Management’s Discussion and Analysis of Financial Condition
and Results of Operations
The information
contained in this section should be read in conjunction with our consolidated
financial statements and related notes and the information contained elsewhere
in this annual report. Our financial statements have been prepared in
accordance with United States generally accepted accounting principles (“GAAP”).
Overview
The
following discussion should be read in conjunction with selected financial data
included in “Item 3: Key Financial Information” above, our Consolidated
Financial Statements and the related Notes thereto included in this report and
incorporated herein by reference and “Item 4: Information on the Company.”
30
We
were originally engaged in the fields of laser-based robotic components,
standardized on-line quality assurance systems and parallel associative
computing. However, by February 1999,
all of our operating activities in these fields were either sold or
discontinued. Pursuant to United States GAAP, the results of operations of our
sold or discontinued operations are reflected as losses from discontinued
operations. In 2000 we implemented our
new business objectives and raised funds and purchased interests principally in
eLady Ltd. and Dirad. Due to market
conditions and the difficulties being experienced by start-up companies in
raising funds for their operations, we provided in our financial statements as
of December 31, 2000 for impairment losses from long-term investments
aggregating approximately $2,079,000 and impairment losses from long-term
investments aggregating approximately $1,390,000 in our financial statements as
of December 31, 2001. We purchased the
shares of Franz Kalff on January 24, 2001 and therefore Franz Kalff’s financial
statements are only consolidated for the year 2001. We acquired Tadiran Telecom’s Israeli activity in the last
quarter of 2004, therefore this activity, carried out through Telecom Israel
are only consolidated for the fourth quarter of 2004.
Our results of operations for the years 1998 and 1999
were significantly affected by the gradual discontinuation and sale of our
original activities. We therefore believe that they are not indicative of our
future results of operations and that they are not comparable to our results of
operations for the years 2002, 2003 and 2004.
Critical Accounting Policies
The
preparation of financial statements requires management to make estimates,
assumptions, and judgments that affect both (1) the reported amounts of assets
and liabilities and the disclosure of contingent liabilities as of the date of
the financial statements, and (2) the reported amounts of revenues and expenses
during the reporting period. On an ongoing basis, management evaluates its
estimates, assumptions, and judgments. Management bases its estimates, assumptions,
and judgments on historical experience and on various other factors that it
believes to be reasonable under the circumstances, some of which may not be
readily apparent from other sources. Under different estimates, assumptions,
judgments, factors or circumstances, results might differ from the results that
were reported.
Our
financial statements are prepared in accordance with accounting principles, and
audited annually in accordance with auditing standards, generally accepted in
the United States (U.S. GAAP). A
discussion of the significant accounting policies which we follow in preparing
our financial statements is set forth in Note 2 to our consolidated financial
statements included elsewhere in this annual report and incorporated herein by
reference. The following is a summary
of certain principles which have a substantial impact upon our financial
statements and, we believe, are most important to keep in mind in assessing our
financial condition and operating results:
Revenue
recognition.
The
Company through its subsidiary, Franz Kalff, generates revenues mainly from
sales of first-aid kits. The Company sells its products primarily through
retail stores and car manufacturers in Germany. Additionally, the Company,
through Telecom Israel, generates revenues from sales of contact centers, as
well as maintenance services. Revenues from product sales are recognized in
accordance with Staff Accounting Bulletin No. 101 “Revenue Recognition in
Financial Statements” (“SAB No. 101”), as amended by SAB No. 104, when delivery
has occurred, persuasive evidence of an agreement exists, the vendor’s fee is
fixed or determinable and collectibility is probable. A major component of
service revenues are maintenance services, which are recognized ratably over
the term of the maintenance period.
31
Investments.
We classify our marketable
securities as
available-for-sale. Available-for-sale securities are recorded at fair value.
Unrealized holding gains and losses on available-for-sale securities are
excluded from earnings and are reported as a separate component of other
comprehensive income, until realized. A decline in the market value of any
available-for-sale security below cost, that is deemed to be other than
temporary, results in a reduction in carrying amount to fair value. The
impairment is charged to earnings and a new cost basis for the security is
established. Non-marketable securities are presented at cost, less any decline
in value that is not of a temporary nature.
Impairment
of long-lived assets.
The
Company and its subsidiaries’ long-lived assets are reviewed for impairment in
accordance with Statement of Financial Accounting Standard No. 144 “Accounting
for the Impairment of 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. As of December 31, 2004, no impairment losses have been identified.
Recent Accounting Pronouncements under
U.S. GAAP as They Apply to Us
SFAS No. 123 (Revised 2004) “Share Based Payments”.
In December 2004, the FASB issued SFAS No. 123 (revised 2004) “Share Based
Payments” (“SFAS 123(R)”). This Statement is a revision of FASB Statement No.
123, “Accounting for Stock-Based Compensation”, which supersedes APB Opinion
No. 25, “Accounting for Stock Issued Employees” and its authoritative
interpretations. SFAS 123(R) establishes standards for the accounting for
transactions in which an entity exchanges its equity instruments for goods or
services; focuses primarily on accounting for transactions in which an entity
obtains employee and directors services in share-based payment transactions;
and does not change the accounting guidance for share-based payment
transactions with parties other than employees. SFAS 123(R) eliminates the
alternative to use APB 25’s intrinsic value method of accounting that was
provided in SFAS 123 as originally issued and requires the measuring of the
cost of employee services received in exchange for an award of equity
instruments based on the grant-date fair value of the award. The
fair-value-based method in this Statement is similar to the fair-value-based
method in SFAS 123 in most respects. The costs associated with the awards will
be recognized over the period during which an employee is required to provide
service in exchange for the award- the requisite service period (usually the
vesting period). The grant-date’s fair value of employee share options and
similar instruments will be estimated using option-pricing models adjusted for
the unique characteristics of those instruments (unless observable market
prices for the same or similar instruments are available). If an equity award
is modified after the grant date, incremental compensation cost will be
recognized in an amount equal to the excess of the fair value of the modified
award over the fair value of the original award immediately before the modification.
32
The provisions of SFAS 123(R) apply to all awards to
be granted by the Company after June 30, 2005 and to awards modified,
repurchased, or cancelled after that date. When initially applying the
provisions of SFAS 123(R), in the first quarter of 2006, the Company will be
required to elect between using either the “modified prospective method” or the
“modified retrospective method”. Under the modified prospective method, the
Company is required to recognize compensation cost for all awards granted after
the adoption of SFAS 123(R) and for the unvested portion of previously granted
awards that are outstanding on that date. Under the modified retrospective
method, the Company is required to restate its previously issued financial
statements to recognize the amounts previously calculated and reported on a pro
forma basis, as if the original provisions of SFAS 123 had been adopted. Under
both methods, it is permitted to use either a straight line or an accelerated
method to amortize the cost as an expense for awards with graded vesting.
Management has recently commenced identifying the potential future impact of
applying the provisions of SFAS 123(R), including each of its proposed
transition methods, yet is currently unable to fully quantify the effect of
this Standard on the Company’s future financial position and results of
operations in accordance with U.S. GAAP. Nonetheless, it is expected that the
adoption of SFAS 123(R) will increase the stock-based-award expenses the
Company is to record in the future in comparison to the expenses recorded under
the guidance currently applied by the Company.
SFAS 153, “Exchange of Non-Monetary Assets”
.
In December 2004, the FASB issued SFAS No.
153, “Exchanges of Non-monetary Assets an amendment of APB No. 29”. This
Statement amends Opinion 29 to eliminate the exception for non-monetary
exchanges of similar productive assets and replaces it with a general exception
for exchanges of non-monetary assets that do not have commercial substance. The
Statement specifies that a non-monetary exchange has commercial substance if
the future cash flows of the entity are expected to change significantly as a
result of the exchange. This Statement is effective for non-monetary asset
exchanges occurring in fiscal periods beginning after June 15, 2005. Earlier
application is permitted for non-monetary asset exchanges occurring in fiscal
periods beginning after the date this Statement is issued. Retroactive
application is not permitted. The Company does not expect the adoption of SFAS
153 to have a material effect on the Company’s results of operations.
33
FASB Statement No. 151, Inventory Costs, an amendment to ARB
43 (SFAS 151)
In November 2004, the FASB issued FASB
Statement No. 151,
Inventory Costs,
an
amendment to ARB 43,
Chapter 4 (SFAS 151). The amendment made by SFAS 151 clarify that abnormal
amounts of idle facility expense, freight, handling costs, and wasted material
(spoilage) should be recognized as current-period charges, and also require the
allocation of fixed production overhead inventory based on the normal capacity
of the production facilities. The guidance is effective for inventory costs
incurred during fiscal years beginning after June 15, 2005. Earlier application
is permitted for inventory costs incurred during fiscal years beginning after
November 23, 2004. The provision of SFAS 151 should be applied prospectively.
The Company does not expect the adoption of SFAS 151 to have a material effect
on the Company’s results of operations.
Results of Operations
You should read the following discussion and analysis
of our financial condition and results of operations in conjunction with the
financial statements and the related notes thereto included in this annual
report. The following table sets forth certain statement of operations data as
a percentage of sales for the years indicated.
Year Ended
December 31,
2002
2003
2004
Statement
of Operations Data:
Sales
100
%
100
%
100
%
Cost of sales
77.1
77.2
74.7
Gross profit
22.9
22.8
25.3
Research and development expenses, net
–
–
–
Marketing, general and administrative expenses
24.4
23.2
17.8
Operating income (loss)
(1.5
)
(0.4
)
7.5
Other income (expense)
3.0
8.4
0.6
Impairment of long term investment
–
–
(9.4
)
Impairment of available-for-sale marketable
securities
(2.4
)
Financial income (expense), net
(2.2
)
(0.1
)
(1.6
)
Income (loss) before taxes on income
(0.7
)
7.9
(5.3
)
Taxes on income
4.3
1.6
1.4
Equity in earnings of an affiliate
–
3.9
–
Net income (loss)
(5.1
)
10.2
(6.7
)
Year Ended December 31, 2004 Compared To Year Ended December
31, 2003
Sales.
Sales in 2004 increased to $23,597,000 compared to $12,493,000
in 2003. This increase is a result of our consolidation of the activities of
Telecom Israel into our financial results beginning from the fourth quarter of
2004 and the resulting inclusion of Telecom Israel’s fourth quarter sales
constituting approximately $5,800,000. The increase in sales is also a result
of an increase in sales by Franz Kalff due to the expansion of its product
lines and growing demands from its customers, and in addition, Franz Kalff’s sales are in Euro, whose value
increased against the U.S. dollar, while our financial statements are in U.S.
dollars.
34
Cost
of Sales.
Costs of sales in 2004 increased to $17,627,000 compared to $9,649,000 in 2004 as a result of the increase in sales
by Franz Kalff and the high Euro/Dollar exchange rate and our consolidation of
the activities of Telecom Israel into our financial results beginning from the
fourth quarter of 2004, resulting in the inclusion of Telecom Israel’s fourth
quarter cost of sales constituting approximately $2,480,000.
Gross
Profit.
Gross
profit in 2003 was $5,970,000 compared with a gross profit of $2,844,000 for
2003. The difference is a result of increased sales by Franz Kalff, a higher
Euro/Dollar exchange rate and the fact the Franz Kalff’s sales are in Euro and
our financial statements are in dollars and our incorporation of the activities
of Telecom Israel into our financial results beginning from the fourth quarter
of 2004.
Research
and Development Expenses, Net.
Following the
discontinuation of our previous business, we ceased research and development
activities. Therefore, for the years 2004, and 2003 we had no research and
development expenses.
Selling
and Marketing Expenses, General and Administrative Expenses.
Marketing, general and administrative expenses in 2004 were $4,196,000 as
compared to $2,895,000 in 2003. The increase is a result of growth in turnover
in Franz Kalff and the start of property lease expenses for Franz Kalff and our
incorporation of the activities of Telecom Israel into our financial results beginning from the fourth
quarter of 2004.
Operating
Loss/Income.
Operating income in 2004 was $1,774,000 compared to a loss of $51,000 in 2003.
The change from loss to profit in 2004 was due to improvement in the
profitability of Franz Kalff and our consolidation of the activities of Telecom
Israel into our financial results beginning from the fourth quarter of 2004.
Financial
Expenses, net.
Financial expenses for the year 2004 were $388,000 compared to $10,000 in 2003.
The increase in financial expenses in 2004 is attributable to exchange rate
differentials between the Dollar and the Swiss Franc, which was the
denomination of some of our acquisition-financing loans.
Impairment
of long term investment.
In 2004 we recorded an impairment loss of approximately $2,218,000
with respect of our holdings in eLady Ltd.
Impairment
of available– for– sale marketable securities.
In
2004 we recorded an impairment loss of $572,000 with respect of our holdings in
available–for-sale marketable securities.
35
Other
Income (Expenses), net.
Other income, net, in 2004
was $142,000 compared to other income, net, of $1,045,000 in 2003. Other
income, net, for the year 2004 was primarily attributable to rent income of
Franz Kalff and in 2003 to the sale of our holdings in Edco Technologies.
Taxes
on Income.
Taxes
on income in 2004 were $332,000 compared to $195,000 in 2003. Taxes on income
in 2004 and in 2003 were primarily due to deferred taxes of Franz Kalff.
Equity
in Earnings of an Affiliate.
Equity in earnings
was $6,000 in 2004 compared to $481,000 in 2003.
Net
Income (Loss).
For the year 2004, we had a net loss of
$1,588,000 compared with a net income of $1,270,000 in 2003. The loss was
primarily due to the write-off of long-term investments and marketable
securities which offset the profits from our consolidated companies.
Year Ended December 31, 2003 Compared To Year Ended December
31, 2002
Sales.
Sales in 2003 increased to $12,493,000 compared to
$8,704,000 in 2002. This increase is a result of an increase in sales by Franz
Kalff due to the expansion of its product lines and growing demands from its
customers. In addition, Franz Kalff’s sales are in Euro, whose value increased
against the Dollar, while our financial statements are in dollars.
Cost
of Sales.
Costs of sales in 2003 increased to
$9,649,000 compared to $6,708,000 2002 as a result of the increase in sales by
Franz Kalff and the high Euro/Dollar exchange rate.
Gross
Profit.
Gross
profit in 2003 was 2,844,000 compared with a gross profit of $1,996,000 for
2002. The difference is a result of increased sales by Franz Kalff, a higher
Euro/Dollar exchange rate and the fact the Franz Kalff’s sales are in Euro and
our financial statements are in dollars.
Research
and Development Expenses, Net.
Following the
discontinuation of our previous business, we ceased research and development
activities. Therefore, for the years 2003, and 2002 we had no research and
development expenses.
Marketing,
General and Administrative Expenses.
Marketing, general
and administrative expenses in 2003 were $2,895,000 as compared to $2,126,000
in 2002. The increase is a result of growth in turnover in Franz Kalff and the
start of property lease expenses for Franz Kalff.
Operating
Loss.
Operating loss in 2003 was $51,000 compared to
$130,000 in 2002. The decreased loss in 2003 was due to the higher
profitability of Franz Kalff in 2003.
Financial
Income (expenses), net.
Financial expenses for the year
2003 were $10,000 compared to $191,000 in 2002. The decrease in financial
expenses in 2003 is attributable to exchange rate differentials between the
Euro and the Swiss Franc.
36
Other
Income (Expenses), net.
Other income, net, in 2003 was $1,045,000 compared to other income, net,
of $257,000 in 2002. Other income, net for the year 2003 was primarily
attributable to the sale of our holdings in Edco Technologies and in 2002 to
lease income received by Franz Kalff.
Taxes on Income.
Taxes
on income in 2003 were $195,000 compared to $378,000 in 2002. Taxes on income
in 2003 were primarily due to deferred taxes of Franz Kalff and in 2002 to
taxes on non-deductable expenses.
Equity
in Earnings of an Affiliate.
Equity in earnings was $481,000 in 2003. This
was attributable to our share in Edco Technologies prior to its sale in March
2003.
Net
Income (Loss).
For
the year 2003, we had a net income of $1,270,000 compared with a net loss of $442,000 in 2002. The income was primarily due to the sale of Edco Technologies.
Impact of Inflation and Currency
Fluctuations on Results of Operations, Liabilities and Assets
Euro
Currency Fluctuations
With
respect to our operating results, the operating results of Franz Kalff play a
material role. The Euro is the operating currency of Franz Kalff. Consequently,
if the value of the Euro increases against the U.S. dollar, because our
financial statements are in U.S. dollars, we will experience an increase in
revenues, and vice versa.
Inflation
in Israel and Currency Fluctuations
For
many years prior to 1986, the Israeli economy was characterized by high rates
of inflation and devaluation of the Israeli currency against the U.S. dollar
and other currencies. However, since
the institution by the Israeli government of an economic recovery program in
1985, inflation, while continuing, has been significantly reduced and until
recently the rate of devaluation has substantially diminished. Inflation and
U.S. dollar exchange rate fluctuations, however, have some effect on our
expenses and, as a result, on our net income/loss. The cost of our Israel operations, as expressed in U.S. dollars,
is influenced by the extent to which any increase in the rate of inflation in
Israel is not offset (or is offset on a lagging basis) by a devaluation of the
NIS in relation to the U.S. dollar. With respect to our operating results, the
operating results of Telecom Israel play a material role. The NIS is the
operating currency of Telecom Israel. As a result, if the value of the U.S
dollar increases against the NIS, because our financial statements are in U.S.
dollars, we will experience a decrease in revenues, and vice versa.
The
exchange rate between NIS and the U.S. dollar has fluctuated from December 2004
through May 2005 from a low of NIS 4.299 to the dollar to a high of NIS 4.634
to the dollar. The high and low
exchange rates between the NIS and U.S. dollar during the six most recent
months, as published by the Bank of Israel, were as follows:
37
LOW 1 U.S. dollar =
HIGH 1 U.S. dollar =
MONTH
4.308
4.367
December
2004
4.352
4.414
January
2005
4.357
4.392
February
2005
4.299
4.379
March
2005
4.36
4.395
April
2005
4.348
4.416
May
2005
The
average exchange rate, using the average of the exchange rates on the last day
of each month during the period, for each of the five most recent fiscal years,
was as follows:
Exchange Rate
Period
4.067 NIS/$1
January
1, 2000 – December 31, 2000
4.219 NIS/$1
January
1, 2001 – December 31, 2001
4.7378 NIS/$1
January
1, 2002 – December 31, 2002
4.5442 NIS/$1
January
1, 2003 – December 31, 2003
4.483NIS/$1
January
1, 2004 – December 31, 2004
As
of the date of this report, increases or decreases in the value of the NIS in
relation to the dollar do not materially affect our operating results. However, it could affect our financial
expenses.
B.
Liquidity and
Capital Resources
Our
cash and cash equivalents aggregated $535,000, $1,742,000 and $381,000 as of
December 31, 2004, December 31, 2003 and December 31, 2002, respectively.
Net
cash used in operating activity for the year ended December 31, 2004 was $1,656,000as compared
with net cash used in operating activity of $596,000 for the year ended December
31, 2003 and net cash used in operating activity of $270,000 for the year ended
December 31, 2002.
Net
cash used in investing activities for the year ended December 31, 2004 was $
709,000 as compared with net cash provided
by investing activities for
the year ended December 31, 2003 of $2,280,000 as compared with net cash
provided by investing activities for the year ended December 31, 2002 of
$180,000. The net cash used in investing activities for 2004 was attributed
mostly to the acquisition of Tadiran Telecom’s Israeli assets. The net cash
provided by investing activities for 2003 was attributed mostly to the sale of
the property of Franz Kalff. In 2002, our cash flow stemmed from the sale of
our holdings in our inactive subsidiary Robomatix (Israel) Ltd.
38
Net
cash provided by financing activities for the year ended December 31, 2004 was
$
1,157
,
000 as compared with net cash used in financing activities of
$396,000 for the year ended December 31, 2003 and as compared to net cash
provided by financing activities of $65,000 for the year ended December 31,
2002. In 2002 and 2003, we sold our
shareholdings in inactive subsidiaries. In addition, in 2003 we returned part
of the loan used to finance the purchase of Franz Kalff but we borrowed funds
from Bank Hapoalim again to invest in two privately held insurance companies,
one of which has since gone public and the other we sold in 2004. The net cash used in financing activities in
2003 was due to partial repayment of loans from Bank Hapoalim offset by the
loans received from Bank Hapoalim. In 2004, the net cash provided by financing
activities was attributed mostly to the acquisition of the Telecom Israeli
assets. For more information, see “Item 4: Information on the Company – History
and Development – Changes of Ownership and Capital Structure”.
As
of December 31, 2004, our aggregate outstanding liabilities were approximately
$19,662,000. Currently, part of the
loans we took from Bank Hapoalim to finance our acquisitions is repayable
through November 2007 and bears interest at 3.5% per annum for the loan
denominated in Swiss Francs and 6.29% per annum for the loan denominated in
NIS. We believe that our working capital is sufficient for our present
requirements but in order to expand our investment portfolio we expect that we
will either realize certain of our investments or will need to obtain
additional debt financing in the future.
We expect to derive cash flow from future returns on existing
investments, repayment of loans and payment of dividends from our operating
companies. We expect these sources to be sufficient to meet our cash
obligations.
Impairment
Losses
. In our financial
statements as of December 31, 2004, we recorded an impairment loss on our
investment in eLady Ltd. of $2,218,000 and impairment losses on
available-for-sale marketable securities of $572,000. In our financial
statements as of December 31, 2003 and December 31, 2002 we did not record
impairment losses.
C. Research and Development,
Patents and Licenses
As
part of past operations, we invested in research and development and registered
trademarks and patents. Currently, as a
holding company, we do not invest in research and development nor in the
registration of patents and licenses, except for extension of certain existing
patents.
D. Trend Information
In 2004, we were not materially influenced by any identifiable trends. Franz
Kalff did experience a certain increase in demand for its products but it is
difficult to attribute this to any particular trend. In addition, due to the
volatility in the securities markets, we may have to continue to reduce the
book value of a certain number of our holdings.
With respect to Telecom Israel, the
world communications market has evolved substantially in the past three years
towards greater technological convergence and equipment variability. New
technologies for the in-premise as well as out of premise telecommunications
have emerged and have revolutionized the way we communicate. Wireless
communications have tightened their grip and their share in the total volume
and VoIP has made its debut as a new and evolving means of voice transport.
39
The
Coral FlexiCom family of products has evolved in concert with these trends. We
believe that Coral FlexiCom offers a growing variety of IP products and
facilities to take advantage of this trend and provides several benefits and
advantages by combining stability and dependability with the Voice over IP
transmission interfaces and user equipment types.
E. Off-Balance
Sheet Arrangements
We
are not a party to any material off-balance sheet arrangements. In addition, we
have no unconsolidated special purpose financing or partnership entities that
are likely to create material contingent obligations.
F. Tabular
Disclosure of Contractual Obligations
The
following table summarizes our contractual obligations and commercial
commitments as of December 31, 2004:
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