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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
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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)
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DELAWARE 22-2786081
(State or other jurisdiction of (I.R.S. employer identification no.)
incorporation or organization)
200 ROUTE 17, MAHWAH, NEW JERSEY 07430
(Address of principal executive offices) (Zip code)
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(201) 529-2026
Registrant's telephone number, including area code
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 19, 1999 was approximately $14.1 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
22, 1999: 7,433,278.
DOCUMENTS INCORPORATED BY REFERENCE:
Certain sections of the registrant's Proxy Statement to be filed pursuant to
Regulation 14A under the Securirties Exchange Act of 1934 within 120 days of the
end of the registrant's fiscal year are incorporated by reference into Part III
of this Form 10-K.
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TABLE OF CONTENTS
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PART I
Item 1 Business.................................................................... 1
Item 2 Properties.................................................................. 10
Item 3 Legal Proceedings........................................................... 11
Item 4 Submission of Matters to a Vote of Security Holders......................... 11
PART II
Item 5 Market for the Company's Common Equity and Related Stockholder Matters...... 12
Item 6 Selected Financial Data..................................................... 12
Item 7 Management's Discussion and Analysis of Financial Condition and Results of 14
Operations..................................................................
Item 7A Quantitative and Qualitative Disclosures About Market Risk.................. 22
Item 8 Financial Statements and Supplementary Data................................. 23
Item 9 Changes in and Disagreements with Accountants on Accounting and Financial 23
Disclosure..................................................................
PART III
Item 10 Directors and Executive Officers of the Company............................. 24
Item 11 Executive Compensation...................................................... 24
Item 12 Security Ownership of Certain Beneficial Owners and Management.............. 24
Item 13 Certain Relationships and Related Transactions.............................. 24
PART IV
Item 14 Exhibits, Financial Statements Schedules and Reports on Form 8-K............ 25
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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., a Delaware corporation ("DSSI"), through its
subsidiaries and affiliates (collectively, the "Company"), (i) provides
consulting and development services for computer software and systems, (ii) is
an authorized dealer and a value-added-reseller ("VAR") of computer hardware,
(iii) develops and markets data communications solutions for utilities and (iv)
through its Tower Semiconductor Ltd. affiliate ("Tower"), engages in the
manufacture of semiconductors.
PRODUCTS AND SERVICES
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 1996, 1997 and 1998, sales attributable to
services provided on a time and materials basis were $12.2 million, $16.8
million and $15.3 million, respectively, accounting for approximately 36%, 42%
and 44% of computer related 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. The Company accounts for these
services on the percentage of completion method. Profits derived from such
contracts may vary substantially as a result of various factors, including risk
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 1996, 1997 and 1998 sales from fixed price contracts were $2.7 million,
$2.8 million and $3.4 million respectively, accounting for approximately 8%, 7%
and 9% of computer related revenues during these years, respectively.
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-added reseller and an
authorized service provider for equipment and software from such well-known
industry leaders as Compaq, IBM, Microsoft, Hewlett-Packard, AST, Acer, Apple
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.
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DATA COMMUNICATIONS SOLUTIONS FOR UTILITIES
Since 1992, through its PowerCom division, the Company has been designing,
developing and marketing two-way interactive communications solutions which
provide real-time remote automated meter reading ("AMR") 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. The Company believes that the EPSM provides a cost-effective
solution for the AMR and data management needs of utilities in the international
market. Through December 31, 1998 the Company had invested approximately $7.1
million (net of government and customer participation) on development and
marketing of the EPSM.
In January 1998, the Company's Comverge Technologies, Inc. subsidiary
acquired certain assets and licensed intellectual property which had been
utilized by Lucent Technologies, Inc. in Lucent's Customer Connection for
Utilities (CCU). The CCU had been previously deployed by Lucent 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 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 has broadened its target markets beyond utility companies to include
energy service providers, cooperatives, aggregators, municipals, large consumers
of energy and telecommunications network service providers.
Comverge is currently marketing the Comverge Distributed Connection. The
Comverge Distributed Connection is a low-cost, rapidly installed, CDPD wireless
meter-reading device which provides utilities and energy service companies with
accurate, detailed information on patterns of energy consumption from
geographically dispersed customers. The Comverge Distributed Connection designed
to meet the needs of utilities that are implementing metering and data
communications solutions for commercial and industrial customers. The system
provides options for using CEBus protocol power line interfaces to hub multiple
meters within a location and to enable cost-effective demand control reporting
of real time energy prices and other value-added services. The Comverge system
operates with electronic or pulse meters and interfaces to utility billing
systems. The Company believes that the system's use of CDPD technology provides
significant economic advantages over competing solutions for the commercial and
industrial market which utilize analog cellular or "plain old telephone" (POTS)
solutions.
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 US
market and exploit the data communications and energy management needs of the
global utilities markets which are rapidly undergoing deregulation.
INTERNET ACTIVITIES
The Company's Cinnetic division is engaged in a number of Internet related
activities. Cinnetic offers web hosting for business customers and provides
dedicated Internet access to business customers in greater Cincinnati, Ohio. In
addition, Cinnetic has developed and maintains PLACEUM.COM, an up to date
international resume database of experienced information systems professionals,
which it provides to professional recruiters and employers on a subscription
basis. These operations began in 1998 and have contributed as yet insubstantial
revenues to the Company.
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Starting in January 1999, Cinnetic was approved by
Netscape-Registered Trademark- as a member of the Premier Netscape Solution
Expert program. As a Netscape Premier partner the Company will work closely with
the Netscape direct sales force to provide top-level enterprise software and
services solutions to customers, including Netscape's popular CommerceXpert
e-commerce suite, and Application Server products.
DISCONTINUED ACTIVITIES
In April 1998, the Company sold the assets of its PHD help desk software
segment. The multimedia entertainment software segment, which consisted of the
Company's Cybrcard entertainment products, suspended operating activity in the
first quarter of 1998.
SALES BY ACTIVITY
The following table shows, for the years indicated, the dollar amount and
the percentage of the sales attributable to each of the activities of the
Company's operations, excluding the activities of Tower. Sales attributable to
the multimedia entertainment activity (which has suspended operations) and
certain miscellaneous computer related activities have been included within the
total sales amounts shown for consulting and development services. The Company's
help desk software operation was sold in April 1998.
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YEAR ENDED DECEMBER 31,
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1996 1997 1998
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AMOUNT % AMOUNT % AMOUNT %
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(DOLLARS IN THOUSANDS)
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Consulting and development services...................... $ 19,783 59% $ 20,573 52% $ 19,764 53%
Computer hardware and VAR sales.......................... 12,285 36% 15,170 38% 16,374 44%
Data communications solutions for utilities.............. -- -- -- -- 212 1%
Help desk software....................................... 1,802 5% 3,842 10% 785 2%
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Total computer related operations........................ $ 33,870 100% $ 39,585 100% $ 37,135 100%
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CUSTOMERS AND MARKETS
The Company commenced its computer related operations in Israel in 1986 and
Israel historically was the primary area of its operations. Due primarily to
significant growth of the United States subsidiaries, the percentages of revenue
from the activities of the United States subsidiaries grew to 64% of these
revenues in 1997. However, due primarily to decreased United States consulting
activities, the percentage of revenues from activities of the United States
subsidiaries decreased to 58% in 1998.
The Company's computer hardware and VAR sales commenced in 1992, accounting
for 36% of computer related operations sales in 1996, increasing by
approximately 33% to 44% of these sales in 1998. The Company's two largest
customers (Montefiore Medical Center and Shearman & Sterling, a large national
law firm) accounted for approximately 11% and 12% and 12% and 16% of computer
related sales in 1997 and 1998, 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 Company's backlog of work to be completed was approximately $2.1 million
as of January 1, 1999, compared to $1.7 million as of January 1, 1998. The
Company estimates that virtually all of the backlog will be performed in 1999.
Customer orders requesting services on a time and materials basis are
generally cancelable on a minimum of 30 days advance notice. Fixed price
projects are often subject to termination for convenience
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without substantial penalty and, accordingly, there can be no assurance 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.
COMPETITION
In its computer consulting and development services segment, 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, see "Item 1. Business--Factors Which May Affect Future
Results--General Factors--Competition."
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, see "Item 1. Business--Factors Which May Affect Future
Results--General Factors--Dependence on Intellectual Property of Third Parties."
TOWER SEMICONDUCTOR LTD.
INTRODUCTION
Through the end of 1996, the Company fully consolidated the operations of
Tower Semiconductor Ltd., with Tower's sales having represented approximately
74% of the Company's consolidated sales in 1996. Although the Company retains
effective control of Tower, due to changes in the Company's voting control in
Tower, the balance sheets since December 31, 1996 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
(loss) as equity income (loss) in affiliates.
Tower is an independent "foundry" manufacturer of semiconductor integrated
circuits ("ICs") on silicon wafers and provider of related design and turnkey
services. As a foundry, Tower manufactures wafers using its advanced process
technologies, 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.
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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, EPROM, Flash and other commodity
memories) to more differentiated products (such as microprocessors, ASICs and
numerous digital, analog, embedded memory and mixed-signal ICs).
SERVICES
Tower manufactures ICs on silicon wafers based upon proprietary designs
provided by its customers, using process technologies developed internally by
Tower or licensed from customers or others. Tower specializes in the manufacture
of differentiated IC products, which generally require greater process
flexibility and customization than commodity products. Recently, however, Tower
has also begun to manufacture commodity products. The end-product manufactured
by Tower is a silicon wafer containing multiple ICs.
In 1998, 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") and CMOS image sensor markets. In cooperation with certain customers
and strategic partners, Tower has developed or is in the process of developing a
variety of advanced process technologies, involving EPROM, Flash, mixed-signal
and CMOS image sensor devices. These processes include the Company's specialized
MICROFLASH-TM- process based on the breakthrough Flash technology of Saifun
Semiconductor Ltd., which is currently under development and is expected to be
introduced to production in 1999.
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 1998, approximately 75% of Tower's sales were
attributable to two large customers, National and Motorola.
During 1998, 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). The number of products that Tower
manufactures will be determined by customer orders.
Following a market downturn in 1996, growth for the foundry industry has
been flat primarily as a result of massive price reductions, offset by continued
increases in wafer consumption in the end markets. The situation in the
marketplace remains uncertain and there can be 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 competitors and
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."
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 ability to successfully develop and
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introduce to production advanced process technologies which meet its customers'
needs. Tower's manufacturing technologies currently include 1.0 micron, 0.8
micron, 0.6 micron, 0.5 micron and 0.35 micron CMOS (complementary metal oxide
silicon) process technologies, with one to three levels of metal and single or
double poly, for standard logic, mixed signal, EPROM and image sensor products.
Tower is currently working on the development of numerous process technologies
ranging from 0.35 to 0.8 microns, including Flash, low voltage EPROM, CMOS image
sensors and mixed signal applications. Tower expects to introduce most of these
technologies into production in 1999, although there can be no assurance of
this.
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 and, therefore, cannot predict when or if the development and
introduction to production of its 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 of the Company. 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 does not
currently intend to significantly increase the overall capacity of its facility.
Tower intends, however, to continue to make significant expenditures during 1999
to fund its process technology advancement program and to purchase equipment to
increase Tower's capacity to manufacture wafers using more advanced processes,
including those currently under development by Tower.
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. Many of Tower's
competitors have greater manufacturing capacity, 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, shorter delivery times and
time to market, and a high level of service and process customization.
INVESTMENTS
MOFET VENTURE CAPITAL FUND
The Company, together with other investors, established Mofet Israel
Technology Fund ("Mofet Fund"), 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 Fund has raised aggregate net proceeds of approximately $26.1
million. As of December 31, 1998, the Company owned approximately 4% of the
equity of Mofet Fund. Due to the Company's intention to dispose of its Mofet
Fund shares in 1999, the investment in Mofet Fund is being accounted for at fair
market value, which at December 31, 1998 exceeded its cost investment by
approximately $110,000.
Mofet Fund is managed by Mofet Risk Capital Fund Management (1992) Ltd.
("Mofet Management") pursuant to a management agreement expiring January 2000.
Mofet Fund has agreed to pay Mofet
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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 the Company 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 bearing interest at 8.25% per annum, payable July 1,
1998. The Company 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. In April 1998, the Company converted the note receivable into shares of
common stock of Geotek. The delivery of these shares represented payment of
approximately $1.7 million of the approximately $2.3 million principal of and
accrued interest on the note. These shares were subsequently sold by the Company
for approximately $1.9 million. In June 1998, Geotek 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 $610,000,
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 of approximately $192,000.
EMPLOYEES
At December 31, 1998, the Company employed a total of 299 people, including
228 persons in engineering and technical support (approximately one-half with
advanced degrees in computer and electronic engineering), 17 in marketing and
sales, and 54 in management, administration and finance. At December 31, 1998,
Tower had a total of 652 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, 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 administers Israel's social
security programs. 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 Item 7. "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and Notes 1 and 9 to
the Consolidated Financial Statements appearing elsewhere in this Report.
SEGMENT INFORMATION
For additional 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" and
Note 19 to the Consolidated Financial Statements appearing elsewhere in this
Report.
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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
NEED FOR ADDITIONAL CAPITAL. Although the Company believes that it has
sufficient liquidity to fund its ongoing corporate activities, the Company will
require additional financing to continue the activities of its data
communications solutions for utilities segment. If the Company is unable to
obtain such financing on commercially reasonable terms, it may have to
discontinue or curtail the activities of this segment. There can be no assurance
that the Company will obtain the resources needed to adequately finance the
product development and marketing efforts of its data communications solutions
segment.
RAPID TECHNOLOGICAL CHANGE; NEED FOR CONTINUED PRODUCT DEVELOPMENT. The
technologies related to the Company's data communications solutions for
utilities are subject to rapid change. There can be no assurance that the
Company will have the resources to invest in the continued product development
required to keep pace with changing technologies or that such product
development efforts will be successful.
COMPETITION. In its computer consulting and development services segment,
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 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
feels 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 data communications solutions for utilities is highly
competitive. The Company believes that the principal competitive factors
affecting its ability to compete in this market are its products' technological
capabilities, design features and functionality, price, reliability, ease of
installation and scalability. While the Company believes that its products offer
competitive advantages 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.
DEPENDENCE ON INTELLECTUAL PROPERTY OF THIRD PARTIES. Certain of the
Company's activities are dependent upon intellectual property owned by third
parties. For example, some of the Company's data communications solutions
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.
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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.
IMPACT OF INFLATION AND CURRENCY FLUCTUATIONS. A majority of the Company's
sales are made in dollars or in New Israeli Shekels ("NIS") linked to the
dollar. The dollar cost of the Company's operations in Israel is affected
adversely by the devaluation of the NIS in relation to the dollar.
As of December 31, 1998, 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.
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%.
FACTORS RELATED TO TOWER
The Company's equity interest in Tower subjects it to certain risks related
to Tower's business and the semiconductor industry, generally. These risks
include the following.
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, Tower's business and
financial condition would be materially adversely effected.
RISK OF OPERATING BELOW FULL CAPACITY; RISK OF CONTINUED OPERATING
LOSSES. 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. Tower is currently operating significantly below
full capacity, operated at a loss throughout 1998 and is expecting to operate at
a loss in 1999. There can be no assurance that utilization of Tower's capacity
will improve to the level required for profitable operations.
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 ability to
successfully develop and introduce to production advanced process technologies
which meet its customers' needs. The failure by Tower to develop and introduce
new process technologies successfully and in a timely manner would have a
material adverse effect on Tower'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 on specific
wafers to be non-functional, and result in reduced manufacturing yields. Despite
extensive quality control and testing programs, 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
9
<PAGE>
production yields in the future, which could have a material adverse effect on
Tower's business and financial condition.
RISKS RELATING TO ISRAELI GOVERNMENT PROGRAMS. Virtually all of Tower's
existing facilities and programs, including Tower's current $240 million
investment program and the investment program which was substantially completed
in 1995, have been granted "Approved Enterprise" status, qualifying Tower for
certain grants and tax benefits from the Government of Israel. To remain
eligible for these grants and tax benefits, Tower must continue to meet certain
conditions, including making certain specified investments in fixed assets.
Tower's certificate of approval for its current Approved Enterprise program, as
extended, requires, among other things, that all investments under the program
be completed by the end of 2000. There can be no assurance that such grants and
tax benefits will be continued in the future at their current levels or at all.
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.
As a result of the current downturn in the semiconductor market, the Company
is facing increased competition from other foundries, from its customers'
internal manufacturing capacity and from other semiconductor manufacturers who
have underutilized capacity. Since the end of 1996, Tower has experienced
increased pressure to reduce prices due to reductions in prices by its
competitors, including the excess internal capacity of certain customers. As a
result, Tower has had to reduce prices. In some cases these price reductions
have resulting in wafer sales prices at or near the variable cost of producing
the wafer. In addition, due to the trend in the semiconductor industry toward
sub-quarter micron process geometries, Tower faces increasing competitive
pressure from foundries that have the capacity to manufacture products below
0.35 and 0.25 microns.
ITEM 2. PROPERTIES
The Company's corporate headquarters (as well as the principal office for
its United States operations representing all of its reportable segments) 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 expires in
August 2000, at a current rent of $75,000 per annum, and of approximately 8,300
square feet in Florham Park, New Jersey used solely in the U.S. data
communications solutions segment, at an annual rent of $126,000, which expires
January 2003.
The facilities of the Company's Decision Systems Israel Ltd. subsidiary
("DSI 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 $325,000. These facilities are used
for the Company's Israeli operations in the computer consulting and development
services segment and the data communications solutions for utilities segment.
10
<PAGE>
ITEM 3. LEGAL PROCEEDINGS
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 (who is also
the Chairman of the Board of the Company), and the Company. The consolidated
complaint filed in the action 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.
In January 1999, Tower and the other defendants in the action entered into a
stipulation settling the action for $16,275,000, all of will be covered by
insurance policies covering Tower and the other defendants. Tower and the other
defendants have denied any wrongdoing in connection with the action. Tower will
incur certain costs associated with the defense of the action, which costs are
not expected to materially exceed amounts previously accrued by Tower in
connection with the action. The settlement is subject to court approval.
Tower has recently been separately approached by two parties alleging that
Tower is infringing on certain semiconductor production patents owned by such
parties and requesting that Tower enter into negotiations for a royalty-bearing
license for the use of the technology covered by such patents. Tower is
presently assessing these allegations and is engaged in discussions to determine
whether there is any merit to their claims. In addition, Tower is assessing if
and to what extent Tower may be able to seek indemnification from third parties
for all or part of any royalties or other amounts which may be paid or payable
by Tower in connection with these claims. Tower and the Company are unable to
determine at this time with any certainty the ultimate outcome of the
aforementioned matter or its effect, if any, on Tower's and the Company's
financial condition, operating results and business.
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.
11
<PAGE>
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>
1997:
First Quarter....................................................................................... 6 1/16 4 3/8
Second Quarter...................................................................................... 6 1/8 4 5/8
Third Quarter....................................................................................... 7 3/16 4 13/16
Fourth Quarter...................................................................................... 7 1/16 3 3/4
1998:
First Quarter....................................................................................... 5 3/4 4
Second Quarter...................................................................................... 6 1/2 4 1/8
Third Quarter....................................................................................... 5 2 5/16
Fourth Quarter...................................................................................... 3 1/8 1 13/16
</TABLE>
As of March 22, 1999 there were approximately 86 record holders of the
Common Stock. The Company estimates that there are approximately 2,600
beneficial owners of the Common Stock.
The Company paid no dividends in 1997 or 1998.
ITEM 6. SELECTED FINANCIAL DATA
The following selected statement of operations data for the years ended
December 31, 1997 and 1998 and balance sheet data as of December 31, 1997 and
1998 have been derived from the consolidated financial statements of the Company
included elsewhere in this Annual Report which have been audited by Deloitte &
Touche LLP (a member of Deloitte Touche Tohmatsu International), independent
auditors. The following selected statement of operations data for the year ended
December 31, 1996 has been derived from the financial statements of the Company
appearing elsewhere in this Annual Report which have been audited by Brightman
Bar Levav & Co. (a member of Deloitte Touche Tohmatsu International),
independent auditors. The selected statements of operations data for the years
ended December 31, 1994 and 1995 and balance sheet data as of December 31, 1994,
1995 and 1996 are derived from audited financial statements not included herein.
This data is qualified in its entirety by reference to, and should be read
in conjunction with, the Company's Consolidated Financial Statements (including
the notes thereto) and "Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations."
The balance sheet data as of December 31, 1996, 1997 and 1998 and the
statement of operations data for the years ended December 31, 1997 and 1998
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.
12
<PAGE>
STATEMENT OF OPERATIONS DATA:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------------------------
1994 1995 1996 1997 1998
---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Sales................................................ $ 79,711 $ 129,823 $ 131,755 $ 39,996 $ 37,495
Cost of sales........................................ 58,527 90,839 102,094 32,437 29,175
---------- ---------- ---------- ---------- ----------
Gross profit..................................... 21,184 38,984 29,661 7,559 8,320
Research & development expenses, net................. 4,126 4,375 5,611 1,335 1,605
Selling, general and administrative expenses......... 10,602 15,926 18,635 18,859 14,303
---------- ---------- ---------- ---------- ----------
Operating income (loss).......................... 6,456 18,683 5,415 (12,635) (7,588)
Interest income...................................... 1,313 5,188 5,321 478 147
Interest expense..................................... (1,532) (2,434) (2,218) (225) (360)
Gain on changes in ownership interests in
subsidiaries....................................... 14,755 26,339 -- -- --
Gain on sale of division............................. -- -- -- -- 5,998(1)
Loss accrual for bank guarantees..................... -- -- -- -- (1,135)(2)
Unrealized loss from writedown of investment......... -- -- -- -- (6,103)(3)
Other income (loss), net............................. (147) 5 609 (111) (889)
---------- ---------- ---------- ---------- ----------
Income (loss) before taxes....................... 20,845 47,781 9,127 (12,493) (9,930)
Income taxes......................................... 1,632 4,837 2,141 3,507 35
---------- ---------- ---------- ---------- ----------
Income (loss) after taxes........................ 19,213 42,944 6,986 (16,000) (9,965)
Minority interests................................... (10,143) (25,026) (7,699) 676 929
Equity (loss) in affiliates.......................... (227) (169) (1,767) 4,880 (3,908)
---------- ---------- ---------- ---------- ----------
Net income (loss)................................ $ 8,843 $ 17,749 $ (2,480) $ (10,444) $ (12,944)
---------- ---------- ---------- ---------- ----------
---------- ---------- ---------- ---------- ----------
Earnings (loss) per share............................ $ 1.31 $ 2.43 $ (0.34) $ (1.42) $ (1.75)
---------- ---------- ---------- ---------- ----------
---------- ---------- ---------- ---------- ----------
Weighted average number of shares.................... 6,728 7,307 7,369 7,369 7,391
---------- ---------- ---------- ---------- ----------
---------- ---------- ---------- ---------- ----------
</TABLE>
BALANCE SHEET DATA:
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
----------------------------------------------------------
1994 1995 1996 1997 1998
---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
(IN THOUSANDS)
Working capital...................................... $ 63,895 $ 141,850 $ 13,676 $ 7,201 $ 5,719
Total assets......................................... 127,533 271,631 97,818 92,366 73,244
Short-term debt, including current maturities of
long-term debt..................................... 3,821 16,371 2,124 3,709 974
Long-term debt, net of current maturities............ 12,485 22,499 331 481 687
Minority interests................................... 42,327 128,959 28,407 29,094 25,560
Total shareholders' equity........................... 44,937 64,779 62,556 52,308 39,418
</TABLE>
- ------------------------
(1) Gain from the sale of the assets of the help desk segment in April 1998.
(2) Loss from the accrual of loss contingencies in 1998 in connection with
guarantees given by the Company on behalf of an affiliate and former
subsidiary of the Company.
(3) Unrealized loss from the writedown of the Company's investment in Tower to
reflect market value of Tower's shares at December 31, 1998.
13
<PAGE>
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."
During 1998, the Company operated in five reportable segments: computer
consulting and development services, VAR computer hardware, data communication
solutions for utilities, help desk software and multimedia entertainment
software. The assets of the help desk software segment, which provided solutions
for the computer help desk market, were sold in April 1998. The multimedia
entertainment software segment suspended operating activity in the first quarter
of 1998.
COMPUTER CONSULTING SERVICES AND SYSTEMS
The computer consulting services and systems segment commenced operations in
Israel in 1986; U.S. operations commenced in 1991. While Israel has historically
been the primary area of the segment's operations, the United States operations
had been steadily increasing. However, due to increased competition and lower
prices and profit margins, revenue from and the profits of the United States
operations of the segment decreased in 1998. Gross profit margins in the Israeli
operations continue to experience downward pressure due to increased labor costs
resulting from the relative shortage of qualified programmers and engineers and
there can be no assurance that the competitive market place for qualified
engineers will not continue to affect margins in 1999 and future periods.
VAR COMPUTER HARDWARE
The Company, through its Databit subsidiary, sells and services
comprehensive PC-based computer hardware/software/networking solutions. This
segment has shown steady growth in both revenue and profit. However, the
industry has been experiencing increasing pressure on prices and increased
competition from the direct sales efforts of the major equipment vendors. There
is no assurance that the Company will not be adversely affected by these
developments.
DATA COMMUNICATIONS SOLUTIONS FOR UTILITIES
Since 1992, through the PowerCom division of the Company's Decision Systems
Israel subsidiary, 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. In January 1998, the
Company acquired certain assets and licensed intellectual property from Lucent
Technologies, Inc. This technology is being used by the Company's Comverge
Technologies subsidiary, which is marketing the Comverge Distributed Connection
to customers in the U.S.
TOWER SEMICONDUCTOR LTD.
In addition to its operating segments, the Company through its equity
investment in Tower, is engaged in the manufacture of semiconductor products.
Through the end of 1996, the Company fully consolidated the operations of Tower.
Although the Company retains effective control of Tower, due to changes in the
Company's voting control in Tower, commencing in 1997 the Company has accounted
for its interest in Tower's results using the equity method, including its pro
rata share of Tower's net income (loss) as equity (loss) in affiliates.
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
14
<PAGE>
production capability and the proprietary IC designs of its customers. Products
manufactured by Tower 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.
From the time of its organization 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 through 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. Tower expects such overcapacity to
continue into 1999. Due to the preceding and the continued trading of the Tower
stock at substantially below its carrying cost, the Company recorded a writedown
of approximately $6.1 million with respect to its Tower investment.
As a result of conditions in the market, Tower does not currently intend to
increase significantly the overall capacity of its facility in 1999. Tower
intends, however, to continue to make expenditures during 1999 as part of its
ongoing process technology advancement.
15
<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,
-----------------------------------------------------
1994 1995 1996 1997 1998
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
Sales............................................................ 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of sales.................................................... 73.4 70.0 77.5 81.1 77.8
--------- --------- --------- --------- ---------
Gross profit................................................. 26.6 30.0 22.5 18.9 22.2
Research and development expenses, net........................... 5.2 3.4 4.3 3.3 4.3
Selling, general and administrative expenses..................... 13.3 12.3 14.1 47.2 38.1
--------- --------- --------- --------- ---------
Operating income (loss)...................................... 8.1 14.3 4.1 (31.6) (20.2)
Financial income (expenses), net................................. (0.3) 2.1 2.4 0.6 (0.6)
Gain on changes in ownership interests in subsidiary............. 18.5 20.3 -- -- --
Gain on sale of division......................................... -- -- -- -- 16.0
Loss accrual for bank guarantees................................. -- -- -- -- (3.0)
Unrealized loss from writedown of investment..................... -- -- -- -- (16.3)
Other income (loss), net......................................... (0.2) -- 0.4 (0.2) (2.4)
--------- --------- --------- --------- ---------
Income (loss) before income taxes.............................. 26.1 36.8 6.9 (31.2) (26.5)
Income taxes..................................................... 2.0 3.7 1.6 8.8 0.1
--------- --------- --------- --------- ---------
Income (loss) after income taxes............................... 24.1 33.1 5.3 (40.0) (26.6)
Minority interests............................................... (12.7) (19.3) (5.9) 1.7 2.5
Equity (loss) in affiliates...................................... (0.3) (0.1) (1.3) 12.2 (10.4)
--------- --------- --------- --------- ---------
Net income (loss)................................................ 11.1% 13.7% (1.9%) (26.1%) (34.5%)
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
</TABLE>
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 (loss) as equity
(loss) in affiliates. The Company therefore believes that the statement of
operations for the years ended December 31, 1997, and 1998 are not comparable
with those of prior years.
The following table sets forth certain information with respect to revenues
and profits of the Company's five reportable business segments for the year
ended December 31, 1998, including the percentages of such aspects attributable
to the segment. The column marked "Other" aggregates information relating to
miscellaneous operating segments which may be combined for reporting under
applicable accounting principles.
<TABLE>
<CAPTION>
COMPUTER VAR DATA MULTIMEDIA
CONSULTING COMPUTER COMMUNICATIONS HELP DESK ENTERTAINMENT
SERVICES HARDWARE FOR UTILITIES SOFTWARE SOFTWARE OTHER TOTAL(*)
------------ ----------- ----------------- ----------- --------------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
(IN THOUSANDS)
Year ended December 31, 1998:
Revenues from external
customers.................. $ 18,640 $ 16,374 $ 212 $ 785 $ 152 $ 972 $ 37,135
Percentage of total revenues
from external customers 50% 44% 1% 2% -- 3% 100%
Segment profit............... $ 5,742 $ 1,514 $ (3,428) $ (1,352) $ (663) $ (294) $ 1,519
</TABLE>
- ------------------------
(*) The Company's consolidated sales for 1998 included $360,000 in management
fees received from Tower. See Note 19 to the consolidated financial
statements included elsewhere in this Report for reconciliations to the
Company's consolidated financial information.
16
<PAGE>
YEARS ENDED DECEMBER 31, 1998 AND 1997
SALES. The decrease in sales for the year ended December 31, 1998, as
compared to the year ended December 31, 1997, was primarily due to the sale of
the Company's PHD help desk division in the beginning of the second quarter of
1998, as well as decreased consulting services in the United States, partially
offset by increased computer hardware VAR sales and increased sales of
consulting services in Israel in the first three quarters of 1998.
GROSS PROFIT. The increase in gross profits for the year ended December 31,
1998, as compared to the year ended December 31, 1997, was primarily due to (i)
a non-recurring writedown of previously deferred production expenses related to
the Company's Cybrcard product in the first quarter of 1997, (ii) improved
computer hardware VAR sales and margins in the first three quarters of 1998 and
(iii) increased gross profits and margins on sales of consulting services in
Israel during that same period, partially offset by a decrease due to the sale
of PHD. Gross profit margins in the computer consulting services and systems
segment experienced downward pressure due to increased labor costs resulting
from the relative shortage of qualified programmers and engineers.
RESEARCH AND DEVELOPMENT EXPENSES ("R&D"). The increase in R&D for the year
ended December 31, 1998 as compared to the year ended December 31, 1997, was due
to increased EPSM product development expenses, as a result of accelerated
development costs in related to full-scale release of the product.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES ("SG&A"). The decrease in SG&A
for the year ended December 31, 1998, as compared to the year ended December 31,
1997, was primarily due to the sale of PHD and reduced Cybrcard activity,
partially offset by (i) increased marketing activity related to the Company's
data communications solutions for utilities, (ii) increased marketing and
administrative activities related to its newly established Cinnetic division and
(iii) non-recurring administrative expenses related to the severance obligations
to an executive officer who resigned at the end of 1998.
OPERATING LOSS. The decrease in the operating loss for the year ended
December 31, 1998, as compared to the year ended December 31, 1997, was
primarily attributable to the aforementioned decrease in SG&A and increase in
gross profits, partially offset by the increase in R&D.
GAIN ON SALE OF DIVISION. The Company recognized a gain from the sale of
the Company's PHD division in the second quarter of 1998.
UNREALIZED LOSS FROM WRITEDOWN OF INVESTMENT. Due to the continued decrease
in Tower's share price in the last quarter of 1998, the Company wrote down its
investment to market value. Tower's share price as of December 31, 1998 was
$9.50 and this caused an expense of approximately $6.1 million to be recorded in
the last quarter of 1998.
OTHER LOSS, NET. The Company's other loss for the year ended December 31,
1998 was primarily due to the recording in the third quarter of 1998 of an
accrual of loss contingencies in connection with guarantees by the Company of
the debt of an affiliate and with the writeoff of the Company's investment in
such affiliate, as well as due to the settlement of certain litigation.
INCOME TAXES. The income tax provisions for the years ended December 31,
1998 and December 31, 1997 are based on actual tax computations for each of such
years. The Company generally establishes valuation allowances against its net
operating loss carryforwards and therefore does not recognize deferred tax
assets in connection therewith.
SHARE OF AFFILIATED COMPANY'S NET INCOME (LOSS). The decrease in the equity
income, resulting in an equity loss, for the year ended December 31, 1998 as
compared to the year ended December 31, 1997,
17
<PAGE>
resulted from losses in Tower, primarily attributable to a continued decrease in
Tower sales and capacity utilization.
NET LOSS. The increase in net loss for the year ended December 31, 1998, as
compared to the year ended December 31, 1997, was primarily attributable to the
aforementioned writedown of its investment in, and equity losses, from Tower
partially offset by the gain from the sale of PHD and the decrease in operating
loss in the 1998 periods.
YEARS ENDED DECEMBER 31, 1997 AND 1996
The following table sets forth certain information with respect to the
results of operations of the Company and its two previously reportable business
segments for 1996 and 1997, including percentages 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 years ended December 31, 1997 reflect
Tower's activity on the equity method, while that of 1996 reflects Tower's
activity on a fully consolidated basis. Therefore, the information presented for
1997 is not directly comparable to that presented for 1996.
<TABLE>
<CAPTION>
DOLLAR % OF DOLLAR % OF INCREASE
AMOUNT SALES AMOUNT SALES (DECREASE)
--------- --------- --------- ----------
1996 1997 FROM 1996
-------------------- --------------------- -----------
<S> <C> <C> <C> <C> <C>
SEMICONDUCTOR OPERATIONS
Sales.................................................... $ 97,885
Gross profit............................................. 22,447 22.9%
R&D expenses, net........................................ 4,062 4.1%
SG&A expenses............................................ 7,119 7.2%
Operating income......................................... 11,266 11.5%
COMPUTER OPERATIONS
Sales.................................................... 33,870 $ 39,585 16.9%
Gross profit............................................. 7,214 21.3% 7,194 18.2% (0.3%)
R&D expenses, net........................................ 1,549 4.6% 1,335 3.4% (13.8%)
SG&A expenses............................................ 9,966 29.4% 16,274 41.1% 63.3%
Operating loss........................................... (4,301) (12.7%) (10,415) (26.3%) 142.2%
CORPORATE UNITED STATES
Sales.................................................... -- 411
Gross profit............................................. -- 365 88.8%
SG&A expenses............................................ 1,550 2,585 629.0% 66.8%
Operating loss........................................... (1,550) (2,220) (540.1%) 43.2%
COMBINED
Sales.................................................... 131,755 39,996
Gross profit............................................. 29,661 22.5% 7,559 18.9%
R&D expenses, net........................................ 5,611 4.3% 1,335 3.3%
SG&A expenses............................................ 18,635 14.1% 18,859 47.2%
Operating income (loss).................................. 5,415 4.1% (12,635) (31.6%)
</TABLE>
SALES. Computer Operations 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
Operations sales was primarily attributable to (i) the writedown of $1.7 million
in previously capitalized development costs
18
<PAGE>
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 Operations in 1997 were attributable
to the Company's EPSM product.
SG&A. The increase in Computer Operations SG&A 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 resulting in an
operating loss for the year ended December 31, 1998 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 a
$6.3 million increase in the valuation allowance against tax benefits associated
with Federal tax loss and tax credit carryforwards.
NET LOSS. The increase in the net loss was primarily attributable to the
aforementioned (i) decrease in gross profits, (ii) increase in SG&A and (iii)
increase in income taxes.
LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 1998, DSSI and its U.S. subsidiaries had working capital
of $3.7 million (including unrestricted cash and cash equivalents of $1.0
million) and DSI Israel had working capital of $1.9 million (net of short term
bank credit of $290,000). Although there is no legal restriction preventing
disposition of the Company's investments or the distribution to the Company of
their earnings, cash of DSI Israel and Tower is generally not available for use
by DSSI or its U.S. subsidiaries.
DSSI has financed the operations of its U.S. 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 1996 and 1997. DSSI believes
that it has adequate liquidity to finance its ongoing corporate activities.
However, in order to continue financing its data communications solutions
segment 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 its data communications solutions segment. There can be
no assurance that the Company will obtain the resources to finance its data
communications solutions segment product development and marketing efforts.
In 1998, the Company and Databit entered into an agreement with a bank under
which the Company has opened a bank credit line of $2.2 million. In 1998, the
Company borrowed $180,000 which was repaid in full in January 1999.
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. Certain of its bank deposits serve as collateral for
bank loans and guarantees.
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, 1998, Tower had working capital of $66 million, including cash,
short-term bank deposits and marketable securities of $64.4 million.
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
19
<PAGE>
to consolidate Tower's balance sheet and commencing in 1997 has accounted for
its interest in Tower's results using the equity method.
IMPACT OF INFLATION AND CURRENCY FLUCTUATIONS
During 1998 a majority of the Company's sales were denominated in dollars.
The remaining portion is 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 1998 were 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 affected adversely by the devaluation of the NIS in
relation to the dollar since most of its transactions are linked to or are
denominated in US dollars. This adverse effect principally arises with respect
to its severance pay obligations and also with respect to the unbilled portion
of long term projects.
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 itself, except as
described through its equity investment in Tower, does not engage in any other
hedging activities.
As of December 31, 1998, 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 DISCLOSURE
The Company has conducted a review of its computer systems and operations,
both those for internal use and those developed for customers, to identify and
determine the extent to which any systems may be vulnerable to potential errors
and failures as a result of the "Year 2000 problem." Any of these programs that
have time-sensitive software could experience system failures or miscalculations
and result in disruption of operations.
The Company has completed a comprehensive review of these computer systems
to ensure that all such systems are Year 2000 compliant prior to the
commencement of the year 2000. The Company's plan for its Year 2000
compatibility effort included the following: (i) conducting a comprehensive
inventory of the Company's internal systems, including non-information
technology systems (e.g. switching, billing and other platforms and electrical
systems) and any systems intended to be acquired by the Company, (ii) conducting
a comprehensive review of the systems developed by or licensed to the Company
for customers either under development or within their warranty period, (iii)
assessing and prioritizing any required remediation, and (iv) remediating any
problems by modifying, or replacing where appropriate, non-compliant systems.
In connection with its Year 2000 remediation efforts, the Company has not
and does not expect to incur any significant costs. Any such efforts, are
expected to be handled by Company personnel as part of their regular duties. In
respect to Tower's remediation efforts, Tower expects to incur staff costs as
well as consulting and other expenses incremental to current spending levels.
Tower anticipates that such costs will not be material. Tower estimates that the
total cost associated with the Year 2000 projects will be $1 million to $2
million, of which approximately $400,000 has been expended to date.
Both the Company and Tower do not believe that any of its products have any
direct Year 2000 compliance problems.
20
<PAGE>
In addition to assessing its own internal or externally supplied systems,
the Company has made efforts to identify and remedy potential implications to
the Company as a result of its suppliers' vulnerability to Year 2000 problems.
There can be no assurance that the Company has or will be able to identify all
aspects of its business that are subject to Year 2000 problems of customers or
suppliers that affect the Company's business. There can also be no assurance
that the Company's software suppliers are correct in their assertions that the
software is Year 2000 compliant. Should either the Company's internal systems or
the internal systems of any of the more significant suppliers or customers fail
to achieve Year 2000 compliance, the Company's business and its results of
operations could be adversely affected. The Company has reviewed all of its key
systems and has satisfied itself that it has identified substantially any
potential problems and has either corrected or is in the midst of replacing
them. As of December 31, 1998, the Company's Year 2000 remediation efforts were
approximately 60% completed. The Company expects to complete the remediation by
the end of the second quarter of 1999.
Tower believes that it has or will have addressed all Year 2000 issues
before the end of 1999; however, there can be no assurance that Tower will
achieve Year 2000 compliance as scheduled.
SUMMARY QUARTERLY FINANCIAL DATA
The following table sets forth certain unaudited quarterly financial
information for the Company for the years ended December 31, 1997 and 1998. This
information should be read in conjunction with the financial statements of the
Company and the notes thereto.
<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>
1997 1998
<CAPTION>
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Sales............................................. $10,040 $10,141 $ 9,363 $10,452 $11,717 $ 9,734 $ 8,151 $ 7,893
Cost of sales..................................... 10,289 7,756 6,852 7,540 9,199 7,407 6,451 6,118
------- ------- ------- ------- ------- ------- ------- -------
Gross profit (loss)............................. (249) 2,385 2,511 2,912 2,518 2,327 1,700 1,775
R&D, net.......................................... 338 323 364 310 342 416 496 351
SG&A.............................................. 4,391 4,789 4,574 5,105 4,889 2,867 2,825 3,722
------- ------- ------- ------- ------- ------- ------- -------
Operating loss.................................. (4,978) (2,727) (2,427) (2,503) (2,713) (956) (1,621) (2,298)
Financial income (expenses), net.................. 108 277 75 (207) (31) (10) (30) (142)
Gain on sale of division.......................... -- -- -- -- -- 5,998 -- --
Loss accrual for bank guarantees.................. -- -- -- -- -- -- (1,135) --
Unrealized loss from writedown of investment...... -- -- -- -- -- -- -- (6,103)
Other income (loss), net.......................... 2 21 32 (166) 45 (427) (609) 102
------- ------- ------- ------- ------- ------- ------- -------
Income (loss) before income taxes............... (4,868) (2,429) (2,320) (2,876) (2,699) 4,605 (3,395) (8,441)
Income tax expense (benefit)...................... 484 49 (7) 2,981 31 42 (41) 3
------- ------- ------- ------- ------- ------- ------- -------
Income (loss) after income taxes................ (5,352) (2,478) (2,313) (5,857) (2,730) 4,563 (3,354) (8,444)
Minority interests................................ 245 108 37 286 175 220 184 350
Equity (loss) in affiliates....................... 1,041 1,375 873 1,591 (349) (1,247) (1,336) (976)
------- ------- ------- ------- ------- ------- ------- -------
Net income (loss)............................... $(4,066) $ (995) $(1,403) $(3,980) $(2,904) $ 3,536 $(4,506) $(9,070)
------- ------- ------- ------- ------- ------- ------- -------
------- ------- ------- ------- ------- ------- ------- -------
Earnings (loss) per share......................... $ (0.55) $ (0.14) $ (0.19) $ (0.54) $ (0.39) $ 0.48 $ (0.62) $ (1.23)
------- ------- ------- ------- ------- ------- ------- -------
------- ------- ------- ------- ------- ------- ------- -------
Weighted average number of shares outstanding..... 7,369 7,369 7,369 7,369 7,369 7,376 7,310 7,402
------- ------- ------- ------- ------- ------- ------- -------
------- ------- ------- ------- ------- ------- ------- -------
</TABLE>
21
<PAGE>
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
GENERAL
The Company is required to make certain disclosures in respect to its
financial instruments, including derivatives, if any.
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. The disclosures below
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.
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).
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. The Company
does not hold or issue derivative financial instruments for trading purposes.
FOREIGN EXCHANGE TRANSACTIONS
Losses recognized on Tower's forward exchange transactions amounted to $3.6
million for 1996. Of this amount, $3 million was capitalized to property and
equipment; and the remaining amount of $596,000 was reflected in financing
expenses. No such transactions are reflected for 1997 and 1998.
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 $335,000 as of December 31, 1998) was not
practicable, although the Company believes that the estimated fair value of such
financial instruments was not materially different from their book value.
The market value of the Company's investment in Tower as of December 31,
1998 was approximately $30.9 million, significantly below the carrying value of
the equity investment as of December 31, 1998 of $37 million (after minority
interest). Although the Company has no current intentions to dispose of its
investment in Tower, the Company has recorded a writedown to market value of
$6.1 million at December 31, 1998 with respect to its Tower investment, since
the decline in market price has been determined to be other than temporary.
Subsequent to December 31, 1998, the Tower market price continued to decline.
Marketable equity securities consist solely of approximately 3,000,000
shares (approximately 4% ownership) of the Mofet Fund. For the year ended
December 31, 1997, the ownership of the Mofet Fund shares was presented as a
long-term cost investment and, for the year ended December 31, 1998, this
ownership has been presented at fair market value to reflect the Company's
intention to dispose of the shares in 1999. At December 31, 1998, the market
value of the Mofet Fund shares exceeded their cost investment by approximately
$110,000.
22
<PAGE>
CONCENTRATIONS OF CREDIT RISK
The Company is subject to credit risk through its trade receivables. As of
December 31, 1998, 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. Approximately 20% of the trade accounts receivable were due from
a U.S. customer that continues to pay its trade receivables over usual credit
periods. The remaining balance consists primarily of receivables from various
customers.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Furnished at the end of this Report commencing on page F-1. Consolidated
Financial Statements of Tower Semiconductor Ltd. are included commencing at page
F-31 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.
23
<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information relating to each director and nominee for director of the
Company and the information relating to the Company's executive officers,
appearing under the captions "Election of Directors -- Certain Information
Regarding Directors and Executive Officers" in the Company's definitive proxy
statement for the 1999 Annual Meeting of Stockholders to be filed on or before
May 1, 1999 (the "1999 Proxy Statement") is hereby incorporated by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information relating to compensation of directors and executive officers
appearing under the caption "Election of Directors--Directors' Remuneration",
"Election of Directors -- Employment Arrangements--Executive Compensation" in
the 1999 Proxy Statement is hereby incorporated by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information relating to security ownership appearing under the caption
"Stock Ownership" in the 1999 Proxy Statement is hereby incorporated by
reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information relating to certain relationships and transactions appearing
under the caption "Certain Transactions" in the 1999 Proxy Statement is hereby
incorporated by reference.
24
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(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
herein 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 (incorporated herein by reference to Exhibit 10.1 to the Company's
Annual Report on Form 10-K for the year ended December 31, 1997 (the "1997 10-K").
*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 Agreement between the Registrant and Shmuel Fogel, dated December 23, 1998.
10.4 Agreement between the Registrant and Shmuel Fogel, dated December 24, 1998.
*10.5 1991 Stock Option Plan (incorporated herein by reference to Exhibit 10.4 to the 1992
Registration Statement).
*10.6 1994 Stock Incentive Plan, as amended (incorporated herein by reference to Exhibit
10.4 to the 1995 10-K).
*10.7 1994 Stock Option Plan for Outside Directors, as amended (incorporated herein by
reference to Exhibit 10.5 to the 1995 10-K).
10.8 1995 Stock Option Plan for Nonmanagement Employees (incorporated herein by reference
to Exhibit 10.6 to the 1995 10-K).
10.9 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 Tower's Registration Statement
on Form S-1 (File No. 33-83126) (the "First Tower Registration Statement").
10.10 Agreement between the Registrant and Tower dated January 18, 1994 (incorporated
herein by reference to Exhibit 10.21 to the First Tower Registration Statement).
</TABLE>
25
<PAGE>
<TABLE>
<C> <S>
10.11 Agreement between the Registrant and Tower, dated June 12, 1995 (incorporated herein
by reference to Exhibit 10.22 to Tower's Registration Statement on Form F-1 (File
No. 33-93434)).
10.12 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 Registrant's Annual Report on Form 10-K for the
year ended December 31, 1996 (the "1996 10-K")).
10.13 Letter Agreement between Geotek Communications, Inc. and the Registrant dated
February 26, 1998 (incorporated herein by reference to Exhibit 10.32 of the 1997
10-K).
10.14 Letter Agreement between Geotek Communications, Inc. and the Registrant dated April
23, 1998.
10.15 Installment Promissory Note among the Registrant, Databit Inc., and Bank Leumi Trust
Company dated February 9, 1998 (incorporated herein by reference to Exhibit 10.33 to
the 1997 10-K).
10.16 Security Agreement between the Registrant and Bank Leumi Trust Company (incorporated
herein by reference to Exhibit 10.34 to the 1997 10-K).
10.17 Security Agreement between Databit Inc. and Bank Leumi Trust Company (incorporate
herein by reference to Exhibit 10.35 to the 1997 10-K).
10.18 Promissory Note among the Registrant, Databit Inc., and Bank Leumi USA dated March
24, 1998.
10.19 Promissory Note between George Morgenstern and the Registrant, dated as of December
31, 1997 (incorporated herein by reference to Exhibit 10.36 to the 1997 10-K).
10.20 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).
10.21 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).
*10.22 Employment Agreement between the Registrant and Yacov Kaufman, dated as of January
1, 1999.
10.23 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 (incorporated herein by reference to the 1997 10-K) .
</TABLE>
- ------------------------
* This exhibit includes a management contract, compensatory plan or
arrangement in which one or more directors or executive officers of the
Company participate.
(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
1998.
26
<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 report to be signed on
its behalf by the undersigned, thereunto duly authorized, in the Township of
Mahwah, State of New Jersey, on March 22, 1999.
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 March 22, 1999
George Morgenstern Director
/s/ ROBERT L. KUHN Vice Chairman and Director
- ------------------------------ March 22, 1999
Robert L. Kuhn
Vice President, Chief
/s/ YACOV KAUFMAN Financial Officer
- ------------------------------ (Principal Financial March 22, 1999
Yacov Kaufman Officer and Principal
Accounting Officer)
/s/ HARVEY EISENBERGER Director
- ------------------------------ March 22, 1999
Harvey Eisenberger
/s/ ALLEN I. SCHIFF Director
- ------------------------------ March 22, 1999
Allen I. Schiff
/s/ MAXWELL M. RABB Director
- ------------------------------ March 22, 1999
Maxwell M. Rabb
/s/ SUSAN MALLEY Director
- ------------------------------ March 22, 1999
Susan Malley
/s/ SHELDON KRAUSE Secretary and Director
- ------------------------------ March 22, 1999
Sheldon Krause
<PAGE>
DATA SYSTEMS & SOFTWARE INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<S> <C>
CONSOLIDATED FINANCIAL STATEMENTS OF DATA SYSTEMS & SOFTWARE INC.:
Report of Deloitte & Touche LLP...................................................... F-1
Report of Igal Brightman & Co........................................................ F-2
Consolidated Balance Sheets as of December 31, 1997 and December 31, 1998............ F-3
Consolidated Statements of Operations and Comprehensive Loss for the years ended
December 31, 1996, December 31, 1997 and December 31, 1998......................... F-4
Consolidated Statements of Changes in Shareholders' Equity for the years ended
December 31, 1996, December 31, 1997 and December 31, 1998......................... F-5
Consolidated Statements of Cash Flows for the years ended December 31, 1996, December
31, 1997 and December 31, 1998..................................................... F-6
Notes to Consolidated Financial Statements........................................... F-8
CONSOLIDATED FINANCIAL STATEMENTS OF TOWER SEMICONDUCTOR LTD.:
Auditors' Report..................................................................... F-31
Consolidated Balance Sheets as of December 31, 1998 and December 31, 1997............ F-32
Consolidated Statements of Operations for the years ended December 31, 1998, December
31, 1997 and December 31, 1996..................................................... F-33
Consolidated Statements of Changes in Shareholders' Equity for the years ended
December 31, 1998, December 31, 1997 and December 31, 1996......................... F-34
Consolidated Statements of Cash Flows for the years ended December 31, 1998, December
31, 1997 and December 31, 1996..................................................... F-35
Notes to Consolidated Financial Statements........................................... F-36
</TABLE>
<PAGE>
INDEPENDENT AUDITORS' REPORT
TO THE BOARD OF DIRECTORS AND SHAREHOLDERS OF
DATA SYSTEMS & SOFTWARE INC.
We have audited the accompanying consolidated balance sheets of Data Systems
& Software Inc. (the "Company") and its subsidiaries as of December 31, 1998 and
1997 and the related consolidated statements of operations and comprehensive
loss, changes in shareholders' equity and cash flows for the years ended
December 31, 1998 and 1997. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with 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
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
the Company and its subsidiaries as of December 31, 1998 and 1997, and the
results of their operations, changes in shareholders' equity and cash flows for
the years ended December 31, 1998 and 1997, in conformity with generally
accepted accounting principles.
Deloitte & Touche LLP
New York, New York
March 16, 1999
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 statement of operations and
comprehensive loss of Data Systems & Software Inc. (the "Company") and its
subsidiaries and the related consolidated statements of changes in shareholders'
equity and cash flows for the year ended December 31, 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 audit.
We conducted our audit 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 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 results of the Company's and its
subsidiaries' operations, changes in shareholders' equity and cash flows for the
year ended December 31, 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.
IGAL BRIGHTMAN & CO.
Certified Public Accountants (Isr.)
Tel Aviv, Israel
March 31, 1997
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>
1997 1998
--------- ---------
ASSETS
Current assets:
Cash and cash equivalents................................................................... $ 1,424 $ 1,003
Short-term interest bearing bank deposits................................................... 73 1,252
Marketable debt securities (Note 3)......................................................... 1,600 --
Marketable equity securities, available for sale (Note 3)................................... -- 1,383
Restricted cash (Note 11)................................................................... 1,786 752
Trade accounts receivable, net (Note 19e)................................................... 9,003 7,244
Inventory (Note 4).......................................................................... 377 704
Note receivable (Note 5).................................................................... 2,248 --
Other current assets (Note 6)............................................................... 1,173 960
--------- ---------
Total current assets...................................................................... 17,684 13,298
--------- ---------
Investments (Note 7).......................................................................... 70,695 56,490
--------- ---------
Property and equipment, net (Note 8).......................................................... 2,181 1,738
--------- ---------
Other assets:
Goodwill and organization costs, net........................................................ 313 190
License, net (Note 10)...................................................................... 25 471
Other....................................................................................... 1,468 1,057
--------- ---------
1,806 1,718
--------- ---------
Total assets.............................................................................. $ 92,366 $ 73,244
--------- ---------
--------- ---------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Short-term debt (Note 11)................................................................... $ 2,581 $ 470
Current maturities of long-term debt (Note 12).............................................. 1,128 504
Trade accounts payable...................................................................... 2,606 2,105
Accrued payroll, payroll taxes and social benefits.......................................... 2,464 2,561
Other current liabilities................................................................... 1,704 1,939
--------- ---------
Total current liabilities................................................................. 10,483 7,579
--------- ---------
Long-term liabilities:
Long-term debt, net of current maturities (Note 12)......................................... 248 102
Other (Note 13)............................................................................. 233 585
--------- ---------
Total long-term liabilities............................................................... 481 687
--------- ---------
Commitments and contingencies (Note 14)
Minority interests............................................................................ 29,094 25,560
--------- ---------
Shareholders' equity (Note 15):
Common stock--$.01 par value per share:
Authorized 20,000,000 shares; issued and outstanding--7,708,540
and 7,923,540 shares at December 31, 1997 and 1998, respectively.......................... 77 79
Additional paid-in capital.................................................................. 34,193 34,979
Deferred compensation expense............................................................... -- (327)
Retained earnings........................................................................... 19,886 6,942
--------- ---------
54,151 41,673
Treasury stock, at cost--339,362 and 490,262 shares at December 31, 1997
and 1998, respectively...................................................................... (1,848) (2,365)
Accumulated other comprehensive income (Note 3)............................................. -- 110
--------- ---------
Total shareholders' equity................................................................ 52,308 39,418
--------- ---------
Total liabilities and shareholders' equity................................................ $ 92,366 $ 73,244
--------- ---------
--------- ---------
</TABLE>
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 AND COMPREHENSIVE LOSS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------
<S> <C> <C> <C>
1996 1997* 1998*
---------- ---------- ----------
Sales:
Products.................................................................... $ 113,235 $ 19,950 $ 18,062
Services.................................................................... 18,520 20,046 19,433
---------- ---------- ----------
131,755 39,996 37,495
---------- ---------- ----------
Cost of sales:
Products.................................................................... 87,706 16,744 14,306
Services.................................................................... 14,388 15,693 14,869
---------- ---------- ----------
102,094 32,437 29,175
---------- ---------- ----------
Gross profit.............................................................. 29,661 7,559 8,320
---------- ---------- ----------
Research and development expenses, net........................................ 5,611 1,335 1,605
Selling, general and administrative expenses.................................. 18,635 18,859 14,303
---------- ---------- ----------
Operating income (loss)................................................... 5,415 (12,635) (7,588)
Interest income............................................................... 5,321 478 147
Interest expense.............................................................. (2,218) (225) (360)
Gain on sale of division (Note 17)............................................ -- -- 5,998
Loss from contingent performance of bank guarantees for affiliate (Note 7c)... -- -- (1,135)
Unrealized loss from writedown of investment (Note 7b)........................ -- -- (6,103)
Other income (loss), net...................................................... 609 (111) (889)
---------- ---------- ----------
Income (loss) before income taxes......................................... 9,127 (12,493) (9,930)
Provision for income taxes (Note 18).......................................... 2,141 3,507 35
---------- ---------- ----------
Income (loss) after income taxes.......................................... 6,986 (16,000) (9,965)
Minority interests............................................................ (7,699) 676 929
Equity income (loss) in affiliates, net of minority interests................. (1,767) 4,880 (3,908)
---------- ---------- ----------
Net loss.................................................................. $ (2,480) $ (10,444) $ (12,944)
---------- ---------- ----------
---------- ---------- ----------
Other comprehensive income:
Unrealized gain on securities available for sale (Note 3)................... -- -- 110
---------- ---------- ----------
Comprehensive loss........................................................ $ (2,480) $ (10,444) $ (12,834)
---------- ---------- ----------
---------- ---------- ----------
Basic net loss per share...................................................... $ (0.34) $ (1.42) $ (1.75)
---------- ---------- ----------
---------- ---------- ----------
Weighted average number of shares outstanding (in thousands).................. 7,369 7,369 7,391
---------- ---------- ----------
---------- ---------- ----------
Diluted net loss per share.................................................... $ (0.34) $ (1.42) $ (1.75)
---------- ---------- ----------
---------- ---------- ----------
Weighted average number of shares outstanding and common share equivalents (in
thousands).................................................................. 7,369 7,369 7,391
---------- ---------- ----------
---------- ---------- ----------
</TABLE>
- ------------------------
* The statements of operations for the years ended December 31, 1997 and 1998
reflect the results of Tower Semiconductor Ltd. on the equity method, while
the statement of operations for the year ended December 31, 1996 reflects
the results of Tower Semiconductor Ltd. 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 STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
(IN THOUSANDS)
<TABLE>
<CAPTION>
ACCUMULATED
ADDITIONAL OTHER
NUMBER COMMON PAID-IN DEFERRED TREASURY RETAINED COMPREHENSIVE
OF SHARES STOCK CAPITAL COMPENSATION STOCK EARNINGS INCOME TOTAL
------------- ----------- ----------- ------------- --------- --------- -------------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balances, January 1,
1996................... 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............... -- -- -- -- -- (2,480) -- (2,480)
------ ----------- ----------- ------------- --------- --------- -------------- ---------
Balances, December 31,
1996................... 7,709 77 33,997 -- (1,848) 30,330 -- 62,556
Amortization of
restricted stock
award compensation... -- -- 196 -- -- -- -- 196
Net loss............... -- -- -- -- -- (10,444) -- (10,444)
------ ----------- ----------- ------------- --------- --------- -------------- ---------
Balances, December 31,
1997................... 7,709 77 34,193 -- (1,848) 19,886 -- 52,308
Common stock issued
upon exercise of
options.............. 10 -- 55 -- -- -- -- 55
Common stock issued as
compensation......... 50 1 100 -- -- -- -- 101
Common stock issued in
restricted stock
award................ 155 1 435 -- -- -- -- 436
Unamortized restricted
stock award
compensation......... -- -- -- (436) -- -- -- (436)
Purchase of treasury
stock................ -- -- -- -- (517) -- -- (517)
Amortization of
restricted stock
award compensation... -- -- 196 109 -- -- -- 305
Unrealized gain on
securities available
for sale............. -- -- -- -- -- -- 110 110
Net loss............... -- -- -- -- -- (12,944) -- (12,944)
------ ----------- ----------- ------------- --------- --------- -------------- ---------
Balances, December 31,
1998................... 7,924 $ 79 $ 34,979 $ (327) $ (2,365) $ 6,942 $ 110 $ 39,418
------ ----------- ----------- ------------- --------- --------- -------------- ---------
------ ----------- ----------- ------------- --------- --------- -------------- ---------
</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
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
<S> <C> <C> <C>
1996 1997 1998
--------- --------- ---------
Cash flows provided by (used in) operating activities:
Net loss....................................................................... $ (2,480) $ (10,444) $ (12,944)
Adjustments to reconcile net loss to net cash provided by
(used in) operating activities-see Schedule A................................ 16,399 602 7,163
--------- --------- ---------
Net cash provided by (used in) operating activities........................ 13,919 (9,842) (5,781)
--------- --------- ---------
Cash flows provided by (used in) investing activities:
Short-term and long-term bank deposits, net.................................... (403) 363 (1,179)
Restricted cash................................................................ -- (330) 1,034
Investment in marketable securities............................................ (194,798) (33,122) (5,898)
Proceeds from realization of marketable securities............................. 243,257 37,102 7,527
Net proceeds from sale of division-see Schedule C.............................. -- -- 6,595
Acquisitions of property and equipment......................................... (51,728) (862) (929)
Proceeds from sale of property and equipment................................... 229 53 135
Acquisitions of intangible assets.............................................. -- -- (554)
Proceeds from sale of shares in a non-affiliated company....................... 80 -- --
Investments in capitalized software development costs, net..................... (830) -- --
Increase in other assets....................................................... (36) 4,291 --
Loan to affiliates............................................................. (2,785) -- --
Net effect of change in reporting method-see Schedule B........................ (11,459) 102 --
Net cash transferred on sale of subsidiaries................................... (130) -- --
--------- --------- ---------
Net cash provided by (used in) investing activities........................ (18,603) 7,597 6,731
--------- --------- ---------
Cash flows provided by (used in) financing activities:
Proceeds from exercise of option warrants of subsidiary, net................... -- (211) --
Proceeds from issuance of common stock, net.................................... 106 -- 156
Minority interest portion of subsidiary dividend distribution.................. (14,931) -- --
Purchase of treasury stock..................................................... -- -- (517)
Proceeds from sale of shares received in partial conversion
of note receivable........................................................... -- -- 1,871
Short-term debt, net........................................................... (1,625) 566 (2,064)
Proceeds from long-term debt................................................... 230 1,359 453
Repayments of long-term debt................................................... (341) (509) (1,270)
Repayment of liability in respect of customer advances......................... (2,250) -- --
--------- --------- ---------
Net cash provided by (used in) financing activities........................ (18,811) 1,205 (1,371)
--------- --------- ---------
Net decrease in cash and cash equivalents........................................ (23,495) (1,040) (421)
Cash and cash equivalents at beginning of year................................... 25,959 2,464 1,424
--------- --------- ---------
Cash and cash equivalents at end of year......................................... $ 2,464 $ 1,424 $ 1,003
--------- --------- ---------
--------- --------- ---------
Supplemental cash flow information:
Cash paid during the period for:
Interest..................................................................... $ 829 $ 183 $ 205
--------- --------- ---------
--------- --------- ---------
Income taxes................................................................. $ 2,360 $ 773 $ 195
--------- --------- ---------
--------- --------- ---------
</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>
1996 1997 1998
--------- --------- ---------
A. Adjustments to reconcile net loss to net cash provided by
(used in) operating activities:
Depreciation and amortization................................................. $ 16,829 $ 1,479 $ 1,092
Gain on sale of affiliate..................................................... (1,710) -- --
Minority interests............................................................ 7,699 687 (3,534)
Writedown of capitalized software development costs........................... -- 1,663 --
Allowance for writeoff against note receivable................................ -- -- 610
Allowance for bank guarantees for affiliate................................... -- -- 1,135
Writeoff of investment in affiliates and related receivables.................. -- -- 498
Earnings on marketable debt securities........................................ (3,330) (107) (30)
Deferred income taxes......................................................... 1,715 2,982 --
Increase in liability for severance pay....................................... 176 120 351
Loss (equity) in affiliates................................................... 1,767 (8,027) 6,568
Gain on sale of division-see Schedule C....................................... -- -- (5,998)
Gain on sale of securities.................................................... -- -- (192)
Unrealized loss from writedown of investment.................................. -- -- 6,103
Loss (gain) on sale of property, plant and equipment, net..................... 55 (15) (37)
Amortization of restricted stock award compensation........................... 150 196 305
Other......................................................................... (426) (348) (4)
Decrease (increase) in accounts receivable and other current assets........... 7,757 (1,327) 1,136
Decrease (increase) in inventory.............................................. (2,461) 424 (327)
Decrease (increase) in long-term receivables.................................. (163) (165) 227
Increase (decrease) in accounts payable and other current liabilities......... (10,219) 3,040 (809)
Increase (decrease) in liability in respect of customer advances, net......... (1,440) -- 69
--------- --------- ---------
$ 16,399 $ 602 $ 7,163
--------- --------- ---------
--------- --------- ---------
B. Net effect of change in reporting method-see Note 2 for Year 1996 and Note 7c
for Year 1997:
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. Assets/liabilities transferred upon sale of division (Note 17):
Trade accounts receivable, net................................................ $ 754
Property and equipment, net................................................... 405
Accrued payroll, payroll taxes and social benefits............................ (111)
Other current liabilities..................................................... (452)
---------
$ 596
---------
---------
D. Non-cash activities:
Notes received upon sale of subsidiary........................................ $ 589 -- --
--------- --------- ---------
--------- --------- ---------
Note received upon sale of affiliate.......................................... $ 2,000 -- --
--------- --------- ---------
--------- --------- ---------
Receipt of capital stock in partial conversion of note receivable (Note 5).... -- -- $ 1,871
--------- --------- ---------
--------- --------- ---------
Unrealized gain on securities available for sale (Note 3)..................... -- -- $ 110
--------- --------- ---------
--------- --------- ---------
</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 (collectively, the "Company"), (i) provides consulting and
development services for computer software and systems, (ii) is an authorized
dealer and a value-added-reseller of computer hardware, (iii) is a provider of
data communications solutions for utilities and (iv) through an equity
affiliate, engages in the manufacture of semiconductor products. DSSI's 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 requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and the
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.
RECLASSIFICATIONS
Certain prior period amounts included in the consolidated statements of
operations have been reclassified to conform to the 1998 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 that the Company has the positive intent and
ability to hold to maturity are reflected at amortized cost, which approximates
market value. Marketable equity securities which are available for sale are
reflected at market value, and the amount of market value in excess of cost is
reflected in shareholders' equity, in conformance with provisions of SFAS 115.
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)
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 a change in the value of the Company's
holdings in subsidiaries 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. The carrying values
of these investments are periodically reviewed to determine whether impairment
exists. See Note 7b for a description of the impairment arising with respect to
the Company's investment in Tower Semiconductor Ltd. ("Tower"), a manufacturer
of semiconductor products.
PROPERTY AND EQUIPMENT
Property and equipment are presented at cost. Depreciation is calculated
based on the straight-line method over periods ranging from three to 10 years.
COMPUTER SOFTWARE DEVELOPMENT COSTS
Computer software development costs 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
on the earlier of general release to customers or the receipt of revenues from
the product, 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 the software product (primarily three years).
Capitalized software development costs that exceed their net realizable value at
each balance sheet date, as determined by management, are written off.
GOODWILL
Goodwill 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 $221, $288 and
$120 during the years ended December 31, 1996, 1997 and 1998, respectively.
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)
LICENSE
The costs of a technology license, including professional fees related
thereto, are presented at estimated fair market value at acquisition date. These
costs are amortized on a straight-line basis over the five-year term of the
license. Amortization expense related to this license amounted to $112 in 1998,
the first year of the term of the license.
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. Percentage-of-completion
estimates are reviewed periodically, 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.
RESEARCH AND DEVELOPMENT EXPENSES
Research and development ("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 15a 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 $438 and $86, at December 31, 1997 and 1998, respectively.
Bad debt expense related to trade accounts receivable was $95, $8 and $37 for
the years ended December 31, 1996, 1997 and 1998, respectively. Of the change in
the allowance for doubtful accounts during 1998, $315 was attributable to the
sale of a division of the Company (see Note 17).
FOREIGN EXCHANGE AGREEMENTS
The Company (through Tower in 1996-see Note 2) 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.
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)
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 carrying value of long-lived assets is periodically reviewed to
determine whether impairment exists. In accordance with 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," long-lived
assets are segregated and stated at the lower of the expected net realizable
value or cost. The review is based on comparing the carrying amount of the
assets to the undiscounted estimated cash flows over the remaining useful lives.
If the sum of the expected undiscounted future cash flows is less than the
carrying amount of the assets, the Company would recognize an impairment loss.
The impairment loss, if determined to be necessary, would be measured as the
amount by which the carrying amount of the asset exceeds the fair value of the
asset. The Company determined that, as of December 31, 1997 and 1998, there had
been no impairment in the carrying value of the long-lived assets.
BASIC AND DILUTED NET INCOME (LOSS) PER SHARE
The Company has adopted the provisions of SFAS No. 128 "Earnings Per Share,"
which establishes standards for computing and presenting net income (loss) per
share. SFAS No. 128 prescribes 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 would result from
the exercise of stock options.
The following is a reconciliation of the weighted average shares used in the
computation of basic and dilutive net loss per share: (000's)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER31,
-------------------------------
<S> <C> <C> <C>
1996 1997 1998
--------- --------- ---------
Weighted average number of common shares outstanding used for basic
net loss per share................................................. 7,340 7,369 7,391
Dilutive stock options............................................... -- -- --
--------- --------- ---------
Weighted average number of common shares outstanding used for
dilutive net loss per share........................................ 7,340 7,369 7,391
--------- --------- ---------
--------- --------- ---------
</TABLE>
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)
No stock options were included in the computations above, as doing so would
have been anti-dilutive. The number of stock options and warrants that could
potentially dilute basic net loss per share in the future that were not included
in the table above in years ended December 31, 1996, 1997 and 1998 were 2,022,
1,911 and 1,749, respectively.
COMPREHENSIVE LOSS
During 1998, the Company adopted SFAS No. 130 "Reporting Comprehensive
Income." Comprehensive income includes both net income and other comprehensive
income. The Company's accumulated other comprehensive income consisted of an
unrealized gain on an available for sale investment. Since this standard applies
only to the presentation of comprehensive income, it does not have any effect of
the Company's financial position, results of operations, or cash flows. Prior
year financial information has been presented to conform with SFAS 130
requirements.
EFFECTS OF RECENTLY ISSUED ACCOUNTING STANDARDS
In June, 1998, the FASB issued SFAS No. 133 "Accounting for Derivative
Instruments and Hedging Activities." SFAS 133 establishes accounting and
reporting standards for derivative instruments and for hedging activities,
requiring the recognition of all derivatives as either assets or liabilities and
to measure those instruments at fair value, as well as to identify the
conditions for which a derivative may be specifically designed as a hedge. SFAS
133 is effective for fiscal years beginning after June 15, 1999. Management is
currently addressing the financial reporting measures that will be needed in
order to comply with this disclosure.
NOTE 2-INVESTMENT IN TOWER
From the time of the organization of Tower in 1993 through December 1996,
DSSI maintained voting control of more than 50% of Tower's shares, through
DSSI's ownership of 60% of the shares of, and resulting control of, Tower
Semiconductor Holdings 1993 Ltd. ("Tower Holdings"), and through a voting
agreement with another shareholder. Tower Holdings owned 41.0%, 41.0% and 44.8%
of Tower at December 31, 1996, 1997 and 1998, respectively. 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. The consolidated statements of operations
reflect Tower's revenues and expenses on a fully consolidated basis for the year
ended December 31, 1996. As the Company's consolidated statements of operations
for the years ended December 31, 1997 and December 31, 1998 do not include
amounts related to Tower, the Company's 1996, 1997 and 1998 statements of
operations are not directly comparable. See Note 7b for summary financial
information of Tower.
NOTE 3-MARKETABLE SECURITIES
Marketable debt securities consist primarily of United States Treasury Bills
at yields to maturity ranging from 4.9% to 5.1%. The balances approximate market
value. At December 31, 1998, all of the Company's marketable debt securities had
matured.
F-12
<PAGE>
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 3-MARKETABLE SECURITIES (CONTINUED)
Marketable equity securities consist solely of approximately 3,000,000
shares (approximately 4% ownership) of Mofet Israel Technology Fund, Ltd.
("Mofet Fund"), a public venture capital fund whose shares are traded on the Tel
Aviv Stock Exchange. For the year ended December 31, 1997, the investment in the
Mofet Fund was presented as a long-term investment using the cost method, and,
for the year ended December 31, 1998, this investment has been presented at fair
market value to reflect the Company's intention to dispose of the shares in
1999. At December 31, 1998, the market value of the Mofet Fund shares exceeded
their cost investment by approximately $110.
NOTE 4-INVENTORY
Inventory consists of the following:
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
--------------------
<S> <C> <C>
1997 1998
--------- ---------
Raw materials, spare parts and supplies................................... $ -- $ 250
Work in process........................................................... 33 7
Finished goods and merchandise............................................ 344 447
--------- ---------
$ 377 $ 704
--------- ---------
--------- ---------
</TABLE>
NOTE 5-NOTE RECEIVABLE
In 1996, the Company sold its interest in a joint venture to its joint
venture partner in exchange for a $2,000 unsecured note, bearing annual interest
of 8.25%, payable July 1, 1998. In February 1998, the Company signed an
agreement with the maker of the note ("the maker"), modifying the note to permit
its conversion into shares of publicly traded common stock of the maker. In
April 1998, the maker issued to the Company 3,000,000 such shares, which, based
on its agreement with the maker, represented payment of approximately $1,700 of
the approximately $2,300 principal of and accrued interest on the note. The
Company subsequently sold these shares for approximately $1,900. In June 1998,
the maker filed for protection under Chapter 11 of the Bankruptcy Act, and the
Company therefore established a reserve for doubtful debts equal to the
remaining balance of approximately $610 that remains outstanding on the note.
The doubtful debt expense resulting from this allowance, partially offset by a
gain of $192 from the sale of the shares, is included in other income (loss),
net for the year ended December 31, 1998.
F-13
<PAGE>
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 6-OTHER CURRENT ASSETS
Other current assets consist of the following:
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
--------------------
<S> <C> <C>
1997 1998
--------- ---------
Prepaid expenses.......................................................... $ 481 $ 304
Employees................................................................. 115 156
Receivable from Israeli government........................................ 20 22
Foreign income tax receivable (Israel).................................... 347 --
Other..................................................................... 210 478
--------- ---------
$ 1,173 $ 960
--------- ---------
--------- ---------
</TABLE>
NOTE 7-INVESTMENTS
(A) COMPOSITION
Investments consist of the following:
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
--------------------
<S> <C> <C>
1997 1998
--------- ---------
Investment in Tower (see (b) below)..................................... $ 68,630 $ 56,155
Other investments (see (c) below)....................................... 2,065 335
--------- ---------
$ 70,695 $ 56,490
--------- ---------
--------- ---------
Minority interests in Tower............................................. $ 27,930 $ 25,266
--------- ---------
--------- ---------
</TABLE>
(B) INVESTMENT IN TOWER
Set forth below is condensed financial information of Tower:
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
---------------------
<S> <C> <C>
1997 1998
---------- ---------
Current assets......................................................... $ 115,738 $ 85,285
Property and equipment................................................. 99,216 88,429
Current liabilities.................................................... 24,813 19,248
Long-term debt......................................................... 12,117 12,127
Other long-term liabilities............................................ 13,753 5,347
Shareholders' equity................................................... 166,881 143,325
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------
<S> <C> <C> <C>
1996 1997 1998
--------- ---------- ---------
Sales....................................................... $ 97,885 $ 125,917 $ 69,637
Operating income (loss)..................................... 9,652 20,140 (23,998)
Net income (loss)........................................... 10,014 19,171 (15,544)
</TABLE>
F-14
<PAGE>
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 7-INVESTMENTS (CONTINUED)
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, 1998 was approximately $30,889,
significantly below the carrying value of the equity investment as of December
31, 1988 of $36,992 (after minority interest). Although the Company has no
current intention to dispose of its investment in Tower, the Company has
recorded a writedown to market value of $6,103 at December 31, 1998 with respect
to its Tower investment, since the decline in market price has been determined
to be other than temporary. The Tower market price continued to decline
subsequent to December 31, 1998.
(C) OTHER INVESTMENTS
In 1995, the Company established a joint venture for the development and
production of multimedia entertainment software, in which the Company owned a
50% interest. In 1997, the Company purchased the other 50% interest in the joint
venture, and, accordingly, the Company has consolidated this activity since
1997. In 1998, the Company suspended all development and marketing related to
this activity.
The Company owns approximately 4% of the Mofet Fund and 50% of the Mofet
Fund's management company. The Company's investment in the Mofet Fund, which was
accounted for on the cost method at December 31, 1997, amounted to $1,273 at
December 31, 1997. At December 31, 1998, the investment is treated as available
for sale (see Note 3). The Company's investment in the management company, which
is accounted for on the equity method, amounted to $295 and $98 at December 31,
1997 and 1998, respectively. The management contract of the management company
will terminate on January 5, 2000. The Company recorded a $50 writedown against
this investment in 1998 in order to reflect the carrying value of the investment
at the amount of its estimated cash flows through the termination of the
management contract.
The Company owns approximately 15% of the outstanding common stock of an
Israeli manufacturer of real-time meteorological systems. The Company's
investment in this manufacturer at December 31, 1997 was $23. Due to this
investment's recent financial difficulties, the Company wrote off this
investment in 1998. See Note 11 concerning the accrual of loss contingencies
with respect to this investment.
The Company owns approximately 17% of the outstanding common stock of a
privately-held Beijing-based software consulting and development company. The
Company accounts for its investment on a cost basis, which amounted to $237 at
December 31, 1997 and 1998.
F-15
<PAGE>
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 8-PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
<TABLE>
<CAPTION>
ESTIMATED USEFUL AS OF DECEMBER 31,
LIFE --------------------
(IN YEARS) 1997 1998
------------------- --------- ---------
<S> <C> <C> <C>
Cost:
Computer equipment................................. 3-5 $ 1,963 $ 2,392
Office furniture and equipment..................... 4-10 1,841 1,477
Motor vehicles..................................... 7 1,107 766
Leasehold improvements............................. Term of Lease 197 220
--------- ---------
5,108 4,855
--------- ---------
Accumulated depreciation and amortization:
Computer equipment................................. 1,375 1,647
Office furniture and equipment..................... 478 940
Motor vehicles..................................... 952 360
Leasehold improvements............................. 122 170
--------- ---------
2,927 3,117
--------- ---------
Property and equipment, net........................ $ 2,181 $ 1,738
--------- ---------
--------- ---------
</TABLE>
Depreciation and amortization in respect of property and equipment amounted
to $16,019, $886 and $867 for 1996, 1997 and 1998, respectively.
NOTE 9-CAPITALIZED SOFTWARE DEVELOPMENT COSTS, NET
Capitalized software development costs consist of the following:
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
--------------------
1997 1998
--------- ---------
<S> <C> <C>
Capitalized software development costs.................................... $ 2,909 $ --
Less: Accumulated amortization............................................ (1,246) --
Accumulated writedowns to net realizable value...................... (1,663) --
--------- ---------
$ 0 $ --
--------- ---------
--------- ---------
</TABLE>
Based on management's determination in 1997 that certain capitalized
software costs exceeded their net realizable value, capitalized software costs
relating to certain sub-systems in development projects were written-down. The
writedowns were included in cost of sales for capitalized software for which
amortization had already commenced and in research and development expenses for
capitalized software which had not yet been released to customers and had not
yet generated revenues. The writedowns amounted to $0, $1,663 and $0 for the
years ended December 31, 1996, 1997 and 1998, respectively. Amortization of
capitalized software amounted to $578, $305 and $0 during the years ended
December 31, 1996, 1997 and 1998, respectively.
F-16
<PAGE>
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 10-LICENSE
In January 1998, the Company acquired certain assets and licensed
intellectual property for use in its data communications solutions for utilities
segment. The acquisition was accounted for by the purchase method of accounting
and, accordingly, the purchase price of $1,353 (including professional fees and
value of common stock given related thereto) was allocated to the assets
acquired (primarily fixed assets, inventory and an exclusive license) based on
their estimated fair value at the date of acquisition. Of the purchase price,
$578 was allocated to the license agreement and is being amortized over the
five-year period of this agreement.
NOTE 11-SHORT-TERM DEBT
Short-term debt at December 31, 1997 included $1,456 received from investors
as financing for future projects of the Company. In January, 1998 this amount
was repaid in full. The debt was secured by a bank deposit, which was classified
as restricted cash and which bore interest of approximately 4% per annum. The
Company undertook a direct guarantee, by means of a deposit (classified as
restricted cash), of approximately $330 and $752 in the years ended December 31,
1997 and 1998, respectively, of certain bank commitments arising out of the
operating activities of an Israeli affiliate, a former subsidiary of the
Company, the total of such commitments being approximately $1,135. The Company
has accrued as of December 31, 1998 loss contingencies of approximately $1,390
in connection with these guarantees and with the writeoff of related
receivables. In February 1999, the Company was required to perform under
approximately $422 of these guarantees.
All lines of credit with Israeli banks were being fully utilized as of
December 31, 1998. Unused lines of credit with U.S. banks as of December 31,
1998 amounted to approximately $2,000. The Company owed $180 on this line at
December 31, 1998. Substantially all of the Company's U.S. assets have been
pledged in connection with this credit line. Pursuant to this credit line, the
Company also agreed not to dispose of the Company's investment in Tower.
NOTE 12-LONG-TERM DEBT
Long-term debt consists of the following:
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
--------------------
<S> <C> <C>
1997 1998
--------- ---------
Debt to Israeli banks and lease companies, bearing interest at 5%-10% per
annum................................................................... $ 1,376 $ 606
Less-current maturities................................................... 1,128 504
--------- ---------
$ 248 $ 102
--------- ---------
--------- ---------
</TABLE>
The long-term balance is repayable in the year 2000.
Certain assets in Israel have been pledged as collateral for long-term and
short-term bank debt amounting to approximately $800 and for guarantees.
Interest expense on short-term and long-term debt for 1996, 1997 and 1998
amounted to $734, $183 and $205, respectively.
F-17
<PAGE>
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 13-OTHER LONG-TERM LIABILITIES
Other long-term liabilities include unfunded severance pay obligations of
$233 and $585 as of December 31, 1997 and 1998, 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
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 1996, 1997 and 1998
were approximately $2,236, $949 and $1,486, respectively.
NOTE 14-COMMITMENTS AND CONTINGENCIES
(A) LEASES OF PROPERTY AND EQUIPMENT
Rental and leasing expenses for 1996, 1997 and 1998 amounted to $625, $777
and $951, respectively. Future minimum lease payments on non-cancelable
operating leases as of December 31, 1998 are as follows:
<TABLE>
<CAPTION>
YEAR ENDING
DECEMBER 31,
- -------------------------------------------------------------------------------------
<S> <C>
1999............................................................................... $ 629
2000............................................................................... 589
2001............................................................................... 126
2002............................................................................... 126
2003............................................................................... 11
---------
$ 1,481
---------
---------
</TABLE>
(B) GUARANTEES
The Company has provided bank guarantees of approximately $1,397 as security
for payment of obligations of affiliates and other companies. See Note 11
concerning the accrual of loss contingencies in connection with these
guarantees.
(C) ROYALTIES
Certain research and development programs have received 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
Company is 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.
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)
(D) LEGAL ACTIONS
Between June and September 1996, several lawsuits 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 (who is also
the Chairman of the Board of the Company) and the Company. The consolidated
complaint filed in the action 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 U.S. Federal securities laws.
In January, 1999, Tower and the other defendants in the action entered into
a stipulation settling the action for $16,275, all of which will be covered by
insurance policies covering Tower and the other defendants. Tower and the other
defendants have denied any wrongdoing in connection with the action. Tower will
incur certain costs associated with the defense of the action, which costs are
not expected to materially exceed amounts previously accrued by Tower in
connection with the action. The settlement is subject to court approval.
Tower has recently been separately approached by two parties alleging that
Tower is infringing on certain semiconductor production patents owned by such
parties and requesting that Tower enter into negotiations for a royalty-bearing
license for the use of the technology covered by such patents. Tower is
presently assessing these allegations and is engaged in discussions to determine
whether there is any merit to their claims. In addition, Tower is assessing if
and to what extent Tower may be able to seek indemnification from third parties
for all or part of any royalties or other amounts which may be paid or payable
by the Company in connection with these claims. Tower and the Company are unable
to determine at this time with any certainty the ultimate outcome of the
aforementioned matter or its effect, if any, on Tower's and the Company's
financial condition, operating results and business.
(E) EMPLOYEE RETIREMENT SAVINGS PLAN
The Company sponsors a tax deferred retirement savings plan that permits
eligible U.S. employees to contribute varying percentages of their compensation
up to the limit allowed by the Internal Revenue Service. This plan also provides
for discretionary Company contributions. No discretionary contributions were
made for the years ended December 31, 1996, 1997 and 1998.
(F) LETTERS OF CREDIT
The Company has contingent obligations for letters of credit of
approximately $134 expiring in 1999 and 2000.
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
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)
plans at market value. All options expire within five to ten years from the date
of the grant. The options generally vest over a two to three year period from
the date of grant of the option. The total authorized number of options under
the various plans is 2,000,000, and the number remaining available for issuance
is 402,350.
A summary of the status of the Company's option plans as of December 31,
1996, 1997 and 1998, as well as changes during each of the years then ended, is
presented below:
<TABLE>
<CAPTION>
1996 1997 1998
----------------------- ----------------------- -----------------------
<S> <C> <C> <C> <C> <C> <C>
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
NUMBER OF EXERCISE NUMBER OF EXERCISE NUMBER OF EXERCISE
OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE
---------- ----------- ---------- ----------- ---------- -----------
<CAPTION>
(IN (IN (IN
SHARES) SHARES) SHARES)
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning of year......... 1,361,567 $ 6.70 1,423,492 $ 6.60 1,456,067 $ 6.57
Granted.................................. 226,500 $ 5.90 53,500 $ 5.82 95,000 $ 3.49
Exercised................................ (17,875) $ 5.89 -- -- (10,000) $ 5.50
Forfeited................................ (146,700) $ 6.38 (20,925) $ 6.38 (42,350) $ 6.02
---------- ---------- ----------
Outstanding at end of year............... 1,423,492 $ 6.60 1,456,067 $ 6.57 1,498,717 $ 6.39
---------- ---------- ----------
---------- ---------- ----------
Exercisable at end of year............... 826,601 $ 6.61 1,162,816 $ 6.66 1,309,050 $ 6.64
---------- ---------- ----------
---------- ---------- ----------
</TABLE>
<TABLE>
<CAPTION>
OUTSTANDING AS OF EXERCISABLE AS OF
DECEMBER 31, 1998 DECEMBER 31, 1998
------------------------------------------------- -------------------------
<S> <C> <C> <C> <C> <C>
WEIGHTED WEIGHTED
WEIGHTED AVERAGE AVERAGE
NUMBER AVERAGE REMAINING EXERCISE NUMBER EXERCISE
RANGE OF EXERCISE PRICES OUTSTANDING CONTRACTUAL LIFE PRICE EXERCISABLE PRICE
- --------------------------------------- ----------- --------------------- ------------- ---------- -------------
<CAPTION>
(IN
(IN SHARES) (IN YEARS) SHARES)
<S> <C> <C> <C> <C> <C>
$2.44-2.94............................. 62,500 6.7 $ 2.76 -- --
$4.50-5.88............................. 270,000 3.0 $ 5.58 167,833 $ 5.65
$6.06-7.88............................. 1,136,217 3.9 $ 6.66 1,111,217 $ 6.67
$11.13................................. 30,000 6.7 $ 11.13 30,000 $ 11.13
----------- ----------
1,498,717 $ 6.39 1,309,050 $ 6.64
----------- ----------
----------- ----------
</TABLE>
The weighted average grant-date fair value of the 226,500, 53,500 and 95,000
options granted during 1996, 1997 and 1998, respectively, amounted to $3.56,
$5.24 and $1.65 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>
1996 1997 1998
---------- ---------- ----------
<S> <C> <C> <C>
Risk-free interest rate.................................. 6.30% 6.00% 5.00%
Expected life of options................................. 5.9 years 5.9 years 6.6 years
Expected annual volatility............................... 59% 47% 39%
Expected dividend yield.................................. none none none
</TABLE>
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)
Had compensation cost for the Company's option plans been determined based
on fair value at the grant dates for awards made in 1996, 1997 and 1998 under
such plans in accordance with SFAS No. 123, the Company's pro forma net loss and
loss per share would have been as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------
<S> <C> <C> <C>
1996 1997 1998
--------- ---------- ----------
Net loss-as reported........................................ $ (2,480) $ (10,444) $ (12,944)
Pro forma net loss.......................................... (3,427) (10,566) (13,010)
Basic net loss per share-as reported........................ (0.34) (1.42) (1.75)
Pro forma net loss per share................................ (0.47) (1.44) (1.77)
Diluted net loss per share-as reported...................... (0.34) (1.42) (1.75)
Pro forma diluted net loss per share........................ (0.47) (1.44) (1.77)
</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 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>
1996 1997 1998
------------------------------ ------------------------------ ------------------------------
<S> <C> <C> <C> <C> <C> <C>
WEIGHTED AVERAGE WEIGHTED AVERAGE WEIGHTED AVERAGE
NUMBER OF EXERCISE NUMBER OF EXERCISE NUMBER OF EXERCISE
OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE
----------- ----------------- ----------- ----------------- ----------- -----------------
<CAPTION>
(IN SHARES) (IN SHARES) (IN SHARES)
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning of
year......................... 433,825 $ 9.06 433,825 $ 9.06 197,500 $ 10.18
Granted........................ -- -- -- -- -- --
Exercised...................... -- -- -- -- -- --
Forfeited...................... -- -- (236,325) $ 8.13 -- --
----------- ----------- -----------
Outstanding at end of year..... 433,825 $ 9.06 197,500 $ 10.18 197,500 $ 10.18
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
(C) STOCK AWARDS
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, $196 and $196 was amortized
to compensation expense during 1996, 1997 and 1998, respectively.
In August 1998, the Company granted 155,000 shares of common stock to its
Chief Executive Officer. The shares generally vest over a two-year period,
except that the vesting of 20,000 of the shares may be
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)
delayed until additionally certain performance goals have been met. These
performance goals have not been met since the date of grant. Deferred
compensation in the aggregate amount of $436 was recorded against additional
paid-in capital at the date of grant, of which $109 was amortized to
compensation expense during 1998.
(D) STOCK REPURCHASE PROGRAM
In August 1998, the Company's Board of Directors authorized the purchase of
up to 500,000 shares of the Company's common stock. During 1998, the Company
purchased 150,630 of its own shares and now owns in the aggregate, including
shares it owned prior to the 1998 purchase authorization, 490,262 of its own
shares.
(E) 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 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 loan, bearing interest at an annual rate of 7%, to
its Chief Executive Officer. The balance of this loan, including interest, was
approximately $650 and $612, at December 31, 1997 and 1998, respectively. Such
loan is repayable in installments over a period of five years. Other assets also
include a non-interest bearing loan of $357 and $80, at December 31, 1997 and
1998, respectively, made to an executive officer of the Company, who resigned
from his position at December 31, 1998. The Company paid consulting and other
fees to directors of $85, $45 and $80 for the years ended December 31, 1996,
1997 and 1998, respectively. Sales for the year ended December 31, 1996 included
$102 to an affiliate. No sales to affiliates were made in 1997 and 1998.
Approximately $66 and $92 received from an affiliate for
F-22
<PAGE>
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 16-RELATED PARTY BALANCES AND TRANSACTIONS (CONTINUED)
expense reimbursement during the years ended December 31, 1997 and 1998 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 $450, $401 and $410 for the years ended December 31,
1996, 1997 and 1998, respectively. Approximately $117 and $66, included in other
current liabilities, was owed to this firm as of December 31, 1997 and 1998,
respectively. The Company paid the director of operations of one of its
subsidiaries, who is the son of the Company's Chief Executive Officer,
approximately $122 in 1998.
NOTE 17-GAIN ON SALE OF DIVISION
In April 1998 the Company sold certain assets and the technology related to
its help desk software segment for approximately $6,595. The Company recognized
a gain of approximately $5,998 before taxes in the second quarter of 1998 in
connection with this transaction.
NOTE 18-INCOME TAXES
(A) COMPOSITION
Income taxes consist of the following:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------
<S> <C> <C> <C>
1996 1997 1998
--------- --------- -----
Current:
Federal........................................................... $ 8 $ (4) $ --
State and local................................................... -- 161 (8)
Foreign........................................................... 418 716 52
--------- --------- ---
426 873 44
--------- --------- ---
Deferred:
Federal........................................................... (677) 1,853 --
State and local................................................... (187) 218 (9)
Foreign........................................................... 2,579 563 --
--------- --------- ---
1,715 2,634 (9)
--------- --------- ---
$ 2,141 $ 3,507 $ 35
--------- --------- ---
--------- --------- ---
</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)
(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,
-------------------------------------
1996 1997 1998
----------- ----------- -----------
<S> <C> <C> <C>
Statutory Federal rates............................................... 34% 34% 34%
Increase (decrease) in income tax rate resulting from:
Israeli operations-net impact of Israeli statutory rate and special
deduction......................................................... (10) (3) --
Non-deductible expenses............................................. 2 (1) (18)
State and local income taxes-net.................................... (4) 9 1
Net operating loss carryforward..................................... (1) -- (2)
Other............................................................... 2 (5) (1)
Increase in valuation allowance..................................... 1 (62) (14)
----- ----- -----
Effective income tax rates............................................ 24% (28)% 0%
----- ----- -----
----- ----- -----
</TABLE>
(C) ANALYSIS OF DEFERRED TAX ASSETS (LIABILITIES)
Deferred tax assets (liabilities) consist of the following:
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
--------------------
<S> <C> <C>
1997 1998
--------- ---------
Accelerated depreciation for tax purposes..................................................... $ (50) $ (14)
Intangible asset basis differences............................................................ (93) 1
Nondeductible accrued expenses................................................................ (661) 32
Net operating and capital loss carryforwards.................................................. 9,883 9,928
Foreign tax credit carryforwards.............................................................. 241 241
--------- ---------
9,320 10,188
Valuation allowance........................................................................... (9,320) (10,188)
--------- ---------
Net deferred tax asset (liability)............................................................ $ 0 $ 0
--------- ---------
--------- ---------
</TABLE>
Due to the history of losses in the Company's operations, a valuation
allowance has been established against all deferred tax assets. The valuation
allowance relates principally to net operating loss and capital loss
carryforwards and Federal foreign tax credit carryforwards.
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)
(D) SUMMARY OF TAX LOSS AND CREDIT CARRYFORWARDS
As of December 31, 1998, 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>
2001.............................................................. -- -- -- $ 241
2003-2004......................................................... -- $ 6,504 -- --
2008-2009......................................................... $ 2,758 -- -- --
2010-2011......................................................... 2,841 -- -- --
2012-2013......................................................... 9,302 9,947 -- --
Unlimited......................................................... -- -- $ 8,900 --
--------- --------- --------- -----
Total....................................................... $ 14,901 $ 16,451 $ 8,900 $ 241
--------- --------- --------- -----
--------- --------- --------- -----
</TABLE>
(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>
1996 1997 1998
--------- ---------- ---------
Income (loss) before income taxes:
Domestic....................................................................... $ (4,128) $ (11,206) $ (7,501)
Foreign........................................................................ 13,255 (1,287) (2,429)
--------- ---------- ---------
$ 9,127 $ (12,493) $ (9,930)
--------- ---------- ---------
--------- ---------- ---------
</TABLE>
(F) OTHER
As of December 31, 1997 and 1998, the aggregate unrecognized deferred tax
liability related to investments in foreign subsidiaries that are essentially
permanent in duration amounted to approximately $933 and $21, respectively.
NOTE 19-SEGMENT REPORTING AND GEOGRAPHIC INFORMATION
(A) GENERAL INFORMATION
The Company has five reportable segments: computer consulting services,
value added reseller ("VAR") computer hardware, data communications solutions
for utilities, help desk software and multimedia entertainment software. The
computer consulting services and systems segment provides computer software and
systems consulting and development services, primarily to high-technology
customers in Israel and the United States. The VAR computer hardware segment
sells and services comprehensive PC-based computer hardware/software/networking
solutions. The data communications solutions segment develops and markets
interactive real-time communications solutions targeted for the utilities
market. The help desk software segment, which provided solutions for the help
desk market, was sold in 1998. The multimedia entertainment software segment,
which consisted of the Company's Cybrcard multimedia entertainment products,
suspended operating activity in the first quarter of 1998.
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)
The Company's reportable segments are strategic business units that offer
different products and services. They are managed separately because each
business requires different technology and marketing strategies. Similar
operating segments that operate in different countries are managed separately,
and, in accordance with the provisions of SFAS 131, the Company has aggregated
similar operating segments into one reportable segment.
(B) INFORMATION ABOUT PROFIT OR LOSS AND ASSETS
The accounting policies of the segments are the same as those described in
the summary of significant accounting policies. The Company evaluates
performance based on the profit or loss from operations before income taxes not
including nonrecurring gains and losses.
The Company accounts for intersegment sales and transfers as if the sales or
transfers were to third parties, that is, at current market prices. The Company
does not systematically allocate assets to the divisions of the subsidiaries
constituting its consolidated group, unless the division constitutes a
significant operation. Accordingly, where a division of a subsidiary constitutes
a segment that does not meet the quantitative thresholds of FAS 131,
depreciation expense is recorded against the operations of such segment, without
allocating the related depreciable assets to that segment. However, where a
division of a subsidiary constitutes a segment that does meet the quantitative
thresholds of FAS 131, related depreciable assets, along with other identifiable
assets, are allocated to such division.
The following table represents segmented data for the year ended December
31, 1998:
<TABLE>
<CAPTION>
COMPUTER VAR DATA MULTIMEDIA
CONSULTING COMPUTER COMMUNICATION HELP DESK ENTERTAINMENT
SERVICES HARDWARE FOR UTILITIES SOFTWARE SOFTWARE OTHER(*)
----------- ----------- --------------- ----------- --------------- -----------
<S> <C> <C> <C> <C> <C> <C>
Year ended December 31, 1998:
Revenues from external customers..... $ 18,640 $ 16,374 $ 212 $ 785 $ 152 $ 972
Intersegment revenues................ 124 22 -- -- 159 --
Interest revenue..................... 57 -- -- -- -- --
Interest expense..................... 235 9 2 -- -- --
Depreciation and amortization........ 458 45 359 -- 20 52
Segment profit....................... 5,742 1,514 (3,428) (1,352) (663) (294)
Sale of division (Note 17)........... 5,998 -- -- -- -- --
Loss on note (Note 5)................ 418 -- -- -- -- --
Equity in net income of investees.... (198) -- -- -- -- --
Income tax expense (benefit)......... 20 (43) -- -- -- --
Segment assets....................... 7,796 3,659 1,544 -- 26 --
Expenditures for segment assets...... 301 30 591 -- -- --
<CAPTION>
TOTAL
---------
<S> <C>
Year ended December 31, 1998:
Revenues from external customers..... $ 37,135
Intersegment revenues................ 305
Interest revenue..................... 57
Interest expense..................... 246
Depreciation and amortization........ 934
Segment profit....................... 1,519
Sale of division (Note 17)........... 5,998
Loss on note (Note 5)................ 418
Equity in net income of investees.... (198)
Income tax expense (benefit)......... (23)
Segment assets....................... 13,025
Expenditures for segment assets...... 922
</TABLE>
- ------------------------
(*) Represents two operating segments below the quantitative thresholds of FAS
131, a VAR software operation in Israel and an Internet database venture.
F-26
<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)
Prior period data is presented in the following table, which reflects the
same format as in prior years. The Company is not presenting prior period data
in accordance to the provisions of FAS 131, as it would be impracticable to do
so. The data for each business segment is presented in this table 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
------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
ADJUSTMENTS TOTAL SEMICONDUCTOR CORPORATE
UNITED AND COMPUTER SEGMENT UNITED
ISRAEL STATES ELIMINATIONS SEGMENT ISRAEL STATES TOTAL
--------- --------- ------------- ----------- ------------- ----------- ----------
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 -- 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......................... -- (354) 354 -- -- -- --
--------- --------- ----- ----------- ------------- ----------- ----------
Net sales............................ 14,346 25,239 -- 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........ 466 958 -- 1,424 -- 55 1,479
Capital expenditures................. 324 535 -- 859 -- 3 862
</TABLE>
- ------------------------
(*) See Note 2.
(**) The Company also operated in 1996 in the Computer segment via an affiliate
in the United States that was engaged in the development and production of
multimedia entertainment software. The Company's share in the affiliate's
losses (reflected in equity in affiliates in the statement of operations)
amounted to $1,600 in 1996. The affiliate was consolidated in 1997 and
1998.
F-27
<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)
(C) RECONCILIATIONS
The following tables represent data for the year ended December 31, 1998
(for prior period data, see b. above):
<TABLE>
<CAPTION>
<S> <C>
REVENUES
Total revenues for reportable segments.......................... $ 36,163
Other operational segment revenues.............................. 972
Revenue from management fee derived by non-operating segment
(corporate headquarters)........................................ 360
---------
Total consolidated revenues..................................... $ 37,495
---------
---------
PROFIT OR LOSS
Total profit for reportable segments............................ $ 1,813
Other operational segment loss.................................. (294)
Unallocated amounts: Net loss of corporate headquarters(*)...... (14,463)
---------
Total consolidated net loss..................................... $ (12,944)
---------
---------
ASSETS
Total assets for reportable segments............................ $ 13,025
Unallocated amounts: Net assets of corporate headquarters(**)... 60,219
---------
Total consolidated assets....................................... $ 73,244
---------
---------
</TABLE>
- ------------------------
(*) Includes Tower writedown of $6,103 (see Note 7b), equity in losses of Tower
(net of minority interest) of $3,710, and a one-time loss accrual for bank
guarantees and writeoffs related to an affiliate of $1,391 (see Note 11).
(**) Includes Tower investment of $56,155 (see Note 7).
<TABLE>
<CAPTION>
SEGMENT CONSOLIDATED
TOTALS ADJUSTMENTS TOTALS
----------- ------------- -------------
<S> <C> <C> <C>
OTHER SIGNIFICANT ITEMS
Depreciation and amortization......................... $ 934 $ 158 $ 1,092
Expenditures for assets............................... 922 7 929
Gain on sale of division.............................. 5,998 -- 5,998
Equity in net income of investees..................... (198) (3,710) (3,908)
</TABLE>
The reconciling items are all corporate headquarters data, which are not
included in the segment information. Note that the reconciling item to adjust
equity in net income of investees is the Company's share of Tower's loss in
1998. None of the other adjustments are significant.
F-28
<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)
(D) GEOGRAPHIC INFORMATION
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------
<S> <C> <C> <C>
1996 1997(*) 1998(*)
---------- --------- ---------
Revenues attributable to countries based
on location of customer:
Israel...................................................... $ 12,061 $ 12,769 $ 14,637
United States............................................... 62,438 27,164 22,858
Far East.................................................... 56,773 -- --
Europe...................................................... 483 63 --
---------- --------- ---------
$ 131,755 $ 39,996 $ 37,495
---------- --------- ---------
---------- --------- ---------
</TABLE>
- ------------------------
(*) See Note 2.
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
1998
-------------
<S> <C>
Long-lived assets located in the following countries:
Israel.......................................................................... $ 1,393
United States................................................................... 2,055
------
$ 3,448
------
------
</TABLE>
(E) MAJOR CUSTOMERS
<TABLE>
<CAPTION>
REVENUES FROM MAJOR CONSOLIDATED SALES
CUSTOMERS YEAR ENDED DECEMBER 31,
- --------------------------------- ----------------------------------------------------------------
CUSTOMER SEGMENT 1996 1997 1998
- ------------- ------------------ -------------------- -------------------- --------------------
<S> <C> <C> <C> <C> <C> <C> <C>
A Semiconductors $ 65,599 49.8% --(*) -- --(*) --
B VAR Hardware 1,541 1.2 $ 4,617 11.5% $ 5,930 15.8%
C VAR Hardware 3,410 2.6 4,273 10.7 4,470 11.9
--------- --- --------- --- --------- ---
$ 80,266 61.0% $ 8,890 22.2% $ 10,400 27.7%
--------- --- --------- --- --------- ---
--------- --- --------- --- --------- ---
</TABLE>
- ------------------------
(*) See Note 2.
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.
F-29
<PAGE>
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 20-FINANCIAL INSTRUMENTS (CONTINUED)
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 from 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).
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. 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 $3,598 for
1996. Of this amount, $3,002 was capitalized to property and equipment; and the
remaining amount of $596 was reflected in interest expense. No such transactions
are reflected for 1997 and 1998. 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 $335 as of December 31, 1998) was not practicable,
although the Company believes that the estimated fair value of such financial
instruments was not materially different from their book value. See Note 7b for
information regarding the book and fair market value of the Company's investment
in Tower and for a description of the recorded impairment arising with respect
to such investment. See Note 3 for information regarding the book and fair
market value of the Company's investment in the Mofet Fund and for a description
of the unrealized mark-to-market gain arising with respect to such investment.
(E) CONCENTRATIONS OF CREDIT RISK
The Company is subject to credit risk through its trade receivables. As of
December 31, 1998, 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. Approximately 20% of the trade accounts receivable were due from
a U.S. customer that continues to pay its trade receivables over usual credit
periods. The remaining balance consists primarily of receivables from various
customers.
NOTE 21-FOURTH QUARTER ADJUSTMENT
During the fourth quarter of 1998, since the decline in the market price of
Tower has been determined to be other than temporary, the Company recorded a
writedown to market value of $6,103 with respect to its Tower investment. See
Note 7b for additional information.
F-30
<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, 1998 and
1997, and the related consolidated statements of operations, changes in
shareholders' equity and cash flows for each of the three years in the period
ended December 31, 1998. 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, 1998 and 1997, 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, 1998, 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.
Brightman Bar-Levav Friedman & Co.
Certified Public Accountants
Tel Aviv, Israel
January 26, 1999
F-31
<PAGE>
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
----------------------
<S> <C> <C> <C>
NOTE 1998 1997
--------- ---------- ----------
ASSETS
CURRENT ASSETS
Cash and cash equivalents....................................................... $ 7,320 $ 4,792
Short-term interest-bearing deposits............................................ 11 31,962 53,046
Marketable debt securities...................................................... 3 25,160 26,207
Trade accounts receivable (net of allowance for doubtful accounts of $530 in
1998)......................................................................... 9,14 5,249 11,008
Other receivables............................................................... 4 3,792 6,974
Inventories..................................................................... 5 9,839 12,432
Other current assets............................................................ 1,963 1,279
---------- ----------
Total current assets.......................................................... 85,285 115,738
---------- ----------
LONG-TERM INVESTMENTS............................................................. 6 6,333 2,610
---------- ----------
PROPERTY AND EQUIPMENT, NET....................................................... 7,11 88,429 99,216
---------- ----------
TOTAL ASSETS................................................................ $ 180,047 $ 217,564
---------- ----------
---------- ----------
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Short-term debt................................................................. 8 $ 21 $ 308
Trade accounts payable.......................................................... 11,713 13,124
Current portion of long-term liability in respect of customer advances.......... 16 4,560 5,450
Due to related parties.......................................................... 9 42 207
Other current liabilities....................................................... 10 2,912 5,724
---------- ----------
Total current liabilities..................................................... 19,248 24,813
LONG-TERM DEBT.................................................................... 11 12,127 12,117
LONG-TERM LIABILITY IN RESPECT OF CUSTOMER ADVANCES............................... 16 1,076 3,340
OTHER LIABILITIES................................................................. 12 4,271 10,413
COMMITMENTS AND CONTINGENCIES..................................................... 16
---------- ----------
Total liabilities............................................................. 36,722 50,683
---------- ----------
SHAREHOLDERS' EQUITY
Ordinary shares, NIS 1 par value--authorized 30,000,000 shares; issued and
outstanding 13,241,502 and 13,235,360 shares, respectively.................... 13 4,324 4,323
Additional paid-in capital...................................................... 138,354 138,013
Shareholder receivables and unearned compensation............................... (981) (736)
Retained earnings............................................................... 9,737 25,281
---------- ----------
151,434 166,881
Treasury stock, at cost--1,157,500 shares....................................... 13 (8,109) --
---------- ----------
Total shareholders' equity.................................................... 143,325 166,881
---------- ----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY.................................. $ 180,047 $ 217,564
---------- ----------
---------- ----------
</TABLE>
See notes to consolidated financial statements.
F-32
<PAGE>
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------
<S> <C> <C> <C> <C>
NOTE 1998 1997 1996
--------- ---------- ---------- ---------
SALES................................................................. 14,16 $ 69,637 $ 125,917 $ 97,885
COST OF SALES......................................................... 76,781 89,556 75,727
---------- ---------- ---------
GROSS PROFIT (LOSS)............................................... (7,144) 36,361 22,158
---------- ---------- ---------
OPERATING COSTS AND EXPENSES
Research and development, net....................................... 16 8,107 7,271 4,062
Marketing, general and administrative............................... 9 8,747 8,550 7,001
Other expenses...................................................... 7 -- 400 1,443
---------- ---------- ---------
16,854 16,221 12,506
---------- ---------- ---------
OPERATING INCOME (LOSS)........................................... (23,998) 20,140 9,652
FINANCING INCOME, NET................................................. 2,741 2,452 2,661
GAIN FROM SALE OF EQUIPMENT........................................... 13 615 --
---------- ---------- ---------
INCOME (LOSS) BEFORE INCOME TAXES (BENEFIT)....................... (21,244) 23,207 12,313
INCOME TAXES (BENEFIT)................................................ 15 (5,700) 4,036 2,299
---------- ---------- ---------
NET INCOME (LOSS)............................................... $ (15,544) $ 19,171 $ 10,014
---------- ---------- ---------
---------- ---------- ---------
BASIC EARNINGS (LOSS) PER ORDINARY SHARE
Earnings (loss) per share........................................... $ (1.18) $ 1.45 $ 0.76
---------- ---------- ---------
---------- ---------- ---------
Net income (loss) used to compute basic earnings (loss) per share... $ (15,544) $ 19,171 $ 10,014
---------- ---------- ---------
---------- ---------- ---------
Weighted average number of ordinary shares outstanding--in
thousands......................................................... 13,137 13,235 13,205
---------- ---------- ---------
---------- ---------- ---------
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-33
<PAGE>
TOWER SEMICONDUCTOR LTD.
STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
SHAREHOLDER
RECEIVABLES
ORDINARY SHARES ADDITIONAL AND
----------------------- PAID-IN UNEARNED RETAINED TREASURY
SHARES AMOUNT CAPITAL COMPENSATION EARNINGS STOCK
------------ --------- ---------- ------------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
BALANCE--JANUARY 1, 1996........................... 13,205,450 $ 4,314 $ 138,063 $ (1,165) $ 29,139 $ --
Cancellation of unearned compensation in respect
of non-vested options, net..................... (121) 121
Amortization of unearned compensation............ 183
Expenses connected with issuance of employee
share options.................................. (155)
Cash dividend paid............................... (19,808)
Net income....................................... 10,014
------------ --------- ---------- ------------- --------- ---------
BALANCE--DECEMBER 31, 1996......................... 13,205,450 4,314 137,787 (861) 19,345 --
Exercise of share options........................ 29,910 9 290
Cancellation of unearned compensation in respect
of non-vested options, net..................... (39) 39
Amortization of unearned compensation............ 86
Expenses connected with issuance of employee
share options.................................. (25)
Cash dividend paid............................... (13,235)
Net income....................................... 19,171
------------ --------- ---------- ------------- --------- ---------
BALANCE--DECEMBER 31, 1997......................... 13,235,360 4,323 138,013 (736) 25,281 --
Exercise of share options........................ 6,142 1 50
Cancellation of unearned compensation in respect
of non-vested options, net..................... 291 (291)
Amortization of unearned compensation............ 46
Purchase of treasury stock....................... (8,109)
Net loss......................................... (15,544)
------------ --------- ---------- ------------- --------- ---------
BALANCE--DECEMBER 31, 1998......................... 13,241,502 $ 4,324 $ 138,354 $ (981) $ 9,737 $ (8,109)
------------ --------- ---------- ------------- --------- ---------
------------ --------- ---------- ------------- --------- ---------
<CAPTION>
TOTAL
----------
<S> <C>
BALANCE--JANUARY 1, 1996........................... $ 170,351
Cancellation of unearned compensation in respect
of non-vested options, net..................... --
Amortization of unearned compensation............ 183
Expenses connected with issuance of employee
share options.................................. (155)
Cash dividend paid............................... (19,808)
Net income....................................... 10,014
----------
BALANCE--DECEMBER 31, 1996......................... 160,585
Exercise of share options........................ 299
Cancellation of unearned compensation in respect
of non-vested options, net..................... --
Amortization of unearned compensation............ 86
Expenses connected with issuance of employee
share options.................................. (25)
Cash dividend paid............................... (13,235)
Net income....................................... 19,171
----------
BALANCE--DECEMBER 31, 1997......................... 166,881
Exercise of share options........................ 51
Cancellation of unearned compensation in respect
of non-vested options, net..................... --
Amortization of unearned compensation............ 46
Purchase of treasury stock....................... (8,109)
Net loss......................................... (15,544)
----------
BALANCE--DECEMBER 31, 1998......................... $ 143,325
----------
----------
</TABLE>
See notes to consolidated financial statements.
F-34
<PAGE>
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------
<S> <C> <C> <C>
1998 1997 1996
---------- ---------- -----------
CASH FLOWS--OPERATING ACTIVITIES
Net income (loss).......................................................... $ (15,544) $ 19,171 $ 10,014
Adjustments to reconcile net income (loss) to net cash provided by
operating activities:
Income and expense items not involving cash flows:
Depreciation and amortization.......................................... 25,414 23,648 17,515
Deferred income taxes (benefit)........................................ (5,700) 4,036 2,299
Gain from sale of equipment............................................ (13) (615) --
Earnings on marketable debt securities................................. (1,394) (1,637) (2,959)
Changes in assets and liabilities:
Decrease in trade accounts receivable.................................. 5,759 86 2,408
Decrease (increase) in other receivables and other current assets...... 923 (1,156) 2,207
Decrease (increase) in inventories..................................... 2,593 1,857 (1,082)
Increase (decrease) in trade accounts payable.......................... 276 1,923 (2,895)
Decrease in due to related parties..................................... (165) (207) (239)
Increase (decrease) in other current liabilities....................... (3,050) 1,803 (1,074)
Decrease in liability in respect of customer advances, net............. (3,154) (8,824) (1,439)
Increase (decrease) in other long-term liabilities..................... (762) 577 117
---------- ---------- -----------
Net cash provided by operating activities............................ 5,183 40,662 24,872
---------- ---------- -----------
CASH FLOWS--INVESTING ACTIVITIES
Investments in property and equipment...................................... (20,878) (29,390) (84,475)
Investment grants received................................................. 6,685 13,041 30,800
Proceeds from sale of equipment............................................ 69 766 --
Decrease (increase) in deposits............................................ 21,113 (25,978) (1,684)
Investments in marketable debt securities.................................. (35,648) (48,836) (109,951)
Proceeds from realization of marketable debt securities.................... 38,089 57,876 151,736
Long-term investments...................................................... (3,750) (2,000) --
---------- ---------- -----------
Net cash provided by (used in) investing activities.................. 5,680 (34,521) (13,574)
---------- ---------- -----------
CASH FLOWS--FINANCING ACTIVITIES
Proceeds from exercise of share options.................................... 51 299 --
Share option plan and share issuance expenses.............................. -- (25) (155)
Repayment of liability in respect of customer advances..................... -- -- (2,250)
Increase (decrease) in short-term debt..................................... (294) 86 (1,641)
Increase in long-term debt................................................. 17 67 --
Purchase of treasury stock................................................. (8,109) -- --
Cash dividend paid......................................................... -- (13,235) (19,808)
---------- ---------- -----------
Net cash used in financing activities................................ (8,335) (12,808) (23,854)
---------- ---------- -----------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS....................... 2,528 (6,667) (12,556)
CASH AND CASH EQUIVALENTS--BEGINNING OF YEAR................................. 4,792 11,459 24,015
---------- ---------- -----------
CASH AND CASH EQUIVALENTS--END OF YEAR................................. $ 7,320 $ 4,792 $ 11,459
---------- ---------- -----------
---------- ---------- -----------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the year for interest..................................... $ 730 $ 748 $ 702
---------- ---------- -----------
---------- ---------- -----------
Cash paid during the year for income taxes................................. $ 371 $ 1,578 $ 1,515
---------- ---------- -----------
---------- ---------- -----------
</TABLE>
See notes to consolidated financial statements.
F-35
<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. In addition, the
Company also offers certain integrated circuit design services.
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.
The Company has a wholly owned marketing subsidiary in the U.S. and a
50.1%-owned (on a fully diluted basis) ASIC design center subsidiary in Israel.
The operations of these subsidiaries have not been material to the Company's
financial position or results of operations since their incorporation.
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 that the Company has the positive intent and
ability to hold to maturity are reflected at amortized cost.
D. ALLOWANCE FOR DOUBTFUL ACCOUNTS
The allowance for doubtful accounts is computed on the specific
identification basis for accounts whose collectibility, in management's
estimation, is uncertain.
F-36
<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)
E. 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.
F. 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.
G. 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>
Land and buildings under capital lease.......................... 14-25
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.
H. 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.
Deferred tax benefits are recorded to the extent that their realization is
considered more likely than not.
I. REVENUE RECOGNITION
Revenues are recognized upon delivery or as services are rendered. An
accrual for estimated returns, computed primarily on the basis of historical
experience, is recorded at the time of sale.
J. 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.
K. EARNINGS (LOSS) PER ORDINARY SHARE
Basic earnings (loss) 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
F-37
<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)
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 (loss) per share include the effects of all outstanding options
which have a dilutive effect on earnings (loss) per share. Diluted earnings per
share data for 1996 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 1998
and 1997 earnings (loss) 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.
L. FOREIGN EXCHANGE AGREEMENTS
The Company, from time to time, enters into foreign exchange agreements as a
hedge against non-dollar equipment purchase and other firm commitments. Gains
and losses on such agreements through the date that the equipment is received or
the commitment is realized are deferred, while gains and losses subsequent
thereto, through the date of actual payment of the liability, are included in
financing income, net.
M. 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 $523, $384
and $677 in 1998, 1997 and 1996, respectively.
N. 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"("APB 25"). 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. The compensation cost of
plans not considered fixed as defined by APB 25 is remeasured at each balance
sheet date. Deferred compensation is amortized to compensation expense over the
vesting period of the underlying options. See Note 13B for pro forma disclosures
required by Financial Accounting Standards Board Statement No. 123, "Accounting
for Stock-Based Compensation" ("SFAS 123").
O. NEW ACCOUNTING PRONOUNCEMENTS
(1) Comprehensive Income
Statement of Financial Accounting Standards No. 130, "Reporting
Comprehensive Income" ("SFAS 130"), effective for December 31, 1998 financial
statements, establishes standards for the reporting and display of comprehensive
income and its components in the financial statements. SFAS 130 has no effect on
the presentation of these financial statements, nor any impact on the Company's
results of operations, financial position or cash flows.
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)
(2) Disaggregated Information
Statement of Financial Accounting Standards No. 131, "Disclosure about
Segments of an Enterprise and Related Information" ("SFAS 131"), effective for
December 31, 1998 financial statements, establishes standards for reporting
information about operating segments. It also establishes standards for
entity-wide disclosures about products and services, geographic areas and major
customers. The Company operates in one segment and, accordingly, does not
provide disaggregated operating segment information. The entity-wide disclosures
have been included in the notes to the financial statements.
(3) Derivative Instruments
Statement of Financial Accounting Standards No. 133, "Accounting for
Derivative Instruments and Hedging Activities" ("SFAS 133"), effective for
fiscal years beginning in 2000, requires, among other provisions, that a company
disclose all derivatives as either assets or liabilities on the balance sheet
and measure those instruments at fair value. The Company has not yet assessed
the ramifications of SFAS 133 on the Company's future results of operations or
financial position.
P. RECLASSIFICATIONS
Certain amounts in prior years' financial statements have been reclassified
in order to conform to the 1998 presentation.
NOTE 3--MARKETABLE DEBT SECURITIES
Marketable debt securities consist of the following:
<TABLE>
<CAPTION>
YIELD TO MATURITY AS OF DECEMBER 31,
AS OF DECEMBER 31, --------------------
1998 1998 1997
------------------ --------- ---------
<S> <C> <C> <C>
U.S. government agencies notes...................... 4.8%-5.6% $ 25,160 $ --
U.S. treasury bills................................. -- 15,749
U.S. treasury notes................................. -- 9,433
Israeli government bonds............................ -- 1,025
--------- ---------
$ 25,160 $ 26,207
--------- ---------
--------- ---------
</TABLE>
Marketable debt securities mature between April 1999 and December 1999. The
market value of the securities as of December 31, 1998 and 1997 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>
1998 1997
--------- ---------
Investment grants receivable............................................ $ 1,793 $ 3,414
Government agencies..................................................... 1,999 3,560
--------- ---------
$ 3,792 $ 6,974
--------- ---------
--------- ---------
</TABLE>
F-39
<PAGE>
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 5--INVENTORIES
Inventories consist of the following (1):
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
--------------------
<S> <C> <C>
1998 1997
--------- ---------
Raw materials............................................................ $ 2,928 $ 3,214
Spare parts and supplies................................................. 3,627 3,570
Work in process.......................................................... 2,651 4,059
Finished goods........................................................... 633 1,589
--------- ---------
$ 9,839 $ 12,432
--------- ---------
--------- ---------
</TABLE>
- ------------------------
(1) Net of write-downs to net realizable value of $610 and $350 as of December
31, 1998 and 1997, respectively.
NOTE 6--LONG-TERM INVESTMENTS
Long-term investments consist primarily of the following:
A. An investment in Saifun Semiconductor Ltd. ("Saifun") based on an
agreement between the Company and Saifun signed in October 1997. Pursuant to
such agreement, the Company has certain exclusive semiconductor manufacturing
rights for certain licensed technology. The agreement also sets certain
limitations on Saifun regarding future licensing of such technology.
As of December 31, 1998 and 1997, the Company has invested an aggregate of
$4,250 and $2,000, respectively, in Saifun in exchange for 14.6% and 10.0%,
respectively, of Saifun's equity (on a diluted basis--13.4%, and 10.0%,
respectively). In addition, pursuant to the agreement, the Company is obligated
to invest another $750 upon the achievement of specific development milestones
with regard to such technology.
Pursuant to certain provisions of the agreement, the Company and Saifun are
obligated, under certain circumstances, to pay each other royalties and Saifun
is obligated to produce, through the Company, at least 75% of its products based
on the aforementioned technology.
B. In 1998, the Company invested $1,500 in shares of Virage Logic
Corporation ("Virage") for 8.4% of that company's share capital (on a diluted
basis--8.1%). Virage specializes in the development of intellectual property for
advanced memories. In June 1998, the Company and Virage signed an agreement for
the development and supply of certain design tools based on the Company's
technologies.
F-40
<PAGE>
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 7--PROPERTY AND EQUIPMENT
A. COMPOSITION
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
--------------------
1998 1997
--------- ---------
<S> <C> <C>
Cost (1) (2):
Land and buildings under capital lease................................ $ 30,134 $ 27,627
Machinery and equipment............................................... 132,324 120,735
Transportation vehicles............................................... 2,414 2,075
--------- ---------
164,872 150,437
--------- ---------
--------- ---------
Accumulated depreciation and amortization:
Land and buildings under capital lease................................ 5,968 4,314
Machinery and equipment............................................... 69,638 46,343
Transportation vehicles............................................... 837 564
--------- ---------
76,443 51,221
--------- ---------
--------- ---------
$ 88,429 $ 99,216
--------- ---------
--------- ---------
</TABLE>
- ------------------------
(1) As of December 31, 1998, the cost of buildings, machinery and equipment is
reflected net of investment grants of $77,670 (as of December 31,
1997--$72,158).
(2) Due to uncertainty with respect to the form and location of a plant whose
construction has been suspended, all capitalized design costs in the
aggregate amount of $400 and $1,443 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 provides for a benefit track
entitling the Company to investment grants at a rate of 38% of the investments
included in such certificate. The Company completed its investments under this
program during 1996, and received final approval from the Investment Center in
November 1997 for the investments made under 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 provides for a benefit track
entitling the Company to investment grants at a rate of 34% of the investments
included in such certificate. The Company invested approximately $120,600
through December 31, 1998 under the existing program. Pursuant to the approval,
as amended, the investments in respect of the existing program are required to
be completed by December 31, 2000.
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
F-41
<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)
assets of the Company. In management's opinion, the Company has been in full
compliance with the conditions through December 31, 1998.
NOTE 8--SHORT-TERM DEBT
The Company received letters of intent from its banks, pursuant to which
they will make available to the Company, during 1999, short-term credits of up
to $60,000, at terms to be agreed upon prior to drawdown.
NOTE 9--RELATED PARTIES BALANCES AND TRANSACTIONS
A. BALANCES
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
--------------------
1998 1997
--------- ---------
<S> <C> <C>
Trade accounts receivable................................................. $ 174 $ 5,080
--------- ---------
--------- ---------
Accounts payable.......................................................... $ 989
---------
---------
</TABLE>
B. TRANSACTIONS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
Purchases of raw materials........................................... $ 55 $ 260
--------- ---------
--------- ---------
Management fees...................................................... $ 480 $ 480 $ 480
--------- --------- ---------
--------- --------- ---------
Purchases of fixed assets............................................ $ 1,528 $ 962 $ 18
--------- --------- ---------
--------- --------- ---------
Services provided, net............................................... $ 41 $ 361 $ 800
--------- --------- ---------
--------- --------- ---------
Expense reimbursements............................................... $ 256
---------
---------
Participation in third party funds................................... $ 94
---------
---------
</TABLE>
NOTE 10--OTHER CURRENT LIABILITIES
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
--------------------
<S> <C> <C>
1998 1997
--------- ---------
Other current liabilities consist of the following:
Accrued salaries........................................................ $ 1,391 $ 3,836
Vacation accrual........................................................ 1,216 1,758
Other................................................................... 305 130
--------- ---------
$ 2,912 $ 5,724
--------- ---------
--------- ---------
</TABLE>
F-42
<PAGE>
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 11--LONG-TERM DEBT
In connection with the formation of the Company, the Company assumed certain
long-term bank loans in the aggregate amount of $12,064 ("Original Term Loans").
The Company was obligated to repay the principal of the Original Term Loans in
quarterly installments commencing in March 1993 and ending in May 1998.
The Company's 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 New Term loans bear interest at 0.3% over the rate that the Company earns on
deposits maintained by the Company at its banks; any 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 Company's 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,
1998, the Company was in full compliance with such covenants.
NOTE 12--OTHER LIABILITIES
A. COMPOSITION
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
--------------------
1998 1997
--------- ---------
<S> <C> <C>
Net liability for employee termination benefits (see B below):
Gross obligation..................................................... $ 6,929 $ 6,794
Amounts funded through deposits to severance pay funds and purchase
of insurance policies.............................................. (6,238) (5,489)
--------- ---------
691 1,305
Deferred income taxes (see Note 15B)..................................... 2,679 8,490
Other.................................................................... 901 618
--------- ---------
$ 4,271 $ 10,413
--------- ---------
--------- ---------
</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 monthly 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.
Expenses relating to employee termination benefits were approximately
$1,266, $1,674 and $1,311 for 1998, 1997 and 1996, respectively.
F-43
<PAGE>
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
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. All shares under the plan are 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 five share option plans as follows:
(1) 1994 SHARE OPTION PLAN AND 1995 SHARE OPTION PLAN--These 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 options granted may not be excercisable
beyond 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 at
such date 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.
(2) 1998 SHARE OPTION PLAN--In May 1998, the Board of Directors of the
Company approved a new stock option plan for the grant of options to certain
Company employees. In November 1998, approximately half of the options was
exchanged for new options (see (4) below). All options under this plan were
granted at an exercise price equal to the market price of the Company's
shares at the date of grant. Options granted under this plan are exercisable
over a ten-year period from the date of grant, subject to certain time and
performance vesting criteria.
The options granted are to be held in trust on an irrevocable basis
until the date of exercise. In the event the vesting criteria of the options
are met, the trustee of the trust is generally required to exercise the
options and sell the underlying shares at the prevailing market price. At
the end of the ten-year exercise period, the trustee is required to exercise
the options and sell the underlying shares if the market price of the shares
at such time exceeds the exercise price of the options by $1.00.
Pursuant to generally accepted accounting principles, the options are
treated as the equivalent of a stock appreciation right. Accordingly,
changes in the market price of the Company's shares may have an effect on
the aggregate compensation expense recorded in respect of these options.
(3) OPTIONS GRANTED TO the CO-CEOS DURING 1998--In October 1998, the
Board of Directors of the Company approved a stock option plan pursuant to
which each of the Company's two Co-Chief Executive Officers was granted the
right to purchase up to 300,000 ordinary shares of the Company at
F-44
<PAGE>
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 13--SHAREHOLDERS' EQUITY (CONTINUED)
an exercise price of $7.00, the market price of the Company's shares on the
date of grant. The options vest at the end of seven years from the date of
grant and may be exercised for a period of five years from the date they
become exercisable. The options provide for accelerated vesting at certain
milestones based primarily on the market price of the Company's shares
reaching a level ranging from $20-$32 per share.
(4) OPTIONS GRANTED TO SENIOR EMPLOYEES DURING 1998--In November 1998,
in the framework of the exchange of options mentioned in paragraph (2)
above, new options were granted to senior employees. Such options were
granted at an exercise price equal to the market price of the Company's
shares at the date of grant. Options granted under this plan vest after six
years with accelerated vesting if certain performance criteria are met. The
options are exercisable for five years following the vesting date.
A summary of the status of the Company's share option plans as of
December 31, 1998, 1997 and 1996, as well as changes during each of the
years then ended, is presented below:
<TABLE>
<CAPTION>
1998 1997 1996
----------------------- ---------------------- ----------------------
<S> <C> <C> <C> <C> <C> <C>
WEIGHTED WEIGHTED WEIGHTED
NUMBER AVERAGE NUMBER AVERAGE NUMBER AVERAGE
OF SHARE EXERCISE OF SHARE EXERCISE OF SHARE EXERCISE
OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE
---------- ----------- --------- ----------- --------- -----------
Outstanding as of beginning of year (1).......... 769,567 $ 9.45 729,656 $ 9.10 265,000 $ 17.16
Granted.......................................... 1,089,659 7.56 104,340 11.84 528,960 8.80
Exercised........................................ (6,142) 8.33 (29,910) 10.00 --
Terminated....................................... -- -- --
Forfeited........................................ (71,301) 9.90 (34,519) 8.60 (64,304) 15.65
---------- --------- ---------
Outstanding as of end of year.................... 1,781,783 8.25 769,567 9.45 729,656 9.10
---------- --------- ---------
---------- --------- ---------
Options exercisable as of end of year............ 360,046 9.42 199,107 9.72 52,804 12.95
---------- --------- ---------
---------- --------- ---------
</TABLE>
----------------------------
(1) During 1996, the exercise price of share options granted under the 1994
plan was reduced.
F-45
<PAGE>
TOWER SIMICONDUCTOR
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 13--SHARHOLDERS' EQUITY (CONTINUED)
The following table summarizes information about share options outstanding
as of December 31, 1998:
<TABLE>
<CAPTION>
EXERCISABLE AS OF
OUTSTANDING AS OF DECEMBER 31, 1998 DECEMBER 31, 1998
- ----------------------------------------------------------- ------------------------
<S> <C> <C> <C> <C> <C>
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
RANGE OF REMAINING AVERAGE AVERAGE
EXERCISE NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE
PRICES OUTSTANDING LIFE PRICE EXERCISABLE PRICE
- -------------- ----------- --------------- ------------- ----------- -----------
<CAPTION>
(IN YEARS)
<S> <C> <C> <C> <C> <C>
$7.00- 7.25 628,000 11.41 $ 7.00 2,500 $ 7.00
8.06- 8.75 824,068 8.97 8.43 207,367 8.75
9.13- 9.81 212,570 7.42 9.29 93,264 9.13
10.25-11.25 50,000 8.78 10.52 11,250 10.54
12.00-13.82 67,145 7.08 12.72 45,665 12.90
----------- -----------
1,781,783 360,046
----------- -----------
----------- -----------
</TABLE>
The weighted average grant-date fair value of the 1,089,659, 104,340 and
528,960 options granted during 1998, 1997 and 1996 amounted to $4.14, $7.56 and
$4.50 per option, respectively. The Company utilized the Black-Scholes option
pricing model to estimate fair value, utilizing the following assumptions for
the years 1998, 1997 and 1996 (all in weighted averages):
<TABLE>
<CAPTION>
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
Risk-free interest rate...................................................... 5.50% 5.50% 5.50%
Expected life of options..................................................... 7.3 years 4.5 years 4.4 years
Expected annual volatility................................................... 44% 79% 58%
Expected dividend yield...................................................... none none none
</TABLE>
Had compensation cost for the Company's share option plans been determined
based on fair value at the grant dates for awards made in 1998, 1997 and 1996 in
accordance with SFAS 123, the Company's pro forma net income (loss) and earnings
(loss) per share would have been as follows:
<TABLE>
<CAPTION>
1998 1997 1996
---------- --------- ---------
<S> <C> <C> <C>
Pro forma net income (loss)...................................................... $ (16,104) $ 17,860 $ 9,221
---------- --------- ---------
---------- --------- ---------
Pro forma basic earnings (loss) per share........................................ $ (1.23) $ 1.35 $ 0.70
---------- --------- ---------
---------- --------- ---------
Pro forma diluted earnings per share............................................. $ 1.28
---------
---------
</TABLE>
C. DESCRIPTION OF ORDINARY SHARES
As of December 31, 1998 and 1997, the Company had authorized 30,000,000 par
value NIS 1 ordinary shares, of which 13,241,502 and 13,235,360, respectively,
were issued and outstanding. Holders of ordinary shares are entitled to
participate equally in the payment of cash dividends and bonus share (stock
dividend) 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.
F-46
<PAGE>
TOWER SIMICONDUCTOR
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 13--SHARHOLDERS' EQUITY (CONTINUED)
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.
E. TREASURY STOCK
During 1998, the Company funded the purchase by a trustee of 1,157,500 of
the Company's ordinary shares to facilitate the exercise of employee stock
options under the Company's share option plans. The Board of Directors of the
Company has authorized the purchase of up to an aggregate 1,400,000 ordinary
shares for such purpose, subject to certain conditions.
NOTE 14--INFORMATION ON GEOGRAPHIC AREAS AND MAJOR CUSTOMERS
A. SALES BY GEOGRAPHIC AREA (as percentage of total sales)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------
<S> <C> <C> <C>
1998 1997 1996
----- ----- -----
United States............................................................ 88% 38% 41%
Far East--primarily Singapore............................................ 10 61 58
Other.................................................................... 2 1 1
--- --- ---
Total.................................................................... 100% 100% 100%
--- --- ---
--- --- ---
</TABLE>
B. LONG-LIVED ASSETS BY GEOGRAPHIC AREA
Substantially all of the Company's long-lived assets are located in Israel.
C. MAJOR CUSTOMERS (AS PERCENTAGE OF TOTAL SALES)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------
<S> <C> <C> <C>
1998 1997 1996
----- ----- -----
Customer A............................................................... 47% 70% 67%
Customer B............................................................... 27 15 10
Customer C............................................................... 9 7 8
Customer D............................................................... -- -- 8
</TABLE>
As of both December 31, 1998 and 1997, the above major customers constituted
most of the trade accounts receivable reflected on the balance sheet (see also
Note 17E).
F-47
<PAGE>
TOWER SIMICONDUCTOR
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
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 ("Investments Law") (see Note 7B).
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 2009, depending on the
specific approval certificate. The portion of the Company's taxable income that
is not attributable to approved enterprise investments is subject to regular
"Company Tax" (36%).
The tax benefits are also conditioned upon fulfillment of the requirements
stipulated by the Investments 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, 1998.
B. 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:
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
----------------------
<S> <C> <C>
1998 1997
---------- ----------
DEFERRED TAX BENEFIT--CURRENT
Accrued vacation pay...................................................................... $ 241 $ 352
Other..................................................................................... 33 33
---------- ----------
Total current deferred tax benefit.................................................... $ 274 $ 385
---------- ----------
---------- ----------
NET DEFERRED TAX LIABILITY--LONG-TERM
Deferred tax asset--long-term
Net operating loss carryforward......................................................... $ 7,588 $ 71
Research and development................................................................ 1,566 1,240
Liability for employee rights upon severance............................................ 138 261
Unearned compensation................................................................... 77 71
---------- ----------
9,369 1,643
Deferred tax liability--long-term
Depreciation............................................................................ (12,048) (10,133)
---------- ----------
---------- ----------
Total net long-term deferred tax liability............................................ $ (2,679) $ (8,490)
---------- ----------
---------- ----------
</TABLE>
F-48
<PAGE>
TOWER SIMICONDUCTOR
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 15--INCOME TAXES (CONTINUED)
C. 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
-------------------------------------
<S> <C> <C> <C>
1998 1997 1996
----- ----- -----
Israeli statutory rate................................................... (36)% 36% 36%
Reduced tax rate for approved enterprise................................. 16 (16 ) (16 )
Permanent differences and other, net (1)................................. (7 ) (3 ) (1 )
-- -- --
(27 )% 17% 19%
-- -- --
-- -- --
</TABLE>
- ------------------------
(1) Primarily includes special depreciation deduction in connection with the
location of the Company's plant.
D. NET OPERATING LOSS CARRYFORWARD
The Company has net operating loss carryforwards of approximately $38,000 as
of December 31, 1998, which may be carried forward for an unlimited period of
time.
E. FINAL TAX ASSESSMENTS
The Company has not received final tax assessments from the income tax
authorities since its incorporation.
F. AMENDED TAX ASSESSMENTS
In June 1998, the Company filed amended tax assessments with the Israeli
income tax authorities relating to certain tax years regarding certain income
which, in the Company's opinion and based on the advice of legal counsel, is
tax-exempt. The aggregate contingent potential tax reduction of $2,700, based on
the Company's approach, has not been reflected in the financial statements.
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 the Company's indirect principal
shareholder. The suits were consolidated in the United States District Court for
the District of New Jersey. The consolidated complaint filed in the action
alleged that the defendants made misstatements and omissions in violation of
certain U.S. Federal securities laws.
Although the Company believes that it had meritorious defenses against the
action, in January 1999, the Company had entered into an agreement settling the
action. The settlement, which is subject to, among other things, judicial
approval, provides for a cash settlement of $16,275, all of which will be
covered by insurance policies covering the Company and the other defendants. The
Company will incur certain costs associated with the defense of the action,
which are not expected to materially exceed amounts previously accrued by the
Company in connection with the action
F-49
<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)
B. The Company has recently been separately approached by two parties
alleging that the Company is infringing on certain semiconductor production
patents owned by such parties and requesting that the Company enter into
negotiations for a royalty-bearing license for the use of the technology covered
by such patents.
The Company is presently engaged in discussions with the parties to
determine whether there is any merit to their claim. In addition, the Company is
assessing if and to what extent the Company may be able to seek indemnification
from third parties for all or part of any royalties or other amounts which may
be paid or payable by the Company in connection with this matter. The Company is
unable to determine at this time with any certainty the ultimate outcome of the
aforementioned claims or their effect, if any, on the Company's financial
condition, operating results and business.
C. 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, 1998.
D. PURCHASE AGREEMENTS
(1) 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 at prices which are stipulated in
the agreements and are subject to periodic re-negotiations. From
commencement of the Company's operations through December 31, 1998, a
substantial portion of the Company's production has been sold under such
agreements.
(2) Pursuant to an agreement, as amended from time to time, signed with
a major customer, during 1995 and 1996 the customer provided the Company
with an advance payment in the amount of $28,875. The advance bears interest
at the three-month Libor rate.
Such agreement sets out a mechanism for offsetting the aforementioned
advance payment against wafer purchases through February 2000. Under certain
circumstances, the Company may be required to repay the customer a portion
of the advance payment still outstanding at that time.
The portion of the advance outstanding as of December 31, 1998 that is
expected to be offset in 1999 in accordance with the agreement is presented
as a current liability.
(3) Pursuant to a certain purchase agreement with a customer, the
Company is entitled to receive warrants to purchase share capital of the
customer under conditions stipulated in the agreement.
(4) 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% of the Company's sales in 1996.
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 (CONTINUED)
E. 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 and $1,231 for 1997 and 1996,
respectively.
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 both the other entities and the
Company. Certain of such agreements contain commitments by the Company and/or
the other entities to purchase specific quantities of the products developed.
G. OTHER COMMITMENTS
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, 1998.
H. YEAR 2000 ISSUE
The Year 2000 Issue has arisen due to the fact that numerous computer
systems use two digits, rather than four, to signify a year. Date-sensitive
systems may process the digits "00" as "1900" or some other date, causing errors
in processing data which contains dates in 2000. In addition, similar problems
may arise in systems using the digits "99" in the date fields to signify
something other than the year 1999. The impact of the Year 2000 Issue may occur
on January 1, 2000, before that date or afterwards, and if these issues are not
resolved, the consequences on operations and financial reporting may range from
insignificant errors to major system-wide failure which could possibly affect
the ability to conduct normal business activities.
The Company is engaged in a program to address Year 2000 Issues throughout
the Company. The Company, in conjunction with its vendors, wherever possible, is
working to identify and solve potential Year 2000 problems. Specifically, the
Company has implemented a program to identify and upgrade, or replace when
necessary, embedded microprocessors throughout its operations. In addition, the
Company has obtained and begun implementation of vendor-supplied upgrades to the
software that controls the fab systems, machinery and equipment. However, due to
the fact that certain vendors have not responded to the Company's requests, the
Year 2000 Issue status of certain embedded fab machinery remains unclear.
In connection with its Year 2000 remediation efforts, the Company expects to
incur costs of approximately $1,500, of which $730 have already been expended.
No assurance can be made that all aspects of the Year 2000 Issue affecting
the Company, including those relating to the solution efforts of customers,
vendors or other outside parties, will be resolved.
F-51
<PAGE>
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
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 and other firm commitments.
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.
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
The aggregate contract amount of foreign exchange agreements outstanding as
of December 31, 1998 was $6,000.
Gains recognized on foreign exchange agreements amounted to $238 in 1998,
which were reflected primarily in cost of sales.
There were no outstanding foreign exchange agreements as of December 31,
1997 and the results of such agreements were not material for 1997.
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.
F-52
<PAGE>
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 17--FINANCIAL INSTRUMENTS (CONTINUED)
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, 1998
and 1997.
E. CONCENTRATIONS OF CREDIT RISK
Most of the Company's trade accounts receivable (81% as of December 31,
1998) were due from the Company's two major customers, both of whom are large
multinational companies (see Note 14C).
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 (loss) per share data in 1998 and 1997. Set forth below is the
Company's earnings (loss) per share data in accordance with U.S. GAAP (SFAS
128).
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER
31,
--------------------
<S> <C> <C>
1998 1997
--------- ---------
Basic earnings (loss) per share............................................. $ (1.20) $ 1.45
--------- ---------
--------- ---------
Diluted earnings (loss) per share........................................... $ (1.20) $ 1.43
--------- ---------
--------- ---------
</TABLE>
The following table provides a reconciliation of the numerators and
denominators of the basic and diluted per share computations for 1998 in
accordance with U.S. GAAP:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1998
-------------------------------------------
<S> <C> <C> <C>
SHARES
LOSS (IN THOUSANDS) PER-SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
------------- --------------- -----------
BASIC LOSS PER SHARE
Loss available to ordinary shareholders............ $ (15,544) 12,913 $ (1.20)
------------- ------ -----------
------------- ------ -----------
EFFECT OF DILUTIVE SECURITIES
Options............................................ -- --
------------- ------
------------- ------
DILUTED LOSS PER SHARE
Loss available to ordinary shareholders after
assumed conversions.............................. $ (15,544) 12,913 $ (1.20)
------------- ------ -----------
------------- ------ -----------
</TABLE>
Options to purchase 1,781,783 ordinary shares at an average exercise price
of $8.25 per share were outstanding during 1998 but were not included in the
computation of diluted loss per share because their effect was anti-dilutive.
The options, which expire between April 2004 and July 2010 (weighted average
remaining contractual life of 9.57 years), were still outstanding as of December
31, 1998.
F-53
<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>
SHARES
INCOME (IN THOUSANDS) 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 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-54
<PAGE>
Exhibit 10.3
DATA SYSTEMS & SOFTWARE INC.
- --------------------------------------------------------------------------------
200 ROUTE 17, MAHWAH, NEW JERSEY 07430 (201) 529-2026
FAX (201) 529-3163
December 23, 1998
Samuel Fogel
31 Rechov Argaman
Ramat Efal, ISRAEL
Dear Mr. Fogel,
This letter agreement confirm the agreement between Data Systems & Software
Inc., a Delaware corporation (including its subsidiaries and affiliates,
"DSSI"), and Samuel Fogel ("Fogel"), as follows:
1. RESIGNATION FROM DSSI. Fogel hereby resigns from his positions as
Executive Vice President and director of DSSI, effective immediately.
2. CONTEMPLATED RESIGNATION FROM DECISION. Fogel will resign from his
positions as President and General Manager of Decision Systems Israel Ltd.
("Decision") upon terms to be duly approved by Decision.
3. MOFET MANAGEMENT. It is contemplated that Fogel shall continue to serve as
Chairman of the Board of Directors of Mofet Management as a designee of
Decision.
4. OPTIONS TO PURCHASE DSSI STOCK. The 220,000 vested options to purchase
shares of DSSI stock currently owned by Fogel will be amended so that they
shall remain exercisable until the stated expiration thereof. The
amendment will make the exercise of the options subject to the full and
faithful performance by Fogel of his obligations under this letter
agreement and any other obligations of Fogel to DSSI. The 20,000 unvested
performance-based options owned by Fogel shall expire in accordance with
the terms thereof.
5. LOANS TO FOGEL. Fogel's outstanding loans from DSSI shall be repaid as
follows: (a)approximately $287,000 by December 31, 1998; (b) $38,000 by
June 30, 1999 to be paid from Fogel's severance from Decision; and (c)
$42,000 on terms to be agreed upon.
6. CONSULTING AGREEMENT. DSSI and Fogel shall enter into a multi-year
consulting arrangement under such terms as shall be mutually agreed upon.
7. NON COMPETITION; CONFIDENTIALITY.
(a)Fogel shall be prohibited from soliciting (or being otherwise
associated with any company, partnership or group which shall solicit)
to assume the management of the Mofet Fund or take any other action
which conflicts with the interests of Decision in connection with such
management, unless, as a condition to assuming such management,
Decision shall have received its portion of 10% of the profits of the
Mofet Fund.
(b) Fogel shall not disclose to any person, firm or corporation, except as
otherwise required by law, any information concerning the business,
clients or affairs of DSSI or its subsidiaries that he may have
acquired in the course of, or as an incident to, his employment by
DSSI, for his own benefit or that of any such person, firm or
corporation, or to the detriment or intended or probable detriment of
DSSI.
(c) Fogel shall be prohibited for a period equal to the greater of two
years from the date hereof and the termination of Fogel's consulting
relationship with DSSI, from (i) accepting employment with or serving
as a consultant or in a similar capacity with a competitor of DSSI or
(ii) intentionally engaging in any activity which is contrary to the
interests of DSSI.
If the foregoing accurately sets forth our agreement, please indicate your
acceptance by executing the attached copy of this letter on the space indicated.
Very truly yours,
DATA SYSTEMS & SOFTWARE INC.
/s/ Samuel Fogel By: /s/ George Morgenstern
---------------------- -----------------------
Samuel Fogel George Morgenstern, CEO
<PAGE>
Exhibit 10.4
DATA SYSTEMS & SOFTWARE INC.
- --------------------------------------------------------------------------------
200 ROUTE 17, MAHWAH, NEW JERSEY 07430 (201) 529-2026
FAX (201) 529-3163
December 24, 1998
Samuel Fogel
31 Rechov Argaman
Ramat Efal, ISRAEL
Dear Mr. Fogel,
This letter agreement confirm the agreement between Data Systems &
Software Inc., a Delaware corporation ("DSSI" or the "Company") and Samuel Fogel
(the "Consultant") as follows:
1. CONSULTING SERVICES. DSSI agrees to retain the Consultant to provide
consulting services to DSSI for a period ending on the fourth anniversary
of this Agreement, and the Consultant agrees to provide such services to
DSSI. Such services shall be rendered from time to time, as requested by
the Chief Executive Officer of DSSI. All services hereunder shall be
provided outside the United States.
2. COMPENSATION. In consideration for the services to be provided pursuant to
Paragraph 2, DSSI agrees to pay to the Consultant $72,500 per annum. The
annual retainer shall be payable to the Consultant on a "take or pay"
basis, i.e., whether or not DSSI chooses to use the Consultant's services.
In the event that DSSI requires and the Consultant agrees to provide more
than 300 hours in any particular year, DSSI shall pay the Consultant at
the rate of $250 per hour for such additional services. Such additional
hours may at DSSI's option be deducted from the consulting hours for
future years. At the request of the Consultant, DSSI will prepay all or
part of the consulting fees payable to the Consultant, provided that such
prepayment shall not diminish or otherwise affect the obligations of the
Consultant under this Agreement or the letter agreement dated December 23,
1998 relating to Samuel Fogel's resignation from employment with DSSI (the
"Resignation Agreement").
3. ASSIGNABILITY.
(a) In the event that DSSI shall merge or consolidate with any other
corporation, or all or substantially all DSSI's business or assets
shall be transferred in any manner to any other person, such successor
shall thereupon succeed to, and be subject to, all rights, interests,
duties and obligations of, and shall thereafter be deemed to be DSSI
for all purposes hereunder. This Agreement shall be binding upon and
inure to the benefit of any such successor.
(b) This Agreement is personal in nature and neither of the parties hereto
shall assign or transfer this Agreement or any rights or obligations
hereunder, except by operation of law or pursuant to the terms of this
Paragraph; PROVIDED THAT the Consultant may assign this Agreement to a
corporation owned or controlled by him, if such corporation agrees in
writing to be bound by the terms hereof. Notwithstanding such
assignment, (i) the services hereunder will be performed only by
Samuel Fogel or by such other persons as DSSI shall have approved in
writing and (ii) Samuel Fogel will continue to be bound by the terms
of this Agreement and the Resignation Agreement, including without
limitation all confidentiality and noncompetition covenants.
(c) Except as otherwise provided in this Paragraph, nothing expressed or
implied herein is intended or shall be construed to confer upon or
give to any person, other than the parties hereto, any right, remedy
or claim under or by reason of this Agreement or of any term, covenant
or condition hereof.
<PAGE>
DATA SYSTEMS & SOFTWARE INC.
- --------------------------------------------------------------------------------
200 ROUTE 17, MAHWAH, NEW JERSEY 07430 (201) 529-2026
FAX (201) 529-3163
4. CONFIDENTIALITY. The Consultant shall not during the term of this
Agreement or thereafter disclose to any person, firm or corporation,
except as otherwise required by law, any information concerning the
business, clients or affairs of DSSI (which as used in Paragraphs 4 and 5
of this Agreement shall include all of DSSI's subsidiaries and affiliates)
that he may have acquired in the course of, or as an incident to, his
employment or his relationship as a consultant with DSSI.
5. NONCOMPETE.The Consultant shall be bound by the covenants against
competition set forth in the Resignation Agreement..
If the foregoing accurately sets forth our agreement, please indicate
your acceptance by executing the annexed copy of this letter in the space
indicated and returning it to us at the above address.
Very truly yours,
DATA SYSTEMS & SOFTWARE INC.
By: /s/ George Morgenstern
--------------------------
George Morgenstern
AGREED AND ACCEPTED:
/s/ Samuel Fogel
- -----------------
Samuel Fogel
<PAGE>
Exhibit 10.14
Decision Systems Israel Ltd.
11 Ben Gurion Avenue
Givat Shmuel, ISRAEL 51905
April 23, 1998
Geotek Communications, Inc.
102 Chestnut Ridge Road
Montvale, NJ 07645
Attn: Robert Vecsler, Esq.
Re: $2,000,000 Unsecured Promissory Note dated July 1, 1996 by
Geotek Communications, Inc. to Decisions Systems Israel Ltd.
------------------------------------------------------------
Dear Sirs:
Reference is made to the above-captioned note and the letter agreement
dated February 26, 1998 ("the February Letter Agreement"). All capitalized terms
not otherwise defined herein shall have the meanings given them on the February
Letter Agreement. Geotek and DSI hereby further agree as follows:
1. Geotek will issue to DSI 3,000,000 shares of Common Stock. These
shares will be delivered by DWACS transfer on Friday, April 24, 1998 as per the
instructions previously delivered to you.
2. After the delivery of the shares referred to in paragraph 1 above,
the indebtedness of Geotek under the Note shall be $610,856, plus accrued
interest thereon from April 21, 1998.
3. Geotek and DSI hereby agree that all principal amounts outstanding
on the Note and all accrued and unpaid interest thereon as of the Additional
Conversion Date (as defined below) shall be converted on the Additional
Conversion Date into shares of Common Stock (the "Additional Conversion"). In
connection with the Additional Conversion, DSI shall be entitled to receive a
whole number of shares of Common Stock equal to the principal amount outstanding
on the Note and all accrued and unpaid interest thereon as of the Additional
Conversion Date, divided by the closing bid price on the Additional Conversion
Date of the Common Stock on the principal market on which shares of Common Stock
are traded (the "Additional Conversion Shares"). Such notice may be given after
the close of trading of the Common Stock on the
<PAGE>
Geotek
April 22, 1998
Page 2 of 2
Additional Conversion Date, but no later than 6:00 p.m. As used herein, the term
"Additional Conversion Date" shall mean the date on which DSI shall have
received written notice from Geotek that it is legally able to issue the
Additional Conversion Shares. Such notice shall be made in writing (by hand
delivery or confirmed facsimile) and shall be effective upon delivery to EACH of
the persons named on Schedule I hereto.
4. Delivery of the Additional Conversion Shares shall be made no later
than three days after the Additional Conversion Date by DWACS transfer to a
brokerage account designated in writing by DSI.
5. Geotek hereby agrees in good faith to take reasonable steps to
effectuate the conversion of the unpaid amount of the Note in accordance with
the terms of this Letter Agreement and the registration of the Additional
Conversion Shares.
6. In the event that the Additional Conversion Date has not occurred on
or prior to July 1, 1998, this Agreement shall become void and of no further
force and effect and the amount of $610,856 plus accrued interest thereon from
April 21, 1998 shall remain due and payable on the Note in accordance with the
terms thereof.
7. DSI represents to Geotek that it is an "accredited investor" as
defined in Rule 501 promulgated under the Securities Act of 1933, as amended.
Please confirm Geotek's acceptance of this agreement by signing the
enclosed copy of this letter below and returning it to me at your earliest
opportunity.
Sincerely yours,
DECISION SYSTEMS ISRAEL LTD.
/s/ George Morgenstern
------------------------------
By: George Morgenstern
Title: Chairman
Accepted and Agreed:
GEOTEK COMMUNICATIONS, INC.
/s/ Robert Vecsler
- ----------------------------------
By: Robert Vecsler, Esq.
Title: Senior Vice President and General Counsel
<PAGE>
Exhibit 10.18
[LOGO] Bank Leumi PROMISSORY NOTE (GRID)
Trust Company of New York
MEMBER FDIC
@@ Wherever used herein, the name Bank Leumi Trust Company of New York is
replaced with the name Bank Leumi USA.
New York, N.Y. March 24 , 1998 $ 1,000,000.00
For Value Received, Data Systems & Software Inc. and Databit Inc. promise
to pay to the order of BANK LEUMI TRUST COMPANY OF NEW YORK @@ ("the Bank")at
its offices at 579 Fifth Avenue, New York, New York, the principal sum of One
Million*************************************************************************
Dollars or, if less, the aggregate unpaid principal sum of all loans made by the
Bank, in its sole discretion, to the maker of this Note from time to time. The
principal sum of each such loan shall be payable (strike out whichever is not
applicable):
360 days after the date of such loan.
Each loan shall bear Interest (from the date of such loan) at a rate per
annum which shall be equal to 1% per annum above the rate of interest
designated by the Bank, and In effect from time to time, as its "Reference
Rate", adjusted when said Reference Rate changes. (The maker acknowledges that
the Reference Rate may not necessarily represent the lowest rate of interest
charged by the Bank to customers.)
The Bank is hereby authorized to enter on the schedule attached hereto the
amount of each loan and each payment of principal thereon, without any further
authorization on the part of the maker or any endorser or guarantor of this
Note, but the Bank's failure to make such entry shall not limit or otherwise
affect the obligations of the maker or any endorser or guarantor of this Note.
The maker and each endorser and guarantor of this Note acknowledge and
agree that the use of this form of Note is for their convenience, and there is
no obligation on the part of the Bank to make loans to the maker whatsoever.
Interest shall be computed on the basis of a 360-day year and shall be
payable at the end of each month and at maturity, but the foregoing provision
shall not be deemed to change the maturity of this Note if payable on demand.
The charging of interest on the basis of a 360--day year results in the payment
of more interest than would be required if interest were charged on the basis of
the actual number of days in the year. In no event shall interest exceed the
maximum legal rate permitted for the maker.
Each maker or endorser authorizes (but shall not require) the Bank to
debit any account maintained by the maker or endorser with the Bank, at any date
on which the payment of principal of or interest on any of the liabilities (as
hereinafter defined) is due, in an amount equal to any unpaid portion of such
payment. If the time for payment of principal of or interest on any of the
Liabilities or any other money payable hereunder or with respect to any of the
Liabilities becomes due on a day on which the Bank's offices are closed (as
required or permitted by law or otherwise), such payment shall be made on the
next succeeding business day, and such extension shall be included in computing
interest in connection with such payment. All payments by any maker or endorser
of this Note on account of principal, interest or fees hereunder shall be made
in lawful money of the United States of America, in immediately available funds.
All Property (as hereinafter defined) held by the Bank shall be subject to
a security interest in favor of the Bank or holder hereof as security for any
and all Liabilities. The term "Property" shall mean the balance of every deposit
account of the maker with the Bank or any of the Banks nominees or agents and
all other obligations of the Bank or any of its nominees or agents to the maker,
whether now existing or hereafter arising, and all other personal property of
the maker (including without limitation all money, accounts, general intangibles
goods, instruments, documents and chattel paper) which, or evidence of which,
are now or at any time in the future shall come into the possession or under the
control of or be in transit to the Bank or any of its nominees or agents for any
purpose, whether or not accepted for the purposes for which it was delivered.
The term "Liabilities" shall mean the indebtedness evidenced by this Note and
all other indebtedness, liabilities and obligations of any kind of the maker (or
any partnership or other group of which the maker is a member) to (a) the Bank,
(b) any group of which the Bank is a member, or (c) any other person if the Bank
has a participation or other interest in such indebtedness, liabilities or
obligations, whether (i) for the Bank's own account or as agent for others, (ii)
acquired directly or indirectly by the Bank from the maker or others, (iii)
absolute or contingent, joint or several, secured or unsecured, liquidated or
unliquidated, due or not due, contractual or tortious, now existing or hereafter
arising, or (iv) incurred by the maker as principal, surety, endorser, guarantor
or otherwise, and including without limitation all expenses, including
attorneys' fees, incurred by the Bank in connection with any such indebtedness,
liabilities or obligations or any of the Property (including any sale or other
disposition of the Property).
Upon the happening, with respect to any maker, endorser or guarantor of
this Note or any assets of any such maker, endorser or guarantor, of any of the
following events: death; the issuance of a warrant of attachment whether valid
or not; dissolution (if a corporation or partnership); the making of a mortgage
or pledge; the commencement of a foreclosure proceeding; default in the payment
of principal of interest on title Note or in the payment of any other obligation
of any said maker, endorser or guarantor held by the Bank or holder hereof;
default in the payment of principal of or interest on any indebtedness for
borrowed money owed to the Bank or any other person or entity (including any
such indebtedness in the nature of a lease) or default in the performance or
observance of the terms of any instrument pursuant to which such indebtedness
was created or is secured, the effect of which default is to cause or permit any
holder of any such indebtedness to cause the same to become due prior to its
stated maturity (and whether or not such default is waived by the holder
thereof); a change in the financial condition or affairs of any of them which in
the opinion of the Bank or subsequent holder hereof materially reduces his,
their or its ability to pay all of his, their or its obligations; the suspension
of business; the filing of a petition in bankruptcy whether voluntary or
involuntary; the filing of an application, whether voluntary or involuntary, for
reorganization or any arrangement or readjustment of indebtedness; the
appointment or the filing of an application for the appointment of any receiver,
trustee, liquidator or any committee; an assignment for the benefit of
creditors; the calling of a meeting of creditors; the offering of a composition
or extension to creditors: the sending of notice of an intended bulk sale: the
entry of judgements; or the issuance of a warrant of distraint or assertion of a
lien for unpaid taxes, this Note, if not then due or payable on demand, shall
become due and payable immediately without demand or notice and all other debts
or obligations of the makers and endorsers hereof to the Bank or holder hereof,
whether due or not due end whether direct or contingent and howsoever evidenced,
shall, at the option of the Bank or holder hereof, also become due and payable
immediately without demand or notice. After this Note becomes due, at stated
maturity or on acceleration, any unpaid balance hereof shall bear interest from
the date it becomes due until paid at a rate per annum 3% above the rate borne
by this Note when it becomes due or, if such rate shall not be lawful with
respect to the undersigned, then at the highest lawful rate. The liability of
any party to commercial paper held by the Bank or holder hereof, other than the
makers and endorsers hereof, shall remain unaffected hereby and such parties
shall remain liable thereon in accordance with the original tenor thereof. Each
maker and endorser agrees that if an attorney is retained to enforce or collect
this Note or any other obligations by reason of non-payment of this Note when
due or made due hereunder, a reasonable attorneys' fee shall be paid in
addition, which fees shall be computed as follows: 15% of the principal,
interest and all other sums due and owing to the payee or holder or the
reasonable value of the attorneys services, whichever is greater.
This Note shall be governed by the laws of the State of New York and shall
be binding upon the maker and each endorser and the maker's and each endorser's
heirs, administrators, successors and assigns. The maker and each endorser
hereby irrevocably consent to the jurisdiction of any New York State or Federal
court located in New York City over any action or proceeding arising out of any
dispute between the maker and each endorser and the Bank, and the maker further
irrevocably consents to the service of process in any such action or proceeding
by the mailing of a copy of such process to the maker at the address set forth
below. In the event of litigation between the Bank and the maker over any matter
connected with this Note or resulting from transactions hereunder, the right to
a trial by jury is hereby waived by the Bank and the maker. A waiver by the
Bank, in one or more instances, of any of the terms and provisions of this Note
shall be in writing, shall apply to the particular instance or instances and at
the particular time or times only, and shall not be deemed to be a continuing
waiver.
* See Rider annexed hereto and made a part hereof. Data Systems & Software Inc.
----------------------------
----------------------------
----------------------------
(Address)
VALUE RECEIVED 200 Rt. 17 Mahwah. NJ
----------------------------
Databit Inc.
----------------------------
----------------------------
FORM NO. 763 (10/86)
200 Re. 17 Mahwah, NJ
<PAGE>
RIDER TO PROMISSORY NOTE (GRID)
EXECUTED ON _____________BY
DATABIT, INC. ("DATABIT")
AND
DATA SYSTEMS & SOFTWARE, INC.
* the Liabilities shall exceed, at any time, eighty percent (80%) of
eligible receivables (determined in the Bank's sole and absolute discretion but
in any event such receivables shall not be aged more than ninety (90) days from
the invoice date); DataBit shall fail to submit, by the tenth day of each month,
an accounts receivable aging for the immediately preceding month; DataBit shall
loan, contribute or otherwise transfer any cash or property to any Affiliate of
DataBit or enter into any transaction, including without limitation the
purchase, sale or exchange of property or the rendering of any service to any
Affiliate of DataBit, except for transactions with Affiliates of DataBit which
are at arms length, are for fair value and are in the ordinary course of
DataBit's and such Affiliate's business (the term "Affiliate" shall mean and
include any corporation, person, or entity (1) which directly or indirectly
controls, or is controlled by, or is under common control with DataBit; (2)
which directly or indirectly beneficially owns or holds ten percent (10%) or
more of any class of voting stock of DataBit or any subsidiary, or (3) ten
percent (10%) or more of the voting stock of which is directly or indirectly
beneficially owned or held by DataBit of one of its shareholders. The term
"control" means the possession, directly or indirectly, of the power to direct
or cause the direction of the management and polices of a corporation, person,
or entity, whether through the ownership of voting securities, by contact or
otherwise. The term "Subsidiary" means any corporation of which more than 50% of
the outstanding shares of capital stock having ordinary voting power to elect a
majority of the Board of Directors of such Corporation (irrespective of whether
or not at the time capital stock of any other class or classes of such
corporation shall or might have voting power upon the occurrence of any
contingency) is at the time, directly or indirectly owned by DataBit or by one
or more other Subsidiaries);
"The foregoing shall in no way inhibit DataBit from repaying obligations to its
parent company, Data Systems & Software, Inc. ("Systems") which obligations are
presently in excess of $850,000. Nor shall this note inhibit DataBit from paying
Systems management fees, which fees shall not exceed 30% of DataBit's general
and administrative expenses or from declaring and paying out dividends of up to
50% of DataBit's current year's net income, provided, however, that DataBit
maintain a minimum Tangible Net Worth, exclusive of amounts due from Affiliates,
of $1,400,000.00 "Tangible Net Worth" shall mean the excess of the total assets
of DataBit over their Total Liabilities, excluding, however, from the
determination of total assets, all assets which would be classified as
intangible under generally accepted accounting principles, including, without
limitation, patents, trademarks, trade names, copyrights, franchises, deferred
charges and goodwill and any write up of the book value of assets since December
31, 1997. "Total Liabilities" shall mean all items of liability, indebtedness
and obligation of DataBit which would, in accordance with generally accepted
accounting principles, be classified as liabilities on the combined balance
sheet of DataBit."
DATABIT, INC.
Shlomie Morgenstern, Treasurer Alice M. Knoll, Secretary
By: /s/ Shlomie Morgenstern By: /s/ Alice M. Knoll
-------------------------- ---------------------------
DATA SYSTEMS & SOFTWARE, INC.
George Morgenstern, President & C.E.O.
By: /s/ George Morgenstern
----------------------------
<PAGE>
Exhibit 10.22
EMPLOYMENT AGREEMENT
--------------------
EMPLOYMENT AGREEMENT dated as of January 1, 1999 between DATA
SYSTEMS & SOFTWARE INC., a Delaware corporation (the "Company"), and YACOV
KAUFMAN (the "Executive").
W I T N E S S E T H:
WHEREAS, the Executive has been the Vice President and Chief
Financial Officer of the Company since 1996, Vice President of its
subsidiary Decision Systems Israel Ltd. ("DSI") since 1990 and under its
employ since May 1986, and has successfully fulfilled the responsibilities
of his positions in the Company and its subsidiaries; and
WHEREAS, the Company desires to assure itself of the Executive's
continued services, and the Executive is willing to continue to provide
such services to the Company, all upon the terms and conditions
hereinafter set forth.
NOW, THEREFORE, in consideration of the promises hereinafter set
forth, the parties hereto, intending to be legally bound, hereby agree as
follows:
1. EMPLOYMENT.
The Company shall employ the Executive, and the Executive shall serve, as
Vice President and Chief Financial Officer of the Company and DSI during
the period commencing January 1, 1999 through December 31, 2000 (the
"Employment Period"). During the Employment Period the Executive shall
devote his best efforts and services to his employment on a substantially
full-time basis. The place of employment shall be the headquarters of DSI,
which shall at all times be in the Central Area of Israel. The Employment
Period may be extended by agreement of the parties.
2. COMPENSATION.
(a) During the Employment Period the Company shall pay the Executive a
salary at the rate of $10,679 per month commencing on January 1,
1999. This rate shall be adjusted annually, effective as of January
1 of each year, to reflect the increase in the Cost of Living Index
in the US. In addition to this adjustment, during the Employment
Period, the Executive's salary rate shall be reviewed annually by
the Company's Board of Directors (the "BoD"), which may increase the
Executive's salary, as it deems appropriate. The salary shall be
paid in arrears no later than the second day of the month following
the month in which it was earned.
(b) As an inducement to his entering into this Agreement, the Company
agrees to recommend to the Compensation and Stock Option Committee
of the BoD (the "Committee") that the Company grant the Executive
options to purchase 25,000 shares of Common Stock exercisable at
fair market value on the date of the grant. The Executive will be
eligible for future grants of stock options if and as recommended by
management of the Company and the Committee..
(c) During the Employment Period the Executive shall be reimbursed by
the Company for reasonable business expenses actually incurred or
paid by him in connection with the
-1-
<PAGE>
performance of his duties hereunder in accordance with the policies
of the Company. All air travel shall be business class.
(d) During the Employment Period the Company shall contribute and the
Executive shall participate in all of the employee benefit plans
provided to the Company's management employees in Israel, including
without limitation, monthly contribution of (i) 15.83% of the
Executive's salary to the Executive's Management Insurance policy,
(5% pension, 8.33% severance and 2.5% disability insurance), and
(ii) an additional 7.5% of the Executive's salary to the Executive's
Continued Education Fund ("Keren Hishtalmut" in Israel). These funds
and policies will be owned and controlled entirely and solely by the
Executive.
(e) At all times during the Employment Period the Company shall maintain
in the severance portion of the Executive's Manager's Insurance Fund
an amount equal to his monthly salary multiplied by the number of
years (and fractions thereof) that the Executive has been employed
by the Company or any of its subsidiaries. This balance is to be
deducted from any sums owing to the Executive as severance pay
pursuant to Paragraph 4(b) hereof.
(f) The Executive shall be entitled to 22 workdays vacation which shall
be accrued from year to year and redeemable for a cash payment at
the option of the Executive. All accrued vacation exceeding 44 days
shall be automatically redeemed and paid to the Executive.
(g) The Company shall make available to the Executive during the
Employment Period an automobile for the Executive's exclusive use at
the Company's expense. The Company shall also at its own expense pay
for all operating costs, repairs, insurance, parking and all
withholding taxes for such automobile.
3. OTHER ACTIVITIES.
The Executive expressly agrees, as a condition to the performance by the
Company of its obligations hereunder, that at all times during the
Employment Period, the Executive shall not directly or indirectly engage
in, as a director, officer, employee, partner or stockholder in any
business, association, firm or corporation (other than the Company or
any parent, subsidiary or successor of it) that is engaged in whole or
in part in a business that is in substantial and direct competition with
the business of the Company or any of its subsidiaries, except that the
Executive may own not in excess of 10% (or such greater percentage as to
which the Board of Directors of the Company shall consent) of any class
of securities of any such competitive entity that is registered under
Section 12 of Exchange Act or otherwise publicly traded.
4. TERMINATION.
(a) Each of the Company and the Executive shall have the right to
terminate the Executive's employment with the Company and its
subsidiaries upon written notice to the other party. Such notice
shall specify the date (the "Termination Date") upon which the
Executive's services to the Company shall terminate (which date
shall be the last day of a calendar month not less than 30 days
after the date such notice is given, unless such termination is for
Cause as defined in Paragraph 4(g)).
(b) Upon the Termination Date or upon expiration of the Employment
Period, the Company shall pay the Executive severance pay equal to
150% his last months salary multiplied by the number of years (and
any fraction of any year) that the Executive has been employed
-2-
<PAGE>
by the Company or any of its subsidiaries. Such payment shall be
reduced by the balance in the Executive's severance fund pursuant to
Paragraph 2(d) above.
(c) In addition to the severance payment pursuant to Paragraph 4(b),
i. upon expiration of the Employment Period or upon the Termination
Date, if the Company initiates the termination pursuant to Paragraph
4(a) hereof or the Executive exercises his right under Paragraph
4(c) hereof, the Company shall pay the Executive a termination
payment equal to five times his last month's salary; or
ii. in the event that the Executive terminates his employment pursuant
to Paragraph 4(a) hereof, upon the Termination Date the Company
shall pay the Executive a termination payment equal to two times his
last month's salary.
These payments are in addition to any other rights and payments
owing to the Executive under this Agreement. Notwithstanding any of
the foregoing provisions to the contrary of this Paragraph 4(c), the
Executive shall not be entitled to a termination payment hereunder
in the event of the termination of his employment for Cause as
defined in Paragraph 4(g).
(d) Notwithstanding anything to the contrary herein, if at any time
during the Employment Period, the Company breaches any of its
obligations hereunder or there shall occur a "Change in Control of
the Company" (as hereinafter defined), the Executive shall have the
option, upon written notice to the Company that such breach or a
Change in Control of the Company has occurred and that the Executive
intends to exercise such option, to terminate his employment with
the Company. For purposes of this Agreement, a "Change in Control of
the Company" shall be deemed to have occurred if (i) there shall be
consummated (A) any consolidation or merger of the Company in which
the Company is not the continuing or surviving corporation or
pursuant to which shares of the Company's Common Stock would be
converted in whole or in part into cash, securities or other
property, other than a merger of the Company in which the holders of
the Company's Common Stock immediately prior to the merger have
substantially the same proportionate ownership of common stock of
the surviving corporation immediately after the merger, or (B) any
sale, lease, exchange or transfer (in one transaction or a series of
related transactions) of all or substantially all the assets of the
Company, or (ii) the stockholders of the company shall approve any
plan or proposal for the liquidation or dissolution of the Company,
or (iii) any "person" (as such term is used in Sections 13 (d) and
14 (d) (2) of the Securities Exchange Act of 1934, as amended (the
"Exchange Act"), other than the Company or a subsidiary thereof or
any employee benefit plan sponsored by the Company or a subsidiary
thereof, shall become the beneficial owner (within the .meaning of
Rule 13d-3 under the Exchange Act) of securities of the Company
representing 20% or more of the combined voting power of the
Company's then outstanding securities ordinarily (and apart from
rights accruing in special circumstances) having the right to vote
in the election of directors, as a result of a tender or exchange
offer, open market purchases, privately negotiated purchases or
otherwise, or (iv) at any time during a period of two consecutive
years, individuals who at the beginning of such period constituted
the Board of Directors of the Company shall cease for any reason to
constitute at least a majority thereof, unless the election or the
nomination for election by the Company's stockholders of each new
director during such two-year period was approved by a vote of at
least two-thirds of the
-3-
<PAGE>
directors then still in office who were directors at the beginning
of such two-year period or (v) any other event shall occur that
would be required to be reported in response to Item 6(e) of
Schedule 14A of Regulation 14A promulgated under the Exchange Act.
(e) The Executive shall not be required to seek other employment in
order to mitigate his damages hereunder, and no amounts received
from any such employment shall reduce any amount that the Company
would otherwise be required to pay to under this Agreement or
applicable law.
(f) In the event that the Executive institutes any legal action to
enforce his rights under, or to recover damages for breach of this
Agreement, the Executive, if he is the prevailing party, shall be
entitled to recover from the Company any actual expenses of such
action, including attorneys' fees, disbursements and travel
expenses, incurred by him.
(g) The Company may at any time terminate Executive's employment
hereunder for Cause by delivering notice of termination to Executive
(such termination to be effective upon delivery of such notice). For
purposes of this Agreement, "Cause" means the occurrence in fact of
any of the following:
i. Executive is convicted of a felony or other crime involving moral
turpitude;
ii. Executive performs his duties hereunder with gross negligence;
iii. Executive engages in gross misconduct that materially injures the
Company;
iv. Executive materially breaches his fiduciary duties as an employee of
the Company and fails to cure such breach promptly upon written
notice thereof; or
v. Executive materially breaches any of his other obligations under
this Agreement.
5. CONFIDENTIALITY.
The Executive shall not during the term of this Agreement or thereafter
disclose to any person, firm or corporation, except as otherwise required
by law, any information concerning the business, clients or affairs of the
Company that he may have acquired in the course of, or as an incident to,
his employment by the Company, for his own benefit or that of any such
person, firm or corporation, or to the detriment or intended or probable
detriment of the Company.
6. INDEMNIFICATION.
The Executive shall be entitled throughout the term of this Agreement and
thereafter to indemnification in respect of any claim, suit, action, loss
or damages arising out of or relating to his acts or omissions as an
employee, officer or director of the Company, and\or any of its
subsidiaries, (or any successor pursuant to Paragraph 12 hereof) to the
fullest extent permitted by the Delaware General Corporation Law or other
applicable law, provided, however, that in the event of a suit by the
Company against the Executive, the Company shall have no obligation to
advance any costs of counsel.
7. REMEDIES.
The Company hereby waives, and will not assert, any right to set off the
amount of any claims, liabilities, damages or losses the Company may have
against any amounts payable by the Company to the Executive hereunder, and
any amounts payable to or otherwise accrued for the account of the
Executive in respect of any period prior to the effective termination of
this Agreement shall be paid as provided in this Agreement without any
such set-off.
-4-
<PAGE>
8. ARBITRATION.
Any controversy or claim arising out of or relating to this Agreement, or
any breach thereof, shall be settled by arbitration in accordance with the
rules of the American Arbitration Association, and judgement upon such
award rendered by the arbitrator may be entered in any court having
jurisdiction thereof. The arbitration shall be held in New York, New York,
or such other place as may be agreed upon at the time by the parties to
the arbitration. The Company will pay for all travel and related expenses
as may be reasonably required by the Executive so as to afford his
presence at all such proceedings.
9. GOVERNING LAW.
This Agreement shall be governed by and construed and enforced in
accordance with the laws of the State of New York, without giving effect
to the conflicts of law principles thereof.
10. EMPLOYMENT AGREEMENT WITH SUBSIDIARY.
The Executive may have an employment agreement with a subsidiary or
subsidiaries of the Company. Any payments made in accordance with such
agreements are to be deducted from the Company's similar obligations in
this agreement.
11. ENTIRE AGREEMENT.
This Agreement constitutes the whole agreement of the parties hereto in
reference to any employment of the executive by the Company and in
reference to any of the matters or things herein provided for or discussed
or mentioned in reference to such employment, all prior agreements,
promises, representations and understandings relative thereto being herein
merged.
12. ASSIGNABILITY.
(a) In the event that the Company shall merge or consolidate with any
other corporation or all or substantially all the Company's business
or assets shall be transferred in any manner to any other person,
such successor shall thereupon succeed to, and be subject to, all
rights, interests, duties and obligations of, and, subject to the
provisions of Paragraph 4(d) relating to Change in Control, shall
thereafter be deemed for all purposes hereto to be the Company
hereunder. This Agreement shall be binding upon and inure to the
benefit of any such successor and the legal representatives of the
Executive.
(b) This Agreement is personal in nature and neither of the parties
hereto shall assign or transfer this Agreement or any rights or
obligations hereunder, except by operation of law or pursuant to the
terms of this Paragraph 12.
(c) Except as otherwise provided in this Paragraph 12, nothing expressed
or implied herein is intended or shall be construed to confer upon
or give to any person, other than the parties hereto any right,
remedy or claim under or by reason of this Agreement or of any term,
covenant or condition hereof.
13. AMENDMENTS; WAIVERS.
This Agreement may be amended, modified, superseded or cancelled and the
terms or covenants hereof may be waived only by a written instrument
executed by both of the parties hereto, or in the case of a waiver, by the
party waiving compliance. The failure of either party at any time or times
to require performance of any provision hereof shall in no manner affect
the right at a later time to enforce the same. No waiver by either party
of the breach of any term or covenant contained in this Agreement, whether
by conduct or otherwise, in any one or more instances, shall be deemed to
be, or construed as, a further or continuing waiver of any such breach, or
a waiver of the breach of any other term or covenant contained in this
Agreement.
-5-
<PAGE>
14. NOTICES.
All notices and other communications given pursuant to this Agreement
shall be in writing and shall be deemed given if (i) delivered by hand,
(ii) mailed by registered or certified mail (return receipt requested),
postage prepaid, or (iii) deposited with Federal Express or other
recognized over-night courier service, to any party addressed as follows
(or to such other address as shall be specified by a party by like
notice).
If to the Company: If to the Executive:
Data Systems & Software Inc. Yacov Kaufman
200 Route 17 42 Ginio St.
Mahwah, New Jersey 07430 Jerusalem, 97289
USA ISRAEL
15. SEVERABILITY.
If for any reason any provision of this Agreement shall be determined to
be illegal and unenforceable by any court of law, the validity and effect
of all other provisions hereof shall not be affected thereby.
16. HEADINGS.
Section headings are for convenience only and shall not be considered a
part of the terms and provisions of this Agreement.
17. COUNTERPARTS.
This Agreement may be executed in counterparts, each of which shall
constitute an original and which together shall constitute one and the
same agreement.
IN WITNESS WHEREOF the parties hereto have executed this
Agreement, as of the day and year first above written.
DATA SYSTEMS & SOFTWARE INC.
/s/ Yacov Kaufman By: /s/ George Morgenstern
------------------------- ----------------------
Yacov Kaufman George Morgenstern
CEO and President
By: /s/ Sheldon Krause
------------------
Sheldon Krause
Secretary
-6-
<PAGE>
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in the Registration Statements of
Data Systems & Software Inc. (Forms S-8 Nos. 33-88442, 33-99196, 33-94974,
333-65799 and 333-36159) of our report dated March 16, 1999 relating to the
consolidated financial statements of Data Systems & Software Inc., appearing in
the Annual Report on Form 10-K of Data Systems & Software for the year ended
December 31, 1998.
Deloitte & Touche LLP
New York, New York
March 22, 1999
<PAGE>
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in the Registration
Statements of Data Systems & Software Inc. (Forms S-8 Nos. 33-88442,
33-99196, 33-9474, 333-65799 and 333-36159) of (i) our report dated March 31,
1997, relating to the consolidated financial statements of Data Systems &
Software Inc. and (ii) our report dated January 26, 1999 relating to the
consolidated financial statements of Tower Semiconductor Ltd., both such
reports appearing in the Annual Report on Form 10-K of Data Systems &
Software Inc. for the year ended December 31, 1998.
Brightman Bar-Levav & Co.
Certified Public Accountants (Isr.)
Tel Aviv, Israel
March 22, 1999
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<PAGE>
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This schedule contains summary financial information extracted from the
consolidated financial statements and is qualified in its entirety by reference
to such financial statements.
</LEGEND>
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<PERIOD-END> DEC-31-1998
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