Three months ended
-------------------------------------------------------------------------------------------------------------------------
2004* 2005
--------------------------------------------------------- ---------------------------------------------------------
MAR. 31, JUN. 30, SEPT. 30, DEC. 31, MAR. 31,* JUN. 30,* SEPT. 30,* DEC. 31,
--------- --------- --------- --------- --------- --------- --------- ---------
CONSOLIDATED STATEMENT OF INCOME DATA:
Revenues $ 14,082 $ 14,374 $ 15,152 $ 16,860 $ 13,726 $ 13,238 $ 15,761 $ 18,557
Cost of revenues 7,779 7,879 8,346 9,222 7,459 8,865 9,817 13,013
--------- --------- --------- --------- --------- --------- --------- ---------
Gross profit 6,303 6,495 6,806 7,638 6,267 4,373 5,944 5,544
--------- --------- --------- --------- --------- --------- --------- ---------
Operating expenses:
Research and development, net 1,131 1,161 1,193 1,198 1,156 1,276 1,337 1,496
Selling and marketing, net 2,587 3,043 2,974 3,915 2,726 3,340 3,503 3,611
General and administrative 1,301 1,417 1,415 1,638 1,413 1,438 1,367 1,743
Award granted by principal shareholders - 1,200 - - - - - -
--------- --------- --------- --------- --------- --------- --------- ---------
Total operating expenses 5,019 6,821 5,582 6,751 5,295 6,054 6,207 6,850
--------- --------- --------- --------- --------- --------- --------- ---------
Operating income (loss) 1,284 (326) 1,224 887 972 (1,681) (263) (1,306)
Financial income (expenses), net (93) (258) (223) (188) (329) (37) (119) (315)
--------- --------- --------- --------- --------- --------- --------- ---------
Income (loss) before income taxes 1,191 (584) 1,001 699 643 (1,718) (382) (1,621)
Income taxes (tax benefit) 451 140 310 232 318 (170) (27) (144)
--------- --------- --------- --------- --------- --------- --------- ---------
Income (loss) from continuing operations 740 (724) 691 467 325 (1,548) (355) (1,477)
Loss from discontinued operations,
net (53) (14) (27) (27) (31) (24) (21) (80)
--------- --------- --------- --------- --------- --------- --------- ---------
Net income 687 (738) 664 440 294 (1,572) (376) (1,557)
========= ========= ========= ========= ========= ========= ========= =========
CONSOLIDATED STATEMENT OF INCOME DATA,
EXPRESSED AS A PERCENTAGE OF REVENUES:
Revenues 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of revenues 55.2 54.8 55.1 54.7 54.3 67.0 62.3 70.1
--------- --------- --------- --------- --------- --------- --------- ---------
Gross profit 44.8 45.2 44.9 45.3 45.7 33.0 37.7 29.9
--------- --------- --------- --------- --------- --------- --------- ---------
Operating expenses: 0.0 0.0 0.0
Research and development, net 8.0 8.1 7.9 7.1 8.4 9.6 8.5 8.1
Selling and marketing, net 18.4 21.2 19.6 23.2 19.9 25.2 22.2 19.5
General and administrative 9.2 9.9 9.3 9.7 10.3 10.9 8.7 9.4
Award granted by principal shareholders - 8.3 - - - - - -
--------- --------- --------- --------- --------- --------- --------- ---------
Total operating expenses 35.6 47.5 36.8 40.0 38.6 45.7 39.4 36.9
--------- --------- --------- --------- --------- --------- --------- ---------
Operating income (loss) 9.1 (2.3) 8.1 5.3 7.1 (12.7) (1.7) (7.0)
Financial income (expenses), net (0.7) (1.8) (1.5) (1.1) (2.4) (0.3) (0.8) (1.7)
--------- --------- --------- --------- --------- --------- --------- ---------
Income (loss) before income taxes 8.5 (4.1) 6.6 4.1 4.7 (13.0) (2.4) (8.7)
Income taxes (tax benefit) 3.2 1.0 2.0 1.4 2.3 (1.3) (0.1) (0.8)
--------- --------- --------- --------- --------- --------- --------- ---------
Income (loss) from continuing operations 5.3 (5.0) 4.6 2.8 2.4 (11.7) (2.3) (8.0)
Loss from discontinued operations, net (0.4) (0.1) (0.2) (0.2) (0.2) (0.2) (0.1) (0.4)
--------- --------- --------- --------- --------- --------- --------- ---------
Net income (loss) 4.9% (5.1)% 4.4% 2.6% 2.2% (11.9)% (2.4)% (8.4)%
========= ========= ========= ========= ========= ========= ========= =========
(*) Reclassified.
SEASONALITY
Our operating results are characterized by a seasonal pattern, with a
higher volume of revenues towards the end of the year and lower revenues in the
first part of the year. This pattern, which is expected to continue, is mainly
due to two factors:
o our customers are mainly budget-oriented organizations with lengthy
decision processes which tend to mature late in the year; and
o due to weather and other conditions, payments are often postponed from
the first quarter to subsequent quarters.
See also Item 3.D. "Key Information-Risk Factors." Our revenues are
dependent on government procurement procedures and practices, and because we
receive large product orders from a relatively small number of customers, our
revenues and operating results are subject to substantial periodic variations.
37
IMPACT OF INFLATION AND DEVALUATION ON RESULTS OF OPERATIONS, LIABILITIES AND ASSETS
Exchange rate fluctuations between the NIS and the dollar, particularly
larger periodic devaluations, may have an impact on our profitability and
period-to-period comparison of our results. In 2001, 2002 and 2005, the rate of
devaluation of the NIS against the dollar was 9.3%, 7.3% and 6.8% respectively,
while in 2003 and 2004 the NIS appreciated in value in relation to the dollar by
7.6% and 1.6%, respectively. A portion of our expenses, primarily labor
expenses, is incurred in NIS and a part of our revenues are quoted in NIS.
Additionally, certain assets, as well as a portion of our liabilities, are
denominated in NIS. Our results may be adversely affected by the devaluation of
the NIS in relation to the dollar (or if such devaluation is on lagging basis),
if our revenues in NIS are higher than our expenses in NIS and/or the amount of
our assets in NIS are higher than our liabilities in NIS. Alternatively, our
results may be adversely affected by an appreciation of the NIS in relation to
the dollar (or if such appreciation is on a lagging basis), if the amount of our
expenses in NIS are higher than the amount of our revenues in NIS and/or the
amount of our liabilities in NIS are higher than our assets in NIS.
The following table presents information about the rate of devaluation of
the NIS against the dollar:
Israeli inflation
Year ended Israeli inflation NIS devaluation adjusted for devaluation
December 31, rate % rate % %
----------- ----------------- --------------- ------------------------
2001 1.4 9.3 (7.9)
2002 6.5 7.3 (0.8)
2003 (1.9) (7.6) 5.7
2004 1.2 (1.6) 2.8
2005 2.4 6.8 (4.4)
Because exchange rates between the NIS and the dollar fluctuate
continuously, exchange rate fluctuations, particularly larger periodic
devaluations, may have an impact on our profitability and period-to-period
comparisons of our results. We are also subject to exchange rate fluctuations
related to our activities in Canada. During the three years ended December 31,
2005, foreign currency fluctuations had an adverse impact on our results of
operations, and our foreign exchange losses, net were ($569,000), ($120,000) and
($145,000), respectively. We cannot assure you that in the future our results of
operations may not be materially adversely affected by currency fluctuations.
To protect against the change in the forecasted foreign currency cash flows
of certain sale arrangements resulting from changes in the exchange rate, during
2003, 2004 and 2005 we entered into forward contracts in order to hedge portions
of our forecasted revenue and unbilled accounts receivable denominated in Euros
and Polish Zlotys. We have designated the forward instruments as cash flow
hedges for accounting purposes.
For derivative instruments designated as cash flow hedges (i.e., hedging
the exposure to variability in expected future cash flows that is attributable
to a particular risk), the effective portion of the gain or loss on the
derivative instrument is reported as a component of other comprehensive income
and reclassified into earnings in the same line item associated with the
forecasted transaction in the same period or periods during which the hedged
transaction affects earnings.
During 2005, we recognized no hedge ineffectiveness for the Euro contract
cash flows hedge as we concluded that the changes in the cash flows attributable
to the changes in the exchange rates were completely offset by the forward
contract.
We determined that sales arrangement in Polish Zlotys and the related
forecasted revenues and unbilled accounts receivable would not occur by the end
of the specified time period. Accordingly, the forward loss was recorded in
financial expenses in 2005.
As of December 31, 2005, we expect to reclassify $6,000 of net income on
derivative instruments from other comprehensive income to earnings during the
next 12 months due to actual sales and related payments.
38
EFFECTIVE CORPORATE TAX RATE
Israeli companies are generally subject to income tax on their worldwide
taxable income. The applicable rate for 2005 was 34%, which was reduced to 31%
in 2006, and will be further reduced to 29% in 2007, 27% in 2008, 26% in 2009
and 25% in 2010 and thereafter. However, certain of our manufacturing facilities
have been granted "Approved Enterprise" status under the Law for the
Encouragement of Capital Investments, 1959, as amended, commonly referred to as
the Investment Law, and, consequently, are eligible, subject to compliance with
specified requirements, for tax benefits beginning when such facilities first
generate taxable income. The tax benefits under the Investment Law are not
available with respect to income derived from products manufactured outside of
Israel. We have derived, and expect to continue to derive, a substantial portion
of our income from our Approved Enterprise facilities. Subject to certain
restrictions, we are entitled to a tax exemption in respect of income derived
from our approved facilities for a period of two years, commencing in the first
year in which such income is earned, and will be entitled to a reduced tax rate
of 10% to 25% for an additional five to eight years if we qualify as a foreign
investors' company. If we do not qualify as a foreign investors' company, we
will instead be entitled to a reduced rate of 25% for an additional five years,
rather than eight years. A foreign investors' company is defined in the
Investment Law as a company in which more than 25% of its shareholders are
non-Israeli residents. Pursuant to the Investment Law, a foreign investors'
company may enjoy benefits for a period of up to ten years, (the actual length
of the benefits period is graduated based on the percentage of foreign
ownership).
Our effective corporate tax rate may substantially exceed the Israeli tax
rate. Our U.S. subsidiaries will generally be subject to applicable federal,
state, local and foreign taxation, and we may also be subject to taxation in the
other foreign jurisdictions in which we own assets, have employees or conduct
activities. Because of the complexity of these local tax provisions, it is not
possible to anticipate the actual combined effective corporate tax rate, which
will apply to us.
As of December 31, 2005, our subsidiaries in the United States and the
United Kingdom had estimated total available carry forward tax losses of $8.3
million and $944,000, respectively, to offset against future taxable income for
16 to 20 years and an indefinite period, respectively. A full valuation
allowance was recorded due to the uncertainty of the tax assets' future
realization. Utilization of U.S. net operating losses may be subject to a
substantial annual limitation due to the "change in ownership" provisions of the
Internal Revenue Code of 1986 and similar state tax law provisions. The annual
limitation may result in the expiration of net operating losses before
utilization.
B. LIQUIDITY AND CAPITAL RESOURCES
GENERAL
Our ongoing liquidity requirements arise primarily from our need to service
debt and provide working capital. From our inception until our initial public
offering in March 1993, we financed our activities mainly through cash flow from
operations and bank loans. In March 1993, we received proceeds of $9.8 million
from an initial public offering of 1,380,000 ordinary shares. In February 1997,
we raised $9.4 million from a follow-on offering of 2,085,000 ordinary shares.
In April 2005, we raised an additional $15.2 million from a follow-on offering
of 1,700,000 ordinary shares. The proceeds from these offerings together with
cash flow from operations and our credit facilities are our main sources of
working capital.
Our working capital at December 31, 2005 was $35.5 million compared to
$21.6 million at December 31, 2004. Cash and cash equivalents amounted to $10.1
million at December 31, 2005 compared to $12.0 million at December 31, 2004.
Short-term and long-term bank deposits and structured notes amounted to $18.9
million at December 31, 2005 compared to $6.0 million at December 31, 2004. Our
cash and cash equivalents, short and long-term bank deposits and a structured
note are held mainly in U.S. dollars.
39
We expect to fund our short-term liquidity needs, including our obligations
under our credit facilities, other contractual agreements and any other working
capital requirements, from cash and cash equivalents, operating cash flow and
our credit facilities. We believe that our current cash and cash equivalents,
including bank deposits, structured note and our expected cash flow from
operations in 2006 will be sufficient to meet our planned and potential cash
requirements through 2006.
CASH FLOWS
The following table summarizes our cash flows for the periods presented:
YEARS ENDED DECEMBER 31,
---------------------------------------
2003 2004 2005
------- -------- --------
(in thousands)
Net cash provided by (used in) continuing operations $ 1,705 $ 3,988 $ (3,820)
Net cash provided by (used in) discontinued operations 19 (310) (319)
------- -------- --------
Net cash provided by (used in) operating activities 1,724 3,678 (4,139)
Net cash provided by (used in) investing activities (3,606) 512 (15,248)
Net cash provided by financing activities 3,500 3,096 17,269
Effect of exchange rate changes on cash and cash equivalents 252 289 253
------- -------- --------
Increase (decrease) in cash and cash equivalents 1,870 7,575 (1,865)
Cash and cash equivalents at the beginning of the year 2,519 4,389 11,964
------- -------- --------
Cash and cash equivalents at the end of the year $ 4,389 $ 11,964 $ 10,099
------- -------- --------
Net cash used in operating activities was ($4.1) million for the year ended
December 31, 2005 compared to net cash provided by operating activities of $3.7
million and $1.7 million for the years ended December 31, 2004 and 2003,
respectively. The decrease in cash from operations was primarily due to losses
incurred in 2005 as a result of expenses related to the project in Eastern
Europe which was cancelled and to the increase in revenues in 2005 attributable
to the seam line project. A large portion of the seam line project was recorded
in the second half of 2005, and a substantial portion of the billing under this
project was collected in the first six months of 2006. Purchases of property and
equipment in 2003, 2004 and 2005 were $3.2 million, $4.9 million and $2.7
million, respectively. Capital expenditures in 2003, 2004 and 2005 were
principally for equipment for Smart, computers and other machinery and
equipment. We estimate that our capital expenditures for 2006 will total
approximately $2.7 million, of which 65% will be spent in Israel, 30% in the
U.S. and Canada and 5% in other countries. We expect to finance these
expenditures primarily from our cash and cash equivalents, operating cash flow
and our credit facilities. However, the actual amount of our capital
expenditures for 2006 will depend on a variety of factors, including general
economic conditions, changes in the demand for our products and the risks and
uncertainties involved in doing business in Israel.
CREDIT LINES AND OTHER DEBT
We currently have credit lines with Bank Leumi Le-Israel B.M., or BLL,
Union Bank of Israel Ltd., or Union Bank, Mizrahi Tefahot Bank B.M., or MTB, and
Bank Hapoalim B.M. totaling $39.6 million in the aggregate. There are no
restrictions as to our use of any of these credit lines. We agreed not to pledge
any of our assets without the consent of these banks. In addition, in connection
with two of these credit lines, a fixed charge was placed on our physical plant
in Israel by each of BLL and Union Bank, each of which ranks pari-passu with the
other.
We have undertaken to maintain the following financial ratios and terms in
respect of our credit lines with each of BLL and MTB:
o A ratio of at least 40% of shareholders' equity out of the
consolidated total assets;
40
o Minimal annual consolidated net income in the amount of $1 million;
and
o The same shareholders maintain the core of control in our company.
We have also undertaken to maintain the same financial ratios in respect of
our long term credit line with Union Bank, which credit line was not used as of
December 31, 2005.
As of December 31, 2005, we were not in compliance with the requirement
under our credit lines with BLL and MTB that we will have a minimum annual
consolidated net income of $1 million. BLL has agreed to waive such requirement
for 2005 and informed us that it will not require the immediate repayment of our
outstanding indebtedness as a result of such non-compliance. While we have not
received a formal waiver from MTB to date, we believe that such waiver will be
obtained within the next few weeks. As of December 31, 2005, the balance of
short-term bank credit due to MTB amounted to approximately $2.4 million.
If we fail to fulfill our undertakings and covenants as aforesaid, these
three banks will be entitled to demand the immediate repayment of any of our
outstanding indebtedness to them and may terminate our credit lines with them.
Our loans under these credit lines are generally denominated in dollars.
However, we may occasionally have short-term NIS-denominated loans.
In addition, our subsidiaries currently have credit lines with Bank Leumi
USA, Royal Bank of Canada and Deutsche Bank totaling $9.3 million in the
aggregate.
Our Canadian subsidiary, Senstar Stellar Corporation, or Senstar, has
undertaken to maintain general covenants and the following financial ratios and
terms in respect of its outstanding credit lines:
o A quick ratio of not less than 1.25;
o A ratio of total liabilities to tangible net worth of not greater than
0.75; and
o Tangible net worth of at least $9.0 million.
o As of December 31, 2005, Senstar was in compliance with these ratios
and terms.
As of December 31, 2005, we had approximately $12.0 million available under
our credit lines. In addition, our subsidiaries had approximately $3.8 million
available under their credit lines.
As of December 31, 2005, our outstanding balance under our credit lines
consisted of:
o Short-term NIS-denominated loans of approximately $1.7 million,
bearing an average interest at a rate of 5%;
o Short-term dollar-denominated loans of approximately $15.1 million,
bearing an average interest at a rate of 4.1%;
o Short-term Polish Zloty-denominated loan of approximately $1.2
million, bearing an average interest at a rate of 5.9%;
o Several bank performance and advance payment guarantees totaling
approximately $8.6 million, at an annual cost of 0.5%-1.0%; and
o Forward contracts of approximately $1.1 million.
41
As of December 31, 2005, our subsidiaries had outstanding, in the
aggregate, $5.3 million in long-term loans as follows:
o $2.5 million, bearing interest at a fixed annual rate of 3.1%. The
interest on the outstanding balance under this loan is due monthly.
This loan is due in one installment in April 2006;
o $500,000, bearing interest at an annual rate of 5.6% and
collateralized by the assets of our US subsidiary, Magal Senstar Inc.,
or MSI. This loan is due in one installment in April 2006;
o $500,000, bearing interest at an annual rate of 5.2% and
collateralized by MSI's assets. This loan is due in one installment in
April 2006;
o $820,000 to MSI, bearing interest at a fixed rate of 5.5%. The loan is
due in 20 quarterly installments of $47,200, commencing February 2006.
We have guaranteed the full amount of this loan; and
o $980,000 to MSI, bearing interest at a fixed rate of 5.5%. The loan is
due in one installment in November 2010. We have guaranteed the full
amount of this loan.
In connection with the related loans listed immediately above, Bank Leumi
USA placed a $3.0 million fixed charge on our deposits with that bank.
The two $500,000 promissory notes issued to Bank Leumi USA both have
covenants that require us to maintain $1.0 million in deposits at all times,
otherwise the interest rate on the notes become the bank's rate plus 0.3% until
the minimum deposit is maintained.
As of December 31, 2005, Senstar GmbH obtained bank performance guarantees
in the amount of $130,000.
As of December 31, 2005, Senstar issued a letter of credit in the amount of
$96,000 in connection with the purchase of supplies.
C. RESEARCH AND DEVELOPMENT, PATENTS AND LICENSES.
GOVERNMENT GRANTS
We participate in programs sponsored by the Israeli Government for the
support of research and development activities. In the years ended December 31,
2003, 2004 and 2005, we obtained $139,000 $228,000 and $8,000, respectively, of
royalty-bearing grants from the OCS for certain of our research and development
projects. We are obligated to pay royalties to the OCS amounting to 3%-4.5% of
revenues derived from sales of the products funded with these grants, up to 100%
of the grants received, linked to the U.S. dollar. All grants received after
January 1, 1999 will also bear interest at the rate of LIBOR. The obligation to
pay these royalties is contingent on actual sales of the products, and in the
absence of such sales no payment is required.
Royalties paid to the OCS amounted to $80,000, $61,000 and $83,000 in the
years ended December 31, 2003, 2004 and 2005, respectively.
As of December 31, 2005, we had a contingent obligation to pay royalties of
approximately $1.8 million to the OCS upon the successful sale of products
developed using such research and development programs sponsored by the OCS.
42
The Israeli Government, through the Fund for the Encouragement of Marketing
Activities, awarded us grants for overseas marketing expenses. We are obligated
to pay royalties to this fund at the rate of 3% of the increase in export sales,
up to the amount of the grants we received. To date, we have received $253,000
in grants from the Fund and, during the years ended December 31, 2003, 2004 and
2005, we did not pay any royalties. As of December 31, 2005, we had a remaining
contingent obligation to the Fund of $82,000.
INVESTMENT TAX CREDIT
Senstar is eligible for investment tax credits on its research and
development activities and on certain current and capital expenditures. During
the years ended December 31, 2003, 2004 and 2005, Senstar recognized $216,000,
$177,000 and $153,000, respectively, of investment tax credits as a reduction of
research and development expenses. Senstar has available investment tax credits
of approximately $249,000 to reduce future federal Canadian income taxes
payable. These credits will expire at various dates from 2014 through 2015. See
also Item 4.B. "Information on the Company-Business Overview-Research and
Development; Royalties."
D. TREND INFORMATION.
We cannot assure you that the MOD, IDF or any of our other major customers
will maintain their volume of business with us or that, if such volume is
reduced, other customers of similar volume will replace the lost business. The
loss of one or more of these existing customers without replacement by a
customer or customers of similar volume would have a material adverse effect on
our financial results.
For additional discussion of the information required by this item see
"Operating and Financial Review and Prospects-Operating Results" and "Operating
and Financial Review and Prospects-Liquidity and Financial Resources" above.
E. OFF-BALANCE SHEET ARRANGEMENTS.
At December 31, 2005, we have guaranteed the advance payments and the
performance of our work to certain of our customers (usually government
entities). Such guarantees are required by contract for our performance during
the installation and operational period of projects throughout Israel and the
rest of the world. The guarantees for installation typically expire soon after
certain milestones are met and guarantees for operations typically expire
proportionally over the contract period. The maximum potential amount of future
payments we could be required to make under our guarantees at December 31, 2005
and March 31, 2006 were $8.7 million and $8.0 million, respectively. We have not
recorded any liability for such amounts, as we expect that our performance will
be acceptable and to date, no performance bank guarantees have been exercised
against us; however, on July 11, 2006 a customer made demand for the payment
under a bank performance guarantee in the amount of $1.4 million, for which we
have recorded a provision in our financial statements for the year ended
December 31, 2005. On our motion, the District Court in Haifa, Israel has issued
a temporary injunction against the payment of such guarantee pending a hearing
in August 2006. Although we obtained the temporary injunction, according to our
legal counsel, our chances to ultimately prevent the forfeiture of the guarantee
remain unclear. In view of the above and due to the uncertainty in preventing
the forfeiture of the performance bank guarantee, we included a provision in the
amount of $1.4 million in respect of this guarantee in our financial statements.
43
F. TABULAR DISCLOSURE OF CONTRACTUAL OBLIGATIONS.
The following table summarizes our minimum contractual obligations and
commercial commitments as of December 31, 2005 and the effect we expect them to
have on our liquidity and cash flow in future periods.
Contractual Obligations Payments due by Period
----------------------- ----------------------
less than 1 more than 5
Total year 1-2 Years 3-5 Years years
----- ---- --------- --------- -----
Long-term debt obligations $5,300,000 $3,647,000 $318,000 $1,335,000 $ -
Capital (finance) lease obligations - - - - -
Operating lease obligations 821,000 404,000 380,000 37,000 -
Purchase obligations 300,000 - 300,000 - -
Other long-term liabilities reflected on
the company's balance sheet under U.S.
GAAP - - - - -
---------- ---------- -------- ---------- ---
Total $6,421,000 $4,051,000 $998,000 $1,372,000 $ -
========== ========== ======== ========== ===
44
ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES
A. DIRECTORS AND SENIOR MANAGEMENT.
Set forth below are the name, age, principal position and a biographical
description of each of our directors and executive officers:
NAME AGE POSITION
---- --- --------
Jacob Even-Ezra 75 Chairman of the Board and Chief Executive Officer
Izhar Dekel 54 President and Director
Chaim Porat 70 Vice President - Far East and Australia Marketing
Yehezkel Farber 65 Vice President - Operations
Zvi Dank 56 Vice President - Research and Development
Raya Asher 38 Vice President - Finance, Chief Financial Officer and Secretary
Asaf Even-Ezra 40 Vice President - Israel and West European Marketing
Dany Pizen 54 Vice President - East European and CIS Marketing
Ofer Katz 57 Vice President - Aviation Security
Raffi Netzer 43 Vice President - Africa and Latin America Marketing
Nathan Kirsh 74 Director
Jacob Nuss 58 Director
Jacob Perry 62 Director
Zeev Livne 61 Director
Shaul Kobrinsky 54 Outside Director
Anat Winner 47 Outside Director
Messrs. Even-Ezra, Dekel, Kirsh, Nuss, Perry and Livne will serve as
directors until our 2006 Annual General Meeting of Shareholders. Mr. Kobrinsky
and Mrs. Winner will serve as outside directors pursuant to the provisions of
the Israeli Companies Law for three-year terms until our 2008 annual general
meeting of shareholders, following which their service may be renewed for only
one additional three-year term.
Jacob Even-Ezra and Asaf Even-Ezra are father and son. Izhar Dekel is Jacob
Even-Ezra's son-in-law and Asaf Even-Ezra's brother-in-law. Other than these
relationships, there are no other family relationships among our directors and
senior executives.
JACOB EVEN-EZRA has served as our chairman of the board and chief executive
officer since 1984, and from 1987 until 1990 he also served as our president. He
is currently a member of the Executive Council and the Management Committee of
Tel-Aviv University. From 1985 to 1988, Mr. Even-Ezra was also chairman of the
Israel Export Institute. Mr. Even-Ezra holds a B.Sc. in Electrical Engineering
from Israel Institute of Technology, or the Technion.
IZHAR DEKEL has served as our president since 1990 and as a director since
1993. Mr. Dekel served as our finance manager from 1984 to 1990. Mr. Dekel holds
an M.B.A. and a B.A. in Economics and International Relations from the Hebrew
University of Jerusalem.
CHAIM PORAT has served as our vice president - Far East and Australian
marketing since 1988. Prior to joining us, Mr. Porat served as the head of the
security division of Beta Engineering Ltd. Mr. Porat holds a B.Sc. in Electrical
Engineering from the Technion.
YEHEZKEL FARBER has been our vice president - operations since 1986.
Previously Mr. Farber served as the manager of the customer systems department
of IAI.
45
ZVI DANK has served as our vice president - research and development since
1984. Before joining us, Mr. Dank worked as an electronic engineer in the
electronics division of IAI. Mr. Dank holds a B.Sc. in Electrical Engineering
from the Technion.
RAYA ASHER has served as our vice president - finance, chief financial
officer and secretary since 1998. Prior to joining us, Ms. Asher served as a
senior audit manager with Kost Levary and Forer, Certified Public Accountants in
Israel, the predecessor of our auditors, Kost Forer Gabbay & Kasierer, a
Member of Ernst & Young Global. Ms. Asher holds an M.B.A. in Business and a
B.A. in Accounting and Economics from Tel Aviv University.
ASAF EVEN-EZRA joined us in 1995 and has served as our vice president -
Israel and West European marketing since 1998. Mr. Even-Ezra also heads our
video motion detection division. Mr. Even Ezra holds an M.B.A. and a B.A. in
Business from the New York Institute of Technology.
DANY PIZEN has served as our vice president - East European and CIS
marketing since 1995. Before joining us, Mr. Pizen served as vice president of
business development of Eldor Electronics Ltd., before which he served for 20
years in the IDF and retired as a Lieutenant Colonel. Mr. Pizan holds a B.A. in
Social Science from Bar Ilan University.
OFER KATZ has served as our vice president - aviation security since 1995.
Prior to that and since 1984 he served in our software and computer development
department as manager of our production line and in operations and special
projects.
RAFI NEZER has served as our vice president - Africa and Latin America
marketing since 2004. Before joining us and since 1999, Mr. Nezer acted as
director of marketing for Rada Electronic Industries Ltd. Mr. Nezer holds an
M.B.A. in Business Administration from INSEAD and an L.L.B. from the Tel Aviv
University.
NATHAN KIRSH has served as a director since 1984. Mr. Kirsh is an
independent investor. Mr. Kirsh serves as one of the trustees of the Eurona
Foundation, the beneficial owner of 81.5% of the ordinary shares of our company
that are held by Mira Mag Inc. Mr. Kirsh holds a B.A. in Commerce from the
University of Witwatersrand, Johannesburg.
JACOB NUSS has served as a director since 1993. Mr. Nuss currently serves
as the vice president - internal auditing of IAI, and served as IAI's deputy
vice president - internal auditing from 1999 to 2003. From 1993 to 1999, Mr.
Nuss served as the director of finance of IAI's electronics group. From 1991 to
1993, Mr. Nuss served as assistant to the chairman of the board of IAI. Mr. Nuss
has served in various financial management capacities at IAI since 1975. Mr.
Nuss holds an M.B.A. in Business from the Tel Aviv University and a B.A. in
Economics and Business Management from Bar Ilan University. Mr. Nuss holds a
certificate in internal auditing.
JACOB PERRY was appointed to serve as a director in December 2002. From
1995 to December 2002, Mr. Perry was President and CEO of Cellcom Israel Ltd.,
Israel's largest cellular phone operator. Mr. Perry served 29 years with the
Israeli General Security Service, and served as its chief from 1988 until 1995.
Mr. Perry has also served as an adviser to the Israeli Prime Minister on the
subject of prisoners of war and missing persons. He was a board member of El-Al
Israel Airlines and a member of the management of many public organizations. Mr.
Perry is also a chairman of the board of directors of various companies,
including Mizrahi Tefahot Bank B.M. and Lipman Electronic Engineering Ltd. Mr.
Perry holds an A.M.P. from Harvard Business School and a B.A. in Oriental
Studies and History of the Jewish People from Tel-Aviv University.
46
ZEEV LIVNE was appointed to serve as a director in July 2004. Mr. Livne has
served as the chairman of Livne Strategic Consultants LTD. since 2001. Mr. Livne
served 39 years with the IDF until 2001. During his long military career with
the IDF, Mr. Livne served as the Defense Attache to the U.S. and Canada from
1997 to 2001, Military Secretary to the Prime Minister of Israel from 1996 to
1997 and Ground Force Commander from 1994 to 1996. From 1992 to 1994 Mr. Livne
established the IDF Home Front Command and served as its first Commander. Mr.
Livne serves on the board of directors of "PAZKAR," a private Israeli company.
Mr. Livne holds a B.A. in History from the Tel Aviv University, and an M.A. in
Geography from the University of Haifa.
SHAUL KOBRINSKY was appointed to serve as an outside director in July 2004.
Mr. Kobrinsky has served as the President and Chief Executive Officer of Urdan
Industries Ltd., an investment and holding company since 1997. Since 2003 Mr.
Kobrinsky has served as senior managing director of Alagem Capital Group (a
Beverly Hills based investment group). From 1989 to 1997, Mr. Kobrinsky served
as chief executive officer of Cargal Ltd., an Israeli company that manufactures
corrugates. Previously, and since 1984, Mr. Kobrinsky served as deputy managing
director of Clal Industries Ltd., a holding and investment company. Mr.
Kobrinsky serves as an outside director of Scope Metal Trading Ltd. Mr.
Kobrinsky holds a B.A. in Economics from Tel Aviv University.
ANAT WINNER was appointed to serve as an outside director in July 2004.
Mrs. Winner has been a business advisor since 2003. Mrs. Winner served from
October 2001 to July 2004 as Chief Executive Officer and Chief Financial Officer
of Israel News Ltd. From 1999 to October 2001, Mrs. Winner served as Chief
Financial Officer of DBS Satellite Services (1998) Ltd. (YES), an Israeli
company that is engaged in setting up and operating DBS television systems.
Previously, and since 1995, Mrs. Winner served as chief financial officer of
Eurocom Cellular Communications Ltd., an Israeli company that is engaged in
importing and marketing cellular phones. Mrs. Winner also serves as a director
of Internet Gold-Golden Lines Ltd. Mrs. Winner holds a B.A. degree in Accounting
and Economics from Haifa University and has been a certified public accountant
for 15 years.
B. COMPENSATION.
During the fiscal year ended December 31, 2005, we paid aggregate
compensation to all of our officers and directors as a group (consisting then of
16 persons) of approximately $1.4 million. In addition, we have provided
automobiles to our executive officers at our expense. We have two key-man life
insurance policies for Izhar Dekel. We are the beneficiary of one of these
policies and certain of Mr. Dekel's family members are the beneficiaries of the
other policy. We bear the cost of each of these insurance policies. We also have
a key-man life insurance policy for Jacob Even-Ezra, of which we are the
beneficiary.
Directors who are not officers of us or of any entity that beneficially
owns 5% or more of our ordinary shares, as well as our outside directors,
receive an annual fee of approximately $5,600 and an additional fee of
approximately $300 for each board or committee meeting that they attend.
Under the Israeli Companies Law, the board of directors must approve all
compensation arrangements for the chief executive officer of the company, and
unless provided otherwise in the company's articles of association, all
compensation arrangements for officers and employees (other than the company's
directors) are subject to the chief executive officer's approval. Directors'
compensation arrangements (other than outside directors) also require audit
committee approval before board approval and shareholder approval. However,
pursuant to amendments to the Companies Regulations (Relief from Related Party
Transactions), 5760-2000, directors' compensation and employment arrangements do
not require, in certain circumstances, shareholder approval. In addition, under
these regulations, if the director or office holder is a controlling shareholder
of the company, then the employment and compensation arrangements of such
director or office holder do not require shareholder approval if such
arrangements meet certain criteria.
An outside director is entitled to compensation as provided in regulations
promulgated under the Israeli Companies Law and is otherwise precluded from
receiving any other compensation, directly or indirectly, in connection with
such service.
47
During 2005, we granted options for the purchase of total of 53,500
ordinary shares to certain of our directors and executive officers. During 2004,
we granted options to purchase 94,500 ordinary shares to certain of our
directors and executive officers. We have no service contracts with any of our
directors to provide services as a director that provide for benefits upon
termination of employment. However, we do have employment agreements with
certain of our directors in connection with their service as employees.
C. BOARD PRACTICES.
INTRODUCTION
According to the Israeli Companies Law and our Articles of Association, the
management of our business is vested in our board of directors. The board of
directors may exercise all powers and may take all actions that are not
specifically granted to our shareholders. Our executive officers are responsible
for our day-to-day management. The executive officers have individual
responsibilities established by our chief executive officer and board of
directors. Executive officers are appointed by and serve at the discretion of
the board of directors, subject to any applicable agreements.
ELECTION OF DIRECTORS AND OFFICERS
Our articles of association provide for a board of directors of not less
than three and not more than eleven members as may be determined from time to
time at our annual general meeting. Our Board of Directors is currently composed
of eight directors.
Our directors, (except the outside directors as detailed below), are
elected by our shareholders at our annual general meeting and hold office until
the next annual general meeting. All the members of our board of directors,
(except the outside directors as detailed below), may be reelected upon
completion of their term of office. Our annual general meetings are held at
least once every calendar year, but not more than fifteen months after the last
preceding annual general meeting. In the intervals between our annual general
meetings, the board of directors may appoint new directors to fill vacancies.
All of our current directors, including the outside directors, were elected by
our shareholders at our annual general meeting of shareholders of July 2005.
Under a recent amendment to the Israeli Companies Law, our board of
directors is required to determine the minimum number of directors who must have
"accounting and financial expertise," as such term is defined in regulations
promulgated under the Israeli Companies Law. Our Board of Directors has
determined that our Board of Directors will include at least one director who
has "accounting and financial expertise," within the meaning of the regulations
promulgated under the Israeli Companies Law. Our Board of Directors has further
determined that Ms. Anat Winner has the requisite "accounting and financial
expertise."
We do not follow the requirements of the NASDAQ Marketplace Rules with
regard to the nomination process of directors, and instead, we follow Israeli
law and practice, in accordance with which our directors are recommended by our
board of directors for election by our shareholders. See below in this Item 6.C.
"Directors, Senior Management and Employees - Board Practices - NASDAQ
Exemptions for Foreign Private Issuers."
48
DIRECTORS' SERVICE CONTRACTS
Two of our directors, Jacob Even-Ezra and Izhar Dekel, entered into
substantially similar employment agreements with us, effective January 1993.
These agreements contain certain non-competition and confidentiality provisions.
In addition, each agreement establishes a base salary and a package of benefits
with an aggregate value of approximately 20% of the base salary, as well as a
possible bonus. In December 2005, our board of directors, subject to
shareholders approval, extended the appointment of Mr. Even-Ezra as chairman of
the board until January 2008 and as chief executive officer for such period
until a new chief executive officer is appointed,. Under the Israeli Companies
Law, such dual positions require shareholders, approval which must be renewed
every three years. Our shareholders approved this dual position in July 2004. In
December 2000, our board of directors extended the term of Mr. Dekel's
employment until such time as it is terminated by us or by Mr. Dekel pursuant to
the terms of the agreement. Under the Israeli Companies Law, the terms of
employment of Mr. Dekel, who is also a member of our board of directors requires
shareholders' approval. Our shareholders approved Mr. Dekel's terms of
employment in July 2004. See also Item 6.B. "Directors, Senior Management and
Employees-Compensation" above.
OUTSIDE DIRECTORS
The Israeli Companies Law requires Israeli companies with shares that have
been offered to the public in or outside of Israel to appoint at least two
outside directors. Outside directors must be Israeli residents who are qualified
to be appointed as directors, unless the company's shares have been offered to
the public outside of Israel or have been listed on a stock exchange outside of
Israel. No person may be appointed as an outside director if, at the time of the
appointment or during the two years that preceded the appointment, the person or
the person's relative, partner, employer or an entity of which he is a
controlling shareholder had an interest in the company, in a person who was a
controlling shareholder of the company at the time of the appointment, or in an
entity which was controlled by the company or its controlling shareholder at the
time of the appointment or during the two years that preceded the appointment.
In addition, no person may serve as an outside director if the person's
position or other activities create, or may create, a conflict of interest with
the person's responsibilities as an outside director or may otherwise interfere
with the person's ability to serve as an outside director. If, at the time
outside directors are to be appointed, all current members of the board of
directors are of the same gender, then at least one outside director must be of
the other gender.
According to a March 2005 amendment to the Israeli Companies Law, effective
as of January 2006, at least one of the outside directors must be an "accounting
and financial expert" and the other outside directors must be "professional
experts," as such terms are defined by regulations promulgated under the Israeli
Companies Law. This requirement does not apply to outside directors appointed
prior to the March 2005 amendment, however a company can not renew the
appointment of any such outside director for an additional term unless the
outside director is (i) an accounting and financial expert or (ii) a
professional expert and at the time the appointment is to be renewed, an outside
director who is an accounting and financial expert serves on the board of
directors.
The outside directors are elected by shareholders. The shareholders voting
in favor of their election must include at least one-third of the shares of the
non-controlling shareholders of the company who voted on the matter. This
minority approval requirement need not be met if the total shareholdings of
those non-controlling shareholders who vote against their election represent 1%
or less of all of the voting rights in the company. Outside directors serve for
a three-year term, which may be renewed for only one additional three-year term.
Outside directors can be removed from office only by the same special percentage
of shareholders that can elect them, or by a court, and then only if the outside
directors cease to meet the statutory qualifications with respect to their
appointment or if they violate their duty of loyalty to the company.
Any committee of the board of directors that is authorized to exercise
powers vested in the board of directors must include at least one outside
director and the audit committee must include all the outside directors. An
outside director is entitled to compensation as provided in regulations adopted
under the Israeli Companies Law and is otherwise prohibited from receiving any
other compensation, directly or indirectly, in connection with such service.
49
INDEPENDENT DIRECTORS
In general, under NASDAQ Stock Market Rules a majority of our Board of
Directors must qualify as independent directors within the meaning of the NASDAQ
Marketplace Rules and our audit committee must have at least three members and
be comprised only of independent directors, each of whom satisfies the
respective "independence" requirements of NASDAQ and the Securities and Exchange
Commission. However, on June 27, 2006, we provided NASDAQ with a notice of
non-compliance with respect to the requirement to maintain a majority of
independent directors, as defined under NASDAQ Marketplace Rules. Instead, we
follow Israeli law and practice which requires that we appoint at least two
outside directors, within the meaning of the Israeli Companies Law, to our board
of directors. (See below in this Item 6C. "Directors, Senior Management and
Employees - Board Practices - NASDAQ Marketplace Rules and Home Country
Practices.") In addition, in accordance with rules of the Securities and
Exchange Commission, we have the mandated three independent directors, as
defined by the Securities and Exchange Commission and NASDAQ rules, on our audit
committee.
Our Board of Directors has determined that Ms. Winner and Mr. Kobrinsky
qualify both as independent directors under the Securities and Exchange
Commission and NASDAQ requirements and as outside directors under the Israeli
Companies Law requirements. Our Board of Directors has further determined that
Messrs. Nuss and Livne qualify as independent directors under the Securities and
Exchange Commission and NASDAQ requirements.
AUDIT COMMITTEE
Our audit committee, which was established in accordance with Section 114
of the Israeli Companies Law and Section 3(a)(58)(A) of the Securities Exchange
Act of 1934, assists our board of directors in overseeing the accounting and
financial reporting processes of our company and audits of our financial
statements, including the integrity of our financial statements, compliance with
legal and regulatory requirements, our independent public accountants'
qualifications and independence, the performance of our internal audit function
and independent public accountants, finding any defects in the business
management of our company for which purpose the audit committee may consult with
our independent auditors and internal auditor, proposing to the board of
directors ways to correct such defects, approving related-party transactions as
required by Israeli law, and such other duties as may be directed by our board
of directors.
The responsibilities of the audit committee also include approving
related-party transactions as required by law. Under Israeli law an audit
committee may not approve an action or a transaction with a controlling
shareholder, or with an office holder, unless at the time of approval two
outside directors are serving as members of the audit committee and at least one
of the outside directors was present at the meeting in which an approval was
granted.
Our audit committee consists of three board members who satisfy the
respective "independence" requirements of the Securities and Exchange
Commission, NASDAQ and Israeli Law for audit committee members. Our audit
committee is currently composed of Mrs. Anat Winner and Messrs. Shaul Kobrinsky
and Jacob Nuss. Our Board of Directors has determined that Ms. Anat Winner
qualifies as a financial expert. The audit committee meets at least once each
quarter. Our audit committee charter is available on our website at
www.magal-ssl.com.
INTERNAL AUDITOR
Under the Israeli Companies Law, the board of directors must appoint an
internal auditor proposed by the audit committee. The role of the internal
auditor is to examine whether the company's actions comply with the law,
integrity and orderly business procedure. Under the Israeli Companies Law, the
internal auditor may not be an interested party, an office holder, or an
affiliate, or a relative of an interested party, office holder or affiliate, nor
may the internal auditor be the company's independent accountant or its
representative. Mr. Daniel Spira, CPA (Isr.) is our internal auditor.
50
APPROVAL OF SPECIFIC RELATED-PARTY TRANSACTIONS
The Israeli Companies Law imposes a duty of care and a duty of loyalty on
all office holders of a company, including directors and executive officers. The
duty of care requires an office holder to act with the level of competence at
which a reasonable office holder would employ under the same circumstances,
including. An office holder's duty of care includes a duty to use reasonable
means to obtain:
o information on the appropriateness of a given action brought for his
approval or performed by him by virtue of his position; and
o all other important information pertaining to these actions.
The duty of loyalty requires an officer holder to act in good faith and in
the company's interest. The duty of loyalty includes a duty to:
o refrain from any conflict of interest between the performance of his
duties in the company and his personal affairs;
o refrain from any activity that is competitive with the company;
o refrain from exploiting any business opportunity of the company to
receive a personal gain for himself or others; and
o disclose to the company any information or documents relating to the
company's affairs which the office holder has received by virtue of
his position in the company.
Each person listed as a director or executive officer in the table under
"Item 6.A. Directors, Senior Management and Employees -- Directors and Senior
Management" above is an office holder. Under the Israeli Companies Law, all
arrangements as to compensation of executive office holders who are not
directors require approval of the chief executive officer, and the compensation
of office holders who are directors must be approved by our audit committee,
board of directors and shareholders.
The Israeli Companies Law requires that an office holder promptly disclose
any personal interest that he may have and all related material information
known to him in connection with any existing or proposed transaction by the
company. If the transaction is an extraordinary transaction, that is, a
transaction other than in the ordinary course of business, other than on market
terms, or likely to have a material impact on the company's profitability,
assets or liabilities, the office holder must also disclose any personal
interest held by:
o the office holder's spouse, siblings, parents, grandparents,
descendents, spouse's descendents and the spouses of any of these
people; or
o any corporation in which the office holder is a 5% or greater
shareholder, director or general manager or in which he has the right
to appoint at least one director or the general manager.
Under the Israeli Companies Law, once an office holder complies with the
above disclosure requirement, the board of directors may approve a transaction
between the company and an office holder, or a third party in which an office
holder has a personal interest, unless the articles of association provide
otherwise. A transaction that is adverse to the company's interest may not be
approved.
51
In some cases, including in the case of an extraordinary transaction, such
a transaction, action and arrangement must be approved by the audit committee
and by the board of directors itself, and further shareholder approval is
required to approve the terms of compensation of an office holder who is a
director. An office holder who has a personal interest in a matter, which is
considered at a meeting of the board of directors or the audit committee, may
not be present during the board of directors or audit committee discussions and
may not vote on this matter, unless the majority of the members of the board or
the audit committee have a personal interest, as the case may be.
Under the Israeli Companies Law, the disclosure requirements that apply to
an office holder also apply to a controlling shareholder of a public company. A
controlling shareholder is a shareholder that holds 25% or more of the voting
rights in a public company, provided no other shareholder owns more than 50% of
the voting rights in the company. Extraordinary transactions with a controlling
shareholder or in which a controlling shareholder has a personal interest,
(including private offerings in which a controlling shareholder has a personal
interest) and a transaction with a controlling shareholder or his relative
regarding terms of service and employment, require the approval of the audit
committee, the board of directors and the shareholders of the company. The
shareholder approval for such transactions must include either at least
one-third of the shareholders who have no personal interest in the transaction
and are present and voting on the matter, in person, by proxy or by written
ballot, at the meeting, or a majority of the voting power present and voting on
the matter, provided that the shareholders who have no personal interest in the
transaction who vote against the transaction do not represent more than one
percent of the voting rights in the company. For a discussion of certain Israeli
Companies Law regulations pertaining to tender offers by shareholders, see Item
10.B. "Additional Information-Memorandum and Articles of Association-Provisions
Restricting a Change in Control of Our Company."
The Israeli Companies Law requires that every shareholder that
participates, either in person or by proxy, in a vote regarding a transaction
with a controlling member of the company indicate whether or not he or she has a
personal interest in the vote in question, the failure of which results in the
invalidation of that shareholder's vote. Regulations promulgated under the
Israeli Companies Law provide that this requirement does not apply to a company
whose shares are publicly traded outside of Israel if, pursuant to applicable
foreign securities laws, the company is required to distribute a proxy
statement.
However, under the Companies Regulations (Relief From Related Party
Transactions), 5760-2000, promulgated pursuant to the Israeli Companies Law,
each of the following transactions between a company and its controlling
shareholder(s) does not require shareholder approval:
o the extension of the term of an existing related-party transaction;
provided that the original transaction was duly approved in accordance
with the applicable provisions of the Israeli Companies Law or the
Israeli Securities Law and regulations promulgated thereunder;
o a transaction that has been approved by the audit committee and the
board of directors as being solely for the benefit of the company;
o a transaction between the company and its controlling shareholder(s)
or an entity in which the controlling shareholder has a personal
interest, provided that the audit committee and the board of directors
approve the transaction and determine that the transaction is in
accordance with the terms defined in a duly approved frame-work
transaction. A frame-work transaction is a transaction that defines
the general terms under which the company may, in the ordinary course
of business, enter into transactions of a similar type;
52
o a transaction between the company and its controlling shareholder(s)
or an entity in which the controlling shareholder has a personal
interest, for the purpose of entering into a transaction with a third
party or to submit a joint offer to conduct business with a third
party, provided that the audit committee and the board of directors
have approved the transaction and that the terms of the transaction in
relation to the company are not materially different from those
relating to the controlling shareholder(s) or an entity in which the
controlling shareholder has a personal interest, taking into account
their proportionate participation in the transaction; and
o a transaction between companies that are controlled by the same
controlling shareholder or between the company and an entity in which
the controlling shareholder has a personal interest, provided that for
each public company involved, the audit committee and the board of
directors find that the transaction is in accordance with market
terms, is in the ordinary course of business and does not harm the
welfare of the company.
In addition, pursuant to amendment to these regulations, directors'
compensation and employment arrangements do not require shareholder approval,
provided certain criteria are met. Also, pursuant to this amendment, if the
director or the office holder is a controlling shareholder of the company, then
the employment and compensation arrangements of such director or office holder
do not require shareholder approval, provided certain criteria are met.
The relief from having to obtain shareholder approval set forth above will
not apply, and shareholder approval will be required, if one or more
shareholders, holding at least 1% of the issued and outstanding share capital of
the company or of the company's voting rights, object to the grant of such
relief, provided that such objection is submitted to the company in writing not
later than seven days from the date of the filing of a report regarding the
adoption of such resolution by the company pursuant to the requirements of the
Israeli Securities Law (which reporting requirements are not applicable to us as
a "double foreign company").
Further, since our ordinary shares are listed on the Tel Aviv Stock
Exchange, we are subject to additional provisions of the Israeli Companies Law,
as amended. These provisions require that the board of directors and
shareholders approve any private placement of securities by a public company
that will:
o increase the relative holdings of a shareholder that holds 5% or more
of that company's outstanding share capital; or
o cause any person to become, as a result of such issuance, a holder of
more than 5% of such company's outstanding share capital.
However, in accordance with the Companies Regulations (Relief From Related
Party Transactions), 5760-2000, shareholder approval is not required for a
private placement in which less than 20% of the voting rights in the company,
prior to such offer, are offered. For purposes of such exemption, the definition
of a private placement includes:
o private placements that are part of the same transaction or that are
contingent or conditioned upon a previous private placement; and
o all private placements effected by the issuer in the previous
twelve-month period in which the same parties, or relatives or
affiliates thereof, were involved, or the consideration thereof
consists of rights to the same assets.
These private placement exemptions do not apply to private placements by a
director or chief executive officer of the issuer or to a person or entity that
will become, as a result of such private placement, a controlling shareholder of
the issuer.
The Israeli Companies Law further provides that a shareholder shall refrain
from oppressing other shareholders. In addition, any controlling shareholder,
any shareholder who knows that it possesses the power to determine the outcome
of a shareholder vote and any shareholder who, pursuant to the provisions of a
company's articles of association, has the power to appoint or prevent the
appointment of an office holder in the company, or has any other power over the
company, is under a duty to act with fairness towards the company and can be
personally liable for a breach of such duty.
53
INDEMNIFICATION OF DIRECTORS AND OFFICERS AND LIMITATIONS OF LIABILITY
EXCULPATION OF OFFICE HOLDERS. Israeli law allows a company, if permitted
by its articles of association, to exculpate an office holder in advance, in
whole or in part, from liability for damages sustained by a breach of duty of
care to the company, except with respect to a breach of his or her duty of care
in the event of distributions.
OFFICE HOLDERS' INSURANCE. Israeli law provides that a company may, if
permitted by its articles of association, enter into a contract to insure its
office holders for liabilities incurred by the office holder with a respect to
an act performed in his or her capacity as an office holder, as a result of: (i)
the breach of his or her duty of care to the company or another person; (ii) a
breach of his or her duty of loyalty to the company, provided that the office
holder acted in good faith and had reasonable cause to assume that the act would
not prejudice the company's interests; and (iii) a financial liability imposed
upon the office in favor of another person.
INDEMNIFICATION OF OFFICE HOLDERS. Under Israeli law a company may, if
permitted by its articles of association, indemnify an office holder for acts
performed by the office holder in such capacity for (a) monetary liability
imposed upon the office holder in favor of another person pursuant to a court
judgment, including a settlement or an arbitration award approved by a court;
(b) reasonable litigation expenses, including attorney's fees, actually incurred
by the office holder as a result of an investigation or proceeding instituted
against him by a competent authority, provided that such investigation or
proceeding concluded without the filing of an indictment against the office
holder or the imposition of any financial liability in lieu of criminal
proceedings, or concluded without the filing of an indictment against the office
holder and a financial liability was imposed on him or her in lieu of criminal
proceedings with respect to a criminal offense that does not require proof of
criminal intent; and (c) reasonable litigation expenses, including attorneys'
fees, actually incurred by the office holder or imposed upon the office holder
by a court: (i) in an action, suit or proceeding brought against the office
holder by or on behalf of the company or another person, (ii) in connection with
a criminal action in which the office holder was acquitted, or (iii) in
connection with a criminal action in which the office holder was convicted of a
crime that does not require proof of criminal intent.
Israeli law provides that a company's articles of association may permit
the company to (a) indemnify an office holder retroactively, following a
determination to this effect made by the company after the occurrence of the
event in respect of which the office holder will be indemnified; and (b)
undertake in advance to indemnify an office holder, except that with respect to
a financial liability imposed on the office holder by any judgment, settlement
or court-approved arbitration award, the undertaking must be limited to types of
occurrences, which, in the opinion of the company's board of directors, are, at
the time of the undertaking, foreseeable due to the company's activities and to
an amount or standard that the board of directors has determined is reasonable
under the circumstances.
LIMITATIONS ON EXCULPATION, INSURANCE AND INDEMNIFICATION. These provisions
are specifically limited in their scope by Israeli law, which provides that a
company may not indemnify an office holder, nor exculpate an office holder, nor
enter into an insurance contract which would provide coverage for any monetary
liability, incurred as a result of certain improper actions.
The term "office holder" of a company includes a director, general manager
or chief executive officer, a vice president or any officer who reports directly
to the general manager or chief executive officer of a company and any other
person assuming the responsibilities of any of the foregoing positions without
regard to such person's title.
54
Pursuant to the Israeli Companies Law, exculpation of, procurement of
insurance coverage for, and an undertaking to indemnify or indemnification of,
our office holders must be approved by our audit committee and our board of
directors and, if the office holder is a director, also by our shareholders.
Our shareholders approved our entering into an agreement to indemnify our
office holders up to $5 million, in advance. We currently maintain a directors
and officers liability insurance policy with a per claim and aggregate coverage
limit of $5 million.
Our Articles of Association allow us to insure, indemnify and exempt our
office holders, subject to the provisions of the Israeli Companies Law. We
maintain a directors' and officers' liability insurance policy with a per claim
and aggregate coverage limit of $5 million, including legal costs incurred in
Israel. In addition, our Audit Committee, Board of Directors and shareholders
resolved to indemnify our office holders, pursuant to a standard indemnification
agreement that provides for indemnification of an office holder in an amount up
to $5 million.
NASDAQ EXEMPTIONS AND HOME COUNTRY PRACTICES
Under NASDAQ Marketplace Rule 4350, or Rule 4350, foreign private issuers,
such as our company, are permitted to follow certain home country corporate
governance practices instead of certain provisions of Rule 4350, without the
need to seek individual exemptions from NASDAQ. A foreign private issuer that
elects to follow a home country practice instead of any of such provisions of
Rule 4350, must submit to NASDAQ, in advance, a written statement from an
independent counsel in such issuer's home country certifying that the issuer's
practices are not prohibited by the home country's laws.
On July 7, 2005 and June 26, 2006, we provided NASDAQ with notices of
non-compliance with Rule 4350. We informed NASDAQ that we do not comply with the
following requirements of Rule 4350, and instead follow Israeli law and practice
in respect of such requirements:
o the requirement regarding the process of nominating directors.
Instead, we follow Israeli law and practice in accordance with which
our directors are recommended by our board of directors for election
by our shareholders. See above in this Item 6.C. "Directors, Senior
Management and Employees - Board Practices - Election of Directors."
o the requirement regarding the compensation of our chief executive
officer and all other executive officers. Instead, we follow Israeli
law and practice in accordance with which our board of directors must
approve all compensation arrangements for our chief executive officer
and all compensation arrangements for officers are subject to the
chief executive officer's approval. See above in this Item 6.C.
"Directors, Senior Management and Employees - Compensation."
o the requirement that our independent directors have regularly
scheduled meetings at which only independent directors are present.
Under Israeli law independent directors are not required to hold
executive sessions.
o the requirement that we distribute to shareholders, and file with
NASDAQ, copies of an annual report containing audited financial
statements of our company and its subsidiaries within a reasonable
period of time prior to our annual meeting of shareholders. Under
Israeli law, as a company that is publicly traded both in Israel and
outside of Israel, we are not required to distribute such annual
reports to our shareholders. Our annual report on Form 20-F and
audited financial statements are available on our website
(www.magal-ssl.com, and we will send it to shareholders upon written
request.
55
o the requirement to maintain a majority of independent directors, as
defined under the NASDAQ Marketplace Rules. Instead, we follow Israeli
law and practice which requires that we appoint at least two outside
directors, within the meaning of the Israeli Companies Law, to our
Board of Directors. In addition, we have the mandated three
independent directors that meet the independent standards contained in
the rules of the Securities and Exchange Commission and NASDAQ on our
audit committee. See above in this Item 6C. "Directors, Senior
Management and Employees - Board Practices - Independent and Outside
Directors."
D. EMPLOYEES.
As of December 31, 2005, we employed 309 full time employees, of whom 34
were employed in general management and administration, 47 in marketing, 20 in
production management, 155 in production, installation and maintenance, and 53
in engineering and research and development. Of our 309 full time employees, 129
were employed in Israel, 56 were employed in the U.S., 89 were employed in
Canada and 35 were employed in various other countries.
As of December 31, 2004, we employed 303 full-time employees, of whom 32
were employed in general management and administration, 55 in marketing, 19 in
production management, 148 in production, installation and maintenance, and 49
in engineering and research and development. Of our 303 full-time employees, 120
were employed in Israel, 64 were employed in the U.S., 87 were employed in
Canada and 32 were employed in various other countries.
As of December 31, 2003, we employed 288 full-time employees, of whom 24
were employed in general management and administration, 51in marketing, 49 in
production management, 114 in production, installation and maintenance, and 50
in engineering and research and development. Of our 288 full-time employees, 120
were employed in Israel, 61 were employed in the U.S., 79 were employed in
Canada and 28 were employed in various other countries.
We are subject to various Israeli labor laws, collective bargaining
agreements entered into from time to time between the Manufacturers Association
and the Histadrut, as well as collective bargaining arrangements. These laws,
agreements and arrangements cover a wide range of areas, including minimum
employment standards, such as working hours, minimum wages, vacation, severance
pay and pension plans, and special issues, such as equal pay for equal work,
equal opportunity in employment and employment of youth and army veterans.
Certain of our employees are parties to individual employment agreements. We
generally provide our employees with benefits and working conditions beyond the
required minimums. Each of our subsidiaries provides a benefits package and
working conditions which are competitive with other firms in their area of
operations.
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 predetermined sums to the
National Insurance Institute, which is similar to the U.S. Social Security
Administration, which amounts also include payments for national health
insurance.
E. SHARE OWNERSHIP.
The following table sets forth certain information regarding the ownership
of our ordinary shares by our directors and executive officers as of July 11,
2006.
56
Number of Ordinary Shares Percentage of Outstanding
Name Owned(1) Ordinary Shares(2)
------------------------ --------- ------
Jacob Even-Ezra(3)(6)(7) 348,969 3.33%
Izhar Dekel(4)(7) 154,427 1.47%
Raffi Netzer - -
Chaim Porat - -
Yehezkel Farber - -
Zvi Dank - -
Raya Asher - -
Asaf Even-Ezra(6) 121,426 1.16%
Dany Pizen - -
Ofer Katz - -
Nathan Kirsh(5) 1,832,227 17.63%
Jacob Nuss - -
Zeev Livne - -
Jacob Perry - -
Shaul Kobrinsky - -
Anat Winner - -
All directors and executive
officers as a group (16 persons) 2,608,775 24.77%
----------
*Less than 1%
(1) Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission and generally includes voting or
investment power with respect to securities. Ordinary shares relating to
options or convertible debenture notes currently exercisable or exercisable
within 60 days of the date of this table are deemed outstanding for
computing the percentage of the person holding such securities but are not
deemed outstanding for computing the percentage of any other person. Except
as indicated by footnote, the persons named in the table above have sole
voting and investment power with respect to all shares shown as
beneficially owned by them.
(2) The percentages shown are based on 10,390,248ordinary shares issued and
outstanding as of July 11, 2006.
(3) Includes 76,915 ordinary shares held by a trustee.
(4) Include Mr. Dekel's beneficial ownership of 42,000 ordinary shares and
112,427 shares held by Mr. Dekel's wife, Ornit Dekel.
(5) Includes Mr. Kirsh's beneficial ownership of 1,485,852 ordinary shares held
by Mira Mag Inc. Mr. Kirsh is a trustee of the Eurona Foundation.
(6) Jacob Even-Ezra and Asaf Even-Ezra are father and son.
(7) Izhar Dekel is Jacob Even-Ezra's son- in-law and Asaf Even Ezra's
brother-in- law.
As of July 11, 2006, the 16 directors and executive officers listed above,
as a group, held options to purchase 142,800 of our ordinary shares at a
weighted average exercise price of $7.96 per share. Out of such options 94,500
options expire in January 2009 and 48,300 options expire in December 2010.
STOCK OPTION PLAN
On October 27, 2003, our board of directors approved the 2003 Israeli Share
Option Plan ("the 2003 Plan") which was approved by our shareholders in July
2004. The Board has elected to allot the options under Israel's capital gain tax
treatment.
Under the 2003 Plan, stock options will be periodically granted to our
employees, directors, officers and consultants, in accordance with the decision
of our board of directors. Our board of directors has the authority to determine
the number of options, if any, which will be granted to each of the recipients,
the dates of the grant of such options, the date of their exercise as well as
their rate of conversion into shares in respect of each stock option, and the
purchase price thereof. Subject to shareholder approval, the 2003 Plan will be
effective for ten years and shall terminate in October 2013.
57
Under the 2003 Plan, no option may be exercised before the second
anniversary of the date on which it was granted, and each option expires on or
before the fifth anniversary of the date on which it was granted. Pursuant to
the plan, any options that are cancelled or not exercised within the option
period will become available for future grants.
Pursuant to the provisions of the 2003 Plan, if we issue a stock dividend,
the number of shares purchasable by any grantee upon the exercise of options
that were granted prior to the issuance of the stock dividend will be
correspondingly increased.
As of December 31, 2005, options to purchase 343,000 shares were
outstanding and additional options to purchase 299,676 shares were available for
grant.
Grants of stock options under the 2003 Plan are accounted for by us over
the exercise periods thereof as a compensation expense with a corresponding
credit to our contributed capital. Ordinary shares subject to options under the
2003 Plan are to be valued for this purpose at their market value at the time
the options are granted.
ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS
A. MAJOR SHAREHOLDERS
The following table sets forth certain information regarding the beneficial
ownership of our ordinary shares as of July 11, 2006, by each person or entity
known to own beneficially more than 5% of our outstanding ordinary shares based
on the information provided to us by the holders or disclosed in public filings
with the Securities and Exchange Commission. The voting rights of the
shareholders listed below are not different from the voting rights of our other
shareholders.
Number of
Ordinary Shares Percentage of
Beneficially Outstanding
Name Owned(1) Ordinary Shares(2)
-------------------------------- --------- ------
Nathan Kirsh (3) 1,832,227 17.63%
Mira Mag Inc.(4) 1,485,852 14.30%
Clough Capital Partners L.P. (5) 663,069 6.38%
Diker Management LLC (6) 612,077 5.89%
----------
(1) Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission and generally includes voting or
investment power with respect to securities. Ordinary shares relating to
options or convertible debenture notes currently exercisable or exercisable
within 60 days of the date of this table are deemed outstanding for
computing the percentage of the person holding such securities but are not
deemed outstanding for computing the percentage of any other person. Except
as indicated by footnote, the persons named in the table above have sole
voting and investment power with respect to all shares shown as
beneficially owned by them.
(2) The percentages shown are based on 10,390,248 ordinary shares issued and
outstanding as of July 11, 2006.
(3) Includes Mr. Kirsh's beneficial ownership of 1,485,852 ordinary shares held
by Mira Mag Inc. (see footnote (4) below).
(4) Mira Mag Inc. is the holder of 1,485,852 ordinary shares. The beneficial
owner of such shares is The Eurona Foundation. The Eurona Foundation is an
entity controlled by Nathan Kirsh, the trustees of which are Prinz Michael
von Liechtenstein, Altenbach 8, P.O. Box 339, FL-9490 Vaduz, Liechtenstein,
and Nathan Kirsh, Spintex Village, Ezulwini, Swaziland.
(5) Based on information provided by Clough Capital Partners L.P. in a filing
with the Securities and Exchange Commission, dated December 31, 2005.
(6) Based on information provided by Diker Management LLC in a filing with the
Securities and Exchange Commission, dated November 18, 2005.
58
SIGNIFICANT CHANGES IN THE OWNERSHIP OF MAJOR SHAREHOLDERS
In March and April 2004, Mira Mag Inc. sold an aggregate of 2,429,836, or
29.6%, of our ordinary shares in a series of open market transactions. In March
and April 2004, Mr. Even-Ezra sold an aggregate of 210,666, or 2.6%, of our
ordinary shares in a series of open market transactions.
On April 19, 2005, Mr. Kirsh, a trustee of the Eurona Foundation, Mira Mag
Inc.'s controlling shareholder, and Mr. Jacob Even-Ezra participated in the
offering of our ordinary shares and purchased 346,375 and 78,625 ordinary
shares, respectively, at a purchase price of $9.92 per ordinary share, the
closing price of our ordinary shares at the date of the offering.
MAJOR SHAREHOLDERS VOTING RIGHTS
Our major shareholders do not have different voting rights.
RECORD HOLDERS
Based on a review of the information provided to us by our transfer agent,
as of July 11, 2006, there were 61 holders of record of our ordinary shares, of
which 49 record holders holding approximately 0.2% of our ordinary shares had
registered addresses in the United States and 10 record holders holding
approximately 16.4% of our ordinary shares had registered addresses in Israel.
These numbers are not representative of the number of beneficial holders of our
shares nor is it representative of where such beneficial holders reside since
many of these ordinary shares were held of record by brokers or other nominees,
including CEDE & Co., the nominee for the Depositary Company (the central
depositary for the U.S. brokerage community), which held approximately 76.0% of
our outstanding ordinary shares as of said date.
B. RELATED PARTY TRANSACTIONS.
In 2003 Mira Mag Inc., our then controlling shareholder, and Jacob
Even-Ezra purchased IAI'S interest in our company.
On April 19, 2005 Mr. Kirsh, a trustee of the Eurona Foundation, Mira Mag
Inc.'s controlling shareholder, and Mr. Even-Ezra participated in the offering
of our ordinary shares and purchased 346,375 and 78,625 ordinary shares,
respectively, at a purchase price of $9.92 per ordinary share, the closing price
of our ordinary shares at the date of the offering.
REGISTRATION RIGHTS AGREEMENT
In furtherance of the approval obtained at the extraordinary general
meeting of our shareholders held on November 20, 1995, we entered into a
registration rights agreement, dated as of November 18, 1996, with Mira Mag, IAI
and Jacob Even-Ezra. Pursuant to the registration rights agreement, upon the
request of any of these principal shareholders, we are required to prepare and
file, at our expense, with the Securities and Exchange Commission, a shelf
registration statement for the ordinary shares held by them. In addition, we
will indemnify them and any underwriter of such ordinary shares against certain
civil liabilities under the Securities Act in connection with an offering of
such ordinary shares. Pursuant to the registration rights agreement, in July
1998 we filed a registration statement on Form F-3, File No. 333-9050, for the
ordinary shares held by Mira Mag.
59
SALES TO A PRINCIPAL SHAREHOLDER
Our U.S. subsidiary, Smart, provides video monitoring services to companies
controlled by Mr. Kirsh. The terms of the contracts under which we make sales to
these companies were negotiated on an arms'-length basis and the terms of such
contracts are no more favorable to these companies than those it could have
obtained from an unaffiliated third party. Our sales to these companies during
the years ended December 31, 2003, 2004 and 2005 were $108,000, $386,000 and
$671,000 respectively.
EMPLOYMENT CONTRACTS
Jacob Even-Ezra and Izhar Dekel entered into substantially similar
employment agreements with us, effective January 1993. These agreements contain
certain non-competition and confidentiality provisions. In addition, each
agreement establishes a base salary and a package of benefits with an aggregate
value of approximately 20% of the base salary, as well as a possible bonus. In
December 2005, our board of directors, subject to the approval of our
shareholders, extended the appointment of Mr. Even-Ezra as chairman of the board
until January 2008 and as chief financial officer for such period until a new
CEO is appointed. Under the Israeli Companies Law, such dual positions require
shareholders' approval which must be renewed every three years. Our shareholders
approved this dual position in July 2004. In December 2000, our board of
directors extended the term of Mr. Dekel's employment until such time as it is
terminated by us or by Mr. Dekel pursuant to the terms of the agreement. Under
the Israeli Companies Law, the terms of employment of Mr. Dekel, who is also a
member of our board of directors requires shareholders' approval. Our
shareholders approved Mr. Dekel's terms in July 2004. See also Item 6.B.
"Directors, Senior Management and Employees-Compensation" above.
C. INTERESTS OF EXPERTS AND COUNSEL.
Not applicable.
ITEM 8. FINANCIAL INFORMATION
A. CONSOLIDATED STATEMENTS AND OTHER FINANCIAL INFORMATION.
The Financial Statements required by this item are found at the end of this
annual report, beginning on page F-1.
In 2005, the total amount of our revenues from our facilities located
outside of Israel to customers outside of Israel was approximately $34 million,
or 55.7% of our total revenues. The total amount of our export revenues from our
Israeli facilities to countries outside of Israel was approximately $7.8
million, or 12.8% of our total revenues.
LEGAL PROCEEDINGS
In April 2003, Rav-Tec Ltd. filed a civil action against us, the MOD and
Mr. Giora Cohen in the District Court of Tel-Aviv. The plaintiff alleges that
its failure in the field trials of the perimeter systems executed by the MOD
during 1996-1997 resulted from intentional damage to its perimeter system and
diversion of the results of certain intrusion tests made by Cohen who was then a
soldier in the IDF. The plaintiff alleges that we were the employer of Cohen
during 1995 and we still employed him as our agent during the field trials. The
plaintiff requests the courts to annul the field trial and award it
approximately $714,000 in damages. We have denied all of the above allegations
and claimed that the plaintiff's perimeter system failure was not the result of
Cohen's actions. According to our legal counsel, we have good defenses against
the aforementioned claims. The action has been forwarded to mediation.
60
In May 2005 we entered into an agreement to supply comprehensive security
solutions for a sensitive site in Eastern Europe. As part of the agreement, we
received an advance payment, secured by a bank advanced payment guarantee that
was to be reduced proportionally as execution of the project progressed. In
addition we issued the customer a performance bank guarantee. We commenced the
project and delivered some of the equipment and other deliverables to the
customer in 2005. In April 2006, the customer informed us that it was canceling
the agreement due to errors in the design documents submitted by us. In
addition, the customer did not make payments required under the agreement. Based
on its cancellation of the agreement, the customer collected $3.2 million under
bank advance payment guarantee, on June 20, 2006.
We believe that there is no factual or legal ground for the cancellation of
the agreement or the demand for payment under the bank performance guarantee.
Accordingly, we believe that the agreement is still valid. On April 28, 2006, we
commenced arbitration proceedings against the customer. In these proceedings we
asked the arbitrators to find that the agreement is valid and to enforce the
payments due to us pursuant to the agreement. The customer has not yet filed its
response. Based on the opinion of our legal counsel, we believe that there is a
good likelihood that the arbitration will result in a favorable determination.
We intend to vigorously pursue our claim.
On July 11, 2006, the customer made a demand for additional payment under a
bank performance guarantee for $1.4 million. Upon our motion, the District Court
in Haifa, Israel issued a temporary injunction against the payment of such
guarantee pending a hearing in August 2006. Although we obtained the temporary
injunction, according to our legal counsel, our chances to ultimately prevent
the forfeiture of the guarantee remain unclear.
In addition, we are subject to legal proceedings arising in the normal
course of business. Based on the advice of our legal counsel, management
believes that these proceedings will not have a material adverse effect on our
financial position or results of operations.
DIVIDEND POLICY
In each of 1999 and 2000, we paid a cash dividend to our shareholders of
$0.10 per ordinary share, representing approximately 32.0% of our net income
before writing off the investment in our affiliate in each of 1998 and 1999. In
2001, we paid a cash dividend to our shareholders of $0.13 per ordinary share,
representing approximately 33.0% of our net income in 2000. In each of August
2002 and 2003, we paid a 3.0% stock dividend as a final dividend for the years
ended December 31, 2001 and 2002, respectively.
On January 27, 2004 we paid a cash dividend to our shareholders of $0.05
per ordinary share, representing approximately 17.0% of our net income in 2003.
In August 2004, we paid a 5.0% stock dividend to our shareholders as a final
dividend for 2003.
B. SIGNIFICANT CHANGES.
Except as otherwise disclosed in this annual report, there has been no
material change in our financial position since December 31, 2005.
ITEM 9. THE OFFER AND LISTING
A. OFFER AND LISTING DETAILS.
ANNUAL STOCK INFORMATION
Our shares have traded on the NASDAQ National Market since our initial
public offering in 1993 and on the Tel Aviv Stock Exchange since July 2001.
61
The following table sets forth, for each of the years indicated, the range
of high ask and low bid prices of our ordinary shares on the NASDAQ National
Market and the Tel Aviv Stock Exchange:
NASDAQ NATIONAL MARKET TEL AVIV STOCK EXCHANGE
------------------------- --------------------------
HIGH LOW HIGH LOW
----- ---- ----- -----
2001 15.20 2.87 NIS 64.00 NIS 20.50
2002 13.49 4.57 59.60 22.24
2003 9.97 4.74 42.68 22.69
2004 40.35 6.75 156.68 32.25
2005 12.22 7.87 53.45 35.74
QUARTERLY STOCK INFORMATION
The following table sets forth, for each of the full financial quarters in
the two most recent full financial years and any subsequent period, the range of
high ask and low bid prices of our ordinary shares on the NASDAQ National Market
and the Tel Aviv Stock Exchange:
NASDAQ NATIONAL MARKET TEL AVIV STOCK EXCHANGE
------------------------- --------------------------
HIGH LOW HIGH LOW
----- ---- ----- -----
2004
First Quarter $23.22 $6.75 NIS 88.10 NIS 32.25
Second Quarter 40.35 12.35 156.68 56.77
Third Quarter 19.45 12.60 84.77 57.12
Fourth Quarter 17.05 10.60 74.70 47.20
2005
First Quarter $12.22 $9.50 NIS 53.45 NIS 42.27
Second Quarter 11.37 7.89 49.35 36.19
Third Quarter 11.21 7.87 50.13 35.74
Fourth Quarter 10.96 8.40 49.56 39.24
2006
First Quarter $14.2 $8.75 NIS 64.25 NIS 40.61
Second Quarter $13.36 $9.01 61.15 40.57
MONTHLY STOCK INFORMATION
The following table sets forth, for each of the most recent six months, the
range of high ask and low bid prices of our ordinary shares on the NASDAQ
National Market and the Tel Aviv Stock Exchange:
NASDAQ NATIONAL MARKET TEL AVIV STOCK EXCHANGE
------------------------- --------------------------
HIGH LOW HIGH LOW
----- ---- ----- -----
2006
January $11.80 $ 8.75 NIS 53.18 NIS 40.61
February 12.68 10.40 56.06 48.61
March 14.20 12.05 64.25 58.95
April 13.36 10.70 61.15 49.64
May 11.49 9.31 49.91 42.95
June 10.70 9.01 47.34 40.57
62
B. PLAN OF DISTRIBUTION.
Not applicable.
C. MARKETS.
Our ordinary shares have traded on the NASDAQ National Market under the
symbol MAGS since our initial public offering in 1993. As of July 1, 2001, our
ordinary shares are also traded on the Tel Aviv Stock Exchange under the symbol
MAGS.
D. SELLING SHAREHOLDERS.
Not applicable.
E. DILUTION.
Not applicable.
F. EXPENSES OF THE ISSUE.
Not applicable.
ITEM 10. ADDITIONAL INFORMATION
A. SHARE CAPITAL.
Not applicable.
B. MEMORANDUM AND ARTICLES OF ASSOCIATION.
We are registered with the Israeli Companies Registry and have been
assigned company number 52-003892-8. Section 2 of our memorandum of association
provides, among other things, that we were established for the purposes of
acquiring from IAI a plant, known as the Magal Plant, engaged in the
development, manufacture, sale and support of alarm devices and dealing in the
development, manufacturing and support of security alarm devices and other
similar products. In addition, the purpose of our company is to be eligible to
perform and act in connection with any right or obligation of whatever kind or
nature permissible under Israeli law.
BOARD OF DIRECTORS
The strategic management of our business (as distinguished from the daily
management of the our business affairs) is vested in our board of directors,
which may exercise all such powers and do all such acts as our company is
authorized to exercise and do, and which are not required to be exercised by a
resolution of the general meeting of our shareholders. The board of directors
may, subject to the provisions of the Israeli Companies Law, delegate some of
its powers to committees, each consisting of one or more directors, provided
that at least one member of such committee is an outside director.
According to the Israeli Companies Law, we may stipulate in our articles of
association that the general meeting of shareholders is authorized to assume the
responsibilities of the board of directors. In the event the board of directors
is unable to act or exercise its powers, the general meeting of shareholders is
authorized to exercise the powers of the board of directors, although the
articles of association do not stipulate so. Our board of directors has the
power to assume the responsibilities of our chief executive officer if he is
unable to act or exercise his powers or if he fails to fulfill the instructions
of the board of directors with respect to a specific matter.
63
Our articles of association do not impose any mandatory retirement or
age-limit requirements on our directors and our directors are not required to
own shares in our company in order to qualify to serve as directors.
For a discussion of the Israeli Companies Law regulations concerning a
director's duty of care and duty of loyalty, see Item 6.C. "Directors, Senior
Management and Employees-Board Practices-Approval of Specific Related-Party
Transactions." For a discussion of the Israeli Companies Law regulations
regarding indemnification of directors, see Item 6.C. "Directors, Senior
Management and Employees-Board Practices-Indemnification of Directors and
Officers and Limitations of Liability."
Directors' compensation arrangements (other than outside directors) require
the approval of our audit committee before board and shareholder approval.
However, pursuant to amendments to the Companies Regulations (Relief from
Related Party Transactions), 5760-2000, directors' compensation and employment
arrangements do not require shareholder approval if such arrangements are
approved by both the audit committee and the board of directors, and meet
certain criteria. In addition, if the director is a controlling shareholder of
the company, then the employment and compensation arrangements of such director
do not require shareholder approval; provided such arrangements meet certain
specified criteria.
The relief from having to obtain shareholder approval set forth above will
not apply, and shareholder approval will be required, if one or more
shareholders, holding at least 1% of the issued and outstanding share capital of
the company or of the company's voting rights, object to the grant of such
relief, provided that such objection is submitted to the company in writing not
later than seven days from the date of the filing of a report regarding the
adoption of such resolution by the company pursuant to the requirements of the
Israeli Securities Law (which reporting requirements are not applicable to us as
a double foreign company).
The board of directors may from time to time, at its discretion, cause the
company to borrow or secure the payment of any money for the purposes of the
company, and may secure or provide for the repayment of such money in the manner
as it deems fit.
SHARE CAPITAL
Our share capital consists of NIS 19,748,000 divided into 19,748,000
ordinary shares, par value NIS 1.00 each, all ranking PARI PASSU. All our
ordinary shares have the same rights, preferences and restrictions, some of
which are detailed below. At the general meeting of shareholders, our
shareholders may, subject to certain provisions detailed below, create different
classes of shares, each class bearing different rights, preferences and
restrictions.
DIVIDENDS
Holders of ordinary shares are entitled to participate in the payment of
dividends in accordance with the amounts paid-up or credited as paid up on the
nominal value of such ordinary shares at the time of payment (without taking
into account any premium paid thereon). However, under article 13 of our
articles of association no shareholder shall be entitled to receive any
dividends until he shall have paid all calls then currently due and payable on
each ordinary share held by such shareholder.
Declaration of a final dividend requires the approval by ordinary
resolution of our shareholders at a general meeting of shareholders. Such
resolution may reduce but not increase the dividend amount recommended by the
board of directors. Dividends may be paid, in whole or in part, by way of
distribution of dividends in kind.
Dividends may be paid only out of our distributable earnings, as defined in
the Israeli Companies Law. Prior to any distribution of dividends, our board of
directors has to determine that there is no reasonable concern that such
distribution will prevent us from executing our existing and foreseeable
obligations as they become due.
64
VOTING RIGHTS
Holders of ordinary shares are entitled to one vote for each share of
record on all matters submitted to a vote of shareholders. Voting is done by a
show of hands, unless a poll is demanded prior to a vote by a show of hands.
Generally, resolutions are adopted at the general meeting of shareholders by an
ordinary resolution, unless the Israeli Companies Law or the articles of
association require an extraordinary resolution.
An ordinary resolution, such as a resolution approving the declaration of
dividends or the appointment of auditors, requires approval by the holders of a
simple majority of the shares represented at the meeting, in person or by proxy,
and voting thereon. An extraordinary resolution requires approval by the holders
of at least 75% of the shares represented at the meeting, in person or by proxy,
and voting thereon.
The primary resolutions required to be adopted by an extraordinary
resolution of the general meeting of shareholders are resolutions to:
o amend the memorandum or the articles of association;
o change the share capital, for example, increasing or canceling the
authorized share capital or modifying the rights attached to shares;
and
o approve mergers, consolidations or winding up of our company.
Our articles of association do not contain any provisions regarding a
classified board of directors or cumulative voting for the election of
directors.
RIGHTS IN THE COMPANY'S PROFITS
Our shareholders have the right to share in our profits distributed as a
dividend or any other permitted distributions.
LIQUIDATION
Article 111 of our articles of association provides that upon any
liquidation, dissolution or winding-up of our company, our remaining assets
shall be distributed pro-rata to our ordinary shareholders.
REDEMPTION
Under article 38 of our articles of association, we may issue redeemable
stock and redeem the same.
TRANSFER OF SHARES
The transfer of a fully paid-up ordinary share does not require the
approval of our board of directors. However, according to article 17 of our
articles of association, any transfer of an ordinary share requires an
instrument of transfer in the form designated by the board of directors together
with any other evidence of title as the board of directors may reasonably
request.
65
SUBSTANTIAL LIMITATIONS ON SHAREHOLDERS
See Item 6.C. "Directors, Senior Management and Employees-Board
Practices-Approval of Specific Related-Party Transactions."
CAPITAL CALLS
Under our memorandum of association and the Israeli Companies Law, the
liability of our shareholders is limited to the par value of the shares held by
them.
MODIFICATIONS OF SHARE RIGHTS
Shares which confer preferential or subordinate rights relating to, among
other things, dividends, voting, and payment of capital may be created only by
an extraordinary resolution of the general meeting of shareholders. The rights
attached to a class of shares may be altered by an extraordinary resolution of
the general meeting of shareholders, provided the holders of 75% of the issued
shares of that class approve such change by the adoption of an extraordinary
resolution at a separate meeting of such class, subject to the terms of such
class. The provisions of the articles of association pertaining to general
meetings of shareholders also apply to a separate meeting of a class of
shareholders.
GENERAL MEETINGS OF SHAREHOLDERS
An annual general meeting of shareholders is held at least once every
calendar year, not later than 15 months after the last annual general meeting of
shareholders, at such time and at such place as may be fixed by the board of
directors. Any additional general meetings of shareholders are called
"extraordinary general meetings." The board of directors may, in its discretion,
convene an extraordinary general meeting and is obliged to do so upon receipt of
a written request from the holders of at least 5% of our outstanding ordinary
shares and/or of our voting rights.
The Israeli Companies Law provides that a company whose shares are traded
on a stock exchange must give notice of a general meeting of shareholders to its
shareholders of record at least twenty-one days prior to the meeting. A
shareholder present, in person or by proxy, at the commencement of a general
meeting of shareholders may not seek the cancellation of any proceedings or
resolutions adopted at such general meeting of shareholders on account of any
defect in the notice of such meeting relating to the time or the place thereof.
Shareholders who are registered in our register of shareholders at the record
date may vote at the general meeting of shareholders. The record date is set in
the resolution to convene the general meeting of shareholders, provided,
however, that such record date must be between four to twenty-one days or, in
the event of a vote by ballots, between four to forty days prior the date the
general meeting of shareholders is held.
The quorum required for a general meeting of shareholders consists of at
least two record shareholders, present in person or by proxy, who hold, in the
aggregate, at least one third of the voting power of our outstanding shares. A
general meeting of shareholders will be adjourned for lack of a quorum after
half an hour from the time appointed for such meeting to the same day in the
following week at the same time and place or any other time and place as the
board of directors designates in a notice to the shareholders. At such
reconvened meeting, if a quorum is not present within half an hour from the time
appointed for such meeting, two or more shareholders, present in person or by
proxy, will constitute a quorum. The only business that may be considered at an
adjourned general meeting of shareholders is the business that might have been
lawfully considered at the general meeting of shareholders originally convened
and the only resolutions that may be adopted are the resolutions that could have
been adopted at the general meeting of shareholders originally convened.
LIMITATIONS ON THE RIGHT TO OWN OUR SECURITIES
Neither our memorandum or articles of association nor the laws of the State
of Israel restrict in any way the ownership or voting of our ordinary shares by
non-residents, except that the laws of the State of Israel may restrict the
ownership of ordinary shares by residents of countries that are in a state of
war with Israel.
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PROVISIONS RESTRICTING A CHANGE IN CONTROL OF OUR COMPANY
The Israeli Companies Law requires that mergers between Israeli companies
be approved by the board of directors and general meeting of shareholders of
both parties to the transaction. The approval of the board of directors of both
companies is subject to such board of directors' confirmation that there is no
reasonable doubt that after the merger the surviving company will be able to
fulfill its obligations to its creditors. Each company must notify its creditors
about the contemplated merger. Under the Israeli Companies Law, our articles of
association are deemed to include a requirement that such merger be approved by
an extraordinary resolution of our shareholders, as explained above. The
approval of the merger by the general meetings of shareholders of each of the
companies is also subject to additional approval requirements as specified in
the Israeli Companies Law and regulations promulgated thereunder.
The Companies Law also provides that an acquisition of shares in a public
company on the open market must be made by means of a tender offer if as a
result of the acquisition the purchaser would become a 25% or greater
shareholder of the company. However, this rule does not apply if there already
is another 25% or greater shareholder of the company. Similarly, the Israeli
Companies Law provides that an acquisition of shares in a public company must be
made by means of a tender offer if as a result of the acquisition the purchaser
would hold greater than a 45% interest in the company, unless there is another
shareholder holding more than a 45% interest in the company. These requirements
do not apply if, in general, the acquisition (1) was made in a private placement
that received shareholder approval, (2) was from a 25% or greater shareholder of
the company which resulted in the acquiror becoming a 25% or greater shareholder
of the company, or (3) was from a shareholder holding more than a 45% interest
in the company which resulted in the acquiror becoming a holder of more than a
45% interest in the company.
However, under the Companies Law, if as a result of any acquisition of
shares the acquirer would hold more than 90% of the company's outstanding
shares, the acquisition must be made by means of a tender offer for all of the
outstanding shares. If less than 5% of the outstanding shares are not tendered
in the tender offer, all the shares that the acquirer offered to purchase will
be transferred to the acquirer. The Israeli Companies Law provides for appraisal
rights if any shareholder files a request in court within three months following
the consummation of a full tender offer. If more than 5% of the outstanding
shares are not tendered in the tender offer, then the acquiror may not acquire
shares in the tender offer that will cause his shareholding to exceed 90% of the
outstanding shares. These rules do not apply if the acquisition is made by way
of a private placement, provided such private placement is approved by the
shareholders of the company. In addition, these rules do not apply to a company
whose shares are publicly traded outside of Israel if applicable foreign
securities laws restrict the acquisition of any level of control of the company
or require the purchaser to make a tender offer to the public shareholders upon
the acquisition of any level of control of the company.
DISCLOSURE OF SHAREHOLDERS' OWNERSHIP
The Israeli Securities Law, 5728-1968 and regulations promulgated
thereunder contain various provisions regarding the ownership threshold above
which shareholders must disclose their share ownership. However, these
provisions do not apply to companies, such as ours, whose shares are publicly
traded in Israel as well as outside of Israel. As a result of the listing of our
ordinary shares on the Tel Aviv Stock Exchange, we are required pursuant to the
Israeli Securities Law and the regulations promulgated thereunder to deliver to
the Israeli Share Registrar, the Israeli Securities Exchange Commission and the
Tel Aviv Stock Exchange, all reports, documents, forms and information received
by us from our shareholders regarding their shareholdings, provided that such
information was published or required to be published under applicable foreign
law.
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C. MATERIAL CONTRACTS.
We are not a party to any material contracts other than those entered into
in the ordinary course of business.
D. EXCHANGE CONTROLS.
Israeli law and regulations do not impose any material foreign exchange
restrictions on non-Israeli holders of our ordinary shares. In May 1998, a new
"general permit" was issued under the Israeli Currency Control Law, 1978, which
removed most of the restrictions that previously existed under such law, and
enabled Israeli citizens to freely invest outside of Israel and freely convert
Israeli currency into non-Israeli currencies.
Non-residents of Israel who purchase our ordinary shares will be able to
convert dividends, if any, thereon, and any amounts payable upon our
dissolution, liquidation or winding up, as well as the proceeds of any sale in
Israel of our ordinary shares to an Israeli resident, into freely repatriable
dollars, at the exchange rate prevailing at the time of conversion, provided
that the Israeli income tax has been withheld (or paid) with respect to such
amounts or an exemption has been obtained.
E. TAXATION.
The following is a discussion of Israeli and United States tax consequences
material to us and to our shareholders. To the extent that the discussion is
based on new tax legislation which has not been subject to judicial or
administrative interpretation, the views expressed in the discussion might not
be accepted by the tax authorities in question. The discussion is not intended,
and should not be construed, as legal or professional tax advice and does not
exhaust all possible tax considerations.
HOLDERS OF OUR ORDINARY SHARES SHOULD CONSULT THEIR OWN TAX ADVISORS AS TO
THE UNITED STATES, ISRAELI OR OTHER TAX CONSEQUENCES OF THE PURCHASE, OWNERSHIP
AND DISPOSITION OF ORDINARY SHARES, INCLUDING, IN PARTICULAR, THE EFFECT OF ANY
FOREIGN, STATE OR LOCAL TAXES.
ISRAELI TAX CONSIDERATIONS
The following is a summary of the current tax structure applicable to
companies in Israel, with special reference to its effect on us. The following
also contains a discussion of the material Israeli tax consequences to
purchasers of our ordinary shares and Israeli government programs benefiting us.
This summary does not discuss all the aspects of Israeli tax law that may be
relevant to a particular investor in light of his or her personal investment
circumstances or to some types of investors subject to special treatment under
Israeli law.
GENERAL CORPORATE TAX STRUCTURE
Israeli companies are subject to income tax on their worldwide income.
Pursuant to tax reform legislation that came into effect in 2003, the corporate
tax rate is to undergo staged reductions to 25% by the year 2010. In order to
implement these reductions, the corporate tax rate is scheduled to decline to
31% in 2006, 29% in 2007, 27% in 2008, and 26% in 2009.
However, the effective tax rate payable by a company that derives income
from an approved enterprise, discussed further below, may be considerably less.
See "-Tax Benefits under the Law for the Encouragement of Capital Investments,
1959."
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LAW FOR THE ENCOURAGEMENT OF CAPITAL INVESTMENTS, 1959
GENERAL
The Law for the Encouragement of Capital Investments, 1959, commonly
referred to as the Investment Law, provides that a proposed capital investment
in eligible facilities may, upon application to the Investment Center of the
Ministry of Industry, Trade and Labor of the State of Israel, commonly referred
to as the Investment Center, be designated as an approved enterprise. Each
certificate of approval for an approved enterprise relates to a specific
investment program delineated both by its financial scope, including its capital
sources, and by its physical characteristics, for example, the equipment to be
purchased and utilized under the program. The tax benefits derived from any
certificate of approval relate only to taxable income attributable to the
specific approved enterprise. If a company has more than one approval or only a
portion of its capital investments is approved, its effective tax rate is the
result of a weighted average of the applicable rates.
Certain of our production facilities have been granted approved enterprise
status pursuant to the Investment Law, which provides certain tax and financial
benefits to investment programs that have been granted this status.
TAX BENEFITS
Taxable income of a company derived from an approved enterprise is
generally subject to company tax at the maximum rate of 25%, rather than 31%,
for the benefit period. This period is ordinarily seven years, or ten years if
the company qualifies as a foreign investors' company as described below,
commencing with the year in which the approved enterprise first generates
taxable income. However, this period is limited to the earlier of twelve years
from commencement of production or fourteen years from the date of approval.
A company that owns an approved enterprise may elect to receive an
alternative package of benefits. Under the alternative package of benefits, a
company's undistributed income derived from an approved enterprise will be
exempt from company tax for a period of between two and ten years from the first
year of taxable income, depending on the geographic location of the approved
enterprise within Israel, and the company will be eligible for a reduced tax
rate for the remainder of the benefits period.
A company that has an approved enterprise program is eligible for further
tax benefits if it qualifies as a foreign investors' company. A foreign
investors' company is a company more than 25% of whose share capital and
combined share and loan capital is owned by non-Israeli residents. A company
that qualifies as a foreign investors' company and has an approved enterprise
program is eligible for tax benefits for a ten year benefit period. Income
derived from the approved enterprise program will be exempt from tax for a
period of two years and will be subject to a reduced tax rate for an additional
eight years, provided that the company qualifies as a foreign investors'
company. The tax rate for the additional eight-year period is 25%. However, if
the level of foreign investment exceeds 49% but is less than 74%, then the tax
rate for the additional eight-year period is 20%. If the level of foreign
investment exceeds 74% but is less than 90%, then the tax rate for the
additional eight-year period is 15%. If the level of foreign investment exceeds
90%, then the tax rate for the additional eight-year period is 10%. If the
company does not qualify as a foreign investors' company, the period of the
reduced tax rate will be five years.
A company that has elected the alternative package of benefits and that
subsequently pays a dividend out of income derived from the approved enterprise
during the tax exemption period will be subject to tax on the amount distributed
at the rates mentioned above. The tax rate will be the rate that would have been
applicable had the company not elected the alternative package of benefits. This
rate is generally 10%-25%, depending on the percentage of the company's shares
held by foreign shareholders. The dividend recipient is taxed at the reduced
rate applicable to dividends from approved enterprises, which is 15% if the
dividend is distributed during the tax benefit period and within 12 years after
the period. The company must withhold this tax at the source.
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Subject to applicable provisions concerning income under the alternative
package of benefits, all incomes are considered to be attributable to the entire
enterprise and their effective tax rate is the result of a weighted average of
the various applicable tax rates. Under the Investment Law, a company that has
elected the alternative package of benefits is not obliged to distribute exempt
retained profits, and may generally decide from which year's profits to declare
dividends.
The benefits available to an approved enterprise program are dependent upon
the fulfillment of conditions stipulated in applicable law and in the
certificate of approval. If we fail to comply with these conditions with regard
to our approved enterprises, the tax and other benefits we receive could be
rescinded, in whole or in part, and we may be required to refund the amount of
previously received benefits in addition to Israeli CPI linkage adjustments and
interest costs. We believe that our approved enterprises currently substantially
comply with all such conditions.
On April 1, 2005, an amendment to the Investments Law came into force.
Pursuant to the amendment, a company's facility will be granted the status of
"Approved Enterprise" only if it is proven to be an industrial facility (as
defined in the Investments Law) that contributes to the economic independence of
the Israeli economy and is a competitive facility that contributes to the
Israeli gross domestic product. The amendment provides that the Israeli Tax
Authority and not the Investment Center will be responsible for an Approved
Enterprise under the alternative package of benefits, referred to as a
Benefiting Facility. A company wishing to receive the tax benefits afforded to a
Benefiting Facility is required to select the tax year from which the period of
benefits under the Investment Law are to commence by simply notifying the
Israeli Tax Authority within 12 months of the end of that year. In order to be
recognized as owning a Benefiting Facility, a company is required to meet a
number of conditions set forth in the amendment, including making a minimal
investment in manufacturing assets for the Benefiting Facility and having
completed a cooling-off period of no less than two to four years from the
company's previous year of commencement of benefits under the Investments Law.
Pursuant to the amendment, a company with a Benefiting Facility is
entitled, in each tax year, to accelerated depreciation for the manufacturing
assets used by the Benefiting Facility and to certain tax benefits, provided
that no more than 12 to 14 years have passed since the beginning of the year of
commencement of benefits under the Investments Law. The tax benefits granted to
a Benefiting Factory are determined according one of the following new tax
routes:
(a) Similar to the currently available alternative route, exemption from
corporate tax on undistributed income for a period of two to ten years,
depending on the geographic location of the Benefiting Facility within Israel,
and a reduced corporate tax rate of 10% to 25% for the remainder of the benefits
period, depending on the level of foreign investment in each year. Benefits may
be granted for a term of from seven to ten years, depending on the level of
foreign investment in the company. If the company pays a dividend out of income
derived from the Benefiting Facility during the tax exemption period, such
income will be subject to corporate tax at the applicable rate (10%-25%). The
company is required to withhold tax at the source at a rate of 15% from any
dividends distributed from income derived from the Benefiting Facility.
(b) A special tax route enabling companies owning facilities in certain
geographical locations in Israel to pay corporate tax at the rate of 11.5% on
income of the Benefiting Facility. The benefits period is ten years. Upon
payment of dividends, the company is required to withhold tax at source at a
rate of 15% for Israeli residents and at a rate of 4% for foreign residents.
(c) A special tax route that provides a full exemption from corporate tax
and from tax with respect to dividends for companies with an annual income of at
least NIS 13-20 billion that have invested a total of between NIS 600-900
million in facilities in certain geographical locations in Israel.
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Generally, a company that is Abundant in Foreign Investment (as defined in
the Investments Law) is entitled to an extension of the benefits period by an
additional five years, depending on the rate of its income that is derived in
foreign currency.
The amendment changes the definition of "foreign investment" in the
Investments Law so that instead of an investment of foreign currency in the
company, the definition now requires a minimal investment of NIS 5 million by
foreign investors. Furthermore, such definition now also includes the purchase
of shares of a company from another shareholder; provided that the company's
outstanding and paid-up share capital exceeds NIS 5 million. Such changes to the
aforementioned definition will take effect retroactively from 2003.
The amendment will apply to approved enterprise programs in which the year
of commencement of benefits under the Investments Law is 2004 or later, unless
such programs received approval from the Investment Center on or prior to
December 31, 2004 in which case the provisions of the amendment will not apply.
FINANCIAL BENEFITS
An approved enterprise is also entitled to a grant from the Government of
Israel for investments in certain production facilities located in designated
areas within Israel, provided it did not elect the alternative benefits program.
Grants are available for enterprises situated in development areas and for
high-technology or skill-intensive enterprises in Jerusalem. The investment
grant is computed as a percentage of the original cost of the fixed assets for
which the approved enterprise has been granted.
From time to time, the Government of Israel has discussed reducing the
benefits available to companies under the Investment Law. In 1996, the
investment grant was decreased from 38% to 34% and in January 1997 the grant was
reduced to 20%. Currently, grants generally range between 10% and 20%. If the
benefits available under the Investment Law are terminated or substantially
reduced, it could have a material adverse effect on our future investments in
Israel.
For companies such as ours, whose foreign shareholders hold more than 25%
of the company's outstanding ordinary shares, future approved enterprises would
entitle such companies to receive reduced tax rates for up to ten tax years,
rather than the maximum seven tax years applicable to companies with a smaller
foreign investment.
As long as we are in compliance with the conditions set forth in the
certificates of approval granted to us, our income derived from our approved
enterprise expansion programs will be tax exempt for the prescribed period and
thereafter will enjoy reduced tax rates as detailed above. If we violate these
conditions, we may be required to refund the amount of tax benefits we
previously received in addition to Israeli CPI linkage adjustments and interest
costs.
We currently have two approved enterprise expansion programs which were
approved in 1997 and 2001, and under which we are entitled to tax benefits. The
periods of benefits for two of our approved enterprise programs will expire in
2007 and in 2012, respectively. The benefits we receive in connection with our
approved enterprise programs are conditioned upon the fulfillment of a marketing
plan filed by us with the Investment Center.
LAW FOR THE ENCOURAGEMENT OF INDUSTRY (TAXES), 1969
Under the Law for the Encouragement of Industry (Taxes), 1969, or the
Industry Encouragement Law, "Industrial Companies" are entitled to certain
corporate tax benefits, including, among others:
o Deduction, under certain conditions, of purchases of know-how and
patents over an eight-year period for tax purposes;
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o right to elect, under specified conditions, to file a consolidated tax
return with additional related Israeli industrial companies; and
o accelerated depreciation rates on equipment and buildings; and
o Deductions over a three-year period of expenses in connection with the
issuance and listing of shares on the Tel Aviv Stock Exchange, or TASE
or, on or after January 1, 2003, on a recognized stock market outside
of Israel.
Eligibility for benefits under the Industry Encouragement Law is not
subject to receipt of prior approval from any governmental authority. Under the
Industry Encouragement Law, an "Industrial Company" is a company resident in
Israel, at least 90% of the income of which, in any tax year, determined in
Israeli currency, exclusive of income from government loans, capital gains,
interest and dividends, is derived from an "Industrial Enterprise" owned by it.
An "Industrial Enterprise" is an enterprise owned by an Industrial Company,
whose major activity in a given tax year is industrial production activity.
We believe that we currently qualify as an industrial company as defined by
the Industry Encouragement Law. We cannot assure you that we will continue to
qualify as an industrial company or that the benefits described above will be
available to us in the future.
LAW FOR THE ENCOURAGEMENT OF INDUSTRIAL RESEARCH AND DEVELOPMENT, 1984
Under the Law for the Encouragement of Industrial Research and Development,
1984, or the Research Law, research and development programs that meet specified
criteria and are approved by a governmental committee of the OCS are eligible
for grants of up to 50% of certain of the project's expenditures, as determined
by the research committee.
In exchange, the recipient of such grants is required to pay the OCS
royalties from the revenues derived from products incorporating technology
developed within the framework of the approved research and development program
or derived from such program (including ancillary services in connection with
such program), usually up to100% of the U.S. dollar-linked value of the total
grants received in respect of such program, plus LIBOR interest.
The terms of the Israeli government participation also require that
products developed with government grants be manufactured in Israel. However,
under the regulations of the Research Law, upon the approval of the OCS, some of
the manufacturing volume may be performed outside Israel, provided that the
grant recipient pays royalties at an increased rate. The Research Law also
allows for the approval of grants in cases in which the applicant declares that
part or all of the manufacturing will be performed outside of Israel or by
non-Israeli residents and the research committee is convinced that this is
essential for the execution of the program. The Research Law also provides that
know-how developed under an approved research and development program may not be
transferred to third parties in Israel without the prior approval of the
research committee. The Research Law further provides that the know-how
developed under an approved research and development program may not be
transferred to any third parties outside Israel. No approval is required for the
sale or export of any products resulting from such research and development.
However, In June 2005, an amendment to the Research Law became effective,
which amendment was intended to make the Research Law more compatible with the
global business environment by, among other things, relaxing restrictions on the
transfer of manufacturing rights outside Israel and on the transfer of
OCS-funded know-how outside of Israel. The amendment permits the OCS, among
other things, to approve the transfer of manufacturing rights outside Israel in
exchange for an import of different manufacturing into Israel as a substitute,
in lieu of demanding the recipient to pay increased royalties as described
above. The amendment further permits, under certain circumstances and subject to
the OCS's prior approval, the transfer outside Israel of know-how that has been
funded by OCS, generally in the following cases: (a) the grant recipient pays to
the OCS a portion of the consideration paid for such funded know-how (according
to certain formulas), (b) the grant recipient receives know-how from a third
party in exchange for its funded know-how, or (c) such transfer of funded
know-how arises in connection with certain types of cooperation in research and
development activities.
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The Research Law imposes reporting requirements with respect to certain
changes in the ownership of a grant recipient. The law requires the grant
recipient and its controlling shareholders and interested parties to notify the
OCS of any change in control of the recipient or a change in the holdings of the
means of control of the recipient that results in a non-Israeli becoming an
interested party directly in the recipient and requires the new interested party
to undertake to the OCS to comply with the Research Law. In addition, the rules
of the OCS may require prior approval of the OCS or additional information or
representations in respect of certain of such events. For this purpose,
"control" is defined as the ability to direct the activities of a company other
than any ability arising solely from serving as an officer or director of the
company. A person is presumed to have control if such person holds 50% or more
of the means of control of a company. "Means of control" refers to voting rights
or the right to appoint directors or the chief executive officer. An "interested
party" of a company includes a holder of 5% or more of its outstanding share
capital or voting rights, its chief executive officer and directors, someone who
has the right to appoint its chief executive officer or at least one director,
and a company with respect to which any of the foregoing interested parties owns
25% or more of the outstanding share capital or voting rights or has the right
to appoint 25% or more of the directors. Accordingly, any non-Israeli who
acquires 5% or more of our ordinary shares will be required to notify the OCS
that it has become an interested party and to sign an undertaking to comply with
the Research Law.
The funds generally available for grants by the OCS were reduced for 2003,
and the Israeli authorities have indicated that the government may further
reduce or abolish grants from the OCS in the future. Even if these grants are
maintained, we cannot assure you that we will receive OCS grants in the future.
In addition, each application to the OCS is reviewed separately, and grants are
based on the program approved by the research committee. Generally, expenditures
supported under other incentive programs of the State of Israel are not eligible
for grants from the OCS.
TAXATION UNDER INFLATIONARY CONDITIONS
The Income Tax Law (Inflationary Adjustments), 1985, generally referred to
as the Inflationary Adjustments Law, represents an attempt to overcome the
problems presented to a traditional tax system by an economy undergoing rapid
inflation. The Inflationary Adjustments Law is highly complex. Its features
which are material to us can be described as follows:
o There is a special tax adjustment for the preservation of equity
whereby some corporate assets are classified broadly into fixed assets
and non-fixed assets.
o Where a company's equity, as defined in such law, exceeds the
depreciated cost of fixed assets, a deduction from taxable income that
takes into account the effect of the applicable annual rate of
inflation on such excess is allowed up to a ceiling of 70% of taxable
income in any single tax year, with the unused portion permitted to be
carried forward on a linked basis. If the depreciated cost of fixed
assets exceeds a company's equity, then such excess multiplied by the
applicable annual rate of inflation is added to taxable income.
o Subject to specified limitations, depreciation deductions on fixed
assets and losses carried forward are adjusted for inflation based on
the increase in the Israeli CPI.
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STAMP TAX
Under the Stamp Tax on Documents Law, certain documents are subject to
stamp tax. Promulgated regulations provide for a gradual phase-out of the stamp
tax by 2008. A new regulation abolished the Stamp Tax for documents signed after
January 1, 2006. We may be liable to pay stamp tax with respect to documents
that were signed in the period beginning June 1, 2003 and ending on December 31,
2005. Based on the advice of our counsel, our management believes that the
potential costs arising from this matter are not material.
CAPITAL GAINS TAX ON SALES OF OUR ORDINARY SHARES
As of January 1, 2003, when the recent Israeli tax reform came into effect,
individuals and companies on which the provisions of the income tax law
(Inflationary Adjustments), 1985 are not imposed, are subject to a 15% tax rate
on the real capital gains derived on or after January 1, 2003 from the sale of
shares in Israeli companies publicly traded on a recognized stock exchange
outside of Israel. This will be the case so long as our securities remain listed
on NASDAQ or traded on a stock exchange in Israel or another country.
Under a recent amendment to the income tax ordinance, effective as of
January 1, 2003 and with respect to sales of shares on or after January 1 2006,
individuals are subject to a 20% tax rate on the real capital gains derived on
or after January 1, 2003 from the sale of shares. Substantial individual
shareholders (who are defined as shareholders of 10% or more of the shares of
the company on the date of the sale of the shares or any date during the 12
months before the sale of the shares) are subject to a 25% tax rate on the real
capital gains derived on or after January 1, 2003 from the sale of shares.
Companies on which the provisions of the income tax law (Inflationary
Adjustments), 1985 were not imposed before January 1, 2006 are subject to 25%
tax rate on real capital gains derived on or after January 1, 2003 from the sale
of the shares. Notwithstanding the above, companies on which the provisions of
the income tax law (Inflationary Adjustments), 1985 were imposed before January
1, 2006 are subject to regular corporate tax rate on real capital gains derived
on the sale of the shares.
The law distinguishes between real gain and inflationary surplus. The
inflationary surplus is a portion of the total capital gain which is equivalent
to the increase of the relevant asset's purchase price which is attributable to
the increase in the Israeli consumer price index between the date of purchase
and the date of sale. The real gain is the excess of the total capital gain over
the inflationary surplus.
Under income tax regulations non-Israeli residents, who sell shares of an
Israeli company publicly traded on a recognized stock exchange outside of
Israel, will be exempt from tax subject to the satisfaction of all following
conditions:
o The capital gain is not attributable to a permanent establishment in
Israel.
o The shares were purchased after the first initial public offering on
the recognized stock exchange outside of Israel.
Pursuant to the Convention between the governments of the United States of
America and Israel with respect to taxes on income, as amended, or the
"U.S.-Israel Tax Treaty", the sale, exchange or disposition of ordinary shares
by a person who (i) holds the ordinary shares as a capital asset, (ii) qualifies
as a resident of the United States within the meaning of the U.S.-Israel Tax
Treaty and (iii) is entitled to claim the benefits afforded to such person by
the U.S.-Israel Tax Treaty generally will not be subject to the Israeli capital
gains tax unless such Treaty U.S. Resident holds, directly or indirectly, shares
representing 10% or more of our voting power during any part of the 12-month
period preceding such sale, exchange or disposition, subject to certain
conditions. In this case, the sale, exchange or disposition of ordinary shares
would be subject to Israeli tax, to the extent applicable; however, under the
U.S.-Israel Tax Treaty, such Treaty U.S. Resident would be permitted to claim a
credit for such taxes against the U.S. federal income tax imposed with respect
to such sale, exchange or disposition, subject to the limitations in U.S. laws
applicable to foreign tax credits. The Treaty does not relate to U.S. state or
local taxes.
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TAXATION OF NON-RESIDENT HOLDERS OF SHARES
Non-residents of Israel are subject to income tax on income accrued or
derived from sources in Israel. Such sources of income include passive income
such as dividends, royalties and interest, as well as non-passive income from
services rendered in Israel. On distributions of dividends after January 1, 2006
other than bonus shares or stock dividends, income tax at the rate of 20% will
be withheld on dividends distributed to Israeli individual shareholders or to
non-residents.
The foregoing tax rates are withheld at source, unless a different rate is
provided in a treaty between Israel and the shareholder's country of residence
(for instance, under the provisions of the Treaty between Israel and the United
States a 12.5% tax rate is imposed on dividends not generated by an approved
enterprise if the non-resident is a U.S. corporation that holds 10% of a
company's voting power, and 15% on dividends generated by an approved
enterprise). In addition under the Treaty, the maximum tax on dividends paid to
a holder of ordinary shares who is a U.S. resident within the meaning of the
Treaty will be 25%.
TAX REFORM
On January 1, 2003, the Law for Amendment of the Income Tax Ordinance
(Amendment No.132), 5762-2002, known as the Tax Reform, came into effect,
following its enactment by the Israeli Parliament on July 24, 2002.
The tax reform, aimed at broadening the categories of taxable income and
reducing the tax rates imposed on employment income, introduced the following,
among other things:
o Reduction of the tax rate levied on capital gains (other than gains
deriving from the sale of listed securities) derived after January 1,
2003, to a general rate of 25% for both individuals and corporations.
With respect to assets acquired prior to January 1, 2003, the reduced
tax rate will apply to a proportionate part of the gain, in accordance
with the holding periods of the asset, before or after January 1,
2003, on a linear basis;
o Imposition of Israeli tax on all income of Israeli residents,
individuals and corporations, regardless of the territorial source of
income, including income derived from passive sources such as
interest, dividends and royalties;
o Introduction of controlled foreign corporation, or CFC, rules into the
Israeli tax structure. Generally, under such rules, an Israeli
resident who holds, directly of indirectly, 10% or more of the rights
in a foreign corporation whose shares are not publicly traded, in
which more than 50% of the rights are held directly or indirectly by
Israeli residents, and a majority of whose income in a tax year is
considered passive income, will be liable for tax on the portion of
such income attributed to his holdings in such corporation, as if such
income were distributed to him as a dividend;
o Imposition of capital gains tax on capital gains realized by
individuals as of January 1, 2003 from the sale of shares of publicly
traded companies (such gain was previously exempt from capital gains
tax in Israel). For information with respect to the applicability of
Israeli capital gains taxes on the sale of ordinary shares, see
"Capital Gains Tax on Sales of Our Ordinary Shares" above; and
75
o Introduction of a new regime for the taxation of shares and options
issued to employees and officers (including directors).
The material consequences of the amendment applicable to our company
include, among other things, imposing a tax upon all income of Israeli
residents, individuals and corporations, regardless of the territorial source of
the income and certain modifications in the qualified taxation tracks of
employee stock options. In addition, a foreign tax credit was introduced,
allowing us to credit the income tax paid by our subsidiaries abroad against our
tax liabilities on dividends paid to us by such subsidiaries.
UNITED STATES FEDERAL INCOME TAX CONSEQUENCES
The following is a summary of certain material U.S. federal income tax
consequences that apply to U.S. Holders who hold ordinary shares as capital
assets. This summary is based on the United States Internal Revenue Code of
1986, as amended (the "Code"), Treasury regulations promulgated thereunder,
judicial and administrative interpretations thereof, and the U.S.-Israel Tax
Treaty, all as in effect on the date hereof and all of which are subject to
change either prospectively or retroactively. This summary does not address all
tax considerations that may be relevant with respect to an investment in
ordinary shares. This summary does not discuss all the tax consequences that may
be relevant to a U.S. Holder in light of such holder's particular circumstances
or to U.S. Holders subject to special rules, including persons that are non-U.S.
Holders, broker-dealers, financial institutions, certain insurance companies,
investors liable for alternative minimum tax, tax-exempt organizations,
regulated investment companies, taxpayers whose functional currency is not the
U.S. dollar, persons who hold the ordinary shares through partnerships or other
pass-through entities, persons who acquired their ordinary shares through the
exercise or cancellation of employee stock options or otherwise as compensation
for services, investors that actually or constructively own 10 percent or more
of our voting shares, and investors holding ordinary shares as part of a
straddle or appreciated financial position or as part of a hedging or conversion
transaction.
If a partnership or an entity treated as a partnership for U.S. federal
income tax purposes owns ordinary shares, the U.S. federal income tax treatment
of a partner in such a partnership will generally depend upon the status of the
partner and the activities of the partnership. A partnership that owns ordinary
shares and the partners in such partnership should consult their tax advisors
about the U.S. federal income tax consequences of holding and disposing of
common shares.
This summary does not address the effect of any U.S. federal taxation other
than U.S. federal income taxation. In addition, this summary does not include
any discussion of state, local or foreign taxation.
You are urged to consult your tax advisors regarding the foreign and United
States federal, state and local tax considerations of an investment in ordinary
shares.
For purposes of this summary, the term "U.S. Holder" means an individual
who is a citizen or, for U.S. federal income tax purposes, a resident of the
United States, a corporation or other entity taxable as a corporation created or
organized in or under the laws of the United States or any political subdivision
thereof, an estate whose income is subject to U.S. federal income tax regardless
of its source, or a trust that (a) is subject to the primary supervision of a
court within the United States and the control of one or more U.S. persons or
(b) has a valid election in effect under applicable U.S. Treasury regulations to
be treated as a U.S. person.
76
TAXATION OF DIVIDENDS
Subject to the discussion below under the heading "Passive Foreign
Investment Companies," the gross amount of any distributions received with
respect to ordinary shares, including the amount of any Israeli taxes withheld
therefrom, will constitute dividends for U.S. federal income tax purposes, to
the extent of our current and accumulated earnings and profits as determined for
U.S. federal income tax purposes. You will be required to include this amount of
dividends in gross income as ordinary income. Distributions in excess of our
current and accumulated earnings and profits will be treated as a non taxable
return of capital to the extent of your tax basis in the ordinary shares and any
amount in excess of your tax basis will be treated as gain from the sale of
ordinary shares. See "Disposition of Ordinary Shares" below for the discussion
on the taxation of capital gains. Dividends will not qualify for the dividends
received deduction generally available to corporations under Section 243 of the
Code.
Dividends that we pay in NIS, including the amount of any Israeli taxes
withheld therefrom, will be included in your income in a U.S. dollar amount
calculated by reference to the exchange rate in effect on the day such dividends
are received. A U.S. Holder who receives payment in NIS and converts NIS into
U.S. dollars at an exchange rate other than the rate in effect on such day may
have a foreign currency exchange gain or loss that would be treated as ordinary
income or loss. U.S. Holders should consult their own tax advisors concerning
the U.S. tax consequences of acquiring, holding and disposing of NIS.
Subject to complex limitations, any Israeli withholding tax imposed on such
dividends will be a foreign income tax eligible for credit against a U.S.
Holder's U.S. federal income tax liability (or, alternatively, for deduction
against income in determining such tax liability). The limitations set out in
the Code include computational rules under which foreign tax credits allowable
with respect to specific classes of income cannot exceed the U.S. federal income
taxes otherwise payable with respect to each such class of income. Dividends
generally will be treated as foreign source passive income or, in the case of
certain U.S. Holders, financial services income for United States foreign tax
credit purposes. U.S. Holders should note that recently enacted legislation
eliminates the "financial services income" category with respect to taxable
years beginning after December 31, 2006. Under this legislation, the foreign tax
credit limitation categories will be limited to "passive category income" and
"general category income." Further, there are special rules for computing the
foreign tax credit limitation of a taxpayer who receives dividends subject to a
reduced rate of tax, see discussion below. A U.S. Holder will be denied a
foreign tax credit with respect to Israeli income tax withheld from dividends
received on the ordinary shares to the extent such U.S. Holder has not held the
ordinary shares for at least 16 days of the 31-day period beginning on the date
which is 15 days before the ex-dividend date or to the extent such U.S. Holder
is under an obligation to make related payments with respect to substantially
similar or related property. Any days during which a U.S. Holder has
substantially diminished its risk of loss on the ordinary shares are not counted
toward meeting the 16-day holding period required by the statute. The rules
relating to the determination of the foreign tax credit are complex, and you
should consult with your personal tax advisors to determine whether and to what
extent you would be entitled to this credit.
Subject to certain limitations, "qualified dividend income" received by a
noncorporate U.S. Holder in tax years beginning on or before December 31, 2010
will be subject to tax at a reduced maximum tax rate of 15 percent.
Distributions taxable as dividends paid on the ordinary shares should qualify
for the 15 percent rate provided that either: (i) we are entitled to benefits
under the income tax treaty between the United States and Israel (the "Treaty")
or (ii) the ordinary shares are readily tradable on an established securities
market in the United States and certain other requirements are met. We believe
that we are entitled to benefits under the Treaty and that the ordinary shares
currently are readily tradable on an established securities market in the United
States. However, no assurance can be given that the ordinary shares will remain
readily tradable. The rate reduction does not apply unless certain holding
period requirements are satisfied. With respect to the ordinary shares, the U.S.
Holder must have held such shares for at least 61 days during the 121-day period
beginning 60 days before the ex-dividend date. The rate reduction also does not
apply to dividends received from passive foreign investment companies, see
discussion below, or in respect of certain hedged positions or in certain other
situations. The legislation enacting the reduced tax rate contains special rules
for computing the foreign tax credit limitation of a taxpayer who receives
dividends subject to the reduced tax rate. U.S. Holders of ordinary shares
should consult their own tax advisors regarding the effect of these rules in
their particular circumstances.
77
DISPOSITION OF ORDINARY SHARES
If you sell or otherwise dispose of ordinary shares, you will recognize
gain or loss for U.S. federal income tax purposes in an amount equal to the
difference between the amounts realized on the sale or other disposition and
your adjusted tax basis in the ordinary shares. Subject to the discussion below
under the heading "Passive Foreign Investment Companies," such gain or loss
generally will be capital gain or loss and will be long-term capital gain or
loss if you have held the ordinary shares for more than one year at the time of
the sale or other disposition. In general, any gain that you recognize on the
sale or other disposition of ordinary shares will be U.S.-source for purposes of
the foreign tax credit limitation; losses will generally be allocated against
U.S. source income. Deduction of capital losses is subject to certain
limitations under the Code.
In the case of a cash basis U.S. Holder who receives NIS in connection with
the sale or disposition of ordinary shares, the amount realized will be based on
the U.S. dollar value of the NIS received with respect to the ordinary shares as
determined on the settlement date of such exchange. A U.S. Holder who receives
payment in NIS and converts NIS into United States dollars at a conversion rate
other than the rate in effect on the settlement date may have a foreign currency
exchange gain or loss that would be treated as ordinary income or loss.
An accrual basis U.S. Holder may elect the same treatment required of cash
basis taxpayers with respect to a sale or disposition of ordinary shares,
provided that the election is applied consistently from year to year. Such
election may not be changed without the consent of the Internal Revenue Service
(the "IRS"). In the event that an accrual basis U.S. Holder does not elect to be
treated as a cash basis taxpayer (pursuant to the Treasury regulations
applicable to foreign currency transactions), such U.S. Holder may have a
foreign currency gain or loss for U.S. federal income tax purposes because of
differences between the U.S. dollar value of the currency received prevailing on
the trade date and the settlement date. Any such currency gain or loss would be
treated as ordinary income or loss and would be in addition to gain or loss, if
any, recognized by such U.S. Holder on the sale or disposition of such ordinary
shares.
PASSIVE FOREIGN INVESTMENT COMPANIES
For U.S. federal income tax purposes, we will be considered a passive
foreign investment company ("PFIC") for any taxable year in which either (i) 75%
or more of our gross income is passive income, or (ii) at least 50% of the
average value of all of our assets for the taxable year produce or are held for
the production of passive income. For this purpose, passive income includes
dividends, interest, royalties, rents, annuities and the excess of gains over
losses from the disposition of assets which produce passive income. If we were
determined to be a PFIC for U.S. federal income tax purposes, highly complex
rules would apply to U.S. Holders owning ordinary shares. Accordingly, you are
urged to consult your tax advisors regarding the application of such rules.
Based on our current and projected income, assets and activities, we
believe that we are not currently a PFIC nor do we expect to become a PFIC in
the foreseeable future. However, because the determination of whether we are a
PFIC is based upon the composition of our income and assets from time to time,
there can be no assurances that we will not become a PFIC for any future taxable
year.
If we are treated as a PFIC for any taxable year, dividends would not
qualify for the reduced maximum tax rate, discussed above, and, unless you elect
either to treat your investment in ordinary shares as an investment in a
"qualified electing fund" (a "QEF election") or to "mark to market" your
ordinary shares, as described below:
o you would be required to allocate income recognized upon receiving
certain dividends or gain recognized upon the disposition of ordinary
shares ratably over the holding period for such ordinary shares,
78
o the amount allocated to each year during which we are considered a
PFIC other than the year of the dividend payment or disposition would
be subject to tax at the highest individual or corporate tax rate, as
the case may be, in effect for that year and an interest charge would
be imposed with respect to the resulting tax liability allocated to
each such year,
o the amount allocated to the current taxable year and any taxable year
before we became a PFIC would be taxable as ordinary income in the
current year, and
o you would be required to make an annual return on IRS Form 8621
regarding distributions received with respect to ordinary shares and
any gain realized on your ordinary shares.
If you make either a timely QEF election or a timely mark-to-market
election in respect of your ordinary shares, you would not be subject to the
rules described above. If you make a timely QEF election, you would be required
to include in your income for each taxable year your pro rata share of our
ordinary earnings as ordinary income and your pro rata share of our net capital
gain as long-term capital gain, whether or not such amounts are actually
distributed to you. You would not be eligible to make a QEF election unless we
comply with certain applicable information reporting requirements.
Alternatively, if the ordinary shares are considered "marketable stock" and
if you elect to "mark-to-market" your ordinary shares, you will generally
include in income any excess of the fair market value of the ordinary shares at
the close of each tax year over your adjusted basis in the ordinary shares. If
the fair market value of the ordinary shares had depreciated below your adjusted
basis at the close of the tax year, you may generally deduct the excess of the
adjusted basis of the ordinary shares over its fair market value at that time.
However, such deductions generally would be limited to the net mark-to-market
gains, if any, that you included in income with respect to such ordinary shares
in prior years. Income recognized and deductions allowed under the
mark-to-market provisions, as well as any gain or loss on the disposition of
ordinary shares with respect to which the mark-to-market election is made, is
treated as ordinary income or loss (except that loss on a disposition of
ordinary shares is treated as capital loss to the extent the loss exceeds the
net mark-to-market gains, if any, that you included in income with respect to
such ordinary shares in prior years). Gain or loss from the disposition of
ordinary shares (as to which a mark-to-market election was made) in a year in
which we are no longer a PFIC, will be capital gain or loss.
BACKUP WITHHOLDING AND INFORMATION REPORTING
Payments in respect of ordinary shares may be subject to information
reporting to the U.S. Internal Revenue Service and to U.S. backup withholding
tax at a rate equal to the third highest income tax rate applicable to
individuals (which, under current law, is 28%). Backup withholding will not
apply, however, if you (i) are a corporation or come within certain exempt
categories, and demonstrate the fact when so required, or (ii) furnish a correct
taxpayer identification number and make any other required certification.
Backup withholding is not an additional tax. Amounts withheld under the
backup withholding rules may be credited against a U.S. Holder's U.S. tax
liability, and a U.S. Holder may obtain a refund of any excess amounts withheld
under the backup withholding rules by filing the appropriate claim for refund
with the IRS.
Any U.S. holder who holds 10% or more in vote or value of our ordinary
shares will be subject to certain additional United States information reporting
requirements.
79
U.S. GIFT AND ESTATE TAX
An individual U.S. Holder of ordinary shares will be subject to U.S. gift
and estate taxes with respect to ordinary shares in the same manner and to the
same extent as with respect to other types of personal property.
F. DIVIDENDS AND PAYING AGENTS.
Not applicable.
G. STATEMENTS BY EXPERTS.
Not applicable.
H. DOCUMENTS ON DISPLAY.
We are subject to the informational requirements of the Securities Exchange
Act of 1934, as amended, applicable to foreign private issuers and fulfill the
obligations with respect to such requirements by filing reports with the
Securities and Exchange Commission. You may read and copy any document we file
with the Securities and Exchange Commission without charge at the Securities and
Exchange Commission's public reference room at 100 F Street, N.E., Room 1580,
Washington, D.C. 20549, and on the Securities and Exchange Commission Internet
site (http://www.sec.gov) and on our website www.magal-ssl.com. Copies of such
material may be obtained by mail from the Public Reference Branch of the
Securities and Exchange Commission at such address, at prescribed rates. Please
call the Securities and Exchange Commission at l-800-SEC-0330 for further
information on the public reference room.
As a foreign private issuer, we are exempt from the rules under the
Exchange Act prescribing the furnishing and content of proxy statements, and our
officers, directors and principal shareholders are exempt from the reporting and
"short-swing" profit recovery provisions contained in Section 16 of the Exchange
Act. In addition, we are not required under the Exchange Act to file periodic
reports and financial statements with the Securities and Exchange Commission as
frequently or as promptly as U.S. companies whose securities are registered
under the Exchange Act. A copy of each report submitted in accordance with
applicable U.S. law is available for public review at our principal executive
offices.
In addition, since we are also listed on the TASE, we submit copies of all
our filings with the SEC to the Israeli Securities Authority and TASE. Such
copies can be retrieved electronically through the TASE internet messaging
system (www.maya.tase.co.il) and, in addition, with respect to filings made as
of November 2003, through the MAGNA distribution site of the Israeli Securities
Authority (www.magna.isa.gov.il).
I. SUBSIDIARY INFORMATION.
Not applicable.
ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to a variety of risks, including changes in interest rates
and foreign currency fluctuations.
INTEREST RATE RISK
Our exposure to market risk for changes in interest rates is related to our
long-term and short-term loans.
80
Our financial expenses are sensitive primarily to LIBOR, since the majority
of our short-term loans bear a LIBOR-based interest rate.
The table below presents principal amounts and related weighted average
interest rates by date of maturity for our loans:
INTEREST RATE SENSITIVITY
PRINCIPAL AMOUNT BY EXPECTED MATURITY
WEIGHTED AVERAGE INTEREST RATE
(U.S. DOLLARS IN THOUSANDS)
FAIR
VALUE AT
DECEMBER
2006 2007 2008 2009-2010 TOTAL 31, 2005
---------- ---- ---- ----- ---------- -------
LIABILITIES:
Short Term Loans $ 18,068 - - - $ 18,068 $18,068
Weighted Average Interest Rate 4.62% - - - 4.62% -
Long Term Loans $ 3,647 155 163 1,335 $ 5,300 $ 5,259
Weighted Average Interest Rate 3.83% 5.45% 5.45% 5.45% 4.33% -
FOREIGN CURRENCY EXCHANGE RISK
We sell most of our products in North America, Europe and Israel. The
majority of our revenues and expenditures are denominated in dollars. A portion
of our revenues in Israel are made in NIS, and we expect to make NIS denominated
revenues in 2006 as well. Our foreign currency exposure with respect to our
revenues is mitigated, and we expect it will continue to be mitigated, through
salaries, materials and support operations, in which part of these costs are
denominated in NIS. Since the beginning of 2006, the NIS has appreciated by
approximately 3.6% against the dollar. We are also subject to exchange rate
fluctuations related to our activities in Canada.
Because exchange rates between the NIS and the dollar fluctuate
continuously, exchange rate fluctuations, particularly larger periodic
devaluations, may have an impact on our profitability and period-to-period
comparisons of our results. In 2001,2002 and 2005, the rate of devaluation of
the NIS against the dollar was 9.3% and 7.3% and 6.8%, respectively, while in
2003 and 2004 the NIS was revaluated in relation to the dollar by 7.6% and 1.6%,
respectively. A portion of our expenses, primarily labor expenses, is incurred
in NIS and a part of our revenues are quoted in NIS. Additionally, certain
assets especially trade receivables, as well as part of our liabilities are
denominated in NIS. Our results may be adversely affected by devaluation of the
NIS in relation to the dollar (or if such devaluation is on lagging basis), if
our revenues in NIS are higher than our expenses in NIS and/or the amount of our
assets in NIS are higher than our liabilities in NIS. On the contrary, our
results may be adversely affected by the revaluation of the NIS in relation to
the dollar (or if such revaluation is on a lagging basis), if the amount of our
expenses in NIS are higher than the amount of our revenues in NIS and/or the
amount of our liabilities in NIS are higher than our assets in NIS.
We are also subject to exchange rate fluctuations related to our activities
in Canada.
During the years ended December 31, 2003, 2004 and 2005, foreign currency
fluctuations had an adverse impact on our results of operations, and our foreign
exchange (losses), net were ($569,000), ($120,000) and ($145,000), respectively.
We cannot assure you that in the future our results of operations may not be
materially adversely affected by currency fluctuations.
To protect against the change in the forecasted foreign currency cash flows
of certain sale arrangements resulting from changes in the exchange rate during
2003, 2004 and 2005, we entered into forward contracts in order to hedge
portions of our forecasted revenue and unbilled accounts receivable denominated
in Euros and Polish Zlotys. We have designated the forward instruments as cash
flow hedges for accounting purposes.
81
For derivative instruments designated as cash flow hedges (i.e., hedging
the exposure to variability in expected future cash flows that is attributable
to a particular risk), the effective portion of the gain or loss on the
derivative instrument is reported as a component of other comprehensive income
and reclassified into earnings in the same line item associated with the
forecasted transaction in the same period or periods during which the hedged
transaction affects earnings.
During 2005, we recognized no hedge ineffectiveness for the Euro contract
cash flows hedge as we concluded that the changes in the cash flows attributable
to the changes in the exchange rates were completely offset by the forward
contract.
We determined that sales arrangement in Polish Zlotys and the related
forecasted revenues and unbilled accounts receivable would not occur by the end
of the specified time period. Accordingly, the forward loss was recorded in
financial expenses in 2005.
As of December 31, 2005, we expect to reclassify $6,000 of net income on
derivative instruments from other comprehensive income to earnings during the
next 12 months due to actual sales and related payments.
ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES
Not applicable.
PART II
ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES
Not applicable.
ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF
PROCEEDS
Not applicable.
ITEM 15. CONTROLS AND PROCEDURES
Our management, including our chief executive officer and chief financial
officer, evaluated the effectiveness of our disclosure controls and procedures
(as defined in Exchange Act Rule 13a-15(e)) as of the end of the period covered
by this annual report on Form 20-F. Based upon that evaluation, our chief
executive officer and chief financial officer have concluded that, as of such
date, our disclosure controls and procedures were effective to ensure that
information required to be disclosed by our company in reports that we file or
submit under the U.S. Securities Exchange Act of 1934, as amended, is recorded,
processed, summarized and reported within the time periods specified in the
Securities and Exchange Commission's rules and forms and that such information
was made known to them by others within the company, as appropriate to allow
timely decisions regarding required disclosure.
82
ITEM 16. [RESERVED]
ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT
Our Board of Directors has determined that Mrs. Anat Winner, an independent
director, meets the definition of an audit committee financial expert, as
defined in Item 401(h) of Regulation S-K. For a brief listing of Mrs. Winner's
relevant experience, see Item 6.A. "Directors, Senior Management and Employees
-- Directors and Senior Management."
ITEM 16B. CODE OF ETHICS
We have adopted a code of ethics that applies to our chief executive
officer and all senior financial officers of our company, including the chief
financial officer, chief accounting officer or controller, or persons performing
similar functions. The code of ethics is publicly available on our website at
www.magal-ssl.com. Written copies are available upon request. If we make any
substantive amendment to the code of ethics or grant any waivers, including any
implicit waiver, from a provision of the codes of ethics, we will disclose the
nature of such amendment or waiver on our website.
ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES
FEES PAID TO INDEPENDENT PUBLIC ACCOUNTANTS
The following table sets forth, for each of the years indicated, the fees
paid to our independent public accountants and the percentage of each of the
fees out of the total amount paid to the accountants.
The following table sets forth, for each of the years indicated, the fees
paid to our principal independent registered public accounting firm, Kost Forer
Gabbay & Kasierer. All of such fees were pre-approved by our Audit Committee.
Year Ended December 31,
-------------------------
2004 2005
-------- --------
Services Rendered Fees Fees
-------------------------------- -------- --------
Audit (1) $275,311 $266,936
Audit-related (2) 17,404 10,000
Tax (3) 18,183 45,100
Other (4) 19,380 184,124
-------- --------
Total $330,278 $506,160
----------
1. Audit fees consist of services that would normally be provided in
connection with statutory and regulatory filings or engagements.
2. Audit-related fees relate to assurance and associated services that
traditionally are performed by the independent accountant, including:
attest services that are not required by statute or regulation;
accounting consultation and audits in connection with mergers,
acquisitions and divestitures; employee benefit plans audits; and
consultation concerning financial accounting and reporting standards.
3. Tax fees relate to services performed by the tax division for tax
compliance, planning, and advice.
4. Other fees in 2005 include mainly fees related to our public offering.
83
PRE-APPROVAL POLICIES AND PROCEDURES
Our audit committee has adopted a policy and procedures for the
pre-approval of audit and non-audit services rendered by our independent public
accounting firm, Kost Forer Gabbay & Kasierer and their affiliates. Pre-approval
of an audit or non-audit service may be given as a general pre-approval, as part
of the audit committee's approval of the scope of the engagement of our
independent auditor, or on an individual basis. Any proposed services exceeding
general pre-approved levels also requires specific pre-approval by our audit
committee. The policy prohibits retention of the independent public accountants
to perform the prohibited non-audit functions defined in Section 201 of the
Sarbanes-Oxley Act or the rules of the SEC, and also requires the audit
committee to consider whether proposed services are compatible with the
independence of the public accountants.
ITEM 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEE
Not applicable.
ITEM 16E. PURCHASE OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS
ISSUER PURCHASE OF EQUITY SECURITIES
Neither we nor any affiliated purchaser has purchased any of our securities
during 2005.
PART III
ITEM 17. FINANCIAL STATEMENTS
We have responded to Item 18 in lieu of this item.
ITEM 18. FINANCIAL STATEMENTS
The Financial Statements required by this item are found at the end of this
annual report, beginning on page F-1.
ITEM 19. EXHIBITS
The exhibits filed with or incorporated into this annual report are listed
on the index of exhibits below:
EXHIBIT
NO. DESCRIPTION
---------- -----------------------------------------------------------------
1.1* Memorandum of Association of the Registrant
1.2** Articles of Association of the Registrant
2.1*** Specimen Share Certificate for Ordinary Share
2.2**** The Registrant's Stock Option Plan (1993), as amended
84
EXHIBIT
NO. DESCRIPTION
---------- -----------------------------------------------------------------
2.3***** Registration Rights Agreement, dated as of November 18, 1996, by
and among the Registrant, Mira Mag Inc., Israel Aircraft
Industries Ltd. and Jacob Even-Ezra
8 List of Subsidiaries of the Registrant
12.1 Certification of Chief Executive Officer pursuant to Rule
13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as
amended
12.2 Certification of Chief Financial Officer pursuant to Rule
13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as
amended
13.1 Certification of Chief Executive Officer pursuant to 18 U.S.C.
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
13.2 Certification of Chief Financial Officer pursuant to 18 U.S.C.
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
15.1 Schedule of Valuation and Qualifying Accounts
15.2 Consent of Kost Forer Gabbay & Kasierer
15.3 Consent of Salles, Sainz - Grant Thornton, S. C.
----------
* Previously filed as an exhibit to our Registration Statement on Form F-1
(No. 33-57438), filed with the Commission on January 26, 1993, as amended, and
incorporated herein by reference.
** Previously filed as an exhibit to our Registration Statement on Form F-1
(No. 33-57438), filed with the Commission on January 26, 1993, as amended, and
incorporated herein by reference and an amendment thereto previously filed as an
exhibit to our Registration Statement on Form S-8 (No. 333-6246), filed with the
Commission on January 7, 1997 and incorporated herein by reference and further
amendments thereto previously filed as an exhibit to our Annual Report on Form
20-F for the fiscal year ended December 31, 2000, filed with the Commission on
June 29, 2001 and incorporated herein by reference.
*** Previously filed as an exhibit to our Registration Statement on Form
8-A, filed with the Commission on March 18, 1993, as amended, and incorporated
herein by reference.
**** Previously filed as an exhibit to our Registration Statement on Form
S-8 (No. 333-6246), filed with the Commission on January 7, 1997 and
incorporated herein by reference and further amendments thereto previously filed
as an exhibit to our Annual Report on Form 20-F for the fiscal year ended
December 31, 2000, filed with the Commission on June 29, 2001 and incorporated
herein by reference.
***** Previously filed as an exhibit to our Registration Statement on Form
F-2 (No.333-5970), filed with the Commission on November 8, 1996, as amended,
and incorporated herein by reference.
85
MAGAL SECURITY SYSTEMS LTD. AND ITS SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
AS OF DECEMBER 31, 2005
IN U.S. DOLLARS
INDEX
PAGE
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM F-2
CONSOLIDATED BALANCE SHEETS F-3-F-4
CONSOLIDATED STATEMENTS OF OPERATIONS F-5
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY F-6
CONSOLIDATED STATEMENTS OF CASH FLOWS F-7-F-8
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS F-9-F-43
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
TO THE SHAREHOLDERS OF
MAGAL SECURITY SYSTEMS LTD.
We have audited the accompanying consolidated balance sheets of Magal
Security Systems Ltd. ("the Company") and its subsidiaries as of December 31,
2004 and 2005, and the related consolidated statements of income, changes in
shareholders' equity and cash flows for each of the three years in the period
ended December 31, 2005. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We did not audit the financial statements of a certain subsidiary, whose
assets constitute approximately 3.2% of total consolidated assets as of December
31, 2005, and whose revenues constitute approximately 4.6% of total consolidated
revenues for the year ended December 31, 2005. The financial statements of this
company were audited by other auditors, whose reports have been furnished to us,
and our opinion, insofar as it relates to amounts included for this subsidiary,
is based solely on the reports of the other auditors.
We conducted our audits in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. We were not engaged to
perform an audit of the Company's internal control over financial reporting. Our
audits included consideration of internal control over financial reporting as a
basis for designing audit procedures that are appropriate in the circumstances,
but not for the purpose of expressing an opinion on the effectiveness of the
Company's internal control over financial reporting. Accordingly, we express no
such opinion. An audit also includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits and the reports of the other auditors provide a reasonable basis for our
opinion.
In our opinion, based on our audits and the reports of the other auditors,
the consolidated financial statements referred to above present fairly, in all
material respects, the consolidated financial position of the Company and its
subsidiaries as of December 31, 2004 and 2005, and the consolidated results of
their operations and their cash flows for each of the three years in the period
ended December 31, 2005, in conformity with accounting principles generally
accepted in the United States.
Tel-Aviv, Israel
February 22, 2006 (except Note 17 KOST FORER GABBAY & KASIERER
dated July 13, 2006) A Member of Ernst & Young Global
F - 2
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
DECEMBER 31,
------------------------
2004 2005
------- --------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $11,964 $ 10,099
Short-term bank deposits - 17,053
Trade receivables (net of allowance for doubtful accounts of $ 320 and $ 306 at
December 31, 2004 and 2005, respectively) *)15,102 24,012
Unbilled accounts receivable *) 5,595 8,596
Other accounts receivable and prepaid expenses 3,858 4,455
Deferred income taxes 488 1,187
Inventories (Note 3) 12,702 11,110
------- --------
TOTAL current assets 49,709 76,512
------- --------
LONG-TERM INVESTMENTS AND RECEIVABLES:
Long-term trade receivables 344 290
Long-term bank deposits 2,994 1,800
Structured notes 3,000 -
Severance pay fund 2,142 2,070
------- --------
TOTAL long-term investments and receivables 8,480 4,160
------- --------
PROPERTY AND EQUIPMENT, NET (Note 4) 14,659 15,587
------- --------
DEFERRED INCOME TAXES 186 828
------- --------
OTHER INTANGIBLE ASSETS, NET (Note 5) 656 569
------- --------
GOODWILL 4,286 4,186
------- --------
TOTAL assets $77,976 $101,842
======= ========
*) Reclassified.
The accompanying notes are an integral part of the consolidated financial
statements.
F - 3
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE AND PER SHARE DATA)
DECEMBER 31,
---------------------------
2004 2005
-------- ---------
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Short-term bank credit (Note 6) $ 15,618 $ 18,068
Current maturities of long-term debt (Note 8) 1,849 3,647
Trade payables 3,189 6,360
Customer advances - 3,990
Other accounts payable and accrued expenses (Note 7) 6,669 8,914
Unrealized losses on hedging forward contracts 781 79
-------- ---------
TOTAL current liabilities 28,106 41,058
-------- ---------
LONG-TERM LIABILITIES:
Unrealized losses on hedging forward contracts 650 50
Long-term bank debt (Note 8) 3,500 1,653
Accrued severance pay 2,172 2,131
-------- ---------
TOTAL long-term liabilities 6,322 3,834
-------- ---------
COMMITMENTS AND CONTINGENT LIABILITIES (Note 9)
SHAREHOLDERS' EQUITY (Note 10):
Share capital -
Ordinary shares of NIS 1 par value -
Authorized: 19,748,000 shares at December 31, 2004 and 2005; Issued and
outstanding: 8,672,448 and 10,372,448 shares at December 31, 2004 and 2005,
respectively 2,825 3,220
Additional paid-in capital 32,526 47,509
Deferred stock compensation (477) (38)
Accumulated other comprehensive income 1,639 2,435
Retained earnings 7,035 3,824
-------- ---------
TOTAL shareholders' equity 43,548 56,950
-------- ---------
TOTAL liabilities and shareholders' equity $ 77,976 $ 101,842
======== =========
The accompanying notes are an integral part of the consolidated financial
statements.
F - 4
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT PER SHARE DATA)
YEAR ENDED DECEMBER 31,
-------------------------------------------
*) 2003 *) 2004 2005
------- -------- --------
Revenues $58,655 $ 60,468 $ 61,282
Cost of revenues 32,847 33,226 39,154
------- -------- --------
Gross profit 25,808 27,242 22,128
------- -------- --------
Operating expenses:
Research and development, net (Note 15a) 4,773 4,683 5,265
Selling and marketing, net 11,427 12,519 13,180
General and administrative 5,305 5,771 5,961
Award granted by principal shareholders - 1,200 -
------- -------- --------
TOTAL operating expenses 21,505 24,173 24,406
------- -------- --------
Operating income (loss) 4,303 3,069 (2,278)
Financial expenses, net (Note 15b) 1,003 762 800
------- -------- --------
Income (loss) before income taxes 3,300 2,307 (3,078)
Income taxes (tax benefit) (Note 12) 910 1,133 (23)
------- -------- --------
Income (loss) from continuing operations 2,390 1,174 (3,055)
Gain (loss) from discontinued operations, net (Note 16) 14 (121) (156)
------- -------- --------
Net income (loss) $ 2,404 $ 1,053 $ (3,211)
======= ======== ========
Basic net earnings (loss) per share from continuing operations $ 0.30 $ 0.13 $ (0.31)
Basic net loss per share from discontinued operations - (0.01) (0.01)
------- -------- --------
Basic net earnings (loss) per share (Note 11) $ 0.30 $ 0.12 $ (0.32)
======= ======== ========
Diluted net earnings (loss) per share from continuing operations $ 0.30 $ 0.13 $ (0.31)
Diluted net loss per share from discontinued operations - (0.01) (0.01)
------- -------- --------
Diluted net earnings (loss) per share (Note 11) $ 0.30 $ 0.12 $ (0.32)
======= ======== ========
*) Reclassified.
The accompanying notes are an integral part of the consolidated financial
statements.
F - 5
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARTIES
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE DATA)
ACCUMULATED
ADDITIONAL DEFERRED OTHER TOTAL TOTAL
NUMBER OF ORDINARY PAID-IN STOCK COMPREHENSIVE RETAINED COMPREHENSIVE SHAREHOLDERS'
SHARES SHARES CAPITAL COMPENSATION INCOME (LOSS) EARNINGS INCOME EQUITY
---------- ------------ ------- ------------- ------- ------------ --------- --------
Balance as of January 1, 2003 7,666,370 $ 2,600 $21,791 $ (3) $(1,006) $ 11,649 $ 35,031
Declared dividend - - - - - (401) (401)
Exercise of stock options 137,446 30 432 - - - 462
Amortization of deferred stock compensation 231,963 - - 3 - - 3
Stock dividend - 53 1,875 - - (1,928) -
Comprehensive income:
Net income - - - - - 2,404 $ 2,404 2,404
Unrealized losses on forward contracts, net - - - - (807) - (807) (807)
Foreign currency translation adjustments - - - - 2,292 - 2,292 2,292
---------- ------------ ------- ------------- ------- ------------ --------- --------
Total comprehensive income $ 3,889
=========
Balance as of December 31, 2003 8,035,779 2,683 24,098 - 479 11,724 38,984
Exercise of stock options 225,338 51 916 - - - 967
Deferred stock compensation related to
officers' options grant - - 661 (661) - - -
Amortization of deferred stock compensation
related to officers' options grant - - - 184 - - 184
Award granted by principal shareholders - - 1,200 - - - 1,200
Stock dividend 411,331 91 5,651 - - (5,742) -
Comprehensive income:
Net income - - - - - 1,053 $ 1,053 1,053
Unrealized gains on forward contracts, net - - - - 103 - 103 103
Foreign currency translation adjustments - - - - 1,057 - 1,057 1,057
---------- ------------ ------- ------------- ------- ------------ --------- --------
Total comprehensive income $ 2,213
=========
Balance as of December 31, 2004 8,672,448 2,825 32,526 (477) 1,639 7,035 43,548
Issuance of share capital, net 1,700,000 395 14,793 - - - 15,188
Amortization of deferred stock compensation
related to officers' options grant - - - 439 - - 439
Deferred taxes on stock options - - 190 - - - 190
Comprehensive income:
Net loss - - - - - (3,211) $ (3,211) (3,211)
Unrealized gains on forward contracts, net - - - - 709 - 709 709
Foreign currency translation adjustments - - - - 87 - 87 87
---------- ------------ ------- ------------- ------- ------------ --------- --------
Total comprehensive income $ (2,415)
=========
Balance as of December 31, 2005 10,372,448 $ 3,220 $47,509 $ (38) $ 2,435 $ 3,824 $ 56,950
========== ============ ======= ============= ======= ============ ========
Accumulated unrealized earnings on forward
contracts, net $ 5
Accumulated foreign currency translation
adjustments 2,430
-------
Accumulated other comprehensive income as of
December 31, 2005 $ 2,435
=======
The accompanying notes are an integral part of the consolidated financial
statements.
F - 6
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARTIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
YEAR ENDED DECEMBER 31,
--------------------------------------
2003 2004 2005
------- ------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 2,404 $ 1,053 $ (3,211)
Adjustments required to reconcile net income (loss) to net
cash provided by (used in) operating activities:
Loss (gain) from discontinued operations (14) 121 156
Depreciation and amortization 1,378 1,966 1,964
Gain on sale of property and equipment (9) (18) (10)
Decrease (increase) in accrued interest on short-term and
long-term bank deposits (199) 657 (322)
Amortization of deferred stock compensation 3 184 439
Decrease (increase) in trade receivables, net *)(2,977) *) 3,956 (8,998)
Decrease in receivables from related parties 28 - -
Decrease (increase) in unbilled accounts receivable *) 1,533 *)(4,130) (2,819)
Decrease (increase) in other accounts receivable and prepaid
expenses (836) 16 (599)
Decrease (increase) in deferred income taxes (88) 178 (1,020)
Decrease (increase) in inventories (2,581) (552) 1,676
Decrease (increase) in long-term trade receivables 1,210 (44) 54
Increase (decrease) in trade payables 49 (1,953) 3,096
Increase in other accounts payable and accrued expenses 1,727 880 2,194
Increase in customer advances - - 3,990
Accrued severance pay, net 77 (2) 31
Award granted by principal shareholders - 1,200 -
Realized losses (gains) on hedging forward contract - 476 (441)
------- ------- --------
Net cash provided by (used in) continuing operations 1,705 3,988 (3,820)
Net cash provided by (used in) discontinued operations 19 (310) (319)
------- ------- --------
Net cash provided by (used in) operating activities 1,724 3,678 (4,139)
------- ------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of short-term deposits - - (16,731)
Purchase of long-term bank deposits - (3,000) -
Proceeds from sale of long-term deposits - - 1,194
Purchase of structured notes (3,000) - -
Redemption of structured notes - - 3,000
Proceeds from sale of short-term bank deposits 3,505 8,400 -
Proceeds from sale of property and equipment 33 59 71
Purchase of property and equipment (3,194) (4,858) (2,736)
Purchase of know-how and patents (48) (89) (46)
Acquisition of the business activity of Dominion Wireless Inc. (a) (902) - -
------- ------- --------
Net cash provided by (used in) investing activities (3,606) 512 (15,248)
------- ------- --------
*) Reclassified.
The accompanying notes are an integral part of the consolidated financial
statements.
F - 7
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARTIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
----------------------------------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
YEAR ENDED DECEMBER 31,
---------------------------------------
2003 2004 2005
------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Short-term bank credit, net 3,098 2,895 2,402
Proceeds from long-term bank loans 43 - 1,800
Principal payment of long-term bank loans (103) (365) (1,849)
Proceeds from exercise of employee stock options 462 967 -
Proceeds from issuance of shares, net - - 14,916
Dividend paid - (401) -
------- -------- --------
Net cash provided by financing activities 3,500 3,096 17,269
------- -------- --------
Effect of exchange rate changes on cash and cash equivalents 252 289 253
------- -------- --------
Increase (decrease) in cash and cash equivalents 1,870 7,575 (1,865)
Cash and cash equivalents at the beginning of the year 2,519 4,389 11,964
------- -------- --------
Cash and cash equivalents at the end of the year $ 4,389 $ 11,964 $ 10,099
======= ======== ========
SUPPLEMENTAL DISCLOSURES OF CASH FLOWS ACTIVITIES:
Cash paid during the year for:
Interest $ 1,099 $ 1,093 $ 828
======= ======== ========
Taxes $ 1,544 $ 1,164 $ 887
======= ======== ========
NON-CASH ACTIVITIES:
Declared dividend $ 401 $ - $ -
======= ======== ========
(a) ACQUISITION OF THE BUSINESS ACTIVITY OF DOMINION WIRELESS
INC.:
Net fair value of the assets acquired at the acquisition
date was as follows:
Inventories $ 376
Property and equipment 90
Technology 436
-------
$ 902
=======
The accompanying notes are an integral part of the consolidated financial
statements.
F - 8
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
NOTE 1:- GENERAL
a. Magal Security Systems Ltd. ("the Company") and its subsidiaries
(together - "the Group") are engaged in the development, manufacture,
marketing and sale of complex computerized security systems used to
automatically detect and deter human intrusion for both civilian and
military markets. A majority of the Group's sales are generated in the
U.S., Canada, Europe and Israel.
As for major customer data, see Note 14b.
b. Acquisition of the business activity of Dominion Wireless Inc.:
On July 1, 2003, a subsidiary of the Company acquired the business
activity of Dominion Wireless Inc. ("DW") for a total consideration of
$ 902 (including $ 74 in transaction costs), paid in cash.
The Asset Purchase Agreement with DW, stipulated for additional
payments to be made conditioned upon the achievement of operating
income milestones during the periods ending on December 31, 2003, 2004
and 2005. Since such goals were not met, no additional payments were
due.
DW develops, manufactures, sells and supports personal duress alarm
systems that locate an individual with accuracy and reliability in
correctional and other institutions. The acquisition of the business
activity of DW expanded the Company's product line offerings and
enabled it to provide its customers a comprehensive range of security
systems.
The acquisition was accounted for under the purchase method of
accounting in accordance with SFAS No. 141, and accordingly, the
purchase price has been allocated to the assets acquired based on
their estimated fair values at the date of acquisition.
Based upon a valuation of tangible and intangible assets acquired, the
Company's subsidiary allocated the total cost of the acquisition to
the assets acquired, as follows:
JULY 1,
2003
----
UNAUDITED
----
Inventories $376
Property and equipment 90
Technology 436
----
$902
====
*) Reclassified.
F - 9
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT PER SHARE DATA)
NOTE 1:- GENERAL (CONT.)
The value assigned to the tangible and intangible assets has been
determined as follows:
1. DW's inventories and property and equipment are presented at
current replacement cost.
2. The value assigned to technology was determined using the Income
Approach on the basis of the present value of cash flows
attributable to the intellectual property over its expected
future life. Technology is amortized on a straight-line basis
over a period of 8 years.
The results of operations of DW have been included in the consolidated
financial statements since July 1, 2003.
The following unaudited pro forma information does not purport to
represent what the Group's results of operations would have been had
the acquisition been consummated on January 1, 2003, nor does it
purport to represent the Group's results of operations for any future
period. Pro forma results of operations for the period:
YEAR ENDED
DECEMBER 31,
2003
---------
Revenues $ 59,227*)
=========
Net income $ 1,910
=========
Basic net earnings per share $ 0.24
=========
Diluted net earnings per share $ 0.24
=========
*) Reclassified.
c. Award granted by principal shareholders:
In June 2004, two principal shareholders of the Company awarded the
Group's employees an award in the net amount of $ 1,200. The award was
allocated among the employees according to their position and
seniority. The Group recorded the award expense against additional
paid-in capital in accordance with Staff Accounting Bulletin ("SAB")
Topic 5T, "Accounting for Expenses or Liabilities Paid by Principal
Stockholder".
F - 10
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES
The consolidated financial statements have been prepared in accordance with
United States generally accepted accounting principles ("U.S. GAAP").
a. Use of estimates:
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates
and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Actual results could differ from
those estimates.
b. Financial statements in U.S. dollars:
Significant portion of the Company's revenues is generated in U.S.
dollars ("dollars"). Financing and investing activities including
credit, loans, equity transactions and cash investments are executed
in dollars. The Company's management believes that the dollar is the
primary currency of the economic environment in which the Company
operates. Thus, the functional and reporting currency of the Company
is the dollar.
The dollar was also determined to be the functional currency of the
Company's U.S. subsidiaries.
Accordingly, monetary accounts maintained in currencies other than the
dollar are remeasured into dollars in accordance with SFAS No. 52,
"Foreign Currency Translation". All transaction gains and losses from
the remeasured monetary balance sheet items are reflected in the
statement of income as financial income or expenses, as appropriate.
The financial statements of all foreign subsidiaries whose functional
currency is their local currency, excluding the U.S. ones, have been
translated into dollars. All balance sheet accounts have been
translated using the exchange rates in effect at the balance sheet
date. Statement of income amounts have been translated using the
average exchange rate for the year. The resulting translation
adjustments are reported as a component of shareholders' equity in
accumulated other comprehensive income (loss).
c. Principles of consolidation:
The consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiaries. Intercompany balances and
transactions including intercompany sales not yet realized outside the
Group, have been eliminated upon consolidation.
d. Cash equivalents:
Cash equivalents are short-term highly liquid investments that are
readily convertible into cash with original maturities of three months
or less at the date acquired.
F - 11
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)
e. Short-term and long-term bank deposits:
Short-term bank deposits are deposits with maturities of more than
three months and less than one year, and presented at their cost.
A bank deposit with maturities of more than one year is included in
long-term bank deposits, and presented at cost. The deposit is in U.S.
dollars, bears interest of 4.75% and matures in 2010.
f. Structured notes:
During 2003, the Company purchased structured notes ("the Notes") at
par value totaling $ 3,000 to be settled in 2013. Under the terms of
the Notes, the Notes bear interest of 10% for the first year.
Thereafter, interest is determined based on six months LIBOR rates
using the following formula: 10% minus two times six months LIBOR
rate. The Notes are callable immediately after accumulating 12%
interest payments.
The Company accounts for its investment in structured notes in
accordance with SFAS No. 115, "Accounting for Certain Investments in
Debt and Equity Securities" and FASB Emerging Issues Task Force Issue
("EITF") No. 96-12, "Recognition of Interest Income and Balance Sheet
Classification of Structured Notes". Management determines the
appropriate classification of its investments in debt securities at
the time of purchase and reevaluates such determinations at each
balance sheet date. Structured notes securities are classified as
held-to-maturity since management believes the Company has the intent
and ability to hold these securities to maturity and are stated at
amortized cost. As of December 31, 2004, the investments in the Notes
approximate their fair market value. During 2005, the notes were fully
repaid.
g. Inventories:
Inventories are stated at the lower of cost or market value. The Group
periodically evaluates the quantities on hand relative to historical
and projected sales volumes, current and historical selling prices and
contractual obligations to maintain certain levels of parts. Based on
these evaluations, inventory write-offs are provided to cover risks
arising from slow-moving items, discontinued products, excess
inventories, market prices lower than cost and adjusted revenue
forecasts. Such write-offs are included in cost of revenues.
Cost is determined as follows:
Raw materials, parts and supplies - using the "first-in, first-out"
method.
Work in progress and finished products - on the basis of direct
manufacturing costs with the addition of allocable indirect
manufacturing costs.
During 2003, 2004 and 2005, the Group recorded inventory write-offs in
the amount of $ 601, $ 224 and $ 507, respectively.
F - 12
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)
h. Long-term trade receivables:
Long-term trade receivables derive from operating lease arrangements
and from long-term payment arrangements.
i. Property and equipment:
Property and equipment are stated at cost, net of accumulated
depreciation. Depreciation is calculated by the straight-line method
over the estimated useful lives of the assets at the following annual
rates:
%
--------------------
Buildings 4
Machinery and equipment (including machinery
and equipment leased to customers under
operating leases) 10 - 33 (mainly 10%)
Motor vehicles 15
Promotional display 25 - 50
Office furniture and equipment 6 - 33
Leasehold improvements By the shorter of the
term of the lease or
the life of the assets
j. Intangible assets:
Intangible assets are amortized over their useful lives using a method
of amortization that reflects the pattern in which the economic
benefits of the intangible assets are consumed or otherwise used up,
in accordance with SFAS No. 142, "Goodwill and Other Intangible
Assets".
Know-how is amortized over 8 to 10 years, patents are amortized over a
period of 10 years and technology is amortized over 8 years.
k. Impairment of long-lived assets:
The Group's long-lived assets and certain identifiable intangibles are
reviewed for impairment in accordance with SFAS No. 144, "Accounting
for the Impairment or Disposal of Long-Lived Assets" whenever events
or changes in circumstances indicate that the carrying amount of a
group of assets may not be recoverable. Recoverability of a group of
assets to be held and used is measured by a comparison of the carrying
amount of the group to the future undiscounted cash flows expected to
be generated by the group. If such group of assets is considered to be
impaired, the impairment to be recognized is measured by the amount by
which the carrying amount of the assets exceeds their fair value.
During 2003, 2004 and 2005, no impairment losses have been identified.
F - 13
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)
l. Goodwill:
Goodwill represents excess of the costs over the net fair value of the
assets of the businesses acquired. Under SFAS No, 142, goodwill
acquired in a business combination on or after July 1, 2001, shall not
be amortized, and goodwill acquired in prior periods ceased to be
amortized since January 1, 2002.
SFAS No. 142 requires goodwill to be tested for impairment on adoption
and at least annually thereafter or between annual tests in certain
circumstances, and written down when impaired, rather than being
amortized as previous accounting standards required. Goodwill
attributable to each of the reporting units is tested for impairment
by comparing the fair value of each reporting unit with its carrying
value. Fair value is determined using discounted cash flows.
Significant estimates used in the methodologies include estimates of
future cash flows, future short-term and long-term growth rates and
weighted average cost of capital for each of the reportable units.
During 2003, 2004 and 2005, no impairment losses have been identified.
Differences between the balance of goodwill as of December 31, 2004
and 2005 derive from functional currency translation adjustments. The
entire goodwill balance relates to the Perimeter segment.
m. Revenue recognition:
The Group generates its revenues mainly from (1) installation of
comprehensive security systems for which revenues are generated from
long-term fixed price contracts; (2) sales of security products; and
(3) services and maintenance, which are performed either on a
fixed-price basis or as time-and-materials based contracts.
Revenues from installation of comprehensive security systems are
generated from fixed-price contracts according to which the time
between the signing of the contract and the final customer acceptance
is over one year. Such revenues are recognized in accordance with
Statement of Position ("SOP") No. 81-1, "Accounting for Performance of
Construction-Type and Certain Production-Type Contracts," using
contract accounting on a percentage of completion method, in
accordance with the "Input Method". The amounts of revenues recognized
are based on the total fees under the agreements and the percentage to
completion achieved.
F - 14
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)
Project costs include materials purchased to produce the system,
related labor and overhead expenses and subcontractor's costs. The
percentage to completion is measured by monitoring costs and efforts
devoted using records of actual costs incurred to date in the project
compared to the total estimated project requirement, which corresponds
to the costs related to earned revenues. Estimates of total project
requirements are based on prior experience of installing and
integrating security systems, a history of no collection issues,
delivery and acceptance of similar services and a history of no
cancellation problems, which are reviewed and updated regularly by
management. Provisions for estimated losses on uncompleted contracts
are made in the period in which such losses are first determined, in
the amount of the estimated loss on the entire contract.
Estimated gross profit or loss from long-term contracts may change due
to changes in estimates resulting from differences between actual
performance and original forecasts. Such changes in estimated gross
profit are recorded in results of operations when they are reasonably
determinable by management, on a cumulative catch-up basis.
The Group believes that the use of the percentage of completion method
is appropriate as the Group has the ability to make reasonably
dependable estimates of the extent of progress towards completion,
contract revenues and contract costs. In addition, contracts executed
include provisions that clearly specify the enforceable rights
regarding services to be provided and received by the parties to the
contracts, the consideration to be exchanged and the manner and the
terms of settlement, including in cases of terminations for
convenience. In all cases the Group expects to perform its contractual
obligations and its customers are expected to satisfy their
obligations under the contract.
Accounting for long-term contracts using the percentage-of-completion
method stipulates that revenue and expense are recognized throughout
the life of the contract, even though the project is not completed and
the purchaser does not have possession of the project.
Fees are payable upon completion of agreed upon milestones and subject
to customer acceptance. Amounts recognized in advance of contractual
billing, mainly as a result of using the "Input Method", are recorded
as unbilled accounts receivable. The period between most instances of
advanced recognition of revenues and the customers' billing generally
range between one to six months.
The Group sells security products to customers according to customers'
orders without installation work. The customers are not entitled to
return the products. Revenues from security product sales are
recognized in accordance with SAB No. 104, "Revenue Recognition in
Financial Statements", when delivery has occurred, persuasive evidence
of an agreement exists, the vendor's fee is fixed or determinable, no
further obligation exists and collectability is probable.
F - 15
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)
Services and maintenance are performed under either fixed-price based
or time-and-materials based contracts. Under fixed-price contracts,
the Group agrees to perform certain work for a fixed price. Under
time-and-materials contracts, the Group is reimbursed for labor hours
at negotiated hourly billing rates and for materials. Such service
contracts are not in the scope of SOP No. 81-1, and accordingly,
related revenues are recognized in accordance with SAB No. 104, as
those services are performed or over the term of the related
agreements provided that, an evidence of an arrangement has been
obtained, fees are fixed and determinable and collectibillity is
reasonably assured.
One of the Company's subsidiaries provides security video monitoring
services. The majority of its contracts are for a five year term and
do not include terms that result in the transfer of title of the
equipment to the customer. Under the contracts service is not
dependent on specific equipment. The subsidiary's obligation is
related to the provision of monitoring services. In accordance with
EITF No. 01-08, "Determining Whether an Arrangement Contains a Lease"
and SFAS No. 13, "Accounting for Leases", the service contract does
not meet the definition of a lease and as such the subsidiary
recognizes monthly service fees over the term of the agreement.
Deferred revenue includes unearned amounts under installation
services, service contracts and maintenance agreements.
n. Accounting for stock-based compensation:
The Company has elected to follow Accounting Principle Board Opinion
("APB") No. 25, "Accounting for Stock Issued to Employees," and FASB
Interpretation ("FIN") No. 44, "Accounting for Certain Transactions
Involving Stock Compensation," in accounting for its employee stock
option plans. Under APB No. 25, when the exercise price of the
Company's share options is less than the market price of the
underlying shares on the date of grant, compensation expense is
recognized.
The Company adopted the disclosure provisions of SFAS No. 148,
"Accounting for Stock-Based Compensation - Transition and Disclosure",
which amended certain provisions of SFAS No. 123, "Accounting for
Stock-Based Compensation", to provide alternative methods of
transition for an entity that voluntarily changes to the fair value
based method of accounting for stock-based employee compensation,
effective as of the beginning of the prior fiscal year. The Company
continues to apply the provisions of APB No. 25 in accounting for
stock-based compensation.
Pro forma information regarding net income and net earnings per share
is required by SFAS No. 123, and has been determined as if the Company
had accounted for its employee stock options under the fair value
method prescribed by SFAS No. 123.
F - 16
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
-------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT PER SHARE DATA)
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)
The fair value for options granted in 2004 and 2005 is amortized over
their vesting period and estimated at the grant date using the Black
and Scholes option pricing model with the following weighted-average
assumptions:
2004 2005
---------------- ----------------
Dividend yield 0% 0%
Expected volatility 97.9% 83.4%
Risk-free interest 2.46% 4%
Expected life of up to 1.5 years 2.5 years
Pro forma information under SFAS No. 123:
YEAR ENDED DECEMBER 31,
---------------------------------------------------
2003 2004 2005
------------ ------------ ---------
Net income (loss) as reported: $ 2,404 $ 1,053 $ (3,211)
Add: stock-based compensation expenses
determined under the intrinsic value based
method included in the reported net income 3 184 439
Deduct: stock-based compensation expenses
determined under fair value based method for
all awards (111) (198) (1,493)
------------ ------------ ---------
Pro forma net income $ 2,296 $ 1,039 $ (4,265)
============ ============ =========
Basic net earnings (loss) per share, as reported $ 0.30 $ 0.12 $ (0.32)
============ ============ =========
Diluted net earnings (loss) per share, as
reported $ 0.30 $ 0.12 $ (0.32)
============ ============ =========
Pro forma basic net earnings (loss) per share $ 0.29 $ 0.12 $ (0.43)
============ ============ =========
Pro forma diluted net earnings (loss) per share $ 0.29 $ 0.12 $ (0.43)
============ ============ =========
o. Research and development costs:
Research and development costs incurred in the process of developing
product improvements or new products, are charged to expenses as
incurred, net of grants received and investment tax credit.
F - 17
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)
p. Warranty costs:
The Group provides a warranty for up to 24 months, at no extra charge.
The Group estimates the costs that may be incurred under its warranty
and records a liability in the amount of such costs at the time
product revenue is recognized in accordance with FIN No. 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others" and SFAS No.
5, "Accounting for Contingencies". Factors that affect the Group's
warranty liability include the number of units, historical and
anticipated rates of warranty claims and cost per claim. The Group
periodically assesses the adequacy of its recorded warranty
liabilities and adjusts the amounts as necessary. A tabular
reconciliation of the changes in the Group's aggregate product
warranty liability is not provided due to immateriality.
q. Royalty-bearing grants:
Royalty-bearing grants from the Government of Israel for funding
research and development projects are recognized at the time the
Company is entitled to such grants on the basis of the related costs
incurred and recorded as a reduction of research and development
costs. Research and development grants recognized amounted to $ 128, $
228 and $ 8 in 2003, 2004 and 2005, respectively.
r. Net earnings (loss) per share:
Basic net earnings per share is computed based on the weighted average
number of shares of Ordinary shares outstanding during each year.
Diluted net earnings per share is computed based on the weighted
average number of shares of Ordinary shares outstanding during each
year, plus dilutive potential shares of Ordinary shares considered
outstanding during the year, in accordance with SFAS No. 128 ,
"Earnings Per Share".
s. Concentrations of credit risk:
Financial instruments that potentially subject the Group to
concentrations of credit risk consist principally of cash and cash
equivalents, short-term and long-term bank deposits, structured notes,
unbilled accounts receivable, trade receivables and long-term trade
receivables.
Cash and cash equivalents, short-term and long-term bank deposits and
structured notes are mainly invested in major Israeli and U.S. banks.
Cash and cash equivalents in the United States may be in excess of
insured limits and are not insured in other jurisdictions. Management
believes that the financial institutions that hold the Group's
investments are financially sound and, accordingly, minimal credit
risk exists with respect to these investments.
F - 18
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)
The short-term and long-term trade receivables of the Group, as well
as the unbilled accounts receivable, are derived from sales to large
and solid organizations and governmental authorities located mainly in
Israel, the United States, Canada and Europe. The Group performs
ongoing credit evaluations of its customers and to date have not
experienced any material losses. An allowance for doubtful accounts is
determined with respect to those amounts that the Group has determined
to be doubtful of collection and in accordance with an aging key. In
certain circumstances, the Group may require letters of credit, other
collateral or additional guarantees.
The Group has no significant off-balance sheet concentration of credit
risks, such as foreign exchange contracts or foreign hedging
arrangements, except derivative instruments, which are detailed in x.
below.
t. Income taxes:
The Group accounts for income taxes in accordance with SFAS No. 109,
"Accounting for Income Taxes." This Statement prescribes the use of
the liability method whereby deferred tax assets and liability account
balances are determined based on differences between financial
reporting and tax bases of assets and liabilities and are measured
using the enacted tax rates and laws that will be in effect when the
differences are expected to reverse. The Group provides a valuation
allowance, if necessary, to reduce deferred tax assets to their
estimated realizable value.
u. Severance pay:
The Company's liability for its Israeli employees severance pay is
calculated pursuant to Israel's Severance Pay Law based on the most
recent salary of the employees multiplied by the number of years of
employment, as of the balance sheet date. Employees are entitled to
one month's salary for each year of employment or a portion thereof.
The Company's liability for its employees in Israel is fully provided
by monthly deposits with insurance policies and by an accrual. The
value of these policies is recorded as an asset in the Company's
balance sheet.
The deposited funds include profits accumulated up to balance sheet
date. The deposited funds may be withdrawn only upon the fulfillment
of the obligation pursuant to Israel's Severance Pay Law or labor
agreements. The value of the deposited funds is based on the cash
surrendered value of these policies, and includes immaterial profits.
Severance expenses for the years ended December 31, 2003, 2004 and
2005, amounted to approximately $ 313, $ 306 and $ 362, respectively.
F - 19
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)
v. Fair value of financial instruments:
The following methods and assumptions were used by the Group in
estimating its fair value disclosures for financial instruments:
(i) The carrying amounts of cash and cash equivalents, short-term
bank deposits, trade receivables, unbilled accounts receivable,
short-term bank credit and trade payables approximate their fair
value due to the short-term maturity of such instruments.
(ii) The carrying amount of the Group's long-term trade receivables,
long-term bank deposits and structured notes approximate their
fair value. The fair value was estimated using discounted cash
flows analyses, based on the Group's investment rates for similar
type of investment arrangements.
(iii) The carrying amounts of the Group's long-term debt are estimated
by discounting the future cash flows using current interest rates
for loans of similar terms and maturities. As of December 31,
2004, the fair value of the Company's long-term borrowing was $
5,318, compared to the carrying amount of $ 5,349. As of December
31, 2005, the fair value of the Company's long-term borrowing was
$ 5,259, compared to the carrying amount of $ 5,300.
(iv) The fair value of foreign currency contracts (used for hedge
purposes) is estimated by obtaining current quotes from brokerage
firms.
w. Advertising expenses:
Advertising costs are expensed as incurred. Advertising expenses for
the years ended December 31, 2003, 2004 and 2005, were $ 422, $ 495
and $ 420, respectively.
x. Derivative instruments:
SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities", requires a company to recognize all of its derivative
instruments as either assets or liabilities in the statement of
financial position at fair value. The accounting for changes in the
fair value (i.e., gains or losses) of a derivative instrument depends
on whether it has been designated and qualifies as part of a hedging
relationship and further, on the type of hedging relationship. For
those derivative instruments that are designated and qualify as
hedging instruments, a company must designate the hedging instrument,
based upon the exposure being hedged.
To protect against the change in the forecasted foreign currency cash
flows of certain sale arrangements resulting from changes in the
exchange rate, the Company has entered during 2003, 2004 and 2005 into
forward contracts in order to hedge portions of its forecasted revenue
and unbilled accounts receivable denominated in Euros and Polish
Zlotys. The Company has designated the forward instruments as cash
flow hedges for accounting purposes.
F - 20
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)
For derivative instruments designated as cash flow hedge (i.e.,
hedging the exposure to variability in expected future cash flows that
is attributable to a particular risk), the effective portion of the
gain or loss on the derivative instrument is reported as a component
of other comprehensive income and reclassified into earnings in the
same line item associated with the forecasted transaction in the same
period or periods during which the hedged transaction affects
earnings.
During 2005, the Company recognized no hedge ineffectiveness for the
Euro contract cash flows hedge as the Company concluded that the
changes in the cash flows attributable to the changes in the exchange
rates are completely offset by the forward contract.
The Company determined that sales arrangement in Polish Zlotys and the
related forecasted revenues and accounts receivable will not occur by
the end of the specified time period. Accordingly, the forward loss
was recorded in financial expenses in 2005.
As of December 31, 2005, the Company expects to reclassify $ 6 of net
income on derivative instruments from other comprehensive income to
earnings during the next 12 months due to actual sales and related
payments.
y. Reclassification:
An amount of $ 1,870 in billed accounts receivable was reclassified
from unbilled accounts to trade receivables to conform to current year
presentation. The reclassification had no effect on previously
reported net income, shareholders' equity or cash flows.
See also Note 16a.
z. Impact of recently issued accounting standards:
On December 16, 2004, the FASB issued SFAS No. 123(R) (revised 2004),
"Share-Based Payment," which is a revision of SFAS No. 123,
"Accounting for Stock-Based Compensation" ("SFAS 123(R)"). Generally,
the approach in SFAS 123(R) is similar to the approach described in
SFAS No. 123. However, SFAS 123 permitted, but did not require,
share-based payments to employees to be recognized based on their fair
values while SFAS 123(R) requires all share-based payments to
employees to be recognized based on their fair values. SFAS 123(R)
also revises, clarifies and expands guidance in several areas,
including measuring fair value, classifying an award as equity or as a
liability and attributing compensation cost to reporting periods. The
Company adopted SFAS 123(R) on January 1, 2006.
F - 21
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)
SFAS 123(R) permits companies to adopt its requirements using one of
the following two methods:
1. The "modified prospective" method, in which compensation cost is
recognized commencing with the effective date (i) based on the
requirements of SFAS 123(R) for all share-based payments granted
after the effective date and (ii) based on the requirements of
SFAS 123 for all awards granted to employees prior to the
effective date of SFAS 123(R) that remain unvested at the
effective date.
2. The "modified retrospective" method, which includes the
requirements of the modified prospective method described above,
but also permits entities to restate based on the amounts
previously recognized under SFAS 123, for purposes of pro forma
disclosures all prior periods presented.
As permitted by SFAS 123, the Company currently accounts for
share-based payments to employees using APB 25, the intrinsic value
method. The impact of the adoption of SFAS 123(R) cannot be predicted
at this time, as it depends on levels of share-based payments for
future grant. However, had the Company adopted SFAS 123(R) in prior
periods, the impact of that Standard would have approximated the
impact of SFAS 123, as described in the disclosure of the pro forma
information above.
In March 2005, the SEC Staff issued Staff Accounting Bulletin No. 107
(SAB 107) to give guidance on implementation of SFAS 123(R).
NOTE 3:- INVENTORIES
DECEMBER 31,
-----------------------
2004 2005
------- -------
Raw materials $ 6,806 $ 4,902
Work in progress 2,320 1,855
Finished products 3,576 4,353
------- -------
$12,702 $11,110
======= =======
F - 22
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
NOTE 4:- PROPERTY AND EQUIPMENT
a. Composition:
DECEMBER 31,
-----------------------
2004 2005
------- -------
Cost:
Land and buildings $ 8,790 $ 8,949
Machinery and equipment 4,411 5,401
Machinery and equipment leased to customers under
operating leases 4,952 6,796
Motor vehicles 1,341 1,297
Promotional display 4,236 4,115
Office furniture and equipment 2,924 3,190
Leasehold improvements 784 780
------- -------
27,438 30,528
------- -------
Accumulated depreciation:
Buildings 2,404 2,698
Machinery and equipment 2,958 3,846
Machinery and equipment leased to customers under
operating leases 845 1,342
Motor vehicles 833 941
Promotional display 3,322 3,433
Office furniture and equipment 2,356 2,554
Leasehold improvements 61 127
------- -------
12,779 14,941
------- -------
Depreciated cost $14,659 $15,587
======= =======
b. Depreciation expenses amounted to $ 1,241, $ 1,822 and $ 1,823 for the
years ended December 31, 2003, 2004 and 2005, respectively.
c. As for charges, see Note 9g.
F - 23
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
NOTE 5:- OTHER INTANGIBLE ASSETS, NET
a. Composition:
DECEMBER 31,
---------------------
2004 2005
------ ------
Cost:
Know-how $ 502 $ 502
Patents 2,639 2,787
Technology 436 436
------ ------
3,577 3,725
------ ------
Accumulated amortization:
Know-how 396 446
Patents 2,443 2,575
Technology 82 135
------ ------
2,921 3,156
------ ------
Amortized cost $ 656 $ 569
====== ======
b. Amortization expenses related to intangible assets amounted to $ 137,
$ 144 and $ 141 for the years ended December 31, 2003, 2004 and 2005,
respectively.
c. Estimated amortization of intangible assets for the years ended:
DECEMBER 31,
------------
2006 $111
2007 102
2008 93
2009 86
2010 177
----
$569
====
F - 24
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
NOTE 6:- SHORT-TERM BANK CREDIT
a. Classified by currency, linkage terms and interest rates:
INTEREST RATE DECEMBER 31,
----------------- -----------------------
2004 2005 2004 2005
---- ---- ------- -------
%
-----------------
In or linked to U.S. dollars (1) 4.08 4.14 $ 8,600 $15,100
In or linked to NIS (1) 5.47 5.00 5,556 1,742
In or linked to Canadian
dollars (2) 4.75 - 1,462 -
In or linked to PLN (1) - 5.92 - 1,226
------- -------
$15,618 $18,068
======= =======
Weighted average interest 4.64 4.62
rates at the end of the year
Total authorized credit lines
approximate $33,245 $48,895
======= =======
Unutilized credit lines
approximate $ 6,352 $15,781
======= =======
(1) The Company has undertaken to maintain the following financial
ratios and terms in respect of its used credit line: (i) a ratio
of at least 40% of consolidated shareholders' equity out of the
consolidated total assets, (ii) minimal annual consolidated net
income in the amount of $ 1,000 and (iii) the same shareholders
maintain the core of control in the Company.
As of December 31, 2005, the Company was not in compliance with
the requirement under its credit lines that the Company will have
a minimum annual consolidated net income of at least $ 1,000. One
of the banks has agreed to waive such requirement for 2005 and
informed the Company that it will not require the immediate
repayment of the Company's outstanding indebtedness as a result
of such non-compliance. Although the Company has not received a
formal waiver from the other bank to date, management believes
that such waiver will be obtained within the next few weeks. As
of December 31, 2005, the balance due to the abovementioned bank,
amounts to approximately $ 2,370 in short-term bank credit.
(2) The loan to a subsidiary is collateralized by a general security
agreement. The subsidiary has undertaken to maintain general
covenants and the following financial ratios, with respect to the
subsidiary's financial statements, and terms in respect of its
used credit lines: (i) a quick ratio of not less than 1.25, (ii)
a ratio of total liabilities to tangible net worth of not greater
than 0.75 and (iii) tangible net worth of at least $ 9,000.
As of December 31, 2005, the subsidiary has no commitments to the
bank.
b. As for charges, see Note 9g.
F - 25
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
NOTE 7:- OTHER ACCOUNTS PAYABLE AND ACCRUED EXPENSES
DECEMBER 31,
---------------------
2004 2005
------ ------
Employees and payroll accruals $1,380 $1,596
Provision in respect of demand for bank performance guarantee (1) - 1,436
Accrued expenses 3,911 4,599
Deferred revenues 81 284
Government authorities 308 84
Income tax payable 3 249
Others 986 666
------ ------
$6,669 $8,914
====== ======
(1) See also Note 17.
NOTE 8:- LONG-TERM BANK DEBT
a. Classified by currency, linkage terms and interest rates:
INTEREST RATE DECEMBER 31,
LINKAGE ------------------ --------------------
TERMS 2004 2005 2004 2005
----- ---- ---- ---- ----
%
------------------
Bank loan U.S. $ 3.10 3.10 $2,500 $2,500
Bank promissory note U.S. $ - 5.45 - 820
Bank promissory note U.S. $ - 5.45 - 980
Bank promissory note (1) U.S. $ 3.05 5.175 500 500
Bank promissory note (1) U.S. $ 3.50 5.625 500 500
------ ------
3,500 5,300
Mortgage payable U.S. $ 8.25 - 1,849 -
------ ------
5,349 5,300
Less - current
maturities 1,849 3,647
------ ------
$3,500 $1,653
====== ======
Weighted average
interest rates at
the end of the
year 4.91 4.33
F - 26
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
NOTE 8:- LONG-TERM BANK DEBT (CONT.)
(1) As for financial ratios and terms in respect of long-term loans,
the two $ 500 promissory notes both have covenants that require
the Group to maintain $ 1 thousand in deposits at all times
otherwise the interest rate on the notes becomes the bank's rate
plus 0.25% until the minimum deposit is maintained.
As of December 31, 2005, management believes that the Group was
in compliance with these ratios and terms.
b. As of December 31, 2005, the aggregate annual maturities of the
long-term loans are as follows:
2006 $ 3,647
2007 155
2008 163
2009 173
2010 1,162
--------
$ 5,300
========
c. As for charges, see Note 9g.
NOTE 9:- COMMITMENTS AND CONTINGENT LIABILITIES
a. Royalty commitments to the Office of the Chief Scientist of the
Israeli Ministry of Industry and Trade ("OCS"):
Under the research and development agreements of the Company with the
OCS and pursuant to applicable laws, the Company is required to pay
royalties at the rate of 3%-4.5% of sales of products developed with
funds provided by the OCS, up to an amount equal to 100% of the OCS
research and development grants received, linked to the U.S. dollars
plus interest on the unpaid amount received based on the 12-month
LIBOR rate applicable to dollar deposits. The Company is obligated to
repay the Israeli Government for the grants received only to the
extent that there are sales of the funded products.
Royalties paid amounted to $ 80, $ 61 and $ 83 for the years ended
December 31, 2003, 2004 and 2005, respectively. As of December 31,
2005, the Company had remaining contingent obligations to pay
royalties in the amount of approximately $ 1,792.
F - 27
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
NOTE 9:- COMMITMENTS AND CONTINGENT LIABILITIES (CONT.)
b. Royalty commitments to the Fund for Encouragement of Marketing
Activities:
The Israeli Government, through the Fund for the Encouragement of
Marketing Activities, awarded the Company grants for participation in
expenses for foreign marketing. The Company is committed to pay
royalties at the rate of 3% of the increase in export sales, up to the
amount of the grants received.
No royalties were paid during the years ended December 31, 2003, 2004
and 2005. As of December 31, 2005, the Company's aggregate contingent
obligation amounted to $ 82.
c. Royalty commitments to third party:
During 2002, the Company entered into a development agreement for
planning, developing and manufacturing a security system with a third
party. Under the agreement, the Company agreed to pay the third party
royalty fees, based on a formula as defined in the agreement. Under
this agreement, the Company also committed to purchase a certain
volume of products at a minimum amount of approximately $ 300 over 2.5
years after achievement of certain milestones. As of December 31,
2005, royalty commitments under the agreement amounted to $ 17.
d. Lease commitments:
The Group rents its facilities and some of its motor vehicles under
various operating lease agreements, which expire on various dates, the
latest of which is in 2009.
Future minimum lease payments under non-cancelable operating lease
agreements as of December 31, are as follows:
2006 $ 404
2007 243
2008 137
2009 37
-------
$ 821
=======
Total rent expenses for the years ended December 31, 2003, 2004 and
2005, were approximately $ 368, $ 671 and $ 593, respectively.
F - 28
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
NOTE 9:- COMMITMENTS AND CONTINGENT LIABILITIES (CONT.)
e. Guarantees:
As of December 31, 2005, the Group obtained bank performance
guarantees and advance payment guarantees and bid bond guarantees from
several banks mainly in Israel in the amount of $ 8,670. As for a
customer's demand for the payment under a bank performance guarantee,
see Note 17.
f. Legal proceedings:
In April 2003, a competitor filed a civil action suit against the
Company and others. The plaintiff alleged that the failure of its
perimeter systems in field trials executed by the Ministry of Defense
during 1996 and 1997, resulted from intentional damage to the fence
and diversion of the results of certain tests by a former employee of
the Company, who was then a soldier in the Israeli Defense Force. The
plaintiff alleged that the Company, which was the employer of this
employee during 1995, still employed him as an agent during the field
trials, and directed the actions of the former employee. The plaintiff
requested the courts to annul the field trial and sought approximately
$ 714 in damages. The Company denied all of the above allegations and
claimed that the plaintiff's perimeter system failure was not the
result of the former employee's actions.
In July 2005, the parties agreed to appoint a mediator, as proposed by
the court. The Company's legal counsel believes that the Company has
valid defenses against the aforementioned claims and, therefore, no
provision was recorded in the financial statements.
For arbitration procedures against Company's customer, see Note 17.
g. Charges:
As collateral for all of the Group liabilities to banks:
1. A fixed charge has been placed on the Company's property.
2. The Company agreed not to pledge any of its assets without the
consent of several banks.
3. A fixed charge in the amount of $ 3,000 has been placed on the
Company's bank deposits.
4. A subsidiary of the Company has two bank promissory notes in the
aggregate amount of $ 1,000 due on April 15, 2006, collateralized
by substantially all of the subsidiary's assets.
F - 29
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE AND PER SHARE DATA)
NOTE 10:- SHAREHOLDERS' EQUITY
a. Pertinent rights and privileges conferred by Ordinary shares:
The Ordinary shares of the Company are listed for trade on NASDAQ
National Market and in Israel, on the Tel-Aviv Stock Exchange. The
Ordinary shares confer upon their holders the right to receive notice
to participate and vote in the general meetings of the Company and the
right to receive dividends, if declared.
b. Issued and outstanding share capital:
On April 19, 2005, the Company completed a public offering of $ 16.3
thousand in consideration of 1,700,000 of the Company's Ordinary
shares at a price per share of $ 9.5 and at a price of $ 9.92 (the
closing price of the Ordinary shares on the date of the transaction)
to two principal shareholders of the Company.
c. Stock Option Plan:
On October 27, 2003, the Company's Board of Directors approved the
2003 Israeli Share Option Plan ("the 2003 Plan"). Under the 2003 Plan,
stock options will be periodically granted to employees, directors,
officers and consultants of the Company or its subsidiaries, in
accordance with the decision of the Board of Directors of the Company
(or a committee appointed by it). The Board of Directors has the
authority to determine the number of options, if any, which will be
granted to each of the aforementioned, the dates of the grant of such
options, the date of their exercise as well as their rate of
conversion into shares in respect of each stock option, and the
purchase price thereof.
The 2003 Plan is effective for ten years and shall terminate in
October 2013. Any options that are cancelled or forfeited before
expiration become available for future grant.
As of December 31, 2005, there were 299,676 options available for
future grant.
F - 30
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE AND PER SHARE DATA)
NOTE 10:- SHAREHOLDERS' EQUITY (CONT.)
A summary of the Company's stock options activities in 2003, 2004 and
2005, is as follows:
YEAR ENDED DECEMBER 31,
---------------------------------------------------------------------------------------
2003 2004 2005
----------------------- ----------------------- -----------------------
WEIGHTED WEIGHTED WEIGHTED
NUMBER AVERAGE NUMBER AVERAGE NUMBER AVERAGE
OF EXERCISE OF EXERCISE OF EXERCISE
OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE
-------- ----- -------- ----- ------- -----
Outstanding at the
beginning of the
year 358,234 $4.23 223,216 $4.61 105,000 $7.66
Granted - $ - 100,000 $7.66 238,000 $8.65
Adjustment as a
result of stock
dividend 10,256 $ - 7,652 $ - - $ -
Exercised (137,446) $3.55 (225,338) $4.61 - $ -
Forfeited (7,828) $ - (530) $ - - $ -
-------- -------- -------
Outstanding at the
end of the year 223,216 $4.61 105,000 $7.66 343,000 $8.35
======== ===== ======== ===== ======= =====
Exercisable options
at the end of
the year 223,216 $4.61 - $ - 231,200 $8.56
======== ===== ======== ===== ======= =====
The options outstanding as of December 31, 2005 have been separated
into ranges of exercise price as follows:
OPTIONS
OPTIONS EXERCISABLE AS
OUTSTANDING WEIGHTED AVERAGE OF
AS OF REMAINING DECEMBER 31,
DECEMBER 31, 2005 EXERCISE PRICE CONTRACTUAL LIFE 2005
-------------------- ----------------- ------------------- -----------------
(IN MONTHS)
105,000 $ 7.66 1 -
233,000 $ 8.56 - 231,200
5,000 $13 24 -
--------- -------
343,000 $ 8.35 231,200
========= ====== =======
Where the Company has recorded deferred stock compensation for options
issued with an exercise price below the fair market value of the
Ordinary shares, the deferred stock compensation has been amortized
and recorded as compensation expense ratably over the vesting period
of the options. Compensation expenses of approximately $ 3, $ 184 and
$ 439 were recognized during the years ended December 31, 2003, 2004
and 2005, respectively.
F - 31
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT SHARE AND PER SHARE DATA)
NOTE 10:- SHAREHOLDERS' EQUITY (CONT.)
d. Dividends:
1. Dividends, if any, will be declared and paid in U.S. dollars.
Dividends paid to shareholders in Israel will be converted into
NIS on the basis of the exchange rate prevailing at the date of
payment. The Company has determined that it will not distribute
dividends out of tax-exempt profits.
2. The Company's Board of Directors declared stock dividends of 3%,
3% and 5% in May 2002, May 2003 and July 2004, respectively. All
shares, options and net earnings per share data have been
retroactively adjusted to reflect the stock dividend.
3. At the Annual General Meeting of Shareholders held on July 29,
2004, the shareholders approved the payment of an interim cash
dividend in the amount of $ 0.05 per Ordinary share of NIS 1 par
value each, which was declared by the Board of Directors in
December 2003.
NOTE 11:- BASIC AND DILUTED NET EARNINGS PER SHARE
YEAR ENDED DECEMBER 31,
--------------------------------------------------------
2003 2004 2005
---------- ------------- -------------
Numerator:
Income (loss) from continuing operations $ 2,390 $ 1,174 $ (3,055)
Gain (loss) on discontinued operations 14 (121) (156)
---------- ------------- -------------
Net income (loss) $ 2,404 $ 1,053 $ (3,211)
========== ============= =============
Denominator:
Denominator for basic net earnings per share -
weighted-average number of shares outstanding 7,947,778 8,581,348 9,883,407
Effect of diluting securities:
Employee stock options and warrants to underwriters 80,848 55,031 16,926
---------- ------------- -------------
Denominator for diluted net earnings per share -
adjusted weighted average shares and assumed
exercises 8,028,626 8,636,379 9,900,333
========== ============= =============
Basic net earnings (loss) per share from continuing
operations $ 0.30 $ 0.13 $ (0.31)
Basic net loss per share from discontinued operations - (0.01) (0.01)
---------- ------------- -------------
Basic net earnings (loss) per share $ 0.30 $ 0.12 $ (0.32)
========== ============= =============
Diluted net earnings (loss) per share form continuing
operations $ 0.30 $ 0.13 $ (0.31)
Diluted net loss per share from discontinued operations - (0.01) (0.01)
---------- ------------- -------------
Diluted net earnings (loss) per share $ 0.30 $ 0.12 $ (0.32)
========== ============= =============
F - 32
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
NOTE 12:- TAXES ON INCOME
a. Tax benefits in Israel under the Law for the Encouragement of Capital
Investments, 1959 ("the Law"):
The Company has been granted the status of an "Approved Enterprise"
under the Law. Currently, there are three expansion programs under
which the Company is entitled to tax benefits:
1. In 1992, a program of the Company was granted the status of an
"Approved Enterprise". The Company has elected to enjoy the
"alternative benefits" track - waiver of grants in return for tax
exemption - and, accordingly, the Company's income from this
program was tax-exempt for a period of four years, and was
subject to a reduced tax rate of 15%-25% for a period ranging
between three to six years (depending on the percentage of
foreign ownership of the Company). The period of benefits under
this program began in 1994 and terminated in 2003.
2. On March 18, 1997, a program of the Company was granted the
status of an "Approved Enterprise". The Company elected to enjoy
the "alternative benefits" track - waiver of grants in return for
tax exemption and accordingly, the Company's income from this
program was tax-exempt for a period of four years, and is subject
to a reduced tax rate of 15%-25% for a period ranging between
three to six years (depending on the percentage of foreign
ownership of the Company). The period of benefits under this
program began in 1998 and will terminate in 2007.
3. On August 13, 2002, a program of the Company was granted the
status of an "Approved Enterprise". The Company elected to enjoy
the "alternative benefits" track - waiver of grants in return for
tax exemption - and, accordingly, the Company's income from this
program is tax-exempt for a period of two years, and is subject
to a reduced tax rate of 15%-25% for a period of five to eight
years (depending upon the percentage of foreign ownership of the
Company). The benefit period for this program began in 2003 and
will terminate in 2012.
The entitlement to the above benefits is conditional upon the Company
fulfilling the conditions stipulated by the Law, regulations published
there under and the letters of approval for the specific investments
in "Approved Enterprises". In the event of failure to comply with
these conditions, the benefits may be canceled and the Company may be
required to refund the amount of the benefits, in whole or in part,
including interest. As of December 31, 2005, management believes that
the Company is in compliance with all of the aforementioned
conditions.
F - 33
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
NOTE 12:- TAXES ON INCOME (CONT.)
The period of tax benefits detailed above is subject to limits of the
earlier of 12 years from the commencement of production or 14 years
from receiving the approval.
A recent amendment to the Law, which has been officially published
effective as of April 1, 2005 ("the Amendment") has changed certain
provisions of the Law. As a result of the Amendment, a company is no
longer obliged to implement an Approved Enterprise status in order to
receive the tax benefits previously available under the Alternative
Benefits provisions, and therefore there is no need to apply to the
Investment Center for this purpose (Approved Enterprise status remains
mandatory for companies seeking grants). Rather, a company may claim
the tax benefits offered by the Investment Law directly in its tax
returns, provided that its facilities meet the criteria for tax
benefits set out by the Amendment. A company is also granted a right
to approach the Israeli Tax Authority for a pre-ruling regarding their
eligibility for benefits under the Amendment.
Tax benefits are available under the Amendment to production
facilities (or other eligible facilities), which are generally
required to derive more than 25% of their business income from export.
In order to receive the tax benefits, the Amendment states that a
company must make an investment in the Beneficiary Enterprise
exceeding a minimum amount specified in the Law. Such investment may
be made over a period of no more than three years ending at the end of
the year in which a company requested to have the tax benefits apply
to the Beneficiary Enterprise ("the Year of Election"). Where a
company requests to have the tax benefits apply to an expansion of
existing facilities, then only the expansion will be considered a
Beneficiary Enterprise and the company's effective tax rate will be
the result of a weighted combination of the applicable rates. In this
case, the minimum investment required in order to qualify as a
Beneficiary Enterprise is required to exceed a certain percentage of
the company's production assets before the expansion. The duration of
tax benefits is subject to a limitation of the earlier of 7 years from
the Commencement Year, or 12 years from the first day of the Year of
Election.
Income from sources other than "Approved Enterprise", during the
benefit period will be subject to tax at regular rate of 34% in 2005
(see d. below).
By virtue of the Law, the Company is entitled to claim accelerated
depreciation on equipment used by the "Approved Enterprise" during
five tax years.
Since the Company is operating under more than one approval and since
part of its taxable income is not entitled to tax benefits under the
aforementioned law and is taxed at regular rates (currently 34%), its
effective tax rate is the result of a weighted combination of the
various applicable rates and tax-exemptions. The computation is made
for income derived from each program on the basis of formulas
determined in the law and in the approvals.
F - 34
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
NOTE 12:- TAXES ON INCOME (CONT.)
The tax-exempt income attributable to the "Approved Enterprises" can
be distributed to shareholders without subjecting the Company to taxes
only upon the complete liquidation of the Company. If the retained
tax-exempt income is distributed in a manner other than in the
complete liquidation of the Company, it would be taxed at the
corporate tax rate applicable to such profits as if the Company had
not chosen the alternative tax benefits (currently - 15%).
b. Measurement of taxable income under the Income Tax (Inflationary
Adjustments) Law, 1985:
Under the Income Tax (Inflationary Adjustments) Law, 1985, results for
tax purposes are measured in real terms, in accordance with the
changes in the Israeli Consumer Price Index ("Israeli CPI").
Accordingly, until 2002, results for tax purposes were measured in
terms of earnings in NIS after certain adjustments for increases in
the Israeli CPI. Commencing in taxable year 2003, the Company has
elected to measure its taxable income and file its tax return under
the Israeli Income Tax Regulations (Principles Regarding the
Management of Books of Account of Foreign Invested Companies and
Certain Partnerships and the Determination of Their Taxable Income),
1986. Such an elective obligates the Company for three years.
Accordingly, commencing taxable year 2003, results for tax purposes
are measured in terms of earnings in dollar.
c. Tax benefits (in Israel) under the Law for the Encouragement of
Industry (Taxes), 1969:
The Company is an "industrial company" as defined by this law and, as
such, is entitled to certain tax benefits including accelerated
depreciation, deduction of the purchase price of patents and know-how
and deduction of public offering expenses.
d. Tax rates:
1. On July 25, 2005, the Knesset (Israeli Parliament) passed the Law
for the Amendment of the Income Tax Ordinance (No. 147), 2005,
which prescribes, among others, a gradual decrease in the
corporate tax rate in Israel to the following tax rates: in 2006
- 31%, in 2007 - 29%, in 2008 - 27%, in 2009 - 26% and in 2010
and thereafter - 25%.
The amendment had no material impact on the Company's financial
statements.
2. The tax rates of the Company's subsidiaries range between
25%-40%.
e. Investment tax credit:
One of the Company's subsidiaries is eligible for investment tax
credits on its research and development activities and on certain
current and capital expenditures. During fiscal year 2005, the
subsidiary recognized $ 153 of investment tax credits as a reduction
of research and development expenses. In total, the subsidiary has
investment tax credits available to reduce future federal income taxes
payable, amounting to $ 249, which will expire at various dates from
2014 through 2015.
F - 35
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS (EXCEPT PER SHARE DATA)
NOTE 12:- TAXES ON INCOME (CONT.)
f. Reconciliation between the theoretical tax expense, assuming all
income is taxed at the Israeli statutory rate, and the actual tax
expense, is as follows:
YEAR ENDED DECEMBER 31,
-------------------------------------------
2003 2004 2005
------- ------- -------
Income (loss) before taxes as reported in the $ 3,300 $ 2,307 $(3,078)
statements of income
======= ======= =======
Tax rate 36% 35% 34%
======= ======= =======
Theoretical tax expense (tax benefit) $ 1,188 $ 807 $(1,047)
Increase (decrease) in taxes:
Non-deductible items, net 17 (400) 25
Deferred taxes on losses for which valuation
allowance was provided 298 1,163 579
Tax exemption applicable to "Approved
Enterprises" and exempted income (440) (302) 347
Taxes in respect of prior years (107) (23) 52
Other (46) (112) 21
------- ------- -------
Taxes on income (tax benefit) in the statements
of income $ 910 $ 1,133 $ (23)
======= ======= =======
Per share amounts (basic and diluted) of the tax
benefit resulting from "Approved Enterprises" $ 0.06 $ 0.03 $ (0.04)
======= ======= =======
g. Taxes on income included in the statements of income:
Current taxes:
Domestic $ 395 $ 460 $ -
Foreign 534 518 620
Deferred income taxes (tax benefit):
Domestic - (70) (642)
Foreign 88 248 (53)
Taxes in respect of prior years:
Domestic (107) - -
Foreign - (23) 52
------- ------- -------
Taxes on income (tax benefit) from continuing
operations 910 1,133 (23)
Taxes on income (tax benefit) from discontinued
operations 3 (32) (37)
------- ------- -------
Total taxes on income $ 913 $ 1,101 $ 14
======= ======= =======
F - 36
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
NOTE 12:- TAXES ON INCOME (CONT.)
h. Deferred 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. Significant components of the Group deferred tax assets are
as follows:
DECEMBER 31,
------------------------
2004 2005
------- -------
Operating loss carryforward $ 2,992 $ 3,923
Reserves and tax allowances (26) 963
------- -------
Total deferred assets before valuation allowance 2,966 4,886
Valuation allowance (2,292) (2,871)
------- -------
Net deferred tax assets $ 674 $ 2,015
======= =======
Domestic $ 288 $ 1,553
Foreign 386 462
------- -------
$ 674 $ 2,015
======= =======
i. The domestic and foreign components of income (loss) before taxes are
as follows:
YEAR ENDED DECEMBER 31,
---------------------------------------
2003 2004 2005
------ ------- -------
Domestic $2,200 $ 2,290 $(2,998)
Foreign 1,100 17 (80)
------ ------- -------
$3,300 $ 2,307 $(3,078)
====== ======= =======
j. Net operating losses carryforward:
The Company has estimated total available carryforward tax losses of $
2,377 to offset against future taxable income.
The Company's subsidiaries in the U.S. and the U.K. have estimated
total available carryforward tax losses of $ 8,331 and $ 944,
respectively, to offset against future taxable income for 16 to 20
years, and an indefinite period, respectively. As of December 31,
2005, the Company recorded a full valuation allowance of the
subsidiaries' abovementioned tax assets due to the uncertainty of
their future realization.
Utilization of U.S. net operating losses may be subject to a
substantial annual limitation due to the "change in ownership"
provisions of the Internal Revenue Code of 1986 and similar state
provisions. The annual limitation may result in the expiration of net
operating losses before utilization.
F - 37
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
NOTE 13:- BALANCES AND TRANSACTIONS WITH RELATED PARTIES
a. Balances with related parties:
DECEMBER 31,
-----------------
2004 2005
---- ----
Balances with related parties $ 35 $290
==== ====
b. Sales to related parties:
YEAR ENDED DECEMBER 31,
------------------------------
2003 2004 2005
---- ---- ----
Sales to related parties (1) $196 $386 $671
==== ==== ====
(1) Sales to related parties represent services provided by the
Company's subsidiary.
NOTE 14:- SEGMENT INFORMATION
The Group adopted SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information". The Group operates in three major
reportable segments, which represent the Group's operating segments as
follows:
1. Perimeter security systems - The Group's line of perimeter security
systems consists of the following: Microprocessor-based central
control units, taut wire perimeter intrusion detection systems, INNO
Fences, vibration detection systems, field disturbance sensors, and
other.
2. Security turnkey projects - The Group is executing turnkey projects
based on the Company's security management system and acting as an
integrator.
3. Video monitoring services - The Group supplies video monitoring
services through Smart Interactive Systems, Inc., a subsidiary
established in the U.S. in June 2001.
F - 38
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
-------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
NOTE 14:- SEGMENT INFORMATION (CONT.)
a. The following data present the revenues, expenditures, assets and
other operating data of the Group's operating segments:
YEAR ENDED DECEMBER 31,
--------------------------------------------------------------------------------------------------------------------------------------------------------
2003 2004 2005
------------------------------------------------ --------------------------------------------------- -------------------------------------------------
VIDEO VIDEO VIDEO
PERIMETER PROJECTS MONITORING OTHER TOTAL PERIMETER PROJECTS MONITORING OTHER TOTAL PERIMETER PROJECTS MONITORING OTHER TOTAL
-------- ------- ------- ------- -------- -------- ------- ------- ------- -------- -------- ------- ------- -------- --------
Revenues $ 51,077 $ 6,720 $ 403 $ 455 $ 58,655 $ 46,342 $11,375 $ 2,060 $ 691 $ 60,468 $ 40,143 $17,970 $ 2,897 $ 272 $ 61,282
======== ======= ======= ======= ======== ======== ======= ======= ======= ======== ======== ======= ======= ======== ========
Depreciation and
amortization $ 1,056 $ 20 $ 292 $ 10 $ 1,378 $ 1,252 $ 11 $ 698 $ 5 $ 1,966 $ 1,228 $ 19 $ 713 $ 4 $ 1,964
======== ======= ======= ======= ======== ======== ======= ======= ======= ======== ======== ======= ======= ======== ========
Operating income
(loss),
before
financial
expenses and
taxes on income $ 5,803 $ 936 $(1,870) $ (566) $ 4,303 $ 4,978 $ 1,430 $(2,262) $(1,077) $ 3,069 $ 4,334 $(5,290) $(1,375) $ 53 $ (2,278)
======== ======= ======= ======= ======== ======= ======= ======= ======== ======= ======= ========
Financial
expenses, net (1,003) (762) (800)
Taxes on income 910 1,133 23
Gain (loss) on
discontinued
operations, net 14 (121) (156)
-------- -------- --------
Net income $ 2,404 $ 1,053 $ (3,211)
======== ======== ========
DECEMBER 31,
--------------------------------------------------------------------------------------------------------------------------------------------------------
2003 2004 2005
------------------------------------------------ --------------------------------------------------- -------------------------------------------------
VIDEO VIDEO VIDEO
PERIMETER PROJECTS MONITORING OTHER TOTAL PERIMETER PROJECTS MONITORING OTHER TOTAL PERIMETER PROJECTS MONITORING OTHER TOTAL
-------- ------- ------- ------- -------- -------- ------- ------- ------- -------- -------- ------- ------- -------- --------
Total long-lived
assets $13,476 $88 $2,787 $12 $16,363 $13,576 $192 $5,814 $19 $19,601 $13,042 $194 $7,087 $19 $20,342
======= === ====== === ======= ======= ==== ====== === ======= ======= ==== ====== === =======
F - 39
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
-------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
NOTE 14:- SEGMENT INFORMATION (CONT.)
b. Major customer data (percentage of total revenues):
YEAR ENDED DECEMBER 31,
---------------------------
2003 2004 2005
---- ---- ----
Customer A 27.5% *) - 23.9%
==== ==== ====
Customer B *) - 15.7% 10.2%
==== ==== ====
*) Less than 10% of total revenues.
c. Geographical information:
The following is a summary of revenues within geographic areas based
on end customer's location and long-lived assets:
YEAR ENDED DECEMBER 31,
-----------------------------------
2003 2004 2005
------- ------- -------
1. Revenues:
Israel $19,797 $ 9,617 $19,309
Romania 5,151 9,521 6,244
Europe (excluding Romania) 5,465 9,150 3,691
USA 13,292 17,871 13,185
Canada 6,338 4,068 8,759
Others 8,612 10,241 10,094
------- ------- -------
$58,655 $60,468 $61,282
======= ======= =======
2. Long-lived assets:
Israel $ 3,626 $ 3,211 $ 2,930
Europe 980 1,069 921
USA 8,655 11,518 12,714
Canada 2,998 3,649 3,656
Others 104 154 121
------- ------- -------
$16,363 $19,601 $20,342
======= ======= =======
F - 40
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
-------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
NOTE 15:- SELECTED STATEMENTS OF INCOME DATA
a. Research and development expenses, net:
YEAR ENDED DECEMBER 31,
-------------------------------------
2003 2004 2005
------- ------- -------
Expenses $ 5,128 $ 5,088 $ 5,427
Less - royalty-bearing grants and investment
tax credit 355 405 162
------- ------- -------
$ 4,773 $ 4,683 $ 5,265
======= ======= =======
b. Financial income (expenses):
Financial expenses:
Interest on long-term debt $ (298) $ (289) $ (622)
Interest on short-term bank credit (808) (849) (630)
Forward contracts loss - - (110)
Foreign exchange losses (692) (161) (314)
------- ------- -------
(1,798) (1,299) (1,676)
------- ------- -------
Financial income:
Interest on short-term and long-term bank
deposits and structured notes 672 496 707
Foreign exchange gains 123 41 169
------- ------- -------
795 537 876
------- ------- -------
$(1,003) $ (762) $ (800)
======= ======= =======
NOTE 16:- DISCONTINUED OPERATIONS
a. General:
On July 28, 2005, the Company decided to dispose of the indoor
security sensors operations ("the operations").
In view of the above, the operating results and cash flows attributed
to the operations were presented in the Company's statements of income
and cash flows as discontinued operations, accordingly, the
comparative figures were reclassified for all periods presented.
F - 41
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
-------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
NOTE 16:- DISCONTINUED OPERATIONS (CONT.)
b. The following are the results of discontinued operations for the years
ended December 31, 2003, 2004 and 2005:
YEAR ENDED DECEMBER 31,
-----------------------------
2003 2004 2005
---- ----- -----
Revenues $706 $ 506 $ 427
Cost of revenues 531 499 470
---- ----- -----
Gross profit (loss) 175 7 (43)
---- ----- -----
Operating expenses:
Sales and marketing, net 158 160 149
---- ----- -----
Operating income (loss) 17 (153) (192)
Taxes on income (tax benefit) 3 (32) (36)
---- ----- -----
Net income (loss) $ 14 $(121) $(156)
==== ===== =====
NOTE 17:- SUBSEQUENT EVENT
In May 2005, the Company entered into an agreement to supply comprehensive
security solutions for a sensitive site in Europe. As part of the
agreement, the Company received an advance payment, in the amount of $
3,990, secured by a bank advance payment guarantee, which was to be reduced
proportionally according to the progress of the execution of the project.
In addition, the Company issued to the customer a bank performance
guarantee in the amount of $ 1,436. The Company commenced the execution of
the project and delivered part of the equipment and other deliverables to
the customer. In April 2006, the customer informed the Company that it was
canceling the agreement due to errors in the design documents submitted by
the Company. In addition, the customer did not make the payments required
under the agreement. The Company believes that there are no factual or
legal grounds for the cancellation and, accordingly, the agreement is still
valid. Based on the cancellation of the agreement, the customer collected $
3,181 related to an advance payment that was secured by a bank advance
payment guarantee on June 20, 2006.
F - 42
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
-------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS
NOTE 17:- SUBSEQUENT EVENT (CONT.)
On April 28, 2006, the Company commenced arbitration proceedings against
the customer. In these proceedings, the Company asked the arbitrators to
find that the agreement is valid and to enforce the payment of the amounts
due pursuant to the agreement. The customer has not yet filed its response.
Based on the opinion of the Company's legal counsel, the Company believes
that there is a good likelihood that the arbitration will result in a
favorable decision for the Company.
Due to uncertainty, the Company did not recognize any revenues from this
project.
On July 11, 2006, the customer made a demand for the payment under the
performance bank guarantee in the amount of approximately $ 1,436. Upon the
Company's motion, the District Court in Haifa, Israel has issued a
temporary injunction against the payment of such guarantee pending a
hearing in August 2006. Although the Company obtained the temporary
injunction, according to its legal counsel, the Company's chances to
ultimately prevent the forfeiture of the guarantee remain unclear. In view
of the above, and due to the uncertainty in preventing the forfeiture of
the guarantee, the Company included a provision in the amount of $ 1,436 in
respect of this guarantee in its financial statements.
F - 43
SIGNATURE
The registrant hereby certifies that it meets all of the requirements for
filing on Form 20-F and that it has duly caused and authorized the undersigned
to sign this annual report on its behalf.
MAGAL SECURITY SYSTEMS LTD.
By: /s/ Jacob Even-Ezra
-----------------------
Jacob Even-Ezra
Chairman of the Board and
Chief Executive Officer
Date: July 14, 2006
86