-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, FrFt/KACEYWLUcvEBNKRn7iqvHPaYeQ/Hq4b6fwTcj2jUaHNHen9dgwrwU11giyM 6hqAcfRjX74RtYVhwd4hXA== 0001178913-07-000685.txt : 20070402 0001178913-07-000685.hdr.sgml : 20070402 20070402122230 ACCESSION NUMBER: 0001178913-07-000685 CONFORMED SUBMISSION TYPE: 6-K PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 20070402 FILED AS OF DATE: 20070402 DATE AS OF CHANGE: 20070402 FILER: COMPANY DATA: COMPANY CONFORMED NAME: VOCALTEC COMMUNICATIONS LTD CENTRAL INDEX KEY: 0001005699 STANDARD INDUSTRIAL CLASSIFICATION: TELEPHONE COMMUNICATIONS (NO RADIO TELEPHONE) [4813] IRS NUMBER: 000000000 STATE OF INCORPORATION: L3 FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 6-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-27648 FILM NUMBER: 07736838 BUSINESS ADDRESS: STREET 1: 2 MASKIT ST CITY: HERZLIYA 46733 STATE: L3 BUSINESS PHONE: 01197299707845 MAIL ADDRESS: STREET 1: 2 MASKIT ST STREET 2: HERZLIYA ISRAEL 46733 CITY: HERZLIYA STATE: L3 FORMER COMPANY: FORMER CONFORMED NAME: VOCALTEC LTD DATE OF NAME CHANGE: 19960109 6-K 1 zk73598.txt FORM 6-K SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 REPORT OF FOREIGN PRIVATE ISSUER PURSUANT TO RULE 13A-16 OR 15D-16 OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE MONTH OF APRIL 2007 VOCALTEC COMMUNICATIONS LTD. (Translation of registrant's name in English) 60 Medinat Hayehudim Street, P.O. Box 4041 Herzliya 46140, Israel (Address of principal executive offices) Indicate by check mark whether the registrant files or will file annual reports under cover of Form 20-F or Form 40-F: Form 20-F [X] Form 40-F [_] Indicate by check mark if the registrant is submitting the Form 6-K in paper as permitted by Regulation S-T Rule 101(b)(1): ____ Indicate by check mark if the registrant is submitting the Form 6-K in paper as permitted by Regulation S-T Rule 101(b)(7): ____ Indicate by check mark whether registrant by furnishing the information contained in this Form the registrant is also thereby furnishing the information to the Commission pursuant to Rule 12g3-2(b) under the Securities Exchange Act of 1934: Yes [_] No [X] If "Yes" is marked, indicate below the file number assigned to the registrant in connection with rule 12g3-2(b): 82-___________________. THIS FORM 6-K IS INCORPORATED BY REFERENCE INTO OUR REGISTRATION STATEMENT ON FORM F-3 FILED WITH THE SECURITIES AND EXCHANGE COMMISSION (REGISTRATION NO. 333-134917). SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized. By: /s/ Joseph Albagli ---------------------- Joseph Albagli Chief Executive Officer Dated: April 2, 2007 EXHIBIT LIST Exhibit A - Audited consolidated financial statements of the registrant as of and for the year ended December 31, 2006. Exhibit B - Operating and Financial Review and Prospects. Exhibit C - Consent of Kost Forer Gabbay & Kasierer (a Member of Ernst & Young Global). Exhibit D - Consent of Kesselman & Kesselman (a Member of PriceWaterhouseCoopers). EX-99 2 exhibit_a.txt EXHIBIT A VOCALTEC COMMUNICATIONS LTD. AND ITS SUBSIDIARIES CONSOLIDATED FINANCIAL STATEMENTS AS OF DECEMBER 31, 2006 IN U.S. DOLLARS INDEX PAGE ----------- REPORTS OF REGISTERED PUBLIC ACCOUNTING FIRMS F-2 - F-3 CONSOLIDATED BALANCE SHEETS F-4 - F-5 CONSOLIDATED STATEMENTS OF OPERATIONS F-6 STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (DEFICIENCY) F-7 CONSOLIDATED STATEMENTS OF CASH FLOWS F-8 - F-9 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS F-10 - F-38 [ERNST & YOUNG LOGO] REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM TO THE BOARD OF DIRECTORS AND SHAREHOLDERS OF VOCALTEC COMMUNICATIONS LTD. We have audited the accompanying consolidated balance sheets of VocalTec Communications Ltd. ("the Company") and its subsidiaries as of December 31, 2006 and 2005, and the related consolidated statements of operations, changes in shareholders' equity and cash flows for the years then ended. 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 audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Company's and its subsidiaries' internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's and its subsidiaries' internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits 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, 2006 and 2005, and the consolidated results of their operations and their cash flows for the years then ended , in conformity with U.S. generally accepted accounting principles. As discussed in Note 2 to the consolidated financial statements, effective January 1, 2006 the Company adopted Statement of Financial Accounting Standards Board No. 123 (revised 2004) "Share Based Payment". Tel-Aviv, Israel KOST FORER GABBAY & KASIERER March 30, 2007 A Member of Ernst & Young Global F - 2 [KESSELMAN & KESSELMAN, A MEMBER OF PRICEWATERHOUSECOOPERS] REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM TO THE SHAREHOLDERS OF TDSOFT LTD. We have audited the accompanying consolidated balance sheet of Tdsoft Ltd. (the "Company") and its subsidiaries as of December 31, 2004 and the related consolidated statements of operations, changes in capital deficiency and cash flows for each of the two years in the period ended December 31, 2004. These consolidated financial statements are the responsibility of the Company's board of directors and management. Our responsibility is to express an opinion on these financial statements based on our 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 about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by the Company's Board of Directors and management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company and its subsidiaries as of December 31, 2004 and the results of their operations, changes in capital deficiency and their cash flows for each of the two years in the period ended December 31, 2004, in conformity with accounting principles generally accepted in the United States of America. As more fully described in Note 1b to the accompanying consolidated financial statements, subsequent to December 31, 2005, the Company may be dependent on obtaining additional funding in order to continue its activities. Tel-Aviv, Israel November 17, 2005 except shares and per share data as to which the date is April 20, 2006 F - 3 VOCALTEC COMMUNICATIONS LTD. AND ITS SUBSIDIARIES CONSOLIDATED BALANCE SHEETS - -------------------------------------------------------------------------------- U.S. DOLLARS IN THOUSANDS
DECEMBER 31, --------------------- NOTE 2006 2005 ---- ------- ------- ASSETS CURRENT ASSETS: Cash and cash equivalents $ 5,954 $ 5,138 Short term deposit 4 3,000 - Restricted cash 162 153 Trade receivables (net of allowance for doubtful accounts of $120 and $50 as of December 31, 2006 and 2005, respectively 1,443 575 Prepaid expenses and other accounts receivable 5 768 1,387 Severance pay funds 91 338 Inventories 6 1,098 951 ------- ------- TOTAL current assets 12,516 8,542 ------- ------- SEVERANCE PAY FUNDS 1,186 1,628 ------- ------- PROPERTY AND EQUIPMENT, NET 7 888 1,082 ------- ------- INTANGIBLE ASSETS: 3,8 Goodwill 6,950 7,237 Other intangible assets 3,047 3,953 ------- ------- TOTAL intangible assets 9,997 11,190 ------- ------- Total assets $24,587 $22,442 ======= =======
The accompanying notes are an integral part of the consolidated financial statements. F - 4 VOCALTEC COMMUNICATIONS LTD. AND ITS SUBSIDIARIES CONSOLIDATED BALANCE SHEETS - -------------------------------------------------------------------------------- U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE DATA
DECEMBER 31, ------------------------ NOTE 2006 2005 ---- -------- -------- LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES: Trade payables $ 930 $ 1,446 Accrued expenses and other accounts payable 9 2,996 4,128 Accrued severance pay 217 841 Loan from shareholder 10 - 1,031 Deferred revenues 177 171 -------- -------- TOTAL current liabilities 4,320 7,617 -------- -------- LONG-TERM LIABILITIES: Other liabilities 8 168 Accrued severance pay 1,721 1,794 -------- -------- TOTAL long-term liabilities 1,729 1,962 -------- -------- TOTAL liabilities 6,049 9,579 -------- -------- COMMITMENTS AND CONTINGENCIES 11 SHAREHOLDERS' EQUITY: 12 Share capital Ordinary shares of NIS 0.13 par value: Authorized - 150,000,000 shares at December 31, 2006 and 2005; Issued and outstanding - 7,376,364 and 4,661,627 shares at December 31, 2006 and 2005, respectively 213 132 Deferred stock based compensation - (67) Additional paid-in capital 92,228 79,652 Accumulated deficit (73,903) (66,854) -------- -------- TOTAL shareholders' equity 18,538 12,863 -------- -------- $ 24,587 $ 22,442 ======== ========
The accompanying notes are an integral part of the consolidated financial statements. F - 5 VOCALTEC COMMUNICATIONS LTD. AND ITS SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS - -------------------------------------------------------------------------------- U.S. DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA
YEAR ENDED DECEMBER 31, --------------------------------------- NOTE 2006 2005 *) 2004 ---- -------- -------- ------- Sales: 14 Products $ 4,738 $ 3,668 $ 3,719 Services 2,542 925 433 -------- -------- ------- 7,280 4,593 4,152 -------- -------- ------- Cost of sales **): Products 2,171 1,450 1,587 Services 563 315 22 -------- -------- ------- 2,734 1,765 1,609 Inventory write-off - 639 - Amortization of intangible assets 392 172 206 -------- -------- ------- 3,126 2,576 1,815 -------- -------- ------- Gross profit 4,154 2,017 2,337 -------- -------- ------- Operating expenses: Research and development, net **) 15 4,619 4,363 5,474 Selling and marketing **) 4,147 2,763 1,909 General and administrative **) 2,474 1,748 805 -------- -------- ------- TOTAL operating expenses 11,240 8,874 8,188 -------- -------- ------- Operating loss (7,086) (6,857) (5,851) Other income, net 42 24 - Financial income, net 16 32 184 165 -------- -------- ------- Loss before tax benefit (7,012) (6,649) (5,686) Tax benefit 17 - 19 - -------- -------- ------- Net loss $ (7,012) $ (6,630) $(5,686) ======== ======== ======= Accretion of redeemable convertible Preferred shares 12 $ - $ (348) $(3,256) Induced conversion of convertible Preferred shares 12 - (17,406) - -------- -------- ------- Cumulative dividend on convertible Preferred shares - (2,585) - -------- -------- ------- Dividend in respect of reduction in exercise price of certain warrants (37) - - -------- -------- ------- Net loss attributable to common shareholders $ (7,049) $(26,969) $(8,942) ======== ======== ======= Basic and diluted net loss per Ordinary share 13 $ (1.30) $ (34.05) $(24.16) ======== ======== ======= Weighted average number of Ordinary shares used in computing net loss per Ordinary share - basic and diluted 5,436 792 370 ======== ======== ======= *) See Note 3a **) Expenses include stock based compensation related to employees as follows: Cost of sales $ 8 $ - $ - Research and development, net 248 522 (26) Selling and marketing 138 13 - General and administrative 554 268 (6) -------- -------- ------- $ 948 $ 803 $ (32) ======== ======== =======
The accompanying notes are an integral part of the consolidated financial statements. F - 6 VOCALTEC COMMUNICATIONS LTD. AND ITS SUBSIDIARIES STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (DEFICIENCY) - -------------------------------------------------------------------------------- U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE DATA
NUMBER OF SHARES (*) AMOUNT -------------------------------------- ------------------------ ORDINARY ORDINARY A PREFERRED ORDINARY ORDINARY A PREFERRED --------- ------- -------- ---- --- --- Balance as of January 1, 2004 370,059 - 83,479 $ 14 $ - $ 3 Issuance of Ordinary A shares - 45,590 - - 1 - Forfeiture of options granted to employees, net - - - - - - Accretion of redeemable convertible Preferred shares - - - - - - Net loss - - - - - - --------- ------- -------- ---- --- --- Balance as of December 31, 2004 370,059 45,590 83,479 14 1 3 Accretion of redeemable convertible Preferred shares - - - - - - Conversion of redeemable convertible Preferred B and C shares into Preferred shares - - 70,752 - - 2 Stock based compensation related to shares and options issued to employees 122,343 - - 3 - - Conversion of convertible Preferred shares into Ordinary shares 199,821 (45,590) (154,231) 6 (1) (5) Issuance of shares and options pursuant to the merger with VocalTec 1,162,142 - - 32 - - Exercise of employees stock options 17,979 - - - - - Induced conversion of convertible Preferred shares 2,789,283 - - 77 - - Net loss - - - - - - --------- ------- -------- ---- --- --- Balance as of December 31, 2005 4,661,627 - - 132 - - Reclassification of deferred stock compensation due to the adoption of SFAS 123(R) - - - - - - Stock based compensation related to options issued to employees Exercise of employees stock options 29,737 - - 1 - - Issuance of ordinary shares and warrants in private placements 2,685,000 80 Dividend in respect of reduction in exercise price of certain warrants Net loss --------- ------- -------- ---- --- --- Balance as of December 31, 2006 7,376,364 - - 213 - - ========= ======= ======== ==== === ===
TOTAL ADDITIONAL TREASURY DEFERRED SHAREHOLDERS' PAID-IN STOCK STOCK BASED ACCUMULATED EQUITY CAPITAL AT COST COMPENSATION DEFICIT (DEFICIENCY) -------- --------- ---- -------- -------- Balance as of January 1, 2004 $ - $ (1,445) $(15) $(33,926) $(35,369) Issuance of Ordinary A shares **) 445 - - - 446 Forfeiture of options granted to employees, net (47) - 15 - (32) Accretion of redeemable convertible Preferred shares (398) - - (2,858) (3,256) Net loss - - - (5,686) (5,686) -------- --------- ---- -------- -------- Balance as of December 31, 2004 - (1,445) - (42,470) (43,897) Accretion of redeemable convertible Preferred shares - - - (348) (348) Conversion of redeemable convertible Preferred B and C shares into Preferred shares 54,903 - - - 54,905 Stock based compensation related to shares and options issued to employees 867 - (67) - 803 Conversion of convertible Preferred shares into Ordinary shares - - - - - Issuance of shares and options pursuant to the merger with VocalTec 6,401 1,445 - - **)7,878 Exercise of employees stock options 152 - - - 152 Induced conversion of convertible Preferred shares 17,329 - - (17,406) - Net loss - - - (6,630) (6,630) -------- --------- ---- -------- -------- Balance as of December 31, 2005 79,652 - (67) (66,854) 12,863 Reclassification of deferred stock compensation due to the adoption of SFAS 123(R) (67) - 67 - Stock based compensation related to options issued to employees 948 - 948 Exercise of employees stock options 149 - - - 150 Issuance of ordinary shares and warrants in private placements **)11,509 11,589 Dividend in respect of reduction in exercise price of certain warrants 37 (37) - Net loss (7,012) (7,012) -------- --------- ---- -------- -------- Balance as of December 31, 2006 92,228 - - (73,903) 18,538 ======== ========= ==== ======== ========
*) For the periods until the date of the business combination (November 2005) - restated to reflect the number of the Company's shares issued in exchange for each type of Tdsoft shares in the business combination - see Notes 3a and 12a. **) Net of issuance expenses of $ 1,075 and $ 217 and $ 50 in 2006, 2005 and 2004, respectively. The accompanying notes are an integral part of the consolidated financial statements. F - 7 VOCALTEC COMMUNICATIONS LTD. AND ITS SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS - -------------------------------------------------------------------------------- U.S. DOLLARS IN THOUSANDS
YEAR ENDED DECEMBER 31, --------------------------------------- 2006 2005 *) 2004 -------- ------- -------- CASH FLOWS FROM OPERATING ACTIVITIES: Net loss $ (7,012) $(6,630) $ (5,686) Adjustments required to reconcile net loss to net cash used in operating activities: Depreciation and amortization 1,428 811 686 Changes in the accrued liability for severance pay (697) 77 157 Compensation expense related to shares and options issued to employees, net 948 803 (32) Gain on sale of equipment (19) (8) (41) Loss (gain) on amounts funded in respect of severance pay (158) 14 (27) Decrease (increase) in trade receivables, net (868) 379 (233) Decrease (increase) in prepaid expenses and other receivables 610 (624) (45) Decrease (increase) in inventories (43) 500 628 Increase (decrease) in trade payables (483) (423) 155 Increase (decrease) in accrued expenses and other liabilities (1,142) 295 67 Increase (decrease) in deferred revenues 6 37 (141) -------- ------- -------- Net cash used in operating activities (7,430) (4,769) (4,512) -------- ------- -------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of property and equipment (335) (308) (189) Cash and cash equivalents resulting from the merger between VocalTec and Tdsoft (schedule A) - 727 - Cash and cash equivalents resulting from the acquisition of Be-Connected (schedule B) - - (20) Proceeds from sale of property and equipment 26 109 229 Investment in short term deposit (3,000) - - Amounts withdrawn (funded) in respect of severance pay funds, net 847 (33) (132) -------- ------- -------- Net cash provided by (used in) investing activities (2,462) 495 (112) -------- ------- -------- CASH FLOWS FROM FINANCING ACTIVITIES: Repayment of loan from shareholder (1,031) - - Proceeds from issuance of shares upon exercise of stock options by employees 150 152 - Issuance of shares, net 11,589 - - Issuance expenses for Ordinary A shares - - (50) -------- ------- -------- Net cash provided by (used in) financing activities 10,708 152 (50) -------- ------- -------- Increase (decrease) in cash and cash equivalents 816 (4,122) (4,674) Cash and cash equivalents at the beginning of the year 5,138 9,260 13,934 -------- ------- -------- Cash and cash equivalents at the end of the year $ 5,954 $ 5,138 $ 9,260 ======== ======= ======== SUPPLEMENTAL CASH FLOWS INFORMATION: Cash paid during the year for income taxes $ 27 $ 10 $ 21 ======== ======= ========
*) See Note 3a. The accompanying notes are an integral part of the consolidated financial statements. F - 8 VOCALTEC COMMUNICATIONS LTD. AND ITS SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS - -------------------------------------------------------------------------------- U.S. DOLLARS IN THOUSANDS SCHDULE A: CASH AND CASH EQUIVALENTS RESULTING FROM THE MERGER BETWEEN VOCALTEC AND TDSOFT
YEAR ENDED DECEMBER 31, ------------------------------------------- 2006 2005 2004 ---------- ------- ---------- Working capital deficiency, excluding cash $ - $ 3,708 $ - Loan granted to VocalTec prior to the acquisition - 341 - Accrued severance pay, net - 261 - Property and equipment - (328) - Intangible assets other than goodwill - (3,896) - Goodwill - (7,237) - Issuance of shares - 7,878 - ---------- ------- ---------- $ - $ 727 $ - ========== ======= ==========
SCHEDULE B: CHANGE IN CASH AND CASH EQUIVALENTS RESULTING FROM THE ACQUISITION OF BE-CONNECTED YEAR ENDED DECEMBER 31, --------------------------- 2006 2005 2004 ----- ------ ----- Assets of business upon acquisition: Inventories $ - $ - (236) Trade receivables - - (64) Fixed assets - - (3) Issuance of shares 496 Intangible assets - - (213) ----- ------ ----- $ - $ - $ (20) ===== ====== ===== The accompanying notes are an integral part of the consolidated financial statements. F - 9 VOCALTEC COMMUNICATIONS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA NOTE 1:- GENERAL a. VocalTec Communications Ltd. ("VocalTec") and its subsidiaries ("the Company"), is a global provider of carrier-class multimedia and voice-over-IP solutions for communication service providers. The Company provides trunking, peering, access gateway and service delivery solutions that enable flexible deployment of next-generation networks (NGNs). b. On November 24, 2005, VocalTec acquired all of the issued and outstanding Ordinary shares of Tdsoft Ltd. ("Tdsoft"), a privately-held company organized in Israel, and as consideration issued to Tdsoft shareholders Ordinary shares of VocalTec constituting, immediately following such issuance, 75% of the issued and outstanding share capital of VocalTec. For accounting purposes, the transaction was accounted for as a reverse acquisition, with Tdsoft treated as the accounting acquirer. Accordingly, the acquisition was accounted for as a purchase business combination using Tdsoft's historical financial information and recording VocalTec acquired assets and assumed liabilities at fair value as of November 24, 2005 (see Note 3a). c. During 2006, 2005 and 2004, 31%, 34% and 46% of the Company's revenues, respectively, were derived from major customers (see Note 14). NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES The consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States ("U.S. GAAP"). The significant accounting policies followed in the preparation of the financial statements, applied on a consistent basis, are: a. Use of estimates: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements, and the reported amounts of income and expenses during the reported period. Actual results could differ from those estimates. F - 10 VOCALTEC COMMUNICATIONS 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.) b. Financial statements in U.S. dollars: The financial statements have been prepared in U.S. dollars ("dollar"), since the currency of the primary economic environment in which the operations of the Company are conducted is the dollar. Most of the Company's revenues are generated in dollar. In addition, a considerable portion of the Company's costs is incurred in dollars and the Company's financing is obtained in dollar. The Company's management believes that the dollar is the currency of the primary economic environment in which the Company operates. Thus, the functional and reporting currency of the Company is the dollar. Accordingly, the Company's and its subsidiaries' transactions and balances denominated in dollars are presented at their original amounts. Transactions and balances in other currencies have been remeasured into dollars in accordance with the guidance in Statements of the Financial Accounting Standard No. 52, "Foreign Currency Translation" ("SFAS No. 52"). Amounts in currencies other than the dollar have been translated as follows: Monetary balances - at the exchange rate in effect on the balance sheet date. Revenues and costs - at the exchange rates in effect as of the date of recognition of the transactions. All exchange gains and losses from the remeasurement mentioned above are reflected in the statement of operations under financial income, net. The representative rate of exchange for the new Israeli shekel ("NIS") and the U.S. dollar at December 31, 2006 was $ 1.00 = NIS 4.225 (December 31, 2005 - NIS 4.603 and December 31, 2004 - NIS 4.308). c. Principles of consolidation: The consolidated financial statements include the accounts of the Company and its directly and indirectly wholly-owned subsidiaries. As of the balance sheet date the only significant subsidiary is Tdsoft Ltd. F - 11 VOCALTEC COMMUNICATIONS 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.) d. Business combination: Business combinations have been accounted for using the purchase method of accounting. Under the purchase method of accounting the results of operations of the acquired business are included from the effective date of acquisition. The costs to acquire companies, including transactions costs, have been allocated to the underlying net assets of the acquired company in proportion to their respective fair values. Any excess of the purchase price over estimated fair values of the identifiable net assets acquired has been recorded as goodwill. e. Cash equivalents, restricted cash and short term bank deposits: Cash equivalents are short-term, highly liquid investments that are readily convertible to cash with original maturities of three months or less. Restricted cash is invested in highly liquid deposits, which are used as security for bank guarantees provided primarily to lessors of office premises and motor vehicles. Short term bank deposits with original maturities of more than three months but less than one year are presented as part of short-term investments. Such deposits are presented at cost including accrued interest. Interest on the deposits is recorded as financial income. 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, technological obsolescence and discontinued products. Costs are determined as follows: Components cost is determined by the average-cost method. Finished goods are determined on the basis of direct costs, with costs measured on an average basis. Write-off of inventories for the years ended December 31,2006, 2005 and 2004 amounted to $0, $639 and $0, respectively. g. Fair value of financial instruments: SFAS No. 107 "Disclosure about Fair Value of Financial Instruments", requires disclosure of an estimate of the fair value of certain financial instruments. The Company's financial instruments consist of cash and cash equivalents, short-term deposit, trade receivables, other accounts receivable, trade payables, other accounts payable and other liabilities. The estimated fair value of these financial instruments approximates their carrying value as of December 31, 2006 and 2005 due to the short term maturities of those instruments. F - 12 VOCALTEC COMMUNICATIONS 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.) h. Property and equipment, net: Equipment is stated at cost less accumulated depreciation. Depreciation is calculated by the straight-line method over the estimated useful lives of the assets at the following annual rates: % ----------------------------------------- Computers and related equipment 33 Office furniture and equipment 6 - 25 Motor vehicles 15 Leasehold improvements Over the shorter of the term of the lease or the life of the asset *) *) See also Note 11d. i. Impairment and disposal of long-lived assets: The Company's amortizable long-lived assets are reviewed for impairment in accordance with Statement of Financial Accounting Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" 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 asset. If an asset is considered to be impaired, the impairment is measured by the difference between the carrying amount of the asset and its fair value. During the periods presented no impairment changes were recorded. j. Intangible assets: Intangible assets include mainly goodwill technology, customers relations, customer contracts and other identifiable intangible assets acquired in connection with the purchase of businesses. Technology and other identifiable intangible definite lived assets are amortized over their estimated useful lives. The Company evaluates the amortization periods of all identifiable intangible assets to determine whether events or circumstances warrant revised estimates of useful lives. Under Statement of Financial Accounting Standard No. 142 "Goodwill and other Intangible Assets" ("SFAS 142") goodwill is no longer amortized but instead is tested for impairment at least annually (or more frequently if impairment indicators arise). SFAS No. 142 requires to compare the fair value of the reporting unit to its carrying amount on an annual basis to determine if there is a potential impairment. If the fair value of the reporting unit is less than its carrying value, an impairment loss is recorded to the extent that the implied fair value of the goodwill within the reporting unit is less than its carrying value. The fair value of the reporting unit is determined based on market capitalization. During the periods presented no impairment charges were recorded. F - 13 VOCALTEC COMMUNICATIONS 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.) k. Revenue recognition: The Company generates revenues from licensing the rights to use its software products, from the sale of its systems and from providing maintenance and support services. The Company's products are sold also to resellers, who are considered end-users for the purpose of revenue recognition (except as indicated below). Revenue from software products is recognized when all criteria outlined in SOP 97-2 are met: persuasive evidence of an arrangement exists, the product has been delivered, no significant obligation to the customer remains, the sales price is fixed or determinable and collectibility is reasonably assured. The Company does not grant a right of return to its customers. Revenue from sale of systems is recognized upon delivery to the end-user or the reseller. Provisions for warranty are made at the time of the sale. Such revenues are recognized in accordance with Staff Accounting Bulletin No. 104 "Revenue Recognition in Financial Statements" ("SAB No. 104") Where software arrangements involve multiple elements, revenue is allocated to each undelivered element based on vendor specific objective evidence ("VSOE") of the fair value of the undelivered element. The VSOE used by the Company to allocate the arrangement fees to support services and maintenance is based on the price charged when these elements are sold separately (upon renewal). Revenues for the delivered product are recorded based on the "residual method" presented by SOP 98-9, "Modification of SOP 97-2, Software Revenue Recognition With Resepct to Certain Transactions", whereby the reminder of the arrangement fee, after allocating revenue to undelivered elements as described above is allocated to the delivered product. Under the residual method revenue is recognized for the delivered elements when (1) there is VSOE of fair value on all the undelivered elements and (2) all revenue recognition criteria of SOP 97-2 are satisfied. Under the residual method any discount in the arrangement is allocated to the delivered element. When an arrangement provides for acceptance of the product by the customer, revenue is not recognized until such acceptance is received. In certain cases, when the company sells its products through resellers in new and emerging market channels for which no comparable history has been established, the Company recognizes revenues only when all obligations to the end user have been completed, provided all other revenue recognition criteria have been met. Arrangements including training and installation services are recognized only after the services are performed. Revenue from software maintenance and technical support contracts is recognized on a straight line basis over the term of the maintenance and support arrangement. Engineering services are recognized as services are performed Deferred revenue includes unearned amounts received under the maintenance and support contracts, and amounts received from customers but not recognized as revenues. F - 14 VOCALTEC COMMUNICATIONS 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.) For the sale of systems the Company records at the time of sale a provision to cover the expected costs in order to honor its warranty obligation. As of December 31, 2006 and 2005 the warranty provision amounted to $ 20 and $ 180, respectively. l. Research and development costs, net: Research and development costs, net of grants received, are charged to the statement of operations as incurred. Statement of Financial Accounting Standard No. 86, "Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed", ("SFAS No. 86"), requires capitalization of certain software development costs subsequent to the establishment of technological feasibility. Costs incurred by the Company between the establishment of technological feasibility and the point at which the products are ready for general release, have been insignificant. Therefore, all research and development costs have been expensed. Research and development grants were deducted from research and development costs (See m below). m. Royalties-bearing grants Royalty-bearing grants from the Government of Israel and other governmental institutions for funding approved research and development projects are recognized at the time the Company is entitled to such grants, on the basis of the research and development costs incurred. Such grants are included as a deduction of research and development costs since at the time received it is not probable the Company will generate sales from these projects and pay the royalties resulting from such sales. For the grants received and deducted from the research and development costs - see Note 15. F - 15 VOCALTEC COMMUNICATIONS 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.) n. Income taxes: Income taxes are accounted for 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 asset and liability account balances are determined based on temporary differences between financial reporting and tax bases of assets and liabilities and for carry forward losses. Deferred taxes are measured using the enacted tax rates that will be in effect when the differences are expected to reverse. The Company provides a valuation allowance, to reduce deferred tax assets to their estimated realizable value. o. Share-based compensation: Until January 1, 2006, the Company has elected to follow Accounting Principles Board Statement No. 25, "Accounting for Stock Options Issued to Employees" ("APB No. 25") and Financial Accounting standard Board (FASB) Interpretation No. 44, "Accounting for Certain Transactions Involving Stock Compensation" ("FIN No. 44") in accounting for its employee stock option plans. According to APB No. 25, compensation expense is measured under the intrinsic value method, whereby compensation expense is equal to the excess, if any, of the quoted market price of the stock over the exercise price at the grant date of the award. Forfeitures are accounted for as occurred. Effective January 1, 2006, the Company adopted FASB Statement No. 123 (revised 2004), "Share-Based Payment" ("SFAS 123(R)") , and related Securities and Exchange Commission rules included in Staff Accounting Bulletin No. 107, on a modified prospective basis. Under this method, compensation cost recognized in 2006 includes costs related to 1) all share-based payments granted prior to but not yet vested as of January 1, 2006, based on the grant-date fair value estimated in accordance with the original provisions of SFAS 123 and 2) all share-based payments granted subsequent to January 1, 2006 based on the grant-date fair value estimated in accordance with the provisions of SFAS 123(R). Results for prior periods have not been restated. Compensation cost for stock options is recognized ratably over the vesting period using the straight line method. SFAS No. 123(R) requires companies to estimate the fair value of equity based payment awards on the date of grant using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as an expense over the requisite service periods in the Company's consolidated income statements. As a result of adopting Statement 123(R) on January 1, 2006 the Company's loss before income taxes and net loss for the year ended December 31, 2006 are $585 higher, respectively, than if the Company had continued to account for share-based compensation under Opinion 25. Basic and diluted loss per share for the year ended December 31, 2006 are $0.11 higher, respectively, than if the Company had continued to account for share-based compensation under Opinion 25. F - 16 VOCALTEC COMMUNICATIONS 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.) The Company estimates the fair value of stock options on the grant date using the Black-Scholes option-pricing model with the following weighted average assumptions: 2006 2005 2004 --------- ---------- --------- Dividend yield 0% 0% 0% Expected volatility 105% 102% 94% Risk-free interest rate 4.9% 4.4% 3.9% Weighted average expected life 4.6 years 4.17 years 5.0 years Forfeiture rate 7.5% - - The Company is required to assume a dividend yield as an input in the Black-Scholes model. The dividend yield assumption is based on Company's historical and expectation of future dividend. The dividend yield used for the twelve months ended December 31, 2006 was 0%, as the Company does not expect to pay dividend over the option terms. The weighted average volatility used for the twelve months ending December 31, 2006 was 105%. This assumption is based on the historical volatility of the Company's stock over a period equal to the expected life of the option. The risk-free interest rate assumption is based on observed interest rates appropriate for the term of the Company's employee stock options. Weighted average interest rate used for the twelve months ended December 31, 2006 was 4.9%. The Company determined the expected life of the options according to the "simplified method" allowed under SAB107, which is the average of the vesting and the contractual term of the Company's stock options. Expected life used for the twelve months ended December 31, 2006 was 4.6 years. The computation of the forfeiture rate is based on the historical observation of employees pre-vesting termination behavior. The Company's aggregate compensation cost for the twelve months ended December 31, 2006 totaled $948. F - 17 VOCALTEC COMMUNICATIONS 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.) The following table illustrates the effect on net and net earnings loss per share, assuming that the Company had applied the fair value recognition provisions of SFAS 123 to options granted under the Company's stock options plans in all periods presented prior to the adoption of SFAS 123(R). For purposes of this pro forma disclosure, the value of the options is estimated using a Black-Scholes-Merton option-pricing model and amortized to expense over the options' vesting periods using the accelerated attribution method.
YEAR ENDED DECEMBER 31 ----------------------- 2005 2004 -------- ------- Net loss as reported $ (6,630) $(5,686) Add: stock based employee compensation expense (reversal income) included in reported net loss for the year 803 (32) Deduct: stock based employee compensation expense reversal income determined under fair value method for all options granted (1,129) (220) -------- ------- Pro forma net loss $ (6,956) $(5,938) ======== ======= Accretion of redeemable convertible Preferred shares $ (348) $(3,256) Induced conversion of convertible Preferred shares (17,406) - -------- ------- Cumulative dividend on convertible preferred shares (2,585) - -------- ------- Pro forma net loss attributable to common shareholders $(27,295) $(9,194) ======== ======= Basic and diluted net loss per Ordinary share: Net loss per Ordinary share as reported $ (34.05) $(24.16) Pro forma net loss per Ordinary share $ (34.46) $(24.84)
The Company's additional disclosures required by SFAS 123(R) are provided in Note 12. As of December 31, 2006, the total unrecognized estimated compensation cost related to non-vested stock options granted prior to that date was $2,545, which is expected to be recognized over a period of up to four years. The total intrinsic value of stock options exercised during 2006 was $102. The Company recorded cash received from the exercise of stock options of $150 during the year ended December 31, 2006. F - 18 VOCALTEC COMMUNICATIONS 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.) p. Severance pay: The Company's liability for severance pay for its Israeli employees is calculated pursuant to Israel's Severance Pay Law and employment agreements based on the most recent salary of the employees. The Company's liability for all of its employees, is fully covered for by monthly deposits with insurance policies and by an accrual. The value of these insurance policies is recorded as an asset in the Company's balance sheet. The deposited funds include profits accumulated up to the balance sheet date. The deposited funds may be withdrawn only upon the fulfillment of the obligation pursuant to Israel's Severance Pay Law or labor agreements. The value of the deposited funds is based on the cash surrendered value of these funds and includes immaterial profits. Severance expense for the years ended December 31, 2006, 2005 and 2004 amounted to approximately $ 170, $ 77 and $ 157, respectively. q. Concentration of credit risks: Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of cash and cash equivalents, restricted cash, marketable securities and trade receivables. Cash and cash equivalents and the short term deposit are invested in U.S. dollars with major banks in the United States and in Israel. Management believes that the financial institutions that hold the Company investments are financially sound and, accordingly, minimal credit risk exists with respect to these investments. The Company's trade receivables are generally derived from sales of products and services rendered to large and solid organizations located primarily in Europe, North America, and the Far East. The Company performs ongoing credit evaluations of its customers. To date the Company has not experienced any material losses in respect of its trade receivable. For new customers, the Company may require a letter of credit or. An allowance for doubtful accounts is determined based on Management's estimation and historical experience. Expense resulting from the net increase in the allowance for doubtful accounts was $ 70, $ 0 and $ 38 for the years ended December 31, 2006, 2005 and 2004, respectively. As of December 31, 2006, there is no significant off-balance sheet concentration of credit risk such as foreign exchange contracts, options contracts or other foreign hedging arrangements. F - 19 VOCALTEC COMMUNICATIONS 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.) r. Net loss per share: Basic net loss per share is computed using the weighted average number of Common shares outstanding during the period, and excludes any dilutive effects of options. Diluted net loss per share is computed using the weighted average number of Common shares plus dilutive potential shares of Ordinary stock considered outstanding during the period. In accordance with Emerging Issues Task Force Issue 03-6 "Participating Securities and the Two-Class Method under FASB Statement No. 128" ("EITF 03-6"), participating convertible securities are excluded from the computation since there is no contractual obligation for these securities to share in the Company net loss. In the years ended December 31, 2006, 2005 and 2004, all outstanding stock options and in the years ended December 31, 2005 and 2004 also all the series of Preferred shares have been excluded from the calculation of the diluted net loss per Ordinary share since such securities were anti-dilutive. s. Recently issued Accounting Standards: In September 2006, the Financial Accounting Standards Board ("FASB") issued SFAS No. 157, "Fair Value Measurements". This Standard defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. The Company has not yet determined the effect that adoption of SFAS No. 157 will have on its consolidated Financial Statements. In June 2006, the FASB issued Interpretation No. 48, "Accounting for Uncertainty in Income Taxes" ("FIN 48"), an interpretation of SFAS 109, "Accounting for Income Taxes". FIN 48 prescribes a comprehensive model for how companies should recognize, measure, present and disclose, in their financial statements uncertain tax positions taken or expected to be taken on a tax return. Under FIN 48, tax positions shall initially be recognized in the financial statements when it is more-likely-than-not the position will be sustained upon examination by the tax authorities. Such tax positions shall initially and subsequently be measured as the largest amount of tax benefit that is greater than 50% likely of being realized upon ultimate settlement with the tax authority assuming full knowledge of the position and all relevant facts. FIN 48 also revises disclosure requirements to include an annual tabular rollforward of unrecognized tax benefits. The provisions of this Interpretation are required to be adopted for fiscal periods beginning after December 15, 2006. The Company will be required to apply the provisions of FIN 48 to all tax positions upon initial adoption with any cumulative effect adjustments to be recognized as an adjustment to retained earnings. The Company has not yet determined the effect of adoption of FIN No. 48 will have on its consolidated Financial Statements. F - 20 VOCALTEC COMMUNICATIONS 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.) In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities," ("SFAS No. 159"), which permits companies to choose to measure certain financial instruments and other items at fair value that are not currently required to be measured at fair value. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. The Company will adopt SFAS No. 159 no later than January 1, 2008. The Company has not yet determined the effect that the adoption of SFAS No. 159 will have on its consolidated financial statements. t. Reclassification: Certain figures from prior years have been reclassified in order to conform to the 2006 presentation. F - 21 VOCALTEC COMMUNICATIONS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA NOTE 3:- BUSINESS COMBINATION a. TdSoft: On November 24, 2005 VocalTec acquired all the issued and outstanding Ordinary shares of Tdsoft Ltd. ("Tdsoft"), a provider of Voice over IP gateways for carriers, in consideration for issuance of shares to Tdsoft shareholders representing as of the closing date of the transaction 75% of the issued and outstanding share capital of VocalTec. As a result, Tdsoft became a wholly-owned subsidiary of VocalTec. Although the merger with Tdsoft was formed as a merger of Tdsoft into VocalTec, immediately after the merger the shareholders of Tdsoft held the majority of VocalTec outstanding Ordinary shares. Accordingly, for accounting and financial reporting purposes, the merger was treated as a reverse acquisition of VocalTec by Tdsoft under the purchase method of accounting pursuant to Statement of Financial Accounting Standard No. 141 "Business Combination" ("SFAS 141"). The financial statements of the combined company reflect the financial statements of Tdsoft on a historical basis and include the results of operations and cash flows of VocalTec from November 24, 2005. However, Tdsoft's shareholders' equity was restated retroactively to reflect the transaction as a reverse recapitalization. As such, all share capital (number and amounts) reflect Vocaltec shares exchanged for the Tdsoft shares existing at each relevant date. The fair value of the Ordinary shares of VocalTec was determined based on the average market price of the shares during the period of two days before and ending two days after the date VocalTec and Tdsoft announced the merger agreement on October 28, 2005. The purchase price also included the fair value of the VocalTec stock options and other costs of the transaction. Accordingly, the total purchase price was as follows:
Number of shares of VocalTec outstanding as of November 24, 2005 $1,162,142 ========== VocalTec's average share price for the two trading days before through the two trading days after October 28, 2005, the date VocalTec and Tdsoft announced their merger 6.77 ========== Fair value of VocalTec's Ordinary shares $ 7,869 Fair value of 186,597 VocalTec share options *) 226 Transaction costs of Tdsoft 138 ---------- Purchase price $ 8,233 ==========
*) The fair value of the options was determined based on the Black & Scholes options pricing model. F - 22 VOCALTEC COMMUNICATIONS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA NOTE 3:- BUSINESS COMBINATION (CONT.) The purchase price was allocated based on an estimate of the fair value of the assets acquired and the liabilities assumed as of November 24, 2005, as follows: Current assets $ 2,009 Severance pay funds 1,123 Equipment 328 -------- TOTAL tangible assets 3,460 -------- Identifiable intangible assets: Current Essentra technology (7 years useful life) 1,963 Current VEA technology (2 years useful life) 123 Customer contract (1 year useful life) 372 Customer relations (7 years useful life) 887 Trade name (10 years useful life) 301 Patents (10 years useful life) 250 Goodwill (*) 6,950 -------- TOTAL intangible assets acquired 10,846 -------- TOTAL tangible and intangible assets acquired 14,306 -------- TOTAL liabilities assumed (*) (6,073) -------- Net assets acquired $ 8,233 ======== (*) After reduction of $287 due to adjustments to the estimated fair value of the inventory acquired and certain liabilities assumed, mainly the accrued expenses with respect to office lease. The resulting goodwill is attributed but is not limited to the synergistic value and potential benefits that could be realized by the Company from the acquisition, as well as VocalTec's skilled and specialized workforce. The goodwill is not deductible for tax purposes. In accordance with Statement of Financial Accounting Standards No. 142 ("SFAS 142") "Goodwill and Other Intangible Assets", goodwill arising from acquisition will not be amortized. Values assigned to intangible assets were determined using the income approach by discounting the future cash flows an asset will generate over its remaining useful life. Current assets and liabilities were recorded at their carrying value since such carrying amounts were proxies for their market values due to their short-term maturities. F - 23 VOCALTEC COMMUNICATIONS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA NOTE 3:- BUSINESS COMBINATION (CONT.) b. Be-Connected: In May 2004, Tdsoft entered into an Assets Purchase Agreement with Be-Connected Ltd., an Israeli privately held company, pursuant to which Tdsoft acquired Be-Connected's assets, including the intellectual property rights and the business of the TAS product, a multi service access platform and assumed certain liabilities, primarily related to supporting customers and paying royalties to the Office of the Chief Scientist of the Ministry of Industry and Trade in Israel. The purchase was in consideration of $ 20 in cash and issuance of 45,439 Ordinary A shares, representing 8% ownership of Tdsoft, which were valued at approximately $ 496, based on the Tdsoft's average share price of $ 0.25, as determined by an external appraiser. Tdsoft incurred $ 50 of issuance expenses with respect to the issuance of the shares. In addition, the results of Be Connected operation have been included in the consolidated financial statements since May 1, 2004. The acquisition was accounted for using the purchase method under SFAS No. 141. The purchase price was allocated to those assets acquired based on the estimated fair value of those assets as of the acquisition date, as follows:
Current assets $ 300 Property and equipment 3 Identifiable intangible assets: Technology (11 years useful life)* 182 Customer backlog (1 year useful life) 3 Customer relationship (5 years useful life) 28 ------ Assets acquired $ 516 ====== Excess of net fair value over purchase price allocated to none-current assets $1,197 ======
(*) In 2005 the Company changed estimated useful life acquired technology from 11 to 5 years. c. Supplemental pro forma information (unaudited): The unaudited pro forma information regarding 2005 and 2004 presents the results of operations of Tdsoft after giving effect to the merger with Vocaltec in 2005 and the acquisition of Be-Connected in 2004, and includes the effect of amortization of intangible assets from these dates. The pro forma information is based upon the historical financial statements of VocalTec, TdSoft and Be-Connected. The pro forma data does not incorporate, nor does it assume, any benefits from cost savings or synergies of the combined companies. The pro forma data is presented for comparative purposes only and is not necessary indicative of the operating results that would have occurred had the merger been consummated at the dates indicated, nor are they necessarily indicative of future operating results or financial conditions. F - 24 VOCALTEC COMMUNICATIONS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA NOTE 3:- BUSINESS COMBINATION (CONT.)
YEAR ENDED DECEMBER 31, --------------------------- 2005 2004 ------------ -------- (UNAUDITED) --------------------------- Sales $ 8,427 $ 9,987 ============ ======== Operating loss $ (16,833) $(20,227) ============ ======== Net loss $ (15,137) $(19,893) ============ ======== Basic and diluted net loss per Ordinary share $ (19.28) $ (15.11) ============ ======== Weighted average number of Ordinary shares used in computation of basic and diluted net loss per share 1,840 1,532 ============ ========
NOTE 4:- SHORT TERM DEPOSIT Includes a bank deposit in U.S. dollars, bearing an annual weighted average interest rate of 5.2% per annum. NOTE 5:- PREPAID EXPENSES AND OTHER ACCOUNTS RECEIVABLE DECEMBER 31, ------------------- 2006 2005 ------ ------ Prepaid expenses $ 112 $ 105 Research and development participation and grants receivable 460 970 Government authorities 162 226 Other 34 86 ------ ------ $ 768 $1,387 ====== ====== NOTE 6:- INVENTORIES DECEMBER 31, ----------------- 2006 2005 ------ ---- Components and work in progress $ 538 $752 Finished goods **) 560 199 ------ ---- 1,098 $951 ====== ==== *) Write-off of inventories for the years ended December 31, 2006, 2005 and 2004 amounted to $ 0, $ 757 and $ 0, respectively. **) As of December 31, 2006 and 2005, $ 560 and $ 199, respectively, finished goods were delivered to customers' sites and were not recognized as cost of sales since revenue recognition criteria for the related sales have not been met. F - 25 VOCALTEC COMMUNICATIONS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA NOTE 7:- PROPERTY AND EQUIPMENT, NET
DECEMBER 31, ------------------- 2006 2005 ------ ------ Cost: Computers and related equipment $4,409 $4,083 Office furniture, equipment and leasehold improvements 1,304 1,295 Motor vehicle 29 122 ------ ------ 5,742 5,500 Less - accumulated depreciation 4,854 4,418 ------ ------ Depreciated cost $ 888 $1,082 ====== ======
Nearly all of the property and equipment is located in Israel. Depreciation expense was $ 522, $ 581 and $ 484 for the years ended December 31, 2006, 2005 and 2004, respectively. NOTE 8- GOODWILL AND OTHER INTANGIBLE ASSETS
DECEMBER 31, -------------------- 2006 2005 ------ ------- Cost: Technology, customer relations and other intangible assets (1) $4,859 $ 4,859 Accumulated amortization: Technology, customer relations and other intangible assets (1) 1,812 906 ------ ------- 3,047 3,953 ------ ------- Goodwill 6,950 7,237 ------ ------- Amortized cost $9,997 $11,190 ====== =======
1. The future annual estimated amortization expense in the next 5 years relating to VocalTec's amortizable intangible assets existing as of December 31, 2006, is approximately as follows: TOTAL AMORTIZATION ---------------- 2007 $ 566 2008 511 2009 462 2010 462 2011 462 F - 26 VOCALTEC COMMUNICATIONS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA NOTE 8:- GOODWILL AND OTHER INTANGIBLE ASSETS (CONT.) 2. The changes in the carrying amount of goodwill for the period ended December 31, 2006 is as follows: Balance as of December 31, 2004 $ - ------- Newly consolidated Company 7,237 Balance as of December 31, 2005 $ 7,237 Adjustment to the initial allocation of the purchase price resulted from changes in the estimated fair value of Vocaltec assets acquired and liabilities assumed (see note 3a) (287) ------- Balance as of December 31, 2006 $ 6,950 ======= 3. Amortization expenses amounted to approximately $ 906, $ 230 and $ 206 for the years ended December 31, 2006, 2005 and 2004, respectively. 4. In 2005, Tdsoft changed the estimated useful life of the acquired technology acquired, as part of the Be-Connected asset purchase from May 2004 from 11 years to 5 years (see Note 3b) in order to reflect the expected useful life of the assets as a result of the rapid changes in the industry. Accordingly, the amortization expenses were increased by $ 20 in 2005. NOTE 9:- ACCRUED EXPENSES AND OTHER ACCOUNTS PAYABLE DECEMBER 31 ------------------- 2006 2005 ------ ------ Employees and payroll accruals $ 948 $ 773 Accrued expenses 303 777 Accrued vacation pay 620 778 Government Institutions 962 911 Office lease 97 288 Directors and officers insurance - 438 Other 66 163 ------ ------ $2,996 $4,128 ====== ====== NOTE 10- LOAN FROM SHAREHOLDER In July 2005, the Company received a bridge loan in the amount of $ 1,000 from Deutsche Telekom, one of its major shareholders prior to the merger with Tdsoft Ltd. The loan bears interest at the rate of 7.05% per annum payable along with the principal in July 2006. In connection with the loan, the Company agreed to put the source code of one of its products in escrow in favor of Deutsche Telekom and not to create, without the approval of Deutsche Telekom, any security interest over such source code. During July 2006, the loan was fully repaid, including accrued interest. F - 27 VOCALTEC COMMUNICATIONS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA NOTE 11: COMMITMENTS AND CONTINGENCIES a. In connection with its research and development activities through December 31, 2006, the Company received and accrued participation payments from the Office of the Chief Scientist of the Ministry of Industry and Trade in Israel ("OCS"). In return for the Government of Israel's participation, the Company is committed to pay royalties at a rate of 3.5% - 4.5% of sales of the developed product, up to 100% of the amount of grants received linked to the U.S. dollar (for grants received under programs approved subsequent to January 1, 1999, 100% plus interest at LIBOR). The Company's total contingent liability for royalties payable to the OCS with respect to future sales, based on Government of Israel participations received or accrued, net of royalties paid or accrued, totaled approximately $ 19,322 as of December 31, 2006 and $17,128 as of December 31, 2005. 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. Cost of sales includes royalties paid and accrued to the Government of Israel in the amount of $ 201, $ 63 and $ 67 for the years ended December 31, 2006, 2005, and 2004, respectively. b. In April 2005, Tdsoft entered into a co-operation and project funding agreement effective as of December 1, 2004, with Nuera Communications, Inc. ("Nuera") and the Israel-United States Bi-national Industrial Research and Development Fund ("BIRD"), for the development of "Next Generation VoIP Gateway" with certain funding assistance from the BIRD. Under the agreement, Tdsoft shall be reimbursed by the BIRD for 50% of its research and development expenses, up to an aggregate amount of $ 770. In accordance with the agreement with BIRD, Tdsoft is obligated to pay royalties at the rate of 5% of the sales of the developed products up to a maximum of 150% of the amount received depending of the year following the termination of the agreement in which the participation is fully paid. During 2006 and 2005, grants received and accrued from BIRD amounted to $ 21 and 749, respectively. Tdsoft's contingent liability to the BIRD amounts to approximately $ 770. 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. The Company has no future commitments for royalties in respect of other participations received. c. Certain allegations, mainly for patent infringement and breach of contract have been made against VocalTec Ltd., Tdsoft Ltd. or its U.S. subsidiary. These allegations have not resulted in any action brought against the Company. The Company's management does not believe that it is probable that the above mentioned allegations will result in a loss to the Company. Accordingly, no provision was recorded with respect to these allegations. F - 28 VOCALTEC COMMUNICATIONS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA NOTE 11: COMMITMENTS AND CONTINGENCIES (CONT.) d. The Company's facilities in Israel are rented under operating leases with different periods ending through April 2010 (with renewal option). Rent expense amounted to $ 256, $ 308 and $ 368 for the years ended December 31, 2006, 2005 and 2004, respectively. Annual minimum rental commitments under non-cancelable leases at balance sheet date are approximately as follows: 2007 $ 415 2008 468 2009 468 2010 117 ------- Total $ 1,468 The Company also maintains motor vehicle leases. The total liability for early termination of such leases is approximately $ 48. Motor vehicle lease expense amounted to $ 470, $ 390 and $ 130 for the years ended December 31, 2006, 2005 and 2004, respectively. e. Under the purchase agreement with Be-Connected (see Note 3b), the bank provided the shareholders of Be-Connected on behalf of Tdsoft a bank guarantee of $ 500, in respect of certain guarantees that a shareholder of Be-Connected gave to its customers. $ 140 out of the $ 500 expired in November 2006, the other $ 360 will expire in May 2009. f. The bank provided with respect to offices lessors bank guarantee on behalf of Tdsoft, in the amount of $ 166. The bank provided certain lessors bank guarantees in the total amount of $ 140 on behalf of the Company, primarily in connection with its offices and motor vehicles. NOTE 12:- SHARE CAPITAL a. Share capital 1. All Ordinary shares of the Company have the same rights. Dividends declared by the company will be distributed to shareholders in proportion to their holdings. If the Company is liquidated, after satisfying liabilities to creditors, the Company's assets will be distributed to the holders of Ordinary shares in proportion to their holdings. Holders of Ordinary shares have one vote for each paid-up Ordinary share on all matters submitted to a vote of our shareholders. These voting rights may be affected by the grant of any special voting rights to the holders of a class of shares with preferential rights that may be authorized in the future. F - 29 VOCALTEC COMMUNICATIONS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA NOTE 12:- SHARE CAPITAL (CONT.) 2. Pursuant to an amendment to the articles of association of Tdsoft, which amendment was adopted immediately prior to the consummation of the business combination between VocalTec and TdSoft in November 2005, all series of convertible Preferred shares were converted into Ordinary shares of TdSoft. Immediately after, all the Ordinary shares of TdSoft were exchanged for VocalTec Ordinary shares. The conversion ratio was established for each class of shares. The group of the founders and the employees of the Company received a preferred conversion ratio, according to which the founders and the employees received approximately twice the amount received by the other Ordinary shareholders. Accordingly the Company recorded stock-based compensation in the amount of $ 870, of which $ 803 was recorded in the statement of operations in 2005. In addition, the Preferred shareholders also received a preferred conversion ratio over the Ordinary Shares, although the original terms of the convertible Preferred shares provided for a conversion at the ratio of 1:1. Consequently, as required by EITF D-42, "The Effect on the Calculation of Earnings per Share to the Redemption or Induced Conversion of Preffered Stock" and EITF D-53, "Compatation of Earnings per Share for a Period that Includes a Redemption or an Induced Conversion of a Portion of a Class of Preffered Stock", the financial statements for the year ended December 31, 2005 include an amount of $ 17,406 attributed to the value of the incremental number of Ordinary shares received by the holders of the preferred stock upon the conversion of the preferred stock as part of the business combination with VocalTec. All the share stock amounts have been restated to reflect the Ordinary shares received as part of the business combination, as described in Note 3a. 3. Prior to the conversion and exchange of all the shares of TdSoft, the holders of series B and C Preferred shares of Tdsoft had certain redemption rights. In February 2005, all redemption rights were waived and the redeemable convertible Preferred shares were converted into convertible Preferred shares. The Preferred shares also held certain liquidation preferences over Ordinary shares (Preferred C prior to Preferred A and Preferred B, Preferred A and B prior to all Ordinary shares and Ordinary A shares prior to Ordinary shares), and were convertible into Ordinary shares as follows: each series A Preferred share, series B and B-2 Preferred share and series C Preferred share was convertible at any time into an Ordinary share at the option of the holder. In addition, holders of series A, series B, series B-2 and series C convertible Preferred shares were entitled to receive cumulative dividends in preference to the holders of Ordinary and Ordinary A shares at the rate of 8% per annum. Such dividends would accrue quarterly for the benefit of the holders of the Preferred shares. 4. On November 25, 2005, the Company effected a reverse split of its issued and outstanding share capital of 1:13. All the stock share amounts were adjusted to reflect the reverse split. F - 30 VOCALTEC COMMUNICATIONS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA NOTE 12:- SHARE CAPITAL (CONT.) b. In May 2006 the Company issued in a private placement in consideration for $ 4,591, net of issuance expenses of $ 548, 935,000 Ordinary Shares and warrants to purchase up to 424,050 Ordinary Shares at an exercise price of $ 7.9 per share. The warrants became exercisable 6 months after issuance and will remain exercisable until the fifth anniversary of the date of issuance. According to the agreements, the investors have the right to receive payment for liquidated damages if a registration statement on Form F-3 is not declared effective within 60 days from the date of the closing and/or the failure to maintain the registration Statement effective. The liquidated damages will be in the amount of 0.0333% of the purchase price paid by the investors for each day of delay up to 10% of the proceeds received. The shares and shares to be derived from the warrants were registered for trading on NASDAQ on May 22, 2006. As of December 31, 2006 no liability was recorded in respect of the liquidated damages as the Company does not deem it probable that such liquidated damages will be made. In December 2006 the Company decided to reduce the exercise price of the warrants issued by the Company to the investors from $7.9 per share to $6.87 per share - the closing price of the Company's ordinary shares on the Nasdaq Capital Market at the close of business immediately prior to execution of the agreement relating to the May 2006 issuance. The benefit of $37 to the warrant holders from the aforementioned reduction in the exercise price was recorded as a preferred dividend to the warrant holders. As of December 31, 2006, none of these warrants were exercised into the Company's ordinary shares. c. In November 2006 the Company issued in a private placement in consideration for $ 6,998, net of issuance expenses of $ 527, 1,750,000 Ordinary Shares and warrants to purchase up to 1,400,000 Ordinary Shares at an exercise price of $ 5.5 per share. The warrants are exercisable during a period ending June 30, 2011. The shares were registered for trading on NASDAQ on December 4, 2006. As of December 31, 2006, none of these warrants were exercised into the Company's ordinary shares. d. Share option plans: Tdsoft had seven Share Option Plans, which provided for the grant by Tdsoft of option awards to purchase Ordinary shares of Tdsoft to officers, employees and directors of Tdsoft and its subsidiaries. Immediately upon allotment, the Ordinary shares purchased in exercise of the options would have the same rights as other Tdsoft Ordinary shares. The options vest ratably over vesting periods ranging from three to five years (mainly 5 years). The options expire 84 months from the date of issuance which was extended by the board of directors by additional 36 months. The exercise price of options under the plans is to be determined by the compensation committee. The exercise price for options granted in 2005, 2004 and 2003 was determined at fair market value at the date of each grant. F - 31 VOCALTEC COMMUNICATIONS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA NOTE 12:- SHARE CAPITAL (CONT.) In August 2005, the board of directors of VocalTec resolved to transfer to the VocalTec 2003 Master Stock Option Plan all of the shares then available for grants of options under the other VocalTec option plans. Pursuant to the business combination, the number of shares underlying the 2003 Master Stock Option Plan was increased by 576,923 to a total of 1,038,462 shares, and VocalTec adopted each of Tdsoft's option plans, such that all outstanding options granted under the various Tdsoft option plans to purchase Ordinary shares of Tdsoft were assumed by VocalTec, except that the Tdsoft Ordinary shares underlying such options were replaced by VocalTec's Ordinary shares in amounts and for exercise prices in accordance with the conversion ratio set forth in the agreement for the business combination (and which options continued to be subject, except as set forth herein, to the terms of the Tdsoft option plans under which they were granted). Following consummation of the business combination, the Company's board of directors resolved (i) to effect certain amendments to the 2003 Master Stock Option Plan and (ii) that options granted under older stock option plans shall revert to the amended 2003 Master Stock Option Plan upon the expiration or cancellation of such option. Options granted under the VocalTec amended 2003 Master Stock Option Plan generally have a term of seven (7) years. However, options granted prior to December 13, 2005 have a term of ten (10) years. Earlier termination may occur if the employee's employment with the Company is terminated or if certain corporate changes or transactions occur. The Company's board of directors determines the grant and the exercise price at the time the options are granted upon recommendation of the compensation committee. Each stock option agreement specifies the date and period over which the option becomes exercisable. Options granted generally vest over a period of four years, either in equal quarterly installments of 6.25% of the option shares, starting three months after the date of grant, or 25% of the option shares are vested one year following option grant, and the remaining 75% vest in equal quarterly installments of 6.25% over the remaining three years. Vesting of options granted to employees is conditional upon the grantee remaining continuously employed by VocalTec or its subsidiaries. As of December 31, 2006, 357,670 share options are still available for future grants under the Company's existing plans, including an annual increase of 180,000 share options approved by the 2006 annual general meeting of the shareholders. Options which are cancelled or forfeited before expiration, become available for future grants. F - 32 VOCALTEC COMMUNICATIONS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA NOTE 12:- SHARE CAPITAL (CONT.) A summary of the Company's share option activity under the plans is as follows: YEAR ENDED DECEMBER 31, -------------------------------------------------- 2005 2004 ---------------------- --------------------- WEIGHTED WEIGHTED AVERAGE AVERAGE AMOUNT OF EXERCISE AMOUNT OF EXERCISE OPTIONS *) PRICE OPTIONS *) PRICE -------- ------ ------- ------ Outstanding - beginning of year 52,315 $ 8.05 49,776 $ 8.68 Granted 860,416 $11.92 15,372 $ 3.50 Exercised (17,979) $ 8.44 - $ - Forfeited (25,852) $44.51 (12,833) $ 5.04 -------- ------- Outstanding - end of year 868,900 $10.79 52,315 $ 8.05 ======== ====== ======= ====== Options exercisable - end of year 214,817 $26.68 22,357 $11.57 ======== ====== ======= ====== *) The number and the exercise price of the options were restated to reflect such amounts and exercise prices as adjusted in business combination. YEAR ENDED DECEMBER 31, 2006 -------------------------------------------- WEIGHTED WEIGHTED AVERAGE AVERAGE REMAINING AGGREGATE AMOUNT OF EXERCISE CONTRACTUAL INTRINSIC OPTIONS PRICE TERM VALUE ------- ----- ---- ----- Outstanding - beginning of year 868,900 $10.79 Granted 148,870 $ 5.62 Exercised (29,776) $ 5.04 Forfeited (278,141) $14.24 -------- ------ Outstanding - end of year 709,853 $ 8.60 6.14 $ 27 ======== ====== ==== ====== Vested and expected to vest - end of year 608,713 $ 6.14 6.11 $ 26 ======== ====== ==== ====== Options exercisable - end of year 227,986 $ 7.13 5.77 $ 17 ======== ====== ==== ====== The weighted average fair values of the options granted during 2006, 2005 and 2004, were $ 3.22, $ 3.42 and $ 0.38, respectively. The total intrinsic value of options exercised during the year ended December 31,2006 was $102. All options were granted at an exercise price equal to the market value of the share at the date of grant. The following table summarizes information about options outstanding and exercisable at December 31, 2006:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE ---------------------- ---------------------------------- WEIGHTED- AMOUNT AVERAGE WEIGHTED AMOUNT WEIGHTED OUTSTANDING AT REMAINING AVERAGE OUTSTANDING AT AVERAGE RANGE OF DECEMBER 31, CONTRACTUAL EXERCISE DECEMBER 31, EXERCISE EXERCISE PRICES 2006 LIFE PRICES 2006 PRICES - ----------- ------- ---- ------- ------- ------- (YEARS) ---- $ 3.00-7.50 649,935 6.35 $ 5.42 171,565 $ 5.42 $ 7.50-18.75 18,969 4.78 $ 11.07 16,216 $ 9.97 $ 18.75-46.88 20,934 5.21 $ 26.59 20,430 $ 26.26 $ 46.88-117.20 17,919 2.21 $ 84.33 17,679 $ 84.68 $ 117.20-224.25 2,096 2.80 $154.79 2,096 $154.79 ------- ------- ------- 709,853 6.14 $ 8.60 227,986 $ 15.07 ======= ======= =======
F - 33 VOCALTEC COMMUNICATIONS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA NOTE 13:- NET LOSS PER SHARE The following table sets forth the computation of basic and diluted net loss per Ordinary share:
YEAR ENDED DECEMBER 31, -------------------------------------- 2006 2005 2004 ------- -------- ------- Numerator: Net loss $(7,012) $ (6,630) $(5,686) Accretion of redeemable convertible Preferred shares - (348) (3,256) Induced conversion of convertible Preferred shares - (17,406) - Cumulative dividend on convertible preferred shares - (2,585) - Dividend in respect to reduction in exercise price of certain warrants (37) ------- -------- ------- Net loss attributable to common shareholders after allocation of undistributed earnings to convertible Preferred shares $(7,049) $(26,969) $(8,942) ======= ======== ======= Denominator: Weighted average number of Ordinary shares outstanding during the year used to compute basic and diluted net loss per Ordinary share 5,436 792 370 ======= ======== ======= Basic and diluted net loss per Ordinary share $ (1.30) $ (34.05) $(24.16) ======= ======== =======
NOTE 14:- GEOGRAPHIC AND MAJOR CUSTOMERS INFORMATION The Company manages its business on a basis of one reportable segment. The Company follows the guidance in Statement of Financial Accounting Standards No. 131, "Disclosure about Segment of an Enterprise and Related Information".
YEAR ENDED DECEMBER 31, -------------------------------- 2006 2005 2004 ------ ------ ------ Sales classified by geographic areas based on end- customer location: Europe $4,299 $2,718 $1,599 Americas (principally United States) 770 992 655 Asia 882 275 567 Israel 540 608 1,331 Africa and Middle East 789 - - ------ ------ ------ $7,280 $4,593 $4,152 ====== ====== ======
F - 34 VOCALTEC COMMUNICATIONS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA NOTE 14:- GEOGRAPHIC AND MAJOR CUSTOMERS INFORMATION (CONT.)
YEAR ENDED DECEMBER 31, -------------------------------------------- 2006 2005 2004 ------------ ------------ ---------- % ------------------------------------------- Sales to a single customer exceeding 10%:*) Customer A 13 18 *) Customer B *) *) 12 Customer C *) *) 11 Customer D *) 16 13 Customer E *) *) 10 Customer F 18 *) *)
*) Less than 10% NOTE 15:- RESEARCH AND DEVELOPMENT, NET YEAR ENDED DECEMBER 31, -------------------------------- 2006 2005 2004 ------ ------ ------ Research and development expenses $5,439 $5,669 $5,474 Less- participations from: OCS 799 557 - BIRD 21 749 - ------ ------ ------ $4,619 $4,363 $5,474 ====== ====== ====== NOTE 16:- FINANCIAL INCOME, NET
YEAR ENDED DECEMBER 31, ----------------------------- 2006 2005 2004 ----- ---- ----- Financial income : Interest on cash and cash equivalents, net of bank fees $ 112 $173 $ 168 Foreign currency translation adjustments, net (80) 11 (3) ----- ---- ----- $ 32 $184 $ 165 ===== ==== =====
F - 35 VOCALTEC COMMUNICATIONS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA NOTE 17:- TAXES ON INCOME a. Measurement of taxable income under the Income Tax Law (Inflationary Adjustments), 1985: Results for tax purposes are measured and reflected in real terms in accordance with the change in the Israeli Consumer Price Index ("CPI"). As explained in Note 2b, the consolidated financial statements are presented in U.S. dollars. 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, VocalTec Ltd. and Tdsoft Ltd. have not provided deferred income taxes on the differences resulting from changes in exchange rates and indexing for tax purposes. b. Tax benefits under Israel's Law for the Encouragement of Industry (Taxation), 1969: VocalTec Ltd. and Tdsoft Ltd. are considered each an "industrial company", as defined by the Law for the Encouragement of Industry (Taxes), 1969, and as such, are entitled to certain tax benefits, mainly the right to claim public issuance expenses and accelerated depreciation. c. Tax benefits under the Law for the Encouragement of Capital Investments, 1959: Certain investments of VocalTec Ltd. and Tdsoft Ltd. received "Approved Enterprise" status through the "Alternative Benefits" track, and, as such, are eligible for various benefits. VocalTec Ltd. and Tdsoft Ltd. currently have two and four "Approved Enterprise" programs, respectively. These benefits include accelerated depreciation of equipment used in the investment program, as well as a full tax exemption on undistributed income for a period of two years and reduced tax rates of 25% or less for an additional period of up to eight years (depending on the percentage of foreign ownership), commencing with the date on which taxable income is first earned. Since VocalTec Ltd. and Tdsoft Ltd. have had no taxable income since inception, the benefits period has not yet commenced. The period of tax benefits detailed above, except in the full tax exemption period, is subject to a limit of 12 years from the commencement of production, or 14 years from the approval date, whichever is earlier. The entitlement to the above benefits is conditional upon VocalTec Ltd. and Tdsoft Ltd. fulfilling the conditions stipulated by the above law, regulations published there-under and the letters of approval for the specific investments in "Approved Enterprises". In the event of failure to comply with these conditions, the benefits may be cancelled and VocalTec Ltd. and Tdsoft Ltd. may be required to refund the amount of the benefits, in whole or in part, including interest. As of December 31, 2006, management believes that VocalTec Ltd. and Tdsoft Ltd. are meeting all of the aforementioned conditions. F - 36 VOCALTEC COMMUNICATIONS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA NOTE 17:- TAXES ON INCOME (CONT.) The tax-exempt income attributable to the "Approved Enterprise" can be distributed to shareholders without subjecting the distributing company to taxes only upon the complete liquidation of the company. If these retained tax-exempt profits are distributed in a manner other than in the complete liquidation of the company, they would be taxed at the corporate tax rate applicable to such profits as if the company had not elected the alternative track of benefits, currently 25% for an "Approved Enterprise". As of December 31, 2006, the accumulated deficit of each company does not include tax-exempt profits earned by their "Approved Enterprise". Income from sources other than the "Approved Enterprise" during the benefit period will be subject to tax at the regular corporate tax rate of 31%. The regular corporate tax rate is to be gradually reduced to 25% by 2010 (29% in 2007, 27% in 2008, 26% in 2009 and 25% in 2010). d. VocalTec Ltd. received final tax assessment for the tax years up to 2000. Tdsoft Ltd. received final tax assessment for the tax years up to 2001. e. VocalTec Ltd. and Tdsoft Ltd. have net operating loss carryforwards for tax purposes of approximately $ 117,000 and $ 43,000 as of December 31, 2006, respectively, which may be carried forward indefinitely. VocalTec Communications Inc. and Tdsoft Communications, Inc., which are subject to U.S. income taxes, have a loss for tax purposes of approximately $9,000 as of December 31, 2006. These losses can be carried forward until 2025. A valuation allowance was recorded for the entire deferred tax asset in respect of the carryforward losses, due to the uncertainty regarding future realization. Management currently believes that since the Company has a history of losses it is more likely than not that the deferred tax regarding the loss carryforward will not be realized in the foreseeable future. Utilization of U.S. net operating losses may be subject to substantial annual limitations due to the "change in ownership" provisions of the Internal Revenue code of 1986 and similar state provisions. The annual limitation may result in the expiration of net operating losses before utilization. f. Tax benefit is comprised as follows: YEAR ENDED DECEMBER 31, ------------------------------------------ 2006 2005 2004 ----------- ------ ----------- Foreign: Current taxes $ - $ 19 $ - =========== ====== =========== F - 37 VOCALTEC COMMUNICATIONS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA NOTE 17:- TAXES ON INCOME (CONT.) g. Deferred taxes on income: Deferred income taxes reflect the net tax effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes and the tax effect for carryforward losses. Significant components of the Company's deferred tax assets are as follows: DECEMBER 31 ------------------------ 2006 2005 -------- -------- Deferred tax asset: Reserves and allowances $ 468 $ 707 Net operating losses carryforward 42,250 36,063 -------- -------- Net deferred tax asset before valuation allowance 42,718 36,770 Valuation allowance (42,718) (36,770) -------- -------- Net deferred tax asset $ - $ - ======== ======== Management currently believes that since the Company has a history of losses, it is more likely than not that the deferred tax asset will not be utilized. h. Loss before income taxes is comprised as follows: YEAR ENDED DECEMBER 31, ------------------------------------- 2006 2005 2004 ------- ------- ------- Israel $(6,396) $(6,429) $(5,392) Foreign (616) (220) (294) ------- ------- ------- $(7,012) $(6,649) $(5,686) ======= ======= ======= i. The difference between the theoretical tax computed and the actual tax expense resulted mainly from valuation allowance recorded with respect to carryforward losses and other temporary differences, primarily related to severance and vacation reserves. F - 38 EX-99 3 exhibit_b.txt EXHIBIT B OPERATING AND FINANCIAL REVIEW AND PROSPECTS You should read the following discussion and analysis in conjunction with our audited consolidated financial statements for the year ended December 31, 2006 and notes thereto. This "Operating and Financial Review and Prospects" section contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements. OVERVIEW We are a provider of carrier-class multimedia and voice-over-IP (VoIP) solutions for communication service providers. We provide trunking, peering, service delivery and access gateway solutions that enable flexible deployment of next-generation networks (NGNs). Partnering with prominent system integrators, resellers and equipment manufacturers, we serve an installed base of leading service providers including Deutsche Telekom, and Telecom Italia San Marino. Designed for easy integration in multi-vendor and complex networks, our solutions handle call control, media processing, signaling and security within state-of-the-art NGN networks. Our SIP-based solutions support a variety of protocols, including Megaco/H.248, MGCP, H.323, V5.2 and GR-303, and incorporate key elements of the IMS/TISPAN (IP Multimedia Subsystem) architecture. Growth in the VoIP market is being driven largely by new entrants and service providers looking to reduce operational costs and easily add new, advanced services to their offering. While there are favorable industry trends that we believe create an opportunity for us, the ultimate demand for our products will depend upon the magnitude and timing of capital spending on VoIP infrastructure by telecommunications service providers and our ability to penetrate the market with new products and win market share. We are also subject to downturns that may occur within the telecommunications equipment market, such as the downturn that occurred in 2001 through 2003 and negatively affected our revenue growth in that period. In November 2005, VocalTec acquired all of the issued and outstanding ordinary shares of Tdsoft and as consideration issued to the Tdsoft shareholders ordinary shares of VocalTec constituting, immediately following such issuance, 75% of the issued and outstanding share capital of VocalTec. For accounting purposes, the business combination was accounted for as a reverse acquisition with Tdsoft treated as the accounting acquirer. Therefore, and in accordance with U.S. GAAP. The financial statements reflect TdSoft's financial results until the date of the business combination and the combined financial results of TdSoft and VocalTec from the date of the business combination. VocalTec acquired assets and assumed liabilities were recorded at fair value as of the date of the business combination. Page 1 REVENUES. In 2006, we had sales of $7.3 million, compared to $4.6 million in 2005. Through 2006, we generated our revenues from sales of our products and related services. Sales of products accounted for 65% of our revenues in 2006. We expect to continue to generate revenues primarily from the sale of the Essentra family products, and to a lesser extent from sales of other products and maintenance services. As a result of the business combination with Tdsoft, we have been promoting sales of the expanded product offering to VocalTec's and Tdsoft's customers and channels. We have expanded offering and sales channels following the business combination of VocalTec and Tdsoft. To date, we have derived a substantial portion of our revenues from a relatively small number of customers. Each of the following customers accounted for more than 10% of our revenues for the periods indicated: YEAR ENDED DECEMBER 31, ------------------------------------- 2004 2005 2006 ----- ------ ------ Lucent * 18% 13% Graybar 12% * * ECI 11% * * OG Vodafone 13% 16% * VoIP Pty Ltd. 10% * * Deutche telecom * * 18% * less than 10% Total sales to major customers representing each more than 10% of revenues accounted for 46%, 34% and 31% of our total revenues for the years ended December 31, 2004, 2005 and 2006, respectively. Sales to our customers are generally made under short-term non-cancelable purchase orders. Although our customers may provide us with forecasts, our ability to predict revenues in any future period is limited and subject to change based on demand for our customers' equipment. We market and sell our products worldwide. The percentages of our revenues by geographic area for the periods indicated were as follows: YEAR ENDED DECEMBER 31, ---------------------------- 2004 2005 2006 ------ ------ ------ % % % North and South America 16 22 11 Europe and Israel 70 72 66 Asia Pacific ("APAC"), Africa and Middle East 14 6 23 ------ ------ ------ 100% 100% 100% ------ ------ ------ Page 2 We attribute revenues to the geographic area where the customer, or its business unit that makes the purchase, is based. COST OF SALES. Our cost of sales in 2006 was $3.1 million (including an amortization of acquired intangibles in the amount of $0.4 million), or 43% of sales, compared with $2.6 million (including an inventory write-off in the amount of $0.6 million and amortization of acquired intangibles in the amount of $0.2 million), or 56% of sales in 2005. Our cost of sales in 2006, excluding the amortization of acquired intangibles, was $2.7 million, or 38% of sales. The cost of our sales consists primarily of (i) the cost of hardware components (ii) salaries and other related expenses of our employees who are engaged in the production and support of our products and (iii) royalties paid by us to 3rd party software licenses and the Chief Scientist. Our consolidated financial statements are prepared in accordance with U.S. GAAP, and are the basis for the discussion and analysis of our results of operations and liquidity and capital resources. Our functional and reporting currency is the U.S. dollar, which is the currency of the primary economic environment in which our consolidated operations are conducted. Transactions and balances originally denominated in dollars are presented at their original amounts. Transactions and balances in currencies other than dollars (including NIS) are re-measured in dollars in accordance with the principles set forth in FASB Statement No. 52 - "Foreign Currency Translation". Our reported amounts of assets, liabilities, revenues and expenses and the related disclosure of contingent assets and liabilities are based on certain estimates and judgments made in the preparation of our financial statements, which estimates and judgments are revised periodically as required. Our estimates and assumptions are based on factors such as analysis of prior years' experience, trends within the Company and the telecommunications industry, and general economic conditions. However, actual results may differ from our estimates and assumptions as a result of varying market and economic conditions, and may result in lower revenues and bigger operating losses. CRITICAL ACCOUNTING POLICIES Our discussion and analysis of our financial condition and the results of operations is based on our consolidated financial statements that have been prepared in accordance with US GAAP. The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. On an ongoing basis, we evaluate our estimates, including those related to revenue recognition, inventories and accounting for stock based compensation. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Page 3 We have identified below our critical accounting policies. These policies are both the most important to the portrayal of our financial condition and results of operations and require our management's most difficult, subjective and complex judgments and estimates. Actual results may differ from these estimates under different assumptions or conditions. REVENUE RECOGNITION: The Company generates revenues from licensing the rights to use its software products, from the sale of its systems and from providing maintenance and support services. The Company's products are sold also to resellers, who are considered end-users for the purpose of revenue recognition (except as indicated below). Revenue from software products is recognized when all criteria outlined in SOP 97-2 are met: persuasive evidence of an arrangement exists, the product has been delivered, no significant obligation to the customer remains, the sales price is fixed or determinable and collectibility is reasonably assured. The Company does not grant a right of return to its customers. Revenue from sale of systems is recognized upon delivery to the end-user or the reseller. Provisions for warranty are made at the time of the sale. Such revenues are recognized in accordance with Staff Accounting Bulletin No. 104 "Revenue Recognition in Financial Statements" ("SAB No. 104") Where software arrangements involve multiple elements, revenue is allocated to each undelivered element based on vendor specific objective evidence ("VSOE") of the fair value of the undelivered element. The VSOE used by the Company to allocate the arrangement fees to support services and maintenance is based on the price charged when these elements are sold separately (upon renewal). Revenues for the delivered product are recorded based on the "residual method" presented by SOP 98-9, "Modification of SOP 97-2, Software Revenue Recognition With Resepct to Certain Transactions", whereby the reminder of the arrangement fee, after allocating revenue to undelivered elements as described above is allocated to the delivered product. Under the residual method revenue is recognized for the delivered elements when (1) there is VSOE of fair value on all the undelivered elements and (2) all revenue recognition criteria of SOP 97-2 are satisfied. Under the residual method any discount in the arrangement is allocated to the delivered element. When an arrangement provides for acceptance of the product by the customer, revenue is not recognized until such acceptance is received. In certain cases, when the company sells its products through resellers in new and emerging market channels for which no comparable history has been established, the Company recognizes revenues only when all obligations to the end user have been completed, provided all other revenue recognition criteria have been met. Arrangements including training and installation services are recognized only after the services are performed. Revenue from software maintenance and technical support contracts is recognized on a straight line basis over the term of the maintenance and support arrangement. Engineering services are recognized as services are performed. Page 4 Deferred revenue includes unearned amounts received under the maintenance and support contracts, and amounts received from customers but not recognized as revenues. For the sale of systems the Company records at the time of sale a provision to cover the expected costs in order to honor its warranty obligation. As of December 31, 2006 and 2005 the warranty provision amounted to $ 20 and $ 180, respectively. BUSINESS COMBINATIONS AND PURCHASE PRICE ALLOCATION: As a result of the business combination with Tdsoft in November 2005, our balance sheet as of December 31, 2006 includes acquired intangible assets and goodwill which totaled approximately $9,997,000 as of the balance sheet date. Business combinations are accounted for using the purchase method of accounting, under which the total purchase price is allocated to the acquired company's assets and liabilities, based on their estimated fair values, and the remainder, if any, is attributed to goodwill. The aggregate purchase price is being allocated to identifiable net assets, intangible assets other than goodwill, and to goodwill. The amounts allocated to intangible assets other than goodwill are amortized on a straight-line basis over their weighted average expected useful life. Estimating the fair value of certain assets acquired and liabilities assumed is judgmental in nature and often involves the use of significant estimates and assumptions, mainly with respect to intangible assets. While there are a number of different methods for estimating the value of intangibles acquired, the primary method being used is the discounted cash flow approach. Some of the more significant estimates and assumptions inherent in the discounted cash flow approach include projected future cash flows, including their timing, a discount rate reflecting the risk inherent in the future cash flows and a terminal growth rate. Another area which required judgment which can impact our results of operations was estimating the expected useful lives of the intangible assets. To the extent intangible assets are ascribed with longer useful lives, there may be less amortization expenses recorded in any given period. As we operate in an industry which is rapidly evolving and extremely competitive, the value of the intangible assets, including goodwill, and their respective useful lives is exposed to future adverse changes which can result in a charge to our results of operations. Page 5 IMPAIRMENT OF GOODWILL AND OTHER INTANGIBLE ASSETS: In accordance with Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets", ("SFAS No. 142"), goodwill acquired in a business combination that closes on or after July 1, 2001 is deemed to have indefinite life and will not be amortized. SFAS No. 142 requires us to conduct an impairment review at least annually on goodwill and on an interim basis whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors that we may consider important which could trigger an impairment review include significant underperformance relative to historical or expected future operating results and significant negative industry or economic trends. We test for impairment at a level referred to as a reporting unit. Determining fair value involves the use of significant estimates and assumptions. These estimates and assumptions could have an impact on whether or not an impairment charge is recognized. To determine fair value, we may use a number of valuation methods including quoted market prices, discounted cash flows and revenue multipliers. As mentioned above, these approaches use estimates and assumptions including projected future cash flows, discount rate and terminal growth rate. Using different assumptions could result in different results. As we operate in an industry which is rapidly evolving and extremely competitive, it is possible that our estimates could change in the near term and there can be no assurance that future goodwill impairment review will not result in a charge to our results of operations. In 2006 and 2005, no impairment of good will was recorded. At December 31, 2006, goodwill amounted to approximately $ 7.0 million. Other intangible assets with definite useful lives are to be reviewed for impairment 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 asset. If an asset is considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the asset exceeds its fair value. In the evaluation of fair value, we may use significant estimates and assumptions such as projected future cash flows which are subject to high degree of judgment. As we operate in an industry which is rapidly evolving and extremely competitive, changes in the assumptions and estimates may affect the carrying value of the intangible assets, and could result in an impairment charge to our results of operations. In 2006 and 2005, no impairment of other intangible assets was recorded. At December 31, 2006, consolidated intangible assets, other than goodwill, amounted to approximately $3.0 million. TAX ALLOWANCE PRACTICES: At the end of each reported period, we are required to estimate our actual current tax liabilities and make an assessment of 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 net deferred tax assets will be realized through future taxable income, and, to the extent we believe that realization is not likely, we must establish a valuation allowance. Management judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities and any valuation allowance recorded against our net deferred tax assets. Our judgment as to the probability to realize our net deferred tax assets is largely based upon interpretations of certain tax laws and estimates and assumption. Changes in our assumptions and estimates may require us to increase (or decrease)_the valuation allowance and therefore we may be required to include an expense (or income) within the tax provision in our statement of operations. Page 6 As of December 31, 2006, VocalTec Ltd. and Tdsoft Ltd. have net operating loss carryforwards for tax purposes of approximately $ 117,000 and $ 43,000, respectively. In July 2006, the FASB issued FASB Interpretation No. 48, "Accounting for Uncertainty in Income Taxes, and Interpretation of FASB Statement No. 109" ("FIN 48"). FIN 48 clarifies the accounting for income taxes by prescribing the minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. FIN 48 utilizes a two-step approach for evaluating tax positions. Recognition (step one) occurs when an enterprise concludes that a tax position, based solely on its technical merits, is more-likely-than-not to be sustained upon examination. Measurement (step two) is only addressed if step one has been satisfied (i.e. the position is more-likely-than-not to be sustained). Under step two, the tax benefit is measured as the largest amount of benefit, determined on a cumulative probability basis that is more-likely-than-not to be realized upon ultimate settlement. FIN 48 applies to all tax positions related to income taxes subject to the Financial Accounting Standard Board Statement No. 109, "Accounting for Income Taxes" ("FAS 109"). This includes tax positions considered to be "routine" as well as those with a high degree of uncertainty. FIN 48 has expanded disclosure requirements, which include a tabular roll forward of the beginning and ending aggregate unrecognized tax benefits as well as specific detail related to tax uncertainties for which it is reasonably possible the amount of unrecognized tax benefit will significantly increase or decrease within twelve months. These disclosures are required at each annual reporting period unless a significant change occurs in an interim period. FIN 48 is effective for fiscal years beginning after December 15, 2006. The cumulative effect of applying FIN 48 will be reported as an adjustment to the opening balance of retained earnings. We are currently reviewing this new standard to determine its effect, if any, on our results of operations. INVENTORIES: Our policy for valuation of inventory and commitments to purchase inventory, including the determination of obsolete or excess inventory, requires us to perform a detailed assessment of inventory at each balance sheet date which includes a review of, among other factors, an estimate of future demand for products, valuation of existing inventory, as well as product life-cycle and product development plans. Inventory reserves are also provided to cover risks arising from slow moving items. We write down our inventory for estimated obsolescence or unmarketable inventory equal to the difference between the cost of inventory and the market value based upon assumptions about future demand, market conditions and prices. Page 7 USE OF ESTIMATES: The preparation of the financial information requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, mainly related to trade receivables, inventories, long-lived assets, restructuring charges, revenues and contingencies. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. STOCK OPTIONS: Until December 31, 2005, we elected to follow the intrinsic value-based method prescribed by Accounting Principles Board Opinion 25, "Accounting for Stock Issued to Employees," or APB 25, and related interpretations in accounting for employee stock options rather than adopting the alternative fair value accounting provided under Statement of Financial Accounting Standards, or SFAS, No. 123, "Accounting for Stock Based Compensation." Therefore, in these years we have not recorded any compensation expense for stock options we granted to our employees where the exercise price equals the fair market value of the shares on the date of grant and the exercise price, number of shares eligible for issuance under the options and vesting period are fixed. However, where the exercise price is less than the fair market value of the shares on the date of grant, compensation expense was recognized.. We complied with the disclosure requirements of SFAS No. 123 and SFAS No. 148, which require that we disclose our pro forma net income or loss and net income or loss per ordinary share as if we had expensed the fair value of the options. In calculating such fair value, there are certain assumptions that we use, as disclosed in Note 2 of our consolidated financial statements included elsewhere in this annual report. For purposes of this pro forma disclosure, we estimated the fair value of stock options issued to employees using the Black-Scholes option pricing model. In addition, option valuation models require the input of highly subjective assumptions, including the expected life of options and our expected share price volatility. Therefore, the estimated fair value of our employee stock options could vary significantly as a result of changes in the assumptions used. Effective January 1, 2006, the Company adopted FASB Statement No. 123 (revised 2004), "Share-Based Payment" ("SFAS 123(R)") , and related Securities and Exchange Commission rules included in Staff Accounting Bulletin No. 107, which requires companies to expense the fair value of employee stock options and other forms of share-based compensation. Accordingly, SFAS 123(R) eliminates the use of the intrinsic value method to account for share-based compensation transactions as provided under APB Opinion No. 25. Under SFAS 123(R), we are required to determine the appropriate fair value model to be used for valuing share-based payments, the amortization method for compensation cost and the transition method to be used at date of adoption. We currently use the Black-Scholes option-pricing model to value options for pro forma financial statement disclosure purposes. The use of a different model to value options may result in a different fair value than the use of the Black-Scholes option-pricing model. Deferred compensation is amortized to compensation expense over the vesting period of the options, generally four or five years, on a straight-line basis. Page 8 5A. OPERATING RESULTS YEAR ENDED DECEMBER 31, 2006 COMPARED TO YEAR ENDED DECEMBER 31, 2005 SALES We recorded sales of $7.3 million in 2006 compared to $4.6 million in 2005 (which comprised primarily of the Tdsoft operations), an increase of 59%. The increase in sales in 2006 compared with 2005 was attributable to the inclusion of the results of operations of VocalTec, which were not included in 2005. Product sales in 2006 were $4.7 million, an increase of 29% compared to $3.7 million in 2005 (which comprised primarily of the Tdsoft products), mainly attributable to the inclusion of VocalTec products (which were not included in 2005), offset by a decrease in sales of Tdsoft's products. Revenues from engineering, maintenance, support and other services in 2006 were $2.5 million, an increase of 275% compared to 2005 support services revenues of $0.9 million. Services revenues increased in 2006 compared with 2005 due to the inclusion of maintenance services provided to VocalTec's customers and engineering services which were not included in the 2005 results. To date, most of our global sales have been in U.S. dollars and have not been adversely affected by foreign currency fluctuations. If global business conditions require us to sell our solutions in other local currencies, our sales may be adversely affected by devaluation of local currencies against the U.S. dollar. If, on the other hand, such local currencies' value increases against the U.S. dollar, our sales (in U.S. dollar terms) will be positively affected. We plan to increase our market share in the growing VoIP market. In 2006, we started selling our products in new regions, including Russia, Africa and Vietnam. COST OF SALES Cost of sales in 2006 was $3.1 million, or 43% of sales (including an amortization of acquired intangibles in the amount of $0.4 million), compared with $2.6 million, or 56 % of sales (including an inventory write-off in the amount of $0.6 million and amortization of acquired intangibles in the amount of $0.2 million), in 2005. The decrease in the cost of sales in percentage in 2006 compared to 2005 resulted from a write-off of $0.6 million of obsolete inventories in 2005 and of a provision for warranty of $0.2 million in 2005, reversed in 2006 due to a decrease in sales of related products, offset by an increase in amortization of acquired intangibles from $0.2 million in 2005 to $0.4 million in 2006 Page 9 Cost of products was $2.2 million in 2006 compared with $1.5 million in 2005. Cost of services was $0.6 million in 2006 compared with $0.3 million in 2005. The increase in cost of products in 2006 compared to 2005 was mainly due to the increase in sales. Cost of our sales consists primarily of the cost of hardware components, salaries and other related expenses of our employees who are engaged in the production and support of our products and royalties paid by us to licensors of software and to the Chief Scientist. In 2006, gross margins were 57%, including amortization of acquired intangibles, or 62%, excluding amortization of acquired intangibles. In 2005, gross margins were 44%, including inventory write-off and amortization of acquired intangibles, or 62%, excluding inventory write-off and amortization of acquired intangibles. OPERATING EXPENSES RESEARCH AND DEVELOPMENT, NET Research and development costs, net were $4.6 million in 2006, or 63% of sales, compared with $4.4 million, or 95% of sales, in 2005. Research and development costs, net consist principally of salaries and benefits for software and hardware engineers and sub contractors, related facilities costs and activities and expenses associated with computer, software and other equipment used in software and hardware development and testing. Research and development costs, net in 2006 included stock-based compensation amount of $248,000 due to the implementation of FASB 123 in 2006. Research and development costs, net in 2005 included a non recurring stock-based compensation amount of $522,000 which resulted from the amount of VocalTec shares issued to founders and employees of Tdsoft pursuant to the business combination being in excess of the pro rata holding percentage of such founders and employees of Tdsoft prior to the business combination. None of our software or hardware development costs have been capitalized during any of the reported periods, as the amount of software and hardware development costs eligible for capitalization at this stage has historically been insignificant. The increase in research and development costs, net, in absolute numbers in 2006 compared to 2005, resulted mainly from a decrease in the participation of the BIRD (Bi-national Industrial Research and Development) foundation in our research and development expenses. We believe that continued investment in research and development is essential to remain competitive in the marketplace and is directly related to the timely development of new and enhanced products. Specifically, in order to bring our future products to maturity and thereafter increase sales, we are allocating significant resources to research and development activities, including outsourcing certain research and development assignments. Page 10 Our research and development efforts have been financed from internal resources and through programs sponsored by the Chief Scientist and the BIRD foundation. As a result of the acquisition of the assets owned by Cisco Systems and the assets of Be-Connected in 2001 and 2004, respectively, Tdsoft assumed the liability to pay royalties to the Chief Scientist in connection with grants received prior to the purchase of such products. Such royalties were paid during 2004, 2005 and 2006. Pursuant to the terms of the Chief Scientist royalty-bearing program, we are required to pay royalties of between 3% and 4.5% of sales of products and related services developed in any project partially funded by the Chief Scientist, up to an amount of 100% of the grant obtained. For grants received under programs approved subsequent to January 1, 1999, royalties are payable up to 100% of the grant obtained plus interest at LIBOR. Pursuant to the terms of the BIRD foundation royalty-bearing program, we are required to pay royalties of 5% of sales of products and related services developed in any project partially funded by the BIRD foundation, up to an amount of 150% of the grant obtained, depending on the year following the termination of the agreement with the BIRD foundation on which the grant is fully paid. We expect to participate only in royalty bearing programs but we cannot make any assurances that we will be awarded any future grants. Our research and development expenses in 2006 and 2005 were net of participation from the Chief Scientist and the BIRD foundation. In 2006, participation received or accrued from the Chief Scientist and the BIRD foundation was $0.8 million compared with $1.3 million in 2005. In 2006, we paid or accrued royalties to the Chief Scientist in an aggregate amount of approximately $201,000 compared with $63,000 in 2005. Our contingent liability to the BIRD foundation amounts to approximately $770,000. Our contingent liability to the Chief Scientist amounts to approximately $19 millions. SELLING AND MARKETING In 2006, selling and marketing expenses were $4.1 million, or 57% of sales, compared with $2.8 million or 60% of sales in 2005. Selling and marketing expenses include salaries and benefits, sales commissions, travel expenses and related costs for our sales, marketing, and distribution personnel, reserves for potential damages to, loss of, or obsoleteness of trial systems. Selling and marketing expenses in 2006 included stock-based compensation amount of $138,000 due to the implementation of FASB 123 in 2006. Selling and marketing expenses in 2005 included a non recurring stock-based compensation amount of $13,000 which resulted from the amount of VocalTec shares issued to founders and employees of Tdsoft pursuant to the business combination being in excess of the pro rata holding percentage of such founders and employees of Tdsoft prior to the business combination. Selling and marketing expenses also include the costs of programs aimed at increasing revenue, such as advertising, trade shows and other market development programs. The increase in selling and marketing expenses in absolute numbers in 2006 compared to 2005 resulted primarily from an increase in salaries and benefits related to increase in personnel engaged in selling and marketing activities and due to amortization of the intangibles acquired in the business combination between Tdsoft and VocalTec, offset by a decrease in material use for selling and marketing activities. Page 11 GENERAL AND ADMINISTRATIVE General and administrative expenses consist principally of salaries and benefits, outside legal, accounting and consultant fees, travel expenses and related costs for management, finance, logistics, human resources, communication, legal, information systems and administrative personnel. General and administrative expenses in 2006 included stock-based compensation amount of $554,000 due to the implementation of FASB 123 in 2006. General and administrative expenses in 2005 included a non recurring stock-based compensation amount of $268,000 which resulted from the amount of VocalTec shares issued to founders and employees of Tdsoft pursuant to the business combination being in excess of the pro rata holding percentage of such founders and employees of Tdsoft prior to the business combination. General and administrative expenses also include expenses associated with computing equipment and software used in the administration operations General and administrative expenses consist. General and administrative expenses were $2.5 million, or 34% of sales, in 2006, compared with $1.7 million, or 38% of sales, in 2005. The increase in general and administrative expenses in absolute numbers resulted primarily from an increase in salaries and benefits related to personnel engaged in general and administrative activities and to an increase in stock based compensation expenses. OTHER INCOME (EXPENSE), NET We had immaterial other income in 2006 and 2005. FINANCIAL INCOME, NET Financial income, net in 2006 consisted principally of interest income received in connection with our bank deposits, bank charges and currency differences between the NIS and US dollar. In 2006, financial income, net was $32,000 - less than 1% of sales, compared to $0.2 million, or 4% of sales, in 2005. TAXES ON INCOME, TAX REFUNDS AND TAX BENEFITS In 2006, Vocaltec and Tdsoft had two and four, respectively, Approved Enterprise programs under the Law for the Encouragement of Capital Investments, 1959, respectively. Such programs are eligible for certain tax benefits for the first several years in which they generate taxable income. Income derived from an Approved Enterprise is subject to a zero tax rate for two years and up to an additional eight years of reduced corporate tax rate of 25% until the earlier of (i) seven to ten consecutive years, commencing in the year in which the specific Approved Enterprise first generates taxable income (which income is not offset by deductions attributable to the other sources), (ii) twelve years from commencement of production or (iii) fourteen years from the date of approval of the Approved Enterprise status. Some of our production and development facilities have been granted Approved Enterprise status. To date, neither of our Approved Enterprise programs has generated any taxable income. Page 12 As of December 31, 2006, we had net operating loss carryforwards in Israel of approximately $160 million ($117 million allocated to VocalTec and $43 million allocated to Tdsoft), and an aggregate net operating loss carryforwards in the U.S. of approximately $8.5 million. These net operating losses may be carried forward and offset against future taxable income under applicable tax laws. Tax benefits, which apply to us under Israeli law, do not apply to any income generated by any of our other subsidiaries. NET INCOME (LOSS) Net loss in 2006 was $7.0 million, representing 96% of sales, compared with a net loss of $6.6 million, representing 144% of sales in 2005. Our financial statements are reported in dollars and the vast majority of our sales are made in U.S. dollars. Most of our expenses are in New Israeli Shekels (NIS) and dollars. The cost of our operations in Israel, as expressed in dollars, is influenced by the extent to which any increase/decrease in the rate of inflation in Israel is not offset by the appreciation/depreciation of the NIS in relation to the dollar. In 2006, the rate of inflation in Israel was -0.1% and the rate of depreciation of the NIS in relation to the dollar was -8.2%. YEAR ENDED DECEMBER 31, 2005 COMPARED TO YEAR ENDED DECEMBER 31, 2004 SALES We recorded sales of $4.6 million in 2005 compared to $4.2 million in 2004, an increase of 11%. The increase in sales in 2005 compared with 2004 was attributable to the increase from maintenance and other support services. Product sales in 2005 were $3.7 million, essentially the same as in 2004. A decrease in sales of a product that is being phased out was offset by increased sales of other products including the TdMAX product. Revenues from engineering, maintenance and other support services in 2005 were $925,000, an increase of 114% compared to 2004 support services revenues of $433,000. Support service revenues increased in 2005 compared with 2004 due to an increased for maintenance services by various then current customers, engineering services provided to a certain customer in for the first time in 2005 and maintenance services provided by VocalTec in December 2005. Page 13 COST OF SALES Cost of sales in 2005 was $2.6 million, or 56% of sales (including an inventory write-off in the amount of $0.6 million and amortization of acquired intangibles in the amount of $0.2 million), compared with $1.8 million, or 44 % of sales (including the amortization of acquired intangibles in the amount of $0.2 million), in 2004. The increase in cost of sales in 2005 compared to 2004 resulted from a write-off of $0.6 million of obsolete inventories and a provision for warranty of $0.2 million representing the cost of fixing technical problems at customers' sites. Cost of products was $1.5 million in 2005 compared with $1.6 million in 2004. Cost of services was $0.3 million in 2005 compared with $22,000 in 2004. The decrease in cost of products in 2005 compared to 2004 was due to a decrease in the cost of production resulting from sales of TdGate to certain customers that involved no costs of production, and from decreased sales of Tdsoft's TAS product. The reduction in the cost of production was off-set by a provision for warranty in the amount of $180,000. The increase in the cost of services in 2005 compared to 2004 was due primarily to cost incurred by us in connection with a turnkey engineering project that commenced in 2005. Cost of sales of products primarily includes the cost of hardware in our products, reserves for products, royalties to third parties, and other expenses associated with the provisioning of products. Cost of services primarily consists of salaries and travel expenses for rendering maintenance, support and engineering services to customers. In 2005 and 2004, cost of sales increased as a percentage of sales compared to 2003 due to increased competition in the market, resulting in lower prices for our products. In 2005, we wrote off obsolete inventory in the amount of $0.6 million. Excluding such write-off, cost of sales in 2005 remained materially the same as in 2004. Amortization of acquired intangibles in 2005 was $0.2 million, or 4% of sales, compared to $0.2 million, or 5% of sales, in 2004. Amortization of acquired intangibles in 2004 included $188,000 from the Hunt product line acquired from Cisco Systems during 2001 and $18,000 for the TAS product acquired through the acquisition of the assets of Be-Connected. Amortization of acquired intangibles in 2005 consisted of $94,000 (the remaining amortization amount of the Hunt product), $41,000 for the TAS product and $37,000 reflecting one month of amortization of the intangibles acquired in the business combination between Tdsoft and VocalTec. In 2005, gross margins were 44%, including inventory write-off and amortization of acquired intangibles, or 62%, excluding inventory write-off and amortization of acquired intangibles, compared to 56%, including amortization of acquired intangibles, or 61%, excluding amortization of acquired intangibles, in 2004. Our gross margins increased slightly from 61% in 2004 to 62% in 2005. Page 14 OPERATING EXPENSES RESEARCH AND DEVELOPMENT, NET Research and development costs, net were $4.4 million in 2005, or 95% of sales, compared with $5.5 million, or 132% of sales, in 2004. Research and development costs, net in 2005 included a non recurring stock-based compensation amount of $522,000 which resulted from the amount of VocalTec shares issued to founders and employees of Tdsoft pursuant to the business combination being in excess of the pro rata holding percentage of such founders and employees of Tdsoft prior to the business combination. The decrease in research and development costs, net, both in absolute numbers and as a percentage of sales in 2005 compared to 2004, resulted from participation of the Chief Scientist and the BIRD (Bi-national Industrial Research and Development) foundation in our research and development expenses. Our research and development expenses in 2005 were net of participation from the Chief Scientist and the BIRD foundation. In 2005, participation received or accrued from the Chief Scientist and the BIRD foundation was $1.3 million compared with $0 in 2004. All of these participations are related to royalty bearing programs. In 2005, we paid or accrued royalties to the Chief Scientist in an aggregate amount of approximately $63,000 compared with $67,000 in 2004. Our contingent liability to the BIRD foundation amounts to approximately $749,000. SELLING AND MARKETING In 2005, selling and marketing expenses were $2.8 million, or 60% of sales, compared with $1.9 million or 46% of sales in 2004. Selling and marketing expenses in 2005 included a non recurring stock-based compensation amount of $13,000 which resulted from the amount of VocalTec shares issued to founders and employees of Tdsoft pursuant to the business combination being in excess of the pro rata holding percentage of such founders and employees of Tdsoft prior to the business combination. The increase in selling and marketing expenses both in absolute numbers and as a percentage of sales in 2005 compared to 2004 resulted from an increase in salaries and benefits and in travel expenses, both related to an increase in personnel engaged in selling and marketing activities, and from the write-off of obsolete trial systems. GENERAL AND ADMINISTRATIVE General and administrative expenses in 2005 included a non recurring stock-based compensation amount of $268,000 which resulted from the amount of VocalTec shares issued to founders and employees of Tdsoft pursuant to the business combination being in excess of the pro rata holding percentage of such founders and employees of Tdsoft prior to the business combination. General and administrative expenses were $1.7 million, or 38% of sales, in 2005, compared with $0.8 million, or 19% of sales, in 2004. The increase in general and administrative expenses both in absolute numbers and as a percentage of sales resulted primarily from the inclusion of VocalTec's general and administrative expenses during December 2005 and increases in provisions related to social benefits and outside legal, accounting and consulting fees. Page 15 OTHER INCOME (EXPENSE), NET We had immaterial other income in 2005 and no other income in 2004. FINANCIAL INCOME, NET Financial income, net consists principally of interest income received in connection with our bank deposits held in the U.S. In 2005, financial income, net was $0.2 million, or 4% of sales, essentially the same as in 2004. TAXES ON INCOME, TAX REFUNDS AND TAX BENEFITS In 2005 Tdsoft and VocalTec had four and two Approved Enterprise programs under the Law for the Encouragement of Capital Investments, 1959, respectively. As of December 31, 2005, we had net operating loss carryforwards in Israel of approximately $136 million ($99 million allocated to VocalTec and $37 million allocated to Tdsoft), and an aggregate net operating loss carryforwards in the U.S. of approximately $8.5 million. These net operating losses may be carried forward and offset against future taxable income under applicable tax laws. Tax benefits, which apply to us under Israeli law, do not apply to any income generated by any of our other subsidiaries. In 2005 we received a tax refund of one of our foreign subsidiaries in the amount of $19,000. NET INCOME (LOSS) Net loss in 2005 was $6.6 million, representing 144% of sales, compared with a net loss of $5.7 million, representing 137% of sales in 2004. In 2005, the rate of inflation in Israel was 2.4% and the rate of depreciation of the NIS in relation to the dollar was 6.8%. 5B. LIQUIDITY AND CAPITAL RESOURCES During the past three years, we covered our cash flow requirements from operating revenues , cash proceeds from the issuance of shares and warrants to investors, and grants from the Chief Scientist and the BIRD foundation. Page 16 As of December 31, 2006, we had approximately $9.0 million in cash, cash equivalents and bank deposits, comprised of $6.0 million in cash and cash equivalents and $3.0 million in bank deposits. As of December 31, 2005, we had approximately $5.1 million in cash and cash equivalents, which excluded $0.2 million in restricted cash. As of December 31, 2006, we had working capital of approximately $8.2 million, compared with $0.9 million as of December 31, 2005. The net increase in working capital during 2006 resulted primarily from cash received from the issuance of shares to investors and a decrease in trade payables and other accrued expenses. On November 27, 2006, we received and accepted orders from Israeli institutional investors for a private placement of 1,750,000 ordinary shares at a price of $4.3 per share. As part of the offering, the Company issued to the investors warrants exercisable during a period ending on June 30, 2011 into 1,312,500 additional ordinary shares and warrants for 87,500 additional ordinary shares as a finder's fee, at an exercise price per share of $5.5. In May 2006, we consummated a private placement with various US investors, pursuant to which we issued to such investors an aggregate of 935,000 ordinary shares for an aggregate purchase price of $5.1 million, or $5.5 per ordinary share (our net proceeds were $4.7 million). We also issued to the investors warrants to purchase up to an aggregate of 374,000 ordinary shares and warrants for 50,050 additional ordinary shares as a finder's fee, at an exercise price of $7.9 per share. The warrants became exercisable on November 24, 2006 and will remain exercisable until May 24, 2011. During December 2006, we agreed to reduce the exercise price of the warrants issued in the foregoing private placement to $6.87 per share. In July 2005, VocalTec received a loan in the amount of $1,000,000 from Deutsche Telekom, then a holder of approximately 15.3% of VocalTec's issued and outstanding obligation. The Company paid back the loan and all interest accrued thereon (at an annual rate of 7.05%) in July 2006. Net cash used in operating activities was $7.4 million, $4.8 million and $4.5 million for the years ended December 31, 2006, 2005 and 2004, respectively. The principal use of cash in each of these years was to fund our operations. Net cash provided by (used in) investing activities was $(2.5) million, $0.5 million and $(0.1) million for the years ended December 31, 2006, 2005 and 2004, respectively. Cash used for purchase of equipment was $0.3 million, $0.3 million and $0.2 million for 2006, 2005 and 2004, respectively. Proceeds from the sale of equipment were $26,000, $0.1 million and $0.2 million for 2006, 2005 and 2004, respectively. Cash provided by the business combination in 2005 was $0.7 million. Investment in short term deposit in 2006 was $3.0 million. Net cash generated by financing activities in 2006 from exercise of stock options by employees was $0.2 million. Net cash from issuance of shares in 2006 was $11.6 million. Page 17 We anticipate that operating expenses may exceed revenues, net of cost of sales in 2007 and possibly beyond if we do not sufficiently increase sales and reduce our costs. We believe that current cash and cash equivalents balances, cash flows from operations and grants from the Chief Scientist are sufficient to meet our anticipated cash needs for working capital and capital expenditures for at least the next 12 months. If our revenues do not increase substantially, whether due to a failure to increase the market share for our products, evolving industry standards and rapid technological changes that could result in our products being no longer in demand, the reduction in our product prices, slower pace of expansion or voice over IP penetration, or our failure to retain our customers, we will need to reduce our operating expenses or use more of our cash reserves to fund operating expenses. Similarly, in the event that the amounts we receive from research and development grants decline, we will need to reduce operating expenses or utilize more of our cash reserves for our operations. If such measures are insufficient, we may attempt to establish lines of credit or sell additional equity or debt securities. Capital expenditures in 2006 were approximately $335,000, compared with $308,000 in 2005 and $189,000 in 2004. We maintained annual car leases in the amount of approximately $470,000 in 2006, and our total liability for early termination of the leases is in the amount of up to approximately $48,000. INVENTORY AND RECEIVABLES Inventories as of December 31, 2006 were $1.1 million, compared to $1.0 million as of December 31, 2005. Trade receivables are from purchases of our products, primarily by telecommunications System Integrators, Resellers and service providers. Trade receivables are presented at gross value less reserves for doubtful accounts of $120,000 and $50,000 as of December 31, 2006 and 2005, respectively. Trade receivables, net, as of December 31, 2006 were $1.4 million, compared to trade receivable, net of $0.6 million as of December 31, 2005. The increase in trade receivable, net resulted from an increase in sales. Prepaid expenses and other receivables were $0.8 million as of December 31, 2006, compared with $1.4 million as of December 31, 2005. The decrease in 2006 was mainly due to the payment by the Chief Scientist of the receivable outstanding as of December 31, 2005, partially offset by a receivable relating to a new plan approved by the Chief Scientist for 2006. Page 18 5C. RESEARCH AND DEVELOPMENT, PATENTS AND LICENSES INTELLECTUAL PROPERTY We believe that the improvement of existing products, our technologies and the development of new products are important in establishing and maintaining a competitive advantage. We believe that the value of our products is dependent, to a certain extent, upon the maintenance of patent, trade secret or copyright protection of our proprietary software and technologies. We rely on a combination of trade secrets, copyright, trademark and patent law, together with non-disclosure and invention assignment agreements, to establish and protect the technology used in our products. We have filed numerous patent applications in the United States and other countries with respect to certain technologies employed in our products. Some of those applications have already registered and we own those registered patents. In addition, we have filed trademark applications in the United States and other countries with respect to trademarks associated with us, and our products. Some of those applications have already been registered and we own those registered trademarks. Generally, we enter into non-disclosure and invention assignment agreements with our employees, and into non-disclosure agreements with our consultants, subcontractors and distributors and channel partners. However, there can be no assurance that such measures will protect our proprietary technology, that competitors will not develop products with features based upon, or otherwise similar to, our products or that we will be able to enjoin competitors from selling similar products. Although we do not believe that our products infringe on any valid claim of a patent owned by any third party, third parties have asserted infringement and other claims against us from time to time. These claims have been directed at certain basic and fundamental components of our products, those of which were not abandoned were resolved by successfully implementing a licensing agreement. There can be no assurance that third parties will not assert such claims against us in the future or that such claims will not be successful. We could incur substantial costs and diversion of management resources with respect to the defense of any claims relating to proprietary rights that could have a material adverse effect on our business, financial condition or results of operations. If any such claims or actions are asserted or prosecuted against us, we may seek to obtain a license under a third party's intellectual property rights. There can be no assurance, however, that under such circumstances a license would be available on reasonable terms or at all. In the event a party that is successful in asserting a claim against us does not grant a license, such party could secure a judgment resulting in the award of damages, as well as injunctive or other equitable relief which could effectively block us from manufacturing, using, selling, or otherwise distributing its products. Page 19 VocalTec, Essentra, Internet Phone Surf&Call, TdSOFT, TdGATE and TdVIEW are trademarks or registered trademarks of VocalTec and its fully owned subsidiaries. All other trademarks or registered trademarks used in this Annual Report are the property of their respective owners. RESEARCH AND DEVELOPMENT We believe that our ability to enhance our current products, develop and introduce new products on a timely basis, maintain technological competitiveness and meet customer requirements is essential to our future success. Accordingly, we devote and intend to continue to devote a significant portion of our personnel and financial resources to research and development. We also intend to continue seeking and maintaining close relationships with our customers in order to remain responsive to their needs. We have an educated and experienced research and development team that specializes in telecommunications and networking, computer and networking software, server and embedded software, hardware integration and communications protocols and drivers. We seek to employ highly qualified technical personnel in order to maintain and expand our technological expertise. The Company may engage in the future in joint research and development projects with third parties. The ownership of any intellectual or other proprietary property developed in such projects shall be negotiated between the Company and the relevant third party. During 2005, Tdsoft and Nuera commenced developing, as part of a joint project, certain hardware and software of a VoIP gateway platform. Following completion of the project, each of Tdsoft and Nuera could add its application software on top of the platform, to further develop it into a generally available product, targeting various gateway applications. Both companies have full ownership rights with respect to the platform, including intellectual property, manufacturing and marketing rights. In connection with that project, Tdsoft has been engaged by Nuera to develop certain application software that will integrate with the platform. The intellectual property rights of this application software shall be owned solely by Nuera. That project was terminated in mid 2006 after the acquisition of Nuera by AudioCodes. See "Item 5 - Operating and Financial Review and Prospects - Operating Results - Research and development costs, net". 5D. TREND INFORMATION We believe that our business is subject to the following trends: TRENDS IN THE COMMUNICATIONS INDUSTRY Service providers worldwide are facing an increasing array of challenges given the ongoing regulatory changes and technological advances in the communications industry. Global deregulation is promoting competition to incumbent service providers from both new entrants and operators in adjacent industries, such as wireless, satellite, Internet and cable television service providers. At the same time, end user demands are rapidly evolving. While in the past, communications traffic consisted primarily of traditional voice communications and basic data traffic, such as email and facsimiles, in recent years , with the wide acceptance of the Internet and broadband infrastructure, end users are increasingly seeking fast, personalized, content-rich, easy-to-use communications and are relying on these applications in both their professional and personal lives. Accordingly, this trend is increasing demand for high-speed access services, including voice, video, data and wireless. Page 20 The combination of competitive pressures and end user demands is placing pressure on service providers to add new services to their existing offerings quickly, with the flexibility to continue to add functionality and to scale as needed. Many new and incumbent service providers presently offer a bundle of voice, video and data services to end users, often referred to as "triple-play, or "multi-play"." For example, these services may include both traditional and enhanced voice services, broadcast television and on-demand video, and high-speed Internet access delivered over a converged broadband connection to the home or office. Operators also are increasingly adding wireless to the triple-play bundle, referred to as "quad-play," which has contributed to consolidation in the service provider market. The bundling of services enables service providers to generate new sources of revenue and enhance customer relationships. The initial capital costs and ongoing operating expense associated with the deployment of new services are considerable. Many service providers have significant investments in their existing network infrastructures, which may consist of disparate media, such as copper, coaxial and fiber, as well as numerous protocol families based on Internet Protocol, or IP, Asynchronous Transfer Mode, or ATM, and Time Division Multiplexing, or TDM. Service providers generally seek to maximize their return on investment by leveraging existing infrastructure to offer new services. This has increased the demand both for upgrades to existing equipment and for cost-effective new equipment that supports disparate media and numerous protocol families. INVESTMENT MADE BOTH IN THE CORE AND IN THE ACCESS NETWORK: As voice, video and data traffic travels over communications network infrastructure, it typically passes through the core and access networks before arriving at the customer premise, or destination. The growing demand for Internet bandwidth over the last decade prompted service providers to make significant capacity investments in the core network, which is the part of the network that is responsible for transporting large volumes of traffic between and within cities. Service providers have also made significant investments in upgrading the core network to a mostly IP-based infrastructure to more efficiently manage the increased data traffic. Page 21 The access network is located between the core network and the customer premise and is integral to the aggregation and distribution of network services and to the creation of new services. Service providers have begun to spend a greater proportion of their capital budgets on the development of their access networks to enable deployment of new services with ever-increasing bandwidth requirements, such as video or bundled services. To complement the investments previously made in the core network and to combine voice, video and data over a common network, service providers are increasingly seeking to upgrade access networks to emerging IP standards. Increasingly, the use of IP as a transport technology to combine voice, video and data over a common network is emerging as the principal network architecture for service providers. The access networks, better known as the "last mile", have been the most significant factor in the limitation of competition in the local telephony exchange business. In an effort to overcome this barrier, incumbent carriers were forced by law to agree to rent unbundled network elements to competitive carriers. This had a limited success in opening up the local telecom market for competition. Wireless technologies provided an alternative low cost method of offering last mile services. The demand for broadband connectivity to the Internet and the cable competition led incumbent local exchange carriers to offer broadband over copper to the residential market. This was offered using ADSL technology. The fast deployment of ADSL opened up an opportunity for alternative carriers to offer voice over this broadband connection, bypassing the need for any permission from the provider of the ADSL service. This is a very significant factor in the ability to offer Essentra BAX as a service delivery platform, for providing Class 5 Voice over Broadband (VoBB) services. Various market research firms estimate that in 2010 approximately 20% of all wire line telephone lines will implement Voice over Broadband (VoBB) technology. CONVERGENCE OF VOICE AND DATA: The maturing VoIP technology and the advantages of an IP network, not is leading to the convergence of the two - data and voice networks - and the offering of a mix of data and voice services over a single packet based IP network. This trend is expected to change telephony network deployment and operation by removing all territorial/localized networks and the localization aspect of the telephone number and possibly even replacing traditional telephone numbers with an alternative personal ID. Converged networks will reduce (according to various estimates - by 60%) the cost of deployment of telephony switching equipment. Converged networks will also reduce the cost of operation as the same packet-based network will serve voice and data. Soft-switch technology is at the heart of this evolution. The soft-switch will not only replace the legacy TDM switch, but it will no longer be an integral part of each and every neighborhood. Fewer high capacity soft switches will serve larger populations. The physical location of the soft switch will not be related to the subscribers that it will serve. Massive efforts and large projects are planned by most telephony service providers, which will result in over 390 million telephony lines connected to soft switches by 2010 (according to a 2006 Frost & Sullivan report). Essentra product family aims at this market, which is expected to grow by an annual average of 33% in the coming years. WIRE LINE AND MOBILE CONVERGENCE: A new network architecture has been defined by the Internet Multimedia Subsystem (IMS), a mobile standards committee. This will be the network architecture for the mobile third generation migration to packetized voice. The unique abilities of IMS to offer fast implementations of new services and the comfortable handling of access networks led the industry to consider the adoption of IMS for the wire line business, especially for VoIP technology to be used as an access network. In few years, we expect to start experiencing IMS offering Fixed-Mobile Convergence (FMC), where the same handset will be used in both networks and offer identical services to the consumer. This will be the final step in convergence of all multimedia fixed and mobile networks, offering a single service platform to all terminals, being either a computer, a PDA, a wire line phone or a mobile phone. Essentra architecture has followed the guidelines of IMS, and more adjustments will be needed as implementation of IMS commences. Page 22 INCREASING NEED FOR VOIP INTERCONNECTION: With the dramatic rise in Broadband infrastructure and access throughout the world, service providers and end user demand for VoIP is growing rapidly. Established global telecommunications service providers such as British Telecom, AT&T and KDDI are joining new entrants such as Skype and Vonage, as well as cable operators such as Comcast and Cablevision in offering IP telephony services. Currently, there are over 1,600 VoIP providers operating throughout the world. Some offer stand-alone telephony service, while others bundle VoIP with Internet access and video service for a full triple play suite. With this tremendous growth come a variety of challenges for carriers and service providers as they either build out their networks or migrate from legacy TDM technology to an IP-based infrastructure. Traditional fixed-line service providers are not the only ones migrating to IP, several leading mobile operators have announced plans to convert to an IP-based infrastructure in the coming years. The growing implementation of IP communications, coupled with the emerging fixed-mobile convergence over IP and the migration from TDM to ATM and IP-based networks, are driving the need for more sophisticated infrastructure solutions that can facilitate smooth deployments and transitions. Unlike traditional telephony service, there is no single global standard for VoIP. As such, VoIP implementations are based on a variety of different standards, making VoIP networks essentially a growing number of islands. In order to ensure a successful VoIP roll out and generate steady revenues for providers, these islands need to be connected to one another in a manner that is secure, reliable and seamless. While traditional architecture was once an effective way in which to connect multiple islands, it is becoming increasingly necessary for carriers to rely on IP-based solutions for VoIP interconnection. HOSTED SERVICES FOR ENTERPRISES: Carriers have never succeeded to offer more than basic services to enterprises. The basic services included E1/T1 trunking with PRI, or Primary Rate Interface (an ISDN link between customer premises, usually a PBX, and the Class 5 switch) and DID, or Direct Inward Dialing (which allows to call a person's office telephone extension from an outside telephone service). Centrex services have been offered by carriers, mainly in the US, since the early 1980's, but it never became a significant business. Soft switch technology combined with application servers offering a rich PBX-type set of features and the trends of outsourcing such services as IT lead to the reevaluation of the potential of the new Centrex services. The availability of web based self service encourages carriers to offer Centrex as a competing service to IPPBX solutions. IP technology adds the ability to combine Centrex with VPN to interconnect multiple corporate offices which may be given the feel and look of one office. Considering this, Essentra is offering rich Centrex features combined with VPN capability and corporate level provisioning tools. The expected size of the Centrex market is currently unclear, but the feature set is becoming a must in every sale of a soft switch. Page 23 CONSOLIDATION: In recent years, we have witnessed a consolidation in our industry. Large service providers are acquiring other service providers, and large equipment vendors are acquiring smaller vendors, in order to leverage the benefits of synergies, size and to provide their customers with a complete solution. The new VocalTec is the result of a merger with Tdsoft. We expect such trend to continue in the near future. OTHER TRENDS: In addition to the foregoing, we have identified the following trends: (i) VoIP networks have emerged in many business segments, in both the carrier and the enterprise market. Due to reasons such as security, protocol variance and other reasons, these networks are still not linked to each other using native IP. This has created an opportunity, which the Company is planning to leverage using the Essentra EX Peering Manager and derivatives of that product, to provide products that meet the need to connect these islands; (ii) Adoption of a standard called IMS (IP Multimedia Subsystem) by a majority of carriers and vendors, including mobile and fixed carriers and networks, resulting in a new definition of telecom infrastructure, focusing on IP multimedia service implementation. To address this trend, the Company's strategy is in alignment with the functional description described in the standard; (iii) Conveyance between fixed and mobile networks, both on the infrastructure and the service and business aspects, with respect to which the Company offers a vertical solution providing some of the elements in an FMC (fixed mobile conveyance)-type implementation. This trend is characterized by the unification of infrastructures (including unification at the infrastructure and service layers); (iv) The recent transition of existing and newly formed service providers towards packet-based networks, creating a variety of network islands, has resulted in IP peering among the islands (which traditionally were connected through PSTNs), due in part to the fact that being connected using IP is more cost-effective than being connected through PSTNs; (v) Distribution of soft switch functions towards the border (the gateway) and the application services layer (which enables the application service vendors to function as a soft switch), the Company can now transfer a portion of the intelligence from the BAX product to the border (the gateway); Page 24 (v) Entry of large Chinese vendors into the VoIP market, resulting in a dramatic reduction in the prices of commodity-based products. To overcome this difficulty, the Company is focusing on the development of a product that is less commoditized; and has a higher barrier of entry. 5E. OFF-BALANCE SHEET ARRANGEMENTS There are no off-balance sheet arrangements that have or are reasonably likely to have a current or future material effect on the company's financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources. 5F. TABULAR DISCLOSURE OF CONTRACTUAL OBLIGATIONS Contractual Obligations Payment Due by Period (in thousands of dollars) - ------------------------ ------------------------------------------------ More Less than than Total 1 Year 1-3 Years 3-5 years 5 Years ------- ------ ------ ------ ------ Contractual obligations Short term debt obligations - - - - - Operating Lease Obligations 1,468 415 936 117 - Other Long Term Liabilities Reflected on the Registrant's Balance Sheet under U.S. GAAP 1,938* 217 - - 1,721 Total 3,406 632 936 117 1,721 * As of December 31, 2006 we had 1,277 in severance pay funds to cover such liabilities. Page 25 EX-99 4 exhibit_c.txt EXHIBIT C CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUTING FIRM We consent to the incorporation by reference in the Registration Statements (Forms S-8 Nos. 2-0-27648, 333-100120, 333-10648, 333-106400 and 333-131870) pertaining to the VocalTec Communications Ltd. (the "Company") 1996 Stock Option Plan and Incentive Plan, 1997 Stock Option and Incentive Plan, 1998 and 1999 Stock Option Plan and Incentive Plan and Amended 2003 Master Stock Option Plan and in the Registration Statement of the Company on Form F-3 (File No. 333-134917) of our report dated March 30, 2007 with respect to the consolidated financial statements of the Company included in the Company's annual report on Form 6-K for the year ended December 31, 2006, filed with the US Securities and Exchange Commission. Tel Aviv, Israel KOST FORER GABBAY & KASIERER April 1, 2007 A Member of Ernst & Young Global EX-99 5 exhibit_d.txt EXHIBIT D CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM We hereby consent to the incorporation by reference in the Registration Statements on Forms S-8 (File Nos. 2-0-27648, 333-100120, 333-10648, 333-106400 and 333-131870) pertaining to the 1996 Stock Option Plan and Incentive Plan, 1997 Stock Option and Incentive Plan, 1998 and 1999 Stock Option Plan and Incentive Plan and Amended 2003 Master Stock Option Plan of VocalTec Communications Ltd. and the Registration Statement of VocalTec Communications Ltd. on Form F-3 (File No. 333-134917) of our report dated November 17, 2005 except for shares and per share data as to which the date is April 20, 2006 relating to the 2004 consolidated financial statements of TDSOFT Ltd., which appears in this Form 6-K. Tel Aviv, Israel KESSELMAN & KESSELMAN March 31, 2007 A Member of PriceWaterhouseCoopers -----END PRIVACY-ENHANCED MESSAGE-----