SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 20-F
(Mark One)
[ ] 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, 1999
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ____ to ____
Commission File Number 2-0-27648
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VOCALTEC COMMUNICATIONS LTD.
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(Exact Name of Registrant as Specified in Its Charter)
N/A
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(Translation of Registrant's Name Into English)
ISRAEL
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(Jurisdiction of Incorporation or Organization)
2 Maskit Street, Herzliya, 46733, Israel
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(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 NIS 0.01 Per Share
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(Title of Class)
Securities for which there is reporting obligation pursuant to
Section 15(d) of the Act: None
Indicate the number of outstanding shares of each of the issuer's
classes of capital or common stock as of the close of the period covered by
the annual report.
11,771,302 Ordinary Shares, Par Value NIS 0.01 Per Share
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 filing requirements for the past 90 days. Yes X No
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Indicate by check mark which financial statement item the registrant
has elected to follow. Item 17 Item 18 X
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PART I
ITEM 1. DESCRIPTION OF BUSINESS
GENERAL
VocalTec develops and markets Internet telephony products for all
classes of service providers worldwide and also offers enhanced Web-based
multimedia communications services through two operating units in the U.S.
Our Internet Protocol ("IP") Telephony Products Group, based in Israel,
provides open, standards-based systems that leverage the power and
flexibility of Voice over IP ("VoIP") technology. Our e-commerce
Application Service Provider business, Surf&Call(R) Network Services(TM),
headquartered in Fort Lee, New Jersey, provides Web-enabled call center and
other e- commerce services based on our award-winning Surf&Call Center
platform. TrulyGlobal, Inc., a wholly-owned subsidiary of VocalTec, also
headquartered in Fort Lee, offers Web-based Internet telephony services
from an innovative consumer communications portal.
We are credited with pioneering the commercial Internet telephony
industry with the introduction of the consumer client software program,
Internet Phone(R), in 1995. Since then, we have developed and introduced
full end-to-end solutions targeted primarily to telecommunications
companies and other service providers, such as competitive local exchange
carriers ("CLECs"), alternative carriers, telephony wholesalers, Internet
telephony service providers ("ITSPs") and clearinghouses. These solutions
enable IP telephony based on the VocalTec Ensemble Architecture(TM), which
includes component products such as the VocalTec Gatekeeper(TM), the
VocalTec Network Manager(TM), the VocalTec Telephony Gateway(TM), the
VocalTec UniPOP(TM) and Internet Phone(R) Lite(TM) client software.
RECENT RESTRUCTURING OF OPERATING DIVISIONS
During 1999 and the first quarter of 2000, we undertook a comprehensive
strategic reassessment of our organization, products and market
opportunities, aiming to sharpen our marketing focus and to improve our
execution capabilities. This strategic evaluation process culminated in
several initiatives including operational and management changes and a
reorganization into three groups:
The IP Telephony Products Group, headquartered in Israel with multiple
sales offices around the world, will continue to supply end-to-end,
standards-compliant solutions focusing on ITSPs and CLECs. The group will
also continue working with major telecom carriers worldwide.
Surf&Call Network Services, a new U.S.-based business, has been
established as an e-commerce Application Service Provider ("ASP").
Surf&Call will enable e-commerce storefronts to provide integrated voice,
co-browsing, text chat and form completion assistance to their customers.
This will allow these e-commerce Web Sites to offer their customers a wide
range of shopping-related services without the complexity and cost of
on-site technology installation and maintenance. The service will be based
on the award winning VocalTec Surf&Call Center platform. This unit intends
to launch its service in the second half of 2000, and will target various
vertical markets within the Web-enabled call center sector.
TrulyGlobal Inc., a U.S. based-business, is a wholly-owned subsidiary
of VocalTec that offers a Web-based Internet telephony service via a
consumer communications portal. TrulyGlobal's service is intended to
enhance Internet telephony voice quality and to increase communication
flexibility by allowing subscribers to customize their Internet
communications on their own personal Web-page. The first phase of service
is expected to be available during the second quarter of 2000.
In this report all references to "we", "us", "our", "our company" or
"VocalTec" include VocalTec Communications Ltd. and its wholly-owned
subsidiaries, VocalTec Communications Inc., VocalTec Communications Japan
KK, VocalTec Communications GmbH, TrulyGlobal Inc., TrulyGlobal Ltd., VT
Rocket, Inc. and VocalTec Hong Kong Limited.
INDUSTRY BACKGROUND
Historically, voice and data has been transmitted over separate
networks using different technologies. Traditional carriers have typically
built telephone networks based on circuit switching. Circuit switching
establishes and maintains a dedicated path until a call is terminated.
While a circuit-switched system reliably transmits voice communications,
circuit switching does not efficiently use transmission capacity. Once a
circuit is dedicated, it is unavailable to transmit any other information,
even when the particular users of that circuit are not speaking or
otherwise transmitting information.
However, packet switching, the technology used in data networks, is
rapidly replacing circuit switching. Packet-switching technology, such as
IP, divides signals into packets that are simultaneously routed over
different channels to a final destination where they are reassembled in the
original order in which they were transmitted. Packet switching provides
for more efficient use of the capacity in the network because the network
does not establish dedicated circuits, which waste unused capacity. As a
result, substantially greater traffic can be transmitted over a
packet-switched network, such as the Internet, than over a circuit-switched
network.
Although the use of packet-switched networks has traditionally resulted
in lower quality voice calls due to delay and lost packets resulting from
congestion on the Internet, recent advances in packet-switching technology
and the expanded use of intranet networks have significantly improved the
quality of packet-switched voice calls.
The technology has improved to the point that phone-to-phone calls can
be transmitted over data networks with quality approaching that of
traditional phone networks.
With advancements in quality and capabilities the initial market driver
of telephony over IP networks was the cost saving resulting from avoiding
tariffs on the Public Switch Telephony Network ("PSTN"). We believe that
additional factors may drive the continued growth of this market. For
example, in contrast to the closed, proprietary structure inherent in
traditional circuit- switched voice networks, Internet telephony embraces
an open architecture and open standards which enables, service providers to
quickly add additional features and services without the need for costly
network upgrades.
The integration of voice capabilities and the Internet can enhance the
potential for the Internet to become the preferred medium for both
communications and commerce. The use of the Internet as a predominant means
of communication, combined with recent personal computer purchasing trends
and advances in related technologies, have resulted in the emergence of a
market for voice services over the Internet. The proliferation of
multimedia personal computers, equipped with a sound card, microphone and
speakers, has created a large potential customer base for related products
and services. At the same time, the advent of faster modems and new
broadband Internet access devices such as Digital Subscriber Line ("DSL")
and cable modems that provide greater access and bandwidth, and the
increase in personal computer processing has set the stage for significant
growth in demand for multimedia enhanced services.
We believe that the integration of voice with current text-based modes
of Internet communication such as e-mail and online "chat" by adding voice
and collaborative capabilities would offer significant benefits to
consumers and businesses. For example, enabling Internet shoppers to speak
directly with a call center agent without the need to disconnect from the
session may increase the probability that a sale will be made and give
online retailers more choices in the type of products and services that
they can offer on the Web.
Integrating voice into existing communications services such as e-mail,
fax and voicemail and creating enhanced unified messaging capabilities will
give users more flexibility. While basic phone-to-phone and fax-to-fax
services are the predominant communications methods, we believe that
additional market growth will come from the demand for a variety of
enhanced services required by the growth in e-commerce and the desire for
more direct control over the ability to customize communications.
The future of the IP telephony industry continues to be promising. For
example, International Data Corporation, a provider of information
technology industry analysis, forecasts that worldwide IP telephony will
grow from 310 million minutes in 1998 to 135 billion minutes in 2004, with
associated revenues reaching $19 billion, approximately half of which will
be generated by new enhanced services. In addition, according to Allied
Business Intelligence, a technology research think-tank, the market for
VoIP equipment -- gateways and gatekeepers -- is growing in excess of 60%
annually. A 1998 study by Probe Research forecasts the VoIP equipment
market will exceed $7 billion by 2005.
OUR PRODUCTS AND SOLUTIONS
We believe that a successful VoIP communications deployment requires
three basic building blocks, which include (i) telephony gateways to bridge
the PSTN and the IP network; (ii) communications servers (gatekeepers) that
provide the intelligence of the IP network for functions including call
control, centralized addressing, security and accounting and
authentication; and (iii) client software with enriched features and
applications. VocalTec products and solutions provide these building
blocks.
VOCALTEC ENSEMBLE ARCHITECTURE
In March 1998, we announced the VocalTec Ensemble Architecture ("VEA"),
an open standards-based software platform that leverages the power and
flexibility of VoIP communications and forms the foundation of all IP
solutions from VocalTec. VEA provides the building blocks for VocalTec's
communication solutions for IP networks. Key components of VEA include the
VocalTec Gateway, the VocalTec Carrier-grade Gateway, the VocalTec
Gatekeeper and the VocalTec Network Manager. VEA combines all the software
and hardware elements required to build the infrastructure for global IP
telephony networks. The platform is highly scalable, centrally manageable,
open for integration with third party products and is based on the
International Telecommunications Union's international standards. VEA is
implemented in product suites, which allows services to evolve from basic
implementation to value-added services. VEA provides a platform for new
applications that are not available on the PSTN, such as Web-enabled call
centers and PC-to-phone applications.
SOLUTIONS BASED ON VOCALTEC ENSEMBLE ARCHITECTURE
We currently offer the following solutions based on our VocalTec
Ensemble Architecture: Calling Card, PC-to-phone, VoIP Virtual Private
Network, VoIP Clearinghouse VoIP for Mobile Operators, Web-enabled Call
Centers, Web-to-Phone and Web Toll-free.
PRODUCTS
SERVERS
VocalTec Gatekeeper(TM) - the intelligent hub for IP telephony
networks, which acts as the platform for enhanced services. This is the IP
service and control server that provides centralized addressing, system
security and accounting for networks designed with VEA components. VocalTec
Gatekeeper allows organizations to set up robust and secure Internet
telephony networks, suitable for high quality service or internal corporate
use. It facilitates authenticated call initiation in order to provide the
following services in an IP telephony environment: Phone-to-phone,
PC-to-phone, Web-to-phone, Fax-to-fax, Real Time Fax and Internet
Phone(R)?Call Waiting(TM).
VocalTec UniPOP(TM) - a complete VoIP solution providing gatekeeper,
gateway and network management functionality, all you need to run an IP
telephony network, in a single box (most VoIP solutions require three
separate units). UniPOP is a high quality entry level solution, that is
easily deployed and can scale up and into the full VEA platform.
VocalTec Call Center Server(TM) - a data collaboration server that
provides the interface between an incoming customer call, the VocalTec
gateways and call center equipment. This server is responsible for the
integration and data transfer between the call center and the customer's
call from the Web using VocalTec Web-to-phone client.
VocalTec Billing Server(TM) - provides real-time billing in a
centralized and highly scalable environment and can be situated anywhere
within the IP network and secured on permission-based access levels.
GATEWAYS
VocalTec Telephony Gateway (TM) Series 120 and 2000 - a family of
Internet telephony servers which link IP networks with the PSTN in order to
minimize long distance expenses and provide a number of enhanced multimedia
services. These gateways provide the critical bridge between IP telephony
networks and the PSTN, by dynamically converting traditional PSTN signals
into streams of data communication packets, transporting voice and data
anywhere in the world. The Series 2000 is a high-capacity, carrier-class
embedded solution based on ECI Telecom Ltd.'s multi-service platform. It is
highly scalable and, when coupled with other Gateways within the series,
can process thousands of calls at a time. These gateways support the
following services: Phone-to-phone, PC-to- phone, Fax-to-fax and
Web-to-phone.
VocalTec Signaling Gateway for SS7 - a high density, carrier-grade
product which is fully compliant with SS7 (also referred to as "out-of-band
signaling" or "signaling system 7"), which is the common channel signaling
protocol used for call handling within the PSTN.
CLIENTS
VocalTec Internet Phone(R) Lite(TM) - a software client specifically
designed for making calls between a multimedia PC and a regular telephone
through service provider gateways. The interface may be customized for
redistribution by a service provider. The product is one of the end user
components of VEA and includes features such as inexpensive long distance
calls, clear high quality audio, keypad, quick dial buttons and a compact
address book that mimics an ordinary phone.
VocalTec Web-to-Phone Client - a plug-in that enables voice
connectivity from a Web-site to a call center using regular telephones, for
the cost of an Internet connection, anywhere in the world. The call is
routed from the user's PC, over the Internet, though a VocalTec Telephony
Gateway, to a regular phone, thereby bypassing the toll charges of the
PSTN.
NETWORK MANAGEMENT TOOLS
VocalTec Network Manager - an operations, administration, management
and provisioning tool for server elements of VEA, capable of managing a
large-scale, distributed IP telephony network. The graphical user interface
allows network administrators ease of use, managing and monitoring all VEA
network elements.
Simple Network Management Protocol ("SNMP") - provides support for
third party management platforms such as HP OpenView. It includes the SNMP
agent that transfers requests to the VocalTec Telephony Gateway terminals
and VocalTec Gatekeeper terminals.
STRATEGIC AGREEMENTS
DEUTSCHE TELEKOM
In December 1997, we established a strategic relationship with Deutsche
Telekom whereby Deutsche Telekom made an equity investment in our company
and simultaneously entered into a strategic business cooperation agreement.
Under the strategic business cooperation agreement, Deutsche Telekom
undertook to purchase from us, products and services in a total amount of
$33 million, of which $21.7 million was to be purchased prior to December
31, 1999 at an agreed quarterly schedule. In September 30, 1998 we signed
an amendment to the strategic business cooperation agreement under which
the period during which Deutsche Telekom is to purchase $21.7 million of
our products and services was extended to March 31, 2000 or until the
minimum purchase commitment is fulfilled. As of December 31, 1999, Deutsche
Telekom had purchased $24.4 million of products and services from us.
Pursuant to the strategic cooperation agreement Deutsche Telekom has
the right to use our products and to distribute them worldwide. In
addition, the agreement provides, among other things, for (a) joint
cooperation in marketing and promotional activities, (b) priority on the
provision of product alpha and early product beta versions, (c) a five
percent (5%) discount for Deutsche Telekom from our best distributor prices
and (d) Deutsche Telekom to have the right to acquire from us any hardware
developed by us in the future.
The strategic business cooperation prevents us from entering into a
relationship with a competitor of Deutsche Telekom that would provide the
competitor with the overall preferential treatment accorded to Deutsche
Telekom unless Deutsche Telekom enters into a strategic relationship in the
area of Internet telephony that is, in its totality, substantially similar
to Deutsche Telekom's strategic relationship with us. Sales to Deutsche
Telekom accounted for 49% of our total sales in 1999. (See Item 9.
"Management's Discussion and Analysis of Financial Condition and Results of
Operations"- Acquisitions.)
In January 2000, we entered into a product purchase agreement with
Deutsche Telekom in the form of a Letter of Understanding (the "LOU") to
provide products and services valued at approximately $11 million. The LOU
incorporates the terms of the strategic business cooperation agreement
until a final agreement is executed. Under the LOU, we will provide
Deutsche Telekom with an application service hosting platform, allowing
Deutsche Telekom's Freecall Online program to offer e-commerce and call
center customer care service. This application is expected to enable
Deutsche Telekom to provide its e-commerce business customers with enhanced
and interactive online customer assistance capabilities. As a result, the
customers call center representatives will be able to assist consumers at
their PCs with joint surfing-to-Web pages, collaboration on forms, text
chat and voice support, all over a single Internet connection. Consumers
with a second phone line will also be able to schedule a return call from a
Web-based business via a "call back" service. Deutsche Telekom expects to
roll out the new services over an 18-month period starting in the second
quarter of 2000.
CISCO SYSTEMS INC.
In September 1999 we entered into a joint development, marketing and
sales agreement with Cisco Systems Inc. to provide integrated solutions to
service providers. In the fourth quarter of 1999, partnering with Cisco, we
received a contract from Bell Atlantic Corporation for an end-to-end
solution to provide wholesale VoIP services to ITSPs for pre-and post-paid
calling services. The solution features Cisco's gateways and VocalTec's
gatekeeper.
MARKETING AND DISTRIBUTION
IP TELEPHONY PRODUCTS
We market our products through multiple distribution channels. We have
designed our distribution strategy to address the diverse markets we
target, including telecommunications service providers, ITSPs, CLECs and
clearinghouses. Our marketing strategy includes direct sales to
telecommunication service providers, strategic partnerships, value added
resellers and integration arrangements with vendors of complementary
hardware and software products and services. In 1998, we expanded our
distribution network in order to accelerate market penetration and combine
our marketing efforts with enhanced technical marketing capability to
enable quality pre-sale and post-sale support to our telecommunications
service providers and other customers. In order to accelerate marketing
penetration in the Far East and Europe, we established wholly-owned
subsidiaries in Japan and Germany in 1998.
In 1999 we established a wholly owned subsidiary in Hong Kong and a
representative office in China. We intend to continue to devote significant
resources to marketing efforts in international telecommunications markets
as well as in the U.S. Sales in the U.S. and Canada accounted for 70%, 32%
and 13% of our sales in 1997, 1998 and 1999, respectively. (See Item 19.
"Financial Statements and Exhibits" - Note 13 - Net Sales.)
In March 1998, we signed a distribution agreement with Fujitsu Business
Systems Ltd. (part of the Fujitsu group), a leading systems integrator in
Japan, to provide IP telephony solutions and bring network solutions to
service providers and corporate customers. Also in March 1998, we opened an
office in Tokyo in order to serve the Asian market.
During 1999, we worked closely with ECI to develop a high-capacity
carrier-class gateway based on ECI's mature multi-service platform which
features a built-in networking switch that can process up to 1,920 calls.
In March 2000, we formalized the relationship by entering into a joint
development and marketing agreement.
DIRECT SALES OVER THE INTERNET:
We have offered our Internet Phone client product directly to users via
the Internet. As part of our strategy to move toward a service-based
business model in the consumer market, we phased out our client sales and
will offer those customers a suite of services with similar capabilities
that will be upgraded in later phases. (See "Our Services" above.)
OUR SERVICES
As a result of our strategic planning process during 1999, we underwent
a comprehensive reorganization, creating separate business units to focus
on distinct market opportunities. Two of these units E-commerce services
and TroulyGlobal, Inc. represent new service-based business models.
E-COMMERCE SERVICES
A new U.S. based business, Surf&Call Network Services, is being
established as an e-commerce Application Service Provider ("ASP"). The new
group enables e-commerce storefronts to provide integrated voice (Internet
telephony), co-browsing, text chat and joint form completion assistance
directly to customers via the Web.
As of May 31, 2000, the group had 31 employees. Surf&Call Network
Services, which is expected to launch its service in the second half of
2000, will target various vertical markets within the Web-enabled call
center sector. The service will be based on the award-winning VocalTec
Surf&Call Center platform. The e-commerce business unit will have a small
direct sales force that will initially target businesses with e-commerce
sites and later will sell through channel partners such as outsourced
contact center providers.
TRULYGLOBAL, INC.
Truly Global, Inc., a wholly-owned subsidiary of VocalTec headquartered
in the U.S., develops Web-based Internet telephony service via a consumer
communications portal. The first phase of service will begin towards the
end of the second quarter of 2000. As of May 31, 2000 this company had 25
employees. The new company will offer consumers Web-based Internet
telephony services. This service was designed using the input of Internet
Phone users by the creators of Internet Phone. TrulyGlobal will engage in
direct Internet marketing, initially to its existing base of Internet Phone
users, and will also seek distribution agreements with partners.
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 in a number of
international standard bodies, including: the International
Telecommunications Union, the European Telecommunications Standards
Institute and the International Multimedia Teleconferencing Consortium -
Voice Over Internet Protocol, and participate in the Internet Engineering
Task Force.
In September 1998, together with Lucent Technologies and ITXC, we
established iNOW!, or Interoperability Now, which is a standards-based,
multi-vendor initiative designed to provide interoperability among gateways
of various IP telephony platforms. The iNOW! initiative is based on the
H.323 V2 international standard. In December 1998, six other major IP
telephony hardware vendors announced their support of the iNOW! initiative.
In October 1998, we joined the PacketCable project established by
CableLabs, which aims to develop standards for offering IP telephony
services over cable networks and test vendor compliance with these
standards. CableLabs is a research and development consortium jointly owned
by many of the leading cable operators in North-America.
Our employees have held the following positions since 1999: (1) editor
of H.225/Annex G, the International Telecommunications Unit standard for
Inter-carrier connectivity, supporting clearing- house functionality; (ii)
editor of the Interdomain Profile of iNow in IMTC; and (iii) editor of the
back-end service architecture in ETSI/TIPHONE, supporting the future
architecture of IP telephony servers.
We plan to continue to be an active participant in standards as we
believe customers must be assured that new features will adhere to
international standards to ensure consistency and interoperability.
CUSTOMER AND TECHNICAL SUPPORT
We believe that responsive, prompt and efficient customer and technical
support is essential to the success of obtaining and retaining customers.
We currently maintain a staff of customer and technical support personnel
in our offices in the U.S., Israel, Japan, China and Germany. We offer
support to our customers and back office support to our resellers and
distributors. For telecommunications market products, we have entered into
several agreements that provide a percentage charge of the cost of the
system purchased for technical support. We intend to charge for such
technical support in the future. We also train certain distributors,
resellers and bundling partners to provide customers with first level
technical support.
On a routine basis, our technical support staff provides feedback to
our marketing and research and development groups. This enables us to
design products featuring ease of use and installation, to maintain
compatibility with third party products in order to minimize the
requirements for service and support and to improve the products' quality.
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 which
specializes in audio and voice processing, computer and networking
software, embedded software, hardware integration, and communications
protocols and drivers. We seek to recruit highly qualified technical
personnel in order to maintain our technological expertise.
Our research and development personnel regularly examine and test new
software and communication and networking technologies in order to evaluate
their applicability to our products. Our research and development personnel
are also involved in creating and improving standards within the
international standard, setting bodies, so as to lead the industry into
compliance with interoperable and robust solutions that will enable
mainstream acceptance of new technologies and products.
We intend to continue to devote resources to the improvement of our
Web-based client products and to develop products and platforms that are
complementary to our products, including enhancing the functionality and
the efficiency of our server technology, as part of the end-to-end complete
telephony solution. In the year 2000, we intend to continue to develop
VocalTec Ensemble Architecture components and other solutions to provide
carrier-grade VoIP telephony equipment and solutions. However, we can
provide no assurance that we will successfully develop new or enhanced
products.
As of May 31, 2000, our research and development group consisted of 110
employees, 108 of whom were located in Herzliya, Israel, and 2 of whom were
located in Fort Lee, New Jersey. During 1997, 1998 and 1999, research and
development costs, net, were $5.5 million, $11.1 million and $13.2 million,
respectively. Our research and development efforts have been financed
through our internal resources and through programs sponsored by the
Government of Israel, through the Office of the Chief Scientist (the
"OCS"). Research and development grants from the OCS totaled approximately
$261,000 and $1,316,000 for 1998 and 1999, respectively. In 1997, we did
not apply for a royalty bearing grant. (See Item 9. "Management's
Discussion and Analysis of Financial Condition and Results of Operations" -
Results of Operations and - Research and Development Grants.)
Generally, grants from the OCS constitute up to 50% of certain research
and development expenses related to the development of products intended
for export. Under our terms of the OCS's participation, a royalty of 3-5%
of the net sales of products developed in, and related services resulting
from, a project funded by it is generally required to be paid beginning
with the commencement of sales of such products and ending when 100-150% of
the grant is repaid in New Israeli Shekels ("NIS") linked to the U.S.
dollar. In 1997, 1998 and 1999 we paid (or accrued) royalties on account of
sales of such products in the amount of $100,000, $71,000, and $183,000
respectively. Terms of the Government of Israel's participation also
require that the research and development be conducted by the applicant for
the grant as specified in the application and that the manufacturing of
products developed with government grants be performed in Israel, unless
special approval has been granted. Separate Israeli Government consent is
required to transfer technologies to third parties that have been developed
through projects in which the government participates. Such restrictions,
however, do not apply to exports from Israel of products developed with
such technologies. From time to time, the Government of Israel has revised
its policies regarding the availability of grants, and there can be no
assurance that the Government of Israel's support of research and
development will continue. (See Item 7. "Taxation.")
RESEARCH AND DEVELOPMENT CONSORTIUM
In addition to royalty-bearing grants from the OCS, we have received
grants from the OCS in connection with a generic research consortium which
is comprised of several high technology companies in Israel, under the
Magnet program. The consortium is known as the Multimedia OnLine Services
Technologies Consortium, (the "MOST Consortium"), and is devoted to generic
technology research for on-line broadband multimedia services. In general,
any member of the MOST Consortium who develops technology within the
framework of the MOST Consortium retains the intellectual property rights
to the technology developed and all members of the MOST Consortium have the
right to utilize and implement any such technology without having to pay
royalties to the developing MOST Consortium member.
The OCS contributes 66% of the approved budget for the MOST Consortium
and the members of the MOST Consortium contribute the remaining 34%. No
royalties are payable to the Government of Israel with respect to this
funding. Expenses in excess of the approved budget are borne by the MOST
Consortium members. In 1997, 1998 and 1999, we received or accrued
approximately $1,424,000, $1,166,000 and $772,000, respectively, in grants
from the OCS through the MOST Consortium.
The following table sets forth, for the periods indicated, our gross
research and development expenditures, the portion of such expenditures
which was funded by royalty-bearing and non-royalty bearing grants and the
net cost to us of our research and development activities:
YEAR ENDED DECEMBER 31
1997 1998 1999
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(In thousands)
Gross research and development costs $6,943 $12,619 $15,245
Less:
Royalty-bearing grants (the OCS) --- (261) (1,316)
Non-Royalty-bearing grants (the OCS) --- (261) (1,316)
Research and development costs - net $5,519 $11,192 $13,157
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COMPETITION
IP TELEPHONY PRODUCTS
The VoIP Communications industry is highly competitive. We are active
in this industry which is still in an early stage of development. Entry
barriers into this market are relatively low, and we expect that
competition will intensify in the future. The market environment in which
we operate is extremely dynamic and is characterized by evolving standards,
new alliances and emerging market entrants. We believe that in such a
rapidly changing market, key competitive factors include a broad base of
users, strategic alliances, key reference customers, interoperability,
integration of products with vendors of complementary hardware and software
products and services, technological leadership, product performance and
ease of use, price, customer support, name recognition, distribution
channels and the ability to respond quickly to emerging opportunities.
Various innovative voice, collaborative, data, video and other
communications alternatives which may compete with our products are often
introduced and may be introduced in the future. Such new communications
alternatives may be based on traditional telephone lines, ISDN lines, the
Internet or cable networks and may be combined with other computing and
broadcasting technologies.
We believe that a successful VoIP Communications deployment requires
three basic building blocks. Such building blocks include: ; (i) telephony
gateways to bridge PSTN and IP networks; (ii) communications servers
(gatekeepers) that provide the intelligence of the IP network for functions
including call control, centralized addressing, security and accounting and
authentication; and (iii) client software with enriched features and
applications.
We compete in the telecommunications service provider market with data
networking companies as well as traditional telecommunications equipment
suppliers and smaller specialized IP telephony companies such as Cisco
Systems, Inc., Clarent Corporation, Ericsson Corp., Lucent Technologies,
Inc., Netspeak Corporation, and Nortel Networks, provide IP telephony
products and services. See "Risk Factors."
We expect that numerous companies will eventually compete in the market
for voice communications over IP networks. Additional competitors may
include companies that currently provide traditional telecommunications and
PSTN equipment to telecommunications service providers as well as
networking companies that provide data network products to corporate and
telecommunications services providers and companies that provide computer
software products and services such as telephone, media, publishing and
cable television. The ability of some of our competitors to integrate their
VoIP Communications products with their existing products and other
services and other products with Internet/intranet voice products could
give such competitors an advantage over us. Many of our competitors have
significantly greater technical and financial resources, service expertise,
customer bases and name recognition.
WEB-BASED MULTIMEDIA COMMUNICATIONS SERVICES
We expect that numerous companies will provide Internet telephony
services to consumers and several may do so through consumer communications
portals on the Internet. Currently, companies like PhoneFree.com and
Dialpad.com are offering such services; however, they are focusing on PC-
to-phone service, while TrulyGlobal will offer PC-to-PC calling during the
launch phase.
Similarly, there are a number of companies that offer Web-enabled call
center products and services. We expect to compete with both voice-based
vendors such as Net2Phone and Deltathree as well as collaboration-based
vendors such as Neteffect and LivePerson.
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 several patent applications in the United States and
other countries with respect to certain technologies employed in our
products. Several of those applications have been already registered and we
own those registered patents. In addition, we have filed several trademark
applications in the United States and other countries with respect to
trademarks associated with us and our products. Several 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. On February 15, 2000, Multi-Tech Systems,
Inc., filed a complaint in the United States District Court for the
District of Minnesota, in which it alleged that we and our wholly owned
subsidiary, VocalTec Communications Inc., as well as other named
defendants, are infringing four of Multi-Tech's Patents. We intend together
with VocalTec Communications Inc to vigorously defend the suit. The
ultimate outcome, however, cannot be determined at this time.
We could incur substantial costs and diversion of management resources
with respect to the defense of any claims relating to proprietary rights
which 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. (See
Item 3. "Legal Proceedings.")
VocalTec, VocalTec Telephony Gateway, Internet Phone, Internet Voice
Mail, VocalTec Conference Server, VocalTec Ensemble Architecture, VocalTec
Network Manager, VocalTec Gatekeeper, I2N, TrulyGlobal, PassaPort,
PassaFax, Surf&Call, Internet Phone Call Waiting, VocalTec Ensemble Sound
and VocalTec Surf&Call Center are all trademarks or registered trademarks
of VocalTec. All other trademarks or registered trademarks used in this
Annual Report on Form 20-F are the property of their respective owners.
EMPLOYEES
As of May 31, 2000, we employed 277 full time employees, including 153
employees in the IP Telephony Products unit, 31 employees in the Surf&Call
Network Services unit, 25 in TrulyGlobal and 68 employees in shared
services and administration. Of these employees, 209 were based in our
facilities in Israel, 49 were employed by VocalTec Communications Inc. in
the United States, 5 employees were employed by VocalTec Communications
Japan KK, 4 employees were employed by VocalTec Communications GmbH in
Germany, and 10 employees were employed by our representative office in
Beijing, China. We believe that our relations with our employees are good.
Neither we nor our employees are parties to any collective bargaining
agreements, except as otherwise applicable under Israeli law. (Please see
the risk factor under caption "Conditions in Israel" for further details.)
U.S. FEDERAL COMMUNICATIONS REGULATION
Interexchange (long distance) telephone service in the United States
has historically been used to subsidize local exchange telephone services.
Following the 1982 consent decree that split AT&T into a long distance
carrier and Regional Bell Operating Companies, the Federal Communications
Commission ("FCC") devised a complex system of access charges and universal
service contributions through which local telephone exchange carriers
received subsidies from interexchange carriers to reduce the price of basic
local telephone service. The Telecommunications Act of 1996 (the "1996
Act") included provisions that require the FCC to convert these implicit
subsidies to explicit, specific, and predictable support mechanisms, to
make affordable basic telephone services available throughout the United
States, and to provide additional support for telecommunications and
information services for school, libraries, and health care providers. The
1996 Act requires every telecommunications carrier that provides interstate
telecommunications services to contribute to the support of universal
service.
In rulemaking proceedings regarding universal service and access charge
reform, the FCC has addressed the statutory distinction between
"telecommunications carriers", who transmit information of user's choosing
between or among points specified by the user without change in the form or
content of the information, and "information service" providers, who offer
a capability for generating, acquiring, storing, transforming, processing,
retrieving, utilizing, or making available information via
telecommunications. The FCC determined that Internet services, to the
extent they are information services, are not telecommunications services
and that providers of such services are not required to contribute to
universal service support.
On March 4, 1996, the America's Carriers Telecommunications Association
("ACTA"), a trade association representing small long distance companies,
filed a petition with the FCC requesting, among other things, that the FCC
subject developers of Internet voice software such as VocalTec, to the same
FCC regulations as long distance telecommunications carriers. ACTA
requested that the FCC commence a rule - making proceeding regarding the
regulation of Internet voice software such as our "Internet Phone" and that
it order such companies to immediately cease distributing Internet voice
software until the FCC completes the rule-making proceeding. In response to
the ACTA petition, the FCC received hundreds of comments from the general
public and the computer and telecommunications industries, including
ourselves, the overwhelming majority of which requested that the FCC deny
the ACTA petition. Most parties argued that the FCC lacks authority to
regulate Internet voice software in the same manner as long distance
companies and that alternatively, even if it could assert such authority,
the FCC should treat the software in the same manner as deregulated
telecommunications equipment. If the FCC were to grant the ACTA petition,
we would have to comply with the full panoply of federal telecommunications
regulations governing long distance carriers including access charges and
universal service contributions. Although the FCC has not yet issued a
notice of proposed rulemaking or otherwise acted on ACTA's petition it has
stated its intention to address the petition and broader issues involving
IP telephony.
In April 1998 the FCC submitted a report to Congress providing details
on its implementation of the universal service provisions of the 1996 Act.
In this report the FCC discussed the provisions of IP telephony, mentioning
us as a provider of software that makes possible both computer to computer
conversations as well as IP calls to ordinary telephones connected to the
public switched network through gateways.
The FCC stated that phone-to-phone IP telephony bears the
characteristics of telecommunications services, which would subject
providers of such services to access charges and universal service support
obligations. The FCC decided to defer a definitive resolution of this issue
to specific cases as they are brought before it. Members of Congress, the
Administration, and the public have strongly supported the forbearance of
telecommunications regulation on the Internet and on services providers
through the Internet, such as IP telephony.
In proceedings that remain pending, the FCC has requested comment on
various aspects of IP telephony, seeking to determine, among other things,
the extent to which IP telephony is, or soon will be, an effective
substitute for conventional circuit-switched telephony. The FCC has asked
whether differences between computer-based and phone-based IP telephony and
conventional telephony merit different regulatory treatment with due
consideration given to the rapid pace of technological change in the
telecommunications market. At this time it is uncertain whether the FCC
will impose access charges, universal service contributions, and other
common carrier regulations on providers of IP telephony, yet there can be
no assurance that future action on ACTA's petition or in other proceedings
will not result in decisions that may impact on us, directly or indirectly.
From time to time members of Congress have considered bills that would
variously either impose new restrictions or regulations on IP telephony or
restrict agencies from imposing such restrictions or regulations. Bills
regarding the Internet are expected to remain the subject of Congressional
interest into the foreseeable future. It is not possible to determine
whether any such bills will become law and what effect future legislation
would have on our business.
RISK FACTORS
Certain statements included in this annual report, which use the terms
"estimate," "project," "intend," "expect" and other similar expressions are
intended to identify forward-looking statements within the Private
Securities Litigation Reform Act of 1995. These forward-looking statements
are subject to risks and uncertainties that could cause actual results to
differ materially from those contemplated by such forward-looking
statements, including the factors set forth herein and elsewhere in this
Annual Report. (See Item 1. "Business" and Item 9. "Management's Discussion
and Analysis of Financial Condition and Results of Operations.") Although
we believe that the assumptions underlying the forward-looking statements
contained in this annual report are reasonable, any of the assumptions
could be inaccurate. Therefore, there can be no assurance that the
forward-looking statements in this annual report will prove to be accurate.
In light of the significant uncertainties inherent in the forward-looking
statements included in this report, the inclusion of such information
should not be regarded as a representation by us or any other person that
our objectives and plans will be achieved.
PERIOD TO PERIOD FLUCTUATIONS IN OUR OPERATING RESULTS
Our operating results may fluctuate from period to period for a number
of reasons. We have short delivery cycles and as a result we do not have a
large order backlog. This makes the forecasting of net sales inherently
uncertain. This uncertainty is compounded because each quarter's net sales
are predominantly from orders booked and shipped during the last month of
that quarter. Furthermore, a disproportionately large amount of sales of
the last month of each quarter are booked and shipped in the latter half of
the month. Significant annual and quarterly fluctuations in our results of
operations may be caused by, among other factors, the timing and
composition of orders from our customers, the economic viability of our
customers, especially as it impacts the quality of our receivables (please
see the risk factor under the caption "Account Receivables" for further
details), the mix of distribution channels used by us, the timing of new
product announcements and releases by both us and our competitors, currency
exchange rate fluctuations and general economic conditions in the
geographical areas in which we operate.
Our future results may also be affected by factors including our
ability to continue to develop, introduce and deliver enhanced and new
products in a timely manner, to offer new products at competitive prices
and to anticipate customer demands. There can be no assurance that the
growth in sales achieved by us in prior quarters will continue or that
sales or profitability in any particular quarter will not be lower than
those of the preceding quarters, including comparable quarters. Our expense
levels are based, in part, on expectations of future revenues. If revenue
levels are below expectations, operating results are likely to be adversely
affected. Net income, if achieved, may be disproportionately affected by a
reduction in revenues because the corresponding reduction in expenses may
not be proportionate to such reduction in revenues. Because we plan our
operating expenses, many of which are relatively fixed in the short term,
on the basis that our net sales will continue to grow, even a relatively
small shortfall in net sales may cause a period's results to be
substantially below expectations. For example, our financial results for
the first quarter of 1999 were significantly below expectations. The
greater than expected loss was attributed to lower than expected sales, a
less favorable sales mix and higher operating expenses, including larger
than expected reserves for bad debt and other adjustments.
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. (See Item 9.
"Management's Discussion and Analysis of Financial Condition and Results of
Operations.")
Our share price, like that of other Internet-related companies, is
subject to significant volatility. If net sales or earnings in any quarter
fail to meet the investment community's expectations, there could be an
immediate impact on our stock share price. The stock share price may also
be affected by broader market trends unrelated to our performance.
NEED TO MANAGE GROWTH
Our annual revenue growth rate was 8% in 1999, 57% in 1998 and 85% in
1997. We have been pursuing aggressive growth by, among other things,
making substantial investments in our sales and marketing organizations,
creating new research and development programs and increasing funding of
existing programs, as well as investments in corporate infrastructure. This
strategy involves a high level of operating expenses, and entails
complexities associated with managing a larger and growing organization.
Although we reduced our worldwide workforce by approximately 40 people in
May 1999, we have been and are looking to add additional personnel in key
positions involved in serving the telecommunications service provider
market, as well as other aspects of our organization. Failure to hire new
personnel on a timely basis and integrate them smoothly into our
organization could have an adverse effect on our operations. Furthermore,
the expenses associated with expanding our management team and hiring new
employees may be incurred prior to the generation of any associated
revenues. The inability to manage our growth effectively could have a
material adverse effect on the quality of our products, our ability to
retain key personnel and on our business, financial condition or results of
operations.
SIGNIFICANT HISTORICAL OPERATING LOSSES
Since our incorporation in 1989, we have had limited sales and have
incurred significant operating losses. In 1999, 1998 and 1997, we incurred
net losses of approximately $28.39 million (including a one-time charge
with respect to restructuring costs of $0.83 million), $23.18 million
(including a one-time charge in respect of acquired research and
development of $9.6 million), and $7.68 million respectively. Our future
prospects must be considered in light of the risks, expenses and
difficulties frequently encountered by companies in new and rapidly
evolving industries. To address these risks and achieve profitability and
increased sales levels, we must, among other things, establish and increase
market acceptance of our products and systems, respond effectively to
competitive pressures, offer high quality customer service and support,
introduce, on a timely basis, advanced versions and enhancements of our
products and successfully market and support such advanced versions and
enhancements.
We expect to continue to incur operating losses in 2000 and 2001 and
may incur operating losses thereafter. There can be no assurance that we
will achieve or sustain significant sales or profitability in the future.
(See Item 9. "Management's Discussion and Analysis of Financial Condition
and Results of Operations.")
PRODUCT DEVELOPMENT AND INTRODUCTION
We are involved in the development and introduction of new products and
applications. A number of risks are inherent in this process. The
development of new technologies and products is increasingly complex and
uncertain, this can delay the introduction of new technology 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 or to miss aggressive time table
that we may establish. As the variety and complexity of our product lines
increase, the process of planning production and inventory levels also
becomes more difficult.
Short product life cycles place a premium on our ability to manage the
transition from current products to new products. Our results could be
adversely affected by factors such as development or manufacturing delays,
variations in product costs, and delays in customer purchases of existing
products in anticipation of the introduction of new products and the
rapidly changing landscape of emerging standards.
The markets for our products have only recently begun to develop, and
are rapidly evolving and characterized by an increasing number of market
entrants who have introduced or developed products and services. As is
typical in the case of a new and rapidly evolving industry, demand and
market acceptance for recently introduced technology products and services
are subject to a high level of uncertainty. Broad acceptance of our
technology, products and systems is critical to our success and ability to
generate revenues. Acceptance of our technology, products and systems will
be highly dependent on the functionality, reliability , stability and
performance of the products and systems, and particularly of the success of
the initial implementation of our products and systems. In addition,
acceptance of our technology will depend on matters beyond our control such
as the introduction of competing products or technologies into the market
before our new technologies and products. There can be no assurance that
voice and audio communications over the Internet will become widespread,
that connections between IP networks and the PSTN will become widespread or
that our ITSP and telecommunications oriented products will gain market
acceptance. The adaptation process 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.
Because the market for our products is new and evolving, it is difficult
to predict its future growth rate, if any, and the size of our market.
There can be no assurance that the market for our products and services
will develop or that our products will achieve market acceptance. If the
market fails to develop, develops more slowly than expected, or if our
products do not achieve market acceptance, our business, financial
condition or results of operations will be materially adversely affected.
(See Item 1."Business" - Industry Background.)
Furthermore, products offered by us may contain undetected errors or
defects when first introduced or as new versions are released. Our
introduction of products with reliability, quality or compatibility
problems could result in reduced revenues and orders, uncollectible
accounts receivable, delays in collecting accounts receivable and
additional costs. 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. Errors of this sort could result in
product redevelopment costs and loss of, or delay in, market acceptance. In
addition, there can be no assurance that we will not experience in the
future significant product returns through both retail and other
distribution channels. Any such event could have a material adverse effect
on our business, financial condition or results of operations.
COMPETITION
Almost all of our current and potential competitors have longer
operating histories, greater name recognition, larger installed customer
bases and significantly greater financial, technical and marketing
resources than us. The competition in the VoIP Communications market is
very strong. Competition includes telecommunications companies, data
communication companies and pure voice over IP companies product and
service companies.
If we have to lower our prices below current levels, there can be no
assurance that we will be able to successfully launch our new products or
compete successfully and effectively against other companies' product
offerings.
Various innovative voice, audio, video and other communications
alternatives, which may compete with our products are often introduced, and
may be introduced in the future. Such new communication alternatives may be
based on traditional telephone lines, the Internet or cable networks and
may be combined with other computing and broadcasting capabilities.
We expect that additional companies will compete in the Internet voice
and audio communications 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 telephone companies and other
telecommunications providers. Additional competitors may include companies
that currently provide computer software products and services such as
telephone, media, publishing and cable television. The ability of some of
our competitors to bundle other Internet services and other products with
Internet voice products could give these competitors an advantage over us.
GOVERNMENT REGULATION AND LEGAL UNCERTAINTIES
We have sold our products directly via the Internet and other channels
to customers in over 50 countries. There can be no assurance that the sale
and use of those products does not violate telecommunications or other
regulations of any of the countries in which our products are marketed
and used.
In the United States, there are currently few laws or regulations
directly applicable to voice and audio communications over the Internet, or
Internet commerce generally. However, changes in the regulatory
environment, particularly in regulations relating to the telecommunications
industry, could have an adverse effect on our business. The increased
acceptance of voice and audio communications over the Internet could result
in intervention by governmental regulatory agencies in the United States or
elsewhere in the world under existing or newly enacted legislation and in
the imposition of fees or charges on users and providers of products and
services in this area. For example, until now, the FCC has prohibited local
telephone companies from charging Internet service providers the type of
"access charges" that apply to long distance telephone carriers. In April
1998, however, the FCC submitted a report to Congress in which it stated
that Phone-to-Phone IP telephony bears the characteristics of
telecommunications services, which would subject providers of such services
to access charge and universal support obligations, and other common
carrier regulations. The FCC for now has decided to defer a definitive
resolution of this issue to specific cases as they are brought before it.
Although members of Congress, the Administration, and the public have
strongly supported the forbearance of telecommunications regulations on
services provided through the Internet, it is uncertain at this time what
action the FCC will take when a case is brought before it. From time to
time members of Congress have considered bills that would variously either
impose new restrictions or regulations on IP telephony or restrict agencies
from imposing such restrictions or regulations. Bills regarding the
Internet are expected to remain the subject of Congressional interest into
the foreseeable future. It is not possible to determine whether any such
bills will become law and what effect future legislation would have on our
business.
Additionally, the European Commission has requested comments on the
regulatory status of voice on the Internet. There can be no assurance that
such intervention or imposition of fees or charges would not have a
material adverse impact upon the acceptance and attractiveness of Internet
voice communications. Legislative proposals from international, federal and
state government bodies could also impose additional regulations and
obligations upon on-line service providers. The growing popularity and use
of the Internet, generally, has increased public focus and could lead to
increased pressure on legislatures to impose regulations with respect to,
among other things, user privacy, pricing and the characteristics and
quality of products and services. We are unable to predict the impact, if
any, that future legislation, legal decisions or regulations concerning the
Internet may have on our business, financial condition or results of
operations. While we are not aware of any proposed federal regulation
directly affecting our business, we cannot predict the likelihood that any
future legislation will be enacted, nor the financial impact, if any, of
such resulting regulation. In the future, we may also develop and introduce
other products with new or additional telecommunications capabilities or
services, which could be subject to existing federal government regulations
or result in the imposition of new government regulations, either in the
United States or elsewhere.
On March 4, 1996, the ACTA, a trade association representing small long
distance companies, filed a petition with the FCC, among other things, that
the FCC subject developers of Internet voice software like us, to the same
FCC regulations as long distance telecommunications carriers .(See "U.S.
Federal Communications Commission Regulation.")
CARRYING AND COLLECTING ACCOUNTS RECEIVABLE
Trade receivables as of December 31, 1999 amounted to approximately
$6.2 million, net of allowances of approximately $6.6 million (mainly a
reserve for returns and doubtful debts). The trade receivables represent
open accounts to be collected mainly in the two first quarters of 2000.
Trade receivables as of March 31, 2000 amounted to approximately $6.9
million, net of allowances of approximately $7.1 million, to be collected
in the two following quarters. A portion of the account receivables is a
consequence of retail sales and other portions are initial sales to
telecommunication companies and value added resellers and other customers.
In addition, a portion of our receivables result from credit extended to
ITSPs for purchases of our products. Some of these ITSPs may prove to be
credit risks. There can be no assurance that any of our accounts receivable
will be completely collected.
INCREASED COSTS OF SALES
An increasing number of our customers and potential customers are
demanding end-to-end turnkey solutions that provide all necessary hardware
and software for their VoIP Communications solutions. Accordingly, we have
begun to purchase readily available hardware components, such as servers
and circuit boards, to integrate into our solutions. The need to buy such
components has increased our costs of sales and negatively impacted our
gross margins. We expect this trend to continue in 2000. Any continuation
or intensification of these trends could delay or prevent us from achieving
profitability.
DEPENDENCE ON KEY PARTNER
Our relationship with Deutsche Telekom provided for the purchase of $33
million in our products and services by Deutsche Telekom between December
1997 and March 2000. As of December 31, 1999, Deutsche Telekom had
purchased $24.4 million of our products and service, and sales to them
constituted 49% of our net sales in 1999. In January, 2000 we entered into
a product purchase agreement with Deutsche Telekom a Letter of
Understanding (the "LOU") valued at approximately $11 million. Under the
agreement, we will provide Deutsche Telekom with an application service
hosting platform allowing businesses in its Freecall Online program to
offer e- commerce and call center customer care service.
If for any reason, our relationship with Deutsche Telekom is
terminated, our business, financial condition and results of operations
would be materially adversely affected. In addition, in the event that the
LOU expires and is not renewed or replaced by a similar agreement either
with Deutsche Telekom or another party, or we are unable to increase sales
so as to reduce the percentage of our total sales represented by sales to
Deutsche Telekom, our business, financial condition and results of
operations would be materially adversely affected.
DEPENDENCE UPON THE INTERNET INFRASTRUCTURE; RISK OF SYSTEM FAILURE;
SECURITY RISKS
The success of our products is dependent, among other things, on the
continued expansion of the Internet and its network infrastructure. There
can be no assurance that the infrastructure or complementary products
necessary to make the Internet a viable commercial network will continue to
be developed. In particular, there can be no assurance that the Internet
will retain its current pricing structure with regard to volume, distance
(the physical location of any user) and the lack of varying rates for
different times of day. Moreover, critical issues concerning the commercial
use of the Internet (including security, reliability, cost, ease of use and
access and quality of service) remain unresolved and may affect the growth
of Internet use. There can be no assurance that the Internet will be able
to meet additional demands or its users' evolving requirements on a timely
basis, at a commercially reasonable cost, or at all. While we anticipate
the continued evolution of the Internet and related infrastructure, any
failure to develop accordingly could have a material adverse impact on our
business, financial condition or results of operations.
Our products can be vulnerable to computer viruses or similar
disruptive problems. Computer viruses or problems caused by third parties
could lead to interruptions, delays or cessation in service. Furthermore,
inappropriate use of the Internet by third parties could potentially
jeopardize the security of confidential information, such as credit card
information used in order to license Internet Phone or the content of
Internet phone conversations, which may deter certain potential customers
from ordering and using our products. Until more comprehensive security
technologies are developed, the security and privacy concerns of existing
and potential users may inhibit the growth of the Internet industry in
general and the market for our products in particular.
DEPENDENCE ON KEY PERSONNEL
Our future success depends to a significant extent upon the continued
active participation of Dr. Elon Ganor, our Chairman of the Board of
Directors and CEO. We have an employment agreement with Dr. Ganor, which
provides that following an initial two-year period that has ended in early
1998, the agreement can be terminated by each party with one-year's notice.
In addition, such agreement contains certain non-competition and
confidentiality provisions. We have key employee life insurance coverage
for Dr. Ganor. The loss of the services of Dr. Ganor could have a material
adverse effect on our business.
Our future is also dependent upon our continuing ability to attract and
retain highly qualified personnel, sales and marketing personal and
management to perform research and development, commercialize products, and
perform the sales and marketing functions required to bring these products
to the market. By May 31, 2000, approximately 110 of our employees were
engaged in research and development. There is a large demand for highly
qualified technical personnel in Israel and competition for such personnel
is generally intense. There can be no assurance that we will continue to be
successful in attracting and retaining such personnel. (See "Research and
Development.")
DEPENDENCE ON PROPRIETARY TECHNOLOGY; INFRINGEMENT CLAIMS
Our success is dependent, to a certain extent, upon our proprietary
technology. We currently rely on a combination of trade secret, copyright
and trademark law, together with non-disclosure 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.
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. We believe that
claims which have been asserted against us, to date, will not have a
material adverse effect on our business or financial condition; however,
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. Patents which relate 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 could incur substantial costs and diversion of
management resources with respect to the defense of any claims relating to
proprietary rights which 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. Generally, litigation, which could be 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
either case, 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. On February 15, 2000, Multi-Tech Systems, Inc., filed a complaint in
the United States District Court for the District of Minnesota, in which it
alleged that we and our wholly owned subsidiary VocalTec Communications
Inc., as well as other named defendants, infringe four of Multi-Tech's
Patents. We intend, together with VocalTec Communications Inc., to
vigorously defend the suit. The ultimate outcome, however, cannot
determined at this time. (See "Intellectual Property" and Item 3. "Legal
Proceedings".)
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. We received indications that unauthorized reproduction of it's the
registration codes contained in our various software products, such as
Internet Phone, may have occurred. This type of reproduction may continue
to occur in the future. There can be no assurance that Internet Phone, its
registration codes, the VocalTec Telephony Gateway or other of our software
products will not experience unauthorized reproduction on a massive scale
which may adversely affect our business, financial condition or results of
operations.
DEPENDENCE ON DISTRIBUTORS AND LOCAL AGENTS
Our marketing strategy includes sales through distributors. Our
marketing efforts could be adversely affected by changes in the financial
condition of our distributors, value added resellers and agents, or by
other changes to their respective businesses. There is no assurance that we
will be successful in extending the term of our various agreements or in
establishing similar relationships with other entities if our current
agreements are not extended. Although we believe that our relationship with
our distributors, value added resellers and agents is generally good, the
loss of our distributors or any event negatively affecting their financial
condition could have a material adverse effect on our business, financial
condition or results of operations. (See "Marketing and Distribution.")
EXPANSION INTO NEW INTERNATIONAL MARKETS
A substantial portion of our sales are made directly or indirectly into
international markets. A key component of our strategy is to continue to
penetrate international markets, the most significant of which are the
United States, the Far East and Europe. There are certain risks inherent in
conducting business in international markets, including unexpected changes
in regulatory requirements, export restrictions, tariffs and other trade
barriers, difficulties in staffing and managing foreign operations, longer
payment cycles, difficulties in collecting accounts receivable, political
instability, and seasonal reductions in business activities, all of which
adversely impact the success of our international operations. 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. (See "Marketing and
Distribution.")
IMPACT OF INFLATION AND CURRENCY FLUCTUATIONS
The vast majority of our sales are made in dollars and most of our
expenses are in dollars and 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. In 1999, we experienced an increase in the cost of
our operations in Israel, as expressed in dollars, as inflation in Israel
exceeded the devaluation of the NIS against the dollar. The increase in the
cost of our operations in Israel, as expressed in dollars, relates
primarily to the cost of salaries in Israel, a substantial portion of which
are paid in NIS linked to the Consumer Price Index in Israel. Although to
date we have not, we may in the future, to the extent we deem it advisable,
purchase forward currency options to decrease such risk. (See Item 9.
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" - Impact of Inflation and Currency Fluctuations and Item 9A.
"Quantitative and Qualitative Disclosures about Market Risk" - Investment
Portfolio.)
FUTURE CAPITAL NEEDS; UNCERTAINTY OF ADDITIONAL FINANCING
We may need to raise additional funds through public or private debt or
equity issuance in order to take advantage of unanticipated opportunities,
including more rapid international expansion or acquisitions of
complementary businesses or technologies, to develop new products or to
otherwise respond to unanticipated competitive pressures. Additional
funding, whether obtained through public or private debt or equity
financing, from strategic alliances or from the OCS, may not be available
when needed or may not be available on terms acceptable to us, if at all.
Failure to secure needed additional financing, if and when needed, may
have a material adverse effect on our business, financial condition and
results of operations. If additional funds are raised through the issuance
of equity securities, the net tangible book value per share may decrease,
the percentage ownership of our then current shareholders may be diluted
and such equity securities may have rights, preferences or privileges
senior or more advantageous to those of the holders of our ordinary shares.
There can be no assurance that additional financing will be available
on terms favorable to us, or at all. If adequate funds are not available or
are not available on acceptable terms, we may not be able to take advantage
of unanticipated opportunities, develop new products or otherwise respond
to competitive pressures. Such inability could have a material adverse
effect on our business, financial condition or results of operations. (See
Item 9. "Management's Discussion and Analysis of Financial Condition and
Results of Operations"--Liquidity and Capital Resources.)
MAKING AND INTEGRATING ACQUISITIONS
One of our business strategies is to pursue acquisitions of
complementary businesses, products and technologies. To date, we have had
limited experience in making such acquisitions.
In March, 1998, we acquired substantially all of the assets of RADLinx
Ltd., a leader in standards-based real-time fax over the Internet. The
acquisition was intended to expand our product line by adding in-house fax
capabilities.
We have no current understandings, commitments or agreements with
respect to any other acquisitions. However, acquisitions of companies
involve a number of risks including the difficulty of assimilating the
operations and personnel of the 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.
Integrating the products, business and personnel from such acquisitions
requires significant management time and skills. Integrating acquired
companies may place significant demands on our operations and financial
resources. Acquisitions of companies involve financial, operational and
legal risks, including the difficulty of assimilating operations and
personnel of the acquired companies and of maintaining uniform standards,
controls, procedures and policies, and the possibility of divesting partial
segments of any acquisition that does not fit our business strategy. There
can be no assurance that we will be successful in making additional
acquisitions or effective in integrating such acquisitions. Any failure to
effectively integrate future acquisitions could have a material adverse
effect on our business, financial condition and results of operations. 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.
POSSIBLE VOLATILITY OF SHARE PRICE
The stock market has from time to time experienced significant price
and volume fluctuations which have particularly affected the market prices
of the stocks of high technology, Internet-related and Israeli companies,
including ourselves, and which may be unrelated or disproportionate to the
operating performance of particular companies. Factors such as quarterly
variations in actual or anticipated operating results, changes in earnings
estimates by analysts, market conditions in the industry, analysts reports,
announcements by competitors, regulatory actions or other events or
factors, including the risk factors described herein and general economic
conditions may have a significant effect on the market price of our
ordinary shares. In the past, following volatility in the market price of a
company's securities, securities class action litigation has often been
instituted against such a company. 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. (See Item 9. "Management's Discussion and
Analysis of Financial Condition and Results of Operations" --Variability of
Quarterly Operating Results" and Item 5. "Nature of Trading Market.")
CONTROL BY PRINCIPAL SHAREHOLDERS
As of May 31, 2000 our principal shareholders, including our directors
and certain executive officers, beneficially owned more than 30% of the
outstanding ordinary shares of our company. Certain principal shareholders
entered into shareholders agreements concerning, among other things, the
election of directors. As a result, such shareholders together have the
ability to significantly influence the election of our directors and most
corporate actions.
PASSIVE FOREIGN INVESTMENT - OUR STATUS
Depending on various factors described below for United States income
tax purposes, we could be characterized as a passive foreign investment
company ("PFIC"). Such characterization could result in adverse United
States tax consequences to U.S. Holders (as hereinafter defined) which may
be eliminated or ameliorated by a QEF Election (as hereinafter defined)
that is made or effective for any year in which we are a PFIC. Each U.S.
Holder will be responsible for making this QEF Election on such holder's
own tax return. Failure to make a QEF Election may cause any gain
recognized on the sale or disposition of our ordinary shares to be treated
as ordinary income for U.S. Holders. U.S. Holders should consult their
United States tax advisors with respect to the United States tax
consequences of investing in our ordinary shares, and the benefits of a QEF
Election, as applied to their own circumstances. We believe that in 1998 we
were not a PFIC and we intend to continue to manage our business so as to
avoid PFIC status to the extent consistent with its other business goals.
(See "Taxation and Foreign Exchange Regulations--U.S. Federal Tax
Considerations".)
RISKS RELATING TO OPERATIONS IN ISRAEL
LOCATION IN ISRAEL
We are incorporated under the laws of, and our principal offices and
research and development facilities are located 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
and military conditions affecting Israel, and 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.
GOVERNMENT PROGRAMS AND TAX BENEFITS
We benefit from certain government programs and tax benefits,
particularly as a result of the "Approved Enterprise" status of certain
existing facilities and approved programs. To be eligible for these
programs and tax benefits, we must continue to meet certain conditions,
including making certain specified investments in fixed assets. If we fail
to meet such conditions in the future, we could be required to refund tax
benefits already received. There can be no assurance that such programs and
tax benefits will be continued at their current levels or otherwise. The
termination or reduction of certain programs and 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. We received approval of an extension of an existing Approved
Enterprise program and approval of an additional Approved Enterprise
program. (See Item 7. "Taxation" - Israeli Tax Considerations.)
INFLATION AND CURRENCY FLUCTUATIONS
We generate most of our revenues in dollars but incur the majority of
our expenses in NIS. As a result, we are exposed to risk to the extent that
the rate of inflation in Israel exceeds the rate of devaluation of the NIS
in relation to the dollar and or if the timing of such devaluation lags
behind inflation in Israel. In that event, the dollar cost of our
operations in Israel will increase and our dollar-measured results of
operations will be adversely affected. Our operations also could be
adversely affected if we are unable to guard against currency fluctuations
in the future. Accordingly, we may enter into currency hedging transactions
to decrease the risk of financial exposure from fluctuations in the
exchange rate of the dollar against the NIS. These measures, however, may
not adequately protect us from material adverse effects due to the impact
of inflation in Israel. (See Item 9. "Management's Discussion and Analysis
of Financial Condition and Results of Operations"- Impact of International
Currency Fluctuations and Item 9A. "Quantitative and Qualitative
Disclosures About Market Risks.")
ITEM 2. DESCRIPTION OF PROPERTY
Until July 1999, our executive offices and marketing, sales and
customer support operations occupied approximately 9,900 square feet in
Herzliya, Israel, pursuant to a lease that expired in July 1999. The
monthly rental fee for these offices was approximately $12,000, linked to
the Israeli Consumer Price Index (CPI).
At the same time, our research and development operations occupied
approximately 35,000 square feet in Herzliya, Israel, pursuant to a lease
expiring in June 2002. We paid a monthly rental fee of approximately
$63,000 linked to the Israeli CPI for these facilities.
As of July 1999, our entire headquarters were located in these new
facilities occupying approximately 49,400 square feet (including the
portion previously occupied by our research and development operations),
pursuant to a lease expiring in June 2002, with an option to extend the
lease for an additional ten years ending in June 2012. We pay a monthly
rental fee of approximately $89,000 linked to the Israeli CPI for these
facilities.
Since May 1992, we have operated sales, marketing and customer support
facilities in Northvale, New Jersey. In 1998 and early 1999, the facilities
occupied approximately 9,200 square feet, for which we paid a monthly
rental fee of approximately $9,700. On April 19, 1999, we relocated our New
Jersey operations to new facilities occupying approximately 16,500 square
feet in Fort Lee, New Jersey, pursuant to a lease expiring April 30, 2004.
We pay a monthly rental fee of approximately $29,000 for these facilities.
Between April 1996 and November 1999, we conducted a portion of our
research and development operations in the U.K. Since August 1996, our U.K.
offices in Tongham, Surrey, have occupied approximately 2,200 square feet,
pursuant to a lease that expired in December 1999. We paid a monthly rental
fee of approximately $3,600 for these facilities.
Since January 1998, we have operated pre-sale and post-sale customer
support facilities in Tokyo, Japan, occupying approximately 925 square
feet, pursuant to a lease that expired in January 2000 and was extended
until January 2002 under the same terms. We pay a monthly rental fee of
approximately $3,800 for these facilities.
Since May 1, 1999, we have operated pre-sale and post-sale customer
support facilities in Bonn, Germany. Initially, the facilities occupied
approximately 500 square feet, pursuant to a lease that expired on August
15, 1999, for a monthly rental fee of approximately $2,600. On August 16,
1999 we relocated our German operations to new facilities occupying
approximately 850 square feet, pursuant to a lease agreement that expires
on June 30, 2002, with an option to extend the lease for an additional two
years. We pay a monthly rental fee of approximately $2,200 for these
facilities.
Since August 1, 1999 we have operated pre-sale and post-sale customer
support facilities in Beijing, China, occupying approximately 1,050 square
feet, pursuant to a lease expiring on July 31, 2002. We pay a monthly
rental fee of $3,700 for these facilities.
We believe that the properties described above are in good condition
and are adequate to meet our current and foreseeable needs.
ITEM 3. LEGAL PROCEEDINGS
From time to time, we are involved in various routine legal proceedings
incident to the ordinary course of our business. We do not believe that the
outcome of these pending legal proceeding will have a material adverse
effect on our business or consolidated financial condition.
On February 15, 2000, Multi-Tech Systems, Inc., filed a complaint in
the United States District Court for the District of Minnesota, in which it
alleged that we and our wholly owned subsidiary VocalTec Communications
Inc., as well as other named defendants, infringe four of Multi-Tech's
Patents. We intend, together with VocalTec Communications Inc., to
vigorously defend the suit. The ultimate outcome, however, cannot be
determined at this time.
ITEM 4. CONTROL OF REGISTRANT
To our knowledge, (A) we are not directly or indirectly owned or
controlled (i) by another corporation or (ii) by any foreign government and
(B) there are no arrangements, the operation of which may at a subsequent
date result in a change in control of VocalTec.
The following table sets forth, as of May 31, 2000, 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 10% 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
---------------- ------ -------
Deutsche Telekom A.G. (1) 2,300,000 19.02%
Friedrich-Ebert-Allee 140
D-53113 Bonn, Germany
LaCresta International Trading Inc. (2) 1,185,050 9.61%
c/o L.C.I.T. S.A Dufourstrasse 131
P.O.B. 219 Zurich 8034, Switzerland
Officers and directors as a group (3) 2,066,866 16.44%
(14 persons)
-------------------------------
(1) Deutsche Telekom is a party to a Shareholders Agreement, dated
December 29, 1997, with LaCresta International Trading Inc.
("LaCresta"), Messrs. Haramaty, Cohen, Ganor and Tal and the Polaris
Fund I.L.P. ("Polaris"), and may therefore be deemed to beneficially
own all the ordinary shares held by the other parties thereto. (See
Item 13. "Interest of Management in Certain Transactions.")
(2) LaCresta is a party to the Shareholders Agreement, dated January 31,
1996, with Mr. Haramaty, Mr. Cohen, and Polaris and may therefore be
deemed to beneficially own the 642,500 ordinary shares held by the
other parties thereto. (See Item 13. "Interest of Management in
Certain Transactions.")
Dr. Elon Ganor, who is VocalTec's Chairman of the Board and Chief
Executive Officer, and Ami Tal, who is VocalTec's Chief Operating
Officer, Senior Vice President of Global Sales and a Director, each
own 50% of the outstanding voting shares of LaCresta. Dr. Ganor and
Mr. Tal are also brothers-in-law.
Includes (i) options for 170,000 ordinary shares held by Dr. Ganor
that are exercisable within 60 days of the date stated above and (ii)
options for 75,000 ordinary shares held by Mr. Tal that are
exercisable within 60 days of the date stated above.
(3) Includes (i) 484,316 ordinary shares for which options granted to
officers and directors of our Company are exercisable within 60 days
of the date stated above, (ii) 940,050 ordinary shares held by
LaCresta, which may be deemed to be beneficially owned by Dr. Ganor
and Mr. Tal and (iii) 12,500 ordinary shares held by Polaris, which
may be deemed to be beneficially owned by Rami Kalish, a director of
our company. Does not include 510,684 ordinary shares for which
options granted to officers and directors of our company are
outstanding but are not currently exercisable.
ITEM 5. NATURE OF TRADING MARKET
Our ordinary shares have been quoted on the Nasdaq National Stock
Market, Inc. since February 7, 1996 under the symbol "VOCLF," which was
changed to "VOCL" on April 20, 1999. Through May 31, 2000, for the periods
indicated, the high and low reported sale prices of our ordinary shares as
respected by Nasdaq were as follows:
HIGH LOW
---- ---
1998
----
First Quarter 24 5/8 17 3/4
Second Quarter 21 3/4 10
Third Quarter 14 1/4 7 5/16
Fourth Quarter 15 9/16 5 9/16
1999
----
First Quarter 17 1/4 10 3/16
Second Quarter 14 3/8 9 5/8
Third Quarter 15 13/16 8
Fourth Quarter 19 3/4 9 7/8
2000
----
First Quarter 53 1/4 14 15/16
Second Quarter 29 1/4 121/2
(through May 31, 2000)
As of May 31, 2000, 12,090,520 of our ordinary shares were issued and
outstanding. At such date, the last reported sale price of the ordinary
shares was $16 per share and the ordinary shares were held by 135 record
holders. 108 holders, who collectively held approximately 80% of the
outstanding ordinary shares, 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.
ITEM 6. EXCHANGE CONTROLS AND OTHER LIMITATIONS AFFECTING SECURITY HOLDERS
While the State of Israel has, in the past, maintained extensive
controls on foreign currency, these regulations were, in large part, lifted
in 1998. 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 which
are in a state of war with Israel.
ITEM 7. TAXATION
The following is a summary of the current tax structure, which is
applicable to companies in Israel, with special reference to its effect on
our company, and certain Israeli Government programs benefitting our
company. The following also contains a discussion of certain Israeli and
U.S. tax consequences to persons purchasing the 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.
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 invest 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 the tax laws.
ISRAELI TAX REFORM PROPOSALS
In May, 2000, a committee of the Israeli Ministry of Finance
recommended a major reform of the Israeli tax law. The proposal recommends,
among other things, certain material changes in the current Israeli tax
structure. Some of these changes, if made, could have adverse tax
consequences on us, as well as on our shareholders. Although, the tax
reform must be approved by the Israeli Parliament prior to becoming
effective, the Israeli Minister of Finance has enacted certain directives
related to the committee's proposals with immediate effect. We cannot
predict whether, and to what extent, the committee's proposals, will
eventually be adopted and enacted into law. Significant changes recommended
by the committee include, among others: Imposing a capital gains tax of 25%
on individuals, and possibly a higher rate on corporate entities, on sales
of our ordinary shares, subject to any applicable tax treaty. Replacing the
existing tax exemption granted with respect to income generated from an
Approved Enterprise under the "alternative package of benefits" with a 10%
tax rate, and eliminating the differences between foreign and Israeli
investors with respect to the tax rates applicable to income derived from
an Approved Enterprise.
ISRAELI TAX CONSIDERATIONS
GENERAL CORPORATE TAX STRUCTURE
The regular rate of corporate tax which Israeli companies are subject
to, has decreased in the last few years and is currently 36%. 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. (See "Law for the Encouragement of Capital Investments,
1959.")
Dividends received by an Israeli corporation from foreign
subsidiaries are generally subject to Israeli tax of up to 25% regardless
of its status as an Approved enterprise.
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 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 production activity.
We believe that we 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) over a period of eight years beginning with
the year in which such rights were first used. In addition, we are entitled
to a deduction of 33% per annum on expenses incurred in connection with the
issuance of publicly traded shares over a period of three years from the
time the expenses were incurred.
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.
Eligibility for benefits under the Encouragement of Industry Law is
not contingent upon the approval of any government agency. 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.
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. Each approval for approved
enterprise status relates to a specific investment program, delineated both
by the financial scope of the investment, including sources of funds, and
by the physical characteristics of the facility or other assets. The tax
benefits available under any approval relate only to taxable income
attributable to the specific investment program and are contingent upon
meeting the criteria set out in the instrument of approval.
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.
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.
Tax Benefits. Income derived from an approved enterprise is subject
to corporate tax at the reduced rate of 25% subject to exceptions discussed
below, until the earlier of (a) seven 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), (b) 12 years from the year of commencement of production or (c)
14 years from the year of approval of the approved enterprise status.
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. The tax holiday
ranges between two and ten years from the first year of taxable income
subject to the limitations as described above, depending principally upon
the geographic location within Israel and the type of the Approved
Enterprise. Upon expiration of the tax holiday, the approved enterprise is
eligible for a beneficial tax rate (25%), for the remainder of the
otherwise applicable period of benefits, as described above.
Dividends paid out of income derived by an approved enterprise and
dividends received from a company out of dividends it received from an
approved enterprise are generally subject to withholding tax at the rate of
15% (deductible at the source). In the case of companies , which do not
qualify as an FIC, which is at least 25% owned by non Israeli residents,
the reduced rate of 15% is limited to dividends and distributions out of
income derived during the benefits period and actually paid at any time up
to 12 years thereafter. In addition, a company which elects the alternative
benefits package and which, at any time, pays a dividend out of income
derived from its approved enterprise during the tax holiday period, will be
subject to corporate tax at the otherwise applicable rate of 25% on the
income grossed up out of which such dividend has been paid an additional
15% withholding tax in respect of the amount distributed. We have elected
the alternative benefits with respect to our current approved enterprise,
including the exemption pursuant to which we will enjoy a tax holiday for a
period of two years and reduced tax rates for an additional period of up to
eight years (depending on the percentage of foreign stock ownership in our
company).
The tax benefits available to an Approved Enterprise relate only to
taxable income attributable to that specific enterprise and are contingent
upon the fulfillment of the conditions stipulated by the Investment Law,
the regulations published thereunder and the instruments of approval for
the specific investments in the Approved Enterprises. 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.
A company which qualifies as an FIC is a company, like us, more than
25% of whose share capital (in terms of shares, rights to profit, voting
and appointment of directors), and of whose combined share and loan
capital, is owned, directly or indirectly, by persons who are not residents
of Israel, is 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 its foreign investment rise 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 holiday available to Approved
Enterprise for example or because of losses for tax purposes, we would have
no Israeli tax liability against which to credit the foreign withholding
tax. Furthermore, under Israeli law, we can not carry forward such unused
credit for benefit in 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.
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 income
computed under regular historical cost principles.
The Inflationary Adjustments Law introduced 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.
Under the Inflationary Adjustments Law, 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 the income 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.
TAX BENEFITS AND GOVERNMENT SUPPORT FOR RESEARCH AND DEVELOPMENT
Israeli tax laws have allowed, under certain conditions, a tax
deduction in the year incurred for expenditures (including capital
expenditures) in scientific research and development projects, if the
expenditures are approved or funded by the relevant Israeli Government
Ministry (determined by the field of research) and the research and
development is for the promotion of the enterprise and is carried out by or
on behalf of our company seeking such deduction. Expenditures not so
approved or funded are deductible over a three-year period, however grants
made available to our company by the Israeli Government are not included in
the amount of the R&D expenses.
Under the law for the Encouragement of Industrial Research and
Development, 1984 (the "Research Law"), research and development programs
approved by a research committee of the OCS are eligible for grants of up
to 66% of the project's expenditures (depending on the circumstances) upon
meeting certain criteria, against payment of royalties from the sale of the
product developed in accordance with the program. We are generally required
to pay royalties at a rate of 3%-5% of sales of products developed with
such grants, up to a dollar-linked amount equal to 100% (in the past up
to-150%). Effective for grants received from the OCS under programs
approved after January 1, 1999 the outstanding balance of such grants to be
repaid through the payments of royalties will be subject to interest at a
rate equal to LIBOR for 12 months applicable to dollar deposits. The funds
generally available for OCS grants were reduced in 1998 and remained at the
same level in 1999, and the Israeli authorities have indicated that the
government may further reduce or abolish OCS grants in the future.
Generally, the Research Law requires that the manufacture of any product
developed as a result of research and development funded by the Israeli
Government shall take place in Israel. It also provides that know-how from
the research and development which is used to produce the product may not
be transferred to third parties without the approval of a research
committee. Such approval is not required for the export of any products
resulting from such research or development. (See "Business Research and
Development.")
However, under the Regulations, in the event that any of the
manufacturing volume is not performed in Israel, if approved by the OCS, we
would be required to pay an increased royalty and the payback sum is 120%,
150% or 300% of the grant if the manufacturing volume that is performed
outside of Israel is less than 50%, between 50% and 90% and more than 90%
or more, respectively. The Regulations are effective as to January 1, 1994,
but under the Regulations, the increased rate applies from January 1996.
TAXATION OF NON-ISRAELI SUBSIDIARIES
The taxation of our subsidiaries, which is managed or controlled
outside of Israel, is based upon applicable tax laws in the country of
residence of the particular subsidiary.
CAPITAL GAINS AND INCOME TAXES APPLICABLE TO NON-ISRAELI SHAREHOLDERS;
ESTATE AND GIFT TAX
Israeli law generally imposes a capital gains tax on the sale of
securities and any other capital asset. The basic tax rate applicable to
corporations is currently 36% in 1997 and thereafter. From 1994, the
maximum tax rate for individuals was fixed at 50%. These 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.
Under existing regulations, as long as our ordinary shares are quoted
on Nasdaq (or listed on a stock exchange recognized by the Israeli Ministry
of Finance) and we continue to qualify as an Industrial Company under the
Industry Law, gains on the sale of the ordinary shares will generally be
exempt from Israeli capital gains tax. There can be no assurance that we
will maintain such listing or qualification. Notwithstanding the foregoing,
dealers in securities in Israel are taxed at regular tax rates applicable
to business income. The foregoing exemption does not apply to companies
subject to the Inflationary Adjustments Law.
Individuals who are non-residents of Israel are subject to a
graduated income tax on income derived from sources in Israel. On the
distribution of dividends other than stock dividends, income tax at the
rate of 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. 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
The Treaty became effective as of January 1, 1995. Under the Treaty,
the maximum tax on dividends paid to a holder of ordinary shares who is a
resident of the United States will be 25%; as noted above, however, under
the Investment Law and the Treaty, dividends generated by an Approved
Enterprise are taxed at the rate of 15%. The Treaty further provides that a
12.5% Israeli dividend withholding tax would apply to dividends paid to a
U.S. corporation owning 10% or more of an Israeli company's voting stock
for, in general, the current and preceding taxable years of the Israeli
company. The lower 12.5% rate applies only to dividends from income not
derived from an Approved Enterprise in the applicable period and does not
apply if we have certain amounts of passive income. Residents of the United
States generally will have withholding tax in Israel deducted at source.
They may be entitled to a credit or deduction for U.S. federal income tax
purposes in the amount of the taxes withheld, subject to detailed rules
contained in the Treaty and in U.S. tax legislation. (See "--U.S. Federal
Income Tax Considerations, --Taxation of U.S.
Holders and--Distributions.")
As noted above, under current Israeli law, capital gains on the sale
of ordinary shares are exempt from Israeli capital gains tax, provided
certain conditions are met. Additionally, even where the aforementioned
conditions are not satisfied, pursuant to the Treaty, sale, exchange or
disposition of ordinary shares by a person who qualifies as a resident of
the United States within the meaning of the Treaty and who is entitled to
claim the benefits afforded to such residents under the Treaty ("Treaty
U.S. Resident") would not be subject to Israeli capital gains tax unless
such Treaty U.S. Resident holds, directly or indirectly, shares
representing 10% or more of the voting power of our company during any part
of the 12-month period preceding such sale, exchange or disposition. A
sale, exchange or disposition of ordinary shares by a Treaty U.S. Resident
who holds, directly or indirectly, shares representing 10% or more of the
voting power of our company at any time during such preceding 12-month
period would be subject to such Israeli tax (unless Israeli law provides an
exemption, as described above); however, under the Treaty, such Treaty U.S.
Resident would be permitted to claim a credit for such taxes against the
U.S. income tax imposed on any gain from such sale, exchange or
disposition, subject to the limitations applicable to foreign tax credits
generally under U.S. federal income tax law.
U.S. FEDERAL TAX INCOME 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 U.S. 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
U.S. federal income tax consequences of purchasing, holding or disposing of
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 taxpayers whose
functional currency is not the dollar. The following discussion also does
not address any aspect of state, local or non-U.S. tax laws. Further, this
summary generally considers only a U.S. Holder (as defined below) that will
own ordinary shares as capital assets (generally, assets held for
investment) and does not consider the tax treatment of persons who will
hold ordinary shares through a partnership or other pass-through entity.
Each prospective investor is advised to consult such person's own tax
advisor with respect to the specific U.S. federal, state and local tax
consequences to such person of purchasing, holding or disposing of ordinary
shares.
TAXATION OF U.S. HOLDERS
For purposes of this discussion, a "U.S. Holder" is any holder of
ordinary shares who is: (i) a citizen or resident of the United States:
(ii) a corporation partnership or limited liability company organized under
the laws of the United States or any state thereof or the District of
Columbia; (iii) an estate the income of which is included in gross income
for U.S. federal income tax purposes regardless of source; or (iv) a trust,
generally if a U.S. court is able to exercise primary supervision over its
administration and one or more U.S. fiduciaries have the authority to
control all of its substantial decisions.
Distributions. While it is not anticipated that we will pay dividends
in the foreseeable future, the gross amount of any distribution from our
company received by a U.S. Holder which is treated as a dividend for U.S.
federal income tax purposes (before reduction for any Israeli tax withheld
at source), will be included in such U.S. Holder's gross income, will be
subject to tax at the rates applicable to ordinary income and will not
qualify for the dividends received deductions applicable in certain cases
to U.S. corporations. For U.S. federal income tax purposes, the amount of
any dividend paid in NIS by our company 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. U.S.
Holders should consult their own tax advisors concerning the treatment of
foreign currency gain or loss, if any, on any NIS received which are
converted into U.S. dollars subsequent to receipt.
Credit for Israeli Taxes Withheld. Any dividends paid by our company
to a U.S. Holder with respect to the ordinary shares generally will be
treated for U.S. 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 the ordinary shares generally will be
eligible for credit against the U.S. Holder's U.S. 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 U.S. federal income taxes
otherwise payable with respect to such classes of income. Subject to the
particular circumstances of a U.S. Holder, dividends distributed by our
company with respect to ordinary shares generally will be classified as
"passive income."
Alternatively, a U.S. Holder may elect to claim a U.S. tax deduction for
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 tax. In addition, a
non-corporate U.S. holder may not elect to deduct Israeli taxes if such
U.S. Holder does not itemize deductions.
Dispositions. In general, any gain or loss recognized by a U.S.
Holder on the sale or other disposition of ordinary shares will be U.S.-
source income or loss for purposes of the U.S. federal foreign tax credit
limitation. However, a U.S. Holder who is also a U.S. Treaty Resident and
who sells the ordinary shares in Israel may elect to treat gain from the
sale or other disposition of ordinary shares as foreign-source income for
purposes of the U.S. federal 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 ordinary shares as a foreign-source
for purposes of such tax credit limitation. U.S. Holders should consult
their own tax advisors regarding the application of the U.S. federal
foreign tax credit limitation to gain or loss recognized on the disposition
of 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 ordinary
shares.
SPECIAL U.S. TAX CONSIDERATIONS
U.S. Holders of ordinary shares may be subject to one or more of the
special anti-deferral regimes pertaining to foreign corporations. Various
provisions contained in the Code impose special taxes in certain
circumstances on non-U.S. corporations and their shareholders. In addition,
U.S. persons who own an interest in a foreign corporation may be required
to file a Form 5471 with the IRS.
TAXATION OF NON-U.S. HOLDERS
Subject to the discussion below with respect to the U.S. backup
withholding tax, a non-U.S. Holder (i.e., any person other than a U.S.
Holder) generally will not be subject to U.S. federal income tax on
dividends from our company, 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 U.S. trade or
business, or 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, U.S. tax information
reporting and "backup withholding" of U.S. federal income tax at a 31% on
dividends on, and the proceeds of dispositions of, ordinary shares may
apply to both U.S. 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 U.S. backup withholding rules will be allowed as a
refund or credit against the U.S. Holder's or non-U.S. Holder's U.S.
federal income tax liability, provided the required information is
furnished to the IRS.
ITEM 8. SELECTED FINANCIAL DATA
The consolidated statement of operations data set forth below with
respect to the years ended December 31, 1997, 1998 and 1999 and the
consolidated balance sheet data as of December 31, 1998 and 1999 have been
derived from our consolidated financial statements and notes thereto
included in this report, which have been prepared in accordance with U.S.
GAAP (as applied to our financial statements, such accounting principles as
they relate to our company are identical to Israeli GAAP) and audited by
Luboshitz, Kasirer & Co., independent certified public accountants in
Israel, and a member firm of Andersen Worldwide. The consolidated statement
of operations data set forth below with respect to the years ended December
31, 1995 and 1996 and the consolidated balance sheet data as of December
31, 1995, 1996 and 1997 has been derived from other consolidated financial
statements not included herein which also have been prepared in accordance
with U.S. GAAP (as applied to our financial statements, such accounting
principles as they relate to our company are practically identical to the
Israeli GAAP), which also have been audited by Luboshitz, Kasierer & Co.
The selected consolidated financial information set forth below should be
read in conjunction with Item 9. "Management's Discussion and Analysis of
Financial Condition and Result of Operations" and the consolidated
financial statements and notes thereto included in this report.
STATEMENT OF OPERATIONS DATA
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1995 1996 1997 1998 1999
(In thousands, except per share data)
<S> <C> <C> <C> <C> <C>
Net sales $2,468 $8,495 $15,683 $24,650 $26,615
Cost of sales 336 1,232 2,243 5,938 8,156
Gross profit 2,132 7,263 13,440 18,712 18,459
Research and development costs, net 793 3,250 5,519 11,192 13,157
Marketing and selling expenses, net 2,029 9,673 13,449 18,509 21,171
General and administrative expense 646 1,524 3,196 5,204 6,592
Total operating expenses 3,468 14,447 22,164 34,905 46,920
Loss before one-time charge 1,336 7,184 8,724 16,193 28,461
One time charge in respect of acquired
in-process research and development
(1999 - restructuring costs) --- 1,285 --- 9,656 827
Operating loss 1,336 8,469 8,724 25,849 29,288
Financing expenses (income), net 32 (1,309) (1,044) (2,668) (902)
Net loss 1,368 7,160 7,680 23,181 28,386
Net loss per share 0.23 0.86 0.89 2.08 2.47
Weighted average number of shares 5,930 8,290 8,618 11,145 11,498
outstanding
BALANCE SHEET DATA
<CAPTION>
YEAR ENDED DECEMBER 31,
1995 1996 1997 1998 1999
(In thousands, except per share data)
<S> <C> <C> <C> <C> <C>
Working capital $1,250 $25,123 $16,093 $42,501 $35,975
Total assets 3,201 30,773 24,757 59,945 89,271
Short-term borrowings 0 0 0 0 0
Long-term liabilities 520 377 726 1,224 21,778
Total shareholders' equity 1,311 27,218 19,711 50,871 58,990
</TABLE>
EXCHANGE RATES AND DEVALUATION RATES
The following table sets forth, for the periods indicated, certain
information with respect to the rate of inflation in Israel, the exchange
rate of New Israeli Shekels (NIS) into U.S. Dollars, the rate of
devaluation in Israel and the rate of devaluation in the United States. The
closing exchange rate of the U.S. Dollar on March 31, 2000 was NIS 4.026.
For information about how the changes in these rates had an effect on our
company specifically. (See Item 9. "Management's Discussion and Analysis of
Financial Condition and Results of Operations" - Impact of Inflation and
Currency Fluctuations.)
<TABLE>
<CAPTION>
CLOSING ANNUAL
ISRAELI ISRAELI EXCHANGE ANNUAL INFLATION
YEAR ENDED CONSUMER INFLATION RATE OF THE DEVALUATION ADJUSTED FOR
DECEMBER 31, PRICE INDEX(1) RATE(2) U.S. DOLLAR(3) RATE(4) DEVALUATION(5)
------------ -------------- ------- -------------- ------- --------------
<S> <C> <C> <C> <C> <C>
1995 129.4 8.1 NIS3.135 3.9 4.0
1996 143.1 10.6 NIS3.251 3.7 6.6
1997 153.1 7.0 NIS3.536 8.8 (1.7)
1998 166.3 8.6 NIS4.160 17.6 (7.7)
1999 168.5 1.3 NIS4.153 (0.2) 1.5
</TABLE>
--------------------------
(1) For purposes of this table, the Israeli Consumers Price Index figures
use 1993 as base equal to 100. These figures are based on reports of
the Israel Central Statistics Bureau.
(2) Annual inflation is the percentage change in the Israeli CPI between
December of the year indicated and December of the preceding year.
(3) Closing exchange rate is the rate of exchange between the Israeli
currency and the dollar at December 31, of the year indicated, as
reported by Bank of Israel.
(4) Annual devaluation is the percentage increase in the value of the
dollar in relation to the Israeli currency during the year indicated.
(5) Annual inflation adjusted for devaluation is obtained by dividing the
Israeli inflation rate (column 2 plus 1) by the annual devaluation
rate (column 4 plus 1), minus 1.
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.
ITEM 9. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Please read the following discussion and analysis in conjunction with
our audited consolidated financial statements and related notes. Statements
in this discussion and analysis document concerning our business outlook or
future economic performance, anticipated revenues, expenses or other
financial items, introductions and advancements in development of products,
and plans and objectives related thereto; and statement concerning
assumptions made or expectations as to any future vents, conditions,
performance or other matters, are forward-looking statements within the
meaning of Section 27A of the Securities Act of 1993 and Section 21E of the
Securities Exchange Act of 1934, and involve risks and uncertainties.
Actual events or results could differ materially from those discussed
herein due to various factors, including without limitation, the risk
factors set forth in Item 1 under the caption "Risk Factors."
OVERVIEW
We develop and market comprehensive Voice over Internet Protocol
("VoIP") communications solutions, primarily for service providers. Our
systems are used worldwide for voice, and fax communications over the
Internet or VoIP managed networks, telephony networks and private networks
to improve productivity and reduce telecommunication costs. We also provide
products to bridge the Internet to the Public Switch Telephone Network
("PSTN"). We distribute our products to the following market segments:
telecommunications service providers, Internet telephony service providers
("ITSPs"), and consumers. The distribution channels we use include direct
sales to telecommunications service providers through strategic
partnerships and alliances, distributors, international dealers and agents,
value-added resellers, direct sales over the Internet and bundling our
software through original equipment manufacturers. Our headquarters are in
Israel and we have subsidiaries in the United States, the United Kingdom,
Hong Kong, Japan and Germany. We pioneered the commercial VoIP telephony
industry in 1995 with the first commercial VOIP telephony solution. Our
technical expertise drives the industry forward by providing end-to-end
standards and compliant solutions for global multi-service deployments for
all classes of carriers.
In October 1997, we helped establish ITXC, a global provider of high
quality Internet based voice and fax services. ITXC provides Internet
telephony exchange carrier services to ITSPs. These services allow
communications users and service providers, such as traditional telephone
companies, Internet service providers and data networks providers, to
capitalize on the convergence of the public Internet and the traditional
telephone network. Currently we have a minority equity stake in ITXC and
have provided ITXC with products in return for additional equity in ITXC.
ITXC completed its initial public offering on October 1 , 1999. In March
2000, we sold 779,743 shares of ITXC common stock in a secondary offering
conducted by ITXC. We realized net proceeds of approximately $50 million
from the sale, and we continue to hold 4,788,165 shares of ITXC common
stock.
In December 1997, we established a strategic relationship with
Deutsche Telekom, the third largest telecommunications company in the
world, by entering into a strategic business cooperation agreement and a
share purchase agreement with Deutsche Telekom. The share purchase
agreement provided for Deutsche Telekom to purchase 2,300,000 of our
ordinary shares at a price per share of $21.0, or $48.3 million. This
investment was made in January 1998. At the time of the investment, these
shares represented approximately 21% of our issued share capital. In
connection with the investment, Deutsche Telekom undertook to purchase,
pursuant to a products purchase agreement, up to $33 million of our
products and services. Of that amount, $21.7 million worth of products and
services was required to be purchased prior to December 31, 1999. In
September 30, 1998, we signed an amendment to the agreement under which the
purchasing period was extended to March 31, 2000. As of December 31, 1999,
Deutsche Telekom had purchased $24.4 million worth of our products and
services. Deutsche Telekom also has the right to distribute our products
world-wide, except in South Korea.
On January 6, 2000, we signed an LOU with Deutsche Telekom. Pursuant
to this LOU, we will provide Deutsche Telekom with an application service
for e-commerce and call center customer care service which is valued at
approximately $11.0 million. This application will enable Deutsche Telekom
to provide their e-commerce business customers with enhanced and
interactive online customer assistance capabilities. As a result, the
customer call center representatives will be able to assist consumers at
their PCs with joint surfing to Web pages, collaboration on forms, text
chat and voice support, all over a single Internet connection. Consumers
with a second phone line may also schedule a return call from a Web-based
business via a "call back" service. Deutsche Telekom expects to roll out
the new services over an 18-month period starting in the second quarter of
2000.
RESULTS OF OPERATIONS
The following tables set forth items in our consolidated statements
of operations as (i) a percentage of our total net sales for the years
ended December 31, 1999, 1998 and 1997 and (ii) the year-to-year percentage
change for certain items in 1999, 1998 and 1997. These operating results
are not necessarily indicative of the results for any future period.
YEAR ENDED DECEMBER 31,
1999 1998 1997
---- ---- ----
Net sales 100% 100% 100%
Gross profit 69% 76% 86%
Research and development costs, net 49% 45% 35%
Marketing and selling expenses, net 102% 76% 86%
General and administrative expenses 25% 21% 20%
Operating loss before one time charge 107% 66% 56%
One-time charge in respect of acquired - 39% -
in-process research and development
One time charge in respect of 3% - -
restructuring costs
Operating loss 110% 105% 56%
Finance income, net 3% 11% 7%
Net loss after one-time charge 107% 94% 49%
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1999 % CHANGE 1998 % CHANGE 1997
---- -------- ---- -------- ----
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
Net sales $26,615 8% $24,650 57% $15,683
Gross profit (loss) $18,459 -1% $18,712 39% $13,440
Operating expenses, excluding one-time
charge in respect of acquired in-
process research and development $46,920 34% $34,905 57% $22,164
Operating expenses, including
charge (1998 - in respect of acquirement
in-process research and development
and 1999 - restructuring costs) $47,747 7% $44,561 101% $22,164
Net loss $28,386 22% $23,181 202% $7,680
Net loss per share after one-time Charge $2.47 19% $2.08 134% $0.89
</TABLE>
NET SALES
Net sales include revenues from consulting and services to communication
companies. We began to provide consulting and other services in connection
with our turnkey solutions in 1998. Revenues from consulting and other
services accounted for approximately 35% of our net sales in 1999 and
approximately 22% of our net sales in 1998. We did not have revenues from
consulting and other services in 1997.
Our net sales were $26.6 million in 1999 compared with $24.7 million in
1998 and $15.7 million in 1997. The increase in net sales in 1999 was
primarily attributable to revenues from consulting and other services,
including research and developments projects. The increase in net sales in
1998 compared to 1997 was primarily attributable to revenues from sales to
service providers and corporate markets.
Revenues are generally recognized upon shipment of the product and when
collectibility is probable. An estimated reserve for product returns is
recorded at the time of sale where applicable.
Sales of VocalTec Ensemble Architecture ("VEA") and Gateway products to
the service provider market comprised the most significant portion of sales
in 1999. These products accounted for approximately 57% of our net sales in
1999, compared with 59% in 1998 and 48% in 1997.
Internet Phone and related client software sales to the consumer market
accounted for approximately 5% of our net sales in 1999 compared with 12%
of net sales in 1998 and 49% in 1997. The decrease in Internet Phone sales,
both in monetary values and as a percentage of net sales, was a direct
consequence of the shift in our focus to other products, such as VEA, and
other markets, such as the telecommunications and service provider markets.
PassaFax and PassaPort accounted for 3% of our net sales in 1999,
compared with 7% of our net sales in 1998. PassaFax and PassaPort are
products that were acquired from RADLinx in April 1998. Some of the 1998
sales were initiated before the acquisition of RADLinx.
We distribute substantially all of our products through a combination of
direct sales to telecommunications service providers, strategic partners
and alliances, VARs and international dealers and agents. We sell our
products to the consumer market through distributors, retail channels,
direct sales over the Internet, as well as through bundled OEM agreements.
In 1999 and 1998, we experienced an increase in net sales in absolute terms
through distribution channels serving the carrier or corporate markets,
which include direct sales to carriers, strategic partners and VARs. These
channels represented a higher percentage of net sales in 1999 compared with
1998, and in 1998 compared with 1997, due to our increased sales and
marketing efforts in such markets. Other channels, mainly those which serve
the consumer market, represented a lower percentage of net sales in 1999
compared with 1998, and in 1998 compared with 1997, due to the decreased
percentage of Internet Phone's contribution to overall net sales.
The sales channels addressing the consumer markets, the majority of
which relate to Internet Phone sales, represented a lower percentage of net
sales in 1999 compared to 1998, and in 1998 compared to 1997. In 1999
compared with 1998, and in 1998 compared with 1997, direct sales over the
Internet decreased in absolute terms and as a percentage of net sales, due
to the expansion of other channels and introduction of new products. Retail
distribution channels decreased in absolute terms and as a percentage of
sales in 1999 and 1998 due to a smaller offering of consumer products. This
decrease was also due to the fact that sales pursuant to bundled OEM
agreements decreased in absolute terms and on a percentage basis in 1999
compared to 1998 and in 1998 compared to 1997 as a result of competing
client software addressing the consumer market being distributed for free
as a part of packaged software.
The direct sales operations to telecommunications service providers was
initiated to a limited extent in 1997, primarily due to the strategic
business cooperation agreement with Deutsche Telekom. This channel was
expanded in 1998 and 1999, due to increased sales to Deutsche Telekom, as
well as initial sales to other telecommunication companies. Sales to
Deutsche Telekom in 1999 accounted for 49% of net sales compared with 39%
of net sales in 1998 and 11% of net sales in 1997. In addition to strategic
partners addressing the carrier market, this direct sales channel may
account for an increasing percentage of net sales in future periods as the
direct sales operations to telecommunications service providers becomes
further established.
During 1999, we marketed Internet Phone and VocalTec Telephony Gateway
software through a distribution agreement with Ingram Micro Inc. Sales to
Ingram Micro Inc. accounted for approximately 1% of our total net sales in
1999 compared with 4% of net sales in 1998 and 11% in 1997. In addition,
America Online Inc. ("AOL") marketed Internet Phone through its on-line
General Store in the second and third quarters of 1997. There were no sales
to AOL in 1999 and 1998. Sales to AOL accounted for approximately 11% of
our total net sales in 1997. (See Note 13 of the Notes to the Consolidated
Financial Statements.)
Sales outside of North America were approximately 87% (Europe 63%, Far
East 21% and other 3%) of total revenues for 1999, compared with 68%
(Europe 54%, Far East 9% and other 5%) of total revenues for 1998 and 30%
(Europe 18%, Far East 9% and other 3%) of total revenues for 1997. European
sales increased each year both in monetary value and as a percentage of
total sales. The increase in European sales in 1999 and 1998 was primarily
due to increased sales and marketing efforts in Europe through direct sales
channels, primarily to telecommunication companies. As a result of the
strategic business cooperation agreement with Deutsche Telekom and due to
the increased interest of international telecommunications service
providers and national Post Telephony and Telegraphy Companies and markets
opening to competition, we expect that international sales activity outside
of North America will continue to be a major component of net sales in the
future and may increase as a percentage of overall net sales in the very
near future.
COST OF SALES
Cost of sales was $8.2 million, or 31% of net sales, in 1999 compared
with $5.9 million, or 24% of net sales, in 1998 and $2.2 million, or 14% of
net sales, in 1997.
In 1999, as a result of increased sales of turnkey solutions, containing
both software and hardware components, cost of sales included cost of
hardware and integrating boards as well as third party billing software.
Cost of sales in 1999 also included additional reserves for the cost of
sales related to servicing evaluation units provided to certain customers
in order to make them marketable and other inventory amortization.
In 1998 and 1997, the cost of sales consisted primarily of the cost of
product media and duplication, manuals, packing materials, customer and
technical support, amounts paid to third party vendors for sales or
fulfillment and royalties to the OCS and, in some cases, hardware
components.
In 1998, some service provider customers requested a full software-hardware
Internet telephony solution, and cost of sales included hardware consisting
primarily of telephony boards purchased from third parties. In addition,
cost of PassaFax and PassaPort products sold subsequent to the acquisition
of RADLinx in April 1998 contributed to higher overall cost of sales.
We expect that cost of sales may increase in the future due to
customers' preference for a full software-hardware solution and increased
expenditures on customer support.
Gross margins were 69%, 76% and 86% in the years 1999, 1998 and 1997,
respectively. The decrease in gross margins was a result of the change in
mix of products sold, from Internet Phone and related products to VEA,
which includes hardware components in 1998 and the shift to a full solution
incorporating hardware as well as software in 1999. Accordingly, 1998
margins include hardware related expenses for VEA components, and 1999
margins include hardware and billing systems as well as inventory
amortization. We expect that our gross margins will be affected in future
periods by the mix of customers, products sold and distribution channels,
and the level of combined software and hardware solutions provided as we
continue to provide total solutions for our service provider customers, the
mix of international versus North American revenues and the prices charged
for products. In addition, we believe that the gross margin on product
sales may decrease in future periods due to increased competition which may
cause us to reduce prices of certain of our products, increased amounts
paid for licensed technology to be incorporated in future products and
increased costs associated with providing customer support.
OPERATING EXPENSES
Research and development costs, net. Research and development costs, net
were $13.2 million, or 49% of net sales, in 1999 compared with $11.2
million, or 45% of net sales, in 1998, and $5.5 million, or 35% of net
sales, in 1997. Research and development costs, net consist principally of
salaries and benefits for software engineers, contracted development
efforts, related facilities costs, standards-based efforts and activities
and expenses associated with computer equipment used in software
development. Research and development costs, net have increased
significantly over the last three years as we have invested in the
development and enhancement of existing products, new technologies, new
product development and the infrastructure to support such activities. We
also invested in product development for new markets and applications
primarily for the service providers and enterprise markets, as well as in
the infrastructure to support such activities.
None of our software development costs have been capitalized during any
of the reported periods as the amount of software development costs
eligible for capitalization at this stage has historically been
insignificant.
We believe that the continued investment in research and development is
necessary to remain competitive in the marketplace and is directly related
to timely developments of new and enhanced products. Accordingly, we intend
to continue recruiting and hiring experienced software engineers. While we
expect that research and development expenditures in the future will
increase in absolute dollars, we also expect that these expenditures will
decline as a percentage of net sales.
Our research and development efforts have been financed through internal
resources and through royalty bearing programs sponsored by the Government
of Israel through the OCS. The royalty bearing programs are grants directly
from the OCS. The non-royalty bearing program is a government research and
development grant-based program of the OCS called "MAGNET" that is based on
a consortium of companies collaborating in the area of multimedia. We
expect to participate only in royalty bearing programs but we cannot make
any assurances that we will be awarded any future grants.
Pursuant to the terms of the royalty bearing programs of the OCS, we are
required to pay a royalty of 3-5% of net sales of products developed and
related services resulting from any project by the OCS, up to an amount of
100-150% of the grant obtained. There are no royalty payments required
under the MAGNET program.
In 1999, total research and development grants from the OCS were
$2,088,000, of which $1,316,000 related to royalty bearing programs and
$772,000 related to the MAGNET program. Total cash payments from the OCS in
1999 were $1,358,000, of which $711,000 related to royalty bearing programs
and $647,000 related to the MAGNET program. As of December 31, 1999, grants
receivables were $1,198,000.
In 1999, we paid royalties to the OCS in an aggregate amount of
approximately $44,000, with an additional $183,000 in accrued obligations
to pay for royalties previously incurred under royalty bearing programs of
the OCS.
In 1998, total research and development grants from the OCS were
$1,427,000, of which $261,000 related to royalty bearing programs and
$1,166,000 related to the MAGNET program. Total cash payments from the OCS
in 1998 were $1,295,000, of which $144,000 related to royalty bearing
programs and $1,141,000 related to the MAGNET program. As of December 31,
1998, grants receivables were $435,000.
In 1998, we paid royalties to the OCS in an aggregate amount of
approximately $41,000, with an additional $30,000 in accrued obligations to
pay for royalties previously incurred under royalty bearing programs of the
OCS.
In 1997, research and development grants from the OCS totaled
$1,424,000, all from the MAGNET program, of which $850,000 was received in
cash and the balance accrued. As of December 31, 1998, the accrued amount
for 1997 was $133,000.
In 1997, we paid or accrued royalties to the OCS in an aggregate amount
of approximately $100,000, for royalties previously incurred under royalty
bearing programs of the OCS.
Marketing and selling expenses, net. Marketing and selling expenses, net
were $27.2 million, or 102% of net sales, in 1999, compared with $18.5
million, or 76% of net sales, in 1998 and $13.4 million, or 86% of net
sales, in 1997.
Marketing and selling expenses, net generally include salaries and
benefits, sales commissions, travel expenses and related facilities costs
for our sales, marketing, customer support expenses and distribution
personnel as well as royalties to third parties and bad debts of our U.S.
subsidiary VocalTec Communications Inc.. Marketing and selling expenses,
net also include the costs of programs aimed at increasing revenue, such as
advertising, trade shows and other market development programs.
The increases in marketing and selling expenses, net in 1999 and 1998,
were the result of the expansion of the marketing, sales and customer
support operations relating to the carrier and service providers markets of
our U.S. subsidiary, VocalTec Communications Inc.
In 1999, the increase in marketing and selling expenses was a result of
the establishment of sales and marketing activities in Germany and China.
In 1998, the increase was due to the expansion of sales activity in the Far
East, including the opening of a sales and marketing subsidiary in Japan
and higher travel, depreciation and bad debt expenses. The increase in
marketing and selling expenses, net in 1998, also represents the expansion
and strengthening of product management pre-sales and post-sales teams
which handled the additional market segments we addressed in 1997 and the
additional channels required to approach such markets.
Beginning in 1994, we received grants from the Government of Israel,
through the Fund for the Encouragement of Marketing Activities (the "Fund")
for marketing expenses incurred to increase export from Israel. Such
marketing grants totaled approximately $400,000 for 1997 (of which
approximately $133,000 was received in 1998 and approximately $267,000 is
an accrual). No such grants were received in 1998 or 1999. Under the terms
of the grants, if and when export sales from Israel exceed a predetermined
base of historical export sales, a royalty of 4% on the increase of our
exports during the base year, as defined in the "Approved Enterprise"
program, with maximum royalties of 100% of the total grant. In 1997 and
1998, we paid or accrued an obligation to pay royalties in the amount of
approximately $331,000 and $400,000, respectively. Our total obligation to
the Fund as of December 31, 1999 was $400,000.
General and administrative expenses. General and administrative expenses
consist principally of salaries and benefits, travel expenses, and related
facility costs for management, finance, human resources, legal, information
services, and administrative personnel. General and administrative expenses
also include outside legal, accounting and consultant fees, bad debt, and
expenses associated with computer equipment and software used in the
administration operations. General and administrative expenses were $6.6
million, or 25% of net sales, in 1999, compared with $5.2 million, or 21%
of net sales, in 1998, and $3.2 million, or 20% of net sales, in 1997.
General and administrative expenses increased in 1999 as a percentage of
revenue compared to 1998 by 4%. The increase in 1999 compared to 1998 was
due to costs related to the expansion of our headquarters. The increase in
1998 compared to 1997 was primarily due to recruitment of additional
administrative staff and to bad debt expenses. We expect that general and
administrative expenses will continue to increase due to the addition of
systems, processes and people necessary to support overall increases in the
scope of our operations.
One time charge with respect to restructuring costs. In May 1999, we
made a decision to intensify strategic market focus, based on an ongoing
review of our operations. This initiative consisted of a number of
organizational changes, including a reduction in worldwide headcount of
approximately 40 people. As part of our decision to intensify strategic
market focus, VocalTec Communications UK Ltd., our U.K. subsidiary, which
had focused on research and development and product management for
collaboration software products for corporate intranets, was liquidated in
November 1999. Total costs associated with those changes were $827,000.
One time charge with respect to acquired in-process research and
development. In April 1998, we acquired substantially all of the assets of
RADLinx, an Israeli corporation engaged in providing fax services over the
Internet. As consideration for the acquisition we issued to RADLinx 421,905
of our ordinary shares, representing a purchase price of approximately $7.7
million, and assumed RADLinx's liabilities of approximately $2.6 million.
The acquisition was accounted for as a purchase and, accordingly,
operating results subsequent to the date of acquisition were included in
our Consolidated Financial Statements for 1998. Of the total purchase price
of approximately $10.5 million, approximately $9.7 million was allocated to
RADLinx's research and development projects in process. As these projects
had no alternative future use, we wrote them off as a non-recurring expense
at the date of purchase. Approximately $50,000 of the purchase price was
allocated to other good-will type assets, which are being amortized over
5 years by the straight line method. Approximately $800,000 of the purchase
price was allocated to net tangible assets.
OTHER INCOME
Finance income net was $0.9 million, or 3% of net sales, in 1999
compared with $2.7 million, or 11% of net sales, in 1998 compared with $1.0
million, or 7% of net sales, in 1997. The decrease in 1999 compared to 1998
was due to a lower level of cash and short-term investments resulting from
the use of net proceeds from our agreement with Deutsche Telekom and the
increase in operating expenses. The increase in finance income in 1998
compared to 1997 was primarily due to the interest income earned on cash
and short-term investments resulting from the net proceeds of the
investment agreement between VocalTec and Deutsche Telekom. Under that
agreement, Deutsche Telekom paid $48.3 million for 2,300,000 of our
ordinary shares in January 1998. (See "Liquidity and Capital Resources"
below.)
NET LOSS
Net loss in 1999 was $28.39 million, or 107% of net sales, or $2.47 per
share. This includes a one time charge of restructuring costs of $0.83
million, or $0.07 per share. The net loss excluding the one time charge was
$27.56 million, or $2.40 per share, or 104% of net sales. Net loss in 1998
was $23.18 million, or 94% of net sales, or $2.08 per share. This includes
a one-time charge in respect of acquired in-process research and
development of $9.7 million, or $0.85 per share. The net loss excluding the
one-time charge was $13.525 million, or $ 1.21 per share, or 55% of net
sales. The net loss for 1997 was $ 7.7 million, or 49% of net sales, or
$0.89 per share. The net losses in 1999, 1998 and 1997 were primarily due
to accelerated sales, marketing and research and development activities.
LIQUIDITY AND CAPITAL RESOURCES
On December 31, 1999, we had approximately $31.9 million in cash and
cash equivalents and $1.7 million in short-term investments, compared to
$5.0 million in cash and cash equivalents and $31.4 million in short term
investments in 1998, compared to $6.8 million in cash and cash equivalents
and $5.6 million in short-term investments in 1997.
As of December 31, 1999, we had working capital of approximately $36.0
million compared with working capital of $42.5 million at December 31, 1998
and $16.1 million at December 31, 1997. The decrease in working capital
over 1999 resulted from the high level of investment in research and
development as well as sales and marketing expenses, general and
administrative expenses and restructuring costs. The increase in working
capital over 1998 resulted primarily from the investment by Deutsche
Telekom in our company, net of our loss from operations. At December 31,
1999, total borrowings amounted to approximately $20.0 million, consisting
of a loan in the principal amount of $10.0 million, which is to be repaid
in four equal quarterly installments commencing in April 2001 and a loan in
the principal amount of $10 million, which is repayable in August 2002. The
loans bear interest of Libor plus 1.5% (Libor at December 31, 1999 was
6.18%). As collateral for the loans, we pledged shares of ITXC with an
aggregate fair market value of approximately $91.9 million as of December
31, 1999. We also had an unutilized credit line in the amount of $5.0
million available until April 2000 at the same interest rate as the above
mentioned loans.
Following the sale of ITXC shares in ITXC's secondary offering, we repaid
those loans in March 2000. On March 31, 2000 we had no borrowings.
On December 31, 1998 and December 31, 1997 we had no debt.
Capital expenditures in 1999 were approximately $3.2 million compared
with $4.6 million in 1998, and $1.8 million in 1997. The decrease in 1999,
compared to 1998 was primarily due to lower capital investment in leasehold
improvements. The increase in 1998 over 1997 was primarily due to
investments in computer and other related equipment and for leasehold
improvements.
On October 1, 1999, ITXC consummated its initial public offering. In
March 2000, we sold shares of ITXC common stock in a secondary offering
conducted by ITXC. We realized net proceeds of approximately $50 million
from the sale, and we continue to hold 4,788,165 shares, or approximately
12.5% of ITXC's outstanding common stock. As a condition to our
participation in the March 2000 secondary offering, we are prohibited from
selling any of our remaining holdings until 240 days from the date of the
secondary offering. For information relating to the valuation of our
investment in ITXC and the presentation of this investment on our balance
sheet. (See Item 9A.
"Quantitative and Qualitative Disclosures About Market Risks.")
Negative cash flows from operations through the end of 1999 were a
result of higher cost of goods sold, resulting from the change in the mix
of products sold in 1999, as well as increased expenditures in research and
development, sales and marketing and general and administration
expenditures. The effect of negative cash flows from operations was offset
by the loans mentioned above. Negative cash flows from operations through
the end of 1998 were primarily a result of increased expenditures on
research and development and marketing and sales infrastructure. The effect
of negative cash flows from operations was offset through the use of the
net proceeds from Deutsche Telekom's investment in 1998, and in prior years
through the use of proceeds from of sales of equity securities.
We believe that current cash and cash equivalents balances and cash
flows from operations will be sufficient to meet our anticipated cash needs
for working capital and capital expenditures for at least the next 12
months. In addition, we intend to sell shares of ITXC from time to time, if
necessary, to meet our cash needs subject to the terms of our March 2000
lockup agreement with the underwriters for ITXC's secondary offering.
Thereafter, if cash generated from operations is insufficient to satisfy
our liquidity requirements, we may sell additional equity securities or
debt securities or seek credit facilities.
INVENTORY AND RECEIVABLES
Inventories at the end of 1999 were $1.60 million compared with $1.65
million at the end of 1998 and $0.4 million at the end of 1997. The
decrease of inventory in 1999 compared with 1998 resulted from an accrual
for inventory write-off, lower level of evaluation inventory at customers
and outsourcing of components integration of the PassaPort product. The
increase of inventory in 1998 compared with 1997 was driven by the shift to
sales of hardware related products, including VEA, PassaFax and PassaPort
to service providers. In addition, the inventory included VEA products at
customer sites for evaluation purposes. Soft media products have virtually
no inventory or very low inventory values.
Trade receivables net rose from $5.8 million at the end of 1997 to
approximately $9.0 million at the end of 1998, and decreased to
approximately $6.2 million at the end of 1999. Such receivables are
primarily from telecommunications companies and service providers. The
majority of net sales in 1999 and 1998 were direct sales. The majority of
net sales in 1997 were through VARs and retail channels, which typically
have longer payment cycles than other sales channels, resulting in
increased trade receivables. Net trade receivable as a percentage of net
sales in 1999 decreased compared to 1998. Net trade receivables as a
percentage of net sales were similar at the end of 1998 to the end of 1997.
There can be no assurance that our reserves for returns and bad debts is
adequate due to the short history and lack of collection experience we have
with these types of providers.
Other receivables decreased from $3.3 million at the end of 1998 to $3.1
million at the end of 1999. Other receivables increased from $1.8 million
at the end of 1997 to $3.3 million at the end of 1998. The decrease in 1999
was due to decrease in pre-paid expenses and repayment of employee loans.
The increase in 1998 is due to accruals of interest on short-term
investments, accruals for government related grants, pre-paid expenses and
VAT refunds.
RESEARCH AND DEVELOPMENT GRANTS
Our research and development efforts have been financed through our
internal resources and through programs sponsored by the Government of
Israel through the OCS starting in 1993. Research and development grants
from the OCS totaled $1,316,000 and $261,000 for the years 1999 and 1998,
respectively. In addition, in the years 1999, 1998 and 1997, we had
received or accrued approximately $772,000, $1,166,000 and $1,424,000,
respectively, in grants from the OCS through the MOST consortium, under the
MAGNET program. There can be no assurance that such grants will be paid to
us in the future. Pursuant to the terms of the OCS participation, we are
required to pay a royalty of 3%-5% of the net sales of products developed,
and related services resulting from, a project funded by the OCS, up to an
amount of 100% (in the past up to 150%) of the grant obtained in NIS linked
to the U.S. dollar. Grants under the MAGNET program are royalty free. In
1999, 1998 and 1997, we paid royalties in an aggregate amount of
approximately $35,000, $160,000 and $100,000, respectively. (See Item 1.
"Description of Business" -Research and Development.)
EFFECTIVE CORPORATE TAX RATE
Due to reported losses, our effective corporate tax rate was 0% in 1999,
1998 and 1997. We currently have two Approved Enterprise programs under the
Law for Encouragement of Capital Investments, 1959. 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 reduced corporate tax until the earlier of (i) seven to ten
consecutive years, commencing the year in which the specific Approved
Enterprise first generates taxable income, (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.
From 1992 through December 31, 1999, we have incurred net operating
losses. As of December 31, 1999, we had net operating loss carry forwards
of approximately $33 million, of which approximately $25 million is
attributable to us. This loss has no expiration period. The balance of
approximately $8 million (net of unrealized gain on available for sale
securities of approximately $34 million) in net operating loss carry
forwards is attributable to VocalTec Communications Inc., our U.S.
subsidiary, which will expire in 2013. Tax benefits which apply to us under
Israeli law do not apply to any income generated by VocalTec Communications
Inc.
IMPACT OF INFLATION AND CURRENCY FLUCTUATIONS
The cost of our operations in Israel, as expressed in U.S. dollars, is
influenced by the extent to which any increase in the rate of inflation in
Israel is not offset (or is offset on a lagging basis) by a devaluation of
the New Israeli Shekel (NIS) in relation to the U.S. dollar. The inflation
rate in Israel was 1.3% in 1999, compared with 8.6% in 1998 and 7.0% in
1997. At the same time, the rate of devaluation of the NIS against the U.S.
dollar was (0.2%) in 1999, 17.6% in 1998 and 8.8% in 1997. As a result of
the differential between the rate of inflation and the rate of devaluation
of the NIS in 1999 we experienced slight increases in the costs of
operations in Israel, as expressed in U.S. dollars, which did not
materially adversely effect our result of operations in this period. As a
result of the differential between the rate of inflation and the rate of
devaluation of the NIS, mainly during the last few months of 1998, we
experienced a lower level of expenses, as expressed in U.S. dollars, and
finance gains on monetary liability items, as they are calculated and
expressed in NIS. As a result of the differential between the rate of
inflation and the rate of devaluation of the NIS in 1997, we experienced
increases in the costs of operations in Israel, as expressed in U.S.
dollars, which did not materially adversely affect our results of
operations in this period. The increase in the cost of our operations in
Israel, as expressed in dollars, relates primarily to the cost of salaries
in Israel, which are paid in NIS linked to the Israeli Consumer Price
Index. We have, in the past, purchased forward currency options to decrease
the risk of financial exposure from fluctuations in the exchange rate of
the dollar against the NIS. We no longer have any forward currency options
or other hedging instruments outstanding. We may in the future, to the
extent we deem it advisable, purchase additional forward currency options
to decrease such risk.
RISKS RELATING TO YEAR 2000
In many of our customer contracts we provide assurances and warranties
regarding the Year 2000 compliance of our products. Our business may suffer
as a result of problems relating to Year 2000 compliance issues that have
not yet been detected or may still arise. The potential for failure
encompasses all aspects of our business, including software that we license
to third parties and software that we use internally. Since our products
operate over the internet, our products may fail to function properly in
the event that the Internet encounters Year 2000 compliance problems.
We cannot be certain that our products, particularly when they
incorporate third party software, contain all date code changes necessary
to ensure future Year 2000 compliance. The sale and support of products
that are not Year 2000 compliant entail the risk of claims and lawsuits.
Our defense against any future lawsuits, regardless of their merit, could
result in substantial expense to us as well as the diversion of management
time and attention. In addition, Year 2000 product liability claims,
regardless of the merit or eventual outcome of these claims, could affect
our reputation and ability to retain existing customers or attract new
customers.
With the passage of the critical January 1, 2000, and February 29, 2000,
dates, we have not experienced any significant business disruptions as a
result of the year 2000 date change. We will continue to monitor its
systems for ongoing Year 2000 compliance until we are reasonably assured
that no significant business interruptions are likely to occur. Based on
the actions taken by us and our experience to date, we do not believe that
its operations will be materially impacted by the Year 2000 issue.
ITEM 9A. 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 and short-term bonds,
at a minimum rating of single "A." 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 principle 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 (National) Amounts by Expected Maturity in U.S. Dollars:
FY 2000 FY 2001 FY 2002 TOTAL FAIR VALUE AT
DECEMBER 31,
1999
(IN THOUSANDS, EXCEPT INTEREST RATES)
Cash Equivalents $31,915 $31,915 $31,915
Average Interest Rate 6% 6%
Short Term Investments 1,730 1,730 1,730
Average Interest Rate 5.75% 5.75%
Total Portfolio 33,645 33,645
Average Interest Rate 6% 6%
Long Term Debts 7,517 12,500 20,017 20,017
Average Interest Rate 7.68% 7.68% 7.68%
INVESTMENT IN ITXC
The investment in ITXC is presented in the balance sheet as of December
31, 1999 as follows: the portion of 1,043,983 shares "available - for -
sale" during the year 2000 is stated at fair market value which was $33.625
per share, representing a total of $35.1 million and the restricted portion
of the shares (4,523,925 shares) is presented at cost of $2.7 million. The
fair market value of this portion of the ITXC investment, as of December
31, 1999, was approximately $152.1 million.
As of March 31, 2000, the portion of 399,014 shares "available-for-sale"
during the next following months is stated at fair market value, which was
$47.063 per share or a total of $18.8 million. The restricted portion of
the shares, 4,389,151 shares is presented at a cost of $2.7 million. The
fair market value of this portion of our ITXC investment as of March 31,
2000 was $206.6 million.
ITEM 10. DIRECTORS AND OFFICERS OF REGISTRANT
DIRECTORS AND EXECUTIVE OFFICERS
The following sets forth certain information regarding our directors and
executive officers:
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
Dr. Elon A. Ganor(1) 50 Chairman of the Board of Directors and Chief
Executive Officer
Ami Tal(1) 52 Chief Operating Officer, Senior Vice President of
Global Sales and Director
Alon Cohen 37 Director
Lior Haramaty 34 Director
Rami Kalish 43 Director
Douglas Dunn 58 Director
William Schrader 48 Director
Jeff Dykan 41 Chief Financial Officer
Ira Palti 42 President of IP Telephony Group
Dafna Golan 39 Vice President of Human Resources
Ada Markman 41 Vice President of Information, Technology and
Systems
Dr. Aharon Satt 40 Chief Technology Officer
Ariel Rabban 34 Vice President of Corporate Development
Ian Tick 42 Vice President of Marketing/Communications
</TABLE>
-----------------
(1) A nominee of LaCresta.
Set forth below, is a biographical summary of the business experience of
each of the directors and executive officers named above:
DR. ELON A. GANOR has served as the chairman of our board of directors
since 1993. From 1993 to October 1998, and from November 1999, Dr. Ganor
also served as our chief executive officer. From 1990 to 1992, Dr. Ganor
was responsible for the sales and marketing of our products through his
association with a subsidiary of LaCresta, where he served as a vice
president. Before becoming a shareholder of our company, LaCresta acted as
a distributor of our products. Dr. Ganor is the brother-in-law of Ami Tal.
AMI TAL has served as senior vice president of global sales since November
1999, vice president of operations since April 1998, chief operating
officer since 1995 and director since 1992. Mr. Tal also served as our
chief financial officer from 1992 to 1995. From 1990 to 1992, Mr. Tal
served as vice president and head of the international trading division of
LaCresta. Mr. Tal is the brother-in- law of Dr. Ganor.
ALON COHEN is a co-founder of our company and has served as director since
1989. Mr. Cohen has served as chief engineer (his former title was chief
technology officer) from November 1995 to 1998. From 1987 to 1989, Mr.
Cohen served as a software and hardware development engineer at the Israeli
army in the computer and communications wing at Indigo N.V., an electronic
system manufacturer. Mr. Cohen has been on sabbatical since mid-1998 and
now functions solely as a board member.
LIOR HARAMATY is a co-founder of our company and has served as director
since 1989. Mr. Haramaty served as senior vice president of commercial
development from December 1999, vice president of professional services
from May 1999, vice president of technical marketing from November 1995 and
a director of technical marketing from 1993, until mid 2000. Prior to 1993,
Mr. Haramaty was responsible for VocalTec's R&D and operations groups.
RAMI KALISH has served as director since 1993. Since 1993, Mr. Kalish has
been the managing director of Polaris. Mr. Kalish is also a managing
general partner of DS Polaris Ltd., which manages Polaris and the Polaris
Fund II. In addition, Mr. Kalish currently serves as a director of several
companies, including VCON Telecommunications Ltd. and Card Guard Scientific
Survival Ltd.
DOUGLAS DUNN has served as director since January 2000. Mr. Dunn, former
vice president of visual communications and multimedia strategy at AT&T,
has spent 26 years at the telecommunications and multimedia company where
his business acumen spanned both the commercial sector and research arenas
at Bell Laboratories.
WILLIAM L. SCHRADER has served as director since November 1999. Mr.
Schrader is chairman, chief executive officer and founder of PSINet, an IP
data communications carrier. Mr. Schrader has been instrumental in the
formation of industry groups such as the Commercial Internet Exchange and
the Internet Society. Prior to forming PSINet in 1989, Mr. Schrader was
founder, president and chief executive officer of NYSERNet, the corporation
that created the first regional Internet network. Prior to his involvement
with NYSERNet, Mr. Schrader was director and founder of Northeast Parallel
Architectures at Syracuse University and of the Cornell Theory Center, at
Cornell University, where he helped plan and build the first non-military
supercomputer center.
JEFF DYKAN has served as chief financial officer since February 1999.
From 1990 to 1999, Mr. Dykan held multiple positions within Applied
Materials Inc.'s global finance organization, the most recent of which was
Israeli regional controller. Between 1987 and 1990, Mr. Dykan held several
positions in Opal Inc. the last of which was managing director of finance.
IRA PALTI has served as vice president of research and development since
February 1999 and president of the IP Telephony group since November 1999.
From 1997 to 1999, Mr. Palti served as the chief executive officer of
Automedia Ltd. From 1995 to 1997, Mr. Palti served as the vice president of
research and development at Netmanage Corp. From 1984 to 1994, Mr. Palti
held various management and software development positions at
Rosh/ServiceSoft Corp.
DAFNA GOLAN has served as vice president of human resources since
February 2000. From 1996 until February 2000, she served as the human
resources director. Prior to joining VocalTec, Ms. Golan held positions in
various companies, including human resources manager at Flying Cargo and
software engineer at Digital Ltd.
ADA MARKMAN has served as vice president of information systems &
technology and systems and vice president of operations since November
1999. From 1998 to 1999, Ms. Markman served as the director of information
systems & technology, and in 1997, as IS manager of our company. Prior to
joining VocalTec, Ms. Markman served as a project manager at Motorola
Communications Israel and as an area manager at the Israeli Military
Industries.
DR. AHARON SATT has served as chief technology officer since November 1999.
Dr. Satt served as the chief scientist for VocalTec from January 1999 to
November 1999. Prior to joining us, Dr. Satt held positions at IBM and the
IBM Haifa Research Lab, as research fellow and technology group manager.
ARIEL RABBAN has served as vice president of corporate development since
November 1999. Mr. Rabban is also serving as interim co-president of the
Surf & Call Network Services group and TrulyGlobal Inc. Since January 1998,
when he joined our company, Mr. Rabban served as the strategic and
operational planning manager. Prior to joining VocalTec, Mr. Rabban served
as the manager of strategic planning and business development at the
communication software business unit of Lucent Technologies in New Jersey.
IAN TICK has served as vice president of marketing/communications since
April 2000. From 1993 to 2000, Mr. Tick was director of corporate marketing
at Gilat Satellite Networks Ltd. Prior to his hi-tech experience, Mr. Tick
held key creative and management positions in advertising agencies in New
York and Tel Aviv.
BOARD OF DIRECTORS
EXTERNAL DIRECTORS
We are subject to the provisions of the new Israeli Companies Law,
5739-1999 (the "Companies Law"), which became effective on February 1,
2000. 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 two external directors, who must also be
residents of Israel. 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:
o an employment relationship;
o a business or professional relationship maintained on a regular basis;
o control; and
o service as an office holder.
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 an additional 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 is required to include at least one external director.
INDEPENDENT DIRECTORS
We are subject to the rules of the Nasdaq National Market applicable to
listed companies. Under the Nasdaq rules, we are required to appoint a
minimum of three independent directors. The independence standard under the
Nasdaq rules excludes any person who is a current or former employee of a
company or of any of its affiliates, as well as any immediate family member
of an executive officer of a company or of any of its affiliates. At least
three of our current directors meet the independence standard of the Nasdaq
rules.
AUDIT COMMITTEE
Under the Companies Law, the board of directors of any company that is
required to nominate external directors 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.
The role of the audit committee under the Companies Law is to detect
defects in the management of the company's business through, among other
things, consultation with the Company's internal or external auditor and to
suggest to the board methods to correct those defects. 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 they have
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. We intend to appoint the external directors
elected under the Companies Law to our audit committee. Our current audit
committee consists of Rami Kalish, whom, we believe, is independent under
Nasdaq rules.
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 affiliate, nor
may the internal auditor be the company's independent accountant or its
representative. We intend to appoint an internal auditor in accordance
with the requirements of the Companies Law.
APPROVAL OF SPECIFIED 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 which 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 good
of the company. An "office holder" as defined in the Companies Law is 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 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 specified circumstances, subsequent
shareholder approval.
Under the Companies Law, the disclosure requirements which 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 13. "Interest of Management in Certain
Transactions."
EXCULPATION, INSURANCE AND INDEMNIFICATION OF DIRECTORS AND OFFICERS
Under the Companies Law, an Israeli company may not exempt an office
holder from liability with respect to a breach of his duty of loyalty, but
may exempt in advance an office holder from his liability to the company,
in whole or in part, with respect to a breach of his duty of care. Under
the Companies Law, a company may not indemnify an office holder, nor enter
into an insurance contract which would provide coverage for any monetary
liability incurred as a result of any of the following:
o a breach by the office holder of his duty of loyalty unless the
office holder acted in good faith and had a reasonable basis to
believe that the act would not prejudice the company;
o a breach by the office holder of his duty of care if such breach was
done intentionally or in disregard of the circumstances of the breach
or its consequences;
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 judgement, 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.
Under the Companies Law, our Articles of Association may also
include:
o a provision authorizing us to grant in advance an undertaking to
indemnify an office holder, provided that the undertaking is limited
to types of events which the board of directors deems to be
anticipated and limited to an amount determined by the board of
directors to be reasonable under the circumstances; and
o 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.
ITEM 11. COMPENSATION OF DIRECTORS AND OFFICERS
The aggregate compensation paid to or accrued on behalf of all our
directors and officers as a group (18 persons) for the year ended December
31, 1999, was $2,480,110 in salaries, directors' fees, commissions and
bonuses and $270,892 in pension, retirement and similar benefits.
ITEM 12. OPTIONS TO PURCHASE SECURITIES FROM REGISTRANT OR SUBSIDIARIES
As of May 31, 2000, options granted to our employees, officers, and
directors to purchase up to 2,576,504 ordinary shares were outstanding, of
which 511,623 ordinary shares relate to options granted to current officers
and directors. Such options vested or vest at various dates between
September 1996 and January 2004 and may be exercised at a price ranging
between the par value of the ordinary shares (NIS0.01) and $16.15, which
represents 85% of our initial public offering price of $19 per share.
In 1999, we adopted a stock option and incentive plan, that provides for
the grant of restricted shares or options to purchase up to an aggregate of
1,000,000 ordinary shares to our officers, directors, key employees and
consultants. Pursuant to this 1999 option plan, the board of directors has
granted 853,450 options to our employees, officers, directors and
consultants to purchase ordinary shares, of which 50,000 ordinary shares
relate to options granted to our officers and directors.
Our option plans are administered by the board of directors or a
committee appointed by the board. The purpose of these plans is to enable
us to attract and retain qualified persons as employees, officers,
directors and consultants and to motivate these persons by providing them
with an equity participation in our company. Each plan expires 10 years
after its adoption unless terminated earlier by the board of directors. The
exercise price of options issued under the plans is not less than 95% of
the fair market value of the ordinary shares as of the date of grant for
our 1996 option plan, 1997 option plan, 1998 option plan and 1999 option
plan.
The ordinary shares acquired upon exercise of an option and the
restricted shares are subject to certain restrictions on transfer, sale or
hypothecation. Options are exercisable and restrictions on disposition of
shares lapse pursuant to the terms of the individual agreements under which
such options were granted or shares issued. Ordinary shares as to which the
optionee's rights have not vested are held by a trustee until vesting and
may be voted by the grantee of such options.
Pursuant to a share purchase agreement dated December 29, 1997, between
us and Deutsche Telekom, Deutsche Telekom was granted preemptive rights
with respect to any issuance or sale by us of our equity securities or
securities convertible into our equity securities or which entitle the
recipient to acquire our equity securities. However, Deutsche Telekom is
only entitled to exercise these rights to the extent necessary to maintain
certain minimum percentage ownership levels in our company (initially 21%
of our issued and outstanding share capital and in no event exceeding 26%).
The consideration for and terms pursuant to which Deutsche Telekom may
acquire shares by exercising its preemptive rights, will be the same as
those provided to the party acquiring the shares being issued or sold,
except that in certain situations (i.e., the issuance of equity securities
pursuant to certain stock options or stock option programs, in connection
with the acquisition by us of another business entity or assets, or for
less than the market price or other than for cash to a strategic investor)
the price per share will equal the average of the closing bid prices for
our shares during the 20 trading days preceding the date on which such
preemptive rights are exercised. Deutsche Telekom has 15 German business
days within which to decide whether to exercise its preemptive rights after
receiving notice of our intention to issue equity securities. The
preemptive rights granted under the share purchase agreement continue for
so long as (a) Deutsche Telekom holds not less than 8% of our issued and
outstanding ordinary shares and (b) the strategic business cooperation
agreement between us and Deutsche Telekom is in effect (other than solely
as a result of an automatic extension thereof to allow Deutsche Telekom
more time to place orders to fulfill its total purchase commitment (an
"Automatic Extension") or Deutsche Telekom and/or any of its affiliates is
otherwise making Substantial Purchases (as discussed below) of products
and/or services from us. Notwithstanding these two conditions, in the event
that we materially breach the strategic business cooperation agreement and
the agreement is terminated as a result Deutsche Telekom, will retain their
preemptive rights so long as it continues to hold not less than 8% of our
issued and outstanding ordinary shares. Deutsche Telekom and/or its
affiliates will be deemed to be making "Substantial Purchases" unless (a)
they are not purchasing products and services (1) at a rate in U.S. dollar
terms at least comparable to that of the same quarter in the prior year or
(2) at levels of at least 5% of our prior quarter revenues on a quarterly
basis and (b) we deliver notice to Deutsche Telekom that this minimum order
threshold is not being achieved and 14 days have elapsed from the date of
delivery of such notice without action by Deutsche Telekom that causes such
threshold to be achieved.
ITEM 13. INTEREST OF MANAGEMENT IN CERTAIN TRANSACTIONS
SHAREHOLDERS AGREEMENT
Some of our shareholders, including LaCresta, Mr. Haramaty, Mr. Cohen,
and Polaris, who hold together approximately 17% of our outstanding share
capital (as of May 31, 2000), entered into a shareholders agreement on
January 31, 1996. This shareholders agreement provides, among other things,
that, subject to certain conditions, the parties to it will exercise their
voting rights in a general meeting to elect six directors to the board of
directors as follows: three directors nominated by LaCresta, one director
nominated by Mr. Haramaty, one director nominated by Mr. Cohen and one
director nominated by Polaris.
In addition, this shareholders agreement provides that all the parties
to it will vote as a group on all matters brought before a general meeting
of shareholders, so long as a majority (as measured by the voting power in
our company) of the shareholders which are party to the shareholders
agreement are in agreement as to the manner in which to vote their shares
on any issue brought before such general meeting.
The term of the shareholders agreement is five years. However, any
shareholder who is a party to the shareholders agreement may, by written
notice to the other parties, unilaterally withdraw, pursuant to the terms
and subject to the conditions of the shareholders agreement.
REGISTRATION RIGHTS AGREEMENT
In 1997, we entered into a registration rights agreement with Deutsche
Telekom, which was effective as of December 29, 1997. Pursuant to the terms
of the registration rights agreement, Deutsche Telekom may demand
registration of all of the ordinary shares that it purchased from us under
the share purchase agreement, at any time following the earlier of (a) a
material breach by us of our obligations under the strategic business
cooperation agreement or (b) the expiration of the strategic business
cooperation agreement. Such demand by Deutsche Telekom shall be in the form
of a written request that all or part of its ordinary shares shall be
registered and/or listed so as to be eligible for public trading on any
securities exchange or exchanges on which our shares are otherwise traded.
In addition, we have agreed to grant Deutsche Telekom certain piggy back
rights if we decide to register ordinary shares, subject to certain
limitations. Under the registration rights agreement, we have also agreed,
to the extent permitted by law, to indemnify Deutsche Telekeom
for claims arising under United States and Israeli securities laws in
connection with material misstatements, omissions or violations by us in a
registration statement effecting a registration under the registration
rights agreement.
DEUTSCHE TELEKOM SHAREHOLDERS AGREEMENT
In connection with the share purchase and strategic business cooperation
agreements, certain of our shareholders, including LaCresta, Messrs.
Haramaty, Cohen, Ganor and Tal and Polaris, also entered into a
shareholders agreement with Deutsche Telekom. Pursuant to this agreement,
each of LaCresta and Messrs. Haramaty, Cohen and Ganor agreed to not reduce
their holdings in VocalTec below 50% of their respective direct or indirect
holdings in VocalTec as of the date of the agreement (December 29, 1997)
without Deutsche Telekom's prior written consent. In addition, under the
agreement, each of LaCresta, Deutsche Telekom , Mr. Haramaty and Mr. Cohen
possess a right of first refusal with respect to the transfer by any of
them of any or all of his or its shares in our company. Although the
agreement contains undertakings of the parties to it to confer with each
other regarding how to vote on any matter put to vote at a meeting of our
shareholders, it does not bind any of the parties to it to vote in any
specific manner. It does, however, restrict the ability of each of the
parties to enter agreements after the effective date of the shareholders
agreement to elect nominees or representatives of third parties to our
board of directors. LaCresta, Polaris, Mr. Haramaty and Mr. Cohen undertook
to, if so requested, vote in favor of a nominee of Deutsche Telekom for our
board of directors if (a) their aggregate holdings of our shares drops
below 12% of our issued and outstanding shares or (b) a person or group of
persons acting together (other than the parties to the agreement) acquires
more than 20% of our shares. The term of this agreement is ten years from
December 29, 1997, provided that Deutsche Telekom may terminate the
agreement if its percentage ownership in our shares declines to less than
5%.
OPTIONS TO SHAREHOLDERS
In August 1995, select shareholders, who also serve as our directors and
officers, were granted options, vesting at various dates between 1997 and
1999, to purchase ordinary shares for an exercise price based on the
valuation of our company at $25 million (which is equal to an exercise
price of $3.983 per share), as follows:
o Lior Haramaty was granted options to purchase 60,000 ordinary shares,
all of which are vested and outstanding;
o Alon Cohen was granted options to purchase 60,000 ordinary shares,
all of which are vested and outstanding;
o Ami Tal was granted options to purchase 60,000 ordinary shares, all
of which are vested and outstanding; and
o Elon Ganor was granted options to purchase 120,000 ordinary shares,
all of which are vested and outstanding.
Dr. Ganor and Mr. Tal, who are brothers in-law, each own 50% of LaCresta,
and each may therefore be deemed to beneficially own all the ordinary
shares owned by the other. In addition, pursuant to the shareholders
agreement described above, each of Mr. Haramaty, Mr. Cohen, Mr. Tal and Dr.
Ganor may be deemed to beneficially own all the ordinary shares owned by
the other parties to the shareholders agreement.
PART II
ITEM 14. DESCRIPTION OF SECURITIES TO BE REGISTERED
Not applicable.
PART III
ITEM 15. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 16. CHANGES IN SECURITIES, CHANGES IN SECURITY FOR REGISTERED
SECURITIES AND USE OF PROCEEDS
Not applicable.
PART IV
ITEM 17. FINANCIAL STATEMENTS
Not applicable.
ITEM 18. FINANCIAL STATEMENTS
Reference is made to the Index on page F-1 of the Consolidated Financial
Statements of our company and the notes thereto contained in this report.
ITEM 19. FINANCIAL STATEMENTS AND EXHIBITS
(a) The following consolidated financial statements, together with the
report of Luboshitz Kasierer & Co., are filed as part of this annual
report:
Page
Index to Consolidated Financial Statements F-1
Independent Auditors' Report F-2
Consolidated Financial Statements and Notes thereto F-3
Financial statement schedules are not included because they are not
applicable or because the required information is contained in the
Consolidated Financial Statements or notes thereto.
(b) None.
SIGNATURE
Pursuant to the requirements of Section 12 of the Securities Exchange
Act of 1934, the Registrant certifies that it meets all the requirements
for filing on Form 20-F and has duly caused this annual report to be signed
on its behalf by the undersigned, thereunto duly authorized.
VOCALTEC COMMUNICATIONS LTD.
By : /s/ Elon Ganor
-------------------------------------
Name: Dr. Elon Ganor
Title: Chairman of the Board of Directors
and Chief Executive Officer
Dated: June 15, 2000
------------------------------------------------------------------------
VOCALTEC COMMUNICATIONS LTD.
------------------------------------------------------------------------
CONSOLIDATED FINANCIAL STATEMENTS AS OF DECEMBER 31, 1999
CONTENTS
PAGE
----
INDEPENDENT AUDITORS' REPORT F-2
CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Balance Sheets F-3 - F-4
Consolidated Statements of Operations F-5
Consolidated Statements of Changes in Shareholders' Equity F-6
Consolidated Statements of Cash Flows F-7 - F-8
Notes to the Consolidated Financial Statements F-9 - F-24
# # # # # #
F-1
(Letterhead of Arthur Andersen)
INDEPENDENT AUDITORS' REPORT
To the Shareholders of
VocalTec Communications Ltd.
We have audited the consolidated balance sheets of VocalTec Communications
Ltd. (an Israeli Corporation) as of December 31, 1998 and 1999, and the
related consolidated statements of operations, changes in shareholders'
equity and cash flows for each of the three years in the period ended
December 31, 1999. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards in Israel and in the United States, including those prescribed
under the Auditors' Regulations (Auditor's Mode of Performance), 1973.
Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used
and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of the
Company as of December 31, 1998 and 1999, and the results of its
operations, the changes in its shareholders' equity and its cash flows for
each of the three years in the period ended December 31, 1999, in
conformity with accounting principles generally accepted in the United
States.
/S/ LUBOSHITZ KASIERER
LUBOSHITZ KASIERER
Member Firm of Arthur Andersen
Tel-Aviv, Israel
January 25, 2000
F-2
VOCALTEC COMMUNICATIONS LTD.
CONSOLIDATED BALANCE SHEETS
In thousands of U.S. dollars (except share data)
DECEMBER 31
-------------------
NOTE 1998 1999
---- ------- -------
CURRENT ASSETS
Cash and cash equivalents (3) 4,990 31,915
Short-term investments (4) 31,374 1,730
Trade receivables (net of allowances) (5) 9,012 6,163
Other receivables and deferred charges (6) 3,322 3,068
Inventories 1,653 1,602
------- -------
Total current assets 50,351 44,478
------- -------
INVESTMENT IN A COMPANY (7) 2,373 37,845
------- -------
EQUIPMENT (8) 6,126 5,619
------- -------
DEPOSIT WITH INSURANCE COMPANIES (10) 1,095 1,329
------- -------
59,945 89,271
======= =======
F-3
DECEMBER 31
-------------------
NOTE 1998 1999
---- ------- -------
CURRENT LIABILITIES
Accounts payable and accrued expenses (9) 7,850 8,503
------- -------
LONG-TERM LIABILITIES
Long term bank loans (11) - 20,017
Accrued severance pay (10) 1,224 1,761
------- -------
1,224 21,778
------- -------
Total liabilities 9,074 30,281
------- -------
COMMITMENTS AND CONTINGENCIES (12)
SHAREHOLDERS' EQUITY
Share capital (13)
Ordinary shares of NIS 0.01 par value:
Authorized - 30,000,000 shares;
Issued and outstanding - 11,771,302
shares as of December 31, 1999, and
11,413,420 shares as of December
31, 1998 35 35
Share premium 92,696 94,627
Deferred compensation (291) (188)
Accumulated other comprehensive income - 34,471
Accumulated deficit (41,569) (69,955)
------- -------
Total shareholders' equity 50,871 58,990
------- -------
59,945 89,271
======= =======
THE ACCOMPANYING NOTES FORM AN INTEGRAL PART OF THESE
CONSOLIDATED FINANCIAL STATEMENTS.
F-4
VOCALTEC COMMUNICATIONS LTD.
CONSOLIDATED STATEMENTS OF OPERATIONS
In thousands of U.S. dollars (except share and per share data)
YEAR ENDED DECEMBER 31
------------------------------
NOTE 1997 1998 1999
---- -------- -------- --------
Net sales (14) 15,683 24,650 26,615
Cost of sales (15) 2,243 5,938 8,156
-------- -------- --------
Gross profit 13,440 18,712 18,459
-------- -------- --------
Operating expenses
Research and development costs (16) 5,519 11,192 13,157
Marketing and selling expenses (17) 13,449 18,509 27,171
General and administrative expenses 3,196 5,204 6,592
-------- -------- --------
22,164 34,905 46,920
-------- -------- --------
Operating loss (8,724) (16,193) (28,461)
Financing income, net 1,044 2,668 902
-------- -------- --------
Loss before one time charge (7,680) (13,525) (27,559)
One time charge in respect of acquired
in-process research and development
(1999 - restructuring costs) - 9,656 827
-------- -------- --------
Net loss (7,680) (23,181) (28,386)
======== ======== ========
Basic and diluted net loss per share (0.89) (2.08) (2.47)
======== ======== ========
Weighted average number of shares
outstanding - basic and diluted 8,618,161 11,144,584 11,497,723
======== ======== ========
THE ACCOMPANYING NOTES FORM AN INTEGRAL PART OF THESE
CONSOLIDATED FINANCIAL STATEMENTS.
F-5
<TABLE>
<CAPTION>
VOCALTEC COMMUNICATIONS LTD.
CONSOLIDATED STATEMENTS OF CHANGES IN
SHAREHOLDERS' EQUITY
In thousands of U.S. dollars (except share data)
ACCUMULATED
OTHER
NUMBER SHARE SHARE DEFERRED COMPREHENSIVE ACCUMULATED
OF SHARES CAPITAL PREMIUM COMPENSATION INCOME DEFICIT TOTAL
---------- ------- ------- ------------ ------------- ----------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance as of
January 1, 1997 8,612,990 28 38,224 (326) - (10,708) 27,218
Shares issued 14,500 - 68 - - - 68
Deferred compensation - - 137 (137) - - -
Amortization of
deferred compensation - - - 105 - - 105
Net loss - - - - - (7,680) (7,680)
---------- ------- ------- ------------ ------------- ----------- --------
Balance as of
December 31, 1997 8,627,490 28 38,429 (358) - (18,388) 19,711
Shares issued 2,785,930 7 54,267 - - - 54,274
Amortization of
deferred compensation - - - 67 - - 67
Net loss - - - - - (23,181) (23,181)
---------- ------- ------- ------------ ------------- ----------- --------
Balance as of
December 31, 1998 11,413,420 35 92,696 (291) - (41,569) 50,871
Shares issued 357,882 - 1,999 - - - 1,999
Deferred compensation - - 177 (177) - - -
Amortization of
deferred compensation - - (245) 280 - - 35
Comprehensive income:
Net loss - - - - - (28,386) -
Unrealized gain from
available-for-sale
securities - - - - 34,471 - -
---------- ------- ------- ------------ ------------- ----------- --------
Total comprehensive
income - - - - - - 6,085
---------- ------- ------- ------------ ------------- ----------- --------
Balance as of
December 31, 1999 11,771,302 35 94,627 (188) 34,471 (69,955) 58,990
========== ======= ======= ============ ============= =========== ========
THE ACCOMPANYING NOTES FORM AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.
</TABLE>
F-6
<TABLE>
<CAPTION>
VOCALTEC COMMUNICATIONS LTD.
CONSOLIDATED STATEMENTS OF CASH FLOWS
In thousands of U.S. dollars
YEAR ENDED DECEMBER 31
---------------------------------
1997 1998 1999
-------- -------- --------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss (7,680) (23,181) (28,386)
Adjustments to reconcile net loss to net cash
in operating activities
Expenses not affecting operating cash flows:
Amortization of deferred compensation 105 67 35
Severance pay, net 19 (28) 303
Depreciation 718 1,914 3,584
Equity in losses of an affiliated company 80 201 -
Acquired of in-process research and
development - 9,656 -
Other - (1,000) 24
Changes in operating assets and liabilities:
Decrease (increase) in trade receivables (1,879) (3,003) 2,849
Decrease (increase) in other receivables (62) (1,429) 254
Decrease (increase) in inventories 46 (758) 51
Increase in accounts payable and accrued 1,142 3,406 653
-------- -------- --------
Net cash used in operating activities (7,511) ( 14,155) ( 20,633)
-------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Short-term investments 8,822 (25,772) 29,644
Investment in a company (510) (1,140) (1,000)
Purchase of equipment (1,830) (4,568) (3,228)
Proceeds from sale of equipment - - 143
Purchase of Radlinx, net of cash acquired - (2,837) -
-------- -------- --------
Net cash provided by (used in) investing 6,482 (34,317) 25,559
-------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuance of share capital 68 46,298 -
Deferred charges in connection with shares
issuance (390) - -
Long-term bank loans received - - 20,000
Proceeds from options exercised - 322 1,999
-------- -------- --------
Net cash provided by (used in) financing
activities (322) 46,620 21,999
-------- -------- --------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (1,351) (1,852) 26,925
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 8,193 6,842 4,990
-------- -------- --------
CASH AND CASH EQUIVALENTS AT END OF YEAR 6,842 4,990 31,915
======== ======== ========
NON-CASH ACTIVITIES
Unrealized gain from available-for-sale
securities - - 34,471
======== ======== ========
Investment in other company in consideration
for Company's products - 1,000 -
======== ======== ========
THE ACCOMPANYING NOTES FORM AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.
</TABLE>
F-7
VOCALTEC COMMUNICATIONS LTD.
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONT.)
In thousands of U.S. dollars
YEAR ENDED DECEMBER 31
----------------------------
1997 1998 1999
-------- -------- --------
PURCHASE OF RADLINX
Assets and liabilities at date of purchase:
Working capital (excluding cash) - (680) -
Fixed assets - (104) -
Acquired of in-process research and
development - (9,656) -
Other goodwill-type intangible assets - (51) -
-------- -------- --------
(10,491) -
Less - Issuance of shares - 7,654 -
-------- -------- --------
- (2,837) -
======== ======== ========
THE ACCOMPANYING NOTES FORM AN INTEGRAL PART OF THESE
CONSOLIDATED FINANCIAL STATEMENTS.
F-8
VOCALTEC COMMUNICATIONS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
In thousands of U.S. dollars
NOTE 1 - GENERAL
A. The Company, an Israeli corporation, develops and markets
systems enabling voice, fax and multimedia communications
over packaging networks, including both private networks and
the public internet.
B. The accompanying financial statements have been prepared in
U.S. dollars, as the currency of the primary economic
environment in which the operations of the Company are
conducted is the U.S. dollar. Most of the Company's sales
are made outside Israel in non-Israeli currencies (mainly
the U.S. dollar). A majority of the costs and expenses are
made outside Israel in non-Israeli currencies, primarily in
U.S. dollars. Thus, the functional currency of the Company
is the U.S. dollar.
Transactions and balances originally denominated in U.S.
dollars are presented at their original amounts.
Transactions and balances in other currencies are remeasured
into U.S. dollars in accordance with principles identical to
those set forth in Statement No. 52 of the Financial
Accounting Standards Board of the United States ("FASB").
Accordingly, items have been remeasured as follows:
Monetary items - at the current exchange rate at balance
sheet date.
Nonmonetary items - at historical exchange rates.
Income and expenditure items - at exchange rates current as
of date of recognition of those items (excluding
depreciation and other items deriving from nonmonetary
items).
Exchange gains and losses from the translation mentioned
above (which are immaterial for each reported period) are
reflected in the statement of operations. The representative
rate of exchange at December 31, 1999 was U.S. $1.00 - 4.153
New Israeli Shekel (NIS) (December 31, 1998 and 1997 - NIS
4.16 and NIS 3.536, respectively).
F-9
VOCALTEC COMMUNICATIONS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONT.)
In thousands of U.S. dollars
NOTE 2 - SIGNIFICANT ACCOUNTING POLICIES
The financial statements have been prepared in conformity with
accounting principles generally accepted in the United States.
The significant accounting policies followed in the preparation
of the financial statements, applied on a consistent basis, are
as follows:
A. PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts
of the Company and its wholly-owned subsidiaries in the U.S.
(VocalTec Communications Inc.), in the U.K. (VocalTec
Communications U.K. Limited), in Japan (VocalTec
Communications Japan K.K.) in Germany (VocalTec
Communications GmbH) and in China (VocalTec representative
office Beijing China). Material intercompany balances and
transactions have been eliminated.
B. INVESMENT IN A COMPANY
The non-restricted portion of an investment in a
publicly-traded company which is available for sale is
recorded at fair market value in accordance with Statement
of Financial Accounting Standards No. 115 "Accounting for
Certain Investments in Debt and Equity Securities". The
difference between the fair market value and cost
(unrealized gain) is included as a separate component of
shareholders' equity.
C. CASH AND CASH EQUIVALENTS
For the purpose of the statements of cash flows, all highly
liquid investments (short-term bank deposits) are considered
cash equivalents if the investments mature within three
months from the date of acquisition.
D. ALLOWANCE FOR DOUBTFUL DEBTS
Allowance for doubtful debts is computed for specific debts
the collectibility of which, is doubtful and based upon the
Company's experience.
F-10
VOCALTEC COMMUNICATIONS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONT.)
In thousands of U.S. dollars
NOTE 2 - ACCOUNTING POLICIES (CONT.)
E. INVENTORIES
Inventories are stated at the lower of cost or market.
Inventory cost is determined by the "first-in, first-out"
method.
F. EQUIPMENT
Equipment is stated at cost. Depreciation is computed by the
straight-line method over the estimated useful life of the
assets.
G. RESEARCH AND DEVELOPMENT COSTS
Research and development costs, net of participations by the
Government of Israel through the Ministry of Industry and
Trade, Office of the Chief Scientist, are charged to
operations as incurred. Software development costs are
considered for capitalization when technological feasibility
is established in accordance with Statement of Financial
Accounting Standards ("SFAS") No. 86, "Accounting for the
Costs of Computer Software to be Sold, Leased or Otherwise
Marketed." Costs incurred subsequent to achievement of
technological feasibility in the process of software
production have not been material. Therefore, the Company
has not capitalized any of its research and development
expenses and does not anticipate that its development
process will differ materially in the future.
H. INCOME TAXES
The Company accounts for income taxes under the liability
method of accounting. Under the liability method, deferred
taxes are determined based on the differences between the
financial statement and tax bases of assets and liabilities
at enacted tax rates in effect in the year in which the
differences are expected to reverse. Valuation allowances
are established, when necessary, to reduce deferred tax
assets to amounts expected to be realized.
F-11
VOCALTEC COMMUNICATIONS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONT.)
In thousands of U.S. dollars
NOTE 2 - ACCOUNTING POLICIES (CONT.)
I. REVENUE RECOGNITION
Revenues are generally recognized upon shipment of the
product and when collectibility is probable. An estimated
reserve for product returns is recorded at the time of sale
where applicable.
J. SHARE-BASED COMPENSATION
The Company has adopted the disclosure provisions of SFAS
No. 123, "Accounting for Stock-Based Compensation," and the
accounting rules set forth in Accounting Principles Board
("APB") Opinion No. 25, "Accounting for Stock Issued to
Employees." The Company has provided the necessary pro forma
disclosures as if the fair value method had been applied
(See Note 13).
K. BASIC AND DILUTED NET LOSS PER SHARE
Basic and diluted net loss per share are presented in
accordance with SFAS No. 128, "Earnings per Share", for all
periods presented. Basic and diluted net loss per share have
been computed using the weighted-average number of ordinary
shares outstanding during the period. The total number of
shares related to the outstanding options excluded from the
calculations of diluted net loss per share were 1,294,850,
2,007,575 and 2,879,943 for the years ended December 31,
1997, 1998 and 1999, respectively.
L. 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 disclosure of
contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues
and expenses during the reporting period. Actual results
could differ from those estimates.
F-12
VOCALTEC COMMUNICATIONS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONT.)
In thousands of U.S. dollars
NOTE 3 - CASH AND CASH EQUIVALENTS
DECEMBER 31
------------------
1998 1999
------- -------
Cash in banks 1,817 1,277
Bank deposits (bearing annual
interest rate of 4.88% to 6.18%) 3,173 30,638
------- -------
4,990 31,915
======= =======
NOTE 4 - SHORT-TERM INVESTMENTS
DECEMBER 31
-------------------
1998 1999
------- --------
Bank deposits (bearing annual
interest rate of 6.38%) 19,012 730
Marketable securities 12,362 1,000
------- -------
31,374 1,730
======= =======
NOTE 5 - TRADE RECEIVABLES
DECEMBER 31
-------------------
1998 1999
------- --------
Trade receivables 16,793 12,806
Allowance for doubtful debts
and unrecognized income 7,781 6,643
------- -------
9,012 6,163
======= =======
NOTE 6 - OTHER RECEIVABLES AND DEFERRED CHARGES
DECEMBER 31
-------------------
1998 1999
------- --------
Government participation receivables 701 1,703
Prepaid expenses 685 620
Other 1,936 745
------- -------
3,322 3,068
======= =======
F-13
VOCALTEC COMMUNICATIONS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONT.)
In thousands of U.S. dollars
NOTE 7 - INVESTMENT IN A COMPANY
The Company has an investment in ITXC Inc. ("ITXC") that in
October 1999 completed its initial public offering ("IPO") on the
Nasdaq in the U.S. As part of the offering the Company agreed not
to dispose of any shares of ITXC for a period ending in March
2000. In addition, the Company's investment in ITXC is subject to
Rule 144 under the Securities Act of 1933 which restricts during
a specified period the number of shares of ITXC that the Company
may sell. As of December 31, 1999, the portion of the Company's
investment in ITXC which is not restricted is classified as
"available-for-sale" and stated at fair market value. A portion
of the above shares have been pledged as security for bank loans
- see Note 11. The investment in ITXC is presented in the balance
sheet as follows:
DECEMBER 31
-------------------
1998 1999
------- --------
At fair market value - 35,104
At cost (fair market value at
December 31, 1999 - $152,117) 2,373 2,741
------- -------
2,373 37,845
======= =======
NOTE 8 - EQUIPMENT
ANNUAL DECEMBER 31
RATES OF -----------------
DEPRECIATION 1998 1999
------------ ------ -------
Computers and related 25-33% 6,632 9,018
Office furniture, equipment
and leasehold improvements 7-25% 2,317 2,511
Motor vehicles 15-25% 177 10
------ ------
9,126 11,539
Less - accumulated
depreciation 3,000 5,920
------ ------
Net book value 6,126 5,619
====== ======
F-14
VOCALTEC COMMUNICATIONS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONT.)
In thousands of U.S. dollars
NOTE 9 - ACCOUNTS PAYABLE AND ACCRUED EXPENSES
DECEMBER 31
-----------------
1998 1999
----- -----
Suppliers 4,015 2,612
Employees and related expenses 2,077 2,139
Other (mainly accrued expenses) 1,758 3,752
----- -----
7,850 8,503
===== =====
NOTE 10 - SEVERANCE PAY
The Company's severance pay obligation to its employees is
partially covered by payments to insurance companies. The accrual
for severance pay and deposits with insurance companies in
respect of severance pay are included in the balance sheet.
Severance pay expenses, amounted to $349, $498 and $537 for the
years ended December 31, 1997, 1998 and 1999, respectively.
NOTE 11 - LONG-TERM BANK LOANS
The loans bear interest at Libor plus 1.5% (libor at December 31,
1999 - 6.2%). Loan principal of $10,000 is to be repaid in four
equal quarterly installments commencing in April 2001 and loan
principal of $10,000 is repayable in August 2002. As collateral
for the loans, the Company has pledged shares of ITXC stock with
an aggregate fair market value of approximately $91,900 as of
December 31, 1999. Should the aggregate fair market value decline
below approximately $50,000, the Company will be required to
provide additional security or repay a portion of the loans. The
loan agreements also contain financial covenants.
The Company also has an unutilized credit line in the amount of
$5,000 available until April 2000 at the same interest rate as
the abovementioned loans.
F-15
VOCALTEC COMMUNICATIONS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONT.)
In thousands of U.S. dollars
NOTE 12 - COMMITMENTS AND CONTINGENCIES
A. In connection with its research and development, the Company
received and accrued participation payments from the Office
of the Chief Scientist of the Ministry of Industry and Trade
in Israel in the total amount of approximately $2.0 million.
In return for the Government of Israel's participation, the
Company is committed to pay royalties at a rate of 3% - 5%
of sales of the developed product, up to 100%-150% of the
amount of grants received (for grants received under
programs approved subsequent to January 1, 1999, 100% plus
interest at LIBOR). The Company's total commitment for
royalties payable with respect to future sales, based on
Government of Israel participations received or accrued, net
of royalties paid or accrued, totaled approximately $1.4
million as of December 31, 1999.
B. Certain claims, mainly for patent infringement and breach of
contract, have been asserted against the Company or its U.S.
subsidiary. Management estimates that these claims will not
have material effect on the Company.
C. The Company's facilities in Israel are rented under an
operating lease for the periods ending July, 2001 to April,
2004 (some with renewal options). Annual minimum future
rental payments at balance sheet date are approximately as
follows:
2000 1,730
2001 1,620
2002 920
2003 350
2004 120
-----
4,740
=====
F-16
VOCALTEC COMMUNICATIONS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONT.)
In thousands of U.S. dollars
NOTE 13 - SHARE CAPITAL
Through December 31, 1999, the Company has granted options to
purchase Ordinary Shares to key employees, officers, directors
and consultants of the Company as an incentive to attract and
retain qualified persons. Options generally become exercisable
within two to four years from the date of the grant. Options were
granted at varying prices ranging from $0 to the fair market
value at the date of the grant.
In 1997 and 1998, the Company adopted a stock option and
incentive plan (the "Option Plan") which provides for the grant
by the Company of restricted shares or options to purchase up to
an aggregate of 750,000 and 1,000,000 Ordinary Shares
respectively, to officers, directors, key employees, or
consultants of the Company or any of its subsidiaries. The plan
will expire 10 years after its adoption unless terminated earlier
by the Board of Directors. The exercise price of stock options
issued under the Option Plan will be no less than 95%, of the
fair market value of the Ordinary Shares as of the date of grant.
In 1999, the Company adopted a stock option and incentive plan
(the "Option Plan") which provides for the grant by the Company
of restricted shares or options to purchase up to an aggregate of
1,000,000 Ordinary Shares to officers, directors, employees, and
consultants of the Company or any of its subsidiaries. The plan
will expire 10 years after its adoption unless terminated earlier
by the Board of Directors. The exercise price of stock options
issued under the Option Plan will be no less than 95% of the fair
market value of the Ordinary Shares as of the date of grant.
The Ordinary Shares acquired upon exercise of an option and the
restricted shares will be subject to certain restrictions on
transfer, sale or hypothecation. Options will be exercisable and
restrictions on deposition of shares will lapse pursuant to the
terms of the individual agreements under which such options were
granted or shares issued.
F-17
VOCALTEC COMMUNICATIONS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONT.)
In thousands of U.S. dollars
NOTE 13 - SHARE CAPITAL (CONT.)
Transactions related to the above discussed options during the
three years ended December 31, 1999 are summarized as follows:
WEIGHTED
AVERAGE
WEIGHTED- FAIR
AVERAGE VALUE OF
NUMBER PRICE OPTIONS
OF SHARE PER SHARE GRANTED
---------- --------- --------
Outstanding January 1, 1997 778,850
Granted 571,500 $6.56 $4.04
Exercised (14,500) $4.76
Forfeited (41,000) $4.21
Outstanding December 31, 1997 1,294,850
Granted 961,500 $7.35 $4.73
Exercised (64,025) $4.96
Forfeited (184,750) $6.53
Outstanding December 31, 1998 2,007,575
Granted 1,775,950 $10.92 $6.00
Exercised (357,882) $6.23
Forfeited (545,700) $7.66
Outstanding December 31, 1999 2,879,943
=========
F-18
VOCALTEC COMMUNICATIONS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONT.)
In thousands of U.S. dollars
NOTE 13 - SHARE CAPITAL (CONT.)
The following table summarizes information about options
outstanding and exercisable at December 31, 1999:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
--------------------------------------- ------------------------
NUMBER WEIGHTED- WEIGHTED- NUMBER WEIGHTED-
RANGE OF OUTSTANDING AVERAGE AVERAGE OUTSTANDING AVERAGE
EXERCISE AT REMAINING EXERCISE AT EXERCISE
PRICES DECEMBER 31, CONTRACTUAL PRICES DECEMBER 31, PRICES
1999 LIFE 1999
$ $ $
-------- ------------ ----------- -------- ------------ --------
<S> <C> <C> <C> <C> <C>
0 30,000 5.00 0.00 15,000 0
3.95-5.95 464,200 6.00 4.27 433,337 4.18
6.29-6.65 187,750 7.50 6.64 144,500 6.64
7.00 109,934 7.50 7.00 24,001 7.00
7.13-7.50 543,250 8.50 7.39 106,164 7.42
8.96-9.43 441,009 9.50 9.18 99,970 9.08
10.45-11.00 401,000 9.50 10.52 0 10.52
11.5-11.81 68,000(*) 9.75 11.72 3,000 11.81
12.83-14.00 603,300 10.00 13.25 0 13.25
16.15-16.79 31,500 6.00 16.85 6,500 16.15
--------- -------
2,879,943 832,472
========= ========
</TABLE>
(*) Includes 28,000 options granted to Consultants in 1999 for whom
deferred compensation in the amount of $177 was calculated based
on the fair value of the options on the date granted using the
Black-Scholtes method. Under SFAS No. 123 the compensation cost
that has been charged to operations for the year ended December
31, 1999 amounted to $8.
The aggregate amount of deferred compensation recorded arising
from the difference between the exercise price and the fair
market value on the date of the grant of $772 is included in
shareholders' equity and is being amortized over the vesting
periods of the respective options in accordance with APB 25. The
balance of unamortized compensation at December 31, 1999 is $19.
Under APB 25 the compensation cost that has been charged to
operations for the year ended December 31, 1999 amounted to $27
(1998 - $67).
F-19
VOCALTEC COMMUNICATIONS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONT.)
In thousands of U.S. dollars
NOTE 13 - SHARE CAPITAL (CONT.)
Had compensation cost been determined under the alternative fair
value accounting method provided for under FASB Statement No.
123, "Accounting for Stock-Based Compensation" the Company's net
loss and net loss per share would have been increased to the
following pro forma amounts:
1997 1998 1999
-------- -------- --------
Net loss:
As reported (7,680) (23,181) (28,386)
Pro forma (8,714) (24,497) (30,657)
Net loss per share:
As reported (0.89) (2.08) (2.47)
Pro forma (1.01) (2.20) (2.67)
Under Statement 123 the fair value of each option grant is
estimated on the date of grant using the Black-Scholes
option-pricing model with the following weighted-average
assumptions used for grants in 1997, 1998 and 1999: (1) expected
life of the option of 2.5 years (1997 - 3, 1998 - 2); (2)
dividend yield of 0% (1997, 1998 - same); (3) expected volatility
of 95% (1997 - 92%, 1998 - 120%), (4) risk-free interest rate of
5% (1997, 1998 - 6%).
F-20
VOCALTEC COMMUNICATIONS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONT.)
In thousands of U.S. dollars
NOTE 14 - NET SALES
YEAR ENDED DECEMBER 31
-------------------------
1997 1998 1999
------ ------ ------
The Company's sales by
North America (principally
United States 10,980 7,917 3,556
Europe 2,845 13,355 16,687
Far East 1,475 2,084 5,573
Other 383 1,294 799
------ ------ ------
15,683 24,650 26,615
====== ====== ======
% % %
------ ------ ------
Sales to a single customer
exceeding 10%:
Customer A 11 - -
Customer B 11 - -
Customer C 11 39 49
NOTE 15 - COST OF SALES
Cost of sales include royalties
to the Government of Israel 103 73 219
====== ====== ======
F-21
VOCALTEC COMMUNICATIONS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONT.)
In thousands of U.S. dollars
NOTE 16 - RESEARCH AND DEVELOPMENT COSTS, NET
YEAR ENDED DECEMBER 31
---------------------------
1997 1998 1999
------ ------ ------
Payroll and related expenses 5,147 9,001 10,055
Subcontractors and other expenses 1,796 3,618 5,190
------ ------ ------
6,943 12,619 15,245
Less - participations by the
Government of Israel:
Royalty bearing participation - 261 1,316
Other participation 1,424 1,166 772
------ ------ ------
5,519 11,192 13,157
====== ====== ======
NOTE 17 - MARKETING AND SELLING EXPENSES, NET
YEAR ENDED DECEMBER 31
---------------------------
1997 1998 1999
----- ----- -----
Marketing and selling expenses
include:
Royalties to the Government
of Israel 331 410 -
===== ===== =====
Bad and doubtful debt 2,284 2,015 2,637
===== ===== =====
Marketing and selling expenses
are net of participations by
the Government of Israel 198 432 -
===== ===== =====
F-22
VOCALTEC COMMUNICATIONS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONT.)
In thousands of U.S. dollars
NOTE 18 - TAXES ON INCOME
The Company is subject to the Income Tax Law (Inflationary
Adjustments), 1985, measuring income on the basis of changes in
the Israeli Consumer Price Index.
The Company's investment in equipment in the amount of
approximately $300 has received approval in accordance with the
Law for the Encouragement of Capital Investments, 1959 ("approved
enterprise" status). The Company has chosen to receive its
benefits through the "Alternative Benefits" program, and, as
such, is eligible for various benefits. These benefits include
accelerated depreciation of fixed assets 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 for an additional
period of up to eight years (depending on the percentage of
foreign share ownership in the Company), commencing with the date
on which taxable income is first earned. The benefits are subject
to the fulfillment of the conditions of the letter of approval.
As the Company has not yet reported any taxable income, the
benefits period has not yet commenced.
The regular tax rate applicable to the Company is 36%. Income
derived by the Company from its approved enterprise, is to be
exempt from tax for two years and will be liable to reduced rate
of 25% for additional period of up to 8 years. The 25% rate may
be reduced further, depending on the rate of foreign share
holding in the Company. Dividends paid by the Company out of
regular income are liable to 25% withholding at source. Dividends
paid out of the approved plan income are liable to 15%
withholding. Should the Company pay dividends out of income
earned during the two-year tax holiday, it will be liable to 25%
tax on that income (or lower rate depending on the rate of
foreign share holding).
As the Company is exempt from tax, the statutory tax rate for the
purposes of the reconciliation of reported tax expense is zero.
Tax assessments for the years up to 1995 have been agreed with
the tax authorities.
F-23
VOCALTEC COMMUNICATIONS LTD.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONT.)
In thousands of U.S. dollars
NOTE 18 - TAXES ON INCOME (CONT.)
The Company has net operating loss carryforwards for tax purposes
of approximately $33 million as of December 31, 1999, of which
approximately $8 million (net of unrealized gain on available for
sale securities of approximately $34 million) is attributable to
the U.S. subsidiary and will expire in 2013. The balance of
approximately $25 million is attributable to the Company and has
no expiration period. Due to the uncertainty of realizing the
benefit of the loss carryforwards, a valuation allowance for the
entire deferred tax assets has been recorded. Deferred taxes in
respect of other temporary difference are immaterial.
NOTE 19 - RELATED PARTIES' BALANCES AND TRANSACTIONS
A. BALANCES WITH RELATED PARTIES
DECEMBER 31
-----------------
1998 1999
----- -----
Trade receivables 4,025 4,017
B. TRANSACTIONS WITH RELATED PARTIES
FOR THE YEAR ENDED
---------------------------
DECEMBER 31
---------------------------
1997 1998 1999
------ ------ ------
Sales 243 9,613 13,092
# # # # # # # #
F-24
VOCALTEC COMMUNICATIONS LTD. AND SUBSIDIARIES
Schedule II
Valuation and Qualifying Accounts
<TABLE>
<CAPTION>
INCREASE (DECREASE)
CHARGED TO
(DEDUCTED CHARGED TO
BALANCE AT FROM) (DEDUCTED BALANCE AT
BEGINNING BAD DEBT FROM) END OF
OF PERIOD EXPENSE SALES PERIOD
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Year ended December 31, 1997
Allowance for doubtful accounts - $696 - $696
Allowance for sales returns $2,687 - $2,811 $5,498
Year ended December 31, 1998
Allowance for doubtful accounts $696 $1,559 - $2,255
Allowance for sales returns $5,498 - $28 $5,526
Year ended December 31, 1999
Allowance for doubtful accounts $2,255 $(833) - $1,422
Allowance for sales returns $5,526 - $(305) $5,221
</TABLE>
