-----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, JlCGoCHg7ggeIs2rvWv9AbFZmzcEUwcmGq9H/O5+iSuiLGnzKV/UaKpoJpC6Gl8d DLuKGyt82vibcv5UL4fwow== 0000950130-02-004685.txt : 20020628 0000950130-02-004685.hdr.sgml : 20020628 20020627213924 ACCESSION NUMBER: 0000950130-02-004685 CONFORMED SUBMISSION TYPE: 20-F PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 20011231 FILED AS OF DATE: 20020628 FILER: COMPANY DATA: COMPANY CONFORMED NAME: IIS INTELLIGENT INFORMATION SYSTEMS LTD CENTRAL INDEX KEY: 0000742358 STANDARD INDUSTRIAL CLASSIFICATION: COMPUTER TERMINALS [3575] IRS NUMBER: 000000000 FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 20-F SEC ACT: 1934 Act SEC FILE NUMBER: 000-13012 FILM NUMBER: 02689966 BUSINESS ADDRESS: STREET 1: 33 JABOTINSKY ST STREET 2: RAMAF GAN ISREAL BUSINESS PHONE: 9724892077 MAIL ADDRESS: STREET 1: 33 JABOTINSKY STREET STREET 2: RAMAF GAN ISRAEL CITY: RAMAF GAN STATE: L3 ZIP: 00000 20-F 1 d20f.txt FORM 20-F FORM 20-F U.S. SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 [ ] REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF 1934 OR [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2001 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to --------- -------- Commission File No. 0-13012 I.I.S. Intelligent Information Systems Limited ---------------------------------------------- (Exact name of Registrant as specified in its charter and translation of Registrant's name into English) ISRAEL ------ (Jurisdiction of incorporation or organization) 33 Jabotinsky Street, Ramat Gan, Israel --------------------------------------- (Address of principal executive offices) Securities registered or to be registered pursuant to Section 12(b) of the Act: None Securities registered or to be registered pursuant to Section 12(g) of the Act: Ordinary Shares, NIS 0.003 par value per share ---------------------------------------------- (Title of Class) Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act: None Indicate the number of outstanding shares of each of the issuer's classes of capital or common stock as of the close of the period covered by the annual report: As of December 31, 2001, the Registrant had 11,498,436 Ordinary Shares, NIS 0.003 par value per share, outstanding ("Ordinary Shares"). Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark which financial statement item the registrant has elected to follow. Item 17 [ ] Item 18 [X] This Annual Report on Form 20-F contains historical information and forward-looking statements. Statements looking forward in time are included in this Form 20-F pursuant to the "safe harbor" provision of the Private Securities Litigation Reform Act of 1995. They involve known and unknown risks and uncertainties that may cause the Company's actual results in future periods to be materially different from any future performance suggested herein. Further, the Company operates in an industry sector where securities values may be volatile and may be influenced by economic and other factors beyond the Company's control. In the context of the forward-looking information provided in this Form 20-F and in other reports, please refer to the discussions of risk factors detailed in, as well as the other information contained in, this Form 20-F and the Company's other filings with the Securities and Exchange Commission during the past 12 months. PART I Item 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS - ------- ----------------------------------------------------- Not applicable. Item 2. OFFER STATISTICS AND EXPECTED TIMETABLE - ------- --------------------------------------- Not applicable. Item 3. KEY INFORMATION - ------- --------------- A. Selected Financial Data. The following selected consolidated financial data of the Company as of December 31, 2001 and 2000 and for the three years ended December 31, 2001, are derived from the Company's audited consolidated financial statements which are included in this Annual Report and have been prepared in accordance with U.S. GAAP. The selected consolidated financial data as of December 31, 1999, 1998 and 1997 and for the years ended December 31, 1998 and 1997 have been derived from audited consolidated financial statements not included in this Annual Report and have also been prepared in accordance with U.S. GAAP. The Selected Financial Data set forth below should be read in conjunction with and are qualified by reference to Item 5 (Operating and Financial Review and Prospects), and the Consolidated Financial Statements included elsewhere in this Annual Report. Since December 2000, as a result of the decline of the Company's interest in StoreAge Networking Technologies Ltd. ("StoreAge") to 39%, the Company's and StoreAge's operations are no longer reported on a consolidated basis and the Company's investment in StoreAge is accounted for in accordance with the equity method. 1 Statement of Operations Data (in thousands, except per share data): - -------------------------------------------------------------------
Year Ended December 31, ------------------------------------------------ 1997 1998 1999 2000 2001 ------- -------- ------- ------- ------- Sales revenues $37,981 $ 31,481 $ 5,408 $ 96 $ 83 Revenues from related party -- -- -- -- 251 Maintenance and other services 6,417 4,467 547 -- -- Total revenues 44,398 35,948 5,955 96 334 Cost of sales 26,930 23,327 4,484 27 28 Cost of revenues from related party -- -- -- -- 155 Inventories write off -- 5,442 -- -- -- Cost of maintenance and other services 5,316 2,836 429 -- -- Total cost of revenues 32,246 31,605 4,913 27 183 Gross profit 12,152 4,343 1,042 69 151 Research and 2,719 2,410 686 925 479 development costs, net Selling and marketing expenses 9,245 7,589 1,417 639 21 General and administrative expenses 6,465 5,870 1,777 899 888 Write-off of trade receivables -- 470 -- -- -- Restructuring charges -- 1,071 467 -- -- Non recurring income -- -- -- -- (180) Operating loss (6,277) (13,067) (3,305) (2,394) (1,057) Financial income (expenses), net from (203) (1,022) 173 277 (56) operation Financial expenses from conversion of -- -- -- -- (1,491) convertible debentures Financial income (expenses) (203) (1,022) 173 277 (1,547) Other income (expenses), net (36) (267) (1,770) (12) -- Loss before equity in losses of affiliate (6,516) (14,356) (4,902) (2,129) (2,604) and minority interest in losses of subsidiaries Income taxes 75 -- -- -- -- Equity in losses of affiliate -- -- -- -- (877) Minority interest in losses of subsidiary -- -- 55 740 -- Net loss $(6,591) $(14,356) $(4,847) $(1,389) $(3,481) Basic and diluted net earnings (loss) per $ (1.41) $ (2.55) $ (0.55) $ (0.16) $ (0.37) share Weighted average number of shares 4,649 5,621 8,860 8,901 9,409 used in computing basic and diluted net earnings (loss) per share (in thousands)
2
At December 31, --------------- Balance Sheet Data (in thousands): 1997 1998 1999 2000 2001 - ---------------------------------- ------- -------- ------- ------- ------- Working capital $14,175 $ 3,761 $ 5,590 $ 2,254 $ 1,024 Cash and cash equivalents 5,958 5,661 7,350 3,077 1,556 Total assets 35,326 17,992 8,496 6,349 3,233 Short-term bank credits 2,370 3,588 142 10 10 Long-term debt 2,706 568 122 2,839 1 Shareholders' equity $16,289 $ 4,005 $ 2,757 $ 1,882 $ 2,535
B. Capitalization and Indebtedness. Not applicable. C. Reasons for the Offer and Use of Proceeds. Not applicable. D. Risk Factors. An investment in the Company involves a high degree of risk. The following risk factors should be considered carefully in evaluating an investment in the Company. Since StoreAge is the Company's most valuable asset, a number of the following risks relate to the Company's investment in, and affiliation with, StoreAge. We Depend on StoreAge's Future Success For Continued Growth. We are highly dependent on the success of our StoreAge affiliate for future profits. We cannot assure you that StoreAge will prove commercially successful, or that our investment in StoreAge will be profitable. To date, StoreAge's revenues have been very limited. We have a History of Substantial Recurring Losses. We lost approximately $3.5 million during the year ended December 31, 2001, $1.4 million during the year ended December 31, 2000, $4.8 million during the year ended December 31, 1999, $14.4 million during the year ended December 31, 1998, and $6.6 million during the year ended December 31, 1997. Our ability to achieve profitable operations depends on, among other things, the successful marketing of storage technology products which we have only recently introduced into the market. However, we cannot assure you that we will become and stay profitable. Since We Have a Minority Ownership Interest in StoreAge, Our Interest in StoreAge's Profits and Our Ability to Direct Its Business Affairs Are Limited. Our interest in StoreAge was reduced following StoreAge's private placement, completed in January 2001, to a 39% ownership interest (and may be further reduced). Cisco Systems, Inc., CDC Holdings Ltd., Morgan Keegan Entities, Genesis Partners, Koonras Technologies Ltd., The Challenge Fund and Ophir Tech Ltd. 3 (together, the "Private Investors"), hold the remaining 61% ownership interest. Because we hold a diminished percentage interest in StoreAge, our shareholders will also have a smaller indirect interest in StoreAge. In addition, future financing needs of StoreAge are likely to require additional private or public equity financing, thus further diluting our shareholding percentage. The significant ownership interest in StoreAge held by the Private Investors (which may be further increased) and the rights granted to the Private Investors, including preferences in liquidation and receipt of dividends, registration rights and various negative covenants, will also reduce the flexibility that we will have in the operation and any future disposition of StoreAge. Our Future Capital Needs Could Adversely Affect Us if We are Unable to Raise Additional Capital. Given the business levels we presently expect, we believe that our existing cash on hand will be sufficient to meet our working capital requirements, including normal capital expenditures, for at least the next 12 months, and that StoreAge's existing cash on hand, including the net proceeds of its private placement in January 2001, will be sufficient to meet its working capital requirements, including normal capital expenditures, for at least the next 12 months. However, continued losses could reduce StoreAge's and/or our working capital and cash equivalents, which could adversely affect StoreAge's or our future operations unless we secure additional financing. If financing is not available when required or is not available on acceptable terms, we may be unable to develop or enhance our services, take advantage of business opportunities or respond to competitive pressures. Competition From Other Companies That Have Greater Resources Than We Do Could Adversely Affect Us. The markets in which StoreAge's technology products will be sold, especially the United States, are highly competitive. Most of our competitors have substantially greater financial, technical and marketing resources than we do. Our Business Prospects May Suffer If StoreAge Is Unable To Keep Up With The Rapid Technological Developments In The Storage Industry. The market for StoreAge's products is characterized by rapidly changing technology and evolving industry standards. The introduction of new technologies and the emergence of new industry standards can render existing products obsolete and unmarketable. StoreAge's ability to anticipate such changes and to develop and introduce successfully new and enhanced products on a timely basis will be a very significant factor in its ability to grow and to remain competitive. StoreAge will need to make substantial expenditures (including commitments to pay royalties) for research, development and introduction of new products. If StoreAge is unable, for technological or other reasons, to develop products in response to changes in the industry, its business and our prospects will be materially and adversely affected. We cannot assure you that StoreAge will not encounter technical or other difficulties that could delay the introduction of new products in the future. If StoreAge is unable to introduce new products in response to changes in the industry, StoreAge's business and the market price of our Ordinary Shares will be materially and adversely affected. If There Are Changes in StoreAge's Future Customers' Requirements, Its Business May Suffer. The markets for computer and storage technology equipment are changing rapidly and often unpredictably. Changes in customer requirements and preferences, introduction or modification of new industry standards, or variations in the relative cost-effectiveness of different storage technology solutions could adversely affect its growth and future financial performance. If future customer requirements differ from those projected by StoreAge, its future product sales would be adversely affected. 4 Our Business Depends on a Limited Number of Key Personnel, the Loss of Whom Could Adversely Affect Us. Our continued success depends to a significant extent upon the performance of our senior executives. We do not maintain key-man life insurance policies covering any of our executives. The loss of one or more senior executives' services would likely have a material adverse effect on us. Our iSCSI Business is Only in its First Stages of Market Penetration. The Internet Small Computer Systems Interface ("iSCSI") market is highly volatile and end users adaptation of iSCSI technology has been much slower than anticipated. In addition, iSCSI standardization is not yet complete and its completion is required before the introduction of products to the market by storage vendors. Although the potential exists in the iSCSI market, we anticipate fierce competition for testing tools products from large companies, which are better financed, and have larger marketing resources. Our Quarterly Results May Fluctuate. Our future quarterly results may vary significantly due to a combination of several factors, including fluctuations in research and development expenses and the absence of sales. Anti-takeover Provisions Could Negatively Impact Our Shareholders. Provisions of Israeli law may delay, prevent or make difficult an acquisition of our Company, which could prevent a change of control and therefore depress the price of our stock. Israeli corporate law regulates mergers and acquisitions of shares through tender offers in certain circumstances, requires special approvals for transactions involving significant shareholders and regulates other matters that may be relevant to these types of transactions. Because Our Board of Directors Is Classified, it Could Hinder a Merger, Proxy Contest or Tender Offer, Whether or Not They Would Be Beneficial to Our Shareholders. The classification of our board of directors could delay or impede the removal of incumbent directors and could therefore complicate a merger, tender offer or proxy contest involving us, even if such events would be beneficial to the interests of our shareholders, or could discourage a third party from attempting to acquire control of the Company. A Substantial Number of Our Shares Can Be Sold in the Future under Rule 144, Which Could Lower the Price of Our Shares. Existing shareholders may sell Ordinary Shares pursuant to Rule 144 promulgated under the Securities Act, or otherwise. Such sales could adversely affect the price of the Ordinary Shares. We cannot predict the effect that future sales of the Ordinary Shares, or the availability of the Ordinary Shares for future sales, will have on the market price of the Ordinary Shares. Prevailing market prices for the Ordinary Shares could drop if substantial amounts of the Ordinary Shares are sold, or if others perceive that such sales could occur. In addition, proposed changes in Israeli taxation of capital gain may result in the sale of a substantial number of the Ordinary Shares in a short period of time in the future. We May Be Subject to a Delisting Action by the Nasdaq SmallCap Stock Market. Our Ordinary Shares are quoted on the Nasdaq SmallCap Market under the symbol "IISL". In order for our Ordinary Shares to continue to be quoted on the Nasdaq SmallCap Market, we must satisfy various listing maintenance standards, including certain net tangible assets and shareholders' equity tests established by Nasdaq. Although we currently have sufficient shareholders' equity and net tangible assets to meet the requirements for continued inclusion on the Nasdaq SmallCap Market, there can be no assurance that we will be able to continue to meet these requirements and the other listing requirements of the Nasdaq SmallCap Market. A delisting action by the Nasdaq SmallCap Market would have a material adverse effect on the liquidity of our Ordinary Shares and may have a material adverse effect on its trading value. We Do Not Presently Intend To Pay Dividends. We have not declared or paid dividends on our Ordinary Shares since 1989, and do not intend to declare or pay any dividends to our shareholders in the foreseeable future. Our Share Price May Be Volatile. The market price of our Ordinary Shares may fluctuate following the announcement of financial results or new product introductions by us or our competitors or other matters such as military, political or economic developments in the Middle East and the market for technology stocks generally. Our Financial Results May Be Adversely Affected By Inflation and Currency Fluctuations. Since we report our financial results in dollars, fluctuations in rates of exchange between the dollar and non- 5 dollar currencies may have a material adverse affect on our results of operations. The majority of our expenses are paid in NIS (primarily salaries) and are influenced by the timing of, and the extent to which, any increase in the rate of inflation in Israel over the rate of inflation in the United States is not offset by the devaluation of the NIS in relation to the dollar. We believe that the rate of inflation in Israel has not had a material adverse effect on our business to date. However, our dollar costs in Israel will increase if inflation in Israel exceeds the devaluation of the NIS against the dollar or if the timing of such devaluation lags behind inflation in Israel. Over time, the NIS has been devalued against the dollar, generally reflecting inflation rate differentials. Likewise, our operations could be adversely affected if we are unable to guard against currency fluctuations in the future. We do not currently engage in any currency hedging transactions intended to reduce the effect of fluctuations in foreign currency exchange rates on our results of operations. We cannot guarantee that we will not enter into such transactions in the future or that such measures will adequately protect us from serious harm due to the impact of inflation in Israel. Since StoreAge Currently Has a Limited Number of Customers, Loss of Any One Customer in the Future as StoreAge Builds Its Customer Base Could Hurt Its Business. A material percentage of StoreAge's revenues are derived from a limited number of customers. We do not anticipate that StoreAge generally will enter into long-term contracts with its customers, and customers generally will have certain rights to extend or delay the shipment of their orders or cancel orders without penalty. Loss of one or more principal customers or a material decrease in orders could materially and adversely affect its business, financial position and results of operations. StoreAge's Proprietary Technology Enjoys Only Limited Protection; Third-Party Claims of Infringement Could Harm StoreAge's Business. StoreAge has limited patent protection for its products and has attempted to protect its proprietary software and other intellectual property rights through trade secrets, nondisclosure agreements and other measures. StoreAge has applied for several patents for its technology. We cannot assure you, however, that StoreAge will receive these patents and/or be able to protect its proprietary software and other intellectual property rights adequately or that competitors, all of whom have legitimate access to any non-proprietary technical standards utilized by StoreAge will not be able to develop similar technology independently. For example, a number of StoreAge's competitors are producing or plan to produce products that incorporate Virtualization technology. Third parties may from time to time notify StoreAge that it may be infringing patents owned by or proprietary rights of third parties, although no such claims are currently pending against StoreAge. If necessary, StoreAge may have to seek a license under any such patent, or redesign or modify its products and processes in order to avoid infringement of such patents. There can be no assurance that such a license would be available on acceptable terms, if at all, or that StoreAge could so avoid infringement of such patents, in which case StoreAge's business, financial position and results of operations could be materially and adversely affected. There has been substantial litigation in the technology industry regarding intellectual property rights, and litigation may be necessary to protect StoreAge's proprietary technology. It is also possible that StoreAge will increasingly have to litigate infringement claims with companies in the storage system market, as the number of competitive products and companies grow. Any such claims or litigation may be time-consuming and costly, cause product shipment delays, require StoreAge to redesign or modify its products or require StoreAge to enter into royalty or licensing agreements, any 6 of which could have a material adverse effect on StoreAge's business, operating results or financial condition. Despite StoreAge's efforts to protect its proprietary rights, unauthorized parties may attempt to copy aspects of StoreAge's products or to obtain and use information that StoreAge regards as proprietary. In addition, the laws of some foreign countries do not protect proprietary rights to as great an extent as do the laws of the United States. There can be no assurance that StoreAge's means of protecting its proprietary rights will be adequate or that StoreAge's competitors will not independently develop similar technology or duplicate StoreAge's products or design. StoreAge Depends on a Limited Number of Key Suppliers of Key Components to Manufacture Its Products. StoreAge's reliance on a limited number of suppliers for key components of its products, the absence of long term purchase agreements with those suppliers, the fact that StoreAge is likely to maintain only minimum inventory levels and the fact that there may be a significant market demand for those components involve several risks in addition to inadequate supply. These risks include potential price increases, selective supply allocations, late deliveries and poor component quality. We cannot assure you that StoreAge will not experience shortages of key components in the future or that StoreAge will not be subject to selective supply allocations and increased prices of components. Any shortage of key components and any delay or other difficulty in obtaining such components from other suppliers and integrating them into StoreAge's products could materially and adversely affect StoreAge's business, financial position and results of operations. StoreAge Depends on Subcontractors to Manufacture its Products. StoreAge depends on subcontractors to manufacture its products. StoreAge's future results of operations will be dependent in large part upon its ability to have products manufactured and delivered promptly upon the receipt of orders and to provide prompt and efficient service to its customers. As a result, any disruption of its day-to-day operations, or the day-to-day operations of its subcontractors, could have a material adverse effect upon StoreAge. StoreAge's operations, including, research, marketing, customer service and distribution functions, are based in and managed from a single facility in Israel. It relies on the manufacturing facilities of subcontractors that may be based in and managed from a small number of facilities in Israel. A fire, flood, earthquake or other disaster or condition affecting these facilities could disable these functions. Any such damage to, or other condition interfering with the operation of, these facilities would have a material adverse effect on the business of StoreAge and its financial position and results of operations. StoreAge is Subject to Warranty Claims for Defective Products. Products offered by StoreAge may contain defects in hardware, software or workmanship that remain undetected until after commercial shipment. Any loss or delay in customer or market acceptance attributable to such defects or any material replacement or repair expenses due to any such defects could have a material adverse effect on StoreAge's business, financial position and results of operations. StoreAge's Planned International Expansion Will Expose It to New Risks. StoreAge intends to expand its operations internationally. These efforts will require significant management attention and financial resources. There can be no assurance that these efforts will be successful. Although sales are effected in U.S. dollars, international sales are subject to a number of risks, including longer payment cycles, unexpected changes in regulatory requirements, import and export restrictions and tariffs, the burden of complying with a variety of foreign laws, potentially adverse tax consequences, currency fluctuations, the imposition of currency exchange or price controls, and political and economic 7 instability abroad. If StoreAge increases its international sales, seasonal fluctuations may also affect to a greater extent StoreAge's total revenues due to lower sales that typically occur during the summer months in Europe and other parts of the world. Risk Factors Relating to Our Operations in Israel Conducting Business in Israel Entails Special Risks. We are incorporated under the laws of, and our executive offices and research and development facilities, and those of StoreAge, are located in, the State of Israel. Although most of StoreAge's sales are made to customers outside Israel, it is nonetheless directly affected by the political, economic and military conditions affecting Israel. Any of StoreAge's manufacturing operations would be heavily dependent upon components imported from outside of Israel. Any major hostilities involving Israel or the interruption or curtailment of trade between Israel and its present trading partners could have a material adverse effect on our business, financial condition and results of operations and that of StoreAge. Since the establishment of the State of Israel in 1948, a state of hostility has existed, varying in degree and intensity, between Israel and the Arab countries. While Israel has entered into peace agreements with both Egypt and Jordan and several other countries have announced their intentions to establish trade and other relations with Israel, Israel has not entered into any peace arrangement with Syria or Lebanon. Since September 2000 there has been a significant deterioration in the relationship between Israel and the Palestinian Authority and as a result of violence between Israelis and Palestinians, the peace process between the parties has stagnated. Efforts to resolve the problem have failed to result in an agreeable solution. In recent months there has been a marked deterioration in the conflict, which culminated in several lethal suicide attacks in Israel and in response the Israeli Army called up a large number of reserve duty soldiers and has made incursions into most Palestinian-controlled cities and towns. The continued hostilities between the Palestinian community and Israel and the failure to settle the conflict has had and continues to have a material adverse effect on the Israeli economy and may have a material adverse effect on our business and that of StoreAge. Further deterioration of hostilities might require more widespread military reserve service by our and StoreAge's employees that may have a material adverse effect on our business and that of StoreAge. In addition, termination or reduction of certain governmental grants, programs and tax benefits could have a material adverse effect on us and StoreAge. Most of Our Directors, Officers and Employees are Obligated to Perform Annual Military Reserve Duty in Israel. We cannot assess the potential impact of these obligations on our business. Our directors, officers and employees who are male adult citizens and permanent residents of Israel under the age of 48 are, unless exempt, obligated to perform annual military reserve duty and are subject to being called to active duty at any time under emergency circumstances. We cannot assess the full impact of these requirements on our workforce or business if conditions should change, and we cannot predict the effect on us if there is any expansion or reduction of these obligations. 8 We May be Adversely Affected by Proposed Tax Reform in Israel. In February 2002, the Minister of Finance appointed a committee to review and make recommendations with respect to the current Israeli tax structure. The committee presented its recommendations to the Minister of Finance on June 12, 2002. If implemented, the recommendations might result in the imposition of Israeli capital gains taxes at the rate of 15% to 35% on sales of securities of Israeli companies by Israeli residents. In addition, the committee has proposed that a tax be imposed on all income of Israeli residents (individuals and corporations) regardless of the territorial source of income and a tax will be imposed on income of foreign corporations controlled by Israeli residents if the majority of profits or income of such foreign corporations originate from "passive income", including interest, dividends, royalties and rental income. We cannot predict whether, and to what extent, such recommendations will be adopted and eventually enacted into law. Anti-takeover Provisions Could Negatively Impact Our Shareholders. Some of the provisions of Israeli law could: . discourage potential acquisition proposals; . delay or prevent a change in control over us; and . limit the price that investors might be willing to pay in the future for our ordinary shares. Generally, under Israeli corporate law, a merger must be approved by the board of directors and the shareholders of each of the merging companies. If the share capital of the non-surviving company consisted of more than one class of shares, the approval of each class is also required. In certain cases, court approval is also required. Under the Companies Law, a merger may be completed only after 70 days have elapsed from the date all the necessary approvals and the merger proposals have been submitted to the Israeli Companies Registrar. The Companies Law also provides that an acquisition of shares of a public company must be made by means of a tender offer if, as a result of such acquisition, the purchaser would become a 25% or more shareholder of the company. This rule does not apply if there is already another 25% shareholder of the company. Similarly, the Companies Law provides that an acquisition of shares in a public company must be made by means of tender offer if, as a result of the acquisition, the purchaser would become a 45% shareholder of the company, unless someone else already holds a majority of the voting power of the company. These rules may not apply if the acquisition is made by way of a merger. The requirements of Israeli corporate law generally make these forms of acquisition significantly more difficult than under United States corporate laws. Other potential means of acquiring a public Israeli company might involve significant obstacles, such as a requirement for court approval for the acquisition. In addition, a body of case law has not yet developed with respect to the new Companies Law. Until this happens, uncertainties will exist regarding its interpretation. 9 Item 4. INFORMATION ON THE COMPANY -------------------------- A. History and Development of the Company. Until early 1999, I.I.S. Intelligent Information Systems Limited ("IIS" or the "Company") was engaged in the development, manufacture, marketing and service of data communication and intelligent peripheral products targeted at the International Business Machines ("IBM") midrange, IBM mainframe and open systems computing environments. In late 1998, the Company implemented a restructuring plan (the "Restructuring") which resulted in the disposition of most of the assets of the Company, substantial changes in the Company's structure and a focus exclusively on storage area networking ("SAN"). For information regarding the Company's products prior to completion (in early 1999) of the Restructuring, please refer to the Company's Annual Report on Form 20-F for the fiscal year ended December 31, 1997. In January 1999, StoreAge Networking Technologies Ltd., an Israeli company, ("StoreAge") was organized as a wholly-owned subsidiary of IIS and commenced development and marketing of products based on its SAN Virtualization technology. In January 1999, the Company divested itself of its 62.3% equity interest in NetWiz Ltd., an Israeli development-stage company ("NetWiz"). In the transaction, it transferred its entire interest in NetWiz to a non-affiliated third party and such non-affiliated third party assumed all liabilities associated with such interest. The divestiture required the Company to expend $945,000. Net gain realized as a result of the sale of NetWiz amounted to $616,000. In February 1999, the Company disposed of its networking products and network integration services division, which was comprised of Adanet Communications, Ltd. ("Adanet"), an Israeli company which the Company acquired in June 1994, and I.I.S. Computer Maintenance and Services (1983) Limited ("I.I.S. Maintenance"), an Israeli company. The Company realized net proceeds of $1.506 million and net gain of $175,000 as a result of the sale of Adanet and I.I.S. Maintenance. In March 1999, the Company sold most of the assets and the buyer assumed most of the liabilities of its Decision Data Division ("Decision Data"), which comprised all of the Company's United States, United Kingdom and German operations. The Company realized net proceeds of $2.487 million and net gain of $205,000 as a result of the sale of Decision Data. During November 2000, the Company acquired the assets of Eastek Embedded Systems (Meitav) Ltd. ("Eastek"), a private Israeli software company, to enhance its R&D capabilities in order to develop storage networking solutions for the SAN market with a focus on storage over IP applications. In December 2000, the Company completed a private placement of $3 million in the issuance of convertible secured debentures and warrants to qualified investors. The net proceeds from the offering were used to fund the Company's investment in StoreAge's second round of financing. On January 25, 2001, StoreAge completed its second round of financing, raising a total of $25 million from strategic and institutional investors in a private placement. The Company was an investor in the financing, investing a total of $4.2 million. Following the consummation of the financing, the Company held 39% of the outstanding shares of StoreAge. 10 In order to maintain its Nasdaq SmallCap Market listing, the Company completed a transaction with the holders of its convertible secured debentures and warrants (the "Purchasers") to exchange such securities for the Company's Ordinary Shares and cash. Under the terms of the transaction, the Purchasers converted $2,426,576.40 principal amount of the debentures into an aggregate of 1,797,464 of the Company's Ordinary Shares, received a cash payment of $573,423.60 and relinquished all of the warrants. The warrants and the remaining debentures were cancelled. As a result of the completion of the transaction in December 2001, the Company had sufficient shareholders' equity and net tangible assets to meet the requirements for continued inclusion on the Nasdaq SmallCap Market. IIS was incorporated in Israel in 1980. The executive offices of the Company are located at 33 Jabotinsky Street, Ramat Gan, Israel, its telephone number is (+972) 3-751-0007 and its facsimile number is (+972) 3-575-0595. The Company's agent in the United States is Brown Raysman Millstein Felder & Steiner LLP located at 900 Third Avenue New York, NY 10022. B. Business Overview. With the ever growing need for storage in computing systems, resulting among other things from the wide applications of Internet and Intranet technologies, coupled with the deployment of data warehouses and other decision support systems, the storage industry is changing its structure. Storage is developing into a separate industry, with information technology departments seeking to purchase storage systems independently from purchasing and upgrading computing environments. An additional aspect of the phenomenal growth of the installed storage is the increasing dependency of users on their storage systems and, hence, the requirement for high availability as well as protection from malfunctions and disasters. With data growing at an exponential rate, it was inevitable that a logical method of data storage, retrieval and management be developed, thus the formation of storage area networks ("SANs"). A SAN configuration is typically based on a "fabric" of fibre channel cables, switches and hubs that provide the connectivity necessary to establish data patterns between a heterogeneous set of servers and storage devices on a many-to-many basis. This storage network helps companies gain a competitive edge by assisting them in the management of storage and the retrieval of the explosive growth of stored digital data. SAN provides users with the ability to quickly share information assets, regardless of their location, in any desired format. SAN technology enables the user to connect multiple hosts to multiple storage systems using a hub or a switch, making all storage systems accessible to all or specified servers. The complexity, rapid growth and increased importance of data to mission-critical applications has led to the development of storage management software. This software allows IT managers to effectively manage and maintain the integrity of the data stored. The growing size and complexity of storage installations, combined with the rapid growth in the demand for storage, has made the administration of storage resources more challenging as administrators seek to solve the problem of assuring the availability of data across multiple platforms and geographies. Consequently, the storage management process now has much broader implications for many organizations. Enterprises now want integrated storage management solutions that provide centralized management of storage resources and support high data availability, scalability, and performance in heterogeneous environments. 11 In order to enable total focus on the new fast growing, large SAN and fibre channel market, in January 1999, IIS formed StoreAge, a separate entity whose sole purpose is to concentrate on storage networking development, production and marketing activities. StoreAge's goal is to be a leader in the storage networking industry. Its personnel has extensive experience in the design and implementation of leading edge technologies. Its mission includes the development and deployment of products and services in areas such as (i) Virtualization of storage networks for Open Systems (including Windows 2000, NT, Linux and UNIX), (ii) storage networking middleware (distributed RAID, volume management), (iii) storage management software, and (iv) storage related applications including disaster recovery and backup solutions, such as snapshot, remote mirroring and others. The innovative approach to enterprise storage systems proposed by StoreAge has attracted interest from original equipment manufacturers ("OEMs"), including those whose range of options do not include similar solutions. Therefore, StoreAge is employing an OEM, Value Added Resellers ("VAR") and systems integrator market strategy, as opposed to a direct market strategy targeted at end-users. StoreAge seeks to make strategic alliances with major corporations that have developed customer bases, such as computing platforms manufacturers, networking platforms manufacturers and possibly storage systems manufacturers. Such strategic alliances and business cooperation may benefit StoreAge by providing it with promising distribution avenues, while introducing these partners to StoreAge's advanced technology and products. Products and Systems In June 2001, the Company launched the iSCSI SWAT ("iSWAT"(TM)) software, an advanced suite of applications for enhanced development, testing and conformance of storage solutions based on the Internet Small Computer Systems Interface ("iSCSI") communication protocol specification for the SAN. iSCSI is a new protocol that is expected to eventually replace the "Fibre Channel" protocol currently being used for SAN. The advantage of the iSCSI is that it works with standard Ethernet (Fast and Gigabit Ethernet), the existing enterprise networking infrastructure built over many years for a Local Area Network ("LAN"). iSCSI enables the implementation of cost-effective and high-performance storage solutions designed for the SAN over regular Ethernet offering management and transfer of storage data without sacrificing ease of access. The iSWAT is designed for developers and vendors of iSCSI products. It leverages iSCSI development and creates a single test environment that incorporates all professional features and functionality required for error injection, validation and conformance testing. It emulates iSCSI environment components and traffic to simplify and shorten development and Quality Assurance ("QA") processes. StoreAge's family of products include the Storage Virtualization Manager ("SVM(TM)"). StoreAge has developed the SVM(TM) as a SAN storage management solution. The SVM(TM) is a storage area network appliance that works with StoreAge's proprietary software through the creation and allocation of virtual volumes ("virtualization") to provide overall virtual volume management in a heterogeneous SAN environment. The SVM(TM) features physical device monitoring, volume definitions and virtual storage allocations for all servers and storage connected to the Fibre Channel loop or fabric. It provides a common graphical user interface ("GUI") through which storage is virtualized and 12 selectively presented to users in a flexible way. Unlike other competing management solutions, the SVM(TM) does not impose any performance degradation on the I/O traffic on a SAN. The SVM(TM) serves as a platform for disaster and recovery and backup storage applications, such as remote mirroring and snapshot, and is a key enabler for functions such as serverless, LAN-free backup, shared file systems and multi-node clusters among other services that require a uniform overall view of and multiple access to all storage resources of the enterprise ("Storage Applications"). The SVM(TM) enables the flexibility of a centrally managed highly scalable SAN without incurring degradation of performance or high cost of hardware. The SVM(TM) appliance can be a small and inexpensive unit since it does not have to conduct the actual data transfer. In the SVM(TM) based solution all storage is handled uniformly, independent of the type of storage subsystem or operating systems. Virtual volumes can be created, expanded, deleted, moved from server to server and assigned to multiple servers. An important aspect of the SVM(TM) is that Storage Applications, in addition to human administrators (via the management GUI), can request volume allocations from the SVM(TM) appliance, giving a SAN new capabilities for improved data management. Applications such as Snapshot and others can create, expand and delete their own volumes, communicating directly with the SVM(TM). The SVM(TM) delivers the following key functions critical for SAN management: ... SAN manageability: A central point for managing entire SAN resources via a Web-enabled intuitive GUI effected through any standard browser and the ability to administer multiple RAID subsystems as if it was one large system (RAID pooling). ... SAN Scalability: Unlimited SAN growth from a number of servers, storage capacity, I/O performance or bandwidth viewpoint. ... SAN Security: Selective presentation of volumes to users with a fabric zoning control, which protects data from access via unauthorized path. ... High Availability: Complete redundancy is supported. Modifications to the system are done on the fly without system re-boot. SAN bottlenecks are avoided due to multiple paths with load balancing and automatic failover. ... Interoperability and Sharing: Volume masking enables sharing of storage among servers with different OS and FS. Volumes can be seen by more than one host, creating an ideal platform for shared file systems and clusters. Volumes can be moved from host to host (without copying). ... Performance Enhancement: Striping across RAID subsystems for increased performance. Performance statistics help to facilitate removal of SAN bottlenecks. SVM(TM) provides a central management point for storage virtualization while the data is directly transferred between the host computer and storage devices. This architecture meets all key requirements from a good virtualization scheme and in particular the total independence of the virtual storage from both the servers and the storage subsystems, thus creating true heterogeneous SANs. SVM(TM) provides significant scalability, performance, reliability and price advantages over alternative architectures. The SVM offers a particular advantage for high scale SAN installations (large number of 13 servers) and demanding environments such as video and television related applications due to its extremely large number of devices supported and off the data path architecture. Sales and Marketing StoreAge's objective is to become the leading provider of SAN Storage Management software solutions offering high availability and increased protection of data over distributed networks. In order to achieve this objective, StoreAge is pursuing the following strategies: . Accelerate sales through strategic partnerships with OEM suppliers . Develop a reseller distribution channel . Accelerate the build-up of its U.S. operation StoreAge targets its products to industry leaders in the following areas: . Server Suppliers. These companies design, make and sell the computers that are shared on a network. Traditionally they are also the largest suppliers of storage used by these servers. Some of the largest companies in this area include Compaq Computer Corp., Dell Computer Corp., Hewlett-Packard Company, IBM Corp. and Sun Microsystems, Inc. . Storage System Suppliers. Storage systems suppliers make products such as disk and tape drives and cartridge libraries. Some of the biggest enterprises in this space include EMC Corporation and Storage Technology Corp. . Systems Integrators. Systems integrators custom-design data storage systems for organizations. These companies include Electronic Data Systems Corporation (EDS) and Datalink Corp. . Suppliers of Computer-Based Products with High Storage Content. . Storage Service Providers. These companies provide outsourced data storage services to organizations. The main companies include StorageNetworks, Inc. and Storability, Inc. StoreAge has traditionally marketed its products through one-on-one presentations to potential OEM partners, as well as through appearances at industry conferences/trade shows. In addition, StoreAge also promotes its products through frequent press releases covering its developments and technological breakthroughs and through StoreAge's Web site located at www.store-age.com. - ----------------- StoreAge's major markets are in the US. In particular, most of the potential OEM partners are U.S. based companies with only a small number in Europe and the Far East. StoreAge opened its first U.S. office in Scottsdale, Arizona, in May 2000. The office re-located to Irvine, California in early 2002. In addition to the Irvine sales and technical support headquarters, StoreAge has also hired local U.S. salespeople on the East Coast. Additionally, certain members of senior management participate in sales and marketing. Product Research and Development The Company is currently engaged in the Internet Small Computer Systems Interface ("iSCSI") space and is looking into new applications for its iSCSI and storage expertise. The Company has a continuing program of product research and development that is exclusively directed at developing new 14 data storage products for open systems environments. The Company's research and development staff works closely with its marketing and field personnel in an effort to determine emerging user needs and continually reviews and evaluates technological changes affecting the Company's markets. In past years, a significant portion of the Company's and StoreAge's research and development expenses have been financed by grants from the office of the Chief Scientist of the Israeli Ministry of Industry and Trade (the "Chief Scientist"), which typically provides grants up to 50% of the expenditures connected with a project which it approves, in return for royalties at the rate of 3% to 5% of sales of products developed with funds provided, up to a dollar-linked amount equal to the grant received bearing interest of LIBOR in respect of the particular project. The terms of these grants prohibit the manufacture of products developed outside of Israel and the transfer of the technology developed through projects funded by these grants to any person or entity without the prior consent of the Research Committee of the Chief Scientist. There can be no assurance that such consent, if requested, will be granted. Such restrictions do not apply to exports of the Company's or StoreAge's products developed with the assistance of the Chief Scientist. As of December 31, 2000, both the Company and StoreAge ceased to apply for grants from the Chief Scientist due to the restrictions described above and certain other restrictions on the sale of technology under the terms of the grants. The elimination of such grants requires additional expenditures by the Company and StoreAge and, accordingly, will result in increased net research and development expenses in the future. The following table shows the net consolidated research and development expenditures of the Company and participation in such expenditures by the Chief Scientist since 1999: Year Ended December 31, ----------------------- 1999 2000 2001 (in thousands) Company-funded research and $686 $ 925 $479 development expenditures Chief Scientist participation $223 $ 403 $ 0 ---- ------ ---- Total outlay for research and development $909 $1,328 $479 ==== ====== ==== In 1999, 2000 and 2001 the Company incurred royalty expenses of approximately $63,000, $15,000 and $0 respectively, for payment to the Chief Scientist. These amounts were included in cost of sales expenses for such periods. The Company's net research and development expenses constituted 11.5% of total revenues for the year ended December 31, 1999 and such expenses exceeded total revenues by $829,000 and $145,000 for the years ended December 31, 2000 and December 31, 2001, respectively. As of December 31, 2001, the Company and StoreAge had a research and development staff of 9 and 32 employees, respectively. All such employees are engineers and technicians engaged in applied research, development of new products and enhancement of existing products. 15 Despite the Company's commitment to product research and development, there can be no assurance that any of the Company's development efforts will result in commercially successful products, that such products will be released in a timely manner or that the Company will be able to respond effectively to technological changes or new product announcements by others. Customer Service and Support In conjunction with implementing an OEM strategy, StoreAge has chosen not to invest a significant part of its resources in building direct customer service and support, but instead has chosen to invest in making strategic alliances with major corporations that have developed customer service and support. StoreAge expects to indirectly provide the same level of support as many of its competitors through these alliances. Therefore, service revenues are not expected to comprise a significant portion of StoreAge's revenues. StoreAge's office in California is providing the first line of support to its OEM customers and system integrators. A local distributor through several regional sales offices is distributing and supporting the iSWAT product line in the U.S. The Company's development team is taking responsibility of second line technical support. Manufacturing StoreAge expects that some of its customers will prefer to license its designs and have the modules produced by their own sources, and, in such cases, it is not expected that StoreAge will be directly involved in the production or assembly of hardware modules, unless its OEM customers require it. To the extent necessary, StoreAge expects to implement its production through authorized sub-contractors. By relying on other companies to supply certain key components of its products that are available only from limited sources in the quantities and quality demanded by StoreAge, the company runs the risk that there may be a shortage in certain products it obtains from these outside vendors. For example, some of StoreAge's hardware modules are built based on components which may not be available in great quantities in the market, and may have only a single source, such as Intel and Q-Logic. While these sources are major, and generally reliable companies, the fact that there is a single source for some of the components may result in potential supply problems. Competition StoreAge believes it is the first company that has completed the development of an Asymmetric (off-the-data-path) SAN volume (virtualization) management appliance. Compaq Computer Corporation (which recently merged into Hewlett-Packard Company), EMC Corporation, Veritas Software and TrueSAN Networks, Inc. are developing products with an architecture which is based on similar concepts, however this was a technology announcement only and no products have been formally launched. StoreAge's primary competition currently is from companies that offer Symmetric storage virtualization (in-the-data-path). Included in this category are DataCore Software Corporation, 16 FalconStor, StorageApps Inc. (recently acquired by Hewlett-Packard Company) and Vicom Systems, Inc. Veritas Software has also announced its intention to release such a software product. StoreAge believes that its off-the-data-path Virtualization technology is far superior to the alternative architecture. StoreAge believes that its system architecture provides it with competitive advantages over its competitors because of user benefits, such as incremental growth capability, scalability, availability and performance, and OEM benefits, such as cost effective solutions and time to market advantage. However, even with these competitive advantages, there can be no assurance that StoreAge will be able to compete successfully or that competition will not have a material adverse effect on its results of operations. In addition, there are a number of companies whose product offerings fall within the bounds of the storage management software market. These companies include major players in the data storage industry, such as Commvault Systems, Inc., Computer Associates International, Inc., EMC Corporation, Hewlett-Packard Company, IBM Corp., Legato Systems, Inc. and Veritas Software. Nevertheless, these companies' storage management applications relate primarily to data backup and replication, disaster recovery and load balancing rather than SAN virtualization and management and, therefore, do not compete directly with StoreAge's solutions, for the most part. Some of StoreAge's potential customers may become its competitors in the storage management software market. These companies may dedicate or acquire greater resources in the future geared toward providing storage management solutions that compete directly with StoreAge's products. Such actions could preclude any future relationship between StoreAge and these customers. StoreAge also expects that competition will increase as a result of growth in the SAN industry and the resulting increase in demand for SAN management solutions. Current and potential competitors may also establish cooperative relationships among themselves or with third parties, including StoreAge's potential OEM partners, in order to increase the ability of their products to address the needs of prospective customers and end-users. Accordingly, new competitors or alliances among competitors may emerge and rapidly acquire significant market share. See Note 12 to the Company's Consolidated Financial Statements for information regarding the geographic distribution of the Company's revenues since 1999. Substantially all revenues were generated by assets and operations which have subsequently been disposed of in the Restructuring. Proprietary Technology and Intellectual Property To date, the Company has not entered into any agreements with third-parties whereby it has sold substantially all of its existing rights to technology. However, the Company does contemplate licensing as a means of exploiting its technology as part of its business. The Company and StoreAge rely on a combination of trade secret, patent and trademark law, together with non-disclosure agreements and technical measures, to establish and protect proprietary rights in their products. StoreAge has filed several patents for its technology and plans to apply for patent protection on more of its inventions in the future. Currently, StoreAge has very limited patent protection and has registered only certain of its trademarks. It may be possible for unauthorized third parties (including competitors) to copy aspects of StoreAge's products, whether or not in violation of 17 StoreAge's rights. However, the Company believes that, because of the rapid pace of technological change in the networking and data communications and computer industries, legal protection for its products is less significant to its prospects than the knowledge, ability and expertise of its management and technical personnel to rapidly develop and produce new products and product enhancements. The Company and StoreAge do not believe that their products, trademarks or other proprietary rights infringe upon the proprietary rights of any third parties. However, there can be no assurance that one or more third parties will not make a contrary assertion. The cost of responding to any such assertion may be material, whether or not the assertion is validated. C. Organizational Structure. In January 1999, StoreAge, an Israeli company, was organized as our wholly-owned subsidiary and commenced development and marketing of products based on Storage Area Network ("SAN") Virtualization technology. We currently hold 39% of the outstanding shares of StoreAge. D. Property, Plants and Equipment. Our executive offices are currently located at 33 Jabotinsky Street, Ramat Gan, Israel, where we lease premises of 200 square meters and conduct all of our business activities. The annual rent for this space is approximately $43,000, with total annual occupancy costs, including local taxes, utilities, maintenance and other costs of approximately $24,000. StoreAge conducts all of its activities, including their corporate administration, research and development and testing laboratory activity from a 9,400 square foot rented facility located in Nesher, Israel. The annual rent for this space is approximately $132,500, with total annual occupancy costs, including local taxes, utilities, maintenance and other costs of approximately $35,600 (excluding parking costs of $20,340). StoreAge also leases space of 8,700 square feet for its sales and marketing office located in Irvine, California. The annual rent for this space is approximately $112,700, with total annual occupancy costs, including local taxes, utilities, maintenance and other costs of approximately $38,600. Item 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS - ------- -------------------------------------------- Forward Looking Statements Some of the information in this section contains forward looking statements that involve substantial risks and uncertainties. You can identify these statements by forward looking words such as "expect", "anticipate", "believe", "seek", "estimate" and similar words. Statements that we make in this section that are not statements of historical fact also may be forward looking statements. Forward looking statements are not guarantees of our future performance, and involve risks, uncertainties and assumptions that may cause our actual results to differ materially from the expectations we describe in our forward looking statements. There may be events in the future that we are not accurately able to predict, or over which we have no control. You should not place undue reliance on forward looking statements. We do not promise to notify you if we learn that our assumptions or projections are wrong 18 for any reason. We disclaim any obligation to update our forward looking statements. See "Risk Factors" for more information. Critical Accounting Policies The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On an on-going basis, management evaluates its estimates and judgments. Management bases its estimates and judgments on historical experience and on various other factors 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. Under different assumptions or conditions, actual results may differ from these estimates. Management believes the following critical accounting policies, among others, affect its more significant judgments and estimates used in the preparation of its consolidated financial statements. Work force During November 2000, the Company acquired all the activities, assets and rights, and assumed certain obligations of Eastek. The excess cost over the fair value of net assets acquired was allocated to the assembled work force which was amortized on a straight-line basis over a three-year period. According to Statement of Financial Accounting Standard No. 142 "Goodwill and Other Intangible Assets" ("SFAS 142") effective as of January 1, 2002, goodwill and intangible assets with indefinite lives are no longer amortized but are reviewed annually (or more frequently if impairment indicators arise) for impairment. Therefore, work force will be subject to annual amortization impairment tests based on management's estimates and judgment. Legal Contingencies As discussed in note 9 to the Company's financial statements included herewith, the Company is involved in certain legal proceedings. As of December 31, 2001, management has accrued its estimates of the probable costs for the resolution of these claims. Management arrived at this estimate after consultation with outside counsel handling the Company's defense in these matters and is based upon an analysis of potential outcomes. Management does not believe these proceedings will have a material adverse effect on the Company's consolidated financial position. It is possible, however, that future results of operations for any particular quarterly or annual period could be materially affected by changes in the Company's assumptions and estimates related to these proceedings or the outcome of these proceedings. Investment in StoreAge The Company currently holds a 39% interest in StoreAge. In order to determine whether its investment in StoreAge has experienced a decline in value (other than a temporary decline) and therefore requires an impairment charge, management evaluates its investment based on its estimates, judgments and understanding of the economic environment in which StoreAge operates. Future adverse changes in market conditions or poor operating results of StoreAge could result in losses or an inability to recover 19 the carrying value of the investment that may not be reflected in the investment's current carrying value, thereby possibly requiring an impairment charge in the future. A. Operating Results. General The Company currently holds a 39% equity interest in StoreAge. Since December 2000, the operations of the Company and StoreAge are no longer reported on a consolidated basis and the Company's investment in StoreAge is accounted for using the equity method. Accordingly, this change in reporting practice should be taken into account when reviewing the comparison of the results of operations of the Company for the fiscal year ended December 31, 2001 to the consolidated results of operations of the Company and StoreAge for prior periods set forth below. IIS is an Israeli company which, following the Restructuring, operates in one business segment - the research, development and, ultimately, production, marketing, sale and/or licensing of products based on SAN space. The functional currency of the Company and its subsidiaries is the U.S dollar, as the U.S. dollar is the primary currency of the economic environment in which the Company and its subsidiaries have operated and expect to continue to operate in the foreseeable future. The majority of the Company's operations are currently conducted in Israel and most of the Israeli expenses are currently paid in new Israeli shekels ("NIS"); however, most of the expenses are denominated and determined in U.S. dollars. Financing and investing activities including loans, equity transactions and cash investments, are made in U.S. dollars. In 2000, approximately 58.3% of the Company's revenues were derived from sales and services outside of Israel in United States dollars and other non-Israeli currencies compared to 5.7% in 2001. A majority of the Company's purchases of materials and components are also made in non-Israeli currencies (mainly the dollar). In addition, most marketing costs are incurred outside of Israel. Thus, the functional currency of the Company is the dollar. Transactions and balances originally denominated in dollars are presented at their original amounts. Transactions and balances in other currencies are re-measured into dollars in accordance with the principles set forth in Statement No. 52 of the Financial Accounting Standards Board of the United States ("FASB") "Foreign Currency Translation". The implementation of the Restructuring has resulted in the disposition of most assets of the Company, substantial changes in the Company's structure and a focus on the SAN space. This new business, run by the Company and StoreAge, an affiliate of the Company, focuses on the storage market. The Company believes that new market trends have resulted in the creation of a significant market niche which can be exploited by the Company using its storage technology and which could generate significant sales within two to three years. 20 Results of Operations The following tables set forth for the periods indicated selected income statement items as a percentage of the total revenues of the Company. Year Ended December 31, ------------------------ ----- ----- ----- 1999 2000 2001 ----- ----- ----- Sales revenues 90.8% 100.0% 24.9% Revenues from related party 0 0 75.1 Maintenance and other services revenues 9.2 0 0 ----- ----- ----- Total revenues 100.0% 100.0% 100.0% ----- ----- ----- Cost of sales 75.3 28.1 8.4 Cost of revenues from related party -- -- 46.4 Cost of maintenance and other services 7.2 0 0 ----- ----- ----- Total cost of revenues 82.5 28.1 54.8 ----- ----- ----- Gross profit 17.5 71.9 45.2 Research and development costs, net 11.5 * * Selling, marketing, general and administrative expenses 53.6 * * ----- ----- ----- Non recurring charges (income) and restructuring 7.8 -- (53.9) Operating loss (55.5) * * ----- ----- ----- Financial and other income (expenses), net (26.8) * * Loss before minority interest in losses of subsidiary (82.3) * * Minority interest in losses of subsidiary 0.9 * * ===== ===== ===== Net loss (81.4%) * * - ---------- * Greater than revenues The Company currently holds a 39% equity interest in StoreAge. Since December 2000, the operations of the Company and StoreAge are no longer reported on a consolidated basis and the Company's investment in StoreAge is accounted for using the equity method. Accordingly, this change in reporting practice should be taken into account when reviewing the following comparison of the results of operations of the Company for the fiscal year ended December 31, 2001 to the consolidated results of operations of the Company and StoreAge for prior periods. Years Ended December 31, 2001, 2000 and 1999 In 2001, total revenues increased by $238,000 or 348% to $334,000 compared with $96,000 in 2000, and in 2000 total revenues decreased by $5,859,000 or 98.4% from $5,955,000 in 1999. The increase in 2001 was mainly as a result of research and development services provided to a related party (StoreAge). Revenues from sales and services to unaffiliated customers outside of Israel represented approximately 5.7% of revenues in 2001 and 58.3% of revenues in 2000 compared with 72.9% of revenues in 1999. See Note 12 to the Company's Consolidated Financial Statements for additional information regarding the geographic distribution of the Company's revenues since 1999. Substantially 21 all 1999 revenues were generated by assets and operations which were subsequently disposed of in the Restructuring. Gross profit as a percentage of total revenues was approximately 45.2% in 2001 compared with 71.9% in 2000 and 17.5% in 1999. The decrease in 2001 was primarily due to less profitable research and development services fees from a related party (StoreAge). The increase in 2000 was primarily due to sales of more profitable StoreAge products and other software products. Marketing efforts to penetrate the emerging storage area networking market may produce a new source of revenue, offsetting, at least in part, the loss of revenue, but there is no assurance that such revenue growth will occur. Total outlays for research and development decreased to approximately $479,000 in 2001 from $1.33 million in 2000 and approximately $909,000 in 1999. The net cost to the Company of such outlays was $479,000 ($145,000 greater than revenues) in 2001 compared with $925,000 ($829,000 greater than revenues) in 2000, and approximately $686,000 (11.5% of revenues) in 1999. The Company anticipates a continued investment by it and StoreAge in research and development in storage subsystems to address future market demands for storage technology products. Selling and marketing expenses decreased to approximately $21,000 (6.3% of revenues) in 2001 from approximately $639,000 in 2000 ($543,000 greater than revenues) and $1.4 million in 1999 (23.8% of revenues). General and administrative expenses decreased to approximately $888,000 ($554,000 greater than revenues) in 2001 from approximately $899,000 in 2000 ($803,000 greater than revenues) and $1.8 million in 1999 (29.8% of revenues). The decrease in expenses reflects the effects of the Company's current structure and the completion of the Restructuring. In 2001, the Company recorded an operating loss of approximately $1.06 million compared with $2.39 million in 2000 and an operating loss of approximately $3.31 million in 1999. The 2001 operating loss reflects the increased investment in iSCSI research and development. The lower operating loss in 2000 compared to 1999 reflects the Company's current structure. There were no taxes on income in 2001, 2000 or 1999. See "Effective Corporate Tax Rate". As a result of the foregoing factors, the Company recorded a net loss of approximately $3.48 million in 2001, net loss of approximately $1.39 million in 2000, and a net loss of approximately $4.85 million in 1999. The Company does not expect to be profitable in the foreseeable future. Impact of Inflation and Exchange Rates The dollar cost of the Company's operations in Israel is related to the extent to which the rate of inflation in Israel is offset by the devaluation of Israeli currency in relation to the dollar without significant timing delays. The Company's dollar costs in Israel will increase if devaluation fails to keep 22 pace with the rate of inflation. Conversely, those costs will decrease if the rate at which Israeli currency devalues against the dollar exceeds the rate of inflation in Israel on a relatively even basis. Periodically, dependent upon inflation and other considerations, both fiscal and monetary, the Bank of Israel resets the target (middle of the range) exchange rate of the NIS in relation to a weighted basket of foreign currencies of Israel's major trading partners and allows the actual exchange rate to float within a range determined by the Bank of Israel. During 1999, 2000 and 2001, the NIS was devalued (appreciated) approximately (3.2%), (5.5%) and 7.02% respectively, against the currency basket, and approximately (0.17%), (2.7%) and 9.28% respectively, against the dollar. Our operations could be adversely affected if we are unable to guard against currency fluctuations in the future. We do not currently engage in any currency hedging transactions intended to reduce the effect of fluctuations in foreign currency exchange rates on our results of operations. We cannot guarantee that we will not enter into such transactions in the future or that such measures will adequately protect us from serious harm due to the impact of inflation in Israel. The relationship between the Company's assets and liabilities in Israeli currency and whether they are linked to a foreign currency or price index also affects the Company's financial results. In the past IIS has managed its exposure in Israeli currency so that unlinked liabilities generally exceeded unlinked monetary assets in Israeli currency. The Company cannot predict whether it will be able to continue to manage its assets and liabilities in this manner in the future. Effective Corporate Tax Rate The income tax obligations of IIS in Israel are based upon earnings determined for Israeli statutory purposes and not as determined from the amounts reported in dollars. Therefore, the provision for income taxes included in the financial statements does not directly relate to income shown on those statements. If certain conditions are met, IIS will be deemed an "Industrial Company." In the past, certain of its Israeli operations have been granted "Approved Enterprise" status under the Law for the Encouragement of Capital Investments, 1959, as amended (an "Approved Enterprise"). Consequently, part of its Israeli activities were subject to taxation at reduced rates and were permitted special deductions in computing taxable income. Income arising from an Approved Enterprise may be subject to a reduced company tax at the rate of 25% (rather than the regular company tax rate of 36% in 2000), or may be exempt from company tax for a period of time, depending on the election made by the enterprise. Since the Company's Israeli operations are operating under more than one Approved Enterprise designation and since part of its taxable income is not entitled to tax benefits and is taxed at regular rates, its past effective tax rate was the result of a weighted combination of the various applicable rates or tax exemptions. We cannot assure you that we will maintain our status as an Industrial Company for year 2002 or beyond. If we do not maintain our status as an Industrial Company, the applicable Israeli income tax with respect to capital gain realized by an individual shareholder with respect to the Ordinary Shares will be as follows: 35% for individuals who are Israeli residents, 36% for Israeli companies and 50% for non-residents of Israel. See also Item 10.E. "Taxation." 23 Net loss carry forwards of the Company totaled approximately $76 million as of December 31, 2001 and are unlimited in time. See Note 11 to the Company's Consolidated Financial Statements. Quarterly Results The Company's operating results in the near future may vary significantly from quarter to quarter, in part because of the substantial changes in the Company's structure and a focus on SAN channel technology. The Company's operating results for any particular quarter are not necessarily indicative of any future results. The nature of the Company's industry and business has changed, and the accelerated and unpredictable pace of new product introduction and market trends, which is expected to continue, limits management's ability to accurately forecast short-term results of operations. Furthermore, there can be no assurance that the Company will return to profitability in 2002 or thereafter. Governmental, Economic, Fiscal, Monetary or Political Factors Our principal offices and our principal facilities, and those of StoreAge, are located in Israel, and each of us is directly affected by the political, economic and military conditions to which that country is subject. Any of StoreAge's manufacturing operations would be heavily dependent upon components imported from outside of Israel. A substantial majority of StoreAge's future sales, if any, will be made outside of Israel. Accordingly, our operations and those of StoreAge could be materially adversely affected if major hostilities involving Israel should occur or if trade between Israel and its present trading partners were interrupted or curtailed. In addition, termination or reduction of certain governmental grants, programs and tax benefits could have a material adverse effect on us and StoreAge. In February 2002, the Minister of Finance appointed a committee to review and make recommendations with respect to the current Israeli tax structure. The committee presented its recommendations to the Minister of Finance on June 12, 2002. If implemented, the recommendations might result in the imposition of Israeli capital gains taxes at the rate of 15% to 35% on sales of securities of Israeli companies by Israeli residents. In addition, the committee has proposed that a tax be imposed on all income of Israeli residents (individuals and corporations) regardless of the territorial source of income and a tax will be imposed on income of foreign corporations controlled by Israeli residents if the majority of profits or income of such foreign corporations originate from "passive income", including interest, dividends, royalties and rental income. We cannot predict whether, and to what extent, such recommendations will be adopted and eventually enacted into law. Political Conditions Since the establishment of the State of Israel in 1948, a state of hostility has existed, varying in degree and intensity, between Israel and the Arab countries. While Israel has entered into peace agreements with both Egypt and Jordan and several other countries have announced their intentions to establish trade and other relations with Israel, Israel has not entered into any peace arrangement with Syria or Lebanon. Since September 2000 there has been a significant deterioration in the relationship between Israel and the Palestinian Authority, and as a result of riots in Gaza and the West Bank and a spate of terrorist attacks inside Israel, the peace process between the parties has stagnated. Efforts to 24 resolve the problem have failed to result in an agreeable solution. In recent months there has been a marked deterioration in the conflict, which culminated in several lethal suicide attacks in Israel and in response the Israeli Army called up a large number of reserve duty soldiers and has made incursions into most Palestinian-controlled cities and towns. The continued hostilities between the Palestinian community and Israel and the failure to settle the conflict has had and continues to have a material adverse effect on the Israeli economy and may have a material adverse effect on our business and us. Despite the peace between Israel and Egypt and Jordan, some countries, companies and organizations continue to participate in a boycott of Israeli firms and others doing business with Israel or with Israeli companies. Although we are precluded from marketing our products to such countries, we believe that in the past the boycott has not had a material adverse effect on us. In addition, as a result of the Israeli military activities in the West Bank during April 2002, several European countries are considering to participate in a boycott of Israeli firms as well as on the shipment of weapons and other military supply to Israel. Restrictive laws, policies or practices directed towards Israel or Israeli businesses could have an adverse impact on the expansion of our business. All male adult citizens and permanent residents of Israel under the age of 48 are, unless exempt, obligated to perform up to 30 days of military reserve duty annually. Additionally, all such residents are subject to being called to active duty at any time under emergency circumstances. Many of our officers and employees and those of StoreAge are currently obligated to perform annual reserve duty. While we have operated effectively under these requirements since we began operations, we cannot assess the full impact of such requirements on our workforce or business if conditions should change, and we cannot predict the effect on us of any expansion or reduction of such obligations. Economic Conditions Israel's economy has been subject to numerous destabilizing factors, including a period of rampant inflation in the early to mid-1980s, low foreign exchange reserves, fluctuations in world commodity prices, military conflicts and civil unrest. The Israeli government has, for these and other reasons, intervened in various sectors of the economy, by utilizing, among other means, fiscal and monetary policies, import duties, foreign currency restrictions and control of wages, prices and foreign currency exchange rates. In 1998, the Israeli currency control regulations were liberalized significantly, as a result of which Israeli residents may deal in foreign currency and non-residents of Israel may purchase and sell Israeli currency and assets. The Israeli government has periodically changed its policies in all these areas. There are currently no Israeli currency control restrictions on remittances of dividends on ordinary shares or the proceeds from the sale of shares; however, legislation remains in effect pursuant to which currency controls can be imposed by administrative action at any time. In addition, Israeli residents are required to file reports pertaining to specific types of actions or transactions. The Israeli government's monetary policy contributed to relative price and exchange rate stability in recent years, despite fluctuating rates of economic growth and a high rate of unemployment. In addition, as a result of the political instability, the continuous hostilities with the Palestinian Authority and the world-wide economic crisis in the hi-tech and communication industries, during 2001 and especially during the first five months of 2002 the Israeli rate of economic growth has deteriorated, the Israeli currency has been devalued and the rate of inflation has increased. The Israeli 25 government has proposed certain budgetary cuts and other changes but it is not certain if such measures will be adopted by the Israeli Parliament and what will be the impact of these and other measures, if adopted, on the Israeli economy. In addition, certain credit agencies such as Standard & Poors have announced that they are reviewing the credit rating of Israel. Should such agencies resolve to decrease Israel's credit rating, the ability of the Israeli government to generate foreign financial and economic assistance may be adversely affected. We cannot assure you that the Israeli government will be successful in its attempts to stabilize the Israeli economy or to maintain the current credit rating of Israel. Economic decline as well as price and exchange rate instability may have a material adverse effect on us and on StoreAge. B. Liquidity and Capital Resources. In late 1999, StoreAge completed a private placement of 707,558 convertible preferred shares to outside investors for a total net consideration of approximately $3.12 million. Accordingly, the Company's equity interest in StoreAge was reduced to 58.56%. The excess received by StoreAge from the issuance of convertible preferred shares to outside investors, over the amount invested by the Company, amounting to approximately $2.24 million, was recorded as a quasi-equity item, preferred shares of subsidiary. During November 2000, the Company acquired the assets of Eastek to enhance its R&D capabilities in order to develop synergetic software solutions for the SAN market. The acquisition was completed through the issuance of shares to Eastek and its founder, Danny Shavit. If certain conditions are met, a total of 180,000 shares will be delivered to Eastek and Mr. Shavit. In December 2000, the Company completed a private placement of $3 million through the issuance of convertible secured debentures and warrants to qualified investors. The Company subsequently entered into a securities purchase agreement (the "Securities Purchase Agreement") with such qualified investors dated as of January 31, 2001 pursuant to which the convertible secured debentures in an aggregate principal amount of $3,000,000, exercisable at $3.00 per share and warrants to purchase up to 300,000 Ordinary Shares at $4.50 per share were issued. The net proceeds from the offering were used to fund part of the Company's investment in StoreAge's second round of financing. On January 25, 2001, StoreAge completed its second round of financing, raising a total of $25 million from strategic and institutional investors in a private placement. The Company was an investor in the financing, investing a total of $4.2 million. Following the consummation of the financing, the Company held 39% of the outstanding shares of StoreAge. In order to maintain its Nasdaq SmallCap Market listing, the Company entered into an agreement dated as of December 5, 2001 to amend the Securities Purchase Agreement with the holders of its convertible secured debentures and warrants (the "Purchasers") to exchange such securities for the Company's Ordinary Shares and cash. Under the terms of the agreement, the Purchasers converted part of the debentures, the warrants and the floating charge registered on the Company's assets were cancelled and the Company repaid the Purchasers the principal amount of the debentures which was not converted, plus interest accrued up to the date of the agreement. As a result of the completion of the transaction in December 2001, the Company had sufficient shareholders' equity and net tangible assets to meet the requirements for continued inclusion on the Nasdaq SmallCap Market. 26 Under the terms of the transaction, the Purchasers converted $2,426,576.40 principal amount of the debentures into an aggregate of 1,797,464 of the Company's Ordinary Shares, received a cash payment of $573,423.60 and relinquished all of the warrants. The warrants and the remaining debentures were cancelled. The transaction represented an implied exchange value of at least $1.35 per Ordinary Share based solely on the debt amounts extinguished, without giving any effect to the cancelled warrants, and represented a substantial premium over the market price of the Company's Ordinary Shares at the time the agreements in principle with the Purchasers were reached. The Company had cash and cash equivalents of approximately $7.35 million at December 31, 1999, $3.08 million at December 31, 2000 and $1.56 million at December 31, 2001. The ratio of current assets to current liabilities was 3.59:1.00 at December 31, 1999, 2.42:1.00 at December 31, 2000 and 2.52:1.00 at December 31, 2001. The decrease in the current ratio in 2000 was primarily due to operating losses and de-consolidation of StoreAge. The increase in the current ratio in 2001 was primarily due to elimination of certain liabilities, including $180,000 with respect to sales tax in the United States that the Company recorded as non-recurring income. For a discussion of the primary currency in which the operations of the Company are conducted see Item 5.A., "Operating Results," above. In 2001, the Company recorded a net negative cash flow from operations of approximately $(1.68) million and in 2000, the Company recorded a net negative cash flow from operations of approximately $(2.04) million, compared with a net negative cash flow from operations of approximately $(2.19) million in 1999. Net cash flow from operations in 1999, 2000 and 2001 was adversely affected by the operating losses during those years. The Company anticipates that its existing cash on hand, will be sufficient, at the business levels presently projected, to meet its working capital requirements, including normal capital expenditures, for at least the next 12 months. However, continued losses from operations or inability to secure additional financing for StoreAge, if required, may reduce the Company's working capital and cash equivalents to a level which could adversely affect the Company's future operations. StoreAge has certain limitations in respect of its Approved Enterprise status. StoreAge has been granted Approved Enterprise status and has elected the "alternative track of benefits." Income derived from an Approved Enterprise is tax exempt for the first two years of a 7-year period of benefits. Income derived during the remaining five years of benefits is taxed at a reduced tax rate. The period of benefits commences with the first year in which StoreAge has taxable income. The period of benefits relating to StoreAge's Approved Enterprise status will expire no later than the year 2013. In the event of distribution of cash dividends from income which is tax exempt due to the above, StoreAge would have to pay tax at the rate of 25% on an amount equal to the amount of dividends distributed. The Company does not control StoreAge and consequently has no ability to receive loans or advances from StoreAge. In the event that StoreAge declares dividends, the holders of the preferred shares will receive the greater of (i) their investment plus 8% per annum, compounded annually or (ii) their pro rata portions of the dividends available for distribution to all the shareholders. 27 C. Research and Development, Patents and Licenses, etc. See the information in "Item 4. Information on the Company - B. Business Overview - Product Research and Development". D. Trend Information. StoreAge is a start-up company that has only recently begun to sell its products and the Company is in the earliest stages of establishing its own research & development unit, specializing in storage technology. As a result of this limited history, there are no trends yet known to the Company that are likely to have a material effect on the Company's revenues, income from continuing operations, profitability, liquidity or capital resources. For additional information please see the "Risk Factors" listed in Item 3 above. Item 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES - ------- ------------------------------------------ A. Directors and Senior Management. The Company's executive officers and directors as of June 1, 2002 were as follows: - ------------------------------------------------------------------- Name Age Position with the Company - ---- --- ------------------------- - ------------------------------------------------------------------- Robi Hartman 41 Chairman of the Board, Director, Chief Executive Officer and Acting Chief Financial Officer - ------------------------------------------------------------------- Moshe Kahn* 43 External Director - ------------------------------------------------------------------- David Rubner 61 Director - ------------------------------------------------------------------- Aharon Jacobowitz* 52 Director - ------------------------------------------------------------------- Yael Ilan 52 Director - ------------------------------------------------------------------- Jonathan Nativ* 54 External Director - ------------------------------------------------------------------- Danny Shavit 46 Chief Technology Officer - ------------------------------------------------------------------- * Member of the Audit Committee and Compensation Committee David Rubner has been a director of the Company since March 2000. Mr. Rubner is Chairman and Chief Executive Officer of Rubner Technology Ventures Ltd. and is a General Partner in Hyperion Israel Advisors Ltd., a venture capital firm. From 1991 to 2000 he served as Chief Executive Officer of ECI Telecom Ltd. Previous to his appointment as Chief Executive Officer, Mr. Rubner served in various management positions at ECI Telecom. Mr. Rubner is Chairman of the Board of ECtel Ltd., a publicly traded subsidiary of ECI Telecom, and serves on the board of directors of Checkpoint Software Ltd., Koor Industries Ltd. and a number of privately held companies. Additionally, Mr. Rubner serves on the Board of Governors of Bar-Ilan University, Jerusalem College of Technology and Sha'arei Tzedek Hospital. Mr. Rubner was a recipient of the Industry Prize for 1995. 28 Robi Hartman has been a Director of the Company since September 1998, Vice Chairman of the Board from October 1998 to March 2000, Acting Chief Financial Officer since December 1998, and Chairman of the Board and Chief Executive Officer of the Company since March 2000. Before joining the Company, from 1987 to 1996, Mr. Hartman was the manager of Teledata Communications Ltd., a leading supplier of advanced access solutions, beginning as a manager and progressing to the Chief Financial Officer and finally as Chief Executive Officer and President. From 1996 to 1997, Mr. Hartman was the President of VCON Telecommunications, a pioneer in PC based teleconferencing. Since 1997 he owns and manages West End Technology Investments Ltd. Currently, he is also a director of NSI Communications in Canada. Mr. Hartman received his B.A. in Economics and Political Science from Bar Ilan University and his Masters degree in Business Administration (MBA) from Bentley College. Dr. Yael Ilan has been a director of the Company since November 1997. She is the President of Yedatel Ltd., an economic consulting company, and is a director of CI Systems Ltd. Until October 2001, Dr. Ilan served as the Chief Executive Officer of Optichrom Ltd., an optical components private company. Until 1998, she was a director of Bezeq - Israel's Telecommunication Company in which she was also a member of the audit committee and the committee for strategic planning and investments. Until December 2000, Dr. Ilan served as the head of the Broadband Communication Programs administration, a consortium of MAGNET - the Israeli Government hi-tech cooperation initiative. Dr. Ilan holds a Ph.D. in industrial engineering, Ph.D. in physical chemistry and a Masters degree in business administration. Aharon Jacobowitz has been a director of the Company since May 1995. Since 1989, Mr. Jacobowitz has been a management consultant to large organizations on data processing issues. His clients include the Accountant General, Ministry of Finance, State of Israel, General Manager of the Social Security Institute in Israel and Teva Pharmaceutical Industries Ltd., the largest pharmaceutical manufacturer of Israel. Prior to 1989, Mr. Jacobowitz was employed for 14 years in various capacities in the marketing division of IBM Israel Ltd. His main specialties were networking and midrange systems. Mr. Jacobowitz is a member of our Audit Committee. Jonathan Nativ has been a director of the Company since November 2000. Mr. Nativ was elected as an external director in accordance with the Israeli Companies Law. He has served since 1997 as the Chief Executive Officer of Compwise Ltd., a company that develops, markets and sells special-purpose software for tariff modeling and analysis and auditing solutions to telecommunications companies, particularly those involved in wireless telecommunications. From 1978 until 1983, he served as project manager at Tadiran Ltd. (Telecommunications Division), one of Israel's leading electronics firms. From 1983 to 1995, Mr. Nativ served as the Director of Research and Development, Executive Vice President of Marketing, and Executive Vice President of Strategy and Business Development at Teledata Communications Ltd., a leading supplier of advanced access network solutions to telecommunication network operators worldwide. From 1995 to 1997 he served as a consultant to Teledata Communications Ltd. Mr. Nativ serves as director of TDSoft Ltd. and other Israeli technology-based companies. Mr. Nativ earned a bachelor's degree in Electronic Engineering from the Technion, Israel Institute of Technology and an Executive MBA from Tel-Aviv University. Mr. Nativ is a member of our Audit Committee. 29 Moshe Kahn has been a director of the Company since November 2000. Mr. Kahn was elected as an external director in accordance with the Israeli Companies Law. He is an attorney admitted to practice in Israel and the State of New York. He is a partner of the law firm of M. Porath and Co. in Tel Aviv, where he is engaged in corporate law and commercial mediation and acts as counsel for local and international firms. Mr. Kahn serves as a Major in the Legal Department of the Armed Forces of the State of Israel reserves. Mr. Kahn has an L.L.B. in Law from Bar Ilan University. Mr. Kahn is a member of our Audit Committee. Danny Shavit has been the Chief Technology Officer of the Company since November 2000. He was the Co-Founder and Managing Director of Eastek, a company that developed CDROM and hard-disk drive test software from October 1995 until November 2000. From January 1992 until August 1995 he was the R&D Manager of Meitav Ltd., a company that developed real-time temperature control systems. From October 1987 until December 1991 he was the Co-Founder and R&D Manager of Maintek LTD., a start-up in the field of hard-disk controllers doing a joint venture with Standard Microsystems Corporation in the United States. Mr. Shavit is an expert in real-time microprocessor based, mass-storage controllers and test systems. He earned a Bachelor of Science degree in Computer Engineering and a Masters of Science degree in Digital Signal Processing from the Technion in Israel. There is no family relationship between any of the persons named above. Furthermore, there are no arrangements or understandings with any of the major shareholders, customers, suppliers or others, pursuant to which any person referred to above was selected as a director or member of senior management. B. Compensation. During the fiscal year ended December 31, 2001, the aggregate remuneration paid to all officers and directors of the Company as a group (then eight persons) was approximately $346,000. In connection with the Eastek acquisition, 100,000 Ordinary Shares of the Company were issued to Danny Shavit. Subject to certain conditions, the Ordinary Shares issued to Mr. Shavit will be delivered to him in installments of 30,000, 35,000 and 35,000 Ordinary Shares on the first, second and third anniversaries of the Eastek acquisition, respectively. The first installment of 30,000 Ordinary Shares has been delivered to Mr. Shavit. See Note 2 to the Consolidated Financial Statements of the Company for information regarding certain severance pay and pension plans generally available to employees of the Company, and in which certain officers and directors participate. No options were granted to officers or directors during the fiscal year ended December 31, 2001. An aggregate of 656,550 options were granted to the Company's directors during the fiscal year ended December 31, 2000. All of such options are exercisable for Ordinary Shares of the Company and have an exercise price of $3.625. With the exception of the options held by Robi Hartman, the options become exercisable in four equal annual installments from the date of grant and expire six years after the date of grant. Mr. Hartman holds a total of 356,550 options, of which 206,550 are currently fully exercisable and expire on November 30, 2006. The other 150,000 options held by Mr. Hartman become exercisable in two equal annual installments from March 22, 2003 and expire on November 30, 2006. For information on the Company's stock option plan, see "Stock Option Plans" below and Note 10 to the Company's Consolidated Financial Statements. 30 C. Board Practices. In August 1993 the Company's articles of association were amended to provide, among other matters, for a classified board of directors. These provisions were retained with minor amendments, in the new articles of associations of the Company approved on November 19, 2000 (the "Articles of Association"). Dr. Ilan has served as a director of the Company since November 1997, was re-elected to serve as a director at the 2001 annual meeting, and will continue to serve until the 2004 annual meeting and until her successor has been elected and qualified. Gideon Marks, who served as a director of the Company since July 2000 and whose term of office expired at the Company's 2001 annual meeting, did not seek re-election to such position. Mr. Hartman has been a director of the Company since September 1998 and currently serves until the 2002 annual meeting and until his successor has been elected and qualified. However, since Mr. Hartman is Chief Executive Officer of the Company, in accordance with the provisions of the Articles of Association, he shall serve as a director as long as he remains Chief Executive Officer. Messrs. Jacobowitz and Rubner have been directors of the Company since May 1995 and March 2000, respectively, and currently serve until the 2003 annual meeting and until their successors have been elected and qualified. Messrs. Nativ and Kahn have each served as directors of the Company since November 2000 when they were elected as external directors (as defined below) pursuant to the Israeli Companies Law. Under Israeli Companies Law, the initial term of an external director is three years and may be extended for an additional three years. Officers serve at the discretion of the board of directors, subject to the terms of any agreement between them and the Company. Mr. Shavit has served as the Company's Chief Technology Officer since November 2000 and will continue to serve in this position subject to the terms of his employment agreement. There are no service contracts between the Company and any of its directors providing for benefits upon termination of employment. External and Independent Directors Under the new Israeli Companies Law, Israeli companies whose shares have been offered to the public in or outside of Israel are required to appoint two people to serve as external directors on the board of directors of a company. The Companies Law provides that a person may not be appointed as an external director if the person or the person's relative, partner, employer or any entity controlled by that person has at the date of appointment, or has had at any time during the two years preceding that date, any affiliation with the company, any entity controlling the company or any entity controlled by the company or by this controlling entity. The term "affiliation" includes: . an employment relationship; . business or professional relationship maintained on a regular basis; . control; or . service as an officer. 31 No person can serve as an external director if the person's position or other business creates, or may create, conflict of interests with the person's responsibilities as an external director or if such position or other business may impair such director's ability to serve as an external director. No person who is a director in one company can serve as an external director in another company, if at that time a director of the other company serves as an external director in the first company. The Companies Law further provides that when, at the time of appointment of an external director, all members of the board of directors of the company are of one gender, then the external director appointed shall be of the other gender. External directors are appointed by a majority vote at a shareholders' meeting, provided that either: (1) the majority of shares voted at the meeting, including at least one third of the shares of non-controlling shareholders voted at the meeting, vote in favor of appointment of the director or (2) the total number of shares of non-controlling shareholders voted against the election of the director does not exceed one percent of the aggregate voting rights in the company. The initial term of an external director will be three years and may be extended for an additional three-year period. Each committee of a company's board of directors will be required to include at least one external director and all external directors must be members of the company's audit committee. In addition, we are obligated under the requirements for quotation on the Nasdaq SmallCap Market to have at least two independent directors on our board of directors, who also may serve as external directors under the Companies Law, and to establish an audit committee, at least a majority of whose members are independent of management. The audit committee should adopt a formal written audit committee charter to be reviewed annually. An external director is entitled to consideration and to the refund of expenses, only as provided in regulations adopted under the Companies Law and is otherwise prohibited from receiving any other consideration, directly or indirectly, in connection with service provided as an external director. Nevertheless, the grant of an exemption from liability for breach of fiduciary duty or duty of care, an undertaking to indemnify, indemnification or insurance under the provisions of the Companies Law shall not be deemed as consideration. Under the Companies Law, an external director cannot be dismissed from the office unless: . the board of directors determines that the external director no longer meets the requirements for holding such office, as set forth in the Companies Law or that the director is in breach of his or her fiduciary duties to the company and the shareholders of the company vote (by the same majority required for the appointment) to remove the external director after the external director has been given the opportunity to present his or her position; . an Israeli court determines, upon a request of a director or a shareholder, that the director no longer meets the requirements for holding such office as set forth in the Companies Law or that the director is in breach of his or her fiduciary duties to the company; or . the court determines, upon a request of the company or a director, shareholder or creditor of the company, that the external director is unable to fulfill his or her duty or has been convicted of certain crimes as specified in the Companies Law. 32 Audit Committee The Israeli Companies Law requires public companies to appoint an audit committee. The responsibilities of the audit committee include identifying irregularities in the management of the company's business and approving related party transactions as required by law. An audit committee must consist of at least three directors, including all of the external directors. The chairman of the board of directors, any director employed by or otherwise providing services to the company, and a controlling shareholder or any relative of a controlling shareholder, may not be a member of the audit committee. An audit committee may not approve an action or a transaction with a controlling shareholder, or with an office holder, unless at the time of approval two external directors are serving as members of the audit committee and at least one of the external directors was present at the meeting in which an approval was granted. Our audit committee consists of Messrs. Kahn, Nativ and Jacobowitz. Internal Auditor Under the Israeli Companies Law, the board of directors must appoint an internal auditor, nominated by the audit committee. The role of the internal auditor is to examine, among other matters, whether the company's actions comply with the law and orderly business procedure. Under the Israeli Companies Law, the internal auditor may be an employee of the company but not an office holder, or an affiliate, or a relative of an office holder or affiliate, and he or she may not be the company's independent accountant or its representative. We intend to appoint an internal auditor in the near future. Compensation Committee The Israeli Companies Law does not require public companies to appoint a compensation committee. The Company, however, has selected a compensation committee which makes recommendations to the board with respect to all director and officer compensation issues including the grant of stock options. Our compensation committee consists of Messrs. Kahn, Nativ and Jacobowitz. D. Employees. As of December 31, 2001 the Company and StoreAge employed 13 and 59 persons, respectively: 41 in engineering and research and development, 19 in sales and marketing and technical support and 12 in general management and administration. The Company has never experienced a work stoppage, and the Company considers its relations with its employees to be good. The Company pays competitive salaries and provides competitive benefits to its employees. Certain provisions of the collective bargaining agreements between the Histadrut (the General Federation of Labor in Israel) and the Coordinating Bureau of Economic Organizations (including the Industrialists' Association) (the "CBEO") are applicable to the Company's Israeli employees by order of the Israeli Ministry of Labor. These provisions principally concern the length of the workday, minimum daily wages for professional workers, contributions to a pension fund, insurance for work-related accidents, procedures for dismissing employees, determination of severance pay and other 33 conditions of employment. The Company generally provides its Israeli employees with benefits and conditions beyond the required minimums. An important contractual provision applicable to all employers in Israel is the linkage of wages to increases in the CPI, although the extent of the linkage has been limited in recent years. The specific formula of such linkage varies according to agreements reached between the Government of Israel, the Histadrut and the CBEO. In addition, Israeli law generally requires severance pay (generally one month's salary for each year of employment) upon the retirement or death of an employee or termination of employment without due cause. Furthermore, Israeli employees and employers are required to pay predetermined sums to the National Insurance Institute which is similar to the United States Social Security Administration. Such payments amount to approximately 9% of wages (up to a maximum amount), with the employee contributing approximately 4.5% and the employer contributing the remainder. E. Share Ownership. The following chart sets forth director and senior management share ownership in the Company as of June 26, 2002. Each shareholder listed below enjoys the same voting rights with respect to each share. Number of Percentage of Title of Shares Shares -------- Beneficially Beneficially Name Class Owned/(1)/ Owned (%)/(2)/ Options/(3)/ - ---- ----- ------------ ------------- ------------ Ordinary David Rubner Shares -- * 50,000 Ordinary Robi Hartman Shares 1,111,414 9.60% 356,550 Ordinary Yael Ilan Shares -- * 50,000 Ordinary Aharon Jacobowitz Shares -- * 50,000 Ordinary -- Jonathan Nativ Shares * 50,000 Ordinary -- Moshe Kahn Shares * 50,000 Ordinary Danny Shavit Shares 180,000/(4)/ 1.55% -- - ---------- 34 * Owns less than one percent of the Ordinary Shares outstanding. (1) Beneficial ownership by a person assumes the exercise of all options and warrants held by such person that are currently exercisable or are exercisable within 60 days of such date. (2) Percentage ownership is based on 11,576,539 shares outstanding as of June 25, 2002. (3) All of the options are exercisable for Ordinary Shares of the Company and have an exercise price of $3.625. With the exception of the options held by Robi Hartman, the options become exercisable in four equal annual installments from the date of grant and expire six years after the date of grant. Mr. Hartman holds a total of 356,550 options, of which 206,550 are currently fully exercisable and expire on November 30, 2006. The other 150,000 options held by Mr. Hartman become exercisable in two equal annual installments from March 22, 2003 and expire on November 30, 2006. (4) In connection with the Eastek acquisition, 100,000 and 80,000 shares were issued to Mr. Shavit and Eastek, respectively. Subject to certain conditions, the Ordinary Shares issued to Mr. Shavit will be delivered to him in installments of 30,000, 35,000 and 35,000 Ordinary Shares on the first, second and third anniversaries of the Eastek acquisition, respectively. The first installment of 30,000 Ordinary Shares has been delivered to Mr. Shavit. Additionally, Mr. Shavit is the beneficial owner of the shares issued to Eastek. The Company issued 60,000 of such shares to Eastek as partial consideration for the acquisition and the Company delivered the remaining 20,000 Ordinary Shares to Eastek on the first anniversary of the acquisition. Stock Option Plans In August 1993, the existing employee share incentive plan (the "Plan") was approved by the board of directors and later adopted by the Company's shareholders. The Plan permits the grant of options to purchase Ordinary Shares to officers, directors and key employees of, and consultants to, the Company or any subsidiary of the Company. The Plan presently permits the grant of options to purchase up to an aggregate of 1,192,929 Ordinary Shares. The Plan is administered by the board of directors or by a committee appointed by the board of directors, which designates the optionees, exercise prices and amounts and dates of grant. The exercise price of options granted under the Plan is the fair market value (in NIS linked to the dollar in the case of Israeli employees and in dollars in the case of non-Israeli employees) of the underlying shares on the date of grant, or a lesser percentage of fair market value as is determined by the committee or the board of directors, but in no event less than 85% of the market price of the shares on the date of grant. Options are non-assignable except by the laws of descent and generally vest and are exercisable in three equal annual installments. The options expire 6-10 years subsequent to the date of grant. As of December 31, 2001, options to purchase up to 1,066,803 Ordinary Shares were outstanding, exercisable at prices ranging from $3.63 to $67.14 per share, with expiration dates ranging from February 2002 to November 2006, of which options to purchase up to 606,550 Ordinary Shares were held by all officers and directors of the Company and StoreAge as a group. For additional information regarding the Company's stock option plan, see Note 10 to the Company's Consolidated Financial Statements. 35 Item 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS - ------- ------------------------------------------------- A. Major Shareholders. As reported on its Schedule 13G filed with the Securities & Exchange Commission, dated January 14, 2002, CDC Holdings Ltd. acquired 1,258,255 Ordinary Shares upon its conversion of convertible secured debentures in connection with that certain amendment agreement dated as of December 5, 2001 by and between the Company and the holders of its convertible secured debentures and warrants. During the period from July 24, 2001 to June 25, 2002, Mr. Hartman purchased an aggregate of 539,600 of the Company's Ordinary Shares and as a result of prior acquisitions of shares and such purchases owns 9.60% of the Company's outstanding Ordinary Shares. In December 2001, the Company was advised that Europlan Trust Company Ltd. disposed of its entire position of the Company's securities, an aggregate of 887,145 Ordinary Shares, in the public market. Accordingly, the Company believes that Europlan Trust Company Ltd. is no longer the beneficial owner of 5% or more of the Company's outstanding Ordinary Shares. As of December 31, 1999, Resonance Ltd. beneficially owned 28.3% of the Company's outstanding Ordinary Shares. Subsequently, Resonance Ltd. advised the Company that it was no longer a 10% shareholder of the Company. The Company believes that Resonance Ltd. sold the balance of its shares in the public market and as a result is no longer a beneficial owner of 5% or more of the Company's outstanding Ordinary Shares. The following table sets forth, as of June 26, 2002, the number of Ordinary Shares of the Company owned by all persons known to the Company to beneficially own 5% or more of the Company's Ordinary Shares. The Company's major shareholders do not have different voting rights. Number of Ordinary Shares Percentage of Beneficially Ordinary Shares Name and Address Owned/(1)/ Beneficially Owned/(2)/ - ---------------- --------------- ----------------------- CDC Holdings Ltd.................... 1,258,225/(3)/ 10.87% Robi Hartman........................ 1,111,414/(4)/ 9.60% All directors and officers as a group.......................... 1,305,814/(5)/ 11.28% - ---------- (1) Beneficial ownership assumes the exercise of all options and warrants held by such person or persons that are currently exercisable or are exercisable within 60 days of such date. (2) Percentage ownership is based on 11,576,539 shares outstanding as of June 25, 2002. (3) As reported on Schedule 13G filed with the Securities & Exchange Commission, dated January 14, 2002. 36 (4) As reported on Amendment No. 8 to Schedule 13G filed with the Securities & Exchange Commission, dated June 26, 2002. Mr. Hartman is Chief Executive Officer and Chairman of the Company. (5) Includes 100,000 and 80,000 shares issued to Danny Shavit, the Company's Chief Technology Officer, and Eastek, respectively, in connection with the Company's acquisition of the assets of Eastek in November 2000. Subject to certain conditions, the Ordinary Shares issued to Mr. Shavit will be delivered to him in installments of 30,000, 35,000 and 35,000 Ordinary Shares on the first, second and third anniversaries of the Eastek acquisition, respectively. The first installment of 30,000 Ordinary Shares has been delivered to Mr. Shavit. Additionally, Mr. Shavit is the beneficial owner of the shares issued to Eastek. The Company issued 60,000 of such shares to Eastek as partial consideration for the acquisition and the Company delivered the remaining 20,000 Ordinary Shares to Eastek on the first anniversary of the acquisition. As of June 11, 2002, approximately 82.4% of the outstanding Ordinary Shares of the Company were held of record by approximately 61 holders registered on the books of the Company's United States transfer agent with addresses in the United States. The Company believes that there are more than 500 beneficial owners of its Ordinary Shares in the United States and that a substantial majority of its Ordinary Shares are beneficially owned by non-United States persons. To the extent known to the Company, the Company is not directly or indirectly owned or controlled by another corporation, by any foreign government or by any other natural or legal person. There are currently no arrangements known to the Company that may result in a change in control of the Company. B. Related Party Transactions. In connection with the StoreAge's private placement, in January 2001, the Company, StoreAge and certain investors entered into a shareholders' rights agreement (the "Rights Agreement"). Under the Rights Agreement, in addition to other provisions, each party has the right of first refusal to purchase any shares of StoreAge offered for sale by the Company and the other investors. In February 2001, a portion of the Company's office space located in Ramat Gan, Israel was leased from a company that is owned by Robi Hartman, the Company's Chief Executive Officer and Chairman. The space was leased at 70% of the then generally prevailing market rate for lease space in the area, as approved by the Company's audit committee based upon an independent appraisal report. Several of the Company's employees perform general and administrative services for StoreAge and StoreAge is charged on a percentage of cost basis for such work. Additionally, the Company's research and development team is currently engaged in developing Internet Small Computer Systems Interface ("iSCSI") applications for StoreAge. During 2000, the Company signed an agreement with StoreAge according to which the Company will provide StoreAge iSCSI capabilities to StoreAge's products in consideration of $200,000 according to the milestones defined in the agreement. During 2001, the companies agreed to expand this agreement to provide that the Company may receive an additional $150,000 in consideration for its services. As of December 31, 2001, the Company had recorded accumulated research and development services revenues of $270,000 related to these services. 37 C. Interests of Experts and Counsel. Not applicable. Item 8. FINANCIAL INFORMATION - ------- --------------------- A. Consolidated Statements and Other Financial Information. See pages F-1 - F-30 of the Company's financial statements and pages 1 - - 24 of StoreAge's financial statements following Item 19. Legal Proceedings A suit was filed in Israel in 1995 against the Company and certain of its officers and directors alleging inadequate disclosure in prior years of the Company's financial position, results of operations and prospects, and damages in the amount of $250,000. The Company has answered the complaint, denying all allegations of wrongdoing. The Company believes that the allegations are without merit and, if a settlement is not consummated, intends to continue to defend the action vigorously. While the Company does not believe that the outcome of the action, if not settled, will have a material adverse effect on either its business operations or its financial position, there can be no assurance as to the outcome of the suit. The Company is not a party to any other litigation that would, individually or in the aggregate, have a material adverse effect on the Company or its business, and is not aware that any such litigation is threatened. Dividends The Company has not declared or paid dividends on their Ordinary Shares since 1989, and does not intend to declare or pay any dividends to their shareholders in the foreseeable future. B. Significant Changes. There have been no significant changes since December 31, 2001, the date of the annual financial statements in this annual report. Item 9. THE OFFER AND THE LISTING - ------- ------------------------- The Ordinary Shares of the Company have been traded in the over-the-counter market in the United States since the Company's initial public offering on November 8, 1984. The Ordinary Shares originally traded under the symbol IISLF and now trade under the symbol IISL. From January 22, 1985 to March 17, 1999, the Ordinary Shares traded on the Nasdaq National Market ("Nasdaq"). Since March 18, 1999 the Ordinary Shares have traded on the Nasdaq SmallCap Market. 38 The following table sets forth, for the periods indicated, the annual high and low closing sales price quotes of the Ordinary Shares as reported by Nasdaq for the five most recent full financial years, the quarterly high and low closing sales price quotes for the two most recent full financial years and first quarter 2002 and the monthly high and low price quotes for the most recent six months. High Low ----- ----- Year ended December 31, 1997 $7.88 $3.00 Year ended December 31, 1998 $3.94 $0.28 Year ended December 31, 1999 $7.00 $0.34 Year ended December 31, 2000 $9.56 $1.56 Year ended December 31, 2001 $4.25 $0.75 2000 - ---- First Quarter $9.56 $4.06 Second Quarter 7.06 3.63 Third Quarter 6.88 3.88 Fourth Quarter 5.31 1.56 2001 - ---- First Quarter $4.25 $1.66 Second Quarter 2.95 1.52 Third Quarter 2.39 1.20 Fourth Quarter 1.68 0.75 Most Recent Six Months - ---------------------- December 2001 $1.53 $1.17 January 2002 1.39 1.08 February 2002 1.30 1.08 March 2002 1.24 1.11 April 2002 1.10 0.75 May 2002 1.02 0.77 The foregoing prices reflect inter-dealer quotations without retail mark-ups, mark-downs or commissions and may not represent actual transactions. Item 10. ADDITIONAL INFORMATION - -------- ---------------------- A. Share Capital. Not applicable. 39 B. Memorandum and Articles of Association. Objects and Purposes in the Company's Articles of Association The Company's objects and purposes are specified in its Memorandum of Association filed as Exhibit 3.2 to Registration Statement No. 33-62862 dated August 10, 1993 (the "Memorandum"). Provisions Regarding Directors Pursuant to article 54(b) of our Articles of Association, a transaction entered into by the Company in which a director of the Company has a personal interest, directly or indirectly, will be valid in respect of the Company and the given director only if approved by the Company's board of directors and, if such transactions are "irregular transactions" as defined in the Israeli Companies Law, only if approved in accordance with the requirements of the Israeli Companies Law. An "irregular transaction" pursuant to the Israeli Companies Law is defined as a transaction which is not in the ordinary course of business, a transaction which is not under ordinary market conditions or any transaction which might substantially affect the profitability of the Company, its assets and liabilities. The Israeli Companies Law provides that a director who has personal interest in a given transaction of the Company, brought to the approval of the board of directors, shall not be present and vote at that meeting. Article 55 of the Company's Articles of Association, provides that a director who has a personal interest in a matter which is brought for discussion before the board of directors may participate in said discussion, provided that he shall neither vote in nor attend discussions concerning the approval of the activities or the arrangements. If said director did vote or attend as aforesaid, the approval given to the aforesaid activity or arrangements shall be invalid. Pursuant to article 72 of the Company's Articles of Association, at any meeting of the board of directors at which a quorum is present, the board will have the authority to exercise all or part of the authorities, power of attorney and discretion invested at such time in the directors or regularly exercised by them. With respect to legal quorum at our board meetings, the Israeli Companies Law provides that, unless determined otherwise by the Company, a legal quorum at the board meetings shall consist of the majority of the board members. We have not decided otherwise and therefore, the legal quorum at our board meeting will consist of the majority of the board members. Any transaction concerning compensation to a director requires the approval by the board of directors, the audit committee and the shareholders of the Company. The board of directors may from time to time, in its discretion, cause the Company to borrow or secure the payment of any sum or sums of money for the purpose of the Company. Additionally, the Company may secure or provide for the repayment of such sum or sums in such manner, at such times and upon such terms and conditions in all respects as it sees fit and in particular, by the issuance of bonds, perpetual or redeemable debentures, debenture stock, or any mortgages, charges or other securities on the undertaking, or the whole or any part of the property of the Company, both present and future, including units uncalled or called but unpaid capital for the time being. 40 There is no mandatory retirement age for the directors under our Articles of Association or the Companies Law. There is no requirement concerning the number of shares one individual must hold in order to qualify him or her as a director under our Articles of Association or the Israeli Companies law. Dividends Subject to any preferential, deferred, qualified or other rights, privileges or conditions attached to any special class of shares with regard to dividends, the profits of the Company available for dividend and resolved to be distributed shall be applied in payment of dividends upon the shares of the Company in proportion to the amount paid up or credited as paid up per the nominal value thereon respectively. Unless not otherwise specified in the conditions of issuance of the shares, all dividends with respect to shares which were not fully paid up within a certain period, for which dividends were paid, shall be paid proportionally to the amounts paid or credited as paid on the nominal value of the shares during any portion of the above-mentioned period. The board of directors may declare a dividend to be paid to the shareholders according to their rights and interests in the profits, and may fix the record date for eligibility and the time for payment. The directors may from time to time pay to the shareholders on account of the next forthcoming dividend such interim dividends as, in their judgment, the position of the Company justifies. A transfer of shares shall not pass the right to any dividend declared thereon after such transfer and before the registration of the transfer. There is no time limit after which dividend entitlement lapses according to our Articles of Association or the Companies Law. The board of directors may determine that, a dividend may be paid, wholly or partly, by the distribution of specific assets of the Company or by distribution of paid-up shares, debentures or debenture stock or any other securities of the Company or of any other companies or in any one or more of such ways in the manner and to the extent permitted by the Companies Law. Terms of Directors Pursuant to article 50 of our Articles of Association, except for external directors (as defined in the Companies Law) and the Chief Executive Officer of the Company which will automatically be a director of the Company and his term of office as a director shall be vacated, ipso facto, when he ceases to serve as Chief Executive Officer of the Company, all directors shall be classified, with respect to the time for which they severally hold office, into three classes, as nearly equal in number as possible, one class that held office initially for a term that expired at the 2001 annual meeting of the Company, another class to hold office initially for a term expiring at the 2002 annual meeting of the Company, and another class to hold office initially for a term expiring at the 2003 annual meeting of the Company, with the members of each class to hold office until their successors have been duly elected and qualified. The class of directors 41 whose term expires at the annual meeting shall be elected to hold office for a term expiring at the annual meeting of the Company held in the third year following the year of their election and until their successors have been duly elected and qualified. Except for article 50 of the Company's Articles of Association (described above) which may be amended only by the affirmative vote of 75% of our shareholders present (in person or by proxy) and voting on such resolution at a general meeting, all other articles of our Articles of Association may be amended by a majority vote of shareholders present and voting at a meeting of shareholders of the Company. Votes of Shareholders Our shareholders have one vote for each share held on all matters submitted to a vote of shareholders. Except as otherwise provided in our Articles of Association, any resolution at a general meeting shall be deemed adopted if approved by the holders of a majority of the voting rights in the Company represented at the meeting in person or by proxy and voting thereon. In the case of an equality of votes, either on a show of hands or a poll, the chairman of the meeting shall not be entitled to a further or casting vote. At all general meetings, a resolution put to a vote at the meeting shall be decided on a show of hands unless, before or upon the declaration of the result of the show of hands, a poll in writing be demanded by the chairman (being a person entitled to vote), or by at least two shareholders present, in person or by proxy, holding at least 5% of the issued share capital of the Company and, unless a poll be so demanded, a declaration by the chairman of the meeting that a resolution has been carried, or has been carried unanimously or by a particular vote, or lost, or not carried by a particular vote, shall be conclusive, and an entry to that effect in the minute book of the Company shall be conclusive evidence thereof, without proof of the number or proportion of the votes recorded in favor of or against such resolution. If a poll be demanded in manner aforesaid, it shall be taken forthwith, and the result of the poll shall be deemed to be the resolution of the meeting at which the poll was demanded. The demand of a poll shall not prevent the continuance of a meeting for the transaction of any business other than the question on which a poll has been demanded. Any shareholder which is not a natural person may, by resolution of its directors or other governing body, authorize such person as it thinks fit to act as its representative at a general meeting, and the person so authorized to the satisfaction of the Company shall be entitled to exercise the same powers on behalf of such company, which he represents as the company could exercise if it were an individual shareholder. Subject to any rights or restrictions for the time being attached to any class or classes of shares, every shareholder shall have one vote for each share of which he is the holder, whether on a show of hands or on a poll. Our Articles of Association do not permit cumulative voting and it is not mandated by Israeli law. Votes may be given either personally or by proxy. A proxy need not be a shareholder of the Company. If any shareholder be a lunatic, idiot, or non compos mentis, he may vote by his committee, receiver, curator bonis or other legal curator, and such last-mentioned persons may give their votes either personally or by proxy. If two or more persons are jointly entitled to a share then, in voting upon any question, the vote of the senior person who tenders a vote, whether in person or by 42 proxy, shall be accepted to the exclusion of the votes of the other registered holders of the share and, for this purpose seniority shall be determined by the order in which the names stand in the shareholder register. The instrument appointing a proxy shall be in writing in the usual common form, or such form as may be approved by the board of directors, and shall be signed by the appointor or by his attorney duly authorized in writing or, if the appointor is a corporation, the corporation shall vote by its representative, appointed by an instrument duly signed by the corporation. The instrument appointing a proxy shall be deemed to include authorization to demand a poll or to vote on a poll on behalf of the appointor. A vote given in accordance with the terms of an instrument of proxy shall be valid notwithstanding the previous death or insanity of the principal, or revocation of the proxy, or transfer of the share in respect of which the vote is given, unless an intimation in writing of the death, revocation or transfer shall have been received at the office before the commencement of the meeting or adjourned meetings at which the proxy is used. The instrument appointing a proxy shall be deposited at the registered office of the Company or at such other place or places, whether in Israel or elsewhere, as the board of directors may from time to time, either generally or in a particular case or class of cases prescribe, at least forty-eight (48) hours before the time appointed for holding the meeting or adjourned meeting at which the person named in such instrument proposes to vote. Otherwise, the person so named shall not be entitled to vote in respect thereof, but no instrument appointing a proxy shall be valid after the expiration of twelve months from the date of its execution. Subject to the provisions of the Companies Law, a resolution in writing (approved by letter, telex, facsimile or otherwise) by all the shareholders, in person or by proxy, for the time being entitled to vote at a general meeting of the Company, shall be as valid and as effectual as a resolution adopted by a general meeting duly convened, held and constituted for the purpose of passing such resolution. A shareholder will be entitled to vote at the meetings of the Company by several proxies appointed by him, provided that each proxy shall be appointed with respect to different shares held by the appointing shareholder. Every proxy so appointed on behalf of the same shareholder shall be entitled to vote as he sees fit. Further Rights and Preferences of the Ordinary Shares In the event of sale or the undertaking of the Company, the board or the liquidator on a winding up, as the case may be, subject to the authorization by a majority vote at a meeting of shareholders, may distribute to our shareholders all assets remaining after payment of the Company's liabilities. Our Articles of Association allow, subject to the Israeli Companies Law, the issue of redeemable shares and to redeem the same according to terms and conditions determined by the Company. Our Articles of Association do not include provisions related to sinking funds. According to our Articles of Association no person shall be entitled to vote at any general 43 meeting (or be counted as a part of the quorum thereof) unless all calls then payable by him in respect of his shares in the Company shall have been paid. The Israeli Companies Law provides that a company is entitled to determine within its articles a provision allowing the board to place call on shares, in event the consideration for such shares, in full or in part, have not been paid on time and in accordance with the agreeable terms set out in the given agreement or the articles of association of the company. According to our Articles of Association, there are no discriminating provisions against any existing or prospective holders of shares of the Company as a result of a shareholder holding a substantial number of shares. Modification of Class Rights If, at any time, the share capital is divided into different classes of shares, the rights attached to any class (unless otherwise provided by the terms of issuance of the shares of that class) may be varied with the consent in writing of the holders of all the issued shares of that class, or with the sanction of a majority vote at a meeting of the shareholders passed at a separate meeting of the holders of the shares of the class. The provisions of our Articles of Association relating to general meetings shall apply, mutatis mutandis, to every such separate general meeting. Any holder of shares of the class present in person or by proxy may demand a secret poll. Unless otherwise provided by the conditions of issuance, the enlargement of an existing class of shares, or the issuance of additional shares thereof, shall not be deemed to modify or abrogate the rights attached to the previously issued shares of such class or of any other class. These conditions provide for the minimum shareholder approvals permitted by the Israeli Companies Law. General Meetings General meetings shall be held at least once in every calendar year at such time, not being more than fifteen months after the holding of the last preceding general meeting, and at such time and place as may be determined by the board of directors. The board of directors may, whenever it deems necessary, and shall upon such requisition in writing as is provided by Section 63(b) of the Companies Law, convene a general meeting. Any such request must state the purposes for which the meeting is to be called, be signed by the requesting shareholders, and must be deposited at the registered office of the Company. Such request may consist of several documents in like form, each signed by one or more requesting shareholder. Unless a longer period for notice is prescribed by the Companies Law, at least ten (10) days and not more than sixty (60) days notice of any general meeting shall be given, specifying the place, the day and the hour of meeting and, in the case of special business, the nature of such business, shall be given in the manner hereinafter mentioned, to such shareholders as are under the provisions of the Company's Articles of Association, entitled to receive notices from the Company. Notices shall be given by mail or by personal delivery to every registered shareholder of the Company, to his address as described in the shareholders register of the Company or such other address as designated by him in writing for this purpose. Provided that the accidental omission to give such notice to, or the non-receipt of such notice by, any such shareholder shall not invalidate any resolution passed or proceeding held at 44 any such meeting and, with the consent of all the shareholders for the time being entitled to receive notice of meetings, a meeting may be convened upon a shorter notice or without notice, and generally in such manner as such shareholders may approve. Such consent may be given at the meeting or retrospectively after the meeting. If the shareholder did not provide the Company any address for the delivery of notices, the shareholder shall be deemed to have waived his right to receive notices. Only shareholders of record as reflected on the Company's share register at the close of business on the date fixed by the board of directors as the record date determining the then shareholders who will be entitled to vote, shall be entitled to notice of, and to vote, in person or by proxy, at a general meeting and any postponement or adjournment thereof. Quorum at General Meetings No business shall be transacted at any general meeting unless a quorum is present when the meeting proceeds to business. The quorum at any Meeting shall be two shareholders present in person or by proxy, holding or representing at least twenty five percent (25%) of the total voting rights in the Company. A company being a shareholder shall be deemed to be personally present for the purpose of the Company's Articles of Association if represented by its representative duly authorized in accordance with article 42 of the Company's Articles of Association. If, within half an hour from the time appointed for the holding of a general meeting, a quorum is not present, the meeting shall stand adjourned to the same day in the next week at the same time and place, or any time and hour as the board of directors shall designate and state in a notice to the shareholders entitled to vote at the original meeting, and if, at such adjourned meeting, a quorum is not present within half an hour from the time appointed for holding the meeting any two shareholders present in person or by proxy shall constitute a quorum. Notwithstanding the aforesaid, if a general meeting was convened at the demand of shareholders as permitted by Section 63(b) of the Companies Law, then a quorum at such adjourned meeting shall be present only if one or more shareholders are present who held in the aggregate at least 5% of the issued share capital of the Company and at least 1% of the voting rights in the Company or one or more shareholders who hold in the aggregate at least 5% of the voting rights in the Company. Restrictions on Shareholders Rights to Own Securities The Memorandum and Articles of Association of the Company do not restrict in any way the ownership of Ordinary Shares by residents or nonresidents, except with respect to subjects of countries which are in a state of war with Israel, and neither the Memorandum and Articles of Association nor Israeli law restricts the voting rights of residents or nonresidents. Potential Issues that Could Delay a Merger The classification of our board of directors could delay or impede the removal of incumbent directors and could therefore complicate a merger, tender offer or proxy contest involving us, even if such events would be beneficial to the interests of our shareholders, or could discourage a third party from attempting to acquire control of the Company. 45 A merger of the Company requires the approval of the board of directors and the general meeting of shareholders, in accordance with the provisions of the Israeli Companies Law. See also "Anti-Takeover Provisions; Merger and Acquisitions under Israeli Law". Requirement of Disclosure of Shareholder Ownership There are no provisions of our Memorandum or Articles of Association governing the ownership threshold above which shareholder ownership must be disclosed. Approval of Related Party Transactions Under Israeli Law The Companies Law codifies the fiduciary duties that "office holders," including directors and executive officers, owe to a company. An office holder's fiduciary duties consist of a duty of care and a duty of loyalty. The duty of care requires an office holder to act at a level of care that a reasonable office holder in the same position would employ under the same circumstances. The duty of loyalty includes avoiding any conflict of interest between the office holder's position in the company and his personal affairs, avoiding any competition with the company, avoiding exploiting any business opportunity of the company in order to receive personal gain for the office holder or others, and disclosing to the company any information or documents relating to the company's affairs which the office holder has received due to his position as an office holder. Each person listed as a director or executive officer in the table under "Directors, Senior Management and Employees--Directors and Senior Management" above is an office holder. Under the Companies Law, all arrangements as to compensation of office holders who are not directors require approval of our board of directors, and the compensation of office holders who are directors must be approved by our audit committee, board of directors and shareholders. The Companies Law requires that an office holder promptly disclose any personal interest that he or she may have and all related material information known to him or her, in connection with any existing or proposed transaction by us. In addition, if the transaction is an extraordinary transaction, that is, a transaction other than in the ordinary course of business, other than on market terms, or likely to have a material impact on the company's profitability, assets or liabilities, the office holder must also disclose any personal interest held by the office holder's spouse, siblings, parents, grandparents, descendants, spouse's descendants and the spouses of any of the foregoing, or by any corporation in which the office holder or a relative is a 5% or greater shareholder, director or general manager or in which he or she has the right to appoint at least one director or the general manager. Some transactions, actions and arrangements involving an office holder (or a third party in which an office holder has an interest) must be approved by the board of directors or as otherwise provided for in a company's articles of association, as not being adverse to the company's interest. In some cases, such a transaction must be approved by the audit committee and by the board of directors itself (with further shareholder approval required in the case of extraordinary transactions). An office holder who has a personal interest in a matter, which is considered at a meeting of the board of directors or the audit committee, may not be present during the board of directors or audit committee discussions and may not vote on this matter, unless the majority of the members of the board or the audit committee have a personal interest, as the case may be. 46 The Companies Law also provides that some transactions between a public company and a controlling shareholder, or transactions in which a controlling shareholder of the company has a personal interest but which are between a public company and another entity, require the approval of the board of directors and of the shareholders. Once the officer or controlling shareholder complies with these disclosure requirements, the company may approve the transaction in accordance with the provisions of the Companies Law and its articles of association. Generally, the approval of the majority of the disinterested members of the audit committee and the board of directors is required. If audit committee approval is required for a transaction with an interested party, an officer or a controlling shareholder, such approval may not be given unless, at the time the approval was granted two members of the audit committee were external directors and at least one of them was present at the meeting at which the audit committee decided to grant the approval. Shareholder approval may also be required if the transaction is an exceptional transaction. An exceptional transaction is a transaction other than in the ordinary course of business, otherwise than on market terms or that is likely to have a material impact on the company's profitability, assets or liabilities. In such event, the principal terms of such transaction must be disclosed in a notice to the shareholders which will include all substantive documents relating to the transaction. Moreover, an extraordinary transaction with a controlling shareholder or the terms of compensation of a controlling shareholder must be approved by the audit committee, the board of directors and shareholders. The shareholder approval for an extraordinary transaction must include at least one-third of the shareholders who have no personal interest in the transaction and are present at the meeting. The transaction can be approved by shareholders without this one-third approval, if the total shareholdings of those shareholders who have no personal interest and voted against the transaction do not represent more than one percent of the voting rights in the company. If the transaction is with an officer or with a third party in which the officer or the controlling shareholder has a personal interest, the approval must confirm that the transaction is not adverse to the company's interest. Shareholders must also approve all compensation paid to directors in whatever capacity, company's undertaking to indemnify a director or indemnification under a permit to indemnify and any transaction in which a majority of the board members have a personal interest. An officer with a personal interest in any matter may not be present at any committee or board of directors meeting where such matter is being approved, and may not vote thereon, unless the majority of the members of the committee or of the board of directors have a personal interest in such approval. However, under the Companies Regulations (Relief From Related Party Transactions), 5760-2000, promulgated under the Companies Law and amended in January 2002, certain transactions between a company and its controlling shareholder(s) do not require shareholder approval. In addition, pursuant to the recent amendment to these regulations directors' compensation and employment arrangements do not require the approval of the shareholders if both the audit committee and the board of directors approve that such arrangements are for the benefit of the company. If the director or the office holder is a controlling shareholder of the company then the employment and compensation arrangement of such director or office holder does not require the approval of the shareholders if it meets certain criteria. 47 The above relief shall not apply if one or more shareholders, holding at least 1% of the issued and outstanding share capital of the company or of the company's voting rights objects to the grant of such relief, providing that such objection is submitted to the company in writing not later than seven (7) days from the date of the filing of a report regarding the adoption of such resolution by the company pursuant to the requirements of the Israeli Securities Law. If such objection is duly and timely submitted then the compensation arrangement of the directors will require shareholders' approval as detailed above. Indemnification of Directors and Officers The Companies Law provides that an Israeli company cannot exculpate an office holder from liability with respect to a breach of his duty of loyalty, but may exculpate in advance an office holder from his liability to the company, in whole or in part, with respect to a breach of his duty of care. Our articles of association provide that, subject to any restrictions imposed by corporate law, we may enter into a contract for the insurance of the liability of any of our office holders with respect to: . a breach of his duty of care to us or to another person; . breach of his duty of loyalty to us, provided that the office holder acted in good faith and had reasonable cause to assume that his act would not prejudice our interests; or . a financial liability imposed upon him in favor of another person in respect of an act performed by him in his capacity as an office holder. In addition, we may indemnify an office holder against: . a financial liability imposed on him in favor of another person by any judgment, including a settlement or an arbitrator's award approved by a court in respect of an act performed in his capacity as an office holder; and . reasonable litigation expenses, including attorneys' fees, expended by such office holder or charged to him by a court, in proceedings we institute against him or instituted on our behalf or by another person, or in a criminal charge from which he was acquitted, all in respect of an act performed in his capacity as an office holder. These provisions are specifically limited in their scope by the Companies Law, which provides that a company may not indemnify an office holder, nor enter into an insurance contract which would provide coverage for any monetary liability incurred as a result of certain improper actions. Pursuant to the Companies Law, indemnification of, and procurement of insurance coverage for, our office holders must be approved by our audit committee and our board of directors and, in specified circumstances, by our shareholders. We have undertaken to indemnify our office holders to the fullest extent permitted by law. In addition, we currently maintain directors and officers liability insurance. 48 Anti-Takeover Provisions; Mergers and Acquisitions under Israeli Law Pursuant to the Companies Law, if following any acquisition of shares of a public company or of a class of shares of a public company the acquiror will hold 90% or more of the company's shares or 90% of any class of the company's shares, respectively, then the acquiror must make a tender offer for all of the remaining shares or the particular class of shares of the company. In the event that 5% or more of the shareholders have not responded favorably to a tender offer, the offeror may not purchase more than 90% of that class of shares. Furthermore, the Companies Law provides that as long as a shareholder in a public company holds more than 90% of the company's shares or of a class of shares, such shareholder shall be precluded from purchasing any additional shares of that type. The Companies Law further provides that if following the tender offer such acquiring shareholder holds more than 95% of the outstanding shares of any class, the holders of all the remaining shares will be obligated to transfer such shares to the acquiror at the tender offer price. This entails the possibility of additional delay and the imposition of further approval requirements at the court's discretion. The Companies Law requires that each company that is party to a merger approve the transaction by a vote of the board of directors and by a vote of the majority of its outstanding shares, generally excluding shares voted by the other party to the merger or any person holding at least 25% of the other party to the merger, at a shareholders' meeting called for this purpose. In addition, in certain cases court approval of a merger may be required. Upon the request of a creditor to either party to the proposed merger, the court may delay or prevent the merger if it concludes that there exists a reasonable concern that as a result of the merger, the surviving company will be unable to satisfy the obligations of any of the parties to the merger. In addition, a merger may not be completed unless at least 70 days have passed from the time that a proposal for approval of the merger has been filed with the Israeli Registrar of Companies and certain notification and information have been provided to debtors. Notwithstanding the approval requirements set forth in the Companies Law, companies, such as ours, which have been incorporated prior to the Companies Law coming into effect, must specifically amend their articles of association to provide for the shareholder voting requirements contained in the Companies Law. The Companies Law also provides that an open market acquisition of shares in a public company must be made by means of a tender offer if as a result of the acquisition the purchaser would become a holder of 25% of the voting rights in the company. This rule does not apply if there already is another holder of 25% of the voting rights in the company. Similarly, the Companies Law provides that an open market acquisition of shares in a public company must be made by means of a tender offer if as a result of the acquisition the purchaser would become the holder of 45% of the voting rights in the company. This rule does not apply if another party already holds more than 50% of the voting rights in the company. Regulations promulgated under the Companies Law provide that these tender offer requirements do not apply to companies whose shares are listed for trading on a stock exchange outside of Israel only if, according to the laws in the country in which its shares are traded there is either a limitation on the acquisition of a specified percentage of control in the Company or the acquisition of a specified percentage of control requires the purchaser to also make a tender offer to the public. 49 The Companies Law extends the disclosure requirements applicable to an officer of the Company to a shareholder that holds 25% or more of the voting rights in a public company, including an Israeli company that is publicly traded outside of Israel such as on NASDAQ. Certain transactions between a public company and a 25% shareholder, or transactions in which a 25% shareholder of the company has a personal interest but which are between a public company and another entity, require the approval of the board of directors and of the shareholders. Moreover, an extraordinary transaction with a 25% shareholder or the terms of compensation of a 25% shareholder must be approved by the audit committee, the board of directors and shareholders. The shareholder approval for an extraordinary transaction must include at least one third of the shareholders who have no personal interest in the transaction and are present at the meeting; the transaction can be approved by shareholders without this one third approval, if the total share holdings of those who vote against the transaction do not represent more than 1% of the voting rights in the company. The Israeli Companies Ordinance requires that certain transactions, actions and arrangements be approved as provided for in the Company's Articles of Association, by the Company's board of directors, by the audit committee and/or by the Company's shareholders. The vote required by the audit committee and the board for approval of such matters, in each case, is a majority of the disinterested directors participating in a duly convened meeting. Changes in Capital The Company's Memorandum and Articles of Association do not impose any conditions governing changes in capital that are more stringent than required by the Israeli Companies Law. C. Material Contracts. On November 30, 2000, we entered into a purchase and assignment agreement (the "Purchase and Assignment Agreement") with Eastek Embedded Systems (Meitav) Ltd. ("Eastek"), an Israeli based software company, and Eastek's founder, Mr. Danny Shavit ("Mr. Shavit"), to acquire all the assets of Eastek. Under the terms of the Purchase and Assignment Agreement, we issued 60,000 of the Company's Ordinary Shares to Eastek as partial consideration for the acquisition and may deliver an additional 20,000 Ordinary Shares to Eastek on the first anniversary of the acquisition if certain conditions are met. In connection with our acquisition of Eastek, we hired Mr. Shavit to serve as Chief Technology Officer of the Company. On November 30, 2000, we entered into an employment agreement with Mr. Shavit under the terms of which we issued 100,000 of the Company's Ordinary Shares to Mr. Shavit. Subject to certain conditions, the Ordinary Shares will be delivered to Mr. Shavit in installments of 30,000, 35,000 and 35,000 Ordinary Shares on the first, second and third anniversaries of the acquisition respectively. The first installment of 30,000 Ordinary Shares has been delivered to Mr. Shavit. On December 20, 2000, we entered into agreements in principle with qualified investors and subsequently entered into a securities purchase agreement dated as of January 31, 2001 (the "Securities Purchase Agreement") with CDC Holdings Ltd., Armour Investments Ltd., Industrial Systems & Equipment Co., Meir Noga and Nachum Ezra (the "Purchasers"). In accordance with the Securities Purchase Agreement, we issued units, each consisting of $100,000 principal amount of our convertible 50 secured debentures (the "Debentures") and three-year non-redeemable warrants (the "Warrants") to acquire 10,000 Ordinary Shares, par value NIS .003 per share (the "Ordinary Shares") to the Purchasers. We issued a total of 30 Units, representing Debentures in an aggregate principal amount of $3,000,000 and Warrants to acquire an aggregate of 300,000 Ordinary Shares. In connection with StoreAge's private placement, in January 2001, StoreAge entered into a shareholders' rights agreement (the "Rights Agreement") with the Company, Nelson Nahum, Ophirtech Ltd., Koonras Technologies Ltd., Genesis Partners II L.D.C., Genesis Partners II (Israel) L.P., Cisco Systems, Inc., Morgan Keegan & Company, Inc., Morgan Keegan Opportunity Fund, L.P., Morgan Keegan Employee Investment Fund, L.P. and certain other investors (each an "Investor" collectively, the "Investors"). Under the Rights Agreement, in addition to other provisions, each Investor has the right of first refusal to purchase any shares of StoreAge offered for sale by the Company and the other Investors. In January 2001, the Company entered into a lease with West End Technology Investments Ltd. for office space located at 33 Jabotinsky Street, Ramat Gan, Israel. The lease is for an undefined term that began on February 1, 2001. Both parties have the right to terminate the lease at any time, by written notice of 75 days in advance. The annual rent for this space is approximately $34,680, with total annual occupancy costs, including local taxes, utilities, maintenance and other costs of approximately $21,360. The rent is for fully furnished office space. The remaining empty office space is rented from a third party at a higher price. In order to maintain its Nasdaq SmallCap Market listing, the Company entered into an agreement dated as of December 5, 2001 to amend the Securities Purchase Agreement with the Purchasers to exchange their Debentures and Warrants for the Company's Ordinary Shares and cash. Under the terms of the agreement, the Purchasers converted part of the Debentures, the Warrants and the floating charge registered on the Company's assets was cancelled and the Company repaid the Purchasers the principal amount of the Debentures which was not converted, plus interest accrued up to the date of the agreement. As a result of the completion of the transaction in December 2001, the Company had sufficient shareholders' equity and net tangible assets to meet the requirements for continued inclusion on the Nasdaq SmallCap Market. Under the terms of the transaction, the Purchasers converted $2,426,576.40 principal amount of the Debentures into an aggregate of 1,797,464 of the Company's Ordinary Shares, received a cash payment of $573,423.60 and relinquished all of the Warrants. The Warrants and the remaining Debentures were cancelled. The transaction represented an implied exchange value of at least $1.35 per Ordinary Share based solely on the debt amounts extinguished, without giving any effect to the cancelled Warrants, and represented a substantial premium over the market price of the Company's Ordinary Shares at the time the agreements in principle with the Purchasers were reached. During 2000, the Company signed an agreement with its affiliate StoreAge according to which the Company will provide StoreAge iSCSI capabilities to StoreAge's products in consideration of 51 $200,000 according to the milestones defined in the agreement. During 2001, the companies agreed to expand this agreement to provide that the Company may receive an additional $150,000 in consideration for its services. As of December 31, 2001, the Company had recorded accumulated research and development services revenues of $270,000 related to these services. D. Exchange Controls. The Memorandum and Articles of Association of the Company do not restrict in any way the ownership of Ordinary Shares by nonresidents, except with respect to subjects of countries which are in a state of war with Israel, and neither the Memorandum and Articles of Association nor Israeli law restricts the voting rights of nonresidents. The Israeli Currency Control Law, 1978 imposes certain limitations concerning foreign currency transactions and transactions between Israeli and non-Israeli residents, which limitations may be regulated or waived by the Controller of Foreign Exchange at the Bank of Israel, through "general" and "special" permits. In May 1998, a new "general permit" was issued pursuant to which substantially all transactions in foreign currency are permitted. Any dividends or other distributions paid in respect of Ordinary Shares and any amounts payable upon the dissolution, liquidation or winding up of the affairs of a company, as well as the proceeds of any sale in Israel of the company's securities to an Israeli resident are freely repatriable into non-Israeli currencies (including U.S. dollars) at the rate of exchange prevailing at the time of conversion, provided that any Israeli income tax owing has been paid on (or withheld from) such payments. Because exchange rates between the NIS and most foreign currencies fluctuate continuously, non-Israeli shareholders will be subject to any such currency fluctuation during the period from when such dividend is declared through the date payment is made in U.S. dollars. E. Taxation. Capital Gains and Income Taxes Applicable to Non-Israeli Shareholders Under existing regulations, any gain realized by a shareholder with respect to the Company's Ordinary Shares will be exempt from Israeli capital gains tax as long as the Ordinary Shares are listed on an approved foreign securities market (which term includes the Nasdaq SmallCap Market in the United States) and provided that the Company qualifies as an "Industrial Company" within the definition of the Law for the Encouragement of Industry (Taxes), 1969. There can be no assurance, however, that the provisions of the law, with respect to this exemption, will not change. If we fail to maintain our status as an Industrial Company (of which there can be no assurance), the applicable Israeli capital gains tax will be as follows: 35% for individuals who are Israeli residents, 36% for Israeli companies and 50% for non-residents of Israel (subject to an applicable double-taxation treaty). Individuals who are non-residents of Israel are subject to income tax on income derived from sources in Israel, or received in Israel. Such sources of income include passive income such as dividends, royalties and interest, as well as non-passive income form services rendered in Israel. On the distribution of dividends other than bonus shares (stock dividends), income tax is withheld at source at the rate of 25% (or the lower rate payable with respect to "Approved Enterprises"), unless a double taxation treaty which provides for a lower tax rate in Israel or dividends is in effect between Israel and the shareholder's country. 52 The Convention between the State of Israel and the Government of the United States relating to relief from double taxation (the "Treaty") provides for a maximum tax of 25% on dividends paid to a resident of the United States. Generally, under the Treaty, the maximum withholding tax on dividends paid to a holder of Ordinary Shares of the Company who is a resident of the United States (as defined in the Treaty) will be 25%. Dividends of an Israeli company derived from the income of an Approved Enterprise will be subject to a 15% dividend withholding tax. The Treaty exempts from Israeli taxation any capital gain realized on the sale, exchange or other disposition of Ordinary Shares by a United States shareholder who owned, either directly or indirectly, less than 10% of the voting stock of the Company at all times during the 12-month period preceding such sale, exchange or other disposition. A nonresident of Israel who has had income derived or accrued in Israel from which tax was withheld at source and which constitutes income from certain sources, including dividends, is currently exempt from the duty to file an Israeli tax return with respect to such income, provided such income was not derived from a business carried on in Israel by such nonresident. Proposed Reform of Income Taxes in Israel In February 2002, the Minister of Finance appointed a committee to review and make recommendations with respect to the current Israeli tax structure. The committee presented its recommendations to the Minister of Finance on June 12, 2002. If implemented, the recommendations might result in the imposition of Israeli capital gains taxes at the rate of 15% to 35% on sales of securities of Israeli companies by Israeli residents. In addition, the committee has proposed that a tax be imposed on all income of Israeli residents (individuals and corporations) regardless of the territorial source of income and a tax will be imposed on income of foreign corporations controlled by Israeli residents if the majority of profits or income of such foreign corporations originate from "passive income", including interest, dividends, royalties and rental income. We cannot predict whether, and to what extent, such recommendations will be adopted and eventually enacted into law. United States Federal Income Tax Consequences The following is a summary of certain material U.S. Federal income tax consequences that apply to U.S. Holders (as defined below) who hold Ordinary Shares as capital assets. This summary is based on the United States Internal Revenue Code of 1986, as amended (the "Code"), Treasury regulations promulgated thereunder, judicial and administrative interpretations thereof, and the U.S.-Israel Tax Treaty, all as in effect on the date hereof and all of which are subject to change either prospectively or retroactively. This summary does not address all tax considerations that may be relevant with respect to an investment in Ordinary Shares. This summary does not account for the specific circumstances of any particular investor, such as: . broker-dealers, . financial institutions, . certain insurance companies, 53 . investors liable for alternative minimum tax, . tax-exempt organizations, . non-resident aliens of the U.S. or taxpayers whose functional currency is not the U.S. dollar, . persons who hold the Ordinary Shares through partnerships or other pass-through entities, . investors that actually or constructively own 10 percent or more of our voting shares, and . investors holding Ordinary Shares as part of a straddle or a hedging or conversion transaction. This summary does not address the effect of any U.S. Federal taxation other than U.S. Federal income taxation. In addition, this summary does not include any discussion of state, local or foreign taxation. Shareholders are urged to consult their tax advisors regarding the foreign and United States Federal, state and local tax considerations of an investment in Ordinary Shares. For purposes of this summary, a "U.S. Holder" is a shareholder which is: . an individual who is a citizen or, for U.S. Federal income tax purposes, a resident of the United States; . a partnership, corporation or other entity created or organized in or under the laws of the United States or any political subdivision thereof; . an estate whose income is subject to U.S. Federal income tax regardless of its source; or . a trust if: (a) a court within the United States is able to exercise primary supervision over administration of the trust, and (b) one or more United States persons have the authority to control all substantial decisions of the trust. Taxation of Dividends The gross amount of any distributions received with respect to Ordinary Shares, including the amount of any Israeli taxes withheld therefrom, will constitute dividends under U.S. Federal income tax purposes, to the extent of our current and accumulated earnings and profits as determined for U.S. 54 Federal income tax principles. Shareholders will be required to include this amount of dividends in gross income as ordinary income. Distributions in excess of our earnings and profits will be treated as a non-taxable return of capital to the extent of a shareholder's tax basis in the Ordinary Shares and any amount in excess of such shareholder's tax basis, will be treated as gain from the sale of Ordinary Shares. See "Disposition of Ordinary Shares" below for the discussion on the taxation of capital gains. Dividends will not qualify for the dividends-received deduction generally available to corporations under Section 243 of the Code. Dividends that we pay in NIS, including the amount of any Israeli taxes withheld therefrom, will be included in a shareholder's income in a U.S. dollar amount calculated by reference to the exchange rate in effect on the day such dividends are received. A U.S. Holder who receives payment in NIS and converts NIS into U.S. dollars at an exchange rate other than the rate in effect on such day may have a foreign currency exchange gain or loss that would be treated as ordinary income or loss. U.S. Holders should consult their own tax advisors concerning the U.S. tax consequences of acquiring, holding and disposing of NIS. Any Israeli withholding tax imposed on such dividends will be a foreign income tax eligible for credit against a U.S. Holder's U.S. federal income tax liability, subject to certain limitations set out in the Code (or, alternatively, for deduction against income in determining such tax liability). The limitations set out in the Code include computational rules under which foreign tax credits allowable with respect to specific classes of income cannot exceed the U.S. federal income taxes otherwise payable with respect to each such class of income. Dividends generally will be treated as foreign-source passive income or financial services income for United States foreign tax credit purposes. Foreign income taxes exceeding the credit limitation for the year of payment or accrual may be carried back for two taxable years and forward for five taxable years in order to reduce U.S. federal income taxes, subject to the credit limitation applicable in each of such years. Other restrictions on the foreign tax credit include a prohibition on the use of the credit to reduce liability for the U.S. individual and corporation alternative minimum taxes by more than 90%. A U.S. Holder will be denied a foreign tax credit with respect to Israeli income tax withheld from dividends received on the Ordinary Shares to the extent such U.S. Holder has not held the Ordinary Shares for at least 16 days of the 30-day period beginning on the date which is 15 days before the ex-dividend date or to the extent such U.S. Holder is under an obligation to make related payments with respect to substantially similar or related property. Any days during which a U.S. Holder has substantially diminished its risk of loss on the Ordinary Shares are not counted toward meeting the 16-day holding period required by the statute. The rules relating to the determination of the foreign tax credit are complex, and shareholders should consult with their personal tax advisors to determine whether and to what extent they would be entitled to this credit. Dispositions of Ordinary Shares If a shareholder sells or otherwise disposes of Ordinary Shares, such shareholder will recognize gain or loss for U.S. Federal income tax purposes in an amount equal to the difference between the amount realized on the sale or other disposition and the adjusted tax basis of such Ordinary Shares. Subject to the discussion below under the heading "Passive Foreign Investment Companies," such gain or loss generally will be capital gain or loss and will be long-term capital gain or loss if a shareholder has held the Ordinary Shares for more than one year at the time of the sale or other disposition. In general, any gain that a shareholder recognizes on the sale or other disposition of Ordinary Shares will 55 be U.S.-source for purposes of the foreign tax credit limitation; losses, will generally be allocated against U.S. source income. Under the U.S.-Israel Income Tax Convention, gain on the disposition of Ordinary Shares may be treated as Israeli source, if the shareholder has held 10% or more of the voting power of the company at any time during the 12 months preceding the date of disposition. Deduction of capital losses is subject to certain limitations under the Code. In the case of a cash basis U.S. Holder who receives NIS in connection with the sale or disposition of Ordinary Shares, the amount realized will be based on the U.S. dollar value of the NIS received with respect to the Ordinary Shares as determined on the settlement date of such exchange. A U.S. Holder who receives payment in NIS and converts NIS into United States dollars at a conversion rate other than the rate in effect on the settlement date may have a foreign currency exchange gain or loss that would be treated as ordinary income or loss. An accrual basis U.S. Holder may elect the same treatment required of cash basis taxpayers with respect to a sale or disposition of Ordinary Shares, provided that the election is applied consistently from year to year. Such election may not be changed without the consent of the Internal Revenue Service (the "IRS"). In the event that an accrual basis U.S. Holder does not elect to be treated as a cash basis taxpayer (pursuant to the Treasury regulations applicable to foreign currency transactions), such U.S. Holder may have a foreign currency gain or loss for U.S. federal income tax purposes because of differences between the U.S. dollar value of the currency received prevailing on the trade date and the settlement date. Any such currency gain or loss would be treated as ordinary income or loss and would be in addition to gain or loss, if any, recognized by such U.S. Holder on the sale or disposition of such Ordinary Shares. Passive Foreign Investment Companies For U.S. Federal income tax purposes, we will be considered a passive foreign investment company ("PFIC") for any taxable year in which either (i) 75% or more of our gross income is passive income, or (ii) at least 50% of the average value of all of our assets for the taxable year produce or are held for the production of passive income. For this purpose, passive income includes dividends, interest, royalties, rents, annuities and the excess of gains over losses from the disposition of assets which produce passive income. If we were determined to be a PFIC for U.S. Federal income tax purposes, highly complex rules would apply to U.S. Holders owning Ordinary Shares. Accordingly, shareholders are urged to consult their tax advisors regarding the application of such rules. Based on our current and projected income, assets and activities, we believe that we are not currently a PFIC nor do we expect to become a PFIC in the foreseeable future. However, because the determination of whether we are a PFIC is based upon the composition of our income and assets from time to time, there can be no assurances that we will not become a PFIC for any future taxable year. If we are treated as a PFIC for any taxable year, then, unless a shareholder elects either to treat such shareholder's investment in Ordinary Shares as an investment in a "qualified electing fund" (a "QEF election") or to "mark-to-market" such shareholder's Ordinary Shares, as described below: 56 . the shareholder would be required to allocate income recognized upon receiving certain dividends or gain recognized upon the disposition of Ordinary Shares ratably over the holding period for such Ordinary Shares; . the amount allocated to each year during which we are considered a PFIC other than the year of the dividend payment or disposition would be subject to tax at the highest individual or corporate tax rate, as the case may be, and an interest charge would be imposed with respect to the resulting tax liability allocated to each such year; . gain recognized upon the disposition of Ordinary Shares would be taxable as ordinary income; and . the shareholder would be required to make an annual return on IRS Form 8621 regarding distributions received with respect to ordinary shares and any gain realized on such shareholder's Ordinary Shares. If a shareholder makes either a timely QEF election or a timely mark-to-market election in respect of such shareholder's Ordinary Shares, the shareholder would not be subject to the rules described above. If a shareholder makes a timely QEF election, the shareholder would be required to include in such shareholder's income for each taxable year such shareholder's pro rata share of our ordinary earnings as ordinary income and such shareholder's pro rata share of our net capital gain as long-term capital gain, whether or not such amounts are actually distributed to the shareholder. A shareholder would not be eligible to make a QEF election unless we comply with certain applicable information reporting requirements. Alternatively, if a shareholder elects to "mark-to-market" such shareholder's Ordinary Shares, the shareholder will generally include in income any excess of the fair market value of the Ordinary Shares at the close of each tax year over such shareholder's adjusted basis in the Ordinary Shares. If the fair market value of the Ordinary Shares had depreciated below the shareholder's adjusted basis at the close of the tax year, the shareholder may generally deduct the excess of the adjusted basis of the Ordinary Shares over its fair market value at that time. However, such deductions generally would be limited to the net mark-to-market gains, if any, that the shareholder included in income with respect to such Ordinary Shares in prior years. Income recognized and deductions allowed under the mark-to-market provisions, as well as any gain or loss on the disposition of Ordinary Shares with respect to which the mark-to-market election is made, is treated as ordinary income or loss. Backup Withholding and Information Reporting Payments in respect of Ordinary Shares may be subject to information reporting to the U.S. Internal Revenue Service and to a 31 percent U.S. backup withholding tax. Backup withholding will not apply, however, if a shareholder (i) is a corporation or come within certain exempt categories, and demonstrate the fact when so required, or (ii) furnish a correct taxpayer identification number and make any other required certification. Any amount withheld under these rules may be credited against a shareholder's federal income tax liability. 57 Backup withholding is not an additional tax. Amounts withheld under the backup withholding rules may be credited against a U.S. Holder's U.S. tax liability, and a U.S. Holder may obtain a refund of any excess amounts withheld under the backup withholding rules by filing the appropriate claim for refund with the IRS. Any U.S. Holder who holds 10% or more in vote or value of our Ordinary Shares will be subject to certain additional United States information reporting requirements. U.S. Gift and Estate Tax An individual U.S. Holder of Ordinary Shares will be subject to U.S. gift and estate taxes with respect to Ordinary Shares in the same manner and to the same extent as with respect to other types of personal property. F. Dividends and Paying Agents. Not applicable. G. Statements by Experts. Not applicable. H. Documents on Display. The Company is subject to the informational requirements of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and, accordingly, it files reports and other information with the Securities and Exchange Commission (the "SEC"). Individuals can inspect and copy those reports and other information at the public reference facilities maintained by the SEC at Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549 and at the following Regional Offices of the SEC: Northwestern Atrium Center, 500 West Madison Street, Suite 1400, 14th Floor, Chicago, Illinois 60661; and Seven World Trade Center, 13th Floor, New York, New York 10048. You can obtain copies of such material at prescribed rates from the Public Reference Section of the SEC, 450 Fifth Street, N.W., Washington, D.C. 20549. Individuals can also obtain reports and other information from the Internet site maintained by the SEC at http://www.sec.gov. In addition, documents referred to in this 20-F filing are available, at no cost, upon request from Robi Hartman, Chief Executive Officer, I.I.S. Intelligent Information Systems Limited, 33 Jabotinsky Street, Ramat Gan, Israel (Tel. 972-3-751-0007). I. Subsidiary Information. Not applicable. 58 Item 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK - -------- ---------------------------------------------------------- In the normal course of business, the financial position of the Company is routinely subjected to a variety of risks, including market risk associated with interest rate movements and currency rate movements on non-U.S. dollar denominated assets and liabilities. The Company regularly assesses these risks and has established policies and business practices to protect against the adverse effects of these and other potential exposures. As a result, the Company does not anticipate material losses in these areas. For purposes of specific risk analysis, the Company uses sensitivity analysis to determine the impacts that market risk exposures may have on the fair values of the Company's financial instruments. The financial instruments included in the sensitivity analysis consist of all of the Company's cash and cash equivalents. To perform sensitivity analysis, the Company assesses the risk of loss in fair values from the impact of hypothetical changes in interest rates and foreign currency exchange rates on market sensitive instruments. The market values for interest risk are computed based on the present value of future cash flows as impacted by the changes in rates attributable to the market risk being measured. The discount rates used for the present value computations were selected based on market interest rates in effect at December 31, 2001. The market values for foreign exchange risk are computed based on spot rates in effect at December 31, 2001. The market values that result from these computations are compared to the market values of these financial instruments at June 30, 2001. The differences in this comparison are the hypothetical gains or losses associated with each type of risk. The results of the sensitivity analysis are as follows: Interest Rate Risk: A 10% decrease or a 10% increase in the levels of interest rates with all other variables held constant would not materially affect the earnings, cash flow and fair value of the Company's financial instruments at December 31, 2001. Foreign Currency Exchange Rate Risk: A 10% movement in levels of foreign currency exchange rates against the U.S. dollar with all other variables held constant would not materially affect the earnings, cash flow and fair value of the Company's financial instruments at December 31, 2001. Item 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES - -------- ------------------------------------------------------ Not applicable. 59 PART II Item 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES - -------- ----------------------------------------------- Not applicable. Item 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF - -------- ------------------------------------------------------------------- PROCEEDS -------- Not applicable. Item 15. [Reserved] - -------- Item 16. [Reserved] - -------- PART III Item 17. FINANCIAL STATEMENTS - -------- -------------------- Not applicable. Item 18. FINANCIAL STATEMENTS - -------- -------------------- Attached. See Item 19(a) and (b). Item 19. FINANCIAL STATEMENTS AND EXHIBITS - -------- ---------------------------------
(a) Index to Financial Statements of the Company: Page ---- Report of Independent Auditors on Consolidated Financial Statements of the Company and its subsidiaries..................................F-2 Consolidated Balance Sheets at December 31, 2001 and 2000..............................F-3 - F-4 Consolidated Statements of Operations for the Three Years ended December 31, 2001.........................................................................F-5 Consolidated Statements of Changes in Shareholders' Equity for the Three Years ended December 31, 2001...............................................F-6 Consolidated Statements of Cash Flows for the Three Years ended December 31, 2001...................................................................F-7 - F-8 Notes to the Consolidated Financial Statements........................................F-9 - F-30
60
(b) Index to Financial Statements of the StoreAge Networking Technologies Ltd.: Page ---- Report of Independent Auditors on Consolidated Financial Statements of StoreAge and its subsidiaries.......................................2 Consolidated Balance Sheets at December 31, 2001 and 2000..................................3 - 4 Consolidated Statements of Operations for the Two Years ended December 31, 2001...........................................................................5 Consolidated Statements of Changes in Shareholders' Equity for the Two Years ended December 31, 2001...................................................6 Consolidated Statements of Cash Flows for the Two Years ended December 31, 2001...........................................................................7 Notes to the Consolidated Financial Statements............................................8 - 24
All schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are inapplicable and therefore have been omitted. (c) Exhibits 1.1 Memorandum of Association of the Company.* 1.2 Articles of Association of the Company, Amended and Restated as of November 19, 2000.** 4.1 Purchase and Assignment agreement between the Company and Eastek Embedded Systems (Meitav) Ltd., dated November 30, 2000.** 4.2 Employment Agreement of Danny Shavit, dated November 30, 2000.** 4.3 Summary English Translation from the original Hebrew of a Lease Agreement entered into between the Company and West End Technology Investments Ltd., for office space located at 33 Jabotinsky Street, Ramat Gan, Israel, dated January 30, 2001.** 4.4 Shareholders' Rights Agreement dated as of January 18, 2001 between the Company, StoreAge and certain investors.** 4.5 Research & Development Subcontracting Agreement effective as of October 15, 2000, between the Company and StoreAge Networking Technologies Ltd. 8.1 List of significant subsidiaries of the Company. 10.1 Consent of Kost Forer and Gabbay, a Member of Ernst & Young International. 10.2 Consent of Kost Forer and Gabbay, a Member of Ernst & Young International. * Incorporated by reference to Exhibit 3.2 to the Company's Registration Statement No. 33-62862 dated August 10, 1993. ** Incorporated by reference to the corresponding exhibit to the Company's Annual Report on Form 20-F for the year ended December 31, 2000. 61 SIGNATURES The Registrant hereby certifies that it meets all of the requirements for filing on Form 20-F and that it has duly caused and authorized the undersigned to sign this Annual Report on its behalf. I.I.S. INTELLIGENT INFORMATION SYSTEMS LIMITED (Registrant) By: /s/ Robi Hartman ------------------------------------- Robi Hartman, Chief Executive Officer Date: June 27, 2002 I.I.S. INTELLIGENT INFORMATION SYSTEMS LIMITED AND ITS SUBSIDIARIES CONSOLIDATED FINANCIAL STATEMENTS AS OF DECEMBER 31, 2001 IN U.S. DOLLARS INDEX Page ---------- Report of Independent Auditors F-2 Consolidated Balance Sheets F-3 - F-4 Consolidated Statements of Operations F-5 Statements of Changes in Shareholders' Equity F-6 Consolidated Statements of Cash Flows F-7 - F-8 Notes to Consolidated Financial Statements F-9 - F-30 ---------- [LOGO] Ernst & Young Kost Forer & Gabbay Phone: 972-3-6232525 3 Aminadav St. Fax: 972-3-5622555 Tel-Aviv 67067, Israel REPORT OF INDEPENDENT AUDITORS To the Shareholders of I.I.S. INTELLIGENT INFORMATION SYSTEMS LIMITED We have audited the accompanying consolidated balance sheets of I.I.S. Intelligent Information Systems Limited ("the Company") and its subsidiaries as of December 31, 2001 and 2000, and the related consolidated statements of operations, changes in shareholders' equity and cash flows for each of the three years in the period ended December 31, 2001. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by 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, 2001 and 2000, and the consolidated results of their operations and cash flows for each of the three years in the period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States. Tel-Aviv, Israel /s/ Kost Forer & Gabbay March 21, 2002 KOST FORER & GABBAY A Member of Ernst & Young Global F-2 I.I.S. INTELLIGENT INFORMATION SYSTEMS LIMITED AND ITS SUBSIDIARIES CONSOLIDATED BALANCE SHEETS - -------------------------------------------------------------------------------- U.S. dollars in thousands December 31, --------------- 2001 2000 ------ ------ ASSETS CURRENT ASSETS: Cash and cash equivalents $1,556 $3,077 Restricted deposit -- 600 Trade receivables 13 43 Affiliate 21 79 Other accounts receivable and prepaid expenses (Note 3) 109 45 ------ ------ Total current assets 1,699 3,844 - ----- ------ ------ SEVERANCE PAY FUND 10 32 ------ ------ INVESTMENT IN AN AFFILIATE (Note 4) 1,250 2,127 ------ ------ PROPERTY AND EQUIPMENT, NET (Note 5) 88 63 ------ ------ WORK FORCE, NET (Note 6) 186 283 ------ ------ $3,233 $6,349 ====== ====== The accompanying notes are an integral part of the consolidated financial statements. F-3 I.I.S. INTELLIGENT INFORMATION SYSTEMS LIMITED AND ITS SUBSIDIARIES CONSOLIDATED BALANCE SHEETS - -------------------------------------------------------------------------------- U.S. dollars in thousands (except share data)
December 31, ------------------- 2001 2000 -------- -------- LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES: Current maturities of long-term bank loans (Note 8a) $ 10 $ 10 Trade payables 119 177 Other accounts payable and accrued expenses (Note 7) 546 1,403 -------- -------- Total current liabilities 675 1,590 - ----- -------- -------- LONG-TERM LIABILITIES: Long-term bank loans, net of current maturities (Note 8a) 1 11 Convertible debentures (Note 8b) -- 2,828 Accrued severance pay 22 38 -------- -------- Total long-term liabilities 23 2,877 - ----- -------- -------- COMMITMENTS AND CONTINGENCIES (Note 9) SHAREHOLDERS' EQUITY: (Note 10) Ordinary shares of NIS 0.003 par value Authorized: 16,666,667 shares as of December 31, 2001 and 2000; Issued and outstanding: 11,428,436 and 8,987,324 shares as of December 31, 2001 and 2000, respectively; 55 54 Additional paid-in capital 41,419 37,435 Receivables on account of shares -- (16) Deferred stock compensation (89) (222) Accumulated deficit (38,850) (35,369) -------- -------- Total shareholders' equity 2,535 1,882 - ----- -------- -------- $ 3,233 $ 6,349 ======== ========
The accompanying notes are an integral part of the consolidated financial statements. F-4 I.I.S. INTELLIGENT INFORMATION SYSTEMS LIMITED AND ITS SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS - -------------------------------------------------------------------------------- U.S. dollars in thousands (except share data)
Year ended December 31, --------------------------- 2001 2000 1999 ------- ------- ------- Revenues: (Note 12) Products $ 83 $ 96 $ 5,408 Revenues from related party 251 -- -- Maintenance and other services -- -- 547 ------- ------- ------- 334 96 5,955 ------- ------- ------- Cost of revenues: Products 28 27 4,484 Revenues from related party 155 -- -- Maintenance and other services -- -- 429 ------- ------- ------- 183 27 4,913 ------- ------- ------- Gross profit 151 69 1,042 ------- ------- ------- Operating expenses: Research and development, net (Note 14a) 479 925 686 Selling and marketing 21 639 1,417 General and administrative 888 899 1,777 Restructuring and reorganization (Note 1) -- -- 467 Non recurring income (Note 9c) (180) -- -- ------- ------- ------- Total operating expenses 1,208 2,463 4,347 - ----- ------- ------- ------- Operating loss (1,057) (2,394) (3,305) Financial income (expenses), net from operations (56) 277 173 Financial expenses in respect of conversion of convertible debentures (Note 8b) (1,491) -- -- ------- ------- ------- Financial income (expenses),net (Note 14b) (1,547) 277 173 Other expenses, net (Note 14c) -- (12) (1,770) ------- ------- ------- Loss before equity in losses of an affiliate and minority interest in losses of subsidiary (2,604) (2,129) (4,902) Equity in losses of an affiliate (877) -- -- Minority interest in losses of subsidiary -- 740 55 ------- ------- ------- Net loss $(3,481) $(1,389) $(4,847) ======= ======= ======= Basic and diluted net loss per share $ (0.37) $ (0.16) $ (0.55) ======= ======= ======= Number of shares used in computing basic and diluted net loss per share (in thousands) 9,409 8,901 8,860 ======= ======= =======
The accompanying notes are an integral part of the consolidated financial statements. F-5 I.I.S. INTELLIGENT INFORMATION SYSTEMS LIMITED AND ITS SUBSIDIARIES STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY - -------------------------------------------------------------------------------- U.S. dollars in thousands (except share data)
Share capital Additional Receivables Deferred ------------------- paid-in on account stock Shares Amount capital of shares compensation ---------- ------ ---------- ----------- ------------ Balance as of January 1, 1999 8,860,394 $ 54 $33,874 $ -- $ -- Comprehensive loss: Foreign currency translation adjustments -- -- -- -- -- Net loss -- -- -- -- -- Total comprehensive loss Compensation in respect of warrants issued upon settlement of lawsuit -- -- 2,809 -- -- Foreign currency translation adjustment due to realization of investment in subsidiaries -- -- -- -- -- ---------- ----- ------- ---- ----- Balance as of December 31, 1999 8,860,394 54 36,683 -- -- Comprehensive loss: Net loss -- -- -- -- -- Total comprehensive loss Issuance of shares upon acquisition of Eastek 80,000 (*-- 160 -- -- Issuance of warrants related to convertible debentures -- -- 147 -- -- Exercise of options 46,930 (*-- 208 (16) -- Deferred stock compensation related to shares in escrow issued upon acquisition of Eastek -- -- 237 -- (237) Amortization of deferred stock compensation -- -- -- -- 15 ---------- ----- ------- ---- ----- Balance as of December 31, 2000 8,987,324 54 37,435 (16) (222) Comprehensive loss: Net loss -- -- -- -- -- Total comprehensive loss Conversion of convertible debentures 1,797,464 1 2,426 -- -- Payments of receivable on account of shares -- -- -- 16 -- Exercise of warrants 613,648 (*-- 183 -- -- Vested shares of key employee 30,000 (*-- -- -- -- Amortization of deferred stock compensation -- -- -- -- 133 Stock based compensation related to options granted to employees of an affiliate -- -- 29 -- -- Beneficial conversion feature in respect of conversion of convertible debentures -- -- 1,346 -- -- ---------- ----- ------- ---- ----- Balance as of December 31, 2001 11,428,436 $ 55 $41,419 $ -- $ (89) ========== ===== ======= ==== ===== Accumulated other Total Total comprehensive Accumulated comprehensive shareholders' loss deficit loss equity ------------- ----------- ------------- ------------- Balance as of January 1, 1999 $(790) $(29,133) $ 4,005 Comprehensive loss: Foreign currency translation adjustments 73 -- $ 73 73 Net loss -- (4,847) (4,847) (4,847) ------- Total comprehensive loss $(4,774) ======= Compensation in respect of warrants issued upon settlement of lawsuit -- -- 2,809 Foreign currency translation adjustment due to realization of investment in subsidiaries 717 -- 717 ----- -------- ------- Balance as of December 31, 1999 -- (33,980) 2,757 Comprehensive loss: Net loss -- (1,389) $(1,389) (1,389) ------- Total comprehensive loss $(1,389) ======= Issuance of shares upon acquisition of Eastek -- -- 160 Issuance of warrants related to convertible debentures -- -- 147 Exercise of options -- -- 192 Deferred stock compensation related to shares in escrow issued upon acquisition of Eastek -- -- -- Amortization of deferred stock compensation -- -- 15 ----- --------- ------- Balance as of December 31, 2000 -- (35,369) 1,882 Comprehensive loss: Net loss -- (3,481) $(3,481) (3,481) ------- Total comprehensive loss $(3,481) ======= Conversion of convertible debentures -- -- 2,427 Payments of receivable on account of shares -- -- 16 Exercise of warrants -- -- 183 Vested shares of key employee -- -- -- Amortization of deferred stock compensation -- -- 133 Stock based compensation related to options granted to employees of an affiliate -- -- 29 Beneficial conversion feature in respect of conversion of convertible debentures -- -- 1,346 ----- -------- ------- Balance as of December 31, 2001 $ -- $(38,850) $ 2,535 ===== ======== =======
*) Represents an amount lower than $1. The accompanying notes are an integral part of the consolidated financial statements. F-6 I.I.S. INTELLIGENT INFORMATION SYSTEMS LIMITED AND ITS SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS - -------------------------------------------------------------------------------- U.S. Dollars in thousands
Year ended December 31, --------------------------- 2001 2000 1999 ------- ------- ------- Cash flows from operating activities: - ------------------------------------- Net loss $(3,481) $(1,389) $(4,847) Adjustments to reconcile net loss to net cash used in operating activities: Gain on sale of investment in subsidiaries -- -- (996) Depreciation and amortization 127 151 146 Impairment of property and equipment -- -- 467 Amortization of deferred stock compensation 133 15 -- Stock based compensation related to options granted to employees of an affiliate 29 -- -- Loss (gain) on sale of property and equipment (1) 37 (43) Amortization of discount on convertible debentures 172 -- -- Minority interest in losses of subsidiaries -- (740) (55) Equity in losses of an affiliate 877 -- -- Beneficial conversion feature in respect of conversion of convertible debentures 1,346 -- -- Compensation in respect of warrants issued upon settlement of lawsuit -- -- 2,809 Decrease (increase) in trade receivables 30 (96) 1,396 Decrease (increase) in other accounts receivable and prepaid expenses (6) 11 (220) Decrease (increase) in inventories -- (102) 785 Increase (decrease) in trade payables (58) 199 (411) Decrease in other accounts payable and accrued expenses (857) (63) (659) Decrease in provision for warranties -- -- (47) Accrued severance pay, net 6 (58) (517) ------- ------- ------- Net cash used in operating activities (1,683) (2,035) (2,192) ------- ------- ------- Cash flows from investing activities: - ------------------------------------- Proceeds from sale of property and equipment 1 3 93 Purchase of property and equipment (55) (446) (131) Investment in restricted deposit -- (600) -- Proceeds from restricted deposit 600 -- -- Proceeds from sale of investment in subsidiaries, net of cash in the subsidiaries at the time they ceased being consolidated -- -- 825 De-consolidation of previously consolidated subsidiary -- (4,228) -- ------- ------- ------- Net cash provided by (used in) investing activities 546 (5,271) 787 ------- ------- -------
The accompanying notes are an integral part of the consolidated financial statements. F-7 I.I.S. INTELLIGENT INFORMATION SYSTEMS LIMITED AND ITS SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS - -------------------------------------------------------------------------------- U.S. Dollars in thousands
Year ended December 31, -------------------------- 2001 2000 1999 ------- ------- ------ Cash flows from financing activities: - ------------------------------------- Proceeds from issuance of Preferred shares of subsidiary to third party, net -- -- 3,122 Exercise of options -- 192 -- Payments of receivable on account of shares 16 -- -- Issuance of warrants related to convertible debentures -- 147 -- Exercise of warrants 183 -- -- Proceeds from long-term bank loans -- 29 61 Repayment of long-term bank loans (10) (95) (129) Repayment of convertible debentures (573) -- -- Short-term bank credit, net -- (68) -- Proceeds from issuance of convertible debentures, net -- 2,828 -- ------- ------- ------ Net cash provided by (used in) financing activities (384) 3,033 3,054 ------- ------- ------ Effect of exchange rate changes on cash and cash equivalents -- -- 40 ------- ------- ------ Increase (decrease) in cash and cash equivalents (1,521) (4,273) 1,689 Cash and cash equivalents at the beginning of the year 3,077 7,350 5,661 ------- ------- ------ Cash and cash equivalents at the end of the year $ 1,556 $ 3,077 $7,350 ======= ======= ====== Non-cash transactions: - ---------------------- Conversion of convertible debentures $ 2,427 $ -- $ -- ======= ======= ====== Issuance of shares upon acquisition of Eastek: - ---------------------------------------------- Estimated fair value of assets acquired and liabilities assumed at the date of acquisition: Working capital deficiency (excluding cash and cash equivalents) $ (30) Property and equipment 15 Work force 291 Long-term liabilities (116) ------- Issuance of share capital $ 160 ======= Supplemental disclosure of cash flows activities: - ------------------------------------------------- Interest paid during the year $ 145 $ 20 $ 39 ======= ======= ======
The accompanying notes are an integral part of the consolidated financial statements. F-8 I.I.S. INTELLIGENT INFORMATION SYSTEMS LIMITED AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- U.S. dollars in thousands (except shares and per share data) NOTE 1:- GENERAL a.. Until late 1998, I.I.S. Intelligent Information Systems Limited ("IIS" or the "Company") was engaged in the development, manufacturing, marketing and servicing of data communications and intelligent peripheral products targeted at the International Business Machines ("IBM") midrange, IBM mainframe and open systems computing environments. The Company holds a 38.9% interest in StoreAge Networking Technologies ("StoreAge"), an Israeli company, which is engaged in the development and marketing of products based on its SAN Virtualization technology (see b below). The Company currently designs, develops and provides enterprise storage solutions for the Internet Small Computer Systems Interface ("iSCSI"). The Company's products are customized software implementation projects for the development and integration of iSCSI interface into existing storage devices and a family of comprehensive IP storage testing tools, for iSCSI protocol analysis of SAN devices. In late 1998, the Company implemented a restructuring plan (the "Restructuring Plan"), which resulted in the disposal of most of the assets of the Company, substantial changes in the Company's structure and a focus exclusively on storage area networking ("SAN"). In January 1999, the Company divested itself of its 62.3% equity interest in NetWiz Ltd., an Israeli development-stage company ("NetWiz"). In the transaction, it transferred its entire interest in NetWiz to a non-affiliated third party and such non-affiliated third party assumed all liabilities associated with such interest. The divestiture required from the Company an expenditure of $945. Net gain realized as a result of the sale of NetWiz amounted to $616. In February 1999, the Company disposed of its networking products and network integration services division, which is comprised of Adanet Communications, Ltd. ("Adanet"), an Israeli company, which the Company acquired in June 1994, and I.I.S Computer Maintenance and Services (1983) Limited ("I.I.S Maintenance"), an Israeli company. The Company realized net proceeds of $1,506 and a net gain of $175 as a result of the sale of Adanet and I.I.S Maintenance. In March 1999, the Company sold most of the assets and liabilities of its Decision Data Division ("Decision Data") which comprises all of the Company's U.S., United Kingdom and Germany operations. The Company realized net proceeds of $2,487 and a net gain of $205 as a result of the sale of Decision Data. During 1999, the Company recorded restructuring charges of approximately $467. The restructuring cost consist of impairment of property and equipment. b. In January 1999, StoreAge was organized as a wholly-owned subsidiary of IIS and commenced the development and marketing of products based on its SAN Virtualization technology, accordingly, on January 1, 1999, IIS transferred to StoreAge all of its know-how, operations, assets and liabilities in the area of storage in return for the entire share capital of StoreAge. F-9 I.I.S. INTELLIGENT INFORMATION SYSTEMS LIMITED AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- U.S. dollars in thousands (except shares and per share data) NOTE 1:- GENERAL (cont.) In late 1999, 707,558 Preferred A shares of StoreAge were issued to outside investors for a total net consideration of $3,122. Accordingly, the Company's equity interest in StoreAge was reduced to 58.56%. The excess of the value of the investment in StoreAge derived from the issuance of Preferred shares by StoreAge to outside investors, over the amount invested, in the amount of $2,236 was recorded as a quasi-equity item, Preferred shares of a subsidiary. In December 2000, 4,259,268 Preferred B shares of StoreAge were issued for a total consideration of $14,000. The Company has invested $4,220, of which $543 was made by the conversion of a loan, given to StoreAge during 1999, in exchange of 1,283,866 Preferred B shares. Accordingly, the Company's equity interest in StoreAge was reduced to 49%. Thus StoreAge's operations were de-consolidated since December 2000, and the Company's investment in StoreAge was accounted for in accordance with the equity method. In January 2001 as part of the aforementioned financing round, StoreAge issued additional 3,346,567 Preferred B shares for a total consideration of $11,000. The Company's equity interest in StoreAge was reduced to 39% and no gain or loss from reduction of holdings was created (see Note 4). c. During November 2000, the Company acquired all the activities, assets and rights, and assumed certain obligations of Eastek Embedded Systems (Meitav) Ltd. ("Eastek"), a private Israeli software company, to enhance its research and development capabilities in order to develop synergetic software solutions for the SAN market. In consideration of this acquisition the Company issued 80,000 Ordinary shares of the Company, of which 20,000 shares were deposited with a trustee and were delivered twelve months after the closing. The Company also granted a key employee of Eastek 100,000 shares as an incentive to his employment with the Company. The shares are held in escrow and being released annually in three installments of 30,000, 35,000 and 35,000 shares (see Note 10c). The transaction was accounted for by the purchase method of accounting whereby the purchase price of the Eastek acquisition was allocated based on the fair value of assets acquired and liabilities assumed. Eastek's operations were consolidated as of the date of acquisition. The excess cost over the fair value of net assets acquired amounting $291 was allocated to the assembled work force and it is being amortized on a straight-line basis over a three-year period (see Note 2h). F-10 I.I.S. INTELLIGENT INFORMATION SYSTEMS LIMITED AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- U.S. dollars in thousands (except shares and per share data) NOTE 1:- GENERAL (cont.) The following represents the unaudited pro-forma results of operations for the years ended December 31, 2000 and 1999 assuming that the Eastek acquisition had been consummated as of January 1, 2000 and January 1, 1999, respectively: Year ended December 31, ----------------------- 2000 1999 ------- ------- Sales $ 283 $ 6,283 ======= ======= Net loss $(1,465) $(4,897) ======= ======= Basic and diluted net loss per share $(0.16) $ (0.55) ======= ======= d. In December 2000, the Company completed a private placement of $3,000 in the issuance of convertible subordinated debentures and warrants to qualified investors. The net proceeds from the offering were used to fund the Company's investment in StoreAge's second round of financing (see Note 8b). In December 2001, the Company signed an agreement with its lenders according to which the Company converted $2,427 of the principal amount into 1,797,464 Ordinary shares at a price per share of $1.35 and prepaid the remaining principal in the amount of $573. In addition, the lenders agreed to the cancellation of the warrants granted as part of the convertible debentures agreement (see Note 8b). e. During 2000, the Company signed an agreement with its affiliate StoreAge according to which the Company will provide StoreAge iSCSI capabilities to StoreAge's products in consideration of $200, according to the milestones defined in the agreement. During 2001, the Company and StoreAge agreed to extend this agreement by additional $70. As of December 31, 2001, the Company recorded revenues of $251 related to these services (see Note 2k). StoreAge participates in the Company's general and administrative expenses based on services the Company provides to StoreAge. F-11 I.I.S. INTELLIGENT INFORMATION SYSTEMS LIMITED AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- U.S. dollars in thousands (except shares and per share data) NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES The consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States ("U.S. GAAP"). a. Use of estimates: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. b. Financial statements in U.S. dollars: The functional currency of the Company and its subsidiaries is the U.S. dollar ("dollar"), as the dollar is the primary currency of the economic environment in which the Company and its subsidiaries have operated and expect to continue to operate in the foreseeable future. The majority of the Company's operations is currently conducted in Israel and most of the Israeli expenses are currently paid in New Israeli Shekels ("NIS"); however, most of the expenses are denominated and determined in dollars. Financing and investing activities including loans, equity transactions and cash investments, are made in dollars. Accordingly, monetary accounts maintained in currencies other than the dollar are remeasured into dollars in accordance with Statement of Financial Accounting Standard ("SFAS No. 52") "Foreign Currency Translation". All transactions gains and losses of the remeasurement of monetary balance sheet items are reflected in the statement of operations as financial income or expenses, as appropriate. The affiliate's transactions are recorded in new Israeli Shekels ("NIS"); however, the majority of the revenues of the affiliate and its subsidiary are generated in dollars. In addition, a substantial portion of the affiliate's costs is incurred in dollars. Thus, the functional and reporting currency of the affiliate and its subsidiary is the dollar. The financial statements of foreign subsidiaries whose functional currency is their local currency, have been translated into dollars. All balance sheet accounts have been translated using the exchange rates in effect at the balance sheet date. Statement of operations amounts have been translated using the average exchange rate for the period. The resulting translation adjustments are reported as a component of shareholders' equity, "Accumulated other comprehensive loss". c. Principles of consolidation: The consolidated financial statements of the Company include the accounts of the Company and its subsidiaries. Intercompany balances and transactions have been eliminated upon consolidation. F-12 I.I.S. INTELLIGENT INFORMATION SYSTEMS LIMITED AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- U.S. dollars in thousands (except shares and per share data) NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (cont.) d. Cash equivalents: The Company considers all highly liquid investments that are readily convertible to cash with original maturities of three months or less to be cash equivalents. e. Investment in an affiliate: Investments in affiliate are investments in companies held to the extent of 20% or more (which are not subsidiaries), in which the Company can exercise significant influence over operating and financial policy. The investment in affiliates is accounted for by the equity method of accounting and in accordance with EITF 99-10 "Percentage Used to Determine the Amount of Equity Method Losses" which requires that an investor should recognize equity method losses based on the ownership level of the particular investee security held by the investor, or the change in the investor's claim on the investee's book value. f. Restricted deposit: The restricted deposit pertained to the security for the settlement of a lawsuit (see Note 9). g. Property and equipment: Property and equipment are stated at cost, net of accumulated depreciation. Depreciation is calculated by the straight-line method over the estimated useful lives of the assets, at the following annual rates: % ------- Machinery and equipment 10 - 33 Office furniture and equipment 6 - 10 Motor vehicles 15 The Company and its subsidiaries periodically assess the recoverability of the carrying amount of property and equipment and provide for any possible impairment loss based upon the difference between the carrying amount and fair value of such assets in accordance with Statement of Financial Accounting Standards ("SFAS") No. 121 "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of". As of December 31, 2001, no impairment losses have been identified. F-13 I.I.S. INTELLIGENT INFORMATION SYSTEMS LIMITED AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- U.S. dollars in thousands (except shares and per share data) NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (cont.) h. Work force: The work force is stated at cost, net of accumulated amortization. Amortization is calculated by the straight-line method over the estimated useful life (three years). The carrying value of the work force is periodically reviewed by management, based on the expected future undiscounted operating cash flows over the remaining amortization period of the work force. If this review indicates that the work force will not be recoverable, the carrying value of the work force is reduced to the estimated fair value. As of December 31, 2001, no impairment losses have been identified. i. Research and development costs: Statement of Financial Accounting Standards No. 86 "Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed", requires capitalization of certain software development costs subsequent to the establishment of technological feasibility. Based on the Company's product development process, technological feasibility is established upon completion of a working model. The Company does not incur material costs between the completion of the working model and the point at which the products are ready for general release. Therefore, research and development costs are charged to the statement of operations as incurred. j. Royalty-bearing grants: Royalty-bearing grants from the Office of the Chief Scientist ("OCS") for funding approved research and development projects are recognized at the time the Company and its subsidiaries are entitled to such grants, on the basis of the related costs incurred. Such grants are recorded as a reduction of research and development costs (see Note 14a). k. Revenue recognition: The Company and its subsidiaries have derived revenues from research and development services to an affiliate, licensing fees for its products, maintenance and hardware. The Company sells its products primarily through its direct sales force. Research and development services to an affiliate are recognized according to milestones determined in an agreement. F-14 I.I.S. INTELLIGENT INFORMATION SYSTEMS LIMITED AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- U.S. dollars in thousands (except shares and per share data) NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (cont.) Revenue from software license agreements are recognized when all criteria outlined in Statement Of Position (SOP) 97-2 "Software Revenue Recognition" (as amended) are met. Therefore, revenue from license fees is recognized when persuasive evidence of an agreement exists, delivery of the product has occurred, no significant obligations with regard to implementation remain, the fee is fixed or determinable and collectability is probable. The Company generally does not grant a right of return to its customers. If the fee is not fixed or determinable, revenues are recognized as payments become due from the customer provided that all other revenue recognition criteria have been met. Revenues from hardware sales are recognized when persuasive evidence of an agreement exists, delivery of the product has occurred, the fee is fixed or determinable, and collectability is probable. l. Concentrations of credit risk: Financial instruments that potentially subject the Company and its subsidiaries to concentrations of credit risk consist principally of cash and cash equivalents, restricted deposit, trade receivables and affiliate. The Company's cash and cash equivalents and restricted deposit are deposited in major banks in Israel and in the U.S. Such deposits in the U.S. may be in excess of insured limits and are not insured in other jurisdictions. Management believes that the financial institutions that hold the Company and its subsidiaries' investments are financially sound and, accordingly, minimal risk exists with respect to these investments. The trade receivables of the Company and its subsidiaries are mainly derived from sales to customers located primarily in the U.S., Europe and Israel. The Company performs ongoing credit evaluations of its customers and, to date, has not experienced any material losses. An allowance for doubtful accounts is determined with respect to those amounts that the Company has determined to be doubtful of collection. As of December 31, 2001, no allowance for doubtful accounts was provided. The Company has no significant off-balance-sheet concentration of credit risk such as foreign exchange contracts, option contracts or other foreign hedging arrangements. m. Basic and diluted net loss per share: Basic net loss per share is computed based on the weighted average number of Ordinary shares outstanding during each year. Diluted net loss per share is computed based on the weighted average number of Ordinary shares outstanding during each year, plus dilutive potential Ordinary shares considered outstanding during the year, in accordance with Statement of Financial Accounting Standard No. 128, "Earnings Per Share" ("SFAS No. 128"). F-15 I.I.S. INTELLIGENT INFORMATION SYSTEMS LIMITED AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- U.S. dollars in thousands (except shares and per share data) NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (cont.) All outstanding convertible debentures, stock options and warrants have been excluded from the calculation of the diluted net loss per Ordinary share because all such securities are antidilutive for all periods presented. The total weighted average number of Ordinary shares related to convertible debentures, options and warrants excluded from the calculation of diluted net loss per share were 1,109,328, 1,570,193 and 687,808 for the years ended December 31, 2001, 2000 and 1999, respectively. n. Severance pay: The Company's liability for severance pay is calculated pursuant to the Israeli Severance Pay Law based on the most recent salary of the employees multiplied by the number of years of employment as of the balance sheet date. Employees are entitled to one month's salary for each year of employment, or a portion thereof. The Company's liability is fully provided by monthly deposits into severance pay funds, insurance policies and by an accrual. The value of these policies is recorded as an asset in the Company's balance sheet. The deposited funds include profits accumulated up to the balance sheet date. The deposited funds may be withdrawn only upon the fulfillment of the obligations pursuant to Israeli severance pay law or labor agreements. The value of the deposited funds are based on the cash surrendered value of these policies and include immaterial profits. Severance pay expenses for the years ended December 31, 2001, 2000 and 1999 amount to approximately, $33, $81 and $292, respectively. o. Accounting for stock based compensation: The Company has elected to follow Accounting Principles Board Opinion No. 25 "Accounting for Stock Issued to Employees" ("APB 25") and FASB Interpretation No. 44 "Accounting for Certain Transactions Involving Stock Compensation" ("FIN 44") in accounting for its employee stock option plans. Under APB 25, when the exercise price of the Company's share options is less than the market price of the underlying shares on the date of grant, compensation expense is recognized. The pro forma disclosures required by SFAS No. 123 "Accounting for Stock-Based Compensation" ("SFAS No. 123") are provided in Note 10. The Company applies SFAS No. 123 and Emerging Issues Task Force No. 96-18 "Accounting for Equity Instruments That are Issued to Other than Employees for Acquiring, or in Conjunction with Selling, Goods or Services" ("EITF 96-18") with respect to options issued to non-employees and affiliate employees (see Note 10c). SFAS No. 123 requires the use of an option valuation model to measure the fair value of the options at the date of grant. F-16 I.I.S. INTELLIGENT INFORMATION SYSTEMS LIMITED AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- U.S. dollars in thousands (except shares and per share data) NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (cont.) p. Income taxes: The Company and its subsidiaries account for income taxes in accordance with Statement of Financial Accounting Standard No. 109, "Accounting for Income Taxes" ("SFAS No. 109"). This Statement prescribes the use of the liability method, whereby deferred tax asset and liability account balances are determined based on differences between the financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. The Company and its subsidiaries provide a valuation allowance, if necessary, to reduce deferred tax assets to their estimated realizable value. q. Fair value of financial instruments: The following methods and assumptions were used by the Company and its subsidiaries in estimating their fair value disclosure for financial instruments: The carrying values of cash and cash equivalents, restricted deposit, trade receivables, affiliate and trade payables approximate their fair value due to the short-term maturity of such instruments. Convertible debentures and long-term bank loans - the carrying amounts reported in the balance sheet approximate their fair value. Fair values were estimated using discounted cash flow analyses, based on the Company's incremental borrowing rates for similar types of borrowing arrangements. r. Impact of recently issued accounting standards: 1. In July 2001, the Financial Accounting Standards Board, issued Statement of Financial Accounting Standard No. 141 "Business Combinations" ("SFAS 141") and Statement of Financial Accounting Standard No. 142 "Goodwill and Other Intangible Assets" ("SFAS 142"). SFAS 141 requires all business combinations initiated after June 30, 2001 to be accounted for using the purchase method. Under SFAS 142, goodwill and intangible assets with indefinite lives are no longer amortized but are reviewed annually (or more frequently if impairment indicators arise) for impairment. Separable intangible assets that are not deemed to have indefinite lives will continue to be amortized over their useful lives (but with no maximum life). The amortization provisions of SFAS 142 apply to goodwill and intangible assets acquired after June 30, 2001. With respect to goodwill and intangible assets acquired prior to July 1, 2001, the Company is required to adopt SFAS 142 effective January 1, 2002. The Company will apply the new rules on accounting for goodwill and other intangible assets beginning in the first quarter of 2002. F-17 I.I.S. INTELLIGENT INFORMATION SYSTEMS LIMITED AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- U.S. dollars in thousands (except shares and per share data) NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (cont.) Application of the non-amortization provision of the statements is expected to result in a decrease in the net loss of $97 and $89 for 2002 and 2003, respectively, and a decrease in the net loss per share of $0.01 per year. The Company will reclassify an assembled workforce intangible asset with the unamortized balance of $186 to goodwill at the date of adoption. 2. In August 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("FAS 144"), which addresses financial accounting and reporting for the impairment or disposal of long-lived assets and superseded SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of", and the accounting and reporting provisions of APB Opinion No. 30, "Reporting the Results of Operations for a Disposal of a Segment of a Business". FAS 144 is effective for fiscal years beginning after December 15, 2001, with earlier application encouraged. The Company expects to adopt FAS 144 as of January 1, 2002 and it does not expect that the adoption of the Statement will have a significant impact on the Company's financial position and results of operations. NOTE 3:- OTHER ACCOUNTS RECEIVABLE AND PREPAID EXPENSES December 31, ------------ 2001 2000 ---- ---- Prepaid expenses $ 48 $30 Government authorities 13 12 Employees 48 -- Other -- 3 ---- --- $109 $45 ==== === F-18 I.I.S. INTELLIGENT INFORMATION SYSTEMS LIMITED AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- U.S. dollars in thousands (except shares and per share data) NOTE 4:- INVESTMENT IN AN AFFILIATE
December 31, ----------------- 2001 2000 ------- ------- Investment in StoreAge: Investment in Ordinary shares of affiliate in January, 1999 (representing 31% and 39% of voting rights as of December 31, 2001 and 2000, respectively) $(* -- $(* -- Investment in Preferred shares of affiliate in December, 2000 (representing 8% and 10% of voting rights as of December 31, 2001 and 2000, respectively) 4,220 4,220 Equity losses (2,970) (2,093) ------- ------- Total investment (representing 39% and 49% of voting rights as of December 31, 2001 and 2000, respectively) $ 1,250 $ 2,127 ======= =======
*) Represents an amount lower than $1. NOTE 5:- PROPERTY AND EQUIPMENT, NET Cost: Machinery and equipment $ 73 $ 29 Office furniture and equipment 74 70 Motor vehicles 47 47 ------- ------- 194 146 ------- ------- Accumulated depreciation: Machinery and equipment 21 2 Office furniture and equipment 58 60 Motor vehicles 27 21 ------- ------- 106 83 ------- ------- Depreciated cost $ 88 $ 63 ======= ======= Depreciation expenses for the years ended December 2001, 2000 and 1999 amounted to approximately $30, $143 and $146, respectively. As for charges, see Note 9b. F-19 I.I.S. INTELLIGENT INFORMATION SYSTEMS LIMITED AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- U.S. dollars in thousands (except shares and per share data) NOTE 6:- WORK FORCE, NET December 31, ------------ 2001 2000 ---- ----- Work force $291 $291 Less - accumulated amortization 105 8 ---- ----- Amortized cost $186 $283 ==== ===== Amortization expense (included in "General and administrative expenses") for the years ended December 2001 and 2000 amounted to $97 and $8, respectively. NOTE 7:- OTHER ACCOUNTS PAYABLE AND ACCRUED EXPENSES December 31, -------------- 2001 2000 ----- ------ Employees and payroll accruals $ 68 $ 44 Government authorities 13 8 Provision for litigation and others 313 931 Accrued expenses 152 420 ---- ------ $546 $1,403 ==== ====== NOTE 8:- FINANCING ARRANGEMENTS a. Long-term bank loans: December 31, ------------------------------------ 2001 2000 ----------------- ---------------- Interest Interest rate Amount rate Amount -------- ------ -------- ------ U.S. dollar 2.9% $11 7.3% $21 Less - current maturities 10 10 --- --- $ 1 $11 === === As for charges see Note 9b. F-20 I.I.S. INTELLIGENT INFORMATION SYSTEMS LIMITED AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- U.S. dollars in thousands (except shares and per share data) NOTE 8:- FINANCING ARRANGEMENTS (cont.) b. Convertible debentures: In December 2000, the Company issued to investors, convertible debentures and warrants to purchase 300,000 Ordinary shares in consideration of $3,000. The Debentures were convertible, all or in part, at any time in which these debentures were outstanding, into the Company's Ordinary shares, at a price per share of $3. The warrants granted were exercisable into the Company's Ordinary shares at any time until December 2003 at a price per share of $4.5. The discount on convertible debentures at the date of grant amounted to $145. The Company accounted for these convertible debentures in accordance with Emerging Issues Task Force No. 98-5 "Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios" ("EITF 98-5") and Emerging Issues Task Force No. 00-27 "Application of EITF Issue No. 98-5 to Certain Convertible Instruments" ("EITF 00-27"). There was no beneficial conversion feature at the date of grant. In December 2001, the Company signed an agreement with its lenders according to which the Company converted $2,427 of the principal amount into 1,797,646 Ordinary shares at a price per share of $1.35 and prepaid the remaining principal in the amount of $ 573. In addition, the lenders agreed to the cancellation of the warrants granted as part of the convertible debenture agreement. The Company accounted for the adjustments resulted from the inducement conversion offer of the debentures and the cancellation of the warrants in accordance with Statement of Financial Accounting Standard No. 84 "Induced Conversions of Convertible Debt" ("SFAS No. 84"). The Company recorded $1,346 as financial expenses related to the beneficial conversion feature from the induced conversion offer and additional $145 in respect of the discount on the convertible debentures. NOTE 9:- COMMITMENTS AND CONTINGENT LIABILITIES a. Litigation: 1. The Company, certain of its officers and directors and the underwriters of the Company's August 1993 public offering were defendants in a purported class action and two related cases which were filed in the United States District Court for the Eastern District of New York in September 1993, August 1994 and February 1995. The plaintiffs' complaints alleged that the Company violated Section 12(2) of the Securities Act of 1933, as well as Section 10(b) and Section 20 of the Securities Exchange Act of 1934 by failing to disclose early enough that revenues in both the Company's European and United States markets were declining and that the Company was struggling to maintain its growth margins at past levels. F-21 I.I.S. INTELLIGENT INFORMATION SYSTEMS LIMITED AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- U.S. dollars in thousands (except shares and per share data) NOTE 9:- COMMITMENTS AND CONTINGENT LIABILITIES (cont.) The plaintiffs also contended that the Company falsely stated that it had successfully integrated a newly acquired business, the Decision Data Division, into the Company's operations. On December 14, 1999, the Company entered into stipulations of settlement with the plaintiffs, which was approved by the court in 2000. The Class Action Settlement provides for the dismissal with prejudice of the Class Action and the release of all class actions against all defendants, in exchange for (i) a cash payment of $600 by the Company into an insured interest-bearing escrow fund, and (ii) delivery to the plaintiff class by the Company of newly issued freely tradable warrants with rights to purchase, in the aggregate, 886,039 Ordinary shares of the Company, at an exercise price of $0.3 per share. The warrants were issued in December 1999. The fair value for these warrants was estimated at the date of grant using the Black-Scholes option valuation model with the following weighted-average assumptions: risk-free interest rates of 6%, dividend yields of 0%, volatility factors of the expected market price of the Company's Ordinary shares of 1.369 and a weighted-average expected life of an option of one year. Compensation of $2,809 derived from the warrant was charged to "Other expenses" (see Note 14c). As of December 31, 2001, 613,648 of the settlement's warrants were exercised into the Company's Ordinary shares. 2. A suit was filed in Israel in 1995 against the Company and certain of its officers and directors alleging inadequate disclosure in prior years of the Company's financial position, results of operations and prospects, and damages in the amount of $250. The Company, based on the opinion of its legal counsels, does not believe that the outcome of these actions will have a material adverse effect on either its business operations or its financial position. The Company's legal counsels are unable to estimate the outcome of this suit. The Company also recorded an accrual in the amount of $250 in respect of this claim. 3. A claim was filed against NetWiz Ltd. (a former subsidiary of the Company) in respect of a breach of a lease agreement. As part of agreement for the sale of NetWiz, the Company agreed to assume the liabilities in respect of the above claim. The Company's legal counsels estimate that the Company's exposure does not exceed $50. The Company recorded an accrual in the amount of $50 in respect of this claim. b. Charges: The Company had recorded charges on some of its vehicles in favor of banks and lenders. F-22 I.I.S. INTELLIGENT INFORMATION SYSTEMS LIMITED AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- U.S. dollars in thousands (except shares and per share data) NOTE 9:- COMMITMENTS AND CONTINGENT LIABILITIES (cont.) c. Sales taxes: During 1999, the Company was obligated to pay sales taxes in U.S, in a total amount of $350, the Company recorded a full provision in respect of this commitment. In late 2001, the Company reached a compromise settlement with the tax authorities in U.S, according to which the obligation was reduced to $152. The Company recorded a non recurring income in the amount of $180. NOTE 10:- SHARE CAPITAL a. Ordinary shares: The Ordinary shares of the Company are quoted on NASDAQ in the United States. b. Warrants: 1. In 1997, the Company issued convertible debentures and warrants to purchase 200,000 Ordinary shares in consideration of $2,000. All of the debentures were converted during 1998 into 4,211,047 Ordinary shares. The warrants are exercisable into Ordinary shares at any time until December 2002 in consideration of $4.47 per share. 2. As part of the agreement for the dismissal of a lawsuit the Company issued warrants with right to purchase up to 886,039 of the Company's Ordinary shares with an exercise price of $0.3 (see Note 9a). c. Stock Option Plan: Under the Company's 1993 Stock Option Plan ("the Plan"), options may be granted to employees, officers, directors and consultants of the Company or of any subsidiary. The exercise price of options granted under the Plan may not be less than 85% of the fair market value of the Company's Ordinary shares on the date of the grant. The options granted shall vest annually over a period of three to four years, from the first vesting date and expire 6-10 years subsequent to the date of grant. Any options, which are forfeited or canceled before expiration, become available for future grants. The total amount of options available for future grants as of December 31, 2001, amounted to 126,126. As part of the acquisition of Eastek, the Company granted a key employee of Eastek 100,000 shares in escrow which will be released annually in three installments of 30,000 shares, 35,000 shares and 35,000 shares as an incentive to his employment with the Company. F-23 I.I.S. INTELLIGENT INFORMATION SYSTEMS LIMITED AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- U.S. dollars in thousands (except shares and per share data) NOTE 10:- SHARE CAPITAL (cont.) The Company accounted for this transaction in accordance with EITF 95-8 "Accounting for Contingent Consideration Paid to the Shareholders of an Acquired Enterprise in a Purchase Business Combination". Accordingly, the Company recorded deferred stock compensation in the amount of $237, to be amortized to the statement of operations over the vesting period. Amortization expenses in 2001, 2000 and 1999 amounted to $133, $15 and $0, respectively. A summary of the Company's stock option activity and related information:
2001 2000 1999 --------------------- --------------------- --------------------- Weighted Weighted Weighted average average average Number exercise Number exercise Number exercise of options price of options price of options price ---------- -------- ---------- -------- ---------- -------- Outstanding at the beginning of the year 1,148,150 $10.90 499,138 $19.08 664,635 $17.39 Granted 26,000 $ 3.62 716,050 $ 3.63 -- -- Exercised -- -- (46,930) $ 4.43 -- -- Forfeited (107,347) $31.67 (20,108) $15.91 (165,497) $12.12 --------- --------- ------- Outstanding at the end of the year 1,066,803 $ 7.77 1,148,150 $10.09 499,138 $19.08 ========= ========= ======= Exercisable at the end of the year 553,136 $11.61 488,650 $18.83 487,808 $19.44 ========= ========= =======
The options outstanding as of December 31, 2001, have been separated into ranges of exercise price, as follows:
Options Weighted Weighted Options Weighted Ranges of outstanding as of average average exercisable as of average exercise December 31, remaining exercise December 31, exercise price 2001 contractual life price 2001 price - --------------- ----------------- ---------------- -------- ----------------- -------- (Years) $3.63 740,050 5.02 $ 3.63 226,369 $ 3.63 $3.93 - $5.79 123,933 4.69 $ 5.48 123,933 $ 5.48 $6.06 - $8.82 112,967 3.15 $ 7.89 112,967 $ 7.89 $12.75 - $18.50 36,653 0.47 $18.49 36,667 $18.48 $24.00 - $28.89 5,000 2.34 $25.50 5,000 $25.50 $58.65 - $67.14 48,200 1.54 $66.94 48,200 $66.94 --------- ------- 1,066,803 4.45 $ 7.77 553,136 $11.61 ========= =======
F-24 I.I.S. INTELLIGENT INFORMATION SYSTEMS LIMITED AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- U.S. dollars in thousands (except shares and per share data) NOTE 10:- SHARE CAPITAL (cont.) Under SFAS No. 123, pro forma information regarding net income (loss) and net earnings (loss) per share is required and has been determined as if the Company had accounted for its employee stock option under the fair value method of that Statement. The fair value for these options was estimated at the date of grant using the Black-Scholes option valuation model with the following weighted-average assumptions for the years ended December 31, 2001 and 2000 (no options were granted during 1999): risk-free interest rates of 6% and 3%, respectively, dividend yields of 0% for each year, volatility factors of the expected market price of the Company's Ordinary shares of 1.25 and 0.96, respectively, and a weighted-average expected life of an option of four years for each year. Pro forma information under SFAS No. 123:
Year ended December 31, --------------------------- 2001 2000 1999 ------- ------- ------- Net loss as reported $(3,481) $(1,389) $(4,847) ======= ======= ======= Pro forma net loss $(3,850) $(1,674) $(4,905) ======= ======= ======= Pro forma basic and diluted net loss per share $ (0.41) $ (0.19) $ (0.55) ======= ======= =======
The total compensation expense included in the pro forma information for 2001, 2000 and 1999 is $369, $285 and $58, respectively. Weighted average fair values and weighted average exercise prices of options whose exercise price is equal or exceeds market price of the shares at date of grant are as follows:
Year ended December 31, --------------------------------------------------------------------------- 2001 2000 ----------------------------------- ------------------------------------- Weighted Weighted Weighted Weighted average fair average exercise average fair average exercise value of options price of options value of options price of options granted at granted at grants at exercise granted at exercise price exercise price price exercise price ---------------- ---------------- ------------------ ---------------- Equal to market price at date of grant $ -- $ -- $2.94 $3.63 ===== ===== ===== ===== Exceeds market price at date of grant $0.92 $3.62 $1.15 $3.63 ===== ===== ===== =====
For purposes of pro forma disclosure, the estimated fair value of the options is amortized as an expense over the options' vesting period. F-25 I.I.S. INTELLIGENT INFORMATION SYSTEMS LIMITED AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- U.S. dollars in thousands (except shares and per share data) NOTE 10:- SHARE CAPITAL (cont.) During 2000, as a result of the decrease in the Company's equity interest in StoreAge (see Note 1), and the de-consolidation of StoreAge, the status of StoreAge's employees was changed from employees to non-employees of the Company, in addition during 2001, three employees of the Company became StoreAge's employees. Options granted to abovementioned employees were remeasured at the date of change in status under the fair value method, according to FIN 44 "Accounting for Certain Transactions Involving Stock Compensation" and SFAS No. 123. The fair value for these options was estimated using the Black-Scholes option valuation model with the following weighted-average assumptions for October 2001 and May 2000: risk-free interest rates of 3% and 6% respectively , dividend yields of 0% for each date, volatility factors of the expected market price of the Company's Ordinary shares of 1.18 and 0.96, respectively, and a weighted-average expected life of an option of four years for each date. The weighted average fair value of these options is $0.93 and $1 per option, respectively. Compensation expenses of approximately $29 and $17 were recognized during the years ended December 31, 2001 and 2000, respectively. d. Dividends: Dividends, when declared, will be paid in NIS. Dividends paid to shareholders outside Israel will be converted into dollars, on the basis of the exchange rate prevailing at the date of payment. The Company does not intend to pay cash dividends in the foreseeable future. NOTE 11:- INCOME TAXES a. Tax benefits under the Law for the Encouragement of Industry (Taxes), 1969: The Company is an "industrial company", as defined by this law and, as such, is entitled to certain tax benefits, mainly accelerated depreciation of machinery and equipment, as prescribed by regulations published under the Inflationary Adjustments Law, the right to claim public issuance expenses and amortization of patents and other intangible property rights as a deduction for tax purposes. F-26 I.I.S. INTELLIGENT INFORMATION SYSTEMS LIMITED AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- U.S. dollars in thousands (except shares and per share data) NOTE 11:- INCOME TAXES (cont.) b. Measurement of taxable income under the Income Tax (Inflationary Adjustments) Law, 1985: Results of the Company and its Israeli subsidiaries for tax purposes are measured in terms of earnings in NIS after certain adjustments for increases in the Israeli Consumer Price Index ("CPI"). As explained in Note 2b, the financial statements are prepared in U.S. dollars. The difference between the annual change in the Israeli CPI and in the NIS/U.S. dollar exchange rate results in a difference between taxable income and the income before taxes reported in the financial statements. In accordance with paragraph 9(f) of SFAS No. 109, the Company and Israeli subsidiaries has not provided deferred income taxes on the difference between the reporting currency and the tax bases of assets and liabilities. c. Loss before equity in losses of an affiliate and minority interest in losses of subsidiary: Year ended December 31, ------------------------ 2001 2000 1999 ------ ------ ------ Domestic $2,604 $2,129 $4,014 Foreign -- -- 888 ------ ------ ------ $2,604 $2,129 $4,902 ====== ====== ====== d. Deferred income taxes: Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's deferred tax liabilities and assets are as follows:
December 31, ------------------- 2001 2000 -------- -------- Tax loss carryforward $ 27,440 $ 26,506 Reserves and allowances 9 7 -------- -------- Net deferred assets before valuation allowance 27,449 26,513 Valuation allowance (27,449) (26,513) -------- -------- Net deferred tax asset $ -- $ -- ======== ========
F-27 I.I.S. INTELLIGENT INFORMATION SYSTEMS LIMITED AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- U.S. dollars in thousands (except shares and per share data) NOTE 11:- INCOME TAXES (cont.) As of December 31, 2001, the Company and its subsidiaries have increased their valuation allowances from approximately $936 to approximately $27,449 in respect of deferred tax assets resulting from tax loss carryforwards and other temporary differences. Management currently believes that since the Company and its subsidiaries have a history of losses it is more likely than not that the deferred tax regarding the loss carryforwards and other temporary differences will not be realized in the foreseeable future. e. Tax loss carryforward: As of December 31, 2001, the Company has carryforward tax losses in the amount of approximately $76,211, which may be carried forward and offset against taxable income in the future for an indefinite period. NOTE 12:- CUSTOMERS AND GEOGRAPHIC INFORMATION The Company adopted Statement of Financial Accounting Standard No. 131, "Disclosures About Segments of an Enterprise and Related Information", ("SFAS No. 131"). The Company operates in one reportable segment (see Note 1 for a brief description of the Company's business). The total revenues are attributed to geographic areas based on the location of the end customer. The following presents total revenues for the years ended December 31, 2001, 2000 and 1999 and long-lived assets as of December 31, 2001, 2000 and 1999: Year ended December 31, ----------------------- 2001 2000 1999 ----- ----- ------ Sales and maintenance to unaffiliated customers: United States $ 19 $ 41 $3,867 Israel 64 40 1,611 Europe -- 15 477 ----- ----- ------ $ 83 $ 96 $5,955 ===== ===== ====== December 31, ---------------------- 2001 2000 1999 ----- ----- ------ Long-lived assets: Israel $ 274 $ 346 $ 431 ===== ===== ====== F-28 I.I.S. INTELLIGENT INFORMATION SYSTEMS LIMITED AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- U.S. dollars in thousands (except shares and per share data) NOTE 13:- RELATED PARTIES TRANSACTIONS The balances with, the revenues, services and expenses derived from related parties were as follows: a. Balances with related parties: December 31, ------------ 2001 2000 ---- ---- Other accounts receivable: StoreAge $21 $79 ==== ==== (*) The balance is linked to the $ and bears no interest. ii. Revenues, services and expenses from related parties:
Year ended December 31, ----------------------- 2001 2000 1999 ---- ---- ---- Revenues from related party $251 $ -- $-- ==== ==== === Related Party's participation in general and administrative expenses 108 123 73 ==== ==== === Rent to related party $ 35 $ -- $-- ==== ==== ===
NOTE 14:- SELECTED STATEMENTS OF OPERATIONS DATA a. Research and development expenses, net: Total costs $479 $1,328 $ 909 Less - royalty-bearing grants -- (403) (223) ---- ------ ----- $479 $ 925 $ 686 ==== ====== ===== F-29 I.I.S. INTELLIGENT INFORMATION SYSTEMS LIMITED AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- U.S. dollars in thousands (except shares and per share data) NOTE 14:- SELECTED STATEMENTS OF OPERATIONS DATA (cont.)
Year ended December 31, ----------------------- 2001 2000 1999 ------- ----- ----- b. Financial income (expenses), net: Interest income $ 131 $ 389 $ 289 ------- ----- ----- Financial expenses: Interest expenses (170) (67) (76) Foreign currency translation differences (17) (45) (40) Beneficial conversion feature and amortization of discount of convertible debentures (1,491) -- -- ------- ----- ----- (1,678) (112) (116) ------- ----- ----- $(1,547) $ 277 $ 173 ======= ===== ===== c. Other expenses, net: Compensation in respect of warrants issued upon settlement of lawsuit $ -- $ -- $2,809 Gain on sale of investment in subsidiaries -- -- (996) Other -- 12 (43) ------- ----- ------ $ -- $ 12 $1,770 ======= ===== ======
- - - - - - - - - - - - F-30 STOREAGE NETWORKING TECHNOLOGIES LTD. AND ITS SUBSIDIARY CONSOLIDATED FINANCIAL STATEMENTS AS OF DECEMBER 31, 2001 IN U.S. DOLLARS INDEX Page ---- Report of Independent Auditors 2 Consolidated Balance Sheets 3-4 Consolidated Statements of Operations 5 Statements of Changes in Shareholders' Equity 6 Consolidated Statements of Cash Flows 7 Notes to Consolidated Financial Statements 8-24 [LOGO] ERNST & YOUNG Kost Forer & Gabbay Phone: 972-3-6232525 3 Aminadav St. Fax: 972-3-5622555 Tel-Aviv 67067, Israel REPORT OF INDEPENDENT AUDITORS To the Shareholders of STOREAGE NETWORKING TECHNOLOGIES LTD. We have audited the accompanying consolidated balance sheets of StoreAge Networking Technologies Ltd. ("the Company") and its subsidiary as of December 31, 2001 and 2000, and the related consolidated statements of operations, changes in shareholders' equity and cash flows for each of the two years in the period ended December 31, 2001. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by 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 subsidiary as of December 31, 2001 and 2000, and the consolidated results of their operations and cash flows for each of the two years in the period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States. /s/ Kost, Forer & Gabbay Tel Aviv, Israel KOST, FORER & GABBAY March 13, 2002 A Member of Ernst & Young International -2- STOREAGE NETWORKING TECHNOLOGIES LTD. AND ITS SUBSIDIARY CONSOLIDATED BALANCE SHEETS - -------------------------------------------------------------------------------- U.S. Dollars in thousands December 31, ----------------- 2001 2000 ------- ------- ASSETS CURRENT ASSETS: Cash and cash equivalents $18,852 $13,943 Trade receivables 80 53 Other accounts receivable and prepaid expenses (Note 3) 195 260 Inventories (Note 4) 254 102 ------- ------- Total current assets 19,381 14,358 - ----- ------- ------- LONG-TERM INVESTMENTS: Loan to employee (Note 5) 111 -- Restricted long-term bank deposits 141 -- Long-term prepaid expenses 89 -- ------- ------- Total Long term receivables 341 -- - ----- ------- ------- PROPERTY AND EQUIPMENT, NET (Note 6) 1,086 646 ------- ------- Total assets $20,808 $15,004 ======= ======= The accompanying notes are an integral part of the consolidated financial statements. -3- STOREAGE NETWORKING TECHNOLOGIES LTD. AND ITS SUBSIDIARY CONSOLIDATED BALANCE SHEETS - -------------------------------------------------------------------------------- U.S. Dollars in thousands (except share data)
December 31, ----------------- 2001 2000 ------- ------- LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES: Current maturities of long-term loans $ 36 $ 69 Trade payables 337 267 Employees and payroll accruals 508 289 Other accounts payable (Note 7) 97 200 Related party (Note 8) 20 96 ------- ------- Total current liabilities 998 921 - ----- ------- ------- LONG-TERM LOANS, NET OF CURRENT MATURITIES (Note 9) 1 40 ------- ------- COMMITMENTS AND CONTINGENT LIABILITIES (Note 10) -- -- ------- ------- SHAREHOLDERS' EQUITY (Note 11): Ordinary shares of NIS 0.01 par value - Authorized: 35,981,370 shares at December 31, 2001 and 2000; Issued and outstanding: 5,025,000 shares at December 31, 2001 and 2000 12 12 Preferred A shares of NIS 0.01 par value - Authorized: 3,537,790 shares at December 31, 2001 and 2000; Issued and outstanding: 3,537,790 shares at December 31, 2001 and 2000; Aggregate liquidation preference of approximately $ 3,200 at December 31, 2001 and 2000 9 9 Preferred B shares of NIS 0.01 par value - Authorized: 10,480,840 shares at December 31, 2001 and 2000; Issued and outstanding: 7,605,836 and 4,259,268 at December 31, 2001 and 2000, respectively; Aggregate liquidation preference of approximately $ 27,012 and $ 14,000 at December 31, 2001 and 2000, respectively 18 10 Additional paid-in capital 27,145 16,900 Accumulated deficit (7,375) (2,888) ------- ------- Total shareholders' equity 19,809 14,043 - ----- ------- ------- Total liabilities and shareholders' equity $20,808 $15,004 ======= =======
The accompanying notes are an integral part of the consolidated financial statements. -4- STOREAGE NETWORKING TECHNOLOGIES LTD. AND ITS SUBSIDIARY CONSOLIDATED STATEMENTS OF OPERATIONS - -------------------------------------------------------------------------------- U.S. Dollars in thousands Year ended December 31, --------------- 2001 2000 ------ ------ Revenues $ 683 $ 66 Cost of revenues 307 15 ------ ------ Gross profit 376 51 ------ ------ Operating expenses: Research and development, net (Note 13a) 3,212 902 Sales and marketing, net (Note 13b) 1,404 639 General and administrative 979 326 ------ ------ Total operating expenses 5,595 1,867 ------ ------ Operating loss 5,219 1,816 Financial income, net (748) (67) Other expenses 16 37 ------ ------ Net loss $4,487 $1,786 ====== ====== The accompanying notes are an integral part of the consolidated financial statements. -5- STOREAGE NETWORKING TECHNOLOGIES LTD. AND ITS SUBSIDIARY STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY - -------------------------------------------------------------------------------- U.S. Dollars in thousands (except share data)
Ordinary shares Preferred shares Additional Total ------------------ ------------------- paid-in Accumulated shareholders' Shares Amount Shares Amount capital deficit equity --------- ------ ---------- ------ ---------- ----------- ------------- Balance as of January 1, 2000 5,000,000 $ 2 3,537,790 $ 2 $ 3,129 $(1,102) $ 2,031 Stock split effected as stock dividend -- 10 -- 7 (17) -- - Exercise of options, net 25,000 (*-- -- -- 3 -- 3 Issuance of Preferred B shares and warrants, net -- -- 4,259,268 10 13,785 -- 13,795 Net loss -- -- -- -- -- (1,786) (1,786) --------- ----- ---------- --- ------- ------- ------- Balance as of December 31, 2000 5,025,000 12 7,797,058 19 16,900 (2,888) 14,043 Issuance of Preferred B shares and warrants, net -- -- 3,346,568 8 10,243 -- 10,251 Stock based compensation related to options granted to consultants -- -- -- -- 2 -- 2 Net loss -- -- -- -- -- (4,487) (4,487) --------- ----- ---------- --- ------- ------- ------- Balance as of December 31, 2001 5,025,000 $ 12 11,143,626 $27 $27,145 $(7,375) $19,809 ========= ===== ========== === ======= ======= =======
*) Represents an amount lower than $ 1. The accompanying notes are an integral part of the consolidated financial statements. -6- STOREAGE NETWORKING TECHNOLOGIES LTD. AND ITS SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS - -------------------------------------------------------------------------------- U.S. Dollars in thousands
Year ended December 31, ----------------- 2001 2000 ------- ------- Cash flows from operating activities: - ------------------------------------- Net loss $(4,487) $(1,786) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation 328 135 Accrued severance pay, net -- (55) Increase in trade receivables (27) (53) Decrease (increase) in accounts receivable and prepaid expenses (24) 26 Increase in inventories (152) (102) Increase in trade payables 70 172 Increase in Employees and payroll accruals and other accounts payable 256 182 Related party, net (76) 96 Loss on sale of property and equipment 16 37 Other 5 -- ------- ------- Net cash used in operating activities (4,091) (1,348) ------- ------- Cash flows from investing activities: - ------------------------------------- Loan to employee (110) -- Restricted deposits (145) -- Purchase of property and equipment (795) (471) Proceeds from sale of property and equipment 11 3 ------- ------- Net cash used in investing activities (1,039) (468) ------- ------- Cash flows from financing activities: - ------------------------------------- Related party -- (543) Short-term bank credit, net -- (69) Principal payment of long-term loans (72) (68) Proceeds from long-term loans -- 29 Proceeds from issuance of share capital, net 10,111 13,935 Exercise of options, net -- 3 ------- ------- Net cash provided by financing activities 10,039 13,287 ------- ------- Increase in cash and cash equivalents 4,909 11,471 Cash and cash equivalents at the beginning of the year 13,943 2,472 ------- ------- Cash and cash equivalents at the end of the year $18,852 $13,943 ======= ======= Supplemental disclosure of cash flows information: - -------------------------------------------------- Cash paid during the year for: - ------------------------------ Interest $ 5 $ 24 ======= ======= Non-cash transactions: - ---------------------- Issuance expenses $ -- $ 140 ======= =======
The accompanying notes are an integral part of the consolidated financial statements. -7- STOREAGE NETWORKING TECHNOLOGIES LTD. AND ITS SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- U.S. Dollars in thousands (except share data) NOTE 1:- GENERAL a. StoreAge Networking Technologies Ltd. ("the Company") was incorporated in January 1999. The Company develops data storage networking solutions for open system, host independent, multi-server environments. During 2000 the Company established a wholly owned subsidiary - StoreAge Networking Technologies Inc. ("the subsidiary"), which is engaged in selling and marketing of the Company's products in the United States. b. During 1999, the Company reached an agreement with a related company - I.I.S. Intelligent Information Systems Ltd. ("I.I.S") - to purchase by way of assignment all of the I.I.S's activities, assets, rights and obligations in the field of fibre channel technology in consideration of 5,000,000 Ordinary shares. The assets and liabilities were transferred at their carrying amount. As part of the aforementioned agreement, the Company agreed to assume the I.I.S's obligations to pay royalties to the Office of Chief Scientist ("OCS") on sale proceeds from products in which the OCS participates in their research and development in the field of storage. Total commitment assumed by the Company aggregates to $ 764. During 2000, the Company signed a agreement with I.I.S. according to which I.I.S. will provide the Company research and development services for the development of software in consideration of $200, according to the milestones defined in the agreement. During 2001, the companies agreed to expand this agreement. As of December 31, 2001, the Company recorded accumulated research and development costs of $ 270 related to these services (see Note 8). NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES The consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States. a. Use of estimates: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. -8- STOREAGE NETWORKING TECHNOLOGIES LTD. AND ITS SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- U.S. Dollars in thousands NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (cont.) b. Financial statements in U.S. Dollars: The Company's transactions are recorded in new Israeli Shekels ("NIS"); however, the majority of the revenues of the Company and its subsidiary are generated in U.S. Dollars ("Dollar"). In addition, a substantial portion of the Company's costs is incurred in Dollars. Company's management believes that the Dollar is the primary currency of the economic environment in which the Company and its subsidiary operate. Thus, the functional and reporting currency of the Company and its subsidiary is the Dollar. Accordingly, monetary accounts maintained in currencies other than the Dollar are remeasured into U.S. Dollars in accordance with Statement No. 52 of the Financial Accounting standard Board ("FASB"). All transactions gains and losses from the remeasurement of monetary balance sheet items are reflected in the statements of operations as financial income or expenses, as appropriate. c. Principles of consolidation: The consolidated financial statements include the accounts of the Company and its subsidiary. Intercompany transactions and balances, including profits from intercompany sales not yet realized outside the Group, have been eliminated upon consolidation. d. Cash equivalents: Cash equivalents include short-term highly liquid investments that are readily convertible to cash with original maturities of three months or less. e. Restricted cash: Restricted cash is primarily invested in certificates of deposit, which mature within four years and is used as security for the Company's office lease. f. Inventories: Inventories are stated at the lower of cost or market value. Inventory write-offs are provided to cover risks arising from slow-moving items or technological obsolescence. Cost is determined as follows: Raw materials and parts - using the "first-in, first-out" method. Finished products - on the basis of direct manufacturing costs with the addition of allocable indirect manufacturing costs. -9- STOREAGE NETWORKING TECHNOLOGIES LTD. AND ITS SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- U.S. Dollars in thousands NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (cont.) g. Long-term deposits: Bank deposits with maturities of more than one year are included in long-term investments, and presented at their cost. h. Property and equipment: Property and equipment are stated at cost, net of accumulated depreciation. Depreciation is calculated by the straight-line method over the estimated useful lives of the assets, at the following annual rates: % -------------------------- Computers and peripheral equipment 33 Office furniture 6 - 15 Motor vehicles 15 Leasehold improvements over the term of the lease The Company and its subsidiary periodically assess the recoverability of the carrying amount of property and equipment and provide for any possible impairment loss based upon the difference between the carrying amount and fair value of such assets in accordance with Statement of Financial Accounting Standards ("SFAS") No. 121 "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of". As of December 31, 2001, no impairment losses have been identified. i. Research and development costs: Statement of Financial Accounting Standards ("SFAS") No. 86 "Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed", requires capitalization of certain software development costs subsequent to the establishment of technological feasibility. Based on the Company's product development process, technological feasibility is established upon completion of a working model. The Company does not incur material costs between the completion of the working model and the point at which the products are ready for general release. Therefore, research and development costs are charged to the statement of operations as incurred. j. Warranty costs: The Company provides a warranty for up to 12 months to its hardware modules and 3 months to its software modules at no extra charge. A provision is recorded for estimated warranty costs based on the Company's experience. In 2001 and 2000, the Company did not provide for warranty due to immateriality. -10- STOREAGE NETWORKING TECHNOLOGIES LTD. AND ITS SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- U.S. Dollars in thousands NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (cont.) k. Income taxes: The Company and its subsidiary account for income taxes in accordance with Statement of Financial Accounting Standards (SFAS) No. 109, "Accounting for Income Taxes". This statement prescribes the use of the liability method, whereby deferred tax asset and liability account balances are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. The Company and its subsidiary provide a valuation allowance, if necessary, to reduce deferred tax assets to their estimated realizable value. l. Revenue recognition: The Company derives its revenue from hardware and license fees of its products, training and installation. The Company sells its products primarily through its direct sales force and indirectly through distributors. In December 1999, the SEC issued Staff Accounting Bulletin No. 101 ("SAB 101"), as amended in June 2000, which summarizes the staffs views in applying generally accepted accounting principles to revenue recognition in financial statements. The Company adopted SAB 101 and Statement of Position (SOP) 97-2, "Software Revenue Recognition," as amended. SOP 97-2, generally requires revenue earned on software arrangements involving multiple elements to be allocated to each element based on the relative fair value of the elements. The Company has also adopted SOP 98-9, "Modification of SOP 97-2, Software Revenue Recognition with Respect to Certain Transactions," for all transactions entered into after January 1, 2000. SOP 98-9 requires that revenue be recognized under the "residual method" when vendor specific objective evidence (VSOE) of fair value exists for all undelivered elements and no VSOE exists for the delivered elements. Revenue is recognized when persuasive evidence of an agreement exists, delivery of the product has occurred, no significant obligations with regard to implementation remain, the fee is fixed or determinable, and collectibility is probable. The Company does not grant a right of return to its customers. When a right of return exists, the Company defers revenue until the right of return expires, at which time revenue is recognized provided that all other revenue recognition criteria have been met. The Company considers all arrangements with payment terms extending beyond thirty days not to be fixed or determinable. If the fee is not fixed or determinable, revenue is recognized as payments become due from the customer provided that all other revenue recognition criteria have been met. When customer's acceptance is required revenue is recognized upon the acceptance. -11- STOREAGE NETWORKING TECHNOLOGIES LTD. AND ITS SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- U.S. Dollars in thousands NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (cont.) When contracts contain multiple elements wherein VSOE of fair value exists for all undelivered elements, the Company accounts for the delivered elements in accordance with the "Residual Method" prescribed by SOP 98-9. Maintenance and support revenue included in these arrangements is deferred and recognized on a straight-line basis over the term of the maintenance and support agreement. The VSOE of fair value of the undelivered elements (maintenance, support and services) is determined based on the price charged for the undelivered element when sold separately. m. Concentrations of credit risks: Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of cash and cash equivalents, restricted cash and trade receivables. The Company's cash and cash equivalents are denominated in U.S. Dollars and invested mainly in major banks in Israel and in the U.S. Such deposits in the U.S. may be in excess of insured limits and are not insured in other jurisdictions. Management believes that the financial institutions that hold the Company's investments are financially sound and, accordingly, minimal risk exists with respect to these investments. Restricted cash is invested in certificates of deposit in major banks in Israel. The Company's trade receivables are derived from sales to customers located primarily in Israel, the U.S. and Europe. No collateral is required. The allowance for doubtful accounts is determined with respect to specific debts that are doubtful of collection. n. Accounting for stock based compensation: The Company has elected to follow Accounting Principles Board Opinion No. 25 "Accounting for Stock Issued to Employees" ("APB 25") and Interpretation No. 44 "Accounting for Certain Transactions Involving Stock Compensation" ("FIN 44") in accounting for its employee stock option plans. Under APB 25, when the exercise price of the Company's share options is less than the market price of the underlying shares on the date of grant, compensation expense is recognized. The pro forma disclosures required by SFAS No. 123 "Accounting for Stock-Based Compensation" ("SFAS 123"), are provided in Note 11d. The Company applies SFAS No. 123 and EITF 96-18 "Accounting for Equity Instruments that are Issued to Other than Employees for Acquiring, or in Conjunction with Selling, Goods or Services" with respect to options issued to non-employees. SFAS No.123 requires use of an option valuation model to measure the fair value of the options on the date of grant. -12- STOREAGE NETWORKING TECHNOLOGIES LTD. AND ITS SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- U.S. Dollars in thousands NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (cont.) o. Grants and participations: Royalty-bearing grants from the Government of Israel for funding approved research and development projects are recognized at the time the Company is entitled to such grants on the basis of the related costs incurred and included as a deduction of research and development costs. Research and development grants amounted to $ 0 and $ 386 in 2001 and 2000, respectively. The Company also received non-royalty-bearing grants from the Fund for Encouragement of Marketing Activity. These grants are recognized at the time the Company is entitled to such grants on the basis of the costs incurred and included as a deduction of sales and marketing expenses. p. Severance pay: The Company's liability for severance pay is calculated pursuant to Israeli severance pay law based on the most recent salary of the employees multiplied by the number of years of employment, as of the balance sheet date. Employees are entitled to one month's salary for each year of employment or a portion thereof. The 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 Israeli severance pay law or labor agreements. The value of the deposited funds are based on the cash surrendered value of these policies, and include immaterial profits. The Company's liability for all of its employees is fully provided by monthly deposits with insurance policies pursuant to section 14 to the Israeli severance pay law and as of December 31, 2001 there is no outstanding severance pay liability. Severance expenses for the years ended December 31, 2001 and 2000 amounted to approximately $ 150 and $ 71, respectively. q. Fair value of financial instruments: The following methods and assumptions were used by the Company in estimating its fair value disclosures for financial instruments: The carrying amount of cash and cash equivalents, restricted cash, trade receivables and trade payables approximate their fair value due to the short-term maturity of such instruments. The carrying amounts of long-term loans reported in the balance sheet approximate their fair value. The fair value was estimated using discounted cash flow analyses, based on the Company's incremental borrowing rates for similar type of borrowing arrangements. -13- STOREAGE NETWORKING TECHNOLOGIES LTD. AND ITS SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- U.S. Dollars in thousands NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (cont.) The carrying amounts of derivatives were recorded according to speculative transactions under FASB 133, "Accounting for Derivative Instruments and Hedging Activities" at their fair value. As of the balance sheet date the Company recorded a loss in the amount of $12 in respect of those transactions. r. Impact of recently issued accounting standards: In August 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" (FAS 144), which addresses financial accounting and reporting for the impairment or disposal of long-lived assets and superseded SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Dispensed Of", and the accounting and reporting provisions of APB Opinion No. 30, "Reporting the Results of Operations for a Disposal of a Segment of a Business". FAS 144 is effective for fiscal years beginning after December 15, 2001, with earlier application encouraged. The Company expects to adopt FAS 144 as of January 1, 2002 and it does not expect that the adoption of the Statement will have a significant impact on the Company's financial position and results of operations. NOTE 3:- OTHER ACCOUNTS RECEIVABLE AND PREPAID EXPENSES December 31, ------------ 2001 2000 ---- ---- Government authorities $ 91 $ 61 Office of the Chief Scientist -- 188 Prepaid expenses 86 6 Other 18 5 ---- ---- $195 $260 ==== ==== NOTE 4:- INVENTORIES Raw materials and parts $178 $ 60 Finished products 76 42 ---- ---- $254 $102 ==== ==== -14- STOREAGE NETWORKING TECHNOLOGIES LTD. AND ITS SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- U.S. Dollars in thousands NOTE 5:- LOAN TO EMPLOYEE On March 19, 2001, the Company granted to a key employee a loan of $110 (NIS 460 thousand), denominated in NIS (New Israeli Shekels), under the following terms: a. The principal is repayable on the earlier of the following events: consummation of an IPO, sale of all or substantially all of the Company's property and assets, merger or consolidation of the Company or five years from the grant date of the loan. b. The loan bears interest at the greater of the change in the representative exchange rate of the U.S. Dollar during the loan period or the change in the Israeli CPI plus annual interest of 4%. The accrued interest is repayable upon the repayment of the principal of the loan. NOTE 6:- PROPERTY AND EQUIPMENT, NET December 31, ------------- 2001 2000 ------ ---- Cost : Computers and peripheral equipment $1,096 $499 Office furniture 154 39 Motor vehicles 296 270 Leasehold improvements 47 24 ------ ---- 1,593 832 Accumulated depreciation 507 186 ------ ---- Depreciated cost $1,086 $646 ====== ==== Depreciation expenses for the years ended December 31, 2001 and 2000 were $ 328 and $ 135, respectively. As for charges see Note 10c. NOTE 7:- OTHER ACCOUNTS PAYABLE December 31, ------------ 2001 2000 ---- ---- Accrued expenses $41 $200 Others 56 -- --- ---- $97 $200 === ==== -15- STOREAGE NETWORKING TECHNOLOGIES LTD. AND ITS SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- U.S. Dollars in thousands NOTE 8:- BALANCES AND TRANSACTIONS WITH RELATED PARTY *) a. Balances: The balance is linked to the U.S. Dollar and does not bear interest. The balance is generally paid on a quarterly basis. As of the December 31, 2001, the outstanding balance to IIS for administration services amounts to $ 20. b. Transactions with I.I.S.*): December 31, ------------ 2001 2000 ---- ---- Administration services $112 $131 Purchase of motor vehicles -- 29 Research and development costs 250 20 Other -- (8) ---- ---- $362 $172 ==== ==== *) See also Note 1b. NOTE 9:- LONG-TERM LOANS Average interest rate -------- % -------- Linked to the U.S. Dollar 3.79 $37 $109 Less - current maturities 36 69 --- ---- $ 1 $ 40 === ==== As of December 31, 2001, the aggregate annual maturities of long-term loans are as follows: First year (current maturities) $36 $ 69 Second year 1 39 Third year -- 1 --- ---- $37 $109 === ==== -16- STOREAGE NETWORKING TECHNOLOGIES LTD. AND ITS SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- U.S. Dollars in thousands NOTE 10:- COMMITMENTS AND CONTINGENT LIABILITIES a. Royalty commitments: The Company participated in programs sponsored by the Israeli Government for the support of research and development activities. The Company is committed to pay royalties to the Israeli Ministry of Industry and Trade ("the OCS"), amounting to 3%-5% of the proceeds from sales of products in which the Government participated in their research and development by way of grants. The commitment is determined on a product-by-product basis, in an amount not to exceed the total of the grants received (linked to the U.S. Dollar plus interest rate of LIBOR). Royalties paid or accrued for the year ended December 31, 2001 amounted to $ 24. As of December 31, 2001, the Company has an outstanding contingent obligation (including $ 764 as mentioned in Note 1b) to pay royalties in the total amount of $ 1,340. b. Lease commitment: The Company and its subsidiary rent their facilities under various operating lease agreements, which expire on various dates, the latest of which is in 2006. The minimum rental payments under non-cancelable operating leases are as follows: Year ended December 31, ------------ 2002 296 2003 121 2004 121 2005 121 2006 56 Total rent expenses for the years ended December 31, 2001 and 2000 were approximately $ 168 and $ 54, respectively. c. Charges and guarantees: Various motor vehicles of the Company are pledged at fixed charges in favor of a bank. The Company obtained a guarantee in the amount of $ 159 in order to secure its lease obligation. -17- STOREAGE NETWORKING TECHNOLOGIES LTD. AND ITS SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- U.S. Dollars in thousands (except share data) NOTE 11:- SHAREHOLDERS' EQUITY a. The rights conferred by the Company's shares: (1) The Ordinary shares confer upon the holders the right to receive notice, to participate and vote in general meetings of the Company, and the right to receive dividends, if declared. (2) The Preferred shares ("A" and "B") have the same rights as the Ordinary shares. In addition, the shares are convertible into Ordinary shares, have an aggregate preference in liquidation of $ 30,212 as of December 31, 2001, dividend preference, anti-dilution rights, preemptive rights, tag-along rights and preference in voting on certain matters. The Preferred shares are convertible, at the holders' option, or upon an IPO of the Company, into Ordinary shares on a one-for-one basis. b. Stock split effected as stock dividend: During 2000, the Company effected a stock split as stock dividend of 400% on its share capital. All share capital amounts have been retroactively adjusted to reflect this stock dividend. c. Investment agreements: 1. During 1999, the Company signed an investment agreement according to which 3,537,790 Preferred A shares were issued for the aggregate of $ 3,200. 2. From December 2000 until January 2001, the Company signed an investment agreement, according to which 7,605,836 Preferred B shares were issued for $ 3.287 per share in the aggregate of $ 25,000. As a result of the above agreement, the Company repaid during 2000 the shareholders' loans received from I.I.S. amounting to $543. d. Stock option plans: Under the Company's Stock Option Plans (the "Plans"), options may be granted to officers, directors, employees and consultants of the Company or its subsidiary. Pursuant to the Plans, the Company reserved for issuance 4,631,545 Ordinary shares. As of December 31, 2001, an aggregate of 676,765 Ordinary shares of the Company are still available for future grant. Each option granted under the Plans is exercisable until the earlier of ten years from the date of the grant of the option or the expiration dates of the respective option plans. -18- STOREAGE NETWORKING TECHNOLOGIES LTD. AND ITS SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- U.S. Dollars in thousands (except share data) NOTE 11:- SHAREHOLDERS' EQUITY (cont.) The options vest primarily over four years. Any options, which are forfeited or not exercised before expiration, become available for future grants. A summary of the Company's stock option activity in 2001 and 2000:
Year ended December 31, ------------------------------------------- 2001 2000 -------------------- -------------------- Weighted Weighted Number average Number average of exercise of exercise options price options price --------- -------- --------- -------- Outstanding at beginning of year 1,877,780 $0.15 -- $ -- Granted 2,023,000 0.75 1,977,780 0.15 Exercised -- -- (25,000) 0.10 Forfeited (31,000) 0.75 (75,000) 0.10 --------- ----- --------- ----- Outstanding at end of year 3,869,780 $0.46 1,877,780 $0.15 ========= ===== ========= ===== Exercisable options 894,390 $0.13 425,945 $0.10 ========= ===== ========= =====
For exercise prices on the date of grant that --------------------------------------------- Equal Exceed Are less than fair value fair value fair value ------------ ------------ ------------- December 31, December 31, December 31, ------------ ------------ ------------- 2001 2000 2001 2000 2001 2000 ---- ---- ---- ---- ---- ---- Weighted average exercise prices -- -- 0.75 0.15 -- -- Weighted average fair values on date of grant -- -- 0.08 0.05 -- --
The options outstanding as of December 31, 2001, have been separated into ranges of exercise price as follows:
Options Weighted Weighted Outstanding average Option average as of remaining Weighted Exercisable at exercise price exercise December 31, contractual average December 31, of options price 2001 life exercise price 2001 exercisable -------- ------------ ----------- -------------- -------------- -------------- $ Years $ $ -------- ----------- -------------- -------------- 0.10 1,703,780 8.12 0.10 851,890 0.10 0.50 40,000 8.46 0.50 10,000 0.50 0.75 2,126,000 9.55 0.75 32,500 0.75 --------- ------- 3,869,780 8.91 0.46 894,390 0.13 ========= =======
-19- STOREAGE NETWORKING TECHNOLOGIES LTD. AND ITS SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- U.S. Dollars in thousands (except share data) NOTE 11:- SHAREHOLDERS' EQUITY (cont.) Pro forma information regarding net loss is required by SFAS No. 123 and has been determined as if the Company had accounted for its employee stock options under the fair value method of that Statement. The fair value for these options was estimated at the date of the grant using the Black-Scholes Option Valuation Model with the following weighted-average assumptions for the year ended December 31, 2001 and 2000: expected volatility of 0.5 for each year; risk-free interest rates of 3% and 7% respectively, dividend yields of 0% for each year, and a weighted-average expected life of the option of 5 and 6 years, respectively. For purposes of pro forma disclosure, the estimated fair value of the options is amortized to expense over the options' vesting period. Pro forma information under SFAS-123: Year ended December 31, --------------- 2001 2000 ------ ------ Net loss as reported $4,487 $1,786 ====== ====== Pro forma net loss $4,552 $1,853 ====== ====== e. Options granted to consultants: 1. The Company's outstanding options to consultants as of December 31, 2001, are as follows: Options for Exercise Ordinary price Options Issuance date shares per share exercisable ----------------- ----------- --------- ----------- June 2001 (* 60,000 0.75 -- (*) The options vest over four years 2. The Company had accounted for its options to consultants under the fair value method of SFAS No. 123 and EITF 96-18. The fair value for these warrants was estimated using a Black-Scholes Option-Pricing Model with the following weighted-average assumptions for 2001: risk-free interest rate of 3%, dividend yields of 0%, expected volatility of 0.5, and a weighted-average expected life of the warrants of approximately 5 years. 3. In connection with the granting of stock options to consultants, the Company recorded stock compensation expenses totaling $ 2 through December 31, 2001. -20- STOREAGE NETWORKING TECHNOLOGIES LTD. AND ITS SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- U.S. Dollars in thousands (except share data) NOTE 11:- SHAREHOLDERS' EQUITY (cont.) f. Warrants issued to investors: During December 2000 and January 2001 the Company issued to certain investors warrants to purchase 2,875,006 Preferred B shares at a price of $ 4.93 per share. The warrants are exercisable until the earlier of: 1 The Initial Public Offering of the Company's shares for net proceeds of more than $ 30 million and which reflects a pre-offering valuation of the Company of more than $ 150 million. 2. The consummation of a merger, reorganization, acquisition, or sale of all or substantially all of the assets of the Company in which the current holders of the Company's share capital hold less than 50% of the voting power of the surviving entity and which reflects a pre-transaction valuation of more than $ 200 million. 3. Three years from the closing date of the Preferred B share purchase agreement. NOTE 12:- INCOME TAXES a. Measurement of taxable income under the Income Tax (Inflationary Adjustments) Law, 1985: Results for tax purposes are measured in terms of earnings in NIS after certain adjustments for increases in the Israeli Consumers Price Index ("CPI"). As explained in Note 2b, the financial statements are measured in U.S. Dollars. The difference between the annual change in the Israeli CPI and in the NIS/Dollar exchange rate causes a further difference between taxable income and the income before taxes shown in the financial statements. In accordance with paragraph 9(f) of SFAS No. 109, the Company has not provided deferred income taxes on the difference between the functional currency and the tax bases of assets and liabilities. b. Tax benefit under the Law for the Encouragement of Capital Investments, 1959: The Company has been granted an "approved enterprise" status under the above law and has elected to enjoy the "alternative system of benefits" - waiver of grants in return to tax exemption. Income derived from approved enterprises is tax exempt for a period of two years out of 7-year period of benefits. Income derived during the remaining five years of benefits is entitled to reduction in tax rates. The period of benefits commences with the first year in which the company has realized a taxable income. The period of benefits relating to the approved enterprise will expire in the years 2012 through 2014. -21- STOREAGE NETWORKING TECHNOLOGIES LTD. AND ITS SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- U.S. Dollars in thousands NOTE 12:- INCOME TAXES (cont.) If the tax-exempt income attributable to the approved enterprise is distributed in a manner other than in the complete liquidation of the Company, it would be taxed at the corporate tax rate applicable to such profits as if the Company had not chosen the alternative system of benefits (currently - 25%). The entitlement to the above benefits is conditional upon the Company's fulfilling the conditions stipulated by the above law, regulations published thereunder and the instruments of approval for the specific investments in "approved enterprises". In the event of failure to comply with these conditions, the benefits may be canceled and the Company may be required to refund the amount of the benefits, in whole or in part, including interest. Income not eligible for "approval enterprise" benefits mentioned above is taxed at the regular rate of 36%. c. Deferred taxes: Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company and its Subsidiary deferred tax assets are as follows: December 31, ----------------- 2001 2000 ------- ------- Provision for vacation and severance pay $ 60 $ 55 Amortization 212 278 Loss carryforward 2,616 1,133 ------- ------- Net deferred tax asset before valuation allowance 2,888 1,466 Valuation allowance (2,888) (1,466) ------- ------- Net deferred tax assets $ -- $ -- ======= ======= As of December 31, 2001, the Company and its subsidiary have provided valuation allowances of approximately $ 2,888 in respect of deferred tax assets resulting from tax loss carryforwards and other temporary differences. Management currently believes that it is more likely than not that the deferred tax regarding the loss carryforwards and other temporary differences will not be realized in the foreseeable future. -22- STOREAGE NETWORKING TECHNOLOGIES LTD. AND ITS SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- U.S. Dollars in thousands NOTE 12:- INCOME TAXES (cont.) d. Net operating losses carryforward: The Company and its subsidiary have accumulated losses for tax purposes as of December 31, 2001, in the amount of $ 7,129; as follows: $ 5,898 in Israel and $ 1,231 in the U.S. Carryforward tax losses in Israel are linked to the Israeli CPI, and can be carried forward and offset against taxable income in the future for an indefinite period. Carryforward tax losses in the U.S. expire from 2010 to 2012. NOTE 13:- SELECTED STATEMENTS OF OPERATIONS DATA a. Research and development costs, net: Year ended December 31, --------------- 2001 2000 ------ ------ Total cost $3,212 $1,288 Less - grants and participation -- 386 ------ ------ $3,212 $ 902 ====== ====== b. Sales and marketing expenses, net: Total cost $1,444 $ 639 Less - grants and participation 40 -- ------ ------ $1,404 $ 639 ====== ====== NOTE 14:- SEGMENT, CUSTOMERS AND GEOGRAPHIC INFORMATION a. Summary information about geographical areas: The Company operates in one industry segment. Operations in Israel include research and development, selling and marketing. Operations in the United States include selling and marketing. The Company has adopted SFAS No. 131, "Disclosures About Segments of an Enterprise and Related Information". -23- STOREAGE NETWORKING TECHNOLOGIES LTD. AND ITS SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- U.S. Dollars in thousands NOTE 14:- SEGMENT, CUSTOMERS AND GEOGRAPHIC INFORMATION (cont.) The following is a summary of operations within geographic areas based on customer's location. Year ended December 31, ------------- 2001 2000 ------ ---- Revenues from sales to unaffiliated customers: U.S.A $ 508 $ 41 Europe 145 15 Israel -- 10 Others 30 -- ------ ---- $ 683 $ 66 ====== ==== Long-lived assets, by geographic areas: Israel $1,157 $563 United States 270 83 ------ ---- $1,427 $646 ====== ==== b. Major customer data as percentage of total revenues: Customer A 31% 12% Customer B 22% 50% Customer C 15% -- Customer D -- 15% Customer E 3% 15% ---------- -24- Index to Exhibits: Exhibit No. - ----------- 1.1 Memorandum of Association of the Company.* 1.2 Articles of Association of the Company, Amended and Restated as of November 19, 2000.** 4.1 Purchase and Assignment agreement between the Company and Eastek Embedded Systems (Meitav) Ltd., dated November 30, 2000.** 4.2 Employment Agreement of Danny Shavit dated November 30, 2000.** 4.3 Summary English Translation from the original Hebrew of a Lease Agreement entered into between the Company and West End Technology Investments Ltd., for office space located at 33 Jabotinsky Street, Ramat Gan, Israel, dated January 30, 2001.** 4.4 Shareholders' Rights Agreement dated as of January 18, 2001 between the Company, StoreAge and certain investors.** 4.5 Research & Development Subcontracting Agreement effective as of October 15, 2000, between the Company and StoreAge Networking Technologies Ltd. 8.1 List of significant subsidiaries of the Company. 10.1 Consent of Kost Forer and Gabbay, a Member of Ernst & Young International. 10.2 Consent of Kost Forer and Gabbay, a Member of Ernst & Young International. * Incorporated by reference to Exhibit 3.2 to the Company's Registration Statement No. 33-62862 dated August 10, 1993. ** Incorporated by reference to the corresponding exhibit to the Company's Annual Report on Form 20-F for the year ended December 31, 2000. EX-4.5 3 dex45.txt RESEARCH & DEVELOPMENT SUBCONTRACTING AGREEMENT Exhibit 4.5 Research & Development Subcontracting Agreement ----------------------------------------------- THIS AGREEMENT (the "Agreement") is effective as of October 15, 2000 and is entered into by and between StoreAge Networking Technologies Ltd., a private company organized under the laws of the State of Israel, with offices at Gutwirth Science Center, Building 640, Technion City, Haifa, Israel ("StoreAge") and I.I.S. Intelligent Information Systems Ltd., a public company organized under the laws of the State of Israel, with offices at Gutwirth Science Center, Building 640, Technion City, Haifa, Israel (the "Contractor"); WITNESSETH Whereas StoreAge is engaged in development, production, marketing, sale and commercialization of technologies and products in the field of networks storage solutions and iSCSI, all as defined in Appendix A to this Agreement (the "Business"); and Whereas StoreAge wishes to subcontract to the Contractor certain tasks within the above areas; and Whereas Contractor is willing and able to undertake the performance of such tasks; Therefore, the parties have agreed as follows: 1. General ------- 1.1 The preamble and the Appendices hereto are integral and binding parts of this agreement. 1.2 In this agreement the term "Project" shall mean the tasks to be performed by the Contractor hereunder, as described in Appendix A hereto. The term "Services" means all the works to be performed in the framework of the Project. 2. The Project and the Services ---------------------------- 2.1 StoreAge hereby orders and the Contractor undertakes to perform the Project according to the tasks and the time-schedules contained in Appendix B hereto. The Contractor undertakes to dedicate the personnel and other means at its disposal in order to provide the Services and complete the Project on time. Subject to prior approval of StoreAge, the Contractor may retain sub-contractors for certain tasks in the framework of the Project. 2.2 The Contractor will provide the Services on a high professional level, and will submit reports of all its activities hereunder. 2.3 Without limitation to the foregoing, the Contractor undertakes that Mr. Dani Shavit, so long as he is employed by or engaged with the Contractor or any affiliate thereof, shall be available to work on the Project, as and to the extent requested by StoreAge, for the proper performance of the Project, including the management thereof. 2.4 In consideration of the performance of the Project, StoreAge shall pay the Contractor such sums as are detailed in Appendix B hereto, according to the milestones defined therein. In addition, and subject to prior written approval of StoreAge, StoreAge will reimburse the Contractor for certain expenditures. 3. Non-Competition and Non-Solicitation ------------------------------------ 3.1 Commencing on the date hereof and continuing until 18 months after the termination of this Agreement, the Contractor will not, directly or indirectly be involved in any activity which is or may be competitive with the Business or may assist competition with the activities of StoreAge with regard to the Business, including, without limitation, participation or engagement in the design, development, manufacture, production, marketing, sale or servicing of any product, or the provision of any service, that compete with the Business unless otherwise specifically permitted by in writing by StoreAge. 3.2 The Contractor agrees that the character and duration of this non-competition Section are reasonable and necessary in light of the circumstances, as they exist on the date upon which this Agreement has been executed. If any restriction set forth in this non-competition Section is found by a court to be invalid or unreasonable, then the Contractor agrees, and hereby submits, to the reduction and limitation of such prohibition to such character or duration as shall be deemed reasonable and necessary to assure StoreAge of the intended benefit of this Agreement, as shall be determined by such court. 3.3 The Contractor recognizes that the services to be rendered by it under this Agreement are of a special, unique, unusual and extraordinary character and of peculiar value, the loss of which cannot be adequately compensated by monetary damages. In the event of a breach of this Section by the Contractor, StoreAge shall be entitled to injunction relief or any other legal or equitable remedies. The remedies provided in this Agreement shall not preclude the exercise of any other remedy at law or in equity, for the same event or any other event. 3.4 The Contractor and StoreAge both mutually agree that, during the term of this Agreement and for a period of eighteen (18) months after the termination of this Agreement, they will not, directly or indirectly hire, engage, employ or solicit, contact or communicate with, for the purposes of hiring, employing or engaging, any person who is then or was an employee of the other party at any time during the period of this agreement or within the twelve-month period immediately prior thereto without a prior written notice from the other party. 4. Relationship of the Parties --------------------------- 4.1 The Contractor is an independent contractor. The parties do not intend, and this Agreement and the performance hereunder shall not be construed to give effect to employment, partnership, joint venture or agency relations between the parties or between StoreAge and any person engaged by the Contractor in the performance of the Project. The Contractor is fully responsible and will bear and pay all payments due to and for its employees and sub-contractors. The Contractor shall bear and pay all its costs and expenses incurred in the course of its activities under this Agreement. 4.2 The Contractor is not authorized to obligate StoreAge in any way and/or create any commitments except to the extent explicitly authorized by StoreAge in writing. 5. Confidentiality Obligations --------------------------- 5.1 The Contractor shall maintain in confidence all commercial and technical information related to StoreAge, the Project, the Business and any other matter related thereto, as well as information of third parties with whom StoreAge has business relations. All the foregoing is defined as "Information". Information may include commercial, technical, marketing, financial, administrative and management subjects. 5.2 Information, as used herein, shall not include items, which are or become public knowledge through no wrongful act on the part of the Contractor and people acting on its behalf. 5.3 Any and all inventions, technology, know-how, systems, products, processes, software, copyrights and the like, whether patentable or patented or not, and whether subject to any other legal protection or not, which are created, achieved, conceived or arise during or as a result of the performance of the Project and the provision of the Services hereunder, shall collectively be referred to as "Technology". 5.4 The Technology and the Information and any part thereof, and any intellectual property related thereto or based thereon, are and shall be the exclusive property of StoreAge. The Contractor will promptly submit to StoreAge full details in writing, related to the Technology, will promptly deliver to StoreAge any source code in connection to the Technology and will execute patent applications and assignments as may be requested (whether during or after the period hereof) by StoreAge to confirm and register StoreAge's ownership thereof. 5.5 Any developments of the Technology made by the Contractor, as specified in Appendix A shall be the exclusive property of StoreAge. The Contractor will promptly submit to StoreAge full details in writing, related to any such modifications or developments of the Technology, will promptly deliver to StoreAge any source code in connection to such modifications or developments of the Technology and will execute patent applications and assignments as may be requested (whether during or after the period hereof) by StoreAge to confirm and register its ownership of such developments and modifications thereof. 5.6 The Contractor shall ensure that each Contractor's employee, who will be engaged in any activity in connection to the Business, the Technology or to the Project, shall not be engaged in such activity, unless such employee has signed an agreement providing for non-competition, non-disclosure and for the assignment of all proprietary information and inventions related to his employment by the Contractor, to the Contractor. In case of any breach of such agreement which may cause to StoreAge any losses, demands, claims, suits, costs, liabilities or other expenses, StoreAge shall be entitled to enforce such obligations of employees or take any appropriate court action against them instead of or together with IIS (in StoreAge's sole discretion). 5.7 Without limitation to the foregoing and subject to the provisions of Subsection 5.9 below, the Contractor will not use any part of the Technology and the Information, nor disclose or make it available to others, nor allow or assist others to make any use thereof, unless in the framework of the performance of the Project for StoreAge. The Contractor further agrees that any sub-contractor or other third party, which will be engaged in any activity in connection to the Business, Technology or to the Project shall not be engaged in such activity, unless signed a non-disclosure agreement prior to such engagement. 5.8 Upon termination of the Agreement, the Contractor shall immediately return to StoreAge all materials of any kind (whether in written or electronic form, computer files or otherwise) concerning the Information and the Technology, including all copies thereof, and the Contractor shall not retain any copies of such materials, unless explicitly permitted by StoreAge. 5.9 Notwithstanding anything to the contrary in this Section 5 above, the Contractor is hereby granted a non-exclusive, perpetual, royalty-free license to use the Technology, provided that (i) such use by the Contractor shall not compete with StoreAge's activity at such time, including without limitation competing with the Business; and (ii) the license shall not be assignable or transferable in whole or in part to any third party without the prior written consent of StoreAge. The foregoing Section 5 will survive the termination of this Agreement. 6. Right of First Negotiation -------------------------- 6.1 The sale, licensing, assignment, transfer, grant or any other disposal whatsoever ("Disposition") by the Contractor of any inventions, technology, know-how, systems, products, processes, information, software, copyrights and the like, whether patentable or patented or not, and whether subject to any other legal protection or not, relating to iSCSI and storage applications which are not created or conceived within the scope of the Project ("Contractor IP"), to any third party, shall be subject to the right of first negotiation of StoreAge as hereinafter provided: 6.2 The Contractor shall provide to StoreAge a written notice within 24 hours (the "Notice") of the receipt of any offer to dispose of such Contractor IP (or any part thereof) (the "Disposition Proposal") and of the proposed terms of such Disposition Proposal. The Notice shall include the following information: (a) the identity of the party making the Disposition Proposal and (b) the specific terms of the Disposition Proposal, including all material terms thereof. StoreAge shall have a period of fifteen (15) days (which time period may be extended by mutual written agreement) following its receipt of the Notice ("Negotiation Period") in which to present to Contactor a counter offer ("StoreAge Offer"). During such Negotiation Period StoreAge shall have the exclusive right to engage in negotiations with the Contractor with respect to such StoreAge Offer. If the Contractor elects to pursue the StoreAge Offer, then the Contractor will provide StoreAge written acknowledgment of such election. The parties agree to negotiate in good faith for a period of fifteen (15) days (which may be extended by mutual written agreement) after StoreAge's receipt of the Contractor's written acknowledgment to pursue StoreAge's Offer, to reach agreement on mutually agreeable terms. In the event: (i) StoreAge does not deliver a StoreAge Offer within the Negotiation Period, (ii) StoreAge notifies the Contractor, in writing, of StoreAge's decision not to present a StoreAge Offer or (iii) the Contractor elects not to accept the StoreAge Offer, which election shall be subject to the Contractor's obligations under the second and third preceding sentences, then, and only then, the Contractor shall be free, for a period of ninety (90) calendar days following the expiration of the Negotiation Period, to agree to accept the Disposition Proposal on the terms and conditions set forth in the Notice or on such other terms and conditions, in the aggregate, not more favorable to the potential purchaser than those specified in the Notice. Any proposed acquisition of the modifications or developments pursuant to an Disposition Proposal after the end of such 90-day period or any change in the terms of such Disposition Proposal, which are more favorable to the potential purchaser shall require a new Notice, and shall give rise anew to the rights of StoreAge provided in this Section. 6.3 For the removal of doubt and without derogating from the provisions of Section 6.1 and 6.2 above, the Contractor may sell any of its products (including software licensing) to third parties in the ordinary course of its business, provided, however, that (i) no transfer, disposal or disclosure of any intellectual property pertaining to StoreAge's business (at the relevant time) shall be conducted, and (ii) no source code shall be delivered to any third party; unless the Contractor obtains the prior written consent of StoreAge. 7. Representations and Warranties ------------------------------ The Contractor represents and warrants that to the best of its knowledge, neither the development of the Technology nor the delivery of Services by the Contractor under this Agreement infringes or shall infringe any patent, copyright or trademark, or violates (or shall violate) any trade secret or other proprietary right of a third party. 8. Maintenance and Support ----------------------- During the term of this Agreement and for a period of 1 (one) year thereafter, and upon written request of StoreAge, the Contractor shall provide all technical assistance reasonably required to facilitate full use and operations by StoreAge of the Technology developed by the Contractor pursuant to this Agreement for consideration, as specified in Appendix A. 9. Indemnification --------------- The Contractor shall, at its expense and upon StoreAge's request, indemnify and defend StoreAge and hold it harmless against and from any and all claims, suits, losses, demands, costs, liabilities and expenses, which may be asserted against StoreAge or to which StoreAge may be exposed, to the extent such claim is based upon the assertion that any element, method or process used during the development process of the Technology or any Services provided by the Contractor under this Agreement infringes any patent, copyright or trademark, or violates any trade secret or other proprietary right of a third party, unless such element, method or process was specifically requested by StoreAge. 10. Early Termination, prior to completion of the Project ----------------------------------------------------- 10.1 StoreAge may terminate this Agreement if the performance of the Project does not proceed according to the time schedules of Appendix A. 10.2 StoreAge may terminate the Agreement for its convenience, by giving a prior written notice of at least 60 days, during which the Contractor shall complete certain tasks (to be defined by StoreAge) which may be in process at the time of the termination notice. 10.3 Each party may terminate the Agreement immediately in case of a material breach by the other party, which is not cured or waived within 15 days after written notice to that effect. 10.4 Termination of this Agreement is without liability of StoreAge for any claims or payments beyond those earned or accrued as expressly provided herein. 10.5 The provisions of chapters 5 and 6 above shall survive the termination of this Agreement. 11. Miscellaneous ------------- 11.1 This Agreement represents the full agreement between the parties as to its subject matter, supersedes and cancels all prior understandings, whether written or verbal, related thereto. 11.2 No amendment, waiver or cancellation of any part of this Agreement will be valid unless done in writing and signed by the parties. 11.3 The failure or delay of either party to require the performance of any provision herein, or the waiver by either party of any breach of any provision herein, shall not prevent a subsequent enforcement of such provisions, nor be deemed a waiver of any subsequent or prolonged breach. AND IN WITNESS HEREOF, the parties sign this Agreement on this 16th day of January 2001, StoreAge Networking Technologies Ltd. I.I.S. Intelligent Information Systems Ltd BY: /s/ Eli Shapira BY: /s/ Robi Hartman ------------------------------ ------------------------------ NAME: Eli Shapira NAME: Robi Hartman TITLE: President TITLE:CEO DATE: January 16, 2001 DATE: January 16, 2001
EX-8.1 4 dex81.txt LIST OF SIGNIFICANT SUBSIDIARIES OF THE COMPANY Exhibit 8.1 Significant Subsidiaries of I.I.S. Intelligent Information Systems Limited -------------------------------------------------------------------------- Jurisdiction of --------------- Incorporation or ---------------- List of Significant Subsidiaries Organization Business Name - -------------------------------- ------------ ------------- None EX-10.1 5 dex101.txt CONSENT OF INDEPENDENT AUDITORS Exhibit 10.1 CONSENT OF INDEPENDENT AUDITORS ------------------------------- We consent to the incorporation by reference in the Registration Statement (Form S-8) pertaining to the Employees' Stock Option Plan and forms F-3 (File No. 333-8240, 333-12764 and 333-59548) of I.I.S. Intelligent Information Systems Limited of our report dated March 21, 2002, with respect to the consolidated financial statements and schedules of I.I.S. Intelligent Information Systems Limited included in the Annual Report (Form 20-F) for the year ended December 31, 2001, filed with the Securities and Exchange Commission. /s/ Kost, Forer and Gabbay -------------------------------- Tel-Aviv, Israel KOST, FORER & GABBAY June 26, 2002 A member of Ernst & Young Global EX-10.2 6 dex102.txt CONSENT OF INDEPENDENT AUDITORS Exhibit 10.2 CONSENT OF INDEPENDENT AUDITORS ------------------------------- We consent to the incorporation by reference in the Registration Statement (Form S-8) pertaining to the Employees' Stock Option Plan of and forms F-3 (File No. 333-8240, 333-12764 and 333-59548) of I.I.S. Intelligent Information Systems Limited of our report dated March 13, 2002, with respect to the consolidated financial statements and schedules of StoreAge Networking Technologies Ltd included in the Annual Report (Form 20-F of I.I.S. Intelligent Information Systems Limited) for the year ended December 31, 2001, filed with the Securities and Exchange Commission. /s/ Kost, Forer & Gabbay KOST, FORER & GABBAY A member of Ernst & Young Global Tel-Aviv, Israel June 26, 2002 -----END PRIVACY-ENHANCED MESSAGE-----