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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 1996
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________ to ___________
Commission file number 0-19771
DATA SYSTEMS & SOFTWARE INC.
(Exact name of registrant as specified in charter)
Delaware 22-2786081
(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification no.)
200 Route 17, Mahwah, New Jersey 07430
- -------------------------------------- --------
Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code (201) 529-2026
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.01 per share
Common Stock Purchase Rights
(Title of Class)
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.
[X]Yes No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge,
in definitive proxy or information statements incorporated by reference in Part
III of this Form 10-K or any amendment to this Form 10K. [ ]
The aggregate market value of the common stock held by non-affiliates of the
registrant at March 27, 1997 was approximately $ 38,024,503. The aggregate
market value was calculated by using the closing price of the stock on that date
on the Nasdaq National Market.
Number of shares outstanding of the registrant's common stock, as of March 27,
1997: 7,369,178.
Documents incorporated by reference:
Certain sections of the registrant's Proxy Statement to be filed pursuant to
Regulation 14A under the Securities and Exchange Act of 1934 within 120 days of
the end of the registrant's fiscal year are incorporated by reference into Part
III of this Form 10-K.
TABLE OF CONTENTS
PART I
Item 1 Business. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Item 2 Properties. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
Item 3 Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . 13
Item 4 Submission of Matters to a Vote of Security Holders . . . . . . . . 14
PART II
Item 5 Market for the Company's Common Equity and Related
Stockholder Matters . . . . . . . . . . . . . . . . . . . . . . . . 15
Item 6 Selected Financial Data . . . . . . . . . . . . . . . . . . . . . . 15
Item 7 Management's Discussion and Analysis of Financial
Condition and Results of Operations . . . . . . . . . . . . . . . . 16
Item 8 Financial Statements and Supplementary Data . . . . . . . . . . . . 22
Item 9 Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure . . . . . . . . . . . . . . . . 22
PART III
Item 10 Directors and Executive Officers of the Company . . . . . . . . . . 23
Item 11 Executive Compensation. . . . . . . . . . . . . . . . . . . . . . . 23
Item 12 Security Ownership of Certain Beneficial Owners and
Management. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23
Item 13 Certain Relationships and Related Transactions. . . . . . . . . . . 23
PART IV
Item 14 Exhibits, Financial Statements Schedules and
Reports on Form 8-K . . . . . . . . . . . . . . . . . . . . . . . . 24
Certain statements contained in this report are forward-looking in nature.
These statements are generally identified by the inclusion of phrases such as
"the Company expects," "the Company anticipates," "the Company believes,"
"the Company estimates," and other phrases of similar meaning. Whether such
statements ultimately prove to be accurate depends upon a variety of factors
that may affect the business and operations of the Company.
PART I
ITEM 1. BUSINESS
GENERAL
Data Systems & Software Inc., through its subsidiaries in the United States
and Israel (collectively, the "Company"), is a provider of computer consulting
and development services and packaged software products and is an authorized
direct seller and value-added-reseller of computer hardware products. Through
its Tower Semiconductor Ltd. subsidiary ("Tower") the Company also engages in
the manufacture of semiconductors.
Through the end of 1996, the Company has conducted its business through two
business segments: Computer Services and Systems (the "Computer Segment") and
Semiconductor Manufacturing (the "Semiconductor Segment"). Although the Company
retains effective control of its Tower subsidiary, as of the end of December
1996, the Company no longer maintained voting control of more than 50% of
Tower's shares and, therefore, ceased to consolidate Tower's balance sheet as of
year end. As the Company's individual assets and liabilities at December 31,
1996 do not include amounts related to Tower, the Company's 1995 and 1996
balance sheets are not directly comparable. The consolidated statements of
income included in the Consolidated Financial Statements appearing elsewhere in
this Report reflect Tower's revenues and expenses on a consolidated basis for
the years ended December 31, 1994, 1995 and 1996 on a full-year basis for all
years presented. See Note 2 and 7 to the Consolidated Financial Statements.
Commencing 1997, the Company will be reporting as one segment and results of
Tower will be included in the Company's financial results using the equity
method.
COMPUTER SEGMENT
GENERAL
The Company's Computer Segment (i) provides computer consulting and
development services to customers, (ii) has developed and is currently marketing
PHD-TM- - Professional Help Desk-TM-, an integrated software suite for the "help
desk" market, (iii) develops and markets sports related multimedia CD-ROM
software and (iv) acts as an authorized direct seller, value-added-reseller
("VAR") and integrator of computer hardware systems. The Company is also
developing and is conducting beta testing of EPSM, an electric power supply
management system which utilizes existing power lines to automatically read
meters and transmit data.
The following table shows, for the periods indicated, the dollar amount and
the percentage of the sales of the attributable to the different activities of
the Computer Segment:
YEAR ENDED DECEMBER 31,
----------------------
1994 1995 1996
---- ---- ----
(DOLLARS IN THOUSANDS)
AMOUNT % AMOUNT % AMOUNT %
------ --- ------ --- ------ ---
Consulting services $18,104 82% $20,871 69% $19,783 59%
Computer hardware and VAR sales 3,898 18% 8,440 28% 12,285 36%
Professional Help Desk software - - 891 3% 1,802 5%
------- ---- ------- ---- ------- ----
Total Computer Segment $22,002 100% $30,202 100% $33,870 100%
------- ---- ------- ---- ------- ----
------- ---- ------- ---- ------- ----
CONSULTING AND DEVELOPMENT SERVICES
The Company provides computer software and systems consulting and
development services, primarily to high technology customers in Israel and
the United States. The Company's principal area of technological expertise,
is state-of-the-art, embedded real-time software systems in a wide variety of
applications, including, telecommunications, digital signal processing, image
processing and software testing and validation, radar, navigation, electronic
warfare, simulation and electro-optics.
1
The Company provides consulting and development services to customers
primarily by furnishing software and systems engineers, programmers and
technicians who perform design and development activities, generally on the
customer's premises. In these engagements, the Company's personnel generally
work under the customer's direction, having no specific obligation for product
delivery and the customer pays the Company on a time and materials basis for the
services provided. During 1994, 1995 and 1996, sales attributable to services
provided on a time and materials basis were $15.1 million, $14.9 million and
$12.2 million, respectively, accounting for approximately 69%, 49% and 36% of
Computer Segment sales for such years, respectively.
In addition to performing services on a time and materials basis, the
Company also undertakes work on a project basis with full responsibility for
delivering a specific software or hardware/software solution to a customer's
specifications or requirements. These projects generally are performed at fixed
prices and the profit margins on these projects are primarily determined by the
Company's success in controlling project costs. Profits derived from such
contracts may vary substantially as a result of various factors, including risk
of loss due to underestimating costs, difficulties with new technologies and
economic and other changes that may occur during the term of the contract.
During 1994, 1995 and 1996, sales from fixed price contracts were $3.0 million,
$5.9 million and $7.6 million, respectively, accounting for 14%, 20% and 22%,
respectively, of Computer Segment revenues.
HELP DESK SOFTWARE
The Company has developed and is currently marketing PHD-Professional Help
Desk, an integrated packaged software solution for the help desk segment of the
software services market. A help desk is essentially a service center set up by
the information services department of a business or other organization to
answer questions regarding the functionality of computer hardware, software,
telecommunications systems and related peripherals within the company. PHD is a
suite of prepackaged, custom-configurable, simple-to-use software automation
tools for use by help desks to assist them in tracking and resolving support
requests and problems.
The Company's PHD product is designed to allow help desk personnel to
manage incoming telephone calls or e-mail messages, resolve problems and manage
personnel, equipment and telecommunications resources. PHD utilizes Experience
Based Reasoning-TM-(EBR-TM-), the Company's proprietary problem resolution
engine that automatically collects data about the utilization of the help desk
and creates a pool of shared knowledge about the nature of the problems
encountered and the solutions proposed. EBR provides the user with an organic,
growing body of knowledge from which to solve future problems. This information
can be made available to both help desk personnel and end-users, facilitating
self-diagnosis and problem resolution.
PHD currently operates in the Microsoft Windows and Windows95 environments
and is being adapted for future Microsoft environments such as Windows CE (for
use with portable devices such as palmtop PC's and personal communications
devices) and ActiveX, Microsoft's object-oriented document creation system that
enables compartmentalized software components to be linked to components of
other software applications to create customized applications. The Company
plans to develop an ActiveX version of its products so that they can be linked
into any ActiveX application, creating a customized help desk for that
application. The Company is also developing PHDWEB-TM-, an Internet-based
version of PHD.
Through the end of 1996, the Company had invested approximately $4.0
million on development, marketing and other costs associated with introduction
of PHD, including approximately $1.2 million included in capitalized software
costs at December 31, 1996. See "Item 1. Business - Factors Which May Affect
Future Results"-General Factors - Entry Into New Markets" and "-Capitalization
of Software Development Costs; Posssibility of Future Writedowns" and "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations - General".
COMPUTER HARDWARE AND VAR SALES
The Company, through its Databit subsidiary, sells and services PC-based
computer hardware, software, data storage, client/server and networking
solutions. Databit is an authorized direct seller, value-
2
added reseller and\or authorized service provider for equipment and software
from such well-known industry leaders as Compaq, IBM, Microsoft,
Hewlett-Packard, Silicon Graphics, Texas Instruments and Dell. Databit offers
its customers a full range of systems integration services, including design,
implementation, hardware and software selection and network cabling and
installation of local and wide are networks. Databit provides maintenance and
service to customers under extended service agreements.
MULTIMEDIA ENTERTAINMENT
The Company has developed and introduced into the market its first
interactive, multimedia entertainment product, National Football
League-Registered Trademark- CybrCards-TM-, a series of 28 CD-ROM "electronic
trading cards", were released in September 1996. Each NFL-Registered Trademark-
CybrCard offers a complete history of the individual player's career,
including, video and audio highlights and play diagrams. The NFL CybrCards,
with a suggested retail price of just under approximately $20.00 per CD, are
being sold through various distribution channels including department stores,
computer software retailers, card, hobby and sports memorabilia outlets and
direct response. The Company's second multimedia product, Major League
Baseball-Registered Trademark- CybrCards, which will feature 12 of the game's
greatest stars, is scheduled for release in April 1997. CybrCard products are
being designed, developed and marketed by CybrCard, L.P., a Delaware limited
partnership ("CybrCard"), which was established in December 1995 as a joint
venture of the Company and The Topps Company, Inc. In February 1997, the
Company purchased all of Topps' interest in CybrCard. The Company has agreed
to issue up to 10% of the equity interests of CybrCard to two employees of the
Company with substantial responsibility for CybrCard, including a Vice President
of the Company.
During 1996 the Company invested approximately $2.8 million in product
development and marketing and administrative costs in connection with its
establishment of CybrCard and its product lines, approximately $1.2 million of
which was included in investments on the Company's consolidated balance sheet
as of December 31, 1996. See Note 7 to the Consolidated Financial Statements of
the Company included elsewhere in this Report. See "Item 1. Business - Factors
Which May Affect Future Results - General Factors - Entry Into New Markets" and
"-Capitalization of Software Development and Costs; Posssibility of Future
Writedowns" and "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations - General".
ELECTRIC POWER SUPPLY MANAGEMENT SYSTEM
The Company has developed an electric power supply management ("EPSM")
system that reads electric meters automatically, using existing power lines to
transmit the electricity consumption data of each meter to the utility's main
computer, enabling the utility to charge variable time-of-use rates. A
comprehensive software package controls the system's operations and facilitates
functions such as real-time load switching, peak demand control and detection of
leakage and illegal use of electrical power. This system potentially may also be
adapted for other similar uses such as automatic water and gas meter reading.
Beta site testing of the EPSM is currently being conducted in Mexico City and
in a number of towns in Israel. An earlier pilot in Argentina has been
completed. No full system sales of EPSM have been made to date. The Company is
currently negotiating with utilities in several countries regarding installation
of the system on a pilot or trial basis. The Company has also entered into an
agreement with a large United States based information services technology
company. The agreement, which has a term of one year and is terminable by
either party on 120 days written notice, provides for joint marketing of
automatic meter reading solutions utilizing EPSM technology. Through December
31, 1996, the Company had invested approximately $5.4 million (net of government
participation) on development and marketing of the EPSM, including $4.3 million
carried on the balance sheet as capitalized software costs. See "Item 1.
Business - Factors Which May Affect Future Results - General Factors - Entry
Into New Markets" and "-Capitalization of Software Development and Costs;
Posssibility of Future Writedowns" and "Item 7. Management's Discussion and
Analysis of Financial Condition and Results of Operations - General".
CUSTOMERS AND MARKETS
The Company's Computer Segment commenced operations in Israel in 1986 and
Israel historically was the primary area of its operations. Due primarily to
significant growth in the Segment's United States
3
subsidiaries, the percentage of revenues from activities of the United States
subsidiaries increased from 41% in 1994 to 51% in 1995 and 61% in 1996.
The Company commenced its operations in Israel by providing consulting
services to Israel Aircraft Industries Ltd. ("IAI"), which is wholly-owned by
the government of the State of Israel. IAI has been, and continues to be, the
Computer Segment's largest customer. However, as the Company has expanded its
revenue base and sales to IAI have decreased, the percentage of its sales
attributable to IAI has decreased. The percentage of the Company's sales
attributable to IAI in 1994, 1995 and 1996 was 7%, 4% and 2%, representing 26%,
16% and 8% of the Computer Segment sales in those years respectively. The next
three largest customers of the Computer Segment in 1996 accounted in the
aggregate for less than 10% of the Segment's sales.
The Company's customers include major high technology companies, Fortune
500 companies and other leading industrial and service companies, in Israel and
the United States.
BACKLOG
The total backlog of work to be completed in the Company's Computer Segment
was approximately $4.3 million as of January 1, 1997, compared to $7.2 million
as of January 1, 1996. The Company estimates that virtually all of the backlog
will be performed in 1997.
Due to the generally short-term nature of orders received in the Computer
Segment, purchase orders or requisitions from customers requesting services on a
time and materials basis generally are cancelable on a minimum of 30 days
advance notice. Fixed price projects are often subject to termination for
convenience without substantial penalty and, accordingly, there can be no
assurances as to the actual sales to be generated from these contracts. In
light of the above, the Company does not consider backlog to be a meaningful
measure of its operations in its Computer Segment.
COMPETITION
In its computer consulting and development services business, the Company
faces competition from numerous other competitors, both large and small,
operating in the Israeli and United States markets, some with substantially
greater financial and marketing resources. The Company believes that its wide
range of experience and long-term relationship with large corporations in the
United States and Israel, enhances the Company's position with respect to
obtaining future business. For a discussion of factors relating to competition
in the other activities comprising the Company's Computer Segment, See "Item 1.
Business - Factors Which May Affect Future Results -General Factors -
Competition.
PROPRIETARY RIGHTS
Certain products that the Company has and is developing, incorporate or
are derived from intellectual property owned by third parties. A license
from, the consent of, or a joint development and marketing agreement with, such
third parties may be required in order to continue to develop and market such
products and there can be no assurance that such licenses or consents will be
granted, or a joint development and marketing agreement agreed to, on
commercially reasonable terms.
In its product development activities, the Company relies on a combination
of nondisclosure agreements and technical measures to establish and protect
proprietary rights, if any, in its products. The Company believes that, as a
result of the rapid pace of technological change in the software and real-time
system industries, legal protection for its products, if any, will be less
significant to the Company's prospects than the knowledge, ability and expertise
of the Company's management and technical personnel.
In cases where the Company performs services on a time and materials basis,
the intellectual property rights resulting from these services are owned by the
Company's customer.
For further discussion of issues relating proprietary rights to the
operation of the Company's Computer Segment, see "Item 1. Business - Factors
Which May Affect Future Results - General Factors - Dependence on Intellectual
Property of Third Parties".
4
SEMICONDUCTOR MANUFACTURING
INTRODUCTION
Tower is an independent "foundry" manufacturer of semiconductor integrated
circuits ("ICs") on silicon wafers. As a foundry, Tower manufactures wafers
using its advanced production capability and the proprietary IC designs of its
customers. ICs manufactured by Tower are incorporated into a wide range of
products in diverse markets, including computer and office equipment,
communication products and consumer electronics.
Semiconductors are the foundation of modern electronic equipment and
systems, constituting critical components for a wide range of products,
including computers, office equipment, communication equipment and defense,
aerospace, transportation and consumer electronics. A semiconductor may be
either a discrete device, such as an individual transistor, or an IC in which a
number of transistors and other elements are combined to form a more complex
circuit. A wide variety of semiconductor products currently are in use, ranging
from commodity products (such as DRAM, SRAM and other commodity memories) to
more differentiated products (such as microprocessors, ASICs and numerous
digital, analog and mixed-signal ICs).
SERVICES
Tower manufactures ICs on silicon wafers based upon proprietary designs
provided by its customers. Tower specializes in the manufacture of
differentiated IC products, which generally require greater process flexibility
and customization than commodity products. The end-product manufactured by Tower
is a silicon wafer containing multiple ICs.
During 1996, Tower established a team to provide value-added design support
services to its customers, with the goal of offering a full turnkey capability,
including design, mask preparation, manufacturing and packaging of the finished
device.
The Company has also begun to develop proprietary technologies in certain
niche markets where it will enhance the services it can provide to its
customers. Pursuant to an agreement with Wafer Scale Integration, Inc., of
Fremont, California, ("WSI"), a leader in the development of peripheral
system devices containing advanced nonvolatile memory modules, Tower has
exclusive rights for foundry use of embedded erasable and programmable
read-only memories ("EPROMs") based on WSI's proprietary technology and is
developing an advanced 0.6 micron process for use with this technology. When
development of this process is completed, Tower will be able to implement one
of the industry's densest EPROMs, substantially reducing the costs of
embedding large EPROM arrays on logic chips. Tower expects to begin
manufacturing products utilizing this process in 1997 although there can be
no assurance of this.
CUSTOMERS AND MARKETS
At the time of its organization, Tower's only customer was National
Semiconductor Corporation. While Tower has since succeeded in adding new
customers, Tower remains dependent on a small number of customers for virtually
all of its business. In 1996, sales to four customers accounted in the
aggregate for more than 90% of Tower's sales.
During the first half of 1996, there was a downturn in the market for
semiconductor products generally. As a result, commencing in the second quarter
of 1996, Tower experienced reductions in orders from its customers, and
downward pressures on prices from both current and potential new customers. In
June 1996, Tower announced that Tower and Hewlett-Packard had mutually agreed on
the terms for ending the agreement for the purchase by Hewlett-Packard of wafers
from Tower. Sales to Hewlett-Packard accounted for 9% and 19% of Tower's sales
in 1995 and 1994, respectively, and had been expected to account for
approximately 25% of sales in 1996.
As a result of (i) the end of the agreement with Hewlett-Packard, (ii) the
reduction in orders from other customers and (iii) the prevailing weakness in
the demand for semiconductors products generally, Tower operated its
manufacturing facility substantially below capacity for much of 1996.
Utilization improved during the fourth quarter of 1996 and into 1997, primarily
as a result of improvement in the personal computer and peripheral end markets
and certain price reductions implemented by Tower.
5
However, the situation in the marketplace remains uncertain and there is no
assurance that utilization of Tower's facility will continue at the level
necessary to maintain profitable operations. In addition, Tower continues to see
downward pressure on prices from both current and potential new customers. See
"Item 1. "Business - Factors Which May Affect Future Results - Factors Related
to Tower - Reliance on Principal Customers; Need to Expand Customer Base" and
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations--General".
During 1996, Tower manufactured for its customers over 200 sophisticated
semiconductor products that are used by its customers (or end users) in a wide
variety of applications. These applications include personal computer products
and peripherals (such as microprocessors, local area networks and super I/O
devices), communications products (such as pagers), office automation products
(such as facsimile machines, answering machines and advanced printers), cellular
products (such as cellular telephones) and consumer products (such as
televisions and multimedia products). The number of products which Tower
manufactures in 1997 and in future periods, and their end-market distribution,
is and will be determined by customer orders.
PROCESS TECHNOLOGY
Tower's manufacturing process currently uses the following CMOS
(complementary metal oxide silicon) technologies: 1.0 micron double-level metal;
0.8 micron double-level metal; 0.8 micron triple-level metal; 0.6 micron
double-level metal; and 0.6 micron triple-level metal.
The semiconductor industry is characterized by rapid changes in both
product and manufacturing process technology. As a result, Tower's
profitability will depend on its ability to successfully develop and introduce
to production advanced process technologies which meet its customers' needs.
Tower is currently working on the development of (i) a specialized 0.6 micron
process for use in manufacturing wafers utilizing the proprietary embedded
memory technology described above, (ii) a 0.5 micron process and (iii) a 0.35
micron process. Tower is currently running customer prototypes on the 0.5
micron processes and expects to begin running prototypes on the specialized 0.6
micron EPROM process during the second quarter of 1997. Tower expects to
introduce both these new processes into production during 1997, although there
can be no assurance of this. The 0.35 process is scheduled for introduction in
1998.
The development and introduction to production of advanced technologies is
a complex process, the success of which is dependent on many factors, some of
which may be beyond Tower's control. Tower has in the past experienced
unforeseen delays in the development and introduction of new processes. Tower
can, therefore, not predict when or if the development and introduction to
production of these new processes will be successfully completed. The failure
by Tower to develop and introduce new process technologies successfully and in a
timely manner would have a material adverse effect on Tower's business and
financial condition. See "Item 1. Description of Business - Factors That May
Influence Future Results - Factors Related to Tower - Need to Advance Process
Technology".
MANUFACTURING FACILITY
Due to the sensitivity and complexity of the semiconductor manufacturing
process, a semiconductor manufacturing facility requires a special clean room in
which most of the manufacturing functions are performed. Tower's manufacturing
facility includes an approximately 51,500 square foot clean room. Tower has
obtained ISO 9002 certification (a certification with respect to business
process quality standards) for its manufacturing operations.
At the time of its organization in 1993, Tower's facility had a capacity of
5,000 wafer starts per month, using 1.25 and 1.0 micron processes. Since that
time Tower has increased its capacity to approximately 17,000 wafer starts per
month at the current product mix utilizing 1.0, 0.8 and 0.6 micron processes.
This increase in capacity has been achieved through the addition of equipment,
improvement in equipment utilization, the reconfiguration and expansion of its
existing clean room area, and the construction of an additional clean room area.
Tower does not currently intend to significantly increase the overall
capacity of its facility.
6
Tower intends, however, to continue to make significant expenditures during 1997
to fund its process technology advancement program and to purchase equipment to
increase Tower's capacity to manufacture wafers using advanced processes,
including those currently under development by Tower. See "Item 1. Description
of Business - Semiconductor Segment - Process Technology".
COMPETITION
The semiconductor foundry industry is highly competitive. Tower competes
with other dedicated foundries and with integrated semiconductor companies
and end-product manufacturers that produce ICs for their own use and/or
allocate a portion of their manufacturing capacity to foundry operations.
Particularly during periods of market downturn, Tower may face increased
competition from its customers' internal manufacturing capacity and from
other semiconductor manufacturers who have underutilized capacity.
Many of Tower's competitors have more advanced technological capabilities,
a more diverse and established customer base, and greater financial, marketing,
distribution and other resources than Tower. In addition, some competitors of
Tower may have lower labor costs. Tower competes primarily by seeking to offer
customers competitive pricing and a high level of service and process
customization.
PROPRIETARY RIGHTS
Tower uses internally developed process technologies and process
technologies licensed from customers. The 1.0 micron process used by Tower and
elements of the 0.8 process used by Tower are licensed from customers under
royalty-free licenses. The 0.6 micron process currently used by Tower and
specialized 0.6 micron embedded memory process currently under development were
internally developed. Elements of the 0.5 micron and 0.35 micron process
currently under development will be used under royalty-bearing licenses from
third parties.
Investments
MOFET VENTURE CAPITAL FUND
The Company, together with other investors, established Mofet Israel
Technology Fund ("Mofet"), an Israeli public investment company formed for the
purpose of investing in the securities of high technology companies and projects
in Israel. Through two public offerings of its shares, options and convertible
debentures on the Tel Aviv Stock Exchange, and subsequent exercise of options,
Mofet has raised aggregate net proceeds of approximately $23.2 million. As of
December 31, 1996, the Company owned approximately 4% of the equity of Mofet.
The Company accounts for its investments in Mofet on the cost method.
Mofet is managed by Risk Capital Fund Management (1992) Ltd. ("Mofet
Management") pursuant to a management agreement expiring January 2000. The
current shareholders of Mofet Management are DSI (50%), F.I.B.I. Holdings
Company Ltd., a holding company controlled by the Safra family which controls
the First International Bank of Israel Ltd. (25%), and Menorah Insurance
Company Ltd., one of Israel's largest insurance companies (25%). Mofet has
agreed to pay Mofet Management a management fee equal to 4% per annum of the
assets under management. The Company accounts for its investment in Mofet
Management on the equity method.
MOBILE INFORMATION SYSTEMS LTD.
In March 1994, the Company acquired a 50% interest in Mobile Information
Systems Ltd. ("MIS"). a joint venture of DSI and Geotek Communications, Inc.
The Company accounted for its investment in MIS
7
on the equity method. Effective July 1, 1996, the Company sold its shares in
MIS to Geotek in exchange for a $2 million unsecured note which bears annual
interest of 8.25%, payable July 1, 1998. The Company recorded a gain of
approximately $1.7 million in connection with the sale.
EMPLOYEES
At December 31, 1996, the Company (excluding Tower) employed a total of 351
people, including 299 persons in engineering and technical support
(approximately one-half with advanced degrees in computer and electronic
engineering), 13 in marketing and sales, and 39 in management, administration
and finance. At December 31, 1996, Tower had a total of 589 employees.
The Company considers its relationship with its employees to be
satisfactory.
There are no collective bargaining agreements between the Company and any
of its employees. However, certain provisions of the collective bargaining
agreements between the Histadrut (General Federation of Labor in Israel) and the
Coordination Bureau of Economic Organizations (including the Industrialists
Association) are applicable to the Company's Israeli employees by order of the
Israeli Ministry of Labor. These provisions concern mainly the length of the
work day, minimum daily wages, contributions to a pension fund, insurance for
work-related accidents, procedures for dismissing employees, determination of
severance pay and other conditions of employment. The Company generally
provides its Israeli employees with benefits and working conditions beyond the
required minimums.
Israeli law generally requires severance pay upon the retirement or death
of an employee or termination of employment without due cause. Furthermore,
Israeli employees and employers are required to pay specified amounts to the
National Insurance Institute, which is similar to the United States Social
Security Administration. The payments to the National Insurance Institute
include health tax and are approximately 17% of wages (up to a specified
amount), of which the employee contributes approximately 60% and the employer
approximately 40%.
RESEARCH AND DEVELOPMENT
For information on research and development costs, see "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
General" and Notes 1 and 9 to the Consolidated Financial Statements appearing
elsewhere in this Report.
SEGMENT INFORMATION
For financial information regarding the Company's operating segments,
foreign and domestic operations and export sales, see "Management's Discussion
and Analysis of Financial Condition and Results of Operations - Results of
Operations" and Note 19 to the Consolidated Financial Statements appearing
elsewhere in this Report.
FACTORS WHICH MAY AFFECT FUTURE RESULTS
The Company may from time to time issue certain statements, either in
writing or orally, that contain or may contain forward-looking information.
There can be no assurance, however, that actual results will not differ
materially from the Company's expectations, statements or projections. Factors
that could cause actual results to differ from the Company's expectations,
statements or projections include the risks and uncertainties relating to the
Company's business described below.
GENERAL FACTORS
ENTRY INTO NEW MARKETS. The Company has recently devoted substantial
resources to ventures to design and develop software products designed to
address mass market product areas. The Company believes that these markets
provide an opportunity to generate substantially greater revenues and profit
margins than its traditional services markets. However, the Company has had
relatively limited experience with marketing and distribution of such products
and there can be no assurance that the Company will be able to develop the
8
marketing expertise and relationships necessary to identify and capitalize on
opportunities in these product areas.
The limited operating histories of the Company's new product ventures make
prediction of their results and prospects difficult. While the Company believes
that initial market reaction to its product introductions has been positive, it
is too early to tell whether these ventures will become profitable and/or
whether the Company will be able to recover the costs invested in such new
products to date.
CAPITALIZATION OF SOFTWARE DEVELOPMENT COSTS; POSSIBILITY OF FUTURE
WRITEDOWNS. The Company generally capitalizes the costs of new software
product development and amortizes these costs over the useful life of the
product. If the Company is not able to complete development or is
unsuccessful in marketing any of its software products, the Company may be
required to writedown any capitalized development costs related to such
products. As of December 31, 1996 the Company had unamortized capitalized
software development costs of approximately $5.2 million associated with new
software products and additional investments in development costs may be
necessary to continue existing product development projects. In the past,
the Company has taken significant write downs of software development costs
and there can be no assurances that additional write downs will not be
required in the future. The write down of any substantial amounts of such
capitalized costs could have a material adverse impact on the results of the
Company for the period or periods in which any such write down is required
to be made.
MINORITY INTERESTS IN OPERATING SUBSIDIARIES. The Company has a number of
subsidiaries that are not wholly owned (including its principal subsidiaries,
DSI Israel and Tower). Cash of subsidiaries that are not wholly owned is
generally not available for use by the Company or other subsidiaries except to
the extent paid to the Company as reimbursement for general overhead or as
management fees or as dividends. Dividends from the Company's Israeli
subsidiaries are subject to a withholding tax of 15% to 25%.
COMPETITION. In its computer consulting and development services business,
the Company faces competition from numerous other competitors, both large and
small, operating in the Israeli and United States markets, some with
substantially greater financial and marketing resources.
In the help desk market, the Company faces competition from a variety of
companies with greater experience in the marketplace and greater resources
available for product development, sales and marketing and product support.
These competitors include (i) companies that target enterprise-wide
information systems, (ii) companies with specific help-desk applications,
(iii) professional systems integration and services companies that design and
implement custom systems, (iv) large information systems providers, as well as
(v) the internal information systems departments of potential customers.
While the Company believes that PHD has certain product and price advantages
over its competition, it may be difficult to educate its potential customers
of the advantages of PHD in light of the broad range of competing solutions.
The multimedia software market is characterized by intense competition
among several large, well-financed competitors, many of which have a
comparatively long history of success in developing game and entertainment
software. Entertainment software developed and distributed by these
competitors vie for limited shelf space in computer and software retail
establishments. Most, if not all, significant competitors have significantly
greater experience in the development of entertainment-related software than
does the Company. In addition, many of such competitors have significantly
greater numbers of sales and marketing personnel, larger advertising budgets and
other resources to promote and support their products.
The market for personal computer and related peripheral hardware sales in
which the Company's Databit subsidiary operates is characterized by severe
competition in price-performance, breadth of product line, financing
capabilities, technical expertise, service and overall reputation. Trends have
been for ongoing price reductions by manufacturers to end-users, thereby
reducing profit margins for distributors and value added resellers such as
Databit. Competitors include manufacturers, other VAR's, large equipment
aggregators (some of whom sell to the Company) and systems integrators. Many of
the Company's
9
competitors have longer operating histories, greater financial resources and
buying power and larger installed bases of customers. The Company feels that it
competes primarily on the basis of its responsiveness and technical expertise in
evaluating customer needs and tailoring specific solutions to those needs, as
well as price.
DEPENDENCE ON INTELLECTUAL PROPERTY OF THIRD PARTIES. Certain of the
Company's products development efforts are dependent upon intellectual property
owned by third parties. For example, the Company's CybrCard products utilize
intellectual property licensed from major sports leagues and players'
associations and related licensors While the Company believes it is in
continuing compliance with these licensing agreements and that the licensing
agreements adequately protect the Company's rights to integrate such
intellectual property into its products, failure to maintain such licenses could
have a material adverse effect on the business and prospects of the Company.
RAPID TECHNOLOGICAL CHANGE; NEED FOR CONTINUED PRODUCT DEVELOPMENT. The
market for the Company's PHD and CybrCard products are characterized by rapid
technological change, evolving computer hardware and software standards,
frequent new product introductions and continuing customer demands for expanded
features and functions. Accordingly, it will be necessary for the Company to
continue to invest in product development to ensure that such products continue
to evolve and remain competitive. There can be no assurance that the Company
will have the resources to invest in such product development or if such
product development efforts will be successful.
OPERATIONS IN ISRAEL. A substantial portion of the Company's operations
are conducted in the State of Israel and, consequently, the Company is directly
affected by economic, political and military conditions in Israel. Accordingly,
any major hostilities involving Israel or the curtailment of trade between
Israel and its current trading partners could have a material adverse effect on
the company's business and financial condition. In addition, certain
subsidiaries of the Company receive grants and tax benefits from, and
participate in, various programs sponsored by the government of Israel. There
can be no assurance that such grants and tax benefits will be continued in the
future at their current levels or at all. The termination or reduction of
certain grants, programs and tax benefits could have a material adverse effect
on the Company's business and financial condition.
IMPACT OF INFLATION AND CURRENCY FLUCTUATIONS. Substantially all of the
Company's sales are made in dollars or in NIS linked to the dollar. In 1996,
approximately 50% of Tower's expenses were in dollars or dollar-linked NIS
and virtually all the remaining expenses were in NIS. The dollar cost of
Tower's operations in Israel is influenced by the extent to which any
inflation in Israel is not offset (or is offset on a lagging basis) by the
devaluation of the NIS in relation to the dollar. There can be no assurance
that Tower will not be materially adversely affected in the future if
inflation in Israel exceeds the devaluation of the NIS against the dollar or
if the timing of such devaluation lags behind increases in inflation in
Israel.
As of December 31, 1996, the net amount of the Company's monetary assets
that were not denominated in dollars or in NIS linked to the dollar was not
material. In the event that in the future the Company has material net
monetary assets that are not denominated in dollar-linked NIS, such net
assets would be subject to the risk of currency fluctuations.
FACTORS RELATED TO TOWER
DEPENDENCE ON PRINCIPAL CUSTOMERS; NEED TO EXPAND CUSTOMER BASE. Tower is
currently operating significantly below capacity. Tower is making efforts to
attract new customers to utilize all or a portion of its unused capacity. Tower
is currently engaged in discussions with several potential new customers. The
process of attracting new customers includes extensive exchange of product and
process information between Tower and potential customers, including the running
of test wafers and prototypes. This process can be expected to take up to six
months or more. There is no assurance that Tower will be able to attract
additional business from new customers, in the near future, if at all.
Tower currently has a limited number of customers and is dependent on its
two principal customers. If one of these principal customers were to reduce its
commitment or orders, and Tower were to be unsuccessful in selling to new or
existing customers the capacity that becomes available as a result thereof, such
event would have a material adverse effect on Tower's business and financial
condition.
RISK OF OPERATING BELOW FULL CAPACITY. Fixed costs represent a substantial
portion of the total operating costs of a semiconductor manufacturing operation.
As a result, any failure by Tower to operate at or near full capacity, whether
due to mechanical failure, lack of orders, fire or natural disaster, or
otherwise, could result in losses or diminished profitability.
10
NEED TO ADVANCE PROCESS TECHNOLOGY. The semiconductor industry is
characterized by rapid changes in both product and manufacturing process
technology. As a result, Tower's profitability will depend on its ability to
successfully develop and introduce to production advanced process technologies
which meet its customers' needs. Tower is currently working on the
development of a number of advanced processes.
The development and introduction to production of advanced technologies
is a complex process, the success of which is dependent on many factors, some
of which may be beyond Tower's control. Tower has in the past experienced
unforeseen delays in the development and introduction of new processes.
Tower can, therefore, not predict when or if the development and introduction
to production of these new processes will be successfully completed. The
failure by Tower to develop and introduce new process technologies
successfully and in a timely manner would have a material adverse effect on
the Company's earnings and financial condition.
RISK OF SEMICONDUCTOR PROCESS YIELD PROBLEMS. The process technology for
the manufacture of semiconductor products is highly complex and sensitive to
dust and other contaminants. Minor impurities or difficulties in the production
process or defects in the masks used to manufacture a particular device can
cause a percentage of the wafers to be rejected or individual ICs or "die" on
specific wafers to be non-functional, which in each case negatively affects
manufacturing yields. Although Tower has implemented manufacturing control
procedures, tests its products at various stages in the manufacturing process
and conducts numerous quality-control inspections throughout the entire
production process, Tower in the past has experienced lower than expected
production yields (including yield problems with a specialized, advanced 0.8
micron process in March 1996), which have delayed product shipments and reduced
profits. There can be no assurance that Tower will not experience lower than
anticipated production yields in the future, which, if not cured in a timely
manner, could have a material adverse effect on the Company's business and
financial condition.
CURRENT DOWNTURN IN SEMICONDUCTOR MARKET; CYCLICAL NATURE OF SEMICONDUCTOR
INDUSTRY. The semiconductor industry historically has been characterized by wide
fluctuations in product supply and demand. From time to time, the industry also
has experienced significant downturns. These downturns have been characterized
by diminished product demand, production overcapacity and accelerated erosion of
average selling prices of semiconductor products. In some cases, these downturns
have lasted for more than a year. During 1996, there was a downturn in the
market for semiconductor products generally, which resulted in reductions in
orders from customers and downward pressures on prices from both current and
potential new customers. No assurance can be given that Tower's business will
not be adversely affected in the future by cyclical conditions in the
semiconductor industry.
PROCUREMENT AND SOURCING. Tower's manufacturing processes use many raw
materials, including silicon wafers, chemicals, gases and various metals. These
raw materials generally are available from several suppliers and Tower is not
dependent upon any single source of supply, although, in some instances, Tower
elects to purchase certain raw materials from a single source. In those
instances, Tower generally identifies and qualifies alternative sources of
supply. Although supplies for raw materials used by Tower currently are
adequate, shortages could occur in various critical materials due to
interruption of supply or increased industry demand. Any such shortages could
result in production delays which could have a material adverse effect on
Tower's business and financial condition.
In connection with implementing its technology advancement plans, Tower
expects to continue to make significant purchases of equipment required for
semiconductor manufacturing. Some of this equipment is available from only a
single vendor or a limited number of vendors and/or is manufactured in
relatively limited quantities. In addition, certain equipment has only recently
been developed. Delays in delivery and shortages in supply of such equipment, as
well as failures of such equipment to operate in accordance with Tower's
expectations, could result in higher costs and production delays and delay
implementation of Tower's technology and advancement plans. Any such delays,
shortages or failures could have a material adverse effect on Tower.
RISKS RELATING TO ISRAELI GOVERNMENT PROGRAMS. The Investment Law for the
Encouragement of Capital Investments, 1959 (the "Investment Law") provides that
capital investments in certain production facilities (or other eligible
facilities) may, upon application to The Investment Center of the Ministry of
Industry and Trade of the State of Israel ("The Investment Center"), be
designated as an "Approved Enterprise". Virtually all of Tower's existing
facilities and programs, including Tower's current $240 million investment
program and the $93.4 million investment program which was substantially
completed in 1995, have been granted Approved Enterprise status under the
Investment Law. To be eligible for grants and tax benefits, Tower must continue
to meet certain conditions, including making certain specified investments in
fixed assets. The certificate of approval related to Tower's current Approved
Enterprise program
11
requires, among other things, that all investments under the program be
completed by the end of 1998. Should Tower fail to meet such conditions in the
future, it could be required to refund grants or tax benefits already received
(together with interest and certain inflation adjustments). There can be no
assurance that such grants and tax benefits will be continued in the future at
their current levels or at all.
DEPENDENCE ON SENIOR MANAGEMENT AND KEY PERSONNEL. Tower is highly
dependent upon its senior management team, many of whom have been working at the
facility since National commenced the construction of the facility in 1984. The
loss of the services of any member of senior management could have a material
adverse effect on Tower's business and financial condition. Tower does not
maintain key-man life insurance with respect to members of senior management.
Tower also is dependent to a substantial degree upon its skilled
professional and technical personnel and will be required to increase
significantly the number of these employees in the future in order to
implement successfully its plans for the future. There is considerable
competition for the services of qualified personnel in the semiconductor
industry and, consequently, there can be no assurance that Tower will be able
either to retain its present personnel or to attract additional qualified
personnel as and when needed. In addition, Tower may be required to increase
employee compensation levels in order to retain its existing employees and
attract and retain the additional personnel that it expects to require.
COMPETITION. The semiconductor foundry industry is highly competitive.
Tower competes with other dedicated foundries and with integrated semiconductor
and end-product manufacturers that produce ICs for their own use and/or allocate
a portion of their manufacturing capacity to foundry operations. Many of Tower's
competitors have more advanced technological capabilities, a more diverse and
established customer base, and greater financial, marketing, distribution and
other resources than Tower. In addition some of Tower's competitors may have
lower labor costs.
POSSIBLE SHORTAGES OF RAW MATERIALS AND EQUIPMENT. Although supplies for
raw materials and equipment used by Tower currently are adequate, shortages
could occur in the future in various critical materials and equipment due to
interruption of supply or increased industry demand. Any such shortages could
result in higher costs, production delays or delays in Tower's expansion, any of
which could have a material adverse effect on Tower's business and financial
condition.
ENVIRONMENTAL MATTERS. Tower is subject to a variety of governmental
regulations related to the use, discharge and disposal of toxic, volatile or
otherwise hazardous materials used in its manufacturing process. Any failure by
Tower to use, discharge or dispose of hazardous materials appropriately could
subject it to substantial liability or could require it to suspend or adversely
modify its manufacturing operations. In addition, Tower could be liable for
remedial measures if its properties are found to be contaminated even if Tower
is not responsible for such contamination, although Tower's risk in this regard
is reduced by an indemnity from National for violations of environmental
regulations that occurred prior to Tower's acquisition of the facility.
Although Tower believes that it currently is in compliance in all material
respects with all existing environmental regulations, during the ordinary course
of its operations, Tower on occasion has become aware that its operations were
not in compliance with certain applicable environmental regulations. Tower has
resolved all such matters in a manner that has not had a material adverse effect
on its operations. There can be no assurance, however, that in the future Tower
will be as successful in this regard and the failure to resolve a significant
matter could subject it to substantial liability or could require it to suspend
or adversely modify its manufacturing operations. Furthermore, there can be no
assurance that changes in environmental regulations in the future will not
require Tower to make significant capital expenditures to modify, supplement or
replace equipment or to change methods of disposal or discharge or the manner in
which Tower manufactures products or operates its business.
12
ITEM 2. PROPERTIES
The Company's corporate headquarters (as well as the principal office for
its United States operations) are located in Mahwah, New Jersey in
approximately 5,000 square feet of office space, under a lease which expires in
September 1997. The rent for these premises currently is $74,000 per annum.
The Company also rents offices in New York City of approximately 3,500 square
feet, under a lease which expires in August 2000, at a current rent of $75,000
per annum, and of approximately 9,700 square feet in Stamford, Connecticut, at
an annual rent of $96,000.
DSI's facilities in Israel are located in Givat Shmuel in the Tel Aviv area
in approximately 23,900 square feet of office space, under a lease which expires
in April 2000. The annual rent is currently approximately $326,000.
Tower's offices, engineering and manufacturing operations are located in a
building complex situated on 13 acres in an industrial park in Migdal Haemek,
Israel. The buildings comprise approximately 180,000 square feet of space and
include clean room facilities of approximately 51,700 square feet. These
premises currently are occupied under a long-term capital lease from the Israel
Lands Authority which expires in 2032. The lease rights under this lease were
assigned to Tower as part of its acquisition of the facility and the value
attributed to the capitalized lease is being amortized by Tower over the life of
the lease. Tower has no obligation for lease payments related to this lease
through the year 2032.
ITEM 3. LEGAL PROCEEDINGS
The Company is a plaintiff in an action in the United States District
Court for the District of New Jersey against a former officer who resigned in
April 1995, alleging destruction and misappropriation of property and data
owned by the Company. The employee has filed a counterclaim against the
Company, alleging breach by the Company of its employment and resignation
agreements with the employee and seeking compensatory damages of $750,000 and
punitive damages of $25 million. The Company is pursuing its claims against
the employee and is vigorously defending against his counterclaims. The
Company accrued the full amount of severance payable under the resignation
agreement at the time of such employee's resignation. The Company believes it
is unlikely to incur additional material liability in connection with the
counterclaim.
Between June and September 1996, several suits were filed in the United
States on behalf of a purported class of Tower's shareholders against Tower,
its Co-Chief Executive Officers, its Chairman of the Board of Directors, and
DSSI. The complaints seek to certify a class of all persons who purchased or
otherwise acquired Tower's ordinary shares between May 25, 1995 and June 10,
1996. The actions have been consolidated in the United States District Court
for the District of New Jersey. The consolidated complaint filed in the
actions alleges on behalf of the class that the defendants made
misstatements and omissions regarding (i) the relationship between Tower and
a major customer and (ii) Tower's process development efforts in connection
therewith, in violation of certain U.S. Federal securities laws. Tower has
indemnified the defendants, up to the limits permitted by the Israeli
Companies Ordinance, from any liability arising out of the actions. Tower
maintains insurance policies, that, under certain conditions, cover actions
of this type up to an aggregate amount of $20 million. The Company is unable
to determine at this time with any certainty the ultimate outcome of the
aforementioned matter or its effect if any, on the Company's financial
condition, operating results and business. However, the Company believes it
has meritorious defenses and is defending the actions vigorously.
The Company is not involved in any other legal proceedings that management
believes, individually or in the aggregate, will have a material adverse effect
on the Company.
13
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
14
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock is traded on the Nasdaq National Market System
(NASDAQ/NMS) under the symbol "DSSI". The following table sets forth, for the
periods indicated, the high and low reported sales prices per share of the
Common Stock on The Nasdaq Stock Market.
High Low
---- ---
1995:
First Quarter . . . . . . . . . . . . . . . 7 4 7/8
Second Quarter . . . . . . . . . . . . . . . 11 1/2 5 5/16
Third Quarter . . . . . . . . . . . . . . . 13 10 1/8
Fourth Quarter . . . . . . . . . . . . . . . 10 7/8 7
1996:
First Quarter . . . . . . . . . . . . . . . 7 3/4 5 13/16
Second Quarter . . . . . . . . . . . . . . . 8 7/8 6
Third Quarter . . . . . . . . . . . . . . . 6 7/8 5
Fourth Quarter . . . . . . . . . . . . . . . 7 4 3/4
As of March 15, 1997 there were approximately 70 record holders of the
Common Stock. The Company estimates that there are approximately 3,500
beneficial owners of the Common Stock.
The Company paid no dividends in 1995 or 1996.
ITEM 6. SELECTED FINANCIAL DATA
The following selected statement of income data for the years ended
December 31, 1994, 1995 and 1996 and balance sheet data as of December 31, 1995
and 1996 have been derived from the financial statements of the Company included
in this annual report, which have been audited by Igal Brightman & Co. (a member
of Deloitte Touche Tohmatsu International), independent auditors. The selected
statement of income data for the years ended December 31, 1992 and 1993 and
balance sheet data as at December 31, 1992, 1993 and 1994 are derived from
audited financial statements not included herein.
This data is qualified in its entirety by reference to, and should be
read in conjunction with, the Company's Consolidated Financial Statements
(including the notes thereto) and "Item 7. Management's Discussion and
Analysis of Financial Condition and Results of Operations".
The statement of income data for the year ended December 31, 1993
includes Tower's operations for the ten months commencing March 1, 1993.
Since the results for years prior to 1993 do not include results for Tower,
and the results for 1993 include only ten months of Tower operations, the
Company believes that the results for these periods are not directly
comparable. The balance sheet data as of December 31, 1996 reflects the
Company's interest in Tower as an investment on the equity method, not
otherwise including Tower's balances. The balances as of December 31, 1996
are therefore not comparable to those of previous years.
15
Statement of Income Data:
YEAR ENDED DECEMBER 31,
-----------------------
1992 1993 1994 1995 1996
---- ---- ---- ---- ----
(in thousands, except per share data)
Sales $ 14,790 $ 57,945 $ 79,711 $129,823 $131,755
Cost of sales 10,078 43,261 58,527 90,839 102,094
---------- ---------- ---------- --------- ---------
Gross profit 4,712 14,684 21,184 38,984 29,661
Research and development expenses, net 175 1,036 2,911 2,648 5,059
Selling, general and administrative expenses 3,561 7,600 10,602 15,926 18,635
---------- ---------- ---------- --------- ---------
Operating income 976 6,048 7,671 20,410 5,967
Financial income (expenses), net 182 (879) (219) 2,754 3,103
Gain on changes in ownership interests in
subsidiaries 3,917 935 14,755 26,339 -
Other income (expenses), net (206) 188 (147) 5 609
---------- ---------- ---------- --------- ---------
Income before income taxes 4,869 5,916 22,060 49,508 9,679
Income taxes 474 1,605 1,632 4,837 2,141
---------- ---------- ---------- --------- ---------
Net income after income taxes 4,395 4,311 20,428 44,671 7,538
Minority interests (24) (2,153) (10,420) (25,352) (7,804)
Equity in affiliates (53) (40) (227) (169) (1,767)
---------- ---------- ---------- --------- ---------
Net income (loss) $ 4,318 $ 2,118 $ 9,781 $ 19,150 $ (2,033)
---------- ---------- ---------- --------- ---------
---------- ---------- ---------- --------- ---------
Earnings (loss) per share $ 1.05 $ 0.44 $ 1.45 $ 2.62 $ (0.28)
---------- ---------- ---------- --------- ---------
---------- ---------- ---------- --------- ---------
Weighted average number of shares 4,125 4,770 6,728 7,307 7,369
---------- ---------- ---------- --------- ---------
---------- ---------- ---------- --------- ---------
Net income for each of the years 1993 through 1995 includes net income
attributable to gains on changes in ownership interests in subsidiaries or on
the sale of shares in subsidiaries. Excluding the effect of such gains, net
income after income taxes and minority interests for the years ended December
31, 1993, 1994, and 1995 would have been $1,813,000, $883,000 and $3,369,000,
respectively, and earnings per share for the same periods would have been
$0.38, $0.13 and $0.46, respectively.
Balance Sheet Data:
DECEMBER 31,
-----------
1992 1993 1994 1995 1996
--------- --------- --------- --------- ---------
(in thousands)
Working capital $ 10,248 $ 31,459 $ 63,895 $ 141,850 $ 13,679
Total assets $ 19,437 $ 71,741 $ 129,552 $ 275,377 $ 102,088
Short-term debt, including current
maturities of long-term debt $ 1,785 $ 6,971 $ 3,821 $ 16,371 $ 2,124
Long-term debt, net of current maturities $ 331 $ 13,902 $ 12,485 $ 22,499 $ 331
Minority interests $ 1,702 $ 7,379 $ 42,772 $ 129,730 $ 29,283
Total shareholders' equity $ 12,132 $ 30,988 $ 46,511 $ 67,754 $ 65,978
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
General
The following discussion includes statements that are forward-looking in
nature. Whether such statements ultimately prove to be accurate depends upon a
variety of factors that may affect the business and operations of the Company.
Certain of these factors are discussed at "Item 1. Description of
Business-Factors That May Influence Future Results."
The Company commenced providing consulting and development services for
computer software and systems in Israel in 1986 and in the United States in
1991. In March 1993, the Company diversified its business through the
acquisition of a facility in Israel that manufactures semiconductors using CMOS
process technology
16
and the proprietary IC designs of its customers. Since such date the Company
conducted its business through two business segments: the Computer Segment and
the Semiconductor Segment.
Due to changes in the Company's voting control in Tower, the balance sheet
as at December 31, 1996 does not include Tower balances. The Company therefore
believes that these balances are not comparable with those of prior years.
Commencing in 1997, the Company will account for its interest in Tower's results
using the equity method and will include its prorata share of Tower's net
income as equity income.
COMPUTER SOFTWARE SERVICES AND SYSTEMS
The Company's Computer Segment commenced operations in Israel in 1986 with
revenues attributable to the Company's Israeli subsidiaries accounting for 59%,
51%, and 39% of the total revenues of this segment during 1994, 1995 and 1996,
respectively. The decreasing percentage is primarily due to the increasing
revenues from operations in the United States. The Computer Segment's
operations in the United States have had a cumulative operating loss since
commencing operations in 1991, reflecting primarily the significant expenditures
intended to generate revenues over the long term rather than in current periods.
The Company started to realize the benefits of these expenditures towards the
end of 1994, achieving significant revenue growth and improved operating results
in these operations in 1995. In 1996 the Company invested heavily in
development and marketing of these products, resulting in increased operating
losses.
Costs relating to software product development are capitalized (in
accordance with applicable accounting principles for software development) to
the extent that they are incurred after the technological feasibility of the
product has been established and management considers that these costs are
recoverable from expected future revenues. When the foregoing criteria are not
satisfied, research and development costs relating to product development are
expensed as incurred. The Company's results of operations for 1994, 1995 and
1996 reflect $2 million, $914,000 and $415,000 respectively, of research and
development expenses (net of government grants) attributable to the Computer
Segment. In addition, based on an evaluation by management of the net
realizable value of software costs associated with certain of its products under
development, the Company recorded write-downs and amortized previously
capitalized software costs totaling $1.14 million, $183,000 and $881,000 in
1994, 1995 and 1996 respectively, included in research and development expenses
and costs of sales.
As of December 31, 1994, 1995 and 1996, capitalized software development
costs reflected on the balance sheet were $2.2 million, $4.4 million and $5.2
million, respectively. Of such capitalized software costs as of December 31,
1996, $4.3 million relates to the Company's EPSM product which is in beta test.
There have been no full product sales of the EPSM to date and there can be no
assurance that the Company will in fact derive significant revenues from EPSM.
The remaining balance as of December 31, 1996 relates to the Company's
PHD-Professional Help Desk product. The Company has initiated amortization of
capitalized costs relating to PHD. Costs related to new software modules are
capitalized in accordance with applicable accounting principles as described
above. The balance sheet as of December 31, 1996 also includes an investment
of $1.2 million in the Company's CybrCard multimedia entertainment product,
development of which has only recently been completed.
Applicable accounting principles require that capitalized software costs
be periodically reviewed and are written down to net realizable value. Possible
additional write-downs of capitalized software costs associated with the
products above may significantly affect operating results in 1997 and future
periods. See "Item 1. Business Factors Which May Affect Future Results -
General Factors - Capitalization of Software Development Costs; Possibility of
Future Writedowns".
Gross profit margins in the operations of the Computer Segment,
particularly in Israel, continue to experience downward pressure due to
increased labor costs resulting from the relative shortage of qualified
programmers and engineers. There can be no assurance that the competitive
market place for qualified engineers will not continue to affect margins in
future periods.
SEMICONDUCTOR MANUFACTURING
Tower is an independent "foundry" manufacturer of semiconductor ICs on
silicon wafers. As a foundry, Tower manufactures wafers using its advanced
production capability and the proprietary IC designs of its customers. Tower
manufactures primarily differentiated ICs rather than commodity products. These
ICs are incorporated into a wide range of products in diverse markets, including
computer and office equipment,
17
communication products and consumer electronics.
Tower commenced operations as an independent business in March 1993, when
it acquired its manufacturing facility from National Semiconductor Corporation
(the "Acquisition"). Since the Acquisition through the end of 1995, Tower
increased its sales and profitability by (i) expanding its customer base; (ii)
expanding its manufacturing capacity, through installation of new equipment,
improvement of equipment utilization, reduction of cycle time and streamlining
of the manufacturing process; (iii) reducing costs through improvement of
equipment, process yields and operational efficiencies and realization of
economies of scale; and (iv) advancing its process technology. This allowed
Tower to improve its gross profit and operating margins from commencement of
operations through the end of 1995.
During 1996, there was a downturn in the market for semiconductor products
generally. In June 1996, Tower announced that Tower and Hewlett-Packard had
mutually agreed on the terms for ending the agreement for the purchase by
Hewlett-Packard of wafers from Tower. Sales to Hewlett-Packard accounted for 9%
and 19% of Tower's sales in 1995 and 1994, respectively, and had been expected
to account for approximately 25% of sales in 1996.
As a result of (i) the end of the agreement with Hewlett-Packard, (ii) the
reduction in orders from other customers and (iii) the prevailing weakness in
the demand for semiconductors products generally, Tower operated its
manufacturing facility substantially below capacity for much of 1996.
Utilization improved during the fourth quarter of 1996 and into 1997, primarily
as a result of improvement in the personal computer and peripheral end markets
and reduction by Tower of its prices . However, the situation in the marketplace
remains uncertain and there is no assurance that utilization of Tower's
facility will continue at the level necessary to maintain profitable operations.
In addition, Tower continues to see downward pressure on prices from both
current and potential new customers.
During 1996, Tower modified its plans for 1996 and 1997, scaling back its
capacity expansion plan and increasing the resources allocated to Tower's
technology advancement plan, as well as to improvements in infrastructure and
operating procedures. Tower does not currently intend to significantly increase
the overall capacity of the facility during 1997. Tower intends, however, to
continue to make significant expenditures during the remainder of 1997 to
continue its process technology advancement program. See "Item 1. Description
of Business - Semiconductor Segment - Process Technology," and "Item 1.
Description of Business - Semiconductor Segment - Manufacturing Facility".
Results of Operations
The following table sets forth selected statement of income items as a
percentage of total sales of the Company.
Year Ended December 31,
-----------------------
1992 1993 1994 1995 1996
---- ---- ---- ---- ----
Sales 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of sales 68.1% 74.7% 73.4% 70.0% 77.5%
------ ------ ------ ------ ------
Gross profit 31.9% 25.3% 26.6% 30.0% 22.5%
Research and development expenses, net 1.2% 1.8% 3.7% 2.0% 3.8%
Selling, general and administrative expenses 24.1% 13.1% 13.3% 12.3% 14.1%
------ ------ ------ ------ ------
Operating income 6.6% 10.4% 9.6% 15.7% 4.5%
Financial income (expenses), net 1.2% (1.5%) (0.3%) 2.1% 2.4%
Gain on changes in ownership interests in subsidiary 26.5% 1.6% 18.5% 20.3% -
Other income (expenses), net (1.4%) 0.3% (0.2%) - 0.4%
------ ------ ------ ------ ------
Income before income taxes 32.9% 10.2% 27.6% 38.2% 7.3%
Income taxes 3.2% 2.8% 2.0% 3.7% 1.6%
------ ------ ------ ------ ------
Net income after income taxes 29.7% 7.4% 25.6% 34.5% 5.7%
Minority interests (0.1%) (3.7%) (13.1%) (19.5%) (5.9%)
Equity in affiliates (0.4%) ( - ) (0.2%) (0.1%) (1.3%)
------ ------ ------ ------ ------
Net income (loss) 29.2% 3.7% 12.3% 14.8% (1.5%)
------ ------ ------ ------ ------
18
The following table sets forth certain information with respect to the
results of operations of the Company and its two business segments for the
period from 1994 through 1996, the percentage of total revenues during each year
attributable to selected components of the statement of operations data and the
year to year percentage changes in such components.
1994 1995 1996
---- ---- Increase ---- Increase
Dollar % of Dollar % of (Decrease) Dollar % of (Decrease)
Amount Sales Amount Sales from 1994 Amount Sales from 1995
------ ----- ------ ----- ---------- ------ ----- ----------
SEMICONDUCTOR SEGMENT
Sales $57,709 $99,621 72.6% $97,885 (1.7%)
Gross profit $15,061 26.1% $31,626 31.7% 110.0% $22,447 22.9% (29.0%)
Research and development expenses, net $902 1.6% $1,734 1.7% 92.2% $4,062 4.1% 134.3%
Selling, general, administrative expenses $3,126 5.4% $6,369 6.4% 103.7% $7,119 7.2% 11.8%
Operating income $11,033 19.1% $23,523 23.6% 113.2% $11,266 11.6% (52.1%)
COMPUTER SEGMENT
Sales $22,002 $30,202 37.3% $33,870 12.1%
Gross profit $6,123 27.8% $7,358 24.4% 20.2% $7,214 21.3% (1.9%)
Research and development expenses, net $2,009 9.1% $914 3.0% (54.5%) $997 2.9% 9.1%
Selling, general, administrative expenses $6,169 28.0% $7,836 25.9% 27.0% $9,966 29.4% 27.2%
Operating income (loss) ($2,055) (9.3%) ($1,392) (4.6%) 32.3% ($3,749) (11.1%) 169.4%
CORPORATE
Selling, general, administrative expenses $1,332 $1,721 31.7% $1,550 (9.9%)
COMBINED
Sales $79,711 $129,823 62.9% $131,755 1.5%
Gross profit $21,184 26.6% $38,984 30.0% 84.0% $29,661 22.5% (23.9%)
Research and development expenses, net $2,911 3.7% $2,648 2.0% (9.0%) $5,059 3.8% 91.0%
Selling, general, administrative expenses $10,602 13.3% $15,926 12.3% 50.2% $18,635 14.1% 17.0%
Operating income $7,671 9.6% $20,410 15.7% 166.% $5,967 4.5% (70.8%)
YEARS ENDED DECEMBER 31, 1996 AND 1995
Sales. The decrease in Semiconductor Segment sales was entirely due to
a decrease in average sales price, resulting from a general downturn in the
market for semiconductor products during the second half of 1996. Computer
Segment sales increased due to a 35% increase in sales from the Company's
United States operations, attributable to a 93% increase in Computer Hardware
- - VAR sales and a 102% increase in PHD-TM-software sales, partially offset by
a decrease in revenues from consulting services.
GROSS PROFIT. The decrease in gross profit as a percentage of
Semiconductor Segment sales, was primarily attributable to the impact of
increased costs associated with the depreciation of the cost of the expansion
of Tower's manufacturing facility and the operation of the plant below
capacity during the second half of 1996 as well as the decrease in average
sales price referred to above. The decrease in gross profits as a percentage
of Computer Segment sales was primarily attributable to (i) the increased
percentage of sales attributable to Computer Hardware-VAR sales which
charictaristcly have lower gross profit margins, and (ii) a decrease in
profitability in the Company's Israeli consulting systems and software
activity, due to increased direct labor costs.
RESEARCH AND DEVELOPMENT EXPENSES. The increase in research and
development expenses in the Semiconductor Segment reflected higher process
development expenses related to the implementation of Tower's technology
advancement plan. For a discussion of research and development costs in the
Computer Segment, see "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations-General".
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES ("SG&A"). The increase in
SG&A and SG&A as a percentage of sales for the Semiconductor Segment was
primarily attributable to increased marketing expenses and professional fees.
The increase in Computer Segment SG&A as a percentage of segment sales was
primarily attributable to SG&A expenses associated with the marketing and
general introduction of the Company's PHD and CybrCard products, as well as a
decrease in the Segment's Israeli operations without a commensurate decrease in
the SG&A of such operations.
19
OPERATING INCOME. The decrease in operating income was primarily due to
the aforementioned decrease in gross profits.
GAIN ON CHANGES IN OWNERSHIP INTEREST IN SUBSIDIARY. The gain in 1995 was
from Tower's public offering, net of certain expenses, minority interests in
this gain was approximately $10.5 million.
INCOME TAXES. The increase in the effective tax rate for the year ended
December 31, 1996 was primarily attributable to (i) the recording in 1995 of
a non-taxable gain on changes in ownership interests in subsidiaries related
to the public offering of stock by the Company's Tower subsidiary, and (ii)
the recording of taxes payable on a dividend distributed to the Company by
its Tower subsidiary in 1996.
YEARS ENDED DECEMBER 31, 1995 AND 1994
SALES. The increase in Semiconductor Segment sales was primarily due to
the following factors: (i) increased shipments (accounting for approximately
90% of the increase) made possible by increased manufacturing capacity; and
(ii) the realization of a higher average wafer sales prices, reflecting a change
in product mix, including the commencement of the sale of wafers manufactured
using the 0.8 micron process double and triple level processes. Computer
Segment sales increased due to a 55% increase in sales from the Company's United
States ongoing operations, the addition of Cornell, acquired in June 1995, and a
14% increase in sales from the Company's Israeli operations.
GROSS PROFIT. The increase in the gross profit margin in the Semiconductor
Segment, was due primarily to the realization of economies of scale and
streamlining of the manufacturing process, thereby reducing average wafer costs
by over 5% in 1995 as compared to 1994, and higher average wafer sales price,
as mentioned above. This increase was partially offset by an increase in
depreciation expenses attributable to the purchase of fixed assets in
connection with the implementation of Tower's expansion plan. The increase in
gross profits of the Computer Segment was entirely attributable to the Company's
United States operations. The decrease in the gross profit margin for the
Computer Segment was attributable to decreased margins in the Segment's Israeli
operation resulting from increased direct labor costs.
RESEARCH AND DEVELOPMENT EXPENSES. The increase in the Semiconductor
Segment reflected higher process development expenses related to the
implementation of Tower's technology advancement plan. The decrease in research
and development expenses in the Computer Segment was primarily attributable to
write-downs in 1994, totaling approximately $1.14 million, of previously
capitalized software.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. The increase in SG&A as a
percentage of sales for the Semiconductor Segment was primarily attributable to
increased salary expenses due to profit sharing as well as increased consulting
fees related to its expansion plans. The decrease in Computer Segment
SG&A as a percentage of segment sales was attributable to the fact that segment
sales of its United States operations increased without a commensurate increase
in SG&A.
OPERATING INCOME. Operating income increased due to significant increases
in both operating segments. The remaining operating losses in the Computer
Segment were attributable to continued development and marketing activity of the
Company's PHD product and other new products. Though these activities have had
initial sales, they have not yet become profitable.
FINANCIAL INCOME. The entire increase in financial income was attributable
to the monetary balances in Tower, primarily due to its public offerings at the
end of 1994 and in July 1995.
GAIN ON CHANGES IN OWNERSHIP INTEREST IN SUBSIDIARY. In 1995 and 1994 the
Company realized gains of approximately $26.3 million and $14.76 million,
respectively, primarily from Tower's public offerings, net of certain expenses.
Minority interests in these gains were approximately $10.5 million in 1995 and
$5.9 million in 1994.
INCOME TAXES. The increase in the effective tax rate for the year ended
December 31, 1995 was primarily attributable to a non-recurring tax reduction
in 1994 of $437,000 relating to employee stock compensation to Israeli
employees.
NET INCOME. Net income for 1995 and 1994 includes net income of $15.8
million (after taxes and minority interest), or $2.17 per share, and $8.9
million (after taxes and minority interest), or $1.32 per share, respectively,
20
attributable to the aforementioned gain resulting from Tower's public offerings.
Excluding this effect, net income increased by more than $2.9 million, or 329%,
to $3.8 million, or $0.46 per share in 1995, from $883,000, or $0.13 per share
in 1994.
LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 1996, DSSI and its wholly-owned subsidiaries had working
capital of $7.1 million including cash and cash equivalents of $2.2 million and
marketable securities and short term bank deposits of $5 million. Although
there is no legal restriction preventing disposition of the Company's
investments or the distribution to the Company of their earnings, cash of these
subsidiaries, (including DSSI's principal subsidiaries, DSI Israel and Tower) is
generally not available for use by DSSI or other subsidiaries. DSSI has
financed the operations of its wholly owned subsidiaries from the proceeds of a
public offering in 1993, an institutional private placement in June 1994 and the
receipt of a cash dividend from Tower in December 1996. DSSI believes that it
has adequate liquidity to finance its ongoing activities. There is no
assurance that the Company will have adequate resources and liquidity to finance
all of its product development and marketing efforts. In such event the Company
may seek financing from others in connection with these activities.
DSI Israel has satisfied its financial and operating requirements
principally through cash from operations and the net proceeds of its initial
public offering in December 1992. As of December 31, 1996 DSI Israel had
working capital of $3.2 million, including cash, short term bank deposits and
marketable securities of $854,000. Certain bank deposits serve as collateral
for bank loans and guarantees.
Although the Company has retained effective control of Tower, as of the end
of December 1996, the Company no longer maintained voting control of more than
50% of Tower's shares and, therefore, ceased to consolidate Tower's balance
sheet as of year end.
Tower has satisfied its financial and operating requirements principally
through cash from operations, Investment Center grants, an advance from a
customer and the net proceeds of its public offerings in 1994 and 1995. As
of December 31, 1996 Tower had working capital of $79.7 million, including
cash, short-term bank deposits and marketable securities of $72.2 million.
IMPACT OF INFLATION AND CURRENCY FLUCTUATIONS
During 1996 approximately 90% of the Company's sales were denominated in
dollars. The remaining portion is primarily denominated in New Israel Shekels
("NIS") that are linked to the dollar. Such sales transactions are negotiated
in dollars; however for the convenience of the customer are settled in NIS.
These transaction amounts are linked to the dollar between the date the
transactions are entered into until the date they are effected and billed for.
Subsequent thereto, through the date of settlement, amounts are primarily
unlinked. The majority of the Company's expenses in 1996 were in dollars or
dollar-linked NIS and virtually all the remaining expenses were in NIS. The
dollar cost of the Company's operations in Israel is 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. During 1996, the NIS was devalued against
the dollar by approximately 3.7%, while the consumer price index in Israel
increased by 10.6%. The Company believes that the rate of inflation in Israel
has had a minor effect on its business to date. However, the Company's dollar
costs in Israel will increase if inflation in Israel continues, as in the past
years, to exceed the devaluation of the NIS against the dollar or if the timing
of such devaluation lags behind inflation in Israel.
Tower has commitments outstanding in Japanese Yen incurred for certain
capital equipment expenditures. Tower purchases forward exchange contracts to
reduce its financial exposure to fluctuation in the Japanese Yen/US, dollar
exchange rate resulting from such commitments. The Company does not engage in
any other hedging activities.
As of December 31, 1996, virtually all of the Company's monetary assets and
liabilities that were not denominated in dollars or dollar-linked NIS were
denominated in NIS, and the net amount of such monetary assets and liabilities
was not material. In the event that in the future the Company has material net
monetary assets or liabilities that are not denominated in dollar-linked NIS,
such net assets or liabilities would be subject to the risk of currency
fluctuations.
21
SUMMARY QUARTERLY FINANCIAL DATA
The following table sets forth certain unaudited quarterly financial
information for the Company for the years ended December 31, 1995 and 1996.
This information should be read in conjunction with the financial statements of
the Company and the notes thereto.
1995 1996
------------------------------------- -------------------------------------
First Second Third Fourth First Second Third Fourth
Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter
------- ------- ------- ------- ------- ------- ------- -------
(Unaudited)
(in thousands, except per share amounts)
Sales $27,944 $31,100 $33,765 $37,014 $30,602 $36,711 $28,702 $35,740
Cost of sales 20,032 21,644 23,807 25,356 25,799 28,815 24,152 23,328
------- ------- ------- ------- ------- ------- ------- -------
Gross profit 7,912 9,456 9,958 11,658 9,933 7,896 4,550 7,282
Research and development expenses, net 574 592 609 873 835 893 1,535 1,796
Selling, general and
administrative expenses 3,425 4,081 4,380 4,040 4,454 4,626 4,192 5,363
------- ------- ------- ------- ------- ------- ------- -------
Operating income (loss) 3,913 4,783 4,969 6,745 4,644 2,377 (1,177) 123
Financial income (expenses), net 199 285 1,343 927 1,165 820 687 431
Gain on changes in ownership
interests in subsidiaries - - 6,339 - - - - -
Other income (expenses), net 9 19 (11) (12) 17 12 1,840 (1,260)
------- ------- ------- ------- ------- ------- ------- -------
Income before income taxes 4,121 5,087 32,640 7,660 5,826 3,209 1,350 (706)
Income taxes 856 1,022 1,099 1,860 1,161 489 1,434 (943)
------- ------- ------- ------- ------- ------- ------- -------
Net income (loss) after income taxes 3,265 4,065 31,541 5,800 4,665 2,720 (84) 237
Minority interests 2,520 3,052 14,891 4,889 3,819 2,325 724 936
Equity in affiliates (93) (34) (20) (22) (73) (53) (416) (1,225)
------- ------- ------- ------- ------- ------- ------- -------
Net income (loss) $652 $979 $16,630 $889 $773 $342 ($1,224) ($1,924)
------- ------- ------- ------- ------- ------- ------- -------
------- ------- ------- ------- ------- ------- ------- -------
Earnings (loss) per share $0.10 $0.14 $2.16 $0.12 $0.10 $0.04 ($0.17) ($0.26)
------- ------- ------- ------- ------- ------- ------- -------
------- ------- ------- ------- ------- ------- ------- -------
Weighted average number
of shares outstanding 6,829 6,885 7,705 7,608 7,310 7,534 7,373 7,400
------- ------- ------- ------- ------- ------- ------- -------
------- ------- ------- ------- ------- ------- ------- -------
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Furnished at end of Report commencing on page F-1. Financial Statements of
Tower Semiconductor Ltd are included commencing at page F-21 in accordance
with Rule 3-09(a) of Regulation S-X.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
22
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY
-----------------------------------------------
The information relating to each director and nominee for director of the
Company and the information relating to the Company's executive officers,
appearing under the captions "Election of Directors -- Certain Information
Regarding Directors and Executive Officers" in the Company's definitive proxy
statement for the 1997 Annual Meeting of Stockholders to be filed on or before
May 1, 1997 (the "1997 Proxy Statement") is hereby incorporated by reference.
ITEM 11. EXECUTIVE COMPENSATION
----------------------
The information relating to compensation of directors and executive
officers appearing under the caption "Election of Directors -- Directors'
Remuneration", "Election of Directors -- Employment Arrangements -- Executive
Compensation" in the 1997 Proxy Statement is hereby incorporated by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
--------------------------------------------------------------
The information relating to security ownership appearing under the caption
"Stock Ownership" in the 1997 Proxy Statement is hereby incorporated by
reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
----------------------------------------------
The information relating to certain relationships and transactions
appearing under the caption "Certain Transactions" in the 1997 Proxy Statement
is hereby incorporated by reference.
-23-
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
-----------------------------------------------------------------
(a) EXHIBITS:
3.1 Certificate of Incorporation of the Registrant, with amendments
thereto (incorporated herein by reference to Exhibit 3.1 to the
Registrant's Registration Statement on Form S-1 (File No. 33-70482)
(the "1993 Registration Statement")).
3.2 By-laws of the Registrant (incorporated herein by reference to
Exhibit 3.2 to the Registrant's Registration Statement on Form S-1
(File No. 33-44027) (the "1992 Registration Statement")).
3.3 Amendments to the By-laws of the Registrant adopted December 27, 1994
(incorporated by reference to Exhibit 3.3 of the Registrant's Current
Report on Form 8-K dated January 10, 1995).
4.1 Specimen certificate for the Common Stock (incorporated herein by
reference to Exhibit 4.2 to the 1992 Registration Statement).
4.2 Form of Underwriter's Warrant Agreement, including form of
Underwriter's Warrant (incorporated herein by reference to Exhibit
4.4 to the 1993 Registration Statement).
4.3 Form of Warrant to Purchase Common Stock (incorporated herein by
reference to Exhibit 4.3 to the Company's Annual Report on Form 10K
for the year ended December 31, 1995 (the "1995 10-K").
*10.1 Employment Agreement between the Registrant and George Morgenstern,
dated as of January 1, 1994 (incorporated herein by reference to
Exhibit 10.1 to the Registrant's Annual Report on Form 10-K for the
year ended December 31, 1993).
*10.2 Employment Agreement between the Registrant and Shmuel Fogel, dated
September 1, 1986 (incorporated herein by reference to Exhibit 10.3
to the 1992 Registration Statement).
*10.3 1991 Stock Option Plan (incorporated herein by reference to Exhibit
10.4 to the 1992 Registration Statement).
*10.4 1994 Stock Incentive Plan, as amended (incorporated herein by
reference to Exhibit 10.4 to the 1995 10-K).
*10.5 1994 Stock Option Plan for Outside Directors, as amended
(incorporated herein by reference to Exhibit 10.5 to the 1995 10-K).
10.6 1995 Stock Option Plan for Nonmanagement Employees (incorporated
herein by reference to Exhibit 10.6 to the 1995 10-K).
10.7 Subcontract between DSI Israel and EDO Corporation for Tasks Related
to the Sonar Project (incorporated herein by reference to Exhibit
10.6 to the 1992 Registration Statement).
*10.8 Trust Agreement between Israel Discount Bank Trust Company Ltd., DSI
Israel, the Registrant and the beneficiaries named therein dated
August 16, 1992 (incorporated by reference to Exhibit 10.19 to the
1992 Registration Statement).
10.9 Lease Agreement between Tower Semiconductor Ltd. ("Tower") and the
Israel Lands Administration (incorporated herein by reference to
Exhibit 10.1 to Tower's Registration Statement on Form S-1 (File No.
33-83126) (the "First Tower Registration Statement")).
10.10 Joint Venture Formation Agreement among the Registrant, National
Semiconductor
-24-
Corporation and National Semiconductor (IC) Ltd., dated December 24,
1992 (incorporated herein by reference to Exhibit 10.2 to the First
Tower Registration Statement).
10.11 Shareholders Agreement between National Semiconductor (IC) Ltd. and
Tower Semiconductor Holdings 1993 Limited, dated as of February 28,
1993, as amended (incorporated herein by reference to Exhibit 10.3 to
the First Tower Registration Statement).
10.12 Amendment dated November 1995 to the Shareholders Agreement listed
above as Exhibit 10.11 (incorporated by reference to Exhibit 1.2 to
Tower's Annual Report on Form 20-F for the year ended December 31,
1994) (the "Tower 1994 20-F").
10.13 Amendment dated June 12, 1995 to the Shareholders Agreement listed
above as Exhibit 10.11 (incorporated by reference to Exhibit 10.3.2
to Tower's Registration Statement on Form F-1 (File No. 33-93434)
(the "Second Tower Registration Statement")).
10.14 Amendment dated as of September 22, 1996 to the Shareholders
Agreement listed above as Exhibit 10.11. (incorporated herein by
reference to the 1995 10-K).
10.15 Registration Rights Agreement among Tower, National Semiconductor
(IC) Ltd., and Tower Semiconductor Holdings 1993 Limited, dated as of
February 28, 1993 (incorporated herein by reference to Exhibit 10.4
to the First Tower Registration Statement).
10.16 Purchase Agreement between National Semiconductor Corporation and
Tower, dated as of February 28, 1993, as amended (incorporated herein
by reference to Exhibit 10.5 to the First Tower Registration
Statement).
10.17 Addendum to Purchase Agreement listed as Exhibit 10.11 above
(incorporated by reference to Exhibit 1.1 to the Tower 1994 20-F).
10.18 Supplement dated May 15, 1995, to Purchase Agreement listed as
Exhibit 10.5 above (incorporated by reference to Exhibit 10.5.2 to
the Second Tower Registration Statement).
10.19 Technology Transfer Agreement between National Semiconductor
Corporation and Tower, dated as of February 28, 1993 (incorporated
herein by reference to Exhibit 10.6 to the First Tower Registration
Statement).
10.20 Joint Venture Formation Agreement between the Registrant and The
Israel Corporation Ltd., dated as of February 28, 1993 (incorporated
herein by reference to Exhibit 10.7 to the First Tower Registration
Statement).
10.21 Shareholders Agreement among the Registrant, The Israel Corporation
Ltd. and Tower Semiconductor Holdings 1993 Limited, dated as of
February 28, 1993, as amended (incorporated herein by reference to
Exhibit 10.8 to the First Tower Registration Statement).
10.22 Mutual Services Agreement between Tower and National Semiconductor
Corporation, dated July 1, 1994 (incorporated herein by reference to
Exhibit 10.9 to the First Tower Registration Statement).
10.23 Purchase Agreement, as amended, between Tower and Hewlett-Packard
Company, dated January 16, 1994 (incorporated herein by reference to
Exhibit 10.10 to the First Tower Registration Statement).
10.24 Technology Transfer and License Agreement between Tower and
Hewlett-Packard Company, dated February 22, 1994 (incorporated herein
by reference to Exhibit 10.11 to the First Tower Registration
Statement).
10.25 Special Collective Agreement and Letter of Indemnity dated October 4,
1994 between Tower, the Histadrut and Mivtachim Social Institute of
Employees Ltd. (incorporated herein by reference to Exhibit 10.12 to
the First Tower Registration Statement).
10.26 Contract Supply Agreement between Tower and Motorola, Inc., dated May
24, 1994, as
-25-
amended (incorporated herein by reference to Exhibit 10.13 to the
First Tower Registration Statement).
10.27 Certificate of Approval of the Investment Center of the Israel
Ministry of Industry and Trade (incorporated herein by reference to
Exhibit 10.14 to the First Tower Registration Statement).**
10.28 Certificate of approval for the Investment Center of the Israel
Ministry of Industry and Trade dated January 24, 1996.**
10.29 Bank Loan and Credit Line Agreements among the Registrant, Bank Leumi
Le-Israel B.M. and Bank Hapoalim B.V., as amended (incorporated
herein by reference to Exhibit 10.15 to the First Tower Registration
Statement).
*10.30 Form of Tower Employee Share Purchase Plan Agreement (incorporated
herein by reference to Exhibit 10.16 to the First Tower Registration
Statement).
*10.31 Employment Agreement between the Registrant and Sanford L. Kane,
dated as of July 1, 1994 (incorporated herein by reference to Exhibit
10.18 to the First Tower Registration Statement).
*10.32 Agreement dated April 10, 1995, between the Company and Sanford L.
Kane (incorporated herein by reference to Exhibit 21.1 to the 1995
10-K).
*10.33 Employment Agreement between Tower and Rafael Levin, dated February
25, 1993, as amended (incorporated herein by reference to Exhibit
10.19 to the First Tower Registration Statement).
*10.34 Employment Agreement between Tower and Yoav Nissan-Cohen, dated
February 25, 1993, as amended (incorporated herein by reference to
Exhibit 10.20 to the First Tower Registration Statement).
10.35 Agreement between the Registrant and Tower dated January 18, 1994
(incorporated herein by reference to Exhibit 10.21 to the First Tower
Registration Statement).
10.36 Agreement between the Registrant and Tower, dated June 12, 1995
(incorporated herein by reference to Exhibit 10.22 to the Second
Tower Registration Statement).
10.37 Promissory Note dated July 1, 1996 of Geotek Communications, Inc. in
the principal amount of $2,000,000 payable to Decision System Israel
Ltd.
11.1 Calculation of earnings per share.
22.1 List of subsidiaries (incorporated by reference to Exhibit 21.1 to
the 1995 Form 10-K).
24.1 Consent of Igal Brightman & Co.
27.1 Financial Data Schedule
- --------------------------
* This exhibit includes a management contract, compensatory plan or
arrangement in which one or more directors or executive officers of the
Company participate.
** Hebrew original, accompanied by English language translation or summary.
(b) FINANCIAL STATEMENT SCHEDULES.
None.
-26-
(C) REPORTS ON FORM 8-K.
The Company filed no reports on Form 8-K during the last three months of
1996.
-27-
SIGNATURE
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized, in the Township of Mahwah,
State of New Jersey, on April 3, 1997.
DATA SYSTEMS & SOFTWARE INC.
By /s/ George Morgenstern
--------------------------------
George Morgenstern
Chairman of the Board, President
and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed by the following persons on behalf of the registrant, in the
capacities and on the dates indicated.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ George Morgenstern
- -------------------------- Chairman of the Board; April 3, 1997
George Morgenstern President; Chief Executive
Officer; and Director
/s/ Robert L. Kuhn
- -------------------------- Vice Chairman and Director April 3, 1997
Robert L. Kuhn
- -------------------------- Executive Vice President April , 1997
Samuel Fogel and Director
/s/ Yacov Kaufman
- -------------------------- Vice President, Chief April 3, 1997
Yacov Kaufman Financial Officer (Principal
Financial Officer and
Principal Accounting Officer)
/s/ Harvey Eisenberger
- -------------------------- Director April 3, 1997
Harvey Eisenberger
/s/ Allen I. Schiff
- -------------------------- Director April 3, 1997
Allen I. Schiff
- -------------------------- Director April , 1997
Maxwell M. Rabb
/s/ Sheldon Krause
- -------------------------- Secretary and Director April 3, 1997
Sheldon Krause
-28-
DATA SYSTEMS & SOFTWARE INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED FINANCIAL STATEMENTS OF DATA SYSTEMS & SOFTWARE INC.:
Report of Independent Auditors . . . . . . . . . . . . . . . . . . . . . . F-1
Consolidated Balance Sheets as of December 31,
1995 and December 31, 1996 . . . . . . . . . . . . . . . . . . . . . . . . F-2
Consolidated Statements of Income for the
years ended December 31, 1994, December 31,
1995 and December 31, 1996. . . . . . . . . . . . . . . . . . . . . . . . F-3
Consolidated Statement of Changes in Shareholders'
Equity for the years ended December 31, 1994
December 31, 1995 and December 31, 1996. . . . . . . . . . . . . . . . . . F-4
Consolidated Statements of Cash Flows for the
years ended December 31, 1994, December 31, 1995
and December 31, 1996. . . . . . . . . . . . . . . . . . . . . . . . . . . F-5
Notes to Consolidated Financial Statements . . . . . . . . . . . . . . . . . F-7
FINANCIAL STATEMENTS OF TOWER SEMICONDUCTOR LTD.:
Auditors' Report . . . . . . . . . . . . . . . . . . . . . . . . . . . . F-21
Balance Sheets as of December 31, 1996 and December 31, 1995 . . . . . . F-22
Statements of Income for the
years ended December 31, 1996, December 31, 1995
and December 31, 1994 . . . . . . . . . . . . . . . . . . . . . . . . . F-23
Statement of Changes in Shareholders' Equity for the
years ended December 31, 1996, December 31, 1995
and December 31, 1994 . . . . . . . . . . . . . . . . . . . . . . . . . F-24
Statements of Cash Flows for the
years ended December 31, 1996, December 31, 1995
and December 31, 1994 . . . . . . . . . . . . . . . . . . . . . . . . . F-25
Notes to Financial Statements . . . . . . . . . . . . . . . . . . . . . . F-26
-29-
REPORT OF INDEPENDENT AUDITORS
TO THE BOARD OF DIRECTORS AND SHAREHOLDERS OF
DATA SYSTEMS & SOFTWARE INC.
We have audited the accompanying consolidated balance sheets of Data Systems &
Software Inc. ("the Company") and its subsidiaries as of December 31, 1995 and
1996, and the related consolidated statements of income, changes in
shareholders' equity and cash flows for each of the three years in the period
ended December 31, 1996. These financial statements are the responsibility of
the Company's Board of Directors and management. Our responsibility is to
express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards
in Israel, including those prescribed by the Israeli Auditors' Regulations
(Auditor's Mode of Performance) - 1973, which auditing standards are
substantially identical to generally accepted auditing standards 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 the
Board of Directors and management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of the Company and its
subsidiaries as of December 31, 1995 and 1996, and the results of their
operations, changes in shareholders' equity and cash flows for each of the three
years in the period ended December 31, 1996, in accordance with accounting
principles generally accepted in Israel and in the United States. As applicable
to these financial statements, such accounting principles are substantially
identical in all material respects.
IGAL BRIGHTMAN & CO.
Certified Public Accountants (Isr.)
Tel Aviv, Israel
March 31, 1997
F-1
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(dollars in thousands)
AS OF DECEMBER 31,
---------------------
ASSETS 1995 1996(*)
---------------------
Current assets:
Cash and cash equivalents $25,959 $2,464
Short-term interest bearing bank deposits 26,991 398
Marketable debt securities (Note 3) 83,965 5,226
Restricted cash (Note 10) 1,366 1,403
Trade accounts receivable (Note 4) 21,040 7,875
Inventory (Note 5) 13,629 953
Other current assets (Note 6) 21,291 1,740
-------- -------
Total current assets 194,241 20,059
-------- -------
Investments (Note 7) 1,763 68,372
-------- -------
Property and equipment, net (Note 8) 71,889 2,279
-------- -------
Other assets:
Capitalized software development costs, net (Note 9) 4,425 5,229
Intangible assets, primarily goodwill 843 468
Note receivable (Note 7) 0 2,083
Other 2,216 3,626
-------- -------
7,484 11,406
-------- -------
Total assets $275,377 $102,116
-------- -------
-------- -------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Short-term debt - banks and others (Note 10) $4,878 $1,962
Current maturities of long-term debt - banks and others (Note 12) 11,493 162
Trade accounts payable (Note 11) 25,300 1,643
Accrued payroll, payroll taxes and social benefits 6,962 2,140
Other current liabilities 3,758 476
-------- -------
Total current liabilities 52,391 6,383
-------- -------
Long-term liabilities:
Long-term debt - banks and others, net of current maturities (Note 12) 22,499 331
Foreign deferred taxes 1,812 0
Other (Note 13) 1,191 141
-------- -------
Total long-term liabilities 25,502 472
-------- -------
Commitments and contingencies (Note 14)
Minority interests 129,730 29,283
-------- -------
Shareholders' equity (Note 15):
Common stock - $.01 par value per share: Authorized 20,000,000 shares;
Issued - 7,590,665 and 7,708,540 shares at
December 31, 1995 and 1996, respectively 75 77
Additional paid-in capital 33,742 33,997
Retained earnings 35,785 33,752
-------- -------
69,602 67,826
Treasury stock, at cost - 339,362 shares at December 31, 1995 and 1996, respectively (1,848) (1,848)
-------- -------
Total shareholders' equity 67,754 65,978
-------- -------
Total liabilities and shareholders' equity $275,377 $102,116
-------- -------
-------- -------
(*) The balances as of December 31, 1996 reflect the investment in Tower
Semiconductor Ltd. on the equity method. Accordingly, the balances of
1995 and 1996 are not comparable - see Note 2.
The accompanying notes are an integral part of these financial statements.
F - 2
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(dollars in thousands, except per share data)
YEAR ENDED DECEMBER 31,
--------------------------------------
1994 1995 1996
--------------------------------------
Sales:
Products $63,443 $110,116 $113,235
Services 16,268 19,707 18,520
-------- -------- --------
79,711 129,823 131,755
-------- -------- --------
Cost of sales:
Products 47,463 76,181 87,706
Services 11,064 14,658 14,388
-------- -------- --------
58,527 90,839 102,094
-------- -------- --------
Gross profit 21,184 38,984 29,661
Research and development expenses, net 2,911 2,648 5,059
Selling, general and administrative expenses 10,602 15,926 18,635
-------- -------- --------
Operating income 7,671 20,410 5,967
Financial income 1,313 5,188 5,321
Financial expenses (1,532) (2,434) (2,218)
Gain on changes in ownership interests in subsidiaries (Note 17) 14,755 26,339 0
Other income (expenses), net (147) 5 609
-------- -------- --------
Income before income taxes 22,060 49,508 9,679
Income taxes (Note 18) 1,632 4,837 2,141
-------- -------- --------
Income after income taxes 20,428 44,671 7,538
Minority interests (10,420) (25,352) (7,804)
Equity in affiliates (227) (169) (1,767)
-------- -------- --------
Net income (loss) $9,781 $19,150 ($2,033)
-------- -------- --------
-------- -------- --------
Earnings (loss) per common and common
equivalent share $1.45 $2.62 ($0.28)
-------- -------- --------
-------- -------- --------
Weighted average number of shares (in thousands) 6,728 7,307 7,369
-------- -------- --------
-------- -------- --------
The accompanying notes are an integral part of these financial statements.
F - 3
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
(dollars in thousands, except share data)
NUMBER ADDITIONAL
OF COMMON PAID-IN TREASURY RETAINED
SHARES STOCK CAPITAL STOCK EARNINGS TOTAL
---------- ---------- ---------- ---------- --------- ----------
Balances, January 1, 1994 6,182,500 $62 $24,072 - $6,854 $30,988
Additional stock issued 947,568 9 6,244 - - 6,253
Amortization of restricted
stock option compensation - - 56 - - 56
Purchase of treasury stock - - - (567) - (567)
Net income - 9,781 9,781
---------- ---------- ---------- ---------- --------- ----------
Balances, December 31, 1994 7,130,068 71 30,372 (567) 16,635 46,511
Purchase of treasury stock - - - (1,281) - (1,281)
Issuance of common stock
relating to business
acquisitions 128,707 1 1,133 - - 1,134
Common stock issued upon
exercise of options and
warrants, net 331,890 3 2,237 - - 2,240
Net income - - - - 19,150 19,150
---------- ---------- ---------- ---------- --------- ----------
Balances, December 31, 1995 7,590,665 75 33,742 (1,848) 35,785 67,754
Common stock issued in
restricted stock award 100,000 1 587 - - 588
Unamortized restricted stock
award compensation - - (437) - - (437)
Common stock issued upon
exercise of options 17,875 1 105 - - 106
Net loss - - - - (2,033) (2,033)
---------- ---------- ---------- ---------- --------- ----------
Balances, December 31, 1996 7,708,540 $77 $33,997 ($1,848) $33,752 $65,978
---------- ---------- ---------- ---------- --------- ----------
---------- ---------- ---------- ---------- --------- ----------
The accompanying notes are an integral part of these financial statements.
F - 4
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in thousands)
YEAR ENDED DECEMBER 31,
--------------------------------
1994 1995 1996
--------------------------------
Cash flows from operating activities:
Net income (loss) $9,781 $19,150 ($2,033)
Adjustments to reconcile net income (loss) to net cash provided
by operating activities - see Schedule A (4,366) 15,097 17,087
--------- -------- --------
Net cash provided by operating activities 5,415 34,247 15,054
--------- -------- --------
Cash flows used in investment activities:
Short-term and long-term bank deposits, net (440) (22,712) (403)
Restricted cash, net 430 0 0
Investment in marketable securities (139,562) (232,184) (194,798)
Proceeds from realization of marketable securities 104,318 200,089 243,257
Acquisitions of property and equipment (16,969) (51,381) (51,728)
Proceeds from sale of property and equipment 116 39 229
Proceeds from sale of shares in a non-affiliated company 0 0 80
Investments in capitalized software development costs, net (1,688) (2,408) (1,965)
Investments in other assets (116) (1,028) (36)
Loans to affiliates (256) (266) (2,785)
Net effect of change in reporting from consolidation
to equity method - see Schedule B 0 0 (11,459)
Net cash acquired (transferred) on purchase (sale) of subsidiaries 0 272 (130)
--------- -------- --------
Net cash used in investment activities (54,167) (109,579) (19,738)
--------- -------- --------
Cash flows from (used in) financing activities:
Net proceeds from public offering of securities of subsidiary 38,338 88,068 0
Proceeds from issuance of common stock, net 6,253 2,240 106
Minority interest portion of subsidiary dividend distribution 0 0 (14,931)
Investment in subsidiary by minority interest 2,533 0 0
Purchase of treasury stock (567) (1,338) 0
Short-term debt, net (125) 2,567 (1,625)
Proceeds from long-term debt 2,057 6,514 230
Repayments of long-term debt (6,478) (7,887) (341)
Liability in respect of customer advances 0 4,500 0
Repayment of liability in respect of customer advances 0 0 (2,250)
--------- -------- --------
Net cash provided by (used in) financing activities 42,011 94,664 (18,811)
--------- -------- --------
Net increase (decrease) in cash and cash equivalents (6,741) 19,332 (23,495)
Cash and cash equivalents at beginning of year 13,368 6,627 25,959
--------- -------- --------
Cash and cash equivalents at end of year $6,627 $25,959 $2,464
--------- -------- --------
--------- -------- --------
Supplemental cash flow information:
Cash paid during the period for:
Interest $1,014 $911 $829
--------- -------- --------
--------- -------- --------
Income taxes $2,604 $3,422 $2,360
--------- -------- --------
--------- -------- --------
The accompanying notes are an integral part of these financial statements.
F - 5
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
SCHEDULES TO CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in thousands)
YEAR ENDED DECEMBER 31,
-------------------------------
1994 1995 1996
-------------------------------
A. Adjustments to reconcile net income (loss) to net cash provided by
operating activities:
Depreciation and amortization $4,263 $8,880 $16,829
Gain on changes in ownership interests in subsidiaries (14,755) (26,339) -
Gain on sale of affiliate - - (1,710)
Minority interests 10,420 25,352 7,804
Write-down of capitalized software development costs 1,144 183 583
Earnings on marketable debt securities (826) (3,775) (3,330)
Deferred income taxes 474 2,421 1,715
Increase in liability for severance pay 117 492 176
Equity in affilliates 227 169 1,767
Gain on sale of property, plant and equipment, net (14) 91 55
Other 62 71 (276)
Decrease (increase) in accounts receivable and other current assets (5,824) (22,789) 7,757
Increase in inventory (3,493) (3,553) (2,461)
Decrease (increase) in long-term receivables (582) 324 (163)
Increase (decrease) in accounts payable and other current liabilities 4,421 16,767 (10,219)
Increase (decrease) in liability in respect of customer advances, net - 16,803 (1,440)
-------- -------- --------
($4,366) $15,097 $17,087
-------- -------- --------
-------- -------- --------
B. Net effect of change in reporting from consolidation to equity method - see Note 2:
Working capital, net of cash - - 68,217
Investment recorded - - (65,884)
Property and equipment - - 104,582
Other assets - - 120
Other liabilities - - (25,256)
Minority interests - - (93,238)
-------- -------- --------
- - ($11,459)
-------- -------- --------
-------- -------- --------
C. Non - cash activities:
Issuance of common stock related to business acquisitions $ 0 $ 1,134 $ 0
-------- -------- --------
-------- -------- --------
Notes received upon sale of subsidiary $ 0 $ 0 $ 589
-------- -------- --------
-------- -------- --------
Note received upon sale of affiliate $ 0 $ 0 $ 2,000
-------- -------- --------
-------- -------- --------
The accompanying notes are an integral part of these financial statements.
F - 6
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(dollars in thousands, except per share data)
NOTE 1 - GENERAL AND SIGNIFICANT ACCOUNTING POLICIES
(a) DESCRIPTION OF BUSINESS
Data Systems & Software Inc., a Delaware corporation ("DSSI"), through its
subsidiaries and affiliates (collectively, "the Company"), (i) provides
consulting and development services for computer software and systems and
pre-packaged software solutions, and is an authorized dealer and a
value-added-reseller of computer hardware, and (ii) engages in the manufacture
of semiconductors. The Company's principal business operations are conducted in
Israel (see Note 19). The Company's shares are traded on the Nasdaq National
Market.
The industries in which the Company operates are characterized by rapid
technological development. Accordingly, the ability to anticipate changes in
technology and to develop and introduce new and enhanced products incorporating
new technologies on a timely basis are significant factors in the ability to
grow and remain competitive. Furthermore, substantial expenditures are required
for research and development and for new product introduction.
(b) USE OF ESTIMATES IN PREPARATION OF FINANCIAL STATEMENTS
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities as of the date of the financial statements,
and the reported amounts of revenues and expenses during the reporting periods.
Actual results could differ from those estimates.
(c) SIGNIFICANT ACCOUNTING POLICIES
FOREIGN CURRENCY TRANSLATION
The currency of the primary economic environment in which the operations of the
Company are conducted is the United States dollar ("dollar"). Accordingly, the
Company uses the dollar as its functional currency. Transactions and balances
that are denominated in dollars are presented at their dollar amounts.
Transactions and balances in other currencies are remeasured into dollars in
accordance with the principles of Statement of Financial Accounting Standards
("SFAS") No. 52. Financial income and expenses reflect foreign currency
transaction gains and losses.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of all majority-owned
or controlled subsidiaries. Material intercompany balances and transactions have
been eliminated. The Company's principal subsidiaries are as follows:
Effective percentage ownership
Name of subsidiary as of December 31,
------------------ 1995 1996
-------- --------
Tower Semiconductor Holdings 1993 Ltd. ("Holdings") 60.0% 60.0%
Tower Semiconductor Ltd. ("Tower") (*) 24.6% 24.6%
Decision Systems Israel Ltd. ("DSI") 79.4% 79.6%
International Data Operations, Inc. 100.0% 100.0%
Databit Inc. 100.0% 100.0%
(*) Tower is a subsidiary of Holdings. Effective December 1996, the Company no
longer maintained voting control over Tower and, accordingly, Tower is no
longer consolidated as of December 31, 1996. See Note 2.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents consist of cash and demand deposits in banks and
short-term investments (primarily time deposits and certificates of deposit)
with original maturities of three months or less.
F-7
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(dollars in thousands, except per share data)
INVESTMENTS IN SECURITIES
Marketable debt securities which the Company has the positive intent and ability
to hold to maturity are reflected at amortized cost, which approximates market
value. Non-current equity investments are carried at cost.
INVENTORY
Inventories are stated at the lower of cost or market. Cost is determined for
raw materials, spare parts and supplies on the average cost method. For work in
process and finished goods, cost is determined on the basis of standard costs,
adjusted for variances as appropriate. For merchandise inventories, cost is
determined on the first-in, first-out method.
INVESTMENTS
Gains or losses resulting from the effective reduction of the Company's holdings
in subsidiaries due to the sale of their shares are included in operating
results.
Investments in 50% or less of the voting control of companies or other entities
over whose operating and financial policies the Company has the ability to
exercise significant influence ("affiliates") are accounted for by the equity
method. Pursuant to this method, the Company includes its share of the
affiliate's earnings or losses in its results of operations.
PROPERTY AND EQUIPMENT
Property and equipment are presented at cost, net of investment grants received
or receivable. Depreciation is calculated based on the straight-line method over
periods ranging from three to 25 years.
COMPUTER SOFTWARE DEVELOPMENT COSTS
Computer software development costs, presented net of participations from
others, are capitalized upon the establishment of technological feasibility for
costs that the Company believes will be recovered from anticipated revenues.
These determinations are made regularly by the Company on a product by product
basis. Amortization of these costs commences on the earlier of general release
to customers or the receipt of revenues from the product, based on the ratio of
current revenues to current and anticipated future gross revenues, but not less
than straight-line amortization over the expected economic life of each product
(primarily three years). Capitalized software development costs which exceed
their net realizable value at each balance sheet date, as determined by
management, are written off.
GOODWILL
Goodwill, included with other assets, represents the excess of cost over the net
carrying value of assets of subsidiaries acquired in purchase transactions.
Goodwill is amortized based on the straight-line method over periods ranging
from five to 10 years. Management reviews goodwill (as well as property and
equipment and other long-lived assets) on a periodic basis to determine whether
events or changes in circumstances indicate that the carrying amount of such
assets may not be recoverable.
REVENUE RECOGNITION
Revenues are recognized as products are shipped or services are provided, except
for revenues from fixed-price contracts, which are recorded on the basis of the
percentage-of-completion method. Revenues from such contracts are recorded as
costs (primarily direct labor) are incurred, in the proportion that actual costs
incurred bear to total estimated costs. Percentage-of-completion estimates are
continually reviewed and any adjustments required are reflected in the period
when such estimates are revised. Losses on contracts, if any, are recognized in
the period in which the loss is determined.
RESEARCH AND DEVELOPMENT EXPENSES
Research and development costs not qualifying for capitalization as software
development costs, net of related participations, are charged to operations as
incurred.
F-8
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(dollars in thousands, except per share data)
STOCK-BASED COMPENSATION
The Company accounts for employee stock-based compensation in accordance with
Accounting Principles Board Opinion No. 25. In accordance therewith, the
Company records compensation for share options granted to employees at the date
of grant based on the difference between the exercise price of the options and
the market value of the underlying shares at that date, as well as for the fair
value of restricted shares issued to employees. Deferred compensation is
amortized to compensation expense over the vesting period of the underlying
options. See Note 15 for proforma disclosures required in accordance with SFAS
No. 123.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
The allowance for doubtful accounts is based on specific identification of
accounts considered to be doubtful of collection. The allowance was not material
as of December 31, 1995 and 1996.
FOREIGN EXCHANGE AGREEMENTS
The Company (primarily through Tower), from time to time, has entered into
foreign exchange agreements (forward agreements) primarily as a hedge against
non-dollar equipment purchase commitments. Gains and losses on foreign exchange
agreements through the date that the equipment is received are deferred and
recorded to property and equipment, while gains and losses subsequent thereto,
through the date of actual payment of the liability, are included in financial
income or expenses.
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, as well as operating
loss, capital loss and tax credit carryforwards. Deferred tax assets and
liabilities are classified as current or noncurrent based on the classification
of the related assets or liabilities for financial reporting, or according to
the expected reversal dates of the specific temporary differences, if not
related to an asset or liability for financial reporting. No provision has been
recorded for taxes which might be owed on disposition of the Company's
investments or on distribution to the Company of their earnings, since the
Company intends to retain the investments and reinvest earnings indefinitely.
EARNINGS PER COMMON AND COMMON EQUIVALENT SHARE
Earnings per share has been computed by dividing net income by the weighted
average number of common and common equivalent shares outstanding. Common
equivalent shares included in the computation represent the dilutive effect of
shares issuable upon assumed exercise of warrants and stock options utilizing
the treasury stock method.
NOTE 2 - INVESTMENT IN TOWER
In March 1993, DSSI, through Holdings, acquired an 80.1% interest in Tower, a
manufacturer of semiconductor products. Tower's shares are traded on the Nasdaq
National Market. As a result of public offerings by Tower, Holdings' interest in
Tower was reduced to 41% and the Company's effective interest in Tower was
reduced to 24.6%. Although the Company has retained effective control of Tower,
as of the end of December 1996, the Company no longer maintained voting control
of more than 50% of Tower's shares and, therefore, ceased to consolidate Tower's
balance sheet as of year end. As the Company's individual assets and liabilities
at December 31, 1996 do not include amounts related to Tower, the Company's 1995
and 1996 balance sheets are not directly comparable. The consolidated statements
of income reflect Tower's revenues and expenses on a full-year basis for all
years presented. See Note 7 for summary financial information of Tower.
NOTE 3 - MARKETABLE DEBT SECURITIES
Marketable debt securities consist primarily of United States Treasury Bills at
yields to maturity ranging from 4.6% to 4.9% (1995 - 4.8% to 5.7%) and maturing
in January 1997.
F-9
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(dollars in thousands, except per share data)
NOTE 4 - PRINCIPAL CUSTOMERS
Sales to and receivables from principal customers for the respective periods
were as follows:
Accounts
Consolidated sales receivable as of
Year ended December 31, December 31,
------------------------------------------------------------------
1994 1995 1996 1995 1996(*)
------------- ------------- ------------- ------- --------
Customer A $31,010 38.9% $57,427 44.2% $65,599 49.8% $8,572 -
Customer B 14,605 18.3 19,725 15.2 9,716 7.4 1,913 -
------------- ------------- ------------- ------- --------
$45,615 57.2% $77,152 59.4% $75,315 57.2% $10,485 -
------------- ------------- ------------- ------- --------
(*) See Note 2.
NOTE 5 - INVENTORY
As of December 31,
------------------
Inventory consists of the following: 1995 1996(*)
-------- --------
Raw materials and supplies $ 8,264 $ -
Work in process 4,774 14
Finished goods and merchandise 591 939
-------- --------
$13,629 $953
-------- --------
-------- --------
(*) See Note 2.
NOTE 6 - OTHER CURRENT ASSETS
As of December 31,
------------------
Other current assets consist of the following: 1995 1996(*)
-------- --------
Investment grant receivable from the Israeli government $14,173 $ -
Israeli government - other 3,092 40
Foreign income tax receivable (Israel) 1,594 515
Other 2,432 1,185
-------- --------
$21,291 $1,740
-------- --------
-------- --------
(*) See Note 2.
NOTE 7 - INVESTMENTS
(a) Composition As of December 31,
Investments consist of the following: 1995 1996(*)
-------- --------
Investment in Tower (see (b) below) $ - $65,884
Other investments (see (c) below) 1,763 2,488
-------- --------
$ 1,763 $68,372
-------- --------
-------- --------
(*) See Note 2.
(b) Investment in Tower As of December 31,
Set forth below is condensed financial information of Tower. 1995 1996
-------- --------
Current assets $168,459 $110,403
Property and equipment 71,171 106,047
Other assets 361 120
Current liabilities 44,642 30,727
Long-term debt 12,064 12,064
Other long-term liabilities 12,934 13,194
Shareholders' equity 170,351 160,585
F-10
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(dollars in thousands, except per share data)
Year ended December 31,
1994 1995 1996
--------- --------- ---------
Sales $57,709 $99,621 $97,885
Operating income 10,763 23,468 9,652
Net income 7,762 20,439 10,014
In November 1996, Tower paid a dividend of $19,808 ($1.50 per share). The
market value of the Company's investment in Tower as of December 31, 1996 was
approximately $57,200.
(c) OTHER INVESTMENTS
In 1995, the Company established CybrCard LP, a limited partnership engaged
in the development and production of sports-related CD-ROMs, in which the
Company owned a 50% interest. Through December 31, 1996, the Company invested
in CybrCard approximately $2,800 in the form of loans and advances, offset by
approximately $1,600 representing the Company's share of CybrCard's losses.
Subsequent to December 31, 1996, the Company purchased the remaining 50%
interest in CybrCard. CybrCard will be consolidated by the Company beginning
in 1997.
Effective July 1996, the Company sold its 50% interest in an affiliate in
consideration for a $2,000 unsecured note. The note bears interest at an annual
rate of 8.25% and is payable on or before July 1, 1998. The Company recorded a
gain of approximately $1,700 on the transaction.
NOTE 8 - PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
Estimated
useful life As of December 31,
(in years) 1995 1996(*)
Cost: --------- ------- --------
Leasehold rights and buildings 14-25 $18,886 $ -
Factory equipment 5 60,675 -
Computer equipment 3-5 2,991 2,616
Office furniture and equipment 5-10 1,689 464
Motor vehicles 7 2,166 1,195
Leasehold improvements 10 208 184
------- --------
86,615 4,459
------- --------
Accumulated depreciation and amortization:
Leasehold rights and buildings 1,203 -
Factory equipment 10,970 -
Computer equipment 1,207 1,456
Office furniture and equipment 622 227
Motor vehicles 589 381
Leasehold improvements 135 116
------- --------
14,726 2,180
------- --------
Property and equipment, net $71,889 $2,279
------- --------
------- --------
(*) See Note 2.
The cost of property and equipment as of December 31, 1995 is net of
investment grants of $38,860.
Depreciation and amortization in respect of property and equipment amounted
to $3,813, $8,471 and $16,019 for 1994, 1995 and 1996, respectively.
F-11
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(dollars in thousands, except per share data)
NOTE 9 - CAPITALIZED SOFTWARE DEVELOPMENT COSTS, NET
Capitalized software development costs consist of the
following: As of December 31,
1995 1996
-------- --------
Capitalized software developments costs $4,906 $7,480
Less:
Israeli government grants (237) (541)
Customer participation in pilot-site costs (61) (366)
Accumulated amortization - (606)
Write-down to net realizable value (183) (738)
-------- --------
$4,425 $5,229
-------- --------
-------- --------
Based on management's determination that certain capitalized software costs
exceeded their net realizable value, capitalized software costs relating to
certain sub-systems in development projects were written-down and included in
research and development expenses during the respective periods.
NOTE 10 - SHORT-TERM DEBT-BANKS AND OTHERS
Unused lines of credit with Israeli banks as of December 31, 1996 amounted to
approximately $1,600. Included with short-term debt is $1,403 received from
foreign investors (December 31, 1995 - $1,366) pending final agreement on the
terms of financing of future projects of the Company. In management's view,
this amount is likely to be repaid without interest within 12 months of the
balance sheet date. The debt is secured by a bank deposit which bears
interest at approximately 4% per annum. The deposit has been classified as
restricted cash.
NOTE 11 - TRADE ACCOUNTS PAYABLE
Trade accounts payable consist of: As of December 31,
1995 1996(*)
------- -------
Trade suppliers $ 8,281 $ 1,643
Suppliers of plant and equipment 17,019 -
------- -------
$25,300 $ 1,643
------- -------
------- -------
(*) See Note 2.
NOTE 12 - LONG-TERM DEBT- BANK AND OTHER
(a) Composition As of December 31,
1995 1996(*)
------- -------
Customer advances - see (b) below $21,304 $ -
Debt to Israeli banks, bearing
interest at 5%-8% per annum 12,688 493
------- -------
33,992 493
Less - current maturities 11,493 162
------- -------
$22,499 $ 331
------- -------
------- -------
(*) See Note 2.
Certain assets in Israel have been pledged as collateral for long-term and
short-term bank debt amounting to approximately $1,000 and for
guarantees.Interest expense on short-term and long-term bank debt for 1994,
1995 and 1996 amounted to $1,013, $1,011 and $734, respectively.
F-12
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(dollars in thousands, except per share data)
(b) CUSTOMER ADVANCES
Pursuant to an agreement between Tower and a customer, such customer was to
provide Tower with an advance in the aggregate amount of $28,875, of which
$23,875 was received through December 31, 1995. The advance bears interest at
the three month Libor rate. The portion of the advance received that was
expected to be offset and repaid in 1996 in accordance with the agreement has
been presented as a current liability on the December 31, 1995 balance sheet.
NOTE 13 - OTHER LONG-TERM LIABILITIES
Other long-term liabilities include unfunded severance pay obligations of $813
and $116 as of December 31, 1995 and 1996, respectively, after deducting fund
balances maintained in the Company's name for the sole purpose of making
severance payments. Israeli law and labor agreements determine the obligations
of the subsidiaries in Israel to make severance and pension payments to
dismissed employees and to employees leaving employment in certain other
circumstances. The obligation for severance pay benefits, as determined by the
Israeli Severance Pay Law, is based upon length of service and last salary.
These obligations are substantially covered by regular deposits with recognized
severance pay and pension funds and by the purchase of insurance policies. The
amounts so funded are not reflected on the balance sheet, since they are not
under the control and management of these subsidiaries, but are controlled by
the funds and insurance companies. The pension plans are multi-employer and
independent of the Company. Therefore, no information is available regarding
their present value and the net assets available for benefits. Pension and
severance pay costs for 1994, 1995 and 1996 were approximately $1,870, $2,173
and $2,236, respectively.
NOTE 14 - COMMITMENTS AND CONTINGENCIES
(a) LEASES OF PROPERTY AND EQUIPMENT
Rental and leasing expenses for 1994, 1995 and 1996 amounted to $502, $554 and
$625, respectively. Future minimum lease payments on non-cancelable operating
leases as of December 31, 1996 are as follows:
Year ending December 31,
1997 $ 548
1998 307
1999 319
2000 300
2001 6
------
$1,480
------
------
(b) GUARANTEES
The Company has provided bank guarantees of approximately $1,500 as security
for payment of obligations of affiliates and other companies.
(c) ROYALTIES
Certain research and development programs are eligible for financial
assistance from the Office of the Chief Scientist of the Israeli Ministry of
Industry and Commerce or from the Israel-United States BIRD Foundation. In
return, the subsidiaries are obligated to pay royalties at a rate of 2% to 5%
of sales of products resulting from the research and development efforts, up
to a maximum of 150% of the financing received.
(d) LEGAL ACTIONS
The Company is a plaintiff in an action against a former officer who resigned in
April 1995, alleging destruction and misappropriation of property and data owned
by the Company. The employee has filed a counterclaim against the Company,
alleging breach by the Company of its employment and resignation agreements
with the employee and seeking compensatory damages of $750 and
punitive damages of
F-13
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(dollars in thousands, except per share data)
$25,000. The Company is pursuing its claims against the employee and is
vigorously defending against his counterclaims. The Company accrued the full
amount of severance payable under the resignation agreement at the time of such
employee's resignation. Based on the opinion of legal counsel handling the
matter, the Company believes it is unlikely to incur additional material
liability in connection with the counterclaim.
Between June and September 1996, several suits were filed in the United
States on behalf of a purported class of Tower's shareholders against Tower,
its Co-Chief Executive Officers, its Chairman of the Board of Directors, and
DSSI. The complaints seek to certify a class of all persons who purchased or
otherwise acquired Tower's ordinary shares between May 25, 1995 and June 10,
1996. The consolidated complaint filed in the action alleges on behalf of the
class that the defendants made misstatements and omissions regarding (i) the
relationship between Tower and a major customer and (ii) Tower's process
development efforts in connection therewith, in violation of certain U.S.
Federal securities laws. Tower has indemnified the defendants, up to the
limits permitted by the Israeli Companies Ordinance, from any liability
arising out of the actions. Tower maintains insurance policies, that, under
certain conditions, cover actions of this type up to an aggregate amount of
$20,000. The Company is unable to determine at this time with any certainty
the ultimate outcome of the aforementioned matter or its effect if any, on
the Company's financial condition, operating results and business. However,
the Company believes it has meritorious defenses and is defending the actions
vigorously.
NOTE 15 - SHAREHOLDERS' EQUITY
(a) STOCK OPTION PLANS
The Company's stock option plans provide for the granting to officers, directors
and other key employees of options to purchase shares of common stock at not
less than 85% of market value on the date of grant. To date, the Company has
issued options under the plans at market value. Certain options are immediately
exercisable and all options expire within five to ten years from the date of the
grant. The options generally vest over a one to three year period from the date
of grant of the option. A summary of the status of the Company's option plans as
of December 31, 1994, 1995 and 1996, as well as changes during each of the years
then ended, is presented below:
1994 1995 1996
------------------------ ------------------------ -------------------------
Weighted Weighted Weighted
average average average
Number of exercise Number of exercise Number of exercise
options price options price options price
----------- ------------ ----------- ------------ ----------- ------------
(in shares) (in dollars) (in shares) (in dollars) (in shares) (in dollars)
----------- ------------ ----------- ------------ ----------- ------------
Outstanding at beginning of year 50,000 3.69 970,500 6.65 1,361,567 6.70
Granted 920,500 6.81 559,400 6.73 226,500 5.90
Exercised - - (65,833) 4.59 (17,875) 5.89
Forfeited - - (102,500) 6.77 (146,700) 6.38
--------- ----------- -----------
Outstanding at end of year 970,500 6.65 1,361,567 6.70 1,423,492 6.60
--------- ----------- -----------
--------- ----------- -----------
Exercisable at end of year 50,000 3.69 407,241 6.57 826,601 6.61
--------- ----------- -----------
--------- ----------- -----------
Exercisable
Outstanding as of December 31, 1996 as of December 31, 1996
- ----------------------------------------------------------- ----------------------------
Range of Weighted average Weighted Weighted
exercise Number remaining average Number average
prices outstanding contractual life exercise price exercisable exercise price
- ------------ ----------- ---------------- -------------- ----------- ---------------
(in dollars) (in shares) (in years) (in dollars) (in shares) (in dollars)
- ------------ ----------- ---------------- -------------- ----------- ---------------
$4.75-5.88 246,500 7.6 5.74 96,666 5.60
6.38-7.88 1,146,992 5.8 6.66 719,935 6.68
11.13 30,000 8.8 11.13 10,000 11.13
----------- -----------
1,423,492 6.60 826,601 6.61
----------- -----------
----------- -----------
F-14
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(dollars in thousands, except per share data)
The weighted average grant-date fair value of the 559,400 and 226,500 options
granted during 1995 and 1996 amounted to $3.12 and $3.56 per option,
respectively. The Company utilized the Black-Scholes option pricing model to
estimate fair value, utilizing the following assumptions for the respective
years (all in weighted averages):
1995 1996
---- ----
Risk-free interest rate 6.70% 6.30%
Expected life of options 3.4 years 5.9 years
Expected annual volatility 59% 59%
Expected dividend yield none none
Had compensation cost for the Company's option plans been determined based on
fair value at the grant dates for awards made in 1995 and 1996 under such
plans in accordance with SFAS No. 123, the Company's pro forma net income
(loss) and earnings (loss) per share would have been as follows:
1995 1996
---- ----
Pro forma net income (loss) $18,498 $(2,980)
------- --------
------- --------
Pro forma earnings (loss) per share $ 2.53 $ (0.41)
------- --------
------- --------
The pro forma information in the above table also gives effect to the
application of SFAS No. 123 on the share option plans of the Company's
subsidiaries.
Due to the fact that the SFAS No. 123 method of accounting for purposes of
the above pro forma calculation has not been applied to options granted prior
to January 1, 1995, the resulting pro forma compensation cost may not be
representative of that to be expected in future years.
(b) WARRANTS
The Company has from time to time issued warrants primarily as compensation
to underwriters in connection with public stock offerings and to investors as
part of a private placement by the Company of common stock and warrants. All
warrants issued to date have been at exercise prices equal to or greater than
market value on the date of issuance. The effect of warrant issuances on the
Company's results of operations for all years presented is immaterial. A
summary of warrant activity follows:
1994 1995 1996
------------------------- ------------------------- -------------------------
Weighted Weighted Weighted
average average average
Number of exercise Number of exercise Number of exercise
warrants price warrants price warrants price
----------- ------------ ----------- ------------ ----------- ------------
(in shares) (in dollars) (in shares) (in dollars) (in shares) (in dollars)
----------- ------------ ----------- ------------ ----------- ------------
Outstanding at beginning of year 117,500 12.38 591,284 8.97 433,825 9.06
Granted 473,784 8.13 100,000 6.34 - -
Exercised - - (257,459) 7.80 - -
--------- ---------- ---------
Outstanding at year end 591,284 8.97 433,825 9.06 433,825 9.06
--------- ---------- ---------
--------- ---------- ---------
(c) STOCK AWARD
In March 1996, the Company granted 100,000 shares of common stock to its
Chief Executive Officer. The shares vest over a three-year period. Deferred
compensation in the aggregate amount of $587 was recorded against additional
paid-in capital at the date of grant, of which $150 was amortized to
compensation expense during the year.
F-15
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(dollars in thousands, except per share data)
(d) OTHER
In March 1996, the Company's Board of Directors adopted a stockholder rights
plan providing for the distribution of common stock purchase rights at the rate
of one right for each share of the Company's common stock held by shareholders
of record as of the close of business on April 1, 1996. The rights plan is
designed to deter coercive takeover tactics, including the accumulation of
shares in the open market or through private transactions, and to prevent an
acquirer from gaining control of the Company without offering a fair price to
all of the Company's shareholders. Each right initially entitles shareholders to
buy one-half of a share of common stock of the Company for $15. Generally, the
right will be exercisable only if a person or group acquires beneficial
ownership of 15% of more of the Company's common stock or commences a tender or
exchange offer upon consummation of which such person or group would
beneficially own 15% or more of the Company's common stock.
If any person ("Acquiring Person") becomes the beneficial owner of 15% or more
of the Company's common stock, other than pursuant to a tender or exchange offer
for all outstanding shares of the Company approved by a majority of the
Company's independent directors, then, subject to certain exceptions set forth
in the rights plan, each right not owned by the Acquiring Person or related
parties will entitle its holder to purchase, at the right's then current
exercise price, shares of the Company's common stock (or in certain
circumstances - as determined by the Board of Directors - cash, other property
or other securities) having a value of twice the right's then current exercise
price.
The Company will generally be entitled to redeem the rights at one half of one
cent per right at any time until 10 days (subject to extension) following a
public announcement that a 15% position has been acquired. The rights plan will
expire in March 2006.
NOTE 16 - RELATED PARTY BALANCES AND TRANSACTIONS
Other assets include a non-interest bearing loan of $277 made to an executive
officer of the Company. Such loan is secured by, and repayable out of, the
proceeds of the sale by the officer of shares of common stock of the Company
owned by him. In addition, during 1996, the Company approved a loan of up to
$550, bearing interest at an annual rate of 7%, to its Chief Executive Officer.
The balance of this loan as of December 31, 1996 was approximately $481. Such
loan is repayable in monthly installments over a period of five years.
The Company paid consulting and other fees to directors of $141, $82 and $85 for
the years ended December 31, 1994, 1995 and 1996, respectively.
Sales for the years ended December 31, 1994, 1995 and 1996 include $592, $1,160
and $102, respectively, to an affiliate. In 1994, the Company recorded an
allowance of $259 with regard to a long-term receivable due from a customer in
which the Company and an executive officer of the Company each own approximately
14.6%, due to the customer's problems in obtaining funding.
Approximately $144 and $152 received from an affiliate for expense reimbursement
during the years ended December 31, 1994 and 1995, respectively, was reflected
as a reduction of selling, general and administrative expenses. No amount was
received in 1996.
The Company paid legal fees to a related party of approximately $715, $535 and
$450 (including payments to a firm in which such related party is a principal)
for the years ended December 31, 1994, 1995 and 1996, respectively.
Approximately $31 and $10, included in other current liabilities, was owed to
the related party as of December 31, 1995 and 1996, respectively.
F-16
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(dollars in thousands, except per share data)
NOTE 17 - GAIN ON CHANGES IN OWNERSHIP INTERESTS IN SUBSIDIARIES
As discussed in Note 2, Tower conducted two public offerings, one in October
1994 and another in July 1995, which resulted in a decrease in the Company's
effective interest in Tower from 48.1% to 24.6%. As a result of the offerings,
the Company recognized a gain on changes in ownership interests in subsidiaries
of $14,755 and $26,339 in 1994 and 1995, respectively.
Detailed information of the stock offerings is as follows:
October July
1994 1995
------- -------
Number of shares issued (in thousands) 3,000 3,205
Price per share $14.00 $29.00
Total net proceeds of offering $38,338 $88,068
Company's effective ownership interest before transaction 48.1% 32.5%
Company's effective ownership interest after transaction 32.5% 24.6%
No deferred taxes were recorded in respect of the gains, as the Company's
investment in Tower is essentially permanent in duration (see Note 18).
NOTE 18 - INCOME TAXES
(a) COMPOSITION
Income taxes consist of the following: Year ended December 31,
1994 1995 1996
------ ------ ------
Current:
Federal $ - $ - $ 8
State and local - 14 -
Foreign 1,158 2,402 418
------ ------ ------
1,158 2,416 426
------ ------ ------
Deferred:
Federal (145) (491) (677)
State and local (14) 18 (187)
Foreign 633 2,894 2,579
------ ------ ------
474 2,421 1,715
------ ------ ------
$1,632 $4,837 $2,141
------ ------ ------
------ ------ ------
(b) EFFECTIVE INCOME TAX RATES
Set forth below is a reconciliation between the Federal tax rate and the
Company's effective income tax rates:
Year ended December 31,
1994 1995 1996
------ ------ ------
Statutory Federal rates 34% 34% 34%
Increase (decrease) in income tax rate
resulting from:
Tax exempt gain from public offering of
subsidiary (22) (18) -
Israeli operations - net impact of
Israeli statutory rate and special
deduction (7) (9) (12)
Non-deductible expenses 1 2 2
State and local income taxes - net (1) 1 (4)
Net operating loss carryforwards (4) (2) (1)
Other 3 1 2
Increase in valuation allowance 3 1 1
------ ------ ------
Effective income tax rates 7% 10% 22%
------ ------ ------
------ ------ ------
F-17
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(dollars in thousands, except per share data)
(c) ANALYSIS OF DEFERRED TAX ASSETS (LIABILITIES)
Deferred tax assets (liabilities) consist of the following:
As of December 31,
1995 1996(*)
-------- -------
Accelerated depreciation for tax purposes $ (3,495) $ (72)
Intangible asset basis differences (304) (187)
Nondeductible accrued expenses 89 (653)
Net operating loss carryforwards 3,061 3,906
Foreign capital loss carryforwards 83 -
Foreign tax credit carryforwards 792 242
Foreign public offering costs 1,127 -
-------- -------
1,353 3,236
Valuation allowance (1,556) (598)
-------- -------
Net deferred tax asset (liability) $ (203) $ 2,638
-------- -------
-------- -------
(*) See Note 2.
The valuation allowance relates principally to net operating loss and capital
loss carryforwards and Federal foreign tax credit carryforwards.
As of December 31, 1996, deferred tax assets of $205 are classified as other
current assets (1995 - $665) and $2,433 as other assets (1995 - $1,350).
(d) SUMMARY OF TAX LOSS AND CREDIT CARRYFORWARDS
As of December 31, 1996, the Company had various tax loss and credit
carryforwards which expire as follows:
Federal
Net Operating Loss foreign
Expiration Federal State Foreign tax credit
------------ --------- ------------- --------- ------------
1999 $317
2000 1,078
2001 1,178 $241
2002 - 2003 1,070
2008 - 2009 $2,758
2010 - 2011 2,841 1,058
Unlimited $3,924
--------- ------------- --------- ------------
Total $5,599 $4,701 $3,924 $241
--------- ------------- --------- ------------
--------- ------------- --------- ------------
(e) COMPOSITION OF INCOME BEFORE INCOME TAXES
Composition of income before income taxes is as follows:
Year ended December 31,
------------------------------
Income (loss) before income taxes: 1994 1995 1996
-------- -------- --------
Domestic $(1,867) $(1,950) $(4,128)
Foreign 23,927 51,458 13,807
-------- -------- --------
$22,060 $49,508 $9,679
-------- -------- --------
-------- -------- --------
(f) OTHER
As of December 31, 1995 and 1996, the aggregate unrecognized deferred tax
liability related to investments in foreign subsidiaries that are essentially
permanent in duration amounted to approximately $7,000 and $8,000,
respectively. As the Company's domestic subsidiaries have accumulated losses,
no deferred tax liability would be recognized in respect of investments
therein.
F-18
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(dollars in thousands, except per share data)
NOTE 19 - SEGMENT REPORTING AND GEOGRAPHIC INFORMATION
The data for each business segment is presented according to geographical
location of the operating facilities. General corporate expenses are included
with selling, general and administrative expenses in the statements of income.
Semiconductor
Computer Segment Segment Corporate Total
----------------------------------------------- --------- --------- -----
Adjustments Total
United and Computer United
Israel States eliminations Segment Israel States
------ ------ ------------ ------- ------ ------
Year ended December 31, 1994:
Total sales $13,300 $ 9,113 $ (411) $22,002 $57,709 - $ 79,711
Intercompany sales (242) (169) 411 - - - -
------- -------- ------- ------- ------- ------ --------
Net sales 13,058 8,944 - . 22,002 57,709 - 79,711
Operating income (loss) (923) (1,107) - . (2,030) 11,033 (1,332) 7,671
Identifiable assets 15,224 2,693 - . 17,917 92,950 18,685 129,552
Depreciation and amortization 793 167 - . 960 3,278 25 4,263
Capital expenditures 1,905 299 - . 2,204 19,679 - 21,883
Year ended December 31, 1995:
Total sales $15,634 $15,600 $(1,032) $30,202 $99,621 - $129,823
Intercompany sales (684) (348) 1,032 - - - -
------- -------- ------- ------- ------- ------ --------
Net sales 14,950 15,252 - 30,202 99,621 - 129,823
Operating income (loss) (419) (973) - (1,392) 23,523 (1,721) 20,410
Identifiable assets 16,497 3,935 - 20,432 238,413 16,532 275,377
Depreciation and amortization 861 174 - 1,035 7,818 27 8,880
Capital expenditures 2,658 730 - 3,388 46,229 26 49,643
Year ended December 31, 1996(*):
Total sales $13,424 $21,045 $(599) $33,870 $ 97,885 - $131,755
Intercompany sales (77) (522) 599 - - - -
------- -------- ------- ------- ------- ------ --------
Net sales 13,347 20,523 - 33,870 97,885 - 131,755
Operating income (loss)(**) (693) (3,058) - (3,751) 11,268 (1,550) 5,967
Identifiable assets 14,824 6,894 - 21,718 65,889 14,509 102,116
Depreciation and amortization 629 907 - 1,536 15,243 50 16,829
Capital expenditures 1,692 1,326 - 3,018 50,565 110 53,693
(*) See Note 2.
(**) The Company also operates in the Computer segment via an affiliate in
the United States which is engaged in the development and production of
software. The Company's share in the affiliate's losses (reflected in equity
in affiliates in the statement of income) amounted to $1,600 in 1996.
Sales classified by geographical markets: Year ended December 31,
1994 1995 1996
------- -------- --------
Israel $13,363 $ 14,672 $ 12,061
United States 28,260 65,941 62,438
Far East 38,088 48,814 56,773
Europe - . 396 483
------- -------- --------
$79,711 $129,823 $131,755
------- -------- --------
------- -------- --------
F-19
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(dollars in thousands, except per share data)
NOTE 20 - SUPPLEMENTARY QUARTERLY FINANCIAL INFORMATION (Unaudited)
Summarized unaudited quarterly financial data for 1995 and 1996 is as follows:
1995 1996
--------------------------------------- ---------------------------------------
First Second Third Fourth First Second Third Fourth
Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter
------- ------- ------- ------- ------- ------- ------- --------
Sales $27,944 $31,100 $33,765 $37,014 $30,602 $36,711 $ 28,702 $ 35,740
Gross profit $ 7,912 $ 9,456 $ 9,958 $11,658 $ 9,933 $ 7,896 $ 4,550 $ 7,282
Net income (loss) $ 652 $ 979 $16,630 $ 889 $ 773 $ 342 $ (1,224) $(1,924)
Earnings per common and
common equivalent share $ 0.10 $ 0.14 $ 2.16 $ 0.12 $ 0.10 $ 0.04 $ (0.17) $ (0.26)
NOTE 21 - FINANCIAL INSTRUMENTS
(a) GENERAL
A financial instrument is defined as cash, evidence of an ownership interest in
an entity, or a contract that imposes on one entity a contractual obligation
either to deliver or receive cash or another financial instrument to or from a
second entity. Examples of financial instruments include cash and cash
equivalents, trade accounts receivable, loans, investments, trade accounts
payable, accrued expenses, options and forward contracts.
In accordance with SFAS Nos. 105, 107, and 119, the Company makes certain
disclosures with regard to financial instruments, including derivatives. These
disclosures include, among other matters, the nature and terms of derivative
transactions, information about significant concentrations of credit risk, and
the fair value of financial assets and liabilities.
(b) FORWARD EXCHANGE AGREEMENTS
The Company, through Tower, has entered into forward exchange agreements to
manage exposure to equipment purchase commitments denominated in Japanese yen.
These transactions qualified for hedge accounting in accordance with generally
accepted accounting principles and, accordingly, the results of such
transactions have been recorded concurrently with the realization of the related
items (i.e., receipt of the equipment and payment of the related liability).
The Company does not hold or issue derivative financial instruments for trading
purposes.
(c) PRESENTATION OF FOREIGN EXCHANGE TRANSACTIONS IN THE FINANCIAL STATEMENTS
Losses recognized on forward exchange transactions amounted to $1,661 and $3,598
for 1995 and 1996, respectively. Of these amounts, $1,130 and $3,002 were
capitalized to property and equipment, respectively; and the remaining amounts
of $531 and $596 were reflected in financing expenses, respectively. The results
of such transactions were not material for 1994.
(d) FAIR VALUE OF FINANCIAL INSTRUMENTS
Fair values are estimated for financial instruments included in current assets
and current liabilities at book value, due to the short maturity of such
instruments. Fair value for long-term debt is estimated based on the current
rates offered to the Company for debt with the same remaining maturities. Fair
value of long-term equity marketable investments is estimated based on market
value. The estimation of fair value for non-marketable long-term equity
investments (at book value of $1,721 as of December 31, 1996) was not
practicable. The estimated fair value of the Company's financial instruments
(other than the investment in Tower - see Note 7 (b)) was not materially
different than their book value.
(e) CONCENTRATIONS OF CREDIT RISK
The Company is subject to credit risk through its trade receivables. As of
December 31, 1996, 9% of the trade accounts receivable were due from a major
Israel government-owned company which, despite experiencing financial
difficulties, continues to pay its trade receivables over extended credit
periods. The remaining balance consists primarily of receivables from various
customers.
F-20
AUDITORS' REPORT
TO THE SHAREHOLDERS OF
TOWER SEMICONDUCTOR LTD.
We have audited the accompanying balance sheets of Tower Semiconductor Ltd.
("the Company") as of December 31, 1996 and 1995, and the related statements of
income, changes in shareholders' equity and cash flows for each of the three
years in the period ended December 31, 1996. These financial statements are the
responsibility of the Company's Board of Directors and management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards, including those prescribed by the Israeli Auditors' Regulations
(Auditor's Mode of Performance) - 1973, which standards are substantially
identical to generally accepted auditing standards 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 the
Board of Directors and management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements present fairly, in all material
respects, the financial position of the Company as of December 31, 1996 and
1995, and the results of its operations, changes in shareholders' equity and
cash flows for each of the three years in the period ended December 31, 1996, in
accordance with generally accepted accounting principles in Israel. As
applicable to these financial statements, such accounting principles are
substantially identical in all material respects to generally accepted
accounting principles in the United States.
Igal Brightman & Co.
Certified Public Accountants
Tel Aviv, Israel
January 28, 1997
F-21
TOWER SEMICONDUCTOR LTD.
BALANCE SHEETS
(dollars in thousands)
As of December 31,
------------------------
1996 1995
--------- -----------
A S S E T S
CURRENT ASSETS
Cash and cash equivalents $ 11,459 $ 24,015
Short-term interest-bearing deposits (Note 10) 27,098 25,414
Marketable debt securities (Note 3) 33,610 72,436
Trade accounts receivable (no allowence
for doubtful accounts) (Notes 8 and 12) 11,094 13,502
Other receivables (Note 4) 11,316 18,486
Inventories (Note 5) 14,289 13,207
Other current assets 1,537 1,399
--------- ---------
Total current assets 110,403 168,459
PROPERTY AND EQUIPMENT, NET (Notes 6 and 10) 106,047 71,171
OTHER ASSETS 120 361
--------- ---------
TOTAL ASSETS $ 216,570 $ 239,991
--------- ---------
--------- ---------
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
CURRENT LIABILITIES
Trade accounts payable $ 16,284 $ 25,985
Short-term debt (Note 7) 208 1,849
Current portion of long-term liability
in respect of customer advances (Note 15) 9,900 11,160
Due to related parties (Note 8) 414 653
Other current liabilities (Note 9) 3,921 4,995
--------- ---------
Total current liabilities 30,727 44,642
LONG-TERM DEBT (Note 10) 12,064 12,064
LONG-TERM LIABILITY IN RESPECT
OF CUSTOMER ADVANCES (Note 15) 7,714 10,143
OTHER LIABILITIES 5,480 2,791
COMMITMENTS AND CONTINGENCIES (Note 15)
--------- ---------
Total liabilities 55,985 69,640
--------- ---------
SHAREHOLDERS' EQUITY (Note 11)
Ordinary shares, NIS 1 par value -
authorized 30,000,000 shares;
issued and outstanding 13,205,450 shares 4,314 4,314
Additional paid-in capital 137,787 138,063
Shareholder receivables and unearned compensation (861) (1,165)
Retained earnings 19,345 29,139
--------- ---------
Total shareholders' equity 160,585 170,351
--------- ---------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 216,570 $ 239,991
--------- ---------
--------- ---------
See notes to financial statements.
F-22
TOWER SEMICONDUCTOR LTD.
STATEMENTS OF INCOME
(dollars in thousands, except per share data)
Year ended December 31,
--------------------------------
1996 1995 1994
--------- --------- ---------
SALES (Notes 12 and 15) $ 97,885 $ 99,621 $ 57,709
COST OF SALES 75,727 68,270 42,918
--------- --------- ---------
GROSS PROFIT 22,158 31,351 14,791
--------- --------- ---------
OPERATING COSTS AND EXPENSES
Research and development 4,062 1,734 902
Marketing, general and administrative (Note 8) 7,001 6,149 3,126
Other expenses (Note 6) 1,443 -- --
--------- --------- ---------
12,506 7,883 4,028
--------- --------- ---------
OPERATING INCOME 9,652 23,468 10,763
FINANCING INCOME (EXPENSES), NET
(including interest expense of $1,928, $1,382 and $964) 2,661 2,138 (774)
--------- --------- ---------
INCOME BEFORE INCOME TAXES 12,313 25,606 9,989
INCOME TAXES (Note 13) 2,299 5,167 2,227
--------- --------- ---------
NET INCOME $ 10,014 $ 20,439 $ 7,762
--------- --------- ---------
--------- --------- ---------
EARNINGS PER ORDINARY SHARE $ 0.76 $ 1.76 $ 1.03
--------- --------- ---------
--------- --------- ---------
WEIGHTED AVERAGE NUMBER OF ORDINARY
SHARES OUTSTANDING - in thousands (Note 11) 13,205 11,593 7,551
--------- --------- ---------
--------- --------- ---------
See notes to financial statements.
F-23
TOWER SEMICONDUCTOR LTD.
STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
(dollars in thousands)
Shareholder
receivables
Ordinary shares Additional and
-------------------- paid-in unearned Retained
Shares Amount capital compensation earnings Total
--------- ------- ----------- --------- ----------- ----------
BALANCE - JANUARY 1, 1994 7,000,000 $ 2,234 $ 9,295 $ (672) $ 938 $ 11,795
Additional proceeds from issuance
of ordinary shares 3,793 3,793
Initial public offering of
ordinary shares, net 3,000,000 995 37,343 38,338
Net income 7,762 7,762
---------- ------- ---------- --------- ---------- ----------
BALANCE - DECEMBER 31, 1994 10,000,000 3,229 50,431 (672) 8,700 61,688
Issuance of employee share options 802 (802) --
Amortization of unearned compensation 309 309
Expenses connected with issuance
of employee share options (153) (153)
Public offering of ordinary shares, net 3,205,450 1,085 86,983 88,068
Net income 20,439 20,439
---------- ------- ---------- --------- ---------- ----------
BALANCE - DECEMBER 31, 1995 13,205,450 4,314 138,063 (1,165) 29,139 170,351
Cancellation of unearned compensation
in respect of non-vested options, net (121) 121 --
Amortization of unearned compensation 183 183
Expenses connected with issuance
of employee share options (155) (155)
Cash dividend paid (19,808) (19,808)
Net income 10,014 10,014
---------- ------- ---------- --------- ---------- ----------
BALANCE - DECEMBER 31, 1996 13,205,450 $ 4,314 $ 137,787 $ (861) $ 19,345 $ 160,585
---------- ------- ---------- --------- ---------- ----------
---------- ------- ---------- --------- ---------- ----------
See notes to financial statements.
F-24
TOWER SEMICONDUCTOR LTD.
STATEMENTS OF CASH FLOWS
(dollars in thousands)
Year ended December 31,
-----------------------
1996 1995 1994
---------- ----------- ---------
CASH FLOWS - OPERATING ACTIVITIES
Net income $ 10,014 $ 20,439 $ 7,762
Adjustments to reconcile net income
to net cash provided by operating activities:
Income and expense items not involving cash flows:
Depreciation and amortization 17,515 8,386 3,532
Deferred income taxes 2,299 2,554 1,109
Earnings on marketable debt securities (2,959) (3,158) (44)
Changes in assets and liabilities:
Decrease (increase) in trade accounts receivable 2,408 (6,493) (2,530)
Decrease (increase) in other receivables and other current
assets 2,207 (2,791) (1,916)
Increase in inventories (1,082) (3,721) (3,453)
Increase (decrease) in trade accounts payable (2,895) 1,643 4,428
Increase (decrease) in due to related parties (239) 233 (255)
Increase (decrease) in other current liabilities (1,074) 2,122 658
Increase (decrease) in liability in respect of customer
advances (1,439) 16,803 --
Increase in long-term liabilities 117 528 303
--------- ----------- ---------
Net cash provided by operating activities 24,872 36,545 9,594
--------- ----------- ---------
CASH FLOWS - INVESTING ACTIVITIES
Additions to property and equipment (84,475) (62,076) (27,391)
Investment grants received 30,800 14,634 10,076
Increase in deposits (1,684) (25,414) --
Investments in marketable debt securities (109,951) (88,139) (39,019)
Proceeds from realization of marketable debt securities 151,736 51,902 6,022
--------- ----------- ---------
Net cash used in investing activities (13,574) (109,093) (50,312)
--------- ----------- ---------
CASH FLOWS - FINANCING ACTIVITIES
Proceeds from issuance of ordinary shares, net -- 86,845 41,503
Share option plan issuance expenses (155) (153) --
Repayment of liability in respect of customer advances (2,250) -- --
Increase in liability in respect of customer advances -- 4,500 --
Increase (decrease) in short-term debt (1,641) 1,171 411
Repayment of long-term debt -- (1,440) (4,320)
Cash dividend paid (19,808) -- --
--------- ----------- ---------
Net cash provided by (used in) financing activities (23,854) 90,923 37,594
--------- ----------- ---------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (12,556) 18,375 (3,124)
CASH AND CASH EQUIVALENTS - BEGINNING OF YEAR 24,015 5,640 8,764
--------- ----------- ---------
CASH AND CASH EQUIVALENTS - END OF YEAR $ 11,459 $ 24,015 $ 5,640
--------- ----------- ---------
--------- ----------- ---------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the year for interest $ 702 $ 816 $ 734
--------- ----------- ---------
--------- ----------- ---------
Cash paid during the year for income taxes $ 1,515 $ 3,167 $ 2,121
--------- ----------- ---------
--------- ----------- ---------
See notes to financial statements.
F-25
TOWER SEMICONDUCTOR LTD.
NOTES TO FINANCIAL STATEMENTS
(dollars in thousands, except per share data)
NOTE 1 - DESCRIPTION OF BUSINESS AND GENERAL
A. DESCRIPTION OF BUSINESS
Tower Semiconductor Ltd. ("the Company"), incorporated in Israel,
commenced operations in March 1993. The Company is an independent
"foundry" manufacturer of semiconductor integrated circuits on
silicon wafers. As a foundry, the Company manufactures wafers using
its advanced production capability and the proprietary integrated
circuit designs of its customers. The industry in which the Company
operates is characterized by wide fluctuations in supply and
demand. Such industry is also characterized by the complexity and
sensitivity of the manufacturing process, by high levels of fixed
costs, and by the need for constant improvements in production
technology.
In March 1993, the Company acquired the plant in Israel (including
leasehold rights, buildings, equipment and inventories) of a
subsidiary of National Semiconductor Corporation, a U.S.
corporation ("National"), in an acquisition ("the Acquisition")
accounted for by the purchase method of accounting. During 1996,
the Company established a marketing subsidiary in the U.S. The
operations of such subsidiary were not material to the Company's
financial position and results of operations as of December 31,
1996 and for the year then ended.
The Company's ordinary shares are traded on the Nasdaq National
Market.
B. USE OF ESTIMATES IN PREPARATION OF FINANCIAL STATEMENTS
The preparation of financial statements in conformity with
generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and
liabilities as of the date of the financial statements, and the
reported amounts of revenues and expenses during the reporting
periods. Actual results could differ from those estimates.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
A. CASH AND CASH EQUIVALENTS
Cash and cash equivalents consist of deposits in banks and
short-term investments (primarily time deposits and certificates of
deposit) with original maturities of three months or less.
F-26
TOWER SEMICONDUCTOR LTD.
NOTES TO FINANCIAL STATEMENTS
(dollars in thousands, except per share data)
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (cont.)
B. MARKETABLE DEBT SECURITIES
Marketable debt securities which the Company has the positive
intent and ability to hold to maturity are reflected at amortized
cost.
C. INVENTORIES
Inventories are stated at the lower of cost or market. Cost is
determined for raw materials, spare parts and supplies on the basis
of average cost per unit. Cost is determined for work in process
and finished goods on the basis of standard costs, adjusted for
variances as appropriate.
D. PROPERTY AND EQUIPMENT
Property and equipment are presented at cost, net of investment
grants received or receivable, and less accumulated depreciation
and amortization. Depreciation is calculated on the straight-line
basis over the estimated economic lives of the assets or terms of
the related leases, as follows:
Land and buildings under capital lease 14-25 years
Machinery and equipment 5 years
Transportation vehicles 7 years
Management reviews property and equipment and other long-lived
assets on a periodic basis to determine whether events or changes
in circumstances indicate that the carrying amount of such assets
may not be recoverable.
E. INCOME TAXES
The Company records deferred income taxes to reflect the net tax
effects of temporary differences between the carrying amounts of
assets and liabilities for financial reporting purposes and for tax
purposes. Deferred taxes are computed based on the tax rates
anticipated to be in effect (under applicable law at the time the
financial statements are prepared) when the deferred taxes are
expected to be paid or realized.
Deferred tax liabilities and assets are classified as current or
noncurrent based on the classification of the related asset or
liability for financial reporting, or according to the expected
reversal dates of the specific temporary differences, if not
related to an asset or liability for financial reporting.
F. REVENUE RECOGNITION
Revenues are recognized upon delivery. An accrual for estimated
returns, computed on the basis of historical experience, is
recorded at the time of sale.
F-27
TOWER SEMICONDUCTOR LTD.
NOTES TO FINANCIAL STATEMENTS
(dollars in thousands, except per share data)
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (cont.)
G. RESEARCH AND DEVELOPMENT
Research and development costs are charged to operations as
incurred.
H. EARNINGS PER ORDINARY SHARE
Earnings per ordinary share are determined using the weighted
average number of ordinary shares outstanding during the period,
after giving retroactive effect to the stock split effected in the
form of a stock dividend and the conversion of all preferred shares
into ordinary shares effected as of October 3, 1994 (see Note 11A).
The effect of the Company's share options on earnings per share was
not material for all years presented.
I. FOREIGN EXCHANGE AGREEMENTS
The Company, from time to time, enters into foreign exchange
agreements (forward agreements) as a hedge against non-dollar
equipment purchase commitments. Gains and losses on such agreements
through the date that the equipment is received are deferred and
recorded to property and equipment, while gains and losses
subsequent thereto, through the date of actual payment of the
liability, are included in financing income (expenses), net.
J. FUNCTIONAL CURRENCY AND TRANSACTION GAINS AND LOSSES
The currency of the primary economic environment in which the
Company conducts operations is the U.S. dollar ("dollar").
Accordingly, the Company uses the dollar as its functional and
reporting currency. Financing income (expenses), net, reflects net
foreign currency transaction losses, which amounted to $677, $473
and $171 in 1996, 1995 and 1994, respectively.
K. STOCK-BASED COMPENSATION
The Company accounts for employee stock-based compensation in
accordance with Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees." Pursuant to this
accounting standard, the Company records deferred compensation for
share options granted to employees at the date of grant based on
the difference between the exercise price of the options and the
market value of the underlying shares at that date. Deferred
compensation is amortized to compensation expense over the vesting
period of the underlying options. See Note 11C for pro forma
disclosures required in accordance with Statement No. 123,
"Accounting for Stock-Based Compensation," ("SFAS 123") of the
Financial Accounting Standards Board.
F-28
TOWER SEMICONDUCTOR LTD.
NOTES TO FINANCIAL STATEMENTS
(dollars in thousands, except per share data)
NOTE 3 - MARKETABLE DEBT SECURITIES
Marketable debt securities consist primarily of United States Treasury
Bills with a maturity value of $32,993, less unamortized discount of
$398 ($73,653 less unamortized discount of $1,217 at December 31,
1995), at yields to maturity ranging from 5.14% to 5.28% and maturing
between January 1997 and July 1997. The market value of the securities
as of December 31, 1996 and 1995 was approximately equal to amortized
cost.
NOTE 4 - OTHER RECEIVABLES
Other receivables consist of the following:
As of December 31,
------------------
1996 1995
---- ----
Investment grants receivable $ 9,043 $14,173
Government agencies 2,273 4,313
------ ------
$11,316 $18,486
====== ======
NOTE 5 - INVENTORIES
Inventories consist of the following:
As of December 31,
------------------
1996 1995
---- ----
Raw materials (1) $ 4,304 $ 4,982
Spare parts and supplies 3,363 3,282
Work in process 5,543 4,552
Finished goods 1,079 391
------ ------
$14,289 $13,207
====== ======
(1) Net of $850 write-down to net realizable value as of December 31,
1996.
F-29
TOWER SEMICONDUCTOR LTD.
NOTES TO FINANCIAL STATEMENTS
(dollars in thousands, except per share data)
NOTE 6 - PROPERTY AND EQUIPMENT
A. COMPOSITION
As of December 31,
------------------
Cost (1): 1996 1995
---- ----
Land and buildings under capital lease $ 26,556 $ 18,958
Machinery and equipment 105,798 63,224
Transportation vehicles 1,541 945
------- -------
133,895 83,127
------- -------
Accumulated depreciation and amortization:
Land and buildings under capital lease 2,702 1,399
Machinery and equipment 25,217 11,727
Transportation vehicles 329 144
------- -------
28,248 13,270
------- -------
105,647 69,857
Design costs in respect of plant
to be constructed, net (2) 400 1,314
------- -------
$106,047 $ 71,171
======= =======
(1) As of December 31, 1996, the cost of buildings, machinery and
equipment is reflected net of investment grants of $64,562 (as
of December 31, 1995 - $38,860).
(2) Due to uncertainty with respect to the form and location of the
plant to be constructed, certain costs in the aggregate amount
of $1,443, the recovery of which was not considered probable by
management, were written-off in 1996 (see B below).
B. INVESTMENT GRANTS
In connection with the formation of the Company, the Investment
Center of the Ministry of Industry and Trade of the State of Israel
("the Investment Center"), under its "approved enterprise" program,
approved an investment program for expenditures on buildings and
equipment in the aggregate amount of $93,400. The approval
certificate was granted in respect of a benefit track providing the
Company with investment grants at a rate of 38% of the investments
included in such certificate. The Company completed its
investments in respect of this program during 1995. During 1996,
the Company received approval for a $3,449 increase in the amount
of the investment program. Investments in respect of such increase
have been completed.
F-30
TOWER SEMICONDUCTOR LTD.
NOTES TO FINANCIAL STATEMENTS
(dollars in thousands, except per share data)
NOTE 6 - PROPERTY AND EQUIPMENT (cont.)
B. INVESTMENT GRANTS (cont.)
In January 1996, an investment program for expansion of the Company's
plant in the aggregate amount of $239,579 was approved by the
Investment Center. The approval certificate was granted in respect of
a benefit track providing the Company with investment grants at a rate
of 34% of the investments included in such certificate. Pursuant to
the approval, the investments in respect of this program are required
to be completed by December 31, 1998. The Company has invested
approximately $82,000 in respect of this program through December 31,
1996.
Receipt of the above grants is subject to various conditions. In the
event the Company fails to comply with such conditions, the Company
may be required to repay all or a portion of the grants received plus
interest and certain inflation adjustments. In management's opinion,
the Company has been in full compliance with the conditions through
December 31, 1996. In addition, in order to assure the fulfillment of
the conditions related to the receipt of investment grants, floating
liens were registered in favor of the State of Israel on substantially
all assets of the Company.
In April 1996, the Company filed a request with the Investment Center
in the amount of approximately $990,000 for an additional approved
enterprise program for the establishment of a new plant. At present,
the Company has decided to defer the procedures required for receipt
of the aforementioned approval due to a reduction in the level of
government assistance provided for such programs.
NOTE 7 - SHORT-TERM DEBT
Short-term debt consists of non-interest bearing short-term loans
received from a bank for the payment of Value Added Tax (V.A.T.).
In January 1997, the Company received letters of intent from certain
Israeli banks, effective through at least December 31, 1997. Pursuant
to such letters of intent, the banks will make available to the
Company, at its request, short-term credits in the aggregate amount of
$30,000, at terms to be agreed upon by the parties prior to the actual
receipt of any credits by the Company.
NOTE 8 - RELATED PARTIES
A. COMPOSITION
Due to related parties consist of the following:
As of December 31,
------------------
1996 1995
---- ----
National $ 348 $ 641
Directors 66 12
----- -----
$ 414 $ 653
===== =====
F-31
TOWER SEMICONDUCTOR LTD.
NOTES TO FINANCIAL STATEMENTS
(dollars in thousands, except per share data)
NOTE 8 - RELATED PARTIES (cont.)
B. OTHER RELATED PARTY BALANCES AND TRANSACTIONS
Trade accounts receivable as of December 31, 1996 includes $9,500
due from National, primarily for wafer purchases ($8,668 as of
December 31, 1995).
The Company purchased materials and received services from National
during the year ended December 31, 1996 in the aggregate amount of
$260 ($2,101 and $1,555 for the years ended December 31, 1995 and
1994, respectively). See Note 15E.
Pursuant to a management agreement with Data Systems & Software
Inc. ("DSSI"), the Company's indirect principal shareholder, the
Company paid DSSI management fees of $40 per month in 1996, 1995
and 1994. Total management fees were $480 for each of the years
ended December 31, 1996, 1995, and 1994. The management agreement
can be terminated by either party as of the end of any year,
subject to certain advance notice requirements.
In addition, the Company purchases computerized testing equipment
from a related party supplier in the normal course of business. The
Company's purchases from this supplier aggregated $18, $282, and
$470 for the years ended December 31, 1996, 1995 and 1994,
respectively.
NOTE 9 - OTHER CURRENT LIABILITIES
As of December 31,
------------------
Other current liabilities consist of the following: 1996 1995
---- ----
Accrued salaries $ 2,463 $ 3,571
Vacation accrual 1,428 1,394
Other accrued expenses 30 30
------ ------
$ 3,921 $ 4,995
====== ======
NOTE 10 - LONG-TERM DEBT
In connection with the Acquisition, the Company assumed certain
long-term bank loans of National in the aggregate amount of $12,064
("the Original Term Loans"). The Original Term Loans are indexed to
the dollar and bear interest (payable quarterly) at a rate of 6% per
annum. The Company is obligated to repay the principal of the Original
Term Loans in quarterly installments commencing in March 1993 and
ending in May 1998. The bank that provided the Original Term Loans,
together with another bank (collectively, "the Banks"), agreed to make
new loans ("the New Term Loans") to the Company to repay and
effectively extend the maturity of all principal installments due on
the Original Term Loans through April 1996. Prior to the new agreement
discussed below, the Company was obligated to repay the principal of
the New Term
F-32
TOWER SEMICONDUCTOR LTD.
NOTES TO FINANCIAL STATEMENTS
(dollars in thousands, except per share data)
NOTE 10 - LONG-TERM DEBT (cont.)
Loans in 12 quarterly installments commencing in May 1996. The New
Term Loans bear interest at the three-month Libor rate plus 1.25%.
The Original Term Loans and the New Term Loans were secured by a first
mortgage on the Company's leasehold rights, a fixed lien on the
Company's goodwill and a floating lien on all of the Company's other
assets.
Pursuant to new agreements with the Banks entered into during the
fourth quarter of 1995 and the first quarter of 1996, the Banks
released all liens existing on the Company's assets and committed to
provide the Company with New Term Loans to repay and effectively
extend the maturity of all remaining principal installments due on the
Original Term Loans through May 1998. The aggregate balance of the New
Term Loans will be repayable in 12 equal quarterly payments commencing
in May 2000. The Banks also agreed that, as long as the Company
maintains deposits at the Banks with original maturities of at least
one year from the date of deposit, the interest rate on the New Term
Loans (up to the amount of such deposits) will be reduced to an annual
rate of 0.3% over the interest rate that the Company receives on the
deposits.
The new agreements with the Banks restrict the Company's ability to
place liens on its assets (other than to the State of Israel in
respect of investment grants) without the prior consent of the Banks.
Furthermore the new agreements contain certain restrictive financial
covenants. As of December 31, 1996, the Company was in full compliance
with such covenants.
NOTE 11 - SHAREHOLDERS' EQUITY
A. RECAPITALIZATION
The financial statements give retroactive effect to a
recapitalization increasing the number of authorized ordinary
shares to 30,000,000, a 3.507 to one stock split effected in the
form of a stock dividend, the conversion of all outstanding
preferred shares into ordinary shares, and the elimination of the
authorized and unissued preferred shares, all of which were
effected on October 3, 1994. The Company also transferred $2,800 of
retained earnings to paid-in capital to comply with one of its
obligations in connection with the transfer from National of
approved enterprise certificates of approval.
B. SHARE PURCHASE PLAN
In December 1993, the Company sold 234,497 ordinary shares to key
senior management employees pursuant to a share purchase plan for
an aggregate purchase price of $678. The purchase price was
determined by the Company based on an independent appraisal. Loans
extended by the Company financed approximately $672 of the
aggregate purchase price required to be paid by the employees. Such
loans are denominated in new Israeli shekels ("NIS") and bear
interest at a rate equivalent to the rate of change of the Consumer
Price Index in Israel. Ordinary shares purchased vest over a
four-year period, with 25% of the ordinary shares vesting on each
anniversary of the purchase date. Ordinary shares not yet
F-33
TOWER SEMICONDUCTOR LTD.
NOTES TO FINANCIAL STATEMENTS
(dollars in thousands, except per share data)
NOTE 11 - SHAREHOLDERS' EQUITY (cont.)
B. SHARE PURCHASE PLAN (cont.)
vested are subject to repurchase by Tower Semiconductor Holdings
1993 Limited (the Company's parent company) and National for a
nominal amount in the event of the employee's termination other
than by reason of the death or disability of the employee. All
vested shares are also subject to restrictions on sale or transfer.
The employee's obligation to repay loans received to finance the
purchase of the ordinary shares is secured by such shares and is
repayable upon the sale of the ordinary shares in accordance with a
formula set forth in the share purchase plan.
C. SHARE OPTION PLANS
The Company maintains two share option plans, which were adopted in
1994 and 1995, respectively. The plans provide for the grant of
options to employees (including senior management) to purchase
ordinary shares at exercise prices which may not be less than 85%
of the market value of the ordinary shares at the date of grant. In
addition, pursuant to the plans, the terms of the options granted
may not exceed ten years from the first grant date under each plan.
Options granted to date become vested over a four-year period
according to various vesting schedules. In July 1996, the exercise
price of vested options granted under the 1994 plan was reduced
from primarily $17 per share to $13 per share and the exercise
price of non-vested options was reduced from primarily $17 per
share to $9.125 per share (the market value of the shares at such
time).
A summary of the status of the Company's share option plans as of
December 31, 1996 and 1995, as well as changes during each of the
years then ended, is presented below:
1996 1995
---- ----
Weighted Weighted
average average
Share options exercise price Share options exercise price
------------- -------------- ------------- --------------
Outstanding as of
beginning of year (1) 265,000 $17.16 -
Granted 528,960 8.80 265,000 $17.16
Exercised - -
Terminated - -
Forfeited (64,304) 15.65 -
------- -------
Outstanding as of end
of year 729,656 9.10 265,000 17.16
======= =======
Options exercisable as
of year end 52,804 12.95 - -
======= =======
(1) During 1996, the exercise price of share options granted under
the 1994 plan was reduced.
F-34
TOWER SEMICONDUCTOR LTD.
NOTES TO FINANCIAL STATEMENTS
(dollars in thousands, except per share data)
NOTE 11 - SHAREHOLDERS' EQUITY (cont.)
C. SHARE OPTION PLANS (cont.)
The following table summarizes information about share options
outstanding as of December 31, 1996:
Exercisable as of
Outstanding as of December 31, 1996 December 31, 1996
----------------------------------- -----------------
Weighted
average
Range of remaining Weighted Weighted
exercise Number contractual average Number average
prices outstanding life exercise price exercisable exercise price
------ ----------- ---- -------------- ----------- --------------
$6.38-7.00 16,000 9.78 $6.62 - -
8.75 488,440 9.91 8.75 - -
9.13 173,037 8.35 9.13 625 $9.13
13.00 52,179 8.25 13.00 52,179 13.00
------- ------
729,656 52,804
======= ======
The weighted average grant-date fair value of the 528,960 and
265,000 options granted during 1996 and 1995 amounted to $4.50 and
$11.20 per option, respectively. The Company utilized the
Black-Scholes option pricing model to estimate fair value,
utilizing the following assumptions for the years 1996 and 1995
(all in weighted averages):
Risk-free interest rate 5.50%
Expected life of options 4.4 years
Expected annual volatility 58%
Expected dividend yield none
Had compensation cost for the Company's share option plans been
determined based on fair value at the grant dates for awards made
in 1996 and 1995 under such plans in accordance with SFAS 123, the
Company's pro forma net income and earnings per share would have
been as follows:
F-35
TOWER SEMICONDUCTOR LTD.
NOTES TO FINANCIAL STATEMENTS
(dollars in thousands, except per share data)
NOTE 11 - SHAREHOLDERS' EQUITY (cont.)
C. SHARE OPTION PLANS (cont.)
1996 1995
---- ----
Pro forma net income $9,221 $19,752
===== ======
Pro forma earnings per share $ 0.70 $ 1.70
===== ======
D. PUBLIC OFFERINGS OF ORDINARY SHARES
In October 1994, the Company conducted an initial public offering
in the United States of 3,000,000 newly issued ordinary shares at
an offering price of $14 per share. Total net proceeds, after
deduction of offering expenses and underwriting commissions,
amounted to $38,338.
In July 1995, the Company completed an additional public offering
in the United States of 3,205,450 newly issued ordinary shares at
an offering price of $29 per share. Total net proceeds, after
deduction of offering expenses and underwriting commissions,
amounted to $88,068.
E. CASH DIVIDENDS
In October 1996, the Company's Board of Directors declared the
payment of a special dividend in the amount of $19,808 ($1.50 per
ordinary share). The dividend was paid in November 1996.
NOTE 12 - CONCENTRATIONS RELATING TO SALES AND
PRINCIPAL GEOGRAPHICAL MARKETS
A. SALES TO MAJOR CUSTOMERS (AS A PERCENTAGE OF TOTAL SALES FOR THE
RESPECTIVE PERIODS)
Year ended December 31,
-----------------------
1996 1995 1994
---- ---- ----
Customer A - National 67% 58% 55%
Customer B 8% 9% 19%
Customer C 10% 20% 25%
Customer D 8% 9% -
As of both December 31, 1996 and 1995, the above major customers
constituted most of the trade accounts receivable reflected on the
balance sheet (see Note 16E).
F-36
TOWER SEMICONDUCTOR LTD.
NOTES TO FINANCIAL STATEMENTS
(dollars in thousands, except per share data)
NOTE 12 - CONCENTRATIONS RELATING TO SALES AND
PRINCIPAL GEOGRAPHICAL MARKETS (cont.)
B. SALES BY GEOGRAPHICAL MARKET (AS A PERCENTAGE OF TOTAL SALES FOR
THE RESPECTIVE PERIODS)
Year ended December 31,
-----------------------
1996 1995 1994
---- ---- ----
United States 41% 47% 51%
Far East 58% 49% 44%
Other 1% 4% 5%
NOTE 13 - INCOME TAXES
A. APPROVED ENTERPRISE STATUS
Virtually all of the Company's facilities have been granted the
status of an approved enterprise, as provided by the Israeli Law
for the Encouragement of Capital Investments - 1959 ("the 1959
Law") (Note 6B). In connection with the Acquisition, the
Government of Israel also agreed to transfer to the Company the
approved enterprise status held by National with respect to its
investment programs.
The tax benefits derived from approved enterprise status relate
only to taxable income attributable to approved enterprise
investments. The Company's income attributable to its various
approved enterprise investments is taxed at a rate of 25% for the
year 1994 and at a rate of 20% thereafter, for periods ending
between 2002 and 2006 depending on the specific approval
certificate. The portion of the Company's taxable income which is
not attributable to approved enterprise investments is subject to
regular "Company Tax" (38% in 1994, declining by 1% per year to 36%
in 1996 and thereafter).
The tax benefits are also conditioned upon fulfillment of the
requirements stipulated by the 1959 Law and the regulations
promulgated thereunder, as well as the criteria set forth in the
certificates of approval. In the event of a failure by the Company
to comply with these conditions, the tax benefits could be
canceled, in whole or in part, and the Company would be required to
refund the amount of the canceled benefits, plus interest and
certain inflation adjustments. In management's opinion, the Company
has been in full compliance with the aforementioned conditions
through December 31, 1996.
Year ended December 31,
-----------------------
B. COMPOSITION 1996 1995 1994
---- ---- ----
Current $ - $2,613 $1,118
Deferred 2,299 2,554 1,109
----- ----- -----
$2,299 $5,167 $2,227
===== ===== =====
F-37
TOWER SEMICONDUCTOR LTD.
NOTES TO FINANCIAL STATEMENTS
(dollars in thousands, except per share data)
NOTE 13 - INCOME TAXES (cont.)
C. COMPONENTS OF DEFERRED TAX ASSET/LIABILITY
The following is a summary of the components of the deferred tax
benefit and liability reflected on the balance sheet as of December
31:
1996 1995
---- ----
DEFERRED TAX BENEFIT - CURRENT
Accrued vacation pay $ 286 $ 279
Other 29 28
------ ------
Total current deferred tax benefit $ 315 $ 307
====== ======
NET DEFERRED TAX LIABILITY - LONG-TERM
Deferred tax asset - long-term
Public offering issuance expenses $ 407 $ 1,127
Liability for employee rights
upon severance 153 130
Research and development 657 291
Net operating loss carryforward 444 -
Unearned compensation 98 61
------ ------
1,759 1,609
Deferred tax liability - long-term
Depreciation (5,878) (3,421)
------ ------
Total net long-term deferred
tax liability $(4,119) $(1,812)
====== ======
D. EFFECTIVE INCOME TAX RATES
The reconciliation of the statutory tax rate to the Company's
effective tax rate is as follows:
Year ended December 31,
-----------------------
1996 1995 1994
---- ---- ----
Israeli statutory rate 36% 37% 38%
Reduced tax rate for
approved enterprise (16) (16) (13)
Benefit from future reduced tax rates - - (3)
Permanent differences and other, net (1) (1) -
--- --- ---
19% 20% 22%
=== === ===
E. NET OPERATING LOSS CARRYFORWARD
The Company has net operating loss carryforwards of approximately
$2,200 as of December 31, 1996, which may be carried forward for an
unlimited period of time.
F-38
TOWER SEMICONDUCTOR LTD.
NOTES TO FINANCIAL STATEMENTS
(dollars in thousands, except per share data)
NOTE 14 - EMPLOYEE RIGHTS UPON SEVERANCE
Israeli law and labor agreements determine the obligations of the
Company to make severance payments to dismissed employees and to
employees leaving employment under certain other circumstances. The
obligation for severance pay benefits, as determined by Israeli Law,
is based upon length of service and the employee's most recent salary.
In connection with the Acquisition, the Company agreed to (i) include
the period of time that an employee worked for National in calculating
severance payments and (ii) subject to certain conditions, make
severance payments in an amount equal to not less than the amount of
severance funds that were transferred by National to the Company with
respect to all employees of National who continued their employment at
the facility following the Acquisition. Most of these obligations are
covered by regular deposits made by the Company into recognized
severance and pension funds and by insurance policies purchased by the
Company. The amounts so funded are not reflected on the balance sheet,
since they are controlled by the fund trustees and insurance companies
and are not under the control and management of the Company.
Unfunded liabilities for employee rights upon severance of $766 at
December 31, 1996 ($648 at December 31, 1995) are included in other
liabilities. For the years ended December 31, 1996, 1995 and 1994,
expenses relating to employee severance rights were approximately
$1,311, $1,303 and $1,009, respectively.
In light of a general downturn in the market for semiconductor
products and reductions in orders from customers, in July 1996, the
Company's management terminated the employment of approximately 120
employees. Costs related to the aforementioned termination of
employment were not material.
NOTE 15 - COMMITMENTS AND CONTINGENCIES
A. LEGAL PROCEEDINGS
Between June and September 1996, several suits were filed in the
United States on behalf of a purported class of the Company's
shareholders, against the Company, its Co-Chief Executive Officers,
its Chairman of the Board of Directors, and DSSI. The complaints
seek to certify a class of all persons who purchased or otherwise
acquired the Company's ordinary shares between May 25, 1995 and
June 10, 1996. The complaints allege, on behalf of the class, that
the defendants made misstatements and omissions regarding (i) the
relationship between the Company and a major customer and (ii) the
Company's process development efforts in connection therewith, in
violation of certain U.S. Federal securities laws.
The Company has indemnified the defendants, up to the limits
permitted by the Israel Companies Ordinance, from any liability
arising out of the actions. The Company maintains
F-39
TOWER SEMICONDUCTOR LTD.
NOTES TO FINANCIAL STATEMENTS
(dollars in thousands, except per share data)
NOTE 15 - COMMITMENTS AND CONTINGENCIES (cont.)
A. LEGAL PROCEEDINGS (cont.)
insurance policies that, under certain conditions, cover actions of
this type up to an aggregate amount of $20,000. The Company is
unable to determine at this time with any certainty the ultimate
outcome of the aforementioned matter or its effect if any, on the
Company's financial condition, operating results and business.
However, the Company believes it has meritorious defenses and
intends to defend the actions vigorously.
B. LEASES
The Company's offices and engineering and manufacturing operations
are located in a building complex situated in an industrial park in
Migdal Haemek, Israel. These premises are currently occupied under
a long-term lease from the Israel Lands Authority, which expires in
2032. The Company has no obligation for lease payments related to
this lease through the year 2032.
C. PURCHASE AGREEMENTS
National and another major customer each purchase products from the
Company under long-term purchase agreements, effective through
February 28, 1998 and December 31, 1998, respectively. Pursuant to
each of the long-term purchase agreements, the customer is
committed to purchase, and the Company is committed to sell, a
specific monthly output derived from the start of processing of
silicon wafers ("wafer starts") at prices stipulated in the
agreements. Such output varies from customer to customer. The
output levels contained in the agreements are subject to material
reductions by the customer on advance written notice. In accordance
with its agreement with the Company, the other major customer has
exercised its right to reduce its purchase commitments. From
commencement of the Company's operations through December 31, 1996,
a substantial portion of the Company's production has been sold in
the framework of such agreements.
In May 1995, the Company and National signed an amendment to the
original purchase agreement (as previously amended). The amendment
called for an increase in the number of wafer starts per month that
National is committed to purchase and the Company is committed to
sell (the "additional output"). In consideration for such increase,
National provided the Company with the amount of $28,875 as an
advance in respect of the additional output. The advance bears
interest at the three-month Libor rate. Any amounts of the advance
not offset against sales of additional output to National through
October 1, 1999 may be retained by the Company without any
obligation to National. The portion of the advance received through
December 31, 1996 (net of the offset against accounts receivable
from National in respect of additional output) that is expected to
be offset in 1997 in accordance with the agreement is presented as
a current liability. The long-term portion is expected to be offset
in 1998. In September 1996, an addendum to the aforementioned
agreements with National was signed which provides for a mechanism
(based substantially on additional quantities purchased) for price
reductions under certain circumstances.
F-40
TOWER SEMICONDUCTOR LTD.
NOTES TO FINANCIAL STATEMENTS
(dollars in thousands, except per share data)
NOTE 15 - COMMITMENTS AND CONTINGENCIES (cont.)
C. PURCHASE AGREEMENTS (cont.)
In June 1996, the Company reached an understanding for the
termination of a purchase agreement with a third major customer.
Sales to such customer accounted for approximately 8%, 9% and 19%
of the Company's sales in 1996, 1995 and 1994, respectively.
D. PROFIT SHARING PLAN
In September 1993, the Board of Directors of the Company adopted an
employee profit sharing plan. Under the terms of this plan (i) 7.5%
of the Company's profit before taxes ("PBT") each year is to be
divided among all employees of the Company, including senior
management (the allocation of which is based on salary and a yearly
performance score for each employee) and (ii) 2.5% of PBT each year
is to be divided among key senior management employees (the
allocation among such employees is to be approved by the Chairman
of the Board of the Company who does not participate in this plan).
The profit sharing award with respect to each year is paid in two
installments in the following year. The Company's expenses pursuant
to the profit sharing plan were $1,231, $2,561 and $1,000 for 1996,
1995 and 1994, respectively.
E. MUTUAL SERVICES AGREEMENTS
In connection with the Acquisition, the Company and National
entered into an agreement relating to certain services to be
provided by National to the Company. These services included
purchase support, use of National computerized process control and
simulation systems, access to National information databases,
library and electronic mail, and certain other technical services.
In addition, the Company performs certain activities for National
pursuant to the agreement, including use of the Company's equipment
for testing prototype wafers and related activities. The original
agreement expired in February 1994 and was renewed several times by
new agreements, the last one of which was dated February 28, 1996,
effective from expiration of the prior agreement through February
28, 1998. Pursuant to the new agreement, the Company generally pays
National's out-of-pocket costs plus a margin of up to 8% for
services provided under the agreement. In accordance with the
aforementioned agreements, for the year ended December 31, 1996,
the Company paid National $260 for various services and National
paid the Company $800 for certain activities ($2,101 and $714,
respectively, for 1995; and $1,555 and $1,140, respectively, for
1994).
F-41
TOWER SEMICONDUCTOR LTD.
NOTES TO FINANCIAL STATEMENTS
(dollars in thousands, except per share data)
NOTE 15 - COMMITMENTS AND CONTINGENCIES (cont.)
F. PENSION CONTRIBUTIONS
The Company historically has made pension contributions for
employees primarily through the purchase of insurance. In 1993, an
Israeli court held that companies that are subject to certain
provisions of the collective bargaining agreements between the
Histadrut (General Federation of Labor in Israel) ("Histadrut") and
the Coordination Bureau of Economic Organizations that are
applicable to the Company by order of the Ministry of Labor ("the
Extension Order") are required to make pension contributions
exclusively through contributions to Mivtachim Social Institute of
Employees Ltd. ("Mivtachim"), a pension fund managed by the
Histadrut. In October 1994, the Company concluded an arrangement
with Mivtachim and the Histadrut in order to bring it into
conformity with this decision. As part of this arrangement,
Mivtachim agreed not to assert any claim against the Company with
respect to any past practices of the Company relating to this
matter. The arrangement provided that the Company would commence
making its pension contributions for employees through either
contributions to Mivtachim or alternative pension arrangements.
This arrangement replaced the Extension Order with respect to the
Company's pension obligations to its employees. Although this
arrangement does not bind employees with respect to instituting
claims relating to any past nonconformity by the Company, the
Company believes the likelihood of the assertion of claims by
employees is low and that any potential claims by employees against
the Company (or against Mivtachim, for which the Company has agreed
to indemnify Mivtachim), if successful, will not result in any
material liability to the Company.
G. PRINCIPAL NEW AGREEMENTS
(1) In November 1996, the Company signed a long-term agreement with
Waferscale Integration Inc., a U.S. corporation ("WSI").
Pursuant to the agreement, the Company and WSI will jointly
develop a production process utilizing technologies owned by
both WSI and the Company. The agreement contains commitments by
the Company and by WSI, respectively, to produce and purchase
specific quantities of silicon wafers to be produced utilizing
the technologies.
(2) In November 1996, the Company signed an MOU with Sayfun
Semiconductor Ltd. ("Sayfun") with respect to examining the
feasibility of certain technology possessed by Sayfun. Subject
to the success of the feasibility study, the Company and Sayfun
will apply such technology in the Company's manufacturing
process in respect of products manufactured for Sayfun and
others. Subject to certain other conditions, the Company
committed to invest an aggregate sum of approximately
$1,000 in consideration for 10% of Sayfun's share capital, and
an aggregate sum of $1,000 on account of future royalties
payable to Sayfun.
F-42
TOWER SEMICONDUCTOR LTD.
NOTES TO FINANCIAL STATEMENTS
(dollars in thousands, except per share data)
NOTE 16 - FINANCIAL INSTRUMENTS
A financial instrument is defined as cash, evidence of an ownership
interest in an entity, or a contract that imposes on one entity a
contractual obligation either to deliver or receive cash or another
financial instrument to or from a second entity. Examples of financial
instruments include cash and cash equivalents, trade accounts
receivable, loans, investments, trade accounts payable, accrued
expenses, options and forward contracts.
In accordance with Statements No. 105, 107 and 119 of the FASB, the
Company makes certain disclosures with regard to financial
instruments, including derivatives. These disclosures include, among
other matters, the nature and terms of derivative transactions,
information about significant concentrations of credit risk, and the
fair value of financial assets and liabilities.
A. FORWARD EXCHANGE AGREEMENTS
The Company, from time to time, enters into forward exchange
agreements to manage exposure to equipment purchase commitments
denominated in Japanese yen. These transactions qualify for hedge
accounting in accordance with generally accepted accounting
principles and, accordingly, the results of such transactions are
recorded concurrently with the realization of the related items
(i.e., receipt of the equipment and payment of the related
liability). The Company does not hold or issue derivative financial
instruments for trading purposes.
B. CREDIT RISK OF FINANCIAL INSTRUMENTS, INCLUDING DERIVATIVES
The face or contract amounts of derivatives do not represent
amounts exchanged by the parties and, accordingly, are not a
measure of the exposure of the Company through its use of
derivatives.
The Company is exposed to credit-related losses in respect of
derivative financial instruments in a manner similar to the credit
risk involved in the realization or collection of other types of
assets. In management's estimation, due to the fact that derivative
financial instrument transactions are entered into solely with
financial institution counterparties, it is not expected that such
counterparties will fail to meet their obligations. See E below
with regard to credit risks in respect of trade accounts
receivable. Substantially all remaining financial instruments held
by the Company are due from governmental entities and, accordingly,
the Company's credit risk in respect thereof is negligible.
F-43
TOWER SEMICONDUCTOR LTD.
NOTES TO FINANCIAL STATEMENTS
(dollars in thousands, except per share data)
NOTE 16 - FINANCIAL INSTRUMENTS (cont.)
C. PRESENTATION OF FOREIGN EXCHANGE TRANSACTIONS IN THE FINANCIAL
STATEMENTS
The aggregate contract amounts of forward exchange agreements
outstanding as of December 31, 1996 and 1995 were $1,016 and
$19,194, respectively. Substantially all outstanding transactions
as of December 31, 1996 are scheduled to mature during 1997.
The credit risk on these transactions was not material as of
December 31, 1996 and 1995. Deferred losses as of December 31, 1996
and 1995 amounted to $0 and $1,815, respectively.
For the year ended December 31, 1996, losses recognized on these
transactions amounted to $3,598. Of this amount, $3,002 was
capitalized to property and equipment during the year and the
remaining amount of $596 was reflected in financing expenses (for
the year ended December 31, 1995 - $1,661, $1,130 and $531,
respectively. The results of such transactions were not material
for the year ended December 31, 1994).
D. FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair values of the Company's financial instruments
did not materially differ from their respective carrying amounts as
of December 31, 1996 and 1995.
E. CONCENTRATIONS OF CREDIT RISK
Most of the Company's trade accounts receivable (91% as of December
31, 1996) were due from the Company's two major customers, both of
whom are large multi-national companies (see Note 12A).
F-44