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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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AMENDMENT NO. 2 ON
FORM 10-K/A
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
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COMMISSION FILE NUMBER 0-19771
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DATA SYSTEMS & SOFTWARE INC.
(Exact name of registrant as specified in charter)
DELAWARE 22-2786081
(State or other jurisdiction of (I.R.S. employer identification
incorporation or organization) no.)
200 ROUTE 17, MAHWAH, NEW JERSEY 07430
Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code (201) 529-2026
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, PAR VALUE $.01 PER SHARE
COMMON STOCK PURCHASE RIGHTS
(Title of Class)
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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes /X/ No / /
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10K. /X/
The aggregate market value of the common stock held by non-affiliates of the
registrant at March 18, 1998 was approximately $41.5 million. The aggregate
market value was calculated by using the closing price of the stock on that date
on the Nasdaq National Market.
Number of shares outstanding of the registrant's common stock, as of March
18, 1998: 7,369,178.
DOCUMENTS INCORPORATED BY REFERENCE:
None
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INTRODUCTORY NOTE
This Amendment on Form 10-K/A amends the Registrant's Annual Report on Form
10-K, as filed by the Registrant on March 31, 1998 as amended on April 30, 1998,
and is being filed to reflect the restatement of the Registrant's consolidated
financial statements (the "Restatement"). The Restatement relates to an order of
the Israel Securities Authority that the Registrant's Decision Systems Israel
Ltd. subsidiary restate its financial statements for all periods commencing
December 31, 1992 through March 31, 1998 and expense certain items on its
balance sheets, primarily all previously capitalized software development costs
associated with its Electric Power Supply Management ("EPSM") system. Unless
otherwise noted, all information provided in this Annual Report is current as
of March 31, 1998, the original filing date of the Form 10-K. Information
regarding recent events at the Registrant can be obtained from reports filed by
the Registrant with respect to its activities during 1998, including the
Registrant's Quarterly Report on Form 10-Q for the period ended June 30, 1998
and Notes 21 and 22 to the consolidated financial statements of the Registrant
included herewith.
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TABLE OF CONTENTS
<TABLE>
<S> <C> <C>
PART I
Item 1 Business................................................................... 1
Item 2 Properties................................................................. 13
Item 3 Legal Proceedings.......................................................... 14
Item 4 Submission of Matters to a Vote of Security Holders........................ 14
PART II
Item 5 Market for Registrant's Common Equity and Related Stockholder Matters...... 15
Item 6 Selected Financial Data.................................................... 15
Item 7 Management's Discussion and Analysis of Financial Condition and Results of 17
Operations.................................................................
Item 8 Financial Statements and Supplementary Data................................ 24
Item 9 Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure................................................................. 24
PART IV
Item 14 Exhibits, Financial Statements Schedules, and Reports on Form 8-K.......... 25
</TABLE>
Certain statements contained in this report are forward-looking in nature.
These statements are generally identified by the inclusion of phrases such as
"the Company expects," "the Company anticipates," "the Company believes," "the
Company estimates," and other phrases of similar meaning. Whether such
statements ultimately prove to be accurate depends upon a variety of factors
that may affect the business and operations of the Company. For a discussion of
such factors see "Item 1. Business-- Factors Which May Affect Future Results."
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PART I
ITEM 1. BUSINESS
GENERAL
Data Systems & Software Inc. ("DSSI"), through its subsidiaries and
affiliates in the United States and in Israel (collectively, the "Company"), (i)
provides computer consulting and development services to customers, (ii) has
developed and is currently marketing PHD-TM---Professional Help Desk-TM-, an
integrated software suite for the "help desk" market, (iii) acts as an
authorized direct seller, value-added-reseller ("VAR") and integrator of
computer hardware systems and (iv) provides data communications and related
products and services to utilities and other customers.
Through the end of 1996, the Company conducted its business through two
business segments: the Computer Segment and the Semiconductor Segment (conducted
through Tower Semiconductor Ltd. ("Tower")). Although the Company retains
effective control of Tower, due to changes in the Company's voting control in
Tower, the balance sheets as at December 31, 1996 and December 31, 1997 do not
include Tower balances. Commencing with 1997, the Company accounts for its
interest in Tower's results using the equity method, including its pro-rata
share of Tower's net income as equity income.
The following table shows, for the years indicated, the dollar amount and
the percentage of the sales attributable to the different activities of the
Computer Segment:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
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<S> <C> <C> <C> <C> <C> <C>
1995 1996 1997
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<CAPTION>
AMOUNT % AMOUNT % AMOUNT %
--------- --------- --------- --------- --------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Consulting and development services............................ $ 20,871 69% $ 19,783 59% $ 20,573 52%
Computer hardware and VAR sales................................ 8,440 28% 12,285 36% 15,170 38%
Professional Help Desk software................................ 891 3% 1,802 5% 3,842 10%
--------- --------- --------- --------- --------- ---------
Total Computer Segment......................................... $ 30,202 100% $ 33,870 100% $ 39,585 100%
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CONSULTING AND DEVELOPMENT SERVICES
The Company provides computer software and systems consulting and
development services, primarily to high technology customers in Israel and the
United States. The Company's principal area of technological expertise is
state-of-the-art, embedded real-time software systems in a wide variety of
applications, including telecommunications, digital signal processing, image
processing and software testing and validation, radar, navigation, electronic
warfare, simulation and electro-optics.
The Company provides consulting and development services to customers
primarily by furnishing software and systems engineers, programmers and
technicians who perform design and development activities, generally on the
customer's premises. In these engagements, the Company's personnel generally
work under the customer's direction, having no specific obligation for product
delivery, and the customer pays the Company on a time and materials basis for
the services provided. During 1995, 1996 and 1997, sales attributable to
services provided on a time and materials basis were $14.9 million, $12.2
million and $16.8 million, respectively, accounting for approximately 49%, 36%
and 42% of Computer Segment sales for such years, respectively.
In addition to performing services on a time and materials basis, the
Company also undertakes work on a project basis with full responsibility for
delivering a specific software or hardware/software solution to a customer's
specifications or requirements. These projects generally are performed at fixed
prices and the profit margins on these projects are primarily determined by the
Company's success in controlling project costs. Profits derived from such
contracts may vary substantially as a result of various factors, including risk
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of loss due to underestimating costs, difficulties with new technologies and
economic and other changes that may occur during the term of the contract.
During 1995, 1996 and 1997, sales from fixed price contracts were $2.3 million,
$2.7 million and $2.8 million, respectively, accounting for approximately 7% of
Computer Segment revenues during these years.
The Company provides dedicated Internet access to business customers in
greater Cincinnati, Ohio. In addition, the Company provides web hosting for
business customers primarily in the United States and provides an international
resume database of experienced information systems professionals (known as
placeum.com) to professional recruiters on a subscription basis.
HELP DESK SOFTWARE
The Company develops and markets customer service and support solutions
catering to the help desk segment of the CIS market. A help desk is, typically,
a service center set up by the information services (IS) department of an
organization to answer questions and solve problems relating to computer
hardware, software, telecommunications systems, or any company-specific issues.
PHD Professional Help Desk solutions address the needs of customers operating
within a client/server environment, with users enjoying out-of-box, customizable
solutions that include call, asset and problem management, in addition to Web-
based support and remote analyst and end-user access.
The Company's products are designed to allow help desk personnel to manage
incoming telephone calls, Web-based inquiries, or e-mail messages (call
management), resolve problems and capture knowledge (problem/knowledge
management), and manage personnel, equipment and other company resources (asset
management). PHD utilizes Experienced Based Reasoning-TM- (EBR-TM-), the
Company's proprietary problem resolution engine that automatically captures
customer data and creates a pool of shared knowledge about the nature of the
problems encountered and the solutions proposed. This effectively helps lessen
the problems associated with the help desk analyst turnover. EBR provides the
user with an organic growing body of knowledge from which to solve future
problems. This information can be made available to both help desk personnel and
end-users, facilitating self-diagnosis and problem resolution.
PHD offers client/server solutions grounded in a Microsoft framework.
Supported platforms include Windows NT, Windows 95, Windows 3.X and Windows CE
(for use with portable devices such as PDAs and PIMs). PHD solutions incorporate
Microsoft's Visual Basic for Applications (VBA), serving as the Company's
universal API. The addition of VBA effectively extends the reach of the help
desk, allowing for unprecedented customization and integration with existing
software investments.
PHD/X, built upon Microsoft's ActiveX technology, will allow application
programmers and developers to embed selected service and support PHD functions
directly into their products. The resulting applications will provide fully
integrated, robust and sophisticated help desk capabilities. The Company's first
ActiveX module, EBR/X, is presently shipping with the Professional Help Desk
suite. Additional modules are currently in development.
Capitalizing on the success and popularity of Java, PHD recently introduced
PHDWeb, the first Sun Microsystems certified "100% Pure Java" help desk
platform. PHDWeb offers the full functionality of the traditional Professional
Help Desk package over the Internet.
Through the end of 1997, the Company had invested approximately $7.9 million
on development, marketing and other costs associated with the introduction of
PHD. See "Item 1. Business--Factors Which May Affect Future Results--General
Factors--Entry Into New Markets" and "Item 7. Management's Discussion and
Analysis of Financial Condition and Results of Operations--General".
COMPUTER HARDWARE AND VAR SALES
The Company, through its Databit subsidiary, sells and services PC-based
computer hardware, software, data storage, client/server and networking
solutions. Databit is an authorized direct seller, value-
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added-reseller and an authorized service provider for equipment and software
from such well-known industry leaders as Compaq, IBM, Microsoft,
Hewlett-Packard, Silicon Graphics, Texas Instruments and Dell. Databit offers
its customers a full range of systems integration services, including design,
implementation, hardware and software selection and network cabling and
installation, of local and wide area networks. Databit provides maintenance and
service to customers under extended service agreements.
DATA COMMUNICATION PRODUCTS AND SERVICES TO UTILITIES
Since 1992, through the PowerCom division of the Company's Decision Systems
Israel Ltd. subsidiary ("DSI Israel"), the Company has been designing,
developing and marketing two-way interactive communications solutions which
provide real-time remote automated meter reading and data management
capabilities to utilities, energy service companies and industrial and
commercial customers. PowerCom's electronic power supply management ("EPSM")
system uses existing power lines to transmit the electricity consumption data of
each meter to the utility's main computer. A comprehensive software package
controls the system's operations and facilitates functions such as real-time
load switching, peak demand control and detection of leakage and illegal use of
electrical power. Pilot testing in Argentina has been completed and is currently
being conducted in Mexico, Venezuela and a number of towns in Israel. Although
no full-scale system sales of EPSM have been made to date, the Company is
currently negotiating with utilities in several countries regarding installation
of a pilot system or on a trial basis. Through December 31, 1997 the Company had
invested approximately $5.4 million (net of government and customer
participation) on development and marketing of the EPSM.
In January 1998, the Company acquired certain assets and licensed
intellectual property from Lucent Technologies, Inc. This technology will be
used by the Company's recently formed Comverge Technologies subsidiary which
will market the Customer Connection for Utilities (CCU) to customers in the U.S.
The CCU has been previously deployed at Public Service Electric and Gas using a
two-way cable TV system and at Duke Power using a cellular digital packet data
(CDPD) network. Five employees involved in developing the CCU have joined the
Comverge team.
The Company's communication systems are designed to allow customers to
compete more effectively by enabling them to reduce costs, defer capital
spending, increase sales revenues and improve service quality and scope. The
Company plans to broaden its target markets beyond utility companies to include
energy service providers, cooperatives, aggregators, municipals, and
telecommunications network service providers, as well as rekindle and expand
former strategic alliances and customer relationships. The Company intends to
expand its systems capabilities to include, in addition to its powerline
communications (PLC) technology, plain old telephone (POTS), personal
communication services (PCS) and Internet transport using its standards-based
open architecture.
The Company believes that its prior experience in the development,
manufacture, marketing and sales of energy management systems internationally,
together with the recently acquired assets and licensed technology, will permit
the Company to take advantage of market and product synergies, expand its U.S.
market and exploit the data communications and energy management needs of the
global utilities markets which are rapidly undergoing deregulation. See "Item 1.
Business--Factors Which May Affect Future Results--General Factors--Entry Into
New Markets" and "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations--General".
MULTIMEDIA ENTERTAINMENT
Since 1996, the Company has engaged in the development and marketing of
interactive, multimedia entertainment products under the Cybrcard-TM- name,
including 1996 NFL-Registered Trademark- Cybrcards, 1997 Major League
Baseball-Registered Trademark- Cybrcards and 1997 NFL-Registered Trademark-
Cybrcards. These products have generated only limited sales to date. Due to the
high costs associated with the marketing of consumer multimedia products, the
Company does not currently intend to develop and market additional multimedia
entertainment products in 1998. The
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Company, however, is actively pursuing projects in the multimedia area in which
the Company would have responsibility for design and development of products
which would be marketed and sold by others. It is contemplated that in any such
projects the cost of development would be covered by the party with
responsibility for the marketing of the product. The Company would receive a
combination of a fixed development fee and/or royalties from the sale of
products.
As of December 31, 1997 the Company had invested approximately $6 million in
product development and marketing and administrative costs in connection with
its establishment of CybrCard and its product lines, all of which was expensed.
CUSTOMERS AND MARKETS
The Company's Computer Segment commenced operations in Israel in 1986, and
Israel historically was the primary area of its operations. Due primarily to
significant growth in the Computer Segment's United States subsidiaries, the
percentage of revenues from activities of the United States subsidiaries
increased from 51% in 1995 to 61% in 1996 and 64% in 1997.
The Company commenced its operations in Israel by providing consulting
services to Israel Aircraft Industries Ltd. ("IAI"), which is wholly owned by
the government of the State of Israel. IAI has been, and continues to be, the
Computer Segment's largest consulting customer. However, as the Company has
expanded its revenue base, and sales to IAI have decreased, the percentage of
its sales attributable to IAI has decreased. The percentage of the Company's
Computer Segment sales attributable to IAI in 1995, 1996 and 1997 was 16%, 8%
and 6%, respectively.
The Company's Computer Hardware and VAR sales commenced in 1992, accounting
for 28% of Computer Segment sales in 1995, increasing by almost 80% to 38% of
these sales in 1997. The Company's two largest hardware customers (a major New
York medical center and a large national law firm) accounted for approximately
10% and 5% and 11% and 12% of Computer Segment sales in 1996 and 1997,
respectively.
The Company's customers include major high technology companies, Fortune 500
companies and other leading industrial and service companies, in Israel and the
United States.
BACKLOG
The total backlog of work to be completed in the Company's Computer Segment
was approximately $1.7 million as of January 1, 1998, compared to $4.3 million
as of January 1, 1997. The Company estimates that virtually all of the backlog
will be performed in 1998.
Due to the generally short-term nature of orders received in the Computer
Segment, purchase orders or requisitions from customers requesting services on a
time and materials basis generally are cancelable on a minimum of 30 days
advance notice. Fixed price projects are often subject to termination for
convenience without substantial penalty and, accordingly, there can be no
assurances as to the actual sales to be generated from these contracts. In light
of the above, the Company does not consider backlog to be a meaningful measure
of operations in its Computer Segment.
COMPETITION
In its computer consulting and development services business, the Company
faces competition from numerous other competitors, both large and small,
operating in the Israeli and United States markets, some with substantially
greater financial and marketing resources. The Company believes that its wide
range of experience and long-term relationships with large corporations in the
United States and Israel enhance the Company's position with respect to
obtaining future business. For a discussion of factors relating to competition
in the other activities comprising the Company's Computer Segment, see "Item 1.
Business--Factors Which May Affect Future Results--General
Factors--Competition."
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PROPRIETARY RIGHTS
Certain products that the Company has developed and is developing
incorporate or are derived from intellectual property owned by third parties. A
license from, the consent of, or a joint development and marketing agreement
with, such third parties may be required in order to continue to develop and
market such products and there can be no assurance that any such arrangements
can be made on commercially reasonable terms.
In its product development activities, the Company relies on a combination
of nondisclosure agreements and technical measures to establish and protect its
proprietary rights, if any, in its products. The Company believes that, as a
result of the rapid pace of technological change in the software and real-time
system industries, legal protection for its products, if any, will be less
significant to the Company's prospects than the knowledge, ability and expertise
of the Company's management and technical personnel.
In cases where the Company performs services on a time and materials basis,
the intellectual property rights resulting from these services are owned by the
Company's customer.
For further discussion of issues relating to proprietary rights to the
operation of the Company's Computer Segment, see "Item 1. Business--Factors
Which May Affect Future Results--General Factors-- Dependence on Intellectual
Property of Third Parties".
SEMICONDUCTOR MANUFACTURING
INTRODUCTION
Tower is an independent "foundry" manufacturer of semiconductor integrated
circuits ("ICs") on silicon wafers, as well as a provider of design and turn-key
services. As a foundry, Tower manufactures wafers using its advanced production
capability and the proprietary IC designs of its customers. ICs manufactured by
Tower are incorporated into a wide range of products in diverse markets,
including computer and office equipment, communication products and consumer
electronics.
Semiconductors are the foundation of modern electronic equipment and
systems, constituting critical components for a wide range of products,
including computers, office equipment, communication equipment and defense,
aerospace, transportation and consumer electronics. A semiconductor may be
either a discrete device, such as an individual transistor, or an IC in which a
number of transistors and other elements are combined to form a more complex
circuit. A wide variety of semiconductor products currently are in use, ranging
from commodity products (such as DRAM, SRAM and other commodity memories) to
more differentiated products (such as microprocessors, ASICs and numerous
digital, analog and mixed-signal ICs).
SERVICES
Tower manufactures ICs on silicon wafers based upon proprietary designs
provided by its customers. Tower specializes in the manufacture of
differentiated IC products, which generally require greater process flexibility
and customization than commodity products. The end product manufactured by Tower
is a silicon wafer containing multiple ICs.
In 1997, Tower continued to implement its strategy to develop and provide
customers with new specialized proprietary process technologies and value-added
services, particularly in certain niche markets, such as nonvolatile memories
("NVMs"). Together with Wafer Scale Integration, Inc., of Fremont, California,
("WSI"), a developer of peripheral system devices containing advanced NVM
modules, Tower developed an advanced embedded erasable and programmable
read-only memory ("EPROM") process based on WSI's proprietary technology. The
EPROM process has been qualified for production and initial production orders
have been received.
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The Company has established a design team to offer specialized NVM design
services, including NVM modules, mixed-signal cells and design library support,
to potential customers and independent design centers seeking to utilize Tower's
NVM process technologies. Since May 1997, the design team has conducted these
activities from Tower's new Design Center in Nethanya, Israel.
In 1997 Tower also entered an agreement with Saifun Semiconductor Ltd. for
use of its breakthrough Flash technology and for the development of a
specialized Flash process. This process is especially suitable for embedding
large NVM arrays in "system-on-a-chip" products and has generated significant
customer interest. Throughout 1998, Tower anticipates continued investment in
the development of Flash features such as large memory arrays, endurance
verification and other support parameters. The Flash memory process is scheduled
to be released to manufacturing by the end of 1998, although there can be no
assurance of this.
CUSTOMERS AND MARKETS
At the time of its organization, Tower's only customer was National
Semiconductor Corporation. While Tower has since succeeded in adding new
customers, Tower remains dependent on a small number of customers for virtually
all of its business. In 1997, over 70% of Tower's sales were attributable to two
large customers, National and Motorola. In January, 1998, Tower entered into a
new purchase agreement with National, extending the foundry relationship with
National until at least February 2000.
Following a market downturn in 1996, growth for the foundry industry was
flat primarily as a result of massive price reductions, offset by continued
increases in wafer consumption in the end markets. Despite the flat market, the
Company, which had operated below capacity for much of 1996, was able to
increase its sales by more than 28% over 1996 and operate at a profit. However,
the situation in the marketplace remains uncertain and there is no assurance
that Tower's facility will operate at the level necessary for profitability. In
addition, Tower continues to see downward pressure on prices from both current
and potential new customers. See "Item 1. Business--Factors Which May Affect
Future Results--Factors Related to Tower--Reliance on Principal Customers; Need
to Expand Customer Base" and "Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations--General."
During 1997, Tower manufactured over 200 sophisticated semiconductor
products that are used by its customers (or end users) in a wide variety of
applications. These applications include personal computer products and
peripherals (such as microprocessors, local area networks and super I/O
devices), communications products (such as pagers), office automation products
(such as facsimile machines, answering machines and advanced printers), cellular
products (such as cellular telephones) and consumer products (such as
televisions and multimedia products). Tower estimates that five products
accounted for approximately 70% of sales. The number of products which Tower
manufactures in 1998 and in future periods will be determined by customer
orders.
PROCESS TECHNOLOGY
Tower's manufacturing process currently uses the following CMOS
(complementary metal oxide silicon) technologies: 1.0 micron double-level metal;
0.8 micron double-level metal; 0.8 micron triple-level metal; 0.6 micron
double-level metal; and 0.6 micron triple-level metal. In 1997, 0.5 micron
processes were qualified and began production in small quantities.
The semiconductor industry is characterized by rapid changes in both product
and manufacturing process technology. As a result, Tower's profitability will
depend on its ability to successfully develop and introduce to production
advanced process technologies which meet its customers' needs. Tower is
currently working on the development of a 0.5 micron double poly process for
mixed signal applications, as well as characterization of a 0.5 micron process
for CMOS image sensor applications. A 0.35 micron process is expected to be
qualified for full production later in 1998, although there can be no assurance
of this.
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The development and introduction to production of advanced technologies is a
complex process, the success of which is dependent on many factors, some of
which may be beyond Tower's control. Tower has in the past experienced
unforeseen delays in the development and introduction of new processes. Tower
can, therefore, not predict when or if the development and introduction to
production of these new processes will be successfully completed. Tower's
failure to develop and introduce new process technologies successfully and in a
timely manner would have a material adverse effect on Tower's business and
financial condition. See "Item 1. Description of Business--Factors That May
Influence Future Results--Factors Related to Tower--Need to Advance Process
Technology".
MANUFACTURING FACILITY
Due to the sensitivity and complexity of the semiconductor manufacturing
process, a semiconductor manufacturing facility requires a special clean room in
which most of the manufacturing functions are performed. Tower's manufacturing
facility includes an approximately 51,500 square foot clean room. Tower has
obtained ISO 9002 certification (a certification with respect to business
process quality standards) for its manufacturing operations.
At the time of its organization in 1993, Tower's facility had a capacity of
5,000 wafer starts per month, using 1.25 and 1.0 micron processes. Since that
time Tower has increased its capacity to approximately 17,000 wafer starts per
month at the current product mix utilizing 1.0, 0.8, 0.6 and 0.5 micron
processes. This increase in capacity has been achieved through the addition of
equipment, improvement in equipment utilization, the reconfiguration and
expansion of its existing clean room area, and the construction of an additional
clean room area.
Tower does not currently intend to significantly increase the overall
capacity of its facility. Tower intends, however, to continue to make
significant expenditures during 1998 to fund its process technology advancement
program and to purchase equipment to increase Tower's capacity to manufacture
wafers using advanced processes, including those currently under development by
Tower. See "Item 1. Description of Business--Semiconductor Segment--Process
Technology".
COMPETITION
The semiconductor foundry industry is highly competitive. Tower competes
with other dedicated foundries and with integrated semiconductor companies and
end-product manufacturers that produce ICs for their own use and/or allocate a
portion of their manufacturing capacity to foundry operations. Particularly
during periods of market downturn, Tower may face increased competition from its
customers' internal manufacturing capacity and from other semiconductor
manufacturers who have underutilized capacity.
Many of Tower's competitors have more advanced technological capabilities, a
more diverse and established customer base, and greater financial, marketing,
distribution and other resources than Tower. In addition, some competitors of
Tower may have lower labor costs. Tower competes primarily by seeking to offer
customers competitive pricing and a high level of service and process
customization.
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PROPRIETARY RIGHTS
Tower uses internally developed process technologies and process
technologies licensed from customers. The 1.0 micron process used by Tower and
elements of the 0.8 process used by Tower are licensed from customers under
royalty-free licenses. The 0.6 micron process currently used by Tower and the
specialized 0.6 micron embedded memory process currently being introduced to
production were internally developed. Elements of the 0.5 micron processes and
0.35 micron process currently under development will be used under
royalty-bearing licenses from third parties.
INVESTMENTS
MOFET VENTURE CAPITAL FUND
The Company, together with other investors, established Mofet Israel
Technology Fund ("Mofet"), an Israeli public investment company formed for the
purpose of investing in the securities of high technology companies and projects
in Israel. Through two public offerings of its shares, options and convertible
debentures on the Tel Aviv Stock Exchange, and subsequent exercise of options,
Mofet has raised aggregate net proceeds of approximately $23.2 million. As of
December 31, 1997, the Company owned approximately 4% of the equity of Mofet.
The Company accounts for its investments in Mofet on the cost method.
Mofet is managed by Mofet Risk Capital Fund Management (1992) Ltd. ("Mofet
Management") pursuant to a management agreement expiring January 2000. The
current shareholders of Mofet Management are DSI Israel (50%), F.I.B.I. Holdings
Company Ltd., a holding company controlled by the Safra family which controls
the First International Bank of Israel Ltd. (25%), and Menorah Insurance Company
Ltd., one of Israel's largest insurance companies (25%). Mofet has agreed to pay
Mofet Management a management fee equal to 4% per annum of the amounts invested
in the Fund (excluding profits). The Company accounts for its investment in
Mofet Management on the equity method.
MOBILE INFORMATION SYSTEMS LTD.
In March 1994, the Company acquired a 50% interest in Mobile Information
Systems Ltd. ("MIS"), a joint venture of DSI Israel and Geotek Communications,
Inc. ("Geotek"). The Company accounted for its investment in MIS on the equity
method. In 1996 the Company sold its shares in MIS to Geotek in exchange for a
$2 million unsecured note which bears annual interest of 8.25%, payable July 1,
1998. The Company thereby recorded a gain in 1996 of approximately $1.7 million
in connection with the sale. In February 1998, the Company signed an agreement
with Geotek, modifying the note to permit its conversion into shares of Geotek
Common Stock. Geotek has filed a registration statement registering the resale
by the Company of these shares. Upon the effectiveness of the registration
statement the Company will be free to sell the shares in the public market.
EMPLOYEES
At December 31, 1997, the Company employed a total of 349 people, including
264 persons in engineering and technical support (approximately one-half with
advanced degrees in computer and electronic engineering), 30 in marketing and
sales, and 55 in management, administration and finance. At December 31, 1997,
Tower had a total of 656 employees.
The Company considers its relationship with its employees to be
satisfactory.
There are no collective bargaining agreements between the Company and any of
its employees. However, certain provisions of the collective bargaining
agreements between the Histadrut (General Federation of Labor in Israel) and the
Coordination Bureau of Economic Organizations (including the Industrialists
Association) are applicable to the Company's Israeli employees by order of the
Israeli Ministry of Labor. These provisions concern mainly the length of the
work day, minimum daily wages,
8
<PAGE>
contributions to a pension fund, insurance for work-related accidents,
procedures for dismissing employees, determination of severance pay and other
conditions of employment. The Company generally provides its Israeli employees
with benefits and working conditions beyond the required minimums.
Israeli law generally requires severance pay upon the retirement or death of
an employee or termination of employment without due cause. Furthermore, Israeli
employees and employers are required to pay specified amounts to the National
Insurance Institute, which is similar to the United States Social Security
Administration. The payments to the National Insurance Institute include health
tax and are approximately 17% of wages (up to a specified amount), of which the
employee contributes approximately 60% and the employer approximately 40%.
RESEARCH AND DEVELOPMENT (R&D)
For information on R&D costs, see "Management's Discussion and Analysis of
Financial Condition and Results of Operations--General" and Notes 1, 10 and 22
to the Company's consolidated financial statements appearing elsewhere in this
Report (the "Consolidated Financial Statements").
SEGMENT INFORMATION
For financial information regarding the Company's operating segments,
foreign and domestic operations and export sales, see "Management's Discussion
and Analysis of Financial Condition and Results of Operations--Results of
Operations" and Note 19 to the Consolidated Financial Statements.
FACTORS WHICH MAY AFFECT FUTURE RESULTS
The Company may from time to time issue certain statements, either in
writing or orally, that contain or may contain forward-looking information.
There can be no assurance, however, that actual results will not differ
materially from the Company's expectations, statements or projections. Factors
that could cause actual results to differ from the Company's expectations,
statements or projections include the risks and uncertainties relating to the
Company's business described below.
GENERAL FACTORS
ENTRY INTO NEW MARKETS. The Company has recently devoted substantial
resources to ventures to design and develop software products. The Company
believes that the markets for these products provide an opportunity to generate
substantially greater revenues and profit margins than its traditional services
markets. However, the Company has had relatively limited experience with
marketing and distribution of such products and there can be no assurance that
the Company will be able to develop the marketing expertise and relationships
necessary to identify and capitalize on opportunities in these product areas.
The limited operating histories of the Company's new product ventures make
prediction of their results and prospects difficult.
MINORITY INTERESTS IN OPERATING SUBSIDIARIES. The Company has a number of
subsidiaries that are not wholly owned. Cash of subsidiaries that are not wholly
owned is generally not available for use by the Company or other subsidiaries
except to the extent paid to the Company as reimbursement for general overhead,
as management fees or as dividends. Dividends from the Company's Israeli
subsidiaries are subject to a withholding tax of 15% to 25%.
COMPETITION. In its computer consulting and development services business,
the Company faces competition from numerous other competitors, both large and
small, operating in the Israeli and United States markets, some with
substantially greater financial and marketing resources.
In the help desk market, the Company faces competition from a variety of
companies with greater experience in the marketplace and greater resources
available for product development, sales and marketing and product support.
These competitors include (i) companies that target enterprise-wide
9
<PAGE>
information systems, (ii) companies with specific help-desk applications, (iii)
professional systems integration and services companies that design and
implement custom systems, (iv) large information systems providers and (v) the
internal information systems departments of potential customers. While the
Company believes that PHD has certain product and price advantages over its
competition, it may be difficult to educate its potential customers of the
advantages of PHD in light of the broad range of competing solutions.
The market for personal computer and related peripheral hardware sales in
which the Company's Databit subsidiary operates is characterized by severe
competition in price-performance, breadth of product line, financing
capabilities, technical expertise, service and overall reputation. Trends have
been for ongoing price reductions by manufacturers to end-users, thereby
reducing profit margins for distributors and value-added-resellers such as
Databit. Competitors include manufacturers, other VAR's, large equipment
aggregators (some of whom sell to the Company) and systems integrators. Many of
the Company's competitors have longer operating histories, greater financial
resources and buying power and larger installed bases of customers. The Company
believes that it competes primarily on the basis of its responsiveness and
technical expertise in evaluating customer needs and tailoring specific
solutions to those needs, as well as price.
The global market for automatic meter reading ("AMR") products is highly
competitive. The Company believes the principal competitive factors affecting
its sales of communication systems for AMR networks are its products'
technological capabilities, design features and functionality, price, quality of
service, reliability, ease of installation and scalability. New technological
developments, technical expertise, vendor reputation and technical support also
affect the competitiveness of the Company's products in the AMR market. While
the Company believes it competes favorably in these areas, many of its
competitors currently have (or may have) substantially greater financial,
marketing, technical or manufacturing resources and name recognition than the
Company. There can therefore be no assurance that the Company will be able to
successfully compete against current or future competitors in this market.
The emerging market for utility network automation systems and the potential
market for other applications accessible once a common infrastructure is in
place, have led electronics, communication and utility product companies to
initiate development of various data communication systems. Some of these
systems currently compete, and others may in the future compete, with the
Company's communication systems. Many companies from diverse industries are
seeking solutions for the transmission of data over traditional communication
media such as radio, as well as more recently developed media such as cellular
networks. Utility companies are testing communication products from various
suppliers for numerous applications and no industry standard has been broadly
adopted. The Company's systems represent only some possible solutions for
automated meter reading.
DEPENDENCE ON INTELLECTUAL PROPERTY OF THIRD PARTIES. Certain of the
Company's product development efforts are dependent upon intellectual property
owned by third parties. For example, some of the Company's data communication
products utilize intellectual property licensed from Lucent Technologies. While
the Company believes it is in continuing compliance with these licensing
agreements and that the licensing agreements adequately protect the Company's
rights to integrate such intellectual property into its products, failure to
maintain such licenses could have a material adverse effect on the business and
prospects of the Company.
RAPID TECHNOLOGICAL CHANGE; NEED FOR CONTINUED PRODUCT DEVELOPMENT. The
market for the Company's PHD product is characterized by rapid technological
change, evolving computer hardware and software standards, frequent new product
introductions and continuing customer demands for expanded features and
functions. Accordingly, it will be necessary for the Company to continue to
invest in product development to ensure that such products continue to evolve
and remain competitive. There can be no assurance that the Company will have the
resources to invest in such product development or that such product development
efforts will be successful.
10
<PAGE>
The rapid technological change in digital communication systems, especially
in the U.S., will necessitate the adaptation of the Company's data communication
systems for utilities to new communication technologies. Accordingly, it will be
necessary for the Company to develop full system compatibility with telephone,
cable television, CDPD and various wireless distribution networks. There can be
no assurance that the Company will have the resources to invest in the continued
product development required to keep pace with the changing technologies or that
such product development efforts will be successful.
OPERATIONS IN ISRAEL. A substantial portion of the Company's operations is
conducted in the State of Israel and, consequently, the Company is directly
affected by economic, political and military conditions in Israel. Accordingly,
any major hostilities involving Israel or the curtailment of trade between
Israel and its current trading partners could have a material adverse effect on
the Company's business and financial condition. In addition, certain
subsidiaries of the Company receive grants and tax benefits from, and
participate in, various programs sponsored by the government of Israel. There
can be no assurance that such grants and tax benefits will be continued in the
future at their current levels, or at all. The termination or reduction of
certain grants, programs and tax benefits could have a material adverse effect
on the Company's business and financial condition.
IMPACT OF INFLATION AND CURRENCY FLUCTUATIONS. Substantially all of the
Company's sales are made in dollars or in New Israeli Shekels ("NIS") linked to
the dollar. In 1997, approximately 50% of Tower's expenses were in dollars or
dollar-linked NIS and virtually all remaining expenses were in NIS. The dollar
cost of the Company's operations in Israel is influenced by the extent to which
any inflation in Israel is not offset (or is offset on a lagging basis) by the
devaluation of the NIS in relation to the dollar. There can be no assurance that
the Company will not be materially adversely affected in the future if inflation
in Israel exceeds the devaluation of the NIS against the dollar or if the timing
of such devaluation lags behind increases in inflation in Israel.
As of December 31, 1997, the net amount of the Company's monetary assets
that were not denominated in dollars or in NIS linked to the dollar was not
material. In the event that in the future the Company has material net monetary
assets that are not denominated in dollar-linked NIS, such net assets would be
subject to the risk of currency fluctuations.
FACTORS RELATED TO TOWER
DEPENDENCE ON PRINCIPAL CUSTOMERS; NEED TO EXPAND CUSTOMER BASE. Tower
currently has a limited number of customers and is dependent on two principal
customers. If one of these principal customers were to reduce its orders, and
Tower were to be unsuccessful in selling to new or existing customers the
capacity that becomes available as a result thereof, such event would have a
material adverse effect on Tower's business and financial condition. Since the
end of 1997, Tower has been operating significantly below capacity. Tower is
making efforts to attract new customers to utilize all or a portion of its
unused capacity. Tower is currently engaged in discussions with several
potential new customers. The process of attracting new customers includes
extensive exchange of product and process information between Tower and
potential customers, including the running of test wafers and prototypes. There
is therefore no assurance that Tower will be able to attract additional business
from new customers in the near future, if at all.
RISK OF OPERATING BELOW FULL CAPACITY. Fixed costs represent a substantial
portion of the total operating costs of a semiconductor manufacturing operation.
As a result, any failure by Tower to operate at or near full capacity, whether
due to mechanical failure, lack of orders, fire or natural disaster, or
otherwise, could result in losses or diminished profitability.
NEED TO ADVANCE PROCESS TECHNOLOGY. The semiconductor industry is
characterized by rapid changes in both product and manufacturing process
technology. As a result, Tower's profitability will depend on its
11
<PAGE>
ability to successfully develop and introduce to production advanced process
technologies which meet its customers' needs. Tower is currently working on the
development of a number of advanced processes.
The development and introduction to production of advanced technologies is a
complex process, the success of which is dependent on many factors, some of
which may be beyond Tower's control. Tower has in the past experienced
unforeseen delays in the development and introduction of new processes.
Therefore, Tower cannot predict when or if the development and introduction to
production of these new processes will be successfully completed. The failure by
Tower to develop and introduce new process technologies successfully and in a
timely manner would have a material adverse effect on the Company's earnings and
financial condition.
RISK OF SEMICONDUCTOR PROCESS YIELD PROBLEMS. The process technology for
the manufacture of semiconductor products is highly complex and sensitive to
dust and other contaminants. Minor impurities or difficulties in the production
process or defects in the masks used to manufacture a particular device can
cause a percentage of the wafers to be rejected or individual ICs or "die" on
specific wafers to be non-functional, which in each case negatively affects
manufacturing yields. Although Tower has implemented manufacturing control
procedures, tests its products at various stages in the manufacturing process
and conducts numerous quality-control inspections throughout the entire
production process, Tower in the past has experienced lower than expected
production yields, which have delayed product shipments and reduced profits.
There can be no assurance that Tower will not experience lower than anticipated
production yields in the future, which, if not cured in a timely manner, could
have a material adverse effect on the Company's business and financial
condition.
CYCLICAL NATURE OF THE SEMICONDUCTOR MARKET. The semiconductor industry
historically has been characterized by wide fluctuations in product supply and
demand. From time to time, the industry has experienced significant downturns
characterized by diminished product demand, production over-capacity and
accelerated erosion of the average selling prices of semiconductor products. In
some cases, these downturns have lasted for more than a year. No assurance can
be given that Tower's business will not be adversely affected in the future by
cyclical conditions in the semiconductor industry.
PROCUREMENT AND SOURCING. Tower's manufacturing processes use many raw
materials, including silicon wafers, chemicals, gases and various metals. These
raw materials generally are available from several suppliers and Tower is not
dependent upon any single source of supply, although, in some instances, Tower
elects to purchase certain raw materials from a single source. In those
instances, Tower generally identifies and qualifies alternative sources of
supply. Although supplies for raw materials used by Tower currently are
adequate, shortages could occur in various critical materials due to
interruption of supply or increased industry demand. Any such shortages could
result in production delays, which could have a material adverse effect on
Tower's business and financial condition.
In connection with implementing its technology advancement plans, Tower
expects to continue to make significant purchases of equipment required for
semiconductor manufacturing. Some of this equipment is available from only a
single vendor or a limited number of vendors and/or is manufactured in
relatively limited quantities. In addition, certain equipment has only recently
been developed. Delays in delivery and shortages in supply of such equipment, as
well as failures of such equipment to operate in accordance with Tower's
expectations, could result in higher costs and production delays and delay
implementation of Tower's technology and advancement plans. Any such delays,
shortages or failures could have a material adverse effect on Tower.
RISKS RELATING TO ISRAELI GOVERNMENT PROGRAMS. The Investment Law for the
Encouragement of Capital Investments, 1959 (the "Investment Law") provides that
capital investments in certain production facilities (or other eligible
facilities) may, upon application to The Investment Center of the Ministry of
Industry and Trade of the State of Israel ("The Investment Center"), be
designated as an "Approved Enterprise". Virtually all of Tower's existing
facilities and programs, including Tower's current $240 million
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<PAGE>
investment program and the $93.4 million investment program which was
substantially completed in 1995, have been granted Approved Enterprise status
under the Investment Law. To be eligible for grants and tax benefits, Tower must
continue to meet certain conditions, including making certain specified
investments in fixed assets. The certificate of approval related to Tower's
current Approved Enterprise program requires, among other things, that all
investments under the program be completed by the end of 1998. Should Tower fail
to meet such conditions in the future, it could be required to refund grants or
tax benefits already received (together with interest and certain inflation
adjustments). There can be no assurance that such grants and tax benefits will
be continued in the future at their current levels or at all.
DEPENDENCE ON SENIOR MANAGEMENT AND KEY PERSONNEL. Tower is highly
dependent upon the members of its senior management team, many of whom have been
working at the facility since National commenced the construction of the
facility in 1984. The loss of the services of any member of senior management
could have a material adverse effect on Tower's business and financial
condition. Tower does not maintain key-man life insurance with respect to
members of senior management.
Tower also is dependent to a substantial degree upon its skilled
professional and technical personnel and will be required to increase
significantly the number of these employees in the future in order to implement
successfully its plans for the future. There is considerable competition for the
services of qualified personnel in the semiconductor industry, particularly in
Israel, and, consequently, there can be no assurance that Tower will be able
either to retain its present personnel or to attract additional qualified
personnel as and when needed. In addition, Tower may be required to increase
employee compensation levels in order to retain its existing employees and
attract and retain the additional personnel that it expects to require.
COMPETITION. The semiconductor foundry industry is highly competitive.
Tower competes with other dedicated foundries and with integrated semiconductor
and end-product manufacturers that produce ICs for their own use and/or allocate
a portion of their manufacturing capacity to foundry operations. Many of Tower's
competitors have more advanced technological capabilities, a more diverse and
established customer base, and greater financial, marketing, distribution and
other resources than Tower. In addition, some of Tower's competitors may have
lower labor costs.
POSSIBLE SHORTAGES OF RAW MATERIALS AND EQUIPMENT. Although supplies for
raw materials and equipment used by Tower currently are adequate, shortages
could occur in the future in various critical materials and equipment due to
interruption of supply or increased industry demand. Any such shortages could
result in higher costs, production delays or delays in Tower's expansion, any of
which could have a material adverse effect on Tower's business and financial
condition.
ENVIRONMENTAL MATTERS. Tower is subject to a variety of governmental
regulations related to the use, discharge and disposal of toxic, volatile or
otherwise hazardous materials used in its manufacturing process. Any failure by
Tower to use, discharge or dispose of hazardous materials appropriately could
subject it to substantial liability or could require it to suspend or adversely
modify its manufacturing operations. In addition, Tower could be liable for
remedial measures if its properties are found to be contaminated even if Tower
is not responsible for such contamination, although Tower's risk in this regard
is reduced by an indemnity from National for violations of environmental
regulations that occurred prior to Tower's acquisition of the facility.
ITEM 2. PROPERTIES
The Company's corporate headquarters (as well as the principal office for
its United States operations) are located in Mahwah, New Jersey in approximately
5,000 square feet of office space, under a lease which expires in September
2000. The rent for these premises currently is $74,000 per annum. The Company
also rents offices in New York City of approximately 3,500 square feet, under a
lease which
13
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expires in August 2000, at a current rent of $75,000 per annum, and of
approximately 9,700 square feet in Stamford, Connecticut, at an annual rent of
$96,000.
DSI's facilities in Israel are located in Givat Shmuel in the Tel Aviv area
in approximately 23,900 square feet of office space, under a lease which expires
in April 2000. The annual rent is currently approximately $326,000.
Tower's offices, engineering and manufacturing operations are located in a
building complex situated on 13 acres in an industrial park in Migdal Haemek,
Israel. The buildings comprise approximately 180,000 square feet of space and
include clean room facilities of approximately 51,700 square feet. These
premises currently are occupied under a long-term capital lease from the Israel
Lands Authority which expires in 2032. The lease rights under this lease were
assigned to Tower as part of its acquisition of the facility and the value
attributed to the capitalized lease is being amortized by Tower over the life of
the lease. Tower has no obligation for lease payments related to this lease
through the year 2032.
ITEM 3. LEGAL PROCEEDINGS
The Company is a plaintiff in an action in the United States District Court
for the District of New Jersey against a former officer who resigned in April
1995, alleging destruction and misappropriation of property and data owned by
the Company. The employee has filed a counterclaim against the Company, alleging
breach by the Company of its employment and resignation agreements with the
employee and seeking compensatory damages of $750,000 and punitive damages of
$25 million. The Company is pursuing its claims against the employee and is
vigorously defending against his counterclaims. The Company accrued the full
amount of severance payable under the resignation agreement at the time of his
resignation. The Company believes it is unlikely to incur additional material
liability in connection with the counterclaim.
Between June and September 1996, several suits were filed in the United
States on behalf of a purported class of Tower's shareholders against Tower, its
Co-Chief Executive Officers, its Chairman of the Board of Directors, and DSSI.
The complaints seek to certify a class of all persons who purchased or otherwise
acquired Tower's ordinary shares between May 25, 1995 and June 10, 1996. The
actions have been consolidated in the United States District Court for the
District of New Jersey. The consolidated complaint filed in the actions alleges
on behalf of the class that the defendants made misstatements and omissions
regarding (i) the relationship between Tower and a major customer and (ii)
Tower's process development efforts in connection therewith, in violation of
certain US federal securities laws. Tower has indemnified the defendants, up to
the limits permitted by the Israeli Companies Ordinance, from any liability
arising out of the actions. Tower maintains insurance policies that, under
certain conditions, cover actions of this type up to an aggregate amount of $20
million. The Company is unable to determine at this time with any certainty the
ultimate outcome of this matter or its effect if any, on the Company's financial
condition, operating results and business. However, the Company believes it has
meritorious defenses and is defending the actions vigorously.
The Company is not involved in any other legal proceedings that management
believes, individually or in the aggregate, will have a material adverse effect
on the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock is traded on the Nasdaq National Market System
(NASDAQ/NNM) under the symbol "DSSI". The following table sets forth, for the
periods indicated, the high and low reported sales prices per share of the
Common Stock on the Nasdaq Stock Market.
<TABLE>
<CAPTION>
HIGH LOW
----- ---
<S> <C> <C>
1996:
First Quarter........................................................................................ 8 53/8
Second Quarter....................................................................................... 91/8 53/4
Third Quarter........................................................................................ 71/4 43/4
Fourth Quarter....................................................................................... 71/4 43/8
1997:
First Quarter........................................................................................ 61/16 43/8
Second Quarter....................................................................................... 61/8 45/8
Third Quarter........................................................................................ 73/16 413/16
Fourth Quarter....................................................................................... 71/16 33/4
</TABLE>
As of March 15, 1998 there were approximately 89 record holders of the
Common Stock. The Company estimates that there are approximately 2,800
beneficial owners of the Common Stock.
The Company paid no dividends in 1996 or 1997.
ITEM 6. SELECTED FINANCIAL DATA
The following selected statement of operations data for the year ended
December 31, 1997 and balance sheet data as of December 31, 1997 have been
derived from the Consolidated Financial Statements which have been audited by
Deloitte & Touche LLP (a member of Deloitte Touche Tohmatsu), independent
auditors, as stated in their report, which is included elsewhere in this Form
10-K. The following selected statement of operations data for the years ended
December 31, 1995 and 1996 and balance sheet data as of December 31, 1996 have
been derived from the Consolidated Financial Statements which have been audited
by Igal Brightman & Co. (a member of Deloitte Touche Tohmatsu), independent
auditors. The selected statements of operations data for the years ended
December 31, 1993 and 1994 and balance sheet data as of December 31, 1993, 1994
and 1995 are derived from audited financial statements not included herein. This
data should be read in conjunction with, the Consolidated Financial Statements
(including the notes thereto) and "Item 7. Management's Discussion and Analysis
of Financial Condition and Results of Operations".
Subsequent to the issuance of the Company's 1997 Consolidated Financial
Statements, DSI Israel filed restated financial statements with the Israel
Securities Authority ("ISA") which have a material effect on the Company's
Consolidated Financial Statements. The restatement relates to the order of the
ISA which required primarily the expensing of previously capitalized software
development costs. As a result, capitalized software development costs on the
Company's balance sheets and R&D expenses on the Company's statements of
operations for the years ended December 31, 1992 through December 31, 1997 have
been restated to reflect the order of the ISA. In addition, deferred income
taxes, which had been classified as part of other current assets and as part of
other noncurrent assets, on the Company's consolidated balance sheet as of
December 31, 1997, and income tax expense on the Company's statement of
operations for the year ended December 31, 1997 have been restated to reflect
the order of the ISA. The following financial data reflects such restatements.
The statement of operations data for the year ended December 31, 1993
includes Tower's operations for the ten months commencing March 1, 1993 and
therefore may not be comparable with statement of
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<PAGE>
operations data for subsequent periods. The balance sheet data as of December
31, 1996 and 1997 and the statement of operations data for the year ended
December 31, 1997 reflect the Company's interest in Tower as an investment on
the equity method, not otherwise including Tower's balances or results of
operations. Such data may therefore not be directly comparable with that
presented for prior periods.
Certain amounts included in the Statement of Operations Data have been
reclassified to conform with current presentation.
STATEMENT OF OPERATIONS DATA:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------------------
<S> <C> <C> <C> <C> <C>
1993 1994 1995 1996 1997
--------- --------- ---------- ---------- ----------
<CAPTION>
(AS RESTATED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
Sales.................................................. $ 57,945 $ 79,711 $ 129,823 $ 131,755 $ 39,996
Cost of sales.......................................... 43,261 58,527 90,839 102,094 32,437
--------- --------- ---------- ---------- ----------
Gross profit......................................... 14,684 21,184 38,984 29,661 7,559
Research and development expenses, net................. 1,633 4,126 4,375 5,611 1,335
Selling, general and administrative expenses........... 7,600 10,602 15,926 18,635 18,859
--------- --------- ---------- ---------- ----------
Operating income (loss).............................. 5,451 6,456 18,683 5,415 (12,635)
Interest income........................................ 280 1,313 5,188 5,321 478
Interest expense....................................... (1,159) (1,532) (2,434) (2,218) (225)
Gain on changes in ownership interests in
subsidiaries......................................... 792 14,755 26,339 -- --
Other income (expenses), net........................... (188) (147) 5 609 (111)
--------- --------- ---------- ---------- ----------
Income (loss) before taxes........................... 5,176 20,845 47,781 9,127 (12,493)
Income taxes........................................... 1,605 1,632 4,837 2,141 3,507
--------- --------- ---------- ---------- ----------
Net income (loss) after taxes........................ 3,571 19,213 42,944 6,986 (16,000)
Minority interests..................................... (2,028) (10,143) (25,026) (7,699) 676
Equity (loss) in affiliates............................ (40) (227) (169) (1,767) 4,880
--------- --------- ---------- ---------- ----------
Net income (loss).................................... $ 1,503 $ 8,843 $ 17,749 $ (2,480) $ (10,444)
--------- --------- ---------- ---------- ----------
--------- --------- ---------- ---------- ----------
Diluted earnings (loss) per share...................... $ 0.32 $ 1.31 $ 2.43 $ (0.34) $ (1.42)
--------- --------- ---------- ---------- ----------
--------- --------- ---------- ---------- ----------
Weighted average number of shares outstanding and
common share equivalents............................. 4,770 6,728 7,307 7,369 7,369
--------- --------- ---------- ---------- ----------
--------- --------- ---------- ---------- ----------
</TABLE>
Net income for each of the years 1993 through 1995 includes net income
attributable to gains on changes in ownership interests in subsidiaries or on
the sale of shares in subsidiaries. Excluding the effect of such gains, net
income (loss) after income taxes and minority interests for the years ended
December 31, 1993, 1994, and 1995 would have been $1,198,000, ($55,000) and
$1,968,000, respectively, and diluted earnings (loss) per share for the same
periods would have been $0.25, ($0.01) and $0.27, respectively.
16
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BALANCE SHEET DATA:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------------------------------------
<S> <C> <C> <C> <C> <C>
1993 1994 1995 1996 1997
--------- ---------- ---------- --------- ---------
<CAPTION>
(AS RESTATED)
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Working capital......................................... $ 31,459 $ 63,895 $ 141,850 $ 13,676 $ 7,201
Total assets............................................ $ 70,937 $ 127,533 $ 271,631 $ 97,818 $ 92,366
Short-term debt, including current maturities of
long-term debt........................................ $ 6,971 $ 3,821 $ 16,371 $ 2,124 $ 3,709
Long-term debt, net of current maturities............... $ 13,902 $ 12,485 $ 22,499 $ 331 $ 481
Minority interests...................................... $ 7,211 $ 42,327 $ 128,959 $ 28,407 $ 29,094
Total shareholders' equity.............................. $ 30,352 $ 44,937 $ 64,779 $ 62,556 $ 52,308
</TABLE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
The following discussion includes statements that are forward-looking in
nature. Whether such statements ultimately prove to be accurate depends upon a
variety of factors that may affect the business and operations of the Company.
Certain of these factors are discussed at "Item 1. Description of
Business--Factors That May Influence Future Results." The figures cited in the
following discussion reflect restated amounts for all of the periods.
The Company commenced providing consulting and development services for
computer software and systems in Israel in 1986 and in the United States in
1991. In March 1993, the Company diversified its business through the
acquisition of a facility in Israel that manufactures semiconductors using CMOS
process technology and the proprietary IC designs of its customers. Since such
date through the end of 1996, the Company conducted its business through two
business segments: the Computer Segment and the Semiconductor Segment. Due to
changes in the Company's voting control in Tower, commencing in 1997, the
Company accounted for its interest in Tower's results using the equity method
including its pro rata share of Tower's net income as equity. The Company
therefore believes that the statement of operations for the year ended December
31, 1997 is not comparable with those of prior years.
COMPUTER SOFTWARE SERVICES AND SYSTEMS
The Company's Computer Segment commenced operations in Israel in 1986 with
revenues attributable to the Company's Israeli subsidiaries accounting for 51%,
39%, and 37% of the total revenues of this segment during 1995, 1996 and 1997,
respectively. The decreasing percentage is primarily due to the increasing
revenues from operations in the United States. The Computer Segment's operations
in the United States have had a cumulative operating loss since commencing
operations in 1991, reflecting primarily the significant expenditures intended
to generate revenues over the long term rather than in current periods. The
Company started to realize the benefits of these expenditures towards the end of
1994, achieving significant revenue growth and improved operating results in
these operations in 1995. In 1996 and 1997 the Company invested heavily in
product development and marketing, resulting in increased operating losses.
Costs relating to software product development have been capitalized (in
accordance with applicable accounting principles for software development) to
the extent that they are incurred after the technological feasibility of the
product has been established and management considers that these costs are
recoverable from expected future revenues. When the foregoing criteria are not
satisfied, R&D costs relating to product development are expensed as incurred.
As described above, subsequent to the issuance of the Company's Consolidated
Financial Statements for the year ended December 31, 1997, the Israel Securities
Authority ("ISA") ordered DSI Israel to restate its financial statements to
reflect as R&D expenses in the
17
<PAGE>
period incurred all previously capitalized EPSM software development costs,
totaling $1,727,000, $552,000 and $332,000 in 1995, 1996 and 1997, respectively.
The following discussion reflects such restatement. The Company's results of
operations for 1995, 1996 and 1997 reflected $2,641,000, $1,549,000 and
$1,335,000, respectively, of R&D expenses (net of government grants)
attributable to the Computer Segment after restatement.
As of December 31, 1995 and 1996, capitalized software development costs
reflected on the balance sheet were $679,000 and $931,000, respectively. As of
December 31, 1997, there were no capitalized software development costs.
Gross profit margins in the Israeli operations of the Computer Segment
continue to experience downward pressure due to increased labor costs resulting
from the relative shortage of qualified programmers and engineers. There can be
no assurance that the competitive marketplace for qualified engineers will not
continue to affect margins in future periods.
SEMICONDUCTOR MANUFACTURING
Tower is an independent foundry manufacturer of semiconductor ICs on silicon
wafers and provider of related design and other services. As a foundry, Tower
manufactures wafers using its advanced production capability and the proprietary
IC designs of its customers. Tower manufactures primarily differentiated ICs
rather than commodity products. These ICs are incorporated into a wide range of
products in diverse markets, including computer and office equipment,
communication products and consumer electronics.
Tower commenced operations as an independent business in March 1993, when it
acquired its manufacturing facility from National Semiconductor Corporation (the
"Acquisition"). From the Acquisition through the end of 1995, Tower increased
its sales and profitability by (i) expanding its customer base, (ii) expanding
its manufacturing capacity through installation of new equipment, improvement of
equipment utilization, reduction of cycle time and streamlining of the
manufacturing process, (iii) reducing costs through improvement of equipment,
process yields and operational efficiencies and realization of economies of
scale, and (iv) advancing its process technology. This allowed Tower to improve
its gross profit and operating margins from commencement of operations through
the end of 1995.
As a result of (i) the end of Tower's purchase agreement with a major
customer, (ii) the reduction in orders from other customers and (iii) the
prevailing weakness in the demand for semiconductors products generally, Tower
operated its manufacturing facility substantially below capacity for part of
1996. Commencing in the fourth quarter of 1996 and into 1997, utilization
improved, primarily as a result of improvement in the personal computer and
peripheral end markets and certain price reductions implemented by Tower. As a
result of the improved utilization and the effect of Tower's successful cost
reduction and efficiency enhancement efforts, Tower was able to increase its
sales despite the reduction in prices and return to its previous levels of
profitability.
Beginning in the fourth quarter of 1997 and continuing into 1998, Tower
experienced reduced orders resulting in underutilization of capacity. Tower
believes that the reduced order levels reflect the conditions in the market for
semiconductor products. Tower also continues to see downward pressure on prices
from both current and potential customers. In March 1998, Tower announced that
it expected to operate at a loss for the first half of 1998, with an estimated
first quarter loss of $0.13 per share.
In 1996, Tower modified its capital plans, scaling back its capacity
expansion plan and increasing the resources allocated to Tower's technology
advancement plan and to improvements in infrastructure and operating procedures.
Tower does not currently intend to increase significantly the overall capacity
of its facility in 1998. Tower intends, however, to continue to make
expenditures during 1998 as part of its ongoing process technology advancement.
See "Item 1. Description of Business--Semiconductor Segment-Process Technology,"
and "--Manufacturing Facility".
18
<PAGE>
RESULTS OF OPERATIONS
The following table sets forth selected statement of operations items as a
percentage of total sales of the Company.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------------------
<S> <C> <C> <C> <C> <C>
1993 1994 1995 1996 1997
--------- --------- --------- --------- ---------
<CAPTION>
(AS RESTATED)
<S> <C> <C> <C> <C> <C>
Sales........................................................... 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of sales................................................... 74.7 73.4 70.0 77.5 81.1
--------- --------- --------- --------- ---------
Gross profit.................................................. 25.3 26.6 30.0 22.5 18.9
R&D expenses, net............................................... 2.8 5.2 3.4 4.3 3.3
Selling, general and administrative expenses.................... 13.1 13.3 12.3 14.1 47.2
--------- --------- --------- --------- ---------
Operating income (loss)....................................... 9.4 8.1 14.3 4.1 (31.6)
Financial income (expenses), net................................ (1.5) (0.3) 2.1 2.4 0.6
Gain on changes in ownership interests in subsidiary............ 1.4 18.5 20.3 -- --
Other income (expenses), net.................................... (0.3) (0.2) -- 0.4 (0.2)
--------- --------- --------- --------- ---------
Income (loss) before income taxes............................. 8.9 26.1 36.8 6.9 (31.2)
Income taxes.................................................... 2.8 2.0 3.7 1.6 8.8
--------- --------- --------- --------- ---------
Net income (loss) after income taxes.......................... 6.1 24.1 33.1 5.3 (40.0)
Minority interests.............................................. (3.5) (12.7) (19.3) (5.9) 1.7
Equity (loss) in affiliates..................................... -- (0.3) (0.1) (1.3) 12.2
--------- --------- --------- --------- ---------
Net income (loss)............................................... 2.6% 11.1% 13.7% (1.9%) (26.1%)
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
</TABLE>
The following table sets forth certain information with respect to the
results of operations of the Company and its two business segments for the years
1995, 1996 and 1997, the percentage of total revenues during each year
attributable to selected components of the statement of operations data and the
year to year percentage changes in such components.
The statement of operations for the year ended December 31, 1997 reflects
Tower's activity on the equity method, while those of previous years reflect
Tower's activity on a fully consolidated basis. Therefore, the information
presented for 1997 is not directly comparable to that presented for 1996 and
1995.
Certain amounts included in the Results of Operations have been reclassified
to conform with current presentation.
19
<PAGE>
<TABLE>
<CAPTION>
DOLLAR INCREASE
AMOUNT % OF DOLLAR % OF (DECREASE) DOLLAR % OF
--------- SALES AMOUNT SALES AMOUNT SALES
----- --------- ----- --------- ---------
1995 1996 FROM 1995 1997
---------------------- ---------------------- ------------- --------------------
(AS RESTATED)
<S> <C> <C> <C> <C> <C> <C> <C>
SEMICONDUCTOR SEGMENT
Sales.............................. $ 99,621 $ 97,885 (1.7%) --
Gross profit....................... $ 31,626 31.7% $ 22,447 22.9% (29.0%) -- --
R&D expenses, net.................. $ 1,734 1.7% $ 4,062 4.1% 134.3% -- --
SG&A expenses...................... $ 6,369 6.4% $ 7,119 7.3% 11.8% -- --
Operating income................... $ 23,523 23.6% $ 11,266 11.5% (52.1%) -- --
COMPUTER SEGMENT
Sales.............................. $ 30,202 $ 33,870 12.1% $ 39,585
Gross profit....................... $ 7,358 24.4% $ 7,214 21.3% (2.0%) $ 7,194 18.2%
R&D expenses, net.................. $ 2,641 8.7% $ 1,549 4.6% (41.3%) $ 1,335 3.4%
SG&A expenses...................... $ 7,836 25.9% $ 9,966 29.4% 27.2% $ 16,274 41.1%
Operating income (loss)............ $ (3,119) (10.3%) $ (4,301) (12.7%) 37.9% $ (10,415) (26.3%)
CORPORATE
Sales.............................. -- -- -- $ 411
Gross Profit....................... -- -- -- -- -- $ 365 88.8%
SG&A expenses...................... $ 1,721 $ 1,550 (9.9%) $ 2,585 629.0%
Operating loss..................... $ (1,721) $ (1,550) (9.9%) $ (2,220) (540.1%)
COMBINED
Sales.............................. $ 129,823 $ 131,755 1.5% $ 39,996
Gross profit....................... $ 38,984 30.0% $ 29,661 22.5% (23.9%) $ 7,559 18.9%
R&D expenses, net.................. $ 4,375 3.4% $ 5,611 4.3% 28.3% $ 1,335 3.3%
SG&A expenses...................... $ 15,926 12.3% $ 18,635 14.1% 17.0% $ 18,859 47.2%
Operating income (loss)............ $ 18,683 14.4% $ 5,415 4.1% (71.0%) $ (12,635) (31.6)%
<CAPTION>
INCREASE
(DECREASE)
FROM 1996
-------------
<S> <C>
SEMICONDUCTOR SEGMENT
Sales.............................. --
Gross profit....................... --
R&D expenses, net.................. --
SG&A expenses...................... --
Operating income................... --
COMPUTER SEGMENT
Sales.............................. 16.9%
Gross profit....................... (0.3%)
R&D expenses, net.................. (13.8%)
SG&A expenses...................... 63.3%
Operating income (loss)............ 142.2%
CORPORATE
Sales..............................
Gross Profit.......................
SG&A expenses...................... 66.8%
Operating loss..................... 43.2%
COMBINED
Sales..............................
Gross profit.......................
R&D expenses, net..................
SG&A expenses......................
Operating income (loss)............
</TABLE>
YEARS ENDED DECEMBER 31, 1997 AND 1996
SALES. Computer Segment sales increased in all areas of activity, although
the increase was primarily due to a 23% increase in Computer Hardware-VAR sales
and a 113% increase in PHD software sales.
GROSS PROFIT. The decrease in gross profits as a percentage of Computer
Segment sales was primarily attributable to (i) the writedown of $1.7 million in
previously capitalized development costs associated with the Company's PHD and
CybrCard products, (ii) continued development and production costs of the
Company's CybrCard product causing a gross loss of over $1 million, (iii) the
increased percentage of sales attributable to Computer Hardware-VAR sales which
characteristically have lower gross profit margins, and (iv) a decrease in
profitability in the Company's Israeli consulting systems and software activity,
due to increased direct labor costs.
R&D. All R&D expenses in the Computer Segment in 1997 were attributable to
the Company's EPSM product. For additional discussion of R&D costs in the
Computer Segment, see "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations--Computer Software Services and Systems".
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. ("SG&A"). The increase in
Computer Segment SG&A nominally and as a percentage of segment sales was
entirely due to increases of $4.1 million and $2.4 million in SG&A expenses
associated with the marketing and general introduction of the Company's PHD and
CybrCard products, respectively.
OPERATING INCOME (LOSS). The decrease in operating income was primarily due
to the aforementioned decrease in gross profits and increase in SG&A expenses.
INCOME TAXES. The increase in income taxes in 1997 was primarily due to the
establishment of an additional $6.3 million valuation allowance against tax
benefits associated with United States federal tax loss and tax credit
carryforwards.
20
<PAGE>
NET LOSS. The increase in the net loss is primarily attributable to the
aforementioned (i) increased direct costs due to writedown of development costs
associated with the Company's PHD and CybrCard products previously capitalized
and since discontinued development and production costs of the Company's
CybrCard product, (ii) marketing and general introduction of the Company's PHD
and CybrCard products and (iii) the tax expense resulting from the valuation
allowance recorded.
YEARS ENDED DECEMBER 31, 1996 AND 1995
SALES. The decrease in Semiconductor Segment sales was entirely due to a
decrease in average sales price, resulting from a general downturn in the market
for semiconductor products during the second half of 1996. Computer Segment
sales increased due to a 35% increase in sales from the Company's United States
operations, attributable to a 93% increase in Computer Hardware-VAR sales and a
102% increase in PHD software sales, partially offset by a decrease in revenues
from consulting services.
GROSS PROFIT. The decrease in gross profit as a percentage of Semiconductor
Segment sales was primarily attributable to the impact of increased costs
associated with the depreciation of the cost of the expansion of Tower's
manufacturing facility and the operation of the plant below capacity during the
second half of 1996 as well as the decrease in average sales price referred to
above. The decrease in gross profits as a percentage of Computer Segment sales
was primarily attributable to (i) the increased percentage of sales attributable
to Computer Hardware-VAR sales, which characteristically have lower gross profit
margins, and (ii) a decrease in profitability in the Company's Israeli
consulting systems and software activity, due to increased direct labor costs.
R&D. The increase in R&D expenses in the Semiconductor Segment reflected
higher process development expenses related to the implementation of Tower's
technology advancement plan. The R&D amount in the computer segment was
significantly affected in this period by the restatement. For a discussion of
R&D costs in the Computer Segment, see "Item 7. Management's Discussion and
Analysis of Financial Condition and Results of Operations--Computer Software
Services and Systems".
SG&A. The increase in SG&A and SG&A as a percentage of sales for the
Semiconductor Segment was primarily attributable to increased marketing expenses
and professional fees. The increase in Computer Segment SG&A as a percentage of
segment sales was primarily attributable to SG&A expenses associated with the
marketing and general introduction of the Company's PHD and CybrCard products,
as well as a decrease in the Segment's Israeli operations without a commensurate
decrease in the SG&A of such operations.
OPERATING INCOME. The decrease in operating income was primarily due to the
aforementioned decrease in gross profits.
GAIN ON CHANGES IN OWNERSHIP INTEREST IN SUBSIDIARY. The gain in 1995 was
from Tower's public offering, net of certain expenses. Minority interests in
this gain was approximately $10.5 million.
INCOME TAXES. The increase in the effective tax rate for the year ended
December 31, 1996 was primarily attributable to (i) the recording in 1995 of a
non-taxable gain on changes in ownership interests in subsidiaries related to
the public offering of stock by the Company's Tower subsidiary, and (ii) the
recording of taxes payable on a dividend distributed to the Company by its Tower
subsidiary in 1996.
LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 1997, DSSI and its wholly-owned subsidiaries had working
capital of $4.1 million (including unrestricted cash and cash equivalents of
$1.2 million) and DSI Israel had working capital of $3.1 million (net of short
term bank credit of $1.1 million). Although there is no legal restriction
preventing disposition of the Company's investments or the distribution to the
Company of their earnings,
21
<PAGE>
cash of subsidiaries that are not wholly-owned is generally not available for
use by DSSI or other subsidiaries.
DSSI has financed the operations of its wholly owned subsidiaries from the
proceeds of a public offering in 1993, an institutional private placement in
June 1994 and the receipt of cash dividends from Tower in December 1996 and
1997. DSSI believes that it has adequate liquidity to finance its ongoing
corporate activities. However in order to continue financing its PHD activities
the Company will require additional financing. If the Company is unable to
obtain such financing on commercially reasonable terms, it may have to
discontinue PHD's operations. There can be no assurance that the Company will
obtain the resources to finance its PHD product development and marketing
efforts.
Due to the high costs associated with CybrCard's marketing of consumer
multimedia products, the Company does not currently intend to develop and market
additional multimedia entertainment products in 1998. The Company, however, is
actively pursuing projects in the multimedia area in which the Company would
have responsibility for design and development of products, which would be
marketed and sold by others. It is contemplated that in any such projects the
cost of development would be covered by the party with responsibility for the
marketing of the product.
In February 1998, the Company and Databit entered into a term loan agreement
with a bank under which the Company borrowed $1.2 million. In connection
therewith, the Company granted security interests in all of its assets as
security for the loan. The loan is repayable in 22 monthly installments
beginning May 1, 1998, with interest at the bank's reference rate plus 1%
(currently 9.50%).
DSI Israel has satisfied its financial and operating requirements
principally through cash from operations and the net proceeds of its initial
public offering in December 1992. DSI Israel has at its disposal additional bank
credit should it require additional cash. Certain of its bank deposits serve as
collateral for bank loans and guarantees.
Although the Company has retained effective control of Tower, since the end
of December 1996, the Company no longer maintained voting control of more than
50% of Tower's shares and, therefore, ceased to consolidate Tower's balance
sheet, and in 1997 consolidated its operations on an equity basis.
Tower has satisfied its financial and operating requirements principally
through cash from operations, Investment Center grants, an advance from a
customer and the net proceeds of its public offerings in 1994 and 1995. As of
December 31, 1997, Tower had working capital of $87.5 million, including cash,
short-term bank deposits and marketable securities of $83.9 million.
IMPACT OF INFLATION AND CURRENCY FLUCTUATIONS
During 1997 a majority of the Company's sales was denominated in dollars.
The remaining portion was primarily denominated in NIS that are linked to the
dollar. Such sales transactions are negotiated in dollars; however, for the
convenience of the customer they are settled in NIS. These transaction amounts
are linked to the dollar between the date the transactions are entered into
until the date they are effected and billed for. Subsequent thereto, through the
date of settlement, amounts are primarily unlinked. The majority of the
Company's expenses in 1997 was in dollars or dollar-linked NIS and virtually all
the remaining expenses were in NIS. The dollar cost of the Company's operations
in Israel is influenced by the timing of, and the extent to which, any increase
in the rate of inflation in Israel over the rate of inflation in the United
States is not offset by the devaluation of the NIS in relation to the dollar.
During 1997, the NIS was devalued against the dollar by approximately 8.8%,
while the consumer price index in Israel increased by 7%. The Company believes
that the rate of inflation in Israel has had a minor effect on its business to
date. However, the Company's dollar costs in Israel will increase if inflation
in Israel continues, as it did in previous years, to exceed the devaluation of
the NIS against the dollar or if the timing of such devaluation lags behind
inflation in Israel.
22
<PAGE>
Tower has commitments outstanding in Japanese Yen incurred for certain
capital equipment expenditures. Tower purchases forward exchange contracts to
reduce its financial exposure to fluctuation in the Japanese Yen/US dollar
exchange rate resulting from such commitments. The Company does not engage in
any other hedging activities.
As of December 31, 1997, virtually all of the Company's monetary assets and
liabilities that were not denominated in dollars or dollar-linked NIS were
denominated in NIS, and the net amount of such monetary assets and liabilities
was not material. In the event that in the future the Company has material net
monetary assets or liabilities that are not denominated in dollar-linked NIS,
such net assets or liabilities would be subject to the risk of currency
fluctuations.
YEAR 2000 COMPLIANCE
The Company's software and hardware systems were developed relatively
recently and the Company therefore believes that the systems do not require
significant modifications to make them Year 2000 compliant. However, the Company
may face Year 2000 compliance issues in relation to projects it performed for
customers in the past, or as it seeks to coordinate with suppliers, customers
and others. Although the Company is not currently aware of any material Year
2000 compliance problems, an assessment has not been made of the anticipated
costs, problems and uncertainties associated with possible Year 2000 compliance
issues and the possible consequences to the Company.
23
<PAGE>
SUMMARY QUARTERLY FINANCIAL DATA
The following table sets forth certain unaudited quarterly financial
information for the Company for the years ended December 31, 1996 and 1997. As
discussed above, this information has been restated primarily to reflect the
expensing of previously capitalized EPSM software development costs. This
information should be read in conjunction with the Consolidated Financial
Statements. The quarterly financial information for the year ended December 31,
1997, reflects Tower's activity on the equity method, while such information for
the year ended December 31, 1996 reflects Tower's activities on a fully
consolidated basis. Therefore information for such periods is not directly
comparable.
Certain amounts included in the Summary Quarterly Financial Data have been
reclassified to conform with current presentation.
<TABLE>
<CAPTION>
FIRST SECOND THIRD FOURTH FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER
--------- --------- --------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
1996 1997
------------------------------------------ ------------------------------------------
<CAPTION>
(UNAUDITED, AS RESTATED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Sales................................. $ 35,732 $ 36,711 $ 28,702 $ 30,610 $ 10,040 $ 10,141 $ 9,363 $ 10,452
Cost of sales......................... 25,799 28,815 24,152 23,328 10,289 7,756 6,852 7,540
--------- --------- --------- --------- --------- --------- --------- ---------
Gross profit (loss)................. 9,933 7,896 4,550 7,282 (249) 2,385 2,511 2,912
R&D, net.............................. 1,162 959 1,659 1,831 338 323 364 310
SG&A.................................. 4,454 4,626 4,192 5,363 4,391 4,789 4,574 5,105
--------- --------- --------- --------- --------- --------- --------- ---------
Operating income (loss)............. 4,317 2,311 (1,301) 88 (4,978) (2,727) (2,427) (2,503)
Financial income (expenses), net...... 1,165 820 687 431 108 277 75 (207)
Other income (expenses), net........ 17 12 1,840 (1,260) 2 21 32 (166)
--------- --------- --------- --------- --------- --------- --------- ---------
Income before income taxes.......... 5,499 3,143 1,226 (741) (4,868) (2,429) (2,320) (2,876)
Income tax expense (benefit).......... 1,161 489 1,434 (943) 484 49 (7) 2,981
--------- --------- --------- --------- --------- --------- --------- ---------
Net income (loss) after income
taxes............................. 4,338 2,654 (208) 202 (5,352) (2,478) (2,313) (5,857)
Minority interests.................... (3,752) (2,312) (698) (937) 245 108 37 286
Equity (loss) in affiliates........... (73) (53) (416) (1,225) 1,041 1,375 873 1,591
--------- --------- --------- --------- --------- --------- --------- ---------
Net income (loss)................... $ 513 $ 289 $ (1,322) $ (1,960) $ (4,066) $ (995) $ (1,403) $ (3,980)
--------- --------- --------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- --------- --------- ---------
Basic earnings (loss) per share....... $ 0.07 $ 0.04 $ (0.18) $ (0.26) $ (0.55) $ (0.14) $ (0.19) $ (0.54)
--------- --------- --------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- --------- --------- ---------
Weighted average number of shares
outstanding......................... 7,310 7,534 7,373 7,400 7,369 7,369 7,369 7,369
--------- --------- --------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- --------- --------- ---------
</TABLE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Furnished at end of this Report commencing on page F-1. Financial Statements
of Tower Semiconductor Ltd. are included commencing at page F-33 in accordance
with Rule 3-09(a) of Regulation S-X.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
24
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
Unless otherwise indicated, all exhibits have been previously filed.
(a) EXHIBITS:
<TABLE>
<C> <S>
3.1 Certificate of Incorporation of the Registrant, with amendments thereto
(incorporated herein by reference to Exhibit 3.1 to the Registrant's Registration
Statement on Form S-1 (File No. 33-70482) (the "1993 Registration Statement")).
3.2 By-laws of the Registrant (incorporated herein by reference to Exhibit 3.2 to the
Registrant's Registration Statement on Form S-1 (File No. 33-44027) (the "1992
Registration Statement")).
3.3 Amendments to the By-laws of the Registrant adopted December 27, 1994 (incorporated
by reference to Exhibit 3.3 of the Registrant's Current Report on Form 8-K dated
January 10, 1995).
4.1 Specimen certificate for the Common Stock (incorporated herein by reference to
Exhibit 4.2 to the 1992 Registration Statement).
4.2 Form of Underwriter's Warrant Agreement, including form of Underwriter's Warrant
(incorporated herein by reference to Exhibit 4.4 to the 1993 Registration
Statement).
4.3 Form of Warrant to Purchase Common Stock (incorporated herein by reference to
Exhibit 4.3 to the Company's Annual Report on Form 10K for the year ended December
31, 1995 (the "1995 10-K")).
*10.1 Employment Agreement between the Registrant and George Morgenstern, dated as of
January 1, 1997.
*10.2 Employment Agreement between the Registrant and Shmuel Fogel, dated September 1,
1986 (incorporated herein by reference to Exhibit 10.3 to the 1992 Registration
Statement).
*10.3 1991 Stock Option Plan (incorporated herein by reference to Exhibit 10.4 to the 1992
Registration Statement).
*10.4 1994 Stock Incentive Plan, as amended (incorporated herein by reference to Exhibit
10.4 to the 1995 10-K).
*10.5 1994 Stock Option Plan for Outside Directors, as amended (incorporated herein by
reference to Exhibit 10.5 to the 1995 10-K).
10.6 1995 Stock Option Plan for Nonmanagement Employees (incorporated herein by reference
to Exhibit 10.6 to the 1995 10-K).
10.7 Lease Agreement between Tower and the Israel Lands
Administration (incorporated herein by reference to Exhibit 10.1 to Tower's
Registration Statement on Form S-1 (File No. 33-83126) (the "First Tower
Registration Statement")).
10.8 Shareholders Agreement between National Semiconductor (IC) Ltd. and Tower
Semiconductor Holdings 1993 Limited, dated as of February 28, 1993, as amended
(incorporated herein by reference to Exhibit 10.3 to the First Tower Registration
Statement).
10.9 Amendment dated November 2, 1995 to the Shareholders Agreement listed above as
Exhibit 10.8 (incorporated by reference to Exhibit 1.2 to Tower's Annual Report on
Form 20-F for the year ended December 31, 1994 (the "Tower 1994 20-F")).
10.10 Amendment dated June 12, 1995 to the Shareholders Agreement listed above as Exhibit
10.8 (incorporated by reference to Exhibit 10.3.2 to Tower's Registration Statement
on Form F-1 (File No. 33-93434) (the "Second Tower Registration Statement")).
10.11 Amendment dated as of September 22, 1995 to the Shareholders Agreement listed above
as Exhibit 10.8. (incorporated herein by reference to the 1995 10-K).
10.12 Amendment dated as of August 1, 1996 to the Shareholders Agreement listed above as
Exhibit 10.8 (incorporated by reference to Exhibit 1.3 to Tower's Annual Report on
Form 20-F for the year ended December 31, 1996 (the "Tower 1996 20-F")).
</TABLE>
25
<PAGE>
<TABLE>
<C> <S>
10.13 Registration Rights Agreement among Tower, National Semiconductor (IC) Ltd., and
Tower Semiconductor Holdings 1993 Limited, dated as of February 28, 1993
(incorporated herein by reference to Exhibit 10.4 to the First Tower Registration
Statement).
10.14 Technology Transfer Agreement between National Semiconductor Corporation and Tower,
dated as of February 28, 1993 (incorporated herein by reference to Exhibit 10.6 to
the First Tower Registration Statement).
10.15 Shareholders Agreement among the Registrant, The Israel Corporation Ltd. and Tower
Semiconductor Holdings 1993 Limited, dated as of February 28, 1993, as amended
(incorporated herein by reference to Exhibit 10.8 to the First Tower Registration
Statement).
10.16 Mutual Services Agreement between Tower and National Semiconductor Corporation,
dated July 1, 1994 (incorporated herein by reference to Exhibit 10.9 to the First
Tower Registration Statement).
10.17 Purchase Agreement, as amended, between Tower and Hewlett-Packard Company, dated
January 16, 1994 (incorporated herein by reference to Exhibit 10.10 to the First
Tower Registration Statement).
10.18 Technology Transfer and License Agreement between Tower and Hewlett-Packard Company,
dated February 22, 1994 (incorporated herein by reference to Exhibit 10.11 to the
First Tower Registration Statement).
10.19 Special Collective Agreement and Letter of Indemnity dated October 4, 1994 between
Tower, the Histadrut and Mivtachim Social Institute of Employees Ltd. (incorporated
herein by reference to Exhibit 10.12 to the First Tower Registration Statement).
10.20 Contract Supply Agreement between Tower and Motorola, Inc., dated May 24, 1994, as
amended (incorporated herein by reference to Exhibit 10.13 to the First Tower
Registration Statement).
10.21 Certificate of Approval of the Investment Center of the Israel Ministry of Industry
and Trade (incorporated herein by reference to Exhibit 10.14 to the First Tower
Registration Statement).**
10.22 Certificate of approval for the Investment Center of the Israel Ministry of Industry
and Trade dated January 24, 1996.**
10.23 Bank Loan and Credit Line Agreements among the Registrant, Bank Leumi Le-Israel B.M.
and Bank Hapoalim B.V., as amended (incorporated herein by reference to Exhibit
10.15 to the First Tower Registration Statement).
*10.24 Form of Tower Employee Share Purchase Plan Agreement (incorporated herein by
reference to Exhibit 10.16 to the First Tower Registration Statement).
*10.25 Employment Agreement between the Registrant and Sanford L. Kane, dated as of July 1,
1994 (incorporated herein by reference to Exhibit 10.18 to the First Tower
Registration Statement).
*10.26 Agreement dated April 10, 1995, between the Company and Sanford L. Kane
(incorporated herein by reference to Exhibit 21.1 to the 1995 10-K).
*10.27 Employment Agreement between Tower and Rafael Levin, dated February 25, 1993, as
amended (incorporated herein by reference to Exhibit 10.19 to the First Tower
Registration Statement).
*10.28 Employment Agreement between Tower and Yoav Nissan-Cohen, dated February 25, 1993,
as amended (incorporated herein by reference to Exhibit 10.20 to the First Tower
Registration Statement).
10.29 Agreement between the Registrant and Tower dated January 18, 1994 (incorporated
herein by reference to Exhibit 10.21 to the First Tower Registration Statement).
10.30 Agreement between the Registrant and Tower, dated June 12, 1995 (incorporated herein
by reference to Exhibit 10.22 to the Second Tower Registration Statement).
10.31 Promissory Note dated July 1, 1996 of Geotek Communications, Inc. in the principal
amount of $2,000,000 payable to Decision System Israel Ltd. (incorporated herein by
reference to Exhibit 10.37 of the Company's Annual Report on Form 10-K for the year
ended December 31, 1996 (the "1996 10-K")).
10.32 Letter Agreement between Geotek Communications, Inc. and the Registrant dated
February 26, 1998.
</TABLE>
26
<PAGE>
<TABLE>
<C> <S>
10.33 Installment Promissory Note among the Registrant, Databit Inc., and Bank Leumi Trust
Company dated February 9, 1998.
10.34 Security Agreement between the Registrant and Bank Leumi Trust Company.
10.35 Security Agreement between Databit Inc. and Bank Leumi Trust Company.
10.36 Promissory Note between George Morgenstern and the Registrant, dated as of December
31, 1997.
10.37 License Agreement between the Registrant and Lucent Technologies Inc. dated as of
January 9, 1998 (incorporated herein by reference to the Registrant's Current Report
on Form 8-K dated February 17, 1998).
10.38 Bill of Sale dated as of January 9, 1998, by and from Lucent Technologies Inc. to
the Registrant (incorporated herein by reference to the Registrant's Current Report
on Form 8-K dated February 17, 1998).
10.39 Settlement Agreement by and among the Registrant, Jeffrey A. Cummer, Dwayne A.
Moyers and affiliates dated February 6, 1998 (incorporated herein by reference to
the Registrant's Current Report on Form 8-K dated February 6, 1998).
22.1 List of subsidiaries
+ 24.1 Consent of Deloitte & Touche LLP
+ 24.2 Consent of Igal Brightman & Co.
27.1 Financial Data Schedule
</TABLE>
- ------------------------
* This exhibit includes a management contract, compensatory plan or
arrangement in which one or more directors or executive officers of the
Company participate.
** Hebrew original, accompanied by English language translation or summary.
+ Filed herewith.
(b) FINANCIAL STATEMENT SCHEDULES.
None.
(c) REPORTS ON FORM 8-K.
The Company filed no reports on Form 8-K during the last three months of
1997.
27
<PAGE>
SIGNATURE
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this amendment to be signed
on its behalf by the undersigned, thereunto duly authorized, in the Township of
Mahwah, State of New Jersey, on September 11, 1998.
DATA SYSTEMS & SOFTWARE INC.
BY /s/ GEORGE MORGENSTERN
-----------------------------------------
George Morgenstern
CHAIRMAN OF THE BOARD, PRESIDENT
AND CHIEF EXECUTIVE OFFICER
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons on behalf of the registrant, in
the capacities and on the dates indicated.
SIGNATURE TITLE DATE
- ------------------------------ --------------------------- -------------------
Chairman of the Board;
/s/ GEORGE MORGENSTERN President; Chief
- ------------------------------ Executive Officer; and September 11, 1998
George Morgenstern Director
Vice Chairman and Director
- ------------------------------ September 11, 1998
Robert L. Kuhn
/s/ SAMUEL FOGEL Executive Vice President
- ------------------------------ and Director September 11, 1998
Samuel Fogel
Vice President, Chief
/s/ YACOV KAUFMAN Financial Officer
- ------------------------------ (Principal Financial September 11, 1998
Yacov Kaufman Officer and Principal
Accounting Officer)
/s/ HARVEY EISENBERGER Director
- ------------------------------ September 11, 1998
Harvey Eisenberger
/s/ ALLEN I. SCHIFF Director
- ------------------------------ September 11, 1998
Allen I. Schiff
Director
- ------------------------------ September 11, 1998
Maxwell M. Rabb
Director
- ------------------------------ September 11, 1998
Susan Malley
/s/ SHELDON KRAUSE Secretary and Director
- ------------------------------ September 11, 1998
Sheldon Krause
28
<PAGE>
DATA SYSTEMS & SOFTWARE INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS (RESTATED)
CONSOLIDATED FINANCIAL STATEMENTS OF DATA SYSTEMS & SOFTWARE INC.:
<TABLE>
<S> <C>
Report of Deloitte & Touche LLP...................................................... F-1
Report of Igal Brightman & Co........................................................ F-2
Consolidated Balance Sheets (Restated) as of December 31, 1996 and December 31,
1997............................................................................... F-3
Consolidated Statements of Operations (Restated) for the years ended December 31,
1995, December 31, 1996 and December 31, 1997...................................... F-4
Consolidated Statement of Changes in Shareholders' Equity (Restated) for the years
ended December 31, 1995 December 31, 1996 and December 31, 1997.................... F-5
Consolidated Statements of Cash Flows (Restated) for the years ended December 31,
1995, December 31, 1996 and December 31, 1997...................................... F-6
Notes to Consolidated Financial Statements........................................... F-8
Financial Statements of Tower Semiconductor Ltd.:
Auditors' Report..................................................................... F-33
Balance Sheets as of December 31, 1997 and December 31, 1996......................... F-34
Statements of Income for the years ended December 31, 1997, December 31, 1996 and
December 31, 1995.................................................................. F-35
Statement of Changes in Shareholders' Equity for the years ended December 31, 1997,
December 31, 1996 and December 31, 1995............................................ F-36
Statements of Cash Flows for the years ended December 31, 1997, December 31, 1996 and
December 31, 1995.................................................................. F-37
Notes to Financial Statements........................................................ F-38
</TABLE>
<PAGE>
INDEPENDENT AUDITORS' REPORT
TO THE BOARD OF DIRECTORS AND SHAREHOLDERS OF
DATA SYSTEMS & SOFTWARE INC.
We have audited the accompanying consolidated balance sheet of Data Systems &
Software Inc. ("the Company") and its subsidiaries as of December 31, 1997 and
the related consolidated statements of operations, changes in shareholders'
equity and cash flows for the year ended December 31, 1997. These consolidated
financial statements are the responsibility of the Company's Board of Directors
and management. Our responsibility is to express an opinion on these financial
statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by the
Board of Directors and management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides 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 and its
subsidiaries as of December 31, 1997, and the results of their operations,
changes in shareholders' equity and cash flows for the year ended December 31,
1997, in conformity with generally accepted accounting principles.
As discussed in Note 22, the accompanying financial statements have been
restated.
Deloitte & Touche LLP
New York, New York
March 30, 1998 (July 30, 1998, as to Note 22)
F-1
<PAGE>
REPORT OF INDEPENDENT AUDITORS
TO THE BOARD OF DIRECTORS AND SHAREHOLDERS OF
DATA SYSTEMS & SOFTWARE INC.
We have audited the accompanying consolidated balance sheet of Data Systems
& Software Inc. ("the Company") and its subsidiaries as of December 31, 1996,
and the related consolidated statements of operations, changes in shareholders'
equity and cash flows for the years ended December 31, 1995 and 1996. These
financial statements are the responsibility of the Company's Board of Directors
and management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards in Israel, including those prescribed by the Israeli Auditors'
Regulations (Auditor's Mode of Performance)-1973, which auditing standards are
substantially identical to generally accepted auditing standards in the United
States. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by the
Board of Directors and management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of the Company
and its subsidiaries as of December 31, 1996, and the results of their
operations, changes in shareholders' equity and cash flows for the years ended
December 31, 1995 and 1996, in conformity with accounting principles generally
accepted in Israel and the United States. As applicable to these financial
statements, such accounting principles are substantially identical in all
material respects.
As discussed in Note 22, the accompanying financial statements have been
restated.
IGAL BRIGHTMAN & CO.
Certified Public Accountants (Isr.)
Tel Aviv, Israel
March 31, 1997 (July 30, 1998, as to Note 22)
F-2
<PAGE>
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
AS OF
DECEMBER 31
--------------------
<S> <C> <C>
1996* 1997*
--------- ---------
<CAPTION>
(AS RESTATED; SEE
NOTE 22)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents.................................................................... $ 2,464 $ 1,424
Short-term interest bearing bank deposits.................................................... 398 73
Marketable debt securities (Note 3).......................................................... 5,226 1,600
Restricted cash (Note 11).................................................................... 1,403 1,786
Trade accounts receivable, net (Note 4)...................................................... 7,875 9,003
Inventory (Note 5)........................................................................... 953 377
Note receivable (Note 6)..................................................................... -- 2,248
Other current assets (Note 7)................................................................ 1,740 1,173
--------- ---------
Total current assets....................................................................... 20,059 17,684
--------- ---------
Investments (Note 8)........................................................................... 68,372 70,695
--------- ---------
Property and equipment, net (Note 9)........................................................... 2,279 2,181
--------- ---------
Other assets:
Capitalized software development costs, net (Note 10)........................................ 931 --
Intangible assets, primarily goodwill........................................................ 468 338
Note receivable (Note 6)..................................................................... 2,083 --
Other........................................................................................ 3,626 1,468
--------- ---------
7,108 1,806
--------- ---------
Total assets............................................................................... $ 97,818 $ 92,366
--------- ---------
--------- ---------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Short-term debt--banks and others (Note 11).................................................. $ 1,962 $ 2,581
Current maturities of long-term debt--banks and others (Note 12)............................. 162 1,128
Trade accounts payable....................................................................... 1,643 2,606
Accrued payroll, payroll taxes and social benefits........................................... 2,140 2,464
Other current liabilities.................................................................... 476 1,704
--------- ---------
Total current liabilities.................................................................. 6,383 10,483
--------- ---------
Long-term liabilities:
Long-term debt--banks and others, net of current maturities (Note 12)........................ 331 248
Other (Note 13).............................................................................. 141 233
--------- ---------
Total long-term liabilities................................................................ 472 481
--------- ---------
Commitments and contingencies (Note 14)
Minority interests............................................................................. 28,407 29,094
--------- ---------
Shareholders' equity (Note 15):
Common stock--$.01 par value per share:
Authorized 20,000,000 shares; Issued--7,708,540 shares at December 31, 1996 and 1997....... 77 77
Additional paid-in capital................................................................... 33,997 34,193
Retained earnings............................................................................ 30,330 19,886
--------- ---------
64,404 54,156
Treasury stock, at cost--339,362 shares at December 31, 1996 and 1997........................ (1,848) (1,848)
--------- ---------
Total shareholders' equity................................................................. 62,556 52,308
--------- ---------
Total liabilities and shareholders' equity................................................. $ 97,818 $ 92,366
--------- ---------
--------- ---------
</TABLE>
- ------------------------
* Reflects the balances of Tower Semiconductor Ltd. ("Tower") on the equity
method.
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
<PAGE>
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------
<S> <C> <C> <C>
1995 1996 1997*
----------- ----------- ----------
<CAPTION>
(AS RESTATED; SEE NOTE 22)
<S> <C> <C> <C>
Sales:
Products.................................................................. $ 110,116 $ 113,235 $ 19,950
Services.................................................................. 19,707 18,520 20,046
----------- ----------- ----------
129,823 131,755 39,996
----------- ----------- ----------
Cost of sales:
Products.................................................................. 76,181 87,706 16,744
Services.................................................................. 14,658 14,388 15,693
----------- ----------- ----------
90,839 102,094 32,437
----------- ----------- ----------
Gross profit........................................................ 38,984 29,661 7,559
----------- ----------- ----------
Research and development expenses, net...................................... 4,375 5,611 1,335
Selling, general and administrative expenses................................ 15,926 18,635 18,859
----------- ----------- ----------
Operating income (loss)............................................. 18,683 5,415 (12,635)
Interest income............................................................. 5,188 5,321 478
Interest expenses........................................................... (2,434) (2,218) (225)
Gain on changes in ownership interests in subsidiaries (Note 17)............ 26,339 -- --
Other income (expenses), net................................................ 5 609 (111)
----------- ----------- ----------
Income (loss) before income taxes................................... 47,781 9,127 (12,493)
Income taxes (Note 18)...................................................... 4,837 2,141 3,507
----------- ----------- ----------
Income (loss) after income taxes.................................... 42,944 6,986 (16,000)
Minority interests.......................................................... (25,026) (7,699) 676
Equity (loss) in affiliates................................................. (169) (1,767) 4,880
----------- ----------- ----------
Net income (loss)................................................... $ 17,749 $ (2,480) $ (10,444)
----------- ----------- ----------
----------- ----------- ----------
Basic net income (loss) per share........................................... $ 2.53 $ (0.34) $ (1.42)
----------- ----------- ----------
----------- ----------- ----------
Weighted average number of shares outstanding (in thousands)................ 7,026 7,369 7,369
----------- ----------- ----------
----------- ----------- ----------
Diluted net income (loss) per share......................................... $ 2.43 $ (0.34) $ (1.42)
----------- ----------- ----------
----------- ----------- ----------
Weighted average number of shares outstanding and common share equivalents
(in thousands)............................................................ 7,307 7,369 7,369
----------- ----------- ----------
----------- ----------- ----------
</TABLE>
- ------------------------
* The statement of operations for the year ended December 31, 1997 reflects
the results of Tower on the equity method, while the statements of
operations for the year ended December 31, 1995 and December 31, 1996
reflect the results of Tower on a fully consolidated basis.
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
<PAGE>
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
ADDITIONAL
THOUSANDS COMMON PAID-IN TREASURY RETAINED
OF SHARES STOCK CAPITAL STOCK EARNINGS TOTAL
----------- ------------- -------------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
Balances, January 1, 1995, as previously
reported...................................... 7,130 $ 71 $ 30,372 $ (567) $ 16,635 $ 46,511
Prior period adjustment (See Note 22)........... -- -- -- -- (1,574) (1,574)
Balances, January 1, 1995, as restated
(See Note 22)................................. 7,130 71 30,372 (567) 15,061 44,937
----- --- ------- --------- --------- ---------
Purchase of treasury stock...................... -- -- -- (1,281) -- (1,281)
Issuance of common stock relating to business
acquisitions.................................. 129 1 1,133 -- -- 1,134
Common stock issued upon exercise of options and
warrants, net................................. 331 3 2,237 -- -- 2,240
Net income, as restated (See Note 22)........... -- -- -- -- 17,749 17,749
----- --- ------- --------- --------- ---------
Balances, December 31, 1995, as restated (See
Note 22)...................................... 7,591 75 33,742 (1,848) 32,810 64,779
Common stock issued in restricted stock award... 100 1 587 -- -- 588
Unamortized restricted stock award
compensation.................................. -- -- (437) -- -- (437)
Common stock issued upon exercise of options.... 18 1 105 -- -- 106
Net loss, as restated (See Note 22)............. -- -- -- -- (2,480) (2,480)
----- --- ------- --------- --------- ---------
Balances, December 31, 1996, as restated (See
Note 22)...................................... 7,709 77 33,997 (1,848) 30,330 62,556
Amortization of restricted stock award
compensation.................................. -- -- 196 -- -- 196
Net loss, as restated (See Note 22)............. -- -- -- -- (10,444) (10,444)
----- --- ------- --------- --------- ---------
Balances, December 31, 1997, as restated (See
Note 22)...................................... 7,709 $ 77 $ 34,193 $ (1,848) $ 19,886 $ 52,308
----- --- ------- --------- --------- ---------
----- --- ------- --------- --------- ---------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
<PAGE>
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------
<S> <C> <C> <C>
1995 1996 1997
----------- ----------- ----------
<CAPTION>
(AS RESTATED; SEE NOTE 22)
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss)......................................................... $ 17,749 $ (2,480) $ (10,444)
Adjustments to reconcile net income (loss) to net cash provided by
operating activities--see Schedule A.................................... 14,616 16,399 602
----------- ----------- ----------
Net cash provided by (used in) operating activities..................... 32,365 13,919 (9,842)
----------- ----------- ----------
Cash flows provided by (used in) investing activities:
Short-term and long-term bank deposits, net............................... (22,712) (403) 363
Restricted cash, net...................................................... -- -- (330)
Investment in marketable securities....................................... (232,184) (194,798) (33,122)
Proceeds from realization of marketable securities........................ 200,089 243,257 37,102
Acquisitions of property and equipment.................................... (51,381) (51,728) (862)
Proceeds from sale of property and equipment.............................. 39 229 53
Proceeds from sale of shares in a non-affiliated company.................. -- 80 --
Investments in capitalized software development costs, net................ (526) (830) --
Investments in other assets............................................... (1,028) (36) 4,291
Loan to affiliates........................................................ (266) (2,785) --
Net effect of change in reporting from consolidation to equity method--see
Schedule B.............................................................. -- (11,459) 102
Net cash acquired (transferred) on purchase (sale) of subsidiaries........ 272 (130) --
----------- ----------- ----------
Net cash provided by (used in) investing activities..................... (107,697) (18,603) 7,597
----------- ----------- ----------
Cash flows provided by (used in) financing activities:
Net proceeds from public offering of securities and exercise of option
warrants of subsidiary.................................................. 88,068 -- (211)
Proceeds from issuance of common stock, net............................... 2,240 106 --
Minority interest portion of subsidiary dividend distribution............. -- (14,931) --
Purchase of treasury stock................................................ (1,338) -- --
Short-term debt, net...................................................... 2,567 (1,625) 566
Proceeds from long-term debt.............................................. 6,514 230 1,359
Repayments of long-term debt.............................................. (7,887) (341) (509)
Liability in respect of customer advances................................. 4,500 -- --
Repayment of liability in respect of customer advances.................... -- (2,250) --
----------- ----------- ----------
Net cash provided by (used in) financing activities..................... 94,664 (18,811) 1,205
----------- ----------- ----------
Net increase (decrease) in cash and cash equivalents........................ 19,332 (23,495) (1,040)
Cash and cash equivalents at beginning of year.............................. 6,627 25,959 2,464
----------- ----------- ----------
Cash and cash equivalents at end of year.................................... $ 25,959 $ 2,464 $ 1,424
----------- ----------- ----------
----------- ----------- ----------
Supplemental cash flow information:
Cash paid during the period for:
Interest................................................................ $ 911 $ 829 $ 183
----------- ----------- ----------
----------- ----------- ----------
Income taxes............................................................ $ 3,422 $ 2,360 $ 773
----------- ----------- ----------
----------- ----------- ----------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
<PAGE>
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
SCHEDULES TO CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------
<S> <C> <C> <C> <C>
1995 1996 1997
---------- ---------- ---------
<CAPTION>
(AS RESTATED; SEE NOTE 22)
<S> <C> <C> <C> <C>
Adjustments to reconcile net income (loss) to net cash provided by (used
in) operating activities:
A.
Depreciation and amortization............................................. $ 8,908 $ 16,829 $ 1,479
Gain on changes in ownership interests in subsidiaries.................... (26,339) -- --
Gain on sale of affiliate................................................. -- (1,710) --
Minority interests........................................................ 25,026 7,699 687
Write-down of capitalized software development costs...................... -- -- 1,663
Earnings on marketable debt securities.................................... (3,775) (3,330) (107)
Deferred income taxes..................................................... 2,421 1,715 2,982
Increase in liability for severance pay................................... 492 176 120
(Equity) loss in affiliates............................................... 169 1,767 (8,027)
(Gain) loss on sale of property, plant and equipment, net................. 91 55 (15)
Other..................................................................... 71 (276) (152)
(Increase) decrease in accounts receivable and other current assets....... (22,789) 7,757 (1,327)
(Increase) decrease in inventory.......................................... (3,553) (2,461) 424
(Increase) decrease in long-term receivables.............................. 324 (163) (165)
Increase (decrease) in accounts payable and other current liabilities..... 16,767 (10,219) 3,040
Increase (decrease) in liability in respect of customer advances, net..... 16,803 (1,440) --
---------- ---------- ---------
$ 14,616 $ 16,399 $ 602
---------- ---------- ---------
---------- ---------- ---------
Net effect of change in reporting method:
B.
Working capital, net of cash.............................................. -- $ 68,217 $ (18)
Investment recorded....................................................... -- (65,884) 1,157
Property and equipment.................................................... -- 104,582 --
Other assets.............................................................. -- 120 (1,037)
Other liabilities......................................................... -- (25,256) --
Minority interests........................................................ -- (93,238) --
---------- ---------- ---------
-- $ (11,459) $ 102
---------- ---------- ---------
---------- ---------- ---------
C. Non-cash activities:
Issuance of common stock related to business acquisitions................. $ 1,134 -- --
---------- ---------- ---------
---------- ---------- ---------
Notes received upon sale of subsidiary.................................... -- $ 589 --
---------- ---------- ---------
---------- ---------- ---------
Note received upon sale of affiliate...................................... -- $ 2,000 --
---------- ---------- ---------
---------- ---------- ---------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-7
<PAGE>
DATA SYSTEMS & SOFTWARE INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 1--GENERAL AND SIGNIFICANT ACCOUNTING POLICIES
(A) DESCRIPTION OF BUSINESS
Data Systems & Software Inc., a Delaware corporation ("DSSI"), through its
subsidiaries and affiliates (collectively, "the Company"), (i) provides
consulting and development services for computer software and systems and
pre-packaged software solutions, and is an authorized dealer and a value-added-
reseller of computer hardware, and (ii) engages in the manufacture of
semiconductors. The Company's shares are traded on the Nasdaq National Market.
The industries in which the Company operates are characterized by rapid
technological development. Accordingly, the ability to anticipate changes in
technology and to develop and introduce new and enhanced products incorporating
new technologies on a timely basis are significant factors in the ability to
grow and remain competitive. Furthermore, substantial expenditures are required
for research and development ("R&D") and for new product introduction.
(B) USE OF ESTIMATES IN PREPARATION OF FINANCIAL STATEMENTS
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 as of the date of the financial
statements, and the reported amounts of revenues and expenses during the
reporting periods. Actual results could differ from those estimates.
(C) SIGNIFICANT ACCOUNTING POLICIES
FOREIGN CURRENCY TRANSLATION
The currency of the primary economic environment in which the operations of
the Company are conducted is the United States dollar ("dollar"). Accordingly,
the Company uses the dollar as its functional currency. Transactions and
balances that are denominated in dollars are presented at their dollar amounts.
Transactions and balances in other currencies are remeasured into dollars in
accordance with the principles of Statement of Financial Accounting Standards
("SFAS") No. 52.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of all
majority-owned or controlled subsidiaries. Material intercompany balances and
transactions have been eliminated. The Company's principal subsidiaries are as
follows:
<TABLE>
<CAPTION>
EFFECTIVE PERCENTAGE
OWNERSHIP
AS OF DECEMBER 31,
------------------------
<S> <C> <C>
NAME OF SUBSIDIARY 1996 1997
- ----------------------------------------------------------------------- ----------- -----------
Tower Semiconductor Holdings 1993 Ltd. ("Holdings").................... 60.0% 60.0%
Tower.................................................................. 24.6% 24.6%
Decision Systems Israel Ltd.("DSI").................................... 79.6% 76.3%
International Data Operations, Inc..................................... 100.0% 100.0%
Databit Inc............................................................ 100.0% 100.0%
</TABLE>
F-8
<PAGE>
DATA SYSTEMS & SOFTWARE INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 1--GENERAL AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
RECLASSIFICATIONS
Certain amounts included in the consolidated statements of operations have
been reclassified to conform with current presentation.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents consist of cash and demand deposits in banks and
short-term investments (primarily time deposits and certificates of deposit)
with original maturities of three months or less.
INVESTMENTS IN SECURITIES
Marketable debt securities which the Company has the positive intent and
ability to hold to maturity are reflected at amortized cost, which approximates
market value. Non-current equity investments in which the Company does not have
significant influence are carried at cost.
INVENTORY
Inventories are stated at the lower of cost or market. Cost is determined
for raw materials, spare parts and supplies on the average cost method. For work
in process and finished goods, cost is determined on the basis of standard
costs, adjusted for variances as appropriate. For merchandise inventories, cost
is determined on the first-in, first-out method.
INVESTMENTS
Gains or losses resulting from the effective reduction of the Company's
holdings in subsidiaries due to the sale of their shares are included in
operating results.
Investments in 50% or less of the voting control of companies or other
entities over whose operating and financial policies the Company has the ability
to exercise significant influence ("affiliates") are accounted for by the equity
method. Pursuant to this method, the Company includes its share of the
affiliate's earnings or losses in its results of operations.
PROPERTY AND EQUIPMENT
Property and equipment are presented at cost, net of investment grants
received or receivable. Depreciation is calculated based on the straight-line
method over periods ranging from three to 25 years.
COMPUTER SOFTWARE DEVELOPMENT COSTS
Computer software development costs, presented net of participation from
others, are capitalized upon the establishment of technological feasibility for
costs that the Company believes will be recovered from anticipated revenues.
These determinations are made regularly by the Company on a product by product
basis. Amortization of these costs commences when the product is available for
general release to customers, based on the ratio of current revenues to current
and anticipated future gross revenues, but not less than straight-line
amortization over the expected economic life of each product (primarily three
years). Capitalized software development costs which exceed their net realizable
value at each balance sheet date are written off.
F-9
<PAGE>
DATA SYSTEMS & SOFTWARE INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 1--GENERAL AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
GOODWILL
Goodwill, included with other assets, represents the excess of cost over the
net carrying value of assets of subsidiaries acquired in purchase transactions.
Goodwill is amortized based on the straight-line method over periods ranging
from five to fifteen years. Management reviews goodwill (as well as property and
equipment and other long-lived assets) on a periodic basis to determine whether
events or changes in circumstances indicate that the carrying amount of such
assets may not be recoverable. Amortization expense related to goodwill amounted
to $409, $221 and $288 during the years ended December 31, 1995, 1996 and 1997,
respectively.
REVENUE RECOGNITION
Revenues are recognized as products are shipped or services are provided,
except for revenues from fixed-price contracts, which are recorded on the basis
of the percentage-of-completion method. Revenues from such contracts are
recorded as costs (primarily direct labor) are incurred, in the proportion that
actual costs incurred bear to total estimated costs. Fixed price projects are
often subject to termination without substantial penalty.
Percentage-of-completion estimates are continually reviewed and any adjustments
required are reflected in the period when such estimates are revised. Losses on
contracts, if any, are recognized in the period in which the loss is determined.
See discussion of SOP 97-2 in "Effects of Recently Issued Accounting Standards."
RESEARCH AND DEVELOPMENT EXPENSES ("R&D")
R&D costs not qualifying for capitalization as software development costs,
net of related participation, are charged to operations as incurred.
STOCK-BASED COMPENSATION
The Company accounts for employee stock-based compensation in accordance
with Accounting Principles Board Opinion No. 25. In accordance therewith, the
Company records compensation for share options granted to employees at the date
of grant based on the difference between the exercise price of the options and
the market value of the underlying shares at that date, as well as for the fair
value of restricted shares issued to employees. Deferred compensation is
amortized to compensation expense over the vesting period of the underlying
options. See Note 15 for pro forma disclosures required in accordance with SFAS
No. 123.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
The allowance for doubtful accounts is based on specific identification of
accounts considered to be doubtful of collection. The allowance for doubtful
accounts amounted to $540 and $438, at December 31, 1996 and 1997, respectively.
Bad debt expense was $288, $95 and $8 for the years ended December 31, 1995,
1996 and 1997, respectively.
F-10
<PAGE>
DATA SYSTEMS & SOFTWARE INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 1--GENERAL AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
FOREIGN EXCHANGE AGREEMENTS
The Company (primarily through Tower), from time to time, has entered into
foreign exchange agreements (forward agreements) primarily as a hedge against
non-dollar equipment purchase commitments. Gains and losses on foreign exchange
agreements through the date that the equipment is received are deferred and
recorded to property and equipment, while gains and losses subsequent thereto,
through the date of actual payment of the liability, are included in financial
income or expenses.
INCOME TAXES
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes, as well as operating
loss, capital loss and tax credit carryforwards. Deferred tax assets and
liabilities are classified as current or noncurrent based on the classification
of the related assets or liabilities for financial reporting, or according to
the expected reversal dates of the specific temporary differences, if not
related to an asset or liability for financial reporting. No provision has been
recorded for taxes which might be owed on disposition of the Company's
investments or on distribution to the Company of their earnings, since the
Company intends to reinvest earnings indefinitely.
LONG-LIVED ASSETS
The Financial Accounting Standards Board (the "FASB") Statement No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed Of" requires that such assets be segregated and stated at the lower
of the expected net realizable value or cost. The carrying value of long-lived
assets is periodically reviewed to determine whether impairment exists. The
review is based on comparing the carrying amount of the assets to the
undiscounted estimated cash flows over the remaining useful lives. No impairment
is indicated as of December 31, 1997. The Company has adopted this statement and
the impact has not been significant.
BASIC AND DILUTED NET INCOME (LOSS) PER SHARE
The Company has adopted Statement of Financial Accounting Standard ("SFAS")
No. 128 "Earnings per Share" (the "Statement"). The Statement establishes
standards for computing and presenting net income (loss) per share and applies
to entities with publicly held common stock or potential stock such as employee
stock options. The Statement replaces the presentation of primary net income
(loss) per share with a presentation of basic net income (loss) per share and
also requires, among other things, dual presentation of basic and diluted net
income (loss) per share for all entities with complex capital structures. Basic
net income (loss) per share excludes dilution and is computed by dividing net
income (loss) by the weighted average number of shares outstanding for each
period presented. Diluted net income (loss) per share is computed by dividing
net income (loss) by the weighted number of shares outstanding plus the dilutive
potential of common shares which will result from the exercise of stock options.
Prior periods have been restated to reflect the requirements of the new
statement.
F-11
<PAGE>
DATA SYSTEMS & SOFTWARE INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 1--GENERAL AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The following is a reconciliation of the weighted average shares used in the
computation of basic and dilutive net income (loss) per share: (000's)
<TABLE>
<CAPTION>
1995 1996 1997
--------- --------- ---------
<S> <C> <C> <C>
Weighted average common shares outstanding used for basic net income
(loss) per share................................................... 7,026 7,340 7,369
Dilutive stock options............................................... 281 -- --
--------- --------- ---------
Weighted average common shares outstanding used for dilutive net
income (loss) per share............................................ 7,307 7,340 7,369
--------- --------- ---------
--------- --------- ---------
</TABLE>
No stock options were included in the computations for 1996 and 1997, as
doing so would have been anti-dilutive of the per-share amounts for those years.
The number of stock options and warrants that could potentially dilute basic net
income (loss) per share in the future that were not included in the table above
in years ended December 31, 1995, 1996 and 1997 were 1,940, 2,022 and 1,911,
respectively.
EFFECTS OF RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income". This statement is effective for financial statements issued for periods
beginning after December 15, 1997. Management has evaluated the effect on its
financial reporting from the adoption of this statement and believes that such
effect would be insignificant.
In June 1997, the FASB issued SFAS No. 131, "Disclosure about Segments of an
Enterprise and Related Information" SFAS 131 requires the reporting of profit
and loss, specific revenue and expense items, and assets for reportable
segments. It also requires the reconciliation of total segment revenues, total
segment profit or loss, total segment assets and other amounts disclosed for
segments to the corresponding amounts in the general purpose financial
statements. SFAS 131 is effective for fiscal years beginning after December 15,
1997. The Company uses data at the subsidiary level to manage the operations and
the Company will expand its current footnote disclosure to meet these criteria.
In October 1997, the American Institute of Certified Public Accountants
issued Statement of Position ("SOP") 97-2, "Software Revenue Recognition." This
SOP is effective for transactions entered into in fiscal years beginning after
December 15, 1997. This SOP provides guidance on when revenue should be
recognized and in what amounts for licensing, selling, leasing or otherwise
marketing computer software. Mangement has evaluated the effect on its financial
reporting from the adoption of this SOP and believes that such effect would be
insignificant.
In February 1998, the FASB issued SFAS No. 132 "Employers' Disclosure about
Pension and Other Postretirement Benefits". SFAS 132 revises and standardizes
employers' disclosures regarding pension and other postretirement benefit plans.
SFAS 132 is effective for fiscal years beginning after December 15, 1997.
Management has evaluated the effect on its financial reporting from the adoption
of this statement and believes that it is already in compliance with this
disclosure.
F-12
<PAGE>
DATA SYSTEMS & SOFTWARE INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 2--INVESTMENT IN TOWER
Since acquiring Tower, a manufacturer of semiconductor products, DSSI
maintained voting control of more than 50% of its shares, through Holdings.
Tower's shares are traded on the Nasdaq National Market. Although the Company
has retained effective control of Tower, as of the end of 1996 the Company no
longer maintained voting control of Tower and, therefore, ceased to consolidate
Tower's balance sheet as of December 31, 1996. As the Company's individual
assets and liabilities at December 31, 1996 and the consolidated statements of
operations for the year ended December 31, 1997 do not include amounts related
to Tower, the Company's 1996 and 1997 consolidated statements of operations are
not directly comparable. The consolidated statements of operations reflect
Tower's revenues and expenses on a full-year basis for the years ended December
31, 1995 and 1996. See Note 8 for summary financial information of Tower. See
Note 21 as to subsequent events.
NOTE 3--MARKETABLE DEBT SECURITIES
Marketable debt securities consist primarily of United States Treasury Bills
at yields to maturity ranging from 4.9% to 5.1% (1996-4.6% to 4.9%) and that
mature in January, 1998. The balances approximate market value.
NOTE 4--PRINCIPAL CUSTOMERS
Sales to and receivables from principal customers for the respective periods
were as follows:
<TABLE>
<CAPTION>
ACCOUNTS RECEIVABLE
CONSOLIDATED SALES AS OF
YEAR ENDED DECEMBER 31, DECEMBER 31,
---------------------------------------------------------------- --------------------
1995 1996 1997* 1996* 1997*
-------------------- -------------------- -------------------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Customer A........... $ 57,427 44.2% $ 65,599 49.8% -- -- -- --
Customer B........... 19,725 15.2 9,716 7.4 -- -- -- --
Customer C........... 535 0.4 1,541 1.2 $ 4,617 11.5% $ 402 $ 946
Customer D........... 462 0.4 3,410 2.6 4,273 10.7 1,193 744
--------- --- --------- --- --------- --- --------- ---------
$ 78,149 60.2% $ 80,266 61.0% $ 8,890 22.2% $ 1,595 $ 1,690
--------- --- --------- --- --------- --- --------- ---------
--------- --- --------- --- --------- --- --------- ---------
</TABLE>
- ------------------------
* See Note 2.
NOTE 5--INVENTORY
Inventory consists of the following:
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
--------------------
<S> <C> <C>
1996 1997
--------- ---------
Work in process........................................................... $ 14 $ 33
Finished goods and merchandise............................................ 939 344
--------- ---------
$ 953 $ 377
--------- ---------
--------- ---------
</TABLE>
F-13
<PAGE>
DATA SYSTEMS & SOFTWARE INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 6--NOTE RECEIVABLE
Effective July 1996, the Company sold its 50% interest in an affiliate in
consideration for a $2,000 unsecured note. The note bears interest at an annual
rate of 8.25% and is payable on or before July 1, 1998. The Company recorded a
gain of approximately $1,700 on the transaction in 1996. In February 1998, the
note was modified to make it convertible into freely tradable common stock of
the maker of the note. See subsequent event in Note 21.
NOTE 7--OTHER CURRENT ASSETS
Other current assets consist of the following:
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
--------------------
<S> <C> <C>
1996 1997
--------- ---------
Israeli government-other................................................ $ 40 $ 20
Foreign income tax receivable (Israel).................................. 515 347
Other................................................................... 1,185 806
--------- ---------
$ 1,740 $ 1,173
--------- ---------
--------- ---------
</TABLE>
NOTE 8--INVESTMENTS
(A) COMPOSITION
Investments consist of the following:
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
--------------------
<S> <C> <C>
1996 1997
--------- ---------
Investment in Tower (see (b) below)..................................... $ 65,884 $ 68,630
Other investments (see (c) below)....................................... 2,488 2,065
--------- ---------
$ 68,372 $ 70,695
--------- ---------
--------- ---------
Minority interests in investments....................................... $ 26,927 $ 27,930
--------- ---------
--------- ---------
</TABLE>
F-14
<PAGE>
DATA SYSTEMS & SOFTWARE INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 8--INVESTMENTS (CONTINUED)
(B) INVESTMENT IN TOWER
Set forth below is condensed financial information of Tower
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
----------------------
<S> <C> <C>
1996 1997
---------- ----------
Current assets........................................................ $ 110,403 $ 115,738
Property and equipment................................................ 106,047 99,216
Other assets.......................................................... 120 --
Current liabilities................................................... 30,727 24,813
Long-term debt........................................................ 12,064 12,117
Other long-term liabilities........................................... 13,194 13,753
Shareholders' equity.................................................. 160,585 166,881
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------
<S> <C> <C> <C>
1995 1996 1997
--------- --------- ----------
Sales....................................................... $ 99,621 $ 97,885 $ 125,917
Operating income............................................ 23,468 9,652 20,140
Net income.................................................. 20,439 10,014 19,171
</TABLE>
In November 1996, Tower paid a dividend of $19,808 ($1.50 per share) and in
October 1997 a dividend of $13,235 ($1.00 per share). The market value of the
Company's investment in Tower as of December 31, 1997 was approximately $32,500.
See Note 21.
(C) OTHER INVESTMENTS
In 1995, the Company established CybrCard LP, a limited partnership engaged
in the development and production of sports-related CD-ROMs, in which the
Company owned a 50% interest. Through December 31, 1996, the Company invested in
CybrCard approximately $2,800 in the form of loans and advances, reduced by
approximately $1,600 representing the Company's share of CybrCard's losses.
Subsequent to December 31, 1996, the Company purchased the remaining 50%
interest in CybrCard, and, accordingly, CybrCard is consolidated by the Company
in 1997.
The Company, together with other investors, established a venture capital
fund, Mofet Israel Technology Fund. The Company owns approximately 4% of the
equity of the Fund and 50% of the Fund's management company. The Company's
investment in the Fund, which is accounted for on the cost method, amounted to
$767 and $1,300 at December 31, 1996 and 1997, respectively. Its investment in
the management company, which is accounted for on the equity method, amounted to
$0 and $295 at December 31, 1996 and 1997, respectively.
F-15
<PAGE>
DATA SYSTEMS & SOFTWARE INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 9--PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
<TABLE>
<CAPTION>
ESTIMATED USEFUL AS OF DECEMBER 31,
LIFE --------------------
(IN YEARS) 1996 1997
------------------- --------- ---------
<S> <C> <C> <C>
Cost:
Computer equipment................................. 3-5 $ 2,616 $ 1,963
Office furniture and equipment..................... 4-10 464 1,841
Motor vehicles..................................... 7 1,195 1,107
Leasehold improvements............................. Term of Lease 184 197
--------- ---------
4,459 5,108
--------- ---------
Accumulated depreciation and amortization:
Computer equipment................................. 1,456 1,375
Office furniture and equipment..................... 227 478
Motor vehicles..................................... 381 952
Leasehold improvements............................. 116 122
--------- ---------
2,180 2,927
--------- ---------
Property and equipment, net.................... $ 2,279 $ 2,181
--------- ---------
--------- ---------
</TABLE>
Depreciation and amortization in respect of property and equipment amounted
to $8,471, $16,019 and $886 for 1995, 1996 and 1997, respectively.
NOTE 10--CAPITALIZED SOFTWARE DEVELOPMENT COSTS, NET
Capitalized software development costs consist of the following:
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
--------------------
<S> <C> <C>
1996 1997
--------- ---------
Capitalized software developments costs.............................. $ 1,537 $ 2,909
Less: Accumulated amortization....................................... (606) (1,246)
Accumulated writedowns to net realizable value.................. -- (1,663)
--------- ---------
$ 931 $ 0
--------- ---------
--------- ---------
</TABLE>
Based on management's determination that certain capitalized software costs
exceeded their net realizable value, capitalized software costs relating to
certain sub-systems in development projects were written-down and included in
cost of sales for capitalized software costs that were being amortized and were
included in research and development expenses for capitalized software costs
relating to products that were not yet available for general release to
customers. Writedowns to the net realizable value of the capitalized software
costs amounted to $0, $0 and $1,663 for the years ended December 31, 1995, 1996
and 1997, respectively. Amortization of capitalized software amounted to $28,
$578 and $305 during the years ended December 31, 1995, 1996 and 1997,
respectively. See Note 22.
F-16
<PAGE>
DATA SYSTEMS & SOFTWARE INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 11--SHORT-TERM DEBT--BANKS AND OTHERS
Included with short-term debt is $1,456 received from foreign investors
(December 31, 1996-$1,403) intended for financing future projects of the
Company. In January 1998 this amount was repaid. The debt was secured by a bank
deposit which bears interest at approximately 4% per annum. The deposit has been
classified as restricted cash. In 1997, the Company undertook a direct
guarantee, by means of a deposit, of $330 of certain bank commitments arising
out of the operating activities of an Israeli affiliate. The deposit has been
classified as restricted cash. All lines of credit with Israeli banks were being
fully utilized as of December 31, 1997.
NOTE 12--LONG-TERM DEBT--BANKS AND OTHERS
Long-term debt--banks and others consists of the following:
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
--------------------
<S> <C> <C>
1996 1997
--------- ---------
Debt to Israeli banks, bearing interest at 5%-8% per annum................ $ 493 $ 1,376
Less-current maturities................................................... 162 1,128
--------- ---------
$ 331 $ 248
--------- ---------
--------- ---------
</TABLE>
Certain assets in Israel have been pledged as collateral for long-term and
short-term bank debt amounting to approximately $1,000 and for guarantees.
Interest expense on short-term and long-term bank debt for 1995, 1996 and 1997
amounted to $1,011, $734 and $183, respectively.
NOTE 13--OTHER LONG-TERM LIABILITIES
Other long-term liabilities include unfunded severance pay obligations of
$116 and $233 as of December 31, 1996 and 1997, respectively, after deducting
fund balances maintained in the Company's name for the sole purpose of making
severance payments. Israeli law and labor agreements determine the obligations
of the subsidiaries in Israel to make severance and pension payments to
dismissed employees and to employees leaving employment in certain other
circumstances. The obligation for severance pay benefits, as determined by the
Israeli Severance Pay Law, is based upon length of service and last salary.
These obligations are substantially covered by regular deposits with recognized
severance pay and pension funds and by the purchase of insurance policies. The
amounts so funded are not reflected on the balance sheet, since they are not
under the control and management of these subsidiaries, but are controlled by
the funds and insurance companies. The pension plans are multi-employer and
independent of the Company. Therefore, no information is available regarding
their present value and the net assets available for benefits. Pension and
severance pay costs for 1995, 1996 and 1997 were approximately $2,173, $2,236
and $591, respectively.
F-17
<PAGE>
DATA SYSTEMS & SOFTWARE INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 14--COMMITMENTS AND CONTINGENCIES
(A) LEASES OF PROPERTY AND EQUIPMENT
Rental and leasing expenses for 1995, 1996 and 1997 amounted to $554, $625
and $777, respectively. Future minimum lease payments on non-cancelable
operating leases as of December 31, 1997 are as follows:
<TABLE>
<CAPTION>
YEAR ENDING DECEMBER 31,
- -------------------------------------------------------------------------------------
<S> <C>
1998................................................................................. $ 967
1999................................................................................. 977
2000................................................................................. 885
2001................................................................................. 361
---------
$ 3,190
---------
---------
</TABLE>
(B) GUARANTEES
The Company has provided bank guarantees of approximately $1,284 as security
for payment of obligations of affiliates and other companies.
(C) ROYALTIES
Certain research and development programs are eligible for financial
assistance from the Office of the Chief Scientist of the Israeli Ministry of
Industry and Commerce or from the Israel-United States BIRD Foundation. In
return, the subsidiaries are obligated to pay royalties at a rate of 2% to 5% of
sales of products resulting from the research and development efforts, up to a
maximum of 150% of the financing received.
(D) LEGAL ACTIONS
The Company is a plaintiff in an action against a former officer who
resigned in April 1995, alleging destruction and misappropriation of property
and data owned by the Company. The employee has filed a counterclaim against the
Company, alleging breach by the Company of its employment and resignation
agreements with the employee and seeking compensatory damages of $750 and
punitive damages of $25,000. The Company is pursuing its claims against the
employee and is vigorously defending against his counterclaims. The Company
accrued the full amount of severance payable under the resignation agreement at
the time of such employee's resignation. Based on the opinion of legal counsel
handling the matter, the Company believes it is unlikely to incur additional
material liability in connection with the counterclaim.
Between June and September 1996, several suits were filed in the United
States on behalf of a purported class of Tower's shareholders who purchased or
otherwise acquired Tower's ordinary shares between May 25, 1995 and June 10,
1996, against Tower, its Co-Chief Executive Officers, its Chairman of the Board
of Directors and the Company. The actions have been consolidated in the United
States District Court for the District of New Jersey. The consolidated complaint
filed in the actions alleges that the defendants made misstatements and
omissions regarding, among other things (i) the relationship between
F-18
<PAGE>
DATA SYSTEMS & SOFTWARE INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 14--COMMITMENTS AND CONTINGENCIES (CONTINUED)
Tower and a major customer and (ii) Tower's process development efforts in
connection therewith, in violation of certain U.S. Federal securities laws.
Tower has indemnified the defendants, up to the limits permitted by the Israel
Companies Ordinance, from any liability arising out of the actions. Tower
maintains insurance policies that, under certain conditions, cover actions of
this type up to an aggregate amount of $20,000. The Company is unable to
determine at this time with any certainty the ultimate outcome of the
aforementioned matter or its effect, if any, on the Company's financial
condition, operating results and business. However, the Company believes it has
meritorious defenses and is defending the actions vigorously.
(E) EMPLOYEE RETIREMENT SAVINGS PLAN (401K)
The Company sponsors a tax deferred retirement savings plan (401K) which
permits eligible employees to contribute varying percentages of their
compensation up to the limit allowed by the Internal Revenue Service. The 401(K)
Plan also provides for discretionary Company contributions. No discretionary
contributions were made for the years ended December 31, 1995, 1996 and 1997.
NOTE 15--SHAREHOLDERS' EQUITY
(A) STOCK OPTION PLANS
The Company's stock option plans provide for the granting to officers,
directors and other key employees of options to purchase shares of common stock
at not less than 85% of market value on the date of grant. The purchase price
must be paid in cash. To date, the Company has issued options under the plans at
market value. All options expire within five to ten years from the date of the
grant. The options generally vest over a one to three year period from the date
of grant of the option. The authorized number of options is 2,000,000 and the
number remaining available for issuance is 247,358.
A summary of the status of the Company's option plans as of December 31,
1995, 1996 and 1997, as well as changes during each of the years then ended, is
presented below:
<TABLE>
<CAPTION>
1995 1996 1997
----------------------- ----------------------- -----------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
NUMBER OF EXERCISE NUMBER OF EXERCISE NUMBER OF EXERCISE
OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE
---------- ----------- ---------- ----------- ---------- -----------
<S> <C> <C> <C> <C> <C> <C>
(IN (IN (IN
SHARES) SHARES) SHARES)
Outstanding at
beginning of year.... 970,500 $ 6.65 1,361,567 $ 6.70 1,423,492 $ 6.60
Granted................ 559,400 $ 6.73 226,500 $ 5.90 53,500 $ 5.82
Exercised.............. (65,833) $ 4.59 (17,875) $ 5.89 -- --
Forfeited.............. (102,500) $ 6.77 (146,700) $ 6.38 (20,925) $ 6.38
---------- ---------- ----------
Outstanding at end of
year................. 1,361,567 $ 6.70 1,423,492 $ 6.60 1,456,067 $ 6.57
---------- ---------- ----------
---------- ---------- ----------
Exercisable at end of
year................. 407,241 $ 6.57 826,601 $ 6.61 1,162,816 $ 6.66
---------- ---------- ----------
---------- ---------- ----------
</TABLE>
F-19
<PAGE>
DATA SYSTEMS & SOFTWARE INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 15--SHAREHOLDERS' EQUITY (CONTINUED)
<TABLE>
<CAPTION>
OUTSTANDING AS OF EXERCISABLE AS OF
DECEMBER 31, 1997 DECEMBER 31, 1997
------------------------------------------------- -------------------------
WEIGHTED WEIGHTED
WEIGHTED AVERAGE AVERAGE
RANGE OF EXERCISE NUMBER AVERAGE REMAINING EXERCISE NUMBER EXERCISE
PRICES OUTSTANDING CONTRACTUAL LIFE PRICE EXERCISABLE PRICE
- ------------------- ----------- --------------------- ------------- ---------- -------------
<S> <C> <C> <C> <C> <C>
(IN
(IN SHARES) (IN YEARS) SHARES)
$4.75-5.88......... 277,500 6.4 $ 5.69 121,583 $ 5.60
$6.06-7.88......... 1,148,567 4.9 $ 6.66 1,021,233 $ 6.70
$11.13............. 30,000 7.8 $ 11.13 20,000 $ 11.13
----------- ----------
1,456,067 $ 6.57 1,162,816 $ 6.66
----------- ----------
----------- ----------
</TABLE>
The weighted average grant-date fair value of the 226,500 and 53,500 options
granted during 1996 and 1997 amounted to $3.56 and $5.24 per option,
respectively. The Company utilized the Black-Scholes option pricing model to
estimate fair value, utilizing the following assumptions for the respective
years (all in weighted averages):
<TABLE>
<CAPTION>
1995 1996 1997
---------- ---------- ----------
<S> <C> <C> <C>
Risk-free interest rate.................................. 6.70% 6.30% 6.00%
Expected life of options................................. 3.4 years 5.9 years 5.9 years
Expected annual volatility............................... 59% 59% 47%
Expected dividend yield.................................. none none none
</TABLE>
Had compensation cost for the Company's option plans been determined based
on fair value at the grant dates for awards made in 1996 and 1997 under such
plans in accordance with SFAS No. 123, the Company's pro forma net income (loss)
and earnings (loss) per share would have been as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------
<S> <C> <C> <C>
1995 1996 1997
--------- --------- ----------
Net income (loss)-as restated (See Note 22)................. $ 17,749 $ (2,480) $ (10,444)
Pro forma net income (loss)................................. $ 17,097 $ (3,427) $ (10,566)
Basic net income (loss) per share-as restated (See Note
22)....................................................... $ 2.53 $ (0.34) $ (1.42)
Pro forma basic net income (loss) per share................. $ 2.43 $ (0.47) $ (1.44)
Diluted net income (loss) per share-as restated (See Note
22)....................................................... $ 2.43 $ (0.34) $ (1.42)
Pro forma diluted net income (loss) per share............... $ 2.34 $ (0.47) $ (1.44)
</TABLE>
The pro forma information in the above table also gives effect to the
application of SFAS No. 123 on the share option plans of the Company's
subsidiaries.
(B) WARRANTS
The Company has from time to time issued warrants primarily as compensation
to underwriters in connection with public stock offerings and to investors as
part of a private placement by the Company of
F-20
<PAGE>
DATA SYSTEMS & SOFTWARE INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 15--SHAREHOLDERS' EQUITY (CONTINUED)
common stock and warrants. All warrants issued to date have been at exercise
prices equal to or greater than market value on the date of issuance. The effect
of warrant issuance on the Company's results of operations for all years
presented is immaterial. A summary of warrant activity follows:
<TABLE>
<CAPTION>
1995 1996 1997
------------------------ ------------------------ ------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
NUMBER OF EXERCISE NUMBER OF EXERCISE NUMBER OF EXERCISE
OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE
----------- ----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
(IN SHARES) (IN SHARES) (IN SHARES)
Outstanding at beginning of
year........................... 591,284 $ 8.97 433,825 $ 9.06 433,825 $ 9.06
Granted.......................... 100,000 $ 6.34 -- -- --
Exercised........................ (257,459) $ 7.80 -- -- --
Forfeited........................ -- -- -- -- (236,325) $ 8.13
----------- ----------- -----------
Outstanding at end of year....... 433,825 $ 9.06 433,825 $ 9.06 197,500 $ 10.18
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
(C) STOCK AWARD
In March 1996, the Company granted 100,000 shares of common stock to its
Chief Executive Officer. The shares vest over a three-year period. Deferred
compensation in the aggregate amount of $587 was recorded against additional
paid-in capital at the date of grant, of which $150 and $196 was amortized to
compensation expense during 1996 and 1997, respectively.
(D) OTHER
In March 1996, the Company's Board of Directors adopted a stockholder rights
plan providing for the distribution of common stock purchase rights at the rate
of one right for each share of the Company's common stock held by shareholders
of record as of the close of business on April 1, 1996. The rights plan is
designed to deter coercive takeover tactics, including the accumulation of
shares in the open market or through private transactions, and to prevent an
acquirer from gaining control of the Company without offering a fair price to
all of the Company's shareholders. Each right initially entitles shareholders to
buy one-half of a share of common stock of the Company for $15. Generally, the
right will be exercisable only if a person or group acquires beneficial
ownership of 15% of more of the Company's common stock or commences a tender or
exchange offer upon consummation of which such person or group would
beneficially own 15% or more of the Company's common stock. If any person
("Acquiring Person") becomes the beneficial owner of 15% or more of the
Company's common stock, other than pursuant to a tender or exchange offer for
all outstanding shares of the Company approved by a majority of the Company's
independent directors, then, subject to certain exceptions set forth in the
rights plan, each right not owned by the Acquiring Person or related parties
will entitle its holder to purchase, at the right's then current exercise price,
shares of the Company's common stock (or, in certain circumstances as determined
by the Board of Directors, cash, other property or other securities) having a
value of twice the right's then current exercise price. The Company will
generally be entitled to redeem the rights at one half of one cent
F-21
<PAGE>
DATA SYSTEMS & SOFTWARE INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 15--SHAREHOLDERS' EQUITY (CONTINUED)
per right at any time until 10 days (subject to extension) following a public
announcement that a 15% position has been acquired. The rights plan will expire
in March 2006.
NOTE 16--RELATED PARTY BALANCES AND TRANSACTIONS
Other assets include a non-interest bearing loan of $277 and $357, at
December 31, 1996 and 1997, respectively, made to an executive officer of the
Company. In addition, the Company approved a loan of up to $650, bearing
interest at an annual rate of 7%, to its Chief Executive Officer. The balance of
this loan as of December 31, 1997 was approximately $650. Such loan is repayable
in installments over a period of five years. The Company paid consulting and
other fees to directors of $82, $85 and $45 for the years ended December 31,
1995, 1996 and 1997, respectively. Sales for the years ended December 31, 1995
and 1996 include $1,160, and $102, respectively, to an affiliate. No sales to
affiliates were made in 1997. Approximately $152 and $66, received from
affiliates for expense reimbursement during the years ended December 31, 1995
and 1997, respectively, was reflected as a reduction of selling, general and
administrative expenses. No amount was received in 1996. The Company paid legal
fees for services rendered and out-of-pocket disbursements to a firm in which a
related party is a principal, of approximately $535, $450 and $401 for the years
ended December 31, 1995, 1996 and 1997, respectively. Approximately $10 and
$117, included in other current liabilities, was owed to this firm as of
December 31, 1996 and 1997, respectively.
NOTE 17--GAIN ON CHANGES IN OWNERSHIP INTERESTS IN SUBSIDIARIES
Tower conducted a public offering in July 1995, which resulted in a decrease
in the Company's effective interest in Tower to 24.6%. As a result of the
offerings, the Company recognized a gain on changes in ownership interests in
subsidiaries of $26,339 in 1995.
Detailed information of the stock offering is as follows:
<TABLE>
<CAPTION>
JULY 1995
-----------
<S> <C>
Number of shares issued (in thousands)............................................. 3,205
Price per share.................................................................... $ 29.00
Total net proceeds of offering..................................................... $ 88,068
Company's effective ownership interest before transaction.......................... 32.5%
Company's effective ownership interest after transaction........................... 24.6%
</TABLE>
No deferred taxes were recorded in respect of the gains, as the Company's
investment in Tower is essentially permanent in duration (see Note 18).
F-22
<PAGE>
DATA SYSTEMS & SOFTWARE INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 18--INCOME TAXES
(A) COMPOSITION
Income taxes consist of the following:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
<S> <C> <C> <C>
1995 1996 1997
--------- --------- ---------
Current:
Federal........................................................ -- $ 8 $ (4)
State and local................................................ $ 14 -- 161
Foreign........................................................ 2,402 418 716
--------- --------- ---------
$ 2,416 $ 426 $ 873
--------- --------- ---------
Deferred:
Federal........................................................ (491) (677) 1,853
State and local................................................ 18 (187) 218
Foreign........................................................ 2,894 2,579 563
--------- --------- ---------
2,421 1,715 2,634
--------- --------- ---------
$ 4,837 $ 2,141 $ 3,507
--------- --------- ---------
--------- --------- ---------
</TABLE>
(B) EFFECTIVE INCOME TAX RATES
Set forth below is a reconciliation between the Federal tax rate and the
Company's effective income tax rates:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------
<S> <C> <C> <C>
1995 1996 1997
----- ----- -----
Statutory Federal rates.................................................. 34% 34% 34%
Increase (decrease) in income tax rate resulting from:
Tax exempt gain from public offering of subsidiary..................... (18) -- --
Israeli operations-net impact of Israeli statutory rate and special
deduction............................................................ (9) (10) (3)
Non-deductible expenses.................................................. 2 2 (1)
State and local income taxes-net......................................... 1 (4) 9
Net operating loss carryforward.......................................... (2) (1) --
Other.................................................................... 1 2 (5)
Increase in valuation allowance.......................................... 1 1 (62)
-- -- --
Effective income tax rates............................................... 10% 24% (28%)
-- -- --
-- -- --
</TABLE>
F-23
<PAGE>
DATA SYSTEMS & SOFTWARE INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 18--INCOME TAXES (CONTINUED)
(C) ANALYSIS OF DEFERRED TAX ASSETS (LIABILITIES)
Deferred tax assets (liabilities) consist of the following:
<TABLE>
<CAPTION>
AS OF
DECEMBER 31,
--------------------
<S> <C> <C>
1996 1997
--------- ---------
Accelerated depreciation for tax purposes.................................. $ (72) $ (50)
Intangible asset basis differences......................................... (187) (93)
Nondeductible accrued expenses............................................. (653) (661)
Net operating and capital loss carryforwards............................... 5,539 9,882
Foreign tax credit carryforwards........................................... 242 242
--------- ---------
4,869 9,320
Valuation allowance........................................................ (2,231) (9,320)
--------- ---------
Net deferred tax asset..................................................... $ 2,638 $ 0
--------- ---------
--------- ---------
</TABLE>
The valuation relates principally to net operating loss and capital loss
carryforwards and Federal foreign tax credit carryforwards. Due to the Company's
recent history of losses, a valuation allowance has been established against the
December 31, 1997 deferred tax assets. As of December 31, 1996, deferred tax
assets of $205 are classified as other current assets and $2,433 as other
assets.
(D) SUMMARY OF TAX LOSS AND CREDIT CARRYFORWARDS
As of December 31, 1997, the Company had various tax loss and credit
carryforwards which expire as follows:
<TABLE>
<CAPTION>
NET OPERATING LOSS
------------------------------- FEDERAL FOREIGN
EXPIRATION FEDERAL STATE FOREIGN TAX CREDIT
- ------------------------------------------------------------------ --------- --------- --------- -----------------
<S> <C> <C> <C> <C>
1999.............................................................. $ 317
2000.............................................................. 1,078
2001.............................................................. 1,178 $ 241
2002-2003......................................................... 1,070
2008-2009......................................................... $ 2,758
2010-2011......................................................... 2,841 1,058
2012-2013......................................................... 7,527 10,330
Unlimited......................................................... $ 5,499
--------- --------- --------- -----
Total....................................................... $ 13,126 $ 15,031 $ 5,499 $ 241
--------- --------- --------- -----
--------- --------- --------- -----
</TABLE>
F-24
<PAGE>
DATA SYSTEMS & SOFTWARE INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 18--INCOME TAXES (CONTINUED)
(E) COMPOSITION OF INCOME BEFORE INCOME TAXES
Composition of income before income taxes is as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------
<S> <C> <C> <C>
1995 1996 1997
--------- --------- ----------
Income (loss) before incomes taxes:
Domestic.................................................. $ (1,950) $ (4,128) $ (11,206)
Foreign................................................... 49,731 13,255 (1,287)
--------- --------- ----------
$ 47,781 $ 9,127 $ (12,493)
--------- --------- ----------
--------- --------- ----------
</TABLE>
(F) OTHER
As of December 31, 1996 and 1997, the aggregate unrecognized deferred tax
liability related to investments in foreign subsidiaries that are essentially
permanent in duration amounted to approximately $8,000 and $933, respectively.
NOTE 19--SEGMENT REPORTING AND GEOGRAPHIC INFORMATION
The data for each business segment is presented according to geographical
location of the operating facilities. General corporate expenses are included
with selling, general and administrative expenses in the statements of
operations.
<TABLE>
<CAPTION>
COMPUTER SEGMENT
---------------------------------------------
ADJUSTMENTS TOTAL SEMICONDUCTOR CORPORATE
UNITED AND COMPUTER SEGMENT UNITED
ISRAEL STATES ELIMINATIONS SEGMENT ISRAEL STATES TOTAL
--------- --------- ----------- ---------- ------------- ----------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
Year ended December 31, 1995:
Total sales........................ $ 15,634 $ 15,600 $ (1,032) $ 30,202 $ 99,621 -- $ 129,823
Intercompany sales................. (684) (348) 1,032 -- -- -- --
--------- --------- ----------- ---------- ------------- ----------- ----------
Net sales.......................... $ 14,950 $ 15,252 $ 0 $ 30,202 $ 99,621 -- $ 129,823
Operating income (loss)............ $ (2,146) $ (973) -- $ (3,119) $ 23,523 $ (1,721) $ 18,683
Identifiable assets................ $ 12,751 $ 3,935 -- $ 16,686 $ 238,413 $ 16,532 $ 271,631
Depreciation and amortization...... $ 861 $ 174 -- $ 1,035 $ 7,818 $ 27 $ 8,880
Capital expenditures............... $ 776 $ 730 -- $ 1,506 $ 46,229 $ 26 $ 47,761
</TABLE>
F-25
<PAGE>
DATA SYSTEMS & SOFTWARE INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 19--SEGMENT REPORTING AND GEOGRAPHIC INFORMATION (CONTINUED)
<TABLE>
<CAPTION>
COMPUTER SEGMENT
---------------------------------------------
ADJUSTMENTS TOTAL SEMICONDUCTOR CORPORATE
UNITED AND COMPUTER SEGMENT UNITED
ISRAEL STATES ELIMINATIONS SEGMENT ISRAEL STATES TOTAL
--------- --------- ----------- ---------- ------------- ----------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
Year ended December 31, 1996*:
Total sales........................ $ 13,424 $ 21,045 $ (599) $ 33,870 $ 97,885 -- $ 131,755
Intercompany sales................. (77) (522) 599 -- -- -- --
--------- --------- ----------- ---------- ------------- ----------- ----------
Net sales.......................... $ 13,347 $ 20,523 $ 0 $ 33,870 $ 97,885 -- $ 131,755
Operating income (loss)**.......... $ (1,245) $ (3,058) -- $ (4,303) $ 11,268 $ (1,550) $ 5,415
Identifiable assets................ $ 10,526 $ 6,894 -- $ 17,420 $ 65,889 $ 14,509 $ 97,818
Depreciation and amortization...... $ 629 $ 907 -- $ 1,536 $ 15,243 $ 50 $ 16,829
Capital expenditures............... $ 557 $ 1,326 -- $ 1,883 $ 50,565 $ 110 $ 52,558
Year ended December 31, 1997*:
Total sales........................ $ 14,346 $ 25,593 $ (354) $ 39,585 -- $ 411 $ 39,996
Intercompany sales................. -- (354) 354 -- -- -- --
--------- --------- ----------- ---------- ------------- ----------- ----------
Net sales.......................... $ 14,346 $ 25,239 $ 0 $ 39,585 -- $ 411 $ 39,996
Operating loss..................... $ (1,482) $ (8,933) -- $ (10,415) -- $ (2,220) $ (12,635)
Identifiable assets................ $ 10,351 $ 6,263 -- $ 16,614 $ 68,649 $ 7,103 $ 92,366
Depreciation and
amortization..................... $ 466 $ 1,030 -- $ 1,496 -- $ 55 $ 1,479
Capital expenditures............... $ 324 $ 535 -- $ 859 -- $ 3 $ 862
</TABLE>
Sales classified by geographical markets:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------
1995 1996 1997*
---------- ---------- ---------
<S> <C> <C> <C>
Israel..................................................... $ 14,672 $ 12,061 $ 12,769
United States.............................................. 65,941 62,438 27,164
Far East................................................... 48,814 56,773 --
Europe..................................................... 396 483 63
---------- ---------- ---------
$ 129,823 $ 131,755 $ 39,996
---------- ---------- ---------
---------- ---------- ---------
</TABLE>
- ------------------------
* See Note 2.
** The Company also operated in 1996 in the Computer segment via an affiliate
in the United States which is engaged in the development and production of
software. The Company's share in the affiliate's losses (reflected in equity
(loss) in affiliates in the statement of income) amounted to $1,600 in 1996.
The affiliate was consolidated in 1997.
F-26
<PAGE>
DATA SYSTEMS & SOFTWARE INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 20--FINANCIAL INSTRUMENTS
(A) GENERAL
A financial instrument is defined as cash, evidence of an ownership interest
in an entity, or a contract that imposes on one entity a contractual obligation
either to deliver or receive cash or another financial instrument to or from a
second entity. Examples of financial instruments include cash and cash
equivalents, trade accounts receivable, loans, investments, trade accounts
payable, accrued expenses, options and forward contracts.
In accordance with SFAS Nos. 105, 107, and 119, the Company makes certain
disclosures with regard to financial instruments, including derivatives. These
disclosures include, among other matters, the nature and terms of derivative
transactions, information about significant concentrations of credit risk, and
the fair value of financial assets and liabilities.
(B) FORWARD EXCHANGE AGREEMENTS
The Company, through Tower, has entered into forward exchange agreements to
manage exposure to equipment purchase commitments denominated in Japanese yen.
These transactions qualified for hedge accounting in accordance with generally
accepted accounting principles and, accordingly, the results of such
transactions have been recorded concurrently with the realization of the related
items (i.e., receipt of the equipment and payment of the related liability). The
Company does not hold or issue derivative financial instruments for trading
purposes.
(C) PRESENTATION OF FOREIGN EXCHANGE TRANSACTIONS IN THE FINANCIAL STATEMENTS
Losses recognized on forward exchange transactions amounted to $1,661 and
$3,598 for 1995 and 1996, respectively. Of these amounts, $1,130 and $3,002 were
capitalized to property and equipment, respectively; and the remaining amounts
of $531 and $596 were reflected in financing expenses, respectively. No such
transactions are reflected for 1997. See Note 2.
(D) FAIR VALUE OF FINANCIAL INSTRUMENTS
Fair values are estimated for financial instruments included in current
assets and current liabilities at book value, due to the short maturity of such
instruments. Fair value for long-term debt is estimated based on the current
rates offered to the Company for debt with the same remaining maturities. Fair
value of long-term equity marketable investments is estimated based on market
value. The estimation of fair value for non-marketable long-term equity
investments (book value of $70,696 as of December 31, 1997) was not practicable.
The estimated fair value of the Company's financial instruments was not
materially different than their book value. See Note 8(b) for information
regarding the book and fair market value of the Company's investment in Tower.
(E) CONCENTRATIONS OF CREDIT RISK
The Company is subject to credit risk through its trade receivables. As of
December 31, 1997, approximately 10% of the trade accounts receivable were due
from a major Israel government-owned company which, despite experiencing
financial difficulties, continues to pay its trade receivables over extended
credit periods. The remaining balance consists primarily of receivables from
various customers.
F-27
<PAGE>
DATA SYSTEMS & SOFTWARE INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 21--SUBSEQUENT EVENTS (UNAUDITED)
In April 1998, the Company converted the note receivable referred to in Note
6 into shares of common stock of the maker of the note. The delivery of these
shares represented payment of approximately $1,700 of the approximately $2,300
principal of and accrued interest on the note. These shares were subsequently
sold by the Company for approximately $1,900. In June 1998, the maker of the
note filed for protection under Chapter 11 of the Bankruptcy Act. The Company,
in the second quarter of 1998, established an allowance for doubtful accounts
equal to approximately $610, which represented the remaining amount then
outstanding on the note. The expense resulting from this allowance was partially
offset in the second quarter of 1998 by the profit from the sale of the common
stock.
In April 1998, the Company sold certain assets and the technology related to
its PHD product for approximately $7,000. The Company recognized a gain of
approximately $5,000 before taxes in the second quarter of 1998 in connection
with such sale.
Due to decline in the market price for Tower's shares, at August 31, 1998
the market value of the Company's investment in Tower was $20,322, significantly
below the carrying value of the equity investment as of December 31, 1997 of
$40,700 (after minority interest). The Company has no current intentions to
dispose of its investment in Tower.
NOTE 22--RESTATEMENT OF CONSOLIDATED FINANCIAL STATEMENTS
Subsequent to the issuance of the Company's 1997 consolidated financial
statements, a subsidiary filed restated financial statements with the Israel
Securities Authority ("ISA") which reflect adjustments having a material effect
on the Company's consolidated financial statements. The subsidiary's restatement
relates to the order of the ISA which required primarily the expensing of
previously capitalized software development costs. As a result, capitalized
software development costs on the Company's consolidated balance sheets and R&D
expenses on the Company's consolidated statements of operations for the years
ended December 31, 1992 through December 31, 1997 have been restated to reflect
the order of the ISA. In addition, deferred income taxes, which had been
classified as part of other current assets and as part of other noncurrent
assets, on the Company's consolidated balance sheet and income tax expense on
the Company's consolidated statement of operations for the year ended December
31, 1997 have been restated to reflect the order of the ISA.
F-28
<PAGE>
DATA SYSTEMS & SOFTWARE INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 22--RESTATEMENT OF CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The effect of the restatements on the Company's balance sheets at December
31, 1996 and 1997 and statements of operations for the years ended December 31,
1995, 1996 and 1997 are summarized as follows:
<TABLE>
<CAPTION>
YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, 1995 DECEMBER 31, 1996 DECEMBER 31, 1997
----------------------- ------------------------ -----------------------
AS AS AS
PREVIOUSLY PREVIOUSLY PREVIOUSLY
REPORTED AS RESTATED REPORTED AS RESTATED REPORTED AS RESTATED
---------- ----------- ----------- ----------- ---------- -----------
<S> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS
Research and development expenses,
net.................................. $ 2,648 $ 4,375 $ 5,059 $ 5,611 $ 1,003 $ 1,335
Operating income (loss)................ $ 20,410 $ 18,683 $ 5,967 $ 5,415 $ (12,303) $ (12,635)
Income (loss) before income
taxes................................ $ 49,508 $ 47,781 $ 9,679 $ 9,127 $ (12,161) $ (12,493)
Income taxes........................... $ 4,837 $ 4,837 $ 2,141 $ 2,141 $ 3,032 $ 3,507
Income (loss) after income taxes....... $ 44,671 $ 42,944 $ 7,538 $ 6,986 $ (15,193) $ (16,000)
Minority interests..................... $ (25,352) $ (25,026) $ (7,804) $ (7,699) $ 374 $ 676
Net income (loss)...................... $ 19,150 $ 17,749 $ (2,033) $ (2,480) $ (9,939) $ (10,444)
Basic net income (loss) per
share................................ $ 2.73 $ 2.53 $ (0.28) $ (0.34) $ (1.35) $ (1.42)
Fully diluted net income (loss) per
share................................ $ 2.62 $ 2.43 $ (0.28) $ (0.34) $ (1.35) $ (1.42)
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, 1996 DECEMBER 31, 1997
----------------------- ------------------------
AS AS
PREVIOUSLY PREVIOUSLY
REPORTED AS RESTATED REPORTED AS RESTATED
---------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
BALANCE SHEET
Other current assets................................... $ 1,740 $ 1,740 $ 1,446 $ 1,173
Total current assets................................... $ 20,059 $ 20,059 $ 17,957 $ 17,684
Capitalized software development costs, net............ $ 5,229 $ 931 $ 4,630 --
Other noncurrent assets................................ $ 3,626 $ 3,626 $ 1,670 $ 1,468
Total other assets..................................... $ 11,406 $ 7,108 $ 6,638 $ 1,806
Total assets........................................... $ 102,116 $ 97,818 $ 97,471 $ 92,366
Minority interests..................................... $ 29,283 $ 28,407 $ 30,272 $ 29,094
Retained earnings...................................... $ 33,752 $ 30,330 $ 23,813 $ 19,886
Total liabilities and shareholders' equity............. $ 102,116 $ 97,818 $ 97,471 $ 92,366
</TABLE>
F-29
<PAGE>
DATA SYSTEMS & SOFTWARE INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 23--SELECTED QUARTERLY DATA (UNAUDITED)
The following table sets forth selected quarterly financial information for
the years ended December 31, 1995, 1996 and 1997:
<TABLE>
<CAPTION>
THREE MONTHS ENDED THREE MONTHS ENDED
MARCH 31, 1995 JUNE 30, 1995
------------------------ ------------------------
AS AS
PREVIOUSLY PREVIOUSLY
REPORTED AS RESTATED REPORTED AS RESTATED
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Research and development expenses, net....... $ 574 $ 1,026 $ 592 $ 1,050
Operating income............................. $ 3,913 $ 3,461 $ 4,783 $ 4,325
Income before income taxes................... $ 4,121 $ 3,669 $ 5,087 $ 4,629
Net income after income taxes................ $ 3,265 $ 2,813 $ 4,065 $ 3,607
Minority interests........................... $ (2,520) $ (2,436) $ (3,052) $ (2,979)
Net income................................... $ 652 $ 284 $ 979 $ 594
Earnings per share........................... $ 0.10 $ 0.04 $ 0.14 $ 0.09
</TABLE>
<TABLE>
<CAPTION>
THREE MONTHS ENDED THREE MONTHS ENDED
SEPTEMBER 30, 1995 DECEMBER 31, 1995
----------------------- ------------------------
AS AS
PREVIOUSLY PREVIOUSLY
REPORTED AS RESTATED REPORTED AS RESTATED
---------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Research and development expenses, net....... $ 609 $ 1,083 $ 873 $ 1,216
Operating income............................. $ 4,969 $ 4,495 $ 6,745 $ 6,402
Income before income taxes................... $ 32,640 $ 32,166 $ 7,660 $ 7,317
Net income after income taxes................ $ 31,541 $ 31,067 $ 5,800 $ 5,457
Minority interests........................... $ (14,891) $ (14,793) $ (4,889) $ (4,818)
Net income................................... $ 16,630 $ 16,254 $ 889 $ 617
Earnings per share........................... $ 2.16 $ 2.11 $ 0.12 $ 0.08
</TABLE>
F-30
<PAGE>
DATA SYSTEMS & SOFTWARE INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 23--SELECTED QUARTERLY DATA (UNAUDITED) (CONTINUED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED THREE MONTHS ENDED
MARCH 31, 1996 JUNE 30, 1996
------------------------ ------------------------
AS AS
PREVIOUSLY PREVIOUSLY
REPORTED AS RESTATED REPORTED AS RESTATED
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Research and development expenses, net....... $ 835 $ 1,162 $ 893 $ 959
Operating income............................. $ 4,644 $ 4,317 $ 2,377 $ 2,311
Income before income taxes................... $ 5,826 $ 5,499 $ 3,209 $ 3,143
Net income after income taxes................ $ 4,665 $ 4,338 $ 2,720 $ 2,654
Minority interests........................... $ (3,819) $ (3,752) $ (2,325) $ (2,312)
Net income................................... $ 773 $ 513 $ 342 $ 289
Earnings per share........................... $ 0.10 $ 0.07 $ 0.04 $ 0.04
</TABLE>
<TABLE>
<CAPTION>
THREE MONTHS ENDED THREE MONTHS ENDED
SEPTEMBER 30, 1996 DECEMBER 31, 1996
------------------------ ------------------------
AS AS
PREVIOUSLY PREVIOUSLY
REPORTED AS RESTATED REPORTED AS RESTATED
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Research and development expenses, net...... $ 1,535 $ 1,659 $ 1,796 $ 1,831
Operating income (loss)..................... $ (1,117) $ (1,301) $ 123 $ 88
Income (loss) before income taxes........... $ 1,350 $ 1,226 $ (706) $ (741)
Net income (loss) after income taxes........ $ (84) $ (208) $ 237 $ 202
Minority interests.......................... $ (724) $ (698) $ (936) $ (937)
Net loss.................................... $ (1,224) $ (1,322) $ (1,924) $ (1,960)
Loss per share.............................. $ (0.17) $ (0.18) $ (0.25) $ (0.26)
</TABLE>
F-31
<PAGE>
DATA SYSTEMS & SOFTWARE INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 23--SELECTED QUARTERLY DATA (UNAUDITED) (CONTINUED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED THREE MONTHS ENDED
MARCH 31, 1997 JUNE 30, 1997
------------------------ ------------------------
AS AS
PREVIOUSLY PREVIOUSLY
REPORTED AS RESTATED REPORTED AS RESTATED
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Research and development expenses, net....... $ 161 $ 338 $ 323 $ 323
Operating loss............................... $ (4,801) $ (4,978) $ (2,727) $ (2,727)
Loss before income taxes..................... $ (4,691) $ (4,868) $ (2,429) $ (2,429)
Income tax expense (benefit)................. $ (164) $ 484 $ 36 $ 49
Net loss after income taxes.................. $ (4,527) $ (5,352) $ (2,465) $ (2,478)
Minority interests........................... $ 88 $ 245 $ 106 $ 108
Net loss..................................... $ (3,398) $ (4,066) $ (984) $ (995)
Loss per share............................... $ (0.46) $ (0.55) $ (0.13) $ (0.14)
</TABLE>
<TABLE>
<CAPTION>
THREE MONTHS ENDED THREE MONTHS ENDED
SEPTEMBER 30, 1997 DECEMBER 31, 1997
------------------------ ------------------------
AS AS
PREVIOUSLY PREVIOUSLY
REPORTED AS RESTATED REPORTED AS RESTATED
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Research and development expenses, net....... $ 231 $ 364 $ 288 $ 310
Operating loss............................... $ (2,294) $ (2,427) $ (2,481) $ (2,503)
Loss before income taxes..................... $ (2,187) $ (2,320) $ (2,854) $ (2,876)
Income tax expense (benefit)................. $ (7) $ (7) $ 3,167 $ 2,981
Net loss after income taxes.................. $ (2,180) $ (2,313) $ (6,021) $ (5,857)
Minority interests........................... $ 10 $ 37 $ 170 $ 286
Net loss..................................... $ (1,297) $ (1,403) $ (4,260) $ (3,980)
Loss per share............................... $ (0.18) $ (0.19) $ (0.58) $ (0.54)
</TABLE>
F-32
<PAGE>
AUDITORS' REPORT
TO THE SHAREHOLDERS OF
TOWER SEMICONDUCTOR LTD.
We have audited the accompanying consolidated balance sheets of Tower
Semiconductor Ltd. ("the Company") and subsidiaries as of December 31, 1997 and
1996, and the related consolidated statements of income, changes in
shareholders' equity and cash flows for each of the three years in the period
ended December 31, 1997. These financial statements are the responsibility of
the Company's Board of Directors and management. Our responsibility is to
express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards, including those prescribed by the Israeli Auditors' Regulations
(Auditor's Mode of Performance)--1973, which standards are substantially
identical to generally accepted auditing standards in the United States. Those
standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by the
Board of Directors and management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements present fairly, in all
material respects, the consolidated financial position of the Company and
subsidiaries as of December 31, 1997 and 1996, and the consolidated results of
their operations, changes in shareholders' equity and cash flows for each of the
three years in the period ended December 31, 1997, in accordance with generally
accepted accounting principles in Israel. As applicable to these financial
statements, such accounting principles are substantially identical in all
material respects to generally accepted accounting principles in the United
States, except as indicated in Note 18.
Igal Brightman & Co.
Certified Public Accountants
Tel Aviv, Israel
January 27, 1998
F-33
<PAGE>
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
----------------------
<S> <C> <C> <C>
NOTE 1997 1996
--------- ---------- ----------
ASSETS
CURRENT ASSETS
Cash and cash equivalents.................................................... $ 4,792 $ 11,459
Short-term interest-bearing deposits......................................... 11 53,046 27,051
Marketable debt securities................................................... 3 26,207 33,610
Trade accounts receivable (no allowance for doubtful accounts)............... 9,14 11,008 11,094
Other receivables............................................................ 4 6,974 11,316
Inventories.................................................................. 5 12,432 14,289
Other current assets......................................................... 1,279 1,157
---------- ----------
Total current assets....................................................... 115,738 109,976
---------- ----------
LONG-TERM INVESTMENTS.......................................................... 6 2,610 427
---------- ----------
PROPERTY AND EQUIPMENT, NET.................................................... 7,11 99,216 106,047
---------- ----------
OTHER ASSETS................................................................... -- 120
---------- ----------
TOTAL ASSETS............................................................... $ 217,564 $ 216,570
---------- ----------
---------- ----------
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Short-term debt.............................................................. 8 $ 308 $ 208
Trade accounts payable....................................................... 13,124 16,284
Current portion of long-term liability in respect of customer advances....... 16 5,450 9,900
Due to related parties....................................................... 9 207 414
Other current liabilities.................................................... 10 5,724 3,921
---------- ----------
Total current liabilities.................................................. 24,813 30,727
LONG-TERM DEBT................................................................. 11 12,117 12,064
LONG-TERM LIABILITY IN RESPECT OF CUSTOMER ADVANCES............................ 16 3,340 7,714
OTHER LIABILITIES.............................................................. 12 10,413 5,480
COMMITMENTS AND CONTINGENCIES.................................................. 16
---------- ----------
Total liabilities.......................................................... 50,683 55,985
---------- ----------
SHAREHOLDERS' EQUITY
Ordinary shares, NIS 1 par value--authorized 30,000,000 shares; issued and
outstanding 13,235,360 and 13,205,450 shares, respectively................. 13 4,323 4,314
Additional paid-in capital................................................... 138,013 137,787
Shareholder receivables and unearned compensation............................ (736) (861)
Retained earnings............................................................ 25,281 19,345
---------- ----------
Total shareholders' equity................................................. 166,881 160,585
---------- ----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY................................. $ 217,564 $ 216,570
---------- ----------
---------- ----------
</TABLE>
See notes to consolidated financial statements.
F-34
<PAGE>
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------
<S> <C> <C> <C> <C>
NOTE 1997 1996 1995
--------- ---------- --------- ---------
SALES................................................................. 14,16 $ 125,917 $ 97,885 $ 99,621
COST OF SALES......................................................... 89,556 75,727 68,270
---------- --------- ---------
GROSS PROFIT...................................................... 36,361 22,158 31,351
---------- --------- ---------
OPERATING COSTS AND EXPENSES
Research and development, net..................................... 16 7,271 4,062 1,734
Marketing, general and administrative............................. 9 8,550 7,001 6,149
Other expenses.................................................... 7 400 1,443 --
---------- --------- ---------
16,221 12,506 7,883
---------- --------- ---------
OPERATING INCOME................................................ 20,140 9,652 23,468
FINANCING INCOME, NET (net of interest expense of $1,519, $1,928 and
$1,382, respectively)............................................... 2,452 2,661 2,138
GAIN FROM SALE OF EQUIPMENT........................................... 615 -- --
---------- --------- ---------
INCOME BEFORE INCOME TAXES...................................... 23,207 12,313 25,606
INCOME TAXES.......................................................... 15 4,036 2,299 5,167
---------- --------- ---------
NET INCOME...................................................... $ 19,171 $ 10,014 $ 20,439
---------- --------- ---------
---------- --------- ---------
BASIC EARNINGS PER ORDINARY SHARE
Earnings per share................................................ $ 1.45 $ 0.76 $ 1.76
---------- --------- ---------
---------- --------- ---------
Net income used to compute basic earnings per share............... $ 19,171 $ 10,014 $ 20,439
---------- --------- ---------
---------- --------- ---------
Weighted average number of ordinary shares outstanding--in
thousands....................................................... 13,235 13,205 11,593
---------- --------- ---------
---------- --------- ---------
DILUTED EARNINGS PER ORDINARY SHARE
Earnings per share................................................ $ 1.38
----------
----------
Net income used to compute diluted earnings per share............. $ 19,225
----------
----------
Weighted average number of ordinary shares outstanding--in
thousands....................................................... 13,945
----------
----------
</TABLE>
See notes to consolidated financial statements.
F-35
<PAGE>
TOWER SEMICONDUCTOR LTD.
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
SHAREHOLDER
RECEIVABLES
ORDINARY SHARES ADDITIONAL AND
----------------------- PAID-IN UNEARNED RETAINED
SHARES AMOUNT CAPITAL COMPENSATION EARNINGS TOTAL
------------ --------- ---------- ------------- --------- ----------
<S> <C> <C> <C> <C> <C> <C>
BALANCE--JANUARY 1, 1995......................... 10,000,000 $ 3,229 $ 50,431 $ (672) $ 8,700 $ 61,688
Issuance of employee share options............... 802 (802) --
Amortization of unearned compensation............ 309 309
Expenses connected with issuance of employee
share options.................................. (153) (153)
Public offering of ordinary shares, net.......... 3,205,450 1,085 86,983 88,068
Net income....................................... 20,439 20,439
------------ --------- ---------- ------------- --------- ----------
BALANCE--DECEMBER 31, 1995....................... 13,205,450 4,314 138,063 (1,165) 29,139 170,351
Cancellation of unearned compensation in respect
of non-vested options, net..................... (121) 121 --
Amortization of unearned compensation............ 183 183
Expenses connected with issuance of employee
share options.................................. (155) (155)
Cash dividend paid............................... (19,808) (19,808)
Net income....................................... 10,014 10,014
------------ --------- ---------- ------------- --------- ----------
BALANCE--DECEMBER 31, 1996....................... 13,205,450 4,314 137,787 (861) 19,345 160,585
Exercise of share options........................ 29,910 9 290 299
Cancellation of unearned compensation in respect
of non-vested options, net..................... (39) 39 --
Amortization of unearned compensation............ 86 86
Expenses connected with issuance of employee
share options.................................. (25) (25)
Cash dividend paid............................... (13,235) (13,235)
Net income....................................... 19,171 19,171
------------ --------- ---------- ------------- --------- ----------
BALANCE--DECEMBER 31, 1997..................... 13,235,360 $ 4,323 $ 138,013 $ (736) $ 25,281 $ 166,881
------------ --------- ---------- ------------- --------- ----------
------------ --------- ---------- ------------- --------- ----------
</TABLE>
See notes to consolidated financial statements.
F-36
<PAGE>
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
<S> <C> <C> <C>
1997 1996 1995
--------- --------- ---------
CASH FLOWS--OPERATING ACTIVITIES
Net Income...................................................................... $ 19,171 $ 10,014 $ 20,439
Adjustments to reconcile net income to net cash provided by operating
activities:
Income and expense items not involving cash flows:
Depreciation and amortization............................................... 23,648 17,515 8,386
Deferred income taxes....................................................... 4,036 2,299 2,554
Earnings on marketable debt securities...................................... (1,637) (2,959) (3,158)
Gain from sale of equipment................................................. (615) -- --
Changes in assets and liabilities:
Decrease (increase) in trade accounts receivable............................ 86 2,408 (6,493)
Decrease (increase) in other receivables and other current assets........... (1,156) 2,207 (2,791)
Decrease (increase) in inventories.......................................... 1,857 (1,082) (3,721)
Increase (decrease) in trade accounts payable............................... 1,923 (2,895) 1,643
Increase (decrease) in due to related parties............................... (207) (239) 233
Increase (decrease) in other current liabilities............................ 1,803 (1,074) 2,122
Increase (decrease) in liability in respect of customer advances, net....... (8,824) (1,439) 16,803
Increase in other long-term liabilities..................................... 577 117 528
--------- --------- ---------
Net cash provided by operating activities................................. 40,662 24,872 36,545
--------- --------- ---------
CASH FLOWS--INVESTING ACTIVITIES
Investments in property and equipment........................................... (29,390) (84,475) (62,076)
Proceeds from sale of property and equipment.................................... 766 -- --
Investment grants received...................................................... 13,041 30,800 14,634
Increase in deposits............................................................ (25,978) (1,684) (25,414)
Investments in marketable debt securities....................................... (48,836) (109,951) (88,139)
Proceeds from realization of marketable debt securities......................... 57,876 151,736 51,902
Long-term investments........................................................... (2,000) -- --
--------- --------- ---------
Net cash used in investing activities..................................... (34,521) (13,574) (109,093)
--------- --------- ---------
CASH FLOWS--FINANCING ACTIVITIES
Proceeds from issuance of ordinary shares, net.................................. -- -- 86,845
Proceeds from exercise of share options......................................... 299 -- --
Share option plan and share issuance expenses................................... (25) (155) (153)
Increase in (repayment of) liability in respect of customer advances............ -- (2,250) 4,500
Increase (decrease) in short-term debt........................................ 86 (1,641) 1,171
Proceeds from (repayment of) long-term debt..................................... 67 -- (1,440)
Cash dividend paid.............................................................. (13,235) (19,808) --
--------- --------- ---------
Net cash provided by (used in) financing activities....................... (12,808) (23,854) 90,923
--------- --------- ---------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS.................................. (6,667) (12,556) 18,375
CASH AND CASH EQUIVALENTS--BEGINNING OF YEAR...................................... 11,459 24,015 5,640
--------- --------- ---------
CASH AND CASH EQUIVALENTS--END OF YEAR............................................ $ 4,792 $ 11,459 $ 24,015
--------- --------- ---------
--------- --------- ---------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the year for interest.......................................... $ 748 $ 702 $ 816
--------- --------- ---------
--------- --------- ---------
Cash paid during the year for income taxes...................................... $ 1,578 $ 1,515 $ 3,167
--------- --------- ---------
--------- --------- ---------
</TABLE>
See notes to consolidated financial statements.
F-37
<PAGE>
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 1--DESCRIPTION OF BUSINESS AND GENERAL
A. DESCRIPTION OF BUSINESS
Tower Semiconductor Ltd. ("the Company"), incorporated in Israel, commenced
operations in March 1993. The Company is an independent "foundry" manufacturer
of semiconductor integrated circuits on silicon wafers. As a foundry, the
Company manufactures wafers using its advanced production capabilities and the
proprietary integrated circuit designs of its customers. The industry in which
the Company operates is characterized by wide fluctuations in supply and demand.
Such industry is also characterized by the complexity and sensitivity of the
manufacturing process, by high levels of fixed costs, and by the need for
constant improvements in production technology.
In March 1993, the Company acquired its plant in Israel from a subsidiary of
National Semiconductor Corporation, a U.S. corporation ("National"), in an
acquisition ("Acquisition") accounted for by the purchase method of accounting.
Pursuant to a shareholders' agreement, as of December 31, 1997, National
maintained the right to nominate one member of the Company's Board of Directors.
During 1996 and 1997, respectively, the Company established a wholly owned
marketing subsidiary in the U.S. and a 51%-owned (on a fully diluted basis) ASIC
design center subsidiary in Israel. The operations of these subsidiaries were
not material to the Company's financial position or results of operations as of
December 31, 1997 and 1996 and for the years then ended.
The Company's ordinary shares are traded on the Nasdaq National Market.
B. USE OF ESTIMATES IN PREPARATION OF FINANCIAL STATEMENTS
The preparation of financial statements in conformity with generally
accepted accounting principles ("GAAP") requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities as of the date of the financial
statements, and the reported amounts of revenues and expenses during the
reporting periods. Actual results could differ from those estimates.
NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
A. PRINCIPLES OF CONSOLIDATION
The Company's financial statements include the financial statements of the
Company and its majority-owned subsidiaries, after elimination of material
intercompany transactions and balances.
B. CASH AND CASH EQUIVALENTS
Cash and cash equivalents consist of deposits in banks and short-term
investments (primarily time deposits and certificates of deposit) with original
maturities of three months or less.
C. MARKETABLE DEBT SECURITIES
Marketable debt securities which the Company has the positive intent and
ability to hold to maturity are reflected at amortized cost.
F-38
<PAGE>
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
D. INVENTORIES
Inventories are stated at the lower of cost or market. Cost is determined
for raw materials, spare parts and supplies on the basis of average cost per
unit. Cost is determined for work in process and finished goods on the basis of
actual production cost.
E. INVESTMENTS IN OTHER ENTITIES
Long-term investments in other entities, over whose operating and financial
policies the Company does not have the ability to exercise significant
influence, are presented at cost.
F. PROPERTY AND EQUIPMENT
Property and equipment are presented at cost, net of investment grants
received or receivable, and less accumulated depreciation and amortization.
Depreciation is calculated based on the straight-line method over the estimated
economic lives of the assets or terms of the related leases, as follows:
<TABLE>
<S> <C>
14-25
Land and buildings under capital lease.......................... years
Machinery and equipment......................................... 5 years
Transportation vehicles......................................... 7 years
</TABLE>
Management reviews property and equipment and other long-lived assets on a
periodic basis to determine whether events or changes in circumstances indicate
that the carrying amount of such assets may not be recoverable.
G. INCOME TAXES
The Company records deferred income taxes to reflect the net tax effects of
temporary differences between the carrying amounts of assets and liabilities for
financial reporting purposes and for tax purposes. Deferred taxes are computed
based on the tax rates anticipated to be in effect (under applicable law at the
time the financial statements are prepared) when the deferred taxes are expected
to be paid or realized.
Deferred tax liabilities and assets are classified as current or noncurrent
based on the classification of the related asset or liability for financial
reporting, or according to the expected reversal dates of the specific temporary
differences, if not related to an asset or liability for financial reporting.
H. REVENUE RECOGNITION
Revenues are recognized upon delivery. An accrual for estimated returns,
computed primarily on the basis of historical experience, is recorded at the
time of sale.
I. RESEARCH AND DEVELOPMENT
Research and development costs are charged to operations as incurred.
Amounts received or receivable from the Government of Israel and others, as
participation in research and development programs, are offset against research
and development costs.
F-39
<PAGE>
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
J. EARNINGS PER ORDINARY SHARE
Basic earnings per ordinary share are calculated based on the weighted
average number of ordinary shares outstanding for each period presented
(including retroactive effect of shares issued upon exercise of share options
during each period) and give effect to shares issuable from share options whose
exercise is probable based on specific calculations. Diluted earnings per share
include the effects of all outstanding options which have a dilutive effect on
earnings per share. Diluted earnings per share data for 1996 and 1995 has not
been presented, since such data did not differ by more than 5% from basic
earnings per share. See Note 18 for disclosure of 1997 earnings per share data
in accordance with U.S. GAAP. Basic and diluted earnings per share data in
accordance with U.S. GAAP, as well as the data relating to earnings and number
of shares used for such calculations, were not materially different from the
data presented in accordance with Israeli GAAP for 1996 and 1995.
K. FOREIGN EXCHANGE AGREEMENTS
The Company, from time to time, enters into foreign exchange agreements as a
hedge against non-dollar equipment purchase commitments. Gains and losses on
such agreements through the date that the equipment is received are deferred and
recorded to property and equipment, while gains and losses subsequent thereto,
through the date of actual payment of the liability, are included in financing
income, net.
L. FUNCTIONAL CURRENCY AND TRANSACTION GAINS AND LOSSES
The currency of the primary economic environment in which the Company
conducts its operations is the U.S. dollar ("dollar"). Accordingly, the Company
uses the dollar as its functional and reporting currency. Financing income, net,
reflects net foreign currency transaction losses, which amounted to $384, $677
and $473 in 1997, 1996 and 1995, respectively.
M. STOCK-BASED COMPENSATION
The Company accounts for employee stock-based compensation in accordance
with Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees." Pursuant to this accounting standard, the Company records deferred
compensation for share options granted to employees at the date of grant based
on the difference between the exercise price of the options and the market value
of the underlying shares at that date. Deferred compensation is amortized to
compensation expense over the vesting period of the underlying options. See Note
13B for pro forma disclosures required in accordance with Statement No. 123,
"Accounting for Stock-Based Compensation" ("SFAS 123"), of the Financial
Accounting Standards Board.
N. RECLASSIFICATIONS
Certain amounts in the 1996 financial statements have been reclassified in
order to conform to the 1997 presentation.
F-40
<PAGE>
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 3--MARKETABLE DEBT SECURITIES
Marketable debt securities consist of the following:
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
YIELD TO --------------------
MATURITY 1997 1996
--------------- --------- ---------
<S> <C> <C> <C>
United States Treasury Bills.......................... 5.2%-6.0% $ 15,749 $ 32,595
United States Treasury Notes.......................... 5.6% 9,433 --
Israeli government bonds.............................. 6.6% 1,025 1,015
--------- ---------
$ 26,207 $ 33,610
--------- ---------
--------- ---------
</TABLE>
Marketable debt securities mature between February 1998 and July 1998. The
market value of the securities as of December 31, 1997 and 1996 was
approximately equal to their book value.
NOTE 4--OTHER RECEIVABLES
Other receivables consist of the following:
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
--------------------
<S> <C> <C>
1997 1996
--------- ---------
Investment grants receivable............................................ $ 3,414 $ 9,043
Government agencies..................................................... 3,560 2,273
--------- ---------
$ 6,974 $ 11,316
--------- ---------
--------- ---------
</TABLE>
NOTE 5--INVENTORIES
Inventories consist of the following (1):
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
--------------------
<S> <C> <C>
1997 1996
--------- ---------
Raw materials........................................................... $ 3,214 $ 4,304
Spare parts and supplies................................................ 3,570 3,363
Work in process......................................................... 4,059 5,543
Finished goods.......................................................... 1,589 1,079
--------- ---------
$ 12,432 $ 14,289
--------- ---------
--------- ---------
</TABLE>
- ------------------------
(1) Net of write-downs to net realizable value of $350 and $850 as of December
31, 1997 and 1996, respectively.
NOTE 6--LONG-TERM INVESTMENTS
Long-term investments consist primarily of an investment in Sayfun
Semiconductor Ltd. ("Sayfun"), according to an agreement between the Company and
Sayfun signed in October 1997 for the development, licensing and future
utilization of certain technology possessed by Sayfun.
F-41
<PAGE>
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 6--LONG-TERM INVESTMENTS (CONTINUED)
As of December 31, 1997, the Company has invested $2,000 in Sayfun in
exchange for 10.0% of Sayfun's equity and, according to the agreement, is
obligated to invest another $3,000 in exchange for additional equity in Sayfun
that will increase the Company's aggregate investment to 15% of Sayfun's equity
(including certain anti-dilution protective rights). These additional
investments are dependent on the achievement of specific development milestones
with regard to the technology.
Pursuant to certain provisions of the agreement, the Company and Sayfun are
obligated, under certain circumstances, to pay each other royalties and Sayfun
is obligated to produce, through the Company, at least 75% of its products based
on such technology.
NOTE 7--PROPERTY AND EQUIPMENT
A. COMPOSITION
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
----------------------
<S> <C> <C>
1997 1996
---------- ----------
Cost (1):
Land and buildings under capital lease.................................................... $ 27,627 $ 26,556
Machinery and equipment................................................................... 120,735 105,798
Transportation vehicles................................................................... 2,075 1,541
---------- ----------
150,437 133,895
---------- ----------
Accumulated depreciation and amortization:
Land and buildings under capital lease.................................................. 4,314 2,702
Machinery and equipment................................................................. 46,343 25,217
Transportation vehicles................................................................. 564 329
---------- ----------
$ 51,221 $ 28,248
---------- ----------
---------- ----------
$ 99,216 $ 105,647
Design costs in respect of plant to be constructed, net (2)............................... -- 400
---------- ----------
$ 99,216 $ 106,047
---------- ----------
---------- ----------
</TABLE>
- ------------------------
(1) As of December 31, 1997, the cost of buildings, machinery and equipment is
reflected net of investment grants of $72,158 (as of December 31,
1996--$64,562).
(2) Due to uncertainty with respect to the form and location of the plant to be
constructed, costs in the aggregate amount of $400 and $1,443, the recovery
of which was not considered probable by management, were written-off in 1997
and 1996, respectively.
B. INVESTMENT GRANTS
In connection with the formation of the Company, the Investment Center of
the Ministry of Industry and Trade of the State of Israel ("Investment Center"),
under its "approved enterprise" program, approved an investment program for
expenditures on buildings and equipment in the aggregate amount (as amended) of
approximately $96,850. The approval certificate was granted in respect of a
benefit track
F-42
<PAGE>
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 7--PROPERTY AND EQUIPMENT (CONTINUED)
providing the Company with investment grants at a rate of 38% of the investments
included in such certificate. The Company completed its investments in respect
of this program during 1996, and received final approval from the Investment
Center in November 1997 for the investments effected in respect of this program.
In January 1996, an investment program ("existing program") for expansion of
the Company's plant in the aggregate amount of $239,579 was approved by the
Investment Center. The approval certificate was granted in respect of a benefit
track providing the Company with investment grants at a rate of 34% of the
investments included in such certificate. Pursuant to the approval, the
investments in respect of this program are required to be completed by December
31, 1998.
Receipt of the above grants is subject to various conditions. In the event
the Company fails to comply with such conditions, the Company may be required to
repay all or a portion of the grants received plus interest and certain
inflation adjustments. In order to assure fulfillment of the conditions related
to the receipt of investment grants, floating liens were registered in favor of
the State of Israel on substantially all assets of the Company. In management's
opinion, the Company has been in full compliance with the conditions through
December 31, 1997.
In respect of the existing program, the Company has invested approximately
$105,500 through December 31, 1997 and estimates that the total investment
within the framework of such program will aggregate approximately $145,000 by
December 31, 1998. In January 1998, the Company applied to the Investment Center
for a two-year extension of time to complete its investments under the existing
program. Based on preliminary discussions with the Investment Center, the
Company's management is of the opinion that such extension will be approved.
NOTE 8--SHORT-TERM DEBT
Short-term debt consists primarily of unlinked, non-interest bearing
short-term loans received from a bank for the payment of Value Added Tax (VAT).
In December 1997 and January 1998, the Company received letters of intent
from certain Israeli banks. Pursuant to such letters of intent, the banks (see
Note 11) and a third bank will make available to the Company, at its request,
short-term credits in the aggregate amount of $75,000, of which $60,000 will be
available through December 1999 and the rest through December 1998, at terms to
be agreed upon by the parties prior to the actual receipt of any credits by the
Company.
F-43
<PAGE>
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 9--RELATED PARTIES
A. COMPOSITION
Amounts due to related parties consist of the following:
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
--------------------
<S> <C> <C>
1997 1996
--------- ---------
National...................................................................... $ 122 $ 348
Directors..................................................................... 85 66
--------- ---------
$ 207 $ 414
--------- ---------
--------- ---------
</TABLE>
B. OTHER RELATED PARTY BALANCES AND TRANSACTIONS
Trade accounts receivable as of December 31, 1997 includes $5,080 due from
National, primarily for wafer purchases ($9,500 as of December 31, 1996).
The Company purchased materials and received services from National during
1997 in the aggregate amount of $55 ($260 and $2,101 for 1996 and 1995,
respectively). See Note 16E.
Pursuant to a management agreement with Data Systems & Software Inc.
("DSSI"), the Company's indirect principal shareholder, DSSI is entitled to
management fees from the Company of $40 per month in 1997, 1996 and 1995. The
management agreement can be terminated by either party as of the end of any
year, subject to certain advance notice requirements.
In addition, the Company purchases computerized testing equipment from a
related party supplier in the normal course of business. The Company's purchases
from this supplier aggregated $962, $18, and $282 for 1997, 1996 and 1995,
respectively.
NOTE 10--OTHER CURRENT LIABILITIES
Other current liabilities consist of the following:
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
--------------------
<S> <C> <C>
1997 1996
--------- ---------
Accrued salaries........................................................... $ 3,836 $ 2,463
Vacation accrual........................................................... 1,758 1,428
Other...................................................................... 130 30
--------- ---------
$ 5,724 $ 3,921
--------- ---------
--------- ---------
</TABLE>
NOTE 11--LONG-TERM DEBT
In connection with the Acquisition, the Company assumed certain long-term
bank loans of National in the aggregate amount of $12,064 ("Original Term
Loans"). The Original Term Loans are indexed to the dollar and bear interest
(payable quarterly) at an annual rate of 6%. The Company is obligated to repay
F-44
<PAGE>
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 11--LONG-TERM DEBT (CONTINUED)
the principal of the Original Term Loans in quarterly installments commencing in
March 1993 and ending in May 1998
The bank that provided the Original Term Loans, together with another bank
(collectively, "Banks"), agreed to make new loans ("New Term Loans") to the
Company to repay and effectively extend the maturity of all principal
installments due on the Original Term Loans. The aggregate balance of the New
Term Loans is repayable in 12 equal quarterly payments commencing in May 2000.
The Banks also agreed that, as long as the Company maintains deposits at the
Banks with original maturities of at least one year from the date of deposit,
the annual interest rate on the New Term Loans (up to the amount of such
deposits) will be 0.3% over the interest rate that the Company receives on the
deposits. The portion of the New Term Loans not covered by such deposits will
bear annual interest at the three-month Libor rate plus 1.25%.
The agreements with the Banks restrict the Company's ability to place liens
on its assets (other than to the State of Israel in respect of investment
grants) without the prior consent of the Banks. Furthermore the agreements
contain certain restrictive financial covenants. As of December 31, 1997, the
Company was in full compliance with such covenants.
NOTE 12--OTHER LIABILITIES
A. COMPOSITION
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
----------------------
1997 1996
---------- ----------
<S> <C> <C>
Net liability for employee termination benefits (see B below):
Gross obligation.................................................. $ 6,794 $ 5,805
Amounts funded through deposits to severance pay funds and
purchase of insurance policies.................................. (5,489) (5,039)
---------- ----------
1,305 766
Deferred income taxes (see Note 15C).................................. 8,490 4,384
Other................................................................. 618 330
---------- ----------
$ 10,413 $ 5,480
---------- ----------
---------- ----------
</TABLE>
B. EMPLOYEE TERMINATION BENEFITS
Israeli law and labor agreements determine the obligations of the Company to
make severance payments to dismissed employees and to employees leaving
employment under certain other circumstances. The liability for severance pay
benefits, as determined by Israeli Law, is based upon length of service and the
employee's most recent salary. This liability is primarily covered by regular
deposits made by the Company into recognized severance and pension funds and by
insurance policies purchased by the Company. The amounts so funded are not
reflected on the balance sheet, since they are controlled by the fund trustees
and insurance companies and are not under the control and management of the
Company.
F-45
<PAGE>
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 12--OTHER LIABILITIES (CONTINUED)
Expenses relating to employee termination benefits were approximately
$1,674, $1,311 and $1,303 for 1997, 1996 and 1995, respectively.
NOTE 13--SHAREHOLDERS' EQUITY
A. SHARE PURCHASE PLAN
In December 1993, the Company sold 234,497 ordinary shares to key senior
management employees pursuant to a share purchase plan for an aggregate purchase
price of $678. Loans extended by the Company financed approximately $672 of the
aggregate purchase price required to be paid by the employees. Such loans are
denominated in new Israeli shekels ("NIS") and are linked to the Israeli
Consumer Price Index ("CPI"). Through December 31, 1997, all shares under the
plan were fully vested. The shares are subject to certain restrictions on sale
or transfer. The employee's obligation to repay loans received to finance the
purchase of the ordinary shares is secured by such shares and is repayable upon
the sale of the ordinary shares in accordance with a formula set forth in the
share purchase plan.
B. SHARE OPTION PLANS
The Company maintains two share option plans, which were adopted in 1994 and
1995, respectively. The plans provide for the grant of options to employees
(including senior management) to purchase ordinary shares at exercise prices
which may not be less than 85% of the market value of the ordinary shares at the
date of grant. In addition, pursuant to the plans, the terms of the options
granted may not exceed ten years from the first grant date under each plan.
Options granted to date become vested over a four-year period according to
various vesting schedules. In July 1996, the exercise price of vested options
granted under the 1994 plan was reduced from primarily $17 per share to $13 per
share, while the exercise price of non-vested options granted was reduced from
primarily $17 per share to $9.125 per share (the market value of the shares at
such time). The exercise price of all options granted under the 1994 plan after
July 1996 has been the market value of the shares on the date of grant.
F-46
<PAGE>
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 13--SHAREHOLDERS' EQUITY (CONTINUED)
A summary of the status of the Company's share option plans as of December
31, 1997, 1996 and 1995, as well as changes during each of the years then ended,
is presented below:
<TABLE>
<CAPTION>
1997 1996 1995
------------------------ ---------------------- ----------------------
WEIGHTED WEIGHTED WEIGHTED
NUMBER OF AVERAGE NUMBER AVERAGE NUMBER AVERAGE
SHARE EXERCISE OF SHARE EXERCISE OF SHARE EXERCISE
OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE
----------- ----------- --------- ----------- --------- -----------
<S> <C> <C> <C> <C> <C> <C>
Outstanding as of beginning of year (1)........ 729,656 $ 9.10 265,000 $ 17.16 --
Granted........................................ 104,340 11.84 528,960 8.80 265,000 $ 17.16
Exercised...................................... (29,910) 10.00 --
Terminated..................................... -- --
Forfeited...................................... (34,519) 8.60 (64,304) 15.65 --
----------- --------- ---------
Outstanding as of end of year.................. 769,567 9.45 729,656 9.10 265,000 17.16
----------- --------- ---------
----------- --------- ---------
Options exercisable as of end of year.......... 199,107 9.72 52,804 12.95 --
----------- --------- ---------
----------- --------- ---------
</TABLE>
- ------------------------
(1) During 1996, the exercise price of share options granted under the 1994 plan
was reduced.
The following table summarizes information about share options outstanding
as of December 31, 1997:
<TABLE>
<CAPTION>
EXERCISABLE AS OF
OUTSTANDING AS OF DECEMBER 31, 1997 DECEMBER 31, 1997
- ------------------------------------------------------------- ------------------------
<S> <C> <C> <C> <C> <C>
EXERCISABLE
WEIGHTED ------------------------
AVERAGE WEIGHTED WEIGHTED
RANGE OF REMAINING AVERAGE AVERAGE
EXERCISE NUMBER CONTRACTUAL LIFE EXERCISE EXERCISE
PRICES OUTSTANDING (IN YEARS) PRICE NUMBER PRICE
- -------------- ----------- ----------------- ------------- --------- -------------
$ 6.38- 7.00 10,000 8.73 $ 6.69 2,500 $ 6.69
8.75... 457,326 8.91 8.75 106,776 8.75
9.13... 155,185 7.37 9.13 47,115 9.13
10.25-11.25.. 53,000 9.65 10.58 -- --
12.00-13.82.. 84,056 8.35 12.57 42,716 13.00
17.38... 10,000 9.55 17.38 -- --
----------- ---------
769,567 199,107
----------- ---------
----------- ---------
</TABLE>
The weighted average grant-date fair value of the 104,340, 528,960 and
265,000 options granted during 1997, 1996 and 1995 amounted to $7.56, $4.50 and
$11.20 per option, respectively. The Company utilized the Black-Scholes option
pricing model to estimate fair value, utilizing the following assumptions for
the years 1997, 1996 and 1995 (all in weighted averages):
<TABLE>
<CAPTION>
1997 1996 1995
---------- ---------- ----------
<S> <C> <C> <C>
Risk-free interest rate.................................. 5.50% 5.50% 5.50%
Expected life of options................................. 4.5 years 4.4 years 4.4 years
Expected annual volatility............................... 79% 58% 58%
Expected dividend yield.................................. none none none
</TABLE>
F-47
<PAGE>
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 13--SHAREHOLDERS' EQUITY (CONTINUED)
Had compensation cost for the Company's share option plans been determined
based on fair value at the grant dates for awards made in 1997, 1996 and 1995
under such plans in accordance with SFAS 123, the Company's pro forma net income
and earnings per share would have been as follows:
<TABLE>
<CAPTION>
1997 1996 1995
--------- --------- ---------
<S> <C> <C> <C>
Pro forma net income.......................................... $ 17,860 $ 9,221 $ 19,752
--------- --------- ---------
--------- --------- ---------
Pro forma basic earnings per share............................ $ 1.35 $ 0.70 $ 1.70
--------- --------- ---------
--------- --------- ---------
Pro forma diluted earnings per share.......................... $ 1.28
---------
---------
</TABLE>
C. DESCRIPTION OF ORDINARY SHARES
As of December 31, 1997 and 1996, the Company had authorized 30,000,000 par
value NIS 1 ordinary shares, of which 13,235,360 and 13,205,450, respectively,
were issued and outstanding. Holders of ordinary shares are entitled to
participate equally in the payment of dividends and bonus share distributions
and, in the event of the liquidation of the Company, in the distribution of
assets after satisfaction of liabilities to creditors. Each ordinary share is
entitled to one vote on all matters to be voted on by shareholders.
D. CASH DIVIDENDS
In September 1997, the Company's Board of Directors declared the payment of
a special dividend in the amount of $13,235 ($1.00 per ordinary share). The
dividend was paid in October 1997.
In October 1996, the Company's Board of Directors declared the payment of a
special dividend in the amount of $19,808 ($1.50 per ordinary share). The
dividend was paid in November 1996.
NOTE 14-- CONCENTRATIONS RELATING TO SALES AND PRINCIPAL GEOGRAPHICAL
MARKETS
A. SALES TO MAJOR CUSTOMERS (AS A PERCENTAGE OF TOTAL SALES FOR THE RESPECTIVE
PERIODS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------
<S> <C> <C> <C>
1997 1996 1995
----- ----- -----
Customer A--National.............................................. 70% 67% 58%
Customer B........................................................ -- 8% 9%
Customer C........................................................ 15% 10% 20%
Customer D........................................................ 7% 8% 9%
</TABLE>
As of both December 31, 1997 and 1996, the above major customers constituted
most of the trade accounts receivable reflected on the balance sheet (see Note
17E).
F-48
<PAGE>
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 14-- CONCENTRATIONS RELATING TO SALES AND PRINCIPAL GEOGRAPHICAL
MARKETS (CONTINUED)
B. SALES BY GEOGRAPHICAL MARKET (AS A PERCENTAGE OF TOTAL SALES FOR THE
RESPECTIVE PERIODS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------
<S> <C> <C> <C>
1997 1996 1995
----- ----- -----
United States..................................................... 38% 41% 47%
Far East (1)...................................................... 61% 58% 49%
Other............................................................. 1% 1% 4%
</TABLE>
- ------------------------
(1) Primarily represents sales to assembly plants owned by National in the Far
East.
NOTE 15--INCOME TAXES
A. APPROVED ENTERPRISE STATUS
Virtually all of the Company's facilities have been granted approved
enterprise status, as provided by the Israeli Law for the Encouragement of
Capital Investments--1959 ("1959 Law") (see Note 7B). In connection with the
Acquisition, the Government of Israel also agreed to transfer to the Company the
approved enterprise status held by National with respect to its investment
programs.
The tax benefits derived from approved enterprise status relate only to
taxable income attributable to approved enterprise investments. The Company's
income attributable to its various approved enterprise investments is taxed at a
rate of 20% through periods ending between 2002 and 2007, depending on the
specific approval certificate. The portion of the Company's taxable income which
is not attributable to approved enterprise investments is subject to regular
"Company Tax" (37% in 1995, declining to 36% in 1996 and thereafter).
The tax benefits are also conditioned upon fulfillment of the requirements
stipulated by the 1959 Law and the regulations promulgated thereunder, as well
as the criteria set forth in the certificates of approval. In the event of a
failure by the Company to comply with these conditions, the tax benefits could
be canceled, in whole or in part, and the Company would be required to refund
the amount of the canceled benefits, plus interest and certain inflation
adjustments. In management's opinion, the Company has been in full compliance
with the aforementioned conditions through December 31, 1997.
B. COMPOSITION
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------
<S> <C> <C> <C>
1997 1996 1995
---------- ---------- ----------
Current................................................... $ -- $ -- $ 2,613
Deferred.................................................. 4,036 2,299 2,554
---------- ---------- ----------
$ 4,036 $ 2,299 $ 5,167
---------- ---------- ----------
---------- ---------- ----------
</TABLE>
F-49
<PAGE>
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 15--INCOME TAXES (CONTINUED)
C. COMPONENTS OF DEFERRED TAX ASSET/LIABILITY
The following is a summary of the components of the deferred tax benefit and
liability reflected on the balance sheet as of December 31:
<TABLE>
<CAPTION>
1997 1996
---------- ----------
<S> <C> <C>
Deferred tax benefit--current
Accrued vacation pay.................................................. $ 352 $ 286
Other................................................................. 33 29
---------- ----------
Total current deferred tax benefit................................ $ 385 $ 315
---------- ----------
---------- ----------
Net deferred tax liability--long-term
Deferred tax asset--long-term
Public offering issuance expenses................................. $ -- $ 407
Liability for employee rights upon severance...................... 261 153
Research and development.......................................... 1,240 657
Net operating loss carryforward................................... 71 444
Unearned compensation............................................. 71 98
---------- ----------
1,643 1,759
Deferred tax liability--long-term
Depreciation...................................................... (10,133) (6,143)
---------- ----------
Total net long-term deferred tax liability........................ $ (8,490) $ (4,384)
---------- ----------
---------- ----------
</TABLE>
D. EFFECTIVE INCOME TAX RATES
The reconciliation of the statutory tax rate to the Company's effective tax
rate is as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
-------------------------------------
1997 1996 1995
----- ----- -----
<S> <C> <C> <C>
Israeli statutory rate............................................ 36% 36% 37%
Reduced tax rate for approved enterprise.......................... (16) (16) (16)
Permanent differences and other, net (1).......................... (3) (1) (1)
-- -- --
17% 19% 20%
-- -- --
-- -- --
</TABLE>
- ------------------------
(1) Primarily includes special depreciation deduction in connection with the
location of the Company's plant.
E. NET OPERATING LOSS CARRYFORWARD
The Company has net operating loss carryforwards of approximately $355 as of
December 31, 1997, which may be carried forward for an unlimited period of time.
F-50
<PAGE>
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 16--COMMITMENTS AND CONTINGENCIES
A. LEGAL PROCEEDINGS
Between June and September 1996, several suits were filed in the United
States on behalf of a purported class of the Company's shareholders who
purchased or otherwise acquired the Company's ordinary shares between May 25,
1995 and June 10, 1996, against the Company, its Co-Chief Executive Officers,
its Chairman of the Board of Directors and DSSI. The actions have been
consolidated in the United States District Court for the District of New Jersey.
The consolidated complaint filed in the actions alleges that the defendants made
misstatements and omissions regarding, among other things (i) the relationship
between the Company and a major customer and (ii) the Company's process
development efforts in connection therewith, in violation of certain U.S.
Federal securities laws.
The Company has indemnified the defendants, up to the limits permitted by
the Israel Companies Ordinance, from any liability arising out of the actions.
The Company maintains insurance policies that, under certain conditions, cover
actions of this type up to an aggregate amount of $20,000. The Company is unable
to determine at this time with any certainty the ultimate outcome of the
aforementioned matter or its effect if any, on the Company's financial
condition, operating results and business. However, the Company believes it has
meritorious defenses and intends to defend the actions vigorously.
B. LEASES
The Company's offices and engineering and manufacturing operations are
located in a building complex situated in an industrial park in Migdal Haemek,
Israel. These premises are currently occupied under a long-term lease from the
Israel Lands Authority, which expires in 2032. The Company has no obligation for
lease payments related to this lease through the year 2032.
The Company occupies certain other premises under various operating leases.
The obligations under such leases were not material as of December 31, 1997.
C. PURCHASE AGREEMENTS
The Company from time to time enters into long-term purchase agreements with
customers. Pursuant to such agreements, the Company is committed to sell, and
the customer is committed to purchase (subject to reductions in certain
circumstances), a specific monthly output derived from the start of processing
of silicon wafers ("wafer starts") at prices stipulated in the agreements. The
Company's existing purchase agreement with National expires on February 28, 1998
(see also below). From commencement of the Company's operations through December
31, 1997, a substantial portion of the Company's production has been sold in the
framework of these agreements.
In May 1995, the Company and National signed an amendment to their original
purchase agreement (as previously amended). The amendment called for an increase
in the number of wafer starts per month that the Company was committed to sell
to National ("additional output"). In consideration for such increase, National
provided the Company with the amount of $28,875 as an advance in respect of the
additional output. The advance bears interest at the three-month Libor rate. Any
amounts of the advance not offset against sales of additional output to National
through October 1, 1999 were to be retained by the Company without any
obligation to National.
F-51
<PAGE>
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 16--COMMITMENTS AND CONTINGENCIES (CONTINUED)
In January 1998, the Company and National signed a new purchase agreement
("new agreement"), effective March 1, 1998 through February 28, 2000, with an
option to extend the agreement for an additional one year. The new agreement
replaces all prior purchase agreements with National, as well as portions of
other agreements pertaining to wafer purchases. Pursuant to the new agreement,
the Company is committed to sell, and National is committed to purchase (subject
to reductions in certain circumstances), quantities as set forth in the
agreement. Such quantities are lower than the commitments of the Company and
National pursuant to the prior agreements mentioned above. The new agreement
also establishes mechanisms for determining the prices to be charged by the
Company during the period of the agreement.
In addition, the mechanism for offsetting the aforementioned advance payment
received from National was revised and extended National's right to offset the
advance payment against wafer purchases through February 2000. Under certain
circumstances, the Company may be required to repay National a portion of the
advance payment still outstanding at that time. The portion of the advance
outstanding as of December 31, 1997 that is expected to be offset in 1998 in
accordance with the new agreement is presented as a current liability.
In the framework of certain purchase agreements with customers, the Company
is entitled to receive warrants to purchase share capital of the customer under
conditions stipulated in the agreements.
In June 1996, the Company reached an understanding for the termination of a
purchase agreement with a former major customer. Sales to such customer
accounted for approximately 8% and 9% of the Company's sales in 1996 and 1995,
respectively.
D. PROFIT SHARING PLAN
The Company maintains an employee profit sharing plan. Under the terms of
this plan (i) 7.5% of the Company's profit before taxes, as defined ("PBT"),
each year is to be divided among all employees of the Company, including senior
management (the allocation of which is based on salary and a yearly performance
score for each employee) and (ii) 2.5% of PBT each year is to be divided among
key senior management employees. The profit sharing award with respect to each
year is paid in two installments in the following year. The Company's expenses
pursuant to the profit sharing plan were $2,312, $1,231 and $2,561 for 1997,
1996 and 1995, respectively.
E. MUTUAL SERVICES AGREEMENTS
In connection with the Acquisition, the Company and National entered into a
mutual services agreement. The agreement, as extended from time to time, is
effective through February 28, 1998. In accordance with the aforementioned
agreement, the Company paid National $55 for various services and National paid
the Company $361 for certain activities in 1997 ($260 and $800, respectively,
for 1996; and $2,101 and $714, respectively, for 1995).
F. OTHER PRINCIPAL AGREEMENTS
The Company from time to time, in the normal course of business, enters into
long-term agreements with various entities for the joint development of products
and processes utilizing technologies owned by
F-52
<PAGE>
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 16--COMMITMENTS AND CONTINGENCIES (CONTINUED)
both the other entities and the Company ("joint ventures"). Certain of such
agreements contain commitments by the Company and/or the other entities to
purchase specific quantities of the products developed. As of December 31, 1997,
the Company's aggregate commitment to invest in such joint ventures was $5,167.
G. OTHER COMMITMENTS
(1) In consideration for research and development funding received by the
Company and another party, aggregating $780 as of December 31, 1997, from
the BIRD--Binational Industrial Research and Development Foundation
("BIRD"), the Company and the other party has undertaken to pay royalties
amounting to primarily 2.5% of the gross sales from products developed
from the research and development financed, not to exceed 150% of the
grants received.
(2) Receipt of certain research and development grants from the Government
of Israel is subject to various conditions. In the event the Company
fails to comply with such conditions, the Company may be required to
repay all or a portion of the grants received. In management's opinion,
the Company has been in full compliance with the conditions through
December 31, 1997.
NOTE 17--FINANCIAL INSTRUMENTS
A financial instrument is defined as cash, evidence of an ownership interest
in an entity, or a contract that imposes on one entity a contractual obligation
either to deliver or receive cash or another financial instrument to or from a
second entity. Examples of financial instruments include cash and cash
equivalents, trade accounts receivable, loans, investments, trade accounts
payable, accrued expenses, options and forward contracts.
In accordance with Statements No. 105, 107 and 119 of the FASB, the Company
makes certain disclosures with regard to financial instruments, including
derivatives. These disclosures include, among other matters, the nature and
terms of derivative transactions, information about significant concentrations
of credit risk, and the fair value of financial assets and liabilities.
A. FOREIGN EXCHANGE AGREEMENTS
The Company, from time to time, enters into foreign exchange agreements to
manage exposure to equipment purchase commitments denominated in Japanese yen.
These transactions qualify for hedge accounting in accordance with GAAP and,
accordingly, the results of such transactions are recorded concurrently with the
realization of the related items (i.e., receipt of the equipment and payment of
the related liability). The Company does not hold or issue derivative financial
instruments for trading purposes.
B. CREDIT RISK OF FINANCIAL INSTRUMENTS, INCLUDING DERIVATIVES
The face or contract amounts of derivatives do not represent amounts
exchanged by the parties and, accordingly, are not a measure of the exposure of
the Company through its use of derivatives.
F-53
<PAGE>
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 17--FINANCIAL INSTRUMENTS (CONTINUED)
The Company is exposed to credit-related losses in respect of derivative
financial instruments in a manner similar to the credit risk involved in the
realization or collection of other types of assets. In management's estimation,
due to the fact that derivative financial instrument transactions are entered
into solely with financial institution counterparties, it is not expected that
such counterparties will fail to meet their obligations. See E below with regard
to credit risks in respect of trade accounts receivable. Substantially all
remaining financial instruments held by the Company are due from governmental
entities and, accordingly, the Company's credit risk in respect thereof is
negligible.
C. PRESENTATION OF FOREIGN EXCHANGE TRANSACTIONS IN THE FINANCIAL STATEMENTS
There were no outstanding foreign exchange agreements as of December 31,
1997 and the results of such agreements were not material for 1997.
The aggregate contract amount of foreign exchange agreements outstanding as
of December 31, 1996 was $1,016. The credit risk on these transactions was not
material as of December 31, 1996 and no deferred losses existed at that date.
Losses recognized on foreign exchange agreements amounted to $3,598 in 1996.
Of this amount, $3,002 was capitalized to property and equipment during 1996 and
the remaining amount of $596 was reflected in financing expenses (1995--$1,661,
$1,130 and $531, respectively).
D. FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair values of the Company's financial instruments did not
materially differ from their respective carrying amounts as of December 31, 1997
and 1996.
E. CONCENTRATIONS OF CREDIT RISK
Most of the Company's trade accounts receivable (73% as of December 31,
1997) were due from the Company's two major customers, both of whom are large
multinational companies (see Note 14A).
NOTE 18--MATERIAL DIFFERENCES BETWEEN ISRAEL AND U.S. GAAP
With regard to the Company's financial statements, the primary material
difference between GAAP in Israel and in the U.S. relates to the presentation of
earnings per share data in 1997. Set forth below is the Company's earnings per
share data in accordance with U.S. GAAP (SFAS 128).
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
1997
---------------
<S> <C>
Basic Earnings Per Share........................................................ 1.45
---
---
Diluted Earnings Per Share...................................................... 1.43
---
---
</TABLE>
F-54
<PAGE>
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 18--MATERIAL DIFFERENCES BETWEEN ISRAEL AND U.S. GAAP (CONTINUED)
The following table provides a reconciliation of the numerators and
denominators of the basic and diluted per share computations for 1997 in
accordance with U.S. GAAP.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1997
-------------------------------------------
<S> <C> <C> <C>
INCOME SHARES PER-SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
------------- --------------- -----------
Basic Earnings Per Share Income available to ordinary shareholders....... 19,171 13,217 1.45
Effect of Dilutive Securities Options.................................... -- 235
------ ------ ---
Diluted Earnings Per Share Income available to ordinary shareholders
after assumed conversions.............................................. 19,171 13,452 1.43
------ ------ ---
------ ------ ---
</TABLE>
Options to purchase 45,000 ordinary shares at an average exercise price of
$11.90 per share were outstanding during 1997 but were not included in the
computation of diluted earnings per share because the exercise prices of the
options were greater than the average market price of the ordinary shares. The
options, which expire in November 2007, were still outstanding as of December
31, 1997.
F-55
<PAGE>
Exhibit 24.1
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in the Registration Statements
of Data Systems & Software Inc. (Forms S-3 Nos. 33-81298 and 33-94428 and
Forms S-8 Nos. 33-88442 and 33-99196) of our report dated March 30, 1998
(July 30, 1998 as to Note 22) (which expresses an unqualified opinion and
includes an explanatory paragraph relating to the restatement described in
Note 22), appearing in the Annual Report on Form 10-K/A of Data Systems &
Software Inc. for the year ended December 31, 1997.
Deloitte & Touche LLP
New York, New York
September 11, 1998
<PAGE>
Exhibit 24.2
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in the Registration Statements
of Data Systems & Software Inc. (Forms S-3 Nos. 33-81298 and 33-94428 and
Forms S-8 Nos. 33-88442 and 33-99196) of our report dated March 31, 1997
(July 30, 1998 as to Note 22) (which expresses an unqualified opinion and
includes an explanatory paragraph relating to the restatement described in
Note 22), appearing in the Annual Report on Form 10-K/A of Data Systems &
Software Inc. for the year ended December 31, 1997.
Igal Brightman & Co.
Certified Public Accountants (Isr.)
Tel Aviv, Israel
September 11, 1998
