MAGAL SECURITY SYSTEMS LTD - 20-F - 20040629 - KEY_INFORMATION
ITEM 3. Key Information
A. Selected Consolidated Financial Data.
We have derived the following selected consolidated financial data as of
December 31, 2002 and 2003 and for each of the years ended December 31, 2001,
2002 and 2003 from our consolidated financial statements set forth elsewhere in
this annual report that have been prepared in accordance with U.S. GAAP. We have
derived the following selected consolidated financial data as of December 31,
1999, 2000 and 2001 and for each of the years ended December 31, 1999 and 2000
from our audited consolidated financial statements not included in this annual
report. You should read the following selected consolidated financial data
together with the section of this annual report entitled "Operating and
Financial Review and Prospects" and our consolidated financial statements and
notes thereto included elsewhere in this annual report.
Year Ended December 31,
--------------------------------------------------
1999 2000 2001 2002 2003
---- ---- ---- ---- ----
(in thousands except per share data)
Consolidated Statement of Income
Data:
Revenues........................... $31,967 $38,571 $41,020 $42,966 $59,361
Cost of revenues................... 16,693 20,523 21,505 23,924 33,378
------- ------- ------- ------- ------
Gross profit....................... 15,274 18,048 19,515 19,042 25,983
------- ------- ------- ------- ------
Operating expenses:
Research and development, net.... 2,676 2,975 3,054 3,128 4,773
Sales and marketing, net......... 5,820 7,129 7,933 8,642 11,585
General and administrative....... 4,104 4,661 4,949 4,938 5,305
------- ------- ------- ------- -----
Total operating expenses........... 12,600 14,765 15,936 16,708 21,663
------- ------- ------- ------- ------
Operating income................... 2,674 3,283 3,579 2,334 4,320
Financial income (expenses), net... (127) (214) 40 199 (1,003)
------- ------ ------- ------- -------
Income before taxes on income
and write-off of investment in
affiliate, net of taxes.......... 2,547 3,069 3,619 2,533 3,317
Taxes on income.................... 259 180 452 645 913
------- ------- ------- ------- ---
Income before write-off of
investment in affiliate.......... 2,288 2,889 3,167 1,888 2,404
Write-off of investment in
affiliate, net of taxes............ 357 - - - -
------- ------- ------- ------- --------
Net income......................... 1,931 2,889 3,167 1,888 2,404
======= ======= ======= ======= =====
Basic net earnings per share....... $ 0.25 $ 0.38 $ 0.41 $ 0.24 $ 0.30
======= ======= ======= ======= ======
Diluted net earnings per share..... $ 0.25 $ 0.37 $ 0.40 $ 0.23 $ 0.30
======= ======= ======= ======= ======
Weighted average number of Ordinary
shares used in computing basic net
earnings per share................. 7,623 7,663 7,738 7,866 7,948
Weighted average number of Ordinary
shares used in computing diluted
net earnings per share............. 7,698 7,750 7,925 8,069 8,029
Cash dividend per share............ $ 0.10 $ 0.10 $ 0.13 $ - $0.05
====== ====== ======== ======= =====
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Our board of directors declared stock dividend distributions of 3% in
May 2002 and 2003. All net earnings per share data in the above table have been
retroactively adjusted to reflect the stock dividends.
As of December 31,
----------------------------------------------------
1999 2000 2001 2002 2003
-------- ------- ------- -------- --------
(in thousands)
Consolidated Balance Sheet Data:
Cash and cash equivalents.......... $ 1,963 $ 3,579 $ 2,738 $ 2,519 $ 4,389
Short and long-term bank deposits.. 10,596 11,213 11,849 12,357 12,051
Working capital.................... 15,520 20,288 18,391 15,688 21,401
Total assets....................... 43,178 48,867 53,347 59,741 71,443
Short-term bank credit (including
current maturities of long-term
loans)............................. 7,199 2,765 6,264 10,357 16,438
Long-term loans.................... 193 6,302 5,038 4,698 1,873
Total shareholders' equity......... 28,874 30,899 32,700 35,031 38,984
B. Capitalization and Indebtedness.
Not applicable
C. Reasons for the Offer and Use of Proceeds.
Not applicable.
D. Risk Factors.
Our business, results of operations and financial condition could be
seriously harmed due to any of the following risks, among others. If we do not
successfully address the risks to which we are subject, our business, results of
operations and financial condition may be materially and adversely affected and
our share price may decline.
Risks Related to our Business
Our revenues are dependent on government procurement procedures and practices. A
substantial decrease in our customers' budgets would adversely affect our
results of operations.
Our products are primarily sold to government agencies, government
authorities and government-owned companies, many of which have complex and
time-consuming procurement procedures. A substantial period of time often
elapses from the time we begin marketing a product until we actually sell that
product to a particular customer. In addition, our sales to government agencies,
authorities and companies are directly affected by these customers' budgetary
constraints and the priority given in their budgets to the procurement of our
products. A substantial decrease in our governmental customers' budgets would
adversely affect our results of operations.
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Because we receive large orders from a relatively small number of customers, our
revenues and operating results are subject to substantial periodic variations.
Our revenues and operating results for a specific quarter may not be indicative
of our future performance, making it difficult for investors to evaluate our
future prospects based on the results of any one quarter.
Due to the nature of our customers and products, we receive relatively
large orders for our products from a relatively small number of customers.
Consequently, individual orders from individual customers can represent a
substantial portion of our revenues in any one period and significant orders by
any customer during one period may not be followed by further orders from the
same customer in subsequent periods. In addition, we have a limited order
backlog, which makes revenues in any quarter substantially dependent upon orders
we deliver in that quarter. Our revenues and operating results are subject to
very substantial variations. Because our quarterly performance is likely to vary
significantly, the results of our operations for any quarter are not necessarily
indicative of the results that we might achieve for any subsequent period.
Consequently, quarter-to-quarter comparisons of our operating results may not be
meaningful.
The loss of one or more of our key customers would result in a loss of a
significant amount of our revenues.
Relatively few customers account for a large percentage of our revenues.
For the years ended December 31, 2001, 2002 and 2003, revenues generated from
sales to the Israeli Ministry of Defense, or MOD, and the Israeli Defense
Forces, or IDF, together accounted for 22.5%, 15.9% and 27.2%, respectively, of
our revenues. For the years ended December 31, 2001, 2002 and 2003 revenues
generated from sales to the State concern civil aviation airlines, or Azal,
Azerbaijan airlines, accounted for 10.5%, 1.8% and 0.2% respectively of our
revenues. We cannot assure you that the MOD, IDF, Azal 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.
In 2001, we established Smart Interactive Systems, Inc. to meet the growing need
for real-time video monitoring services. No assurance can be given that this
company will be successful in the future. If this company is unsuccessful, our
future results of operations may be adversely affected.
In 2001, we established Smart Interactive Systems, Inc., or Smart, to
meet the growing demand for real-time video monitoring services for use in
industrial sites, commercial businesses and VIP residences. We have invested
$6.4 million in Smart through December 31, 2003. Its operations to date have not
been profitable and it has an accumulated deficit of $4.1 million as of December
31, 2003. Smart's success will be dependent upon its ability to penetrate the
market for these services and upon customers' acceptance of these services. If
Smart is unable to market its services or if its services are not accepted by
customers, we may lose our investment in this company and our future results of
operations may be adversely affected.
If we do not receive the government approvals necessary for us to export the
products we produce in Israel, our revenues may decrease.
Under Israeli law, the export of products that we manufacture in Israel
and the export of certain of our know-how are subject to approval by the MOD. We
must obtain permits from the MOD to initiate sales proposals with regard to
these exports, as well as for actual export transactions. We
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cannot assure you that we will receive all the required permits for which we may
apply in the future. If we do not receive the required permits for which we
apply, our revenues may decrease.
The market for our products is characterized by changing technology,
requirements, standards and products, and we may be adversely affected if we do
not respond promptly and effectively to these changes.
The market for our products is characterized by evolving technologies,
changing industry standards, changing regulatory environments, frequent new
product introductions and rapid changes in customer requirements. The
introduction of products embodying new technologies and the emergence of new
industry standards and practices can render existing products obsolete and
unmarketable. Our future success will depend on our ability to enhance our
existing products and to develop and introduce, on a timely and cost-effective
basis, new products and product features that keep pace with technological
developments and emerging industry standards and address the increasingly
sophisticated needs of our customers. We cannot assure you that:
o we will be successful in developing and marketing new products or
product features that respond to technological change or evolving
industry standards;
o we will not experience difficulties that could delay or prevent the
successful development, introduction and marketing of these new
products and features; or
o our new products and product features will adequately meet the
requirements of the marketplace and achieve market acceptance.
We face risks associated with doing business in international markets.
We make a large portion of our sales in markets outside of Israel and a
key component of our strategy is to continue to expand in such markets, the most
significant of which currently are North America, Europe, and Asia. Our
international sales efforts are affected by costs associated with the shipping
of our products and risks inherent in doing business in international markets,
including:
o unexpected changes in regulatory requirements;
o currency fluctuations;
o export restrictions, tariffs and other trade barriers;
o difficulties in staffing and managing foreign operations;
o longer payment cycles;
o difficulties in collecting accounts receivable;
o political instability; and
o seasonal reductions in business activities.
One or more of such factors may have a material adverse effect on us.
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We are engaged in a highly competitive business. If we are unable to compete
effectively, our revenues will be materially and adversely affected.
The business in which we are engaged is highly competitive. Some of our
competitors and potential competitors have greater research and development,
financial and personnel resources, including governmental support, or more
extensive business experience than we do. If we are unable to compete
effectively in the market for our products, our revenues will be materially and
adversely affected.
We may not be able to implement our growth strategy.
As part of our growth strategy, we seek to acquire or invest in
complementary, including competitive, businesses, products and technologies.
Although we have identified potential acquisition candidates, we currently have
no commitments or agreements with respect to any such acquisitions or
investments and we cannot assure you that we will eventually be able to
consummate any acquisition or investment. Even if we do acquire or invest in
these businesses, products or technology, the process of integrating acquired
assets into our operations may result in unforeseen operating difficulties and
expenditures and may absorb significant management attention that would
otherwise be available for the ongoing development of our business. In addition,
we have limited experience in performing acquisitions and managing growth. We
cannot assure you that the anticipated benefits of any acquisition will be
realized. In addition, future acquisitions by us could result in potentially
dilutive issuances of our equity securities, the incurrence of debt and
contingent liabilities and amortization expenses related to goodwill and other
intangible assets, any of which could materially adversely affect our operating
results and financial position. Acquisitions also involve other risks, including
risks inherent in entering markets in which we have no or limited prior
experience and the potential loss of key employees and the risk that we may
experience difficulty or delays in obtaining necessary permits. In addition, as
part of our growth strategy, we developed three new products, DreamBox, Fortis
and the Pipeline Security System. We intend to invest extensive funds in the
marketing and sales of those products. We cannot assure you that our marketing
and sale efforts will be successful, in which case our growth strategy will be
harmed.
We may not be able to protect our proprietary technology and unauthorized use of
our proprietary technology by third parties may impair our ability to compete
effectively.
Our success and ability to compete depend in large part upon protecting
our proprietary technology. We have 45 patents and have patent applications
pending. We also rely on a combination of trade secret and copyright law and
confidentiality, non-disclosure and assignment-of-inventions agreements to
protect our proprietary technology. It is our policy to protect our proprietary
rights in our products and operations through contractual obligations, including
confidentiality and non-disclosure agreements with certain employees and
distributors. These measures may not be adequate to protect our technology from
third-party infringement, and our competitors may independently develop
technologies that are substantially equivalent or superior to ours.
Additionally, our products may be sold in foreign countries that provide less
protection to intellectual property than that provided under U.S. or Israeli
laws.
We could become subject to litigation regarding intellectual property rights,
which could seriously harm our business.
Third parties may in the future assert against us infringement claims or
claims that we have violated a patent or infringed upon a copyright, trademark
or other proprietary right belonging to them.
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In addition, we purchase components for our turnkey products from independent
suppliers. Certain of these components contain proprietary intellectual property
of these independent suppliers. Third parties may in the future assert claims
against our suppliers that such suppliers have violated a patent or infringed
upon a copyright, trademark or other proprietary right belonging to them. If
such infringement by our suppliers or us were found to exist, a party could seek
an injunction preventing the use of their intellectual property. In addition, if
an infringement by us were found to exist, we may attempt to acquire a license
or right to use such technology or intellectual property. Any infringement
claim, even if not meritorious, could result in the expenditure of significant
financial and managerial resources.
We depend on limited sources for components and if we are unable to obtain these
components when needed, we will experience delays in manufacturing our products
and our financial results may be adversely affected.
We acquire most of the components utilized in our products, including,
but not limited to, our turnkey products and certain services from a limited
number of suppliers and subcontractors. We cannot assure you that we will
continue to be able to obtain such items from these suppliers on satisfactory
terms. Temporary disruptions of our manufacturing operations would result if we
were required to obtain materials from alternative sources, which may have an
adverse effect on our financial results. For example, our subsidiary
Senstar-Stellar Corporation, or Senstar, obtains triboelectric sensor cable for
its Intelli-FLEX product from a sole supplier. If this sole supplier were to
discontinue production of the triboelectric sensor cable, it would adversely
affect Senstar's revenues of its Intelli-FLEX product.
Undetected defects in our products may increase our costs and impair the market
acceptance of our products.
The development, enhancement and implementation of our complex systems
entail substantial risks of product defects or failures. We cannot assure you
that, despite testing by us and our customers, errors will not be found in
existing or new products, resulting in delay or loss of revenues, warranty
expense, loss of market share or failure to achieve market acceptance, or
otherwise adversely affecting our business, financial condition and results of
operations. Moreover, the complexities involved in implementing our systems
entail additional risks of performance failures. We cannot assure you that we
will not encounter substantial delays or other difficulties due to such
complexities. Any such occurrence could have a material adverse effect upon our
business, financial condition and results of operations. In addition, the
potential harm to our reputation that may result from product defects or
implementation errors could be damaging to us.
We are dependent on our senior management and key personnel, particularly Jacob
Even-Ezra, our chairman and chief executive officer, and Izhar Dekel, our
president, the loss of whom would negatively affect our business.
Our future success depends in large part on the continued services of
our senior management and key personnel. In particular, we are dependent on the
services of Jacob Even-Ezra, our chairman and chief executive officer, and Izhar
Dekel, our president. We carry key person life insurance for Jacob Even-Ezra and
for Izhar Dekel. Any loss of the services of Jacob Even-Ezra, Izhar Dekel, other
members of senior management or other key personnel would negatively affect our
business.
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Our failure to retain and attract personnel could harm our business, operations
and product development efforts.
Our products require sophisticated research and development, marketing
and sales and technical customer support. Our success depends on our ability to
attract, train and retain qualified research and development, marketing and
sales and technical customer support personnel. Competition for personnel in all
of these areas is intense and we may not be able to hire sufficient personnel to
achieve our goals or support the anticipated growth in our business. If we fail
to attract and retain qualified personnel, our business, operations and product
development efforts would suffer.
Our non-competition agreements with our key employees may not be enforceable. If
any of these employees leaves us and joins a competitor, our competitor could
benefit from the expertise that our former employee gained while working for us.
We currently have non-competition agreements with all of our key
employees in Israel. These agreements prohibit these key employees from directly
competing with us or working with our competitors in the event such key
employees cease to work for us. Under current U.S. and Israeli law, we may not
be able to enforce these non-competition agreements. If we are unable to enforce
any of these agreements, our competitors that employ these former employees
could benefit from the expertise these former employees gained while working for
us. In addition, we do not have non-competition agreements with our U.S.
employees.
Volatility of the market price of our ordinary shares could adversely affect our
shareholders and us.
The market price of our ordinary shares has been, and is likely to be,
highly volatile and could be subject to wide fluctuations in response to
numerous factors, including the following:
o political, economic and other developments in the State of Israel;
o terrorist attacks and other acts of war, and any response to them;
o actual or anticipated variations in our quarterly operating results or
those of our competitors;
o announcements by us or our competitors of technological innovations or
new and enhanced products;
o developments or disputes concerning proprietary rights;
o introduction and adoption of new industry standards;
o changes in financial estimates by securities analysts;
o market conditions or trends in our industry;
o changes in the market valuations of our competitors;
o announcements by us or our competitors of significant acquisitions;
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o entry into strategic partnerships or joint ventures by us or our
competitors; and
o additions or departures of key personnel.
In addition, the stock market in general, and the market for Israeli
companies and home defense companies in particular, has been highly volatile.
Many of these factors are beyond our control and may materially adversely affect
the market price of our ordinary shares, regardless of our performance.
Risk Relating to Our Location in Israel
Conducting business in Israel entails special risks.
We are incorporated under Israeli law and our principal offices and
manufacturing and research and development facilities are located in the State
of Israel. Accordingly, we are directly influenced by the political, economic
and military conditions affecting Israel. Specifically, we could be adversely
affected by any major hostilities involving Israel, a full or partial
mobilization of the reserve forces of the Israeli army, the interruption or
curtailment of trade between Israel and its present trading partners, and a
significant downturn in the economic or financial condition of Israel.
Since the establishment of the State of Israel in 1948, a number of
armed conflicts have taken place between Israel and its Arab neighbors, and a
state of hostility, varying from time to time in intensity and degree, has led
to security and economic problems for Israel. Since September 2000, there has
been a marked increase in violence, civil unrest and hostility, including armed
clashes, between the State of Israel and the Palestinians, and acts of terror
have been committed inside Israel and against Israeli targets in the West Bank
and Gaza. There is no indication as to how long the current hostilities will
last or whether there will be any further escalation. Any further escalation in
these hostilities or any future armed conflict, political instability or
violence in the region may have a negative effect on our business condition,
harm our results of operations and adversely affect our share price.
Furthermore, there are a number of countries that restrict business with Israel
or Israeli companies. Restrictive laws or policies of those countries directed
towards Israel or Israeli businesses may have an adverse impact on our
operations, our financial results or the expansion of our business.
Our results of operations may be negatively affected by the obligation of our
personnel to perform military service.
Many of our executive officers and employees in Israel are obligated to
perform at least 30 days and up to 40 days, depending on rank and position, of
military reserve duty annually and are subject to being called for active duty
under emergency circumstances. There are proposals to increase this annual
commitment. If a military conflict or war arises, these individuals could be
required to serve in the military for extended periods of time. Our operations
could be disrupted by the absence for a significant period of one or more of our
executive officers or key employees or a significant number of other employees
due to military service. Any disruption in our operations could adversely affect
our business.
The economic conditions in Israel have not been stable in recent years.
In recent years Israel has been going through a period of recession in
economic activity, resulting in low growth rates and growing unemployment. Our
operations could be adversely affected if the economic conditions in Israel
continue to deteriorate. In addition, due to significant economic
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measures proposed by the Israeli Government, there have been several general
strikes and work stoppages in 2003 and 2004, affecting all banks, airports and
ports. These strikes have had an adverse effect on the Israeli economy and on
business, including our ability to deliver products to our customers. Following
the passing by the Israeli Parliament of laws to implement the economic
measures, the Israeli trade unions have threatened further strikes or
work-stoppages, and these may have a material adverse effect on the Israeli
economy and on us.
We may be adversely affected if the rate of inflation in Israel exceeds the rate
of devaluation of the New Israeli Shekel against the dollar.
A portion of our expenses, primarily labor expenses, is incurred in NIS.
As a result, we are exposed to the risk that the rate of inflation in Israel
will exceed the rate of devaluation of the NIS in relation to the dollar or that
the timing of this devaluation will lag behind inflation in Israel. In 2001 and
2002, the inflation rate in Israel exceeded the rate of devaluation of the NIS
against the dollar. In 2003 the rate of inflation was negative and the NIS was
revaluated vis-a-vis the dollar. Since the beginning of 2004, the NIS has
devaluated approximately 2.8% against the dollar. In addition, since part of our
revenues are quoted in NIS, and a portion of our expenses are incurred in NIS,
our results may be adversely affected by a change in the rate of inflation in
Israel if the amount of our revenues in NIS decreases and is less than the
amount of our expenses in NIS (or if such decrease is offset on a lagging basis)
or if such change in the rate of inflation is not offset, or is offset on a
lagging basis, by a corresponding devaluation of the NIS against the dollar and
other foreign currencies.
If the rate of inflation in Israel exceeds the rate of devaluation of
the NIS in relation to the dollar or the timing of this devaluation lags behind
inflation in Israel our expenses in NIS in relation to the dollar will increase
and our operating results may be adversely affected.
We currently benefit from government programs and tax benefits that may be
discontinued or reduced.
We currently receive grants and tax benefits under Government of Israel
programs. In order to maintain our eligibility for these programs and benefits,
we must continue to meet specified conditions, including, but not limited to,
making specified investments in fixed assets and paying royalties with respect
to grants received. In addition, some of these programs restrict our ability to
manufacture particular products or transfer particular technology outside of
Israel. If we fail to comply with these conditions in the future, the benefits
we receive could be canceled and we could be required to refund any payments
previously received under these programs or pay increased taxes or royalties.
The Government of Israel has reduced the benefits available under these programs
in recent years and these programs and benefits may be discontinued or curtailed
in the future. If the Government of Israel ends these programs and benefits, our
business, financial condition, results of operations and net income could be
materially adversely affected.
The tax benefits that we currently receive from our approved enterprise programs
require us to satisfy specified conditions. If we fail to satisfy these
conditions, we may be required to pay additional taxes and would likely be
denied these benefits in the future.
The Investment Center of the Ministry of Industry, Trade and Labor of
the State of Israel has granted approved enterprise status to certain of our
manufacturing facilities. Starting from when we begin to generate net income
from these approved enterprise programs, any portion of our income derived from
these approved enterprise programs will be exempt from tax for a period of two
to four
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years and will be subject to a reduced tax for an additional five to eight
years, depending on the percentage of our share capital held by non-Israeli
citizens. The benefits available to our approved enterprise programs are
dependent upon the fulfillment of conditions stipulated in applicable law and in
each program's certificate of approval. If we fail to comply with these
conditions, in whole or in part, we may be required to pay additional taxes for
the period in which we benefited from the tax exemption or reduced tax rates and
would likely be denied these benefits in the future.
Provisions of Israeli law may delay, prevent or make difficult an acquisition of
us, which could prevent a change of control and therefore depress the price of
our shares.
Provisions of Israeli corporate and tax law may have the effect of delaying,
preventing or making more difficult a merger with, or other acquisition of, us.
This could cause our ordinary shares to trade at prices below the price for
which third parties might be willing to pay to gain control of us. Third parties
who are otherwise willing to pay a premium over prevailing market prices to gain
control of us may be unable or unwilling to do so because of these provisions of
Israeli law.
Your rights and responsibilities as a shareholder will be governed by Israeli
law and differ in some respects from the rights and responsibilities of
shareholders under U.S. law.
We are incorporated under Israeli law. The rights and responsibilities of
holders of our ordinary shares are governed by our memorandum of association,
our articles of association and by Israeli law. These rights and
responsibilities differ in some respects from the rights and responsibilities of
shareholders in typical U.S. corporations. In particular, a shareholder of an
Israeli company has a duty to act in good faith toward the company and other
shareholders and to refrain from abusing his power in the company, including,
among other things, in voting at the general meeting of shareholders on certain
matters.
ITEM 4. Information on the Company
A. History and Development of the Company.
We were incorporated under the laws of the State of Israel on March 27,
1984 under the name Magal Security Systems Ltd. We are a public limited
liability company under the Israeli Companies Law, 5739-1999 and operate under
this law and associated legislation. Our principal executive offices and primary
manufacturing and research and development facilities are located near Tel Aviv,
Israel, in the Yahud Industrial Zone. Our mailing address is P.O. Box 70,
Industrial Zone, Yahud 56100, Israel and our telephone number is 972-3-539-1444.
Our agent for service of process in the U.S. is Senstar-Stellar Inc., 43184
Osgood Road, Fremont, CA, 94539. Our address on the Internet is
www.magal-ssl.com. The information on our website is not incorporated by
reference into this annual report.
We develop, manufacture, market and sell complex computerized security
systems, including a line of perimeter security systems, a video motion
detection system, a hardware and software "all in one" security solution which
integrates Closed Circuit Television, or CCTV, related applications, security
management and control systems, personal emergency location systems, a pipeline
security system and we also provide video monitoring services.
For a discussion of our capital expenditures and divestitures, see Item
5.B. "Operating and Financial Review and Prospects-Liquidity and Capital
Resources."
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B. Business Overview.
General
We develop, manufacture, market and sell complex computerized security
systems, including:
o a line of perimeter security systems and a video motion detection
system, which automatically detect and locate intruders and identify
the nature of intrusions
o the DreamBox, which integrates number of CCTV related applications
into one box;
o security management and control systems that integrate the management,
control and display of various security systems into a single,
real-time database and support real-time decision making and wide area
command and control;
o PipeGuard, a pipeline security system; and
o personal emergency location systems.
We also provide video monitoring services.
Our systems are used in more than 75 countries to protect aircraft,
national borders and sensitive facilities, including military bases, power plant
installations, airports, postal facilities, prisons and industrial locations,
from terrorism, theft and other security threats.
Industry Background
Perimeter Security and Video Motion Detection Systems
Perimeter security systems enable customers to monitor, limit and
control access by unauthorized personnel to specific regions or areas. High-end
perimeter systems are sophisticated in nature and are used by correctional
facilities, military installations, power companies and other high-security
installations. We believe that we are a leading provider of security systems and
maintenance in this industry.
DreamBox
The DreamBox is an embedded hardware and software product which
integrates a number of CCTV related applications into one box. The system is
designed to be economical, as well as compact to save space, by avoiding the use
of a complicated cable installation and network protocols integration.
DreamBox contains twelve different applications, including a digital
video and audio recording, video and audio matrix switcher, outdoor and indoor
video motion detection system, or VMD, security management system, or SMS, and a
transmission system.
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The DreamBox, is sold at a substantially lower price than the cost of
the other products applications if sold separately, a factor which positions
DreamBox as the leading security solution for all strategic facilities. Its
target markets include governmental, institutional and other sensitive
facilities, such as airports, train stations, seaports, prisons, casinos and
hospitals, all of which require the use of high quality CCTV applications.
Security Management and Control Systems
The deployment of multiple security systems creates the need for a
system that can manage and control these systems through a single database. In
response to this need, we offer MagNet and Fortis, security management and
control systems that integrate the management, control and display of various
security systems, both outdoor, such as perimeter security systems, and indoor,
such as fire detection, entry monitoring and alarm systems, into a single,
real-time database, and support real-time decision making and wide area command
and control. These systems were developed to improve the response to real-time
security events by sharing video and geographical information between the
control center and security personnel acting in the field.
Pipeline Security System
As of end of year 2002, there were an estimated three million miles of
unprotected oil and gas pipelines worldwide. Although the need for securing
these pipelines has been strongly recognized by the oil and gas industry for
years, and in spite of increasing threats since the 9/11 events and current
instability in Iraq and elsewhere in the Middle-East, there was no effective
solution for securing buried pipes against damage caused by terror, sabotage,
theft or other third party threats. We have identified the demand and have
implemented a technology aimed at meeting this challenge. PipeGuard, our
pipeline security system, provides a solution for securing buried assets and
infrastructure, including oil and gas pipelines and buried communication lines
such as fiber optic cables.
Personal Emergency Location Systems
Our products deliver high reliability personal portable duress alarm
systems to protect personnel in correctional facilities. These products identify
individuals in distress and can pinpoint the location of the distress signal
with an indoor-to-outdoor and floor-to-floor accuracy unmatched by any other
product.
Video Monitoring Services
The rapid consolidation of some of the largest companies in the
electronic security services industry combined with their overall emphasis on
residential security has led to fewer providers of high quality, innovative
commercial electronic security services. We believe that the potential market
for commercial real-time video monitoring security services is large and that
within a few years most of the security systems used at industrial and
commercial sites will adopt video monitoring systems as the preferred method of
surveillance and protection. Consequently, in 2001, we established Smart to
provide commercial real-time video monitoring security services.
Business and Marketing Strategy
Our primary objective is to become a leading provider of security
systems worldwide. To achieve this objective, we have implemented a business
strategy incorporating the following key elements:
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Refine and Broaden Product Line. We have identified the security needs
of our customers and intend to enhance our current products and develop new
products to meet those needs. We intend to continue to focus on improving the
sensitivity, detection ability and reliability of our products. During 2003, we
invested 8% of our revenues in developing new products, expanding the
capabilities of existing products and making custom enhancements for specific
projects. Since the beginning of 2004 we have launched three new products that
significantly broaden the spectrum of security solutions we offer and
substantially expend our potential security markets.
Enter New Markets and Strengthen Presence in Existing Markets. In 2004
we intend to continue to penetrate new geographic markets by various means,
including the establishment of alliances with local distributors. We also intend
to increase our marketing efforts in our existing markets and to acquire or
invest in complementary, including competitive, businesses, products and
technologies.
Leverage Existing Customer Base; Cross-Market Products. We believe that
we have the capability to offer certain of our customers a comprehensive
security package. As part of our product development process, we seek to
maintain close relationships with our customers to identify market needs and to
define appropriate product specifications. We intend to expand the depth and
breadth of our existing customer relationships while initiating similar new
relationships. We believe that our three new products will substantially broaden
our potential markets.
Offer Comprehensive Turnkey Solutions. By broadening our product range
to include both indoor and outdoor security systems and by developing our
security management and control systems and Dreambox "all in one" CCTV security
solution, we now offer comprehensive turnkey security solutions that provide a
comprehensive security implementation process. This process entails:
o in-depth threat analysis;
o determination of the appropriate hardware and software solutions;
o training sessions for systems operators; and
o upon customer approval, integration of the required systems into our
security management and control systems.
We believe that the market for turnkey security solutions presents a
significant opportunity. We are emphasizing our ability to offer turnkey
solutions in keeping with our objective of becoming a leading provider of
comprehensive security solutions.
Products and Services
Perimeter Security Systems
Our line of perimeter security systems consists of the following:
o taut wire perimeter intrusion detection systems;
o vibration detection systems; and
o field disturbance sensors.
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Our line of perimeter security systems utilizes sophisticated sensor
devices to detect and locate intruders and identify the nature of intrusions.
Our perimeter security systems have been installed along thousands of kilometers
of borders and facility boundaries throughout the world, including more than 600
correctional institutions in the U.S. and correctional institutions in several
other countries. In addition, we have installed several hundred miles of high
security electronic perimeter systems along Israel's borders.
Taut Wire Perimeter Intrusion Detection Systems. Our taut wire systems
consist of wire strung at high tension between anchor posts. Sensor posts are
located at the middle between anchor posts. These sensor posts contain one or
more devices that detect changes in the tension being exerted on and by the taut
wires. Any force applied against these wires, or released from them, as by
cutting, unless within the parameters designed into the sensors themselves or
programmed into the central control units, automatically triggers an alarm. We
use taut wire perimeter systems as both an integral component of an intruder
detection system and as a physical barrier to infiltration.
Our sealed sensors are not affected by radio frequency interference,
climatic or atmospheric conditions, or electrical transients from power lines or
passing vehicles. The sensors self-adjust to, or remain unaffected by, extreme
temperature variations, minor soil movements and other similar environmental
changes that might trigger false alarms in less sophisticated systems. Our taut
wire perimeter systems are designed to discriminate automatically between fence
tension changes typically caused by small animals or violent weather and forces
more typically exerted by a human intruder.
Our taut wire perimeter systems offer customers a wide range of
installation options. Sensor posts can be as far as 200 feet apart, with
relatively inexpensive ordinary fence anchor posts between them. These systems
may stand alone, be mounted on a variety of fence posts or added to an existing
wall or other structure, or mounted on short posts, with or without outriggers.
Taut wire perimeter systems have been approved by various Israeli and
U.S. security and military authorities. We have installed several hundred
kilometers of these perimeter systems along Israel's borders to assist in
preventing unauthorized entry and infiltration. Our taut wire perimeter systems
are sold for approximately $50-$100 per meter.
Vibration Detection Systems. We offer two types of vibration detection
systems. While less sensitive than taut wire installations, the adaptability of
these systems to a wide range of pre-existing barrier structures makes these
products viable alternatives for cost-conscious customers. Our vibration
detection devices are most effective when installed on common metal fabric
perimeter systems, such as chain link or welded mesh. In our BARRICADE 500
system, pairs of electro-mechanical sensors are attached to fence panels three
meters apart on any of several common types of fence structures. Once attached
to the fence, each sensor detects vibrations in the underlying structures. The
sensor system's built-in electro-mechanical filtering combines with system input
from a weather sensor to minimize the rate of false alarms from wind, hail or
other sources of nuisance vibrations.
Intelli-FLEX and FPS microprocessor-based triboelectric and
piezoelectric cable fence sensors are vibration sensitive transducers. Both
systems detect any attempt to cut, climb or penetrate the fence and both have
microphonic properties. The microphonic feature permits audio to be used for
low-cost alarm assessment, providing users with an additional tool for
determining the nature of an attempted intrusion. Our vibration detection
systems are sold for between $11-$26 per meter.
Field Disturbance Sensors. We offer two types of field disturbance
sensors. The Intelli-Field volumetric electronic field disturbance sensor can be
installed outdoors on perimeter systems, buildings
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or as free-standing units. The Perimitrax buried volumetric field disturbance
sensor can be buried in most types of soil and paved areas and uses "leaky coax"
technology to detect attempted perimeter penetrations. Both systems detect
intrusions before the intruder touches the sensor. The Intelli-Field system
costs approximately $75-$180 per meter and the Perimitrax system is sold for
approximately $65-$100 per meter.
Video Motion Detection System
Our Video Motion Detection System, or DTS, utilizes advanced video image
processing technology to detect, locate and track intruders automatically. The
system, which was introduced in 1993, experiences fewer false alarms than most
competing products because it is able to distinguish automatically between human
and other forms of infiltration.
DTS is a detection and tracking system that combines our image
processing technology with input from ordinary video surveillance cameras to
detect, locate and track intruders without continuous human monitoring. Our DTS
image processing and graphics overlay cards and software, when installed in an
IBM-compatible personal computer, enable that computer to process video signals,
including signals from visible light, infrared and other camera types. Our image
processing software incorporates a learning cycle that permits the system to
analyze the protected area, including such variable features as changing weather
and lighting conditions, to reduce false alarms. A DTS user can program all the
parameters used to define an alarm condition, including, for example, intruder
speed, object size, threat direction and distance traveled. The user can also
designate specific areas within the camera's field of view to be protected. Each
camera in a multiple camera system can be monitored using different parameters.
Parameters can be switched manually, automatically or by external inputs, and
the cameras can be assigned relative priorities for computer monitoring. These
features enable the DTS to identify an intruder and then track the intruder in
real-time on screen and emit an alarm without the need for continuous human
monitoring. Since 1993, we have continued to improve our DTS system to make it
more user-friendly and to meet other customer expectations.
When a DTS detects an intruder, the control computer automatically
generates an alarm and records the first visual frame of the alarm event on its
hard disk. The system's video monitor will then display the intruder's track
across the camera's field of view. The intruder's track can also be recorded on
an optional computer-controlled videocassette recorder or DVR. Each DTS
integrated circuit board can monitor up to four cameras, so that by using eight
empty card slots, a single computer can be equipped to monitor up to thirty-two
cameras. The DTS system is sold for approximately $10,000 for the first card and
tracking graphics overlay card and $8,000 each for up to seven additional system
cards. Elta Electronics Industries Ltd., a subsidiary of IAI, developed the DTS
for us.
The DreamBox
The DreamBox is an embedded hardware and software product which
integrates a number of CCTV related applications into one box. The system is
designed to be economical, as well as compact to save space, by avoiding the use
of a complicated cable installation and network protocols integration.
DreamBox contains twelve different applications, including a digital
video and audio recording, video and audio matrix switcher, outdoor and indoor
VMD, SMS, and a transmission system.
The DreamBox is sold at a substantially lower price than the cost of the
other products applications if sold separately, a factor which positions
DreamBox as the leading security solution for
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all strategic facilities. Its target markets include governmental, institutional
and other sensitive facilities, such as airports, train stations, seaports,
prisons, casinos and hospitals, all of which require the use of high quality
CCTV applications.
By developing this product, we enter a new area of activity. We refer to
the DreamBox's target market as an `add-on' market for us, and believe that this
product is substantially broadening our target markets. As an example, we enter
the field of digital video recording, which is only one of the DreamBox's
applications out of many.
Security Management System
MagNet, our security management system, integrates the management,
control and display of various security systems into a single, real-time
database. MagNet, which is based on computer communications and controlled by a
unique server developed by us, converts real-time data received from field
units, analyzes that data and transmits operational commands accordingly. It
also generates alarms to indicate problems with any connected security system
and provides explanations as to the causes of the alarms. MagNet displays video
pictures of the alarm source, using an advanced video matrix with a
user-friendly interface. The operational commands transmitted by MagNet are
routed back to the field units or to operator workstations which then convert
these commands to visual information and allow the system operator to respond
and influence the system's operation.
MagNet integrates various detection technologies, including infrared and
microwave, and enables multiple operators to simultaneously control the system.
It can serve and manage multiple security systems, sensors, detectors and
controllers, and is unaffected by the distance between the various system
components under its control. MagNet can integrate and control both outdoor
security systems and indoor security systems, and its open architecture enables
operation with systems manufactured by other manufacturers as well as those
manufactured by us. Data can be entered into the MagNet system from anywhere in
the world through the Internet, provided appropriate authorization exists. In
addition, MagNet's TCP/IP protocol and Ethernet boards, using the Windows NT
operating system, allow the system to use a wide range of communications media,
such as telephone lines, fiber optics and wireless communication. MagNet
operates with, and can provide solutions for, various types of security
configurations, as well as adaptations for additional and new security systems.
We continued to make major improvements to MagNet In 2003.
Integrated Command and Control System
Fortis, our fully Integrated Command and Control System, supports
real-time decision making and wide-area command and control. Fortis reduces the
period of time from intruder detection to intruder engagement, to a minimum.
Fortis was developed to improve the response to real-time security events, by
sharing video and geographical information between the control center and
security personnel acting in the field.
The system creates a unified and interactive intelligence picture -
drawing data from all sensors, while displaying the movement of security
personnel in the field and adding other relevant information, such as video from
various sources, auxiliary services and weather conditions. This combined
picture, which is continuously updated, is sent by the central command to all
security personnel in the command chain, and serves as a unified basis for
operational planning and allocation of tasks. Using advanced technology, Fortis
provides the security officer with a graphical command tool, which updates the
location details and video view of the alerting area, while simultaneously
enabling a constant watch over security personnel movements, thus optimizing the
operational response.
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Fortis's target markets include governmental, institutional and large
sensitive facilities, such as borders, airports, hospitals, power plants and
water sources, as well as large manufacturing facilities requiring real-time
control and protection.
Pipeline Security System
PipeGuard, our pipeline security system, provides a solution for
securing buried assets, gas and oil pipelines and infrastructure of buried
communication lines such as fiber optic cables.
PipeGuard utilizes an innovative and unique technology to guard buried
pipelines, regardless of pipeline length, with the ability to detect potential
attack and alert authorities before potential harm or damage occurs. Its target
market includes oil and gas companies, owners and operators of pipelines or
communication cables and governmental agencies dealing with security and
environment.
PipeGuard combines well proven sensors - geophones, with advanced edge
of technology recognition algorithm capabilities based on the analysis of
seismic signals, thus effectively filtering out false alarms. Using state of the
art communications, only predefined signals are transmitted to the control
station.
PipeGuard is suitable for all pipes or cables, from existing and
operational pipelines, to new pipelines under construction. The system can
easily be integrated into a full turnkey security solution, including perimeter
protection, ground or air patrol and others. By answering the challenge of
securing pipelines, we offer a total security solution for the oil and gas
industry - from the oil field to the refineries.
Personal Emergency Location Systems
Flash Personal Emergency Alarm Systems, or Flash, and Flare Personal
Emergency Locating Systems, or Flare, use radio frequency technology to provide
a one touch emergency system that is so small it can be worn on a belt. The
systems, sold mainly to correctional facilities, consist of transmitters that
send distress signals to receivers mounted throughout the building. Receivers
relay the signal to a central location indicating someone requires assistance
and their location in the building. The systems employ automated testing
procedures that help to reduce maintenance costs. The hardware and software was
developed and researched in the U.S. and competes against infrared and
ultrasonic technologies.
Our personal alarm system, or PAS, uses ultrasonic based emergency
notification and communication system. The system, sold mainly to correctional
facilities, allows individuals moving throughout a facility to quickly indicate
their exact location in a crisis situation through a transmitter that is carried
by them.
Video Monitoring Services
Smart provides remote video verification services and remote video
surveillance services. Smart verification systems are activated by an event,
such as an illegal entry or tampering with property. Within seconds of an event
being triggered by an intrusion, Smart systems automatically store the video
images which are then sent to a central control room. The use of audio response
to an event allows the control room operator to effectively stop a developing
incident by broadcasting a warning message directed at the intruder. In
addition, the control room operator can replay video images captured before and
after the event to verify a criminal intrusion. Smart operators are then able
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to respond to the intrusion quickly and effectively by summoning police
assistance or an entity's appropriate internal security response team. Smart
central monitoring station is able to provide instantaneous security responses
across the U.S.
Marketing, Sales and Distribution
We have marketed our products primarily to government agencies,
government authorities and government-owned companies. However, the activities
of certain of these government bodies, are increasingly being privatized in
jurisdictions throughout the world. We believe that our reputation as a vendor
of high-security products in one of the world's most security-conscious
countries often provides us and our sales representatives with direct access to
senior government and corporate officials in charge of security matters
elsewhere. In recent years, we began investing resources in the distribution of
perimeter intrusion detection systems to private corporations. We attempt to
initiate contact with potential customers at trade shows, where we demonstrate
our products and distribute promotional materials. After initial discussions, we
generally seek to provide potential customers with products on a trial basis or
in a small-scale installation. We believe that this affords prospective
purchasers an opportunity to assess our products over a sustained period of time
under realistic conditions. We have sales offices located in the United Kingdom,
Germany, Mexico, the U.S. and China.
Perimeter Intrusion Detection Systems. We generally sell our perimeter
intrusion detection systems to exclusive distributors for various geographic
territories or for specific projects. These exclusive distributors then resell
these products at prices negotiated with their respective customers. In some
cases, however, we pay commissions on these third-party sales either to the
distributor or to the sales representatives responsible for facilitating the
transaction. In addition to marketing activities, some of our distributors also
provide installation and maintenance services for our products. We currently
have over 50 distributors who resell these systems. We occasionally use agents
to find suitable distributors and pay finders' fees to these agents for their
services.
Since 1988 until March 31, 2004, an unaffiliated third party held the
exclusive right to distribute our taut wire detection systems in the U.S. and
Canada. Since March 31, 2004 we distribute our taut wire detection systems in
the U.S. through our subsidiary Perimeter Products Inc., or PPI, and an
unaffiliated third party who was granted a non-exclusive right to distribute our
taut wire detection systems in the U.S., and in Canada through our subsidiary
Senstar.
DTS. Since 1993, we have continued to improve our DTS system to make it
more user-friendly and to meet other customer expectations. Our marketing
efforts for our DTS system includes participation in exhibitions in Europe,
South America and the Far East. In the U.S., we distributed the DTS system
through an unaffiliated exclusive distributor who was subject to minimum
purchase requirements. This distribution agreement was terminated on March 31,
2004. Since March 31, 2004 we distribute our DTS systems in the U.S. and Canada
through our subsidiaries PPI and Senstar, respectively.
Security Management and Control Systems DreamBox and Turnkey Projects.
Our marketing efforts for our Security Management and Control Systems, DreamBox
and turnkey projects consists of direct contact with potential customers. We
offer the MagNet, the Fortis and the DreamBox primarily as part of comprehensive
turnkey project solutions or, at the customer's preference, as stand-alone
products.
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Pipeline Security System. The target market for the pipeline security
system includes oil and gas companies, owners and operators of pipelines or
communication cables and governmental agencies engaged with security and
environment issues.
Personal Emergency Location Systems. Our marketing efforts for the
personal emergency location systems consist of direct contact with potential
customers, mainly to correctional facilities in North America.
Video Monitoring Services. Smart offers its services mainly to
industrial sites, commercial businesses, educational facilities and VIP
residences. Smart sells its services through its direct sales force.
The following table shows the breakdown of our consolidated revenues for
the calendar years 2001, 2002 and 2003 by operating segment:
Our operating results are characterized by a seasonal pattern, with a
higher volume of revenues towards the end 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, revenues 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.
21
Customers
The following table shows the geographical breakdown of our consolidated
revenues for the calendar years 2001, 2002 and 2003:
For the years ended December 31, 2001, 2002 and 2003, revenues generated
from sales to the MOD and the IDF accounted for 22.5%, 15.9% and 27.2%,
respectively, of our revenues. For the years ended December 31, 2001, 2002 and
2003 revenues generated from sales to Azal accounted for 10.5%, 1.8% and 0.2%,
respectively, of our revenues. We cannot assure you that the MOD, IDF, Azal or
any of our other major customers will maintain their volume of business with us
or that, if such volume is reduced, other customers generate similar revenues
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.
Perimeter Security Systems. We have installed high-security taut wire
electronic perimeter systems over several hundred kilometers of Israel's borders
and have sold a number of our high-security perimeter systems to protect other
locations in Israel, including Ben-Gurion International Airport, facilities of
IAI and the Israel Electric Company, the Knesset, industrial plants, prisons and
military bases. Outside Israel, our high-security perimeter systems have been
purchased to protect various sites, including military installations,
refineries, conventional and nuclear power stations, oil tank farms, industrial
facilities, storage areas and warehouses, royal palaces and presidential
residences in various European countries, North America, and in South America
and the Far East.
Currently, airport security activities concentrate almost exclusively on
screening passengers and luggage within the airport terminal in connection with
passenger check-in. We are aware of only a few airports in the world which
currently have high-security perimeter protection systems to prevent
infiltrators from reaching the airport's tarmac from outside. Most of these
airports utilize a system manufactured by us. In marketing our high-security
perimeter systems, we target authorities responsible for airport security. To
date, we have sold and installed a limited amount of perimeter systems at
certain airports in Israel, Europe, the U.S. and the Far East. We are continuing
to negotiate with authorities in several other countries to install our
perimeter systems around airports. However, we cannot assure you that any
revenues will result from these negotiations.
Our high-security perimeter systems offer prison authorities the
opportunity to address an escape attempt in real-time, rather than at the next
roll-call, which may be several hours after the
22
escape. Our high-security perimeter systems have already been installed in
prisons in Australia, Europe, Israel, North America and the Far East.
Ten of our perimeter intrusion detection systems have been approved by
the U.S. Department of the Air Force, as part of the $498 million Force
Protection Integrated Base Defense Security System (IBDSS) program. The IBDSS
program includes intrusion detection systems designed to prevent unauthorized
entry or access to large, medium and small military facilities. The IBDSS
program to protect classified facilities was initiated in October 2003 and is
scheduled for completion in September 2008. Our products have been approved by
the U.S. Department of the Air Force for use in the various tested applications
and configurations, and they will be supplied to the U.S. Department of the Air
Force through the major U.S. integrators.
The IDF has tested our perimeter security products along with those of
several of our competitors and our system and two competitor's systems were the
only systems to be approved for participation in the MOD's bid for perimeter
security systems. In April and May 2000, the MOD ordered approximately $9
million of new perimeter security systems from us. We delivered most of these
orders during 2000. In March 2001, we won a $2 million MOD bid to install a new
perimeter security system along Israel's borders. In September 2001, we won a
$1.4 million MOD bid to perform restoration work along the Gaza Strip border and
a $500,000 MOD bid to protect the MOD's headquarters. In July 2002, we received
a $1.5 million order from the MOD to install additional perimeter intrusion
detection systems along the Gaza Strip border.
In September 2002, we won 80% of the MOD bids for the installation of
intrusion detection systems along the seam line between Israel and the West
Bank. The MOD bids were for approximately 125 kilometers, or only one third of
the total project. We have won bids having a value of approximately $15 million
to install intrusion detection systems along approximately 100 kilometers. In
January 2004, we received follow on orders of approximately $4 million. As of
December 31, 2003, approximately 85% of this project was completed and the
remainder will be completed in 2004.
In January 2002, Senstar received a $1 million contract from Public
Works and Government Services Canada on behalf of Correctional Service Canada to
supply and install over 700 security cameras and video surveillance equipment to
27 correctional facilities across Canada. In April 2002, Senstar signed a second
contract worth approximately $2.2 million to supply and install Senstar's
Perimitrax sensor as part of Correctional Service Canada's overall perimeter
detection security system at nine of its facilities. Senstar will also provide
operational and maintenance training, as well as a quantity of spare parts and
test equipment and integration into the existing perimeter intrusion detection
system integration units. Installations at six sites, valued at approximately
$1.6 million, were completed during 2002 and the balance of the contract
($600,000) was completed during 2003 . Since April 2002 approximately $500,000
was added to the value of the original contract for additional work with
$300,000 completed in 2003 and the balance of $200,000 to be completed in 2004.
In April 2002, we received orders of approximately $750,000 to protect
major sensitive installations in Israel. Revenues from the majority of these
orders was reflected in our 2002 financial results, with the reminder reflected
on our 2003 financials. The orders were for a number of our security systems,
including our vibration intrusion detection system, video motion detection
system, CCTV cameras and other security systems, all controlled by our MagNet
security management system.
In July 2002, we received a $850,000 order to protect a major
correctional facility in Southeast Asia. We are acting as a sub-contractor for
Megason Electronics and Tyco, who won the tender for the
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total protection of this facility. Our part in this project includes providing
the perimeter security system, which includes taut wire intrusion detection
systems, CCTV cameras and video motion detection systems. This order was
completed by the end of the first quarter of 2004.
In December 2002, Senstar- Stellar Inc., or SSI, and Senstar signed
contracts to supply perimeter intrusion detection systems to correctional
facilities in Canada and to a prison in the state of Pennsylvania. The total
amount of both contracts is approximately $2.3 million, of which orders for
$500,000 were executed in 2002. Senstar will design, supply, install and test
its Intelli-Flex fence disturbance systems at twelve Correctional Service Canada
institutions located across Canada and will also provide operational and
technical training. The Intelli-FLEX sensors will be integrated into the
existing perimeter intrusion detection system (PIDS) integration unit. As of
December 31, 2003, 90% of this project has been completed and the balance was
completed by March 31, 2004.
In August 2003, Senstar Stellar Latin America, our fully owned Mexican
subsidiary, received an order of approximately $1.5 million to install a
perimeter security system at sensitive installations in Mexico. As of December
31, 2003, 95% of this project had been completed and the balance was completed
by March 31, 2004.
In January 2004, we received a $700,000 order from the Israeli Prisons
Authority, to install a perimeter intrusion detection system around one of the
largest prisons in Israel. The order is expected to be completed by the end of
the third quarter of 2004. The order includes installation of our perimeter
intrusion detection systems, as well as cameras, digital video recording and
other security systems, all controlled by our MagNet security management system.
Our fully owned U.S. based subsidiaries, PPI, and SSI, supplied $4.2
million of products to Homeland Security contractors in 2003 for the protection
of various governmental and military sites throughout the United States.
DTS. We are currently focusing our efforts on attracting customers
through upgrading outdoor systems that are currently installed at prisons,
factories, government buildings and other security-conscious installations. In
addition to our traditional customers, customers of this product include private
companies and utilities companies such as refineries and electric power
stations.
Security Management and Control Systems and Turnkey Projects. Since its
introduction, we have sold our security management system and provided turnkey
projects to several customers, including large international companies.
In December 1999, we signed an approximately $5.7 million agreement
(including interest) with Azal to protect its international airport in
Azerbaijan. We have received $4.2 million in installment payments under this
agreement and will receive the remaining installments according to a
predetermined schedule. According to this agreement we are scheduled to receive
payments of approximately $1.3 million in 2004 and $0.2 million in 2005.
In March 2000, we received a $2.7 million order to protect a large
industrial facility in India. This order constituted the first stage of a
comprehensive security installation for this facility and included a variety of
our security systems, all controlled by MagNet. During 2000 and 2001, we
received an aggregate of approximately $800,000 in additional orders.
Since May 2002 we have received orders to protect communication
facilities in India totaling $6 million. We completed 95% of the orders by the
end of 2003 and the balance will be completed in
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2004. These orders constitute part of a comprehensive security installation
program and follows $3.5 million in orders executed for a sister company of the
same Indian concern.
At the end of 2002 we won a bid to protect the Otopeni International
Airport in Bucharest, Romania. The contract totals approximately $16 million.
This turnkey project includes different types of security systems as well as
video and data communication systems that will be integrated by MagNet. In March
2004, we signed an extension of the contract for $3.8 million. This contract,
including the extension, is expected to be completed by the end of 2005.
Video Monitoring Services. We have sold our video monitoring services to
banks and various retail operations.
Personal Emergency Location Systems. In 2003, a contract from the State
of Michigan, for eight correctional facilities, valued at approximately $0.6
million was assigned to PPI through our purchase of the business activity of
Dominion Wireless Inc. At the end of 2003, 23% of the project was completed. We
expect the remainder to be completed by December 2004.
Recent Developments
In July 2003, PPI acquired the business activity of Dominion Wireless,
Inc. for approximately $902,000. Dominion Wireless develops, produces and
manufactures a product that delivers high reliability personal portable duress
alarm systems to protect personal in correctional facilities. As of December 31,
2003, the total purchase price was fully paid in cash. Dominion Wireless, Inc.
will be entitled over the next two and a half years to an "earn out" of 50% of
the operating income related to the acquired activity. When the contingency is
resolved and additional consideration, if any, is distributable, we will record
the amounts as additional consideration for the acquisition.
During 2002 and 2003, we developed the Fortis command and control
system, a fully integrated system that supports decision making and wide-area
command and control in real time. The system creates a unified and interactive
intelligence picture by drawing data from all sensors showing the displacement
of ground forces and adding other relevant information such as video from
different sources, auxiliary services an weather conditions. This combined
picture, constantly updated, is sent by central command to all forces in the
command chain and serves as a uniform basis for operational planning and
allocation of tasks. The beta site has been operating successfully since March
2003.
In 2003, we developed the PipeGuard pipeline security system, which
provides a solution for securing buried assets and infrastructure, including oil
and gas pipelines and buried communication lines such as fiber optic cables.
PipeGuard utilizes an innovative new technology to guard buried pipelines,
regardless of pipeline length, with the ability to detect potential attack and
alert authorities before potential harm or damage occurs. Target markets include
oil and gas companies, owners and operators of pipelines or communication cables
and governmental agencies dealing with security and environment.
During 2002 and 2003, we developed DreamBox, a state-of-the-art embedded
hardware and software product which integrates a number of CCTV related
applications into one box. The system is designed to be economical, as well as
compact to save space, by avoiding the use of a complicated cable installation
and network protocols integration.
DreamBox contains twelve different applications, including a digital
video and audio recording, video and audio matrix switcher, outdoor and indoor
VMD, SMS, and a transmission system.
25
The DreamBox is sold for a substantially lower price than the cost of
the other products applications if sold separately, a factor which positions
DreamBox as the leading security solution for all strategic facilities. Its
target markets include governmental, institutional and other sensitive
facilities, such as airports, train stations, seaports, prisons, casinos and
hospitals, all of which require the use of high quality CCTV applications.
By developing this product, we enter a new area of activity. We refer to
the DreamBox's target market as an `add-on' market for us and believe that this
product is substantially broadening our target markets. As an example, we enter
the field of digital video recording, which is only one of the DreamBox's
applications out of many.
Support and Maintenance
Our systems are installed by us or by the customer after appropriate
training, depending on the size of the specific project and the location of the
customer's facilities, as well as on the customer's prior experience with our
systems. We generally provide our customers with training on the use and
maintenance of our systems. This training is conducted either on-site or at our
facilities. In addition, some of our local perimeter security systems customers
have signed maintenance contracts with us. For systems installed outside of
Israel, maintenance is provided by an independent third party, by distributors
or by the end user. We also provide services, maintenance and support on an "as
needed" basis.
We require distributors of our high-security perimeter systems to
purchase a demonstration kit that includes full-scale models of our perimeter
products, and to send technical personnel to Israel to participate in courses
given by us that focus on the marketing, installation and servicing of our
products.
Similarly, with regard to our subsidiaries' products, customer personnel
are trained in product installation and maintenance either at the subsidiaries'
facilities or at the customer's facility. Installation supervision and
assistance are sometimes purchased along with the equipment. The life expectancy
of a high-security perimeter system is approximately ten years. Consequently,
many miles of perimeter systems need to be replaced each year.
During 2003, we derived less than 5% of our total revenues from
maintenance and services. We generally provide a warranty on most of our
products for defects for which we receive notice within 12 months of the
delivery date of the product.
Research and Development; Royalties
We place considerable emphasis on research and development to improve
our existing products and technology and to develop new products and technology.
We believe that our future success will depend upon our ability to enhance our
existing products and technology and to introduce on a timely basis new
commercially viable products and technology addressing the needs of our
customers. We intend to continue to devote a significant portion of our
personnel and financial resources to research and development. As part of our
product development process, we seek to maintain close relationships with our
customers to identify market needs and to define appropriate product
specifications. Our development activities are a direct result of the input and
guidance we receive from our marketing personnel during our annual meetings with
such personnel. In addition, the heads of research and development for each of
our development centers discussed below meet annually to identify market needs
for new products.
26
Our research and development expenses during 2001, 2002 and 2003 were
approximately $3,331,000, $3,750,000 and $5,128,000, respectively, of which
royalty bearing grants from the Office of the Chief Scientist of the Israel
Ministry of Industry, Trade and Labor, or the OCS, and investment tax credits,
constituted approximately 8.3%,16.6% and 6.9%. In addition to our own research
and development activities, we also acquire know-how from external sources. We
cannot assure you that any of our research and development projects will yield
profitable results.
We have the following three development centers, each of which develops
various products and technologies based on its area of expertise:
o in Israel, we develop a wide range of products including our taut
wire, mechanical vibration, video and high-end SMS systems and
PipeGuard;
o in California, PPI develops our microphonic fence sensors as well as
our microwave detection, personal alarm and small/medium end control
systems; and
o in Canada, Senstar develops our leaky coax radar, triboelectric and
fiber-optic fence sensors, electrostatic volumetric detection and
medium to high-end control systems and personal emergency location
systems.
We seek co-financing of our development projects from the OCS. Through
2003, we had obtained grants from the OCS of $128,000 for certain of our
research and development projects. We are obligated to pay royalties to the OCS,
amounting to 3%-5% of revenues derived from sales of the products funded with
these grants, 100% - 150% of the grants received, linked to the U.S. dollar and
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. We paid
royalties amounting to $0, $131,000 and $80,000 in the years ended December 31,
2001, 2002 and 2003, respectively.
The terms of these grants require that the manufacture of products
developed with these grants be performed in Israel and prohibit transferring
technology developed with grants without the prior consent of the Research
Committee of the OCS. We cannot assure you that, if requested, the OCS will
grant such consent. Each application to the OCS is reviewed separately, so we
cannot assure you that the Israeli Government will continue to support our
research and development.
The Fund for the Encouragement of Marketing Activities
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. Grants received for
the years up to and including 2003 amounted to $253,000 and royalties paid
during 2001, 2002 and 2003 amounted to $104,000 $53,000 and $0, respectively. As
of December 31, 2003, the aggregate contingent obligation amounted to $96,000.
Backlog
As of May 31, 2004, our backlog amounted to approximately $30 million of
which approximately $16 million is expected to be delivered by the end of 2004
and $8 million is expected to be delivered by the end of 2005 and $6 million is
expected to be delivered thereafter.
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Manufacturing and Supply
Our manufacturing operations consist of designing and developing our
products, fabricating and assembling components and finished products, quality
control and final testing. Substantially all of our manufacturing operations are
currently performed at our plant in Yahud, Israel. See "Property, Plants and
Equipment" below.
We acquire most of the components utilized in our products, including,
but not limited to, our turnkey products and certain services from a limited
number of suppliers and subcontractors. We cannot assure you that we will
continue to be able to obtain such items from these suppliers on satisfactory
terms. Alternative sources of supply are available, and therefore, we are not
dependent upon these suppliers and subcontractors. We also maintain an inventory
of systems and spare parts in order to enable us to overcome potential temporary
supply shortages until an alternate source of supply is available. Nevertheless,
temporary disruptions of our manufacturing operations would result if we were
required to obtain materials from alternative sources, which may have an adverse
effect on our financial results.
Senstar's manufacturing operations are located at its facility in Carp,
Ontario, Canada and consist of design and development, assembly, final testing
and quality control. Senstar uses local subcontractors for making and mounting
its printed circuit board assemblies. The triboelectric sensor cable for
Senstar's Intelli-FLEX product is obtained from a sole supplier. If this sole
supplier were to discontinue production of the triboelectric sensor cable, it
would adversely affect Senstar's revenues of its Intelli-FLEX product.
PPI's manufacturing operations are located at its facility in Fremont,
California and consist of development and design, assembly, quality control and
final testing. PPI uses local subcontractors for making and mounting its printed
circuit board assemblies.
Competition
The principal factors affecting competition in the market for security
systems are a system's high probability for detection and low probability of
false and nuisance alarms. We believe that a manufacturer's reputation for
reliable equipment is a major competitive advantage, and that such a reputation
will usually be based on the performance of the manufacturer's installed
systems. Additional competitive factors include quality of customer support,
maintenance and price. We believe that we are competitive with respect to these
factors and that we have a good reputation in the markets in which we compete.
Several companies, including Elbit Systems Ltd., Elfar Ltd., Rav-Tec
Ltd., Trans Ltd. and Gal-Dor Ltd. in Israel, and Detektion Security Systems
Inc., Herras, Pilkington PLC, Del Norte Security, Geoquip Ltd. and Siemens AG
outside of Israel, produce high-security detection systems.
There are a number of companies that have developed video motion
detection systems, including Geutebruck GmbH, Adpro and Siemens AG and Bosch.
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We believe that our principal competitors for Dreambox systems are Nice
Systems Ltd., Verint Systems Inc. and DVTel Inc.
We believe that our principal competitors for security management and
control systems and turnkey project offerings include, among others, Honeywell
Inc., Lockheed Martin Corporation, Raytheon Company, Siemens AG, Dornier, Elbit
Systems Ltd., and Rafael.
We believe that our principal competitor for the Pipeguard system is an
Australian company, Future Fibre Technologies Pty. Ltd.
We believe that our principal competitors for personal emergency
location systems are Actall Corp. and Visonic Networks.
We believe that our principal competitors for video monitoring services
are Westec Security, Inc. and InterSTAR Systems, Inc.
Some of our competitors and potential competitors have greater research,
development, financial and personnel resources, including governmental support,
or more extensive business experience than we do. We cannot assure you that we
will be able to maintain the quality of our products relative to those of our
competitors or continue to develop and market new products effectively.
Intellectual Property Rights
We have 45 patents issued and patent applications pending in the U.S.
and in several other countries and have obtained licenses to use proprietary
technologies developed by third parties. We cannot assure you:
o that patents will be issued from any pending applications, or that the
claims allowed under any patents will be sufficiently broad to protect
our technology;
o that any patents issued or licensed to us will not be challenged,
invalidated or circumvented; or
o as to the degree or adequacy of protection any patents or patent
applications may or will afford.
In addition, we claim proprietary rights in various technologies,
know-how, trade secrets and trademarks relating to our principal products and
operations. We cannot assure you as to the degree of protection these claims may
or will afford. It is our policy to protect our proprietary rights in our
products and operations through contractual obligations, including
confidentiality and non-disclosure agreements with certain employees and
distributors. We cannot assure you as to the degree of protection these
contractual measures may or will afford. Although we are not aware that we are
infringing upon the intellectual property rights of others, we cannot assure you
that an infringement claim will not be asserted against us in the future. We
believe that our success is less dependent on the legal protection that our
patents and other proprietary rights may or will afford than on the knowledge,
ability, experience and technological expertise of our employees. We cannot
provide any assurance that we will be able to protect our proprietary
technology. The unauthorized use of our proprietary
29
technology by third parties may impair our ability to compete effectively. We
could become subject to litigation regarding intellectual property rights, which
could seriously harm our business.
We have trademark rights associated with our use of Flash and
Intelli-FLEX, and rights obtained by trademark registration for Flare,
Perimitrax, Panther, Intelli-FIELD, Senstar, Senstar-Stellar and the
Senstar-Stellar logo.
Government Regulation of Certain Exports
Under Israeli law, the export of products that we manufacture in Israel
and/or certain know-how is subject to approval by the MOD. We must obtain
permits from the MOD to initiate sales proposals with regard to such exports, as
well as for actual export transactions. We cannot assure you that we will
receive all the required permits for which we may apply in the future.
C. Organizational Structure.
The table below lists our subsidiaries. We, or one of our subsidiaries,
own 100% of the outstanding capital stock of the subsidiary.
Name of Subsidiary Country of Incorporation
------------------ ------------------------
Senstar-Stellar Corporation Canada
Perimeter Products Inc. United States
Senstar-Stellar Inc. United States
Senstar GmbH Germany
Kobb Inc. United States
Magal B.V. The Netherlands
Senstar-Stellar Latin America S.A. de C.V. Mexico
Senstar-Stellar Limited United Kingdom
Smart Interactive Systems, Inc. United States
E.S.E. Ltd. Israel
Magal Security Sisteme S.R.L Romania (incorporated in
April 2003)
D. Property, Plants and Equipment
Our two-story 2,533 square meter plant is located on a 4,352 square
meter parcel in the Yahud Industrial Zone. We purchased the rights to the land
in August 1988 from a third party, which had purchased them primarily from the
Israel Land Authority. In accordance with Israeli law, this parcel of land is
still registered in the name of the Israel Land Authority. We will be entitled
to have title to the property recorded in our name when Israeli authorities
subdivide the property into parcels. This
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procedure is a statutory requirement for transferring land ownership in Israel.
The products that we manufacture at this facility include our taut-wire
intrusion detection systems, our vibration detection systems, our video-motion
detection systems, MagNet, Fortis, DreamBox, PipeGuard, and other perimeter
systems.
Senstar owns a 33,000 square foot facility in Carp, Ontario, Canada.
Approximately 7,000 square feet are devoted to administrative, marketing and
management functions and approximately 8,000 square feet are used for
engineering, system integration and customer service. Senstar uses the remaining
18,000 square feet for production operations, including cable manufacturing,
assembly, testing, warehousing, shipping and receiving. Senstar also leases ten
acres of land near this facility that is used as an outdoor sensor test and
demonstration sites for its products. The products that Senstar manufactures at
this facility include the Perimitrax/Panther 2000 buried cable intrusion
detection systems, the Intelli-Field electro static detection system, the
Intelli-FLEX microphonic fence detection system, Flair and Flash, and various
perimeter monitoring and control systems.
PPI owns a 20,000 square foot facility in Fremont, California. The
products that PPI manufactures at this facility include Intelli-Wave, various
sensors, the PAS personal alarm system and the MX control and monitoring center.
In connection with two of our credit lines, a fixed charge was placed on
our physical plant in Israel by each of Bank Leumi Israel and Union Bank of
Israel, each of which ranks pari-passu with the other. In addition, PPI has
granted its mortgage lender a first mortgage on its premises.
We believe that our facilities are suitable and adequate for our
operations as currently conducted and as foreseen. In the event we require
additional facilities, we believe that we could obtain such facilities at
commercially reasonable rates.
ITEM 5. Operating and Financial Review and Prospects
A. Operating Results
The following discussion of our results of operations and financial
condition should be read in conjunction with our consolidated financial
statements and the related notes thereto included elsewhere in this annual
report. This discussion contains forward-looking statements that involve risks
and uncertainties. Our actual results may differ materially from those
anticipated in these forward-looking statements as a result of certain factors,
including, but not limited to, those set forth in Item 3.D. "Key
Information-Risk Factors."
General
We are engaged in the development, manufacture and marketing of
computerized security systems, which automatically detect, locate and identify
the nature of unauthorized intrusions. We also supply video monitoring services
through Smart Interactive Systems, Inc., a subsidiary established in the U.S. in
June 2001. Our products are currently used in more than 75 countries worldwide
to protect national borders, airports, correctional facilities, nuclear power
stations and other sensitive facilities from terrorism, theft and other threats.
Our Israeli-based company has subsidiaries in the U.S., Canada, United Kingdom,
Germany, Mexico, Romania and an office in China.
Economic and Other Factors
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Following the terrorist attacks of September 11, 2001, heightened global
security concerns have increased the demand for products such as ours, which
protect aircraft, national borders and sensitive facilities from terrorism, and
we have experienced an increase in inquiries from prospective customers
regarding our products. Although we expect demand for our products to increase,
because our products are primarily sold to government agencies, government
authorities and government-owned companies, many of which have complex and
time-consuming procurement procedures, we may not make major sales of our
products and may not experience a significant increase in our revenues until, at
the earliest, the end of 2004.
In addition, the continued state of hostility between the State of
Israel and the Palestinian Authority has caused the State of Israel to increase
its efforts to protect its facilities and installations from unauthorized
intrusions. In 2002, the Israeli Government announced the construction of a
perimeter system to seal off parts of the West Bank to prevent Palestinian
terrorists from entering Israel. In September 2002, we won 80% of the bids
published by the MOD for the installation of intrusion detection systems along
the seam line between Israel and the West Bank. To date, we have won bids having
a value of approximately $19 million to install intrusion detection systems
along approximately 150 kilometers. As of December 31, 2003, approximately 85%
of this project was completed and the remainder will be completed in 2004. In
2003, the Israeli Government resolved to extend the perimeter system and to
build it along the seam-line. However, following the UN resolution to refer the
question of the legality of the seam-line perimeter systems to the International
Court of Justice in the Hague, an international opposition to the route selected
by the Israeli government arose, causing the Israeli Government to change and
shorten the route of the seam-line perimeter system. We cannot assure you that
Israel will follow through with its decision to build the perimeter system along
the seam-line, or if such perimeter system is constructed or rebuilt, that our
products will be utilized in its construction.
During 2003, we incurred losses relating to the start-up of the
operations of Smart.
Business Challenges/Areas of Focus
Our primary business challenges and areas of focus include:
o continuing the growth of revenues and profitability of our perimeter
security system line of products;
o enhancing the introduction and recognition of our new products into
the markets;
o penetrating into new markets and strengthen presence in existing
markets; and
o offering our comprehensive turnkey solutions.
Discussion of Critical Accounting Policies
The preparation of financial statements in conformity with U.S. GAAP
requires us to make estimates and assumptions that affect the reported amounts
of assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates and the use of different assumptions would likely result in materially
different results of operations.
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Critical accounting policies are those that are both most important to
the portrayal of our financial position and results of operations, and require
management's most difficult, subjective or complex judgments. Although not all
of our significant accounting policies require management to make difficult,
subjective or complex judgments or estimates, the following policies and
estimates are those that we deem most critical:
Revenue Recognition
We generate revenues mainly from long-term projects and also from sales
of products and rendering maintenance services. Revenues from long-term projects
are recognized in accordance with Statement of Position 81-1 "Accounting for
Performance of Construction - Type and Certain Production - Type Contracts ("SOP
81-1"), using contract accounting on a percentage of completion method, based on
the relationship of actual costs incurred to total costs estimated to be
incurred over the duration of the contract and in accordance with the "Input
Method." 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. As of December 31, 2003, no such
estimated losses were identified.
We apply contract accounting for the following reasons:
o projects for construction of perimeter systems require planning,
development, manufacture and installation of the perimeter system, in
accordance with the customer's security requirements; and
o the project includes various components, e.g. planning of the
perimeter system in accordance with technical specifications,
manufacture of the perimeter system, installation of the perimeter
system on-site and installation of electronic parts on-site.
According to ("SOP 81-1"), costs that are incurred for a specific
anticipated contract are being deferred, subject to evaluation of their probable
recoverability, and only if the costs can be directly associated with a specific
anticipated contract.
Revenues from products are recognized in accordance with Staff
Accounting Bulletin No. 104 "Revenue Recognition," ("SAB No. 104"), when the
following criteria are met: persuasive evidence of an arrangement exists,
delivery of the product has occurred, the fee is fixed or determinable and
collection is probable.
Deferred revenues include unearned amounts received under maintenance
contracts but not yet recognized as revenues.
In November 2002, Emerging Issues Task Force ("EITF") reached a
consensus on Issue No. 00-21, "Revenue Arrangements with Multiple Deliverables."
EITF Issue No. 00-21 provides guidance on how to account for arrangements that
involve the delivery or performance of multiple products, services and/or rights
to use assets. The provisions of EITF Issue No. 00-21 are applied to revenue
arrangements entered into in fiscal periods beginning after June 15, 2003.
Additionally, companies will be permitted to apply the consensus guidance in
this issue to all existing arrangements as the cumulative effect of a change in
accounting principle in accordance with APB Opinion No. 20, "Accounting
Changes." The adoption of EITF Issue No. 00-21 did not have a material impact
upon our financial position, cash flows or results of operations.
33
Management's judgment is required to determine the percentage of
completion based on the output measure of the portion of work performed, to
match expenses to revenues and to estimate future expenses in order to estimate
the provisions for estimated losses on uncompleted contracts.
Inventories
Inventories are stated at the lower of cost or market value. Inventory
write-offs are provided to cover risks arising from slow-moving items,
technological obsolescence, excess inventories, discontinued products, and for
market prices lower than cost. Management's judgment is required to determine
the reserve for obsolete or excess inventory. Inventory on hand may exceed
future demand either because the product is outdated, or obsolete, or because
the amount on hand is more than can be used to meet future need. We provide for
the total value of inventories that we determine to be obsolete based on
criteria such as customer demand and changing technologies.
During 2001, 2002 and 2003, we recorded inventories write-offs in a
total amounts of $808,000 $244,000 and $601,000, respectively.
Inventory cost is determined as follows:
o raw materials, parts and supplies - using the "first in, first out"
method;
o work-in-progress - represents the cost of development in progress; and
o finished products - on the basis of direct manufacturing cost with the
addition of allocable indirect manufacturing costs.
Income taxes
We account for income taxes in accordance with Statement of Financial
Accounting Standard No. 109 "Accounting for Income Taxes," or SFAS No. 109. This
statement prescribes the use of the liability method whereby deferred tax asset
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. We provide a valuation allowance, if necessary, to
reduce deferred tax assets to their estimated realizable value.
As part of the process of preparing our consolidated financial
statements, we are required to estimate our income taxes in each of the
jurisdictions in which we operate. This process involves estimating our actual
current tax exposure together with assessing temporary differences resulting
from differing treatment of items for tax and accounting purposes. These
differences result in deferred tax assets and liabilities, which are included
within our consolidated balance sheet. We must then assess the likelihood that
our deferred tax assets will be recovered from future taxable income and we must
establish a valuation allowance to reduce its deferred tax assets to the amount
that is more likely than not to be realized. Increases in the valuation
allowance result in additional expense to be reflected within the tax provision
in the consolidated statement of income. At December 31, 2003, our deferred tax
asset was $1.3 million. Our subsidiaries in the U.S., United Kingdom and Mexico
have estimated total available carryforward tax losses of $4,002,000, $582,000
and $77,000 respectively, to be offset against future taxable profit for 20
years, an indefinite period and 10 years, respectively. As of December 31, 2003,
we recorded a deferred tax asset of approximately $1.8 million, relating to the
34
available net carryforward tax losses. A valuation allowance of $1.7 million was
recorded due to the uncertainty of the tax assets' future realization.
Goodwill
Goodwill represents excess of the costs over the net fair value of the
assets of the businesses acquired. Goodwill that arose from acquisitions prior
to July 1, 2001 was amortized until December 31, 2001 on a straight-line basis
over a period of 15 years. Under SFAS No, 142, goodwill acquired in a business
combination on or after July 1, 2001 will not be amortized.
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 and market capitalization.
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.
SFAS No. 142 prescribes a two-phase process for impairment testing of
goodwill. The first phase screens for impairment; while the second phase (if
necessary) measures the impairment. We completed our first phase impairment
analysis related to the adoption of SFAS 142 and found no instances of
impairment of our recorded goodwill.
As of December 31, 2003 the goodwill amounted to $4,145,000.
Impairment of long lived assets:
Our long-lived assets and certain identifiable intangibles are reviewed
for impairment in accordance with Statement of Financial Accounting Standard No.
144, "Accounting for the Impairment or Disposal of Long- Lived Assets" ("SFAS
No. 144") whenever events or changes in circumstances indicate that the carrying
amount of an asset may not be recoverable. Recoverability of assets to be held
and used is measured by a comparison of the carrying amount of an asset to the
future undiscounted cash flows expected to be generated by the assets. If such
assets are considered to be impaired, the impairment to be recognized is
measured by the amount by which the carrying amount of the assets exceeds the
fair value of the assets. During the years ended December 31, 2001, 2002 and
2003, no impairment losses were recognized.
Financial statements in U.S. dollars
The majority of our revenues are generated in U.S. dollars. We believe
that the U.S dollar is the primary currency of the economic environment in which
we operate. Accordingly, we and certain of our subsidiaries use the U.S. dollar
as our functional and reporting currency. Therefore, monetary accounts
maintained in currencies other than the U.S dollar are remeasured into U.S.
dollars in accordance with Statement of the Financial Accounting Standards Board
("FASB") 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.
35
The financial statements of certain foreign subsidiaries whose
functional currency is not the dollar, have been translated into U.S. 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 period. The resulting
translation adjustments are reported as a component of shareholders' equity in
accumulated other comprehensive income (loss).
Accordingly, we had accumulated foreign currency translation income
(loss) of approximately ($1) million and $1.3 million that were included as part
of "accumulated other comprehensive income (loss)" within our balance sheet at
December 31, 2002 and 2003, respectively. During 2001, 2002 and 2003, foreign
currency translation income (loss) of ($579,000), $288,000 and $2,292,000,
respectively, were included under "accumulated other comprehensive income
(loss)." Had we determined that the functional currency of our subsidiaries was
the dollar, these gains (loss) would have increased (decreased) our income for
each of the years presented.
Concentrations of credit risk
Financial instruments that potentially subject us and our subsidiaries
to concentrations of credit risk consist principally of cash and cash
equivalents, short and long-term bank deposits, trade receivables and long-term
trade receivables.
Our cash and cash equivalents, short-term and long-term bank deposits
are invested in major Israeli and U.S. banks. Such deposits in U.S. banks may be
in excess of insured limits and are not insured in other jurisdictions. We
believe that the financial institutions that hold our investments are
financially sound and, accordingly, minimal credit risk exists with respect to
these investments.
The trade receivables of our company and our subsidiaries are derived
from sales to large and solid organizations located mainly in Israel, the United
States, Canada and Europe. We perform ongoing credit evaluations of our
customers and to date have not experienced any material losses. An allowance for
doubtful accounts is determined with respect to those amounts that we have
determined to be doubtful of collection and by a general reserve. In certain
circumstances, we may require letters of credit, other collateral or additional
guarantees.
Derivative instruments
Financial Accounting Standards Board Statement No. 133, "Accounting for
Derivative Instruments and Hedging Activities" ("SFAS No. 133"), requires
companies 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,
we must designate the hedging instrument, based upon the exposure being hedged,
as a fair value hedge, cash flow hedge or a hedge of a net investment in a
foreign operation.
For derivative instruments that are designated and qualify as a fair
value hedge (i.e., hedging the exposure to changes in the fair value of an asset
or a liability or an identified portion thereof that is attributable to a
particular risk), the gain or loss on the derivative instrument as well as the
offsetting loss or gain on the hedged item attributable to the hedged risk are
recognized in the same line item associated with the hedged item in current
earnings during the period of the change in fair values. For
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derivative instruments that are designated and qualify as a 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.
To protect against changes in the value of forecasted foreign currency
translations and balances, we have instituted a foreign currency hedging
program. We hedges portions of our forecasted cash flows and balances
denominated in foreign currencies with forward contracts.
During 2003, we entered into forward contracts to hedge a portion of our
Euro revenues. These forward contracts are designated as cash flows hedges, as
defined by SFAS No. 133, as amended, and we believe are effective as a hedge for
these revenues. The effective portion of the gain or loss on derivative
instruments that hedge future revenues is included in revenues and in financial
expenses in our statement of income.
As of the year ended December 31, 2003, the total losses on derivative
instruments were $278,000, of which $178,000 was recorded in revenues, and
$100,000 was recorded in financial expenses. As of December 31, 2003, the
unrealized losses on forward contracts amounted to $950,000.
Fair value of financial instruments:
The following methods and assumptions were used by us and our
subsidiaries in estimating their fair value disclosures for financial
instruments:
o The carrying amounts of cash and cash equivalents, short-term bank
deposits, trade receivables and other accounts receivable, short-term
bank credit, trade payables and other payables approximate their fair
value due to the short-term maturity of such instruments.
o The carrying amount of our long-term trade receivables and long-term
deposits approximate their fair value. The fair value was estimated
using discounted cash flow analyses, based on our investment rates for
similar type of investment arrangements.
o Long-term loans are estimated by discounting the future cash flows
using current interest rates for loans of similar terms and
maturities. As of December 31, 2002 the carrying amount of the our
long-term borrowing approximate its fair value. As of December 31,
2003 the fair value of the our long-term borrowing was $5.6 million,
compared to the carrying amount of $5.7 million.
Results of Operations
Due to the nature of our customers and products, our revenues are often
made pursuant to a relatively small number of large orders. Consequently,
individual orders from individual customers can represent a substantial portion
of our revenues in any one period and significant orders by any customer during
one period may not be followed by further orders from the same customer in
subsequent periods. Our revenues and operating results may, therefore, vary
substantially from period
37
to period. Consequently, we do not believe that our revenues and operating
results should necessarily be judged on a quarter-to-quarter comparative basis.
The following table presents, for the periods indicated, certain
financial data expressed as a percentage of revenues:
Year Ended December 31,
-----------------------------------------
1999 2000 2001 2002 2003
---- ---- ---- ---- ----
Revenues................................. 100% 100% 100% 100% 100%
Cost of revenues......................... 53 53 52 56 56
----- ----- ----- ----- --
Gross profit............................. 47 47 48 44 44
----- ----- ----- ----- --
Operating expenses:
Research and development expenses, net... 8 8 8 7 8
Sales and marketing, net................. 18 18 19 20 20
General and administrative............... 13 12 12 11 9
------ ------ ------ ------ ---
Operating income ........................ 8 9 9 6 7
Financial income (expenses), net......... - (1) - - (2)
----- ------ ----- ----- ---
Income before taxes on income and
write-off of investment in affiliate,
net of taxes........................... 8 8 9 6 5
Taxes on income.......................... 1 1 1 2 1
----- ----- ----- ----- -
Income before write-off of investment
in affiliate........................... 7 7 8 4 4
Write-off of investment in affiliate,
net of taxes........................... (1) - - - -
----- ----- ----- ----- ---
Net income............................... 6% 7% 8% 4% 4%
===== ===== ===== ===== ===
Years ended December 31, 2003 and 2002
Revenues. Revenues increased by 38% to $59.4 million in the year ended
December 31, 2003, compared with $43 million in the year ended December 31,
2002. Revenues from sales of perimeter systems in 2003 were $51.1 million
compared to $36.4 million in 2002, an increase of 40%. Revenues from security
turnkey projects increased by 26% to $6.7 million in 2003, compared with $5.3
million in 2002. Our main projects in 2003 included the installation of
intrusion detection systems along the seam line between Israel and the West Bank
and the protection of the Otopeni International Airport in Romania. The
devaluation of the U.S. dollar against the Canadian dollar and the NIS increased
the revenues that are linked to those currencies in terms of U.S. dollars. Based
on our backlog and estimations, we anticipate that our revenues will increase in
2004.
Cost of revenues. Cost of revenues reached $33.4 million in the year
ended December 31, 2003, compared with $23.9 million in the year ended December
31, 2002. Cost of revenues as a percentage of revenues was 56% in 2003, remained
at the same level as in 2002. We anticipate that our cost of revenues as a
percentage of revenues will remain at the same level in 2004.
38
Gross profit. Gross profit for the year ended December 31, 2003
increased to $26.0 million, compared to $19.0 million for the year ended
December 31, 2002, primarily as a result of our increased revenues.
Research and development expenses, net. Research and development
expenses, net for the year ended December 31, 2003 were $4.8 million, compared
to $3.1 million for the year ended December 31, 2002, an increase of 53%.
Research and development expenses, net amounted to 8% of revenues in 2003,
compared to 7% in 2002. Royalty bearing grants and investment tax credits
decreased to $355,000 in 2003 compared to $622,000 in 2002 due to the decrease
of royalty bearing grants received from OCS. The increase in our research and
development expenses was attributed to our development of three new products
that we launched in the beginning of 2004. We expect that our net research and
development expenses will increase in 2004 in connection with the continuation
of the development of our products.
Sales and marketing expenses, net. Sales and marketing expenses, net
were $11.6 million for the year ended December 31, 2003 compared to $8.6 million
for the year ended December 31, 2002, an increase of 34%. The increase in sales
and marketing expenses in 2003 was primarily due to the increase in our
revenues. Sales and marketing expenses amounted to 20% of revenues in both 2003
and 2002. To the extent our revenues will increase in 2004, we expect that our
sales and marketing expenses will continue to increase in 2004.
General and administrative expenses. General and administrative expenses
were $5.3 million for the year ended December 31, 2003 compared to $4.9 million
for the year ended December 31, 2002. General and administrative expenses
amounted to 9% of revenues in 2003, compared to 11% in 2002. We expect that our
general and administrative expenses will remain at the same level in 2004.
Financial income (expenses), net. Financial expenses, net for the year
ended December 31, 2003 were $1.0 million compared to income of $199,000 for the
year ended December 31, 2002. This increase in financial expenses was due to the
devaluation of the U.S. dollar against the Canadian Dollar and the NIS, since
our major operations are located in Canada and Israel.
Years ended December 31, 2002 and 2001
Revenues. Revenues increased by 5% to $43 million in the year ended
December 31, 2002 compared with $41 million in the year ended December 31, 2001.
Revenues from sales of perimeter systems in 2002 were $36.4 million compared to
$34.9 million in 2001, an increase of 4%. Revenues from security turnkey
projects increased by 7% to $5.3 million in 2002 compared with $5.0 million in
2001.
Cost of revenues. Cost of revenues reached $23.9 million in the year
ended December 31, 2002 compared with $21.5 million in the year ended December
31, 2001. Cost of revenues as a percentage of revenues was 56% in 2002, as
compared to 52% in 2001, due to a different mix of revenues in each year.
Gross profit. Gross profit for the year ended December 31, 2002 was
$19.0 million compared to $19.5 million for the year ended December 31, 2001.
Gross profit as a percentage of revenues decreased to 44% in 2002 compared with
48% in 2001, due to a different mix of revenues in each year.
Research and development expenses, net. Research and development
expenses, net for the year ended December 31, 2002 were $3.1 million for the two
years ended December 31 2001 and 2002.
39
Research and development expenses, net amounted to 7% of revenues in 2002
compared to 8% in 2001. Royalty bearing grants and investment tax credits
increased to $622,000 in 2002 compared to $277,000 in 2001, due to an increase
in grants received from the OCS.
Sales and marketing expenses, net. Sales and marketing expenses, net
were $8.6 million for the year ended December 31, 2002 compared to $7.9 million
for the year ended December 31, 2001, an increase of 9%. Sales and marketing
expenses amounted to 20% of revenues in 2002 compared with 19% in 2001. The
increase in sales and marketing expenses in 2002 was primarily due to an
increase expenses incurred in connection with establishing Smart.
General and administrative expenses. General and administrative expenses
were $4.9 million for the year ended December 31, 2002, substantially unchanged
from the year ended December 31, 2001. General and administrative expenses
amounted to 11% of revenues in 2002 compared to 12% in 2001.
Financial income, net. Financial income, net for the year ended December
31, 2002 was $199,000 compared to income of $40,000 for the year ended December
31, 2001.
Seasonality
Our operating results are characterized by a seasonal pattern, with a
higher volume of revenues towards the end 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, revenues are often postponed from
the first quarter to subsequent quarters.
Impact of Inflation and Devaluation on Results of Operations, Liabilities and
Assets
The dollar cost of our operations in Israel is influenced by the extent
to which any increase in the rate of inflation in Israel is not offset, or is
offset on a lagging basis, by a devaluation of the NIS in relation to the
dollar. When the rate of inflation in Israel exceeds the rate of devaluation of
the NIS against the dollar, companies experience increases in the dollar cost of
their operations in Israel. Unless offset by a devaluation of the NIS, inflation
in Israel will have a negative effect on our profitability, as we receive
payments in dollars or dollar-linked NIS for a portion of our revenues, while we
incur a portion of our expenses in NIS.
In addition, since part of our revenues are quoted in NIS, and a portion
of our expenses are incurred in NIS, our results may be adversely affected by a
change in the rate of inflation in Israel if the amount of our revenues in NIS
decreases and is less than the amount of our expenses in NIS (or if such
decrease is offset on a lagging basis) or if such change in the rate of
inflation is not offset, or is offset on a lagging basis, by a corresponding
devaluation of the NIS against the dollar and other foreign currencies.
The following table presents information about the rate of inflation in
Israel, the rate of devaluation of the NIS against the dollar, and the rate of
inflation in Israel adjusted for the devaluation:
A devaluation of the NIS in relation to the dollar has the effect of
reducing the dollar amount of any of our expenses or liabilities which are
payable in NIS, unless those expenses or payables are linked to the dollar. This
devaluation also has the effect of decreasing the dollar value of any asset
which consists of NIS or revenues payable in NIS, unless the receivables are
linked to the dollar. Conversely, any increase in the value of the NIS in
relation to the dollar has the effect of increasing the dollar value of any
unlinked NIS assets and revenues and reducing the dollar amounts of any unlinked
NIS liabilities and expenses.
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 2003, foreign currency fluctuations
had a material adverse impact on our results of operations, and financial
expenses, net were $1.0 million. We cannot assure you that in the future our
results of operations may not be materially adversely affected by currency
fluctuations.
We periodically enter into foreign exchange contracts to offset the risk
of currency exchange rate fluctuations in connection with certain revenues and
purchase transactions. During 2003, we entered into forward contracts to hedge a
portion of our Euro revenues. These forward contracts are designated as cash
flows hedges, as defined by SFAS No. 133, as amended, and we believe are
effective as a hedge for these revenues when the revenues are recorded. The
effective portion of the derivative instruments is included in revenues and in
financial expenses in the statements of operations.
As of the year ended December 31, 2003, the total losses on derivative
instruments were $278,000, of which $178,000 was recorded in revenues, and
$100,000 was recorded in financial expenses. As of December 31, 2003, the
unrealized losses on forward contracts amounted to $950,000.
Political Conditions
Since the establishment of the State of Israel in 1948, a number of
armed conflicts have taken place between Israel and its Arab neighbors, and a
state of hostility, varying from time to time in intensity and degree, has led
to security and economic problems for Israel. Since September 2000, there has
been a marked increase in violence, civil unrest and hostility, including armed
clashes, between the State of Israel and the Palestinians, and acts of terror
have been committed inside Israel and against Israeli targets in the West Bank
and Gaza. There is no indication as to how long the current hostilities will
last or whether there will be any further escalation. Any further escalation in
these hostilities or any future armed conflict, political instability or
violence in the region may have a negative effect on our business condition,
harm our results of operations and adversely affect our share price.
Furthermore, there are a number of countries that restrict business with Israel
or Israeli companies.
41
Restrictive laws or policies of those countries directed towards Israel or
Israeli businesses may have an adverse impact on our operations, our financial
results or the expansion of our business.
In addition, some of our employees in Israel are subject to being called
upon to perform military service in Israel, and their absence may have an
adverse effect upon our operations. Generally, unless exempt, male adult
citizens and permanent residents of Israel under the age of 40 are obligated to
perform up to 36 days of military reserve duty annually and all such residents
are subject to being called to active duty at any time under emergency
circumstances. While we have operated effectively under these requirements since
we began operations, we cannot assess the full impact of these requirements on
our workforce or business if conditions should change, and we cannot predict the
effect on us of any expansion or reduction of these obligations.
To date, no executive officer or key employee has been recruited for
military service for any significant time period. Any further escalation of the
hostilities between Israel and the Palestinian Authority into a full-scale
conflict might require more significant military reserve service by some of our
employees, which may have a material adverse effect on our business.
Economic Conditions
In recent years Israel has been going through a period of recession in
economic activity, resulting in low growth rates and growing unemployment. Our
operations could be adversely affected if the economic conditions in Israel
continue to deteriorate. In addition, due to significant economic measures
proposed by the Israeli Government, there have been several general strikes and
work stoppages in 2003 and 2004, affecting all banks, airports and ports. These
strikes have had an adverse effect on the Israeli economy and on business,
including our ability to deliver products to our customers. Following the
passing by the Israeli Parliament of laws to implement the economic measures,
the Israeli trade unions have threatened further strikes or work-stoppages, and
these may have a material adverse effect on the Israeli economy and on us.
Trade Agreements
Israel is a member of the United Nations, the International Monetary
Fund, the International Bank for Reconstruction and Development and the
International Finance Corporation. Israel is a signatory to the General
Agreement on Tariffs and Trade, which provides for reciprocal lowering of trade
barriers among its members. In addition, Israel has been granted preferences
under the Generalized System of Preferences from the U.S., Australia, Canada and
Japan. These preferences allow Israel to export products covered by such
programs either duty-free or at reduced tariffs.
Israel and the European Union Community concluded a Free Trade Agreement
in July 1975 which confers certain advantages on Israeli exports to most
European countries and obligates Israel to lower its tariffs on imports from
these countries over a number of years. In 1985, Israel and the U.S. entered
into an agreement to establish a free trade area. The free trade area has
eliminated all tariff and specified non-tariff barriers on most trade between
the two countries. On January 1, 1993, an agreement between Israel and the
European Free Trade Association, known as EFTA, which includes Austria, Finland,
Iceland, Liechtenstein, Norway, Sweden and Switzerland, established a free-trade
zone between Israel and the EFTA nations. In November 1995, Israel entered into
a new agreement with the European Union, which includes redefinement of rules of
origin and other improvements, including providing for Israel to become a member
of the research and technology programs of the European Union. In recent years,
Israel has established commercial and trade relations with a number of other
nations, including China, India, Russia, Turkey and other nations in Eastern
Europe and Asia.
42
Effective Corporate Tax Rate
Israeli companies are generally subject to tax at the rate of 36% of
taxable income. 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 to four years, commencing in the first year in
which such income is earned, and will be entitled to a reduced tax rate of 15%
for an additional 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, rather than eight, years.
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, 2003, our subsidiaries in the U.S., Mexico and the
United Kingdom had total net available carry forward tax losses of approximately
$4.7 million. A valuation allowance of $ 1.7 million 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 raised a net total of
$9,837,000 from an initial public offering of 1,380,000 ordinary shares. In
February 1997, we raised an additional $9,440,000 from an offering of an
additional 2,085,000 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, 2003 was $21.4 million compared to
$15.7 million at December 31, 2002. Cash and cash equivalents amounted to $4.4
million at December 31, 2003 compared to $2.5 million at December 31, 2002.
Short and long-term bank deposits (including restricted bank deposits) amounted
to $12.1 million at December 31, 2003 compared to $12.4 million at December 31,
2002. Our cash and cash equivalents, short and long-term bank deposits are held
mainly in U.S. dollars.
43
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, and our expected cash flow from operations
in 2004 will be sufficient to meet our planned and potential cash requirements
in 2004.
We expect to fund our long-term liquidity needs, including contractual
obligations and anticipated capital expenditures, from our cash and cash
equivalents, operating cash flow and our credit facilities.
Net cash provided from operating activities was $1.8 million for the
year ended December 31, 2003 compared to net cash used from operating activities
of $0.4 million and $2.5 million for the years ended December 31, 2001 and 2002,
respectively. The increase in cash from operations was primarily due to a
decrease in unbilled accounts receivable, a decrease in long term trade
receivables and an increase in other payables, accrued expenses and trade
payables. During 2003, we experienced $1.9 million in losses attributable to the
start-up of operations of Smart. We expect that Smart will operate on a
breakeven basis by the end of 2004.
Purchases of property and equipment in 2001, 2002 and 2003 were $1.2
million, $1.5 million and $3.2 million, respectively. Capital expenditures in
2001, 2002 and 2003 were principally for equipment for Smart, computers and
other machinery and equipment. We estimate that our capital expenditures for
2004 will total approximately $6.5 million, of which 7% will be spent in Israel,
92% in the U.S. and Canada and 1% in other countries. As of May 31, 2004, we
have spent approximately 30% of this amount. 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 2004 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. See Item 3.D. "Key
Information-Risk Factors."
Credit Lines and Other Debt
We currently have credit lines with Bank Leumi Israel, Union Bank of
Israel and Bank Hapoalim Israel totaling $19.8 million in the aggregate. There
are no restrictions as to our use of each 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 Bank Leumi Israel and Union Bank of Israel,
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 Bank Leumi Israel and Union Bank of
Israel:
o A ratio of at least 40% of shareholders' equity out of the total
assets;
o Minimal annual net income in the amount of $1 million; and
o That the same shareholders maintain the core control in our company.
As of December 31, 2003, we were in compliance with these ratios and
terms. These two 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 if we fail to fulfill our undertakings. Our loans under these credit lines
are generally denominated in U.S. dollars. However, we may occasionally have
short-term NIS-denominated loans.
44
In addition, our subsidiaries currently have credit lines with Bank
Leumi USA, Royal Bank of Canada and Deutsche Bank totaling $8.0 million in the
aggregate.
As of December 31, 2003, we had approximately $3.5 million available
under our credit lines. In addition, our subsidiaries have approximately $0.2
million available under their credit lines.
As of December 31, 2003, we had outstanding under our credit lines:
o short-term NIS-denominated loans of approximately $6.6 million,
bearing interest at a rate of 6.83%;
o short-term dollar-denominated loans of approximately $4.3 million,
bearing interest at a rate of 2.68%-3.06%. Interest on the outstanding
balance is due each quarter;
o several bank performance and advance payment guarantees totaling
approximately $3.6 million, at an annual cost of 0.5 %-1.0 %; and
o forward contracts of approximately $1.7 million.
As of December 31, 2003, Senstar had outstanding, in the aggregate,
short-term Canadian $ denominated loans of $1.7 million, bearing interest at a
rate of Canadian Prime plus 0.5% (5.01% at December 31, 2003). This loan is
collateralized by a general security agreement.
As of December 31, 2003, our subsidiaries had outstanding, in the
aggregate, $5.7 million in long-term loans as follows:
o $2.5 million, bearing interest at an annual rate of 4.60%. The
interest on the outstanding balance under this loan is due monthly.
This loan is due in one installment in April 2004;
o $250,000, bearing interest at an annual rate of 4.60%. The interest on
the outstanding balance under this loan is due quarterly. This loan is
due in one installment in April 2004;
o $500,000, bearing interest at an annual rate of 5.662% and
collateralized by PPI's assets. The interest on the outstanding
balance under this borrowing is due quarterly, with the principal due
in one installment in April 2004;
o $500,000, bearing interest at an annual rate of 2.875% and
collateralized by PPI's assets. This loan is due in one installment in
April 2004; and
o $1.96 million mortgage loan to PPI bearing interest at a fixed rate of
8.25%. The mortgage is due in 18 quarterly installments of $64,700,
commencing February 2001, with a final payment of approximately $1.8
million due in November 2005. In connection with this mortgage loan,
PPI has granted the bank a first mortgage on its premises. In
addition, we have guaranteed the full amount of this mortgage loan.
45
In connection with our non-mortgage related loans listed immediately
above, Bank Leumi USA placed a $3.25 million fixed charge on our deposits with
that bank.
As of December 31, 2003, Senstar GmbH obtained bank performance
guarantees in the amount of $ 153,000.
As of December 31, 2003, Senstar issued a letter of credit in the amount
of $278,000 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. Through 2003, we had obtained
royalty bearing grants from the OCS of $128,000 for certain of our research and
development projects. We are obligated to pay royalties to the OCS, amounting to
3%-5% of revenues derived from sales of the products funded with these grants,
100% - 150% of the grants received, linked to the U.S. dollar and 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.
We paid royalties of $0, $131,000 and $80,000 in the years ended
December 31, 2001, 2002 and 2003, respectively.
As of December 31, 2003, we had a remaining contingent obligation to pay
royalties in the amount of approximately $1.7 million upon the successful sale
of products developed using such research and development programs sponsored by
the Chief Scientist.
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 received
$253,000 in grants from the fund and, during 2001, 2002 and 2003, we paid the
fund $104,000, $53,000 and $0, respectively, in royalties. As of December 31,
2003, we had a remaining contingent obligation to the fund of $96,000.
Investment Tax Credit
Senstar is eligible for investment tax credits on its research and
development activities and on certain current and capital expenditures. During
2001, 2002 and 2003, Senstar recognized $277,000, $304,000 and $216,000,
respectively, of investment tax credits as a reduction of research and
development expenses.
Senstar has available investment tax credits of approximately $525,000
to reduce future federal income taxes payable. These credits will expire at
various dates from 2006 through 2012.
See also Item 4.B. "Information on the Company-Business
Overview-Research and Development; Royalties."
46
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
Item 5.A. "Operating and Financial Review and Prospects-Operating Results" and
Item 5.B. "Operating and Financial Review and Prospects-Liquidity and Financial
Resources."
E. Off-Balance Sheet Arrangements
At December 31, 2003, we have guaranteed the advance payments and the
performance of our work to 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. Our maximum potential amount of future payments we could be
required to make under our guarantees at December 31, 2003 was $3.7 million.
This figure includes guarantees of performance for our subsidiary in Germany in
the amount of $153,000. We have not recorded any liability for such amounts, as
we expect that our performance will be acceptable and to date, no guarantees
were exercised against us.
F. Tabular Disclosure of Contractual Obligations
The following table summarizes our minimum contractual obligations and
commercial commitments, including obligations of discontinued operations, as of
December 31, 2003 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 more than
Total 1 year 1-3 Years 3-5 Years 5 years
----- ------ --------- --------- -------
Long-term debt obligations....... $5,714 $3,841 $1,873 $- $-
Capital (finance) lease
obligations - - - - -
Operating lease obligations...... 1,084 357 628 99 -
Purchase obligations............. - - - - -
Other long-term liabilities
reflected on the company's ----------- ---------- ---------- ---------- -----------
balance sheet under U.S. GAAP ... - - - - -
------------ ----------- ----------- ----------- ------------
Total............................ $6,798 $4,198 $2,501 $99 $-
47
ITEM 6. Directors, Senior Management and Employees
A. Directors and Senior Management
Our directors and executive officers are as follows:
Name Age Position
---- --- --------
Jacob Even-Ezra................... 73 Chairman of the Board and Chief Executive Officer
Izhar Dekel....................... 52 President and Director
Brig. Gen. (Ret.) Emanuel Shaked.. 74 Vice President - Africa and Latin America
Marketing
Chaim Porat....................... 68 Vice President - Far East and Australia Marketing
Yehezkel Farber................... 63 Vice President - Operations
Zvi Dank.......................... 54 Vice President - Research and Development
Raya Asher........................ 36 Vice President - Finance, Chief Financial Officer,
Secretary and Director
Asaf Even-Ezra.................... 38 Vice President - Israel and West European Marketing
Dany Pizen........................ 52 Vice President - East European and CIS Marketing
Ofer Katz......................... 55 Vice President - Aviation Security
Nathan Kirsh...................... 72 Director
Jacob Nuss........................ 56 Director
Jacob Perry ...................... 60 Director
Menachem Meron.................... 76 External Director
Itzhak Hoffi...................... 77 External Director
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. All questions that arise at meetings of the
board of directors are decided by majority vote. In the event of a tie, the
chairman of the board casts the deciding vote. All directors, other than
external directors who serve for three years, hold office until the next annual
general meeting of shareholders and until their successors have been elected.
Officers serve at the discretion of the board of directors, subject to the terms
of any agreement between them and us and the provisions of the Israeli Companies
Law, 5739-1999, known as the Companies Law.
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 is a beneficial owner of
18.5% of the ordinary shares of our company held by Mira Mag Inc.
Izhar Dekel has served as our president since 1990. He became a director
in 1993. Mr. Dekel served as our finance manager from 1984 to 1990.
Brigadier-General (Ret.) Emanuel Shaked has been our vice president-
Africa and Latin America marketing since 1986. Before joining us, Mr. Shaked
served as the head of the Operations Department of the IDF, head of special
operations, and commander-in-chief of the Paratroop Corps.
Chaim Porat has been our vice president- Far East and Australian
marketing since 1988. Prior to joining us, Mr. Porat worked for Beta Engineering
Ltd. as the head of its security division.
Yehezkel Farber has been our vice president- operations since 1986.
Previously Mr. Farber was the manager of the customer systems department of IAI.
48
Zvi Dank has been vice president- research and development with us and
our predecessor since 1984. Before joining us, Mr. Dank worked as an electronic
engineer in the electronics division of IAI.
Raya Asher joined us in 1998 as vice president-finance, chief financial
officer and secretary. Ms. Asher was elected to serve as a director in 2001.
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 out
auditors, Kost Forer Gabbay & Kasierer, Certified Public Accountants in Israel,
a Member of Ernst & Young Global. Ms. Asher has a 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 been our vice president- Israel
and West European marketing since 1998. Mr. Even-Ezra also heads our video
motion detection division.
Dany Pizen joined us in 1997 as vice president- East European and CIS
marketing. 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, where he was a Lt. Colonel.
Ofer Katz joined us in 1984. Before becoming our vice president-
aviation security in 1995, he served in our software and computer development
department as manager of our production line and in operations and special
projects.
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 total ordinary shares of our
company held by Mira Mag Inc.
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. Since
1975, Mr. Nuss has served in various financial management capacities at IAI. IAI
is a former shareholder in our company.
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 at 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 executive personal of many public
organizations. Mr. Perry is also a Chairman of the Board of Directors of various
companies, including Mizrahi Bank B.M., Lipman Electronic Engineering Ltd. and
Aeronautics Defense Systems Ltd. Mr. Perry also acts as an advisor to Cellguide
Ltd.
Menachem Meron has served as an external director as of June 2001 and as
a director since 1993. Since 1988 Mr. Meron has been the general manager of
IFTIC Ltd., an international consulting company. Mr. Meron provide consulting
services to Solomon Smith Barney, Citigroup, Lockheed Martin and Northrop
Grumman Corporation. Mr. Meron currently serves on the boards of directors of
the following companies, PAZ Lubricants and Chemicals Co. Ltd., Polar
Investments Ltd., and Supercom Ltd. Mr. Meron, a retired Major General of the
IDF, has previously served as the director general of the Israeli Ministry of
Defense.
49
Itzhak Hoffi has served as an external director as of June 2001 and as a
director since December 1996. Mr. Hoffi is also a member of the boards of
directors of various companies, including: Palram Industries (1990) Ltd. and
Bank Leumi Le Israel Ltd. From 1994 until 2000, and since May 2002, Mr. Hoffi
has served as chairman of the board of Tadiran Ltd. From 1982 to 1990, Mr. Hoffi
served as general manager of the Israel Electric Corporation Ltd. From 1974
until 1982, Mr. Hoffi was the head of the Mossad, Israeli's secret intelligence
service.
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 the
relationships between Jacob Even-Ezra, Asaf Even-Ezra and Izhar Dekel, there are
no other family relationships among our directors and senior executives.
Shlomo Yanai, who served as our director from January 2003, resigned in
June 2004.
B. Compensation
During the fiscal year ended December 31, 2003, 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, for 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 external 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 Companies Law, the board of directors must approve all
compensation arrangements for the CEO 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 CEO's approval. Directors' compensation arrangements (other than
external directors) also require audit committee approval before board approval
and shareholder approval. However, pursuant to recent 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 external director is entitled to compensation as provided in
regulations promulgated under the Companies Law and is otherwise precluded from
receiving any other compensation, directly or indirectly, in connection with
such service.
During 2003, we did not grant any options to purchase ordinary shares to
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.
50
C. Board Practices
We are subject to the provisions of the Companies Law, which became
effective on February 1, 2000, superseding most of the provisions of the Israeli
Companies Ordinance (New Version), 5743-1983. The Companies Law authorizes the
Minister of Justice to adopt regulations exempting from the provisions described
below companies, such as us, whose shares are traded both in Israel and outside
of Israel.
Appointment of Directors and Term of Office
Our directors, other than our external directors as described below, are
appointed by our shareholders at our annual general meeting and hold office
until the next annual general meeting. 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.
Our officers serve at the discretion of the board of directors, subject to the
terms of any agreement between them and us and the provisions of the Companies
Law.
Directors' Service Contracts
See Item 6.B. "Directors, Senior Management and Employees-Compensation"
above.
Alternate Directors
Our articles of association provide that any director may, by written
notice to us, appoint another person to serve as an alternate director, subject
to the approval of the board of directors. Under the Companies Law, any person
who is not a director or an alternate director may act as an alternate director,
but the same person may not act as an alternate for several directors. An
alternate director may be appointed for one meeting or for another specified
period or until notice is given of the cancellation of the appointment. To our
knowledge, no director currently intends to appoint any other person as an
alternate director, except if the director is unable to attend a meeting of the
board of directors.
External Directors
Under the Companies Law, companies incorporated under the laws of Israel
whose shares have been offered to the public in Israel or outside of Israel are
required to appoint two external directors. The Companies Law requires that the
external directors be residents of Israel. However, the Minister of Justice of
the State of Israel has promulgated regulations exempting certain qualifying
dual listed companies, such as us, from the applicability of certain provisions
of the Companies Law. The Companies Regulations (Concessions for Public
Companies Whose Shares are Registered in a Stock Exchange outside Israel),
5760-2000, as amended, define "double foreign company" as a public company whose
shares
o have been offered to the public outside of Israel or were registered
on a non-Israeli stock exchange prior to February 1, 2000; and
o were registered on a stock exchange in Israel after such date.
51
Pursuant to these regulations, an external director of a double foreign company
need not be an Israeli resident.
The Companies Law provides that a person may not be appointed as an
external director if the person or the person's relative, partner, employer or
any entity under the person's control, has, as of the date of the person's
appointment to serve as an external director, or had, during the two years
preceding that date, any affiliation with the company, any entity controlling
the company or any entity controlled by the company or by this controlling
entity. The term affiliation includes:
o an employment relationship;
o a business or professional relationship maintained on a regular basis;
o control; and
o service as an officer holder.
The Companies Law further provides that if at the time the external
directors are appointed a company's board of directors is comprised solely of
members of the same gender, then at least one of the external directors must be
of a different gender than the other directors.
No person may serve as an external director if the person's position or
other business creates, or may create, conflicts of interest with such person's
responsibilities as an external director. Until the lapse of two years from
termination of office, a company may not engage an external director to serve as
an office holder and cannot employ or receive services from that person, either
directly or indirectly, including through a corporation controlled by that
person.
External directors are elected by a majority vote at a shareholders'
meeting, provided that either:
o the majority of shares voted at the meeting including at least one
third of the shares of non-controlling shareholders voted at the
meeting, vote in favor of the election; or
o the total number of shares voted against the election of the external
director does not exceed one percent of the aggregate voting rights in
the company.
The initial term of an external director is three years and may be
extended for an additional three years. Each of the external directors is
required to serve on the company's audit committee. Each other committee of a
company's board of directors is required to include at least one external
director. An external director is entitled to compensation as provided in
regulations under the Companies Law and is prohibited from receiving any other
compensation, directly or indirectly, in connection with such service.
Under the Nasdaq rules, we are required to have at least two independent
directors on our board of directors. In addition, the majority of the members of
our audit committee must be independent. Mr. Meron and Mr. Hoffi qualify as
independent directors under the Nasdaq rules and as external directors under the
Companies Law.
52
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.
Our audit committee consists of three board members who satisfy the
"independence" requirements of the Securities and Exchange Commission, Nasdaq
and Israeli Law for audit committee members. Our audit committee is currently
composed of Messrs. Menachem Meron, Itzhak Hoffi and Jacob Nuss, each of whom
satisfies these requirements. The audit committee meets at least once each
quarter.
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 external directors are serving as members of the audit
committee and at least one of the external directors was present at the meeting
in which an approval was granted.
The audit committee reviewed our audited financial statements for the
year ended December 31, 2003 and members of the committee met with both
management and our external auditors to discuss those financial statements.
Management and the external auditors have represented to the audit committee
that the financial statements were prepared in accordance with U.S. GAAP.
Members of the audit committee have received from and discussed with the
external auditors their written disclosure and letter regarding their
independence from our company as required by Independence Standards Board
Standard No. 1. Members of the audit committee also discussed with the external
auditors any matters required to be discussed by Statement on Auditing Standards
No. 61. Based upon these reviews and discussions, the audit committee has
recommended to the board of directors that the audited financial statements be
included in our Annual Report on Form 20-F for the year ended December 31, 2003.
Internal Auditor
Under the 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 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. Daniel Spira, CPA
(Isr.) is our internal auditor.
Approval of Specific Related-Party Transactions
The 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
53
with the level of care that a reasonable office holder in the same position
would have acted under the same circumstances. 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.
an office holder's 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 due to his
position as an office holder.
The Companies Law requires that an office holder of a company promptly
disclose any personal interest that he may have and all related material
information known to him in connection with any existing or proposed transaction
by the company. If the transaction is an extraordinary transaction, 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 Israeli law, an extraordinary transaction is a transaction:
o other than in the ordinary course of business;
o other than on market terms; or
o that is likely to have a material impact on a company's profitability,
assets or liabilities.
Under the 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.
54
If the transaction is an extraordinary transaction, both the audit
committee and the board of directors must approve the transaction. Under
specific circumstances, shareholder approval may also be required. An office
holder who has a personal interest in a matter that is being considered at a
meeting of the board of directors or the audit committee may not be present at
such meeting or vote on such matter.
Under the Companies Law, the disclosure requirements that apply to an
office holder also apply to a controlling shareholder of a public company. A
controlling shareholder includes a shareholder that holds 25% or more of the
voting rights in a public company, 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, and the terms of compensation of a controlling shareholder who is an
office holder, require the approval of the audit committee, the board of
directors and the shareholders of the company. The shareholder approval may
include either at least one-third of the shareholders who have no personal
interest in the transaction and are present and voting, in person, by proxy or
by written ballot, at the meeting, or a majority of the voting power present and
voting, 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
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 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 that shareholder 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
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 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 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;
55
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 the recent amendment to these regulations,
directors' compensation and employment arrangements do not require shareholder
approval provided certain criteria are met. Also, 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 Companies Law. 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
56
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 made to 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 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.
Indemnification of Directors and Officers and Limitations of Liability
The Companies Law provides that a company may not exonerate office
holders from liability for a breach of their duty of loyalty, but may exonerate
in advance office holders from their liability to the company, in whole or in
part, for a breach of their duty of care. Our articles of association provide
that, subject to any restrictions imposed by the Companies Law, we may enter
into an insurance contract providing coverage for the liability of any of our
office holders for:
o a breach of their duty of care to us or to another person;
o a breach of their duty of loyalty to us, provided that they acted in
good faith and had reasonable grounds to assume that their act would
not prejudice our interests; and
o a financial liability imposed upon them in favor of another person for
an act performed by them in their capacity as office holders.
In addition, we may indemnify office holders against the following
expenses or liabilities imposed upon them in their capacity as office holders:
o a financial liability imposed on them in favor of another person by
any judgment, including a settlement or an arbitrator's award approved
by a court; and
o reasonable litigation expenses, including attorneys' fees, incurred by
such office holders or imposed upon them by a court, in connection
with proceedings instigated by us against them or that are instigated
on our behalf or by another person, or as a result of a criminal
charge from which they were acquitted or a criminal charge in which
they were convicted for a criminal offense that does not require proof
of intent.
The Companies Law provides that a company may not indemnify an office
holder nor enter into an insurance contract which would provide coverage for any
monetary liability incurred as a result of any of the following:
57
o a breach by an officer holder of their duty of loyalty, unless the
office holder acted in good faith and had a reasonable basis to
believe that the act would not prejudice the company;
o a breach by an office holder of their duty of care if such breach was
committed intentionally or recklessly;
o an act or omission with the intent to unlawfully derive a personal
benefit; or
o a fine levied against the office holder as a result of a criminal
offense.
Under the Companies Law, the shareholders of a company may include in,
or amend a company's articles of association to include, either of the
following:
o a provision authorizing the company to grant in advance an undertaking
to indemnify an office holder, provided that the undertaking is
limited to specified classes of events that the board of directors
deem foreseeable at the time of grant and is limited to an amount
determined by the board of directors to be reasonable under the
circumstances; or
o a provision authorizing the company to retroactively indemnify an
office holder.
In addition, pursuant to the Companies Law, indemnification of, and
procurement of insurance coverage for, a company's office holders must be
approved by the audit committee and the board of directors. In the case of
directors, shareholder approval is also required.
We currently maintain a directors and officers liability insurance
policy with a per claim and aggregate coverage limit of $5 million.
D. Employees
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.
As of December 31, 2002, we employed 266 full-time employees, of whom 26
were employed in general management and administration, 46 in marketing, 37 in
production management, 111 in production, installation and maintenance, and 46
in engineering and research and development. Of our 266 full-time employees, 120
were employed in Israel, 44 were employed in the U.S., 80 were employed in
Canada and 22 were employed in various other countries.
As of December 31, 2001, we employed 235 full-time employees, of whom 30
were employed in general management and administration, 35 in marketing, 30 in
production management, 100 in production, installation and maintenance, and 40
in engineering and research and development. Of our 235 full-time employees, 103
were employed in Israel, 38 were employed in the U.S., 73 were employed in
Canada and 21 were employed in various other countries.
58
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
June 24, 2004. The percentage of outstanding ordinary shares is based on
8,205,422 ordinary shares outstanding as of June 24, 2004.
Percentage of
Number of Ordinary Outstanding Ordinary
Name Shares Owned(1) Shares
--------------------------- ------------------ --------------------
Jacob Even-Ezra(2)(6)(7)... 476,656 5.81%
Izhar Dekel(3)(7).......... - -
Brig. Gen. (Ret.)
Emanuel Shaked............. - -
Chaim
Porat...................... - -
Yehezkel Farber............ - -
Zvi Dank................... - -
Raya Asher................. - -
Asaf Even-Ezra(4)(6)....... 107,073 1.3%
Dany Pizen................. - -
Ofer Katz.................. - -
Nathan Kirsh(5)............ 1,415,097 17.25 %
Jacob Nuss................. - -
Jacob Perry................ - -
Menachem Meron............. - -
Itzhak Hoffi............... - -
-------------
*Less than 1%
(1) Except as otherwise noted and pursuant to applicable community property
laws, each person named in the table has sole voting and investment
power with respect to all ordinary shares listed as owned by such
person. Does not include shares that may be acquired pursuant to the
exercise of options.
(2) Includes Mr. Even-Ezra's beneficial ownership of 321,218 ordinary shares
held by Mira Mag, Mr. Even-Ezra is the beneficial owner of an additional
134,220 ordinary shares, and 21,218 ordinary shares held by a trustee.
59
(3) Does not include any of the 321,218 ordinary shares held by Mira Mag in
which Mr. Dekel's wife, Ornit Dekel, has an interest.
(4) Includes one-third, or 107,073 of the 321,218 ordinary shares held by
Mira Mag in which Mr. Even-Ezra has an interest.
(5) The number of ordinary shares beneficially owned by Mr. Kirsh represents
Mr. Kirsh's beneficial ownership of 1,415,097 ordinary shares held by
Mira Mag. Mr. Kirsh is a trustee of the Eurona Foundation, which owns an
84.5% interest in Mira Mag.
(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 June 24, 2004, the directors and executive officers listed above,
as a group, held options to purchase 143,045 of our ordinary shares at a
weighted average exercise price of $5.64 per share, expiring between January
2005 and January 2009.
Stock Option Plan
On February 25, 1993, our board of directors adopted a stock option plan
pursuant to which stock options may be granted to employees, officers, directors
and consultants of us or any of our subsidiaries. The purpose and intent of our
stock option plan is to enhance our ability to attract and retain experienced
and competent employees, officers, directors and consultants by providing them
with opportunities to purchase our ordinary shares.
Our stock option plan is administered by our board of directors, which
has the authority pursuant to the Companies Law to determine the persons to whom
options are granted, the number of ordinary shares to be covered by each option,
the time or times at which options are granted or exercised, and the terms and
provisions of the options. 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. The board of directors may
terminate or amend the plan in any respect, except that without prior
shareholder approval the total number of shares which may be issued under the
plan may not be increased, except by adjustment upon a recapitalization or
distribution of a stock dividend.
In May 2000, our shareholders approved an amendment to our stock option
plan to increase the number of ordinary shares reserved for issuance upon the
exercise of options under the plan to 757,200 and to extend the term of the plan
for an additional four years until February 2005. In July 2002, our shareholders
approved an amendment to our plan to increase the number of ordinary shares
reserved for issuance upon the exercise of options under the plan by an
additional 500,000 ordinary shares. In addition, in July 2002 and in July 2003
our shareholders approved the payment of a 3% stock dividend to our
shareholders. Pursuant to the provisions of our stock option 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.
In July 2002, our shareholders approved an amendment to the plan
according to which stock options granted under the plan are exercisable at a
price per share that is at least 75% of the average market price per share
during the 90-day period preceding the grant of the options. Prior to this
amendment, stock options granted under the plan were exercisable at a price per
share that was 75% of the average market price per share during the 90-day
period preceding the grant of the options.
As of December 31, 2003, options to 223,216 shares were outstanding and
additional 611,542 were available for grant.
60
On October 27, 2003, our board of directors approved the 2003 Israeli
Share Option Plan ("the 2003 plan") subject to shareholder approval. 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.
Until December 31, 2003, we did not grant any stock options under the
2003 plan.
Grants of stock options under the plans 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 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 June 24, 2004, 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)
----------------------------------- ------------ ------------------
Mira Mag Inc.(3).................. 1,736,315 21.16%
Jacob Even-Ezra(4)................ 529,701 6.41%
------------------
(1) Ordinary shares beneficially owned include shares that may be acquired
pursuant to options that are exercisable within 60 days of June 24, 2004.
(2) The percentage of outstanding ordinary shares is based on 8,205,422
ordinary shares outstanding as of June 24, 2004. Ordinary shares deemed
beneficially owned by virtue of the right of any person to acquire such
shares within 60 days of June 24, 2004, are treated as outstanding only for
the purposes of determining the percent owned by such person.
(3) Mira Mag is the holder of 1,736,315 ordinary shares. The beneficial owners
and their percentage interest in these shares are: The Eurona Foundation
81.5%, or 1,415,097ordinary shares, and Jacob Even-Ezra's three children
18.5%, or 321,218 ordinary shares. Jacob Even-Ezra beneficially owns all of
the 321,218 shares held by Mira Mag in which his children, Ornit Dekel and
Guy and Asaf Even-Ezra, have an interest. The purpose of the Eurona
Foundation, the trustees of which are Prinz Michael von Liechtenstein,
Altenbach 8, P.O. Box 339, FL-9490 Vaduz, Liechtenstein, and Nathan Kirsh,
Kapola Estate, Ezulwini, Swaziland, is to provide for the education,
maintenance and support of the family of Nathan Kirsh and such other
persons as the foundation's board may determine.
61
(4) Includes Mr. Even-Ezra's beneficial ownership of 321,218 ordinary shares
held by Mira Mag (see footnote (3) above) and Mr. Even-Ezra's beneficial
ownership of an additional 187,265 ordinary shares and 21,218 ordinary
shares held by a trustee.
As of June 24, 2004 there were 55 holders of ordinary shares of record
registered with a U.S. mailing address, including banks, brokers and nominees.
These holders of record represented less than 1% of our total outstanding
ordinary shares. Because these holders of record include banks, brokers and
nominees, the beneficial owners of these ordinary shares may include persons who
reside outside the U.S. On June 24, 2004, we had approximately 7,758 beneficial
holders of our ordinary shares.
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.
B. Related Party Transactions.
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.
In 2003 Mira Mag Inc., our then controlling shareholder, and Jacob
Even-Ezra purchased the interest of IAI in our company.
Sales to a Former Principal Shareholder
We sell our perimeter systems to IAI, which was one of our principal
shareholders, until July 2003. Jacob Nuss, one of our directors, is currently
the deputy vice-president-internal auditing of IAI, and since 1975, has served
in various financial management capacities at IAI. The terms of the contracts
under which we make sales to IAI were negotiated on an arms'-length basis and
the terms of such contracts are no more favorable to IAI than those it could
have obtained from an unaffiliated third party. Our sales to IAI during the
years ended December 31, 2001, 2002 and 2003 were $261,000, $111,000 and $88,000
respectively.
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, 2001, 2002 and 2003 were $10,000,
$77,000 and $108,000 respectively.
62
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
April 2000, we extended the term of Mr. Even-Ezra's employment agreement until
January 2004. In October 2003, the appointment of Mr. Even-Ezra as chairman of
the board was extended until January 2006 and as CEO for such a period until a
new CEO is appointed. Under the Companies Law such dual positions require
shareholders approval which must be renewed every three years. In December 2000,
our board of directors amended the term of Mr. Dekel's employment agreement.
Under the amended agreement, the term of Mr. Dekel's employment will continue
until such time as it is terminated by us or by Mr. Dekel pursuant to the terms
of the agreement.
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 2003, the total amount of our revenues from our facilities located
outside of Israel to customers outside of Israel was approximately $29.8
million, or 50% of our total revenues. The total amount of our export revenues
from our Israel facilities to countries outside of Israel was approximately $9.1
million, or 15% of our total revenues.
Legal Proceedings
During 2002, several administrative petitions were filed against us by
competitors concerning our winning, the tenders published by the MOD for the
installation of intrusion detection systems along the seam line between Israel
and the West Bank. The main claim was that the conditions for the tenders gave
us an advantage. We have defended these petitions claiming, among others, that
the competitors delayed in filing their claim. The court refused to issue any
interim decree preventing us from commencing our work and the decision was
upheld by the Supreme Court of Israel. Only one of these claims is still pending
and awaits the court resolution of certain preliminary matters. According to our
legal counsel, we have good defenses against the aforementioned claims,
therefore, no allowance was recorded in the financial statements.
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 for
63
approximately $730,000 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 actions. According to our legal counsel, we have good defenses against the
aforementioned claims. The action is in its preliminary stages.
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% 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% of our net income in 2000. In each of August 2002
and 2003, we paid a 3% 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, a total of $401,000, representing approximately 17% of our
net income in 2003. In April 2004, our board resolved to pay an additional 5%
stock dividend to our shareholders as a final dividend for the year 2003. The
payment of the stock dividend is subject to our shareholders' approval.
B. Significant Changes.
Except as otherwise disclosed in this annual report, there has been no
material change in our financial position since December 31, 2003.
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.
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
---- --- ---- ---
Year
----
1999.......... $3.9375 $2.1875 NIS -- NIS --
2000.......... 4.825 2.8125 -- --
2001.......... 14.24 2.9375 64.00 20.50
2002.......... 13.49 4.57 59.60 22.24
2003.......... 9.97 4.74 42.68 22.69
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Quarterly Stock Information
The following table sets forth, for each of the full financial quarters
in 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
---- --- ---- ---
2002
----
First Quarter........ $13.49 $8.50 NIS 59.60 NIS 40.50
Second Quarter....... 12.80 8.50 59.40 43.00
Third Quarter........ 11.65 5.95 53.40 30.64
Fourth Quarter....... 6.93 4.57 31.90 22.24
2003
----
First Quarter........ $6.28 $4.84 NIS 29.66 NIS 24.15
Second Quarter....... 6.81 4.74 28.23 22.69
Third Quarter........ 9.97 5.55 42.68 25.62
Fourth Quarter....... 9.50 7.55 42.23 33.74
Monthly Stock Information
The following table sets forth, for each month in the last six months of
2003, 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
---- --- ---- ---
2003
----
July $9.03 $5.55 NIS 37.17 NIS 25.62
August 9.97 6.00 42.68 36.33
September 9.13 7.75 40.45 35.79
October 9.00 7.55 38.27 35.35
November 9.50 8.47 42.23 37.76
December 8.94 7.60 37.47 33.74
B. Plan of Distribution
Not applicable.
65
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.
On February 1, 2000, the Companies Law, came into effect and superseded
most of the provisions of the Israeli Companies Ordinance (New Version),
5743-1983, except for certain provisions which relate to bankruptcy, dissolution
and liquidation of companies. The Companies Law authorizes the Minister of
Justice to adopt regulations exempting from the provisions of the Companies Law,
certain of which are described below, companies, such as us, whose shares are
traded outside of Israel. Under the Companies Law, various provisions of such
law, some of which are detailed below, overrule the current provisions of our
articles of association.
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 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 external director.
66
According to the 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.
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 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 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 external 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 arrangement
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.
67
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 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.
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 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.
68
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.
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 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 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
69
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 before 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.
Provisions Restricting a Change in Control of Our Company
The 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 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 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% shareholder of the
company. However, this rule does not apply if there already is another 25%
shareholder of the company. Similarly, if there already is another shareholder
who holds more than 25% but less than 50% of the company's outstanding share
capital, 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 45% shareholder of the Company. However, under the Companies Law,
if following any acquisition of shares the acquirer would hold 90% or more of
the company's shares, the acquisition must be made by means of a tender offer
for all of the shares of the class. These rules do not apply if the acquisition
is made by way of a private placement. In addition,
70
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.
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 summary of the current tax structure applicable to
companies in Israel, with special reference to its effect on us and our
shareholders. The following also contains a discussion of Israeli government
programs benefiting us. To the extent that the discussion is based on new tax
legislation that has not been subject to judicial or administrative
interpretation, we cannot assure you that the tax authorities will accept the
views expressed in the discussion in question. The discussion is not intended,
and should not be taken, as legal or professional tax advice and is not
exhaustive of all possible tax considerations.
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
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Parliament on July 24, 2002. On December 17, 2002, the Israeli Parliament
approved a number of amendments to the tax reform, which came into effect on
January 1, 2003.
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.
Regarding 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 (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" below; and
o Introduction of a new regime for the taxation of shares and options
issued to employees and officers (including directors).
General Corporate Tax Structure
Israeli companies are subject to company tax at a rate of 36% of taxable
income. However, the effective tax rate payable by a company that derives income
from an approved enterprise, discussed further below, may be considerably less.
See "-Law for the Encouragement of Capital Investments, 1959." Subject to
relevant tax treaties, dividends or interest received by an Israeli company from
its foreign subsidiaries are generally subject to tax regardless of such
company's status as an approved enterprise.
Law for the Encouragement of Industry (Taxes), 1969
According to the Law for the Encouragement of Industry (Taxes), 1969,
generally referred to as the Industry Encouragement Law, an industrial company
is a company resident in Israel, at least 90% of the income of which, in a given
tax year, determined in Israeli currency exclusive of income from
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specified government loans, capital gains, interest and dividends, is derived
from an industrial enterprise owned by it. An industrial enterprise is defined
as an enterprise whose major activity in a given tax year is industrial
production activity.
Under the Industry Encouragement Law, industrial companies are entitled
to the following preferred corporate tax benefits:
o deduction of purchases of know-how and patents over an eight-year
period for tax purposes, at a rate of 12.5% per year;
o deduction of specified expenses incurred for a public issuance of
securities over a three-year period for tax purposes;
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.
Eligibility for benefits under the Industry Encouragement Law is not
subject to receipt of prior approval from any governmental authority.
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 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 36%,
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
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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 exemption period or within 12 years after
the period. The company must withhold this tax at the source, regardless of
whether the dividend is converted into foreign currency.
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.
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
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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 exceed 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 three approved enterprise expansion programs which
were approved in 1992, 1997 and 2001, respectively, and under which we are
entitled to tax benefits. The periods of benefits for two of our approved
enterprise programs will expire in 2003 and 2007, respectively, and the period
of benefits for our third approved enterprise program has not yet begun. 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 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 for the payment of
royalties from the sale of products developed under the program. Regulations
under the Research Law generally provide for the payment of royalties to the OCS
of 3%-5% on sales of products and services derived from technology developed
using these grants until 100% of the dollar-linked grant is repaid. Upon full
repayment of the grant, there is no further liability for royalties.
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 Chief
Scientist, some of the manufacturing volume may be performed outside Israel,
provided that the we pay royalties at an increased rate and the aggregate
repayment amount is increased. The increase in royalties depends upon the
manufacturing volume that is performed outside of Israel, as follows:
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Manufacturing volume Royalties to the Chief Scientist
outside of Israel as a percentage of grant
--------------------- --------------------------------
less than 50% 120%
between 50% and 90% 150%
more than 90% 300%
Under the Research Law, the technology developed with OCS grants may not
be transferred to third parties without the prior approval of a governmental
committee. However, such approval is not required for the export of any products
developed using the grants. Approval of the transfer of technology may be
granted in specific circumstances if the recipient abides by the provisions of
the Research Law and related regulations, including the restrictions on the
transfer of know-how and the obligation to pay royalties in an amount that may
be increased. We cannot assure you that any consent, if requested, will be
granted.
Effective for grants received from the OCS under programs approved after
January 1, 1999, the outstanding balance of the grants will be subject to
interest equal to the 12 month LIBOR applicable to dollar deposits that is
published on the first business day of each calendar year.
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 as
follows:
o Where a company's equity, as calculated under the Inflationary
Adjustments Law, exceeds the depreciated cost of fixed assets, a
deduction from taxable income is permitted equal to the excess
multiplied by the applicable annual rate of inflation. The maximum
deduction permitted in any single tax year is 70% of taxable income,
with the unused portion permitted to be carried forward.
o Where a company's depreciated cost of fixed assets exceeds its equity,
then the 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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o Gains on traded securities, which are normally exempt from tax, are
taxable in specified circumstances. However, securities dealers are
subject to the regular tax rules applicable to business income in
Israel.
Pursuant to the Inflationary Adjustments Law, results for tax purposes
are measured in real terms in accordance with changes in the Israeli CPI. The
discrepancy between the change in the Israeli CPI and the change in the exchange
rate of the NIS to the dollar, each year and cumulatively, may result in a
significant difference between taxable income and the income denominated in
dollars as reflected in our financial statements (see note 14 of the notes to
our consolidated financial statements). A foreign investors' company may,
subject to certain conditions, elect to measure results, for tax purposes, in
dollar terms.
Until 2002, we measured the results for tax purposes in terms of
earnings in NIS, after certain adjustments for increases in Israel's CPI.
Commencing January 1, 2003, the basis for remeasurement is the changes in the
exchange rate of the U.S. dollar.
For the years 2001 and 2002, the differences between the change in
Israel's CPI and in the NIS/U.S. dollar exchange rate causes a difference
between taxable income or loss and the income or loss before taxes reflected in
the consolidated financial statements. In accordance with paragraph 9(f) of SFAS
No. 109, we have not provided deferred income taxes on this difference between
the reporting currency and the tax bases of assets and liabilities.
Capital Gains Tax
Israeli law generally imposes a capital gains tax on the sale of capital
assets located in Israel, including shares in Israeli companies, by both
residents and non-residents of Israel. Unless a Specific exemption is available
or unless a tax treaty between Israel and the shareholder's country of residence
provides otherwise. 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.
Prior to the tax reform, sales of our ordinary shares by individuals
were generally exempt from Israeli capital gains tax for so long as they were
quoted on Nasdaq or listed on a stock exchange in a country appearing in a list
approved by the Controller of Foreign Currency and we qualified as an Industrial
Company. The above was also applicable following the dual listing of our shares
in the Israeli Stock Exchange.
Pursuant to the tax reform, generally, capital gains tax is imposed at a
rate of 15% on real gains derived on or after January 1, 2003, from the sale of
shares in companies (i) publicly traded on the Tel Aviv Stock Exchange ("TASE")
or; (ii) (subject to a necessary determination by the Israeli Minister of
Finance) Israeli companies publicly traded on a recognized stock exchange
outside of Israel (such as Magal).
This tax rate does not apply to: (i) dealers in securities; (ii)
shareholders that report in accordance with Chapter B to the Inflationary
Adjustment Law; or (iii) shareholders who acquired their shares prior to an
initial public offering (that are subject to a different tax arrangement).
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The tax basis of shares acquired prior to January 1, 2003 will be
determined in accordance with the average closing share price in the three
trading days preceding January 1, 2003. However, a request may be made to the
tax authorities to consider the actual adjusted cost of the shares as the tax
basis if it is higher than such average price.
Non-Israeli residents are exempt from Israeli capital gains tax on any
gains derived from the sale of shares publicly traded on a the TASE, and are
exempt from Israeli capital gains tax on any gains derived from the sale of
shares of Israeli companies publicly traded on a recognized stock exchange
outside of Israel, provided however that such capital gains are not derive from
a permanent establishment in Israel and provided that such shareholders did not
acquire their shares prior to an initial public offering.
However, non-Israeli corporations will not be entitled to such exemption
if an Israeli resident (i) has a controlling interest of 25% or more in such
non-Israeli corporation, or (ii) is the beneficiary or is entitled to 25% or
more of the revenues or profits of such non-Israeli corporation, whether
directly or indirectly.
In any event, the provisions of the tax reform will not affect the
exemption from capital gains tax for gains accrued before January 1, 2003, as
described above. In some instances where our shareholders may be liable for
Israeli tax on the sale of their ordinary shares, the payment of the
consideration may be subject to the withholding of Israeli tax at the source.
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.
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 other than bonus
shares, or stock dividends, income tax at the rate of up to 25% is withheld at
source, unless a different rate is provided in a treaty between Israel and the
shareholder's country of residence. Under the U.S.-Israel Tax Treaty, the
maximum tax on dividends paid to a holder of ordinary shares who is a Treaty
U.S. Resident is 25%. However, under the Investment Law, dividends generated by
an Approved Enterprise are taxed at the rate of 15%. Furthermore, dividends not
generated by an Approved Enterprise paid to a U.S. company holding 10% or more
of our ordinary shares are taxed at a rate of 12.5%.
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Under an amendment to the Inflationary Adjustments Law, non-Israeli
corporations might be subject to Israeli taxes on the sale of traded securities
of an Israeli company, subject to the provisions of any applicable double
taxation treaty or unless a specific exemption is available.
For information with respect to the applicability of Israeli capital
gains taxes on the sale of ordinary shares by United States residents, see above
"-- Capital Gains Tax on Sales of Our Ordinary Shares."
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, non-resident aliens of the U.S. or 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.
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.
Taxation of Dividends
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 principles. You will be required to include this amount of dividends
in gross income as ordinary income (see "-New Tax Law Applicable to Dividends
and Long-Term Capital Gain," below). Distributions in excess of our earnings and
profits will be treated as a non-taxable return of
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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.
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, subject to certain limitations set out in the Code (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 (see "-New Tax Law Applicable to Dividends and Long-Term Capital
Gain," below). Dividends generally will be treated as foreign-source passive
income or financial services income for United States foreign tax credit
purposes. Foreign income taxes exceeding the credit limitation for the year of
payment or accrual may be carried back for two taxable years and forward for
five taxable years in order to reduce U.S. federal income taxes, subject to the
credit limitation applicable in each of such years. Other restrictions on the
foreign tax credit include a prohibition on the use of the credit to reduce
liability for the U.S. individual and corporation alternative minimum taxes by
more than 90%. 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 30-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.
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 amount 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
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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.
New Tax Law Applicable to Dividends and Long-Term Capital Gain
Under recently enacted amendments to the Code, dividends received by
noncorporate U.S. Holders from certain foreign corporations, and long-term
capital gain realized by noncorporate U.S. Holders, generally are subject to
U.S. federal income tax at a reduced maximum tax rate of 15 percent through
December 31, 2008. Dividends received with respect to ordinary shares should
qualify for the 15 percent rate. The rate reduction does not apply to dividends
received from PFICs, see discussion below, or in respect of certain short-term
or hedged positions in common stock 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 rate reduction. U.S. Holders of ordinary shares should consult their own
tax advisors regarding the implications of these rules in light of their
particular circumstances.
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, then, 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, dividends would not qualify for the reduced
maximum tax rate, discussed above, and
81
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,
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 gain recognized upon the disposition of ordinary shares would be
taxable as ordinary income, 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.
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 fourth lowest 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.
82
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.
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 450 Fifth Street,
N.W., 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.
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.
83
Our financial expenses are sensitive primarily to LIBOR, since the
majority of our long-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
2004 2005 2006 2007 Total 12/31/03
---- ---- ---- ---- ----- --------
Liabilities:
Short Term Loans................. $12,597 - - - $12,597 $12,597
Weighted Average Interest Rate... 5.3% - - - -
Long Term Loans.................. $3,841 $1,873 - - $5,714 $5,564
Weighted Average Interest Rate .. 4.60% 8.25% - - -
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 2004 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 2004, the NIS has increased
approximately 2.5% against the dollar. We are also subject to exchange rate
fluctuations related to our activities in Canada.
Since part of our revenues are quoted in NIS, and a portion of our
expenses are incurred in NIS, our results may be adversely affected by a change
in the rate of inflation in Israel if the amount of our revenues in NIS
decreases and is less than the amount of our expenses in NIS (or if such
decrease is offset on a lagging basis) or if such change in the rate of
inflation is not offset, or is offset on a lagging basis, by a corresponding
devaluation of the NIS against the dollar and other foreign currencies. A
hypothetical 10 percent devaluation in the rate of exchange of the NIS against
the dollar, with all other variables held constant, on the exposed revenues
would result in an approximately $280,000 decrease in our expected revenues for
2004.
We periodically enter into foreign exchange contracts to offset the risk
of currency exchange rate fluctuations in connection with certain sales and
purchase transactions. During 2003, we entered into forward contracts to hedge a
portion of our Euro revenues. These forward contracts are designated as cash
flow hedges, as defined by SFAS No. 133, as amended, and we believe they are
effective as a hedge against these Euro denominated revenues. The effective
portion of the gain or loss on such derivative instruments is included in
revenues and in financial expenses in our statement of income.
As of the year ended December 31, 2003, our total losses on derivative
instruments were $278,000, of which $178,000 was recorded in revenues, and
$100,000 was recorded in financial expenses. As of December 31, 2003, the
unrealized losses on forward contracts amounted to $950,000.
ITEM 12. Description of Securities Other Than Equity Securities
Not applicable.
84
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
Pursuant to the Israeli Securities Law, a company may not register its
shares on any Israeli stock exchange unless its share capital consists of only
one class of shares. Further, pursuant to the Israeli Securities Law, an Israeli
company whose shares are traded on a stock exchange outside of Israel or on
Nasdaq, may register its shares on an Israeli stock exchange under a simplified
and expedited process. In connection with effectuating the dual registration of
our ordinary shares on Nasdaq and the Tel Aviv Stock Exchange, we were required
by the Israeli Securities Law to cancel all of our issued and outstanding
deferred shares, by repurchasing such deferred shares. Accordingly, following
approval by our audit committee, our board of directors, and our shareholders at
our 2001 annual general meeting, we entered into an agreement pursuant to which
we purchased 186,480 deferred shares from Mira Mag and 65,520 deferred shares
from IAI for aggregate consideration equal to the aggregate nominal value of
such deferred shares. Subsequent to such purchase, and following approval by our
shareholders at our 2001 annual general meeting, we amended our articles of
association to reclassify the deferred shares we purchased from Mira Mag and IAI
and pursuant to the Companies Law, such shares are currently deemed dormant
shares.
ITEM 15. Controls and Procedures
During the year 2003, we carried out an evaluation, under the
supervision and with the participation of our management, including our chief
executive officer and chief financial officer, of the effectiveness of the
design and operation of our disclosure controls and procedures pursuant to Rule
13a-14 of the Securities Exchange Act of 1934. Based upon that evaluation, our
chief executive officer and chief financial officer concluded that our
disclosure controls and procedures are effective in timely alerting them to
material information relating to us required to be included in our periodic SEC
filings.
There have been no significant changes in our internal controls or other
factors which could significantly affect internal controls subsequent to the
date we carried out the evaluation.
It should be noted that any system of controls, however well designed
and operated, can provide only reasonable, and not absolute, assurance that the
objectives of the system are met. In addition, the design of any control system
is based in part upon certain assumptions about the likelihood of future events.
Because of these and other inherent limitations of control systems, there can be
no assurance that any design will succeed in achieving its stated goals under
all potential future conditions.
ITEM 16. [Reserved]
ITEM 16A. Audit Committee Financial Expert
Our board of directors has determined that Jacob Nuss meets the
definition of an audit committee financial expert, as defined in Item 401 of
Regulation S-K.
85
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 Accounting 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.
(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.
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
accountants, 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.
86
ITEM 16D. Exemptions from the Listing Requirements and Standards for Audit
Committee
Not applicable.
ITEM 16E. Purchase of Equity Securities by the Issuer and Affiliates and
Purchasers
Issuer Purchase of Equity Securities
Not applicable.
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 Shares
2.2**** The Registrant's Stock Option Plan (1993), as amended
2.4***** Form of Underwriters' Warrant Agreement
2.5***** 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
10.1***** Form of Underwriting Agreement
21 List of Subsidiaries of the Registrant
23.1 Consent of Kost Forer Gabbay & Kasierer
31.1 Certification of Chief Executive Officer pursuant to Rule
13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as
amended.
31.2 Certification of Chief Financial Officer pursuant to Rule
13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as
amended
87
Exhibit
No. Description
------- ----------------------------------------------------------------
32.1 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
32.2 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.
---------------
* 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.
88
MAGAL SECURITY SYSTEMS LTD. AND ITS SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
AS OF DECEMBER 31, 2003
IN U.S. DOLLARS
INDEX
Page
----
Report of Independent Auditors F-2
Consolidated Balance Sheets F-3 - F-4
Consolidated Statements of Income F-5
Statements of Changes in Shareholders' Equity and
Comprehensive Income (Loss) F-6
Consolidated Statements of Cash Flows F-7 - F-8
Notes to Consolidated Financial Statements F-9 - F-40
F-1
ERNST & YOUNG
o Kost Forer Gabbay & Kasierer
3 Aminadav St. o Phone: 972-3-6232525
Tel-Aviv 67067, Israel Fax: 972-3-5622555
REPORT OF INDEPENDENT AUDITORS
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,
2002 and 2003, and the related consolidated statements of income, changes in
shareholders' equity and comprehensive income (loss) and cash flows for each of
the three years in the period ended December 31, 2003. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with 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 as to whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above,
present fairly, in all material respects, the consolidated financial position of
the Company and its subsidiaries as of December 31, 2002 and 2003, and the
consolidated results of their operations and cash flows for each of the three
years in the period ended December 31, 2003, in conformity with accounting
principles generally accepted in the United States.
/s/Kost Forer Gabbay and Kasierer
KOST FORER GABBAY & KASIERER
A Member of Ernst & Young Global
Tel-Aviv, Israel
February 10, 2004
Except for Note 10e, for which the date is February 18, 2004
Except for Note 18, for which the date is April 28, 2004
F-2
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
U.S. dollars in thousands
December 31,
------------------
2002 2003
-------- -------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 2,519 $ 4,389
Short-term bank deposits (Note 11c) 3,708 5,750
Restricted bank deposit - 3,250
Trade receivables (net of allowance for doubtful accounts
- $ 150 in 2002 and $ 187 in 2003) 9,133 14,885
Unbilled accounts receivable 7,691 5,072
Other accounts receivable and prepaid expenses 2,256 3,332
Deferred income taxes 602 979
Inventories (Note 3) *)8,112 11,777
------- -------
Total current assets *)34,021 49,434
----- ------- -------
LONG-TERM INVESTMENTS AND TRADE RECEIVABLES:
Long-term trade receivables (Note 2g) 1,510 300
Long-term bank deposits 8,649 3,051
Severance pay fund 1,724 1,960
------- -------
Total long-term investments and trade receivables 11,883 5,311
----- ------- -------
PROPERTY AND EQUIPMENT, NET (Note 5) *)9,128 11,505
------- -------
DEFERRED INCOME TAXES 511 335
------- -------
INTANGIBLE ASSETS, NET (Note 6) 342 713
------- -------
GOODWILL (Note 6) 3,856 4,145
------- -------
Total assets $ 59,741 $71,443
----- ======== =======
*) 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,
--------------------
2002 2003
--------- --------
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Short-term bank credit (Note 7) $ 9,266 $ 12,597
Current maturities of long-term loans (Note 9) 1,091 3,841
Trade payables 4,192 5,077
Other accounts payable and accrued expenses (Note 8) 3,784 6,518
-------- --------
Total current liabilities 18,333 28,033
----- -------- --------
LONG-TERM LIABILITIES:
Unrealized losses on forward contracts - 561
Long-term loans (Note 9) 4,698 1,873
Accrued severance pay 1,679 1,992
-------- --------
Total long-term liabilities: 6,377 4,426
----- -------- --------
COMMITMENTS AND CONTINGENT LIABILITIES (Note 10)
SHAREHOLDERS' EQUITY AND COMPREHENSIVE INCOME (LOSS):
Share capital (Note 12): Ordinary shares of NIS 1 par value:
Authorized: 19,748,000 shares at December 31, 2002 and 2003;
Issued and outstanding: 7,666,370 and 8,035,779 shares at
December 31, 2002 and 2003, respectively 2,600 2,683
Additional paid-in capital 21,791 24,098
Deferred stock compensation (3) -
Accumulated other comprehensive income (loss) (1,006) 479
Retained earnings 11,649 11,724
-------- --------
Total shareholders' equity and comprehensive income (loss) 35,031 38,984
----- -------- --------
Total liabilities and shareholders' equity and
----- comprehensive income (loss) $ 59,741 $ 71,443
======== ========
The accompanying notes are an integral part of the consolidated financial
statements.
F-4
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
U.S. dollars in thousands (except share and per share data)
Year ended December 31,
------------------------------------------
2001 2002 2003
------------ ------------ -------------
Revenues (Note 15 and 16) $ 41,020 $ 42,966 $ 59,361
Cost of revenues 21,505 23,924 33,378
----------- ----------- -----------
Gross profit 19,515 19,042 25,983
----------- ----------- -----------
Operating expenses:
Research and development, net (Note 17a) 3,054 3,128 4,773
Sales and marketing, net 7,933 8,642 11,585
General and administrative 4,949 4,938 5,305
----------- ----------- -----------
Total operating expenses 15,936 16,708 21,663
----------- ----------- -----------
Operating income 3,579 2,334 4,320
Financial income (expenses), net (Note 17b) 40 199 (1,003)
----------- ----------- -----------
Income before taxes on income 3,619 2,533 3,317
Taxes on income (Note 14) 452 645 913
----------- ----------- -----------
Net income $ 3,167 $ 1,888 $ 2,404
=========== =========== ===========
Basic net earnings per share (Note 13) $ 0.41 $ 0.24 $ 0.30
=========== =========== ===========
Diluted net earnings per share (Note 13) $ 0.40 $ 0.23 $ 0.30
=========== =========== ===========
Weighted average number of Ordinary shares used in
computing basic net earnings per share 7,737,512 7,866,477 7,947,778
=========== =========== ===========
Weighted average number of Ordinary shares used in
computing diluted net earnings per share 7,924,849 8,069,138 8,028,626
=========== =========== ===========
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 AND COMPREHENSIVE INCOME (LOSS)
U.S. dollars in thousands
Accumulated
other Total
Additional Deferred comprehensive comprehensive Total
Deferred Ordinary paid-in stock income Retained income shareholders'
shares shares capital compensation (loss) earnings (loss) equity
--------- -------- ---------- ------------ ------------- --------- -------------- -------------
Balance as of January 1, 2001 $ 72 $ 2,478 $ 19,474 $ (58) $ (715) $ 9,648 $ 30,899
Dividend declared and paid - - - - - (942) (942)
Exercise of share options - 19 125 - - - 144
Exercise of warrants - 11 (11) - - - -
Purchase of deferred shares (72) - 11 - - - (61)
Deferred stock compensation - - 34 (34) - - -
Amortization of deferred stock
compensation - - - 72 - - 72
Stock dividend - 75 2,037 - - (2,112) -
Comprehensive income:
Net income - - - - - 3,167 $ 3,167 3,167
Foreign currency translation
adjustments - - - - (579) - (579) (579)
-------- -------- -------- -------- -------- -------- -------- --------
Total comprehensive income $ 2,588
========
Balance as of December 31, 2001 - 2,583 21,670 (20) (1,294) 9,761 32,700
Exercise of share options - 13 125 - - - 138
Exercise of warrants - 4 (4) - - - -
Amortization of deferred stock
compensation - - - 17 - - 17
Comprehensive income:
Net income - - - - - 1,888 $ 1,888 1,888
Foreign currency translation
adjustments - - - - 288 - 288 288
-------- -------- -------- -------- -------- -------- -------- --------
Total comprehensive income $ 2,176
========
Balance as of December 31, 2002 - 2,600 21,791 (3) (1,006) 11,649 35,031
Declared dividend - - - - - (401) (401)
Exercise of share options - 30 432 - - - 462
Amortization of deferred stock
compensation - - - 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 $ - $ 2,683 $ 24,098 $ - $ 479 $ 11,724 $ 38,984
======== ======== ======== ======== ======== ======== ========
The accompanying notes are an integral part of the consolidated financial
statements.
F-6
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
U.S. dollars in thousands
Year ended December 31,
-------------------------------
2001 2002 2003
--------- ------- --------
Cash flows from operating activities:
-------------------------------------
Net income $ 3,167 $ 1,888 $ 2,404
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation and amortization 1,362 1,096 1,399
Gain on sale of property and equipment (27) (15) (9)
Accrued interest on short and long-term deposits 38 (508) (199)
Amortization of deferred stock compensation 72 17 3
Increase in trade receivables (595) (2,861) (4,103)
Decrease in related parties receivables 65 1 28
Decrease (increase) in unbilled accounts receivable (3,151) (2,101) 2,708
Increase in other accounts receivable and prepaid
expenses (4) (1,822) (836)
Decrease (increase) in deferred income taxes (136) 444 (88)
Decrease (increase) in inventories 766 *) 468 (2,586)
Decrease (increase) in long-term trade receivables (2,213) 705 1,210
Increase (decrease) in other payables and accrued
expenses 682 (532) 1,727
Increase (decrease) in trade payables (392) 786 10
Accrued severance pay, net (2) (72) 77
------- ------- -------
Net cash provided by (used in) operating activities (368) *)(2,506) 1,745
------- ------- -------
Cash flows from investing activities:
-------------------------------------
Purchase of short-term and long-term bank deposits (674) - -
Proceeds from short-term deposits - - 505
Proceeds from sale of property and equipment 48 35 33
Purchase of property and equipment (1,158) *)(1,527) (3,194)
Purchase of know-how and patents (18) (14) (48)
Acquisition of activity regarding personal portable
duress alarm system (a) - - (902)
------- ------- -------
Net cash used in investing activities (1,802) *)(1,506) (3,606)
------- ------- -------
*) Reclassified.
The accompanying notes are an integral part of the consolidated financial
statements.
F-7
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
U.S. dollars in thousands
Year ended December 31,
-------------------------------
2001 2002 2003
--------- ------- --------
Cash flows from financing activities:
-------------------------------------
Short-term bank credit, net 1,085 3,911 3,098
Proceeds from long-term bank loans 1,350 - 43
Principal payment of long-term bank loans (180) (158) (103)
Purchase of deferred shares (61) - -
Proceeds from exercise of employee stock options 144 138 462
Dividend paid (942) - -
------- ------- -------
Net cash provided by financing activities 1,396 3,891 3,500
------- ------- -------
Effect of exchange rate changes on cash and cash
equivalents (67) (98) 231
------- ------- -------
Increase (decrease) in cash and cash equivalents (841) (219) 1,870
Cash and cash equivalents at the beginning of the year 3,579 2,738 2,519
------- ------- -------
Cash and cash equivalents at the end of the year $ 2,738 $ 2,519 $ 4,389
======= ======= =======
Supplemental disclosures of cash flows activities:
--------------------------------------------------
(i)Cash paid during the year for:
Interest $ 925 $ 932 $ 1,099
======= ======= =======
Taxes $ 202 $ 1,415 $ 1,544
======= ======= =======
(ii) Non-cash activities:
Declared dividend $ - $ - $ 401
======= ======= =======
(a) Acquisition of activity regarding personal
portable duress alarm system:
Net fair value of the assets acquired at the
acquisition date was as follows:
Inventory $ 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
are engaged in the development, manufacturing and marketing of
computerized security systems used to automatically detect and
deter human intrusion for both civilian and military markets in
Israel and throughout the world. A majority of the Company's
sales is generated in the U.S.A., Canada, Europe and Israel.
As for major customer data, see Note 16b.
b. Acquisition of activity in the field of Personal Emergency
locating systems:
On July 1, 2003, the Company's subsidiary acquired the business
activity of Dominion Wireless Inc. ("DW") for an aggregate
purchase price of $ 902, out of which $ 74 is attributed to
purchase costs.
As of December 31, 2003, the total purchase price was fully paid
in cash. DW will be entitled to an "earn out" of 50% of operating
income related to the acquired activity. When the contingency is
resolved and additional consideration, if any, is distributable,
the Company will record the amounts as additional consideration
for the acquisition.
DW developed, manufactured, sold and supported 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 has expanded the
product line of the Company and enables the Company to offer its
customers a comprehensive range of security systems.
The acquisition was accounted for using the purchase method of
accounting as determined in Statement of the Financial Accounting
Standards Board ("FASB") No. 141, "Business Combinations", and
accordingly, the purchase price has been allocated to the assets
acquired based on the estimated fair value 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, as follows:
Inventory $ 376
Property and equipment 90
Technology 436
-----
$ 902
=====
The amount of the excess cost attributable to the 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.
The amount allocated to technology is amortized on a
straight-line basis over a period of 8 years.
The operations of DW are included in the consolidated statements
since July 1, 2003.
F-9
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
U.S. dollars in thousands
NOTE 1:- GENERAL (Cont.)
The unaudited pro forma information below assumes that the
acquisition had been consummated on January 1, 2002 and 2003, and
includes the effect of amortization of intangible assets from
that date. This data is presented for information purposes only
and is not necessarily indicative of the results that would have
been achieved had the acquisition taken place on those dates. The
pro forma information is as follows:
Year ended December 31,
------------------------------
2002 2003
------------- -------------
Unaudited
------------------------------
Revenues $ 47,474 $ 59,933
============= =============
Net income $ 579 $ 1,910
============= =============
Basic net earnings per share $ 0.07 $ 0.24
============= =============
Diluted net earnings per share $ 0.07 $ 0.24
============= =============
c. Inventories write-off:
The Company periodically assesses the valuation of its
inventories with respect to slow-moving items, revenue forecasts
and technological obsolescence. When inventories on hand exceed
the foreseeable demand or become obsolete, the value of excess
inventory, is written off.
During 2001, 2002 and 2003, the Company recorded inventories
write-offs in a total amount of $ 808, $ 244 and $ 601,
respectively.
d. The Company depends on limited sources for components and if it
is unable to obtain these components when needed, it will
experience delays in manufacturing its products and the financial
results may be adversely affected.
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES
The consolidated financial statements have been prepared in accordance
with accounting principles generally accepted in the United States
("US 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 effect the amounts reported
in the financial statements and accompanying notes. Actual
results could differ from those estimates.
b. Financial statements in U.S. dollars:
The majority of the revenues, of the Company and certain of its
subsidiaries is generated in U.S. dollars ("dollar"). 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 and certain of its subsidiaries is the dollar.
F-10
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
U.S. dollars in thousands
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)
Accordingly, monetary accounts maintained in currencies other
than the dollar are remeasured into dollars in accordance with
Statement of the Financial Accounting Standards Board ("FASB")
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 certain foreign subsidiaries whose
functional currency is not the dollar, 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 period. 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 have been eliminated upon consolidation.
d. Cash equivalents:
Cash equivalents are short-term highly liquid investments that
are readily convertible to cash with original maturities of three
months or less.
e. Short-term, long-term bank deposits and structured note:
Short-term bank deposits have maturities of more than three
months and less than one year. Deposits are presented at their
cost, including accrued interest. As of December 31, 2003, the
deposits are in dollars and bear interest at a weighted average
rate of 4.1%
A bank deposit structured note with maturity of more than one
year is included in long-term investments. This structured note
is based on the changes in the LIBOR rate. As of December 31,
2003, total interest amounted to $ 50. The structured note is
accounted for in accordance with the provisions of FASB Emerging
Issues Task Force Issue No. 96-12, "Recognition of Interest
Income and Balance Sheet Classification of Structured Notes"
(EITF No. 96-12").
f. Inventories:
Inventories are stated at the lower of cost or market value.
Inventory write-offs are provided to cover risks arising from
slow-moving items or technological obsolescence.
Cost is determined as follows:
Raw materials, parts and supplies - using the "first-in,
first-out" method.
Work-in-progress - represents the cost of production in progress.
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.)
Finished products - on the basis of direct manufacturing costs
with the addition of allocable indirect manufacturing costs.
g. Long-term trade receivables:
Long-term receivables from extended payment agreements are
recorded at estimated present value determined based on current
rates of interest and reported at the net amounts in the
accompanying financial statements. Imputed interest is
recognized, using the effective interest method as a component of
financial income in the statements of income.
h. Property and equipment:
Property and equipment are stated at cost, net of accumulated
depreciation.
Depreciation is computed by the straight-line method over the
estimated useful lives of the assets as follows:
%
-------------------------
Buildings 4
Machinery and equipment 10-33 (mainly at 10)
Motor vehicles 15
Promotional display 25-50
Office furniture and equipment 6-33
Over the term of the
Leasehold improvements lease
i. Impairment of long-lived assets:
The Company's long-lived assets and certain identifiable
intangibles are reviewed for impairment in accordance with
Statement of Financial Accounting Standard No. 144, "Accounting
for the Impairment or Disposal of Long- Lived Assets" ("SFAS No.
144") whenever events or changes in circumstances indicate that
the carrying amount of an asset may not be recoverable.
Recoverability of assets to be held and used is measured by a
comparison of the carrying amount of an asset to the future
undiscounted cash flows expected to be generated by the assets.
If such assets are considered to be impaired, the impairment to
be recognized is measured by the amount by which the carrying
amount of the assets exceeds the fair value of the assets. During
the years ended December 31, 2001, 2002 and 2003, no impairment
losses were recognized.
j. Intangible assets:
Intangible assets subject to amortization that arose from
acquisitions prior to July 1, 2001, are being amortized on a
straight-line basis over their useful life in accordance with APB
Opinion No. 17, "Intangible Assets" ("APB No. 17").
Intangible assets acquired in a business combination for which
the date is on or after July 1, 2001, should be 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
Statement of Financial Accounting Standards No. 142 "Goodwill and
Other Intangible Assets" ("SFAS No. 142").
F-12
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
U.S. dollars in thousands (except share and per share data)
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)
Know-how is amortized over 8 to 10 years, and patents are
amortized over a period of 10 years. Know-how includes know-how
of a taut wire perimeter intrusion detection line and know-how of
the VMD system.
Registered patents to protect proprietary technology incorporated
in the Company's products and unauthorized use of our proprietary
technology by third parties.
Technology in the field of portable duress alarm systems enables
the Company to produce premier personal emergency location
systems.
k. Goodwill:
Goodwill represents excess of the costs over the net fair value
of the assets of the businesses acquired. Goodwill that arose
from acquisitions prior to July 1, 2001, was amortized until
December 31, 2001, on a straight-line basis over a period of 15
years. Under SFAS No, 142, goodwill acquired in a business
combination on or after July 1, 2001, shall not be amortized.
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, and market capitalization. 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.
In accordance with Accounting Principles Board ("APB") Opinion
No. 20, "Accounting Changes", the effect of these accounting
changes is reflected prospectively. Supplemental comparative
disclosure, as if the change had been retroactively applied, is
as follows (in thousands, except per share data):
Year ended December 31,
-----------------------------------------
2001 2002 2003
------------ ------------ -----------
Net income:
Reported net income $ 3,167 $ 1,888 $ 2,404
Goodwill amortization 404 - -
------------ ------------ -----------
Adjusted net income $ 3,571 $ 1,888 $ 2,404
============ ============ ===========
Reported basic net earnings per share $ 0.41 $ 0.24 $ 0.30
============ ============ ===========
Reported diluted net earnings per share $ 0.40 $ 0.23 $ 0.30
============ ============ ===========
Goodwill amortization $ 0.05 $ - $ -
============ ============ ===========
Adjusted basic net earnings per share $ 0.46 $ 0.24 $ 0.30
============ ============ ===========
Adjusted diluted net earnings per share $ 0.45 $ 0.23 $ 0.30
============ ============ ===========
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. Research and development costs:
Research and development costs, net of grants received, are
charged to the statement of income as incurred.
m. Warranty costs:
The Company provides a warranty for up to 12 months, at no extra
charge. The Company 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. Factors that
affect the Company's warranty liability include the number of
units, historical rates of warranty claims and cost per claim.
The Company periodically assesses the adequacy of its recorded
warranty liabilities and adjusts the amounts as necessary.
Changes in the Company's warranty allowance during the period are
as follows:
Year ended December 31,
-----------------------
2002 2003
-------- ---------
Balance at the beginning of the year $ 174 $ 159
Warranties issued during the year 237 203
Settlements made during the year (238) (159)
Changes in liability for pre-existing
warranties during the year including
expirations (14) (2)
Foreign currency translation adjustment - 13
-------- ---------
Balance at the end of the year $ 159 $ 214
======== =========
n. Income taxes:
The Company and its subsidiaries account for income taxes in
accordance with Statement of Financial Accounting Standard No.
109 "Accounting for Income Taxes" ("SFAS No. 109"). This
Statement prescribes the use of the liability method whereby
deferred tax 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 Company and its subsidiaries provide a
valuation allowance, if necessary, to reduce deferred tax assets
to their estimated realizable value.
o. Revenue recognition:
The Company generates revenues mainly from long-term projects and
also from sales of products and rendering maintenance services.
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.)
Revenues from long-term projects are recognized in accordance
with Statement of Position 81-1, "Accounting for Performance of
Construction-Type and Certain Production-Type Contracts" ("SOP
81-1"), using contract accounting on a percentage of completion
method, based on the relationship of actual costs incurred to
total costs estimated to be incurred over the duration of the
contract and in accordance with the "Input Method". 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. As of December 31,
2003, no such estimated losses were identified.
The Company applies contract accounting for the following
reasons:
Projects for construction of Perimeter Systems require planning,
development, manufacture and installation of the Perimeter
System, in accordance with the customer's security requirements.
The project includes various components, e.g. planning of the
Perimeter System in accordance with technical specifications,
manufacture of the Perimeter System, installation of the
Perimeter System on-site and installation of electronic parts
on-site.
According to ("SOP 81-1"), costs that are incurred for a specific
anticipated contract are being deferred, subject to evaluation of
their probable recoverability, and only if the costs can be
directly associated with a specific anticipated contract.
Revenues from products are recognized in accordance with Staff
Accounting Bulleting No. 104, "Revenue Recognition" ("SAB No.
104") when the following criteria are met: persuasive evidence of
an arrangement exists, delivery of the product has occurred, the
fee is fixed or determinable and collection is probable.
Deferred revenues include unearned amounts received under
maintenance contracts but not yet recognized as revenues.
In November 2002, Emerging Issues Task Force ("EITF") reached a
consensus on Issue No. 00-21, "Revenue Arrangements with Multiple
Deliverables". EITF Issue No. 00-21 provides guidance on how to
account for arrangements that involve the delivery or performance
of multiple products, services and/or rights to use assets. The
provisions of EITF Issue No. 00-21 are applied to revenue
arrangements entered into in fiscal periods beginning after June
15, 2003. Additionally, companies will be permitted to apply the
consensus guidance in this issue to all existing arrangements as
the cumulative effect of a change in accounting principle in
accordance with APB Opinion No. 20, "Accounting Changes". The
adoption of EITF Issue No. 00-21 did not have a material impact
on the Company's financial position, cash flows or results of
operations.
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.)
p. Advertising expenses:
Advertising expenses are charged to the statement of income as
incurred. Advertising expenses for the years ended 2001, 2002 and
2003, were $ 349, $ 372 and $ 422, respectively.
q. Concentrations of credit risk:
Financial instruments that potentially subject the Company and
its subsidiaries to concentrations of credit risk consist
principally of cash and cash equivalents, short and long-term
bank deposits, trade receivables and long-term trade receivables.
The majority of the Company's cash and cash equivalents,
short-term and long-term bank deposits are invested in major
Israeli and U.S. banks. Such deposits in U.S. banks may be in
excess of insured limits and are not insured in other
jurisdictions. Management believes that the financial
institutions that hold the Company's investments are financially
sound and, accordingly, minimal credit risk exists with respect
to these investments.
The trade receivables of the Company and its subsidiaries are
derived from sales to large and solid organizations located
mainly in Israel, the United States, Canada and Europe. The
Company performs ongoing credit evaluations of its customers and
to date has not experienced any material losses. An allowance for
doubtful accounts is determined with respect to those amounts
that the Company has determined to be doubtful of collection and
by a general reserve. In certain circumstances, the Company may
require letters of credit, other collateral or additional
guarantees.
For derivative instruments, see Note 2v.
r. Stock-based compensation:
The Company has elected to follow Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB
25"), and Interpretation No. 44, "Accounting for Certain
Transactions Involving Stock Compensation" ("FIN 44"), in
accounting for its employee stock option plans. Under APB 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.
Proforma 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 of that Statement. The fair value for these
options was estimated at the grant date using a Black and Scholes
option pricing model with the following weighted-average
assumptions for 2000 and 2001: risk-free interest rates of 5% and
3%, respectively, dividend yields of 3% for each year, a
volatility factor of the expected market price of the Company's
Ordinary shares of 0.556 and 0.628, respectively, and a weighted
average life of the option of two years.
For purposes of pro forma disclosures, the estimated fair value
of the options is amortized to expense over the options' vesting
period.
F-16
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
U.S. dollars in thousands (except share and per share data)
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)
Proforma information under SFAS No. 123:
Year ended December 31,
-----------------------------------------
2001 2002 2003
------------ ------------ -----------
Net income as reported: $ 3,167 $ 1,888 $ 2,404
Add - stock based compensation as
reported 72 17 3
Deduct - total stock-based
compensation determined under fair
value method (238) (246) (111)
------------ ------------ -----------
Proforma net income $ 3,001 $ 1,659 $ 2,296
============ ============ ===========
Proforma basic net earnings per share $ 0.40 $ 0.22 $ 0.29
============ ============ ===========
Proforma diluted net earnings per share $ 0.39 $ 0.22 $ 0.29
============ ============ ===========
s. 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 $ 0, $ 318 and $ 128 in 2001, 2002 and 2003,
respectively.
The Company also received royalty-bearing grants from the Fund
for Encouragement of Marketing Activity. These grants are
recognized at the time the Company is entitled to such grants on
the basis of the costs incurred and included as a deduction of
sales and marketing expenses. Total grants recognized amounted to
$ 0, $ 42 and $ 40 in 2001, 2002 and 2003, respectively.
t. Severance pay:
The Company's liability for 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 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, 2001, 2002
and 2003, amounted to approximately $ 241, $ 60 and $ 313,
respectively.
F-17
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
U.S. dollars in thousands (except share and per share data)
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)
u. Fair value of financial instruments:
The following methods and assumptions were used by the Company
and its subsidiaries in estimating their fair value disclosures
for financial instruments:
The carrying amounts of cash and cash equivalents, short-term
bank deposits, trade receivables and other accounts receivable,
short-term bank credit, trade payables and other payables
approximate their fair value due to the short-term maturity of
such instruments.
The carrying amount of the Company's long-term trade receivables
and long-term deposits approximate their fair value. The fair
value was estimated using discounted cash flows analyses, based
on the Company's investment rates for similar type of investment
arrangements.
Long-term loans are estimated by discounting the future cash
flows using current interest rates for loans of similar terms and
maturities. As of December 31, 2002, the carrying amount of the
Company's long-term borrowing approximates its fair value. As of
December 31, 2003, the fair value of the Company's long-term
borrowing was $ 5,564, compared to the carrying amount of $
5,714.
As for derivative instruments, see Note 2v, below.
v. Derivative instruments:
Financial Accounting Standards Board Statement No. 133,
"Accounting for Derivative Instruments and Hedging Activities"
("SFAS No. 133"), requires companies 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, the
Company must designate the hedging instrument, based upon the
exposure being hedged, as a fair value hedge, cash flow hedge or
a hedge of a net investment in a foreign operation.
For derivative instruments that are designated and qualify as a
fair value hedge (i.e., hedging the exposure to changes in the
fair value of an asset or a liability or an identified portion
thereof that is attributable to a particular risk), the gain or
loss on the derivative instrument as well as the offsetting loss
or gain on the hedged item attributable to the hedged risk are
recognized in the same line item associated with the hedged item
in current earnings during the period of the change in fair
values. For derivative instruments that are designated and
qualify as a 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.
F-18
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
U.S. dollars in thousands (except share and per share data)
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)
To protect against changes in the value of forecasted foreign
currency translations and balances, the Company has instituted a
foreign currency hedging program. The Company hedges portions of
its forecasted cash flows and balances denominated in foreign
currencies with forward contracts.
During 2003, the Company entered into forward contracts to hedge
a portion of Euro revenues. These forward contracts are
designated as cash flows hedges, as defined by SFAS No. 133, as
amended, and are all highly effective as hedges of these
revenues. The effective portion of the gain or loss on derivative
instruments that hedges future revenues is included in revenues
and in financial expenses in the statements of income.
As of the year ended December 31, 2003, the total losses on
derivative instruments amounted to $ 278, of which $ 178 was
recorded in revenues, and $ 100 was recorded in financial
expenses.
As of December 31, 2003, the unrealized losses on forward
contracts amounted to $ 950.
w. Basic and diluted earnings per share:
Basic earnings per share is computed based on the weighted
average number of Ordinary shares outstanding during each year.
Diluted earnings per share is computed based on the weighted
average number of Ordinary shares outstanding during each year,
plus dilutive potential Ordinary shares considered outstanding
during the year, in accordance with FASB Statement of Financial
Accounting Standard No. 128, "Earnings Per Share" ("SFAS No.
128").
x. Reclassification:
Certain amounts from prior years have been reclassified to
conform to the current year's presentation. The reclassification
had no effect on previously reported net loss, shareholders'
equity or cash flows. The Company reclassified inventory to
property and equipment in the amount of $ 139.
y. Impact of recently issued accounting standards:
In January 2003, the FASB issued FASB Interpretation 46 ("FIN
46"), "Consolidation of Variable Interest Entities". FIN 46
clarifies the application of Accounting Research Bulletin 51,
Consolidated Financial Statements", for certain entities that do
not have sufficient equity at risk for the entity to finance its
activities without additional subordinated financial support from
other parties or in which equity investors do not have the
characteristics of a controlling financial interest ("variable
interest entities"). Variable interest entities within the scope
of FIN 46 will be required to be consolidated by their primary
beneficiary. The primary beneficiary of a variable interest
entity is determined to be the party that absorbs a majority of
the entity's expected losses, receives a majority of its expected
returns, or both. FIN 46 applies immediately to variable interest
entities created after January 31, 2003, and to variable interest
entities in which an enterprise obtains an interest after that
date.
F-19
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
U.S. dollars in thousands (except share and per share data)
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)
It applies in the first fiscal year or interim period beginning
after June 15, 2003, to variable interest entities in which an
enterprise holds a variable interest that it acquired before
February 1, 2003. The Company is in the process of determining
what impact, if any, the adoption of the provisions of FIN 46
will have on its financial condition or results of operations.
Certain transitional disclosures required by FIN 46 in all
financial statements initially issued after January 31, 2003,
have been included in the accompanying financial statements. As
of December 31, 2003, the Company does not expect the adoption of
FIN 46 to have material impact on its consolidated financial
statements.
In April 2003, the FASB issued SFAS No. 149 ("SFAS No. 149"),
"Amendment of Statement 133 on Derivative Instruments and Hedging
Activities". SFAS No. 149 amends and clarifies (1) the accounting
guidance on derivative instruments (including certain derivative
instruments embedded in other contracts) and (2) hedging
activities that fall within the scope of FASB Statement No. 133
("SFAS No. 133"), "Accounting for Derivative Instruments and
Hedging Activities". SFAS 149 amends SFAS No. 133 to reflect
decisions made (1) as part of the Derivatives Implementation
Group ("DIG") process that effectively required amendments to
SFAS No. 133, (2) in connection with other projects dealing with
financial instruments, and (3) regarding implementation issues
related to the application of the definition of a derivative.
SFAS No. 149 is effective (1) for contracts entered into or
modified after June 30, 2003, with certain exceptions, and (2)
for hedging relationships designated after June 30, 2003. The
guidance is to be applied prospectively.
Generally, SFAS No 149 improves financial reporting by (1)
requiring that contracts with comparable characteristics be
accounted for similarly and (2) clarifying when a derivative
contains a financing component that warrants special reporting in
the statement of cash flows. SFAS No. 149 is not expected to have
a material impact on the Company's financial statements.
In May 2003, the FASB issued SFAS No. 150, "Accounting for
Certain Financial Instruments with Characteristics of both
Liabilities and Equity". This Statement establishes standards for
how an issuer classifies and measures in its statement of
financial position certain financial instruments with
characteristics of both liabilities and equity. It requires that
an issuer classify a financial instrument that is within its
scope as a liability (or an asset in some circumstances) because
that financial instrument embodies an obligation of the issuer.
This Statement is effective for financial instruments entered
into or modified after May 31, 2003, and otherwise is effective
at the beginning of the first interim period beginning after June
15, 2003, except for mandatory redeemable financial instruments
of nonpublic entities. The Company does not expect that the
adoption of this standard will have a material effect on its
financial position or results of operations.
F-20
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
U.S. dollars in thousands (except share and per share data)
NOTE 3:- INVENTORIES
December 31,
-------------------------------
2002 2003
-------------- --------------
Raw materials $ 4,702 $ 6,843
Work in progress 1,242 2,513
Finished products *) 2,168 2,421
------------- -------------
$*) 8,112 $ 11,777
============= =============
*) Reclassified.
NOTE 4:- LONG-TERM TRADE RECEIVABLES
The Company signed an agreement with a customer, according to which the
payments schedule is for a period ending in February 2005.
As of December 2003, the aggregate annual maturities of the long-term trade
receivables are as follows:
2004 $1,284
2005 300
-------
1,584
Less - current maturities 1,284
-------
$ 300
=======
F-21
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
U.S. dollars in thousands (except share and per share data)
NOTE 5:- PROPERTY AND EQUIPMENT
a. Comprised as follows:
December 31,
--------------------
2002 2003
--------- ---------
Cost:
Land and buildings $ 7,846 $ 8,215
Machinery and equipment *)3,545 6,253
Motor vehicles 1,333 1,414
Promotional display 2,895 3,659
Office furniture and equipment 2,186 2,609
Leasehold improvements 23 23
------- -------
*)17,828 22,173
------- -------
Accumulated depreciation:
Buildings 1,744 2,098
Machinery and equipment 2,416 2,940
Motor vehicles 608 738
Promotional display 2,229 2,891
Office furniture and equipment 1,682 1,980
Leasehold improvements 21 21
------- -------
8,700 10,668
------- -------
Depreciated cost $*)9,128 $11,505
======== =======
*) Reclassified.
b. Depreciation expenses amounted to $ 858, $ 1,014 and $ 1,241 for
the years ended December 31, 2001, 2002 and 2003, respectively.
c. As for charges, see Note 11.
NOTE 6:- GOODWILL AND OTHER INTANGIBLE ASSETS, NET
U.S. dollars in thousands (except share and per share data)
NOTE 6:- GOODWILL AND OTHER INTANGIBLE ASSETS, NET (Cont.)
Amortization expenses related to intangible assets amounted to $
100, $ 82 and $ 137 for the years ended December 31, 2001, 2002
and 2003, respectively.
b. Estimated amortization of the intangible assets for the years
ended:
December 31,
---------------
2004 143
2005 137
2006 129
2007 75
2008 and thereafter 229
---------------
713
===============
c. Goodwill:
December 31,
-------------------------------
2002 2003
-------------- --------------
Original amounts $ 5,443 $ 5,908
Accumulated amortization 1,587 1,763
-------------- --------------
$ 3,856 $ 4,145
============== ==============
Amortization expenses amounted to $ 404, $ 0 and $ 0 for the
years ended December 31, 2001, 2002 and 2003, respectively.
NOTE 7:- SHORT-TERM BANK CREDIT
a. As of December 31, 2003, the Company and its subsidiaries have
authorized credit lines totaling $ 27,800, and unused credit
lines in the amount of $ 3,748.
The Company has undertaken to maintain the following financial
ratios and terms in respect of its short-term and long-term bank
credit and loans:
1. A ratio of at least 40% of shareholders' equity out of the
total assets.
2. Minimal annual net income in the amount of $ 1,000.
3. That the same shareholders maintain the core of control in
the Company.
As of December 31, 2003, the Company was in compliance with these
ratios and terms.
F-23
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
U.S. dollars in thousands (except share and per share data)
NOTE 7:- SHORT-TERM BANK CREDIT (Cont.)
b.
Interest rate December 31,
Linkage --------------------- ---------------------------
terms 2002 2003 2002 2003
---------- ---------- ---------- ------------ ------------
%
---------------------
Short-term bank loan U.S. $ 2.28 2.68 $ 500 $ 500
Short-term bank loan U.S. $ 3.17 3.06 4,600 3,800
Short-term bank loan Canadian $ 5 5.01 843 1,684
Short-term bank loan NIS 10.24 6.83 3,323 6,613
------------ ------------
$9,266 $ 12,597
============ ============
c. As for charges, see Note 11.
NOTE 8:- OTHER ACCOUNTS PAYABLE AND ACCRUED EXPENSES
December 31,
----------------------------
2002 2003
-------------- ------------
Employees and payroll accruals $ 1,414 $ 1,951
Accrued expenses 1,922 2,116
Deferred revenues 84 324
Unrealized losses on forward contracts - 489
Declared dividend - 401
Income tax payable 124 641
Other 240 596
-------------- ------------
$ 3,784 $ 6,518
============== ============
F-24
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
U.S. dollars in thousands (except share and per share data)
NOTE 9:- LONG-TERM LOANS
Interest rate December 31,
Linkage ------------------------ ---------------------
terms 2002 2003 2002 2003
---------- ----------- ----------- ---------- ----------
%
------------------------
Bank (1) U.S. $ 4.60 4.60 $ 2,500 $ 2,500
Bank (2) U.S. $ 4.60 4.60 250 250
Bank (3) U.S. $ 2.87 2.87 500 500
Bank (4) U.S. $ 5.66 5.66 500 500
---------- ----------
3,750 3,750
Mortgage payable (5) U.S. $ 8.25 8.25 2,039 1,964
---------- ----------
5,789 5,714
Less - current maturities 1,091 3,841
---------- ----------
$ 4,698 $ 1,873
========== ==========
As for financial ratios and terms in respect of long-term loans, see
also Note 7a.
As for charges, see Note 11.
As of December 2003, the aggregate annual maturities of the long-term
loans are as follows:
2004 $3,841
2005 1,873
$5,714
(1) Interest on the outstanding balance is due monthly. The loan is
due in one installment on April 1, 2004.
(2) Interest on the outstanding balance is due each quarter. The loan
is due in one installment on April 2, 2004.
(3) The loan is due on April 15, 2004.
(4) The loan is due on April 15, 2004.
(5) The loan is due in 18 quarterly installments of $ 64.7 each,
commencing from February 28, 2001 and thereafter, until a final
payment of $ 1,807 on November 30, 2005.
F-25
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:- COMMITMENTS AND CONTINGENT LIABILITIES
a. Royalty commitments to the Chief Scientist:
The Company participated in programs sponsored by the Israeli
Government for the support of research and development
activities. Through 2003, the Company had obtained grants from
Office of the Chief Scientist of Israel's Ministry of Industry
and Trade ("the OCS") of $ 128 for certain research and
development projects of the Company. The Company is obligated to
pay royalties to the OCS, amounting to 3%-5% of the sales of the
products and other related revenues generated from such projects,
up to 100% of the grants received, linked to the U.S. dollar and
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 amounted to $ 0, $ 131 and $ 80 for the years
ended December 31, 2001, 2002 and 2003, respectively.
As of December 31, 2003, the Company had remaining contingent
obligations to pay royalties in the amount of approximately $
1,700 upon the successful sale of products developed using such
research and development programs sponsored by the Chief
Scientist.
b. 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.
Grants received for the years up to and including 2003, amounted
to $ 253 and royalties paid during 2001, 2002 and 2003, amounted
to $ 104, $ 53 and $ 0, respectively. As of December 31, 2003,
the aggregate contingent obligation amounted to $ 96.
c. Lease commitments:
The Company and its subsidiaries rent their facilities and some
of their motor vehicles under various operating lease agreements,
which expire on various dates, the latest of which is in 2008.
Future minimum lease payments under non-cancelable lease
agreements as of December 31, are as follows:
Total rent expenses for the years ended December 31, 2001, 2002
and 2003, were approximately $ 122, $ 183 and $ 368,
respectively.
F-26
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:- COMMITMENTS AND CONTINGENT LIABILITIES (Cont.)
d. Guarantees:
1. As of December 31, 2003, the Company and its subsidiaries
obtained bank performance guarantees and advance payment
guarantees from several banks mainly in Israel in the amount
of $ 3,714.
2. As of December 31, 2003, the Company obtained bank
guarantees in an amount of $ 1,964, in order to secure
mortgage payable by a subsidiary.
3. As of December 31, 2003, the Company and its subsidiaries
issued a letter of credit in the amount of $ 278, as per the
suppliers' demand.
e. Legal proceedings:
In June 2000, Rapiscan Security Products Inc. ("Rapiscan") filed
a lawsuit against the Company claiming sums allegedly due to
Rapiscan in the context of an agreement between Rapiscan and the
Company amounting to $ 1,600. The Company filed a counter-claim
in the amount of approximately $ 1,350. The financial statements
as of December 31, 2003 include a liability to pay Rapiscan of
approximately $ 1,000, as estimated by the Company's management
(see also Note 18b).
In April 2003, a competitor filed a civil action suit against the
Company and others. The plaintiff alleged that its failure in the
field trials of the perimeter systems executed by the MOD during
1996-1997, resulted from intentional damage to its fence and
diversion of the results of certain intrusion tests made by a
former employee of Magal, who was then a soldier in the IDF. The
plaintiff alleged that the Company was the employer of this
employee during 1995 and the Company still employed him as an
agent during the field trials. The plaintiff requested the courts
to annul the field trial and for approximately $ 730 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. According to its legal counsel,
the Company had valid grounds for defense against the
aforementioned claims and, therefore, no provision was recorded
in the financial statements. The action is in the preliminary
stage.
f. In July 2003, the Company's subsidiary acquired the business
activity of DW. According to the agreement, the Company's
subsidiary paid $ 902 and, in addition, over the next two and a
half years, DW will be entitled to an "Earn Out" of 50% of
operating profits related to the acquired activity (see Note 1b).
NOTE 11:- CHARGES
As collateral for all of the Company and its subsidiaries' liabilities
to banks:
a. A fixed charge has been placed on the Company's property.
b. The Company agreed not to pledge any of its assets without the
consent of several banks.
c. A fixed charge in the amount of $ 3,250 has been placed on the
Company's bank deposits.
F-27
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
U.S. dollars in thousands (except share and per share data)
NOTE 11:- CHARGES (Cont.)
d. The Company's subsidiary has two bank loans in the aggregate
amount of $ 1,000 due on April 15, 2004, collateralized by
substantially all of the subsidiary's assets, and a $ 1,964
mortgage note payable, collateralized by a first mortgage on the
land and building.
NOTE 12:- 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
("TASE"). 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. Deferred shares:
Prior to the Company's initial public offering in 1993, the
Company's existing shareholders agreed to put into escrow 252,000
of the Ordinary shares held by them and to convert all, or a
portion, of such escrowed shares into "Deferred shares", in the
event (after taking into account the effect of the stock
dividend) that specified audited after tax net income levels were
not achieved by the Company in each of the three fiscal years in
the period ended December 31, 1995.
Since the Company did not achieve such levels of net income,
252,000 Ordinary shares have been converted into Deferred shares
of NIS 1 par value each. The Deferred shares entitle their
holders, upon the liquidation of the Company, to the par value of
these shares, but confer no other rights.
During 2001, the Company listed its shares for trade on the
Tel-Aviv Stock Exchange. Pursuant to the Israeli Securities Law,
the Company was required to purchase its Deferred shares. The
annual general meeting that was held on May 16, 2001 approved the
purchase of 252,000 Deferred shares by the Company at their
nominal value.
c. Stock Option Plan:
On February 25, 1993, the Company's Board of Directors authorized
a stock option plan ("the plan"), under which options may be
granted to employees, directors, officers and consultants of the
Company or its subsidiaries.
According to the plan, the exercise price shall be at least 75%
of the average of the closing prices of the shares of the Company
on the NASDAQ National Market during the 90 days period preceding
such grant. The plan was supposed to be terminated on February
25, 2001.
On May 31, 2000, the Company's Board of Directors approved an
extension period to the plan in which options may be granted to
employees until February 2005. Stock options that have not been
exercised will expire, in any case, after five years from the
date of grant. All the options have a vesting period of two
years. Any options that are cancelled or forfeited before
expiration become available for future grant.
F-28
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
U.S. dollars in thousands (except share and per share data)
NOTE 12:- SHAREHOLDERS' EQUITY (Cont.)
During 2000, the Company's Board of Directors and the general
meeting of shareholders, also approved an increase in the number
of options that may be granted to employees by 250,000 options,
and during 2002, was increased by an additional 500,000 options.
On October 27, 2003, the Company's Board of Directors approved
the 2003 Israeli Share Option Plan ("the 2003 plan"). The Board
has elected to allot the options under Israel's capital gain tax
treatment. Until December 31, 2003, the Company did not grant any
stock options under 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.
Subject to shareholder approval, the plan will be effective for
ten years and shall terminated on October 2013.
A summary of the Company's stock options activities in 2001, 2002
and 2003, is as follows:
Options outstanding
---------------------------------------------------------------------
Weighted Market price of
Number of Range of average the Company's
Available options exercise exercise shares at the
for grant outstanding price price date of grant
--------- ----------- ----- ----- -------------
Balance at January 1, 2001 316,200 257,300 $ 2-2.36 $ 2.09 $ -
Options granted (234,400) 234,400 $ 2.43-5.62 $ 5.27 $ 5.42
Options exercised - (79,300) $ 1.61-2 $ 1.80 $ -
------- ------- ------------ ------
Balance at December 31, 2001 81,800 412,400 $ 1.61-5.62 $ 3.93 $ -
Options available for grant 500,000 - $ - $ - $ -
Options forfeited 1,648 (1,648) $ - $ - $ -
Options granted upon stock dividend 2,454 11,232 $ - $ - $ -
Options exercised - (63,750) $ 2-2.36 $ 2.17 $ -
------- ------- ------------ ------
Balance at December 31, 2002 585,902 358,234 $ 1.61-5.62 $ 4.23 $ -
Options forfeited 7,828 (7,828) $ - $ - $ -
Options granted upon stock dividend 17,812 10,256 $ - $ - $ -
Options exercised - (137,446) $ 1.61-5.62 $ 3.55 $ -
------- ------- ------------ ------
Balance at December 31, 2003 611,542 223,216 $ 2.29-5.62 $ 4.61 $ -
======= ======= ============ ========= ======
The weighted average fair values of options granted during the
years ended December 31, 2001, 2002 and 2003, were:
For exercise price on the grant date that:
----------------------------------------------------------------
Equals market price Less than market price
----------------------------- -------------------------------
Year ended December 31, Year ended December 31,
----------------------------- -------------------------------
2001 2002 2003 2001 2002 2003
-------- -------- ------- ------- ------- ----------
Weighted average $5.62 $ - $ - $ 2.69 $ - $ -
exercise prices ======== ======== ======= ======= ======= ==========
Weighted average fair
value on grant date $2.04 $ - $ - $ 1.91 $ - $ -
======== ======== ======= ======= ======= ==========
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 12:- SHAREHOLDERS' EQUITY (Cont.)
The options outstanding as of December 31, 2003 have been
separated into ranges of exercise price as follows:
Options
outstanding Weighted
and exercisable average Weighted
as of remaining average
December 31, contractual exercise
2003 life (years) price
------------------- ----------------- ---------------
6,365 0.48 $ 2.29
53,045 1.01 $ 2.36
11,670 2.26 $ 2.89
152,136 2.49 $ 5.62
----------
223,216 $ 4.61
========== ========
84,000, 118,450 and 223,216 options were exercisable on December
31, 2001, 2002 and 2003, respectively, with a weighted average
exercise price of $ 1.93, $ 2.14 and $ 4.61, respectively.
The total employee stock compensation expenses recorded in 2001,
2002 and 2003, were $ 72, $ 17 and $ 3, respectively, and were
amortized based on the vesting period.
d. Dividends:
Dividends, if any, will be declared and paid in dollars. The
Company has determined that it will not distribute dividends out
of tax-exempt profits.
In 2001, the Company's Board of Directors decided on a dividend
of $ 0.13 per share for the year 2001.
In December 2003, the Company's Board of Directors decided on
dividend of $ 0.05 per share for the year 2003. A total of $ 401
was paid in January 2004.
e. Warrants to underwriters:
In connection with the 1997 Offering, the Company issued to the
underwriters, 200,000 warrants to purchase 200,000 Ordinary
shares of the Company. The warrants were initially exercisable at
an exercise price of 120% of the 1997 Offering price per share ($
5.50) for a period of four years, commencing one year from the
date of the 1997 Offering. As of December 31, 2002, all 200,000
warrants were exercised on a net cash basis and 60,703 Ordinary
shares of NIS 1 par value were issued.
f. The Company's Board of Directors decided on a distribution of
stock dividend of 3% in May 2002 and 2003. All net earnings per
share data have been retroactively adjusted to reflect the stock
dividend.
g. In May 2002, the Company's Board of Directors decided on an
increase of the authorized Ordinary share capital to 19,748,000
shares of NIS 1 par value.
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)
The following table sets forth the computation of basic and diluted
net earnings per share:
Year ended December 31,
------------------------------------------
2001 2002 2003
------------- ------------- ------------
Numerator:
Net income $ 3,167 $ 1,888 $ 2,404
============= ============= ============
Denominator:
Denominator for basic earnings per share -
weighted-average number of shares
outstanding 7,737,512 7,866,477 7,947,778
Effect of diluting securities:
Employee stock options and warrants to
underwriters 187,337 202,661 80,848
------------- ------------- ------------
Denominator for diluted net earnings per
share - adjusted weighted average shares
and assumed conversions 7,924,849 8,069,138 8,028,626
============= ============= ============
Basic net earnings per share $ 0.41 $ 0.24 $ 0.30
============= ============= ============
Diluted net earnings per share $ 0.40 $ 0.23 $ 0.30
============= ============= ============
F-31
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
U.S. dollars in thousands
NOTE 14:- 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 the second 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.
The Company received final approval for this expansion.
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 Company had completed its investment program and,
accordingly, the period of benefits under this program began
in 1998 and will terminate in 2007.
3. On August 13, 2001, 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 end in 2012.
The entitlement to the above benefits is conditional upon the
Company fulfilling the conditions stipulated by the above law,
regulations published thereunder 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.
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.
F-32
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
U.S. dollars in thousands
NOTE 14:- TAXES ON INCOME (Cont.)
Income from sources other than "Approved Enterprise", during the
benefit period will be subject to tax at regular rate of 36%.
By virtue of this 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 36%), 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.
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%), and an income tax liability would be incurred
of approximately $ 900.
b. Measurement of taxable income under the Income Tax (Inflationary
Adjustments) Law, 1985:
Under Israeli law, results for tax purposes are measured in real
terms, in accordance with the changes in Israel's Consumer Price
Index ("Israel's CPI"), or in the exchange rate of the dollar for
a "foreign investors' company". Until 2002, results of tax
purposes were measured in terms of earnings in NIS, after certain
adjustments for increases in Israel's CPI. Commencing January 1,
2003, the basis for remeasurement is the changes in the exchange
rate of the U.S. dollar.
For the years 2001 and 2002, the differences between the change
in Israel's CPI and in the NIS/U.S. dollar exchange rate causes a
difference between taxable income or loss and the income or loss
before taxes reflected in the consolidated financial statements.
In accordance with paragraph 9(f) of SFAS No. 109, the Company
has not provided deferred income taxes on this difference between
the reporting currency and the tax bases of assets and
liabilities.
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.
F-33
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
U.S. dollars in thousands
NOTE 14:- TAXES ON INCOME (Cont.)
d. Israeli tax reform:
On January 1, 2003, a comprehensive tax reform took effect in
Israel. Pursuant to the reform, resident companies are subject to
Israeli tax on income, accrued or derived in Israel or abroad. In
addition, the concept of a "controlled foreign corporation" was
introduced, according to which an Israeli company becomes subject
to Israeli taxes on certain income of a non-Israeli subsidiary,
if the subsidiary's primary source of income is passive income
(such as interest, dividends, royalties, rental income or capital
gains). The tax reform also substantially changed the system of
taxation of capital gains.
e. A 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,
------------------------------------------
2001 2002 2003
------------- ------------- ------------
Income before taxes as reported in the $ 3,619 $ 2,533 $ 3,317
statements of income
============= ============= ============
Tax rate 36% 36% 36%
============= ============= ============
Theoretical tax expense $ 1,303 $ 912 $ 1,194
Increase (decrease) in taxes:
Tax adjustments in respect of
inflation in Israel 214 11 -
Non-deductible items, net 75 (24) 17
Deferred taxes on losses for which
valuation allowance was provided - 442 298
Tax exemption applicable to "Approved
Enterprises" and exempted income (928) (293) (443)
Taxes in respect of prior years (200) (279) (107)
Other (12) (124) (46)
------------- ------------- ------------
Taxes on income in the statements of
income $ 452 $ 645 $ 913
============= ============= ============
Per share amounts (basic and diluted)
of the tax benefit resulting from
"Approved Enterprises" $ 0.12 $ 0.04 $ 0.06
============= ============= ============
The tax rates of the Company's subsidiaries range between
25%-40%.
F-34
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
U.S. dollars in thousands
NOTE 14:- TAXES ON INCOME (Cont.)
f. Taxes on income included in the statement of income:
Year ended December 31,
------------------------------
2001 2002 2003
---------- -------- --------
Current taxes:
Domestic $ 500 $ 269 $ 398
Foreign 138 211 534
Deferred income taxes:
Domestic (39) (30) -
Foreign 53 474 88
Taxes in respect of prior years:
Domestic (200) (279) (107)
----- ----- -----
Taxes on income $ 452 $ 645 $ 913
===== ===== =====
g. 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 Company
and its subsidiaries deferred tax assets are as follows:
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 2003, the
subsidiary recognized $ 216 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 $ 525, which will
expire at various dates from 2006 through 2012.
j. Net operating losses carryforward:
The Company's subsidiaries in the U.S., the U.K. and Latin
America have estimated total available carryforward tax losses of
$ 4,002, $ 582 and $ 77, respectively, to offset against future
taxable profit for 20 years, an indefinite period and 10 years,
respectively. As of December 31, 2003, the Company recorded a
deferred tax asset of approximately $ 1,813, relating to the
available net carryforward tax losses.
A valuation allowance of $ 1,682 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
provisions. The annual limitation may result in the expiration of
net operating losses before utilization.
NOTE 15:- RELATED PARTIES TRANSACTIONS
Year ended December 31,
----------------------------------------
2001 2002 2003
------------ ------------ ------------
Sales to related parties $ 271 $ 188 $ 196
============ ============ ============
F-36
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
U.S. dollars in thousands
NOTE 16:- SEGMENTS INFORMATION
The Company develops, manufactures, markets and sells complex
computerized security systems on a worldwide basis. These products are
grouped into three major categories, which represent the Company's
operating and reportable segments as follows:
1. Perimeter security systems - The Company'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 Company is executing turnkey
projects based on the Company's security management system, and
acting as an integrator.
3. Video monitoring services - The Company supplies video monitoring
services through Smart Interactive Systems, Inc., a subsidiary
established in the U.S. in June 2001.
The data is presented in accordance with SFAS 131, "Disclosure About
Segments of an Enterprise and Related Information".
F-37
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
U.S. dollars in thousands
NOTE 16:- SEGMENTS INFORMATION (Cont.)
a. The following data present the revenues, assets and other data of
the Company's operating segments:
Year ended December 31,
----------------------------------------------------------------------------------------------------------------
2001 2002
----------------------------------------------------------------------------------------------------------------
Video Video
Perimeter Projects monitoring Other Total Perimeter Projects monitoring Other Total
--------- -------- ---------- ----- ----- --------- -------- ---------- ----- -----
Revenues $ 34,893 $ 5,004 $ 142 $ 981 $41,020 $ 36,435 $ 5,340 $ 238 $ 953 $42,966
======== ========= ======= ======= ======= ========= ======== ======== ======== =======
Depreciation
and
amortization $ 1,304 $ 9 $ 28 $ 21 $ 1,362 $ 927 $ 9 $ 149 $ 11 $1,096
======== ========= ======= ======= ======= ========= ======== ======== ======== ======
Operating
income,
before
financial
expenses and
taxes on
income $*)3,303 $*) 1,758 $ (626) $ (856) $ 3,579 $*) 2,948 $*) 2,024 $ (1,556) $ (1,082) $2,334
======== ========= ======= ======= ========= ========= ======== ========
Financial
income
(expenses),
net 40 199
Taxes on income 452 645
--- ---
Net income $ 3,167 $1,888
======= ======
Year ended December 31,
---------------------------------------------------
2003
---------------------------------------------------
Video
Perimeter Projects monitoring Other Total
--------- -------- ---------- ----- -----
Revenues $ 51,077 $ 6,720 $ 403 $ 1,161 $59,361
======== ======= ======= ======= =======
Depreciation
and
amortization $ 1,056 $ 20 $ 292 $ 10 $1,378
======== ======= ======= ======= ======
Operating
income,
before
financial
expenses and
taxes on
income $ 4,120 $ 2,431 $(1,870) $ (361) $4,320
======== ======= ======= =======
Financial
income
(expenses),
net (1,003)
Taxes on income 913
---
Net income $2,404
======
December 31,
----------------------------------------------------------------------------------------------------------------
2001 2002
----------------------------------------------------------------------------------------------------------------
Video Video
Perimeter Projects monitoring Other Total Perimeter Projects monitoring Other Total
--------- -------- ---------- ----- ----- --------- -------- ---------- ----- -----
Total assets $ 11,911 $ 18 $ 324 $ 30 $ 12,283 $ 12,066 $ 30 $ 867 $ 21 $ 12,984
======== ======= ====== ====== ======== ======== ======= ======== ===== ========
December 31,
----------------------------------------------------
2003
---------------------------------------------------
Video
Perimeter Projects monitoring Other Total
--------- -------- ---------- ----- -----
Total assets $ 12,763 $ 88 $ 2,787 $ 12 $15,650
======== ======= ======= ===== =======
*) Reclassified.
F-38
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
U.S. dollars in thousands
NOTE 16:- SEGMENTS INFORMATION (Cont.)
b. Major customer data (percentage of total revenues):
Year ended December 31,
---------------------------------------
2001 2002 2003
------------ ----------- ------------
Israel's Ministry of Defense
and Israel's Defense Forces 22.5% 15.9% 27.2%
============ =========== ============
The State concern civil
aviation airlines "AZAL" 10.5% 1.8% 0.2%
============ =========== ============
c. Geographical information:
The following is a summary of revenues within geographic areas
based on end customer's location and long-lived assets:
a. Research and development expenses, net:
Year ended December 31,
---------------------------------
2001 2002 2003
--------- --------- ----------
Expenses $ 3,331 $ 3,750 $ 5,128
Less - royalty-bearing grants and
investment tax credit 277 622 355
------- ------- -------
$ 3,054 $ 3,128 $ 4,773
======= ======= =======
b. Financial income (expenses):
Financial expenses:
Interest on long-term debt $ (398) $ (371) $ (298)
Interest on short-term bank credit (502) (640) (808)
Foreign exchange losses (42) (6) (692)
------- ------- -------
(942) (1,017) (1,798)
------- ------- -------
Financial income:
From interest 705 732 672
Foreign exchange gains 277 484 123
------- ------- -------
982 1,216 795
------- ------- -------
$ 40 $ 199 $(1,003)
======= ======= =======
NOTE 18: SUBSEQUENT EVENTS
a. In April 2004, the Company's Board of Directors decided to
distribute a 5% stock dividend. The annual general meeting of
shareholders has not yet approved this decision.
b. On February 18, 2004, the court approved a settlement agreement
between the Company and Rapiscan regarding the matter discussed
in Note 10e. According to the agreement, the Company will pay
Rapiscan approximately $ 653. The reduction of $ 347 of the $
1,000 estimated liability recorded at year end will be reflected
in operations during the first quarter of 2004.
F-40
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
----------------------
Name: Jacob Even-Ezra
Title: Chairman of the Board and
Chief Executive Officer
Date: June 29, 2004
89
Exhibit 21
List of Subsidiaries of the Registrant
The table below lists the Registrant subsidiaries. Unless otherwise
indicated, the Registrant, or one of its subsidiaries, own 100% of the
outstanding capital stock of the subsidiary.
Name of Subsidiary Country of Incorporation
------------------ ------------------------
Senstar-Stellar Corporation Canada
Perimeter Products Inc. United States
Senstar-Stellar Inc. United States
Senstar GmbH Germany
Kobb Inc. United States
Magal B.V. The Netherlands
Senstar-Stellar Latin America S.A. de C.V. Mexico
Senstar-Stellar Limited United Kingdom
Smart Interactive Systems, Inc. United States
E.S.E. Ltd. Israel
Magal Security Sisteme S.R.L Romania
Exhibit 23.1
ERNST & YOUNG
o Kost Forer Gabbay & Kasierer
3 Aminadav St. o Phone: 972-3-6232525
Tel-Aviv 67067, Israel Fax: 972-3-5622555
Consent of Independent Public Auditors
We hereby consent to the incorporation by reference in the Registration
Statement on Form S-8 (No. 333-06246) pertaining to the Magal stock option plan
(1993) and in the Registration Statement on Form F-3 (No. 333-9050) of Magal
Security Systems Ltd. of our report, dated February 10, 2004 (except for Note
10e, which is dated February 18, 2004 and except for Note 18, which is dated
April 28, 2004) with respect to the consolidated financial statements of Magal
Security Systems Ltd. included in Form 20-F for the year ended December 31,
2003.
/s/ Kost Forer Gabbay and Kasierer
Tel Aviv, Israel KOST FORER GABBAY & KASIERER
June 28, 2004 A member of Ernst & Young Global
Exhibit 31.1
CERTIFICATION PURSUANT TO
SECTION 302(a) OF THE SARBANES-OXLEY ACT OF 2002
I, Jacob Even-Ezra, certify that:
1. I have reviewed this annual report on Form 20-F of Magal Security Systems
Ltd.;
2. Based on my knowledge, this report does not contain any untrue statement of a
material fact or omit to state a material fact necessary to make the statements
made, in light of the circumstances under which such statements were made, not
misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as
of, and for, the periods presented in this report;
4. The registrant's other certifying officer(s) and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
(a)Designed such disclosure controls and procedures, or caused such disclosure
controls and procedures to be designed under our supervision, to ensure that
material information relating to the registrant, including its consolidated
Subsidiaries, is made known to us by others within those entities, particularly
during the period in which this report is being prepared;
(b) [Paragraph omitted pursuant to SEC Release Nos. 33-8238 and 34-47986]
(c) Evaluated the effectiveness of the registrant's disclosure controls and
procedures and presented in this report our conclusions about the effectiveness
of the disclosure controls and procedures, as of the end of the period covered
by this report based on such evaluation; and
(d) Disclosed in this report any change in the registrant's internal control
over financial reporting that occurred during the registrant's most recent
fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual
report) that has materially affected, or is reasonably likely to materially
affect, the registrant's internal control over financial reporting; and
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation of internal control over financial reporting, to the
registrant's auditors and the audit committee of the registrant's board of
directors (or persons performing the equivalent function):
(a) All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are reasonably
likely to adversely affect the registrant's ability to record, process,
summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal control over
financial reporting.
Date: June 29, 2004
/s/ Jacob Even-Ezra *
---------------------
Jacob Even-Ezra
Chief Executive Officer
* The originally executed copy of this Certification will be maintained at the
Company's offices and will be made available for inspection upon request.
Exhibit 31.2
CERTIFICATION PURSUANT TO
SECTION 302(a) OF THE SARBANES-OXLEY ACT OF 2002
I, Raya Asher, certify that:
1. I have reviewed this annual report on Form 20-F of Magal Security System
Ltd.;
2. Based on my knowledge, this report does not contain any untrue statement of a
material fact or omit to state a material fact necessary to make the statements
made, in light of the circumstances under which such statements were made, not
misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as
of, and for, the periods presented in this report;
4. The registrant's other certifying officer(s) and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
(a)Designed such disclosure controls and procedures, or caused such disclosure
controls and procedures to be designed under our supervision, to ensure that
material information relating to the registrant, including its consolidated
Subsidiaries, is made known to us by others within those entities, particularly
during the period in which this report is being prepared;
(b) [Paragraph omitted pursuant to SEC Release Nos. 33-8238 and 34-47986]
(c) Evaluated the effectiveness of the registrant's disclosure controls and
procedures and presented in this report our conclusions about the effectiveness
of the disclosure controls and procedures, as of the end of the period covered
by this report based on such evaluation; and
(d) Disclosed in this report any change in the registrant's internal control
over financial reporting that occurred during the registrant's most recent
fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual
report) that has materially affected, or is reasonably likely to materially
affect, the registrant's internal control over financial reporting; and
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation of internal control over financial reporting, to the
registrant's auditors and the audit committee of the registrant's board of
directors (or persons performing the equivalent function):
(a) All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are reasonably
likely to adversely affect the registrant's ability to record, process,
summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal control over
financial reporting.
Date: June 29, 2004
/s/ Raya Asher *
----------------
Raya Asher
Chief Financial Officer
* The originally executed copy of this Certification will be maintained at the
Company's offices and will be made available for inspection upon request.
Exhibit 32.1
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report of Magal Security System Ltd. (the
"Company") on Form 20-F for the period ending December 31, 2003 as filed with
the Securities and Exchange Commission on the date hereof (the "Report"), I,
Jacob Even Ezra, Chief Executive Officer of the Company, certify, pursuant to 18
U.S.C. ss. 1350, as adopted pursuant to ss. 906 of the Sarbanes-Oxley Act of
2002, that:
(1) The Report fully complies with the requirements of section 13(a) or
15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all
material respects, the financial condition and result of operations of the
Company.
/s/ Jacob Even-Ezra *
---------------------
Jacob Even-Ezra
Chief Executive Officer
June 29, 2004
* The originally executed copy of this Certification will be maintained at the
Company's offices and will be made available for inspection upon request.
Exhibit 32.2
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report of Magal Security System Ltd. (the
"Company") on Form 20-F for the period ending December 31, 2003 as filed with
the Securities and Exchange Commission on the date hereof (the "Report"), I,
Raya Asher, Chief Financial Officer of the Company, certify, pursuant to 18
U.S.C. ss. 1350, as adopted pursuant to ss. 906 of the Sarbanes-Oxley Act of
2002, that:
(1) The Report fully complies with the requirements of section 13(a) or
15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all
material respects, the financial condition and result of operations of the
Company.
/s/ Raya Asher *
----------------
Raya Asher
Chief Financial Officer
June 29, 2004
* The originally executed copy of this Certification will be maintained at the
Company's offices and will be made available for inspection upon request.
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