SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------------------
F O R M 6-K
REPORT OF FOREIGN PRIVATE ISSUER PURSUANT TO RULE 13a-16 OR
15d-16 UNDER THE SECURITIES EXCHANGE ACT OF 1934
For the month of March 2005
MAGAL SECURITY SYSTEMS LTD.
(Name of Registrant)
P.O. Box 70, Industrial Zone, Yahud 56100 Israel
(Address of Principal Executive Office)
Indicate by check mark whether the registrant files or will file annual
reports under cover of Form 20-F or Form 40-F.
Form 20-F [X] Form 40-F [ ]
Indicate by check mark if the registrant is submitting the Form 6-K in
paper as permitted by Regulation S-T Rule 101(b)(1): [ ]
Indicate by check mark if the registrant is submitting the Form 6-K in
paper as permitted by Regulation S-T Rule 101(b)(7): [ ]
Indicate by check mark whether by furnishing the information contained
in this Form, the registrant is also thereby furnishing the information to the
Commission pursuant to Rule 12g3-2(b) under the Securities Exchange Act of 1934.
Yes [ ] No [X]
If "Yes" is marked, indicate below the file number assigned to the
registrant in connection with Rule 12g3-2(b): 82- ____________
This Report on Form 6-K is incorporated by reference into the Registrant's Form
F-3 Registration Statement File No. 333-9050 and Form S-8 Registration Statement
File No. 333-06246.
Magal Security Systems Ltd.
6-K Items
1. Consolidated Financial Statements of Magal Security Systems Ltd. as of
December 31, 2004
2. Schedule of Valuation and Qualifying Accounts
3 Operating and Financial Review and Prospects
4. Exhibit 23.1-Consent of Kost Forer Gabbay & Kasierer, a member of Ernst
& Young Global
5. Exhibit 12.1-Certification of Chief Executive Officer pursuant to Rule
13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended
6. Exhibit 12.2-Certification of Chief Financial Officer pursuant to Rule
13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended
7. Exhibit 13.1-Certification of Chief Executive Officer pursuant to 18
U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
8. Exhibit 13.2-Certification of Chief Financial Officer pursuant to 18
U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
Item 1
MAGAL SECURITY SYSTEMS LTD. AND ITS SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
AS OF DECEMBER 31, 2004
IN U.S. DOLLARS
INDEX
Page
---------
Report of Independent Registered Public Accounting Firm F-2
Consolidated Balance Sheets F-3 - F-4
Consolidated Statements of Income F-5
Statements of Changes in Shareholders' Equity F-6
Consolidated Statements of Cash Flows F-7 - F-8
Notes to Consolidated Financial Statements F-9 - F-38
- - - - - - - -
F-1
ERNST & YOUNG
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Shareholders of
MAGAL SECURITY SYSTEMS LTD.
We have audited the accompanying consolidated balance sheets of Magal
Security Systems Ltd. (the "Company") and its subsidiaries as of December 31,
2003 and 2004, and the related consolidated statements of income, shareholders'
equity and cash flows for each of the three years in the period ended December
31, 2004. Our audits included the financial statement schedule listed in the
Index at Item 2. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements and schedule based on our audits.
We conducted our audits in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
consideration of internal control over financial reporting as a basis for
designing audit procedures that are appropriate in the circumstances, but not
for the purpose of expressing an opinion on the effectiveness of the Company's
internal control over financial reporting. Accordingly, we express no such
opinion. An audit also includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, based on our audits, the consolidated financial statements
referred to above present fairly, in all material respects, the consolidated
financial position of the Company and its subsidiaries as of December 31, 2003
and 2004, and the consolidated results of their operations and their cash flows
for each of the three years in the period ended December 31, 2004, in conformity
with U.S. generally accepted accounting principles.
Also, in our opinion, the related financial statement schedule, when
considered in relation to the basic financial statements taken as a whole,
presents fairly in all material respects the information set forth therein.
/s/Kost Forer Gabbay and Kasierier
Tel-Aviv, Israel KOST FORER GABBAY & KASIERER
February 13, 2005 A Member of Ernst & Young Global
F-2
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
--------------------------------------------------------------------------------
U.S. dollars in thousands
December 31,
------------------
2003 2004
-------- -------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 4,389 $11,964
Short-term bank deposits 9,000 -
Trade receivables (net of allowance for doubtful accounts of
$187 and $320 as of December 31, 2003 and 2004, respectively) 14,885 13,232
Unbilled accounts receivable 5,072 7,465
Other accounts receivable and prepaid expenses 3,857 3,858
Deferred income taxes 454 488
Inventories 11,777 12,702
------- -------
Total current assets 49,434 49,709
------- -------
LONG-TERM INVESTMENTS AND TRADE RECEIVABLES:
Long-term trade receivables 300 344
Long-term bank deposits - 2,994
Structured notes 3,051 3,000
Severance pay fund 1,960 2,142
------- -------
Total long-term investments and trade receivables 5,311 8,480
------- -------
PROPERTY AND EQUIPMENT, NET 11,505 14,659
------- -------
DEFERRED INCOME TAXES 335 186
------- -------
INTANGIBLE ASSETS, NET 713 656
------- -------
GOODWILL 4,145 4,286
------- -------
Total assets $71,443 $77,976
======= =======
The accompanying notes are an integral part of the consolidated financial
statements.
F-3
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and par value data)
December 31,
-------------------
2003 2004
-------- --------
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Short-term bank credit $ 12,597 $ 15,618
Current maturities of long-term debt 3,841 1,849
Trade payables 5,077 3,189
Other accounts payable and accrued expenses 6,518 7,450
-------- --------
Total current liabilities 28,033 28,106
-------- --------
LONG-TERM LIABILITIES:
Unrealized losses on hedging forward contracts 561 650
Long-term debt 1,873 3,500
Accrued severance pay 1,992 2,172
-------- --------
Total long-term liabilities 4,426 6,322
-------- --------
COMMITMENTS AND CONTINGENT LIABILITIES
SHAREHOLDERS' EQUITY:
Share capital:
Ordinary shares of NIS 1 par value:
Authorized: 19,748,000 shares at December 31, 2003 and 2004;
Issued and outstanding: 8,035,779 and 8,672,448 shares at
December 31, 2003 and 2004, respectively 2,683 2,825
Additional paid-in capital 24,098 32,526
Deferred stock compensation - (477)
Accumulated other comprehensive income 479 1,639
Retained earnings 11,724 7,035
-------- --------
Total shareholders' equity 38,984 43,548
-------- --------
Total liabilities and shareholders' equity $ 71,443 $ 77,976
======== ========
The accompanying notes are an integral part of the consolidated financial
statements.
F-4
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
--------------------------------------------------------------------------------
U.S. dollars in thousands (except per share data)
Year ended December 31,
-------------------------------
2002 2003 2004
-------- -------- --------
Revenues $ 42,966 $ 59,361 $ 60,974
Cost of revenues 23,924 33,378 33,725
-------- -------- --------
Gross profit 19,042 25,983 27,249
-------- -------- --------
Operating expenses:
Research and development, net 3,128 4,773 4,683
Selling and marketing, net 8,642 11,585 12,679
General and administrative 4,938 5,305 5,771
Award granted by principal shareholders - - 1,200
-------- -------- --------
Total operating expenses 16,708 21,663 24,333
-------- -------- --------
Operating income 2,334 4,320 2,916
Financial income (expenses), net 199 (1,003) (762)
-------- -------- --------
Income before taxes on income 2,533 3,317 2,154
Taxes on income 645 913 1,101
-------- -------- --------
Net income $ 1,888 $ 2,404 $ 1,053
======== ======== ========
Basic net earnings per share $ 0.24 $ 0.30 $ 0.12
======== ======== ========
Diluted net earnings per share $ 0.23 $ 0.30 $ 0.12
======== ======== ========
The accompanying notes are an integral part of the consolidated financial
statements.
F-5
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
--------------------------------------------------------------------------------
U.S. dollars in thousands
Accumulated
Additional Deferred other Total Total
Ordinary paid-in stock comprehensive Retained comprehensive shareholders'
shares capital compensation income (loss) earnings income equity
-------- ----------------------- ------------- -------- ------------- -------------
Balance as of January 1, 2002 $ 2,583 $ 21,670 $ (20) $ (1,294) $ 9,761 $ 32,700
Exercise of stock options 13 125 - - - 138
Exercise of warrants 4 (4) - - - -
Amortization of deferred stock compensation - - 17 - - 17
Comprehensive income:
Net income - - - - 1,888 $ 1,888 1,888
Foreign currency translation adjustments - - - 288 - 288 288
-------- ----------------------- ------------- -------- ------------- -------------
Total comprehensive income $ 2,176
=============
Balance as of December 31, 2002 2,600 21,791 (3) (1,006) 11,649 35,031
Declared dividend - - - - (401) (401)
Exercise of stock options 30 432 - - - 462
Amortization of deferred stock compensation - - 3 - - 3
Stock dividend 53 1,875 - - (1,928) -
Comprehensive income:
Net income - - - - 2,404 $ 2,404 2,404
Unrealized losses on forward contracts, net - - - (807) - (807) (807)
Foreign currency translation adjustments - - - 2,292 - 2,292 2,292
-------- ----------------------- ------------- -------- ------------- ------------
Total comprehensive income $ 3,889
=============
Balance as of December 31, 2003 $ 2,683 $ 24,098 $ - $ 479 $ 11,724 $ 38,984
Exercise of stock options 51 916 - - - 967
Deferred stock compensation related to
officers' options grant - 661 (661) - - -
Amortization of deferred stock compensation
related to officers' options grant - - 184 - - 184
Award granted by principal shareholders 1,200 - - 1,200
Stock dividend 91 5,651 - - (5,742) -
Comprehensive income:
Net income - - - - 1,053 $ 1,053 1,053
Unrealized gains on forward contracts, net - - - 103 - 103 103
Foreign currency translation adjustments - - - 1,057 - 1,057 1,057
-------- ----------------------- ------------- -------- ------------ ------------
Total comprehensive income $ 2,213
=============
Balance as of December 31, 2004 $ 2,825 $ 32,526 $ (477) $ 1,639 $ 7,035 $ 43,548
======== ======================= ============= ======== ============
Accumulated unrealized losses on forward
contracts, net $ (704)
Accumulated foreign currency translation
adjustments 2,343
-------------
Accumulated other comprehensive income as of
December 31, 2004 $ 1,639
==============
The accompanying notes are an integral part of the consolidated financial
statements.
F-6
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
--------------------------------------------------------------------------------
U.S. dollars in thousands
Year ended December 31,
-----------------------------
2002 2003 2004
-------- -------- -------
Cash flows from operating activities:
-------------------------------------
Net income $ 1,888 $ 2,404 $ 1,053
Adjustments required to reconcile net income to net
cash provided by (used in) operating activities:
Depreciation and amortization 1,096 1,378 1,966
Gain on sale of property and equipment (15) (9) (18)
Decrease (increase) in accrued interest on
short-term and long-term bank deposits 133 (199) 657
Amortization of deferred stock compensation 17 3 184
Decrease (increase) in trade receivables (2,861) (4,103) 2,049
Decrease in related parties receivables 1 28 -
Decrease (increase) in unbilled accounts receivable (2,101) 2,708 (2,373)
Decrease (increase) in other accounts receivable and
prepaid expenses (1,822) (836) 16
Decrease (increase) in deferred income taxes 444 (88) 178
Decrease (increase) in inventories 468 (2,586) (588)
Decrease (increase) in long-term trade receivables 705 1,210 (44)
Increase (decrease) in trade payables 786 10 (1,956)
Increase (decrease) in other payables and accrued
expenses (532) 1,727 880
Accrued severance pay, net (72) 77 (2)
Award granted by principal shareholders - - 1,200
Realized losses on hedging forward contract - - 476
------- ------- -------
Net cash provided by (used in) operating activities (1,865) 1,724 3,678
------- ------- -------
Cash flows from investing activities:
-------------------------------------
Purchase of long-term bank deposits (8,389) - (3,000)
Purchase of structured notes - (3,000) -
Proceeds from sale of short-term bank deposits 7,748 3,505 8,400
Proceeds from sale of property and equipment 35 33 59
Purchase of property and equipment (1,527) (3,194) (4,858)
Purchase of know-how and patents (14) (48) (89)
Acquisition of the business activity of Dominion
Wireless Inc.(a) - (902) -
------- ------- -------
Net cash used in investing activities (2,147) (3,606) 512
------- ------- -------
The accompanying notes are an integral part of the consolidated financial
statements.
F-7
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
--------------------------------------------------------------------------------
U.S. dollars in thousands
Year ended December 31,
--------------------------------
2002 2003 2004
-------- -------- --------
Cash flows from financing activities:
-------------------------------------
Short-term bank credit, net $ 3,911 $ 3,098 $ 2,895
Proceeds from long-term bank loans - 43 -
Principal payment of long-term bank loans (158) (103) (365)
Proceeds from exercise of employee stock options 138 462 967
Dividend paid - - (401)
-------- -------- --------
Net cash provided by financing activities 3,891 3,500 3,096
-------- -------- --------
Effect of exchange rate changes on cash and cash
equivalents (98) 252 289
-------- -------- --------
Increase (decrease) in cash and cash equivalents (219) 1,870 7,575
Cash and cash equivalents at the beginning of the year 2,738 2,519 4,389
-------- -------- --------
Cash and cash equivalents at the end of the year $ 2,519 $ 4,389 $ 11,964
======== ======== ========
Supplemental disclosures of cash flows activities:
--------------------------------------------------
(i) Cash paid during the year for:
Interest $ 932 $ 1,099 $ 1,093
======== ======== ========
Taxes $ 1,415 $ 1,544 $ 1,164
======== ======== ========
(ii) Non-cash activities:
Declared dividend $ - $ 401 $ -
======== ======== ========
(a) Acquisition of the business activity of Dominion Wireless Inc.:
Net fair value of the assets acquired at the
acquisition date was as follows:
Inventory $ 376
Property and equipment 90
Technology 436
---------
$ 902
=========
The accompanying notes are an integral part of the consolidated financial
statements.
F-8
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)
NOTE 1:- GENERAL
a. Magal Security Systems Ltd. (the "Company") and its subsidiaries
(together "the Group") are engaged in the development,
manufacturing, marketing and sales of compleHx computerized
security systems used to automatically detect and deter human
intrusion for both civilian and military markets. A majority of
the Group's sales is generated in the U.S.A., Canada, Europe and
Israel.
As for major customer data, see Note 14b.
b. Acquisition of the business activity of Dominion Wireless Inc.:
On July 1, 2003, the Company's subsidiary acquired the business
activity of Dominion Wireless Inc. ("DW") for a total
consideration of $902 (including $74 of transaction costs) paid
in cash.
The Asset Purchase Agreement with DW, stipulated for additional
payments to be made conditioned upon the achievement of operating
income milestones during the periods ending on December 31, 2003,
2004 and 2005. Since such goals have not been met, no additional
payments were due for the periods ending December 31, 2003 and
2004. Should DW reach the earn out goals as of December 31, 2005,
an additional payment will become due. Such payment will be
recorded as additional goodwill in accordance with the provisions
of Statement of Financial Accounting Standards ("SFAS") No. 141
"Business Combinations".
DW develops manufactures, sells and supports personal duress
alarm systems that locate an individual with accuracy and
reliability in correctional and other institutions. The
acquisition of the business activity of DW has expanded the
Company's product line offerings and enabled it to provide its
customers a comprehensive range of security systems.
The acquisition was accounted for under the purchase method of
accounting in accordance with SFAS No. 141, and accordingly, the
purchase price has been allocated to the assets acquired based on
their estimated fair values at the date of acquisition.
Based upon a valuation of tangible and intangible assets
acquired, the Company's subsidiary allocated the total cost of
the acquisition to the assets acquired, as follows:
At July 1,
2003
---------------
Unaudited
---------------
Inventories $ 376
Property and equipment 90
Technology 436
---------------
$ 902
===============
The value assigned to the tangible and intangible assets has been
determined as follows:
a. DW's inventories and property and equipment are presented at
current replacement cost.
F-9
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)
NOTE 1:- GENERAL (Cont.)
b. The value assigned to technology was determined using the
Income Approach on the basis of the present value of cash
flows attributable to the intellectual property over its
expected future life. Technology is amortized on a
straight-line basis over a period of 8 years.
The results of operations of DW have been included in the
consolidated financial statements since July 1, 2003.
The following unaudited pro forma information does not purport
to represent what the Group's results of operations would have
been had the acquisition been consummated on January 1, 2002
and 2003, nor does it purport to represent the Group's results
of operations for any future period. Pro forma results of
operations for the period:
Year ended
December 31,
-------------------------
2002 2003
----------- -----------
Revenues $ 47,474 $ 59,933
=========== ===========
Net income $ 680 $ 1,910
=========== ===========
Basic net earnings per share $ 0.09 $ 0.24
=========== ===========
Diluted net earnings per share $ 0.08 $ 0.24
=========== ===========
c. Award granted by principal shareholders:
In June 2004, two principal shareholders awarded the Group's
employees an amount of net $1.2 million. The award was allocated
among the employees according to their position and seniority.
The Group recorded the award expense against additional paid in
capital in accordance with Staff Accounting Bulletin ("SAB")
Topic 5T "Accounting for Expenses or Liabilities Paid by
Principal Stockholder".
F-10
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES
The consolidated financial statements have been prepared in accordance
with United States generally accepted accounting principles ("US
GAAP").
a. Use of estimates:
The preparation of financial statements in conformity with
generally accepted accounting principles requires management to
make estimates and assumptions that effect the amounts reported
in the financial statements and accompanying notes. Actual
results could differ from those estimates.
b. Financial statements in U.S. dollars:
Significant portion of the Company's revenues is generated in
U.S. dollars ("dollars"). Financing and investing activities
including credit, loans, equity transactions and cash investments
are executed in dollars. The Company's management believes that
the dollar is the primary currency of the economic environment in
which the Company operates. Thus, the functional and reporting
currency of the Company is the dollar.
The dollar was also determined to be the functional currency of
the Company's U.S. subsidiaries.
Accordingly, monetary accounts maintained in currencies other
than the dollar are remeasured into dollars in accordance with
SFAS No. 52, "Foreign Currency Translation". All transaction
gains and losses from the remeasured monetary balance sheet items
are reflected in the statement of income as financial income or
expenses, as appropriate.
The financial statements of all foreign subsidiaries whose
functional currency is their local currency, excluding the U.S.
ones, have been translated into dollars. All balance sheet
accounts have been translated using the exchange rates in effect
at the balance sheet date. Statement of income amounts have been
translated using the average exchange rate for the year. The
resulting translation adjustments are reported as a component of
shareholders' equity in accumulated other comprehensive income
(loss).
c. Principles of consolidation:
The consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiaries. Intercompany balances
and transactions including intercompany sales not yet realized
outside the Group, have been eliminated upon consolidation.
d. Cash equivalents:
Cash equivalents are short-term highly liquid investments that
are readily convertible into cash with original maturities of
three months or less at the date acquired.
F-11
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)
e. Short-term and long-term bank deposits:
Short-term bank deposits are deposits with maturities of more
than three months and less than one year, and presented at their
cost.
Bank deposits with maturities of more than one year are included
in long-term bank deposits, and presented at their cost. The
deposits are in U.S. dollars and bear interest at an average rate
of 2.3% and mature in 2006.
f. Structured Notes:
During 2003, the Company purchased structured notes ("the Notes")
at par value totaling $3 million to be settled in 2013. Under the
terms of the Notes, the Notes bear interest at 10% over the first
year. Thereafter, interest is determined based on six months
LIBOR rates using the following formula: 10% minus two times six
months LIBOR rate. The Notes are callable immediately after
accumulating 12% interest payments.
The Company accounts for investment in structured notes in
accordance with SFAS No. 115, "Accounting for Certain Investments
in Debt and Equity Securities" and FASB Emerging Issues Task
Force Issue ("EITF") No. 96-12, "Recognition of Interest Income
and Balance Sheet Classification of Structured Notes". Management
determines the appropriate classification of its investments in
debt securities at the time of purchase and reevaluates such
determinations at each balance sheet date. Structured notes
securities are classified as held-to-maturity since management
believes the Company has the intent and ability to hold these
securities to maturity and are stated at amortized cost. As of
December 31, 2003 and 2004, the investments in the Notes
approximate their fair market value.
g. Inventories:
Inventories are stated at the lower of cost or market value. The
Group periodically evaluates the quantities on hand relative to
historical and projected sales volumes, current and historical
selling prices and contractual obligations to maintain certain
levels of parts. Based on these evaluations, inventory write-offs
are provided to cover risks arising from slow-moving items,
discontinued products, excess inventories, market prices lower
than cost and adjusted revenue forecasts. Such write-offs are
included in cost of revenues.
Cost is determined as follows:
Raw materials, parts and supplies - using the "first-in,
first-out" method.
Work in progress and finished products - on the basis of direct
manufacturing costs with the addition of allocable indirect
manufacturing costs.
F-12
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)
During 2002, 2003 and 2004, the Group recorded inventories
write-offs in the amount of $244, $601 and $224, respectively. A
significant portion of the 2003 write-off was attributed to
discontinued products.
h. Long-term trade receivables:
Long-term trade receivables derive from operating lease
arrangements and from long-term payment arrangements.
i. Property and equipment:
Property and equipment are stated at cost, net of accumulated
depreciation. Depreciation is calculated by the straight-line
method over the estimated useful lives of the assets at the
following annual rates:
%
-----------------------------------
Buildings 4
Machinery and equipment
(including machinery
and equipment leased to
customers under
operating leases) 10-33 (mainly at 10)
Motor vehicles 15
Promotional display 25-50
Office furniture and equipment 6-33
Leasehold improvements By the shorter of the term of the
lease and the life of the assets
j. Intangible assets:
Intangible assets are amortized over their useful lives using a
method of amortization that reflects the pattern in which the
economic benefits of the intangible assets are consumed or
otherwise used up, in accordance with SFAS No. 142 "Goodwill and
Other Intangible Assets".
Know-how is amortized over 8 to 10 years, patents are amortized
over a period of 10 years and technology is amortized over 8
years.
F-13
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)
k. Impairment of long-lived assets:
The Group's long-lived assets and certain identifiable
intangibles are reviewed for impairment in accordance with SFAS
No. 144 "Accounting for the Impairment or Disposal of Long- Lived
Assets" whenever events or changes in circumstances indicate that
the carrying amount of a group of assets may not be recoverable.
Recoverability of a group of assets to be held and used is
measured by a comparison of the carrying amount of the group to
the future undiscounted cash flows expected to be generated by
the group. If such group of assets is considered to be impaired,
the impairment to be recognized is measured by the amount by
which the carrying amount of the assets exceeds their fair value.
During 2002, 2003 and 2004, no impairment losses have been
identified.
l. Goodwill:
Goodwill represents excess of the costs over the net fair value
of the assets of the businesses acquired. Under SFAS No, 142,
goodwill acquired in a business combination on or after July 1,
2001, shall not be amortized, and goodwill acquired in prior
periods ceased to be amortized since January 1, 2002.
SFAS No. 142 requires goodwill to be tested for impairment on
adoption and at least annually thereafter or between annual tests
in certain circumstances, and written down when impaired, rather
than being amortized as previous accounting standards required.
Goodwill attributable to each of the reporting units is tested
for impairment by comparing the fair value of each reporting unit
with its carrying value. Fair value is determined using
discounted cash flows. Significant estimates used in the
methodologies include estimates of future cash flows, future
short-term and long-term growth rates and weighted average cost
of capital for each of the reportable units. During 2002, 2003
and 2004, no impairment losses have been identified.
Differences between the balance of goodwill as of December 31,
2003 and 2004 derive from functional currency translation
adjustments. The entire goodwill balance relates to the Perimeter
segment.
m. Revenue recognition:
The Group generates its revenues mainly from (1) installation of
comprehensive security systems for which revenues are generated
from long-term fixed price contracts; (2) sales of security
products; and (3) services and maintenance, which are performed
either on fixed-price basis or a time-and-materials basis
contracts.
Revenues from installation of comprehensive security systems are
generated from fixed price contracts according to which the time
between the signing of the contract and the final customer
acceptance is over a period generally exceeding one year.
F-14
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)
Fees are payable upon completion of agreed upon milestones, and
subject to customer acceptance. Following customer acceptance for
certain milestone and only thereafter, services could be
performed for the next milestone. Such revenues are recognized in
accordance with Statement of Position ("SOP") No. 81-1
"Accounting for Performance of Construction-Type and Certain
Production-Type Contracts," using contract accounting on a
percentage of completion method, in accordance with the "Input
Method". The amounts of revenues recognized are based on the
total fees under the agreement and the percentage to completion
achieved.
Project costs include material purchased to produce the system,
related labor and overhead expenses and subcontractor's costs.
The percentage to completion is measured by monitoring costs and
efforts devoted using records of actual costs incurred to date in
the project compared to the total estimated project requirement,
which corresponds to the costs related to earned revenues.
Estimates of total project requirements are based on prior
experience of installing and integrating security systems, a
history of no collection issues, delivery and acceptance of
similar services and a history of no cancellation problems, which
are reviewed and updated regularly by management. Provisions for
estimated losses on uncompleted contracts are made in the period
in which such losses are first determined, in the amount of the
estimated loss on the entire contract.
Estimated gross profit or loss from long-term contracts may
change due to changes in estimates resulting from differences
between actual performance and original forecasts. Such changes
in estimated gross profit are recorded in results of operations
when they are reasonably determinable by management, on a
cumulative catch-up basis.
The Group believes that the use of the percentage of completion
method is appropriate as the Group has the ability to make
reasonably dependable estimates of the extent of progress towards
completion, contract revenues and contract costs. In addition,
contracts executed include provisions that clearly specify the
enforceable rights regarding services to be provided and received
by the parties to the contracts, the consideration to be
exchanged and the manner and the terms of settlement, including
in cases of terminations for convenience. In all cases the Group
expects to perform its contractual obligations and its customers
are expected to satisfy their obligations under the contract.
Amounts recognized in advance of contractual billing are recorded
as unbilled accounts receivable.
The Group sells security products to customers according to
customers' orders without installation work. The customers are
not entitled to return the products. Revenues from security
product sales are recognized in accordance with SAB No. 104
"Revenue Recognition in Financial Statements", when delivery has
occurred, persuasive evidence of an agreement exists, the
vendor's fee is fixed or determinable, no further obligation
exists and collectability is probable.
Services and maintenance are performed under either fixed-price
basis or time-and-materials basis contracts. Under fixed-price
contracts, the Group agrees to perform certain work for a fixed
price. Under time-and-materials contracts, the Group is
reimbursed for labor hours
F-15
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)
at negotiated hourly billing rates and for materials. Such
service contracts are not in the scope of SOP No. 81-1, and
accordingly, related revenues are recognized in accordance with
SAB No. 104, as those services are performed or over the term of
the related agreements provided that, an evidence of an
arrangement has been obtained, fees are fixed and determinable
and collectibillity is reasonably assured.
One of the Company's subsidiaries provides security video
monitoring services. The majority of contracts executed are for a
five year term and do not include terms that result in the
transfer of title of the equipment to the customer. Under the
contracts service is not dependent on specific equipment. The
subsidiary's obligation is related to the provision of monitoring
services. In accordance with EITF No. 01-08 "Determining Whether
an Arrangement Contains a Lease" and SFAS No. 13 "Accounting for
Leases," the service contract does not meet the definition of a
lease and as such the subsidiary recognizes monthly service fees
over the term of the agreement.
Deferred revenue includes unearned amounts under installation
services, service contracts and maintenance agreements.
n. Accounting for stock-based compensation:
The Company has elected to follow Accounting Principle Board
Opinion ("APB") No. 25, "Accounting for Stock Issued to
Employees," and FASB Interpretation ("FIN") No. 44, "Accounting
for Certain Transactions Involving Stock Compensation," in
accounting for its employee stock option plans. Under APB No. 25,
when the exercise price of the Company's share options is less
than the market price of the underlying shares on the date of
grant, compensation expense is recognized.
The Company adopted the disclosure provisions of SFAS No. 148
"Accounting for Stock-Based Compensation transition and
disclosure", which amended certain provisions of SFAS No. 123,
"Accounting for Stock-Based Compensation", to provide alternative
methods of transition for an entity that voluntarily changes to
the fair value based method of accounting for stock-based
employee compensation, effective as of the beginning of the prior
fiscal year. The Company continues to apply the provisions of APB
No. 25 in accounting for stock-based compensation.
Proforma information regarding net income and net earnings per
share is required by SFAS No. 123, and has been determined as if
the Company had accounted for its employee stock options under
the fair value method prescribed by SFAS No. 123.
The fair value for options granted in 2004 is amortized over
their vesting period and estimated at the grant date using the
Black and Scholes option pricing model with the following
weighted-average assumptions for 2004: risk-free interest rate of
2.46%, dividend yields of 0%, a volatility factor of the expected
market price of the Company's Ordinary shares of 0.979, and a
weighted average life of the option of 1.5 years.
F-16
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)
Proforma information under SFAS No. 123:
Year ended December 31,
-----------------------------------------
2002 2003 2004
------------ ------------ -----------
Net income as reported: $ 1,888 $ 2,404 $ 1,053
Add: stock based compensation
expenses determined under the
intrinsic value based method
included in the reported net income 17 3 184
Deduct: stock based compensation
expenses determined under fair
value based method for all awards (246) (111) (198)
------------ ------------ -----------
Proforma net income $ 1,659 $ 2,296 $ 1,039
============ ============ ===========
Basic net earnings per share-as reported $ 0.24 $ 0.30 $ 0.12
============ ============ ===========
Diluted net earnings per share-as
reported $ 0.23 $ 0.30 $ 0.12
============ ============ ===========
Proforma basic net earnings per share $ 0.21 $ 0.29 $ 0.12
============ ============ ===========
Proforma diluted net earnings per share $ 0.21 $ 0.29 $ 0.12
============ ============ ===========
o. Research and development costs:
Research and development costs incurred in the process of
developing product improvements or new products, are charged to
expenses as incurred, net of grants received and investment tax
credit.
p. Warranty costs:
The Group provides a warranty for up to 24 months, at no extra
charge. The Group estimates the costs that may be incurred under
its warranty and records a liability in the amount of such costs
at the time product revenue is recognized in accordance with FIN
No. 45 "Guarantor's Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness of
Others" and SFAS No. 5 "Accounting for Contingencies". Factors
that affect the Group's warranty liability include the number of
units, historical and anticipated rates of warranty claims and
cost per claim. The Group periodically assesses the adequacy of
its recorded warranty liabilities and adjusts the amounts as
necessary. A tabular reconciliation of the changes in the Group's
aggregate product warranty liability is not provided due to
immateriality.
F-17
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)
q. Royalty-bearing grants:
Royalty-bearing grants from the Government of Israel for funding
research and development projects are recognized at the time the
Company is entitled to such grants on the basis of the related
costs incurred and recorded as a reduction of research and
development costs. Research and development grants recognized
amounted to $318, $128 and $228 in 2002, 2003 and 2004,
respectively.
The Company also received royalty-bearing grants from the Fund
for Encouragement of Marketing Activity. These grants are
recognized at the time the Company is entitled to such grants on
the basis of the costs incurred and included as a deduction of
selling and marketing expenses. Total grants recognized amounted
to $82, $0 and $0 in 2002, 2003 and 2004, respectively.
r. Net earnings per share:
Basic net earnings per share is computed based on the weighted
average number of shares of Ordinary shares outstanding during
each year. Diluted net earnings per share is computed based on
the weighted average number of shares of Ordinary shares
outstanding during each year, plus dilutive potential shares of
Ordinary shares considered outstanding during the year, in
accordance with SFAS No. 128 , "Earnings Per Share."
s. Concentrations of credit risk:
Financial instruments that potentially subject the Group to
concentrations of credit risk consist principally of cash and
cash equivalents, short-term and long-term bank deposits,
structured notes, unbilled accounts receivable, trade receivables
and long-term trade receivables.
Cash and cash equivalents, short-term and long-term bank deposits
and structured notes are mainly invested in major Israeli and
U.S. banks. Cash and cash equivalents in the United States may be
in excess of insured limits and are not insured in other
jurisdictions. Management believes that the financial
institutions that hold the Group's investments are financially
sound and, accordingly, minimal credit risk exists with respect
to these investments.
The short-term and long-term trade receivables of the Group, as
well as the unbilled accounts receivable, are derived from sales
to large and solid organizations and government authorities
located mainly in Israel, the United States, Canada and Europe.
The Group performs ongoing credit evaluations of its customers
and to date have not experienced any material losses. An
allowance for doubtful accounts is determined with respect to
those amounts that the Group has determined to be doubtful of
collection and in accordance with an aging key. In certain
circumstances, the Group may require letters of credit, other
collateral or additional guarantees.
The Group has no significant off-balance sheet concentration of
credit risks, such as foreign exchange contracts or foreign
hedging arrangements, except derivative instruments, which are
detailed in Note 2x.
F-18
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)
t. Income taxes:
The Group accounts for income taxes in accordance with SFAS No.
109 "Accounting for Income Taxes." This statement prescribes the
use of the liability method whereby deferred tax assets and
liability account balances are determined based on differences
between financial reporting and tax bases of assets and
liabilities and are measured using the enacted tax rates and laws
that will be in effect when the differences are expected to
reverse. The Group provides a valuation allowance, if necessary,
to reduce deferred tax assets to their estimated realizable
value.
u. Severance pay:
The Company's liability for its Israeli employees severance pay
is calculated pursuant to Israel's Severance Pay Law based on the
most recent salary of the employees multiplied by the number of
years of employment, as of the balance sheet date. Employees are
entitled to one month's salary for each year of employment or a
portion thereof. The Company's liability for its employees in
Israel is fully provided by monthly deposits with insurance
policies and by an accrual. The value of these policies is
recorded as an asset in the Company's balance sheet.
The deposited funds include profits accumulated up to balance
sheet date. The deposited funds may be withdrawn only upon the
fulfillment of the obligation pursuant to Israel's Severance Pay
Law or labor agreements. The value of the deposited funds is
based on the cash surrendered value of these policies, and
includes immaterial profits.
Severance expenses for the years ended December 31, 2002, 2003
and 2004, amounted to approximately $60, $313 and $306,
respectively.
v. Fair value of financial instruments:
The following methods and assumptions were used by the Group in
estimating its fair value disclosures for financial instruments:
(i) The carrying amounts of cash and cash equivalents,
short-term bank deposits, trade receivables, unbilled
accounts receivable, short-term bank credit and trade
payables approximate their fair value due to the short-term
maturity of such instruments.
(ii) The carrying amount of the Group's long-term trade
receivables, long-term bank deposits and structured notes
approximate their fair value. The fair value was estimated
using discounted cash flows analyses, based on the Group's
investment rates for similar type of investment
arrangements.
F-19
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)
(iii)The carrying amounts of the Group's long-term debt are
estimated by discounting the future cash flows using current
interest rates for loans of similar terms and maturities. As
of December 31, 2003, the fair value of the Group's
long-term borrowing was $5,564, compared to the carrying
amount of $5,714. As of December 31, 2004, the fair value of
the Company's long-term borrowing was $5,318, compared to
the carrying amount of $5,349.
(iv) The fair value of foreign currency contracts (used for hedge
purposes) is estimated by obtaining current quotes from
investment bankers.
w. Advertising expenses:
Advertising costs are charged to the statement of income as
incurred. Advertising expenses for the years ended December 31,
2002, 2003 and 2004, were $372, $422 and $495, respectively.
x. Derivative instruments:
SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities", requires a company to recognize all of its
derivative instruments as either assets or liabilities in the
statement of financial position at fair value. The accounting for
changes in the fair value (i.e., gains or losses) of a derivative
instrument depends on whether it has been designated and
qualifies as part of a hedging relationship and further, on the
type of hedging relationship. For those derivative instruments
that are designated and qualify as hedging instruments, a company
must designate the hedging instrument, based upon the exposure
being hedged.
To protect against the change in value of forecasted foreign
currency cash flows resulting from certain sale arrangements, the
Company has entered during 2003 and 2004 into forward contracts
in order to hedge portions of its forecasted revenue and unbilled
accounts receivable denominated in euro.
For derivative instruments designated as cash flow hedge (i.e.,
hedging the exposure to variability in expected future cash flows
that is attributable to a particular risk). The effective portion
of the gain or loss on the derivative instrument is reported as a
component of other comprehensive income and reclassified into
earnings in the same line item associated with the forecasted
transaction in the same period or periods during which the hedged
transaction affects earnings. For derivative instruments that are
designated and qualify as a fair value hedge (i.e., hedging the
exposure to changes in the fair value of an asset or a liability
or an identified portion thereof that is attributable to a
particular risk), the gain or loss on the derivative instrument
as well as the offsetting loss or gain on the hedged item
attributable to the hedged risk are recognized in the same line
item associated with the hedged item in current earnings during
the period of the change in fair values.
F-20
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)
NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (Cont.)
As of December 31, 2004, the Company expects to reclassify $649
of net losses on derivative instruments from unrealized losses on
forward contracts to earnings during the next 12 months due to
actual sales and related payments.
y. Reclassification:
Certain amounts from prior years have been reclassified to
conform to the previous year's presentation. The reclassification
had no effect on previously reported net loss, shareholders'
equity or cash flows.
z. Impact of recently issued accounting standards:
In November 2004, the FASB issued SFAS No. 151, "Inventory Costs,
an amendment of ARB No. 43, Chapter 4." SFAS No. 151 amends
Accounting Research Bulletin ("ARB") No. 43, Chapter 4, to
clarify that abnormal amounts of idle facility expense, freight
handling costs and wasted materials (spoilage) should be
recognized as current-period charges. In addition, SFAS No. 151
requires that allocation of fixed production overheads to the
costs of conversion be based on normal capacity of the production
facilities. SAFS No. 151 is effective for inventory costs
incurred during fiscal years beginning after June 15, 2005. The
Company does not expect that the adoption of SFAS No. 151 will
have a material effect on its financial position or results of
operations.
On December 16, 2004, the FASB issued SFAS No. 123(R) (revised
2004), "Share-Based Payment," which is a revision of SFAS No.
123, "Accounting for Stock-Based Compensation." Generally, the
approach in Statement 123(R) is similar to the approach described
in SFAS No. 123. However, SFAS No. 123 permitted, but not
required, share-based payments to employees to be recognized
based on their fair values while SFAS 123(R) requires all
share-based payments to employees to be recognized based on their
fair values. SFAS 123(R) also revises, clarifies and expands
guidance in several areas, including measuring fair value,
classifying an award as equity or as a liability and attributing
compensation cost to reporting periods. The new standard will be
effective for the Company in the first interim period beginning
after June 15, 2005. The adoption of SFAS 123(R) will not have a
significant effect on the Company's results of operations.
F-21
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)
NOTE 3:- INVENTORIES
December 31,
-------------------------------
2003 2004
-------------- --------------
Raw materials $ 6,843 $ 6,806
Work in progress 2,513 2,320
Finished products 2,421 3,576
------------- -------------
$ 11,777 $ 12,702
============= =============
NOTE 4:- PROPERTY AND EQUIPMENT, NET
a. Composition:
December 31,
--------------------------------
2003 2004
--------------- ---------------
Cost:
Land and buildings $ 8,215 $ 8,790
Machinery and equipment 4,170 4,411
Machinery and equipment leased to customers
under operating leases 2,083 4,952
Motor vehicles 1,414 1,341
Promotional display 3,659 4,236
Office furniture and equipment 2,609 2,924
Leasehold improvements 23 784
-------------- --------------
22,173 27,438
-------------- --------------
Accumulated depreciation:
Buildings 2,098 2,404
Machinery and equipment 2,648 2,958
Machinery and equipment leased to customers
under operating leases 292 845
Motor vehicles 738 833
Promotional display 2,891 3,322
Office furniture and equipment 1,980 2,356
Leasehold improvements 21 61
-------------- --------------
10,668 12,779
-------------- --------------
Depreciated cost $ 11,505 $ 14,659
============== ==============
b. Depreciation expenses amounted to $1,014, $1,241 and $1,822 for
the years ended December 31, 2002, 2003 and 2004, respectively.
c. As for charges, see Note 9g.
F-22
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)
NOTE 5:- OTHER INTANGIBLE ASSETS, NET
a. Composition:
December 31,
------------------------------
2003 2004
------------- -------------
Cost:
Know-how $ 1,502 $ 502
Patents 2,381 2,639
Technology 436 436
------------- -------------
4,319 3,577
------------- -------------
Accumulated amortization:
Know-how 1,342 396
Patents 2,237 2,443
Technology 27 82
------------- -------------
3,606 2,921
------------- -------------
Amortized cost $ 713 $ 656
============= =============
b. Amortization expenses related to intangible assets amounted to
$82, $137 and $144 for the years ended December 31, 2002, 2003
and 2004, respectively.
c. Estimated amortization of intangible assets for the years ended:
December 31,
----------------
2005 148
2006 139
2007 77
2008 74
2009 73
----------------
511
================
NOTE 6:- SHORT-TERM BANK CREDIT
a. Classified by currency, linkage terms and interest rates:
Interest rate December 31,
--------------------- -----------------------------
2003 2004 2003 2004
--------- --------- ------------ --------------
%
---------------------
In or linked to U.S. Dollars (1) 3.02 4.08 $ 4,300 $ 8,600
In or linked to NIS (1) 6.83 5.47 6,613 5,556
In or linked to Canadian
Dollars (2) 5.01 4.75 1,684 1,462
------------ --------------
$ 12,597 $ 15,618
============ ==============
Weighted average interest
rates at the end of the year 5.28% 4.64%
============ ==============
Total authorized credit lines
approximate $ 33,245
==============
Unutilized credit lines
approximate $ 6,352
==============
F-23
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)
NOTE 6:- SHORT-TERM BANK CREDIT (Cont.)
(1) The Company has undertaken to maintain the following financial
ratios and terms in respect of its used credit line:
1. A ratio of at least 40% of consolidated shareholders' equity
out of the consolidated total assets.
2. Minimal annual consolidated net income in the amount of $
1,000.
3. The same shareholders maintain the core of control in the
Company.
As of December 31, 2004, management believes that the Company was
in compliance with these ratios and terms.
(2) The loan to a subsidiary is collateralized by a general security
agreement and has undertaken to maintain general covenants and
the following financial ratios, with respect to the subsidiary's
financial statements, and terms in respect of its used credit
lines:
1. A quick ratio of not less than 1.25.
2. A ratio of total liabilities to tangible net worth of not
greater than 0.75.
3. Tangible net worth of at least $9 million.
As of December 31, 2004, management believes that the subsidiary
was in compliance with these ratios and terms.
b. As for charges, see Note 9g.
NOTE 7:- OTHER ACCOUNTS PAYABLE AND ACCRUED EXPENSES
December 31,
------------------------------
2003 2004
-------------- --------------
Employees and payroll accruals $ 1,951 $ 1,380
Accrued expenses 2,116 3,911
Deferred revenues 324 81
Unrealized losses on hedging forward contracts 489 781
Government authorities - 308
Declared dividend 401 -
Income tax payable 641 3
Others 596 986
-------------- -------------
$ 6,518 $ 7,450
============== =============
F-24
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)
NOTE 8:- LONG-TERM DEBT
a. Classified by currency, linkage terms and interest rates:
Interest rate December 31,
Linkage ----------------------- ---------------------------
terms 2003 2004 2003 2004
----------- ----------- ----------- ------------- -------------
%
-----------------------
Bank loan U.S. $ 4.60 3.10 $ 2,500 $ 2,500
Bank loan U.S. $ 4.60 - 250 -
Bank promissory note (1) U.S. $ 2.87 3.05 500 500
Bank promissory note (1) U.S. $ 5.66 3.50 500 500
------------- -------------
3,750 3,500
Mortgage payable U.S. $ 8.25 8.25 1,964 1,849
------------- -------------
5,714 5,349
Less - current
maturities 3,841 1,849
------------- -------------
$ 1,873 $ 3,500
============= =============
Weighted average
interest rates at the
end of the year 5.80% 4.91%
============= =============
(1) As for financial ratios and terms in respect of long-term loans,
the two $500 promissory notes both have covenants that require the
Group to maintain $1 million in deposits at all times otherwise the
interest rate on the notes become the bank's rate plus 0.25% until the
minimum deposit is maintained. The Group is also required to maintain
tangible net worth and subordinated debt of not less than $170 for one
note and not less than $100 for the second note.
As of December 31, 2004, management believes that the Group was in
compliance with these ratios and terms.
b. As of December 31, 2004, the aggregate annual maturities of the
long-term loans are as follows:
2005 $ 1,849
2006 3,500
------------
$ 5,349
============
c. As for charges, see Note 9g.
F-25
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)
NOTE 9:- COMMITMENTS AND CONTINGENT LIABILITIES
a. Royalty commitments to the Office of the Chief Scientist of the
Israeli Ministry of Industry and Trade ("OCS"):
Under the research and development agreements of the Company with
the OCS and pursuant to applicable laws, the Company is required
to pay royalties at the rate of 3%-4.5% of sales of products
developed with funds provided by the OCS, up to an amount equal
to 100% of the OCS research and development grants received,
linked to the U.S. dollars plus interest on the unpaid amount
received based on the 12-month LIBOR rate applicable to dollar
deposits. The Company is obligated to repay the Israeli
Government for the grants received only to the extent that there
are sales of the funded products.
Royalties paid amounted to $131, $80 and $61 for the years ended
December 31, 2002, 2003 and 2004, respectively. As of December
31, 2004, the Company had remaining contingent obligations to pay
royalties in the amount of approximately $1,868.
b. Royalty commitments to the Fund of Encouragement of Marketing
Activities:
The Israeli Government, through the Fund for the Encouragement of
Marketing Activities, awarded the Company grants for
participation in expenses for foreign marketing. The Company is
committed to pay royalties at the rate of 3% of the increase in
export sales, up to the amount of the grants received.
Royalties paid during the years ended December 31, 2002, 2003 and
2004, amounted to $53, $0 and $0, respectively. As of December
31, 2004, the aggregate contingent obligation amounted to $95.
c. Royalty commitments to third party:
During 2002, the Company entered into a development agreement for
planning, developing and manufacturing a security system with a
third party. Under the agreement, the Company agreed to pay the
third party royalty fees, based on a formula as defined in the
agreement. Under this agreement the Company has also committed to
purchase a certain volume of products at a minimum amount of
approximately $300 over 2.5 years after achievement of certain
milestones. As of December 31, 2004, no royalty commitment, under
the agreement, exists.
d. Lease commitments:
The Group rents its facilities and some of its motor vehicles
under various operating lease agreements, which expire on various
dates, the latest of which is in 2008.
F-26
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)
NOTE 9:- COMMITMENTS AND CONTINGENT LIABILITIES (Cont.)
Future minimum lease payments under non-cancelable operating
lease agreements as of December 31, are as follows:
2005 $ 441
2006 290
2007 156
2008 99
-----------
$ 986
===========
Total rent expenses for the years ended December 31, 2002,
2003 and 2004, were approximately $183, $368 and $671,
respectively.
e. Guarantees:
1. As of December 31, 2004, the Group obtained bank performance
guarantees and advance payment guarantees from several banks
mainly in Israel in the amount of $2,935.
2. As of December 31, 2004, the Company obtained bank
guarantees in an amount of $1,849 in order to secure
mortgage payable by a subsidiary.
3. As of December 31, 2004, the Group issued a letter of credit
in the amount of $902, as per suppliers' demand.
f. Legal proceedings:
1. In April 2003, a competitor filed a civil action suit
against the Company and others. The plaintiff alleged that
the failure of its perimeter systems in field trials
executed by the Ministry of Defense during 1996 and 1997,
resulted from intentional damage to the fence and diversion
of the results of certain tests by a former employee of the
Company, who was then a soldier in the Israeli Defense
Force. The plaintiff alleged that the Company, which was the
employer of this employee during 1995, still employed him as
an agent during the field trials, and directed the actions
of the former employee. The plaintiff requested the courts
to annul the field trial and sought, approximately $760 in
damages. The Company denied all of the above allegations and
claimed that the plaintiff's perimeter system failure was
not the result of the former employee's actions. The
Company's legal counsel believes that, the Company has valid
defenses against the aforementioned claims and, therefore,
no provision was recorded in the financial statements. The
action is in the preliminary stage.
2. In June 2000, Rapiscan Security Products Inc. ("Rapiscan")
filed a lawsuit against the Company claiming $1,600 was due
it in the context of an agreement between Rapiscan and the
Company. The Company filed a counter-claim in the amount of
approximately $1,350. The financial statements as of
December 31, 2003 included a reserve computed by management
for this litigation of approximately $1,000. On February 18,
2004, the court approved a settlement agreement between the
Company and Rapiscan, according to which, the Company paid
Rapiscan approximately $653. The reduction of $347 of the
$1,000 estimated reserve was recorded in operations during
the first quarter of 2004.
F-27
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)
NOTE 9:- COMMITMENTS AND CONTINGENT LIABILITIES (Cont.)
g. Charges:
As collateral for all of the Group liabilities to banks:
1. A fixed charge has been placed on the Company's property.
2. The Company agreed not to pledge any of its assets without
the consent of several banks.
3. A fixed charge in the amount of $3,000 has been placed on
the Company's bank deposits.
4. The Company's subsidiary has two bank promissory notes in
the aggregate amount of $1,000 due on April 15, 2006,
collateralized by substantially all of the subsidiary's
assets, and a $1,849 mortgage note payable, collateralized
by a first mortgage on its land and building.
NOTE 10:- SHAREHOLDERS' EQUITY
a. Pertinent rights and privileges conferred by Ordinary shares:
The Ordinary shares of the Company are listed for trade on NASDAQ
National Market and in Israel, on the Tel-Aviv Stock Exchange.
The Ordinary shares confer upon their holders the right to
receive notice to participate and vote in the General Meetings of
the Company and the right to receive dividends, if declared.
b. Stock Option Plan:
On October 27, 2003, the Company's Board of Directors approved
the 2003 Israeli Share Option Plan ("the 2003 Plan"). Under the
2003 Plan, stock options will be periodically granted to
employees, directors, officers and consultants of the Company or
its subsidiaries, in accordance with the decision of the Board of
Directors of the Company (or a committee appointed by it). The
Board of Directors has the authority to determine the number of
options, if any, which will be granted to each of the
aforementioned, the dates of the grant of such options, the date
of their exercise as well as their rate of conversion into shares
in respect of each stock option, and the purchase price thereof.
The 2003 Plan is effective for ten years and shall terminate on
October 2013. Any options that are cancelled or forfeited before
expiration become available for future grant.
As of December 31, 2004, there were 537,606 options available for
future grant.
F-28
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)
NOTE 10:- SHAREHOLDERS' EQUITY (Cont.)
A summary of the Company's stock options activities in 2002, 2003
and 2004, is as follows:
Year ended December 31,
-------------------------------------------------------------
2002 2003 2004
------------------ ------------------ ----------------------
Weighted Weighted Weighted
Number average Number average Number average
of exercise of exercise of exercise
options price options price Options price
------- ----- ------- ----- ------- -----
Outstanding
at the
beginning
of the year 412,400 $ 3.93 358,234 $ 4.23 223,216 $ 4.61
Granted - $ - - $ - 100,000 $ 7.66
Adjustment as
a result of
stock
dividend 11,232 $ - 10,256 $ - 7,652 $ -
Exercised (63,750) $ 2.17 (137,446) $ 3.55 (225,338) 4.61
Forfeited (1,648) $ - (7,828) - (530) $ -
-------- -------- --------
Outstanding
at the
end of the
year 358,234 $ 4.23 223,216 $ 4.61 105,000 $ 7.66
======== ====== ======== ====== ======== =======
Exercisable
options
at the end
of the year 118,450 $ 2.14 223,216 $ 4.61 - $ -
======== ====== ======== ====== ======== =======
All options outstanding as of December 31, 2004 have an exercise
price of $7.66 and a weighted average remaining contractual life
of 1.5 years.
Where the Company has recorded deferred stock compensation for
options issued with an exercise price below the fair market value
of the Ordinary shares, the deferred stock compensation has been
amortized and recorded as compensation expense ratably over the
vesting period of the options. Compensation expense of
approximately $17, $3 and $184 were recognized during the years
ended December 31, 2002, 2003 and 2004, respectively.
c. Dividends:
1. Dividends, if any, will be declared and paid in U.S.
dollars. Dividends paid to shareholders in Israel will be
converted into NIS on the basis of the exchange rate
prevailing at the date of payment. The Company has
determined that it will not distribute dividends out of
tax-exempt profits.
2. The Company's Board of Directors decided on a distribution
of stock dividends of 3%, 3% and 5% in May 2002, May 2003
and July 2004, respectively. All shares, options and net
earnings per share data have been retroactively adjusted to
reflect the stock dividend.
3. At the Annual General Meeting of Shareholders held on July
29, 2004, the shareholders approved the payment of an
interim cash dividend in the amount of $0.05 per Ordinary
Share of NIS 1 par value each, which was declared in
December 2003.
F-29
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)
NOTE 10:- SHAREHOLDERS' EQUITY (Cont.)
d. Warrants to underwriters:
In connection with the 1997 follow-on Offering, the Company
issued to the underwriters, 200,000 warrants to purchase 200,000
Ordinary shares of the Company. The warrants were initially
exercisable at an exercise price of 120% of the 1997 offering
price per share ($5.50) for a period of four years, commencing
one year from the date of the 1997 offering. As of December 31,
2002, all 200,000 warrants were exercised on a net cash basis and
60,703 Ordinary shares of NIS 1 par value were issued.
e. In May 2002, the Company's Board of Directors approved an
increase in the authorized Ordinary share capital to 19,748,000
shares of NIS 1 par value.
NOTE 11:- BASIC AND DILUTED NET EARNINGS PER SHARE
Year ended December 31,
------------------------------------------
2002 2003 2004
------------- ------------- ------------
Numerator:
Net income $ 1,888 $ 2,404 $ 1,053
============= ============= ============
Denominator:
Denominator for basic net earnings per share
- weighted-average number of shares
outstanding 7,866,477 7,947,778 8,581,348
Effect of diluting securities:
Employee stock options and warrants to
underwriters 202,661 80,848 55,031
------------- ------------- ------------
Denominator for diluted net earnings per
share - adjusted weighted average shares
and assumed exercises 8,069,138 8,028,626 8,636,379
============= ============= ============
NOTE 12:- TAXES ON INCOME
a. Tax benefits in Israel under the Law for the Encouragement of
Capital Investments, 1959, (the "Law"):
The Company has been granted the status of an "Approved
Enterprise" under the Law. Currently, there are three expansion
programs under which the Company is entitled to tax benefits:
1. In 1992, a program of the Company was granted the status of
an "Approved Enterprise". The Company has elected to enjoy
the "alternative benefits" track - waiver of grants in
return for tax exemption - and, accordingly, the Company's
income from this program was tax-exempt for a period of four
years, and was subject to a reduced tax rate of 15%-25% for
a period ranging between three to six years (depending on
the percentage of foreign ownership of the Company). The
period of benefits under this program began in 1994 and
terminated in 2003.
F-30
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)
NOTE 12:- TAXES ON INCOME (Cont.)
2. On March 18, 1997, a program of the Company was granted the
status of an "Approved Enterprise". The Company elected to
enjoy the "alternative benefits" track - waiver of grants in
return for tax exemption and accordingly, the Company's
income from this program was tax-exempt for a period of four
years, and is subject to a reduced tax rate of 15%-25% for a
period ranging between three to six years (depending on the
percentage of foreign ownership of the Company). The period
of benefits under this program began in 1998 and will
terminate in 2007.
3. On August 13, 2002, a program of the Company was granted the
status of an "Approved Enterprise". The Company elected to
enjoy the "alternative benefits" track - waiver of grants in
return for tax exemption - and, accordingly, the Company's
income from this program is tax-exempt for a period of two
years, and is subject to a reduced tax rate of 15%-25% for a
period of five to eight years (depending upon the percentage
of foreign ownership of the Company). The benefit period for
this program began in 2003 and will terminate in 2012.
The entitlement to the above benefits is conditional upon the
Company fulfilling the conditions stipulated by the Law,
regulations published there under and the letters of approval for
the specific investments in "approved enterprises". In the event
of failure to comply with these conditions, the benefits may be
canceled and the Company may be required to refund the amount of
the benefits, in whole or in part, including interest. As of
December 31, 2004, management believes that the Company is in
compliance with all of the aforementioned conditions.
The period of tax benefits detailed above is subject to limits of
the earlier of 12 years from the commencement of production or 14
years from receiving the approval.
Income from sources other than "Approved Enterprise", during the
benefit period will be subject to tax at regular rate of 35%.
By virtue of the Law, the Company is entitled to claim
accelerated depreciation on equipment used by the "Approved
Enterprise" during five tax years.
Since the Company is operating under more than one approval and
since part of its taxable income is not entitled to tax benefits
under the aforementioned law and is taxed at regular rates
(currently 35%), its effective tax rate is the result of a
weighted combination of the various applicable rates and
tax-exemptions. The computation is made for income derived from
each program on the basis of formulas determined in the law and
in the approvals.
The tax-exempt income attributable to the "Approved Enterprises"
can be distributed to shareholders without subjecting the Company
to taxes only upon the complete liquidation of the Company. If
the retained tax-exempt income is distributed in a manner other
than in the complete liquidation of the Company, it would be
taxed at the corporate tax rate applicable to such profits as if
the Company had not chosen the alternative tax benefits
(currently - 15%).
F-31
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)
NOTE 12:- TAXES ON INCOME (Cont.)
b. Measurement of taxable income under the Income Tax (Inflationary
Adjustments) Law, 1985:
Under the Income Tax (Inflationary Adjustments) Law, 1985,
results for tax purposes are measured in real terms, in
accordance with the changes in the Israeli Consumer Price Index
("Israeli CPI"). Accordingly, until 2002, results for tax
purposes were measured in terms of earnings in NIS after certain
adjustments for increases in the Israeli CPI. Commencing in
taxable year 2003, the Company has elected to measure its taxable
income and file its tax return under the Israeli Income Tax
Regulations (Principles Regarding the Management of Books of
Account of Foreign Invested Companies and Certain Partnerships
and the Determination of Their Taxable Income), 1986. Such an
elective obligates the Company for three years. Accordingly,
commencing taxable year 2003, results for tax purposes are
measured in terms of earnings in dollar.
c. Tax benefits (in Israel) under the Law for the Encouragement of
Industry (Taxes), 1969:
The Company is an "industrial company" as defined by this law
and, as such, is entitled to certain tax benefits including
accelerated depreciation, deduction of the purchase price of
patents and know-how and deduction of public offering expenses.
d. Tax rates:
1. On June 29, 2004, the Israeli Government passed the
Amendment to the Income Tax Ordinance (No. 140 and Temporary
Provision), 2004, which progressively reduces the tax rates
applicable to companies from 36% to 35% in 2004 to a rate of
30% in 2007. The amendment had no impact on the Company's
financial statements.
2. The tax rates of the Company's subsidiaries range between
25%-40%.
e. Investment tax credit:
One of the Company's subsidiaries is eligible for investment tax
credits on its research and development activities and on certain
current and capital expenditures. During fiscal year 2004, the
subsidiary recognized $176 of investment tax credits as a
reduction of research and development expenses. In total, the
subsidiary has investment tax credits available to reduce future
federal income taxes payable, amounting to $436, which will
expire at various dates from 2012 through 2014.
F-32
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)
NOTE 12:- TAXES ON INCOME (Cont.)
f. Reconciliation between the theoretical tax expense, assuming all
income is taxed at the Israeli statutory rate, and the actual tax
expense, is as follows:
Year ended December 31,
------------------------------------
2002 2003 2004
----------- ----------- ----------
Income before taxes as reported in the $ 2,533 $ 3,317 $ 2,154
statements of income
=========== =========== ==========
Tax rate 36% 36% 35%
=========== =========== ==========
Theoretical tax expense $ 912 $ 1,194 $ 754
Increase (decrease) in taxes:
Tax adjustments in respect of
inflation in Israel 11 - -
Non-deductible items, net (24) 17 (400)
Deferred taxes on losses for which
valuation allowance was provided 442 298 1,163
Tax exemption applicable to "Approved
Enterprises" and exempted income (293) (443) (281)
Taxes in respect of prior years (279) (107) (23)
Other (124) (46) (112)
----------- ----------- ----------
Taxes on income in the statements of
income $ 645 $ 913 $ 1,101
=========== =========== ==========
Per share amounts (basic and diluted)
of the tax benefit resulting from
"Approved Enterprises" $ 0.04 $ 0.06 $ 0.03
=========== =========== ==========
g. Taxes on income included in the statements of income:
Year ended December 31,
------------------------------------
2002 2003 2004
----------- ----------- ----------
Current taxes:
Domestic $ 269 $ 398 $ 428
Foreign 211 534 518
Deferred income taxes:
Domestic (30) - (70)
Foreign 474 88 248
Taxes in respect of prior years:
Domestic (279) (107) -
Foreign - - (23)
----------- ----------- ----------
Taxes on income $ 645 $ 913 $ 1,101
=========== =========== ==========
F-33
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)
NOTE 12:- TAXES ON INCOME (Cont.)
h. Deferred income taxes:
Deferred income taxes reflect the net tax effects of temporary
differences between the carrying amounts of assets and
liabilities for financial reporting purposes and the amounts used
for income tax purposes. Significant components of the Group
deferred tax assets are as follows:
December 31,
----------------------------
2003 2004
------------ ------------
Operating loss carryforward $ 1,813 $ 2,992
Reserves and tax allowances 658 (26)
------------ ------------
Total deferred assets before valuation allowance 2,471 2,966
Valuation allowance (1,682) (2,292)
------------ ------------
Net deferred tax assets $ 789 $ 674
============ ============
Domestic $ 212 $ 288
Foreign 577 386
------------ ------------
$ 789 $ 674
============ ============
During 2004, the Company's subsidiaries have increased the
valuation allowance in the amount of approximately $300, as a
result of change in circumstances that caused a change in
judgment about the certainty of realization of related deferred
tax assets in future years. The total net change in valuation
allowance during 2004 amounted to $610.
i. The domestic and foreign components of income before taxes are as
follows:
Year ended December 31,
------------------------------------
2002 2003 2004
----------- ----------- ----------
Domestic $ 2,217 $ 2,217 $ 2,137
Foreign 316 1,100 17
----------- ----------- ----------
$ 2,533 $ 3,317 $ 2,154
=========== =========== ==========
F-34
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)
NOTE 12:- TAXES ON INCOME (Cont.)
j. Net operating losses carryforward:
The Company's subsidiaries in the U.S. and the U.K. have
estimated total available carryforward tax losses of $7,139 and
$795, respectively, to offset against future taxable profit for
16 to 20 years, and an indefinite period, respectively. As of
December 31, 2004, the Company recorded a full valuation
allowance due to the uncertainty of the tax assets future
realization.
Utilization of U.S. net operating losses may be subject to a
substantial annual limitation due to the "change in ownership"
provisions of the Internal Revenue Code of 1986 and similar state
provisions. The annual limitation may result in the expiration of
net operating losses before utilization.
NOTE 13:- RELATED PARTIES TRANSACTIONS
Year ended December 31,
----------------------------------
2002 2003 2004
---------- ---------- ----------
Sales to related parties (1) $ 188 $ 196 $ 386
========== ========== ==========
(1) Sales to related parties represent services provided b the
Company's subsidiary.
NOTE 14:- SEGMENTS INFORMATION
The Group adopted SFAS No. 131 "Disclosures about Segments of an
Enterprise and Related Information". The Group operates in three major
reportable segments, which represent the Group's operating segments as
follows:
1. Perimeter security systems - The Group's line of perimeter
security systems consists of the following: Microprocessor-based
central control units, taut wire perimeter intrusion detection
systems, INNO Fences, vibration detection systems, field
disturbance sensors, and other.
2. Security turnkey projects - The Group is executing turnkey
projects based on the Company's security management system and
acting as an integrator.
3. Video monitoring services - The Group supplies video monitoring
services through Smart Interactive Systems, Inc., a subsidiary
established in the U.S. in June 2001.
F-35
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)
NOTE 14:- SEGMENTS INFORMATION (Cont.)
a. The following data present the revenues, expenditures, assets and
other operating data of the Group's operating segments:
Year ended December 31,
----------------------------------------------------------------------------------------------------------------
2002 2003
---------------------------------------------------- ---------------------------------------------------------
Video Video
Perimeter Projects monitoring Other Total Perimeter Projects monitoring Other Total
--------- -------- ---------- ----- ----- --------- -------- ---------- ----- -----
Revenues $ 36,435 $ 5,340 $ 238 $ 953 $42,966 $ 51,077 $ 6,720 $ 403 $ 1,161 $59,361
======== ========= ======= ======= ======= ========= ======== ======== ======== =======
Depreciation
and
amortization $ 927 $ 9 $ 149 $ 11 $ 1,096 $ 1,056 $ 20 $ 292 $ 10 $1,378
======== ========= ======= ======= ======= ========= ======== ======== ======== ======
Operating
income,
before
financial
expenses and
taxes on
income $ 4,045 $ 794 $(1,556) $ (949) $ 2,334 $ 5,803 $ 936 $ (1,870) $ (549) $4,320
======== ========= ======= ======= ========= ========= ======== ========
Financial
income
(expenses),
net 199 (1,003)
Taxes on income 645 913
--- ---
Net income $ 1,888 $2,404
======= ======
Year ended December 31,
---------------------------------------------------
2004
---------------------------------------------------
Video
Perimeter Projects monitoring Other Total
--------- -------- ---------- ----- -----
Revenues $ 46,341 $11,375 $ 2,060 $ 1,198 $60,974
======== ======= ======= ======= =======
Depreciation
and
amortization $ 1,252 $ 11 $ 698 $ 5 $1,966
======== ======= ======= ======= ======
Operating
income,
before
financial
expenses and
taxes on
income $ 4,978 $ 1,430 $(2,262) $(1,230) $2,916
======== ======= ======= =======
Financial
income
(expenses),
net (762)
Taxes on income 1,101
-----
Net income $1,053
======
December 31,
----------------------------------------------------------------------------------------------------------------
2002 2003
---------------------------------------------------- ---------------------------------------------------------
Video Video
Perimeter Projects monitoring Other Total Perimeter Projects monitoring Other Total
--------- -------- ---------- ----- ----- --------- -------- ---------- ----- -----
Total
long-lived
assets $ 12,408 $ 30 $ 867 $ 21 $ 13,326 $ 13,476 $ 88 $ 2,787 $ 12 $ 16,363
======== ======= ====== ====== ======== ======== ======= ======== ===== ========
December 31,
----------------------------------------------------
2004
---------------------------------------------------
Video
Perimeter Projects monitoring Other Total
--------- -------- ---------- ----- -----
Total
long-lived
assets $ 13,576 $ 192 $ 5,814 $ 19 $19,601
======== ======= ======= ===== =======
F-36
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)
NOTE 14:- SEGMENTS INFORMATION (Cont.)
b. Major customer data (percentage of total revenues):
Year ended December 31,
-----------------------------------------
2002 2003 2004
------------- ------------- -----------
Israel's Ministry of Defense and
Israel's Defense Forces 15.9% 27.2% *) -%
============= ============= ===========
C.N. Aeroportul international Bucuresti
Otopeni *) -% *) -% 15.6%
============= ============= ===========
*) Less then 10% of total revenues.
c. Geographical information:
The following is a summary of revenues within geographic areas
based on end customer's location and long-lived assets:
Year ended December 31,
------------------------------------------
2002 2003 2004
------------- ------------- ------------
1. Revenues:
Israel $ 11,350 $ 20,503 $ 10,123
Romania 1,023 5,151 9,521
Europe (excluding Romania) 5,376 5,465 9,150
USA 12,641 13,292 17,871
Canada 4,324 6,338 4,068
Others 8,252 8,612 10,241
------------- ------------- ------------
$ 42,966 $ 59,361 $ 60,974
============= ============= ============
December 31,
------------------------------------------
2002 2003 2004
------------- ------------- ------------
2. Long-lived assets:
Israel $ 3,802 $ 3,626 $ 3,211
Europe 786 980 1,069
USA 6,299 8,655 11,518
Canada 2,392 2,998 3,649
Others 47 104 154
------------- ------------- ------------
$ 13,326 $ 16,363 $ 19,601
============= ============= ============
F-37
MAGAL SECURITY SYSTEMS LTD.
AND ITS SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. dollars in thousands (except share and per share data)
NOTE 15:- SELECTED STATEMENTS OF INCOME DATA
a. Research and development expenses, net:
Year ended December 31,
------------------------------------------
2002 2003 2004
------------ ------------ -------------
Expenses $ 3,750 $ 5,128 $ 5,088
Less - royalty-bearing grants and
investment tax credit 622 355 405
------------ ------------ -------------
$ 3,128 $ 4,773 $ 4,683
============ ============ =============
b. Financial income (expenses):
Financial expenses:
Interest on long-term debt $ (371) $ (298) $ (289)
Interest on short-term bank credit (640) (808) (849)
Foreign exchange losses (6) (692) (161)
------------- ------------- ------------
(1,017) (1,798) (1,299)
------------- ------------- ------------
Financial income:
Interest on short-term and long-term
bank deposits and structured notes 732 672 496
Foreign exchange gains 484 123 41
------------- ------------- ------------
1,216 795 537
------------- ------------- ------------
$ 199 $ (1,003) $ (762)
============= ============= ============
NOTE 16:- SUBSEQUENT EVENTS (UNAUDITED)
In 2005, the Company intends to raise additional equity to fund future
growth.
- - - - - - - - -
F-38
Item 2
SCHEDULE OF VALUATION AND QUALIFYING ACCOUNTS
(U.S. dollars in thousands)
Write-offs of
Balance at Provision previously
beginning of for doubtful provided Translation Balance at
period accounts accounts adjustments end of period
------ -------- -------- ----------- -------------
Year ended December 31, 2004:
Allowance for doubtful debts $ 187 $ 131 $ - $ 2 $ 320
Year ended December 31, 2003:
Allowance for doubtful debts $ 150 $ 32 $ - $ 5 $ 187
Year ended December 31, 2002:
Allowance for doubtful debts $ 63 $ 129 $(42) $ - $ 150
Item 3
Operating and Financial Review and Prospects
A. Operating Results
The following discussion and review of our results of operating,
financial conditions and prospects contains various "forward-looking statements"
within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended, and within the
Private Securities Litigation Reform Act of 1995, as amended. Such
forward-looking statements reflect our current view with respect to future
events and financial results. Forward-looking statements usually include the
verbs "anticipates," "believes," "estimates," "expects," "intends," "plans,"
"projects," "understands" and other verbs suggesting uncertainty. We remind
readers that forward-looking statements are merely predictions and therefore
inherently subject to uncertainties and other factors and involve known and
unknown risks that could cause the actual results, performance, levels of
activity, or our achievements, or industry results, to be materially different
from any future results, performance, levels of activity, or our achievements
expressed or implied by such forward-looking statements. Further, our actual
results may differ materially from those anticipated in these forward-looking
statements as a result of certain factors, including, but not limited to, those
set forth in Item 3.D. "Key Information-Risk Factors" of our Annual Report on
Form 20-f for the year ending on December 31, 2003. Readers are cautioned not to
place undue reliance on these forward-looking statements, which speak only as of
the date hereof. We undertake no obligation to publicly release any revisions to
these forward-looking statements to reflect events or circumstances after the
date hereof or to reflect the occurrence of unanticipated events.
The following discussion of our results of operations and financial
condition should be read in conjunction with our consolidated financial
statements and the related notes thereto attached hereto.
General
We are engaged in the development, manufacture, marketing and sales of
computerized security systems, which automatically detect, locate and identify
the nature of unauthorized intrusions. We also supply video monitoring services
through Smart Interactive Systems, Inc., or Smart, a subsidiary established in
the U.S. in June 2001. Our products are currently used in more than 75 countries
worldwide to protect national borders, airports, correctional facilities,
nuclear power stations and other sensitive facilities from terrorism, theft and
other threats. We have subsidiaries in the U.S., Canada, United Kingdom,
Germany, Mexico, Romania and an office in China.
Economic and Other Factors
Following the terrorist attacks of September 11, 2001, heightened global
security concerns have increased the demand for products such as ours, which
protect aircraft, national borders and sensitive facilities from terrorism, and
we have experienced an increase in inquiries from prospective customers
regarding our products. Although we expect demand for our products to increase,
because our products are primarily sold to government agencies, government
authorities and government-owned companies, many of which have complex and
1
time-consuming procurement procedures, we may not make major sales of our
products and may not experience a significant increase in our revenues until, at
the earliest, the end of 2005.
The continued state of hostility between the State of Israel and the
Palestinian Authority has caused the State of Israel to increase its efforts to
protect its facilities and installations from unauthorized intrusions. In 2002,
the Israeli Government announced the construction of a perimeter system to seal
off parts of the West Bank to prevent Palestinian terrorists from entering
Israel. In September 2002, we won 80% of the bids published by the Israeli
Ministry of Defense, or MOD, for the installation of intrusion detection systems
along the seam line between Israel and the West Bank. We received orders having
a value of approximately $19 million to install intrusion detection systems
along approximately 150 kilometers. As of December 31, 2004, this project was
completed. In 2003, the Israeli Government resolved to extend the perimeter
system and to continue construction along most of the remaining parts of the
seam-line. However, following the UN resolution to refer the question of the
legality of the seam-line perimeter systems to the International Court of
Justice in Hague, an international opposition to the route selected by the
Israeli government arose, causing the Israeli Government to change and shorten
the route of the seam-line perimeter system. This opposition as well as certain
resolutions of the Israeli Supreme Court caused a halt in the building of the
seam-line fence during 2004. Recently, the Israeli government approved a new
seam-line fence route. Such resolution is expected to signal the renewal of work
in the southern parts of the seam-line. According to recent reports in the
Israeli press, the MOD is expected to shortly publish orders for the work on the
southern segments of the seam-line fence and it is widely believed that the
majority of the remaining segments of the fence will be completed during 2005.
Although we believe that we will participate in the new construction, we cannot
assure you that Israel will follow through with its decision to build the
perimeter system along the seam-line, or if such perimeter system is constructed
or rebuilt, that our products will be utilized.
During 2004, we continued to incur losses relating to Smart's
operations.
Business Challenges/Areas of Focus
Our primary business challenges and areas of focus include:
o continuing the growth of revenues and profitability of our
perimeter security system line of products;
o enhancing the introduction and recognition of our new products
into the markets;
o penetrating into new markets and strengthening our presence in
existing markets; and
o succeeding in selling our comprehensive turnkey solutions.
Discussion of Critical Accounting Policies
The preparation of financial statements in conformity with U.S. GAAP
requires us to make estimates and assumptions that affect the reported amounts
of assets and liabilities and
2
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates and the use
of different assumptions would likely result in materially different results of
operations.
Critical accounting policies are those that are both most important to
the portrayal of our financial position and results of operations, and require
management's most difficult, subjective or complex judgments. Although not all
of our significant accounting policies require management to make difficult,
subjective or complex judgments or estimates, the following policies and
estimates are those that we deem most critical:
Revenue Recognition
We generate our revenues mainly from (1) installation of comprehensive
security systems for which revenues are generated from long-term fixed price
contracts; (2) sales of security products; and (3) services and maintenance,
which are performed either on a fixed-price basis or on a time-and-materials
basis.
Revenues from installation of comprehensive security systems and turn
key projects are generated from fixed price contracts according to which the
time between the signing of the contract and the final customer acceptance is
over a period generally exceeding one year. Fees are payable upon completion of
agreed upon milestones, and subject to customer acceptance. Following customer
acceptance for certain milestone and only thereafter, services could be
performed for the next milestone. The amounts of revenues recognized are based
on the total fees under the agreement and the percentage to completion achieved.
Project costs include material purchased to produce the system, related
labor and overhead expenses and subcontractor's costs. The percentage to
completion is measured by monitoring costs and efforts devoted using records of
actual costs incurred to date in the project compared to the total estimated
project requirement, which corresponds to the costs related to earned revenues.
Estimates of total project requirements are based on prior experience of
installing and integrating security systems, a history of no collection issues,
delivery and acceptance of similar services and a history of no cancellation
problems, which are reviewed and updated regularly by us. Provisions for
estimated losses on uncompleted contracts are made in the period in which such
losses are first determined, in the amount of the estimated loss on the entire
contract.
Estimated gross profit or loss from long-term contracts may change due
to changes in estimates resulting from differences between actual performance
and original forecasts. Such changes in estimated gross profit are recorded in
our results of operations when they are reasonably determinable by us, on a
cumulative catch-up basis.
We believe that the use of the percentage of completion method is
appropriate as we have the ability to make reasonably dependable estimates of
the extent of progress towards completion, contract revenues and contract costs.
In addition, contracts executed include provisions that clearly specify the
enforceable rights regarding services to be provided and received by the parties
to the contracts, the consideration to be exchanged and the manner and
3
the terms of settlement, including in cases of terminations for convenience. In
all cases we expect to perform our contractual obligations and our customers are
expected to satisfy their obligations under the contract.
Amounts recognized in advance of contractual billing are recorded as
unbilled receivables. At December 31, 2004 we recorded $ 13.2 million of such
unbilled receivables.
We sell security products to a customer according to the customer's
order without installation work. The customer is not entitled to return the
parts. Revenues from security product sales are recognized when delivery has
occurred, persuasive evidence of an agreement exists, the vendor's fee is fixed
or determinable, no further obligation exists and collectability is probable.
Services and maintenance are performed under either fixed-price basis or
time-and-materials basis contracts. Under fixed-price contracts, we agree to
perform certain work for a fixed price. Under time-and-materials contracts, we
are reimbursed for labor hours at negotiated hourly billing rates and materials.
Such service contracts and related revenues are recognized as those services are
performed or over the term of the related agreements provided that, an evidence
of an arrangement has been obtained, fees are fixed and determinable and
collectibillity is reasonably assured.
One of our subsidiaries provides security video monitoring services. The
majority of its executed contracts are for a five year term and do not include
terms that result in the transfer of title of the equipment to the customer.
Under the contracts, service is not dependent on specific equipment. That is,
our subsidiary's obligation is related to the provision of monitoring services.
As such, service contracts do not meet the definition of a lease and our
subsidiary recognizes monthly service fees over the term of the agreements.
Deferred revenue includes unearned amounts under installation services,
service contracts and maintenance agreements.
Inventories
Inventories are stated at the lower of cost or market value. We
periodically evaluate the quantities on hand relative to historical and
projected sales volumes, current and historical selling prices and contractual
obligations to maintain certain levels of parts. Based on these evaluations,
inventory write-offs are provided to cover risks arising from slow-moving items,
discontinued products, excess inventories, market prices lower than cost and
adjusted revenue forecasts. Such write-offs are included in cost of revenues.
Cost is determined as follows:
Raw materials, parts and supplies - using the "first-in, first-out"
method.
Work-in-progress - represents the cost of production in progress.
Finished products - on the basis of direct manufacturing costs with the
addition of allocable indirect manufacturing costs.
4
During 2002, 2003 and 2004, we recorded inventories write-offs in a
total amounts of $244,000, $601,000 and $224,000, respectively. A significant
portion of the 2003 write-off was attributed to discontinued products.
Income taxes
We account for income taxes in accordance with Statement of Financial
Accounting Standard No. 109 "Accounting for Income Taxes." This statement
prescribes the use of the liability method whereby deferred tax asset and
liability account balances are determined based on differences between financial
reporting and tax bases of assets and liabilities and are measured using the
enacted tax rates and laws that will be in effect when the differences are
expected to reverse. We provide a valuation allowance, if necessary, to reduce
deferred tax assets to their estimated realizable value.
As part of the process of preparing our consolidated financial
statements, we are required to estimate our income taxes in each of the
jurisdictions in which we operate. This process involves estimating our actual
current tax exposure together with assessing temporary differences resulting
from differing treatment of items for tax and accounting purposes. These
differences result in deferred tax assets and liabilities, which are included
within our consolidated balance sheet. We must then assess the likelihood that
our deferred tax assets will be recovered from future taxable income and we must
establish a valuation allowance to reduce its deferred tax assets to the amount
that is more likely than not to be realized. Increases in the valuation
allowance result in additional expense to be reflected within the tax provision
in the consolidated statement of income. At December 31, 2004, our deferred tax
asset was $0.7 million. Our subsidiaries in the U.S. and the UK have estimated
total available carry forward tax losses of $7,139,000 and $795,000
respectively, to be offset against future taxable profit for 16-20 years and an
indefinite period, respectively. As of December 31, 2004, we recorded a full
valuation allowance due to the uncertainty of our future realization of the tax
assets.
Goodwill
Goodwill represents the excess of the costs over the net fair value of
the assets of the businesses acquired. Under SFAS No. 142, goodwill acquired in
a business combination on or after July 1, 2001 shall not be amortized and
goodwill acquired in prior periods ceased to be amortized beginning January
2002.
SFAS No. 142 requires goodwill to be tested for impairment on adoption
and at least annually thereafter or between annual tests in certain
circumstances, and written down when impaired, rather than being amortized as
previous accounting standards required. Goodwill attributable to each of the
reporting units is tested for impairment by comparing the fair value of each
reporting unit with its carrying value. Fair value is determined using
discounted cash flow.
Significant estimates used in the methodologies include estimates of
future cash flows, future short-term and long-term growth rates and weighted
average cost of capital for each of the reportable units. During 2002, 2003 and
2004, no impairment losses were identified.
5
As of December 31, 2004, goodwill amounted to $4,286,000. The goodwill
principally relates to our, segment of the Perimeter Security Systems.
Impairment of long lived assets:
Our long-lived assets and certain identifiable intangibles are reviewed
for impairment in whenever events or changes in circumstances indicate that the
carrying amount of a group of assets may not be recoverable. Recoverability of a
group of assets to be held and used is measured by a comparison of the carrying
amount of the group of asset to the future undiscounted cash flows expected to
be generated by the group of assets. If such group of assets is considered to be
impaired, the impairment to be recognized is measured by the amount by which the
carrying amount of the group of assets exceeds their fair value. During 2002,
2003 and 2004, no impairment losses were identified.
Financial statements in U.S. dollars
Significant portion of our revenues is generated in U.S. dollars
("dollar"). Financing and investing activities including credit, loans, equity
transactions and cash investments are executed in dollars. We believe that the
dollar is the primary currency of the economic environment in which the Company
operates. Thus, our functional and reporting currency is the dollar. The dollar
was also determined to be a functional currency of our U.S. subsidiaries.
Accordingly, monetary accounts maintained in currencies other than the
dollar are remeasured into dollars. All transaction gains and losses from the
remeasured monetary balance sheet items are reflected in the statement of income
as financial income or expenses, as appropriate.
The financial statements of all our foreign subsidiaries, excluding our
U.S. subsidiaries, whose functional currency is their local currency, have been
translated into dollars. All balance sheet accounts have been translated using
the exchange rates in effect at the balance sheet date. Statement of income
amounts have been translated using the average exchange rate for the period. The
resulting translation adjustments are reported as a component of shareholders'
equity in accumulated other comprehensive income (loss).
Accordingly, we had accumulated foreign currency translation income of
approximately $1.3 million and $2.3 million that were included as part of
"accumulated other comprehensive income (loss)" within our balance sheets at
December 31, 2003 and 2004, respectively. During 2002, 2003 and 2004, foreign
currency translation income of $288,000, $2,292,000, and $1,057,000
respectively, were included under "accumulated other comprehensive income
(loss)." Had we determined that the functional currency of our subsidiaries was
the dollar, these gains would have increased our income for each of the years
presented.
Concentrations of credit risk
Financial instruments that potentially subject to concentrations of
credit risk consist principally of cash and cash equivalents, short and
long-term bank deposits, structure note, unbilled accounts receivable, trade
receivables and long-term trade receivables.
6
Of our cash and cash equivalents, short-term and long-term bank deposits
at December 31, 2004, $12 million are invested in major Israeli and U.S. banks,
approximately $3 million is invested in other banks, mainly with Deutsche Bank
and RBC Royal Bank and we hold a structured note in the principal amount of $3
million that was issued by the Royal Bank of Scotland. Cash and cash equivalents
in the United States may be in excess of insured limits and are not insured in
other jurisdictions. We believe that the financial institutions that hold our
investments are financially sound and, accordingly, minimal credit risk exists
with respect to these investments.
The short term and long term trade receivables and the unbilled accounts
receivable of our company and our subsidiaries are derived from sales to large
and solid organizations located mainly in Israel, the United States, Canada and
Europe. We perform ongoing credit evaluations of our customers and to date have
not experienced any material losses. An allowance for doubtful accounts is
determined with respect to those amounts that we have determined to be doubtful
of collection and by a general reserve. In certain circumstances, we may require
letters of credit, other collateral or additional guarantees. As of December 31,
2004 the allowance for doubtful accounts amounted to $320,000.
Derivative instruments
We recognize our derivative instruments as either assets or liabilities
in our statement of financial position at fair value. The accounting for changes
in the fair value (i.e., gains or losses) of a derivative instrument depends on
whether it has been designated and qualifies as part of a hedging relationship
and further, on the type of hedging relationship. For those derivative
instruments that are designated and qualify as hedging instruments, a company
must designate the hedging instrument, based upon the exposure being hedged, as
a fair value hedge, cash flow hedge or a hedge of a net investment in a foreign
operation.
We designate our derivative instruments as cash flow hedges (i.e.,
hedging the exposure to variability in expected future cash flows that is
attributable to a particular risk). The effective portion of the gain or loss on
the derivative instrument is reported as a component of other comprehensive
income and reclassified into earnings in the same line item associated with the
forecasted transaction in the same period or periods during which the hedged
transaction affects earnings.
To protect against the reduction in value of forecasted foreign currency
cash flows resulting from certain sale arrangements, we entered into forward
contracts during 2003 and 2004 in order to hedge portions of our forecasted
revenue denominated in Euro. When the dollar strengthens significantly against
the Euro, the decline in value of future Euro revenue is offset by gains in the
value of the forward contracts designated as hedges. Conversely, when the dollar
weakens, the increase in the value of future Euro cash flows is offset by losses
in the value of the forward contracts.
During the year ended December 31, 2004, we recognized a net loss of
$932,000 related to the effective portion of our hedging instruments and a net
loss of $19,000 related to the portion of the hedging instrument excluded from
the assessment of hedge ineffectiveness.
7
We expect that during the next 12 months we will reclassify $649,000 of
net losses on derivative instruments from unrealized losses on forward contracts
to earnings due to actual sales and related payments.
Fair value of financial instruments:
The following methods and assumptions were used by us and our
subsidiaries in estimating their fair value disclosures for financial
instruments:
o The carrying amounts of cash and cash equivalents, short-term
bank deposits, trade receivables, unbilled accounts receivable,
short-term bank credit and trade payables approximate their fair
value due to the short-term maturity of such instruments.
o The carrying amount of our long-term trade receivables, long-term
bank deposits and structured notes approximate their fair value.
The fair value was estimated using discounted cash flows
analyses, based on our investment rates for similar type of
investment arrangements.
o The carrying amounts of our long-term debt are estimated by
discounting the future cash flows using current interest rates
for loans of similar terms and maturities. As of December 31,
2003, the fair value of our Company's long-term borrowings was $
5,564,000, compared to the carrying amount of $ 5,714,000. As of
December 31, 2004, the fair value of the Company's long-term
borrowings was $ 5,318,000, compared to the carrying amount of
$5,349,000.
o The fair value of foreign currency contracts (used for hedge
purposes) is estimated by obtaining current quotes from
investment bankers.
Results of Operations
Due to the nature of our customers and products, our revenues are often
generated from a relatively small number of large orders. Consequently,
individual orders from individual customers can represent a substantial portion
of our revenues in any one period and significant orders by any customer during
one period may not be followed by further orders from the same customer in
subsequent periods. Our revenues and operating results may, therefore, vary
substantially from period to period. Consequently, we do not believe that our
revenues and operating results should necessarily be judged on a
quarter-to-quarter comparative basis.
The following table presents, for the periods indicated, certain
financial data expressed as a percentage of revenues:
8
Year Ended December 31,
--------------------------------------
2000 2001 2002 2003 2004
---- ---- ---- ---- ----
Revenues.............................. 100% 100% 100% 100% 100%
Cost of revenues...................... 53 52 56 56 55
-- -- -- -- --
Gross profit.......................... 47 48 44 44 45
-- -- -- -- --
Operating expenses:
Research and development, net......... 8 8 7 8 8
Selling and marketing, net............ 18 19 20 20 21
General and administrative............ 12 12 11 9 9
Award granted by principal shareholders - - - - 2
-- -- -- -- --
Operating income...................... 9 9 6 7 5
Financial income (expenses), net...... (1) - - (2) (1)
-- -- -- -- --
Income before taxes on income......... 8 9 6 5 4
Taxes on income....................... 1 1 2 1 2
-- -- -- -- --
Net income............................ 7% 8% 4% 4% 2%
-- -- -- -- --
Years ended December 31, 2004 and 2003
Revenues. Revenues increased by 2.7% to $61 million in the year ended
December 31, 2004, as compared with $59.4 million in the year ended December 31,
2003. Revenues from sales of perimeter systems were $46.3 million in 2004, as
compared with $51.1 million in 2003, a decrease of 9%, as a result of decrease
of approximately $10.4 million in the seam-line project, which made a major
contribution to our revenues in 2003 and was halted in 2004 due to litigation in
Israel. Revenues from security turnkey projects increased by 69% to $11.4
million in 2004, as compared with $6.7 million in 2003. One of our main projects
in 2004 was the protection of the Otopeni International Airport in Romania.
Based on our backlog of approximately $25 million and estimations, we anticipate
that our rate of revenue growth will increase in 2005.
Cost of revenues. Cost of revenues reached $33.7 million in the year
ended December 31, 2004,as compared with $33.4 million in the year ended
December 31, 2003. Cost of revenues as a percentage of revenues was 55% in 2004,
as compared with 56% in 2003. We anticipate that our cost of revenues as a
percentage of revenues will remain at the same level in 2005.
Gross profit. Gross profit increased to $27.2 million in the year ended
December 31, 2004, as compared with $26.0 million for the year ended December
31, 2003, primarily as a result of our increased revenues.
Research and development expenses, net. Research and development
expenses, net for the year ended December 31, 2004 were $4.7 million, as
compared with $4.8 million for the year ended December 31, 2003, a decrease of
2%. Research and development expenses, net amounted to 7.7% of revenues in 2004,
as compared with 8% in 2003. Royalty bearing grants and investment tax credits
decreased to $405,000 in 2004 compared to $355,000 in 2003. We expect that our
net research and development expenditures will continue at the same level in
2005.
9
Selling and marketing expenses, net. Selling and marketing expenses, net
were $12.7 million for the year ended December 31, 2004, as compared with $11.6
million for the year ended December 31, 2003, an increase of 9.4%. The increase
in selling and marketing expenses in 2004 was primarily due to increased
marketing and selling expenses for our newly developed products, especially the
DreamBox(R), and the increase in our revenues from projects, mainly our project
in Otopeni International Airport in Romania. Selling and marketing expenses
amounted to 20.8% of revenues in 2004, as compared with 19.5% in 2003. We expect
that our selling and marketing expenses will increase at the same rate as any
increase in revenues in 2005, but will not change materially as a percentage of
revenues.
General and administrative expenses. General and administrative expenses
were $5.8 million for the year ended December 31, 2004 compared to $5.3 million
for the year ended December 31, 2003. General and administrative expenses
amounted to 9.5% of revenues in 2004, compared to 8.9% in 2003. The increase in
general and administrative expenses was due to an $0.2 million increase in the
amortization of deferred stock compensation and an increase in expenses incurred
by Smart due to a $0.2 million increase in rent and depreciation expenses
arising from its relocation to a new facility. We expect that our general and
administrative expenses will increase in 2005 due to the costs associated with
the implementation of the internal controls required under Section 404 of the
Sarbanes-Oxley Act.
Award granted by principal shareholders. Award expenses granted by
principal shareholders amounted to US$1.2 million in 2004 reflecting the net
award expenses paid to all of our employees by our two principal shareholders
out of their personal funds in celebration of our twentieth anniversary.
According to generally accepted accounting principles in the United States, such
grant was recorded in our second quarter statement of income as an expense,
although it did not affect our shareholders' equity nor our statement of cash
flows.
Financial income (expenses), net. Financial expenses, net for the year
ended December 31, 2004 were $762,000, as compared with $ 1 million for the year
ended December 31, 2003. This decrease in financial expenses was due to the
decrease in the rate of devaluation of the U.S. dollar against the Canadian
Dollar and the NIS. Our major operations are located in Canada and Israel.
Years ended December 31, 2003 and 2002
Revenues. Revenues increased by 38% to $59.4 million in the year ended
December 31, 2003, as compared with $43 million in the year ended December 31,
2002. Revenues from sales of perimeter systems were $51.1 million in 2003, as
compared with $36.4 million in 2002, an increase of 40%. Revenues from security
turnkey projects increased by 26% to $6.7 million in 2003, as compared with $5.3
million in 2002. Our main projects in 2003 included the installation of
intrusion detection systems along the seam line between Israel and the West Bank
and the protection of the Otopeni International Airport in Romania. The
devaluation of the U.S. dollar against the Canadian dollar and the NIS increased
by approximately $2 million the revenues that are linked to those currencies in
terms of U.S. dollars.
Cost of revenues. Cost of revenues reached $33.4 million in the year
ended December 31, 2003, as compared with $23.9 million in the year ended
December 31, 2002. Cost
10
of revenues as a percentage of revenues was 56% in 2003, remaining at the same
level as in 2002.
Gross profit. Gross profit increased to $26.0 million in the year ended
December 31, 2003, as compared with $19.0 million for the year ended December
31, 2002, primarily as a result of our increased revenues.
Research and development expenses, net. Research and development
expenses, net were $4.8 million in the year ended December 31, 2003, as compared
with $3.1 million for the year ended December 31, 2002, an increase of 53%.
Research and development expenses, net amounted to 8% of revenues in 2003, as
compared with 7% of revenues in 2002. Royalty bearing grants and investment tax
credits decreased to $355,000 in 2003, as compared with $622,000 in 2002 due to
the decrease of royalty bearing grants received from the Office of Chief
Scientists of the Ministry of Industry, trade of Labor, or the OCS. The increase
in our research and development expenses was attributable to our development of
three new products that were launched in the beginning of 2004.
Selling and marketing expenses, net. Selling and marketing expenses, net
were $11.6 million in the year ended December 31, 2003, as compared with $8.6
million in the year ended December 31, 2002, an increase of 34%. The increase in
selling and marketing expenses in 2003 was primarily due to the increase in our
revenues. Selling and marketing expenses amounted to 20% of revenues in both
2003 and 2002.
General and administrative expenses. General and administrative expenses
were $5.3 million in the year ended December 31, 2003, as compared with $4.9
million in the year ended December 31, 2002. General and administrative expenses
amounted to 9% of revenues in 2003, compared to 11% in 2002.
Financial income (expenses), net. Financial expenses, net were $1.0
million in the year ended December 31, 2003, as compared with financial income
of $199,000 in the year ended December 31, 2002. This increase in financial
expenses was due to the devaluation of the U.S. dollar against the Canadian
Dollar and the NIS Our major operations are located in Canada and Israel.
Seasonality
Our operating results are characterized by a seasonal pattern, with a
higher volume of revenues towards the end of the year. This pattern, which is
expected to continue, is mainly due to two factors:
o our customers are mainly budget-oriented organizations with
lengthy decision processes which tend to mature late in the year;
and
o due to weather and other conditions, revenues are often postponed
from the first quarter to subsequent quarters.
11
Impact of Inflation and Devaluation on Results of Operations, Liabilities and
Assets
Part of our revenues are quoted in NIS, and a portion of our expenses
are incurred in NIS. Our results may be adversely affected by a change in the
rate of inflation in Israel if the amount of our revenues in NIS decreases and
is less than the amount of our expenses in NIS (or if such decrease is offset on
a lagging basis) or if such change in the rate of inflation is not offset, or is
offset on a lagging basis, by a corresponding devaluation of the NIS against the
dollar and other foreign currencies.
The following table presents information about the rate of inflation in
Israel, the rate of devaluation of the NIS against the dollar, and the rate of
inflation in Israel adjusted for the devaluation:
Israeli
Israeli inflation
Year ended inflation NIS devaluation adjusted for
December 31, rate % rate % devaluation %
------------ ------ ------ -------------
2000 0 (2.7) 2.7
2001 1.4 9.3 (7.9)
2002 6.5 7.3 (0.8)
2003 (1.9) (7.6) 5.7
2004 1.2 (1.6) 2.8
A devaluation of the NIS in relation to the dollar has the effect of
reducing the dollar amount of any of our expenses or liabilities which are
payable in NIS, unless those expenses or payables are linked to the dollar. This
devaluation also has the effect of decreasing the dollar value of any asset
which consists of NIS or revenues payable in NIS, unless the receivables are
linked to the dollar. Conversely, any increase in the value of the NIS in
relation to the dollar has the effect of increasing the dollar value of any
unlinked NIS assets and revenues and reducing the dollar amounts of any unlinked
NIS liabilities and expenses.
Because exchange rates between the NIS and the dollar fluctuate
continuously, exchange rate fluctuations, particularly larger periodic
devaluations, may have an impact on our profitability and period-to-period
comparisons of our results. We are also subject to exchange rate fluctuations
related to our activities in Canada. During the three years ended December 31,
2004, foreign currency fluctuations had an adverse impact on our results of
operations, and our foreign exchange gains (losses), net were $478,000,
($569,000) and ($120,000), respectively. We cannot assure you that in the future
our results of operations may not be materially adversely affected by currency
fluctuations.
We periodically enter into foreign exchange contracts to offset the risk
of currency exchange rate fluctuations in connection with certain revenues.
During 2003 and 2004, we entered into forward contracts in order to hedge a
portion of our forecasted revenues denominated in euro. These forward contracts
are designated as cash flows hedges, as defined by SFAS No. 133, as amended, and
we believe are effective as a hedge for these revenues when the revenues are
recorded. The effective portion of the derivative instruments is included in
revenues and in financial expenses in the statements of operations.
12
We expect that during the next 12 months we will reclassify $649,000 of
net losses on derivative instruments from unrealized losses on forward contracts
to earnings due to actual sales and related payments.
Political Conditions
Since the establishment of the State of Israel in 1948, a number of
armed conflicts have taken place between Israel and its Arab neighbors, and a
state of hostility, varying from time to time in intensity and degree, has led
to security and economic problems for Israel. In 1979 Israel signed a peace
agreement with Egypt under which full diplomatic relations were established. In
October 1994 a peace treaty was signed between Israel and Jordan which provides,
among other things, for the commencement of full diplomatic relations between
the two countries. To date, there are no peace treaties between Israel and Syria
or Lebanon.
Since 1993, several agreements have been signed between Israel and the
Palestinian representatives concerning conditions in the West Bank and Gaza and
outlining several interim Palestinian self-government arrangements. The
implementation of these agreements have been subject to difficulties and delays.
Since September 2000, relations between Israel and the Palestinian
Authority have deteriorated and there has been a marked increase in violence,
civil unrest and hostility, including armed clashes, between the State of Israel
and the Palestinians, and acts of terror have been committed inside Israel and
against Israeli targets in the West Bank and Gaza. Recently, the Israeli
government has resolved to unilaterally evacuate all the Jewish settlements in
Gaza Strip, and few settlements in the West Bank. In addition, following the
death of Yasser Arafat the Palestinian Authority has established new regime who
vowed to take active actions against terrorism and caused all Palestinian terror
organizations to co mitt to halt execution of acts of terror in Israel. Such
commitment has not been completely observed. However, there is no indication as
to how long the current hostilities will last or whether there will be any
further escalation. Any further escalation in these hostilities or any future
armed conflict, political instability or violence in the region may have a
negative effect on our business condition, harm our results of operations and
adversely affect our share price.
Furthermore, there are a number of countries that restrict business with
Israel or Israeli companies. Restrictive laws or policies of those countries
directed towards Israel or Israeli businesses may have an adverse impact on our
operations, our financial results or the expansion of our business.
In addition, some of our employees in Israel are subject to being called
upon to perform military service in Israel, and their absence may have an
adverse effect upon our operations. Generally, unless exempt, male adult
citizens and permanent residents of Israel under the age of 40 are obligated to
perform up to 36 days of military reserve duty annually and all such residents
are subject to being called to active duty at any time under emergency
circumstances. While we have operated effectively under these requirements since
we began operations, we cannot assess the full impact of these requirements on
our workforce or business if conditions should change, and we cannot predict the
effect on us of any expansion or reduction of these obligations.
13
To date, no executive officer or key employee has been recruited for
military service for any significant time period. Any further escalation of the
hostilities between Israel and the Palestinian Authority into a full-scale
conflict might require more significant military reserve service by some of our
employees, which may have a material adverse effect on our business.
Economic Conditions
In recent years Israel has been going through a period of recession in
economic activity, resulting in low growth rates and growing unemployment. Our
operations could be adversely affected if the economic conditions in Israel
continue to deteriorate. In addition, due to significant economic measures
proposed by the Israeli Government, there have been several general strikes and
work stoppages in 2003 and 2004, affecting all banks, airports and ports. These
strikes have had an adverse effect on the Israeli economy and on business,
including our ability to deliver products to our customers.
The domestic security situation in Israel and the global slowdown in
demand for high-tech imports continued to be the main factors affecting economic
activity in Israel in 2002 and 2003. Nevertheless, in the second half of 2003,
the business sector's activity showed signs of recovery, based on the rise in
export and private consumption. Toward the end of 2003, budgetary restraint was
exercised as a result of the economic program. The economic program placed much
emphasis on immediately reducing the deficit and on measures expected to lead to
its permanent reduction, and it therefore boosted the credibility of the fiscal
policy and placed the economy on a declining budget deficit path.
During 2004, the expansion of the economic activity and growth that the
Israeli economy experienced since the second half of 2003 continued and
unemployment decreased slightly. During this period inflation reached a rate of
1.2%, and the level expected by the Bank of Israel for the next 12 months is
between 1% and 3%. Interest rates have remained level throughout the year at
approximately 4.1%.
The Israeli government's monetary policy contributed to relative price
and exchange rate stability in recent years, despite fluctuating rates of
economic growth and a high rate of unemployment. There can be no assurance that
the Israeli government will be successful in its attempts to keep prices and
exchange rates stable.
Trade Agreements
Israel is a member of the United Nations, the International Monetary
Fund, the International Bank for Reconstruction and Development and the
International Finance Corporation. Israel is a signatory to the General
Agreement on Tariffs and Trade, which provides for reciprocal lowering of trade
barriers among its members. In addition, Israel has been granted preferences
under the Generalized System of Preferences from the U.S., Australia, Canada and
Japan. These preferences allow Israel to export products covered by such
programs either duty-free or at reduced tariffs.
Israel and the European Union Community concluded a Free Trade Agreement
in July 1975 which confers certain advantages on Israeli exports to most
European countries and
14
obligates Israel to lower its tariffs on imports from these countries over a
number of years. In 1985, Israel and the U.S. entered into an agreement to
establish a free trade area. The free trade area has eliminated all tariff and
specified non-tariff barriers on most trade between the two countries. On
January 1, 1993, an agreement between Israel and the European Free Trade
Association, known as EFTA, which includes Austria, Finland, Iceland,
Liechtenstein, Norway, Sweden and Switzerland, established a free-trade zone
between Israel and the EFTA nations. In November 1995, Israel entered into a new
agreement with the European Union, which includes redefinement of rules of
origin and other improvements, including providing for Israel to become a member
of the research and technology programs of the European Union. In recent years,
Israel has established commercial and trade relations with a number of other
nations, including China, India, Russia, Turkey and other nations in Eastern
Europe and Asia.
Israel receives significant amounts of economic assistance from the
United States, averaging approximately $3 billion annually over the last several
years. We cannot assure you that U.S. economic assistance will continue at or
near amounts received in the past. If U.S. economic assistance is eliminated or
reduced significantly, the Israeli economy could suffer material adverse
consequences which could have a material adverse impact on our financial
condition and results of operations.
Effective Corporate Tax Rate
As of December 31, 2004 the general tax rate applicable to Israeli
companies was 35% of taxable income. However, certain of our manufacturing
facilities have been granted "Approved Enterprise" status under the Law for the
Encouragement of Capital Investments, 1959, as amended, commonly referred to as
the Investment Law, and, consequently, are eligible, subject to compliance with
specified requirements, for tax benefits beginning when such facilities first
generate taxable income. The tax benefits under the Investment Law are not
available with respect to income derived from products manufactured outside of
Israel. We have derived, and expect to continue to derive, a substantial portion
of our income from our Approved Enterprise facilities. Subject to certain
restrictions, we are entitled to a tax exemption in respect of income derived
from our approved facilities for a period of two to four years, commencing in
the first year in which such income is earned, and will be entitled to a reduced
tax rate of 15% to 25% for an additional three to eight years if we qualify as a
foreign investors' company. If we do not qualify as a foreign investors'
company, we will instead be entitled to a reduced rate of 25% for an additional
five years, rather than eight years.
Our effective corporate tax rate may substantially exceed the Israeli
tax rate. Our U.S. subsidiaries will generally be subject to applicable federal,
state, local and foreign taxation, and we may also be subject to taxation in the
other foreign jurisdictions in which we own assets, have employees or conduct
activities. Because of the complexity of these local tax provisions, it is not
possible to anticipate the actual combined effective corporate tax rate, which
will apply to us.
As of December 31, 2004, our subsidiaries in the U.S. and the United
Kingdom had total net available carry forward tax losses of approximately $8
million. A full valuation allowance was recorded due to the uncertainty of the
tax assets' future realization. Utilization of U.S. net operating losses may be
subject to a substantial annual limitation due to the "change in
15
ownership" provisions of the Internal Revenue Code of 1986 and similar state tax
law provisions. The annual limitation may result in the expiration of net
operating losses before utilization.
B. Liquidity and Capital Resources
General
Our ongoing liquidity requirements arise primarily from our need to
service debt and provide working capital. From our inception until our initial
public offering in March 1993, we financed our activities mainly through cash
flow from operations and bank loans. In March 1993, we received proceeds of
$9,837,000 from an initial public offering of 1,380,000 ordinary shares. In
February 1997, we raised an additional $9,440,000 from a follow-on offering of
an additional 2,085,000 ordinary shares. The proceeds from these offerings
together with cash flow from operations and our credit facilities are our main
sources of working capital.
Our working capital at December 31, 2004 was $21.6 million compared to
$21.4 million at December 31, 2003. Cash and cash equivalents amounted to $12
million at December 31, 2004 compared to $4.4 million at December 31, 2003.
Short-term and long-term bank deposits and structured notes amounted to $6
million at December 31, 2004 compared to $12.1 million at December 31, 2003. Our
cash and cash equivalents, short and long-term bank deposits and a structured
note are held mainly in U.S. dollars.
We expect to fund our short-term liquidity needs, including our
obligations under our credit facilities, other contractual agreements and any
other working capital requirements, from cash and cash equivalents, operating
cash flow and our credit facilities. We believe that our current cash and cash
equivalents, including bank deposits, structured note and our expected cash flow
from operations in 2005 will be sufficient to meet our planned and potential
cash requirements in 2005, but we intend to raise additional equity in 2005 to
fund our future growth.
Net cash provided from operating activities was $3.7 million for the
year ended December 31, 2004 compared to $1.7 million for the years ended
December 31, 2003 and net cash used from operating activities of $1.9 million
for the year ended December 31, 2002. The increase in cash from operations was
primarily due to interest received on short and long term bank deposits,
payments received from trade receivable mainly from the MOD and a customer in
Azerbaijan and a decrease in inventories. Purchases of property and equipment in
2002, 2003 and 2004 were $1.5 million, $3.2 million and $4.9 million,
respectively. Capital expenditures in 2001, 2002 and 2003 were principally for
equipment for Smart, computers and other machinery and equipment. We estimate
that our capital expenditures for 2005 will total approximately $5.5 million, of
which 8% will be spent in Israel, 90% in the U.S. and Canada and 2% in other
countries. We expect to finance these expenditures primarily from our cash and
cash equivalents, operating cash flow and our credit facilities. However, the
actual amount of our capital expenditures for 2005 will depend on a variety of
factors, including general economic conditions, changes in the demand for our
products and the risks and uncertainties involved in doing business in Israel.
16
Credit Lines and Other Debt
We currently have credit lines with Bank Leumi Le-Israel B.M. or BLL,
Union Bank of Israel Ltd., or Union Bank, United Mizrahi Bank Ltd., or UMB and
Bank Hapoalim B.M. totaling $24 million in the aggregate. There are no
restrictions as to our use of each of these credit lines. We agreed not to
pledge any of our assets without the consent of these banks. In addition, in
connection with two of these credit lines, a fixed charge was placed on our
physical plant in Israel by each of BLL and Union Bank, each of which ranks
pari-passu with the other.
We have undertaken to maintain the following financial ratios and terms
in respect of our credit lines with each of BLL, Union Bank and UMB:
o A ratio of at least 40% of shareholders' equity out of the
consolidated total assets;
o Minimal annual consolidated net income in the amount of $1
million; and
o The same shareholders maintain the core of control in our
company.
As of December 31, 2004, we were in compliance with these ratios and
terms. If we fail to fulfill our undertakings and covenants as aforesaid, these
three banks will be entitled to demand the immediate repayment of any of our
outstanding indebtedness to them and may terminate our credit lines with them.
Our loans under these credit lines are generally denominated in U.S. dollars.
However, we may occasionally have short-term NIS-denominated loans.
In addition, our subsidiaries currently have credit lines with Bank
Leumi USA, Royal Bank of Canada and Deutsche Bank totaling $9.2 million in the
aggregate.
Our Canadian subsidiary, Senstar Stellar Corporation, or Senstar has
undertaken to maintain general covenants and the following financial ratios and
terms in respect of its used credit lines:
o A quick ratio of not less than 1.25;
o A ratio of total liabilities to tangible net worth of not greater
than 0.75; and
o Tangible net worth of at least $9 million.
As of December 31, 2004, Senstar was in compliance with these ratios and
terms.
As of December 31, 2004, we had approximately $5 million available under
our credit lines. In addition, our subsidiaries had approximately $1.4 million
available under their credit lines.
As of December 31, 2004, we had outstanding under our used credit lines:
o short-term NIS-denominated loans of approximately $5.6 million,
bearing an average interest at a rate of 5.47%;
17
o short-term dollar-denominated loans of approximately $8.6
million, bearing an average interest at a rate of 4.08%;
o several bank performance and advance payment guarantees totaling
approximately $2.8 million, at an annual cost of 0.5 %-1.0 %; and
o forward contracts of approximately $2.1 million.
As of December 31, 2004, Senstar, had outstanding, in the aggregate,
short-term Canadian dollar denominated loans of US$1.5 million, bearing interest
at a rate of Canadian Prime plus 0.5% (4.75% at December 31, 2004). This loan is
collateralized by a general security agreement.
As of December 31, 2004, our subsidiaries had outstanding, in the
aggregate, $5.3 million in long-term loans as follows:
o $2.5 million, bearing interest at an annual rate of 3.1%. The
interest on the outstanding balance under this loan is due
monthly. This loan is due in one installment in April 2006;
o $500,000, bearing interest at an annual rate of 3.5% and
collateralized by the assets of our US subsidiary, Perimeter
Products Inc., or PPI. The interest on the outstanding balance
under this borrowing is due quarterly, with the principal due in
one installment in April 2006;
o $500,000, bearing interest at an annual rate of 3.05% and
collateralized by PPI's assets. This loan is due in one
installment in April 2006; and
o $1.8 million mortgage loan to PPI bearing interest at a fixed
rate of 8.25%. The mortgage is due in 18 quarterly installments
of $64,700, commencing February 2001, with a final payment of
approximately $1.8 million due in November 2005. In connection
with this mortgage loan, PPI has granted the bank a first
mortgage on its premises. In addition, we have guaranteed the
full amount of this mortgage loan.
In connection with our non-mortgage related loans listed immediately
above, Bank Leumi USA placed a $3 million fixed charge on our deposits with that
bank.
The two $500,000 promissory notes issued to Bank Leumi USA both have
covenants that require us to maintain $1 million in deposits at all times,
otherwise the interest rate on the notes become the bank's rate plus 0.25% until
the minimum deposit is maintained. We are also required to maintain tangible net
worth and subordinated debt in an amount of not less than $170,000 for one note
and not less than $100,000 for the second note.
As of December 31, 2004, Senstar GmbH obtained bank performance
guarantees in the amount of $ 136,000.
18
As of December 31, 2004, Senstar issued a letter of credit in the amount
of $902,000 in connection with the purchase of supplies.
C. Research and Development, Patents and Licenses
Government Grants
We participate in programs sponsored by the Israeli Government for the
support of research and development activities. Through 2004, we had obtained
royalty-bearing grants from the OCS, of $228,000 for certain of our research and
development projects. We are obligated to pay royalties to the OCS, amounting to
3%-4.5% of revenues derived from sales of the products funded with these grants,
up to 100% of the grants received, linked to the U.S. dollar and grants received
after January 1, 1999 will also bear interest at the rate of LIBOR. The
obligation to pay these royalties is contingent on actual sales of the products,
and in the absence of such sales no payment is required.
Royalties paid to the OCS amounted to $131,000, $80,000 and $61,000 in
the years ended December 31, 2002, 2003 and 2004, respectively.
As of December 31, 2004, we had a remaining contingent obligation to pay
royalties to the OCS in the amount of approximately $1.9 million upon the
successful sale of products developed using such research and development
programs sponsored by the OCS.
The Israeli Government, through the Fund for the Encouragement of
Marketing Activities, awarded us grants for overseas marketing expenses. We are
obligated to pay royalties to this fund at the rate of 3% of the increase in
export sales, up to the amount of the grants we received. To date, we received
$253,000 in grants from the fund and, during 2002, 2003 and 2004, we paid the
fund $53,000, $0 and $0, respectively, in royalties. As of December 31, 2004, we
had a remaining contingent obligation to the fund of $95,000.
Investment Tax Credit
Senstar is eligible for investment tax credits on its research and
development activities and on certain current and capital expenditures. During
2002, 2003 and 2004, Senstar recognized $304,000, $216,000 and $176,000,
respectively, of investment tax credits as a reduction of research and
development expenses.
Senstar has available investment tax credits of approximately $436,000
to reduce future federal income taxes payable. These credits will expire at
various dates from 2012 through 2014.
See also Item 4.B. "Information on the Company-Business
Overview-Research and Development; Royalties" of our Annual Report on Form 20F
for the year ending December 31, 2003.
D. Trend Information
We cannot assure you that the MOD, IDF or any of our other major
customers will maintain their volume of business with us or that, if such volume
is reduced, other customers of
19
similar volume will replace the lost business. The loss of one or more of these
existing customers without replacement by a customer or customers of similar
volume would have a material adverse effect on our financial results.
For additional discussion of the information required by this item see
"Operating and Financial Review and Prospects-Operating Results" and "Operating
and Financial Review and Prospects-Liquidity and Financial Resources" above.
E. Off-Balance Sheet Arrangements
At December 31, 2004, we have guaranteed the advance payments and the
performance of our work to our customers (usually government entities). Such
guarantees are required by contract for our performance during the installation
and operational period of projects throughout Israel and the rest of the world.
The guarantees for installation typically expire soon after certain milestones
are met and guarantees for operations typically expire proportionally over the
contract period. Our maximum potential amount of future payments we could be
required to make under our guarantees at December 31, 2004 was $2.9 million.
This figure includes guarantees of performance for our subsidiary in Germany in
the amount of $136,000. We have not recorded any liability for such amounts, as
we expect that our performance will be acceptable and to date, no guarantees
were exercised against us.
F. Tabular Disclosure of Contractual Obligations
The following table summarizes our minimum contractual obligations and
commercial commitments as of December 31, 2004 and the effect we expect them to
have on our liquidity and cash flow in future periods.
Contractual Obligations Payments due by Period
----------------------------------- ----------------------------------------------------------------
less than 1 more than
Total year 1-3 Years 3-5 Years 5 years
---------- ----------- ---------- --------- ----------
Long-term debt obligations....... $5,349,000 $1,849,000 $3,500,000 $- $-
Capital (finance) lease obligations - - - - -
Operating lease obligations...... 986,000 441,000 446,000 99,000 -
Purchase obligations............. 300,000 - 300,000 - -
Other long-term liabilities
reflected on the company's
balance sheet under U.S. GAAP . - - - - -
---------- ----------- ---------- --------- ----------
Total............................ $6,635,000 $2,290,000 $4,246,000 $99,000 $-
20
Item 4
Exhibit 23.1
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
--------------------------------------------------------
We consent to the incorporation by reference in the Registration Statement on
Form F-3 (File No. 333-9050) and in the Registration Statement on Form S-8 (File
No. 333-06246) pertaining to the Magal Stock Option Plan (1993) of Magal
Security Systems Ltd. ("the Company") of our report dated February 13, 2005,
with respect to the consolidated financial statements and schedule of the
Company for the year ended December 31, 2004 included in the Company's Report on
Form 6-K for the month of March 2005.
/s/Kost Forer Gabbay and Kasierer
Tel-Aviv, Israel KOST FORER GABBAY & KASIERER
March 3, 2005 A member of Ernst & Young Global
Item 5
Exhibit 12.1
CERTIFICATION PURSUANT TO
SECTION 302(a) OF THE SARBANES-OXLEY ACT OF 2002
I, Jacob Even-Ezra:
1. I have reviewed this filing of the financial statements for the year ended
December 31, 2004 on Form 6-K of Magal Security Systems Ltd.;
2. Based on my knowledge, this report does not contain any untrue statement of a
material fact or omit to state a material fact necessary to make the statements
made, in light of the circumstances under which such statements were made, not
misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as
of, and for, the periods presented in this report;
4. The registrant's other certifying officer(s) and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13(a)-15(e) and 15d-15(e)) for the registrant and have:
(a)Designed such disclosure controls and procedures, or caused such disclosure
controls and procedures to be designed under our supervision, to ensure that
material information relating to the registrant, including its consolidated
Subsidiaries, is made known to us by others within those entities, particularly
during the period in which this report is being prepared;
(b) [Reserved]
(c) Evaluated the effectiveness of the registrant's disclosure controls and
procedures and presented in this report our conclusions about the effectiveness
of the disclosure controls and procedures, as of the end of the period covered
by this report based on such evaluation; and
(d) Disclosed in this report any change in the registrant's internal control
over financial reporting that occurred during the registrant's most recent
fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual
report) that has materially affected, or is reasonably likely to materially
affect, the registrant's internal control over financial reporting; and
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation of internal control over financial reporting, to the
registrant's auditors and the audit committee of the registrant's board of
directors (or persons performing the equivalent function):
(a) All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are reasonably
likely to adversely affect the registrant's ability to record, process,
summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal control over
financial reporting.
Date: March 4, 2005
/s/Jacob Even-Ezra*
-------------------
Jacob Even-Ezra
Chief Executive Officer
* The originally executed copy of this Certification will be maintained at the
Company's offices and will be made available for inspection upon request.
Item 6
Exhibit 12.2
CERTIFICATION PURSUANT TO
SECTION 302(a) OF THE SARBANES-OXLEY ACT OF 2002
I, Raya Asher, certify that:
1. I have reviewed this filing of the financial statements for the year ended
December 31, 2004 on Form 6-K of Magal Security Systems Ltd.;
2. Based on my knowledge, this report does not contain any untrue statement of a
material fact or omit to state a material fact necessary to make the statements
made, in light of the circumstances under which such statements were made, not
misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as
of, and for, the periods presented in this report;
4. The registrant's other certifying officer(s) and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13(a)-15(e) and 15d-15(e)) for the registrant and have:
(a)Designed such disclosure controls and procedures, or caused such disclosure
controls and procedures to be designed under our supervision, to ensure that
material information relating to the registrant, including its consolidated
Subsidiaries, is made known to us by others within those entities, particularly
during the period in which this report is being prepared;
(b) [Reserved]
(c) Evaluated the effectiveness of the registrant's disclosure controls and
procedures and presented in this report our conclusions about the effectiveness
of the disclosure controls and procedures, as of the end of the period covered
by this report based on such evaluation; and
(d) Disclosed in this report any change in the registrant's internal control
over financial reporting that occurred during the period covered by the annual
report that has materially affected, or is reasonably likely to materially
affect, the registrant's internal control over financial reporting; and
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation of internal control over financial reporting, to the
registrant's auditors and the audit committee of the registrant's board of
directors (or persons performing the equivalent function):
(a) All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are reasonably
likely to adversely affect the registrant's ability to record, process,
summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal control over
financial reporting.
Date: March 4, 2005
/s/Raya Asher*
--------------
Raya Asher
Chief Financial Officer
* The originally executed copy of this Certification will be maintained at the
Company's offices and will be made available for inspection upon request.
Item 7
Exhibit 13.1
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the filing of the financial statements for the year-ended
December 31, 2004 of Magal Security Systems Ltd. (the "Company") on Form 6-K as
filed with the Securities and Exchange Commission on the date hereof (the
"Report"), I, Jacob Even-Ezra, Chief Executive Officer of the Company, certify,
pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to ss. 906 of the
Sarbanes-Oxley Act of 2002, that:
(1) The Report fully complies with the requirements of section 13(a) or
15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all
material respects, the financial condition and result of operations of the
Company.
/s/Jacob Even-Ezra*
-------------------
Jacob Even-Ezra
Chief Executive Officer
March 4, 2005
* The originally executed copy of this Certification will be maintained at the
Company's offices and will be made available for inspection upon request.
Item 8
Exhibit 13.2
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the filing of the financial statements for the year-ended
December 31, 2004 of Magal Security Systems Ltd. (the "Company") on Form 6-K as
filed with the Securities and Exchange Commission on the date hereof (the
"Report"), I, Raya Asher, Chief Financial Officer of the Company, certify,
pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to ss. 906 of the
Sarbanes-Oxley Act of 2002, that:
(1) The Report fully complies with the requirements of section 13(a) or
15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all
material respects, the financial condition and result of operations of the
Company.
/s/Raya Asher*
--------------
Raya Asher
Chief Financial Officer
March 4, 2005
* The originally executed copy of this Certification will be maintained at the
Company's offices and will be made available for inspection upon request.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
MAGAL SECURITY SYSTEMS LTD.
(Registrant)
By: /s/Jacob Even-Ezra
------------------
Jacob Even-Ezra
Chief Executive Officer
Date: March 4, 2005