example, during 2005 Tdsoft and Nuera commenced
developing, as part of a joint project, certain hardware and software of a VoIP
gateway platform. Following completion of the project, each of Tdsoft and Nuera
will add its application software on top of the platform, to further develop it
into a generally available product, targeting various gateway applications. Both
companies have full ownership rights with respect to the platform, including
intellectual property, manufacturing and marketing rights. In connection with
the project, Tdsoft has been engaged by Nuera to develop certain application
software that will integrate with the platform. The intellectual property rights
of this application software shall be owned solely by Nuera.
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 of our
former employees obtained from us, if we cannot demonstrate to the court that we
would be harmed.
Page 25
Additionally, our ability to enforce non-compete covenants with our
sub-contractors in foreign jurisdictions 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. 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 abroad.
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.
Page 26
IF WE ARE UNABLE TO MAINTAIN OUR RELATIONSHIPS WITH OUR DISTRIBUTORS, OR IF OUR
DISTRIBUTORS' BUSINESSES ARE ADVERSELY AFFECTED BY DEVELOPMENTS UNRELATED TO US,
OUR SALES COULD BE HARMED.
Our marketing strategy includes sales through channel partners, distributors and
resellers, as well as direct sales by our own sales force. There is no assurance
that we will be successful in extending the terms of our various channel,
distribution and reselling agreements or in establishing similar relationships
with other entities if our current channel, distribution and reselling
agreements are not extended, and changes in our relationships with our channels,
suppliers, distributors, value added resellers and agents, or other changes to
their respective businesses could have a material adverse effect on our
business, financial condition or results of operations.
ANY FUTURE MERGERS WITH OR ACQUISITIONS OF COMPANIES OR TECHNOLOGIES AND THE
RESULTING INTEGRATION PROCESS MAY DISTRACT OUR MANAGEMENT AND DISRUPT OUR
BUSINESS.
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.
We have no current commitments or agreements with respect to any mergers or
acquisitions. However, 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. If we
consummate one or more significant acquisitions in which the consideration
consists of ordinary shares, shareholders would suffer significant dilution of
their interests in us.
OUR PRINCIPAL SHAREHOLDERS, INCLUDING OUR EXECUTIVE OFFICERS AND DIRECTORS, ARE
ABLE TO INFLUENCE MATTERS REQUIRING SHAREHOLDER APPROVAL.
As of March 31, 2006 our principal shareholders, including our directors and
certain executive officers, beneficially owned more than 59% of the outstanding
ordinary shares of our company (including options that are exercisable on the
date hereof or within 60 days after the date hereof). As a result, such
shareholders together have the ability to significantly influence the election
of our directors and most corporate actions.
OUR EARNINGS WILL BE ADVERSELY AFFECTED DUE TO COMPLIANCE WITH NEW ACCOUNTING
POLICIES RELATING TO THE EXPENSING OF STOCK OPTIONS.
We are required to prepare financial statements in accordance with the Financial
Accounting Standards Board's (FASB) recently issued accounting standard SFAS No.
123(R), "Shared-Based Payment." SFAS No. 123(R) requires the fair value of all
equity-based awards granted to employees to be recognized in financial
statements beginning in the first quarter of 2006. The result is that we will be
required to record an expense with respect to stock option grants, even if the
exercise price of the stock options is equal to the market price of the
underlying shares on the date of grant. The adoption of SFAS No. 123(R) will
have a material adverse effect on our results of operations, although it will
have no impact on our overall financial position or cash flows. SFAS No. 123(R)
also requires the benefits of tax deductions in excess of recognized
compensation cost to be reported as a financing cash flow, rather than as an
operating cash flow as required under current literature. This requirement will
reduce net operating cash flows and increase net financing cash flows in periods
after adoption. The impact will depend on our levels of share-based payments
granted in the future, among other things. See also Item 5 - Operating and
Financial Review and Prospects - Critical Accounting Policies.
Page 27
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
three-year terms. 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 provision of the Companies Law relating to mergers
and acquisitions are discussed in greater detail in Item 10 - Additional
Information.
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 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. Although we do not believe that we should
have been characterized as a PFIC for any tax year through and including 2005,
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. For further discussion of the consequences of our
possible PFIC status, please refer to Item 10 - Additional Information -
Taxation and Government Programs.
THE TAX AND OTHER BENEFITS AVAILABLE TO US FROM ISRAELI GOVERNMENT PROGRAMS MAY
BE DISCONTINUED OR REDUCED AT ANY TIME, WHICH WOULD LIKELY INCREASE OUR TAXES IN
THE LONG TERM AND OUR NET RESEARCH AND DEVELOPMENT EXPENSES.
We benefit from certain tax and other benefits, particularly as a result of the
"Approved Enterprise" status of certain existing facilities and approved
programs from the Government of Israel. In addition, we benefit from
participation by the Office of the Chief Scientist of the State of Israel (the
"Chief Scientist") in certain of our research and development projects. To be
eligible for these participations and tax benefits, we must continue to meet
certain conditions, including, with respect to the tax benefits, making certain
specified investments in fixed assets. There can be no assurance that such
participations and tax benefits will be continued at their current levels or
otherwise. The termination or reduction of certain tax benefits (particularly
benefits available to us as a result of the "Approved Enterprise" status of
certain of our existing facilities and approved programs) could have a material
adverse effect on our business, financial condition or results of operations
(this risk is offset to a certain extent due to the fact that to date we have
accrued significant losses, and therefore taxes will become due with respect to
our income only after such income exceeds our accumulated losses). The
termination or reduction of the participation of the Chief Scientist in research
and development projects could increase our net research and development
expenses or limit or terminate certain research and development projects. In
addition, when we become subject to the obligation to pay royalties to the Chief
Scientist with respect to products developed by us through the use of Chief
Scientist grants, such royalty payment obligation will continue even if we
receive no additional, or reduced, grants from the Chief Scientist.
Page 28
WE MAY BE ADVERSELY AFFECTED IF THE RATE OF INFLATION IN ISRAEL EXCEEDS THE RATE
OF DEVALUATION OF THE NEW ISRAELI SHEKEL (NIS) AGAINST THE DOLLAR.
A significant portion of our sales are made outside of Israel in dollars and we
incur a significant portion of our expenses in NIS. The cost of our operations
in Israel, as expressed in dollars, 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 dollar. During the calendar years 2003, 2004 and 2005 the annual
rate of inflation (deflation) was (1.9%), 1.2% and 2.4%, respectively. In 2003
and 2004, the NIS was appreciated against the dollar by 7.6% and 1.6%,
respectively, and devalued against the dollar by 6.8% in 2005. Although to date
we have not purchased forward currency options to decrease our exchange rate
risk, we may do so in the future, to the extent we deem it advisable.
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 a 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:
Page 29
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.
Page 30
COMMUNICATIONS AUTHORITIES MAY IMPOSE CHARGES, CONTRIBUTION AND OTHER COMMON
CARRIER REGULATIONS ON IP TELEPHONY PROVIDERS.
To date, neither the United States Federal Communications Commission ("FCC"),
state communications authorities, nor the communications authorities of other
countries have subjected IP telephony providers nor VoIP solutions providers to
the regulations that apply to long distance telecommunications carriers. At this
time it is uncertain whether or to what extent the FCC, state communications
authorities, or the communications authorities of other countries will impose
access charges, universal service contributions, and other common carrier
regulations on IP telephony providers or to VoIP solutions providers. There can
be no assurance that future action by the FCC or other communications
authorities will not have an impact on us, directly or indirectly.
ITEM 4. INFORMATION ON THE COMPANY
4A. 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 a 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. Our wholly owned U.S. subsidiary, VocalTec
Communications, Inc., is our agent in the United States and its offices are
located at 1732 Southampton Drive Carrollton, TX 75007.
We are a provider of carrier-class multimedia and voice-over-IP solutions for
communication service providers. We provide trunking, peering, access gateway
and service delivery solutions that enable flexible deployment of
next-generation networks (NGNs). We implement and support advanced telecom
solutions, specializing in the smooth migration of voice networks from legacy
networks to next generation, IP based networks. Designed for easy integration in
multi-vendor environments, our solutions handle media processing, signaling,
security and service creation within state-of-the-art NGN networks. Our
SIP-based solutions support a variety of protocols, including Megaco/H.248,
MGCP, H.323, ELCP, V5.2 and GR-303, and incorporate key elements of IMS (IP
Multimedia Subsystem) architecture.
During 2002, we began developing our Essentra products, which replaced our H.323
traditional products that were designed for the use of international long
distance networks and carriers in emerging markets. We released the first
version of the Essentra products during 2003 and a modular decomposition of the
Essentra product line during July 2004. The Essentra products were designed to
provide migration from H.323 networks to new, SIP-based networks. During 2004,
we refocused our product development efforts on the redesign of the Essentra
products to cope with the much wider set of requirements of a Class 5
replacement softswitch, supporting legacy telephony, voice over broadband and
hosted enterprise services. We initiated marketing efforts in order to position
the Company as a provider of solutions for the Class 5 market. In addition,
instead of targeting developing countries (as with our traditional H.323
products), our new Essentra products were also designed for developed countries.
Page 31
During 2005, there were initial deployments and field trials of the Essentra
products as separate modules, including Essentra CX, EX and BAX to new and
existing customers. Tdsoft's sales of products in 2005 included the TdGATE,
TdMAX, TAS, Hunt and Proxi products that are a range of broadband and narrowband
gateways. The TdGATE, first deployed in year 2000 supporting Voice over ATM, has
evolved to support voice over IP, supporting Megaco/H.248, MGCP, V5.2 and GR303.
The primary reason for the business combination with Tdsoft was the belief of
both companies that there are significant synergies between the companies'
products and that the combined company will be better positioned to provide to
customers a solution for their migration and implementation of next generation
packet based networks and service offering. Tdsoft's products include access
gateways, specializing in the transition of networks from TDM (Time Division
Multiplexing) to ATM (Asynchronous Transfer Mode) and to IP infrastructure,
using access protocols such as V5.1/V5.2/GR303, ELCP, MGCP and Megaco/H.248
whereas VocalTec's Essentra products focus on the control/signaling and service
layers, providing a wide range of products for fixed line carriers and Voice
Over Broadband providers. Tdsoft's capabilities compliment VocalTec's products
by providing them with access gateways, protocol signaling software, hardware
platform, strong embedded software and hardware development capabilities. In
addition, the combined company intends to leverage the existing relationships of
Tdsoft with various reseller channels, OEMs and business partners by offering to
them, in addition to the Tdsoft traditional gateway products, also the Essentra
products and the combined company's future products, and the relationships of
VocalTec with its existing customers and channels by offering them the Tdsoft
products. Both companies gained extensive experience and knowledge, develop
products that are used in the conversion and mediation of telecom signaling
protocols, media and services, and the combined company's competitive strength
is its ability to understand multiple legacy and advanced communication
protocols and perform mediation between networks, protocols, media types and
services.
In late 2004, we ceased the operations of our subsidiary in India due mainly to
the reduction in sales of our products and services to DataAccess, which was our
primary customer in India. In late 2004, we also ceased the operations of our
subsidiary in Singapore, due to the fact that a majority of our customers in
such country ceased purchasing our products and services. In the near future, we
intend to resume operations in Singapore, and increase our marketing and sales
effort for the Asian market.
In recent years, our subsidiary in The Netherlands became a holding company
through which we held our interests in various companies in Europe. Towards the
end of 2003, such European companies were liquidated. Therefore, in late 2003
and early 2004 we ceased the operations of our subsidiary in The Netherlands.
Page 32
CAPITAL EXPENDITURES: Tdsoft's capital expenditures for fiscal years 2005, 2004
and 2003 amounted to $308,000, $189,000 and $87,000, respectively. These
expenditures were primarily for hardware and software. VocalTec's capital
expenditures for fiscal years 2005, 2004 and 2003 amounted to $0, $457,000 and
$713,000, respectively. These expenditures were primarily for hardware and
software equipment.
CAPITAL DIVESTITURES: In December 2003, we sold our entire interests in Surf &
Call (an entity in which we held a minority interest following the carve out of
such operations from the Company into a separate corporate entity) to Cosmocom,
Inc, in consideration for full payment of all outstanding debts of Surf & Call
in the amount of $0.1 million, future royalty payments in the event of certain
types of licensing of the Surf & Call technology during the subsequent 24
months, and a portion of the proceeds in the event of a sale of the Surf & Call
technology by Cosmocom to a third party during the subsequent 24 months.
CAPITAL EXPENDITURES CURRENTLY IN PROGRESS: As of March 31, 2006, capital
expenditures in progress consisted of approximately $150,000, to be used during
2006 for research and development activities in Israel and for the relocation of
VocalTec's offices in Israel. 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.
4B. BUSINESS OVERVIEW
VoIP has recently become part of the telecom mainstream. The demand for TDM
technology is declining and all aspects of telephony, including networking,
transport, control and services, are being migrated to IP. All carriers are
evaluating the technology and planning their strategy of migration from current
circuit switched network, which have been used during the last three decades, to
a completely different VoIP next generation network.
We have gained our experience in carrier based VoIP solutions while deploying
H.323 and SIP based networks for the past 10 years. For additional information,
see Item4 - History and development of the Company.
Following consummation of the business combination with Tdsoft, we develop and
sell products targeted to carriers and service providers migrating their network
to next generation network, or which are building new VoIP networks, and to
carriers providing residential and enterprise VoIP services, supporting both
legacy and IP based access devices and advanced IP based multimedia services.
Our solutions provide carriers with call control and interface to legacy
telephone systems, as well as peering with other NGNs. 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 voice and data services, such as Voice over Broadband and hosted PBX
(IP Centrex), thereby helping them to retain and expand their customer base.
Using the Tdsoft access gateways line of products and technology, we also enable
the migration of access networks to NGNs, by facilitating the replacement of the
legacy Class5 switch with an NGN based solution, while maintaining the existing
DLC (Digital Loop Carrier) devices linked to the subscriber's telephone sets.
Page 33
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 (SS7, V5.2, GR-303, ELCP, ISDN).
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 and multi media
solutions for telecommunications service providers.
We believe that our particular advantages are:
o Our products and solutions enable mediation between the core network
and various networks, supporting a variety of types of connections
including:
o Peering to other VoIP networks; and
o Connecting to Legacy Public Switches Telephony Networks (PSTNs);
and
o Connecting with a variety of Access networks;
o Combination of strengths both at the gateway level as well as at the
services level;
o Strong telecom signaling and signaling conversion technology and
know-how;
o In-house signaling and gateway development;
o Significant SS7 and V5.2 experience, resulting from deployment in a
large number of carrier networks worldwide;
o Highly scalable products enabling cost-effective entry and growth for
various sizes of networks; and
o Our products include unique capabilities, such as:
o Multi-tiered service provisioning and management for hosted
services, enabling carriers to offer services to non-facility
based carriers; and
o Built-in Service Creation Environment.
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THE ESSENTRA PRODUCT SUITE
Designed for easy integration in multi-vendor environments, VocalTec's
best-of-breed solutions handle media processing, signaling, security and service
creation 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, SS7, ELCP, V5.2 and GR-303, and incorporate key elements of IMS (IP
Multimedia Subsystem) architecture.
The Essentra product suite is a modular set of open and highly focused VoIP
products for next generation network operators. The Essentra product 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 on 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 smooth migration to NGN, while
maintaining seamless connectivity to PSTN/SS7 and VoIP networks.
VOCALTEC PRODUCT OFFERINGS
The Essentra product family includes four major elements that are required to
the implementation of any VoIP network: (i) trunking; (ii) peering, (iii) access
and (iv) services.
Leveraging the products, technologies and capabilities of both VocalTec and
Tdsoft under the combined company, VocalTec offers an extended product line of
carrier grade VoIP products:
ESSENTRA CX MEDIA GATEWAY CONTROLLER: Essentra CX enables wholesale and retail
long-distance carriers to migrate their legacy trunking networks to VoIP-based
networks, while maintaining 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 fully addresses carriers' requirements in the areas of
protocol interworking, accounting/billing and intelligent voice routing.
ESSENTRA GATE: Essentra GATE (also known as TdGate) enables a standards-based
softswitch to control VoIP subscribers connected through V5.x and GR-303 access
systems. Essentra GATE integrates legacy access infrastructure - including
Digital Loop Carriers, Wireless Local Loop, FTTx, and Cable - into the NGN core
network.
Page 35
ESSENTRA BAX APPLICATION SERVER: Essentra BAX enables the delivery of
residential and hosted enterprise VoIP services over any broadband
infrastructure. With the capability of scaling up to large number of subscribers
over time, it allows service providers to take advantage of evolving IP
opportunities.
Using the Essentra products, a variety of network solutions may be offered, to
OEM's, resellers, exiting carriers and to new emerging operators.
The following are some examples of such solutions:
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 network may be built providing the needs of such carriers. The 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. While the 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.
VOICE OVER BROADBAND/CLASS 5 REPLACEMENT
The standards-based Essentra(R) BAX server can be quickly and easily implemented
in the service provider's network facility. End users connect to the service
through an SIP-based Integrated Access Device (IAD) or SIP Phone, which hooks
into their broadband modem. The Residential/SOHO VoIP Broadband Access
application includes traditional subscriber calling features (e.g., call
waiting, call forward), new IP-enabled features (e.g., conferencing, "do not
disturb") and web-based self-provisioning.
SOHO, SME AND CORPORATE HOSTED SERVICES
Integrated into the Essentra network solution is a powerful Centrex service,
which allows carriers to offer to multiple enterprises, small or large, at one
integrated office or distributed over hundreds of offices globally, a feature
rich hosted PBX service and overlay of Voice VPN services. 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. The Centrex service can be offered to multiple
different enterprises over a single Essentra product, which shares these
services with residential services.
Page 36
The Tdsoft primary products are the following:
o VoIP Gateways, including two main products: the TdGATE(TM) IP and the
TdMAX. Both are access gateways, which allow service providers to
connect their traditional access networks to an IP backbone. The TdMAX
is a Line Access Gateway that connects to the subscriber loop on one
side, and to the IP network on the other. The TdGate IP is an Access
media gateway that connects legacy Digital Loop Carrier (DLC)
equipment using V5.2 and GR-303 interfaces, to the IP backbone.
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.
In the future VocalTec plans to develop integrated products, which will leverage
the combined technology and know-how of Tdsoft and VocalTec. These new products
are intended to support a variety of protocols, including SIP, and will be IMS
compatible, handling the media, signaling, security, QoS advanced voice routing,
service mediation and overlay services.
DEPENDENCE ON CONTRACTS WITH SUPPLIERS AND CUSTOMERS
We are dependent on the following suppliers for the manufacture, supply and
support of hardware and software components that are integrated into our
solutions: IBM for the BladeCenterT platform and blades; AudioCodes Ltd. for the
supply of media gateways; Intel for the supply of signaling boards and
components and various other suppliers for gateway platforms, voice processing
chips, DSP software, SIP software and SS7 Software. 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 component
suppliers is less than the dependency we had on suppliers of hardware components
for our traditional H.323 products, since our Essentra products are based on
general-purpose IBM servers, which are relatively easy to replace. The
replacement of the IBM blade servers we use, although based on the same
technology as the general purpose servers, would require more time, due to the
fact that they are "telco grade" (i.e. comply with all carriers' standards), and
are therefore more scarce.
The Essentra Gate and Tdsoft products include both products that were designed
in-house and some that are purchased from other suppliers on whom we are
dependent.
Page 37
In addition, our dependency on Intel for signaling boards and components has
been reduced due to the support of the standard protocol Sigtran that is used in
both our Essentra CX and on Intel components (Sigtran is a standard based
protocol, which is also available from other signaling gateway vendors). In
developing our traditional H.323 products we supported a proprietary protocol
provided by Intel, 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.
MARKETING, SALES AND DISTRIBUTION
We market and distribute our products both directly and via multiple
distribution channels, and our main target customers include telecommunications
vendors, international long distance carriers, competitive local exchange
carriers (CLEC), incumbent local exchange carriers (ILEC), alternative telephony
carriers (which are virtual operators such as Vonage) and Internet Service
Providers (ISPs).
Following the business combination with Tdsoft, we intend to leverage the
relationships of both companies with their channels and customers, to increase
sales of products of both companies. We also intend to work more closely with
those channels, in order to leverage their market reach and sales
infrastructure.
The combined company is also targeting new markets: Whereas prior to the
business combination VocalTec targeted, among others, the US rural
telecommunications market, the Company has decided that, in light of the
differences in telecommunications standards in the US compared to the rest of
the world and the preference that US operators and carriers have for US vendors,
it will no longer focus its sales efforts on such market except through channels
that already have a strong presence in the market. The Company plans to leverage
the world-wide market coverage obtained by the channel partners and system
integrators.
Our peering, trunking, access gateway and service solutions will evolve together
with the changing needs of the market as carriers expand their deployments of
VoIP. Working together with our channels, we expect this evolution to be based
on our new hardware and software platforms with enhanced feature sets as will be
required by service providers.
In all territories we seek partnerships with resellers or operate through
agents. Typically, resellers are not contracted on an exclusive basis and in
some cases we approach the customer directly. As we have limited presence
globally, we seek local or global partners to offer first level support to
customers. Our Tier 2 support (professional services) operates out of our
Israeli office. We operate sales and customer support offices in the United
States, Germany and Singapore See Item 5 - Operating and Financial Review and
Prospects - for a breakdown of revenues by category of activity and geographic
market for each of the last three financial years.
Page 38
The sales cycles for our solutions are long due to the nature of the
telecommunications market, and our products and solutions. Once purchased by our
end user customers, our solutions require installation in the network. After
installation and completion of a predefined acceptance test, the system usually
enters into a warranty period of three to fifteen months. We offer two
maintenance and service agreements, which are renewed on an annual basis. The
standard service is an 8X5 business days support, including errors fix and
faulty hardware replacement. The premium service includes 24X7 support.
Since our Essentra solutions are relatively new to the market and has not yet
been massively deployed, the cycle of marketing, selling and deploying of the
Essentra solutions is still relatively long. In addition, the level of support
and maintenance required for installation is high.
INDUSTRY STANDARDS
We recognize that standards are important for interoperability and for providing
the means for market growth. Since 1996, we have taken an active role in
international standards bodies. Our strong involvement and contribution led our
employees to hold official positions over the years in a number of international
standard bodies, including: ITU (International Telecommunications Union), ETSI
(the European Telecommunications Standards Institute), MSF Multiservice
Switching Forum, the ATM Forum and IETF (the Internet Engineering Task Force).
We actively support important communications standards in our products,
including IETF SIP, ITU-T H.323, SS7, V5.2, GR-303, ISDN, ELCP, MEGACO, MGCP,
SIGTRAN 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 is
rapidly being adopted by both wireless and fixed line operators.
COMPETITION
Our market is intensely competitive and rapidly evolving, and is characterized
by evolving standards and new alliances. Since the Essentra solution combines
trunking, peering, access and service elements, our competitive space includes
providers of softswitches, session border controllers and application servers.
Our principal competitors include Nortel, Siemens, Huawei, Alcatel, Lucent
Technologies Inc., NetCentrex, Cirpack, Sonus Networks Inc., Italtel and Veraz
as softswitch vendors, Broadsoft and Sylantro as application server vendors and
AcmePacket, Nextone and Ditech as session border controller vendors.
Many of our competitors are difficult to compete with, as they are larger than
we are, have broader name recognition, have greater long-term resources and can
sustain larger price reductions for their products than we can.
Page 39
We believe that in such a rapidly changing market, key competitive factors
include time to market, technology and experience, reputation, broad base of
users, strategic alliances, key reference customers, interoperability, ability,
product performance, product features and ease of use, price, customer support,
distribution channels and the ability to respond quickly to emerging
opportunities.
Our business is not seasonal.
EFFECTS OF GOVERNMENTAL REGULATIONS
See Item 10 - Additional Information - Taxation and Government Programs.
4C. ORGANIZATIONAL STRUCTURE
We are organized under the laws of the State of Israel. Our directly and
indirectly held principal wholly-owned operational 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)
4D. PROPERTY, PLANTS AND EQUIPMENT
Our headquarters are located in Herzliya Pituach, Israel and occupy 21,500
square feet pursuant to a lease expiring on April 2007. We currently pay total
yearly rental and management fees of approximately $258,000, which part of such
fees is linked to the Israeli Consumer Price Index. These facilities are used
for management, marketing, sales, research and development and production.
We maintain car leases, and our total liability for early termination of the
leases is approximately $86,000.
ITEM 4A. - UNRESOLVED STAFF COMMENTS
Not applicable.
Page 40
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.
OVERVIEW
In November 2005, VocalTec acquired all of the issued and outstanding ordinary
shares of 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. For accounting purposes, the
business combination was accounted for as a reverse acquisition with Tdsoft
treated as the accounting acquirer. Therefore, and in accordance with U.S. GAAP,
we are presenting in this report the consolidated financial statements of Tdsoft
for the two years ended December 31, 2004 and for the eleven months ended
November 30, 2005 and the consolidated financial statements of the combined
company for December 2005. Accordingly, the information included in this Item 5
relates primarily to the results of operation of Tdsoft (except with respect to
December 2005).
We are a provider of carrier-class multimedia and voice-over-IP solutions for
communication service providers. We provide trunking, peering, access gateway
and service delivery solutions that enable flexible deployment of
next-generation networks (NGNs). We implement and support advanced telecom
solutions, specializing in the smooth migration of voice networks from TDM to
ATM and IP. Partnering with prominent system integrators and equipment
manufacturers, we serve an installed base of leading carriers including Deutsche
Telekom and Telecom Italia San Marino. Designed for easy integration in
multi-vendor environments, our solutions handle media processing, signaling,
security and service creation within state-of-the-art NGN networks. Our
SIP-based solutions support a variety of protocols, including Megaco/H.248,
MGCP, H.323, V5.2 and GR-303, and incorporate key elements of IMS (IP Multimedia
Subsystem) architecture.
Through 2005, the majority of our sales consisted of our Gateway and
access-concentrator products sold through OEMs, resellers and system
integrators. While the OEMs typically sell our products in conjunction with
their own systems, system integrators and resellers sometimes sell our products
on a stand-alone basis to the end users that are typically service providers.
Our ability to bring new products to market, to fulfill customer orders and to
achieve long-term revenue growth depends on the abilities of our channels and
OEMs to win new business including our products. Growth in the VoIP market is
being driven largely by new entrants and service providers looking to reduce
operational costs and add new services. 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
by telecommunications carriers and our ability to penetrate the market with new
products and win market share. We are also subject to downturns that may occur
within the telecommunications equipment market, such as the downturn that
occurred in 2001 through 2003 and negatively affected our revenue growth in that
period.
Page 41
REVENUES. In 2005, we had sales of $4.6 million, compared to $4.2 million in
2004. Through 2005, we generated our revenues primarily from sales of our
products, which accounted for 80% of our revenues in 2005. We generally
recognize revenues from the sales of products and software when persuasive
evidence of an arrangement exists (typically through a purchase order), delivery
has occurred, the fee is fixed or determinable, no further obligation exists and
collectability is reasonably assured. We recognize revenues from the provision
of maintenance, support and engineering services ratably over the period of the
agreement for such services. We expect to continue to generate revenues
primarily from the sale of products, which will include Tdsoft's TdGATE and
TdMAX products and VocalTec's Essentra products, and to a lesser extent from
increased sales of maintenance services. As a result of the business
combination, we intend to promote sales of the expanded product offering to
VocalTec's and Tdsoft's customers and channels. We expect to sell during 2006
more products than we sold in 2005, due to the expanded family of products that
we offer following the business combination, the existing sales channels and
customer relationships of VocalTec and cross sales of the products of VocalTec
and Tdsoft. We expect to generate a majority of our revenues from sales of
products. Although we expect prices of our products to decrease, we nevertheless
expect our revenues in 2006 to increase compared to 2005 due primarily to an
increase in sales of our products, which will offset such decreases in prices of
our products.
To date, we have derived a substantial portion of our revenues from a relatively
small number of OEM customers. The following customers accounted for more than
10% of our revenues for the periods indicated:
YEAR ENDED DECEMBER 31,
-----------------------------------
2003 2004 2005
---- ---- ----
Lucent 12% 18%
Graybar 18% 12%
TNN 20%
ECI 11%
OG Vodafone 13% 16%
VoIP Pty Ltd. 10%
Total sales to major customers representing more than 10% of revenues accounted
for 50%, 46% and 34% of our total revenues for the years ended December 31,
2003, 2004 and 2005, respectively.
Sales to our customers are generally made under short-term non-cancelable
purchase orders. We also have volume purchase agreements with certain customers
who provide us with non-binding forecasts. 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.
Page 42
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,
-------------------------
2003 2004 2005
---- ---- ----
% % %
North and South America 32 16 22
Europe and Israel 64 70 72
Asia Pacific ("APAC") 4 14 6
--- --- ---
100% 100% 100%
--- --- ---
We attribute revenues to the geographic area where the customer, or its business
unit that makes the purchase, is based.
Payment terms are usually net 30 to net 60 days. Historically, we wrote off
insignificant amounts for bad debts. We currently have a minor provision for
doubtful accounts.
COST OF SALES. Our cost of sales in 2005 was $2.6 million (including an
inventory write-off in the amount of $0.6 million and amortization of acquired
intangibles in the amount of $0.2 million), or 56% of sales, compared with $1.8
million, or 44% of sales in 2004 (including amortization of acquired intangibles
in the amount of $0.2 million). Our cost of sales in 2005, excluding the write
off and the amortization of acquired intangibles, was $1.8 million, or 38% of
sales. We expect cost of sales in 2006 to increase compared to 2005 due
primarily to the expected increased sales of products (resulting from the
purchase by us of more hardware components for the manufacture of our products)
and to a lesser extent from increased sale of maintenance services. The cost of
our sales consists primarily of (i) the cost of hardware components, including
related support, (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 the Chief Scientist. In 2005, our cost of sales also included a
write-off of obsolete inventories. We expect our margins in 2006 to increase due
primarily to a revenue mix that includes products with higher gross margins than
the traditional VocalTec solutions and a reduction in cost of goods sold.
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
and 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.
Page 43
CRITICAL ACCOUNTING POLICIES
Our discussion and analysis of our financial condition and the results of
operations are 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.
REVENUE RECOGNITION: We generate revenues from the sale of our systems,
from providing maintenance, engineering and support services and from licensing
the rights to use our software products. The majority of our revenues are
generated from sale of systems and are recognized in accordance with Staff
Accounting Bulletin No. 104, "Revenue Recognition in Financial Statements",
("SAB No. 104"), when (1) a persuasive evidence of an arrangement (usually in
the form of a purchase order) exists, (2) we deliver the products or fulfill our
obligations to provide the services, (3) payment is fixed and determinable, and
(4) collection is probable. We assess each sale to ensure that the above
conditions are met. In contracts for which an acceptance provision is required
by the customer, the Company defers revenue (and the related costs) until
receiving the acceptance confirmation. Service and maintenance revenues are
recognized over the period during which such services are rendered. We recognize
revenue from the sale of our software products in accordance with Statement of
Position No. 97-2, "Software Revenue Recognition", as amended ("SOP 97-2").
Revenue earned on software arrangements involving multiple elements is allocated
to each element based on the relative fair value of the elements. Fair value is
determined based on vendor specific objective evidence (VSOE) of the fair value
of the elements. The VSOE of fair value of the elements is based on the price
charged for the undelivered element when sold separately. This policy ensures
that we report revenues in accordance with U.S. GAAP. Factors that could
materially adversely affect our revenue recognition include longer payment
terms, longer procurement cycles, financial viability of our customer base, the
mix of products and services provided, failure to timely provide products and
services to customers, and fewer large customers.
Page 44
ACCOUNTING FOR DOUBTFUL ACCOUNTS: Our accounts receivable are derived from
our sales to our customers located all over the world. We maintain an allowance
for doubtful accounts for estimated losses, which may result from the inability
of our customers to make required payments. Management exercises judgment as to
its ability to collect outstanding receivables. Allowance for doubtful accounts
are made based upon a specific review of all significant outstanding invoices.
In determining the allowance, we analyze our historical collection experience
and current economic trends. If the historical data used to calculate the
allowances for doubtful accounts do not reflect the future ability to collect
outstanding receivables, additional allowances for doubtful accounts may be
needed and the future results of operations could be materially affected.
BUSINESS COMBINATIONS AND PURCHASE PRICE ALLOCATION: As a result of the
reverse merger with Tdsoft in November 2005, our balance sheet as of December
31, 2005 includes acquired intangible assets and goodwill which totaled
approximately $ 11,190,000 as of the balance sheet date. Business combinations
are accounted for using the purchase method of accounting, under which the total
purchase price is allocated to the acquired company's assets and liabilities,
based on their estimated fair values, and the remainder, if any, is attributed
to goodwill. The aggregate purchase price is being allocated to identifiable net
assets, intangible assets other than goodwill, and to goodwill. The amounts
allocated to intangible assets other than goodwill are amortized on a
straight-line basis over their weighted average expected useful life.
Estimating the fair value of certain assets acquired and liabilities
assumed is judgmental in nature and often involves the use of significant
estimates and assumptions, mainly with respect to intangible assets. While there
are a number of different methods for estimating the value of intangibles
acquired, the primary method being used is the discounted cash flow approach.
Some of the more significant estimates and assumptions inherent in the
discounted cash flow approach include projected future cash flows, including
their timing, a discount rate reflecting the risk inherent in the future cash
flows and a terminal growth rate. Another area which required judgment which can
impact our results of operations was estimating the expected useful lives of the
intangible assets. To the extent intangible assets are ascribed with longer
useful lives, there may be less amortization expenses recorded in any given
period. As we operate in an industry which is rapidly evolving and extremely
competitive, the value of the intangible assets, including goodwill, and their
respective useful lives is exposed to future adverse changes which can result in
a charge to our results of operations.
Page 45
IMPAIRMENT OF GOODWILL AND OTHER INTANGIBLE ASSETS: In accordance with
Statement of Financial Accounting Standards No. 142, "Goodwill and Other
Intangible Assets", ("SFAS No. 142"), goodwill acquired in a business
combination that closes on or after July 1, 2001 is deemed to have indefinite
life and will not be amortized. SFAS No. 142 requires us to conduct an
impairment review at least annually on goodwill and on an interim basis whenever
events or changes in circumstances indicate that the carrying value may not be
recoverable. Factors that we may consider important which could trigger an
impairment review include significant underperformance relative to historical or
expected future operating results and significant negative industry or economic
trends. Determining fair value involves the use of significant estimates and
assumptions. These estimates and assumptions could have an impact on whether or
not an impairment charge is recognized. To determine fair value, we may use a
number of valuation methods including quoted market prices, discounted cash
flows and revenue multipliers. As mentioned above, these approaches use
estimates and assumptions including projected future cash flows, discount rate
and terminal growth rate. Using different assumptions could result in different
results. As we operate in an industry which is rapidly evolving and extremely
competitive, it is possible that our estimates could change in the near term and
there can be no assurance that future goodwill impairment review will not result
in a charge to our results of operations. At December 31, 2005, goodwill
amounted to approximately $7.2 million.
Other intangible assets with definite useful lives are to be reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. Recoverability of assets to
be held and used is measured by a comparison of the carrying amount of an asset
to the future undiscounted cash flows expected to be generated by the asset. If
an asset is considered to be impaired, the impairment to be recognized is
measured by the amount by which the carrying amount of the asset exceeds its
fair value. In the evaluation of fair value, we may use significant estimates
and assumptions such as projected future cash flows which are subject to high
degree of judgment. As we operate in an industry which is rapidly evolving and
extremely competitive, changes in the assumptions and estimates may affect the
carrying value of the intangible assets, and could result in an impairment
charge to our results of operations. At December 31, 2005, consolidated
intangible assets, other than goodwill, amounted to approximately $4.0 million.
TAX ALLOWANCE PRACTICES: Our subsidiaries operate world-wide under various
tax regimes, and as such, we are subject to the tax laws and regulations of many
countries. At the end of every accounting period, we estimate our existing and
future tax results, and create tax assets or liabilities, as applicable in
accordance with Statement of Financial Accounting Standard No. 109, "Accounting
for Income Taxes" ("SFAS No. 109"). As part of this process, we generally
consult with reputable tax advisors in various overseas locations, and follow
established tax precedents in our tax allowance practices. The tax expense and
benefits of the company of this process are reflected in our financial
statements.
INVENTORIES: Our policy for valuation of inventory and commitments to
purchase inventory, including the determination of obsolete or excess inventory,
requires us to perform a detailed assessment of inventory at each balance sheet
date which includes a review of, among other factors, an estimate of future
demand for products, valuation of existing inventory, as well as product
life-cycle and product development plans. Inventory reserves are also provided
to cover risks arising from slow moving items. We write down our inventory for
estimated obsolescence or unmarketable inventory equal to the difference between
the cost of inventory and the market value based upon assumptions about future
demand, market conditions and prices.
Page 46
USE OF ESTIMATES: The preparation of the financial information requires us
to make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosure of contingent assets
and liabilities. On an on-going basis, we evaluate our estimates, mainly related
to trade receivables, inventories, long-lived assets, restructuring charges,
revenues and contingencies. We base our estimates on historical experience and
on various other assumptions that are believed 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. Actual results may differ from these estimates under different
assumptions or conditions.
STOCK OPTIONS: Through December 31, 2005, we elected to follow the
intrinsic value-based method prescribed by Accounting Principles Board Opinion
25, "Accounting for Stock Issued to Employees," or APB 25, and related
interpretations in accounting for employee stock options rather than adopting
the alternative fair value accounting provided under Statement of Financial
Accounting Standards, or SFAS, No. 123, "Accounting for Stock Based
Compensation." Therefore, we have not recorded any compensation expense for
stock options we granted to our employees where the exercise price equals the
fair market value of the shares on the date of grant and the exercise price,
number of shares eligible for issuance under the options and vesting period are
fixed. However, where the exercise price is less than the fair market value of
the shares on the date of grant, compensation expense was recognized. Deferred
compensation is amortized to compensation expense over the vesting period of the
options on an accelerated method, generally four or five years.
We comply with the disclosure requirements of SFAS No. 123 and SFAS No.
148, which require that we disclose our pro forma net income or loss and net
income or loss per ordinary share as if we had expensed the fair value of the
options. In calculating such fair value, there are certain assumptions that we
use, as disclosed in Note 2 of our consolidated financial statements included
elsewhere in this annual report. For purposes of this pro forma disclosure, we
estimate the fair value of stock options issued to employees using the
Black-Scholes option pricing model. In addition, option valuation models require
the input of highly subjective assumptions, including the expected life of
options and our expected share price volatility. Therefore, the estimated fair
value of our employee stock options could vary significantly as a result of
changes in the assumptions used.
In December 2004, the Financial Accounting Standards Board, or FASB, issued
Statement of Financial Accounting Standards No. 123(R), "Share-Based Payment,"
or SFAS 123(R), which requires companies to expense the fair value of employee
stock options and other forms of share-based compensation. Accordingly, SFAS
123(R) eliminates the use of the intrinsic value method to account for
share-based compensation transactions as provided under APB Opinion No. 25.
Under SFAS 123(R), we are required to determine the appropriate fair value model
to be used for valuing share-based payments, the amortization method for
compensation cost and the transition method to be used at date of adoption. We
currently use the Black-Scholes option-pricing model to value options for pro
forma financial statement disclosure purposes. The use of a different model to
value options may result in a different fair value than the use of the
Black-Scholes option-pricing model. We adopted SFAS 123(R) commencing January 1,
2006 and are in the process of evaluating its requirements to assess what impact
its adoption will have on our financial position and results of operations.
Page 47
5A. OPERATING RESULTS
YEAR ENDED DECEMBER 31, 2005 COMPARED TO YEAR ENDED DECEMBER 31, 2004
SALES
We recorded sales of $4.6 million in 2005 compared to $4.2 million in 2004, an
increase of 11%. The increase in sales in 2005 compared with 2004 was
attributable to the increase from maintenance and other support services.
Product sales in 2005 were $3.7 million, essentially the same as in 2004. A
decrease in sales of a product that is being phased out was offset by increased
sales of other products including the TdMAX product.
Revenues from engineering, maintenance and other support services in 2005 were
$925,000, an increase of 114% compared to 2004 support services revenues of
$433,000. Support service revenues increased in 2005 compared with 2004 due to
an increased for maintenance services by various then current customers,
engineering services provided to a certain customer in for the first time in
2005 and maintenance services provided by VocalTec in December 2005. We expect
our revenues from the provision of services in 2006 to increase compared to 2005
due primarily to the increase in sales of products (a majority of which is
accompanied by the sale of maintenance services).
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.
Page 48
COST OF SALES
Cost of sales in 2005 was $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), compared with $1.8 million, or 44 % of sales
(including the amortization of acquired intangibles in the amount of $0.2
million), in 2004. The increase in cost of sales in 2005 compared to 2004
resulted from a write-off of $0.6 million of obsolete inventories and a
provision for warranty of $0.2 million representing the cost of fixing technical
problems at customers' sites.
Cost of products was $1.5 million in 2005 compared with $1.6 million in 2004.
Cost of services was $0.3 million in 2005 compared with $22,000 in 2004. The
decrease in cost of products in 2005 compared to 2004 was due to a decrease in
the cost of production resulting from sales of TdGate to certain customers that
involved no costs of production, and from decreased sales of Tdsoft's TAS
product. The reduction in the cost of production was off-set by a provision for
warranty in the amount of $180,000. The increase in the cost of services in 2005
compared to 2004 was due primarily to cost incurred by us in connection with a
turnkey engineering project that commenced in 2005.
Cost of sales of products primarily includes the cost of hardware in our
products, reserves for products, royalties to third parties, and other expenses
associated with the provisioning of products. Cost of services primarily
consists of salaries and travel expenses for rendering maintenance, support and
engineering services to customers.
In 2005 and 2004, cost of sales increased as a percentage of sales compared to
2003 due to increased competition in the market, resulting in lower prices for
our products. In 2005, we wrote off obsolete inventory in the amount of $0.6
million. Excluding such write-off, cost of sales in 2005 remained materially the
same as in 2004.
Amortization of acquired intangibles in 2005 was $0.2 million, or 4% of sales,
compared to $0.2 million, or 5% of sales, in 2004. Amortization of acquired
intangibles in 2004 included $188,000 from the Hunt product line acquired from
Cisco Systems during 2001 and $18,000 for the TAS product acquired through the
acquisition of the assets of Be-Connected. Amortization of acquired intangibles
in 2005 consisted of $94,000 (the remaining amortization amount of the Hunt
product), $41,000 for the TAS product and $37,000 reflecting one month of
amortization of the intangibles acquired in the business combination between
Tdsoft and VocalTec.
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, compared to 56%, including amortization of acquired
intangibles, or 61%, excluding amortization of acquired intangibles, in 2004.
Our gross margins increased slightly from 61% in 2004 to 62% in 2005. We expect
our gross margin in 2006 to be in the range of between 50% to 56%, which are
higher than the historical average gross margins of VocalTec, averaged 43% since
2004, due primarily to a revenue mix that includes products with higher gross
margins than the traditional VocalTec solutions and a reduction in cost of goods
sold.
Page 49
OPERATING EXPENSES
RESEARCH AND DEVELOPMENT, NET
Research and development costs, net were $4.4 million in 2005, or 95% of sales,
compared with $5.5 million, or 132% of sales, in 2004. Research and development
costs, net consist principally of salaries and benefits for software engineers
and sub contractors, related facilities costs and activities and expenses
associated with computer, software and other equipment used in software and
hardware development, as well as 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 decrease in research and
development costs, net both in absolute numbers and as a percentage of sales in
2005 compared to 2004 resulted from participation from the Chief Scientist and
the BIRD (Bi-national Industrial Research and Development) foundation in our
research and development expenses.
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 operations, including
outsourcing certain research and development assignments.
Our research and development efforts have been financed 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
2003, 2004 and 2005. In 2005, Tdsoft received participation from the Chief
Scientist and the BIRD foundation. 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 LIBOR.
Pursuant to the terms of the BIRD foundation royalty-bearing program, we are
required to pay royalties of 5% of sales of products and related services
developed in any project partially funded by the BIRD foundation, up to an
amount of 150% of the grant obtained, depending on the year following the
termination of the agreement with the BIRD foundation on which the grant is
fully paid. We expect to participate only in royalty bearing programs but we
cannot make any assurances that we will be awarded any future grants.
Page 50
Our research and development expenses in 2005 were net of participation from the
Chief Scientist and the BIRD foundation. In 2005, participation received or
accrued from the Chief Scientist and the BIRD foundation was $1.3 million
compared with $0 in 2004. All of these participations are related to royalty
bearing programs. In 2005, we paid or accrued royalties to the Chief Scientist
in an aggregate amount of approximately $63,000 compared with $67,000 in 2004.
Our contingent liability to the BIRD foundation amounts to approximately
$749,000.
SELLING AND MARKETING
In 2005, selling and marketing expenses were $2.8 million, or 60% of sales,
compared with $1.9 million or 46% of sales in 2004. 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, as well as 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 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 both in absolute numbers and as a
percentage of sales in 2005 compared to 2004 resulted from an increase in
salaries and benefits and in travel expenses, both related to an increase in
personnel engaged in selling and marketing activities, and from the write-off of
obsolete trial systems.
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, finance, logistics, human resources, legal,
information systems and administrative personnel, as well as of 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 include expenses associated with computing
equipment and software used in the administration operations. General and
administrative expenses were $1.7 million, or 38% of sales, in 2005, compared
with $0.8 million, or 19% of sales, in 2004. The increase in general and
administrative expenses both in absolute numbers and as a percentage of sales
resulted primarily from the inclusion of VocalTec's general and administrative
expenses during December 2005 and increases in provisions related to social
benefits and outside legal, accounting and consulting fees.
OTHER INCOME (EXPENSE), NET
We had immaterial other income in 2005 and no other income in 2004.
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FINANCIAL INCOME, NET
Financial income, net consists principally of interest income received in
connection with our bank deposits held in the U.S. In 2005, financial income,
net was $0.2 million, or 4% of sales, essentially the same as in 2004.
TAXES ON INCOME, TAX REFUNDS AND TAX BENEFITS
In 2005 Tdsoft and VocalTec had four and two 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, 2005, we had net operating loss carryforwards in Israel of
approximately $136 million ($99 million allocated to VocalTec and $37 million
allocated to Tdsoft), and an aggregate net operating loss carryforwards 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. In 2005 we received a tax refund of
one of our foreign subsidiaries in the amount of $19,000.
NET INCOME (LOSS)
Net loss in 2005 was $6.6 million, representing 144% of sales, compared with a
net loss of $5.7 million, representing 137% of sales in 2004.
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 2005, the rate of inflation in Israel was 2.4% and
the rate of depreciation of the NIS in relation to the dollar was 6.8%.
Page 52
YEAR ENDED DECEMBER 31, 2004 COMPARED TO YEAR ENDED DECEMBER 31, 2003
SALES
We recorded sales of $4.2 million in 2004 compared to $3.9 million in 2003, an
increase of 6%. The increase in sales in 2004 compared with 2003 was mainly
attributable to the increase in revenues from maintenance and support services
in the amount of $185,000 (the increase from product sales was in the amount of
$34,000).
Product sales in 2004 were $3.7 million, essentially the same as in 2003.
Revenues from engineering, maintenance and other support services in 2004 were
$433,000 million, an increase of 75% compared to 2003 services revenues of
$248,000 million. Service revenues increased in 2004 compared with 2003 due to
maintenance income recognized in connection with the TAS product (which was sold
for the first time in 2004), a decrease in product sales and the non-renewal of
existing service agreements.
As a percentage of total revenues, revenues from maintenance and other services
were higher in 2004 than in 2003 due to the increase in revenues from sales of
services and the reduced sale of products.
COST OF SALES
Cost of sales in 2004 was $1.8 million, or 43% of sales (including amortization
of acquired intangibles in the amount of $0.2 million), compared with $1.4
million, or 35% of sales (including amortization of acquired intangibles in the
amount of $0.2 million), in 2003. The increase in cost of sales in 2004 compared
to 2003 resulted primarily from the mix of products we sold in such years: while
in 2003 we sold $2 million of products with high gross margins, in 2004 we sold
$0.9 million of such products and $0.7 million of other products which have low
gross margins and which we did not sell in 2003. Such reduced gross margins were
partially offset by the increased sale of software and services (which involves
higher gross margins) in 2004 compared to 2003. Cost of services was $22,000 in
2004 compared with $21,000 in 2003.
Amortization of acquired intangibles consisted in 2004 of $188,000 with respect
to the Hunt product acquired from Cisco Systems during 2001 and $18,000 with
respect to the TAS product acquired from Be Connected, compared to amortization
of acquired intangibles in 2003 of $188,000 with respect to the Hunt product.
In 2004, gross margins were 56% (including amortization of acquired intangibles)
or 61% (excluding amortization of acquired intangibles) compared to 65%
(including amortization of acquired intangibles) or 70% (excluding amortization
of acquired intangibles) in 2003. Such increase resulted primarily from the mix
of products we sold in such years: while in 2003 we sold $2 million of products
with high gross margins, in 2004 we sold $0.9 million of our Hunt product and
$0.7 million of products which have low gross margins and which we did not sell
in 2003.
Page 53
OPERATING EXPENSES
RESEARCH AND DEVELOPMENT, NET
Research and development costs, net were $5.5 million in 2004, or 132% of sales,
compared with $3.2 million, or 82% of sales, in 2003. Research and development
costs, net consist principally of salaries and benefits, related facilities
costs and activities and expenses associated with equipment used in research and
development activity. The increase in research and development costs, net both
in absolute numbers and as a percentage of sales in 2004 compared to 2003
resulted from an increase in personnel and cost incurred as a result of the
immediate use of inventories held by Be Connected at the time of the acquisition
thereof by Tdsoft, an increase in the use of subcontractors' services, and a
one-time compensation received from Tellabs in 2003 for a canceled purchase, all
of which were partially off-set by a reduction in rent expense and depreciation
of property and equipment.
In 2004, we paid or accrued royalties to the Chief Scientist in an aggregate
amount of approximately $67,000 compared to $92,000 in 2003.
SELLING AND MARKETING
In 2004, selling and marketing expenses were $1.9 million, or 46% of sales,
compared with $2.3 million or 59% of sales in 2003. Selling and marketing
expenses include salaries and benefits, sales commissions, travel expenses and
related costs for our sales and marketing personnel, as well as reserves for
potential damages to, loss of, or obsoleteness of trial systems. 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 decrease in selling and marketing expenses both in absolute numbers and as a
percentage of sales in 2004 compared to 2003 resulted from a decrease of
$360,000 in the volume of activity of our subsidiaries in Germany and Spain, the
write-off in the amount of $70,000 of obsolete trial systems and a decrease in
the amount of $70,000 in rent expense and depreciation of property and
equipment, all of which were partially off-set by an increase of $100,000 in
personnel-related expenses.
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, finance, logistics, human resources, legal,
information systems and administrative personnel. General and administrative
expenses also include expenses associated with computing equipment and software
used in the administration operations. General and administrative expenses were
$0.8 million, or 19% of sales, in 2004, compared with $0.9 million, or 23% of
sales, in 2003. The decrease in general and administrative expenses both in
absolute numbers and as a percentage of sales resulted from a reduction in rent
expenses and a depreciation of property and equipment.
Page 54
OTHER INCOME (EXPENSE), NET
We had no other income in 2004 and 2003.
FINANCIAL INCOME, NET
Financial income, net consists principally of interest income received in
connection with our bank deposits held in the U.S. In 2004, financial income,
net was $0.2 million, or 5% of sales, essentially the same as in 2003.
TAXES ON INCOME, TAX REFUNDS AND TAX BENEFITS
In 2004, we had four Approved Enterprise programs under the Law for the
Encouragement of Capital Investments, 1959.
As of December 31, 2004, we had net operating loss carryforwards in Israel of
approximately $118 million (consisting of $86 million in loss carryforwards of
VocalTec and $32 million in loss carryforwards of Tdsoft) for tax purposes, and
an aggregate net operating loss carryforwards in the U.S. of approximately $7.4
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.
NET INCOME (LOSS)
Net loss in 2004 was $5.7 million, representing 137% of sales, compared with a
net loss of $3.8 million in 2003, representing 96% of sales.
In 2004, the rate of inflation in Israel was 1.2% and the rate of appreciation
of the NIS in relation to the dollar was 1.6%.
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 from operating revenues and from grants
from the Chief Scientist and the BIRD foundation. Immediately after consummation
of the business combination, the combined company had an aggregate of
approximately $6.4 million in cash and cash equivalents.
As of December 31, 2005, we had approximately $5.3 million in cash and cash
equivalents and restricted cash, comprised of $5.1 million in cash and bank
deposits and $0.2 million in restricted cash. As of December 31, 2004, we had
approximately $9.3 million in cash and cash equivalents.
Page 55
As of December 31, 2005, we had working capital of approximately $0.9 million,
compared with $9.6 million as of December 31, 2004. The net decrease in working
capital during 2005 resulted primarily from our operating loss. The decrease in
cash and cash investments was a direct result of our use of cash to cover our
operating loss for the year, as sales were insufficient to cover operating
expenses.
In July 2005, VocalTec received a loan in the amount of $1,000,000 from Deutsche
Telekom, then a holder of approximately 15.3% of VocalTec's issued and
outstanding obligation. The principal of the loan and all interest accrued
thereon (at an annual rate of 7.05%) will mature and become payable on July 21,
2006.
Net cash used in operating activities was $4.8 million, $4.6 million and $3.1
million for the years ended December 31, 2005, 2004 and 2003, respectively. The
principal use of cash in each of these years was to fund our operations.
Net cash provided by investing activities was $0.5 million, $20,000 and $0.1
million for the years ended December 31, 2005, 2004 and 2003, respectively. Cash
used for purchase of equipment was $0.3 million, $0.2 million and $0.1 million
for 2005, 2004 and 2003, respectively. Proceeds from the sale of equipment were
$0.1 million, $0.2 million and $0.2 million for 2005, 2004 and 2003,
respectively. Cash provided by the business combination in 2005 was $0.7
million. Cash used in the purchase of Be Connected in 2004 was $20,000.
Net cash generated by financing activities in 2005 from exercise of stock
options by employees was $0.2 million. Net cash used in financing activities in
connection with the issuance of Ordinary A shares of Tdsoft in 2004 was $50,000.
We anticipate that operating expenses may exceed revenues, net of cost of sales
in 2006 and possibly beyond if we do not sufficiently increase sales and reduce
our costs. Current cash and cash equivalents balances, cash flows from
operations and grants from the Chief Scientist are insufficient to meet our
anticipated cash needs for working capital and capital expenditures for at least
the next 12 months. We are considering ways to raise the additional capital
necessary for us to meet our anticipated cash needs for working capital and
capital expenditures for the next 12 months. If we are unable to raise such
capital, on terms favorable to us or at all, we will experience a lack of
liquidity for our activities and accordingly our ability to sustain our current
or future operations, research and development and sales infrastructures, and to
compete in the VoIP market, will be adversely affected. On April 18, 2006, our
audit committee and board of directors approved a contingency plan that will be
used by the Company if we fail to raise, by the end of the second quarter of
2006, the additional capital necessary for us to meet our anticipated cash needs
for working capital and capital expenditures. The contingency plan provides for
certain cost cut measures, which will enable us to finance our operations and to
meet our capital obligations at least through December 31, 2006.
Page 56
Even if we are able to raise the additional capital that we need, if our
revenues do not increase substantially, whether due to a failure to increase the
market share for our products, evolving industry standards and rapid
technological changes that could result in our products being no longer in
demand, the reduction in our product prices, slower pace of expansion or voice
over broadband penetration, or our failure to retain our customers, we will need
to reduce our operating expenses or use more of our cash reserves to fund
operating expenses. Similarly, in the event that the amounts we receive from
research and development grants decline, we will need to reduce operating
expenses and utilize more of our cash reserves for our operations. If such
measures are insufficient, we may attempt to establish lines of credit or sell
additional equity or debt securities.
As of December 31, 2005, we had outstanding debt in the principal amount of
$1,000,000 plus accrued interest of approximately $31,000, owed to Deutsche
Telekom pursuant to the loan extended by Deutsche Telekom to VocalTec in July
2005. Such loan is payable in July 2006.
Capital expenditures in 2005 were approximately $308,000, compared with $189,000
in 2004 and $87,000 in 2003. See Item 4 - Information on the Company - History
and Development of the Company, for further details. As of March 31, 2006,
capital expenditures in progress consisted of approximately $150,000, to be used
during 2006 for research and development activities in Israel and the relocation
of VocalTec's offices in Israel.
We maintained annual car leases in the amount of approximately $390,000 in 2005,
and our total liability for early termination of the leases is in the amount of
up to approximately $86,000.
INVENTORY AND RECEIVABLES
Inventories as of December 31, 2005 were $1.0 million, compared to $1.3 million
as of December 31, 2004. The decrease in 2005 compared with 2004 was mainly due
to an inventory write-off of $0.8 million, which was partially off-set by the
inclusion of VocalTec's inventory of $0.2 million as of December 31, 2005.
Trade receivables are from purchases of our products, primarily by
telecommunications companies and service providers. Trade receivables are
presented at gross value less reserves for doubtful accounts. Trade receivables,
net as of December 31, 2005 were $0.6 million, essentially the same as at
December 31, 2004.
Prepaid expenses and other receivables were $1.4 million as of December 31,
2005, compared with $0.2 million as of December 31, 2004. The increase in 2005
was due to grant payments accrued for in connection with participation from the
Chief Scientist and the BIRD foundation in the total amount of $1 million and
the inclusion of VocalTec's prepaid expenses and other receivables at December
31, 2005 in the amount of $0.2 million.
Page 57
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.
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. 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.
Page 58
VocalTec, Essentra, Internet Phone and Surf&Call, TdSOFT, TdGATE and TdVIEW are
trademarks or registered trademarks of VocalTec. 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 a multi-disciplinary research and
development team that specializes in audio and voice processing, computer and
networking software, embedded software, hardware integration and communications
protocols and drivers. We seek to employ highly qualified technical personnel in
order to maintain our technological expertise.
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. During 2005, Tdsoft and Nuera commenced developing, as
part of a joint project, certain hardware and software of a VoIP gateway
platform. Following completion of the project, each of Tdsoft and Nuera will add
its application software on top of the platform, to further develop it into a
generally available product, targeting various gateway applications. Both
companies have full ownership rights with respect to the platform, including
intellectual property, manufacturing and marketing rights.
In connection with the project, Tdsoft has been engaged by Nuera to develop
certain application software that will integrate with the platform. The
intellectual property rights of this application software shall be owned solely
by Nuera.
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
Service providers 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 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, 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 voice,
video, data and wireless.
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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."
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, coaxial 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.
INVESTMENT MADE BOTH IN THE CORE AND IN THE ACCESS NETWORK: 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.
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 to spend a greater
proportion of their capital budgets on the development of their access networks
to enable deployment of new services with ever-increasing bandwidth
requirements, such as video or bundled services. To complement the investments
previously made in the core network and to combine voice, video and data over a
common network, service providers are increasingly seeking to upgrade access
networks to emerging IP standards. 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 access networks,
better known as the "last mile", have been the most significant factor in the
limitation of competition in the local telephony exchange business. In an effort
to overcome this barrier, incumbent carriers were forced by law to agree to rent
unbundled network elements to competitive carriers. This had a limited success
in opening up the local telecom market for competition. Wireless technologies
provided an alternative low cost method of offering last mile services. The
demand for broadband connectivity to the Internet and the cable competition 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. This is a very significant factor in the ability
to offer Essentra as a soft-switch and Class 5 alternative solutions over
broadband, utilizing Essentra SIP technology. Various market research firms
estimate that in 2008 approximately 15% of all wire line telephone lines will
implement Voice over Broadband (VoBB) technology.
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CONVERGENCE OF VOICE AND DATA: The maturing VoIP technology and the advantages
of an IP network, not only in respect of data exchange but also in respect of
voice exchange, is leading to the convergence of the two - data and voice
networks - and the offering of a mix of data and voice services over a single
packet based IP network. This move 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 (according to various estimates - by 60%) 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. Soft-switch technology is at the heart of this evolution. The soft-switch
will not only replace the legacy TDM Class 5 switch, but it will no longer be an
integral part of each and every neighborhood. Fewer high capacity soft switches
will serve larger populations. The physical location of the soft switch will not
be related to the subscribers that it will serve. Massive efforts and large
projects are planned by most telephony carriers, which will result in over 370
million telephony lines connected to soft switches by 2009 (according to the May
2005 In-Stat report). Essentra soft switch aims at this market, which is
expected to grow by an annual average of 45% in the coming years.
WIRE LINE AND MOBILE CONVERGENCE: A new network architecture has been defined by
the Internet Multimedia Subsystem (IMS), a mobile standards committee. 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 for the wire line business, especially for VoIP
technology to be used as an access network. In 2-3 years, we expect to start
experiencing IMS offering Fixed-Mobile Convergence (FMC), where the same handset
will be used in both 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, being either a
computer, a PDA, a wire line phone or a mobile phone. Essentra architecture has
followed the guidelines of IMS, and more adjustments will be needed as
implementation of IMS commences.
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INCREASING NEED FOR VOIP INTERCONNECTION: With the dramatic rise in Broadband
infrastructure and access throughout the world, carrier and end user demand for
VoIP is growing rapidly. Established global telecommunications service providers
such as British Telecom, AT&T and KDDI are joining 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 over 1,600 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 operators 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 and
the migration from TDM to ATM and IP-based networks, are 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.
HOSTED SERVICES FOR ENTERPRISES: Carriers have never 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 it never became a significant business. Soft switch
technology combined with application servers offering a rich PBX-type set of
features and the trends of outsourcing such services as IT lead to the
reevaluation of the potential of the new Centrex services. The availability of
web based self service encourages carriers to offer Centrex as a competing
service to IPPBX solutions. IP technology adds the ability to combine Centrex
with VPN to interconnect multiple corporate offices which may be given the feel
and look of one office. Considering this, Essentra is offering rich Centrex
features combined with VPN capability and corporate level provisioning tools.
The expected size of the Centrex market is currently unclear, but the feature
set is becoming a must in every sale of a soft switch.
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OFFERING OF SEPARATE COMPONENTS: Merely migrating systems from PSTNs to VoIP
soft switch networks is insufficient to meet customers' increased demands.
Therefore, carriers have started bundling various services, which include
wireless, Internet, voice and television services, all to be provided by a
single vendor. Within such bundling, we provide the voice services. Since the
voice service we provide is bundled with such other services, our products have
to be compatible with various other services provided by vendors. In this
regard, incumbent vendors such as Alcatel and Nortel have an advantage over us
due to their ability to provide to carriers all of the services required by such
vendors. Since we do not offer a full bundle of services (but rather only voice
services), we depend on a demand among carriers for the "best of breed", which
means that rather than purchasing a bundle of services from a vendor, such
customers will purchase separate services from separate suppliers and vendors.
CONSOLIDATION: In recent years, we have witnessed a consolidation in our
industry, primarily the acquisition by large companies, which have the ability
to provide to their customers a bundled product that includes all services, of
smaller companies (such as VocalTec) that develop and offer only part of the
services. We expect such trend to continue in the near 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 and derivatives of that product, to provide
products that meet the need to connect these islands;
(ii) Adoption of a standard called IMS (IP Multimedia Subsystem) by a
majority of carriers and vendors, including mobile and fixed carriers and
networks, resulting in a new definition of telecom infrastructure, focusing on
IP multimedia service implementation. To address this trend, the Company's
strategy is in alignment with the functional description described in the
standard;
(iii) Conveyance between fixed and mobile networks, both on the
infrastructure and the service and business aspects, with respect to which the
Company offers a vertical solution providing some of the elements in an FMC
(fixed mobile conveyance)-type implementation. This trend is characterized by
the unification of infrastructures (including unification at the infrastructure
and service layers);
(iv) The recent transition of existing and newly formed service providers
towards packet-based networks, creating a variety of network islands, has
resulted in IP peering among the islands (which traditionally were connected
through PSTNs), due in part to the fact that being connected using IP is more
cost-effective than being connected through PSTNs;
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(v) Distribution of soft switch functions towards the border (the gateway)
and the application services layer (which enables the application service
vendors to function as a soft switch), the Company can now transfer a portion of
the intelligence from the BAX product to the border (the gateway);
(v) Entry of large Chinese vendors into the VoIP market, resulting in a
dramatic reduction in the prices of commodity-based products. To overcome this
difficulty, the Company is focusing on the development of a product that is less
commoditized; and has a higher barrier of entry.
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 1 1-3 3-5 More than
Total Year Years years 5 Years
----- ----- --- --- -----
Contractual obligations
Short term debt obligations 1,031 1,031 - - -
Operating Lease Obligations 1,275 722 553 - -
Other Long Term Liabilities
Reflected on the Registrant's
Balance Sheet under U.S. GAAP 2,635* 841 - - 1,794
Total 4,941 2,594 553 - 1,794
* As of December 31, 2005 we had $1,966,000 in severance pay funds to cover
such liabilities.
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ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES
6A. DIRECTORS AND SENIOR MANAGEMENT
The following sets forth certain information regarding our directors and
executive officers:
NAME
----
Joseph Albagli Director, President and Chief Executive Officer
Dr. Elon A. Ganor Director
Ilan Rosen Chairman of the Board of Directors
Yoav Chelouche Director
Robert Wadsworth Director
Joseph Atsmon Director
Michal Even-Chen Director
Rafi Wiesler Chief Financial Officer
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.
DR. ELON A. GANOR was appointed as a director in November 2005, after serving as
Chairman of the board of directors from 1993 to 2005, and as Chief Executive
Officer from 1993 to October 1998 and again from November 1999 to November 2005.
From 1990 to 1992, Dr. Ganor was responsible for the sales and marketing of our
products through his association with a subsidiary of LaCresta International
Trading Inc., where he served as a Vice President. Prior to joining VocalTec in
1990, Dr. Ganor, had nearly a decade of international business experience and
several years as a practicing physician. He holds a medical degree from Tel Aviv
University Medical School.
YOAV CHELOUCHE has served as a director since July 2000. Mr. Chelouche is the
Chairman of the Fantine Group. From November 1995 to mid-2001, Mr. Chelouche was
President and Chief Executive Officer of Scitex Corporation Ltd., and was a
director of Scitex from May 1996 to 2001. Since 1979, Mr. Chelouche has held
several positions within Scitex, including executive vice president of marketing
and business development. Mr. Chelouche qualifies as an External Director
according to the Israel Companies Law.
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MICHAL EVEN-CHEN has served as a director since November 2004. Until the end of
2003, she served as Vice President Business Development of Bezeq Ltd., Israel's
national telecommunications company, and was also the driving force and executor
on Bezeq's part of the creation of the venture capital fund Stage-one.
Subsequently, Ms. Even-Chen served for two years as Chairwoman of the fund's
Investment Committee. She also represented Bezeq on the Investment Committee of
Eurofund, a fund managed by Federman Enterprises. Prior to her positions at
Bezeq, Ms. Even-Chen was Vice President of Marketing for 012 Golden Lines, a
telecom and Internet provider. She previously held the position of Head of the
Strategy Department in Bezeq Ltd., and earlier worked in the Budget Department
of the Ministry of Finance of the State of Israel, supervising Water and Sewage.
Ms. Even-Chen qualifies as an External Director under the Israel Companies Law.
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 before that
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), Nuera Communications, 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.
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JOSEPH ATSMON was appointed as a director in November 2005 (following and
pursuant to the business combination). He currently serves as a director and
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 for 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.
RAFI WIESLER has served since July 1999 as Vice President of Finance and Chief
Financial Officer at Tdsoft and became the Company's Chief Financial Officer
following and pursuant to the business combination. Prior to joining Tdsoft, Mr.
Wiesler held a number of key positions, including Chief Financial Officer and
Business Development Manager of Network Communications and Production (NCP
Reshet), a commercial television broadcasting and production company in Israel,
Vice President of Finance and Purchasing at Lebanon Foundry, an industrial
company in Pennsylvania and as Chief of the Economics Department at Urdan
Industries Ltd., an Israeli publicly-held company. In addition, Mr. Wiesler
served as an adviser to the Chief of Staff of the Israel Defense Forces. Mr.
Wiesler holds a B.A. in psychology and economics from Haifa University and an
MBA from Tel Aviv University.
6B. COMPENSATION OF DIRECTORS AND EXECUTIVE OFFICERS
The aggregate compensation paid to VocalTec's and Tdsoft's directors and
executive officers as a group (prior to the business combination) during the
fiscal year ended December 31, 2005 was approximately $1.76 million and $0.23
million, respectively, in salaries, directors' fees and bonuses. The aggregate
compensation paid to the directors and executive officers as a group of the
combined company during the fiscal year ended December 31, 2005 was
approximately $29,000.
During the fiscal year ended December 31, 2005, 23,076 options were granted to
VocalTec's directors and executive officers as a group (prior to the business
combination) and no options were granted to Tdsoft's directors and executive
officers as a group (prior to the business combination).
On November 24, 2005, immediately following consummation of the business
combination, 221,386 options were granted to the directors and executive
officers. Of such options, 136,769 options were granted to the Company's Chief
Executive Officer, at an exercise price per share of $5.93, equal to the average
of the closing prices of the shares on Nasdaq Capital Market over the 30 days
following November 24, 2005. The remaining options were granted at an exercise
price equal to the closing price of the shares on Nasdaq Capital Market on the
30th day following November 24, 2005. Such exercise price was subsequently
amended by the Company's board of directors on December 13, 2005 to $5.93 per
share, which amended exercise price is subject to shareholders approval. In
addition, 13,000 options were approved for grant to the Company's Chief
Financial Officer on December 13, 2005, at an exercise price of $4.60 per share.
Options expire seven years after the date of the grant. No additional amounts
were set aside or accrued by the Company or its subsidiaries in 2005 to provide
pension retirement or similar benefits.
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Pursuant to the business combination, Mr. Joseph Albagli, the Company's Chief
Executive Officer and formerly the Chief Executive Officer of Tdsoft, received
an aggregate of 81,531 ordinary shares of VocalTec in exchange for his Tdsoft
shares. Of such 81,531 VocalTec shares, 41,541 shares reflected the exchange
ratio that was used for other Tdsoft shareholders who received VocalTec shares
pursuant to the business combination. Therefore, the remaining 39,990 issued to
him may be deemed to reflect an additional stock based compensation received by
him.
Pursuant to the business combination, two of our directors and one of our
executive officers, received an aggregate of 18,537 options. Of such 18,537
options, 8,871 options reflected the exchange ratio that was used for other
Tdsoft shareholders who received options pursuant to the business combination.
Therefore, the remaining 9,666 options may be deemed to reflect an additional
stock based compensation received by such directors and executive officer.
6C. 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) Yoav
Chelouche - in May 2006 (which term may not be renewed); (b) Elon Ganor - at the
annual shareholders meeting in 2006 (which term may be renewed); (c) Ilan Rosen
and Joseph Atsmon - at the annual shareholders meeting in 2007 (which term may
be renewed; (d) Michal Even-Chen, who was elected as an external director in
November 2004, will serve in such position for three years and may then be
appointed for an additional three-year term as an external director; and (e)
Joseph Albagli and Robert Wadsworth at the annual shareholders meeting to be
held in 2008 (which term may be renewed).
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
November 2005, we entered into new indemnification agreements with our
directors, 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.
However, with respect to Yoav Chelouche, Michal Even-Chen and Dr. Elon Ganor,
the terms of their prior indemnification agreements (entered into in November
2000 with respect to Dr. Elon Ganor and Yoav Chelouche, and in December 2004
with respect to Michal Even-Chen) shall apply with respect to any fundamental
acts or omissions taken or made by them in their capacity as directors or office
holders of the Company during the six-month period immediately prior to October
27, 2005 (the signing date of the agreement for the business combination)
(provided that the indemnification relates to a claim that is made against them
(alone or together with others) in writing during the 12-month period following
November 24, 2005). 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.
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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, Yoav Chelouche, and Michal
Even-Chen. We believe that Mr. Atsmon and Mr. Chelouche qualify as audit
committee financial experts (as such term is defined under the Exchange Act),
and that all three directors qualify as independent directors (as such term is
defined under the Nasdaq rules). 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.
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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 they have an interest.
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. In addition, at least one of the
external directors must be present at the meeting in which an approval was
granted.
Our audit committee 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, Yoav Chelouche,
Joseph Atsmon and Ilan Rosen and meets several times per year regarding options
allocations and general compensation issues relating to our employees.
6D. EMPLOYEES
At December 31, 2005, we employed 88 full time employees and 3 part-time
employees, of which 51 were employed in research and development, 16 were
employed in sales and marketing, 16 were employed in general and administrative,
and 4 were employed in operations. Of these employees, 87 were based in our
facilities in Israel, 1 in the United States and 3 in Europe. At December 31,
2004, VocalTec employed 93 full time employees and 8 part-time employees, of
which 43 were employed in research and development (compared with 51 in 2003),
42 were employed in sales and marketing (compared with 69 in 2003), 12 were
employed in general and administrative (compared with 22 in 2003), and 4 were
employed in operations (compared with 5 in 2003). At December 31, 2004, Tdsoft
employed 70 full time employees and 2 part-time employees, of which 48 were
employed in research and development (compared with 34 in 2003), 10 were
employed in sales and marketing (compared with 7 in 2003), 8 were employed in
general and administrative (compared with 8 in 2003), and 4 were employed in
operations (compared with 3 in 2003).
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 by virtue of
extension orders issued under applicable Israeli laws.
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6E. SHARE OWNERSHIP
As of March 15, 2006, 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 one (1%) percent 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).
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 exercise price per share 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.
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Each stock option agreement specifies the date and period over which the option
becomes exercisable. Options granted by us 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
7A. MAJOR SHAREHOLDERS
The following table sets forth, as of March 15, 2006, 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.
ORDINARY SHARES BENEFICIALLY OWNED
----------------------------------
NAME AND ADDRESS NUMBER PERCENT
---------------- --------- -------
Cisco Systems International BV (1) 1,673,549 35.45 %
HarbourVest International Private Equity
Partners III - Direct Fund L.P. (1) 910,444 19.28 %
Israel Growth Fund L.P. 251,908 5.34 %
Officers and directors as a group
(8 persons) (2) 146,948 3.11 %
(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.
(2) Includes (i) 45,529 ordinary shares for which options granted to officers
and directors of our Company are exercisable within 60 days of the date
stated above and (ii) 17,738 ordinary shares held by LaCresta International
Trading Inc. (in which Dr. Elon Ganor, one of our directors, holds 50%),
which shares may be deemed to be beneficially owned by Dr. Ganor. Does not
include 237,393 ordinary shares for which options granted to officers and
directors of our company are outstanding but are not exercisable either
currently or within 60 days.
Our major shareholders do not have different voting rights from each other or
from other shareholders.
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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.
7B. RELATED PARTY TRANSACTIONS
o Consulting agreement with Ilan Rosen dated November 24, 2005, pursuant
to which Mr. Rosen agreed to provide us certain services including,
without limitation, as the chairman of our board of directors.
o We have been generating sales of our products and related services to
Deutsche Telekom's T-Systems subsidiary. During the year 2005,
VocalTec (separately of Tdsoft) have generated sales with respect to
Deutsche Telekom's T-Systems subsidiary (consisting mostly of
services), which accounted for approximately $1.3 million. Immediately
prior to consummation of the business combination, Deutsche Telekom
held approximately 15.3% of our issued and outstanding share capital.
o In July 2005, we received a bridge loan in the amount of $1,000,000
from Deutsche Telekom, which at the time of the loan held
approximately 15.3% of our issued and outstanding share capital. The
loan bears an interest rate of 7.05% per annum payable along with the
principal in July 2006. In connection with the loan, we agreed to
deposit the source code of one of our products in escrow in favor of
Deutsche Telekom and not to create, without the approval of Deutsche
Telekom, any security interest over such source code.
7C. INTERESTS OF EXPERTS AND COUNSEL
Not applicable.
ITEM 8. FINANCIAL INFORMATION
8A. 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 (prior to the business combination) in 2005 were $3.8
million or 100% of sales compared with export sales in 2004 which were $5.5
million or almost 100% of sales, and with $18.3 million or 100% of sales in
2003.
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Export sales of Tdsoft (prior to the business combination) in 2005 were $3.3
million or 75% of sales compared with export sales in 2004 which were $2.8
million or almost 68% of sales, and with $2.6 million or 67% of sales in 2003.
Export sales of the combined company in 2005 were $0.7 million or 96% of sales.
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.
8B. SIGNIFICANT CHANGES
Except as disclosed elsewhere in this annual report, there have been no other
significant changes since December 31, 2005.
ITEM 9. THE OFFER AND LISTING
9A. OFFER AND LISTING DETAILS
Through March 31, 2006, for the periods indicated, the high and low reported
trading prices of our ordinary shares as reported by Nasdaq were as follows:
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HIGH LOW
---- ----
2001 8.12 0.60
2002 3.02 0.26
2003 7.60 0.47
2004 6.90 1.06
2005 (1) 24.7 3.45
2003
First quarter 0.77 0.47
Second quarter 4.45 0.59
Third quarter 7.60 2.81
Fourth quarter 6.40 2.50
2004
First quarter 6.90 3.19
Second quarter 4.20 1.90
Third quarter 2.27 1.07
Fourth quarter 1.77 1.06
2005
First Quarter 1.90 1.06
Second Quarter 1.33 0.64
Third Quarter 0.95 0.50
Fourth Quarter(1) 14.75 3.11
MOST RECENT SIX MONTHS
October 2005 0.69 0.37
November 2005(1) 7.67 3.80
December 2005(1) 14.75 3.11
2006
January 2006(1) 11.00 8.00
February 2006(1) 9.08 6.61
March 2006(1) 10.4 7.01
Closing price on the first trading day of:
November 2005 - 7.52(1)
December 2005 - 3.72(1)
January 2006 - 10.42(1)
February 2006 - 8.56(1)
March 2006 - 7.28(1)
April 2006 - 8.72(1)
As of March 15, 2006, 4,675,498 of our ordinary shares were issued and
outstanding. At such date, the last reported sale price of the ordinary shares
was $8.73 per share, and the ordinary shares were held by 64 record holders. Of
those 64 record holders, 35 are shown on our records as having United States
addresses. The number of record holders in the United States is not
representative of the number of beneficial holders nor is it representative of
where such beneficial holders are resident since many of these ordinary shares
were held of record by brokers or other nominees. We believe that as of March
15, 2006 approximately 79% of our outstanding ordinary shares were held in the
United States.
----------
(1) Stock prices reflect the 1-for-13 reverse split we effected on November 25,
2005.
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9B. PLAN OF DISTRIBUTION
Not applicable.
9C. 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.
9D. SELLING SHAREHOLDERS
Not applicable.
9E. DILUTION
Not applicable.
9F. EXPENSES OF THE ISSUE
Not applicable.
ITEM 10. ADDITIONAL INFORMATION
10A. SHARE CAPITAL
Not applicable
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10B. 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 appear in Section 2 of our Memorandum of
Association are: (1) to market, import, purchase computers and software for
companies and other related items; (2) to export, market and sell software for
computers and related items; and (3) to plan and manufacture software for
computers.
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 is divided into
three classes: (a) one class to hold office until our annual meeting of
shareholders to be held in 2006, (b) another class to hold office until our
annual meeting of shareholders to be held in 2007 and (c) a third class to hold
office until our annual meeting of shareholders to be held in 2008.
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.
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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. 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. The shareholder approval requires
that: (a) the majority of shares voted at the meeting, including at least one
third of the shares of disinterested shareholders voted at the meeting, are
voted favor of the transaction; or (b) the total number of shares of
disinterested shareholders voted 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 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 some of the acts and transactions that 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.
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 at least 50% of the voting power of the
affected class represented at the meeting and voting on the change.
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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 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.
Page 79
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. 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. 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.
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. However, in the event that the tender
offer to acquire such amount of shares that will cause him to hold at least 95%
of the Company's outstanding shares is not successful, 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 provision. 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 the caption "rights, preferences and restrictions upon shares."
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.
Page 80
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 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 of
2006, 2007 and 2008. At each shareholder 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 classified 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 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.
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 recently 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 certain professional
qualifications is a director who satisfies one of the following requirements:
(i) the director holds an academic degree in either economics, business
administration, accounting, law or public administration, (ii) the director
either holds another academic degree or has obtained other high education in the
company's primary field of business or in an area that is relevant to his
position, (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 having
financial and accounting specialty, in addition to the external directors. 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, 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:
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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 offer).
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 an 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: (a) the majority of shares voted at the meeting,
including at least one third of the shares of non-controlling shareholders voted
at the meeting, vote in favor of the election; or (b) the total number of shares
of non-controlling shareholders voted against the election of the external
director does not exceed one percent of the aggregate voting rights in the
company.
The initial term of an external director is three years and may be extended for
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. 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.
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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.
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 below), 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. An "office holder" is
defined in the Companies Law as a director, a general manager, a chief executive
officer, a deputy general manager, a vice general manager, other managers
directly subordinate to the general manager and any person who fills one of the
above positions without regard to title.
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.
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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. 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. The shareholder approval requires that: (a) the
majority of shares voted at the meeting, including at least one third of the
shares of disinterested shareholders voted at the meeting, vote in favor of the
transaction; or (b) the total number of shares of disinterested shareholders
voted against the transaction does not exceed one percent of the aggregate
voting rights in the company.
For information concerning the direct and indirect personal interests of certain
of our office holders and principal shareholders in specified transactions with
us, see Item 7 - Major Shareholders and Related Party Transactions - Major
Shareholders.
Under the Companies Law, the entering by a company into a contract with a
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.
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,
respectively, have a personal interest in the approval of the transaction. Where
the majority of the directors have a personal interest in the approval of a
transaction as aforesaid, 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:
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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;
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;
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; and
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.
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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, in specified circumstances, by our
shareholders.
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
Securities Exchange Act of 1934 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) and 4350(c)(2) (Regularly scheduled meetings of
the company's independent directors). 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.
10C. MATERIAL CONTRACTS NOT IN THE ORDINARY COURSE OF BUSINESS
o In November 2005, we consummated the business combination with Tdsoft
and its shareholders. See Item 3 - Key Information - Selected
Financial Data and Item 4 - Information on the Company - History and
Development of the Company.
o Loan agreement with Deutsche Telekom dated July 21, 2005. See Item 7 -
Major Shareholders and Related Party Transaction - Related Party
Transactions.
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o On May 4, 2004, Tdsoft entered into an asset purchase agreement with
Be-Connected Ltd., an Israeli privately held company, pursuant to
which Tdsoft acquired Be-Connected's assets, including the
intellectual property rights and the business of the TAS product, a
multi service access platform and assumed certain liabilities,
primarily related to supporting customers and paying royalties to the
Chief Scientist. The purchase price for the assets was $20,000 in cash
and 45,439 Ordinary A shares of Tdsoft, representing 8% of the then
share capital of Tdsoft, which shares were valued by an external
appraiser at approximately $496,000. The results of Be-Connected's
operations were included in the consolidated financial statements of
Tdsoft since May 1, 2004. Tdsoft incurred expenses of $50,000 in
connection with the issuance of the foregoing shares.
10D. 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.
10E. 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.
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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 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 will receive a credit for 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.
ISRAEL CORPORATE TAX CONSIDERATIONS
GENERAL CORPORATE TAX STRUCTURE
The regular rate of corporate tax, which Israeli companies were subject to in
2005 was 34% (such tax rate has been reduced for 2006 to 31% and is scheduled to
be reduced to 29% in 2007). 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.
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TAX BENEFITS. Taxable income of a company derived from an Approved Enterprise is
subject to company 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.
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 foreign 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:
% OF FOREIGN 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.
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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 subject to deferred
company tax in respect of the amount distributed (including the recipient's tax
thereon) 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.
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.
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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 foreign 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.
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
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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.
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.
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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.
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.
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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).
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.
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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
49% 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.
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
(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
49% 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.
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.
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TAXATION UNDER INFLATIONARY CONDITIONS
The Income Tax Law (Inflationary Adjustments), 1985 ("Inflationary Adjustments
Law") is intended to neutralize the erosion of capital investments in business
and to prevent tax benefits resulting from deduction of inflationary interest
expenses. This law applies a supplementary set of inflationary adjustments to
the normal taxable profits computed under regular historical cost principles.
Under the Inflationary Adjustments Law, results for tax purposes are measured in
real terms, in accordance with the changes in the consumer price index. In
addition, subject to certain limitations, depreciation of fixed assets and
losses carried forward are adjusted for inflation on the basis of changes in the
consumer price index.
The salient features of the Inflationary Adjustments Law can be described
generally as follows:
A special tax adjustment for the preservation of equity, based on changes in the
CPI, whereby certain corporate assets are classified broadly into fixed
(inflation-resistant) assets and non-fixed assets. Where shareholders' equity,
(as defined in the Inflationary Adjustment Law), exceeds the depreciated cost of
fixed assets (as defined in the Inflationary Adjustment Law), a tax deduction
which takes into account the effect of the annual rate of inflation on such
excess is allowed (up to a ceiling of 70% of taxable income for companies in any
single year, with the unused portion carried forward on a CPI-linked basis,
without limit). If the depreciated cost of such fixed assets exceeds
shareholders' equity, then such excess, multiplied by the annual inflation rate,
is added to taxable income.
Subject to certain limitations, depreciation deductions on fixed assets and
losses carried forward are adjusted for inflation based on the increase in the
consumer price index (from the beginning of the 1982 fiscal year, and as of the
1985 fiscal year, with respect to equipment); and gains on the sale of certain
traded securities are taxable. However, dealers in securities are subject to the
regular tax rules applicable to business income in Israel.
Results for tax purposes are measured in real terms, in accordance with the
changes in the CPI. We are taxed under this law. The discrepancy between the
change in (i) the CPI and (ii) the exchange rate of the Israeli currency to the
dollar, each year and cumulatively, may result in a significant difference
between taxable income and other items as denominated in dollars as reflected in
our financial statements (which are reported in dollars). In addition, subject
to certain limitations, depreciation of fixed assets and losses carried forward
are adjusted for inflation on the basis of changes in the Israeli CPI.
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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 the Real Gain and the Inflationary Surplus. The Real Gain
is the excess of the total capital gain over the Inflationary Surplus, computed
on the basis of the increase of the consumer price index between the date of
purchase and date of sale. The Inflationary Surplus accumulated until December
31, 1993 is taxed at a rate of 10% for residents of Israel (reduced to no tax
for non-residents if calculated according to the exchange rate of the foreign
currency lawfully invested in shares of an Israeli resident company, instead of
the consumer price index). Inflationary Surplus accumulated from and after
December 31, 1993 is exempt from any capital gains tax, while the Real Gain is
added to ordinary income, which effective until December 31 2002 is taxed at the
marginal rate of up to 49% for individuals and 34% for corporations (in 2005).
Until January 1, 2003, (the "Effective Date") the basic capital gains tax rate
applicable to corporations was 36% and the capital gains tax rate for
individuals was based on the individual's tax bracket up to 50%. For 2005, the
basic capital gains tax rate applicable to corporations was 34%. Since the
Effective Date the real capital gains tax rate for both individuals and
corporations is up to 25%. However, gains derived from the sale of listed
securities are taxed at the prevailing corporate tax rates (31% for the 2006 tax
year). Specific tax rates apply to sales of publicly traded securities as
described below. These tax rates are subject to the provisions of any applicable
bilateral double taxation treaty. The treaty concerning double taxation between
the United States and Israel (the "Treaty") is discussed below.
Since January 1, 2006, under current law, so long as our ordinary shares are
listed on a stock exchange the sale of these shares is subject to 25% (15% prior
to January 1, 2006) tax in case the shares were purchased after December 31,
2002, and in case the shares were purchased before that date the sale will be
subject to a blended tax in which the portion of the gain accrued until December
31, 2002 will be exempt from Israeli capital gains tax and the portion of the
real gain accrued from the Effective Date until the date of sale will be subject
to 25% tax (15% prior to January 1, 2006). Since January 1, 2006, an individual
shareholder holding less than 10% of the means of control in the company in a 12
months period prior to the sale shall be subject to 20% tax. The taxable real
gain will be based on the difference between the adjusted average value of the
shares during the last three trading days before the Effective Date (or the
adjusted original cost if it is higher than the adjusted average value) and the
value of the shares at the date of sale. In the event the above mentioned
calculation creates a loss, such loss can only be offset against a capital gain
from other traded securities according to the provisions of the Israeli law. The
amount of the loss is limited to the difference between the adjusted average
value and the value of the shares at the date of sale.
However, as of the Effective Date non-residents of Israel will be exempt from
capital gains tax in relation to the sale of our ordinary shares for so long as
(a) our ordinary shares are listed for trading on a stock exchange outside of
Israel, (b) the capital gains are not accrued or derived by the non-resident
shareholder's permanent enterprise in Israel, (c) the ordinary shares in
relation to which the capital gains are accrued or derived were acquired by the
non-resident shareholder after the initial listing of the ordinary shares on a
stock exchange outside of Israel and (d) neither the shareholder nor the
particular capital gain is otherwise subject to certain sections of the Israeli
Income Tax Ordinance. In addition, under the Treaty, a holder of ordinary shares
who is a United States resident will be exempt from Israeli capital gains tax on
the sale, exchange or other disposition of such ordinary shares unless the
holder owns, directly or indirectly, 10% or more of our voting power during the
12 months preceding such sale, exchange or other disposition.
Page 97
Individuals who are non-residents of Israel are subject to a graduated income
tax on income accrued or derived from sources in Israel. On the distribution of
dividends other than stock dividends, income tax at the rate of up to 25% (15%
in the case of dividends distributed from the taxable income attributable to an
Approved Enterprise) is withheld at source, unless a different rate is provided
in a treaty between Israel and the shareholder's country of residence. In the
U.S., if the dividend recipient holds 10% of our voting stock for a certain
period prior to the declaration and payment of the dividend, we are only
required to withhold income tax at a 12.5% rate. A non-resident of Israel who
has interest, dividend or royalty income derived from or accrued in Israel, from
which tax was withheld at source, is generally exempt from the duty to file tax
returns in Israel in respect of such income, provided such income was not
derived from a business conducted in Israel by the taxpayer.
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.
Page 98
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 or through attribution) 10% or more of our outstanding voting stock
or who are broker-dealers, insurance companies, tax-exempt organizations,
financial institutions, non-resident aliens of the United States 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.
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.
Page 99
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. In
the case of an individual holder, dividends received before January 1, 2009 will
be eligible for a maximum tax rate of 15% provided such holder holds our
ordinary shares for at least 60 days of the 121-day period beginning on the date
that is 60 days before the ex-dividend date and provided we are not a PFIC in
the year in which the dividend is paid or in the preceding year. 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.
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.
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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.
However, a U.S. Holder who is also a resident of the United States under the tax
treaty between the United States and Israel and who sells our ordinary shares in
Israel may elect to treat gain from the sale or other disposition of our
ordinary shares as foreign-source income for purposes of the United States
foreign tax credit limitation. Under current law, it is uncertain whether a
similar election may be made to treat losses from the sale or other dispositions
of our ordinary shares as a foreign source for purposes of such tax credit
limitation. 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, 2005. 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 the absence of regulations, case law or other guidance from the IRS
that addresses these questions, there can be no assurance that we are not, and
have not been, a PFIC. In view of this uncertainty, U.S. Holders are urged to
consult their tax advisors for guidance.
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;
Page 101
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.
In the event that we were deemed to be a PFIC for any taxable year, if a U.S.
Holder made a timely and valid QEF election with respect to our ordinary shares:
o the U.S. Holder would be required for each taxable year for which we are a
PFIC to include in income such holder's pro rata share of our (i) ordinary
earnings as ordinary income and (ii) net capital gain as long-term capital
gain, in each case computed under United States federal income tax
principles, even if such earnings or gains have not been distributed,
unless the shareholder makes an election to defer this tax liability and
pays an interest charge;
o the U.S. Holder would not be required to include any amount in income for
any taxable year during which we do not have ordinary earnings or net
capital gain; and
o the U.S. Holder would not be required to include any amount in income for
any taxable year for which we are not a PFIC.
The QEF election is made on a shareholder-by-shareholder basis. Thus, any U.S.
Holder of our ordinary shares can make its own decision whether to make a QEF
election. A QEF election applies to all shares of the PFIC held or subsequently
acquired by an electing U.S. Holder and can be revoked only with the consent of
the IRS. It should be noted that U.S. Holders may not make a QEF election with
respect to an option to acquire ordinary shares, and that certain classes of
investors (for example, consolidated groups and grantor trusts) are subject to
special rules regarding the QEF election.
Page 102
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.
Alternatively, a U.S. Holder of shares in a PFIC can elect to mark the shares to
market annually, recognizing as ordinary income or loss each year the shares are
held, as well as on the disposition of the shares, in an amount equal to the
difference between the U.S. Holder's adjusted tax basis in the PFIC stock and
its fair market value. Losses are allowed only to the extent of net
mark-to-market gains previously included in income by the U.S. Holder under the
election in prior taxable years. As with the QEF election, a U.S. Holder who
makes a mark-to-market election will not be subject to the ratable allocations
of gain, the interest charge, and the denial of basis step-up at death described
above. A mark-to-market election is irrevocable (except to the extent that our
ordinary shares are no longer marketable or the IRS consents to a revocation of
the election) and continues to apply even if the PFIC loses its status as such.
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.
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.
Page 103
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.
10F. DIVIDENDS AND PAYING AGENTS
Not applicable.
10G. STATEMENT BY EXPERTS
Not applicable.
10H. DOCUMENTS ON DISPLAY
We are subject to certain of the information reporting requirements of the U.S.
Securities Exchange Act of 1934, as amended. We, as a "foreign private issuer"
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.
Page 104
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.
10I. SUBSIDIARY INFORMATION
Not applicable.
ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We do not 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.
Principal (Notional) Amounts by Expected Maturity in U.S. Dollars:
FAIR MARKET VALUE ON DECEMBER 31 (WITH RESPECT TO VOCALTEC)
(IN THOUSANDS, EXCEPT INTEREST RATES AND DURATION)
2003 2004
------ -----
Total Portfolio 12,149 7,886
Average Interest Rate 1.0% 1.8%
Average Duration (Month) 1.3 0.8
Cash Equivalents (up to three months
maturity) 12,074 7,886
Average Interest Rate 1.0% 1.8%
Short Term Investments (three-twelve
months maturity) 75 -
Average Interest Rate 1.0% -
Page 105
FAIR MARKET VALUE ON DECEMBER 31
(IN THOUSANDS, EXCEPT INTEREST RATES AND DURATION)
2003(2) 2004(2) 2005(3)
------ ----- -----
Total Portfolio 13,934 9,260 5,291
Average Interest Rate 1.0% 2.2% 4.2%
Average Duration (Month) 0.25 0.25 0.25
Cash Equivalents (up to three months
maturity) 13,934 9,260 5,291
Average Interest Rate 1.0% 2.2% 4.2%
Short Term Investments (three-twelve
months maturity) - - -
Average Interest Rate - - -
ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES
Not applicable.
----------
(2) Data relates to Tdsoft prior to the business combination.
(3) Data relates to the combined company.
Page 106
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 15. 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, have 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. Based on such evaluation, the Company's
Chief Executive Officer and Chief Financial Officer have concluded that, as of
the end of such period, the Company's disclosure controls and procedures are
effective in recording, processing, summarizing and reporting, on a timely
basis, information required to be disclosed by the Company in reports that it
files or submits under the Exchange Act.
15(B) 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.
Page 107
ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT.
The Company's audit committee is comprised of Yoav Chelouche, Joseph Atsmon and
Michal Even-Chen. We believe that Mr. Atsmon and Mr. Chelouche qualify as audit
committee financial experts as such term is defined in the Form 20-F.
ITEM 16B. 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. A copy of our written standards of business
conduct was filed with our annual report on Form 20-F for the year ended
December 31, 2003 as Exhibit 14(a).
ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
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 (prior to consummation of the business combination)
received the following fees for audit and audit-related services in 2004 and
2005 (in thousands of U.S. dollars):
Year Ended December 31,
------------------------------------------------
2004 2005
----------------------- ----------------------
Services rendered Fees Percentages Fees Percentages
----------------- ---- ----------- ---- -----------
Audit (1) 41.7 30% 30 61%
Audit-related (2) 9.5 7% 0 0%
Tax (3) 66.3 47% 12 24%
Other (4) 23.2 16% 8 15%
Total 140.7 100% 50 100%
(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.
(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.
Page 108
(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.
During 2004 and 2005 Tdsoft paid its accountants an aggregate of $11,000 and
$194,000, respectively. Since Tdsoft was a private-held company, it was not
required under Israeli law to have an audit committee.
ITEM 16D. Exemptions from the Listing Standards for Audit Committees
- None.
ITEM 16E. Purchases of Equity Securities by the Issuer and Affiliated Purchasers
- None.
Page 109
PART THREE
ITEM 17. FINANCIAL STATEMENTS
Not applicable.
ITEM 18. FINANCIAL STATEMENTS
CONSOLIDATED FINANCIAL STATEMENTS AS OF DECEMBER 31, 2005
CONTENTS
PAGE
----
REPORTS OF INDEPENDENT AUDITORS F1 - F2
CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Balance Sheets F3 - F4
Consolidated Statements of Operations F5
Statements of Changes in Shareholders' Equity F6 - F7
Consolidated Statements of Cash Flows F8 - F9
Notes to the Consolidated Financial Statements F10 - F37
Schedule II - Allowances for Doubtful Accounts
Additions/(Deductions)
Page 110
ITEM 19. EXHIBITS
1. Amended and Restated Articles of Association.
2.1 Form of Share Certificate of VocalTec Communications Ltd.
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.
(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) Securities purchase agreement dated March 10, 2004 between the
Company and certain investors, previously filed with the SEC on
April 2, 2004 as Exhibit 4.1(i) to the Company's Annual Report on
Form 20-F for the year ended December 31, 2003, and incorporated
herein by reference.
(e) Form of warrant issued to the investors parties to the securities
purchase agreement referred to in clause (d), previously filed
with the SEC on April 2, 2004 as Exhibit 4.1(j) to the Company's
Annual Report on Form 20-F for the year ended December 31, 2003,
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.
(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.
Page 111
(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.
(i) Loan agreement dated July 21, 2005 between the Company and
Deutsche Telekom AG.
(j) Registration rights agreement dated November 24, 2005 by and
among the Company and the shareholders of Tdsoft Ltd.
8. List of Subsidiaries.
11. 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.
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)).
14.1 Consent of Kost Forer Gabbay & Kasierer, an affiliate of Ernst & Young
Global, Independent Auditors.
14.2 Consent of Kesselman & Kesselman, an affiliate of
PriceWaterhouseCoopers, Independent Auditors.
Page 112
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: April 21, 2006
Page 113
VOCALTEC COMMUNICATIONS LTD. AND ITS SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
AS OF DECEMBER 31, 2005
IN U.S. DOLLARS
INDEX
PAGE
-------------
REPORTS OF REGISTERED PUBLIC ACCOUNTING FIRMS F-1 - F-2
CONSOLIDATED BALANCE SHEETS F-3 - F-4
CONSOLIDATED STATEMENTS OF OPERATIONS F-5 - F-6
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (DEFICIENCY) F-7
CONSOLIDATED STATEMENTS OF CASH FLOWS F-8 - F-9
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS F-10 - F-37
[ERNST & YOUNG LOGO]
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
TO THE SHAREHOLDERS OF
VOCALTEC COMMUNICATIONS LTD.
We have audited the accompanying consolidated balance sheet of VocalTec
Communications Ltd. ("the Company") and its subsidiaries as of December 31,
2005, and the related consolidated statement of operations, changes in
shareholders' equity (deficiency) and cash flow for the year 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 audit.
We conducted our audit in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. We were not engaged to
perform an audit of the Company's and its subsidiaries' internal control over
financial reporting. Our audit 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 audit provide a reasonable
basis for our opinion.
In our opinion, based on our audit, the consolidated financial statements
referred to above present fairly, in all material respects, the consolidated
financial position of the Company and its subsidiaries as of December 31, 2005,
and the consolidated results of their operations and their cash flows for the
year then ended in conformity with U.S. generally accepted accounting
principles.
Tel-Aviv, Israel KOST FORER GABBAY & KASIERER
April 18, 2006 A Member of Ernst & Young Global
F - 1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the shareholders of
TDSOFT LTD.
We have audited the accompanying consolidated balance sheet of Tdsoft Ltd. (the
"Company") and its subsidiaries as of December 31, 2004 and the related
consolidated statements of operations, changes in capital deficiency and cash
flows for each of the two years in the period ended December 31, 2004. These
consolidated financial statements are the responsibility of the Company's board
of directors and management. Our responsibility is to express an opinion on
these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by the Company's Board of Directors and management,
as well as evaluating the overall financial statement presentation. We believe
that our audits provide a reasonable basis for our opinion.
In our opinion, the 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, 2004 and the results of their
operations, changes in capital deficiency and their cash flows for each of the
two years in the period ended December 31, 2004, in conformity with accounting
principles generally accepted in the United States of America.
As more fully described in note 1b to the accompanying consolidated financial
statements, subsequent to December 31, 2005, the Company may be dependent on
obtaining additional funding in order to continue its activities.
Tel-Aviv, Israel /s/ Kesselman & Kesselman
November 17, 2005 except shares
and per share data as to which
the date is April 20, 2006
Kesselman & Kesselman is a member of PricewaterhouseCoopers International
Limited, a company limited by guarantee registered in England and Wales
F - 2
VOCALTEC COMMUNICATIONS LTD.
AND ITS SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
DECEMBER 31,
-----------------
NOTE 2005 2004 *)
--- ------- -------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 5,138 $ 9,260
Restricted cash 153 -
Trade receivables (net of allowance for doubtful accounts of $50 as
of December 31, 2005 and 2004) 575 551
Prepaid expenses and other accounts receivable 4 1,387 221
Severance pay funds 338 -
Inventories 5 951 1,267
------- -------
TOTAL current assets 8,542 11,299
------- -------
SEVERANCE PAY FUNDS 1,628 824
------- -------
PROPERTY AND EQUIPMENT, NET 6 1,082 1,128
------- -------
INTANGIBLE ASSETS 3,7
Goodwill 7,237 -
Other intangible assets 3,953 287
------- -------
Total intangible assets 11,190 287
------- -------
$22,442 $13,538
======= =======
*) See Note 3a
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 2005 2004 *)
--- -------- --------
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIENCY)
CURRENT LIABILITIES:
Trade payables $ 1,446 $ 619
Accrued expenses and other accounts payable 8 4,128 1,010
Accrued severance pay 841 -
Loan from shareholder 9 1,031 -
Deferred revenues 171 75
-------- --------
Total Current Liabilities 7,617 1,704
-------- --------
Long-term other liabilities 168 -
Accrued severance pay 1,794 1,174
-------- --------
Total Long-Term Liabilities 1,962 1,174
-------- --------
Total Liabilities 9,579 2,878
-------- --------
COMMITMENTS AND CONTINGENCIES 10
MANDATORILY REDEEMABLE CONVERTIBLE PREFERRED SHARES 11 - 54,557
-------- --------
SHAREHOLDERS' EQUITY (DEFICIENCY): 11
Share capital
Series A convertible Preferred shares of NIS 0.02 par value:
Authorized, Issued and Outstanding - 0 and 314,875
shares as of December 31, 2005 and 2004, respectively - 14
Series B-2 convertible Preferred shares of NIS 0.02 par value:
Authorized, Issued and Outstanding - 0 and 352,653
shares as of December 31, 2005 and 2004, respectively - 4
Ordinary A shares of NIS 0.02 par value:
Authorized, Issued and Outstanding - 0 and 45,439
shares as of December 31, 2005 and 2004, respectively - 8
Ordinary shares of NIS 0.02 par value:
Authorized - 0 and 1,050,367, Issued and Outstanding - 0 and
370,059 shares as of December 31, 2005 and 2004, respectively - 90
Ordinary shares of NIS 0.13 par value: Authorized -
150,000,000 shares; Issued and Outstanding - 4,661,627 and 0
shares as of December 31, 2005 and 2004, respectively 155 -
Treasury Stock - (1,445)
Deferred stock based compensation (67) -
Additional paid-in capital 79,727 -
Accumulated deficit (66,952) (42,568)
-------- --------
Total shareholders' equity (deficiency) 12,863 (43,897)
-------- --------
$ 22,442 $ 13,538
======== ========
*) See Note 3a.
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 2005 2004 *) 2003 *)
--- -------- -------- --------
Sales: 13
Products $ 3,668 $ 3,719 $ 3,685
Services 925 433 248
-------- -------- --------
4,593 4,152 3,933
-------- -------- --------
Cost of sales **):
Products 1,450 1,587 1,174
Services 315 22 21
-------- -------- --------
1,765 1,609 1,195
Inventory write-off 639 - -
Amortization of intangible assets 172 206 188
-------- -------- --------
2,576 1,815 1,383
-------- -------- --------
Gross profit 2,017 2,337 2,550
-------- -------- --------
Operating expenses:
Research and development, net **) 14 4,363 5,474 3,243
Selling and marketing **) 2,763 1,909 2,314
General and administrative **) 1,748 805 919
-------- -------- --------
Total operating expenses 8,874 8,188 6,476
-------- -------- --------
Operating loss (6,857) (5,851) (3,926)
Other income, net 24 - -
Financial income, net 15 184 165 150
-------- -------- --------
Loss before tax benefit (6,649) (5,686) (3,776)
Tax benefit 16 19 - -
-------- -------- --------
Net loss $ (6,630) $ (5,686) $ (3,776)
======== ======== ========
Accretion of redeemable convertible Preferred shares 11 (348) (3,256) (3,256)
Induced conversion of convertible Preferred shares 11 (17,406) - -
-------- -------- --------
Net loss attributable to common shareholders $(24,384) $ (8,942) $ (7,032)
======== ======== ========
Basic and diluted net loss per Ordinary share 12 $ (34.05) $ (24.16) $ (19.00)
======== ======== ========
Weighted average number of Ordinary shares used in computing
net loss per Ordinary share - basic and diluted 792 370 370
======== ======== ========
*) See Note 3a.
The accompanying notes are an integral part of the consolidated financial
statements.
F - 5
VOCALTEC COMMUNICATIONS LTD.
AND ITS SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
**) Expenses include stock based compensation related to employees as follows:
YEAR ENDED DECEMBER 31,
---------------------------
2005 2004 *) 2003 *)
----- ----- -----
Cost of sales $ - $ - $ (2)
Research and development, net $ 522 $ (26) $(165)
Selling and marketing $ 13 $ - $ (53)
General and administrative $ 268 $ (6) $ 3
----- ----- -----
$ 803 $ (32) $(217)
===== ===== =====
The accompanying notes are an integral part of the consolidated financial
statements.
F - 6
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 AMOUNT AMOUNT
ORDINARY ORDINARY A PREFERRED ORDINARY ORDINARY A PREFERRED
---------- ---------- ---------- ---------- ---------- ----------
Balance as of January 1, 2003 370,059 - 667,528 $ 90 $ - $ 18
Forfeiture of options granted to
employees, net - - - - - -
Accretion of redeemable
convertible Preferred shares - - - - - -
Net loss - - - - - -
---------- ---------- ---------- ---------- ---------- ----------
Balance as of December 31, 2003 *) 370,059 - 667,528 90 - 18
Issuance of Ordinary A shares - 45,439 - - 8 -
Forfeiture of options granted to
employees, net - - - - - -
Accretion of redeemable
convertible Preferred shares - - - - - -
Net loss - - - - - -
---------- ---------- ---------- ---------- ---------- ----------
Balance as of December 31, 2004 *) 370,059 45,439 667,528 90 8 18
Accretion of redeemable
convertible Preferred shares - - - - - -
Conversion of redeemable
convertible Preferred B and C
shares into Preferred shares - - 2,276,137 - - 15
Stock based compensation related
to shares and options issued to
employees 122,343 - - - - -
Conversion of convertible
Preferred shares into Ordinary
shares 2,989,104 (45,439) (2,943,665) 41 (8) (33)
Issuance of shares and options
pursuant to the merger with
VocalTec 1,162,142 - - 24 - -
Exercise of employees stock
options 17,979 - - - - -
Induced conversion of convertible
Preferred shares - - - - - -
Net loss - - - - - -
---------- ---------- ---------- ---------- ---------- ----------
Balance as of December 31, 2005 4,661,627 - - $ 155 $ - $ -
========== ========== ========== ========== ========== ==========
TOTAL
ADDITIONAL TREASURY DEFERRED SHAREHOLDERS'
PAID-IN STOCK STOCK BASED ACCUMULATED EQUITY
CAPITAL AT COST COMPENSATION DEFICIT (DEFICIENCY)
---------- ---------- ---------- ---------- ----------
Balance as of January 1, 2003 $ - $ (1,445) $ (86) $ (26,697) $ (28,120)
Forfeiture of options granted to
employees, net - - 71 (288) (217)
Accretion of redeemable
convertible Preferred shares - - - (3,256) (3,256)
Net loss - - - (3,776) (3,776)
---------- ---------- ---------- ---------- ----------
Balance as of December 31, 2003 *) - (1,445) (15) (34,017) (35,369)
Issuance of Ordinary A shares **)438 - - - 446
Forfeiture of options granted to
employees, net (47) - 15 - (32)
Accretion of redeemable
convertible Preferred shares (391) - - (2,865) (3,256)
Net loss - - - (5,686) (5,686)
---------- ---------- ---------- ---------- ----------
Balance as of December 31, 2004 *) - (1,445) - (42,568) (43,897)
Accretion of redeemable
convertible Preferred shares - - - (348) (348)
Conversion of redeemable
convertible Preferred B and C
shares into Preferred shares 54,890 - - - 54,905
Stock based compensation related
to shares and options issued to
employees 870 - (67) - 803
Conversion of convertible
Preferred shares into Ordinary
shares - - - - -
Issuance of shares and options
pursuant to the merger with
VocalTec 6,409 1,445 - - **)7,878
Exercise of employees stock
options 152 - - - 152
Induced conversion of convertible
Preferred shares 17,406 - - (17,406) -
Net loss - - - (6,630) (6,630)
---------- ---------- ---------- ---------- ----------
Balance as of December 31, 2005 $ 79,727 $ - $ (67) $ (66,952) $ 12,863
========== ========== ========== ========== ==========
*) See Note 3a.
**) Net of issuance expenses of $50 and $ 217 in 2004 and 2005, respectively.
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
YEAR ENDED DECEMBER 31
--------------------------------
2005 2004 *) 2003 *)
-------- -------- --------
Cash flows from operating activities
Net loss $ (6,630) $ (5,686) $ (3,776)
Adjustments required to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization 811 686 962
Changes in the accrued liability for severance pay 77 157 (50)
Compensation expense related to shares and options issued to
employees, net 803 (32) (217)
Loss (gain) on sale of property and equipment (8) (41) 32
Loss (Gain) on amounts funded in respect of severance pay 14 (27) (52)
Decrease (increase) in trade receivables, net 379 (233) 149
Decrease (increase) in prepaid expenses and other receivables (624) (45) 28
Decrease in inventories 500 628 103
Increase (decrease) in trade payables (423) 155 72
Increase (decrease) in accrued expenses and other liabilities 295 67 (206)
Increase (decrease) in deferred revenues 37 (141) (211)
-------- -------- --------
Net cash used in operating activities (4,769) (4,512) (3,166)
-------- -------- --------
Cash flows from investing activities
Purchase of property and equipment (308) (189) (87)
Cash and cash equivalents resulting from the merger between VocalTec
and Tdsoft (schedule A) 727 - -
Cash and cash equivalents resulting from the acquisition of
Be-Connected (schedule B) - (20) -
Proceeds from sale of property and equipment 109 229 179
Amounts funded in respect of severance pay, net (33) (132) 94
-------- -------- --------
Net cash provided by (used in) investing activities 495 (112) 186
-------- -------- --------
Cash flows from financing activities
Proceeds from issuance of shares upon exercise of stock options by
employees 152 - -
Issuance expenses for Ordinary A shares - (50) -
-------- -------- --------
Net cash provided by (used in) financing activities 152 (50) -
-------- -------- --------
Decrease in cash and cash equivalents (4,122) (4,674) (2,980)
Cash and cash equivalents at the beginning of the year 9,260 13,934 16,914
-------- -------- --------
Cash and cash equivalents at the end of the year $ 5,138 $ 9,260 $ 13,934
======== ======== ========
Supplemental cash flows information:
Cash paid during the year for income taxes $ 10 $ 21 $ 16
======== ======== ========
*) See Note 3a.
The accompanying notes are an integral part of the consolidated financial
statements.
F - 8
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
------------------------------------
2005 2004 2003
------- ----------- -----------
Working capital, excluding cash $ 3,708 $ - $ -
Loan granted to VocalTec prior to the acquisition 341
Accrued severance pay, net 261
Property and equipment (328) - -
Intangible assets (3,896) - -
Goodwill (7,237) - -
Less - issuance of shares 7,878 - -
------- ----------- -----------
$ 727 $ - $ -
======= =========== ===========
SCHDULE B:
CHANGE IN CASH AND CASH EQUIVALENTS RESULTING FROM THE ACQUISITION OF
BE-CONNECTED
YEAR ENDED DECEMBER 31
----------------------
2005 2004 2003
----- ----- ----
Assets of business upon acquisition:
Intangible assets $ - $(213) $ -
Inventories - (236) -
Trade receivables - (64) -
Fixed assets - (3) -
Issuance of shares - 496 -
----- ----- ----
$ - $ (20) $ -
===== ===== ====
The accompanying notes are an integral part of the consolidated financial
statements.
F - 9
VOCALTEC COMMUNICATIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT 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 that enable flexible deployment of next-generation
networks (NGNs).
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 and commitments at fair value as of
November 24, 2005 (see Note 3a).
During 2005, 2004 and 2003, 34%, 46%, and 50% of the Company's
revenues, respectively, were derived from major customers (see Note
13).
b. As reflected in the consolidated financial statements, in 2005, 2004,
and 2003, the Company had net losses of $ 6,630, $ 5,686 and $ 3,776,
respectively. As of December 31, 2005 its total cash and cash
equivalents and restricted cash amounted to $ 5,291. The Company
anticipates that additional funding from external sources will need to
be raised in order to sustain operations. If such funding will not be
available, the Company is planning to implement a cost cut reduction
plan which will enable the Company to finance its operations and to
complete its obligations at least through December 31, 2006.
F - 10
VOCALTEC COMMUNICATIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT 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
substantial portion of the Company's costs is incurred in dollars. 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").
Accordingly, 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 rate of exchange for the new Israeli shekel ("NIS")
and the U.S. dollar at December 31, 2005 was $ 1.00 = NIS 4.603 (2004
- NIS 4.308 and 2003 - NIS 4.379).
F - 11
VOCALTEC COMMUNICATIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE DATA
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)
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 significant subsidiaries whose balances
and results are consolidated are:
DECEMBER 31,
-----------------------
2005 2004
---------- ----------
% OF
OUTSTANDING SHARE
CAPITAL
-----------------------
VocalTec Communications, Inc. *) U.S. 100 -
VocalTec Communications Deutschland GmbH Germany 100 -
VocalTec Communications Hong-Kong Limited *) Hong-Kong 100 -
Tdsoft Ltd. Israel 100 -
Tdsoft Communications, Inc. U.S. 100 100
Tdsoft B.V. The Netherlands 100 100
*) Ceased operations during 2005.
All inter-company balances and transactions have been eliminated upon
consolidation.
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 each 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 and restricted cash:
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.
F - 12
VOCALTEC COMMUNICATIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE DATA
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)
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.
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 financial instruments consists of
cash and cash equivalents, restricted cash, trade receivables, net,
other accounts receivable, trade payables, short-term loan and other
liabilities. The estimated fair value of these financial instruments
approximates their carrying value as of December 31, 2005 and 2004.
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
i. Impairment and disposal of long-live assets
The Company's 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.
F - 13
VOCALTEC COMMUNICATIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE DATA
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)
j. Intangible assets
Intangible assets include mainly technology, goodwill and other
identifiable intangible assets acquired in connection with the
purchase of subsidiaries and businesses. Technology and other
identifiable intangible definite lived assets are amortized over their
estimated useful lives.
The Company evaluate 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).
k. Revenue recognition:
The Company generates revenues from the sale of its systems, from
providing engineering, maintenance and support services and from
licensing the rights to use its software products. The Company's
products are sold primarily to resellers, who are considered end-users
for the purpose of revenue recognition.
The majority of the Company's revenues are generated from sale of
systems. Revenues from product sales are recognized in accordance with
Staff Accounting Bulletin No. 104 "Revenue Recognition in Financial
Statements" ("SAB No. 104"), when a persuasive evidence of an
arrangement (usually in the form of a purchase order) exists, delivery
has occurred and title passed to the customer, the vendor's fee is
fixed or determinable, no further obligation exists, collectibility is
probable, and if applicable an acceptance requirement has been
fulfilled.
Revenues from maintenance and support services are recognized on a
straight-line basis over the term of the maintenance and support
agreement.
Revenues from the sale of software products are recognized in
accordance with Statement of Position 97-2 "Software Revenue
Recognition," as amended ("SOP 97-2"), when persuasive evidence of an
arrangement exists, delivery of product has occurred, the fee is fixed
or determinable, collectibility is probable and no further obligation
exists.
Engineering services are recognized as services are performed.
Revenues are deferred until the receipt of cash when uncertainty as to
the collectibility exists.
Deferred revenue includes unearned amounts received under the
maintenance and support contracts, and amounts received from customers
but not recognized as revenues.
F - 14
VOCALTEC COMMUNICATIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT 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.
Costs incurred by the Company between the establishment of
technological feasibility and the point at which the products are
ready for general release, have been insignificant. Therefore, all
research and development costs have been expensed.
m. Royalties-bearing grants
Royalty-bearing grants from the Government of Israel and other
governmental institution 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 that they will be
repaid.
n. Income taxes:
Income taxes are accounted for in accordance with Statement of
Financial Accounting Standard No. 109, "Accounting for Income Taxes"
("SFAS No. 109"). This statement prescribes the use of the liability
method whereby deferred tax asset and liability account balances are
determined based on temporary differences between financial reporting
and tax bases of assets and liabilities and for carryforward losses.
Deferred taxes are measured using the enacted tax rates and laws that
will be in effect when the differences are expected to reverse. The
Company provides a valuation allowance, if necessary, to reduce
deferred tax assets to their estimated realizable value.
o. Share-based compensation:
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.
F - 15
VOCALTEC COMMUNICATIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE DATA
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)
The Company adopted the disclosure provisions of Financial Accounting
Standards Board Statement No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure" ("SFAS No. 148"), which
amended certain provisions of Financial Accounting Standards Board
Statement No. 123 ("SFAS 123") to provide alternative methods of
transition for an entity that voluntarily changes to the fair value
based method of accounting for stock-based employee compensation,
effective as of the beginning of the fiscal year. The Company
continues to apply the provisions of APB No. 25, in accounting for
stock-based compensation.
Pro forma information regarding the Company's net loss and net loss
per share is required by SFAS No. 123 as if the Company had accounted
for its employee stock options under the fair value method prescribed
by SFAS No. 123.
For pro forma purposes compensation expenses are amortized over the
vesting period and are estimated at the date of grant using the
Black-Scholes option pricing model with the following weighted average
assumptions:
2005 2004 2003
---------- --------- ---------
Dividend yield 0% 0% 0%
Expected volatility 102% 94% 101%
Risk-free interest rate 4.4% 3.9% 2.4%
Weighted average expected life 4.17 years 5.0 years 5.0 years
F - 16
VOCALTEC COMMUNICATIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE DATA
If the compensation cost had been determined under the alternative
fair value accounting method provided under SFAS No. 123, the
Company's stock-based employee compensation cost, net loss and basic
and diluted net loss per share would have changed to the following pro
forma amounts:
YEAR ENDED DECEMBER 31,
--------------------------------
2005 2004 2003
-------- -------- --------
Net loss as reported $ (6,630) $ (5,686) $ (3,776)
Add: stock based employee compensation expense
(reversal income) included in reported net
loss for the year 803 (32) (217)
Deduct: stock based employee (compensation
expense) reversal income determined under fair
value method for options granted (1,129) (220) 339
-------- -------- --------
Pro forma net loss $ (6,956) $ (5,938) $ (3,654)
======== ======== ========
Accretion of redeemable convertible Preferred
shares (348) (3,256) (3,256)
Induced conversion of convertible Preferred
shares (17,406) - -
-------- -------- --------
Pro forma net loss attributable to common
shareholders $(24,710) $ (9,194) $ (6,910)
======== ======== ========
Basic and diluted net loss per Ordinary share:
Net loss per Ordinary share as reported $ (34.05) $ (24.16) $ (19.00)
Pro forma net loss per Ordinary share $ (34.46) $ (24.84) $ (18.67)
The Company's additional disclosures required by SFAS 123 and SFAS 148
are provided in Note 11.
F - 17
VOCALTEC COMMUNICATIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE DATA
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)
p. Severance pay:
The Company's liability for severance pay for its Israeli employees is
calculated pursuant to Israel's Severance Pay Law and employee
agreements based on the most recent salary of the employees. The
Company's liability for all of its employees, is fully provided for by
monthly deposits with insurance policies and by an accrual. The value
of these policies is recorded as an asset in the Company's balance
sheet.
The deposited funds 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 (income) for the years ended December 31, 2005, 2004
and 2003 amounted to approximately $ 77, $ 157 and $ (50),
respectively.
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 restricted cash 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 and its subsidiaries 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 with respect to those amounts that the Company has
determined to be doubtful of collection.
Expense resulting from the net increase in the allowance for doubtful
accounts was $ 0, $ 38, and $ 69 for the years ended December 31,
2005, 2004 and 2003, respectively.
As of December 31, 2005, there is no significant off-balance sheet
concentration of credit risk such as foreign exchange contracts,
options contracts or other foreign hedging arrangements.
F - 18
VOCALTEC COMMUNICATIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
-------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE DATA
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)
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; participating convertible securities are excluded from the
computation since there is no contractual obligation for these
securities to share in the company net loss 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").
In the years ended December 31, 2005, 2004 and 2003, all outstanding
stock options and 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. The total weighted
average number of outstanding options excluded from the calculations
of diluted net loss per Ordinary share were 370,419, 0, and 0 for the
years ended December 31, 2005, 2004 and 2003, respectively.
s. Recent accounting pronouncements
1. In May 2005, the FASB issued Financial Accounting Standards Board
Statement No. No. 154 "Accounting Changes and Errors Corrections"
("SFAS 154"). SFAS 154 replaces APB No. 20 "accounting changes"
("APB 20") and Financial Accounting Standards Board Statement No.
No. 3 "Reporting Accounting changes in Interim Financial
Statements". SFAS 154 applies to all voluntary changes in
accounting principle, and changes the accounting for and
reporting of a change in accounting principle. SFAS 154 requires,
unless impracticable, retrospective application as the required
method for reporting a change in accounting principle in the
absence of explicit transition requirements specific to the newly
adopted accounting principle. This statement also provides
guidance for determining whether retrospective application of a
change in accounting principle is impracticable and for reporting
a change when retrospective application is impracticable. APB 20
previously required that most voluntary changes in accounting
principle be recognized by including in net income of the period
of the change the cumulative effect of changing to the new
accounting principle. SFAS 154 is effective for accounting
changes and corrections of errors made in fiscal years beginning
after December 15, 2005. There is no effect on the Company's
financial position and results of operations.
2. On December 16, 2004, the FASB issued FASB Statement No. 123
(Revised 2004), "Share-Based Payment" ("Statement 123(R), which
is a revision of FASB Statement No. 123, "Accounting for
Stock-Based Compensation". Statement 123(R) supersedes APB
Opinion No. 25, "Accounting for Stock Issued to Employees", and
amends FASB Statement No. 95, "Statement of Cash Flows".
Generally, the approach in Statement 123(R) is similar to the
approach described in Statement 123. However, Statement 123(R)
requires all share-based payments to employees, including grants
of employee stock options, to be recognized in the income
statement based on their fair values. Pro forma disclosure is no
longer an alternative.
F - 19
VOCALTEC COMMUNICATIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
-------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)
In April 2005, the Securities and Exchange Commission postponed
the required adoption date of SFAS 123(R) from no later than July
1, 2005 to no later than January 1, 2006. Early adoption will be
permitted in periods in which financial statements have not yet
been issued. The Company expects to adopt SFAS 123(R) on January
1, 2006.
Statement 123(R) permits public companies to adopt its
requirements using one of two methods:
a) A "modified prospective" method in which compensation cost
is recognized beginning with the effective date (a) based on
the requirements of Statement 123(R) for all share-based
payments granted after the effective date and (b) based on
the requirements of Statement 123 for all awards granted to
employees prior to the effective date of Statement 123(R)
that remain unvested on the effective date.
b) A "modified retrospective" method which includes the
requirements of the modified prospective method described
above, but also permits entities to restate based on the
amounts previously recognized under Statement 123 for
purposes of pro forma disclosures either (a) all prior
periods presented or (b) prior interim periods of the year
of adoption.
The company plans to adopt SFAS 123(R) using the
modified-prospective method.
Because SFAS 123(R) must be applied not only to new awards but
also to previously granted awards that are not fully vested on
the effective date, compensation cost for previously granted
awards will be recognized under SFAS 123(R). However, had the
Company adopted SFAS 123(R) in prior periods, the impact of that
standard would have approximated the impact of SFAS 123 as
described in the disclosure of pro forma net income and earnings
per share in Note 2(o) to the consolidated financial statements.
In March 2005, the SEC released SEC Staff Accounting Bulletin No.
107, "Share Based Payment" ("SAB 107"). SAB 107 provides the SEC
staff's position regarding the application of FAS 123(R) and
contains interpretive guidance related to the interaction between
FAS 123(R) and certain SEC rules and regulations, and also
provides the SEC staff's views regarding the valuation of
share-based payment arrangements for public companies. SAB 107
highlights the importance of disclosures made relating to the
accounting for share-based payment transactions. The Company is
currently reviewing the effect of SAB 107; however it does not
believe that SAB 107 will have a material effect on its financial
position, results of operations or cash flows.
t. Reclassification:
Certain figures from prior years have been reclassified in order to
conform to the 2005 presentation.
F - 20
VOCALTEC COMMUNICATIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
-------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
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 after the
merger reflect the financial statements of Tdsoft on a historical
basis and include the results of operations of VocalTec from November
24, 2005.
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.
F - 21
VOCALTEC COMMUNICATIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
-------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 3:- BUSINESS COMBINATION (CONT.)
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 7,237
--------
Total intangible assets acquired 11,133
--------
Total tangible and intangible assets acquired 14,593
--------
Total liabilities assumed (6,360)
--------
Net assets acquired $ 8,233
========
Goodwill included 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. The carrying amounts of the current
assets and liabilities were reasonably proxies for their market values
due to their short-term maturities.
b. Be-Connected
In May 2004, Tdsoft entered into an Assets Purchase Agreement with
Be-Connected Ltd., an Israeli privately held company, pursuant to
which Tdsoft acquired Be-Connected's assets, including the
intellectual property rights and the business of the TAS product, a
multi service access platform and assumed certain liabilities,
primarily related to supporting customers and paying royalties to the
Office of the Chief Scientist of the Ministry of Industry and Trade in
Israel. The purchase was in consideration of $ 20 in cash and issuance
of 45,439 Ordinary A shares, representing 8% ownership of Tdsoft,
which were valued at approximately $ 496, based on the Tdsoft's
average share price of $ 0.25, as determined by an external appraiser.
Tdsoft incurred $ 50 of issuance expenses with respect to the issuance
of the shares. In addition, the results of Be Connected operation have
been included in the consolidated financial statements since May 1,
2004.
F - 22
VOCALTEC COMMUNICATIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
-------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 3:- BUSINESS COMBINATION (CONT.)
The acquisition was accounted for using the purchase method under SFAS
No. 141. The purchase price was allocated to those assets acquired
based on the estimated fair value of those assets as of the
acquisition date.
The purchase price was allocated on an estimate fair value of the
assets acquired as of May 1, 2004:
Current assets $ 300
Property and equipment 3
Identifiable intangible assets:
Technology (11 years useful life) 182
Customer backlog (1 year useful life) 3
Customer relationship (5 years useful life) 28
------
Assets acquired $ 516
======
Excess of net fair value over purchase price allocated
to none-current assets $1,197
======
c. Supplemental Pro Forma Information (Unaudited)
The unaudited pro forma information regarding 2005 and 2004 presents
the results of operations of VocalTec after giving effect to the
merger with TdSoft in 2005 and the acquisition of Be-Connected in
2004, 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, TdSoft and Be-Connected.
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 has been consummated at the dates indicated, nor are
they necessarily indicative of future operating results or financial
conditions.
YEAR ENDED
DECEMBER 31
---------------------------
2005 2004
------------ --------
Sales $ 8,427 $ 9,987
============ ========
Operating loss $ (16,833) $(20,227)
============ ========
Net loss $ (15,137) $(19,893)
============ ========
Basic and diluted net loss per Ordinary share $ (19.28) $ (15.11)
============ ========
Weighted average number of Ordinary shares used in computation
of basic and diluted net loss per share 1,840 1,532
============ ========
F - 23
VOCALTEC COMMUNICATIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
-------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 4:- PREPAID EXPENSES AND OTHER ACCOUNTS RECEIVABLE
DECEMBER 31
--------------------
2005 2004
------ ----
Prepaid expenses $ 105 $ 63
Government participation 970 -
Government authorities 226 80
Other 86 78
------ ----
$1,387 $221
====== ====
NOTE 5:- INVENTORIES
DECEMBER 31
----------------------
2005 2004
------ ------
Components and work in progress $ 752 $1,108
Finished goods **) 199 159
------ ------
$ 951 $1,267
====== ======
*) Write-down of inventories for the years ended December 31, 2005,
2004 and 2003 amounted to $ 757, $ 0 and $ 0, respectively.
**) As of December 31, 2005 and 2004, $ 199 and $ 159, respectively,
finished goods were delivered to customers' sites and were not
recognized as cost of sales since revenue recognition criteria
for the related sales have not been met. The Company has title to
the inventories at balance sheet date.
NOTE 6:- PROPERTY AND EQUIPMENT, NET
DECEMBER 31
----------------------
2005 2004
------ ------
Computers and related equipment $4,083 $3,581
Office furniture, equipment and leasehold
improvements 1,295 1,201
Motor vehicle 122 353
------ ------
5,500 5,135
Less - accumulated depreciation 4,418 4,007
------ ------
Depreciated cost $1,082 $1,128
====== ======
Over than 90% of the property and equipment is located in Israel.
Depreciation expense was $ 581, $ 484, and $ 774 for the years ended
December 31, 2005, 2004 and 2003, respectively.
F - 24
VOCALTEC COMMUNICATIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
-------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 7:- GOODWILL AND OTHER INTANGIBLE ASSETS
DECEMBER 31
---------------------
2005 2004
------- ----
Cost:
Technology and other intangible assets (1) $ 4,859 $963
Accumulated amortization:
Technology and other intangible assets (1) 906 676
------- ----
3,953 287
------- ----
Goodwill 7,237 -
------- ----
Amortized cost $11,190 $287
======= ====
1. The annual estimated amortization expense relating to VocalTec's
amortizable intangible assets existing as of December 31, 2005, is
approximately as follows:
TOTAL
AMORTIZATION
------
2006 $ 906
2007 566
2008 511
2009 462
2010 462
2011 and thereafter 1,046
------
$3,953
======
2. The changes in the carrying amount of goodwill for the year ended
December 31, 2005 is as follows:
OTHER HOLDINGS
AND CORPORATE
OPERATIONS
------
Balance as of December 31, 2004 $ -
Newly consolidated company 7,237
------
Balance as of December 31, 2005 $7,237
======
3. Amortization expenses amounted to approximately $ 230, $ 206 and $ 188
for the years ended December 31, 2005, 2004 and 2003, respectively.
F - 25
VOCALTEC COMMUNICATIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
-------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 7:- GOODWILL AND OTHER INTANGIBLE ASSETS (CONT.)
4. In 2005, Tdsoft changed the estimated useful life of the acquired
technology under the agreement with Be-Connected from May 2004 from 11
years to 5 years (see Note 3b) in order to reflect the expected useful
life of the assets as a result of the rapid changes in the industry.
NOTE 8:- ACCRUED EXPENSES AND OTHER ACCOUNTS PAYABLE
DECEMBER 31
----------------------
2005 2004
------ ------
Employees and payroll accruals $ 573 $ 359
Accrued expenses 922 170
Accrued vacation pay 778 481
Government Institutions 966 -
Office lease 288 -
Directors and officers insurance 438 -
Other 163 -
------ ------
$4,128 $1,010
====== ======
NOTE 9:- LOAN FROM SHAREHOLDER
In July 2005, the Company received a bridge loan in the amount of $ 1,000
from Deutsche Telekom, one of its major shareholders prior to the merge
with Tdsoft Ltd. The loan bears interest at the rate of 7.05% per annum
payable along with the principal in July 2006. As of December 31, 2005,
interest expense accrued in connection with the loan amounted to $ 31. In
connection with the loan, the Company agreed to put the source code of one
of its products in escrow in favor of Deutsche Telekom and not to create,
without the approval of Deutsche Telekom, any security interest over such
source code.
NOTE 10:- COMMITMENTS AND CONTINGENCIES
a. In connection with its research and development activities through
December 31, 2005, 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% - 4.5% of sales of the developed product, up to 100% of the
amount of grants received linked to the U.S. dollar (for grants
received under programs approved subsequent to January 1, 1999, 100%
plus interest at LIBOR). 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.
F - 26
VOCALTEC COMMUNICATIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
-------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 10:- COMMITMENTS AND CONTINGENCIES (Cont.)
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 $ 17,128 as of December 31, 2005.
Cost of sales includes royalties paid and accrued to the Government of
Israel in the amount of $ 63, $ 67, and $ 92 for the years ended
December 31, 2005, 2004, and 2003, respectively.
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 the
BIRD.
Under the agreement, Tdsoft shall be reimbursed by the 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 2005, grants received and accrued
from BIRD amounted to $ 749. Tdsoft's contingent liability to the BIRD
amounts to approximately $ 749.
The Company has no future commitments for royalties in respect of
other participations received.
c. Certain allegations, 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.
d. The Company's facilities in Israel and in the United States are rented
under operating leases with different periods ending through April
2007 for facilities in Israel and February 2006 for facilities in the
United States (some with renewal options). Rent expense amounted to $
308, $ 368, and $ 560 for the years ended December 31, 2005, 2004 and
2003, respectively. Annual minimum rental commitments under
non-cancelable leases at balance sheet date are approximately as
follows:
2006 $256
2007 71
----
Total $327
====
The Company also maintains motor vehicle leases. The total liability
for early termination of such leases is approximately $ 86. Motor
vehicle lease expense amounted to $ 390, $ 130, and $ 0 for the years
ended December 31, 2005, 2004 and 2003, respectively.
e. Under the purchase agreement with Be-Connected (see Note 3b), Tdsoft
provided the seller a bank guaranteed of $ 500, in respect of certain
guarantees that a shareholder of Be-Connected gave to its customers.
F - 27
VOCALTEC COMMUNICATIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
-------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 10:- COMMITMENTS AND CONTINGENCIES (Cont.)
f. Tdsoft granted to its offices' lessor bank guarantee in the amount of
approximately $ 166 in effect until May 2006.
VocalTec granted certain lessors guarantees in the total amount of $
140, primarily in connection with its offices and motor vehicles.
Restricted cash are used as security for these guarantees.
NOTE 11:- SHARE CAPITAL
a. Share capital
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.
The Company may, subject to the applicable provisions of the Companies
Law, issue redeemable shares and subsequently redeem them. In
addition, the Company's board of directors 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.
Pursuant to an amendment to the articles of association of Tdsoft,
which amendment was adopted 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. 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, pursuant
to the business combination between TdSoft and VocalTec all the
Ordinary shares of TdSoft were exchanged for VocalTec Ordinary shares.
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 conversion of preferred stock pursuant to the agreement
between Tdsoft shareholders prior to the business combination with
VocalTec as required by EITF D-42, "The Effect on the Calculation of
Earnings per Share for 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."
F - 28
VOCALTEC COMMUNICATIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 11:- SHARE CAPITAL (CONT.)
All the share stock amounts have been adjusted to Ordinary shares
resulted from the business combination, as described in Note 3a.
Prior to the conversion and exchange of all the shares of TdSoft, the
following rights were attached to the shares:
Redemption rights: The holders of series B and C Preferred shares of
Tdsoft had certain redemption rights described below. In February
2005, all redemption rights were waived and the redeemable convertible
Preferred shares were converted into convertible Preferred shares.
Prior to the cancellation of the redemption rights, if within eight
years following January 31, 2000, Tdsoft would not execute consummate
an IPO, a merger or a sale of all or substantially all of the assets
of Tdsoft, the holders of a majority of the series B Preferred shares
would have the right on one occasion to require Tdsoft, subject to
applicable law, to redeem all series B Preferred shares (excluding the
series B-2 Preferred shares), and the holders of a majority of the
series C Preferred shares would have the right to require Tdsoft,
subject to applicable law, to redeem all series C Preferred shares. In
the event of such redemption, for each such Preferred share Tdsoft
would redeem, Tdsoft would pay the holder of such shares an amount
representing the greater of the fair market value of such Preferred
shares (as defined below) or the Adjusted Original Issue Price (as
defined below), plus any accrued dividends. In the event of such
redemption, 33.33% of the series B Preferred shares(excluding the
series B-2 Preferred shares), or of the series C Preferred shares, as
applicable, would be redeemed, on each of the following dates:
February 1, 2008, February 1, 2009 and February 1, 2010. For the
purpose of the foregoing, the fair market value of each series B
convertible Preferred share or each series C Preferred share, as
applicable, would mean the highest price for which such Preferred
share could be sold to an independent third party.
The Adjusted Original Issue Price for each redeemable series B
Preferred share held by each holder of such redeemable series B
Preferred share would be the Original Issue Price of such redeemable
series B Preferred share multiplied by a fraction, the numerator of
which would be the total number of series A, series B and series B-2
Preferred shares then held by such holder, and the denominator of
which would be the sum of number of series B Preferred shares
(excluding series B-2 Preferred shares) then held by such holder;
provided that in making such calculation, the number of series A
Preferred shares would be multiplied by a fraction, the numerator of
which would be the Original Issue Price of a series A Preferred share
and the denominator of which would be the Original Issue Price of a
series B Preferred share. The Adjusted Original Issue Price for each
redeemable series C Preferred share would be $ 12.93.
To the extent that Tdsoft would not be permitted by law to redeem
shares for the amounts calculated above, then it would, to the extent
permitted by law, repurchase the shares for such amounts. Upon the
date of redemption of any series B Preferred shares, Tdsoft would
simultaneously convert 33.33% of the series A and series B-2 shares
originally held by the holder of the redeemed shares into deferred
shares, which would not confer on the holders thereof any rights
accruing to holders of Ordinary shares in Tdsoft, and would carry no
rights other than the rights to receive their nominal value upon
liquidation of Tdsoft.
F - 29
VOCALTEC COMMUNICATIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 11:- SHARE CAPITAL (CONT.)
Redeemable convertible Preferred shares as of December 31, 2004 were
composed as follows:
NUMBER OF SHARES AMOUNTS
----------------------------- ------------------------
ISSUED AND ORIGINAL GROSS
AUTHORIZED OUTSTANDING PROCEEDS REDEMPTION VALUE
--------- ---------- ------- -------
DECEMBER 31, 2004
-------
U.S. DOLLARS IN THOUSANDS
------------------------
Series B Preferred Shares of NIS
0.02 par value 1,171,314 636,032 $10,100 $28,290
Series C Preferred shares of NIS
0.02 par value 1,640,105 1,640,105 20,000 26,267
--------- ---------- ------- -------
2,811,419 2,276,137 $30,100 $54,557
========= ========== ======= =======
Liquidation preferences: Upon any liquidation, the holders of the
series C Preferred shares of Tdsoft were entitled to receive an amount
per share equal to the original issue price of $ 12.93 plus any
accrued and unpaid dividends (the "Preferred C Preference"). In the
event that the assets of Tdsoft available for distribution were
insufficient to make such per share distributions, all such assets
would be distributed proportionately to the holders of the series C
Preferred shares. Second, the holders of the convertible A Preferred
shares and B Preferred shares would be entitled to receive an amount
per share equal to the original issue price of $ 1.82 and $ 6.84,
respectively, plus any accrued and unpaid dividends (the "Series A/B
Preference"). In the event that the assets of Tdsoft available for
distribution would be insufficient to make such per share
distributions, all such assets would be distributed proportionately to
the holders of the A Preferred and B Preferred shares.
The holders of Ordinary A Shares were entitled to certain liquidation
rights following distributions to the holders of the Preferred C
preference and Series A/B Preference). Thereafter, the remaining
assets of Tdsoft available for distribution, if any, would then be
distributed among the holders of the deferred shares and the Ordinary
shares in proportion to their respective percentage holdings, until
the holders of the deferred shares have been paid their nominal value,
and if any assets remained thereafter, such assets would be
distributed pro-rata among the holders of the Ordinary shares and
Ordinary A shares.
Voting rights: The holders of Ordinary shares of Tdsoft had one vote
for each Ordinary share. The holders of Preferred shares and Ordinary
A shares had one vote for each Ordinary share into which such
Preferred shares or Ordinary A shares, as applicable, were
convertible.
Conversion
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.
F - 30
VOCALTEC COMMUNICATIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 11:- SHARE CAPITAL (CONT.)
Dividend
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.
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. 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 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 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.
F - 31
VOCALTEC COMMUNICATIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
NOTE 11:- SHARE CAPITAL (CONT.)
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, 2005, 48,399 share options are still available for
future grants under the Company's existing plans. Options, which are
cancelled or forfeited before expiration, become available for future
grants.
A summary of the Company's share option activity under the plans is as
follows:
YEAR ENDED DECEMBER 31,
-------------------------------------------------------------------------------------------
2005 2004 2003
------------------------- ---------------------- -----------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
AMOUNT OF EXERCISE AMOUNT OF EXERCISE AMOUNT OF EXERCISE
OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE
-------- ------ ------ ------ ------- ------
Outstanding-beginning
of the year 52,315 $ 8.05 49,776 $ 8.68 40,472 $14.55
Granted 860,416 $11.92 15,372 $ 3.50 24,262 $ 3.50
Exercised (17,979) $ 8.44 - $ - - $ -
Forfeited (25,852) $44.51 (12,833) $ 5.04 (14,958) $16.09
-------- ------ -------
Outstanding - end
of the year 868,900 $10.79 52,315 $ 8.05 49,776 $ 8.68
======== ====== ====== ====== ======= ======
Options
exercisable at
the end of the
year 214,817 $26.68 22,357 $11.57 17,864 $11.57
======== ====== ====== ====== ======= ======
The weighted average fair values of the options granted during 2005,
2004 and 2003, was $ 3.42, $ 0.38 and $ 0.39, respectively. All
options were granted at an exercise price equal to the market value of
the share at the date of grant.
F - 32
VOCALTEC COMMUNICATIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
-------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA
NOTE 11:- SHARE CAPITAL (CONT.)
The following table summarizes information about options outstanding
and exercisable at December 31, 2005:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
----------------------------------------- ----------------------------
AMOUNT WEIGHTED- AMOUNT
OUTSTANDING AVERAGE WEIGHTED OUTSTANDING WEIGHTED
AT REMAINING AVERAGE AT AVERAGE
RANGE OF EXERCISE DECEMBER CONTRACTUAL EXERCISE DECEMBER EXERCISE
PRICES 31, 2005 LIFE PRICES 31, 2005 PRICES
-------- ---- --------
(YEARS)
$ 0.0078-3.00 5,879 3.01 $ 2.90 5,879 $ 2.90
$ 3.00-7.50 734,094 7.00 $ 5.32 92,122 $ 5.86
$ 7.50-18.75 44,726 3.73 $ 11.23 35,924 $ 10.28
$ 18.75-46.88 45,711 3.26 $ 31.13 43,950 $ 30.94
$ 46.88-117.20 31,491 2.75 $ 75.81 29,943 $ 76.95
$ 117.20-224.25 6,999 1.99 $162.98 6,999 $162.98
------- -------
868,900 6.41 $ 10.79 214,817 $ 26.68
------- -------
NOTE 12:- NET LOSS PER SHARE
The following table sets forth the computation of basic and diluted net
loss per Ordinary share:
YEAR ENDED DECEMBER 31,
--------------------------------------------
2005 2004 2003
-------- ------- -------
Numerator:
Net loss $ (6,630) $(5,686) $(3,776)
Accretion of redeemable convertible Preferred shares (348) (3,256) (3,256)
Induced conversion of convertible Preferred shares (17,406) - -
Allocation of undistributed earnings to convertible
Preferred shares (2,585) - -
-------- ------- -------
Net loss attributable to common shareholders after
allocation of undistributed earnings to convertible
Preferred shares $(26,969) $(8,942) $(7,032)
======== ======= =======
Denominator:
Weighted average number of Ordinary shares outstanding
during the year used to compute basic and diluted net
loss per Ordinary share 792 370 370
======== ======= =======
Basic and diluted net loss per Ordinary share $ (34.05) $(24.16) $(19.00)
======== ======= =======
F - 33
VOCALTEC COMMUNICATIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
NOTE 13:- GEOGRAPHIC AND MAJOR CUSTOMERS INFORMATION
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,
--------------------------------------
2005 2004 2003
------ ------ ------
Sales classified by geographic areas based on end-
customer location:
Europe $2,718 $1,599 $1,241
Americas (principally United States) 992 655 1,271
Asia 275 567 135
Israel 608 1,331 1,286
------ ------ ------
$4,593 $4,152 $3,933
====== ====== ======
Sales to a single customer exceeding 10%:*)
% % %
-------- -------- --------
Customer A 18 *) 12
Customer B *) 12 18
Customer C *) *) 20
Customer D *) 11 -
Customer E 16 13 -
Customer F *) 10 -
*) Less than 10%
NOTE 14:- RESEARCH AND DEVELOPMENT, NET
YEAR ENDED DECEMBER 31,
------------------------------------------
2005 2004 2003
------- ------- -------
Research and development expenses $ 5,669 $ 5,474 $ 3,243
Less- participations from:
OCS 557 - -
BIRD 749 - -
------- ------- -------
$ 4,363 $ 5,474 $ 3,243
======= ======= =======
F - 34
VOCALTEC COMMUNICATIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
NOTE 15:- FINANCIAL INCOME, NET
YEAR ENDED DECEMBER 31,
----------------------------------
2005 2004 2003
---- ----- ----
Financial income :
Interest on cash and cash equivalents, net of bank
fees $173 $ 168 $140
Foreign currency translation adjustments, net 11 (3) 10
---- ----- ----
$184 $ 165 $150
==== ===== ====
NOTE 16:- 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. in equipment
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.
F - 35
VOCALTEC COMMUNICATIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
NOTE 16:- TAXES ON INCOME (CONT.)
The period of tax benefits, detailed above, 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, 2005,
management believes that VocalTec Ltd. and Tdsoft Ltd. are meeting all
of the aforementioned conditions.
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, 2005, the accumulated
deficit of the 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 34%. The regular corporate tax rate is to be gradually reduced
to 25% by 2010 (31% in 2006, 29% in 2007, 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 $ 99,000 and $ 37,000 as of December
31, 2005, respectively, which may be carried forward indefinitely.
VocalTec Communications Inc. and Tdsoft Communications, Inc., which
are subject to U.S. income taxes, have an aggregate loss for tax
purposes of approximately $ 8,459 as of December 31, 2005. 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 carryforwards 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 - 36
VOCALTEC COMMUNICATIONS LTD.
AND ITS SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
NOTE 16:- TAXES ON INCOME (Cont.)
f. Tax benefit is comprised as follows:
YEAR ENDED DECEMBER 31,
--------------------------------------------------
2005 2004 2003
-------------- -------------- --------------
Foreign:
Current taxes $ 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 carryfoward losses. Significant
components of the Company's deferred tax assets are as follows:
DECEMBER 31
-----------------------
2005 2004
-------- -------
Deferred tax asset:
Reserves and allowances $ 707 $ 222
Net operating losses carryforward 36,063 8,119
-------- -------
Net deferred tax asset before valuation allowance 36,770 8,341
Valuation allowance (36,770) (8,341)
-------- -------
Net deferred tax asset $ - $ -
======== =======
During 2005, the Company increased the allowance due to additional net
operating losses carryforward, reserves and allowances which resulted
from the reverse acquisition with Tdsoft Ltd. 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 in
the foreseeable future.
h. Loss before income taxes is comprised as follows:
YEAR ENDED DECEMBER 31,
-------------------------------------------
2005 2004 2003
------- ------- -------
Israel $(6,429) $(5,392) $(3,218)
Foreign (220) (294) (558)
------- ------- -------
$(6,649) $(5,686) $(3,776)
======= ======= =======
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.
F - 37
SCHEDULE II ALLOWANCES FOR DOUBTFUL ACCOUNTS
ADDITIONS / (DEDUCTIONS)
Beginning Charged Written End of
of period to P&L off period
--------- ------ ------- ------
Year ended December 31, 2003
Allowance for doubtful accounts 200 69 (219) 50
Year ended December 31, 2004
Allowance for doubtful accounts 50 38 (38) 50
Year ended December 31, 2005
Allowance for doubtful accounts 50 - - 50